Item 1A. Risk Factors
Item 1A. Risk Factors
The following discussion
of risk factors contains forward-looking statements. These risk factors may be important to understanding any statement in this Annual
Report on Form 10-K or elsewhere. The following information should be read in conjunction with Part II, Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related
notes beginning on F - 5 of this Annual Report on Form 10-K.
You should consider carefully
the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including
our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Our
business, financial condition and operating results can be affected by a number of factors, whether currently known or unknown, including
but not limited to those described below. Any one or more of such factors could directly or indirectly cause our actual results of operations
and financial condition to vary materially from past or anticipated future results of operations and financial condition. Any of these
factors, in whole or in part, could materially and adversely affect our business, financial condition, results of operations and stock
price. References to past events are provided by way of example only and are not intended to be a complete listing or a representation
as to whether or not such factors have occurred in the past or their likelihood of occurring in the future.
Because of the following
factors, as well as other factors affecting our financial condition and operating results, past financial performance should not be considered
to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future
periods.
RISKS RELATING TO OUR FINANCIAL POSITION
We must raise additional capital to
fund our operations in order to continue as a going concern.
As of December 31, 2025,
we had an accumulated deficit of $763.8 million and total stockholders’ equity of $27.5 million. As of December 31, 2025, we
had total current assets of $35.8 million, including cash of $2.9 million and marketable securities of $4.0 million, and total current
liabilities of $33.5 million. We had working capital of $2.3 million as of December 31, 2025, compared to working capital of $1.2
million as of December 31, 2024. Management has evaluated the significance of these conditions in relation to our ability to meet our
obligations and concluded that there is substantial doubt about our ability to continue as a going concern for a period of at least one
year subsequent to the issuance of the accompanying consolidated financial statements. In order to address our capital needs, we will
need to raise further capital through the sale of equity or debt securities, financing arrangements or by entering into collaborative,
strategic, and/or licensing transactions. There can be no assurance that we will be able to complete any such financing, collaborative
or strategic transactions in a timely manner or on acceptable terms, or at all. Our ability to continue as a going concern is dependent
upon our ability to generate revenue and raise additional capital. There can be no assurance that we will be successful in accomplishing
these objectives. Without such additional capital, we may be required to curtail or cease operations and be required to realize our assets
and discharge our liabilities other than in the normal course of business which could cause investors to suffer the loss of all or a substantial
portion of their investment.
9
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. For the year ended December 31, 2025, we generated net
revenues of $39.4 million and incurred a net loss attributable to Kartoon Studios Inc. of $24.5 million, while for the previous
year, we generated net revenue of $32.6 million and incurred a net loss attributable to Kartoon Studios Inc. of $20.7 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.
The financial statements included
elsewhere in this Annual Report on Form 10-K have been prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating
to the recoverability and classification of asset amounts or the classification of liabilities that might be necessary should we be unable
to continue as a going concern within one year after the date the financial statements are issued.
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.
Limits on our ability to sell securities
under the October 2025 Purchase Agreement may make it difficult for us to procure additional financing. If we are not able to obtain sufficient
capital, we may not be able to continue our growth.
Pursuant to the terms of the
Securities Purchase Agreement that we entered into in connection with the registered direct offering and concurrent private placement
that closed on October 22, 2025 (the “October 2025 Purchase Agreement”), we agreed, subject to limited exceptions, for a period
from October 20, 2025 until October 20, 2027, not to issue, enter into any agreement to issue or announce the issuance or proposed issuance
of any shares of our common stock or common stock equivalents involving a variable rate transaction; provided however, that commencing
October 20, 2026, we are allowed to enter into, and issue shares pursuant to, an “at the market” offering. The October 2025
Purchase Agreement further provides that the investor thereunder (the “October 2025 Investor”) has the right to participate
in certain subsequent financings by us in an amount equal to 50% of such subsequent financings for 12 months following October 22, 2025.
To the extent we require additional
funding, we will therefore be limited in the types of fundraising transactions that we are able to pursue in compliance with the October
2025 Purchase Agreement. If we require additional funding while these restrictive covenants remain in effect, we may be unable to effect
a financing transaction on terms acceptable to us, or at all, while also remaining in compliance with the terms of the October 2025 Purchase
Agreement, or we may be forced to seek a waiver from the October 2025 Investor, which the October 2025 Investor is not obligated to grant
to us. If adequate additional debt and/or equity financing is not available on reasonable terms or at all, we may not be able to fund
or expand our business, and we will have to modify our business plans accordingly. These factors could have a material adverse effect
on our future operating results and our financial condition.
Our revenues and results of operations
may fluctuate from period to period.
Cash flow and projections
for any entertainment company producing original content can be expected to fluctuate until the animated content and ancillary consumer
products are in the market and could fluctuate thereafter even when the content and products are in the marketplace. There is significant
lead time in developing and producing animated content before that content is in the marketplace. Unanticipated delays in entertainment
production can delay the release of the content into the marketplace. Structured retail windows that dictate when new products can be
introduced at retail are also out of our control. While we believe that we have mitigated this in part by creating a slate of properties
at various stages of development or production as well as representing certain established brands which contribute immediately to cash
flow, any delays in the production and release of our content and products or any changes in the preferences of our customers could result
in lower than anticipated cash flows.
10
As with our cash flows, our
revenues and results of operations depend significantly upon the appeal of our content to our customers, the timing of releases of our
products and the commercial success of our products, none of which can be predicted with certainty. Accordingly, our revenues and results
of operations may fluctuate from period to period. The results of one period may not be indicative of the results of any future period.
Any quarterly fluctuations that we report in the future may not match the expectations of market analysts and investors. This could cause
the price of our common stock to fluctuate.
Production costs are amortized
according to the individual film forecasting methodology. If estimated remaining revenue is not sufficient to recover the unamortized
production costs, the unamortized production costs will be written down to fair value. In any given quarter, if we lower our previous
forecast with respect to total anticipated revenue, we would be required to adjust amortization of related production costs. These adjustments
would adversely impact our business, operating results and financial condition.
The value of our investments is subject
to capital markets risk as well as other investment risks, which may adversely affect our results of operations, financial condition or
cash flows.
Our results of operations
may be affected, to a limited extent, by the performance of our investment portfolio. Our excess cash is invested by an external investment
management service provider under the direction of the Company’s management in accordance with the Company’s investment policy.
The investment policy defines constraints and guidelines that restrict the asset classes in which we may invest by type, duration, credit
quality and concentration. Our marketable securities portfolio is composed of high-grade, investment-quality securities intended to preserve
capital and maintain liquidity rather than generate significant returns. As a result, the portfolio is designed to limit exposure to market
risk. These investments remain subject to general market fluctuations and risks inherent in particular securities. While we do not expect
such risks to have a significant impact, adverse market conditions could affect the value or returns of these investments and may impact
our financial condition, results of operations or cash flows. If we reposition or realign portions of our investment portfolio and sell
securities in an unrealized loss position, we will incur a credit loss. Any such loss may have a material adverse effect on our results
of operations and business.
In addition, we maintain an
investment in foreign equity, the securities of YFE that we hold, which is inherently volatile and subject to greater market risk. The
value of this investment may be significantly affected by changes in equity market conditions, foreign currency exchange rate movements,
and economic or geopolitical developments in the relevant jurisdictions. For example, we recognized a loss on revaluation of our equity
investment in YFE of approximately $9.8 million and $1.6 million for the years ended December 31, 2025 and December 31, 2024,
respectively, as a result of decreases in YFE’s stock price during the respective reporting periods. For the year ended December
31, 2025, we incurred net realized and unrealized investment gains and losses, as described in Item 8, “Financial Statements and
Supplementary Data” included herein.
We have incurred indebtedness that
could adversely affect the profitability of our business operations and financial condition.
As of December 31, 2025,
we and our subsidiaries have production loan facility obligations (“production facilities”) of approximately $11.8 million.
Any borrowings under the production facilities are collateralized by a security interest in substantially all of the relevant production
company’s tangible and intangible assets, including primarily federal and provincial tax credits and other government incentives,
as well as production service agreements and license agreements. As of December 31, 2025, we recorded $16.8
million in tax credit receivables related to Wow’s film and television productions, net of $0.4
million in allowance for credit loss. If the production entities default on their obligations under the production facilities,
the lender could foreclose on certain assets held by our subsidiaries and related entities that are parties to those facilities; however,
such foreclosure would only apply to the extent any outstanding amounts exceed the related tax credit receivables securing those obligations.
As the amounts currently outstanding do not exceed the associated tax credit receivables, these assets are not presently at risk. In addition,
the existence of these security interests may adversely affect our financial flexibility. The production 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.
11
RISKS RELATING TO OUR BUSINESS AND INDUSTRY
The loss of one or more significant
customers could have a material adverse effect on us.
A small number of customers
have in the past, and may in the future, account for a significant portion of our revenues in any one year or over a period of several
consecutive years. During the year ended December 31, 2025, four customers each accounted for more than 10% of our total consolidated
revenue. These customers accounted for an aggregate of 81.9% of our total revenue. As of December 31, 2025, we had three customers,
the accounts receivable for each of which exceeded 10% of our total accounts receivable. These customers accounted for an aggregate of
54.5% of the total accounts receivable as of December 31, 2025. The loss of business from a significant customer could have a material
adverse effect on our business, financial condition, results of operations and cash flows.
Inaccurately anticipating changes
and trends in popular culture, media and movies, fashion, or technology can negatively affect our sales.
While trends in the toddler
to tween sector change quickly, we respond to trends and developments by modifying, refreshing, extending, and expanding our product offerings
on an on-going basis. However, we operate in extremely competitive industries where the ultimate appeal and popularity of content and
products targeted to this sector can be difficult to predict. We believe our focus on “content with a purpose” serves an underrepresented
area of the toddler to tween market; however, if the interests of our audience trend away from our current properties toward other offerings
based on current media, movies, animated content or characters, and if we fail to accurately anticipate trends in popular culture, movies,
media, fashion, or technology, our products may not be accepted by children, parents, or families and our revenues, profitability, and
results of operations may be adversely affected.
We face competition from a variety
of content creators that sell similar merchandise and have greater resources than we do.
The industries in which we
operate are competitive, and our results of operations are sensitive to, and may be adversely affected by, competitive pricing, promotional
pressures, additional competitor offerings and other factors, many of which are beyond our control. Indirectly through our licensing arrangements,
we compete for retailers as well as other outlets for the sale and promotion of our licensed merchandise. Our primary competition comes
from competitors such as The Walt Disney Company, Nickelodeon Studios, and the Cartoon Network.
We have sought a competitive
advantage by providing “content with a purpose” which are both entertaining and enriching for children and offer differentiated
value that parents seek in making purchasing decisions for their children. While we do not believe that this value proposition is specifically
offered by our competitors, our competitors have greater financial resources and more developed marketing channels than we do, which could
negatively impact our ability, through our licensees, to secure shelf space, thereby decreasing our revenues or affecting our profitability
and results of operations. In addition, new technological developments, including the development and use of generative artificial intelligence
(“AI”), are rapidly evolving. If our competitors gain an advantage by using such technologies, our ability to compete effectively
and our results of operations could be adversely impacted.
The production of our animated content
is accomplished through third-party production and animation studios around the world, and any failure of these third parties could negatively
impact our business.
As part of our business model
to manage cash flows, we have partnered with a number of third-party production and animation studios around the world for the production
of our new content in which these partners fund the production of the content in exchange for a portion of the revenues generated in certain
territories. We rely on our partners to produce and deliver the content on a timely basis meeting the predetermined specifications for
a specified product. The delivery of inferior content could result in additional expenditures by us to correct any problems to ensure
marketability. Further, delays in the delivery of the finished content to us could result in our failure to deliver the product to broadcasters
to which it has been pre-licensed. While we believe we have mitigated this risk by aligning the economic interests of our partners with
ours and managing the production process remotely on a daily basis, any failures or delays from our production partners could negatively
affect our profitability and reputation.
12
We cannot assure you that our original
programming content will appeal to our distributors and viewers or that any of our original programming content will not be cancelled
or removed from our distributors’ platforms.
Our business depends on the
appeal of our content to distributors and viewers, which is difficult to predict. Our business depends in part upon viewer preferences
and audience acceptance of our original programming content. These factors are difficult to predict and are subject to influences beyond
our control, such as the quality and appeal of competing programming, general economic conditions and the availability of other entertainment
activities. We may not be able to anticipate and react effectively to shifts in tastes and interests in markets. A change in viewer preferences
could cause our original programming content to decline in popularity, which could jeopardize renewal of agreements with distributors.
Low ratings or viewership for programming content produced by us may lead to the cancellation, removal or non-renewal of a program and
can negatively affect future license fees for such program. If our original programming content does not gain the level of audience acceptance
we expect, or if we are unable to maintain the popularity of our original programming, we may have a diminished negotiating position when
dealing with distributors, which could reduce our revenue. We cannot assure you that we will be able to maintain the success of any of
our current original programming content or generate sufficient demand and market acceptance for new original programming content in the
future. This could materially adversely impact our business, financial condition, operating results, liquidity and prospects.
Failure to successfully market or
advertise our products could have an adverse effect on our business, financial condition and results of operations.
Our products are marketed
worldwide through a diverse spectrum of advertising and promotional programs. Our ability to sell products is dependent in part upon the
success of these programs. If we or our licensees do not successfully market our products or if media or other advertising or promotional
costs increase, these factors could have an adverse effect on our business, financial condition, and results of operations.
The failure of others to promote our
products may adversely affect our business.
The availability of retailer
programs relating to product placement, co-op advertising and market development funds, and our ability and willingness to pay for such
programs, are important with respect to promoting our properties. In addition, although we may have agreements in place for the advertising
and promotion of our products through our licensees, we are not and will not be in direct control of those marketing efforts and those
efforts may not be done in a manner that will maximize sales of our products and may have a material adverse effect on our business and
operations.
We may not be able to keep pace with
technological advances.
The entertainment industry
in general, and the music and motion picture industries in particular, continue to undergo significant changes, primarily due to technological
developments, such as AI. Because of the rapid growth of technology, shifting consumer tastes and the popularity and availability of other
forms of entertainment, it is impossible to predict the overall effect these factors could have on potential revenue from, and profitability
of, distributing entertainment programming. As it is also impossible to predict the overall effect these factors could have on our ability
to compete effectively in a changing market, if we are not able to keep pace with these technological advances, our revenues, profitability
and results from operations may be materially adversely affected.
We are exposed to investment risk
with the ownership of an equity interest in Your Family Entertainment AG.
During the year ended December
31, 2021, we acquired a material equity interest in YFE, a company publicly traded on the Frankfurt Stock Exchange. With an ownership
stake of 32.5% as of December 31, 2025, we are exposed to the risk of success of the YFE business. We are also exposed to risk of
adverse reactions to the transaction or changes to business relationships; competitive responses; inability to maintain key personnel
and changes in general economic conditions in Germany. Germany was in a recession for most of 2025 and 2024, largely due to persistent
high inflation and falling household spending. Continued inflation, volatility or recessionary risks in Germany could adversely affect
YFE’s business, results of operations and stock price. If YFE fails to perform to our expectations, it could have a material adverse
effect on our results of operations or financial condition and liquidity. For example, the fair value of the investment as of December 31,
2025 decreased by net $9.8 million, as compared to December 31, 2024. The net decrease is comprised of the net impact of a decrease
in YFE’s stock price, the share sale and exchange transactions completed in the quarter, and the effect of foreign currency remeasurement
from EURO to USD. The total change in fair value is recorded within Other Income (Expense), net on the Company’s consolidated statements
of operations.
13
We operate internationally, which
exposes us to global economic, financial and political risks.
We have expanded into international
operations, including as a result of our acquisitions of Wow and Ameba, our launch of Kartoon Channel! Worldwide and our investment
in YFE. As part of our growth strategy, we intend to continue to evaluate potential opportunities for further international expansion.
Operating in international markets requires significant resources and management attention, and subjects us to legal, regulatory, economic
and political risks in addition to those we face in the United States. We have limited experience with international operations, and further
international expansion efforts may not be successful.
In addition, we face risks
in doing business internationally that could adversely affect our business, including:
• Fluctuations in currency exchange rates, which could increase the price of our products outside of the
United States, increase the expenses of our international operations and expose us to foreign currency exchange rate risk;
• Currency control regulations, which might restrict or prohibit our conversion of other currencies into
U.S. dollars;
• Restrictions on the transfer of funds;
• Difficulties in managing and staffing international operations, including difficulties related to the
increased operations, travel, infrastructure, employee attrition and legal compliance costs associated with numerous international locations;
• Our ability to effectively price our products in competitive international markets;
• New and different sources of competition;
• The need to adapt and localize our products for specific countries;
• Challenges in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
• International trade policies, tariffs and other non-tariff barriers, such as quotas;
• The continued threat of terrorism and the impact of military and other action; and
• Adverse consequences relating to the complexity of operating in multiple international jurisdictions with
different laws, regulations and case law which are subject to interpretation by taxpayers, including us.
Wow's functional currency
is the Canadian dollar; therefore their financial results are translated into U.S. dollars, our reporting currency, upon consolidation
of our financial statements. We are exposed to more significant currency fluctuation risks as a result of our acquisition of Wow in 2021.
Fluctuations between the foreign exchange rates, and in particular the Canadian dollar and the U.S. dollar, affect the amounts we record
for our foreign assets, liabilities, revenues and expenses, and could have a negative effect on our financial results.
14
Further, each entity conducts
a growing portion of their businesses in currencies other than such entity's own functional currency. Therefore, in addition to the foreign
currency translation risk, we face exposure to adverse movements in currency exchange rates with each transaction made outside of the
entities' functional currency, including our investment in YFE. If the functional currency of the entity weakens against the foreign currencies
in which transactions are being made, the remeasurement of these foreign currency denominated transactions will result in increased revenue,
operating expenses and net income or loss. However, if the functional currency of the entity weakens against the foreign currencies in
which transactions are being made, the remeasurement of these foreign currency denominated transactions will result in decreased revenue,
operating expenses and net income (or loss). As exchange rates vary, sales and other operating results, when remeasured, may differ materially
from expectations. We continue to review potential hedging strategies that may reduce the effect of fluctuating currency rates on our
business, but there can be no assurances that we will implement such a hedging strategy or that once implemented, such a strategy would
accomplish our objectives or not result in losses.
Our failure to manage any
of these risks successfully could harm our international operations, and adversely affect our business, results of operations and financial
condition.
A decrease in the fair values of our
reporting units may result in future intangible assets impairments.
When an entity is acquired,
a portion of the purchase price may be allocated to intangible assets. We conduct impairment tests on our intangible assets at least annually
based upon the fair value. We assess intangible assets for impairment whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. This evaluation considers factors such as expected future cash flows, profitability, market conditions,
and industry trends. If we determine such an impairment exists, we adjust the carrying value of the asset by the amount of fair value
in excess of the carrying value. The impairment charge is recorded in our income statement in the period in which the impairment is determined.
If we are required in the future to record additional asset impairments, our financial condition and results of operations would be negatively
affected. In connection with fair value measurements and the accounting for intangible assets, the use of generally accepted accounting
principles requires management to make certain estimates and assumptions. Significant judgment is required in making these estimates and
assumptions, and actual results may ultimately be materially different from such estimates and assumptions.
RISKS RELATED TO INTELLECTUAL PROPERTY, LITIGATION
AND CYBERSECURITY
Protecting and defending against intellectual
property claims may have a material adverse effect on our business.
Our ability to compete in
the animated content and entertainment industry depends, in part, upon successful protection of our proprietary and IP. We protect our
property rights to our productions through available copyright and trademark laws and licensing and distribution arrangements with reputable
companies in specific territories and media for limited durations. Despite these precautions, existing copyright and trademark laws afford
only limited, or no, practical protection in some jurisdictions, especially jurisdictions outside of the United States. It may be possible
for unauthorized third parties to copy and distribute our productions or portions of our productions. In addition, although we own most
of the music and IP included in our products, there are some titles for which the music or other elements are in the public domain and
for which it is difficult or even impossible to determine whether anyone has obtained ownership or royalty rights. It is an inherent risk
in our industry that people may make ownership or royalty claims with respect to any title already included in our products, whether or
not such claims can be substantiated. If litigation is necessary in the future to enforce our IP rights, to protect our trade secrets,
to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any
such litigation could result in substantial costs and the resulting diversion of resources could have an adverse effect on our business,
operating results or financial condition.
15
Failure in our information technology and storage systems
could significantly disrupt the operation of our business.
Our ability to execute our
business plan and maintain operations depends on the continued and uninterrupted performance of our information technology (“IT”)
systems. IT systems are vulnerable to risks and damages from a variety of sources, including telecommunications or network failures, malicious
human acts and natural disasters. Moreover, despite network security and back-up measures, some of our and our vendors’ servers
are potentially vulnerable to physical or electronic break-ins, including cyber-attacks, computer viruses and similar disruptive problems.
These events could lead to the unauthorized access, disclosure and use of non-public information. The techniques used by criminal elements
to attack computer systems are sophisticated, change frequently and may originate from less regulated and remote areas of the world. As
a result, we may not be able to address these techniques proactively or implement adequate preventative measures. If our computer systems
are compromised, we could be subject to fines, damages, litigation and enforcement actions, and we could lose trade secrets, the occurrence
of which could harm our business. Despite precautionary measures to prevent unanticipated problems that could affect our IT systems, sustained
or repeated system failures that interrupt our ability to generate and maintain data could adversely affect our ability to operate our
business.
Our internal computer systems, or
those of our collaborators or other contractors or consultants, may fail or suffer security breaches, which could result in a material
disruption and cause our business and reputation to suffer.
In the ordinary course of
business, our internal computer systems and those of our current and any future collaborators and other contractors or consultants are
vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical
failures. We and many of the third parties we work with rely on open source software and libraries that are integrated into a variety
of applications, tools and systems, which may increase our exposure to vulnerabilities. Additionally, outside parties may attempt to induce
employees, vendors, partners, or users to disclose sensitive or confidential information in order to gain access to data. Any attempt
by hackers to obtain our data (including member and corporate information) or intellectual property (including digital content assets),
disrupt our service, or otherwise access our systems, or those of third parties we use, if successful, could harm our business, be expensive
to remedy and damage our reputation. We have implemented certain systems and processes to thwart hackers and protect our data and systems.
However, the techniques used to gain unauthorized access to data and software are constantly evolving, and we may be unable to anticipate,
detect or prevent unauthorized access or address all cybersecurity incidents that occur. On December 13, 2024, we experienced a cybersecurity
incident involving unauthorized access to one of our management systems. The findings indicated that the unauthorized access incurred
due to leaked credentials of an employee from our partner studio. Although this incident was deemed by us to be immaterial we cannot guarantee
that we can safeguard our assets while maintaining and protecting client trust through robust security measures and risk management practices.
Further, access to, disclosure of, loss of and
misuse of personal or proprietary information could result in legal claims or proceedings.
Litigation may harm our business or otherwise distract
management.
Substantial, complex or extended
litigation could cause us to incur large expenditures and could distract management. For example, lawsuits by licensors, consumers, employees
or stockholders could be very costly and disrupt business. While disputes from time to time are not uncommon, we may not be able to resolve
such disputes on terms favorable to us.
16
RISKS RELATED TO INFLATION, INTEREST RATES,
AND OTHER ADVERSE ECONOMIC CONDITIONS
Changes in the United States, global or regional economic
conditions could adversely affect the profitability of our business.
A decrease in economic activity
in the United States or in other regions of the world in which we do business could adversely affect demand for our products, thus reducing
our revenue and earnings. A decline in economic conditions could reduce demand for and sales of our products. In addition, an increase
in price levels generally, or in price levels in a particular sector, could result in a shift in consumer demand away from the animated
content and consumer products we offer, which could also decrease our revenues, increase our costs, or both.
Further, recent global events
have adversely affected and are continuing to adversely affect workforces, organizations, economies, and financial markets globally, leading
to economic downturns, inflation, and increased market volatility. Military conflicts and wars (such as the ongoing conflicts between
Russia and Ukraine, Israel and Hamas, and the Red Sea crisis and its impact on shipping and logistics), terrorist attacks, other geopolitical
events, high inflation, increasing interest rates, bank failures and associated financial instability and crises, trade wars, and supply
chain issues created by tariffs threatened or imposed by the current U.S. Administration on imports can cause exacerbated volatility and
disruptions to various aspects of the global economy. The uncertain nature, magnitude, and duration of hostilities stemming from such
conflicts, including the potential effects of sanctions and counter-sanctions, or retaliatory cyber-attacks on the world economy and markets,
have contributed to increased market volatility and uncertainty, which could have an adverse impact on macroeconomic factors that affect
our business and operations.
Regulatory requirements or
government action against our service, whether in response to enforcement of actual or purported legal and regulatory requirements or
otherwise, could result in disruption or non-availability of our services or particular content or increased operating costs in the applicable
jurisdiction and foreign intellectual property laws, such as the EU copyright directive, or changes to such laws, among other issues,
may impact the economics of creating or distributing content, anti-piracy efforts, or our ability to protect or exploit intellectual property
rights.
Changes in U.S. trade policy, including
current and proposed tariffs on foreign-produced content, could adversely impact our business operations, particularly due to our reliance
on animation production services based in Canada and Asia.
The U.S. government has indicated
its intent to adopt, and in certain cases has implemented, a new approach to trade policy and in some cases to renegotiate, or potentially
terminate, certain existing bilateral or multilateral trade agreements. It has initiated or is considering the imposition of tariffs on
certain foreign goods. Changes in U.S. trade policy could result in one or more U.S. trading partners adopting responsive trade policies,
making it more difficult or costly for us to conduct our international and domestic operations. As an example, on May 4, 2025, President
Trump announced an intention to impose tariffs on films made outside of the United States, which he reiterated in September 2025. Although
our parent company is based in the United States, our primary animation production operations are located in Canada. The scope and the
extent of the proposed tariffs is not yet finalized and there is a risk that such measures could be extended to include animated content
produced internationally. Our business operations, financial condition, and results of operations could be significantly affected by such
a measure and the potential expansion of existing tariffs or implementation of new tariffs, trade restrictions, or retaliatory measures
by other countries that could disrupt our established operations. This in turn could require us to increase prices to our customers, which
may reduce demand, or, if we are unable to increase prices, result in lowering our profit margin on certain services.
We cannot predict future trade
policy or the terms of any renegotiated trade agreements and their impact on our business. The adoption and expansion of trade restrictions,
the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies has the potential to adversely
impact demand for our services, our costs, our customers, our suppliers, and the U.S. economy, which in turn could adversely impact our
business, financial condition, and results of operations.
17
RISKS RELATED TO REGULATORY MATTERS
Changes in foreign, state and local
tax incentives may increase the cost of original programming content to such an extent that they are no longer feasible.
Original programming requires
substantial financial commitment, which can occasionally be offset by foreign, state or local tax incentives. However, there is a risk
that the tax incentives will not remain available for the duration of a series. If tax incentives are no longer available or reduced substantially,
it may result in increased costs for us to complete the production, or make the production of additional seasons more expensive. If we
are unable to produce original programming content on a cost effective basis our business, financial condition and results of operations
would be materially adversely affected.
Further we are subject to
ordinary course audits from the Canada Revenue Agency (“CRA”) and Provincial agencies. Changes in administrative policies
by the CRA or subsequent review of eligibility documentation may impact the collectability of these estimates. We continuously review
the results of these audits to determine if any circumstances arise that in management’s judgment would result in previously recognized
tax credit receivables to be considered no longer collectible. While we believe our estimates are reasonable, we cannot assure you that
final determinations from any review will not be materially different from those reflected in our financial statements. Any adverse outcome
from any examinations may have an adverse effect on our business and operating results, which could cause the market price of our securities
to decline.
Changes in, or interpretations of,
tax rules and regulations, and changes in geographic operating results, may adversely affect our effective tax rates.
We are subject to income taxes
in Canada, the U.S. and foreign tax jurisdictions. We also conduct business and financing activities between our entities in various jurisdictions
and we are subject to complex transfer pricing regulations in the countries in which we operate. Although uniform transfer pricing standards
are emerging in many of the countries in which we operate, there is still a relatively high degree of uncertainty and inherent subjectivity
in complying with these rules. In addition, due to economic and political conditions, tax rates in various jurisdictions may be subject
to significant change. Our future effective tax rates could be affected by changes in tax laws or regulations or the interpretation thereof,
(including those affecting the allocation of profits and expenses to differing jurisdictions), by changes in the amount of revenue or
earnings that we derive from international sources in countries with high or low statutory tax rates, by changes in the valuation of our
deferred tax assets and liabilities, by changes in the expected timing and amount of the release of any tax valuation allowance, or by
the tax effects of stock-based compensation. Unanticipated changes in our effective tax rates could affect our future results of operations.
Further, we may be subject
to examination of our income tax returns by federal, state, and foreign tax jurisdictions. We regularly assess the likelihood of outcomes
resulting from possible examinations to determine the adequacy of our provision for income taxes. In making such assessments, we exercise
judgment in estimating our provision for income taxes. While we believe our estimates are reasonable, we cannot assure you that final
determinations from any examinations will not be materially different from those reflected in our historical income tax provisions and
accruals. Any adverse outcome from any examinations may have an adverse effect on our business and operating results, which could cause
the market price of our securities to decline.
A shutdown of the U.S. federal government
may adversely affect our business.
A recurring shutdown of the
U.S. federal government may adversely affect our business operations and regulatory compliance. During such shutdowns, while the SEC’s
EDGAR system remains operational, the unavailability of SEC staff to review filings, issue comments, or declare registration statements
effective may delay our ability to complete public offerings, respond to comment letters, or obtain timely regulatory approvals. These
delays could impact our access to capital markets, hinder strategic transactions, and create uncertainty around our disclosure obligations.
Additionally, the lack of interpretive guidance or exemptive relief during a shutdown may increase legal and compliance risks. There can
be no assurance that any future shutdowns will not materially affect our operations or financial condition.
18
Our vendors and licensees may be subject
to various laws and government regulations, violation of which could subject these parties to sanctions which could lead to increased
costs or the interruption of normal business operations that could negatively impact our financial condition and results of operations.
Our vendors and licensees
may operate in a highly regulated environment in the U.S. and international markets. Federal, state and local governmental entities and
foreign governments may regulate aspects of their businesses, including the production or distribution of our content or products. These
regulations may include accounting standards, taxation requirements (including changes in applicable income tax rates, new tax laws and
revised tax law interpretations), product safety and other safety standards, trade restrictions, regulations regarding financial matters,
environmental regulations, advertising directed toward children, product content, and other administrative and regulatory restrictions.
While we believe our vendors and licensees take all the steps necessary to comply with these laws and regulations, there can be no assurance
that they are compliant or will be in compliance in the future. Failure to comply could result in monetary liabilities and other sanctions
which could increase our costs or decrease our revenue resulting in a negative impact on our business, financial condition and results
of operations.
RISKS RELATING TO OUR COMMON STOCK
Our stock price may be subject to
substantial volatility, and stockholders may lose all or a substantial part of their investment.
Our common stock currently
trades on NYSE American. There is limited public float, and trading volume historically has been low and sporadic. As a result, the market
price for our common stock may not necessarily be a reliable indicator of our fair market value. The price at which our common stock trades
may fluctuate as a result of a number of factors, including the number of shares available for sale in the market, quarterly variations
in our operating results, actual or anticipated announcements of new releases by us or competitors, the gain or loss of significant customers,
changes in the estimates of our operating performance, market conditions in our industry and the economy as a whole.
Our failure to meet the continued
listing requirements of NYSE American could result in a delisting of our common stock, which would negatively impact the price of our
common stock and our ability to access the capital markets.
If we fail to satisfy the
continued listing requirements of NYSE American, such as minimum financial and other continued listing requirements and standards, including
those regarding minimum stockholders’ equity, minimum share price, and certain corporate governance requirements, NYSE American
may take steps to delist our common stock. Such a delisting would likely have a negative effect on the price of our common stock and would
impair your ability to sell or purchase our common stock when you wish to do so. In the event of a delisting, we would expect to take
actions to restore our compliance with NYSE American’s listing requirements, but we can provide no assurance that any such action
taken by us would allow our common stock to become listed again, stabilize the market price or improve the liquidity of our common stock,
prevent our common stock from dropping below the NYSE American minimum bid price requirement of $0.10, or prevent future non-compliance
with NYSE American’s listing requirements.
There is no assurance that
we will maintain compliance with all applicable requirements for continued listing on NYSE American. If our common stock were delisted
from NYSE American, trading of our common stock would most likely take place on an over-the-counter market established for unlisted securities,
such as the OTCQB or the Pink Market maintained by OTC Markets Group Inc. An investor would likely find it less convenient to sell, or
to obtain accurate quotations in seeking to buy, our common stock on an over-the-counter market, and many investors would likely not buy
or sell our common stock due to difficulty in accessing over-the-counter markets, policies preventing them from trading in securities
not listed on a national exchange or other reasons. In addition, as a delisted security, our common stock would be subject to SEC rules
as a “penny stock,” which impose additional disclosure requirements on broker-dealers. The regulations relating to penny stocks,
coupled with the typically higher cost per trade to the investor of penny stocks due to factors such as broker commissions generally representing
a higher percentage of the price of a penny stock than of a higher-priced stock, would further limit the ability of investors to trade
in our common stock. In addition, delisting could harm our ability to raise capital through alternative financing sources on terms acceptable
to us, or at all, and may result in the potential loss of confidence by investors, suppliers, customers and employees and fewer business
development opportunities. For these reasons and others, delisting would adversely affect the liquidity, trading volume and price of our
common stock, causing the value of an investment in us to decrease and having an adverse effect on our business, financial condition and
results of operations, including our ability to attract and retain qualified employees and to raise capital.
19
We are authorized to issue “blank
check” preferred stock without stockholder approval, which could adversely impact the rights of holders of our common stock.
Our Articles of Incorporation,
as amended (our “Articles of Incorporation”), authorize us to issue up to 10,000,000 shares of blank check preferred stock
without seeking approval of our shareholders. As of December 31, 2025, 6,000 shares of our authorized preferred stock have been designated
as 0% Series A Convertible Preferred Stock, 1 share of our authorized preferred stock has been designated as Series B Preferred Stock,
and 50,000 shares of our authorized preferred stock have been designated as Series C Preferred Stock, none of which shares were outstanding.
Any preferred stock that we issue in the future may rank ahead of our common stock in terms of dividend priority or liquidation premiums
and may have greater voting rights than our common stock. In addition, such preferred stock may contain provisions allowing those shares
to be converted into shares of common stock, which could dilute the value of common stock to current stockholders and could adversely
affect the market price, if any, of our common stock. In addition, the preferred stock could be utilized, under certain circumstances,
as a method of discouraging, delaying or preventing a change in control of our company. Although we have no present intention to issue
any additional shares of authorized preferred stock, there can be no assurance that we will not do so in the future.
We do not expect to pay dividends
on our common stock in the future and any return on investment may be limited to the value of our common stock.
We do not currently anticipate
paying cash dividends on shares of our common stock in the foreseeable future. The payment of dividends on our common stock will depend
on earnings, financial condition and other business and economic factors affecting it at such time as our Board of Directors may consider
relevant. Our current intention is to apply net earnings, if any, in the foreseeable future to increasing our capital base and development
and marketing efforts. There can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders
of our common stock, and in any event, a decision to declare and pay dividends is at the sole discretion of our Board of Directors. If
we do not pay dividends, our common stock may be less valuable because the return on investment will only occur if its stock price appreciates.
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 or upon 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.
As of March 31, 2026,
approximately 53,898,226 shares of common stock of the 56,336,035 shares of common stock issued are outstanding and freely trading. As
of December 31, 2025, there were 41,622,504 warrants outstanding. Lastly, as of December 31, 2025, there are 969,130 shares
of common stock underlying outstanding options granted, 1,712,395 shares of common stock underlying outstanding restricted stock units
(“RSUs”) and 8,481,135 shares reserved for issuance under our Kartoon Studios, Inc. 2020 Incentive Plan.
RISKS RELATING TO BEING A PUBLIC COMPANY
In the past, we identified material
weaknesses in our internal controls. If we fail to develop, implement and maintain an effective system of internal control over financial
reporting, the accuracy and timing of our financial reporting in future periods may be adversely affected.
The Sarbanes-Oxley Act of
2002, as amended (the “Sarbanes-Oxley Act”), and related rules and regulations require that management report annually on
the effectiveness of our internal control over financial reporting and assess the effectiveness of our disclosure controls and procedures
on a quarterly basis. Effective internal controls are necessary for us to provide timely and reliable financial reports and effectively
prevent fraud. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2025, and
determined that our internal control over financial reporting was effective. However, in the past, including as of December 31, 2024,
our management identified control deficiencies that constituted material weaknesses in our internal controls and procedures resulting
in a determination that our internal control over financial reporting was not effective as of such dates. The material weaknesses, that
were previously identified by management, have been remediated, but if we fail to maintain adequate internal controls, our financial statements
may not accurately reflect our financial condition. Any material misstatements could require a restatement of our consolidated financial
statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information,
leading to a decline in the market value of our securities.
20
We are a “smaller reporting company,” and the
reduced public company reporting and disclosure requirements applicable to smaller reporting companies may make our common stock less
attractive to investors.
We are currently a “smaller
reporting company,” as defined in the Securities Exchange Act and have elected to take advantage of certain of the scaled disclosures
available to smaller reporting companies. For so long as we continue to qualify as a “smaller reporting company, we are permitted
and plan to rely on exemptions from certain disclosure requirements that are applicable to public companies that are not smaller reporting
companies. These provisions include, but are not limited to: being permitted to have only two years of audited financial statements and
only two years of management’s discussion and analysis of financial condition and results of operations disclosure; an exemption
from compliance with the auditor attestation requirement in the assessment of our internal control over financial reporting pursuant to
Sarbanes-Oxley Act; and reduced disclosure obligations regarding executive compensation arrangements in our periodic reports, registration
statements and proxy statements. We will continue to be a “smaller reporting company” until we have more than $250 million
in public float (based on our common stock) measured as of the last business day of our most recently completed second fiscal quarter
or, in the event we have no public float (based on our common stock), annual revenues of more than $100 million during the most recently
completed fiscal year.
As a result, the information
we provide will be different than the information that is available with respect to other larger public companies. We cannot predict whether
investors will find our common stock less attractive if we rely on these exemptions. If some investors find our common stock less attractive
as a result, there may be a less active trading market for our common stock, and the market price of our common stock may be more volatile.