Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide readers of our consolidated financial statements with the perspectives of management. This should allow the readers of this report to obtain a comprehensive understanding of our businesses, strategies, current trends, and future prospects. It should be noted that the MD&A contains forward-looking statements that involve risks and uncertainties. Please refer to the section entitled “Forward-Looking Statements” immediately preceding Part I for important information to consider when evaluating such statements.
This section of this Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Recent Developments
On February 6, 2023, our board of directors approved a 1-for-10 reverse stock split of our outstanding shares of common stock. The reverse stock split was effected on February 10, 2023 at 5:00 p.m. Eastern time. At the effective time, every 10 issued and outstanding shares of the Company's common stock were converted into 1 share of common stock. Any fractional shares of common stock resulting from the reverse stock split were rounded up to the nearest whole post-split share and no shareholders received cash in lieu of fractional shares. The par value of each share of common stock remained unchanged. The reverse stock split proportionately reduced the number of shares of authorized common stock from 400,000,000 to 40,000,000 shares. The reverse stock split also applied to common stock issuable upon the exercise of our outstanding warrants and stock options. The reverse stock split did not affect the authorized preferred stock of 10,000,001 shares. Unless noted, all references to shares of common stock and per share amounts contained in this Annual Report on Form 10-K have been retroactively adjusted to reflect a 1-for-10 reverse stock split.
2022 Investments
On January 13, 2022, we acquired Ameba Inc. ("Ameba") and gained access to its kid-safe platform technology and 13,000 episodes of owned and licensed content. Refer to Note 3 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details.
On April 6, 2022, we completed the acquisition of Wow. On October 26, 2021, our wholly-owned subsidiary, 1326919 B.C. LTD., a corporation existing under the laws of the Province of British Columbia and Wow, entered into an Arrangement Agreement to effect a plan of arrangement under the arrangement provisions of Part 9, Division 5 of the Business Corporations Act. We purchased 100% of the issued and outstanding shares of Wow, including Wow's subsidiary Frederator, for $38.3 million in cash and 1,105,708 shares of our common stock. The plan of arrangement and final agreement, together with the acquisition of Wow’s Mainframe Studios and its subsidiary Frederator, are referred to as the “Wow Acquisition.” Refer to Note 3 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details.
On December 1, 2021, we completed a $6.8 million investment in YFE. In exchange for $3.4 million in cash and 228,127 shares of our common stock (valued at approximately $3.4 million), we received 3,000,500 shares of YFE’s common stock, a 28.7% ownership in YFE. Following the initial equity investment in YFE, we participated in a mandatory tender offer for the remaining publicly traded shares held by YFE shareholders. Upon the expiration of the offer on February 14, 2022, we purchased an additional 2,637,717 shares of YFE at 2.00 EUROS per share or $5.3 million EUROS ($6.0 million USD) in the aggregate. On March 9, 2022, bonds held by YFE shareholders were converted into $2.6 million shares of YFE common stock, 304,431 of which were purchased by us, at 2.00 EUROS per share or $0.6 million EUROS ($0.7 million USD). On April 5, 2022, we exercised our subscription rights to purchase an additional 914,284 shares of YFE’s common stock at 3.00 EUROS per share, or $2.7 million EUROS ($2.9 million USD), increasing the number of YFE’s outstanding shares to 6,857,132. During the fourth quarter of 2022, we did not take part in a round of financing raised by YFE which increased YFE's outstanding shares and therefore decreased our ownership in YFE from 48.03% to 44.8% as of December 31, 2022.
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Results of Operations
Our summary results for the years ended December 31, 2022 and 2021 are below:
Revenues
Year Ended December 31,
2022 2021 Change % Change
(in thousands, except percentages)
Production Services $ 29,620 $ – $ 29,620 – %
Content Distribution 24,747 1,102 23,645 2,146 %
Licensing & Royalties 2,841 1,605 1,236 77 %
Media Advisory & Advertising Services 5,091 5,166 (75) (1) %
Total Revenue $ 62,299 $ 7,873 $ 54,426 691 %
Production Services revenue is generated specifically by Wow providing animation production services for the year ended December 31, 2022.
Content Distribution revenue is generated from the distribution of our properties for broadcast on television, video-on-demand (“VOD”) or subscription video-on-demand (“SVOD”) in domestic and international markets and the sale of DVDs for home entertainment through our partners. Content Distribution also includes our advertising sales generated on our digital network, the Kartoon Channel! in the form of either flat rate promotions or advertising impressions served, SVOD revenues generated by Ameba and revenue generated by Frederator on its multi-channel network.
Fluctuations in Content Distribution revenue are based on the achievement of revenue recognition criteria such as the start of a license period and the delivery of the content or advertisement to the customer. Revenue related to our AVOD and SVOD, including advertising sales for the year ended December 31, 2022, increased 2,146% as compared to the year ended December 31, 2021 primarily due to the acquisition of Ameba, Wow and Frederator, increasing Content Distribution revenue by $23.9 million.
Licensing & Royalties revenues are generated by the items in which we license the rights to our copyrights and trademarks of our brands and those of the brands for which we act as a licensing agent. Revenue related to our licensing and royalties for the year ended December 31, 2022 increased 77% as compared to the year ended December 31, 2021 primarily due to entering an agreement for the licensing of certain Stan Lee Assets.
Media Advisory & Advertising Services revenue is a combination of client retainer fee-based services and media commissions generated by our wholly-owned subsidiary, Beacon Media Group ("Beacon"), which we acquired on February 1, 2021.
Expenses
Year Ended December 31,
2022 2021 Change % Change
(in thousands, except percentages)
Marketing and Sales $ 1,834 $ 5,442 $ (3,608) (66) %
Direct Operating Costs 49,360 21,987 27,373 124 %
General and Administrative 45,851 35,967 9,884 27 %
Impairment of Intangible Assets 4,117 3,452 665 19 %
Impairment of Goodwill 4,857 4,778 79 2 %
Total Expenses $ 106,019 $ 71,626 $ 34,393 48 %
Marketing and Sales expenses consist primarily of advertising expenses and certain payments made to our marketing partners. Advertising expenses include promotional activities such as digital and television advertising. Marketing expenses also include payroll and related expenses for personnel that support marketing activities. The decrease in marketing and sales expenses for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was primarily due to a
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decrease in marketing and advertising expenses incurred to promote the Kartoon Channel! as well as the launch of Superhero Kindergarten.
Direct Operating Costs during the year ended December 31, 2022 consist primarily of salaries and related expenses for the animation production services employees of Mainframe and Frederator. Channel expenses, licensing and production of content costs, such as participation expenses related to profit sharing obligations with various animation studios, post-production studios, writers, directors, musicians or other creative talent that have rendered services and amortization, including any write-downs of film and television costs, make up the remainder of Direct Operating Costs.
The acquisition of Ameba, Wow and Frederator increased Direct Operating Costs for the year ended December 31, 2022 by $41.9 million as compared to the year ended December 31, 2021. The increase is partially offset by a decrease in the write-downs of film and television costs of $11.4 million recorded during the year ended December 31, 2022 as compared to the write-downs recorded during the year ended December 31, 2021.
General and Administrative expenses primarily consist of payroll and related expenses, share-based compensation related to our equity compensation plan, rent, depreciation of our property and equipment and amortization of our intangible assets, as well as professional fees and other general corporate expenses. The $9.9 million increase in general and administrative expenses for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was primarily due to the consolidation of Ameba, Wow and Frederator general and administration expenses of $9.8 million. The expenses during the year ended December 31, 2022 primarily consisted of $10.8 million in salary and wage expenses, $10.9 million in stock based compensation expense, $4.5 million in costs associated with the acquisition of Wow and Frederator and $4.7 million of depreciation and amortization expense related to depreciation of our property and equipment and amortization of our intangible assets and our right of use lease assets.
During the year ended December 31, 2022, as a result of our annual impairment testing, we recorded a non-cash intangible impairment charge of $4.1 million for a determined decrease in value of Beacon's Customer Relationships and Non-Compete Agreements and a non-cash goodwill impairment charge of $4.9 million indicating that the carrying value of the Media Advisory & Advertising Services reporting unit exceeded the estimated fair value. Refer to Note 10 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details.
During the year ended December 31, 2021, we recorded a non-cash intangible impairment charge of $3.5 million for the discontinued use of the ChizComm tradename and we recorded a non-cash goodwill impairment charge of $4.8 million due to our annual impairment test indicating that the carrying value of the Media Advisory & Advertising Services reporting unit exceeded the estimated fair value.
Other Income (Expense), Net
Components of other income (expense), net, are summarized as follows:
Year Ended December 31,
2022 2021 Change % Change
(in thousands, except percentages)
Interest Expense (a) $ (2,329) $ (20) $ (2,309) 11,545 %
Gain on Warrant Revaluation (b) 557 342 215 63 %
Loss on Foreign Exchange (c) (2,161) (26) (2,135) 8,212 %
Loss on Marketable Securities Investments (d) (413) (70) (343) 490 %
Gain (Loss) on Revaluation of Equity Investment in YFE (e) 1,392 (106) 1,498 (1,413) %
Interest Income (f) 1,015 559 456 82 %
Finance Lease Interest Expense (g) (116) – (116) – %
Warrant Incentive Expense (h) – (69,139) 69,139 (100) %
Gain on Contingent Consideration Revaluation (i) 1,345 5,846 (4,501) (77) %
Other 6 – 6 – %
Other Income (Expense) $ 1,625 $ (62,594) $ 64,219 (103) %
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(a) Interest expense during the year ended December 31, 2022 primarily consisted of $1.3 million of interest incurred on the margin loan collateralized by the marketable security investments and $0.9 million of interest incurred on production facilities loans and bank indebtedness assumed as part of the Wow Acquisition.
(b) The gain on warrant revaluation is related to the change in fair value of outstanding warrants that were determined to be derivative liabilities attached to previously issued and converted convertible notes.
(c) The loss on foreign currency exchange during the year ended December 31, 2022 primarily relates to the EURO strengthening against the USD compared to the year ended December 31, 2021. The remeasurement of the investment in YFE’s equity securities resulted in a foreign exchange loss of $1.4 million and the remeasurement of cash held in a German bank account resulted in a foreign exchange loss of $0.5 million. For the year ended December 31, 2021 the loss on foreign currency exchange is related to foreign currency denominated monetary transactions.
(d) The net realized loss on marketable securities reflects the loss that will not be recovered from the investments due to selling securities and issuers' prepayments of principals on certain mortgage-backed securities.
(e) The fair value revaluation of the investment in YFE, accounted for using the fair value option, as of December 31, 2022, resulted in a $1.4 million gain. The gain is a result of the increase in YFE’s stock price as of December 31, 2022, as compared to December 31, 2021.
(f) Interest Income during the year ended December 31, 2022, primarily consisted of cash interest received of $2.0 million from the investments in marketable securities, net of premium amortization expense of $1.1 million.
(g) The finance lease interest expense represents the interest portion of the finance lease obligations assumed as part of the Wow Acquisition for equipment purchased under an equipment lease line. Prior to the acquisition of Wow, we did not have any finance leases.
(h) The Warrant Incentive Expense was related to the fair value of new warrants issued in 2021 to certain existing warrant holders in exchange for previously issued outstanding warrants.
(i) The gain on contingent consideration revaluation is related to the change in fair value of the liability recorded for the earn-out arrangement with the sellers of the ChizComm entity acquired during 2021. The favorable decrease in the liability was based on updated assumptions utilized to value the contingency as of each period presented.
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Liquidity and Capital Resources
During the year ended December 31, 2022, our cash, cash equivalents and restricted cash decreased by $2.6 million. The decrease was primarily due to cash used in investment activities, inclusive of the Wow and Ameba acquisitions and the YFE investments, totaling $30.9 million, $23.7 million used in operational activities, $1.3 million of principal payments made on finance leases and $1.2 million distributed to SLU. Cash used was offset by $55.3 million of proceeds provided by the margin loan, production facilities and bank indebtedness, net of repayments.
As of December 31, 2022, we held available-for-sale marketable securities with a fair value of $83.7 million, a decrease of $28.8 million as compared to December 31, 2021. The decrease was primarily due to selling $14.1 million securities during the year, additional prepayment proceeds of $7.9 million on principals for certain mortgage-backed securities and an increase in unrealized loss of $5.4 million for the securities still held. The available-for-sale securities consist principally of corporate and government debt securities and are also available as a source of liquidity.
We borrowed an additional $68.8 million from our investment margin account during the year ended December 31, 2022 and repaid $15.7 million with cash received from sales and/or redemptions of our marketable securities. During the year ended December 31, 2022, the borrowed amounts were used to finance our additional investments in YFE and the closing of the acquisitions of Ameba and Wow, in each case pledging certain of our marketable securities as collateral. The interest rate for these investment margin account borrowings fluctuates based on the Federal Funds Rate plus 0.65% with interest only payable monthly. The weighted average interest rate was 2.59% and 0.72% on an average margin loan balance of $48.2 million and $5.9 million during the years ended December 31, 2022 and December 31, 2021, respectively. We incurred interest expense on the loan of $1.3 million during the year ended December 31, 2022. The amount of interest incurred on the margin loan during the year ended December 31, 2021 was insignificant. The investment margin account borrowings do not mature but are payable on demand as the custodian can issue a margin call at any time, therefore the margin loan is recorded as a current liability on our consolidated balance sheets. As of December 31, 2022 and December 31, 2021, our margin loan balance was $60.8 million and $6.4 million, respectively.
Upon the acquisition of Wow, we assumed certain credit facilities (the “Facilities”). The Facilities are comprised of: (i) an $8.0 million CAD revolving demand facility, (ii) a $4.3 million CAD equipment lease line, (iii) a treasury risk management facility for foreign exchange forward contracts, (iv) interim financing facilities for specific production titles and (v) a $1.4 million CAD equipment lease facility, separate from the equipment lease line. Refer to Note 13 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details.
Working Capital
As of December 31, 2022, we had current assets of $139.5 million, including cash and cash equivalents of $7.4 million and marketable securities of $83.7 million, and our current liabilities were $110.9 million. We had working capital of $28.6 million as of December 31, 2022 as compared to working capital of $115.1 million as of December 31, 2021. The decrease of $86.4 million in working capital as compared to December 31, 2021 was primarily due to a decrease in our cash and cash equivalents and marketable security position, offset by the change in net current assets and liabilities as a result of the acquisition of Wow and Ameba and additional short-term borrowings from our margin loan account.
During the year ended December 31, 2022, we met our immediate cash requirements through existing cash balances. Additionally, we used equity and equity-linked instruments to pay for services and compensation. We believe that our current cash and cash equivalents balances and our investments in available for sale marketable securities are sufficient to support our operations for at least the next twelve months. To meet our short and long-term liquidity needs, we expect to use existing cash and marketable securities balances.
Comparison of Cash Flows for the Years Ended December 31, 2022 and December 31, 2021
Our total cash, cash equivalents and restricted cash as of December 31, 2022 and December 31, 2021 was $7.4 million and $10.1 million, respectively.
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Year Ended December 31,
2022 2021 Increase (Decrease) in Net Cash
(in thousands)
Net Cash Used in Operating Activities $ (23,653) $ (23,819) $ 166
Net Cash Used in Investing Activities (30,937) (128,732) 97,795
Net Cash Provided by Financing Activities 52,174 62,171 (9,997)
Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash (212) (16) (196)
Decrease in Cash, Cash Equivalents and Restricted Cash $ (2,628) $ (90,396) $ 87,768
Net Noncash Expenses
Items necessary to reconcile from net loss to cash flow used in operating activities included net noncash expenses of $40.1 million for the year ended December 31, 2022 as compared to net noncash expenses of $108.9 million for the year ended December 31, 2021. The majority of the decrease of $68.9 million was due to the $69.1 million incurred in the prior year for warrant incentive expense that did not incur in the current year, a decrease in write-downs of film and television costs of $11.4 million and a decrease of $5.6 million in stock based compensation expense. The decreases in non-cash expenses incurred during December 31, 2022, were offset by an increase in amortization of film and television costs $4.8 million, an increase in the write-off of the contingent consideration liability of $4.5 million, an increase of $2.1 million in the depreciation of property, plant and equipment and an increase of $1.7 million in the amortization of ROU assets.
Change in Operating Assets and Liabilities
The change in the net increase in operating asset activity of $1.9 million as of December 31, 2022 compared to December 31, 2021 was primarily due to acquisition of the tax credits earned, net by the Wow entity of $4.2 million.
The change in operating liability activity of $10.9 million as of December 31, 2022 compared to December 31, 2021 was primarily due to the decrease in deferred revenue of $7.8 million and accrued production costs of $3.2 million.
Change in Investing Activities
Cash used in investing activities for the year ended December 31, 2022 decreased $97.8 million as compared to cash used during the year ended December 31, 2021. The decrease was primarily due to the decrease of cash used in investments of marketable securities of $305.4 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. The decrease of cash used in investing activities is offset by a decrease of $168.4 million in cash received from our investments in marketable securities and an increase of $39.6 million in our investment activity related to the acquisitions of Wow and Ameba and investments in YFE, as compared to the acquisition of Beacon in the prior year period.
Change in Financing Activities
Cash provided by financing activities for the year ended December 31, 2022 decreased by $10.0 million as compared to cash provided during the year ended December 31, 2021. The primary source of cash during the year ended December 31, 2022 was the net proceeds borrowed from our margin loan of $53.1 million and $2.0 million from production loans, compared to the primary source of cash during the year ended December 31, 2021 of $57.3 million from the warrant exercise during January 2021.
Material Cash Requirements
We have entered into arrangements that contractually obligate us to make payments that will affect our liquidity and cash flows in future periods. Our material cash requirements from known contractual and other obligations primarily relate to our debt and lease obligations and our employment and consulting contracts. The aggregate amount of future minimum purchase obligations under these agreements over the period of next five years is approximately $103.4 million as of December 31, 2022, of which about $74.3 million, could be owed within one year, if the margin loan and interim
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production facilities are called. For additional information on our contractual commitments and timing of future payments see Note 20 of the consolidated financial statements included in this Annual Report on Form 10-K.
We plan to utilize our liquidity (as described above) to fund our material cash requirements.
As of December 31, 2022, we have $2.6 million in commitments for capital expenditures, related to equipment leases.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles, or GAAP. This requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures. The following accounting policies involve critical accounting estimates because they are particularly dependent on estimates and assumptions made by management. We also have other significant accounting policies that are relevant to understanding our results. For additional information about these policies, see Note 2 of the Notes to Consolidated Financial Statements in Item 8 of this report. Although we believe that our estimates, assumptions and judgments are reasonable, they are based upon information available at the time. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions.
Business Combinations
We account for transactions that are classified as business combinations in accordance with the Financial Accounting Standards Board's (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”). Once a business is acquired, we allocate the fair value of the purchase consideration of a business acquisition to the tangible assets, liabilities, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. The valuation of acquired assets and assumed liabilities requires significant judgment and estimates, especially with respect to intangible assets. The valuation of intangible assets requires that management use valuation techniques such as the income approach. The income approach includes the use of a discounted cash flow model, which includes discounted cash flow scenarios and requires significant estimates such as future expected revenue, expenses, capital expenditures and other costs, and discount rates. We estimate the fair value based upon assumptions management believes to be reasonable, but are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed. Acquisition-related expenses and any related restructuring costs are recognized separately from the business combination and are expensed as incurred.
Variable Interest Entities
We hold an interest in Stan Lee University (“SLU”), an entity that is considered a variable interest entity (“VIE”). The variable interest relates to 50% ownership in the entity that is comprised of the Stan Lee Assets and that requires additional financial support from us to continue operations. Our total cash investment in SLU was $2.0 million as of December 31, 2021. As of December 31, 2022, our investment in SLU was $1.2 million, net $0.8 million of distributions. We are considered the primary beneficiary and are required to consolidate the VIE.
In evaluating whether we have the power to direct the activities of a VIE that most significantly impact its economic performance, we consider the purpose for which the VIE was created, the importance of each of the activities in which it is engaged and our decision-making role, if any, in those activities that significantly determine the entity’s economic performance as compared to other economic interest holders. This evaluation requires consideration of all facts and circumstances relevant to decision-making that affects the entity’s future performance and the exercise of professional judgment in deciding which decision-making rights are most important.
In determining whether we have the right to receive benefits or the obligation to absorb losses that could potentially be significant to the VIE, we evaluate all of our economic interests in the entity, regardless of form (debt, equity, management and servicing fees, and other contractual arrangements). This evaluation considers all relevant factors of the entity’s design, including the entity’s capital structure, contractual rights to earnings (losses), subordination of our interests relative to those of other investors, contingent payments, as well as other contractual arrangements that have the potential to be economically significant. The evaluation of each of these factors in reaching a conclusion about the potential significance of our economic interests is a matter that requires the exercise of professional judgment. We continuously assess whether we are the primary beneficiary of a variable interest entity as changes to existing relationships or future transactions may result in us consolidating its collaborators or partners.
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Foreign Currency Forward Contracts
Our wholly-owned subsidiary, Wow, is exposed to fluctuations in various foreign currencies against its functional currency, the Canadian dollar. Wow uses foreign currency derivatives, specifically foreign currency forward contracts ("FX forwards"), to manage its exposure to fluctuations in the CAD-USD exchange rates. FX forwards involve fixing the foreign currency exchange rate for delivery of a specified amount of foreign currency on a specified date. The FX forwards are typically settled in CAD for their fair value at or close to their settlement date. We do not currently designate any of the FX forwards under hedge accounting and therefore reflect changes in fair value as unrealized gains or losses immediately in earnings as part of the revenue generated from the transactions hedged. We do not hold or use these instruments for speculative or trading purposes.
Per FASB ASC 815-10-45, Derivatives and Hedging , we have elected an accounting policy to offset the fair value amounts recognized for eligible forward contract derivative instruments. Therefore, we present the asset or liability position of the FX Forwards that are with the same counterparty net as either an asset or liability in our consolidated balance sheets.
Tax Credits Receivable
The Canada Revenue Agency (“CRA”) and certain Provincial governments in Canada provide programs that are designed to assist film and television production in the form of refundable tax credits or other incentives.
Estimated amounts receivable in respect of refundable tax credits are recorded as an offset to the related production operating cost, or to investment in film and television costs when the conditions for eligibility of production assistance based on the government’s criteria are met, the qualifying expenditures are made and there is reasonable assurance of realization. Determination of when and if the conditions of eligibility have been met is based on management’s judgment, and the amount recognized is based on management’s estimates of qualifying expenditures. The ultimate collection of previously recorded estimates is subject to ordinary course audits from the CRA and Provincial agencies. Changes in administrative policies by the CRA or subsequent review of eligibility documentation may impact the collectability of these estimates. We continuously review the results of these audits to determine if any circumstances arise that in management’s judgment would result in a previously recognized amount to be considered no longer collectible.
We classify the tax credits receivable as current based on their normal operating cycle. Government assistance, in the form of refundable tax credits, is relied upon as a key component of production financing. These amounts are claimed from the CRA through the submission of income tax returns and can take up to 18 to 24 months from the date of the first tax credit dollar being earned to being received. As this financing is fundamental to our ability to produce animated productions and generate revenue in the normal course of business, the normal operating cycle for such assets is considered to be a 12-to-24-month period, or the time it takes for the CRA to assess and refund the tax credits earned.
As of December 31, 2022, $26.3 million in current tax credit receivables related to Wow’s film and television productions was recorded, net of $0.2 million recorded as an allowance. The allowance is related to uncertainties in tax credits applied for in the amount of $1.6 million with a Provincial government which we had not yet established a history.
Film and Television Costs
We capitalize production costs for episodic series produced in accordance with FASB ASC 926-20, Entertainment-Films - Other Assets - Film Costs . Accordingly, production costs are capitalized at actual cost and amortized using the individual-film-forecast method, whereby these costs are amortized, and participations costs are accrued based on the ratio of the current period’s revenues to management’s estimate of ultimate revenue expected to be recognized from each production.
Productions in Development
Capitalized development costs are reclassified to productions in progress once the project is approved and physical production of the film or television program commences. Development costs include the costs of acquiring film rights to books, scripts or original screenplays and the third-party costs to adapt such projects, including visual development and design. Advances or contributions received from third parties to assist in development are deducted from these costs.
Productions in Progress
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For our film and television programs in progress, capitalized costs include all direct production and financing costs incurred during production that are expected to provide future economic benefit to us. Borrowing costs and depreciation are capitalized to the cost of a film or television program until substantially all of the activities necessary to prepare the film or television program for its use intended by management are complete.
Completed Productions
Completed productions are carried at the cost of proprietary film and television programs which have been produced by us or to which we have acquired distribution rights, less accumulated amortization and accumulated impairment losses.
Due to the inherent uncertainties involved in making such estimates of ultimate revenues and expenses, these estimates have differed in the past from actual results and are likely to differ to some extent in the future from actual results. In addition, in the normal course of business, some titles are more successful or less successful than anticipated. Management reviews the ultimate revenue and cost estimates on a title-by-title basis, when an event or change in circumstances indicates that the fair value of the production may be less than its unamortized cost. This may result in a change in the rate of amortization of film costs and participations and/or a write-down of all or a portion of the unamortized costs of the film or television production to its estimated fair value. An impairment charge is recorded in the amount by which the unamortized costs exceed the estimated fair value. These write-downs are included in amortization expense within Direct Operating Expenses on the consolidated statements of operations. See further discussion in Note 9 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for impairment charges recorded during the year ended December 31, 2022.
All capitalized costs that exceed the initial market firm commitment revenue are expensed in the period of delivery of the episodes. Additionally, for episodic series, from time to time, we develop additional content, improved animation and bonus songs/features for its existing content. After the initial release of the episodic series, the costs of significant improvement to existing products are capitalized while routine and periodic alterations to existing products are expensed as incurred.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the estimated fair value of net assets acquired in business combinations accounted for by the acquisition method. In accordance with FASB ASC 350, Intangibles Goodwill and Other, goodwill and certain intangible assets are presumed to have indefinite useful lives and are thus not amortized, but subject to an impairment test annually or more frequently if indicators of impairment arise. We complete the annual goodwill and indefinite-lived intangible asset impairment tests at the end of each fiscal year. To test for goodwill impairment, we may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit, of which we have two, is less than its carrying value. If impairment is indicated in the qualitative assessment, or, if management elects to initially perform a quantitative assessment of goodwill, the impairment test uses a one-step approach. The fair value of a reporting unit is compared with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to that reporting unit.
Changes in future results, assumptions, and estimates after the measurement date may lead to an outcome where additional impairment charges would be required in future periods. Specifically, actual results may vary from our forecasts and such variations may be material and unfavorable, thereby triggering the need for future impairment tests where the conclusions may differ in reflection of prevailing market conditions. Further, continued adverse market conditions could result in the recognition of additional impairment if we determine that the fair values of our reporting units have fallen below their carrying values.
Intangible assets have been acquired, either individually or with a group of other assets, and were initially recognized and measured based on fair value. Annual amortization of these intangible assets is computed based on the straight-line method over the remaining economic life of the asset.
We have performed our annual impairment test on goodwill and indefinite-lived intangible assets during the fourth quarter of the year ended December 31, 2022. Refer to Note 10 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details.
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Debt and Attached Equity-Linked Instruments
We measure issued debt on an amortized cost basis, net of debt premium/discount and debt issuance costs amortized using the effective interest rate method or the straight-line method when the latter does not lead to materially different results.
We analyze freestanding equity-linked instruments including warrants attached to debt to conclude whether the instrument meets the definition of the derivative and whether it is considered indexed to our own stock. If the instrument is not considered indexed to our stock, it is classified as an asset or liability recorded at fair value. If the instrument is considered indexed to our stock, we analyze additional equity classification requirements per ASC 815-40, Contracts in Entity’s Own Equity . When the requirements are met, the instrument is recorded as part of our equity, initially measured based on its relative fair value with no subsequent re-measurement. When the equity classification requirements are not met, the instrument is recorded as an asset or liability and is measured at fair value with subsequent changes in fair value recorded in earnings.
When required, we also consider the bifurcation guidance for embedded derivatives per ASC 815-15, Embedded Derivatives .
Revenue Recognition
We account for revenue according to standard FASB ASC 606, Revenue from Contracts with Customers ("ASC 606").
Revenue is measured based on the consideration specified in a contract with a customer. Revenue is recognized when a customer obtains control of the products or services in a contract. Judgment is required in determining the timing of whether the transfer of control occurs at a point in time or over time and is discussed below. We evaluate each contract to identify separate performance obligations as a contract with a customer may have one or more performance obligations. Consideration in a contract with multiple performance obligations is allocated to the separate performance obligations based on their stand-alone selling prices. If a stand-alone selling price is not determinable, we estimate the stand-alone selling price using an adjusted market assessment approach. Our main sources of revenue are derived from animation production services provided to third parties, the sale of licenses for the distribution of films and television programs, advertising revenues, and merchandising and licensing sales.
We have identified the following material and distinct performance obligations:
• Provide animation production services.
• License rights to exploit Functional Intellectual Property (“functional IP”) is defined as intellectual property that has significant standalone functionality, such as the ability to be played or aired. Functional IP derives a substantial portion of its utility from its significant standalone functionality).
• License rights to exploit Symbolic Intellectual Property (“symbolic IP”) is intellectual property that is not functional as it does not have significant standalone use and substantially all of the utility of symbolic IP is derived from its association with the entity’s past or ongoing activities, including our ordinary business activities, such as our licensing and merchandising programs associated with its animated content).
• Provide media and advertising services to clients.
• Fixed and variable fee advertising and subscription-based revenue generated from the Genius Brands Kartoon Channel!, the Frederator owned and operated YouTube channels and revenues generated from the operation of its multi-channel network on YouTube .
• Options to renew or extend a contract at fixed terms. (While this performance obligation is not significant for our current contracts, it could become significant in the future).
• Options on future seasons of content at fixed terms. (While this performance obligation is not significant for our current contracts, it could become significant in the future).
Production Services
Animation Production Services
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For revenue from animation production services, the customer controls the output throughout the production process. Each production is made to an individual customer’s specifications and if the contract is terminated by the customer, we are entitled to be reimbursed for any costs incurred to date, and for any prepaid commitments made, plus the agreed contractual mark-up. Revenue and the associated costs of such contracts are recognized over time on a percentage of completion basis - i.e., as the project is being produced, prior to it being delivered to the customer. The percentage-of-completion is calculated based upon the proportion of costs incurred cumulatively to total expected costs. Changes in revenue recognized as a result of adjustments to total expected costs are recognized in profit or loss on a prospective basis. Invoices related to these projects are issued based on the achievement of milestones during the project or other contractual terms. The difference between contractual payments received and revenue recognized is recorded as deferred revenue when receipts exceed revenue. When revenue exceeds milestone billings, we recognize this difference as unbilled accounts receivable within Other Receivable on our consolidated balance sheet. Unbilled accounts receivables are transferred to accounts receivable when we have an unconditional right to consideration.
When the outcome of an arrangement cannot be estimated reliably, revenue is recognized only to the extent of the expenses incurred that are recoverable.
Content Distribution
Film and Television Licensing
We recognize revenue related to licensed rights to exploit functional IP in two ways; for minimum guarantees, we recognize fixed revenue upon delivery of content and the start of the license period and for functional IP contracts with a variable component, we estimate revenue such that it is probable there will not be a material reversal of revenue in future periods. We recognize revenue related to licensed rights to exploit symbolic IP substantially similarly to functional IP. Although it has a different recognition pattern from functional IP, the valuation method is substantially the same, depending on the nature of the license.
Invoices related to these projects are issued based on the achievement of milestones during the project or other contractual terms. The difference between contractual payments received and revenue recognized is recorded as deferred revenue when receipts exceed revenue. When revenue exceeds milestone billings, we recognize this difference as unbilled accounts receivable within Other Receivable on our consolidated balance sheet. Unbilled accounts receivables are transferred to accounts receivable when we have an unconditional right to consideration.
Advertising revenues
We sell advertising and subscriptions on our wholly-owned AVOD service, Kartoon Channel! , and our SVOD distribution outlets, Kartoon Channel! Kidaverse , and Ameba TV . Advertising sales are generated in the form of either flat rate promotions or advertising impressions served. For flat rate promotions with a fixed term, revenue is recognized when all five revenue recognition criteria under ASC 606 are met. For impressions served, we deliver a certain minimum number of impressions on the channel to the advertiser for which the advertiser pays a contractual cost per mille impressions ("CPM"). Impressions served are reported on a monthly basis, and revenue is reported in the month the impressions are served. For subscription-based revenue, revenue is recognized when a customer downloads the mobile device application and their credit card is charged.
Following the acquisition of Wow, we generate advertising revenue from Frederator’s owned and operated YouTube channels as well as revenues generated from the operation of its multi-channel network on YouTube . Revenue is recognized when services are provided in accordance with our agreement with YouTube , the price is fixed or determinable, and collection of the related receivable is probable. Receivables are usually collectable within 30 days.
Licensing & Royalties
Merchandising and licensing
We enter into merchandising and licensing agreements that allow licensees to produce merchandise utilizing certain of our intellectual property. For minimum guaranteed amounts that make up a contract, revenue is recognized over time, over the term of the license period commencing on the date at which the licensees can use and benefit from the licensed content. Variable consideration in excess of non-refundable guaranteed amounts, such as royalties and other contractual payments are recognized as revenue when the amounts are known and become due provided collectability is reasonably assured. Invoices are issued based on the contractual terms of an agreement and are usually payable within 30-45 days.
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Product Sales
We recognize revenue related to product sales when we complete our performance obligation, which is when the goods are transferred to the buyer.
Media Advisory & Advertising Services
Media and Advertising Services
We provide media and advertising services to clients. Revenue is recognized when the services are performed. When the Company purchases advertising for clients on linear and across digital and streaming platforms and receives a commission, the commissions are recognized as revenue in the month the advertising is displayed.
Gross Versus Net Revenue Presentation
We evaluate individual arrangements with third parties to determine whether we act as principal or agent under the terms. To the extent that we act as the principal in an arrangement, revenues are reported on a gross basis, resulting in revenues and expenses being classified in their respective financial statement line items. To the extent that we act as the agent in an arrangement, revenues are reported on a net basis, resulting in revenues being presented net of any expenses incurred in providing agency services. Determining whether we act as principal or agent is based on an evaluation of which party has substantial risks and rewards of ownership under the terms of an arrangement. The most significant factors that we consider include identification of the primary obligor, as well as which party has credit risk, general and inventory risk and the latitude or ability in establishing prices.
Share-Based Compensation
We issue stock-based awards to employees and non-employees that are generally in the form of stock options or restricted stock units (“RSUs”). Share-based compensation cost is recorded for all options and awards of non-vested stock based on the grant-date fair value of the award.
The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model, which requires management to make assumptions with respect to the fair value on the grant date. The assumptions are as follows: (i) the expected term assumption of the award is based on our historical exercise and post-vesting behavior (ii) the expected volatility assumption is based on historical and implied volatilities of our common stock calculated based on a period of time generally commensurate with the expected term of the award; (iii) the risk-free interest rates are based on the implied yield available on U.S. treasury zero-coupon issues with an equivalent expected term; (iv) and the expected dividend yields of our stock are based on history and expectations of future dividends payable. In the case of RSUs the fair value is calculated based on our underlying common stock on the date of grant.
We recognize compensation expense over the requisite service period ratably, using the graded attribution method, which is in-substance, recognizing multiple awards based on the vesting schedule. We have elected to account for forfeitures when they occur. We issue authorized shares available for issuance under our 2015 Incentive Plan and our 2020 Incentive Plan upon employees’ exercise of their stock options.
Income Taxes
Deferred income tax assets and liabilities are recognized based on differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates. At each balance sheet date, we evaluate the available evidence about future taxable income and other possible sources of realization of deferred tax assets and record a valuation allowance that reduces the deferred tax assets to an amount that represents management’s best estimate of the amount of such deferred tax assets that more likely than not will be realized.
Fair value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
• Level 1 - Observable inputs such as quoted prices for identical instruments in active markets;
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• Level 2 - Inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
• Level 3 - Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The carrying amounts of cash, restricted cash, receivables, payables, accrued liabilities, bank indebtedness and the margin loan approximate fair value due to the short-term nature of the instruments. We used the settlement value for our put option liability on certain warrants and the fair values of the liability-classified derivative warrants are revalued at the end of each reporting period determined using the BSM model (Level 2) with standard valuation inputs. Refer to Note 18 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details. The investment in YFE is also revalued at the end of each reporting period based on the trading price of YFE (Level 1). Refer to Note 5 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details. Upon the acquisition of Wow, foreign currency forward contracts that are not traded in active markets were assumed. These are fair valued using observable forward exchange rates at the measurement dates and interest rates corresponding to the maturity of the contracts (Level 2).
The fair values of the available-for-sale securities are generally based on quoted market prices, where available. These fair values are obtained primarily from third-party pricing services, which generally use Level 1 or Level 2 inputs for the determination of fair value to facilitate fair value measurements and disclosures. Level 2 securities primarily include corporate securities, securities from states, municipalities and political subdivisions, mortgage-backed securities, United States Government securities, foreign government securities, and certain other asset-backed securities. For securities not actively traded, the pricing services may use quoted market prices of comparable instruments or a variety of valuation techniques, incorporating inputs that are currently observable in the markets for similar securities.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements and the potential impact of these pronouncements on our consolidated financial statements, see Note 2 to the financial statements in Item 8 of this Annual Report.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a “smaller reporting company,” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this Item.
Item 8. Financial Statements and Supplementary Data
The financial statements are included herein commencing on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.