FUNKO : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)

You should read the following discussion and analysis of our financial condition
and results of operations together with our audited consolidated financial
statements and related notes included elsewhere in this Annual Report on Form
10-K. This discussion and analysis contains forward-looking statements based
upon current plans, expectations and beliefs involving risks and uncertainties.
Our actual results may differ materially from those anticipated in these
forward-looking statements as a result of various important factors, including
those set forth under "Risk Factors" included in this Annual Report on Form
10-K.
Overview
We are a leading pop culture consumer products company. Our business is built on
the principle that almost everyone is a fan of something and the evolution of
pop culture is leading to increasing opportunities for fan loyalty. We create
whimsical, fun and unique products that enable fans to express their affinity
for their favorite "something"-whether it is a movie, TV show, video game,
musician or sports team. We infuse our distinct designs and aesthetic
sensibility into one of the industry's largest portfolios of licensed content
over a wide variety of product categories, including figures, plush,
accessories, apparel and homewares.
Summary
On November 6, 2017, we completed our IPO of 10,416,666 shares of Class A common
stock at an initial public offering price of $12.00 per share and received
approximately $117.3 million in net proceeds after deducting underwriting
discounts and commissions. We used the net proceeds to purchase 10,416,666 newly
issued common units directly from FAH, LLC at a price per unit equal to the
price per share of Class A common stock in the IPO less underwriting discounts
and commissions. As of December 31, 2019, we held 34,917,582 common units,
representing an approximately 68.7% interest in FAH, LLC.
Key Performance Indicators
We consider the following metrics to be key performance indicators to evaluate
our business, develop financial forecasts, and make strategic decisions.
                                 Year Ended December 31,
                           2019            2018            2017
                                  (amounts in thousands)
Net sales              $ 795,122       $ 686,073       $ 516,084
Net income             $  27,820       $  25,062       $   5,986
EBITDA (1)             $  88,764       $  91,349       $  69,863
Adjusted EBITDA (1)    $ 123,037       $ 113,540       $  90,031


(1)Earnings before interest, taxes, depreciation and amortization ("EBITDA") and
Adjusted EBITDA are financial measures not calculated in accordance with U.S.
GAAP. For a reconciliation of EBITDA and Adjusted EBITDA to net income, the most
closely comparable U.S. GAAP financial measure, see "Non-GAAP Financial
Measures" in this item.
Factors Affecting our Business
Growth in the Market for Pop Culture Consumer Products
Our operating results and prospects will be impacted by developments in the
market for pop culture consumer products. Our business has benefitted from pop
culture trends including (1) technological innovation that has facilitated
content consumption and engagement, (2) creation of more quality content,
(3) greater cultural prevalence and acceptance of pop culture fandom and
(4) increased engagement by fans with pop culture content beyond mere
consumption driven by social media and demonstrated by fan-centric experiences,
such as Comic-Con events around the world. These trends have contributed to
significant recent growth in the demand for pop culture products like ours in
recent years; however, consumer demand for pop culture products and pop culture
trends can and does shift rapidly and without warning. To the extent we are
unable to offer products that appeal to consumers, our operating results will be
adversely affected. This is particularly true given the concentration of our
sales of products under certain of our brands, particularly our Pop! brand,
which represented approximately 79%,
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76% and 70% of our sales for the years ended December 31, 2019, 2018 and 2017,
respectively, and which is sold across multiple product categories.
Relationships with Content Providers
We generate substantially all of our net sales from products based on
intellectual property we license from others. We have strong relationships with
many established content providers and seek to establish licensing relationships
with newer content providers. Our content provider relationships are highly
diversified, allowing us to license a wide array of properties and thereby
reduce our exposure to any individual property or license.
We believe there is a trend of content providers consolidating their
relationships to do more business with fewer licensees. We believe our ability
to help maximize the value and extend the relevance of our content providers'
properties has allowed us to benefit from this trend. Although we have a
successful track record of renewing and extending the scope of licenses, our
license agreements typically have short terms (between two and three years), are
not automatically renewable, and, in some cases, give the licensor the right to
terminate the license agreement at will. In addition, the efforts of our senior
management team have been integral to our relationships with our licensors.
Inability to license newer pop culture properties, the termination or lack of
renewal of one or more of our license agreements, or the renewal of a license
agreement on less favorable terms, could adversely affect our business.
Retail Industry Dynamics; Relationships with Retail Customers
Historically, substantially all of our sales have been derived from our retail
customers and distributors, upon which we rely to reach the consumers who are
the ultimate purchasers of our products. Our top ten customers represented
approximately 44%, 46% and 45% of our sales for the years ended December 2019,
2018 and 2017, respectively. In the fourth quarter of 2019, net sales were below
expectations due to the challenging retail environment, which resulted in lower
than expected purchases among Funko's top customers throughout the holiday
season as well as softness in sales related to certain tentpole movie releases.
We depend on retailers to provide adequate and attractive space for our products
and point of purchase displays in their stores. In recent years, traditional
retailers have been affected by a shift in consumer preferences towards other
channels, particularly e-commerce. We believe that this shift may have benefited
our business in recent periods as brick and mortar retailers dedicated
additional shelf space to our products and pop culture consumer products
generally to drive additional traffic to their stores and improve sales in
previously less productive shelf space. In addition, we have seen an increase in
sales for our product on retailers' e-commerce platforms.
Our customers do not make long-term commitments to us regarding purchase volumes
and can therefore easily reduce their purchases of our products. Any reduction
in purchases of our products by our retail customers and distributors, or the
loss of any key retailer or distributor for any reason could adversely affect
our business. In addition, our future growth depends upon our ability to
successfully execute our business strategy. See Item 1A, "Risk Factors."
Content Mix
The timing and mix of products we sell in any given quarter or year will depend
on various factors, including the timing and popularity of new releases by
third-party content providers and our ability to license properties based on
these releases. We have diversified our product offerings across property
categories. We have visibility into the new release schedule of many our content
providers and our expansive license portfolio allows us to dynamically manage
new product creation. This insight allows us to adjust the mix of products based
on classic evergreen properties and new releases, depending on the media release
cycle. In addition, over time, we have continued to increase our number of
active properties. An active property is a property from which we generate sales
of products during a given period. For the years ended December 31, 2019, 2018
and 2017, we had sales of our products across 804, 672 and 500 properties,
respectively.
Our results of operations may also fluctuate significantly from quarter to
quarter or year to year depending on the timing and popularity of new product
releases and related content releases. Sales of a certain product or group of
products tied to a particular property can dramatically increase our net sales
in any given quarter or year. While we expect to see growth in the number of
properties and products over time, we expect that the number of active
properties and the sales per active property will fluctuate from quarter to
quarter or year over year based on what is relevant in pop culture at that time
and the types of properties we are producing against. In addition, despite our
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efforts to diversify the properties on which we base our products, if the
performance of one or more of these properties fails to meet expectations or are
delayed in their release, our operating results could be adversely affected. For
example, in the fourth quarter of 2019, sales related to certain movie releases
failed to meet expectations, which had an adverse effect on our operating
results.
Taxation and Expenses
After consummation of our IPO on November 6, 2017, we became subject to U.S.
federal, state and local income taxes with respect to our allocable share of any
taxable income of FAH, LLC, and we are taxed at the prevailing corporate tax
rates. In addition to tax expenses, we also will incur expenses related to our
operations, as well as payments under the Tax Receivable Agreement, which we
expect to be significant. We intend to cause FAH, LLC to make distributions in
an amount sufficient to allow us to pay our tax obligations and operating
expenses, including distributions to fund any ordinary course payments due under
the Tax Receivable Agreement.
In addition, as a public company, we have incurred, and will continue to incur,
additional annual expenses related to operating as a public company, including,
among other things, additional directors' and officers' liability insurance,
director fees, reporting requirements of the SEC, transfer agent fees, hiring
additional accounting, legal and administrative personnel, increased auditing
and legal fees and similar expenses. We also incurred non-recurring costs as
part of our transition to a publicly traded company, consisting of professional
fees and other expenses.
Components of our Results of Operations
Net Sales
We sell a broad array of licensed pop culture consumer products across a variety
of categories, including figures, plush, accessories, apparel and homewares,
primarily to retail customers and distributors. We also sell our products
directly to consumers through our e-commerce operations and, to a lesser extent,
at specialty licensing and comic book conventions and exhibitions.
Revenue from the sale of our products is recognized when control of the goods is
transferred to the customer, which is upon shipment or upon receipt of finished
goods by the customer, depending on the contract terms. The majority of revenue
is recognized upon shipment of products to the customer. We routinely enter into
arrangements with our customers to provide sales incentives, support customer
promotions, and provide allowances for returns and defective merchandise. The
estimated costs of these programs reduce gross sales in the period the related
sale is recognized. Sales terms typically do not allow for a right of return
except in relation to a manufacturing defect. Shipping costs billed to our
customers are included in net sales, while shipping and handling costs, which
include inbound freight costs and the cost to ship products to our customers,
are included in cost of sales.
Cost of Sales
Cost of sales consists primarily of product costs, royalty expenses paid to our
licensors and the cost to ship our products, including both inbound freight and
outbound products to our customers. Our cost of sales excludes depreciation and
amortization.
Our products are produced by third-party manufacturers primarily in Vietnam,
China and Mexico. The use of third-party manufacturers enables us to avoid
incurring fixed product costs, while maximizing flexibility, capacity and
capability. As part of a continuing effort to reduce manufacturing costs and
ensure speed to market, we have historically kept our production concentrated
with a small number of manufacturers and factories even as we have grown and
diversified. In recent years, we have worked to improve the efficiency of our
supply chain to improve our gross margins.
Our product costs and gross margins will be impacted from period to period based
on the product mix in any given period. Our plush products tend to have a higher
product cost and lower gross margins than our figures.
Our royalty costs and gross margins will also be impacted from period to period
based on our mix of licensed products sold, as well as a variety of other
factors including reserves for minimum guarantees and ongoing and future royalty
audits.
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Our shipping costs, both inbound and outbound, will fluctuate from period to
period based on customer mix due to varying shipping terms and other factors.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are primarily driven by wages,
commissions and benefits, warehouse, fulfillment (internal and external), rent
and facilities costs, infrastructure and technology costs, advertising and
marketing expenses, including the costs to participate at specialty licensing
and comic book conventions and exhibitions, as well as costs to develop
promotional video and other online content created for advertising purposes.
Credit card fees, insurance, legal expenses, other professional expenses and
other miscellaneous operating costs are also included in selling, general and
administrative expenses. Selling costs generally correlate to revenue timing and
therefore experience similar moderate seasonal trends. We expect general and
administrative costs to increase as our business evolves.
We have invested considerably in general and administrative costs to support the
growth and anticipated growth of our business and anticipate continuing to do so
in the future. Since our IPO, we have experienced a significant increase in
accounting, legal and professional fees associated with being a public company
as further described above under "-Factors Affecting Our Business-Taxation and
Expenses."
Acquisition Transaction Costs
Acquisition transaction costs represent costs incurred for potential and
completed acquisitions. In 2017, we incurred costs related to the Underground
Toys Acquisition, the Loungefly Acquisition, and A Large Evil Corporation
Acquisition.
Depreciation and Amortization
Depreciation expense is recognized on a straight-line basis over the estimated
useful lives of our property and equipment. Amortization relates to
definite-lived intangible assets that are expensed on a straight-line basis over
the estimated useful lives. Our intangible assets, which are being amortized
over a range of two to 20 years, are mainly comprised of trade names, customer
relationships and intellectual property we recognized as part of the ACON
Acquisition and, to a lesser extent, the Underground Toys Acquisition and the
Loungefly Acquisition.
Interest Expense, Net
Interest expense, net includes the cost of our short-term borrowings and
long-term debt, including the amortization of debt issuance costs and original
issue discounts, net of any interest income earned.

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Results of Operations
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
The following table sets forth information comparing the components of net
income for the years ended December 31, 2019 and 2018:
                                                   Year Ended December 31,                                Period over Period Change
                                                   2019                 2018              Dollar              Percentage
                                                                (amounts in thousands, except percentages)
Net sales                                     $    795,122          $ 686,073          $ 109,049                      15.9  %
Cost of sales (exclusive of depreciation and
amortization shown separately below)               512,580            430,746             81,834                      19.0  %
Selling, general, and administrative expenses      193,803            155,321             38,482                      24.8  %
Acquisition transaction costs                            -                 28                (28)                   (100.0) %
Depreciation and amortization                       42,126             39,116              3,010                       7.7  %
Total operating expenses                           748,509            625,211            123,298                      19.7  %
Income from operations                              46,613             60,862            (14,249)                    (23.4) %
Interest expense, net                               14,342             21,739             (7,397)                    (34.0) %
Loss on extinguishment of debt                           -              4,547             (4,547)                   (100.0) %
Other expense (income), net                            (25)             4,082             (4,107)                   (100.6) %
Income before income taxes                          32,296             30,494              1,802                       5.9  %
Income tax expense                                   4,476              5,432               (956)                    (17.6) %
Net income                                          27,820             25,062              2,758                      11.0  %
Less: net income attributable to
non-controlling interests                           16,095             17,599             (1,504)                     (8.5) %

Net income attributable to Funko, Inc. $ 11,725 $ 7,463 $ 4,262

                      57.1  %


Net Sales
Net sales were $795.1 million for the year ended December 31, 2019, an increase
of 15.9% compared to $686.1 million for the year ended December 31, 2018. The
increase in net sales was due primarily to the continued expansion of products
and properties in our portfolio, as well as enhanced distribution and product
placement with our retail partners, partially offset by a more challenging
retail environment, which resulted in lower than expected purchases among
Funko's top customers throughout the 2019 holiday season as well as softness in
sales related to certain tentpole movie releases in the year ended December 31,
2019 as compared to the year ended December 31, 2018 .
In the year ended December 31, 2019, the number of active properties increased
20% to 804 from 672 in the year ended December 31, 2018, and average net sales
per active property remained stable at $1.0 million for both the years ended
December 31, 2019 and 2018. While we expect to see growth in the number of
active properties over time, we expect that the average sales per active
property will fluctuate from year to year or quarter to quarter based on what is
relevant in pop culture at that time and the types of properties we are
producing against.
On a geographical basis, net sales in the United States increased 12.4% to
$523.9 million in the year ended December 31, 2019 as compared to $466.0 million
in the year ended December 31, 2018, and net sales internationally increased
23.3% to $271.2 million in the year ended December 31, 2019 from $220.0 million
in the year ended December 31, 2018, primarily as a result of our growth in
Europe. On a product category basis, net sales of figures increased 14.7% to
$642.5 million in the year ended December 31, 2019 as compared to the year ended
December 31, 2018 and net sales of other products increased 21.4% to
$152.6 million in the year ended December 31, 2019 as compared to the year ended
December 31, 2018.

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Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $512.6 million
for the year ended December 31, 2019, an increase of 19.0%, compared to $430.7
million for the year ended December 31, 2018. Cost of sales (exclusive of
depreciation and amortization) increased primarily as a result of the continued
growth in sales, which drove a $27.5 million increase in product costs, a $16.1
million increase in royalty expenses and a $8.1 million increase in shipping and
freight costs. In addition to the increase as a result of sales growth, cost of
sales for the year ended December 31, 2019 include a one-time $16.8 million
charge related to the write-down of inventory as a result of the Company's
decision to dispose of slower moving inventory to increase operational capacity.
This charge is incremental to normal course reserves.
Gross margin (exclusive of depreciation and amortization), calculated as net
sales less cost of sales as a percentage of sales, was 35.5% for the year ended
December 31, 2019, compared to 37.2% for the year ended December 31, 2018. Gross
margin (exclusive of depreciation and amortization) decreased 170 basis points
for the year ended December 31, 2019 compared to the year ended December 31,
2018, due primarily to a one-time $16.8 million charge related to the write-down
of inventory as a result of the Company's decision to dispose of slower moving
inventory to increase operational capacity and higher duties as a percentage of
net sales related to our Loungefly products, partially offset by lower product
costs as a percentage of net sales and a decrease in shipping and freight costs
as a percentage of net sales for the year ended December 31, 2019 compared to
the year ended December 31, 2018.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $193.8 million for the year
ended December 31, 2019, an increase of 24.8%, compared to $155.3 million for
the year ended December 31, 2018. The increase was driven primarily by a $20.1
million increase in personnel expenses and commissions, a $3.9 million increase
in equity-based compensation, a $3.8 million increase in rent and related
facilities costs and a $3.7 million increase in warehouse and office support
costs. These increases primarily reflect increased headcount, warehouse costs
and marketing to support new product launches as well as new office, retail and
warehouse facilities.
Selling, general, and administrative expenses were 24.4% of sales for the year
ended December 31, 2019, compared to 22.6% of sales for the year ended
December 31, 2018 primarily due to higher personnel expenses and commissions,
equity-based compensation and warehouse and office support costs as a percentage
of net sales.
Depreciation and Amortization
Depreciation and amortization expense was $42.1 million for the year ended
December 31, 2019, compared to $39.1 million for the year ended December 31,
2018, primarily driven by an increase in depreciation on tooling and molds as we
continue to expand our product offerings and an increase in amortization of
intangible assets acquired from the Forrest-Pruzan Acquisition in February 2019.
Interest Expense, Net
Interest expense, net was $14.3 million for the year ended December 31, 2019, a
decrease of 34.0%, compared to $21.7 million for the year ended December 31,
2018. The decrease in interest expense, net was due to lower interest rates and
lower average balances of debt outstanding during the year ended December 31,
2019 under the New Credit Facilities as compared to the interest rates and
average balances of debt outstanding during the year ended December 31, 2018
primarily under the Former Senior Secured Credit Facilities.
Loss on extinguishment of debt
There was no loss on extinguishment of debt for the year ended December 31,
2019, compared to $4.5 million for the year ended December 31, 2018. Loss on
extinguishment of debt for the year ended December 31, 2018 represented the
write-off of $4.1 million of unamortized debt issuance costs on our previous
Term Loan A Facility and $0.4 million of unamortized debt issuance costs on our
previous Revolving Credit Facility, each of which were repaid in full on October
22, 2018 in connection with the Company entering into a new credit agreement
providing
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for the New Term Loan Facility in the amount of $235.0 million and the New
Revolving Credit Facility of $50.0 million.
Income Tax Expense
Income tax expense was $4.5 million for the year ended December 31, 2019, a
decrease of 17.6%, compared to $5.4 million for the year ended December 31,
2018. The decrease was primarily due to lower non-deductible expenses and tax
benefits related to share-based compensation awards for the year ended
December 31, 2019 as compared to the year ended December 31, 2018, partially
offset by an increase in income before income taxes of $1.8 million for the year
ended December 31, 2019 as compared to the year ended December 31, 2018.
Net Income
Net income was $27.8 million for the year ended December 31, 2019, compared to
$25.1 million for the year
ended December 31, 2018. The increase in net income was primarily the result of
the increase in net sales
and the decrease in interest expense, net for the year ended December 31, 2019
as compared to the year
ended December 31, 2018, as discussed above.
Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
The following table sets forth information comparing the components of net
income for the years ended December 31, 2018 and 2017:
                                                   Year Ended December 31,                                Period over Period Change
                                                   2018                 2017              Dollar              Percentage
                                                                (amounts in thousands, except percentages)
Net sales                                     $    686,073          $ 516,084          $ 169,989                      32.9  %
Cost of sales (exclusive of depreciation and
amortization shown separately below)               430,746            317,267            113,479                      35.8  %
Selling, general, and administrative expenses      155,321            120,944             34,377                      28.4  %
Acquisition transaction costs                           28              3,641             (3,613)                    (99.2) %
Depreciation and amortization                       39,116             31,975              7,141                      22.3  %
Total operating expenses                           625,211            473,827            151,384                      31.9  %
Income from operations                              60,862             42,257             18,605                      44.0  %
Interest expense, net                               21,739             30,636             (8,897)                    (29.0) %
Loss on extinguishment of debt                       4,547              5,103               (556)                    (10.9) %
Other expense (income), net                          4,082               (734)             4,816                    (656.1) %
Income before income taxes                          30,494              7,252             23,242                     320.5  %
Income tax expense                                   5,432              1,266              4,166                     329.1  %
Net income                                          25,062              5,986             19,076                     318.7  %
Less: net income attributable to
non-controlling interests                           17,599              2,047             15,552                     759.7  %

Net income attributable to Funko, Inc. $ 7,463 $ 3,939 $ 3,524

                      89.5  %


Net Sales
Net sales were $686.1 million for the year ended December 31, 2018, an increase
of 32.9% compared to $516.1 million for the year ended December 31, 2017. The
increase in net sales was due primarily to the continued expansion of products
and properties in our portfolio, as well as enhanced distribution and product
placement with our retail partners.
In the year ended December 31, 2018, the number of active properties increased
34% to 672 from 500 in the year ended December 31, 2017, and average net sales
per active property remained stable at $1.0 million for both the years ended
December 31, 2018 and 2017. While we expect to see growth in the number of
active properties over time, we expect that the average sales per active
property will fluctuate from year to year or quarter to quarter based on what is
relevant in pop culture at that time and the types of properties we are
producing against.
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On a geographical basis, net sales in the United States increased 23.9% to
$466.0 million in the year ended December 31, 2018 as compared to $376.1 million
in the year ended December 31, 2017, and net sales internationally increased
57.2% to $220.0 million in the year ended December 31, 2018 from $140.0 million
in the year ended December 31, 2017, primarily as a result of our growth in
Europe. On a product category basis, net sales of figures increased 32.7% to
$560.1 million in the year ended December 31, 2018 as compared to the year ended
December 31, 2017 and net sales of other products increased 34.0% to
$126.0 million in the year ended December 31, 2018 as compared to the year ended
December 31, 2017.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $430.7 million
for the year ended December 31, 2018, an increase of 35.8%, compared to $317.3
million for the year ended December 31, 2017. Cost of sales (exclusive of
depreciation and amortization) increased primarily as a result of the continued
growth in sales, which drove both higher product costs and royalty expenses. In
2018, in addition to the increase as a result of sales growth, cost of sales
included $2.0 million of incremental packaging and display costs, a $1.8 million
increase from donating inventory to charitable organizations and a $1.4 million
increase for inventory reserves and adjustments. In 2017, cost of sales included
$3.2 million related to the application of purchase accounting in connection
with the Underground Toys Acquisition and the Loungefly Acquisition, which
required inventory to be recorded at estimated fair value at the time of
acquisition. This step-up in value resulted in an increase to inventory of
$2.6 million and $0.6 million based on the estimated fair value as of the date
of the Underground Toys Acquisition and Loungefly Acquisition, respectively.
Gross margin (exclusive of depreciation and amortization), calculated as net
sales less cost of sales as a percentage of sales, was 37.2% for the year ended
December 31, 2018, compared to 38.5% for the year ended December 31, 2017. Gross
margin (exclusive of depreciation and amortization) decreased 130 basis points
for the year ended December 31, 2018 compared to the year ended December 31,
2017, due primarily to the increase in our average royalty rate to 16.1% for the
year ended December 31, 2018 compared to 14.9% for the year ended December 31,
2017 (primarily reflecting higher reserves for minimum guarantees, due in part
to our subscription box business, which we began phasing out in 2018, and higher
reserves for minimum guarantees on international sales, as well as ongoing and
future royalty audits), higher compliance chargebacks received from our
customers and an increase in inventory reserves, partially offset by inventory
step up costs in 2017 related to our Underground Toys and Loungefly
Acquisitions.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $155.3 million for the year
ended December 31, 2018, an increase of 28.4%, compared to $120.9 million for
the year ended December 31, 2017. The increase was driven primarily by growth in
the business, including incremental expenses associated with our direct
distribution model in Europe, our Loungefly operations and growth in the
staffing at Funko Animation Studios. More specifically, the increase in expenses
primarily resulted from a $20.3 million increase in personnel expenses and
commissions (which included $1.0 million of certain severance costs incurred
during the year ended December 31, 2018 in connection with the departure of
certain members of senior management, including the founders of Loungefly), a
$7.5 million increase in rent and related facilities costs, which is a result of
our continued expanded operations, and a $3.6 million increase in equity-based
compensation expense. These increases were partially offset by a decrease in bad
debt expense of $3.5 million due primarily to the bad debt expense recorded in
2017 related to the Toys 'R Us bankruptcy, which was partially offset by $0.8
million in additional bad debt expense related to the bankruptcy of a European
customer in 2018.
Selling, general, and administrative expenses were 22.6% of sales for the year
ended December 31, 2018, compared to 23.4% of sales for the year ended December
31, 2017. While we have invested considerably in general and administrative
costs to support the growth and anticipated growth of our business and
anticipate continuing to do so in the future, our growth in sales more than
offset the growth of our selling, general and administrative expenses in the
year ended December 31, 2018.
Acquisition Transaction Costs
Transaction costs related to acquisitions were nominal for the year ended
December 31, 2018 and $3.6 million for the year ended December 31, 2017.
Transaction costs for the year ended December 31, 2017 were primarily related to
the Underground Toys and Loungefly Acquisitions.

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Depreciation and Amortization
Depreciation and amortization expense was $39.1 million for the year ended
December 31, 2018, compared to $32.0 million for the year ended December 31,
2017. Depreciation increased $6.5 million, primarily related to the increase in
depreciation on tooling and molds as a result of the expansion of our product
lines, leasehold improvements at our corporate offices and warehouse facilities,
and amortization increased $0.6 million as a result of the Underground Toys
Acquisition and the Loungefly Acquisition.
Interest Expense, Net
Interest expense, net was $21.7 million for the year ended December 31, 2018, a
decrease of 29.0%, compared to $30.6 million for the year ended December 31,
2017. The decrease in interest expense, net was primarily related to the paydown
of the Term Loan B Facility and Revolving Credit Facility with proceeds from our
IPO in November 2017 and lower interest rates on our New Term Loan Facility and
New Revolving Credit Facility as compared to our previous Term Loan A Facility
and previous Revolving Credit Facility.
Loss on extinguishment of debt
Loss on extinguishment of debt was $4.5 million for the year ended December 31,
2018, a decrease of 10.9%, compared to $5.1 million for the year ended December
31, 2017. Loss on extinguishment of debt for the year ended December 31, 2018
represented the write-off of $4.1 million of unamortized debt issuance costs on
our previous Term Loan A Facility and $0.4 million of unamortized debt issuance
costs on our previous Revolving Credit Facility, each of which were repaid in
full on October 22, 2018 in connection with the Company entering into a new
credit agreement providing for the New Term Loan Facility in the amount of
$235.0 million and the New Revolving Credit Facility of $50.0 million. Loss on
extinguishment of debt for the year ended December 31, 2017 represented the
write-off of unamortized discount costs on our Term Loan B Facility which was
repaid in full in November 2017 in connection with the IPO.
Income Tax Expense
Income tax expense was $5.4 million for the year ended December 31, 2018, an
increase of 329.1%, compared to $1.3 million for the year ended December 31,
2017. The increase was primarily due to the increase in income before income
taxes of $23.2 million, or 320.5%, for the year ended December 31, 2018 as
compared to the year ended December 31, 2017. Additionally, in 2017, the LLC
flow-through structure of FAH, LLC benefited our income tax expense as, prior to
the IPO, we were subject to certain LLC entity-level taxes and foreign taxes but
generally not subject to entity-level U.S. federal income taxes. Partially
offsetting the increase in income tax expense was a decrease in the statutory
U.S. federal corporate tax rate to 21% for the year ended December 31, 2018 as
compared to a statutory rate of 34% for the year ended December 31, 2017.
Net income
Net income was $25.1 million for the year ended December 31, 2018, compared to
$6.0 million for the year
ended December 31, 2017. The increase in net income was primarily the result of
the increase in net sales
for the year ended December 31, 2018 as compared to the year ended December 31,
2017, as discussed
above.

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Non-GAAP Financial Measures
EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted Earnings per Diluted
Share (collectively the "Non-GAAP Financial Measures") are supplemental measures
of our performance that are not required by, or presented in accordance with,
U.S. GAAP. The Non-GAAP Financial Measures are not measurements of our financial
performance under U.S. GAAP and should not be considered as an alternative to
net income (loss), earnings per share or any other performance measure derived
in accordance with U.S. GAAP. We define EBITDA as net income (loss) before
interest expense, net, income tax expense (benefit), depreciation and
amortization. We define Adjusted EBITDA as EBITDA further adjusted for
monitoring fees, non-cash charges related to equity-based compensation programs,
earnout fair market value adjustments, inventory step-ups, loss on
extinguishment of debt, acquisition transaction costs and other expenses, the
Loungefly customs investigation and related costs, certain severance, relocation
and other costs, foreign currency transaction gains and losses, Tax Receivable
Agreement liability adjustments and other unusual or one-time items. We define
Adjusted Net Income as net income attributable to Funko, Inc. adjusted for the
reallocation of income attributable to non-controlling interests from the
assumed exchange of all outstanding common units and options in FAH, LLC (or the
common unit equivalent of profit interests in FAH, LLC for periods prior to the
IPO) for newly issued-shares of Class A common stock of Funko, Inc. and further
adjusted for the impact of certain non-cash charges and other items that we do
not consider in our evaluation of ongoing operating performance. These items
include, among other things, reallocation of net income attributable to
non-controlling interests, monitoring fees, non-cash charges related to
equity-based compensation programs, loss on extinguishment of debt, earnout fair
market value adjustments, inventory step-ups, acquisition transaction costs and
other expenses, the Loungefly customs investigation and related costs, certain
severance, relocation and related costs, foreign currency transaction gains and
losses, Tax Receivable Agreement liability adjustments and other unusual or
one-time items, and the income tax expense (benefit) effect of (1) these
adjustments and (2) the pass-through entity taxable income as if the parent
company was a subchapter C corporation in periods prior to the IPO. We define
Adjusted Earnings per Diluted Share as Adjusted Net Income divided by the
weighted-average shares of Class A common stock outstanding, assuming (1) the
full exchange of all outstanding common units and options in FAH, LLC (or the
common unit equivalent of profit interest in FAH, LLC for periods prior to the
IPO) for newly issued-shares of Class A common stock of Funko, Inc and (2) the
dilutive effect of stock options and unvested common units, if any. We caution
investors that amounts presented in accordance with our definitions of the
Non-GAAP Financial Measures may not be comparable to similar measures disclosed
by our competitors, because not all companies and analysts calculate the
Non-GAAP Financial Measures in the same manner. We present the Non-GAAP
Financial Measures because we consider them to be important supplemental
measures of our performance and believe they are frequently used by securities
analysts, investors, and other interested parties in the evaluation of companies
in our industry. Management believes that investors' understanding of our
performance is enhanced by including these Non-GAAP Financial Measures as a
reasonable basis for comparing our ongoing results of operations.
Management uses the Non-GAAP Financial Measures:
•as a measurement of operating performance because they assist us in comparing
the operating performance of our business on a consistent basis, as they remove
the impact of items not directly resulting from our core operations;
•for planning purposes, including the preparation of our internal annual
operating budget and financial projections;
•as a consideration to assess incentive compensation for our employees;
•to evaluate the performance and effectiveness of our operational strategies;
and
•to evaluate our capacity to expand our business.
By providing these Non-GAAP Financial Measures, together with reconciliations,
we believe we are enhancing investors' understanding of our business and our
results of operations, as well as assisting investors in evaluating how well we
are executing our strategic initiatives. In addition, our New Credit Facilities
use Adjusted EBITDA to measure our compliance with covenants such as a senior
leverage ratio. The Non-GAAP Financial Measures have limitations as analytical
tools, and should not be considered in isolation, or as an alternative to, or a
substitute for net income (loss) or other financial statement data presented in
our consolidated financial statements included elsewhere in this Annual Report
on Form 10-K as indicators of financial performance. Some of the limitations
are:
•such measures do not reflect our cash expenditures, or future requirements for
capital expenditures or contractual commitments;
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•such measures do not reflect changes in, or cash requirements for, our working
capital needs;
•such measures do not reflect the interest expense, or the cash requirements
necessary to service interest or principal payments on our debt;
•although depreciation and amortization are non-cash charges, the assets being
depreciated and amortized will often have to be replaced in the future and such
measures do not reflect any cash requirements for such replacements; and
•other companies in our industry may calculate such measures differently than we
do, limiting their usefulness as comparative measures.
Due to these limitations, Non-GAAP Financial Measures should not be considered
as measures of discretionary cash available to us to invest in the growth of our
business. We compensate for these limitations by relying primarily on our U.S.
GAAP results and using these non-GAAP measures only supplementally. As noted in
the table below, the Non-GAAP Financial Measures include adjustments for
non-cash charges related to equity-based compensation programs, earnout fair
market value adjustments, inventory step-ups, loss on extinguishment of debt,
acquisition transaction costs and other expenses, the Loungefly customs
investigation and related costs, certain severance, relocation and related
costs, foreign currency transaction gains and losses, Tax Receivable Agreement
liability adjustments and other unusual or one-time items. It is reasonable to
expect that these items will occur in future periods. However, we believe these
adjustments are appropriate because the amounts recognized can vary
significantly from period to period, do not directly relate to the ongoing
operations of our business and complicate comparisons of our internal operating
results and operating results of other companies over time. In addition, the
Non-GAAP Financial Measures include adjustments for other items, such as
monitoring fees, that we do not expect to regularly record in the future. Each
of the normal recurring adjustments and other adjustments described herein and
in the reconciliation table below help management with a measure of our core
operating performance over time by removing items that are not related
to day-to-day operations.
The following tables reconcile the Non-GAAP Financial Measures to the most
directly comparable U.S. GAAP financial performance measure, which is net income
(loss), for the periods presented:
                                                                       Year 

Ended December 31,

                                                              2019               2018               2017
Net income attributable to Funko, Inc.                    $  11,725          $   7,463          $   3,939
Reallocation of net income attributable to
non-controlling interests from the assumed exchange of
common units of FAH, LLC for Class A common stock (1)        16,095             17,599              2,047
Monitoring fees (2)                                               -                  -              1,676
Equity-based compensation (3)                                13,044              9,140              5,574
Loss on extinguishment of debt                                    -              4,547              5,103
Earnout fair market value adjustment (4)                          -                  -                 30
Inventory step-up (5)                                             -                  -              3,182
Acquisition transaction costs and other expenses (6)            383              3,391              5,336
Customs investigation and related costs (7)                   3,357                  -                  -
Certain severance, relocation and related costs (8)             739              1,031                  -
Foreign currency transaction loss (gain) (9)                   (177)             4,082               (733)
Tax receivable agreement liability adjustments                  152                  -                  -
One-time inventory write-down (10)                           16,775                  -                  -
Income tax expense (11)                                     (12,166)            (7,739)            (8,660)
Adjusted net income                                       $  49,927          $  39,514          $  17,494
Weighted-average shares of Class A common stock
outstanding-basic                                            30,898             23,821             23,338

Equity-based compensation awards and common units of FAH, LLC that are convertible into Class A common stock

           21,167             26,858             27,297
Adjusted weighted-average shares of Class A stock
outstanding - diluted                                        52,065             50,679             50,635
Adjusted earnings per diluted share                       $    0.96          $    0.78          $    0.35



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                                                                                                                                                   Successor                     Predecessor

                                                                                                                                                                  Period from                      Period from
                                                                 Year Ended December 31,                                                                          October 31,                       January 1,
                                                                                                                                                   2015 through   2015 through
                                                                                                                                                   December 31,   October 30,
                                      2019               2018              2017              2016                                                      2015           2015
                                                                           (amounts in thousands)
Net income (loss)                 $  27,820          $  25,062          $  5,986          $ 26,880          $ (15,561)               $  27,499
Interest expense, net                14,342             21,739            30,636            17,267              2,818                    2,202
Income tax expense                    4,476              5,432             1,266                 -                  -                        -
Depreciation and amortization        42,126             39,116            31,975            23,509              3,370                    5,723
EBITDA                            $  88,764          $  91,349          $ 69,863          $ 67,656          $  (9,373)               $  35,424
Adjustments:
Monitoring fees (2)                       -                  -             1,676             1,498                272                    3,346
Equity-based
 compensation (3)                    13,044              9,140             5,574             2,369              4,484                    9,925
Loss on extinguishment
of debt                                   -              4,547             5,103                 -                  -                        -
Earnout fair market value
 adjustment (4)                           -                  -                30             8,561              1,540                        -
Inventory step-up (5)                     -                  -             3,182            13,434              8,688                        -
Acquisition transaction
 costs and other
 expenses (6)                           383              3,391             5,336             3,442              7,559                   13,301
Customs investigation
 and related costs (7)                3,357                  -                 -                 -                  -                        -
Certain severance,
 relocation and
 related costs (8)                      739              1,031                 -                 -                  -                        -
Foreign currency
 transaction loss (gain) (9)           (177)             4,082              (733)                -                  -                        -
Tax receivable
agreement liability
adjustments                             152                  -                 -                 -                  -                        -
One-time inventory
 write-down (10)                     16,775                  -                 -                 -                  -                        -
Adjusted EBITDA                   $ 123,037          $ 113,540          $ 90,031          $ 96,960          $  13,170                $  61,996


(1)Represents the reallocation of net income attributable to non-controlling
interests from the assumed exchange of common units of FAH, LLC in periods in
which income was attributable to non-controlling interests.
(2)Represents monitoring fees paid pursuant to a management services agreement
with ACON that was entered into in connection with the ACON Acquisition, which
terminated upon the consummation of the IPO in November 2017.
(3)Represents non-cash charges related to equity-based compensation programs,
which vary from period to period depending on timing of awards.
(4)Reflects the increase in the fair value of contingent liabilities incurred in
connection with the Underground Toys Acquisition.
(5)Represents a non-cash adjustment to cost of sales resulting from
acquisitions.
(6)Represents legal, accounting, and other related costs incurred in connection
with the IPO, acquisitions and other transactions. Included for the year ended
December 31, 2018 is a one-time $2.0 million consent fee related to certain
existing license agreements which we expect to pay in connection with the
renewal of such licensing agreements and $0.7 million for the recognition of a
pre-acquisition contingency related to our Loungefly acquisition.
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(7)Represents legal, accounting and other related costs incurred in connection
with the Company's investigation of the underpayment of customs duties at
Loungefly. For the year ended December 31, 2019, includes the accrual of a
contingent liability of $0.5 million related to potential penalties that may be
assessed by U.S. Customs in connection with the underpayment of customs duties
at Loungefly.
(8)Represents certain severance, relocation and related costs. For the year
ended December 31, 2019, includes $0.4 million of severance costs incurred in
connection with the departure of our former Chief Financial Officer and $0.3
million of severance, relocation and related costs associated with the
consolidation of our warehouse facilities in the United Kingdom. For the year
ended December 31, 2018, includes severance costs incurred in connection with
the departure of certain members of senior management, including the founders of
Loungefly.
(9)Represents both unrealized and realized foreign currency losses (gains) on
transactions other than in U.S. dollars.
(10)Represents a one-time $16.8 million charge for the year ended December 31,
2019 to cost of goods sold for additional inventory reserves to dispose of
certain inventory items. This charge is incremental to normal course inventory
reserves and was recorded as a result of the Company's decision to dispose of
slower moving inventory to increase operational capacity.
(11)Represents the income tax expense (benefit) effect of (i) the above
adjustments and (ii) the pass-through entity taxable income as if the parent
company was a subchapter C corporation in periods prior to the IPO. This
adjustment uses an effective tax rate of 25% for the years ended December 31,
2019 and 2018 and 36.2% for the year ended December 31, 2017, respectively.
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Liquidity and Financial Condition
Introduction
Our primary requirements for liquidity and capital are working capital,
inventory management, capital expenditures, debt service and general corporate
needs. In the year ended December 31, 2017 we also received contributions from
members of FAH, LLC as further described below under "Liquidity;" however, we do
not anticipate receiving any additional contributions from members of FAH, LLC.
On October 22, 2018 (the "Closing Date"), Funko Acquisition Holdings, L.L.C.,
Funko Holdings LLC, Funko, LLC and Loungefly, LLC (each, an "Original Borrower"
and collectively, the "Original Borrowers"), entered into a Credit Agreement by
and among each Borrower, certain financial institutions party thereto and PNC
Bank, National Association, as administrative agent and collateral agent,
providing for the New Term Loan Facility in the amount of $235.0 million and the
New Revolving Credit Facility of $50.0 million. Proceeds from the New Credit
Facilities were primarily used to repay the Former Senior Secured Credit
Facilities.
On February 11, 2019, the Company amended the Credit Agreement to increase the
New Revolving Credit Facility to $75.0 million, reflecting the incremental
capacity of $25.0 million contemplated under the New Credit Facilities prior to
such amendment.
On September 23, 2019, the Original Borrowers and Funko Games, LLC
(collectively, the "Borrowers") entered into a second amendment to the Credit
Agreement (the "Amendment"). The Amendment, among other things, extends the
maturity date of the New Credit Facilities to September 23, 2024, reduces the
interest margin applicable to all loans under the credit agreement by 0.75% and
reduces certain fees incurred under the credit agreement. The Amendment also
allows the Company to request that the New Term Loan Facility be increased by an
additional $25.0 million.
The New Credit Facilities are secured by substantially all assets of the
Borrowers and any of their existing or future material domestic subsidiaries,
subject to customary exceptions. We are a holding company with no material
assets and we do not conduct any business operations of our own. We have no
independent means of generating revenue or cash flow, and our ability to pay
dividends in the future, if any, is dependent upon the financial results and
cash flows of FAH, LLC and its subsidiaries and distributions we receive from
FAH, LLC. Under the terms of the New Credit Facilities, our operating
subsidiaries are currently limited in their ability to pay cash dividends to the
Company, subject to certain customary exceptions, including:
•the ability to pay, so long as there is no current or ongoing event of default,
amounts required to be paid under the Tax Receivable Agreement, certain expenses
associated with being a public company and reimbursement of expenses required by
the LLC Agreement or the Registration Rights Agreement; and
•the ability to make other distributions of up to $25.0 million during any
period of four fiscal quarters in order to pay dividends to the common unit
holders of FAH, LLC (including the Company) as long as the funds received by the
Company are used to pay dividends to the Company's stockholders, the Leverage
Ratio (as defined in the Credit Agreement) is not greater than a ratio that is
0.50:1.00 less than the Leverage Ratio (as defined in the Credit Agreement) for
the applicable fiscal quarter and there is remaining Availability (as defined in
the Credit Agreement) under the New Credit Facilities of at least $25.0 million.
We expect these limitations to continue in the future under the terms of the New
Credit Facilities and that they may continue under the terms of any future
credit agreement or any future debt or preferred equity securities of ours or of
our subsidiaries.
On February 11, 2019, we acquired Forrest-Pruzan Creative LLC, a board game
development studio in Seattle, WA. See Note 3, Acquisitions for further
information.
On April 20, 2019, we filed a preliminary shelf registration statement on Form
S-3 (as amended on May 13, 2019 and August 30, 2019, the "Form S-3") with the
SEC. The Form S-3 was declared effective by the SEC on September 16, 2019. The
Form S-3 allows us to offer and sell from time-to-time up to $100.0 million of
Class A common stock, preferred stock, debt securities, warrants, purchase
contracts or units comprised of any combination of these securities for our own
account and allows certain selling stockholders to offer and sell 27,884,185
shares of
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Class A common stock in one or more offerings. On September 19, 2019, certain
selling stockholders completed a secondary underwritten public offering of
4,000,000 shares of Class A common stock under our Form S-3.
The Form S-3 is intended to provide us flexibility to conduct registered sales
of our securities, subject to market conditions and our future capital needs.
The terms of any future offering under the shelf registration statement will be
established at the time of such offering and will be described in a prospectus
supplement filed with the SEC prior to the completion of any such offering.
Liquidity and Capital Resources
The following table shows summary cash flow information for the years ended
December 31, 2019, 2018 and 2017 (in thousands):
                                                                    Year 

Ended December 31,

                                                           2019               2018               2017
Net cash provided by operating activities              $  90,765          $  49,991          $  23,837
Net cash used in investing activities                    (48,633)           (27,501)           (65,215)

Net cash provided by (used in) financing activities (28,340) (15,046)

            43,012

Effect of exchange rates on cash and cash equivalents (2,049)

  (1,686)               (67)
Net increase in cash and cash equivalents              $  11,743          $ 

5,758 $ 1,567

Operating Activities. Our net cash provided by operating activities consists of
net income adjusted for certain non-cash items, including depreciation and
amortization, equity-based compensation and fair value adjustments to contingent
consideration, accretion of discount on long-term debt, as well as the effect of
changes in working capital and other activities.
Net cash provided by operating activities was $90.8 million for the year ended
December 31, 2019, compared to $50.0 million for the year ended December 31,
2018. Changes in net cash provided by operating activities result primarily from
cash received from net sales and cash payments for product costs and royalty
expenses paid to our licensors. Other drivers of the changes in net cash
provided by operating activities include shipping and freight costs, selling,
general and administrative expenses (including personnel expenses and
commissions and rent and facilities costs) and interest payments made for our
short-term borrowings and long-term debt. Our accounts receivable typically are
short term and settle in approximately 30 to 90 days.
The increase for the year ended December 31, 2019 compared to the year ended
December 31, 2018 was primarily due to changes in working capital, which
increased net cash provided by operating activities by $39.2 million and were
primarily due to decreases in inventory and accounts receivable, net of $34.3
million and $32.2 million, respectively, and an increase in accounts payable of
$21.0 million, partially offset by decreases to accrued royalties, accrued
expenses and other liabilities and income taxes payable of $17.9 million, $10.0
million and $5.8 million, respectively, and an increase in prepaid expenses and
other assets of $14.6 million. The increase in net cash provided by operating
activities also reflected an increase in net income, excluding non-cash
adjustments, of $1.6 million, driven primarily by an increase in net sales and a
decrease in interest expense, net (excluding the effect of a $0.9 million
decrease in non-cash adjustments related to accretion of discount on long-term
debt and amortization of debt issuance costs), primarily offset by an increase
in cost of sales (exclusive of depreciation and amortization) and selling,
general and administrative expenses.
Net cash provided by operating activities was $50.0 million for the year ended
December 31, 2018, compared to $23.8 million for the year ended December 31,
2017. The increase was primarily due to an increase in net income, excluding
non-cash adjustments, of $30.9 million, driven primarily by an increase in net
sales and a decrease in interest expense, net (excluding the effect of a $2.3
million decrease in non-cash adjustments related to accretion of discount on
long-term debt and amortization of debt issuance costs), primarily offset by an
increase in cost of sales (exclusive of depreciation and amortization) and
selling, general and administrative expenses. The increase in net cash provided
by operating activities was partially offset by a decrease due to changes in
working capital. Changes in working capital decreased net cash provided by
operating activities by $4.8 million and were primarily due a decrease in
accounts payable of $35.4 million and an increase in accounts receivable, net of
$7.7 million, partially offset by a decrease in prepaid expenses and other
assets of $18.5 million, an increase in accrued royalties of $10.8 million and a
decrease in inventory of $8.3 million.
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Investing Activities. Our net cash used in investing activities primarily
relates to the purchase of property and equipment and acquisitions, net of cash
acquired. For the year ended December 31, 2019, net cash used in investing
activities was $48.6 million and was comprised of $42.3 million used for the
purchase of property and equipment, primarily related to tooling and molds used
for the expansion of product lines, and cash consideration, net of cash acquired
of $6.4 million for the Forrest-Pruzan Acquisition.
For the year ended December 31, 2018, net cash used in investing activities was
$27.5 million and was comprised of $26.9 million used for the purchase of
property and equipment, primarily related to tooling and molds used for the
expansion of product lines, and $0.6 million used for acquisitions, specifically
an increase in cash used to acquire Loungefly as a result of certain working
capital adjustments.
For the year ended December 31, 2017, net cash used in investing activities was
$65.2 million and was primarily comprised of initial cash consideration of
$12.6 million, $16.1 million and $3.9 million for the Underground Toys
Acquisition, the Loungefly Acquisition and A Large Evil Corporation Acquisition,
respectively. Additionally, $33.6 million of net cash used in investing
activities was for the purchase of property and equipment and primarily
consisted of $21.1 million for the purchase of property and equipment related to
tooling and molds for the expansion of product lines and $6.6 million for
leasehold improvements related to the build-out of our new headquarters.
Financing Activities. Our financing activities primarily consist of proceeds
from stock issuances, the issuance of long-term debt, net of debt issuance
costs, the repayment of long-term debt, payments and borrowings under our line
of credit facility, contributions from, and distributions to, members and the
payment of contingent consideration. We do not anticipate any financing activity
related to contributions from members going forward.
For the year ended December 31, 2019, net cash used in financing activities was
$28.3 million, primarily related to distributions to the Continuing Equity
Owners of $23.9 million and payments on the New Term Loan Facility of $11.8
million, partially offset by net borrowings on the New Revolving Credit Facility
of $5.7 million and proceeds from the exercise of equity based options of $2.2
million.
For the year ended December 31, 2018, net cash used in financing activities was
$15.0 million, primarily related to payments on the New Term Loan Facility and
Term Loan A Facility of $231.3 million and $20.4 million in distributions to
members of FAH, LLC, partially offset by proceeds from the New Term Loan
Facility of $230.0 million, and net borrowings on the revolving lines of credit
of $9.2 million.
For the year ended December 31, 2017, net cash provided by financing activities
was $43.0 million, primarily related to proceeds from the issuance of Class A
common stock sold in the IPO net of underwriter's discounts and commissions of
$117.3 million, proceeds from the Term Loan A Facility, Term Loan B Facility and
Subordinated Promissory Notes of $86.3 million, and contribution from members of
FAH, LLC of $5.0 million, partially offset by payments on the Term Loan B
Facility and Subordinated Promissory Notes of $79.0 million, $72.8 million in
distributions to members of FAH, LLC and payments for contingent consideration
of $18.0 million. During 2017, we also had net borrowings on the Revolving
Credit Facility of $4.1 million.
Financial Condition
Notwithstanding our obligations under the Tax Receivable Agreement between
Funko, Inc., FAH, LLC and each of the Continuing Equity Owners, we believe that
our sources of liquidity and capital will be sufficient to finance our continued
operations, growth strategy, our planned capital expenditures and the additional
expenses we incur as a public company for at least the next 12 months. However,
we cannot assure you that our cash provided by operating activities, cash and
cash equivalents or cash available under our New Revolving Credit Facility will
be sufficient to meet our future needs. If we are unable to generate sufficient
cash flows from operations in the future, and if availability under our New
Revolving Credit Facility is not sufficient, we may have to obtain additional
financing. If we obtain additional capital by issuing equity, the interests of
our existing stockholders will be diluted. If we incur additional indebtedness,
that indebtedness may contain significant financial and other covenants that may
significantly restrict our operations. We cannot assure you that we could obtain
refinancing or additional financing on favorable terms or at all.
As noted above, on October 22, 2018, we entered into the New Credit Facilities
and repaid in full our Former Senior Secured Credit Facilities. The New Credit
Facilities are secured by substantially all assets of the Borrowers and any of
their existing or future material domestic subsidiaries, subject to customary
exceptions.
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The Borrowers and any of their existing or future material domestic
subsidiaries, subject to customary exceptions, guarantee repayment of the New
Credit Facilities. The New Term Loan Facility matures on September 23, 2024 (the
"Maturity Date"). The New Term Loan Facility amortizes in quarterly installments
in aggregate amounts equal to 5.00% of the original principal amount of the New
Term Loan Facility in the first and second years of the New Term Loan Facility,
10.00% of the original principal amount of the New Term Loan Facility in the
third and fourth years of the New Term Loan Facility and 12.50% of the original
principal amount of the New Term Loan Facility in the fifth and sixth year of
the New Term Loan Facility, with any outstanding balance due and payable on the
Maturity Date. The New Revolving Credit Facility terminates on the Maturity Date
and loans thereunder may be borrowed, repaid, and reborrowed up to such date.
Loans under the New Credit Facilities will, at the Borrowers' option, bear
interest at either the Euro-Rate (as defined in the Credit Agreement) or, in the
case of swing loans, the Swing Rate (as defined in the Credit Agreement), plus
2.50% or the Base Rate (as defined in the Credit Agreement) plus 1.50%, with two
0.25% step-downs based on the achievement of certain leverage ratios. The
Euro-Rate is subject to a 0.00% floor. For loans based on the Euro-Rate,
interest payments are due at the end of each applicable interest period. For
loans based on the Base Rate, interest payments are due quarterly.
The Borrowers may request that the New Term Loan Facility be increased by an
additional $25.0 million.
The Credit Agreement governing the New Credit Facilities contains a number of
covenants that, among other things and subject to certain exceptions, restrict
our ability to:
•incur additional indebtedness;
•incur certain liens;
•consolidate, merge or sell or otherwise dispose of our assets;
•alter the business conducted by us and our subsidiaries;
•make investments, loans, advances, guarantees and acquisitions;
•pay dividends or make other distributions on equity interests, or redeem,
repurchase or retire equity interests;
•enter into transactions with affiliates;
•enter into agreements restricting our subsidiaries' ability to pay dividends;
•issue or sell equity interests or securities convertible into or exchangeable
for equity interests;
•redeem, repurchase or refinance other indebtedness; and
•amend or modify our governing documents.
In addition, the Credit Agreement requires FAH, LLC and its subsidiaries to
comply on a quarterly basis with a maximum senior leverage ratio and a minimum
fixed charge coverage ratio of 1.25:1.00 (in each case, measured on a trailing
four-quarter basis). The maximum senior leverage ratio is currently 2.75:1.00,
which will step down to 2.50:1.00 on December 31, 2020 and to 2.25:1.00 on
December 31, 2021. As of December 31, 2019 and December 31, 2018, we were in
compliance with all covenants in our New Credit Facilities.
The Credit Agreement also contains certain customary representations and
warranties and affirmative covenants, and certain reporting obligations. In
addition, the lenders under the New Credit Facilities will be permitted to
accelerate all outstanding borrowings and other obligations, terminate
outstanding commitments and exercise other specified remedies upon the
occurrence of certain events of default (subject to certain grace periods and
exceptions), which include, among other things, payment defaults, breaches of
representations and warranties, covenant defaults, certain cross-defaults and
cross-accelerations to other indebtedness, certain events of bankruptcy and
insolvency, certain judgments and changes of control. The Credit Agreement
defines "change of control" to include, among other things, any person or group
other than ACON and its affiliates becoming the beneficial owner of more than
35% of the voting power of the equity interests of Funko, Inc.
As of December 31, 2019, we had $25.2 million of cash and cash equivalents and
$101.6 million of working capital, compared with $13.5 million of cash and cash
equivalents and $117.4 million of working capital as of December 31, 2018.
Working capital is impacted by seasonal trends of our business and the timing of
new product releases, as
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well as our current portion of long-term debt and draw downs on our line of
credit. For further discussion of changes in our debt, see below, and Note 10,
Debt of the notes to our consolidated financial statements.
Future Sources and Uses of Liquidity
Sources
As noted above, historically, our primary sources of cash flows have been cash
flows from operating activities and borrowings under our Subordinated Promissory
Notes, Former Senior Secured Credit Facilities and New Credit Facilities. We
expect these sources of liquidity to continue to be our primary sources of
liquidity.
New Credit Facilities. On October 22, 2018, the Company entered into the New
Credit Facilities. Upon closing, proceeds from the New Credit Facilities were
primarily used to repay all of the outstanding aggregate principal balance and
accrued interest of $209.6 million on the previous Term Loan A Facility and
$65.3 million on the previous Revolving Credit Facility. Upon repayment, both
the previous Term Loan A Facility and the previous Revolving Credit Facility
were terminated.  For a discussion of our New Credit Facilities, see Note 10,
Debt of the notes to our consolidated financial statements.
Former Senior Secured Credit Facilities. For a discussion of our Former Senior
Secured Credit Facilities, see Note 10, Debt of the notes to our consolidated
financial statements.
Subordinated Promissory Notes. For a discussion of our former Subordinated
Promissory Notes, see Note 10, Debt of the notes to our consolidated financial
statements.
Offerings of Registered Securities. In addition, as described above, on April
20, 2019, we filed a preliminary shelf registration statement on Form S-3 with
the SEC, which was declared effective by the SEC on September 16, 2019. The Form
S-3 allows us to offer and sell from time to time up to $100.0 million of Class
A common stock, preferred stock, debt securities, warrants, purchase contracts
or units comprised of any combination of these securities for our own account.
The terms of any offering under the shelf registration statement will be
established at the time of such offering and will be described in a prospectus
supplement filed with the SEC prior to the completion of any such offering.
Uses
Additional future liquidity needs may include public company costs, tax
distributions, the redemption right held by the Continuing Equity Owners that
they may exercise from time to time (should we elect to exchange their common
units for a cash payment), payments under the Tax Receivable Agreement and
general cash requirements for operations and capital expenditures. The
Continuing Equity Owners may exercise their redemption right for as long as
their common units remain outstanding. Although the actual timing and amount of
any payments that may be made under the Tax Receivable Agreement will vary, we
expect that the payments we will be required to make to the Continuing Equity
Owners will be significant. Any payments made by us to the Continuing Equity
Owners under the Tax Receivable Agreement will generally reduce the amount of
overall cash flow that might have otherwise have been available to us or to FAH,
LLC and, to the extent that we are unable to make payments under the Tax
Receivable Agreement for any reason, the unpaid amounts generally will be
deferred and will accrue interest until paid by us; provided however, that
nonpayment for a specified period may constitute a material breach under the Tax
Receivable Agreement and therefore may accelerate payments due under the Tax
Receivable Agreement.
Seasonality
While our customers in the retail industry typically operate in highly seasonal
businesses, we have historically experienced only moderate seasonality in our
business. Historically, over 50% of our net sales are made in the third and
fourth quarters, primarily in the period from August through November, as our
customers build up their inventories in anticipation of the holiday season.
Historically, the first quarter of the year has represented the lowest volume of
shipment and sales in our business and in the retail and toy industries
generally and it is also the least profitable quarter due to the various fixed
costs of the business. However, the rapid growth we have experienced in recent
years may have masked the full effects of seasonal factors on our business to
date, and as such, seasonality may have a greater effect on our results of
operations in future periods.
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Contractual Obligations
The following summarizes our principal future minimum commitments as of
December 31, 2019 (in thousands):
                               2020              2021              2022              2023               2024            Thereafter           Total
Long term debt and related
interest (1)                $ 26,825          $ 34,532          $ 34,683          $ 37,565          $ 132,849          $       -          $ 266,454
Operating leases              11,758            12,678            11,159            11,425             10,982             37,168             95,170
Liabilities under tax
 receivable agreement (2)      4,262             3,762             3,525             3,592              3,665             47,010             65,816
Minimum royalty
 obligations (3)              24,011             2,489                29                19                  -                  -             26,548
New Revolving Credit
 Facility (4)                 25,822                 -                 -                 -                  -                  -             25,822
Total                       $ 92,678          $ 53,461          $ 49,396          $ 52,601          $ 147,496          $  84,178          $ 479,810


(1)We estimated interest payments through the maturity of our New Credit
Facilities by applying the interest rate of 5.99% in effect as of December 31,
2019 under our New Term Loan Facility. See Note 10, Debt of the notes to our
consolidated financial statements.
(2)Represents amounts owed under our Tax Receivable Agreement. See Note 13,
Liabilities under Tax Receivable Agreement for additional information.
(3)Represents minimum guaranteed royalty payments under licensing arrangements.
(4)Represents the amount owed as of December 31, 2019 under our New Revolving
Credit Facility.
Off-Balance Sheet Arrangements
As of December 31, 2019, we did not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
See discussion of recently adopted and recently issued accounting pronouncements
in Note 2, Significant Accounting Policies of the notes to our consolidated
financial statements.
Critical Accounting Policies and Estimates
Discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements which have been prepared in
accordance with U.S. GAAP. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets and liabilities and related disclosures of contingent assets and
liabilities, revenue and expenses at the date of the consolidated financial
statements. We base our estimates on historical experience and on various other
assumptions in accordance with U.S. GAAP that we believe to be reasonable under
the circumstances. Actual results may differ from these estimates under
different assumptions or conditions.
Critical accounting policies and estimates are those that we consider the most
important to the portrayal of our financial condition and operating results and
require management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain. Our critical accounting policies and estimates include
those related to revenue recognition and sales allowances, royalties, inventory,
goodwill and intangible assets, equity-based compensation and income taxes.
Changes to these policies and estimates could have a material adverse effect on
our results of operations and financial condition.
The JOBS Act permits us, as an "emerging growth company," to take advantage of
an extended transition period to comply with new or revised accounting standards
applicable to public companies. We have chosen to "opt out" of this provision
and, as a result, we will adopt new or revised accounting standards upon or
prior to required public company adoption dates. This decision to opt out of the
extended transition period under the JOBS Act is irrevocable.
Revenue Recognition and Sales Allowance. Revenue from the sale of our products
is recognized when control of the goods is transferred to the customer, which is
upon shipment or upon receipt of finished goods by the customer, depending on
the contract terms. The majority of revenue is recognized upon shipment of
products to the customer.
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We routinely enter into arrangements with our customers to provide sales
incentives, support customer promotions, and provide allowances for returns and
defective merchandise. These sales adjustments require management to make
estimates. In making these estimates, management considers all available
information including the overall business environment, historical trends and
information from customers, such as agreed upon customer contract terms as well
as historical experience from the customer. The estimated costs of these
programs reduce gross sales in the period the related sale is recognized. We
adjust our estimates at least quarterly or when facts and circumstances used in
the estimate process change; historically adjustments to these estimates have
not been material.
We have elected to account for shipping and handling activities that occur after
control of the related good transfers as fulfillment activities instead of
assessing such activities as performance obligations. Accordingly, shipping and
handling activities that are performed by us, whether before or after a customer
has obtained control of the products, are considered fulfillment costs to
satisfy our performance obligation to transfer the products and are recorded as
incurred within cost of goods sold.
We have made an accounting policy election to exclude from revenue all taxes
assessed by a governmental authority that are both imposed on and concurrent
with a specific revenue-producing transaction and collected by the Company from
a customer (for example, sales, use, value added, and certain excise taxes).
Royalties. We enter into agreements for rights to licensed trademarks,
copyrights and likenesses for use in our products. These licensing agreements
require the payment of royalty fees to the licensor based on a percentage of
revenue. Many licensing agreements also require minimum royalty commitments.
When royalty fees are paid in advance, we record these payments as a prepaid
asset, either current or long- term based on when we expect to realize revenues
under the related licensing agreement. If we determine that it is probable that
the expected revenue will not be realized, a reserve is recorded against the
prepaid asset for the non-recoverable portion. As of December 31, 2019, we
recorded a prepaid asset of $13.0 million, net of a reserve of $2.4 million. As
of December 31, 2018, we recorded a prepaid asset of $5.5 million, net of a
reserve of $5.5 million. As of December 31, 2017, we recorded a prepaid asset of
$6.4 million, net of a reserve of $2.9 million.
We record a royalty liability as revenues are earned based on the terms of the
licensing agreement. In situations where a minimum commitment is not expected to
be met based on expected revenues, we will accrue up to the minimum amount when
it is reasonably certain that revenues generated will not meet the minimum
commitment. Royalty and license expense is recorded within cost of sales on the
consolidated statements of operations. Royalty expenses for the years ended
December 31, 2019, 2018 and 2017, were $126.8 million, $110.7 million and $77.1
million, respectively.
Inventory. Inventory consists primarily of figures, plush and accessories and
other finished goods, and is accounted for using the first-in, first-out, or
FIFO, method. We maintain reserves for excess and obsolete inventories to
reflect the inventory balance at the lower of cost or net realizable value. This
valuation requires us to make judgments, based on currently available
information, about the likely method of disposition, through sales to customers,
or liquidation, and expected recoverable value of each disposition category. We
estimate obsolescence based on assumptions regarding future demand.
Inventory costs include direct product costs and freight costs. As a result of
the ACON Acquisition, the Underground Toys Acquisition and the Loungefly
Acquisition, inventory was adjusted to fair value as of October 31, 2015,
January 27, 2017 and June 28, 2017, respectively. See Note 3, Acquisitions of
the notes to our consolidated financial statements.
In addition, during the year ended December 31, 2019, we recorded a one-time
$16.8 million charge related to the write-down of inventory as a result of the
Company's decision to dispose of slower moving inventory to increase operational
capacity. This charge is incremental to normal course reserves.
Goodwill and Intangible Assets. Goodwill represents the excess of the purchase
price over the net amount of identifiable assets acquired and liabilities
assumed in a business combination measured at fair value. We evaluate goodwill
for impairment annually on October 1 of each year and upon the occurrence of
triggering events or substantive changes in circumstances that could indicate a
potential impairment by assessing qualitative factors or performing a
quantitative analysis in determining whether it is more likely than not that the
fair value of the net assets is below their carrying amounts.
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Intangible assets acquired in a business combination are recognized separately
from goodwill and are initially recognized at their fair value at the
acquisition date. Intangible assets acquired include intellectual property
(product design), customer relationships, and trade names. These are
definite-lived assets and are amortized on a straight-line basis over their
useful lives. Intangible assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets might
not be recoverable. Conditions that would necessitate an impairment assessment
include a significant decline in the observable market value of an asset, a
significant change in the extent or manner in which an asset is used, or any
other significant adverse change that would indicate that the carrying amount of
an asset or group of assets may not be recoverable.
Income Taxes. We apply the provisions of Accounting Standards Codification
("ASC") Topic No. 740, "Income Taxes" ("ASC 740"). Under ASC 740, deferred tax
assets and liabilities are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. We record a valuation allowance against our deferred tax
assets when it is more likely than not that all or a portion of a deferred tax
asset will not be realized. In evaluating our ability to recover our deferred
tax assets, we consider all available positive and negative evidence, including
our operating results, ongoing tax planning and forecasts of future taxable
income on a jurisdiction-by-jurisdiction basis. If we determine we will not be
able to fully utilize all or part of these deferred tax assets, we would record
a valuation allowance through earnings in the period the determination was made,
which would have an adverse effect on our results of operations and earnings. In
accordance with ASC 740, we recognize, in our consolidated financial statements,
the impact of our tax positions that are more likely than not to be sustained
upon examination based on the technical merits of the positions. We recognize
interest and penalties for uncertain tax positions in selling, general and
administrative expenses.
We are subject to U.S. federal, state and local income taxes with respect to our
allocable share of any taxable income of FAH, LLC and are taxed at the
prevailing corporate tax rates. FAH, LLC is treated as a partnership for U.S.
federal income tax purposes and, as such, generally is not subject to any
entity­level U.S. federal income tax. Instead, taxable income is allocated to
holders of its common units, including us. As a result, we incur income taxes on
our allocable share of any net taxable income of FAH, LLC. Pursuant to the
Second Amended and Restated FAH, LLC Agreement, FAH, LLC will generally make pro
rata tax distributions to holders of common units in an amount sufficient to
fund all or part of their tax obligations with respect to the taxable income of
FAH, LLC that is allocated to them.
In connection with the consummation of the IPO, we entered into the Tax
Receivable Agreement with FAH, LLC and each of the Continuing Equity Owners.
Pursuant to the Tax Receivable Agreement, we are required to make cash payments
to the Continuing Equity Owners equal to 85% of the tax benefits, if any, that
we realize, or in some circumstances are deemed to realize, as a result of
(1) any redemptions funded by us or exchanges (or deemed exchanges in certain
circumstances) of common units for Class A common stock or cash, and (2) certain
additional tax benefits attributable to payments under the Tax Receivable
Agreement ("Tax Receivable Agreement Payments"). Amounts payable under the Tax
Receivable Agreement are contingent upon, among other things, (i) generation of
taxable income over the term of the Tax Receivable Agreement and (ii) changes in
tax laws. If we do not generate sufficient taxable income in the aggregate over
the term of the Tax Receivable Agreement to utilize the tax benefits, then we
would not be required to make the related Tax Receivable Agreement Payments.
Therefore, we only recognize a liability for Tax Receivable Agreement Payments
if we determine that it is probable that we will generate sufficient future
taxable income over the term of the Tax Receivable Agreement to utilize the
related tax benefits. Estimating future taxable income is inherently uncertain
and requires judgment. In projecting future taxable income, we consider our
historical results and incorporate certain assumptions, including projected
revenue growth, and operating margins, among others.
Upon redemption or exchange of common units in FAH, LLC, we record a liability
relating to the obligation if we believe that it is probable that we would have
sufficient future taxable income to utilize the related tax benefits. If we
determine in the future that we will not be able to fully utilize all or part of
the related tax benefits, we would derecognize any portion of the liability
related to the benefits not expected to be utilized.
Additionally, we will estimate the amount of Tax Receivable Agreement Payments
expected to be paid within the next 12 months and classify this amount as
current on our consolidated balance sheets. This determination is based on our
estimate of taxable income for the next fiscal year. To the extent our estimate
differs from actual results, we may be required to reclassify portions of our
liabilities under the Tax Receivable Agreement between current and non-current.
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During years ended December 31, 2019 and 2018, the Company acquired an aggregate
of 9.5 million and 1.4 million common units of FAH, LLC, respectively, in
connection with the redemption of common units, which resulted in an increase in
the tax basis of our investment in FAH, LLC subject to the provisions of the Tax
Receivable Agreement. As a result of these exchanges, during the years ended
December 31, 2019 and 2018, the Company recognized an increase to its net
deferred tax assets in the amount of $48.1 million and $7.0 million,
respectively, and corresponding Tax Receivable Agreement liabilities of $59.0
million and $6.8 million, respectively, representing 85% of the tax benefits due
to the Continuing Equity Owners. In addition, during the year ended December 31,
2019, the Company recognized $0.2 million of expenses in other (income) expense,
net on our consolidated statements of operations related to remeasurement
adjustments of Tax Receivable Agreement liabilities.
During the year ended December 31, 2017, there were no redemptions or exchanges
of common units in FAH, LLC under the Tax Receivable Agreement. As such, we did
not record any liabilities relating to our obligations under the Tax Receivable
Agreement for 2017.
Refer to Note 2, Significant Accounting Policies of the notes to our
consolidated financial statements for a discussion of recent accounting
pronouncements.
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