Item 1A. Risk Factors
Item 1A. Risk Factors
We have incurred net losses since inception.
We have a history of operating
losses and incurred net losses in each fiscal quarter since our inception. During the nine months ended September 30, 2024, we generated
total revenues of $23.2 million and incurred a net loss of $15.0 million, while for the same period the previous year, we generated total
revenue of $35.3 million and incurred a net loss of $51.7 million, respectively. For the year ended December 31, 2023, we generated total
revenues of $44.1 million and incurred a net loss of $77.1 million, while for the previous year, we generated net revenue of $62.3 million
and incurred a net loss of $45.6 million. These losses, among other things, have had an adverse effect on our results of operations, financial
condition, stockholders’ equity, net current assets and working capital.
We will need to generate
additional revenue and/or reduce costs to achieve profitability. We are generating revenues derived from our existing properties, properties
in production, and new brands being introduced into the marketplace. However, the ability to sustain these revenues and generate significant
additional revenues and reduce our expenses or achieve profitability will depend upon numerous factors some of which are outside of our
control.
T here is uncertainty
regarding our ability to maintain liquidity sufficient to operate our business effectively, which raises substantial doubt about our ability
to continue as a going concern.
Based on our
current expected level of operating expenditures and the cash and cash equivalents on hand at September 30, 2024, management concludes
that there is substantial doubt about our ability to continue as a going concern for a period of at least 12 months subsequent to the
issuance of the accompanying condensed consolidated financial statements.
Historically, we have financed its operations
primarily through revenue generated from operations, loans and sales of our securities, and we expect to continue to seek and obtain
additional capital in a similar manner. We have filed a registration statement on Form S-3 on December 22,
2023, as amended, registering the sale of up to $75 million of the Company’s securities pursuant to a shelf registration statement,
and a registration statement on Form S-1 on September 27, 2024, as amended, in connection with a best efforts public offering of up to
$8 million of the Company’s securities. However, we do not have any committed sources of financing at this time, and it
is uncertain whether additional funding will be available when we need it on terms that will be acceptable to us, or at all. Our
ability sell securities registered on our registration statement on Form S-3 is limited until such time the market value of our
voting securities held by non-affiliates is $75 million or more. In addition, the number of shares of common
stock and securities convertible or exercisable for common stock that we can sell, under certain circumstances, will be limited by the
NYSE American rules and regulations. There can be no assurance that we will be able to continue to raise funds through the sale
of shares of common stock or issuance of debt. If we raise funds by selling additional shares of common stock or other securities convertible
into common stock, the ownership interest of its existing stockholders will be diluted. The issuance of debt can result in restrictive
covenants that limit operations. If funding is not available or not available at terms acceptable to us,
we will seek to reduce overhead costs and reduce its weekly cash obligations in the short term as needed. In addition, we can
look to divest or bring in equity partners for our various divisions and bring in near term capital. No adjustments have been made to
the presented condensed consolidated financial statements as a result of this uncertainty.
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We have incurred indebtedness that could
adversely affect our operations and financial condition.
As of September 30, 2024,
we and our subsidiaries have production loan facility obligations of approximately $8.7 million and advances outstanding of $0.6 million
under our senior secured revolving credit facility. As of December 31, 2023, we and our subsidiaries have production loan facility obligations
of approximately $15.3 million and advances outstanding of $2.9 million under our senior secured revolving credit facility. We also had
an outstanding margin loan of $0.8 million secured by our marketable investment securities as of December 31, 2023. The facilities are
guaranteed by us and the security reflects substantially all of our tangible and intangible assets including a combination of federal
and provincial tax credits, other government incentives, production service agreements and license agreements. The facilities and the
margin loan are generally repayable on demand and are subject to customary default provisions, representations and warranties and other
terms and conditions.
Our level of debt could have
adverse consequences on our business, such as making it more difficult for us to satisfy our obligations with respect to our other debt;
limiting our ability to refinance such indebtedness or to obtain additional financing to fund future working capital, capital expenditures,
acquisitions or other general corporate requirements; requiring a substantial portion of our cash flows to be dedicated to debt service
payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions
and other general corporate purposes; increasing our vulnerability to economic downturns and adverse developments in our business; exposing
us to the risk of increased interest rates as certain of our borrowings are at fixed long term rates and or variable rates of interest;
limiting our flexibility in planning for, and reducing our flexibility in reacting to, changes in the conditions of the financial markets
and our industry; placing us at a competitive disadvantage compared to other, less leveraged competitors; increasing our cost of borrowing;
and restricting the way in which we conduct our business because of financial and operating covenants in the agreements governing our
existing and future indebtedness and exposing us to potential events of default (if not cured or waived) under covenants contained in
our debt instruments.
We are currently in default under financial
covenants under our revolving demand facility.
We were not in compliance
with a financial covenant under the revolving demand facility as of September 30, 2024. Due to financial
covenant violations in the second quarter of 2024, the Company’s remaining equipment lease agreements with the lender of $0.6
million (CAD 0.8 million) as of September 30, 2024, are subject
to early repayment. During the three months ended September 30, 2024 , the lender and the Company
agreed to a repayment plan for the equipment leases under the equipment lease line to be completed prior to the end of the fourth quarter
of 2024. On August 30, 2024, the Company paid $0.1 million ( CAD 0.1 million) to the lender
as part of its early repayment plan for the existing equipment lease line agreements. Subsequent to September 30, 2024, the Company
paid $0.3 million (CAD 0.4 million) to the lender as part of its repayment plan for the
equipment lease line. The amendment and covenant violations did not have any impact on the Company’s production facilities
that are separate from the revolving demand facility and are used for financing specific productions.
Offers or availability for sale of a substantial
number of shares of our common stock may cause the price of our common stock to decline.
If our stockholders sell substantial
amounts of our common stock in the public market upon the expiration of any statutory holding period under Rule 144, or shares issued
upon the exercise of outstanding options or warrants, it could create a circumstance commonly referred to as an “overhang”
and, in anticipation of which, the market price of our common stock could fall. The existence of an overhang, whether or not sales have
occurred or are occurring, also could make more difficult our ability to raise additional financing through the sale of equity or equity-related
securities in the future at a time and price that we deem reasonable or appropriate. In general, under Rule 144, a non-affiliated person
who has held restricted shares of our common stock for a period of six months may sell into the market all of their shares, subject to
us being current in our periodic reports filed with the SEC.
As of September 30, 2024,
approximately 37,303,946 shares of common stock are outstanding and unrestricted, out of the 39,555,161 shares of common stock issued,
meaning they exclude shares held by insiders and can be freely traded on the open market. As of September 30, 2024, there were 6,926,952
warrants outstanding. Lastly, as of September 30, 2024, there are 953,640 shares of common stock underlying outstanding options granted,
2,385,247 shares, including vested and unvested, of common stock underlying outstanding restricted stock units (“RSUs”) and
1,832,734 shares reserved for issuance under our Kartoon Studios, Inc. 2020 Incentive Plan.
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To date, our revenues have come from a limited
number of customers, making us dependent on those few customers.
During the three months ended
September 30, 2024, we had four customers, whose total revenue exceeded 10% of the total condensed consolidated revenue. These customers
accounted for 77.2% of the total revenue.
During the nine months ended
September 30, 2024, we had three customers, whose total revenue exceeded 10% of the total condensed consolidated revenue. These
customers accounted for 60.2% of the total revenue. As of September 30, 2024, the Company had three customers whose total accounts
receivable exceeded 10% of the total accounts receivable. These customers accounted for 59.4% of the total accounts receivable as of
September 30, 2024.
The loss
of, or a significant reduction of business from, any of our primary customers will have a material adverse effect on our business, financial
condition, and results of operation unless we are able to replace such customers with other primary customers.
We have identified material weaknesses
in our internal control over financial reporting. Failure to remediate the material weaknesses or any other material weaknesses that
we identify in the future could result in material misstatements in our financial statements.
Pursuant to Section 404 of
the Sarbanes-Oxley Act of 2002, as amended, our management is required to report on the effectiveness of our internal control over financial
reporting. The rules governing the standards that must be met for management to assess our internal control over financial reporting
are complex and require significant documentation, testing and possible remediation. Annually, we perform activities that include reviewing,
documenting and testing our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal
control over financial reporting, we will not be able to conclude on an ongoing basis that we have effective internal control over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. If we fail to achieve and maintain an effective internal
control environment, we could suffer misstatements in our financial statements and fail to meet our reporting obligations, which would
likely cause investors to lose confidence in our reported financial information. This could result in significant expenses to remediate
any internal control deficiencies and lead to a decline in our stock price.
We have identified material
weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s
annual or interim financial statements will not be prevented or detected on a timely basis.
We cannot provide assurance
that we have identified all, or that we will not in the future have additional, material weaknesses in our internal control over financial
reporting. As a result, we may be required to implement further remedial measures and to design enhanced processes and controls to address
deficiencies. If we do not effectively remediate the material weaknesses identified by management and maintain adequate internal controls
over financial reporting in the future, we may not be able to prepare reliable financial reports and comply with our reporting obligations
under the Exchange Act on a timely basis. Any such delays in the preparation of financial reports and the filing of our periodic reports
may result in a loss of public confidence in the reliability of our financial statements, which, in turn, could materially adversely affect
our business, the market value of our common stock and our access to capital markets.
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