Kartoon Studios, Inc. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis of our results of operations, financial condition and liquidity and capital resources should be read in conjunction with our financial statements and related notes for the three months ended March 31, 2023 and 2022. Certain statements made or incorporated by reference in this report and our other filings with the Securities and Exchange Commission, in our press releases and in statements made by or with the approval of authorized personnel constitute forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and are subject to the safe harbor created thereby. Forward-looking statements reflect intent, belief, current expectations, estimates or projections about, among other things, our industry, management’s beliefs, and future events and financial trends affecting us. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will” and variations of these words or similar expressions are intended to identify forward looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward looking statements. Although we believe the expectations reflected in any forward-looking statements are reasonable, such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. These differences can arise as a result of the risks described in the section entitled “Item 1A. Risk Factors” in our Annual Report on Form 10-K filed on April 13, 2023 and elsewhere in this report, as well as other factors that may affect our business, results of operations, or financial condition. Forward-looking statements in this report speak only as of the date hereof, and forward-looking statements in documents incorporated by reference speak only as of the date of those documents. Unless otherwise required by law, we undertake no obligation to publicly update or revise these forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks and uncertainties, we cannot assure you that the forward-looking statements contained in this report will, in fact, transpire. 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. Our Business Genius Brands International, Inc. (“we,” “us,” “our,” or the “Company”) is a global content and brand management company that creates, produces, licenses, and broadcasts timeless and educational, multimedia animated content for children. Led by experienced industry personnel, we distribute our content primarily on streaming platforms and television and license properties for a broad range of consumer products based on our characters. We are a “work for hire” producer for many of the streaming outlets and animated content intellectual property ("IP") holders. In the children’s media sector, our portfolio features “content with a purpose” for toddlers to tweens, providing enrichment as well as entertainment. With the exception of selected Wow Unlimited Media Inc. titles, our programs, along with licensed programs, are being broadcast in the United States on our wholly-owned advertisement supported video on demand (“AVOD”) service, our free ad supported TV ("FAST") channels and subscription video on demand (“SVOD”) outlets, Kartoon Channel! and Ameba . These streaming services are available on Apple TV, Apple iOS, Android TV, Android mobile, Amazon Prime, Amazon Fire, Tubi, Roku, Comcast, Cox, Dish/Sling, Xumo, Pluto, Samsung Smart TVs, LG Smart TVs, as well as YouTube, among other platforms. Our in-house owned and produced animated shows include Stan Lee’s Superhero Kindergarten starring Arnold Schwarzenegger, Llama Llama starring Jennifer Garner, Rainbow Rangers, KC Pop Quiz , and the upcoming Shaq’s Garage starring Shaquille O’Neal, scheduled to debut in the second quarter of 2023. Our library titles include the award-winning Baby Genius , adventure comedy Thomas Edison’s Secret Lab®, and Warren Buffett’s Secret Millionaires Club , created with and starring iconic investor Warren Buffett, Team Zenko Go!, Reboot , Bee & PuppyCat: Lazy in Space and Castlevania . We also license our programs to other services worldwide, in addition to the operation of our own channels, including but not limited to Netflix, HBO Max, Paramount+, Nickelodeon, and satellite, cable and terrestrial broadcasters around the world. 37 Table of Contents Through our investments in Germany’s Your Family Entertainment (“YFE”), a publicly traded company on the Frankfurt Exchange (RTV-Frankfurt), we have gained access to one of the largest animation catalogues in Europe with over 50 titles consisting of over 1,600 episodes, and a global distribution network which currently covers over 60 territories worldwide. Through the ownership of WOW Unlimited Media Inc. (“Wow”), we established an affiliate relationship with Mainframe Studios, which is one of the largest animation producers in the world. In addition, Wow owns Frederator Networks Inc. (“Frederator”) and its Channel Frederator Network , the largest animation focused multi-channel network on YouTube with over 2,500 channels. We have rights to a select amount of valuable IP, included among them a controlling interest in Stan Lee Universe (“SLU”), through which we control the name, likeness, signature, and all consumer product and IP rights to Stan Lee (the “Stan Lee Assets”). We also own Beacon Media Group ("Beacon"), the largest media buying service for children in North America. Beacon represents over 30 major toy companies, including Playmobile, Bandai Toys, Bazooka, Moose Toys, and JAKKS Pacific. In addition, we own the Canadian company Ameba Inc. (“Ameba”), which distributes SVOD service for kids, and has become the focal point of revenue growth for Genius Networks’ subscription offering. We and our affiliates provide world class animation production studios, a catalogue representing thousands of hours of premium global content for children, a broadcast system for delivering that content and an in-house consumer products licensing infrastructure to fully exploit the content. Environmental, Social and Governance Strategy We are attempting to shape culture, social attitudes and societal outcomes with our animated content and consumer products that touch the lives of young people and their families. As a global content company that reaches millions of people, we aim to be a positive force in the world. We are committed to advancing and strengthening our approach to environmental, social and governance (“ESG”) topics to help serve our partners, audiences, employees and shareholders — and to enhance our success as a business. We are committed to responsible, ethical and inclusionary business practices as outlined below: Human Capital Management As of March 31, 2023, we employed 715 full-time employees and 46 independent contractors. We aim to build a culture that attracts and retains the best employees and a workplace where everyone feels welcome, safe and inspired. Our human capital management strategy is intended to address the following areas: A Culture of Diversity, Equity and Inclusion We seek to foster a culture of diversity, equity and inclusion through a range of partnerships, collaborations, programs and initiatives, some of which are described below. We strive to be an inclusionary workplace because we believe that it strengthens our business. • In 2021, we created the role of Chief Diversity Officer. That role is responsible for both helping meet our hiring goals and reviewing the content we create. • Our board of directors is diverse with representation from people of color and the LGBTQ community. Preventing Harassment and Discrimination We have enacted policies addressing harassment, discrimination and other behaviors that could create a hostile workplace, some of which are described below. • We make training on preventing sexual harassment, discrimination and retaliation available to our employees. 38 Table of Contents • We expect employees to report any violations of Company policies, including sexual harassment, they witness. Among other ways, employees can report incidents of harassment using our anonymous complaint and reporting hotline. Social Impact and Corporate Social Responsibility We believe that the content we produce, primarily directed at young people and their families, both reflects and influences how our young viewers perceive and understand important issues. We endeavor to earn our viewers’ trust through a variety of practices, and we are focused on using our platforms to create positive social impacts. By way of just a few examples: in our show Rainbow Rangers , a diverse cast of girls works to save animals and protect the environment, while demonstrating the power of teamwork; in our Llama Llama series, we teach kindness and inclusion, and feature a differently abled character, which we have been told is appreciated by moms and kids who deal with physical challenges. In the earliest days of the COVID-19 pandemic, we spread public service messages to keep our audiences safe and informed with animated shorts featuring the iconic voices from our series including Warren Buffett from The Secret Millionaires Club and Jennifer Garner, the voice of Mama Llama from the Llama Llama series. Our mission statement says it all: “Content with a Purpose.” Social justice, caring about the environment and modeling appropriate and inclusionary behavior for kids has been part of our company for many years and we are constantly seeking ways to improve on what we have already been doing. 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 one 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 Quarterly Report on Form 10-Q have been retroactively adjusted to reflect a 1-for-10 reverse stock split. 39 Table of Contents Results of Operations Our summary results for the three months ended March 31, 2023 and 2022 are below: Revenues Three Months Ended March 31, 2023 March 31, 2022 Change % Change (in thousands, except percentages) Production Services $ 9,886 $ – $ 9,886 100 % Content Distribution 3,301 414 2,887 697 % Licensing & Royalties 46 41 5 12 % Media Advisory & Advertising Services 956 986 (30) (3) % Total Revenue $ 14,189 $ 1,441 $ 12,748 885 % Production Services revenue is generated specifically by Wow providing animation production services for the three months ended March 31, 2023. 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 three months ended March 31, 2023, increased 697% as compared to the three months ended March 31, 2022 primarily due to the acquisition of Ameba, Wow and Frederator, increasing Content Distribution revenue by $3.0 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 three months ended March 31, 2023 increased 12% as compared to the three months ended March 31, 2022 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"). Expenses Three Months Ended March 31, 2023 March 31, 2022 Change % Change (in thousands, except percentages) Marketing and Sales $ 245 $ 160 $ 85 53 % Direct Operating Costs 11,285 344 10,941 3181 % General and Administrative 9,225 10,857 (1,632) (15) % Impairment of Property and Equipment 120 – 120 100 % Impairment of Intangible Assets 4,023 – 4,023 100 % Impairment of Goodwill 11,287 – 11,287 100 % Total Expenses $ 36,185 $ 11,361 $ 24,824 219 % 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 increase in marketing and sales expenses for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 was primarily 40 Table of Contents due to a 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 three months ended March 31, 2023 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 increase is primarily due to the acquisition of Ameba, Wow and Frederator, which increased Direct Operating Costs for the three months ended March 31, 2023 by $11.1 million as compared to the three months ended March 31, 2022. 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 $1.6 million decrease in general and administrative expenses for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 was primarily due to a decrease in stock-based compensation of $3.6 million due to the absence of modification expenses that were incurred in the prior year period and a decrease in professional fees of $0.9 million offset by the increase during the three months ended March 31, 2023 of $8.2 million, due to the consolidation of Ameba, Wow and Frederator's general and administration expenses. During the three months ended March 31, 2023, we reassessed our long-lived assets, including our definite-lived intangible assets, our indefinite-lived intangible assets and our remaining goodwill allocated to the Content Production and Distribution reportable segment for impairment. As a result, we recorded an impairment charge to our property and equipment of $0.1 million, our definite-lived intangible assets of $2.8 million, our indefinite-lived intangible assets of $1.3 million and our goodwill recorded within the Content Production and Distribution reporting unit of $11.3 million in our condensed consolidated statement of operations. Other Income (Expense), Net Components of other income (expense), net are summarized as follows: Three Months Ended March 31, 2023 March 31, 2022 Change % Change (in thousands, except percentages) Interest Expense (a) $ (1,085) $ (55) $ (1,030) 1,873 % Gain on Warrant Revaluation (b) 139 41 98 239 % Gain (Loss) on Foreign Exchange (c) 320 (192) 512 (267) % Loss on Marketable Securities Investments (d) (1,537) (79) (1,458) 1,846 % Gain (Loss) on Revaluation of Equity Investment in YFE (e) (895) 5,395 (6,290) (117) % Interest Income (f) 311 248 63 25 % Finance Lease Interest Expense (g) (50) – (50) 100 % Other 1 – 1 100 % Other Income (Expense) $ (1,711) $ 5,413 $ (7,124) (132) % 41 Table of Contents (a) Interest expense during the three months ended March 31, 2023 primarily consisted of $0.7 million of interest incurred on the margin loan collateralized by the marketable security investments and $0.4 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 gain on foreign currency exchange during the three months ended March 31, 2023 primarily related to the EURO weakening against the USD compared to the previous reporting period end date of December 31, 2022. The remeasurement of the investment in YFE’s equity securities resulted in a foreign exchange gain of $0.3 million. (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 March 31, 2023, resulted in a $0.9 million loss, excluding the impact of foreign currency recorded separately as a Gain on Foreign Exchange. The loss is a result of the decrease in YFE’s stock price as of March 31, 2023, as compared to December 31, 2022. (f) Interest Income during the three months ended March 31, 2023 primarily consisted of cash interest received of $0.4 million from the investments in marketable securities, net of premium amortization expense of $0.2 million. The remaining increase is due to interest accrued on the Notes Receivable from Related Parties. (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. 42 Table of Contents Liquidity and Capital Resources As of March 31, 2023, we had cash and cash equivalents of $4.8 million, which decreased by $2.7 million as compared to December 31, 2022. The decrease was primarily due to cash used in financing activities of $12.6 million, primarily due to the repayment of the margin loan, and $4.8 million used in operational activities. The cash used was offset by cash provided by the sales and maturities of marketable securities of $14.3 million. As of March 31, 2023, we held available-for-sale marketable securities with a fair value of $69.7 million, which decreased by $14.1 million as compared to December 31, 2022. The decrease was primarily due to selling $14.3 million of securities, $2.9 million of securities maturing and additional prepayment proceeds of $0.5 million on principals for certain mortgage-backed securities during the three months ended March 31, 2023. The decrease was offset by the net decrease of $0.8 million in unrealized and realized loss activity. 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 $3.7 million from our investment margin account during the three months ended March 31, 2023 and repaid $16.3 million with cash received from sales and maturities of marketable securities. During the three months ended March 31, 2023, the borrowed amounts were primarily used for operational costs. The interest rates for the borrowings fluctuate based on the Federal Funds Rate plus 0.65% with interest only payable monthly. The weighted average interest rates were 0.89% and 1.66% on average margin loan balances of $46.2 million and $27.1 million as of March 31, 2023 and December 31, 2022, respectively. We incurred interest expense on the loan of $0.7 million and $21,846 during the three months ended March 31, 2023 and March 31, 2022, respectively. The investment margin account borrowings do not mature but are collateralized by the marketable securities held by the same custodian and the custodian can issue a margin call at any time, effecting a payable on demand loan. Due to the call option, the margin loan is recorded as a current liability on our condensed consolidated balance sheets. As of March 31, 2023 and December 31, 2022, our margin loan balance was $48.9 million and $60.8 million, respectively. Working Capital As of March 31, 2023, we had current assets of $114.3 million, including cash and cash equivalents of $4.8 million and marketable securities of $69.7 million, and our current liabilities were $90.8 million. We had working capital of $23.5 million as of March 31, 2023 as compared to working capital of $28.6 million as of December 31, 2022. The decrease of $5.1 million 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 three months ended March 31, 2023, 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 Three Months Ended March 31, 2023 and March 31, 2022 Our total cash, cash equivalents and restricted cash as of March 31, 2023 and March 31, 2022 was $4.8 million and $52.8 million, respectively. 43 Table of Contents Three Months Ended March 31, 2023 March 31, 2022 Increase (Decrease) in Net Cash (in thousands) Net Cash Used in Operating Activities $ (4,757) $ (5,363) $ 606 Net Cash Provided by (Used in) Investing Activities 14,648 (3,247) 17,895 Net Cash Provided by (Used in) Financing Activities (12,565) 51,353 (63,918) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash 7 8 (1) Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash $ (2,667) $ 42,751 $ (45,418) Net Noncash Expenses Items necessary to reconcile from net loss to cash flow used in operating activities included net noncash expenses of $21.4 million for the three months ended March 31, 2023 as compared to net noncash expenses of $0.5 million for the three months ended March 31, 2022. The majority of the increase of $20.9 million was due to the impairments of our long-lived assets, intangible assets and goodwill of $15.4 million incurred during the three months ended March 31, 2023, our equity investment in YFE going from a loss of $5.4 million to a gain of $0.9 million and a decrease in stock-based compensation of $3.6 million. Change in Operating Assets and Liabilities The increase in cash provided by operating asset activity of $5.6 million as of March 31, 2023 compared to March 31, 2022 was primarily due to the receipt of tax credits earned, net by the Wow entity of $2.6 million, a decrease in the cash used of $1.3 million in prepaid expenses and assets due to the absence of a prepayment incurred for an insurance policy, that was not incurred in the current period and a decrease in cash used for film and television costs of $0.9 million. The increase in cash used in operating liability activities of $5.6 million as of March 31, 2023 compared to March 31, 2022 was primarily due to the increase in cash used for accounts payable of $3.8 million and deferred revenue of $2.7 million, offset by a decrease in accrued production costs of $1.5 million. Change in Investing Activities Cash investing activities for the three months ended March 31, 2023 compared to the three months ended March 31, 2022, increased from cash used in investing of $3.2 million, to cash provided by investing of $14.6 million, primarily due to using cash of $10.5 million for investments and acquisitions in the prior year, that did not occur in the current period and an increase in proceeds from the sales and maturities of marketable securities of $7.3 million during the three months ended March 31, 2023. Change in Financing Activities Cash financing activities for the three months ended March 31, 2023 compared to the three months ended March 31, 2022, decreased from cash provided by investing of $51.4 million, to cash used in investing of $12.6 million, primarily due to paying down the margin loan during the current quarter compared to additional borrowings in the prior year quarter resulting in a net $63.3 million decrease in cash provided by financing activities. 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 $89.1 million as of March 31, 2023, of which about $60.8 million could be owed within one year if the margin loan and interim production facilities are called. We plan to utilize our liquidity (as described above) to fund our material cash requirements. 44 Table of Contents As of March 31, 2023, we have $3.4 million in commitments for capital expenditures, related to equipment leases. Critical Accounting Policies and Estimates The preparation of the financial statements and related disclosures in conformity with U.S. generally accepted accounting principles and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material. Note 2, “Summary of Significant Accounting Policies” in Part I, Item 1 of this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II, Item 8 of the 2022 Annual Report on Form 10-K, and “Critical Accounting Policies and Estimates” in Part II, Item 7 of the 2022 Annual Report on Form 10-K describe the significant accounting policies and methods used in the preparation of our condensed consolidated financial statements. Off Balance Sheet Arrangements We have no off-balance sheet arrangements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.