GROM Grom Social Enterprises Inc

Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited)

Grom Social Enterprises, Inc. (the “Company”, “Grom” “we”, “us” or “our”), a Florida corporation f/k/a Illumination America, Inc. (“Illumination”), is a media, technology and entertainment company. The Company is focused on (i) delivering content to children under the age of 13 years in a safe secure platform that is compliant with the Children’s Online Privacy Protection Act (“COPPA”) and can be monitored by parents or guardians, (ii) creating, acquiring, and developing the commercial potential of Kids & Family entertainment properties and associated business opportunities, (iii) providing world class animation services, and (iv) offering protective web filtering solutions to block unwanted or inappropriate content.

The Company operates its business through the following five operating subsidiaries:

The Company owns 100% of each of Grom Social, TD Holdings, GES and GNS, and 80% of Curiosity. The Company is headquartered in Boca Raton, Florida with offices in Los Angeles, California; Salt Lake City, Utah; Norcross, Georgia; and Manila, Philippines.

The condensed consolidated financial statements of the Company have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. Based on current operating levels, the Company will need to raise additional funds by selling additional equity or incurring debt.

On a consolidated basis, the Company has incurred significant operating losses since its inception. As of March 31, 2023, The Company has an accumulated deficit of $85.8 million. During the three months ended March 31, 2023, it used approximately $2.2 million in cash for operating activities.

The Company has funded its operations primarily through sales of its common stock in public markets, proceeds from the exercise of warrants to purchase common stock, and the sale of convertible notes. Future capital requirements will depend on many factors, including the (i) rate of revenue growth, (ii) expansion of sales and marketing activities, (iii) timing and extent of spending on content development efforts, and (iv) market acceptance of the Company’s content, products and services.

The Company’s management intends to raise additional funds through the issuance of equity securities or debt to enable the Company to meet its obligations for the twelve-month period. However, there can be no assurance that, in the event the Company requires additional financing, such financing will be available at terms acceptable to the Company, if at all. Failure to generate sufficient cash flows from operations and/or raise additional capital could have a material adverse effect on the Company’s ability to achieve its intended business objectives. These factors raise substantial doubt about the Company’s ability to continue as a going concern for the twelve months from the date of this report.

The accompanying condensed consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

Impact of COVID-19

On January 30, 2020, the World Health Organization announced a global health emergency because of the spread of a new strain of the novel coronavirus (“COVID-19”). On March 11, 2020, the World Health Organization declared the outbreak of COVID-19, a global pandemic. COVID-19 has and continues to significantly affect the United States and global economies.

The Company experienced significant disruptions to its business and operations due to circumstances related to COVID-19, and delays caused government-imposed quarantines, office closings and travel restrictions, which affected both the Company’s and its service providers. The Company has significant operations in Manila, Philippines, which was locked down by the government on March 12, 2020 due to concerns related to the spread of COVID-19. As a result of the Philippines government’s call to contain COVID-19, the Company’s animation studio, located in Manila, Philippines, which accounts for approximately 88% of the Company’s total revenues on a consolidated basis, was forced to close its offices for significant periods of time from March 2020 through December 2021.

In response to the outbreak and business disruption, the Company instituted employee safety protocols to contain the spread, including domestic and international travel restrictions, work-from-home practices, extensive cleaning protocols, social distancing and various temporary closures of its administrative offices and production studio. The Company also implemented a range of actions aimed at temporarily reducing costs and preserving liquidity. In January 2022, the Company started to recall artists and employees to return to the studio. It is currently operating at 50% seat capacity.

The outbreak may continue to spread, which could materially impact the Company’s business. The full extent of potential impacts on the Company’s business, financing activities and the global economy will depend on future developments, which cannot be predicted due to the uncertain nature of the continued COVID-19 pandemic, government mandated shut downs, and its adverse effects, including new information which may emerge concerning the severity of COVID-19 and the actions to contain COVID-19 or treat its impact, among others. These effects could have a material adverse impact on the Company’s business, operations, financial condition and results of operations.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conjunction with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted. For the three months ended March 31, 2023, the condensed consolidated financial statements include the accounts of the Company and its operating subsidiaries Grom Social, TD Holdings, GES, GNS, and Curiosity. The Company recognizes noncontrolling interest related to its less-than-wholly-owned subsidiary, Curiosity, as equity in the consolidated financial statements separate from the parent entity’s equity. The net loss attributable to noncontrolling interest is included in net loss in the condensed consolidated statements of operations and comprehensive loss.

These condensed consolidated financial statements include all of the adjustments, which in the opinion of management are necessary for a fair presentation of financial position and results of operations. All such adjustments, which include intercompany balances and transactions are of a normal and recurring nature. Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto at December 31, 2022, as presented in the Company’s Annual Report on Form 10-K filed on April 17, 2023 with the SEC.

Certain amounts for the prior year period have been reclassified to conform to current year’s presentation.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The most significant estimates relate to revenue recognition, valuation of accounts receivable, goodwill and other long-lived assets, and contingencies. The Company bases its estimates on historical experience, known or expected trends and various other assumptions that are believed to be reasonable given the quality of information available as of the date of these financial statements. The results of these assumptions provide the basis for making estimates about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.

Update to Significant Accounting Policies

There have been no new or material changes to the significant accounting policies discussed in the Company’s audited financial statements in its Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the SEC on April 17, 2023, that are of significance, or potential significance, to the Company.

The Company recognizes revenue from contracts with customers in accordance with FASB ASC 606. The Company’s main types of revenue contracts consists of the following:

Animation Revenue

Animation revenue is primarily generated from contracts with customers for preproduction and production services related to the development of animated movies and television series. Preproduction activities include producing storyboards, location design, model and props design, background color and color styling. Production focuses on library creation, digital asset management, background layout scene assembly, posing, animation and aftereffects.

The Company provides services under fixed-price contracts. Under fixed-price contracts, the Company agrees to perform the specified work for a pre-determined price. To the extent actual costs vary from estimated costs, the Company’s profit may increase, decrease, or result in a loss.

Web Filtering Revenue

Web filtering revenue from subscription sales is recognized on a pro-rata basis over the subscription period. Typically, a subscriber purchases a computer appliance and a software and support service license for a period of use between one year to five years. The subscriber is billed in full at the time of the sale. The Company immediately recognizes revenue attributable to the computer appliance as it is non-refundable and control passes to the customer. The advanced billing component for software and service is initially recorded as deferred revenue and subsequently recognized as revenue on a straight-line basis over the subscription period.

Produced and Licensed Content Revenue

Produced and licensed content revenues are generated from the licensing of internally-produced films and episodic television programs.

Each individual film or television series episode delivered represents a separate performance obligation and revenues are recognized when the episode is made available to the licensee for exhibition. For license agreements containing multiple deliverables, revenues are allocated based on the relative standalone selling price of each film or episode of a television series, which is based on licenses for comparable films or series within the marketplace. Agreements to license programming are often long term, with collection terms ranging from one to five years.

The advanced billing component for licensed content is initially recorded as deferred revenue and subsequently recognized as revenue upon completion of the performance obligation in accordance with the terms of licensing agreement.

Publishing Revenue

The Company has engaged the services of a third-party entity to manage the printing, publishing and distribution of the Company’s publishing content. In accordance with the terms agreed with the third party, the Company’s revenue is recognized as 50% of revenue from sales per title after the third-party vendor earns back the costs to develop, author, publish, market, promote and distribute each title, inclusive of any royalties owed to rights holders, following a six month period in market to allow for returns.

Publishing revenues are eligible for recognition upon the completion of a six-month sales period to provide for any potential returns and notification from the third-party entity that it has earned back all of its related publishing costs.

Other Revenue

Other revenue corresponds to ecommerce sales, commercial services, and subscription and advertising revenue from the Grom Social mobile application.

The following table depicts the disaggregated revenue listed above within the Sales caption in the condensed consolidated statements of operations:

The following table sets forth the components of the Company’s accounts receivable and advanced payments and deferred revenues at March 31, 2023, and December 31, 2022:

During the three months ended March 31, 2023, the Company had three customers that accounted for 76.3% of revenues. During the three months ended March 31, 2022, the Company had three customers that accounted for 65.9% of revenues.

At March 31, 2023, the Company had three customers that accounted for 78.9% of accounts receivable. At December 31, 2022, the Company had two customers that accounted for 73.6% of accounts receivable.

Animation revenue contracts vary with movie contracts typically allowing for progress billings over the contract term while other episodic development activities are typically billable upon delivery of the performance obligation for an episode. These episodic activities typically create unbilled contract assets between episode delivery dates while movies can create contract assets or liabilities based on the progress of activities versus the arranged billing schedule. Revenues from web filtering contracts are all billed in advance and therefore represent contract liabilities until fully recognized on a ratable basis over the contract life.

Inventory consists of costs incurred to produce animated content for third party customers. Costs incurred to produce the animated content for customers, which include direct production costs, production overhead and supplies are recognized as work-in-progress inventory. As animated content is completed in accordance with the terms stated by the customer, inventory is classified as finished products and subsequently recognized as cost of services as animated content is accepted by and available to the customer. Carrying amounts of animated content are recorded at the lower of cost or net realizable value. Cost is determined using a weighted average cost method for direct production costs, productions overhead and supplies used for completing animation projects.

As of March 31, 2023 and December 31, 2022, the Company’s inventory totaled $99,070 and $92,303, respectively, and was comprised of work-in-progress of $85,830 and $85,324, and finished goods of $13,240 and $6,979, respectively.

For the three months ended March 31, 2023 and 2022, the Company recorded depreciation expense of $69,876 and $92,674, respectively.

Capitalized Website Development Costs

The Company capitalizes certain costs associated with the development of its Santa.com website after the preliminary project stage is complete and until the website is ready for its intended use. Planning and operating costs are expensed as incurred. Capitalization begins when the preliminary project stage is complete, project plan is defined, functionalities are determined and internal and external resources are identified. Qualified costs incurred during the operating stage of our software applications relating to upgrades and enhancements are capitalized to the extent it is probable that they will result in added functionality, while costs that cannot be separated between maintenance of, and minor upgrades and enhancements to the websites are expensed as incurred.

Capitalized website costs are amortized on a straight-line basis over their estimated useful life of three years beginning with the time when it is ready for intended use. Amounts amortized are presented through cost of sales. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

Prepublication Costs

Prepublication costs include costs incurred to create and develop the art, prepress, editorial, digital conversion and other content required for the creation of the master copy of a book or other media. Prepublication costs are amortized on a straight-line basis over a two- to five-year period based on expected future revenue. The Company regularly reviews the recoverability of the capitalized costs based on expected future revenues.

Produced and Licensed Content Costs

Produced and licensed content costs include capitalizable direct costs, production overhead, interest and development costs and are stated at the lower of cost, less accumulated amortization, or fair value. Marketing, distribution and general and administrative costs are expensed as incurred.

Film, television and direct to consumers through streaming services production and residual costs are expensed over the product life cycle based upon the ratio of the current period’s revenues to estimated remaining total revenues (Ultimate Revenues) for each production. For film productions and direct to consumer services, Ultimate Revenues include revenues from all sources that will be earned within ten years from the date of the initial release. For television series, Ultimate Revenues include revenues that will be earned within ten years from delivery of the first episode, or if still in production, five years from delivery of the most recent episode, if later. Costs of film, television and direct to consumer productions are subject to regular recoverability assessments, which compare the estimated fair values with the unamortized costs. The Company bases these fair value measurements on the Company’s assumptions about how market participants would price the assets at the balance sheet date, which may be different than the amounts ultimately realized in future periods. The amount by which the unamortized costs of film and television productions exceed their estimated fair values is written off. Costs for projects that have been abandoned are written off. Projects that have not been set for production within three years are also written off unless management has committed to a plan to proceed with the project and is actively working on and funding the project.

The following tables set forth the components of the Company’s capitalized costs at March 31, 2023 and December 31, 2022:

For the three months ended March 31, 2023 and 2022, the Company recorded amortization expense of $94,452 and $0, respectively.

The Company has entered into operating leases primarily for office space. These leases have original terms which range from two years to six years, and often include one or more options to renew or in the case of equipment rental, to purchase the equipment. During the three months ended March 31, 2023, the Company did not record any additional right of use (“ROU”) assets or lease liabilities related to new operating leases.

The future minimum payment obligations at March 31, 2023 for operating leases are as follows:

These operating leases are listed as separate line items on the Company's Consolidated Balance Sheets and represent the Company’s right to use the underlying asset for the lease term. The Company’s obligation to make lease payments are also listed as separate line items on the Company's Consolidated Balance Sheets.

Because the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments.

Information related to the Company's operating right-of-use assets and related lease liabilities are as follows:

For the three months ended March 31, 2023 and 2022, the Company recorded rent expenses related to lease obligations of $100,102 and $105,340, respectively. Rent expenses related to lease obligations are allocated between cost of goods sold and selling, general and administrative expenses in the Company’s condensed consolidated statement of operations.

Acquisition of Curiosity Ink Media, LLC

On July 29, 2021, the Company entered into a membership interest purchase agreement (the “Purchase Agreement”) with Curiosity Ink Media LLC, a Delaware limited liability company (“Curiosity”) and the holders of all of Curiosity’s outstanding membership interests (the “Sellers”), for the purchase of 80% of Curiosity’s outstanding membership interests (the “Purchased Interests”) from the Sellers (the “Acquisition).

On August 19, 2021, pursuant to the terms of the Purchase Agreement, the Company consummated the Acquisition and acquired the Purchased Interests in consideration for the issuance to the Sellers of an aggregate of 1,771,883 shares of the Company’s common stock to the Sellers, pro rata to their membership interests immediately prior to the closing of the Acquisition. The shares were valued at $2.82 per share which represents the 20-day volume-weighted average price of the Company’s common stock on August 19, 2021.

Pursuant to the Purchase Agreement, the Company also paid $400,000 and issued an 8% eighteen-month convertible promissory note in the principal amount $278,000 (the “Curiosity Note”) to pay-down and refinance certain outstanding loans and advances previously made to Curiosity by Russell Hicks and Brett Watts.

The Curiosity Note is convertible into shares of common stock of the Company at a conversion price of $3.28 per share but may not be converted if, after giving effect to such conversion, the noteholder and its affiliates would beneficially own in excess of 9.99% of the Company’s outstanding common stock. The Curiosity Note may be prepaid at any time, in whole or in part. The Curiosity Note is subordinate to the Company’s senior indebtedness.

The Sellers also have the ability to earn up to $17,500,000 (payable 50% in cash and 50% in stock) upon the achievement of certain performance milestones as of December 31, 2025.

In addition to the tangible assets, goodwill totaling $14,271,969 was recorded in connection with the acquisition. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents potential future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Goodwill is not expected to be deductible for tax purposes.

The amounts in the table below represent the allocation of the purchase price. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

During the year ended December 31, 2022, the Company finalized the purchase price allocation, during the permissible measurement period, and obtained new fair value information for certain identifiable intangible assets related to its acquisition of Curiosity. The revised purchase price allocation decreased goodwill by $468,426 and increased intangible assets by $468,426. These adjustments did not have a significant impact on the Company’s consolidated financial statements.

The following table summarizes the individually identifiable intangible assets subsequently recognized: 

Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the Company’s acquisitions is attributable to the value of the potential expanded market opportunity with new customers.

At March 31, 2023 and December 31, 2022, the carrying amount of the Company’s goodwill was $10,567,484.

The following table sets forth the components of the Company’s intangible assets at March 31, 2023 and December 31, 2022:

For the three months ended March 31, 2023 and 2022, the Company recorded amortization expense of $42,505 and $38,157, respectively.

The following table provides information regarding estimated remaining amortization expense for intangible assets subject to amortization for each of the following years ending December 31:

Darren Marks’s Family

The Company has engaged the family of Darren Marks, its Chief Executive Officer, to assist in the development of the Grom Social mobile app. These individuals create and produce original short form content focusing on social responsibility, anti-bullying, digital citizenship, unique blogs, and special events. Sarah Marks, the wife of Mr. Marks, and Zach Marks, Luke Marks, Jack Marks, Dawson Marks, Caroline Marks and Victoria Marks, each Mr. Marks’s children, are, or have been, employed by or independently contracted with the Company.

As of March 31, 2023, Zach and Luke Marks were employed by Grom Social as its Founder and Content Creator, and Content Coordinator, respectively, and receive annual salaries of $103,000 and $30,000, respectively.

For the three months ended March 31, 2023 and 2022, the Marks family was paid a total of $33,250 and $30,000, respectively.

Compensation for services provided by members of the Marks family is expected to continue for the foreseeable future.

Liabilities Due to Executive Officers and Directors

On July 11, 2018, our director Dr. Thomas Rutherford loaned the Company $50,000. The loan bears interest at a rate of 10% per annum and was due on August 11, 2018. No notice of default or demand for payment has been received by the Company. During the three months ended March 31, 2023 and 2022, the Company recorded interest expense of $1,233, respectively.

As of March 31, 2023 and December 31, 2022, the aggregate related party payables balance was $73,616 and $72,383, respectively, of which $23,616 and $22,383 of accrued interest were reported under accrued liabilities on the Company’s consolidated balance sheets.

The Company’s subsidiary, Top Draw Animation, has an unfunded, non-contributory defined benefit plan covering its permanent employees.

Under the existing regulatory framework, the Company is required to pay eligible employees at least the minimum regulatory benefit upon retirement, which provides a retirement benefit equal to 22.5 days’ pay for every year of credited service, subject to age and service requirements. The regulatory benefit is paid in a lump sum upon retirement. The existing regulatory framework does not require minimum funding of the plan.

Retirement benefit expenses and liabilities are determined in accordance with an actuarial study made for the plan utilizing the net interest approach which disaggregates the defined benefit cost into the following components: service costs (cost of services received); net interest (financing effect of paying for benefits in advance or in arrears); and remeasurements (period-to-period fluctuations in the amounts of defined benefit obligations and plan assets).

Under the net interest approach, service cost and net interest on the defined benefit liability (asset) are both recognized in the statement of operations, while remeasurements of the defined benefit liability (asset) are recognized in other comprehensive income. Remeasurements recognized in other comprehensive income shall not be reclassified to profit or loss in a subsequent period.

The amount of the defined benefit liability reported under other noncurrent liabilities in the consolidated balance sheet is determined as follows:

The components of the accumulated benefit cost to be recognized under selling, general and administrative expense in consolidated statement of operations are the service cost (current service cost, past service cost or credit and settlement gains or losses) and net interest expense on the net defined benefit liability:

The change in the accumulated benefit cost in the consolidated balance sheet for the three months ended March 31, 2023 is as follows:

The cumulative amount of actuarial gains recognized in other comprehensive income for the three months ended March 31, 2023 and 2022 is as follows:

The assumptions used to determine retirement benefits for the three months ended March 31, 2023 are as follows:

8% Unsecured Convertible Notes – Curiosity

On July 29, 2021, the Company entered into a membership interest purchase agreement with Curiosity and the holders of all of Curiosity’s outstanding membership interests, for the purchase of 80% of Curiosity’s outstanding membership interests from the sellers. Pursuant to the purchase agreement, the Company issued 8% eighteen-month convertible promissory notes in the aggregate principal amount $278,000 to pay-down and refinance certain outstanding loans and advances previously made by certain of its principals. The notes are convertible into shares of common stock of the Company at a conversion price of $98.40 per share but may not be converted if, after giving effect to such conversion, the noteholder and its affiliates would beneficially own in excess of 9.99% of the Company’s outstanding common stock. The notes may be prepaid at any time, in whole or in part. The notes are subordinate to the Company’s senior indebtedness. 

As of March 31, 2023, the principal balance of the Curiosity note was $278,000.

10% Senior Secured Convertible Note with Original Issuance Discount (L1)

On September 14, 2021, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with L1 Capital Global Master Fund (“L1”) pursuant to which it issued (i) a 10% original issue discount senior secured convertible note in the principal amount of $4,400,000 to L1 (the “L1 Note”) and (ii) a 5 five-year warrant to purchase 27,109 shares of the Company’s common stock at an exercise price of $126.00 per share (“Warrant Shares”) in exchange for $3,960,000 (the “First Tranche Financing”). The Purchase Agreement also provided, subject to shareholder approval, for the issuance, subject to certain conditions, of an additional $1,500,000 of notes and warrants to purchase 9,259 shares of common stock (the “Second Tranche Financing”) on the same terms.

On October 20, 2021, the Company and L1 entered into an amended and restated purchase agreement which increased the amount of the Second Tranche Financing from $1,500,000 to $6,000,000 and provides (i) for an amended and restated 10% original issue discount senior secured convertible note to be issued in exchange for the L1 Note pursuant to the Purchase Agreement and (ii) for the issuance of a five-year warrant to purchase 34,706 shares of the Company’s common stock at an exercise price of $126.00 per share.

During the three months ended March 31, 2022, the Company issued an aggregate 191,192 shares of common stock to L1 upon the conversion of $4,125,000 of outstanding principal.

As of March 31, 2023, the principal balance of L1 Note was $0 and all associated loan discounts were fully amortized.

10% Senior Secured Convertible Note with Original Issuance Discount (L1– Second Tranche)

On January 20, 2022 (the “Second Tranche Closing”), the Company and LI Capital closed on the Second Tranche of the offering, resulting in the issuance of (i) a $1,750,000 10% Original Issue Discount Senior Secured Convertible Note, due July 20, 2023, (the “Second Tranche Note”); and (ii) a five year warrant to purchase 10,123 shares of Common Stock of the Company at an exercise price of $126.00 per share (the “Second Tranche Warrants”), in exchange for consideration of $1,575,000 (i.e. the face amount less the 10% Original Issue Discount of $175,000).

In connection with the Second Tranche Closing, the Company paid to EF Hutton a fee of $126,000.

The Second Tranche Note is convertible into common stock of the Company at a rate of $126.00 per share (the “Conversion Price”) into 13,889 shares of common stock (the “Second Tranche Conversion Shares”) and, is repayable in equal monthly installments of $111,563 commencing on the date that the SEC declares a registration statement with respect to the resale of such shares effective, with all remaining amounts due on July 20, 2023. The Second Tranche Note is repayable by payment of cash, or, at the discretion of the Company and if the below listed “Equity Conditions” are met, by issuance of shares of the common stock at a price of 95% of the lowest daily VWAP during the ten-trading day period prior to the respective monthly redemption dates (with a floor of $57.60) multiplied by 102% of the amount due on such date. In the event that the ten-trading day VWAP drops below $57.60 the Company will have the right to pay in stock at such ten-trading day VWAP with any shortfall paid in cash. The Conversion Price may be adjusted in the event of dilutive issuances but in no event to less than $16.20 (the “Monthly Conversion Price”).

The Company’s right to make monthly payments in stock in lieu of cash for the Second Tranche Note is conditioned on certain conditions (the “Equity Conditions”). The Equity Conditions required to be met each month in order to redeem the Second Tranche Note with stock in lieu of a monthly cash payment, among other conditions set forth therein, include without limitation, that a registration statement be in effect with respect to the resale of the shares issuable upon conversion or redemption of the Second Tranche Note (or, that an exemption under Rule 144 is available), that no default be in effect, that the average daily trading volume of the Company’s common stock would have to be at least $550,000 during the five trading days prior to the respective monthly redemption and that the outstanding principal amounts of the First Tranche Note and Second Tranche Note combined, shall not exceed 30% of the market capitalization of the Company’s Common Stock as reported on Bloomberg L.P., which percentage is subject to increase by LI Capital at its sole discretion.

Other provisions of the Second Tranche Note, which is similar in terms to the First Tranche Note, include that the Second Tranche Note Conversion Price is subject to full anti-dilution price protections in the event of financings that are below the Conversion Price with a floor of $16.20.

In the event of an Event of Default as defined in the notes, if the stock price is below the Conversion Price at the time of default and only for so long as a default is continuing, the Second Tranche Notes would be convertible at a rate of 80% of the lowest VWAP in the ten prior trading days, provided, that if the default is cured the default conversion rate elevates back to the normal Conversion Price

As part of the Second Tranche Closing, the Company issued Second Tranche Warrants exercisable for five years from the date of issuance, at $126.00 per share which carry the same anti-dilution protection as the Second Tranche Notes, subject to the same adjustment floor. The Second Tranche Warrants are exercisable via cashless exercise only for so long as no registration statement covering resale of the shares is in effect.

The Second Tranche Note continues to be subject to (i) the repayment and performance guarantees by the subsidiaries of the Company pursuant to a subsidiary guaranty and, (ii) the Security Agreement pursuant to which the LI Capital was granted a security interest in all of the assets of the Company and certain of its subsidiaries, each as entered into in connection with the First Tranche closing on September 14, 2021.

During the year ended December 31, 2022, the Company issued an aggregate 108,025 shares of common stock and repaid $1,146,901 in cash to L1 upon the conversion of $1,750,000 of outstanding principal.

As of March 31, 2023, the principal balance of the Second Tranche Notes was $0 and all associated loan discounts were fully amortized.

10% Secured Convertible Notes with Original Issuance Discounts (“OID Notes”)

During the year ended December 31, 2017, the Company issued a series of secured, convertible notes with original issuance discounts to accredited investors. The notes were issued with original issuance discounts of 10.0%, bear interest at a rate of 10% per annum (payable semiannually in cash), and carry a two-year term with a fixed conversion price of $748.80. As of March 31, 2023, the remaining principal balance of these notes was $25,000.

During the year ended December 31, 2018, the Company issued a series of secured, convertible notes with original issuance discounts to accredited investors. The notes were issued with original issuance discounts of 20.0%, bear interest at a rate of 10% per annum (payable semiannually in cash), and carry a two-year term with a fixed conversion price of $480.00. As of March 31, 2023, the remaining principal balance of these notes was $50,000.

As of March 31, 2023, the aggregate principal balance of these notes was $75,000 and all associated loan discounts were fully amortized. No notices of default or demands for payment have been received by the Company.

12% Senior Secured Convertible Notes (“TDH Secured Notes”)

On March 16, 2020, the Company sold (the “TDH Secured Notes Offering”) an aggregate $3,000,000 of its 12% senior secured convertible notes (the “TDH Secured Notes”), to eleven accredited investors (the “TDH Secured Note Lenders”), pursuant to a subscription agreement with the TDH Secured Note Lenders. Interest on the TDH Secured Notes accrues on the outstanding principal amount at the rate of 12% per annum. Principal and interest on the TDH Secured Notes are payable monthly, on an amortized basis over 48 months, with the last payment due on March 16, 2024. Pursuant to the TDH Secured Notes, TD Holdings will pay amounts due under the TDH Secured Notes. Prepayment of amounts due under TDH Secured Notes is subject to a prepayment penalty in an amount equal to 4% of the amount prepaid.

The TDH Secured Notes are convertible at the option of the holders at 75% of the average sales price of the Company’s common stock over the 60 trading days immediately preceding conversion provided that the conversion price shall not be less than $96.00 per share.

The Company’s obligations under the TDH Secured Notes, are secured by Grom Holdings’ shares of stock of TDH, and of its wholly owned subsidiary, TDAHK. The TDH Secured Notes rank equally and ratably on a pari passu basis with (i) the other TDH Secured Notes and (ii) the Original TDH Notes issued by the Company pursuant to TDH Share Sale Agreement.

If the Company sells the animation studio located in Manila, Philippines, which is currently owned by TDH through TDAHK (the “Animation Studio”), for more than $12,000,000, and so long as any amount of principal is outstanding under the TDH Secured Notes, the Company will pay the TDH Secured Notes holders from the proceeds of the sale (i) all amounts of principal outstanding under the TDH Secured Notes, (ii) such amount of interest which would be due and payable assuming the TDH Secured Notes were held to maturity (minus any amounts of interest previously paid hereunder), and (iii) an additional 10% of the amount of principal outstanding under the TDH Secured Notes within five days of the closing of such sale.

In connection with the issuance of the TDH Secured Notes, the Company issued to each TDH Secured Note holder shares of common stock equal to 20% of the principal amount of such holder’s TDH Secured Note, divided by $96.00. Accordingly, an aggregate of 6,250 shares of common stock were issued to the TDH Secured Note holders on March 16, 2020. These shares were valued at $420,000, or $67.20 per share, which represents fair market value. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the notes.

As of March 31, 2023, the principal balance of the TDH Secured Notes was $171,219 and the remaining balance on the associated loan discounts was $16,771.

12% Senior Secured Convertible Notes (Additional Secured Notes)

On March 16, 2020, the Company issued to seven accredited investors (the “Additional Secured Note Lenders”) an aggregate of $1,060,000 of its 12% senior secured convertible notes (the “Additional Secured Notes”) in a private offering pursuant to a subscription agreement with substantially the same terms as the TDH Secured Notes except that the Additional Secured Notes are secured by all of the assets of the Company other than the shares and other assets of TDH and TDAHK, pursuant to a security agreement by and among the Company and the Additional Secured Note Lenders.

Interest on the Additional Secured Notes accrues on the outstanding principal amount at the rate of 12% per annum. Principal and interest on the Additional Secured Notes are payable monthly, on an amortized basis over 48 months, with the last payment due on March 16, 2024. Prepayment of the amounts due under the Additional Secured Notes is subject to a prepayment penalty of 4% of the amount prepaid.

The Additional Secured Notes are convertible at the option of the holders at 75% of the average sales price of the Company’s common stock over the 60 trading days immediately preceding conversion provided that the conversion price shall not be less than $96.00 per share.

In connection with the issuance of the Additional Secured Notes, the Company issued to each Additional Secured Note Lender shares of common stock equal to 20% of the principal amount of such holder’s Additional Secured Note, divided by $96.00. Accordingly, an aggregate of 2,208 shares of common stock were issued. These shares were valued at $148,000, or $67.20 per share, which represents fair market value. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the related convertible notes.

As of March 31, 2023, the principal balance of the Additional Secured Notes was $32,518 and the remaining balance on the associated loan discounts was $3,186.

In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon currently known facts and circumstances and applies that rate to its year-to-date earnings or losses. The Company’s effective tax rate is based on expected income and statutory tax rates and takes into consideration permanent differences between financial statement and tax return income applicable to the Company in the various jurisdictions in which the Company operates. The effect of discrete items, such as changes in estimates, changes in rates or tax status, and unusual or infrequently occurring events, is recognized in the interim period in which the discrete item occurs. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the result of new judicial interpretations or regulatory or tax law changes.

The Company’s interim effective tax rate, inclusive of discrete items, for the three-month periods ended March 31, 2023 and 2022 was 0%, respectively, due to recurrent net losses for the periods presented.

Preferred Stock

The Company is authorized to issue 25,000,000 shares of preferred stock, par value of $0.001 per share.

Series A Preferred Stock

As of March 31, 2023 and December 31, 2022, the Company had no shares of Series A Stock issued and outstanding.

Series B Preferred Stock

As of March 31, 2023 and December 31, 2022, the Company had no shares of Series B Stock issued and outstanding, respectively.

Series C Preferred Stock

On May 20, 2021, the Company filed with the Secretary of State of the State of Florida a Certificate of Designation of Preferences, Rights and Limitations of Series C Stock designating 10,000,000 shares as Series C Preferred Stock (the “Series C Stock”). The Series C Stock ranks senior and prior to all other classes or series of the Company’s preferred stock and common stock.

The holder may, at any time after the 6-month anniversary of the issuance of the shares of Series C Preferred Stock, convert such shares into common stock at a conversion rate of $57.60 per share. In addition, the Company may, at any time after the issuance of the shares, convert any or all of the outstanding shares of Series C Preferred Stock at a conversion rate of $57.60 per share.

Each share of Series C Stock entitles the holder to 1.5625 votes for each share of Series C Stock. The consent of the holders of at least two-thirds of the shares of Series C Stock is required for the amendment to any of the terms of the Series C Stock, to create any additional class of stock unless the stock ranks junior to the Series C Stock, to make any distribution or dividend on any securities ranking junior to the Series C Stock, to merge or sell all or substantially all of the assets of the Company or acquire another business or effectuate any liquidation of the Company.

Cumulative dividends accrue on each share of Series C Stock at the rate of 8% per annum of the stated value of $1.00 per share and are payable in arrears quarterly commencing 90 days from issuance. The dividend shall be payable in shares of common stock (a “PIK Dividend”) and are be due and payable on the date on which such PIK Dividend was declared.

Upon a liquidation, dissolution or winding up of the Company, the holders of the Series C Stock are entitled to $1.00 per share plus all accrued and unpaid dividends. No distribution may be made to holders of shares of capital stock ranking junior to the Series C Stock upon a liquidation until Series C stockholders receive their liquidation preference. The holders of 66 2/3% of the then outstanding shares of Series C Stock, may elect to deem a merger, reorganization or consolidation of the Company into or with another corporation, not affiliated with said majority, or other similar transaction or series of related transactions in which more than 50% of the voting power of the Company is disposed of in exchange for property, rights or securities distributed to holders thereof by the acquiring person, firm or other entity, or the sale of all or substantially all of the assets of the Company.

On January 24, 2022, the Company issued 686 shares of common stock to a stockholder upon the conversion of 39,500 shares of Series C preferred stock.

As of March 31, 2023 and December 31, 2022, the Company had 9,281,809 shares of Series C Stock issued and outstanding, respectively.

For the three months ended March 31, 2023, the Company declared cumulative dividends totaling $185,636 for amounts accrued on its Series C Stock.

Common Stock

The Company is authorized to issue 500,000,000 shares of common stock, par value of $0.001 per share and had 7,339,677 and 2,514,858 shares of common stock issued and outstanding as of March 31, 2023 and December 31, 2022, respectively.

Reverse Stock Split

On October 4, 2022, the Board and shareholders approved the granting of authority to the Board to amend the Company’s articles of incorporation to effect a reverse stock split of the issued and outstanding shares of its common stock, by a ratio of no less than 1-for-2 and no more than 1-for-30, with the exact ratio to be determined by the Board in its sole discretion, and with such reverse stock split to be effective at such time and date, if at all, as determined by the Board in its sole discretion. On December 9, 2022, the Board effected a 1-for-30 reverse stock split in connection with the Company’s continued listing of its common stock on Nasdaq.

PIPE Offering and Related Waiver

On January 25, 2023, the Company consummated a private investment in public equity financing (the “PIPE Offering”) pursuant to the terms of the Securities Purchase Agreement, dated January 25, 2023, as amended (the “2023 SPA”), by and between it and the purchaser named therein (the “2023 SPA Selling Stockholder”) and issued (i) 100,000 shares of common stock; (ii) 1,327,434 warrants (the “Purchase Warrants”) to purchase an aggregate of 2,323,010 shares of common stock; and (iii) 1,227,434 prefunded warrants (the “Pre-Funded Warrants,” and together with the Purchase Warrants, the “Warrants”) to purchase an aggregate of 1,227,434 shares of common stock. The purchase price of each share of common stock and associated Purchase Warrant was $2.26. The purchase of each Pre-Funded Warrant and associated Purchase Warrant was $2.25. The aggregate gross proceeds of the PIPE Offering was approximately $3.0 million, before deducting fees to the placement agent and other expenses payable by the Company. EF Hutton, division of Benchmark Investments, LLC, acted as the exclusive placement agent in connection with the PIPE Offering.

In connection with the PIPE Offering, the Company entered into a waiver agreement (the “Waiver”) with L1 Capital Global Opportunities Master Fund (“L1”) waiving certain provisions of the Securities Purchase Agreement, dated as of September 14, 2021 (the “2021 SPA”), by and between it and L1. Pursuant to the terms of the Waiver, L1 waived certain provisions of the 2021 SPA and in consideration thereof, the Company (i) issued 150,000 purchase warrants substantially similar to the Purchase Warrants issued in connection with the 2023 SPA; and (ii) paid a cash fee of $50,000 to L1.

The Purchase Warrants are immediately exercisable for $2.26 per share of common stock, subject to certain adjustments, including with respect to stock dividends, splits, subsequent rights offerings, pro rata distributions and a Fundamental Transaction (as defined in the purchase warrant agreement (the “Purchase Warrant Agreement”)), until the fifth anniversary of the original issuance date (the “Expiration Date”). The Prefunded Warrants are immediately exercisable for $0.01 per share of common stock, subject to certain adjustments, including with respect to stock dividends, splits, subsequent rights offerings, pro rata distributions and a Fundamental Transaction (as defined in the Prefunded Warrant), until all of the Prefunded Warrants are exercised in full. The exercise of the Warrants is subject to beneficial ownership limitations.

Pursuant to the 2023 SPA, the Company is obligated to hold a special stockholders’ meeting no later than 60 days following the date of the 2023 SPA to solicit the approval of the issuance of the shares of common stock, Warrants and the shares of common stock underlying the Warrants in compliance with the rules of the Nasdaq Stock Market (without regard to any limitations on exercise set forth in the Purchase Warrant Agreement or the prefunded warrant agreement (the “Prefunded Warrant Agreement”). On March 27, 2023, the Company held a virtual special meeting of stockholders, and at the meeting, the issuance of the securities in compliance with the rules of the Nasdaq Stock Market has been approved.

In connection with the PIPE Offering, the Company entered into a Registration Rights Agreement with the Purchasers, dated January 25, 2023 (the “Registration Rights Agreement”). The Registration Rights Agreement provides that we shall file a registration statement covering the resale of all of the Registrable Securities (as defined in the Registration Rights Agreement) with the SEC no later than the 7th calendar day following the date of the Registration Rights Agreement, and have the registration statement declared effective by the SEC as promptly as possible after the filing thereof, but in any event no later than the 30th calendar day following the date of the Registration Rights Agreement, or in the event of a “full review” by the SEC, the 45th day following the date of the Registration Rights Agreement. On February 2, 2023, the Company filed the registration statement, and on February 9, 2023, the registration statement was declared effective by the SEC.

Common Stock Issued in Exchange for Consulting, Professional and Other Services

During the three months ended March 31, 2023, the Company issued 23,334 shares of common stock with a fair market value of $31,968 to contractors for services rendered.

During the three months ended March 31, 2022, the Company issued 2,486 shares of common stock with a fair market value of $76,822 to contractors for services rendered.

Common Stock Issued in Connection with the Conversion of Note Principal and Accrued Interest

During the three months ended March 31 2022, the Company issued 191,192 shares of common stock upon the conversion of $4,125,000 in note principal and accrued interest.

Common Stock Issued in Connection with Series C Stock Dividends

During the three months ended March 31, 2022, the Company issued 5,842 shares of common stock valued at $459,068 for cumulative dividends declared as of December 31, 2021 on its Series C Stock.

Stock Purchase Warrants

Stock purchase warrants are accounted for as equity in accordance with ASC 480, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, Distinguishing Liabilities from Equity.

The following table reflects all outstanding and exercisable warrants at March 31, 2023 and December 31, 2022. All warrants are exercisable for a period of three to five years from the date of issuance:

On January 31, 2023, in connection with the PIPE Offering described above, the Company issued 1,327,434 Purchase Warrants to purchase an aggregate of 2,323,010 shares of common stock. The Purchase Warrants are immediately exercisable for $2.26 per share of common stock. The Purchase Warrant holders may also effect an alternative cashless exercise on or after the later of (i) the 30 day anniversary of the initial exercise date and (ii) the stockholder approval date (as defined in the 2023 SPA). In such event, the aggregate number of shares of common stock issuable in such alternative cashless exercise shall equal the product of the aggregate number of shares of common stock that would be issuable upon exercise of the Purchase Warrants and 0.85.

The Purchase Warrants were valued using the Black-Scholes option pricing model with the following average assumptions: the Company’s stock price on the date of the issuance ($2.15), an expected dividend yield of 0%, a historical volatility of 176.6%, a risk-free interest rate of 3.6%, and an expected term of one year. The Purchase Warrants were allocated a relative fair value of $1,387,429.

On January 31, 2023, the Company also issued 150,000 purchase warrants, substantially similar to the Purchase Warrants issued in connection with the PIPE Offering, to purchase an aggregate of 262,500 shares of common stock. The Purchase Warrants were valued using the Black-Scholes option pricing model with the following average assumptions: the Company’s stock price on the date of the issuance ($2.15), an expected dividend yield of 0%, a historical volatility of 176.6%, a risk-free interest rate of 3.6%, and an expected term of 1 year. The fair value of the purchase warrants was $350,039.

During the three months ended March 31, 2023, the Company issued 1,262,787 shares of common stock upon the exercise of 1,262,787 prefunded warrants for gross proceeds of $12,309.

During the three months ended March 31, 2023, the Company also issued 3,438,698 shares of common stock upon the cashless exercise of 4,507,592 purchase warrants.

As of March 31, 2023, the outstanding stock purchase warrants had an aggregate intrinsic value of $0.

During the three months ended March 31, 2023 and 2022, the Company recorded $44,822 and $48,142, respectively, in stock-based compensation costs related to stock options.

As of March 31, 2023, the total unrecognized cost of stock-based compensation related to stock options was $124,130. This cost is expected to be recognized over a weighted average period of 1.3 years.

As of March 31, 2023, the outstanding stock options had an aggregate intrinsic value of $0.

In the ordinary course of business, the Company and its subsidiaries are subject to various pending and potential legal actions, arbitration proceedings, claims, investigations, examinations, regulatory proceedings, information gathering requests, subpoenas, inquiries and matters relating to compliance with laws and regulations (collectively, legal proceedings).

Based on the Company’s current knowledge, and taking into consideration its legal expenses, the Company does not believe it is a party to, nor are any of its subsidiaries the subject of, any legal proceeding that would have a material adverse effect on the Company’s consolidated financial condition or liquidity.

See also Note 8 (“Leases”).

See also Note 9 (“Business Combinations”).

See also Note 15 (“Income Taxes”).

On April 14, 2023, the Company issued 493,000 shares of common stock upon the cashless exercise of 580,000 purchase warrants.

On April 21, 2023, the Company repaid $50,000 of note principal to Dr. Thomas Rutherford, one of its directors.

On April 26, 2023, the Company issued 223,125 shares of common stock upon the cashless exercise of 262,500 purchase warrants.

On April 28, 2023, the Company issued 493,000 shares of common stock upon the cashless exercise of 580,000 purchase warrants.