Kartoon Studios, Inc. 10-K

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 Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this 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 the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020. 20 Recent Investments On February 1, 2021, we purchased the outstanding equity interests of ChizComm Ltd., a corporation organized in Canada, and ChizComm USA Corp., a New Jersey corporation (collectively, “ChizComm”). Total consideration paid by us in the transaction at closing consisted of $8.5 million in cash and 1,980,658 shares of our common stock with a value of approximately $3.5 million. Additionally, the Purchase Agreement provides for the issuance of additional shares of common stock with a fair value of $7.2 million that may be issued to the Sellers if certain EBITDA and performance levels are achieved within a four-year period commencing on the date of the Purchase Agreement (Earn-Out). The transaction was accounted for as a business acquisition and the financial results of the wholly-owned subsidiaries are included in our consolidated financial statements. Effective as of June 1, 2021, we executed an Operating Agreement with POW!, Inc. (“POW!”) to form a joint venture to exploit certain rights in intellectual property created by Stan Lee, as well as the name and likeness of Stan Lee. The entity is called Stan Lee Universe, LLC (“SLU”) and activity commenced during the fourth quarter of 2021. In exchange for a cash investment of $2.0 million, we obtained 50% ownership in the entity as a variable interest in the Stan Lee trade name. This agreement enables us to assume the worldwide rights, in perpetuity, to the name, physical likeness, physical signature, live-action and animated motion picture, television, online, digital, publishing, comic book, merchandising and licensing rights to Stan Lee and over 100 original Stan Lee creations (the “Stan Lee Assets”), from which we plan to develop and license multiple properties each year. SLU is considered a variable interest entity in which we are the primary beneficiary. Accordingly, the transaction was accounted for as an asset acquisition of a trade name intangible in the amount of $4.0 million and the results of SLU are included in our consolidated financial statements, with the portion of non-controlling interest recorded in our stockholders’ equity. During June 2021, we started investing our excess cash into available-for-sale marketable debt securities. As of December 31, 2021, we held $112.5 million of securities, with a recorded unrealized loss on fair value of $1.3 million and received $1.2 million in interest income. On December 1, 2021, we completed a $6.8 million investment in Your Family Entertainment (“YFE”). In exchange for $3.4 million in cash and 2,281,269 shares of our common stock valued at approximately $3.4 million, we received 3,000,500 shares of YFE’s common stock. As of December 31, 2021, we had a 29% economic ownership interest in YFE. On January 13, 2022, we acquired Canadian streaming service Ameba TV and gained access to its kid-safe platform technology and 13,000 episodes of content including Casper the Friendly Ghost , Donkey Kong Country, Gummy Bears and Rescue Heroes . We purchased 100% of Ameba’s issued and outstanding shares for $3.5 million in cash and paid $0.3 million for the underlying software code that powers the subscription video on demand (“SVOD”) deliveries. With the acquisition, we will launch a subscription-based streaming platform, the Kartoon Channel! KidAverse. The platform will include all of the popular animated programs of a children’s channel, metaverse features and it will be fully curated and child-safe. The platform will also offer collectable digital cards based on many of the channel’s popular characters, including those from the upcoming Stan Lee Universe and a digital currency for kids called Kidaverse MetaBuck$. Additionally, we intend for the Kartoon Channel! Kidaverse to introduce child-safe messaging, podcasts, music, and additional content. Pending Acquisition On October 26, 2021, 1326919 B.C. LTD., a corporation existing under the laws of the Province of British Columbia and our wholly-owned subsidiary and Wow Unlimited Media Inc. (“WOW”), a corporation existing under the laws of the Province of British Columbia, entered into an Arrangement Agreement to effect a transaction among the parties by way of a plan of arrangement under the arrangement provisions of Part 9, Division 5 of the Business Corporations Act , whereby we will purchase 100% of WOW’s issued and outstanding shares for $38.4 million in cash and 11,000,000 shares of our common stock. We believe that the acquisition will allow us to expand our audience demographic into the potentially lucrative teen and young adult marketplaces, provide additional content on the Kartoon Channel! and provide additional brands to be licensed for consumer products and our global distribution sales networks. We have not yet completed our initial accounting for the business combination, which will be accounted for using the acquisition method of accounting. The acquisition is expected to be completed during the second quarter of 2022. 21 Recent Financings On January 28, 2021, we entered into letter agreements (the “Letter Agreements”) with certain existing institutional and accredited investors to exercise certain outstanding warrants (the “Existing Warrants”) to purchase up to an aggregate of 39,740,500 shares of our common stock at their original exercise price of $1.55 per share (the “Exercise”). We received approximately $61.6 million in gross proceeds. The Special Equities Group, a division of Bradley Woods & Co. Ltd., acted as warrant solicitation agent and received a cash fee of approximately $4.3 million. In consideration for the exercise of the Existing Warrants for cash, the exercising holders received new unregistered warrants to purchase up to an aggregate of 39,740,500 shares of common stock (the “New Warrants”) at an exercise price of $2.37 per share, exercisable immediately, with an exercise period of five years from the initial issuance date. Pursuant to the Letter Agreements, the New Warrants are substantially in the form of the Existing Warrants (except for customary legends and other language typical for an unregistered warrant, including the ability for the holder of the New Warrant to make a cashless exercise if no resale registration statement covering the common stock underlying the New Warrants is effective after six months). We were required to register the resale of the shares of common stock issuable upon exercise of the New Warrants. During December 2021, we borrowed from our investment margin account the aggregate amount of $6.4 million for our investments in YFE and future closing of our pending acquisition of 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. These investment margin account borrowings do not mature but are payable on demand and recorded as a current liability on our consolidated balance sheets. Results of Operations Our summary results for the years ended December 31, 2021 and 2020 are below: Revenues Year Ended December 31, 2021 2020 Change % Change (in thousands, except percentages) Licensing & Royalties $ 1,605 $ 765 $ 840 110 % Media Advisory & Advertising Services 5,166 – 5,166 n/a Television & Home Entertainment 825 1,465 (640 ) (44) % Advertising Sales 277 253 24 9 % Total Revenue $ 7,873 $ 2,483 $ 5,390 217 % 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, 2021 increased 110% as compared to the year ended December 31, 2020, primarily due to proceeds received in conjunction with the mutually agreed termination of certain licensing rights, partially offset by the expiration of certain consumer product licenses that were not renewed. Media Advisory & Advertising Services revenue is a combination of client retainer fee-based services and media commissions generated by our wholly-owned subsidiary, ChizComm, that we acquired during 2021. Television & Home Entertainment 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. Fluctuations in Television & Home Entertainment revenue are based on the achievement of revenue recognition criteria such as the start of a license period and the delivery of the content to the customer. Revenue related to our VOD and SVOD sales for the year ended December 31, 2021, decreased 44% as compared to the year ended December 31, 2020, primarily due to the delivery of Rainbow Rangers Season 2 on different platforms during the prior year ended December 31, 2020, without comparable deliveries during the current year ended December 31, 2021. 22 Advertising sales are generated on our digital network, the Kartoon Channel! in the form of either flat rate promotions or advertising impressions served. Revenue related to our advertising sales increased by 9% for the year ended December 31, 2021 as compared to the year ended December 31, 2020, primarily due to the addition of new licensed titles and revenue generated by Stan Lee’s Superhero Kindergarten . Expenses Year Ended December 31, 2021 2020 Change % Change (in thousands, except percentages) Marketing and Sales $ 5,442 $ 818 $ 4,624 565 % Direct Operating Costs 21,987 2,124 19,863 935 % General and Administrative 35,967 17,423 18,544 106 % Impairment of Goodwill 4,778 – 4,778 n/a Impairment of Intangible Assets 3,452 – 3,452 n/a Interest Expense 20 1,180 (1,160 ) (98) % Total Expenses $ 71,646 $ 21,545 $ 50,101 233 % 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 year ended December 31, 2021 as compared to the year ended December 31, 2020, was primarily due to an increase in marketing and advertising expenses incurred to promote Stan Lee’s Superhero Kindergarten and the Kartoon Channel!. Amortization, including any impairments of film and television costs makes up the majority of our Direct Operating Costs. Expenses directly associated with the acquisition, licensing and production of content, such as participation expenses related to agreements with various animation studios, post-production studios, writers, directors, musicians or other creative talent with which we are obligated to share net profits of the properties on which they have rendered services and costs of our product sales make up the remainder of Direct Operating Costs. We evaluated our capitalized production costs to determine if the fair value of the capitalized production costs is below the carrying value. Based on management’s updated estimate of ultimate revenues during the fourth quarter of 2021, capitalized production costs were determined to be above the fair value of the content properties and therefore an impairment charge of $18.2 million was recorded as additional amortization expense. The remaining increase in direct operating costs for the year ended December 31, 2021, as compared to the year ended December 31, 2020, was primarily due to an increase in participation expense of $1.3 million for Stan Lee’s Superhero Kindergarten and the amortization of license fees of $0.3 million for the content delivered on the Kartoon Channel!. 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 $18.5 million increase in general and administrative expenses for the year ended December 31, 2021, as compared to the year ended December 31, 2020, primarily consisted of a $7.6 million increase in share-based compensation expense primarily due to the modification of our Chief Executive Officer’s RSUs, a $5.8 million increase due to the current year consolidation of ChizComm expenses as a result of the acquisition on February 1, 2021 and a $3.1 million increase in legal professional fees. The remainder of the increase is related to an increase in salaries and wages and directors’ and officers’ insurance. During the fourth quarter ended December 31, 2021, we incurred $4.8 million of goodwill impairment due to our annual impairment test indicating that the carrying value of the Media Advisory & Advertising Services reporting unit exceeded the estimated fair value. During the fourth quarter ended December 31, 2021, we decided to discontinue the use of the ChizComm trade name acquired as part of the acquisition of ChizComm in February 2021. In connection with the initial accounting for the Acquisition, $3.4 million of the purchase price was allocated to the indefinite-lived trade name within the Media Advisory & Advertising Services segment. As no future cash flows will be attributed to the impacted trade name, the entire book value was written-off, resulting in a non-cash impairment charge of $3.4 million as of December 31, 2021, recorded in our consolidated statements of operations. No impairment existed as of December 31, 2020. 23 Interest expense for the year ended December 31, 2021, decreased as compared to the year ended December 31, 2020, primarily due to the repayment of the outstanding Production Facility balance under the Loan and Security Agreement on July 14, 2021. The interest expense at December 31, 2021, is related to the interest incurred during the year prior to the repayment of the production loan facility on July 14, 2021. Other Income (Expense), Net Components of other income (expense), net, are summarized as follows (in thousands): Year Ended December 31, 2021 2020 Gain on Contingent Consideration Revaluation $ 5,846 $ – Gain (Loss) on Warrant Revaluation 342 (210,895 ) Loss on Foreign Exchange (26 ) – Loss on Marketable Securities Investments (70 ) – Loss on Equity Investment (106 ) – Interest Income 559 145 Warrant Incentive Expense (69,139 ) – Loss on Conversion Option Revaluation – (171,836 ) Loss on Lease Termination – (339 ) Sublease Income – 317 Net Other Expense $ (62,594 ) $ (382,608 ) 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 is based on our updated assumptions utilized to value the contingency. The gain (loss) 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. The foreign exchange gains and losses are due to foreign currency denominated transactions, including our investment in YFE accounted for under the fair value option, in which we also realized a loss due to a decrease in fair value. We started investing in marketable securities during the year ended December 31, 2021. The net realized loss on marketable securities recognized during the year ended December 31, 2021, reflects the loss in our investments in available-for-sale securities that we will not recover due to prepayments of principals on certain mortgage-backed securities. Interest Income, net during the year ended December 31, 2021, primarily consists of cash interest received of $1.2 million on our investments in marketable securities, net of $0.6 million for amortization of premiums. The warrant incentive expense is related to the fair value of new warrants issued in 2021 to certain existing warrant holders in exchange for previously issued outstanding warrants. As of December 31, 2020, all notes were converted and repaid, therefore a revaluation on conversion options was not performed in 2021. In addition, as of December 31, 2020, we terminated the lease that generated sublease income, resulting in the loss on lease termination that did not occur during the year ended December 31, 2021. 24 Liquidity and Capital Resources During the year ended December 31, 2021, our cash and cash equivalents and marketable security positions increased by $14.1 million. During 2021, we started investing our cash in excess of immediate requirements in accordance with our investment policy, primarily with a view for liquidity and capital preservation. Accordingly, available-for-sale securities, consisting principally of corporate and government debt securities, are also available as a source of liquidity. As of December 31, 2021, we held marketable securities with a fair value of $112.5 million that are available-for-sale. A portion of our marketable securities purchased during the year were sold to transfer $8.0 million of cash to an escrow account restricted for use in future commitments of financing related to our investment in YFE. During December 2021, we borrowed from our investment margin account the aggregate amount of $6.4 million for our investments in YFE and future closing of our pending acquisition of 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. These investment margin account borrowings do not mature but are payable on demand and recorded as a current liability on our consolidated balance sheets. As of December 31, 2021, we had the ability to borrow up to 66% of the balance held in marketable securities, with the option to increase our borrowing capacity, if needed. Working Capital As of December 31, 2021, we had current assets of $136.2 million, including cash and cash equivalents of $2.1 million and marketable securities of $112.5 million and our current liabilities were $21.1 million. We had working capital of $115.1 million as of December 31, 2021 as compared to working capital of $101.4 million as of December 31, 2020. The increase of $13.7 million in working capital as compared to December 31, 2020 was primarily due to an increase 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 ChizComm and short-term borrowings from our margin loan account. During the year ended December 31, 2021, 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, 2021, and December 31, 2020 Our total cash, cash equivalents and restricted cash as of December 31, 2021, and December 31, 2020 was $10.1 million and $100.5 million, respectively. Year Ended December 31, 2021 2020 Change % Change (in thousands, except percentages) Cash Used in Operations $ (23,743 ) $ (8,054 ) $ (15,689 ) 195 % Cash Used in Investing Activities (127,456 ) (1,403 ) (126,053 ) 8,985% Cash Provided by Financing Activities 60,819 109,608 (48,789 ) (44.5) % Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash (16 ) – (16 ) n/a Increase/(Decrease) in Cash, Cash Equivalents and Restricted Cash $ (90,396 ) $ 100,151 $ (190,547 ) (190) % Operating Activities Cash used in operating activities for the year ended December 31, 2021, increased $15.7 million as compared to cash used during the year ended December 31, 2020. The increase was primarily due to an increase of $10.4 million in the total net loss, adjusted for non-cash items and an increase in capitalized film and television costs of $6.7 million and accrued production costs of $1.7 million. The increase in film and television costs is primarily related to costs associated with Stan Lee’s Superhero Kindergarten and KC! Pop Quiz. 25 Investing Activities Cash used in investing activities for the year ended December 31, 2021, increased $126.1 million as compared to cash used during the year ended December 31, 2020. The increase in cash used for investing was primarily due to our net investments in marketable securities of $115 million. Our investing activities also include the cash paid for our acquisition of the ChizComm entities of $7.8 million and cash paid to acquire the equity investment in YFE of $3.4 million. Financing Activities Cash provided by financing activities for the year ended December 31, 2021, decreased by $48.8 million as compared to cash used during the year ended December 31, 2020. The primary source of cash during the year ended December 31, 2021, was the net proceeds of $57.3 million from the warrant exercise during January 2021 and the borrowings on our margin loan account of $6.4 million. Our cash proceeds were offset by payments of the remaining outstanding balances of both our Facility Loan and Payroll Protection Program loan of $1.5 million and a note receivable to a related party of $1.3 million. 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 $18.8 million as of December 31, 2021, of which $11.0 million is expected to be paid within one year. Subsequent to December 31, 2021, we have borrowed an additional $51.4 million, net of pay-downs, from our investment margin account, payable on demand. For additional information on our contractual commitments and timing of future payments, see Note 24, to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. In addition to our contractual commitments as of December 31, 2021, the Company has entered into strategic acquisitions and investments to grow our business that have and/or will result in material cash requirements, including our pending acquisition of WOW, our equity investment in YFE and our subsequent acquisition in Ameba TV (see Note 27 in the Notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information). We plan to utilize our liquidity (as described above) to fund our material cash requirements. As of December 31, 2021, we do not have any material commitments for capital expenditures. 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. 26 Business Combinations 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 we 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. 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 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. 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. 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 our business, some titles are more successful or less successful than anticipated. Management reviews its 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 our consolidated statements of operations. We expense all capitalized costs that exceed the initial market firm commitment revenue 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 our 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. 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. 27 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. Other 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. 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, Contract’s 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 . We have identified the following seven material and distinct performance obligations: · License rights to exploit Functional Intellectual Property (“Functional Intellectual Property” or “functional IP” is defined as intellectual property that has significant standalone functionality, such as the ability be played or aired. Functional Intellectual Property derives a substantial portion of its utility from its significant standalone functionality). · License rights to exploit Symbolic Intellectual Property (“Symbolic Intellectual Property” or “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 its ordinary business activities, such as our licensing and merchandising programs associated with its animated content). · Provide media and advertising services to clients. · 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). · Fixed fee advertising revenue generated from the Genius Brands Kartoon Channel! · Variable fee advertising revenue generated from the Genius Brands Kartoon Channel! 28 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. We sell advertising on our App and OTT based “ Kartoon Channel! ” in the form of either flat rate promotions or impressions served. For flat rate promotions with a fixed term, we recognize revenue when all five revenue recognition criteria under FASB 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 CPM per impression. Impressions served are reported to us on a monthly basis, and revenue is reported in the month the impressions are served. We provide media and advertising services to clients. Revenue is recognized when the services are performed. When we purchase 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. We recognize revenue related to product sales when we complete our performance obligation, which is when the goods are transferred to the buyer. 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 Genius Brands International, Inc. 2015 Incentive Plan and our Genius Brands International, Inc. 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 records 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. 29 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; · 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 and the margin loan approximate fair value due to the short-term maturity of the instruments. 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. 30