Dolphin Entertainment, Inc. quarterly report, Q3 FY2019

Dolphin Entertainment, Inc. — Q3 2019 Form 10-Q

Reporting period: Three and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Dolphin provides entertainment publicity, marketing and creative production services through 42West, The Door and Viewpoint, and also develops and distributes film and digital content.

Financial performance and position

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Revenue	$5.95 million	$5.72 million	$18.55 million	$16.72 million
Operating loss	$1.41 million	$0.54 million	$3.44 million	$0.57 million
Net income (loss)	$(0.35) million	$0.18 million	$(1.12) million	$0.67 million
Basic earnings (loss) per share	$(0.02)	$0.01	$(0.07)	$0.05

• Revenue grew approximately 4% in Q3 and 11% for the nine-month period. Publicity and marketing generated 99.9% and 99.5% of revenue, respectively; content production contributed the remainder.
• Operating expenses were $7.36 million in Q3 and $21.99 million year to date. Direct costs rose substantially, including a $629,585 impairment of Max Steel production costs; payroll also increased. The filing does not present a gross-profit or gross-margin measure.
• Q3 net loss was partly offset by $1.06 million of net other income, including gains from the Max Steel debt discharge and the fair-value reduction in 42West put rights. For nine months, net other income was $2.32 million, including a $2.41 million put-rights fair-value gain. These gains are not equivalent to recurring operating earnings.
• Operating cash outflow was $2.15 million for the first nine months, versus $0.38 million in 2018; investing cash outflow was $0.06 million. Financing used $1.80 million, and cash, cash equivalents and restricted cash declined by $4.01 million.
• At September 30, cash and cash equivalents were $1.55 million, plus $0.71 million restricted cash. Current assets were $5.87 million and current liabilities $21.59 million, a $15.73 million working-capital deficit. Total assets were $37.61 million, liabilities $29.89 million and stockholders’ equity $7.72 million.
• The balance sheet included $6.67 million of lease liabilities and a $6.14 million right-of-use asset following adoption of lease accounting guidance. Management reported total debt of approximately $14.6 million, a figure that includes approximately $3.3 million of 42West put-right obligations; the filing’s debt categories and put liabilities should be distinguished when assessing indebtedness.

Material changes and developments

• Publicity and marketing revenue increased with the addition of The Door and Viewpoint, partly offset by lower 42West revenue following the departure of several publicists. Content-production revenue declined as Max Steel’s revenue lifecycle matured.
• On August 23, 2019, Dolphin agreed to assign up to $900,000 of future domestic Max Steel revenue to discharge a prints-and-advertising loan with a then-balance of about $713,000. It recorded a debt-extinguishment gain; future domestic revenue is available to Dolphin only above the agreed amount. The company also impaired the remaining $629,585 Max Steel production-cost balance.
• During the nine months, Dolphin issued $1.6 million of convertible notes for working capital and exchanged certain 42West put rights for common shares or a $702,500 convertible note. Put-right liabilities totaled $3.28 million at quarter-end.
• On October 21, 2019, Dolphin closed a public offering of 2.7 million shares at $0.78 per share, producing approximately $1.8 million net proceeds. It also reported a $500,000 convertible note issued October 11 and a $350,000 working-capital note issued November 5, both at 10% interest.

Outlook, risks and contingencies

• Going concern: The filing states that substantial doubt exists about Dolphin’s ability to continue as a going concern. It cites the working-capital deficit, accumulated deficit of $95.65 million, operating losses and dependence on new debt or equity financing and shareholder support. Without funding within 12 months, the company could be forced to liquidate. Additional equity or convertible securities could substantially dilute existing shareholders.
• Management described potential growth from cross-selling among its marketing businesses, expanding services, and future acquisitions, and expected digital-streaming marketing budgets to support growth. It also intends to finance and produce projects based on scripts it controls. These plans are uncertain; the filing provides no quantitative earnings or revenue guidance and gives no assurance of financing, acquisitions, production or anticipated synergies.
• Approximately $3.3 million of Max Steel production-service debt, including accrued interest, remained outstanding. The lender may foreclose on collateral tied to foreign distribution rights; Dolphin says the lender’s recourse is believed to be limited to that collateral, but a successful claim against the company could materially harm liquidity and results.
• A BankUnited line of credit with $1.70 million outstanding matures March 2020; the company reported covenant compliance at September 30, 2019. The $1.47 million Pinnacle convertible note was due January 2020 and had a 10% voluntary prepayment penalty plus warrant issuance provisions. Other notes and put obligations also require cash or could convert into shares.
• Nasdaq notified Dolphin on October 17, 2019 that its share price had been below the $1 minimum bid for 30 consecutive business days. The initial compliance deadline was April 14, 2020; delisting could impair liquidity and future financing access.
• Management concluded disclosure controls were not effective because previously reported material weaknesses in internal control had not been remediated. A Canadian lease-related litigation matter remained unresolved; possible loss was estimated at $0 to $325,000 and was not accrued because management considered a loss not probable.

Important facts for investors to verify

• Whether the October equity offering and subsequent borrowings provide sufficient liquidity, and the company’s remaining financing needs and dilution exposure.
• Near-term debt maturities, repayment terms, covenants, and the cash impact of 42West put rights and acquisition-related obligations.
• Whether recurring publicity and marketing operations can generate positive operating cash flow after the additions of The Door and Viewpoint.
• The status and potential recoveries of Max Steel domestic and international revenues, and any risk of foreclosure on foreign distribution rights.
• Progress toward Nasdaq’s minimum-bid compliance and remediation of the disclosed control weaknesses.
• Whether the reported fair-value gains, impairment, debt discharge and other unusual items distort comparisons with underlying operating performance.