Business Context and Reporting Period
Genius Brands International, Inc. (now associated with Kartoon Studios, Inc.) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company develops, licenses, and distributes multimedia content and consumer products, primarily for children. Key properties included Llama Llama, SpacePop, Thomas Edison’s Secret Lab, Baby Genius, and Secret Millionaires Club.
The filing reflects a 1-for-3 reverse stock split effective November 9, 2016, with share and per-share information presented retrospectively. The company had 3,990,349 common shares outstanding as of November 11, 2016.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $120,486, down 57% | $648,711, down 9% |
| Gross profit | $99,277 | $554,191 |
| Gross margin | 82.4%, versus 91.8% | 85.4%, versus 93.6% |
| Loss from operations | $(1,533,721) | $(4,616,257) |
| Net loss | $(1,530,900) | $(4,363,567) |
| Net loss per common share | $(0.38) | $(1.12) |
| Net cash used in operating activities | Not separately provided | $(1,885,328) |
Quarterly revenue consisted of $85,660 from licensing and royalties and $34,826 from television and home entertainment. Nine-month revenue consisted of $347,128 from licensing and royalties, $285,433 from television and home entertainment, and $16,150 from product sales.
At September 30, 2016, cash and cash equivalents were $3,642,667, total current assets were $4,167,708, and total current liabilities were $3,554,617, producing reported working capital of $613,091. The cash balance included $1,000,000 restricted for production of Llama Llama.
Total liabilities were $6,543,108, including $3,118,730 of deferred revenue, $1,489,583 of current service advances, a $925,000 disputed trade payable, and $239,655 of net borrowings under the production facility. Stockholders’ equity was $11,559,735, and accumulated deficit was $34,793,193.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue declined $160,264, or 57%, primarily because television and home entertainment revenue fell 81% after the prior-year delivery cycle for Thomas Edison’s Secret Lab.
- Nine-month revenue declined $62,288, or 9%, with licensing and royalties down 7% and television and home entertainment down 12%.
- Operating expenses increased 60% in the quarter and 65% for the nine-month period. General and administrative expense increased primarily because of $358,919 of quarterly and $1,236,880 of nine-month stock-based compensation expense.
- Marketing and sales expense increased 142% for the quarter and 101% for the nine-month period, mainly reflecting promotional activity for SpacePop and external sales consultants.
- Net loss increased from $797,820 to $1,530,900 for the quarter and from $2,421,938 to $4,363,567 for the nine-month period.
- Net cash used in operating activities improved by $726,279 compared with the prior-year nine-month period, partly due to the $2,000,000 Sony advance and increased deferred revenue and advances.
- Cash declined $1,544,953 during the first nine months, compared with a $2,153,168 decline in the prior-year period.
- Film and television costs increased to $1,602,236 from $1,003,546 at December 31, 2015, primarily from production and development of SpacePop, Llama Llama, and Stan Lee’s Cosmic Crusaders.
Guidance, Outlook, Risks, and Unusual Items
- Management stated that available cash, receivables, the production facility, and the deal pipeline were expected to fund operations for the next twelve months, but cautioned that operating cash flows may not continue to improve.
- If the company does not achieve profitable operations and positive operating cash flow, management may need to seek additional funding, scale back development or production, or reduce operations.
- On August 8, 2016, the company established a $5,275,000 secured, non-recourse, non-revolving production facility with Bank Leumi USA for Llama Llama. The facility has a 40-month term and variable interest based on Prime plus 1% or LIBOR plus 3.25%, and is secured by Netflix license fees and the series copyright.
- The facility had gross borrowings of $385,971 and net borrowings of $239,655 at September 30, 2016. The series was scheduled for delivery to Netflix in fall 2017.
- Deferred revenue increased substantially to $3,118,730 from $958,539 at December 31, 2015, representing advances and minimum guarantees that had not yet met revenue-recognition criteria.
- The company disputed a $925,000 trade payable assumed in the A Squared merger and believed the applicable statute of limitations had expired, although it was working with the counterparty to extinguish the liability.
- The company had approximately $19.2 million of net operating loss carryforwards, potentially usable from 2017 through 2036, subject to applicable limitations.
- The filing disclosed no material pending legal proceedings, no changes to previously disclosed risk factors, and no material capital expenditure commitments.
- The company reported effective disclosure controls and no material changes in internal control over financial reporting.
- The filing included an immaterial revision reallocating $3,383,850 between additional paid-in capital and accumulated deficit, with no effect on total equity.
Investor Verification Points
- Verify the company’s current corporate name and the treatment of the 2016 reverse split in historical share counts and per-share data.
- Assess whether the company can convert its content investments and deferred revenue into recognized revenue and positive operating cash flow.
- Review the terms, draw capacity, collateral, covenants, and repayment exposure of the Bank Leumi production facility.
- Evaluate the recoverability of $10,365,805 of goodwill, $1,864,242 of intangible assets, and $1,602,236 of capitalized film and television costs.
- Monitor the disputed $925,000 payable, the $1,489,583 service advance repayment obligation, and other contingent royalty or profit-participation commitments.
- Consider dilution from 1,378,524 outstanding stock options and 1,651,666 outstanding warrants as of September 30, 2016.
- Reconcile management’s liquidity assessment with the recurring quarterly losses, accumulated deficit, restricted cash, and continuing production expenditures.