Pacific Entertainment Corporation (proposed successor to Kartoon Studios, Inc.) — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; unaudited. The filing identifies the registrant as Pacific Entertainment Corporation. On August 5, 2011, the board approved a proposed change of domicile and name to Genius Brands International, subject to shareholder approval. The filing does not identify the company as Kartoon Studios, Inc.
Business context
The company develops, markets and sells children’s DVDs, CDs, books and toys under the Baby Genius and related brands, and earns licensing and royalty revenue. It also distributes selected third-party content and consolidates its 75%-owned Circle of Education LLC subsidiary.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $835,736 | $711,717 | $2,142,912 | $1,687,317 |
| Gross profit | $259,922 | $357,681 | $1,013,190 | $862,910 |
| Gross margin | 31.1% | 50.3% | 47.3% | 51.1% |
| Operating loss | $(747,236) | $(379,668) | $(898,896) | $(694,860) |
| Net loss attributable to the company | $(765,351) | $(381,943) | $(938,157) | $(698,196) |
| Net loss per share | $(0.01) | $(0.01) | $(0.02) | $(0.01) |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $(82,736) | $(41,077) |
Q2 revenue increased 17.4% year over year, while six-month revenue increased 27.0%. Product sales were $791,568 in Q2 and $1,684,859 for the first six months; licensing and royalties were $44,168 and $458,053, respectively.
At June 30, 2011, cash was $739,232, working capital was $496,934, total current assets were $1,743,134 and total current liabilities were $1,246,200. Total liabilities were $3,328,991, including $2,082,791 of related-party notes and accrued interest. Stockholders’ equity was negative $859,507. The accumulated deficit was $7,706,313.
Material changes versus the prior comparable period
- Q2 gross profit declined 27.3% despite higher revenue, reflecting cost of sales growth of 62.6% and a gross-margin reduction of approximately 19 percentage points.
- Q2 operating loss approximately doubled, primarily because operating expenses rose to $1,007,158 from $737,349. Stock compensation expense increased to $304,596 from $60,059.
- Six-month operating expenses increased to $1,912,086 from $1,557,770, with higher salaries, marketing and sales costs, legal and investor-relations expenses, and stock compensation.
- Q2 licensing and royalty revenue fell 70.2% to $44,168 after termination of the Battat toy license. Management expects licensing revenue to decline through the remainder of 2011 and the first two quarters of 2012 before a potential recovery from the planned Jakks Pacific/Tollytots toy line.
- Six-month cash used in operations increased to $82,736 from $41,077. Investing cash use was $124,142, principally for intangible assets and fixed assets.
- Financing activities provided $738,230, primarily from a private placement. The company issued 5.3 million shares for $1.06 million gross proceeds, including 1 million shares issued in exchange for a $200,000 reduction of related-party debt.
- Shares outstanding increased to 60,448,815 at June 30, 2011 from 55,116,515 at December 31, 2010. Options outstanding increased to 14 million, and 471,108 warrants remained exercisable at $0.40 per share.
Guidance, outlook, risks and unusual items
- Management expects continued sales growth from product improvements, competitive pricing, expanded distribution and additional catalog content, but provides no quantified revenue or earnings guidance.
- Management believes cash, operating receipts and potential related-party advances will fund planned operations for the next twelve months. It also states that insufficient profitability or operating cash flow could require additional equity or debt financing, reduced development activity, or a significant reduction or termination of operations.
- Revenue is seasonal, with historically higher sales in the second half of the year as retailers prepare for the holiday season.
- The business faces dependence on consumer demand, a limited customer base, competition, production delays and costs, intellectual-property protection risks, economic conditions, licensing acceptance and the ability to service debt.
- Circle of Education generated no sales during the period and reported a six-month loss of $17,683; management expected product introduction in the third quarter of 2012.
- Future minimum salary payments under new executive employment agreements total $4,243,402 for 2011–2015. Related-party debt generally matures December 31, 2012 and bears stated interest of approximately 6%.
- The financial statements are unaudited, and management states that interim results are not necessarily indicative of the full year.
Most important facts for investors to verify
- Whether the filing’s registrant, Pacific Entertainment Corporation, corresponds to the requested Kartoon Studios, Inc. entity and how the subsequent corporate name and domicile changes were completed.
- The sustainability and quality of revenue growth, particularly the intermittent third-party overstock sales and the decline in licensing revenue after the Battat termination.
- Whether the planned Jakks Pacific/Tollytots toy line launched as expected and generated the anticipated royalties.
- The company’s ability to convert recurring operating losses and negative operating cash flow into positive cash generation before related-party debt maturities.
- The effect of substantial related-party debt, executive compensation commitments, stock options and additional equity issuance on liquidity and dilution.
- The recoverability of intangible assets and $243,623 of capitalized product development in process, including the absence of an impairment charge during the period.