Kartoon Studios, Inc. (formerly Genius Brands International, Inc.) — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period ended March 31, 2018. The filing was signed May 15, 2019. The company develops, distributes, and licenses children’s multimedia content and related consumer products, including Rainbow Rangers, Llama Llama, Baby Genius, and Thomas Edison’s Secret Lab.
Financial highlights
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $1.221 million | $0.093 million | +$1.128 million; +1,210% |
| Loss from operations | $(1.250) million | $(1.263) million | Improved by $0.013 million |
| Net loss | $(5.007) million | $(1.263) million | Loss increased by $3.744 million |
| Net loss applicable to common shareholders | $(5.330) million | $(1.263) million | Loss increased by $4.066 million |
| Basic and diluted loss per share | $(0.54) | $(0.18) | Higher loss per share |
| Cash used in operating activities | $(1.213) million | $(1.214) million | Essentially unchanged |
| Cash, cash equivalents, and restricted cash | $4.030 million | $6.223 million | Lower year over year |
Revenue and margins
- Television and home entertainment revenue was $850,107, compared with $66,812, primarily from delivery of Rainbow Rangers to Viacom Media Network.
- Licensing and royalty revenue was $350,186, compared with $3,754, primarily from Rainbow Rangers and Llama Llama.
- Advertising revenue declined 8% to $20,160; product sales were $478.
- Operating expenses were $2.471 million, including $740,055 of direct operating costs and $1.650 million of general and administrative expense.
- The operating margin was approximately negative 102% of revenue, and the net margin was approximately negative 410%. The filing does not present a conventional gross margin.
- Direct operating costs increased substantially because of film and television amortization of $429,183 and participation expense of $289,333, largely associated with increased Rainbow Rangers revenue.
Liquidity, debt, and balance sheet
- Current assets were $6.267 million versus current liabilities of $8.945 million, resulting in negative working capital of $2.678 million, compared with positive working capital of $0.972 million at December 31, 2018.
- Cash and cash equivalents were $3.629 million, and restricted cash was $401,086. Restricted cash is dedicated to production of Llama Llama.
- The company had $4.500 million of senior secured convertible notes classified as current liabilities. The notes bear 10% interest, mature August 20, 2019, and are convertible at $2.50 per share. If equity conditions are not met at maturity, cash repayment is required in monthly installments over six months.
- Net production-facility borrowings were $2.633 million at March 31, 2019, compared with $2.178 million at year-end 2018. The facility matures March 31, 2021, with reported interest rates of 5.75% to 6.14%.
- Total liabilities increased to $16.783 million from $11.762 million at December 31, 2018. Stockholders’ equity declined to $10.768 million from $12.840 million.
- Deferred revenue totaled $4.487 million, including advances and minimum guarantees that will be recognized when contractual revenue-recognition criteria are met.
Material changes versus the prior comparable period
- Revenue increased more than twelvefold, driven by television distribution and licensing of newer properties.
- Despite the revenue increase, operating loss remained broadly unchanged because direct operating costs and general and administrative expenses increased.
- Net loss worsened primarily because of a $3.352 million loss on extinguishment of debt, $529,202 of interest expense, and a $322,240 beneficial conversion feature related to the Series A convertible preferred stock.
- Interest expense increased from $273 to $529,202 due to the secured convertible notes, debt discount amortization, and production-loan interest.
- Cash from financing activities was $2.163 million, compared with a $36,983 use of cash in Q1 2018, reflecting $1.758 million of net equity-offering proceeds and $454,628 of net production-loan borrowings.
- On February 19, 2019, the company sold 945,894 common shares and related warrants for $1.758 million of net proceeds. It also issued additional warrants and amended the secured-note agreements.
- Common shares outstanding increased to 10,432,718 from 9,457,859 at December 31, 2018. Warrants outstanding increased to 9,591,177 from 5,899,389.
- Adoption of the new lease standard added a right-of-use asset of $1.977 million and lease liabilities totaling approximately $2.023 million at March 31, 2019.
Outlook, risks, contingencies, and unusual items
- Management stated that cash balances, working capital, the production facility, and the deal pipeline were expected to fund operations for the next twelve months, but warned that continued improvement in operating cash flow was not assured.
- If profitable operations and positive operating cash flow are not achieved, management may need additional financing, reduced development or production activity, or other operating reductions.
- Two customers accounted for 78% of Q1 revenue and 28% of accounts receivable, creating significant customer-concentration risk.
- The company had $3.169 million of uninsured cash deposits at March 31, 2019.
- Capitalized film and television costs were $8.397 million, including production and development costs for Rainbow Rangers season one and Llama Llama season two. Recoverability depends on future distribution and licensing revenue.
- The company disclosed a $925,000 disputed trade payable assumed in the 2013 merger. Management believes the liability is not owed and that the applicable statute of limitations has expired.
- Disclosure controls and procedures were reported ineffective for the quarter. Management identified a potential material weakness involving the timely accounting evaluation of warrants issued with convertible notes and stated that remediation efforts were continuing.
- No material legal proceedings were reported, and management disclosed no material changes to the risk factors in its 2018 Form 10-K.
- Subsequent to quarter-end, the company issued 6,012 shares valued at $1.92 per share to a vendor for consulting services.
Most important facts for an investor to verify
- Whether the $4.500 million secured convertible notes due August 20, 2019 were repaid, converted, refinanced, or otherwise modified.
- Whether the company generated positive operating cash flow and improved its negative working-capital position after March 31, 2019.
- The recoverability of $8.397 million in capitalized film and television costs and $10.366 million of goodwill.
- The status and remediation of the disclosed material weakness and ineffective disclosure controls.
- The sustainability of revenue from Rainbow Rangers and Llama Llama, given the high customer concentration and timing-based revenue recognition.
- The potential dilution from 9.591 million outstanding warrants, convertible notes, preferred stock, and stock options.