Kartoon Studios, Inc. — Q3 2023 Form 10-Q Summary
Business context and reporting period
Kartoon Studios, formerly Genius Brands International, is a global children’s content and brand-management company operating in content production and distribution and media advisory and advertising services. Its portfolio includes animated programming, licensing and royalties, AVOD, FAST and SVOD channels, Wow Unlimited Media, Frederator, Ameba, Beacon Media and an investment in Your Family Entertainment AG.
The filing covers the unaudited three and nine months ended September 30, 2023, compared primarily with the corresponding 2022 periods. The company changed its name to Kartoon Studios in June 2023, transferred its listing from Nasdaq to NYSE American and began trading under the symbol TOON. A 1-for-10 reverse stock split became effective in February 2023.
Financial performance and key metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Revenue | $10.1 million | $19.7 million | $35.3 million | $43.2 million |
| Loss from operations | $(12.6) million | $(5.4) million | $(43.2) million | $(24.0) million |
| Net loss | $(15.5) million | $(11.2) million | $(55.6) million | $(27.9) million |
| Net loss attributable to Kartoon Studios | $(15.5) million | $(11.2) million | $(55.5) million | $(29.1) million |
| Loss per diluted share | $(0.44) | $(0.35) | $(1.67) | $(0.93) |
| Cash used in operating activities | Not separately disclosed | Not separately disclosed | $(20.2) million | $(24.0) million |
Approximate operating margins were negative 125% in Q3 2023 versus negative 28% in Q3 2022, and negative 122% for the first nine months of 2023 versus negative 55% in the prior-year period. Approximate net margins were negative 154% and negative 57% for the respective quarters, and negative 157% and negative 65% for the respective nine-month periods.
- Q3 revenue declined 49%, driven by lower content distribution revenue, lower production-services revenue, reduced licensing and royalties, and lower media advisory and advertising services revenue.
- Nine-month revenue declined 18%. Production-services revenue increased on a reported basis because 2023 included nine months of Wow activity versus six months in 2022, but management states that comparable production-services revenue declined when adjusting for the acquisition timing.
- Q3 operating expenses decreased 10% to $22.7 million, primarily from lower marketing, direct operating and general and administrative expenses. The cost reduction was insufficient to offset the revenue decline.
- Nine-month operating expenses increased 17% to $78.5 million, including $6.2 million of film and television cost write-downs, $4.0 million of intangible-asset impairment, $11.3 million of goodwill impairment and $0.1 million of property and equipment impairment.
- Nine-month other expense was $10.3 million, including $16.2 million of warrant incentive expense and $4.2 million of realized losses on marketable securities, partially offset by an $9.0 million warrant-revaluation gain and a $1.1 million gain on the YFE investment.
Liquidity, capital resources and balance sheet
| Balance-sheet item | September 30, 2023 | December 31, 2022 |
|---|---|---|
| Cash | $3.9 million | $7.4 million |
| Marketable securities | $16.2 million | $83.7 million |
| Total current assets | $61.4 million | $139.5 million |
| Total current liabilities | $49.6 million | $110.9 million |
| Working capital | $11.8 million | $28.6 million |
| Margin loan | $2.2 million | $60.8 million |
| Total liabilities | $62.2 million | $125.0 million |
| Total stockholders’ equity | $74.0 million | $112.9 million |
- Operating activities used $20.2 million; investing activities provided $69.4 million, primarily from $67.6 million of marketable-security sales and maturities; financing activities used $52.8 million, primarily for margin-loan repayment.
- The company borrowed $17.6 million and repaid $76.2 million under its investment margin account during the first nine months.
- Management stated that cash and available-for-sale securities were sufficient to fund operations for at least the next 12 months and that operating costs could be reduced and equity or equity-linked instruments used for services and compensation.
- The company was in technical violation of two financial covenants related to its Canadian facilities: minimum fixed-charge coverage and maximum senior funded debt to EBITDA. Certain facilities can be called at any time, and the filing states that no repayment demand had been made as of November 17, 2023.
- Subsequent to quarter-end, the company sold $4.2 million of marketable securities, incurred a $0.3 million realized loss and used the proceeds to repay the remaining margin loan. As of the filing date, the margin loan had been paid off.
Material changes versus the prior comparable period
- Revenue fell substantially in Q3, especially content distribution, which declined 72% because the prior-year period included a $3.4 million Wow IP-project delivery and stronger Frederator YouTube revenue.
- Nine-month content distribution revenue declined 51%, while licensing and royalties declined 90%, primarily because prior-year Stan Lee licensing transactions did not recur.
- Frederator experienced lower YouTube viewership and lower revenue per thousand impressions.
- General and administrative expense decreased $10.1 million for the nine-month period, primarily because of lower stock-based compensation and the absence of 2022 acquisition-related costs.
- The company recognized significant noncash asset impairments and film-cost write-downs in 2023, whereas comparable 2022 periods had no such impairment charges.
- The company issued 2.3 million common shares through a repriced warrant exercise and issued warrants for up to approximately 4.8 million additional shares at a $2.50 exercise price. The transaction generated approximately $5.8 million of gross proceeds but produced substantial warrant-related expense and potential dilution.
- At a November 1, 2023 special meeting, stockholders approved increasing authorized common shares from 40 million to 190 million. The company stated that the outstanding exchange warrants would then be reclassified from liability to equity.
Guidance, outlook, commentary and risks
The filing does not provide formal revenue, earnings or cash-flow guidance. Management expects to fund near-term requirements with existing cash and marketable securities and indicates that cost reductions and equity or equity-linked compensation may be used if needed.
- Liquidity and covenant risk: Cash was only $3.9 million at quarter-end, working capital declined to $11.8 million, and certain facilities were subject to covenant breaches and on-demand repayment provisions.
- Operating losses: The company has a $696.9 million accumulated deficit and continues to generate substantial operating losses and negative operating cash flow.
- Customer concentration: Four customers represented 73.1% of Q3 revenue and 79.3% of nine-month revenue; three customers represented 55.6% of accounts receivable at quarter-end.
- Production and tax-credit dependence: Wow relies on Canadian refundable film and television tax credits, with $26.1 million recorded as receivable and collection generally taking 18 to 24 months.
- Asset valuation: Further impairments could result from weaker forecasts, market conditions or underperformance of content, goodwill and intangible assets.
- Warrant dilution and accounting volatility: Liability-classified warrants are remeasured through earnings and could create significant future gains or losses; exercise of outstanding warrants could materially dilute common shareholders.
- Internal controls: Management concluded that internal control over financial reporting was not effective as of September 30, 2023 because of material weaknesses involving segregation of duties, staffing, technical expertise, risk assessment, review controls and information-technology controls. Disclosure controls and procedures were concluded to be effective.
- Legal proceedings: A securities class-action appeal remained pending, along with related derivative actions and a Section 16(b) action. The company states that it cannot predict the outcomes or timing.
Investor verification checklist
- Verify the company’s post-quarter-end cash position, including the reported payoff of the margin loan and subsequent marketable-security sales.
- Assess whether covenant breaches have been waived, cured or could lead to repayment demands under the Canadian facilities.
- Review production backlog, project completion timing and the sustainability of Wow and Frederator revenue.
- Evaluate the collectability and timing of the $26.1 million tax-credit receivable.
- Quantify potential dilution from approximately 6.9 million outstanding warrants at September 30, 2023, including the newly issued $2.50 warrants and other equity awards.
- Monitor the effect of the authorized-share increase and the expected warrant reclassification on equity, earnings volatility and future financing capacity.
- Track remediation of the material weaknesses in internal control over financial reporting.
- Follow the securities class-action appeal and related derivative and Section 16(b) litigation for potential costs or contingencies.