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, 2022 and 2021. 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 6, 2022 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 The Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide readers of our condensed 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 and licenses multimedia content. Led by experienced industry personnel, we distribute our content primarily on television and streaming platforms and license our properties for a broad range of consumer products based on our characters. In the children's media sector, our portfolio features “content with a purpose” for toddlers to tweens, which provides enrichment as well as entertainment. New intellectual property titles include Stan Lee’s Superhero Kindergarten produced with Stan Lee’s Pow! Entertainment and Oak Productions. Arnold Schwarzenegger lends his voice as the lead and is also an Executive Producer on the series. Another new offering is KC! Pop Quiz , a live action game show featuring kids as contestants. The show is hosted by Casey Simpson, a prominent social media influencer and former Nickelodeon star. Both KC! Pop Quiz and Superhero Kindergarten are being broadcast in the United States on our wholly-owned advertisement supported video on demand (“AVOD”) and subscription video on demand (“SVOD”) distribution outlet, the Kartoon Channel!. Other newer series include, the preschool property Rainbow Rangers , which debuted in November 2018 on Nickelodeon, and was renewed for a third season and preschool property Llama Llama , which debuted on Netflix in January 2018 and was renewed by Netflix for a second season. 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, which is distributed across our Genius Brands Network on Comcast’s Xfinity on Demand, AppleTV, Roku, Amazon Fire, YouTube, Amazon Prime, Cox, Dish, Sling and Zumo, as well as Connected TV. We are in production on a new animated series starring Shaquille O’Neal called Shaq’s Garage which we expect to debut during the fourth quarter of 2022. 34 In addition, we act as a licensing agent for Penguin Young Readers, a division of Penguin Random House LLC which owns or controls the underlying rights to Llama Llama , leveraging our existing licensing infrastructure to expand this brand into new product categories, new retailers, and new territories. 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, 2022, we employed 79 full-time employees and 16 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. 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 available to our employees, training on preventing sexual harassment, discrimination and retaliation. · 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. 35 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. Acquisition of Wow Unlimited Media Inc. On April 6, 2022, we completed the acquisition of Wow Unlimited Media Inc. (“WOW”), a corporation existing under the laws of the Province of British Columbia. 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 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 . We purchased 100% of WOW’s issued and outstanding shares for approximately $38.3 million in cash and 11,057,000 shares of our common stock. We have not completed the initial accounting for the business combination which will be accounted for using the acquisition method of accounting. The fair value of the assets and liabilities are still to be determined. Recent Investments Following the initial equity investment in YFE during the fourth quarter of 2021, 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 $5.7 million in the aggregate. On March 9, 2022, bonds held by YFE shareholders, were converted into 2,574,000 shares of YFE common stock, 304,631 of which were purchased by us, at 2.00 EUROS per share or $0.6 million, increasing the number of YFE’s outstanding shares and our ownership in YFE to 45.6% as of March 31, 2022. 36 Coronavirus (COVID-19) We continue to work with our stakeholders (including customers, employees, consumers, suppliers, business partners and local communities) to responsibly address this global pandemic. We will continue to monitor the situation and assess possible implications to our business and our stakeholders and will take appropriate actions in an effort to mitigate adverse consequences. We cannot assure you that we will be successful in any such mitigation efforts. The extent to which the COVID-19 pandemic will continue to negatively impact our operations will depend on future developments which are highly uncertain and cannot be predicted with confidence, including the duration of the pandemic, the emergence of new virus variants, new information which may emerge concerning the severity of the COVID-19 pandemic, outbreaks occurring at any of our facilities, the actions taken to control the spread of COVID-19 or treat its impact, and changes in worldwide and U.S. economic conditions. Further deteriorations in economic conditions, as a result of the COVID-19 pandemic or otherwise, could lead to a further or prolonged decline in demand for our products and services and negatively impact our business. It may also impact financial markets and corporate credit markets which could adversely impact our access to financing or the terms of any such financing. We cannot at this time predict the extent of the impact of the COVID-19 pandemic and its resulting economic impact, but it could have a material adverse effect on our business, financial position, results of operations and cash flows. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in “Item 1A. Risk Factors” and elsewhere in the 2021 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (the “SEC”) on April 6, 2022, such as our ability to protect our information technology networks and infrastructure from unauthorized access, misuse, malware, phishing and other events that could have a security impact as a result of our remote working environment or otherwise. On March 15, 2022, we began implementing our “Return to Office” plan. We continue to be flexible with employee in-office requirements as we adjust to COVID-19 outbreaks and employee preferences for remote work. Results of Operations Our summary results for the three months ended March 31, 2022, and March 31, 2021 are below. Revenues Three Months Ended March 31, 2022 March 31, 2021 Change % Change (in thousands, except percentages) Media Advisory & Advertising Services $ 986 $ 753 $ 233 31% Content Distribution 414 139 275 198% Licensing & Royalties 41 172 (131 ) (76)% Total Revenue $ 1,441 $ 1,064 $ 377 35% 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, which we acquired on February 1, 2021. The increase of 31% represents an additional month of revenue recognized during the first quarter of 2022 as compared to the first quarter of 2021. 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. 37 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, 2022, increased 198% as compared to the three months ended March 31, 2021, primarily due to the acquisition of Ameba, increasing revenue by $0.2 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, 2022 decreased 76% as compared to the three months ended March 31, 2021, primarily due to the expiration of certain consumer product licenses that were not renewed. Expenses Three Months Ended March 31, 2022 March 31, 2021 Change % Change (in thousands, except percentages) Marketing and Sales $ 160 $ 602 $ (442 ) (73)% Direct Operating Costs 344 248 96 39% General and Administrative 10,857 6,934 3,923 57% Interest Expense 55 8 47 588% $ 11,416 $ 7,792 $ 3,624 47% 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 three months ended March 31, 2022 as compared to the three months ended March 31, 2021 was primarily due to a decrease in marketing and advertising expenses incurred to promote Stan Lee’s Superhero Kindergarten. 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. The increase in direct operating costs for the three months ended March 31, 2022, as compared to the three months ended March 31, 2021, was primarily due to the consolidation of Ameba’s royalty expense into our financial statements related to the Ameba Acquisition. 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 $3.9 million increase in general and administrative expenses for the three months ended March 31, 2022, as compared to the three months ended March 31, 2021, primarily consisted of a $1.9 million increase in share-based compensation expense primarily due to the modification of our Chief Executive Officer’s RSUs, a $1.2 million increase related to an increase in salaries and wages, directors’ and officers’ insurance and a $0.8 million increase in legal professional fees. Interest expense for the three months ended March 31, 2022, increased as compared to the three months ended March 31, 2021, primarily due to the interest incurred on our margin loan balance and the restricted cash balance sitting in an escrow account for future YFE financings. 38 Other Income (Expense), Net Components of other income (expense), net are summarized as follows (in thousands): Three Months Ended March 31, 2022 2021 Gain (Loss) on Warrant Revaluation $ 41 $ (436 ) Loss on Foreign Exchange (192 ) (3 ) Loss on Marketable Securities Investments (79 ) – Gain on Revaluation of Equity Investment in YFE 5,395 – Interest Income 248 47 Warrant Incentive Expense – (69,139 ) Net Other Income (Expense) $ 5,413 $ (69,531 ) 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 the foreign exchange loss on the investment in YFE’s equity securities accounted for under the fair value option. We started investing in marketable securities during the year ended December 31, 2021. The net realized loss on marketable securities recognized during the three months ended March 31, 2022 reflects the loss in the investments in available-for-sale securities that will not be recovered due to prepayments of principals on certain mortgage-backed securities. The gain on revaluation of the equity investment in YFE, is the change in fair value recognized on our investments in YFE accounted for using the fair value option. The gain is a result of the difference in the original cost of the YFE investments and the updated fair value based on YFE’s stock price at the end of the current reporting period. Interest Income during the three months ended March 31, 2022, primarily consists of cash interest of $0.5 million received on the investments in marketable securities, net of $0.3 million for amortization of premiums. The Warrant Incentive Expense is related to the fair value of new warrants that were issued in 2021 to certain existing warrant holders in exchange for previously issued outstanding warrants. Liquidity and Capital Resources During the three months ended March 31, 2022, our cash and cash equivalents (excluding restricted cash) increased by $47.8 million. Of this amount, $43.3 million, including transactional costs, was borrowed and transferred from our investment margin account to subsequently finance the WOW acquisition, as noted above. As of March 31, 2022, we held marketable securities with a fair value of $101.3 million as available-for-sale, a decrease of $11.2 million during the three months ended March 31, 2022. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view for liquidity and capital preservation. Accordingly, the available-for-sale securities, consisting principally of corporate and government debt securities, are also available as a source of liquidity. 39 During the three months ended March 31, 2022, we borrowed an additional $59.6 million from our investment margin account and repaid $8.2 million with cash received from sales and/or redemptions of our marketable securities. The borrowed amounts were used to finance our additional investments in YFE and the closing of our 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. The weighted average interest rate was 0.72% and the average balance of the borrowings was $13.6 million as of March 31, 2022. We incurred interest expense of $21,846 during the three months ended March 31, 2022. 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 condensed consolidated balance sheets. We have the ability to borrow up to 66% of the balance held in marketable securities, with the option to increase its borrowing capacity, if needed. As of March 31, 2022, the outstanding balance of the margin loan was $57.8 million, or 57% of the balance held in marketable securities. Working Capital As of March 31, 2022, we had current assets of $164.3 million, including cash and cash equivalents of $49.8 million and marketable securities of $101.3 million and our current liabilities were $68.9 million. We had working capital of $95.4 million as of March 31, 2022 as compared to working capital of $115.1 million as of December 31, 2021. The decrease of $19.7 million in working capital as compared to December 31, 2021 was primarily due to the $7.8 million increase in our margin loan balance, including the offset of transfer to cash and pay down from our marketable securities and a decrease in the accounts receivable balance of $4.2 million. During the three months ended March 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 Three Months Ended March 31, 2022, and March 31, 2021 Our total cash, cash equivalents and restricted cash as of March 31, 2022 and 2021 was $52.8 million and $100.5 million, respectively. Comparison of Cash Flows Three Months Ended March 31, 2022 March 31, 2021 Change % Change (in thousands, except percentages) Cash Used in Operating Activities $ (5,332 ) $ (5,641 ) $ (309 ) (5.5)% Cash Used in Investing Activities (3,145 ) (8,056 ) (4,911 ) (61)% Cash Provided by Financing Activities 51,220 56,854 (5,634 ) (10)% Effect of Exchange Rate Changes on Cash 8 – 8 100% Increase/(Decrease) in Cash, Cash Equivalents and Restricted Cash $ 42,751 $ 43,157 $ (406 ) (0.9)% Operating Activities Cash used in operating activities for the three months ended March 31, 2022 decreased $0.3 million as compared to cash used during the three months ended March 31, 2021. The change in cash used in operating activities is primarily due to the change in cash receipts and cash payments due to the timing of the acquisition and consolidation of Beacon Media Group into our financial statements on February 1, 2021. 40 Investing Activities Cash used in investing activities for the three months ended March 31, 2022 decreased $4.9 million as compared to cash used during the three months ended March 31, 2021. The decrease in cash used for investing was primarily due to our proceeds from marketable securities of $7.4 million, offset by our investments in YFE of $6.6 million and acquisition of Ameba for $3.9 million compared to the total investment in ChizComm of $7.8 million. Financing Activities Cash provided by financing activities for the three months ended March 31, 2022 decreased by $5.6 million as compared to cash provided during the three months ended March 31, 2021. The primary source of cash during the three months ended March 31, 2022, was the net proceeds borrowed from our margin loan of $51.4 million, compared to the primary source of cash during the three months ended March 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 $67.6 million as of March 31, 2022, of which $61.2 million is expected to be paid within one year. For additional information on our contractual commitments and timing of future payments, see Note 21, to the condensed consolidated financial statements included in this Report on Form 10-Q. In addition to our contractual commitments as of March 31, 2022, 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 subsequent closing of our acquisition of WOW and our additional equity investments in YFE. We plan to utilize our liquidity (as described above) to fund our material cash requirements. As of March 31, 2022, we do not have any material commitments for capital expenditures. Critical Accounting Policies 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 2021 Annual Report on Form 10-K, and “Critical Accounting Policies and Estimates” in Part II, Item 7 of the 2021 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. 41 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.