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, 2025 and 2024. 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 for the year ended December 31, 2024, which was filed with the SEC on March 31, 2025 (“The 2024 Annual Report”), 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 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 Our production services business is focused on creating high-quality original and for hire content in the most efficient way possible. To achieve this, our Mainframe Studios division, the main driver of this business, is exploring more ways to improve operations by adopting a more flexible and efficient approach. This includes collaborating with outsource partners and utilizing artificial intelligence (“AI”) technology to streamline processes and drive efficiencies within the organization. With over 1,200 episodes, 70 movies, and three feature films to its credit, the division has partnered with major industry players to produce acclaimed series such as " Barbie Dreamhouse Adventures ," " Octonauts: Above & Beyond, " “Cocomelon” , and " Unicorn Academy ." Our content distribution business is focused on achieving scale across our networks, including Kartoon Channel! , Frederator, Ameba, and Kartoon Channel! Worldwide. Revenue growth is expected to be driven by the continued focus on licensed content and exploitation of our current content such as with our Stan Lee brand, Shaq's Garage, Rainbow Rangers and many more. Continued profit growth is expected to be realized the more we can scale the business across our platforms. In addition, we have implemented and are continuing to look at AI tools to reduce the cost of operating distribution expenses such as dubbing expenses, video resolution upscaling and converting between 2D and 3D. We believe that our licensing and royalties business has the most upside and potential for us of all our business lines. We are looking to take advantage of our incredible set of Stan Lee assets to drive consumer products - both digitally and physically. We plan to focus on utilizing all of our IP assets further in 2025 and beyond. Our media advisory and advertising services business is focused on driving deal flow opportunities and winning annuity business through retainers and projects. The team continues to focus on the toy business, but also expansion into tangential industries such as family and travel. The team has expanded their reach over the past 12-18 months by leveraging their relationships with influencers to promote products and provide bespoke marketing initiatives for the clients. 30 Results of Operations Our summary results for the three months ended March 31, 2025 and 2024 are below: Revenue Three Months Ended March 31, 2025 2024 Change % Change (in thousands, except percentages) Production Services $ 6,572 $ 2,763 $ 3,809 138% Content Distribution 1,981 2,329 (348 ) (15 )% Licensing and Royalties 84 100 (16 ) (16 )% Media Advisory and Advertising Services 867 886 (19 ) (2 )% Total Revenue $ 9,504 $ 6,078 $ 3,426 56% Production Services revenue was generated specifically by Mainframe Studios providing animation production services. Revenue for production services is recognized over time on a percentage of completion basis, therefore, as the projects are still in progress, we recognize revenue based upon the proportion of costs incurred cumulatively to total expected costs. Consequently, less revenue is recognized during the periods in which the projects are near completion or completed. Revenue for the three months ended March 31, 2025 was higher than the Mainframe Studios’ production services revenue recognized during three months ended March 31, 2024 primarily due to the number of active projects in the current quarter. Revenue related to Content Distribution on AVOD and SVOD, including advertising sales for the three months ended March 31, 2025, decreased by 15% as compared to the three months ended March 31, 2024. The decrease of $0.3 million was due to a decrease of $0.2 million in Frederator’s creator network revenue from YouTube driven by overall less viewership as compared to the prior year period, and a decrease in Kartoon Studios’ content distribution revenue of $0.1 million related to lower volume of licensing agreements signed by the Kartoon Channel! Worldwide division for the broadcast of the channel. Revenue related to Licensing and Royalties for the three months ended March 31, 2025 decreased by 16% as compared to the three months ended March 31, 2024 primarily due to lower amounts earned from our license deals related to our consumer products agreements and music licensing agreements. Revenue generated by Media Advisory and Advertising services for the three months ended March 31, 2025 decreased by 2% as compared to the three months ended March 31, 2024 primarily due to lower net renewal activity and media purchases from clients. Expenses Three Months Ended March 31, 2025 2024 Change % Change (in thousands, except percentages) Marketing and Sales $ 186 $ 444 $ (258 ) (58 )% Direct Operating Costs 6,684 4,325 2,359 55% General and Administrative 5,713 7,603 (1,890 ) (25 )% Total Expenses $ 12,583 $ 12,372 $ 211 2% The decrease in Marketing and Sales expenses for the three months ended March 31, 2025 as compared to the three months ended March 31, 2024 was primarily due to a decrease in advertising efforts aimed at promoting the Kartoon Studios branding. 31 Direct Operating Costs during the three months ended March 31, 2025 consisted of salaries and related expenses for animation production services employees of Mainframe Studios and Frederator. The remainder of Direct Operating Costs consisted of creator network channel expenses, content licensing, and production costs, including participation expenses related to profit-sharing obligations with various animation studios, post-production studios, writers, directors, musicians, and other creative talent, as well as amortization and any write-downs of film and television costs. The increase during the three months ended March 31, 2025 was primarily due to an increase in salary costs and headcount included in Production Services related to new projects that began in the current quarter compared to the same period of the prior year. The decrease in General and Administrative expenses for the three months ended March 31, 2025 as compared to the three months ended March 31, 2024 was primarily due to a decrease of $0.6 million in depreciation expense related to the property and equipment impairment recorded in prior year, a reduction of $1.4 million in overhead costs primarily due to cost-saving initiatives, and a $0.1 million decrease in share-based compensation expense. During the three months ended March 31, 2025, we reassessed our nonfinancial assets, including our definite-lived intangible assets, our indefinite-lived intangible assets for impairment. As a result, we concluded that impairment charges to those assets were not required. Furthermore, we concluded that no indicators of impairment or triggering events were identified during the period. Other Expense, net Components of Other Expense, net, are summarized as follows (in thousands): Three Months Ended March 31, 2025 2024 Interest Expense (a) $ (128 ) $ (203 ) Gain on Revaluation of Warrants (b) $ 446 $ 37 Loss on Revaluation of Equity Investment in YFE (c) (3,640 ) – Realized Gain (Loss) on Marketable Securities Investments (d) 4 (141 ) Gain (Loss) on Foreign Exchange (e) 667 (650 ) Loss on Debt Settlement (f) (944 ) – Interest Income (g) 54 53 Finance Lease Interest Expense (h) (4 ) (30 ) Other (i) 33 164 Other Expense, net $ (3,384 ) $ (567 ) (a) Interest Expense during the three months ended March 31, 2025 primarily consisted of $0.1 million of interest incurred on production facilities and bank indebtedness. Interest Expense during the three months ended March 31, 2024 primarily consisted of $0.2 million of interest incurred on production facilities and bank indebtedness. (b) The Gain on Revaluation of Warrants during the three months ended March 31, 2025 is related to the changes in fair value of the outstanding 7,894,736 Series A and 7,894,736 Series B warrants classified as a liability due to a decrease of expiration period. The Gain on Revaluation of Warrants recorded during the three months ended March 31, 2024 is related to the remeasurement of 89,286 outstanding liability warrants which expired in March 2025. (c) As accounted for using the fair value option, the Loss on Revaluation of Equity Investment in YFE of $3.6 million recorded in the three months ended March 31, 2025, is a result of the decreases in YFE’s stock price as of the current reporting period when compared to the prior reporting period. This excludes the impact of foreign currency recorded separately. (d) The Realized Gain on Marketable Securities Investments of $4,454 recorded during the three months ended March 31, 2025 is attributable to the sale of U.S. Treasury securities. The Realized Loss on Marketable Securities Investments of $0.1 million recorded during the three months ended March 31, 2024, reflects the loss that was not recovered from the investments due to selling securities and issuers' prepayments of principals on certain mortgage-backed securities. (e) The Gain on Foreign Exchange during the three months ended March 31, 2025 primarily related to the revaluation of the YFE investment, resulting in a gain of $0.7 million due to the depreciation of U.S. dollar as compared to three months ended March 31, 2024 in which a loss of $0.6 million was recognized. (f) In April 2025, we entered into a settlement agreement with YFE related to the Shareholder Loan Agreement. As the settlement was considered probable and the loss reasonably estimable as of March 31, 2025, we recorded a loss of approximately $0.9 million during the three months ended March 31, 2025. (g) Interest Income during the three months ended March 31, 2025 and 2024 primarily consisted of income from investments in marketable securities, net of premium amortization expense, as well as other transactions, including interest income related to Employee Retention Tax Credit (“ERTC”) receivable and interest income related to the Shareholder Loan. Each of these sources was individually immaterial. (h) The Finance Lease Interest Expense represents the interest portion of the finance lease obligations for equipment purchased under an equipment lease line. (i) Other Income is primarily related to late fees from select clients on a payment plan. 32 Liquidity and Capital Resources As of March 31, 2025,we had cash and restricted cash of $2.8 million, which decreased by $5.6 million as compared to December 31, 2024. The decrease was primarily due to cash used in financing activities of $2.6 million, cash used in operating activities of $1.8 million and cash used in investing activities of $1.2 million. The cash used in financing activities was primarily due to repayments of the production facilities and margin loan, net of proceeds from each, resulting in net cash used of $2.5 million, and payments of lease obligations of $0.1 million. The cash used in operating activities was primarily due to net loss of $6.6 million partially offset by net change in non-cash adjustments of $4.6 million and net change in operating asset and liabilities of $0.2 million. The cash used in investing activities was due to purchase of marketable securities of $1.8 million. As of March 31, 2025, we held available-for-sale marketable securities with a fair value of $3.2 million. An increase of $1.2 million as compared to December 31, 2024 was due to a purchase transaction during the three months ended March 31, 2025. The available-for-sale securities consist principally of corporate and government debt securities and are also available as a source of liquidity. As of March 31, 2025 and December 31, 2024, our margin loan balance was $0.4 million and $0.9 million, respectively. During the three months ended March 31, 2025, we borrowed an additional $2.7 million from our investment margin account and repaid $3.2 million primarily with cash received from sales and maturities of marketable securities. The borrowed amounts were primarily used for operational costs. The interest rates for the borrowings fluctuate based on the Fed Funds Upper Target plus 0.60%. The weighted average interest rates were 0.32% and 0.46%, respectively, on average margin loan balances of $0.1 million and $1.0 million as of March 31, 2025 and December 31, 2024, respectively. We incurred interest expense on the loan of $1,806 and $18,632 during the three months ended March 31, 2025 and 2024, 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. Over the next 12 months, we expect to use cash primarily to fund ongoing operations, content production, and strategic growth initiatives. Management believes that the future cash needs can be addressed through a combination of actions within its control, including cost reductions, optimization of working capital, and securing licensing and distribution advances. Other potential sources of liquidity that are outside of our control include receipt of IRS Employee Retention Tax Credits, warrant redemptions, or proceeds from capital raises. Any of these could help improve our liquidity position and depend on external factors such as IRS processing timelines, market conditions, and investor participation. Based on current cash balances and the ability to execute on planned initiatives, management believes it has sufficient liquidity to meet its obligations for at least the next 12 months. Working Capital As of March 31, 2025, we had total current assets of $25.1 million, including cash of $2.3 million, restricted cash of $0.5 million and marketable securities of $3.2 million, and our total current liabilities were $26.8 million. We had negative working capital of $1.7 million as of March 31, 2025 as compared to working capital of $1.2 million as of December 31, 2024. The decrease of $2.9 million was du e to a decrease of $9.5 million in current assets and a decrease of $6.6 million in current liabilities compared to the prior period. A decrease in current assets is primarily driven by a decrease of $5.6 million in cash, a decrease of $4.4 million in accounts receivable and a decrease of $2.0 million in production tax credit receivable position, offset by an increase of $1.2 million in marketable securities investments, an increase of $0.4 million in related party notes receivable balance and an increase $0.7 million in prepaid balance. The decrease in current liabilities is primarily driven by a decrease of $6.0 million in accounts payable, a decrease by $1.8 million in production facilities and a decrease of $0.5 million in margin loan balance, offset by an increase of $1.3 million in accrued expenses and an increase of $0.5 million in accrued salaries. During the three months ended March 31, 2025, 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 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. 33 Comparison of Cash Flows for the Three Months Ended March 31, 2025 and March 31, 2024 Our total cash as of March 31, 2025 and March 31, 2024 was $2.3 million and $7.9 million, respectively. Three Months Ended March 31, 2025 2024 Change (in thousands) Net Cash Provided by (Used in) Operating Activities $ (1,822 ) $ 3,845 $ (5,667 ) Net Cash Provided by (Used in) Investing Activities (1,186 ) 2,560 (3,746 ) Net Cash Used in Financing Activities (2,567 ) (7,891 ) 5,324 Effect of Exchange Rate Changes on Cash (38 ) 154 (192 ) Decrease in Cash $ (5,613 ) $ (1,332 ) $ (4,281 ) Net Non-cash Expenses Items necessary to reconcile from net loss to cash used in operating activities included net non-cash expenses of $4.6 million for the three months ended March 31, 2025 as compared to net non-cash expenses of $2.1 million for the three months ended March 31, 2024. The majority of the increase of $2.5 million was primarily due to loss of $3.6 million on the revaluation of our equity investment in YFE securities and a loss of $0.9 million relating to Related Party Notes Receivable settlement agreement that was considered probable during the three months ended March 31, 2025. The increase is offset by an increase of $1.1 million of FX impact on the value of the equity investment in YFE, an increase of $0.4 million in gain related to revaluation of the warrants, a decrease of $0.3 million in amortization of Right-of-Use assets, a decrease of $0.1 million in stock-based compensation expense and a decrease of $0.1 million in realized loss on marketable securities due to the lower sales of our marketable securities prior to their maturity date. Change in Operating Activities The net change in operating asset and liability activities from cash used of $8.8 million as of March 31, 2024 to cash used of $0.2 million as of March 31, 2025 was due to a decrease of $6.8 million in operating assets activity and a decrease of $1.8 million in operating liabilities activity. A decrease of in operating assets activity was primarily due to a decrease of $6.1 million in net receipts tax credits during the current year related to completed projects and an increase of $1.0 million in net Film and Television Cost expenditures, offset by a decrease of $0.3 million in outstanding balance of the ERTC receivable. A decrease of in operating liability activity was primarily due to an increase in accounts payable of $1.1 million due to certain legal expenditures being subject to extended payment terms related to potential insurance recovery and a decrease of $0.5 million in deferred revenue, representing less cash received in advance for projects not yet recognized. Change in Investing Activities The decrease in cash provided by investing activities of $3.7 million was primarily due to a decrease in proceeds from the sales and maturities of marketable securities of $2.0 million during the three months ended March 31, 2025 reflecting fewer sales during the current period. In addition, we made a purchase of additional securities of $1.8 million during the three months ended March 31, 2025. Change in Financing Activities The decrease in cash used in financing activities of $5.3 million was primarily due to a decrease in repayments of our production facilities of $4.8 million, a decrease of bank indebtedness repayment of $2.8 million and a decrease in lease payments of $0.3 million, offset by increase in repayments of margin loan of $2.3 million along with a decrease in borrowings from our margin loan of $0.4 million during the three months ended March 31, 2025 as compared to the three months ended March 31, 2024. 34 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 $24.2 million as of March 31, 2025, of which about $14.3 million could be owed within one year. Included in the amount that could be due within one year is the margin loan current balance of $0.4 million and production facilities of $7.5 million. We plan to utilize our liquidity (as described above) to fund our material cash requirements. As of March 31, 2025, we had $0.2 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 our 2024 Annual Report and “Critical Accounting Policies and Estimates” in Part II, Item 7 of the 2024 Annual Report 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 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.