Kartoon Studios, Inc. quarterly report, Q3 FY2022

Business Context and Reporting Period

Genius Brands International, Inc. (NASDAQ: GNUS), now operating under the Kartoon Studios brand, filed its unaudited Form 10-Q for the quarter and nine months ended September 30, 2022. The company develops, produces, distributes, licenses and advertises children’s entertainment content through Kartoon Channel!, Kartoon Channel! Kidaverse, Ameba TV, third-party platforms and consumer-products licensing. Reportable segments are Content Production & Distribution and Media Advisory & Advertising Services.

The period reflects the January 2022 acquisition of Ameba and the April 2022 acquisition of Wow Unlimited Media, including Mainframe Studios and Frederator Networks. The company also increased its ownership in Your Family Entertainment AG (YFE) to 48.0%.

Key Financial Metrics

Metric	Three months ended September 30, 2022	Three months ended September 30, 2021	Nine months ended September 30, 2022	Nine months ended September 30, 2021
Revenue	$19.7 million	$1.9 million	$43.2 million	$5.3 million
Loss from operations	$(5.4) million	$(9.8) million	$(24.0) million	$(24.1) million
Net loss attributable to the company	$(11.2) million	$(9.3) million	$(29.1) million	$(92.9) million
Loss per share, basic and diluted	$(0.04)	$(0.03)	$(0.09)	$(0.31)
Net cash used in operating activities	Not separately provided	Not separately provided	$(22.8) million	$(16.0) million

Revenue mix: Third-quarter production services revenue was $9.1 million, content distribution was $9.1 million, licensing and royalties were $0.3 million, and media advisory and advertising services were $1.2 million. Nine-month revenue was $19.1 million, $18.0 million, $2.8 million and $3.3 million, respectively.
Growth: Revenue increased 951% in the third quarter and 719% for the nine-month period, primarily because of the Wow and Ameba acquisitions and the resulting production, distribution and advertising activity.
Margins: Approximate operating margins were negative 27.6% for the quarter and negative 55.4% for the nine months. Approximate net margins attributable to the company were negative 57.0% and negative 67.3%, respectively.
Operating expenses: Third-quarter expenses were $25.1 million, including $13.9 million of direct operating costs and $10.4 million of general and administrative expense. Nine-month expenses were $67.2 million.
Other expense: Nine-month net other expense was $4.0 million, compared with $68.8 million in the prior-year period. The 2021 amount included a $69.1 million warrant incentive expense. Third-quarter 2022 other expense included a $4.1 million loss on YFE revaluation, $1.3 million of foreign-exchange losses and $0.8 million of interest expense.
Cash and investments: Cash and cash equivalents were $7.1 million at September 30, 2022, compared with $2.1 million at December 31, 2021. Available-for-sale marketable securities were $89.9 million, down from $112.5 million, with $7.7 million of unrealized losses at September 30, 2022.
Liquidity: Current assets were $143.6 million and current liabilities were $111.2 million, producing working capital of $32.4 million versus $115.1 million at year-end 2021.
Debt and obligations: Current liabilities included a $62.4 million margin loan, $19.3 million of production facilities financing and $2.1 million of bank indebtedness. Total contractual obligations were approximately $107.7 million, including $83.6 million of debt obligations.
Equity: Total stockholders’ equity was $128.5 million, including an accumulated deficit of $624.9 million. Shares outstanding increased to approximately 318.1 million from 303.4 million at December 31, 2021, primarily reflecting acquisition consideration, restricted stock vesting and other equity issuance.

Cash Flow and Material Changes

Operating cash use increased to $22.8 million from $16.0 million in the prior-year nine-month period.
Investing cash use was $37.4 million, principally reflecting $37.3 million paid for Wow, $3.9 million for Ameba and $9.5 million for additional YFE investment, partially offset by proceeds from marketable securities.
Financing activities provided $57.4 million, including $63.2 million of margin-loan borrowings, offset by $7.8 million of repayments and production-facility repayments.
Cash, cash equivalents and restricted cash decreased by $3.0 million during the nine months, ending at $7.1 million.
Production services and direct operating costs increased substantially following consolidation of Wow and Frederator. General and administrative expense also increased because of acquisition costs, professional fees, personnel costs and other integration-related expenses.
Film and television costs increased to $15.0 million from $2.9 million at year-end 2021, partly reflecting production of Shaq’s Garage. Intangible assets increased to $33.8 million and goodwill increased to $35.7 million, primarily from the acquisitions.

Outlook, Risks, Contingencies and Unusual Items

Management stated that cash, cash equivalents and available-for-sale securities were expected to be sufficient to support operations for at least the next twelve months; however, the company continues to generate operating losses and negative operating cash flow.
The margin loan is payable on demand and is collateralized by marketable securities. A margin call could materially reduce liquidity. The interest rate is variable and was based on the federal funds rate plus 0.65%.
Wow’s Canadian credit facilities and production financing are generally repayable on demand and secured by substantially all relevant tangible and intangible assets, tax credits, production contracts and license agreements.
The company recorded $26.4 million of Canadian tax-credit receivables. Collection can take 18 to 24 months and is subject to governmental review, eligibility determinations and audit risk.
Four customers represented 83% of third-quarter revenue and 74% of nine-month revenue, creating significant customer-concentration risk.
The company’s disclosure controls and procedures were determined to be ineffective for the nine months ended September 30, 2022. Management continued remediation efforts, including hiring additional accounting personnel.
Nasdaq granted the company an extension through February 27, 2023 to regain compliance with the $1.00 minimum bid-price requirement. Failure to regain compliance could result in delisting, subject to appeal rights.
The securities class action complaint was dismissed with prejudice, but plaintiffs appealed. Related derivative litigation remained stayed or unresolved, and the company could not predict outcomes. The Chizick employment and escrow disputes were settled and dismissed with prejudice in October 2022.
Acquisition accounting for Ameba and Wow remained preliminary, and final valuation of acquired intangible assets and related goodwill could change.
Management identified risks from foreign-currency movements, acquisition integration, marketable-security values, customer concentration, COVID-19 developments, continuing losses and the company’s ability to meet financing and listing requirements.

Investor Verification Checklist

Verify the sustainability and cash-conversion quality of the substantial revenue increase following the Wow and Ameba acquisitions.
Assess whether operating cash burn and recurring losses can be reduced before available liquidity or securities collateral becomes constrained.
Review margin-loan terms, collateral requirements, interest-rate exposure and potential margin-call scenarios.
Evaluate the collectability and timing of the $26.4 million tax-credit receivable.
Reconcile acquisition purchase-price allocations, goodwill and intangible-asset valuations when finalized.
Monitor customer concentration and revenue contribution from production services, content distribution, licensing and advertising.
Track remediation of ineffective disclosure controls and any subsequent restatements or control deficiencies.
Confirm Nasdaq minimum-bid-price compliance and the status of the securities appeal and related litigation.