Funko, Inc. (FNKO) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. Our results of operations for the year ended December 31, 2022, including a discussion of the year ended December 31, 2023 compared to the year ended December 31, 2022, can be found under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2023.
Overview
Funko is 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, homewares, digital NFTs, vinyl records and limited-edition posters.
We sell our products in numerous countries across North America, Europe, Latin America, Asia and Africa, with approximately 35% of our net sales generated outside of the United States. We also source, procure and assemble inventory, primarily out of Vietnam, China and Mexico. As such, we are exposed to and impacted by global macroeconomic factors. Current macroeconomic factors remain very dynamic, such as greater political uncertainty, unrest or instability in the United States, Central and Eastern Europe (including the ongoing Russia-Ukraine War), the Middle East (including the Israel–Hamas War), and certain Southeast Asia regions as well as financial instability, new or increasing tariffs and general uncertainty over U.S. trade and tariff policies, rising interest rates and heightened inflation that could reduce our net sales or have impacts to our gross margin (as defined below), net income and cash flows.
In addition, we have been and continue to be operating in a challenging retail environment where retailers have slowed their restocking, prioritized lower inventory levels and, in some cases, have canceled their orders. This has had an impact across our brands and geographies of reducing our net sales, gross margin and net income. We have strategically adjusted our inventory buy-in to focus on non-exclusive core products in order to help mitigate this impact.
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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, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| (in thousands) | ||||||
| Net sales | $ | 1,049,850 | $ | 1,096,086 | ||
| Net loss | $ | (15,070) | $ | (164,438) | ||
| EBITDA (1) | $ | 72,652 | $ | 55,792 | ||
| Adjusted EBITDA (1) (2) | $ | 94,741 | $ | (11,822) |
(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 loss, the most closely comparable U.S. GAAP financial measure, see “Non-GAAP Financial Measures” in this item.
(2)Following correspondence with the Securities and Exchange Commission (the “SEC”), we no longer adjust our non-GAAP financial measures for one-time disposal costs for finished goods held at offshore factories, one-time disposal costs for unfinished goods held at offshore factories, and inventory write-down. This change in presentation lowers adjusted EBITDA by $39.0 million for the year ended December 31, 2023. This change did not impact periods prior to fiscal year 2023.
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 benefited 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 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, and content consumption trends by consumers are also rapidly evolving. 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 Core Collectible branded products, which represented approximately 77% and 73% of our sales for the years ended December 31, 2024 and 2023, respectively, and which are sold across multiple product categories.
Relationships with Content Providers
We generate a majority 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 current and former 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, including as a result of members of our senior management team departing the Company, could adversely affect our business.
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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 wholesale customers represented approximately 31% and 32% of our sales for the years ended December 31, 2024 and 2023, respectively. During the years ended December 31, 2024 and 2023, we saw shifts in our client mix as a direct result of our growing direct-to-consumer business and enhanced online presence of our top customers.
Notwithstanding the growth of our direct-to-consumer business, we continue to depend on retailers and, in particular, rely on retailers to provide adequate and attractive space for our products and point of purchase displays in their stores. We continue to have dedicated shelf space for our products in a variety of aisles in mass-market retailer and specialty stores, with our growing diversified product offerings. In recent years, traditional retailers have been affected by a shift in consumer preferences towards other channels, particularly e-commerce.
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 often have visibility into the new release schedule of many our major 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.
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. In addition, despite our efforts to diversify the properties on which we base our products, if the performance of one or more of these properties fail to meet expectations or are delayed in their release, our operating results could be adversely affected.
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Inventory Management
Inventory consists primarily of figures, plush, apparel, homewares, accessories and other finished goods, and is accounted for using the first-in, first-out (“FIFO”) method. Inventory costs include direct product costs and freight costs. We order inventory based on assumptions of future demand and 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, such as through sales to customers, or liquidation, and expected recoverable value of each disposition category. We also monitor our warehouse operations for maximum throughput to minimize carrying costs and aging of on-hand inventory. We may from time to time, liquidate and/or dispose of inventory to increase warehouse operating efficiency. During the year ended December 31, 2023, the Company approved an inventory reduction plan to improve U.S. warehouse operational efficiency. The Company recorded a $30.3 million inventory write-down included in cost of sales as presented in the consolidated statements of operations for the year ended December 31, 2023. The units were identified and recorded based on an estimate of product costs, associated capitalized freight, net of allocated inventory reserves of the identified units and an estimate of physical destruction costs.
Taxation and 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 we are taxed at the prevailing corporate tax rates. In addition to tax expenses, we incur expenses related to our operations, as well as payments under the Tax Receivable Agreement. We have caused and intend to continue 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.
During the year ended December 31, 2023, the Company determined that based on all the available evidence, including the Company’s three-year cumulative pre-tax loss position, it was not more likely than not that the results of operations will generate sufficient taxable income to realize its deferred tax assets. Consequently, the Company established a full valuation allowance of $123.2 million against its deferred tax assets, thus reducing the carrying balance to $0, and recognized a corresponding increase to tax expense in the consolidated statements of operations and comprehensive (loss) income in the year ended December 31, 2023.
As a result of the full valuation allowance on the deferred tax assets, and projected inability to fully utilize all or part of the related tax benefits, the Company determined that certain payments to the TRA Parties related to unrealized tax benefits under the TRA are no longer probable and estimable. Based on this assessment, the Company reduced its TRA Liability as of June 30, 2023, to $9.6 million, and recognized a gain of $99.6 million within the accompanying consolidated statements of operations and comprehensive (loss) income. The Company performed a true-up in the fourth quarter of 2023 based on the filed 2022 consolidated tax return and recognized a further reduction in TRA liability and corresponding $603 thousand gain within the accompanying consolidated statements of operations and comprehensive (loss) income.
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, homewares, NFTs, vinyl records and limited-edition posters, primarily to retail customers and distributors. We also sell our products directly to consumers through our e-commerce operations, our retail stores and, to a lesser extent, at specialty licensing and comic book conventions and exhibitions.
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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. We evaluate the need for price increases along with other incentive arrangements and cost of product to help manage gross margins. In 2023, we instituted price increases for our products, and we may institute additional increases in 2025. Sales terms typically do not allow for a right of return except in relation to a manufacturing defect and certain products purchased through our website. 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, the cost to ship our products, including both inbound freight and duties and outbound products to our customers and inventory management. Our cost of sales excludes depreciation and amortization.
Our products are produced and assembled 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. Our use of international manufacturers, particularly in China and Mexico, may increase the likelihood that our costs are adversely impacted by new tariffs.
Our product costs and gross margins will be impacted from period to period based on the product mix in any given period. Our Loungefly branded products tend to have a higher product cost and higher duties as a percentage of sales and therefore lower gross margins than our Core Collectible branded products.
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.
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. We contract a portion of our freight needs and the remainder is acquired through the spot market, where there may be varying costs and transit times.
We anticipate inflationary pressures throughout our supply chain in future periods, specific to freight and duties costs and, to a lesser extent, product costs.
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.
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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 primarily comprised of trade names, customer relationships and intellectual property.
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.
Results of Operations
Year Ended December 31, 2024 Compared to Year Ended December 31, 2023
The following table sets forth information comparing the components of net loss for the years ended December 31, 2024 and 2023:
| Year Ended December 31, | Period over Period Change | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2024 | 2023 | Dollar | Percentage | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Net sales | $ | 1,049,850 | $ | 1,096,086 | $ | (46,236) | (4.2) | % | ||||||
| Cost of sales (exclusive of depreciation and amortization) | 615,318 | 763,085 | (147,767) | (19.4) | % | |||||||||
| Selling, general, and administrative expenses | 358,958 | 377,065 | (18,107) | (4.8) | % | |||||||||
| Depreciation and amortization | 62,583 | 59,763 | 2,820 | 4.7 | % | |||||||||
| Total operating expenses | 1,036,859 | 1,199,913 | (163,054) | (13.6) | % | |||||||||
| Loss from operations | 12,991 | (103,827) | 116,818 | nm | ||||||||||
| Interest expense, net | 20,575 | 27,970 | (7,395) | (26.4) | % | |||||||||
| Loss on extinguishment of debt | — | 494 | (494) | nm | ||||||||||
| Gain on tax receivable agreement liability adjustment | — | (100,223) | 100,223 | nm | ||||||||||
| Other expense (income), net | 2,922 | (127) | 3,049 | nm | ||||||||||
| Loss before income taxes | (10,506) | (31,941) | 21,435 | (67.1) | % | |||||||||
| Income tax expense | 4,564 | 132,497 | (127,933) | (96.6) | % | |||||||||
| Net loss | (15,070) | (164,438) | 149,368 | (90.8) | % | |||||||||
| Less: net loss attributable to non-controlling interests | (352) | (10,359) | 10,007 | (96.6) | % | |||||||||
| Net loss attributable to Funko, Inc. | $ | (14,718) | $ | (154,079) | $ | 139,361 | (90.4) | % |
Net Sales
Net sales were $1.0 billion for the year ended December 31, 2024, a decrease of 4.2% compared to $1.1 billion for the year ended December 31, 2023. The decrease in net sales was primarily due to decreased sales to our specialty retailers and e-commerce site customers, primarily as a result of the available content slate and performance of certain exclusive products. Our top ten wholesale customers represented approximately 31% and 32% of our sales for the years ended December 31, 2024 and 2023, respectively.
On a geographical basis, net sales in the United States decreased 9.7% to $682.0 million in the year ended December 31, 2024 as compared to $755.6 million in the year ended December 31, 2023, net sales in Europe increased 5.7% to $283.8 million in the year ended December 31, 2024 from $268.5 million in the year ended December 31, 2023 and net sales in other international locations increased 16.8% to $84.1 million in the year ended December 31, 2024 from $72.0 million in the year ended December 31, 2023.
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On a product category basis, net sales of Core Collectible branded products increased 0.2% to $804.4 million in the year ended December 31, 2024 as compared to $803.2 million in the year ended December 31, 2023. Net sales of Loungefly branded products decreased 19.9% to $171.8 million in the year ended December 31, 2024 as compared to $214.5 million in the year ended December 31, 2023. Net sales of other products decreased 6.1% to $73.6 million in the year ended December 31, 2024 as compared to $78.4 million in the year ended December 31, 2023.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $615.3 million for the year ended December 31, 2024, a decrease of 19.4%, compared to $763.1 million for the year ended December 31, 2023. Cost of sales (exclusive of depreciation and amortization) decreased primarily as a result of certain costs incurred during the year ended December 31, 2023, that were not recurring during the year ended December 31, 2024. Other costs decreased $73.7 million or 91.0%, primarily related to domestic inventory and one-time offshore finished and unfinished goods write-offs and increased inventory reserves for the year ended December 31, 2023. Product costs decreased $32.9 million or 8.8%, shipping and freight costs decreased $30.3 million or 23.3% and license and royalty costs decreased $10.8 million or 6.0%.
Gross margin (exclusive of depreciation and amortization), calculated as net sales less cost of sales as a percentage of sales, was 41.4% for the year ended December 31, 2024, compared to 30.4% for the year ended December 31, 2023. Gross margin (exclusive of depreciation and amortization) increased for the year ended December 31, 2024 compared to the year ended December 31, 2023, due to the factors noted above.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $359.0 million for the year ended December 31, 2024, a decrease of 4.8%, compared to $377.1 million for the year ended December 31, 2023. The decrease was driven primarily by a $19.5 million decrease in personnel expenses, commissions and stock option expense, a $12.3 million decrease in professional fees, primarily related to non-recurring severance payments, termination of a lease agreement and related expenses and impairment of assets held-for-sale during the year ended December 31, 2023, offset by an increase in advertising and marketing fees of $20.3 million in 2024, primarily in support of our direct-to-consumer channel.
Selling, general, and administrative expenses were 34.2% of sales for the year ended December 31, 2024, compared to 34.4% of sales for the year ended December 31, 2023, due to the factors noted above.
Depreciation and Amortization
Depreciation and amortization expense was $62.6 million for the year ended December 31, 2024, compared to $59.8 million for the year ended December 31, 2023, primarily driven by the type and timing of assets placed into service.
Interest Expense, Net
Interest expense, net was $20.6 million for the year ended December 31, 2024, a decrease of 26.4%, compared to $28.0 million for the year ended December 31, 2023. The decrease in interest expense, net was due to lower average balances of debt outstanding during the year ended December 31, 2024.
Loss on Debt Extinguishment
As a result of the amendment to our Credit Agreement entered into in February 2023, a $0.5 million loss on debt extinguishment was recorded for the year ended December 31, 2023 as unamortized debt financing fees were written-off.
Gain on Tax Receivable Agreement Liability Adjustment
As a result of recognizing a full valuation allowance related to the Company’s deferred tax assets, the Company determined as of June 30, 2023 that no future tax benefits were expected to be realized under the Tax Receivable Agreement. The long-term portion of the tax receivable agreement liability was reduced and we recorded a gain of $100.2 million during the year ended December 31, 2023.
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Other Expense (Income), Net
Other expense, net was $2.9 million and other income, net was $0.1 million for the years ended December 31, 2024 and 2023, respectively. Other expense (income), net for the years ended December 31, 2024 and 2023 was primarily related to foreign currency gains and losses relating to transactions denominated in currencies other than the U.S. dollar.
Income Tax Expense
Income tax expense was $4.6 million for the year ended December 31, 2024, compared to $132.5 million for the year ended December 31, 2023. The decrease in income tax expense was related to recognizing a full valuation allowance on the Company’s deferred tax assets during the year ended December 31, 2023.
Net Loss
Net loss was $15.1 million for the year ended December 31, 2024, compared to $164.4 million for the year ended December 31, 2023. The decrease in net loss was primarily the result of lower net sales, offset by the nonrecurring events for the year ended December 31, 2023, as discussed above.
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Non-GAAP Financial Measures
EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss) and Adjusted Earnings (Loss) 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 loss, loss per share or any other performance measure derived in accordance with U.S. GAAP. We define EBITDA as net loss before interest expense, net, income tax expense, depreciation and amortization. We define Adjusted EBITDA as EBITDA further adjusted for non-cash charges related to equity-based compensation programs, loss on debt extinguishment, acquisition transaction costs and other expenses, certain severance, relocation and related costs, foreign currency transaction gains and losses, tax receivable agreement liability adjustments and other unusual or one-time items. We define Adjusted Net Income (Loss) as net loss attributable to Funko, Inc. adjusted for the reallocation of loss attributable to non-controlling interests from the assumed exchange of all outstanding common units and options in FAH, LLC 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, non-cash charges related to equity-based compensation programs, loss on debt extinguishment, acquisition transaction costs and other expenses, certain severance, relocation and related costs, foreign currency transaction gains and losses, tax receivable agreement liability adjustments and the income tax expense effect of these adjustments. We define Adjusted Earnings (Loss) per Diluted Share as Adjusted Net Income (Loss) 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 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.
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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. 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 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;
•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, loss on debt extinguishment, acquisition transaction costs and other expenses, 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 certain of 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. Each of the 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.
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The following tables reconcile the Non-GAAP Financial Measures to the most directly comparable U.S. GAAP financial performance measure, which is net loss, for the periods presented:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| (in thousands, except per share data) | ||||||
| Net loss attributable to Funko, Inc. | $ | (14,718) | $ | (154,079) | ||
| Reallocation of net loss attributable to non-controlling interests from the assumed exchange of common units of FAH, LLC for Class A common stock (1) | (352) | (10,359) | ||||
| Equity-based compensation (2) | 13,602 | 10,534 | ||||
| Acquisition transaction costs and other expenses (3) | 3,449 | 14,241 | ||||
| Certain severance, relocation and related costs (4) | 2,093 | 6,486 | ||||
| Loss on extinguishment of debt (5) | — | 494 | ||||
| Foreign currency transaction loss (6) | 2,398 | 854 | ||||
| Tax receivable agreement liability adjustments (7) | 547 | (100,223) | ||||
| Income tax expense (8) | 1,668 | 157,386 | ||||
| Adjusted net income (loss) (9) | $ | 8,687 | $ | (74,666) | ||
| Weighted-average shares of Class A common stock outstanding-basic | 52,043 | 48,332 | ||||
| Equity-based compensation awards and common units of FAH, LLC that are convertible into Class A common stock | 2,049 | 4,021 | ||||
| Adjusted weighted-average shares of Class A stock outstanding-diluted | 54,092 | 52,353 | ||||
| Loss per diluted share | $ | (0.28) | $ | (3.19) | ||
| Adjusted earnings (loss) per diluted share | $ | 0.16 | $ | (1.43) |
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| (in thousands) | ||||||
| Net loss | $ | (15,070) | $ | (164,438) | ||
| Interest expense, net | 20,575 | 27,970 | ||||
| Income tax expense | 4,564 | 132,497 | ||||
| Depreciation and amortization | 62,583 | 59,763 | ||||
| EBITDA | $ | 72,652 | $ | 55,792 | ||
| Adjustments: | ||||||
| Equity-based compensation (2) | 13,602 | 10,534 | ||||
| Acquisition transaction costs and other expenses (3) | 3,449 | 14,241 | ||||
| Certain severance, relocation and related costs (4) | 2,093 | 6,486 | ||||
| Loss on extinguishment of debt (5) | — | 494 | ||||
| Foreign currency transaction loss (6) | 2,398 | 854 | ||||
| Tax receivable agreement liability adjustments (7) | 547 | (100,223) | ||||
| Adjusted EBITDA (9) | $ | 94,741 | $ | (11,822) |
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(1)Represents the reallocation of net loss 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 non-cash charges related to equity-based compensation programs, which vary from period to period depending on timing of awards.
(3)For the year ended December 31, 2024, includes a net one-time legal settlement gain of $1.4 million related to a previously disclosed Loungefly customs-related matter and costs of $4.8 million related to contract settlement agreements and related services for assets held for sale (including fair market value adjustments of $1.3 million) related to a potential business initiative and the sale of certain assets under Funko Games. For the year ended December 31, 2023, includes a lease termination charge related to the abandonment of a potential business initiative of $5.0 million, expenses related to assets held for sale of $6.8 million (including fair market value adjustments of $6.5 million), related charges of termination of service contracts, architecture and design fees of $1.6 million related to the potential business initiative, and a purchase agreement termination charge of $1.0 million related to the abandonment of a potential business initiative, partially offset by acquisition-related benefits of $975,000 related to a working capital adjustment under the Mondo Collectibles, LLC acquisition.
(4)Represents certain severance, relocation and related costs. For the year ended December 31, 2024, includes severance and benefit costs related to certain management departures of $2.1 million. For the year ended December 31, 2023, includes charges to remove leasehold improvements and return multiple Washington-based warehouses of $382,000, and charges related to severance and benefit costs for reductions-in-force of $5.2 million.
(5)Represents write-off of unamortized debt financing fees for the year ended December 31, 2023.
(6)Represents both unrealized and realized foreign currency losses (gains) on transactions other than in U.S. dollars.
(7)Represents recognized adjustments to the tax receivable agreement liability. For the year ended December 31, 2023, reflects a reduction of the tax receivable agreement liability as a result of recognizing a full valuation allowance of the Company's deferred tax assets and anticipated inability to realize future tax benefits.
(8)Represents the income tax expense effect of the above adjustments. This adjustment uses an effective tax rate of 25% for the years ended December 31, 2024 and 2023. For the year ended December 31, 2023, this also includes $123.2 million recognized valuation allowance on the Company’s deferred tax assets.
(9)Following correspondence with the SEC, we no longer adjust our non-GAAP financial measures for one-time disposal costs for finished goods held at offshore factories, one-time disposal costs for unfinished goods held at offshore factories, and inventory write-down. This change in presentation lowers adjusted net income (loss) by $29.3 million and adjusted EBITDA by $39.0 million for the year ended December 31, 2023.
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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.
On September 17, 2021, the Company entered into a new credit agreement (the “Credit Agreement”) providing for a term loan facility in the amount of $180.0 million (the “Term Loan Facility”) and a revolving credit facility of $100.0 million (the “Revolving Credit Facility”) (together the “Credit Facilities”). Proceeds from the Credit Facilities were primarily used to repay the Company’s former $235.0 million term loan facility and its former $75.0 million revolving credit facility. On July 29, 2022, the Revolving Credit Facility was increased to $215.0 million and on February 28, 2023 the Revolving Credit Facility was reduced to $180.0 million and again to $150.0 million on December 31, 2023. The Credit Facilities are secured by substantially all assets of the borrowers under the Credit Facilities and any of their existing or future material domestic subsidiaries, subject to customary exceptions. On June 11, 2024 (the “Consent Effective Date"), the Credit Agreement Parties entered into that certain Limited Waiver and Limited Consent (the “Limited Waiver and Limited Consent”), with the lenders party thereto (the “Required Lenders”) and the Administrative Agent. Pursuant to the Limited Waiver and Limited Consent, the Administrative Agent and the Required Lenders have agreed to irrevocably and permanently waive, from any time prior to or after the Consent Effective Date, the Credit Agreement Parties’ compliance with the covenant to maintain a minimum threshold of Qualified Cash (as defined in the Credit Agreement).
On November 25, 2022, the Company entered into a $20.0 million equipment finance agreement ("Equipment Finance Loan"). The Equipment Finance Loan is secured by certain identified assets held within our Buckeye, Arizona warehouse.
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 Credit Facilities, our subsidiaries are currently limited in their ability to pay cash dividends to the Company, subject to certain customary exceptions, including among others:
•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 FAH 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 consecutive fiscal quarters as long as after giving pro forma effect to such distribution (i) no event of default then exists or would result therefrom and (ii) the Net Leverage Ratio (as defined in the Credit Agreement) is not greater than a ratio that is 0.50:1.00 less than the Net Leverage Ratio set forth in the financial covenant for the applicable fiscal quarter.
We expect these limitations to continue in the future under the terms of our Credit Agreement 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 July 15, 2022, we filed a preliminary shelf registration statement on Form S-3 with the SEC. The Form S-3 was declared effective by the SEC on July 26, 2022 and will remain effective until through July 25, 2025. 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 17,318,008 shares of Class A common stock in one or more offerings.
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.
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Liquidity and Capital Resources
The following table shows summary cash flow information for the years ended December 31, 2024 and 2023 (in thousands):
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Net cash provided by operating activities | $ | 123,524 | $ | 30,935 | ||
| Net cash used in investing activities | (25,228) | (39,796) | ||||
| Net cash (used in) provided by financing activities | (99,242) | 25,596 | ||||
| Effect of exchange rates on cash and cash equivalents | (852) | 518 | ||||
| Net change in cash and cash equivalents | $ | (1,798) | $ | 17,253 |
Operating Activities. Our net cash provided by operating activities consists of net loss adjusted for certain non-cash items, including depreciation and amortization, equity-based compensation, as well as the effect of changes in working capital and other activities.
Net cash provided by operating activities was $123.5 million for the year ended December 31, 2024, compared to $30.9 million for the year ended December 31, 2023. Changes in net cash provided by operating activities resulted 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 (average 57 days).
The increase for the year ended December 31, 2024 compared to the year ended December 31, 2023 was primarily due to changes in net loss of $149.4 million, offset by changes in certain non-cash items, including depreciation and amortization, equity-based compensation, tax receivable liability adjustments and deferred tax expense of $16.8 million and changes in working capital of $39.9 million, which decreased net cash provided by operating activities. Working capital changes were primarily due to increases in inventory of $96.3 million and accounts receivable of $30.9 million, offset by increases in accounts payable of $27.2 million, accrued royalties of $21.7 million and accrued expenses and other liabilities of $19.9 million and a decrease to prepaid expenses and other assets of $19.0 million.
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, 2024, net cash used in investing activities was $25.2 million, which was used for the purchase of property and equipment, primarily related to tooling and molds, offset by proceeds from the sale of inventory and certain intellectual property marketed under and related to Funko Games.
For the year ended December 31, 2023, net cash used in investing activities was $39.8 million and was primarily related to purchases of tooling and molds used in our production product lines and for the acquisition of MessageMe, Inc. (d/b/a HipDot).
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 and distributions to members.
For the year ended December 31, 2024, net cash used in financing activities was $99.2 million, primarily related to net repayments on the Revolving Line of Credit of $60.5 million, payments under the Term Loan and Equipment Financing Loan of $31.1 million and payments to TRA parties of $9.0 million.
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For the year ended December 31, 2023, net cash provided by financing activities was $25.6 million, primarily related to proceeds from net borrowings on the Revolving Line of Credit of $50.5 million, partially offset by payments under the Term Loan and Equipment Financing Loan of $22.6 million.
Financial Condition
We believe that our sources of liquidity and capital will be sufficient to finance our continued operations, growth strategy and our planned capital expenditures 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 Revolving Credit Facility will be sufficient to meet our future needs. In particular, though we were in compliance with the financial and other covenants under the Credit Agreement as of December 31, 2024, we cannot assure you that we will be able to maintain compliance with our financial covenants, or that we will be able to further amend the Credit Agreement should circumstances arise in the future.
If our operating results fail to improve or if we are otherwise unable to maintain compliance with the financial or other covenants under the Credit Agreement, our lenders could, among other things, terminate all outstanding commitments thereunder and accelerate all outstanding borrowings and other obligations, which would require us to seek additional financing. Even in the absence of such event, if we are unable to generate sufficient cash flows from operations in the future, and if availability under our Revolving Credit Facility is not sufficient, or if our debt matures and we are unable to repay amounts owed in full, we may have to obtain additional financing or refinancing. 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 of December 31, 2024, we had $112.2 million of indebtedness outstanding under our Term Loan Facility (net of unamortized discount of $1.0 million) and $60.0 million outstanding borrowings under our Revolving Credit Facility, leaving $90.0 million available under our Revolving Credit Facility. The Term Loan Facility matures on September 17, 2026 (the “Maturity Date”) and amortizes in quarterly installments in aggregate amounts equal to 2.50% of the original principal amount of the Term Loan Facility, with any outstanding balance due and payable on the Maturity Date. The first amortization payment commenced with the quarter ended on December 31, 2021. The Revolving Credit Facility also terminates on the Maturity Date and loans thereunder may be borrowed, repaid, and reborrowed up to such date.
Loans under the Credit Facilities will, at the Borrowers’ option, bear interest at either (i) SOFR, EURIBOR, HIBOR, CDOR, Daily Simple SONIA and/or the Central Bank Rate, as applicable, plus (x) 4.00% per annum and (y) solely in the case of Term SOFR based loans, 0.10% per annum or (ii) ABR or the Canadian prime rate, as applicable, plus 3.00% per annum, in each case of clauses (i) and (ii), subject to two 0.25% step-downs based on the achievement of certain leverage ratios following February 28, 2023. Each of SOFR, EURIBOR, HIBOR, CDOR and Daily Simple SONIA rates are subject to a 0% floor. For loans based on ABR, the Central Bank Rate or the Canadian prime rate, interest payments are due quarterly. For loans based on Daily Simple SONIA, interest payments are due monthly. For loans based on SOFR, EURIBOR, HIBOR or CDOR, interest payments are due at the end of each applicable interest period.
The Credit Agreement 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;
•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 sale and leaseback transactions in respect to real property;
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•enter into swap agreements;
•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 Net Leverage Ratio and a minimum fixed charge coverage ratio (in each case, measured on a trailing four-quarter basis). The maximum Net Leverage Ratio and the minimum fixed charge coverage ratio are 2.50:1.00 and 1.25:1.00, respectively.
As of December 31, 2024 and 2023, we were in compliance with all financial covenants in our respective credit agreements in effect at such time. We expect to maintain compliance with our covenants for at least one year from the issuance of these financial statements based on our current expectations and forecasts. If economic conditions worsen and negatively impact the Company’s earnings and operating cash flows, this could impact our ability to regain compliance with our amended financial covenants and require the Company to seek additional amendments to our Credit Agreement or cause us to default on our obligations under the Credit Agreement.
The Credit Agreement also contains certain customary representations and warranties and affirmative covenants, and certain reporting obligations. In addition, the lenders under the 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 material monetary 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, 2024, we had $34.7 million of cash and cash equivalents and $(18.7) million of working capital, compared with $36.5 million of cash and cash equivalents and $(16.0) million of working capital as of December 31, 2023. Working capital is impacted by seasonal trends of our business and the timing of new product releases, as 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 Consolidated Financial Statements included in this Form 10-K.
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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 Credit Facilities. We expect these sources of liquidity to continue to be our primary sources of liquidity.
Credit Facilities. On September 17, 2021, the Company entered into the Credit Facilities, which mature in September 2026. For a discussion of our Credit Facilities, see Note 10, "Debt" of the Notes to Consolidated Financial Statements included in this Form 10-K.
Offerings of Registered Securities. On July 15, 2022, we filed a preliminary shelf registration statement on Form S-3 with the SEC. The Form S-3 was declared effective by the SEC on July 26, 2022 and will remain effective until through July 25, 2025. 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 17,318,008 shares of Class A common stock in one or more offerings. 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
As noted above, our primary requirements for liquidity and capital are working capital, inventory management, capital expenditures, debt service and general corporate needs. For a description of the Company's future maturities of debt, see Note 10, "Debt" in the Notes to Consolidated Financial Statements, and for a description of the Company's operating lease agreements, see Note 11, "Leases" in the Notes to Consolidated Financial Statements included in this Form 10-K. See Note 13 "Liabilities under Tax Receivable Agreement" in the Notes to Consolidated Financial Statements included in this Form 10-K for a discussion of our obligations under the Tax Receivable Agreement. See Note 14 "Commitments and Contingencies" in the Notes to Consolidated Financial Statements included in this Form 10-K for a discussion of other material contractual obligations.
Additional future liquidity needs may include 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 (including a future enterprise resource management system (ERP), additional platforms to support our direct-to-consumer experience, and capital build out of new leased warehouse and office space). 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 TRA Parties will be significant, which will be contingent on future realizability of the Company's deferred tax assets. Any payments made by us to the TRA Parties 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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Recent Accounting Pronouncements
See discussion of recently adopted and recently issued accounting pronouncements in Note 2, "Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in this Form 10-K.
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 and income taxes. Changes to these policies and estimates could have a material adverse effect on our results of operations and financial condition.
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. When we collect cash from the customer and have not yet filled our obligation for delivery of product or service, we recognize deferred revenue. 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. 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.
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. 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, 2024, we recorded a prepaid asset of $6.1 million, net of a reserve of $8.5 million. As of December 31, 2023, we recorded a prepaid asset of $25.1 million, net of a reserve of $4.5 million.
We record a royalty liability as revenues are recognized 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, 2024, 2023 and 2022 were $168.9 million, $179.7 million and $213.1 million, respectively.
Our license agreements typically grant our licensors the right to audit our compliance with the terms and conditions of such agreements. Any such audit could result in a dispute over whether we have paid the proper royalties and a requirement that we pay additional royalties. We record an audit reserve based on historical audit findings and revenues subject to audit. 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. As of December 31, 2024 and 2023, we had a reserve of $23.5 million and $18.1 million, respectively, related to ongoing and future royalty audits, based on estimates of the costs we expect to incur.
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Inventory. Inventory consists primarily of figures, plush, accessories and other finished goods, and is accounted for using the first-in, first-out, or FIFO, method. Inventory costs include direct product costs and freight costs. 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.
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.
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 estimated 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, as we did during the year ended December 31, 2023. 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 entity‑level 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.
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Pursuant to the Tax Receivable Agreement, we are required to make cash payments to the TRA Parties 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. As a result of the full valuation allowance on the deferred tax assets, and projected inability to fully utilize all or part of the related tax benefits, the Company determined that certain payments to the TRA Parties related to unrealized tax benefits under the TRA are no longer probable and estimable. A gain was recorded during the year ended December 31, 2023 in the consolidated statement of operations as a result of the derecognition of the TRA liability.
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 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.
During years ended December 31, 2024 and 2023, the Company acquired an aggregate of 1.2 million and 1.8 million common units of FAH, LLC, respectively, in connection with the redemption and/or exchange of common units, none of which resulted in an increase in the tax basis of our investment in FAH, LLC subject to the provisions of the Tax Receivable Agreement.
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