Dolphin Entertainment, Inc. quarterly report, Q3 FY2017

Dolphin Entertainment, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2017. The company acquired 42West on March 30, 2017, adding entertainment publicity to its content production business; reported comparisons with 2016 are therefore not like-for-like. The company also effected a 1-for-2 reverse stock split in September, reflected retrospectively in share data.

Financial results and liquidity

Metric	Three months ended Sept. 30, 2017	Nine months ended Sept. 30, 2017	Prior-year comparison
Revenue	$6.81 million	$15.17 million	$1.15 million and $1.17 million, respectively
Income before other expenses	$1.74 million	$1.04 million	Losses of $10.88 million and $13.14 million, respectively
Net income (loss)	$6.17 million	$9.58 million	Losses of $11.54 million and $22.79 million, respectively
Operating cash flow	Not provided for quarter	$6.67 million provided	$15.58 million used
Cash and cash equivalents	$1.96 million at Sept. 30, 2017	$0.66 million at Dec. 31, 2016

Third-quarter revenue comprised $5.41 million of entertainment publicity and $1.40 million of production and distribution. For the nine months, the corresponding reported amounts were $10.55 million and $4.63 million.
Income before other expenses was approximately 25.6% of revenue for the quarter and 6.8% for the nine-month period. These are calculated ratios, not company-reported margin measures.
Reported net income benefited substantially from noncash fair-value gains on warrant liabilities ($1.40 million for the quarter; $7.69 million for nine months) and a roughly $3.88 million debt-extinguishment gain. Net income should not be viewed as a measure of recurring operating performance.
Nine-month operating cash flow improved by about $22.25 million year over year. Management cited lower costs associated with the prior-year release of Max Steel, receivable collections, production tax incentives, and 42West. Financing activities used $6.29 million, primarily reflecting debt repayments and 42West seller put-right repurchases.
At September 30, current assets were $6.39 million and current liabilities were $19.84 million, a reported working-capital deficit of $13.45 million. Accumulated deficit was $90.24 million; stockholders’ equity was $2.73 million.
Management reported total debt of approximately $13.52 million. The balance sheet separately presents debt, notes payable, related-party loans, a line of credit, and acquisition-related put and contingent-consideration liabilities; investors should confirm how management’s debt total is defined.

Material changes and business developments

42West contributed a new entertainment publicity segment, alongside content production. Management described publicity growth opportunities in talent services, entertainment marketing, and strategic communications. The acquisition consideration included stock, additional shares due in January 2018, and potential earn-out shares tied to 42West performance.
42West acquisition accounting remained provisional. The company recorded approximately $9.11 million of identifiable intangible assets and $14.35 million of goodwill. Acquisition-related fair-value liabilities included $3.70 million for seller put rights and $3.97 million for contingent consideration at quarter-end.
Revenue increased sharply against 2016 largely because 42West was not included in the prior-year reported results. The company also reported higher 2017 production and distribution revenue, primarily from Max Steel.
The company decided to discontinue its online kids clubs at the end of 2017 and focus resources on publicity and content production. The clubs generated no revenue in the first nine months of 2017.
Common shares outstanding were 9,367,057 at September 30 and November 16, 2017. The filing reports that 980,911 shares related to the 42West acquisition were scheduled for issuance on January 2, 2018, with additional performance-based shares possible.

Outlook, risks, contingencies, and unusual items

Going concern: The filing states that substantial doubt exists about the company’s ability to continue as a going concern. Management planned to seek additional financing through debt, equity, or convertible securities, but said there was no assurance funding would be available. Additional securities could significantly dilute existing shareholders.
Debt and liquidity: The 42West line of credit, with $750,000 outstanding, matured November 1, 2017 and was not renewed; the company was seeking a replacement facility. Management said the bank had not called the balance and that the company had sufficient liquidity to repay it if called. Certain short-term notes were extended to December 15, 2017.
Max Steel collateral risk: The film’s related production-service and prints-and-advertising loans were not repaid by maturity from film revenues. The company disclosed $2.70 million outstanding on the production-service agreement and $2.37 million on the P&A loan at September 30. Foreclosure could result in loss of film rights and impairment of production costs and foreign-sales receivables. A third-party guarantor paid $4.5 million on the P&A loan; the company recorded a $620,000 backstop obligation.
Seller put rights and dilution: 42West sellers could require repurchase of up to 1,187,094 shares at $9.22 per share through December 2020. The company repurchased 116,591 shares for $1.08 million through September 30; a further 16,268 shares were repurchased for $150,000 in October. Earn-out consideration could reach approximately $9.3 million in shares, subject to performance targets.
Litigation and contingencies: 42West was named in a putative Fyre Festival class action seeking damages exceeding $5 million; the company said it believed the claims were without merit. A separate pension-fund audit exposure was accrued at approximately $300,000, with an indemnification asset recorded for the covered portion. An older Canadian case had a disclosed potential loss range of $0 to $325,000 and was not accrued because management considered a loss not probable.
Management outlook: The company planned to seek financing for film projects during 2018, with anticipated releases beginning in early 2019, and said it intended to pursue at least one acquisition over the next year. It also described prospective growth in 42West, but these plans and expected benefits were not assured.
Controls: Management concluded disclosure controls were not effective because previously reported material weaknesses in internal control over financial reporting had not been fully remediated.
Accounting uncertainty: Fair-value changes for warrants, put rights, and contingent consideration rely on significant unobservable inputs and can create substantial earnings volatility without corresponding cash flows. The company was evaluating the impact of adopting the new revenue-recognition standard in 2018.

Important facts for investors to verify

Reconcile the filing’s 42West nine-month revenue disclosures: the segment table reports $10.55 million of entertainment publicity revenue, while the acquisition note reports $15.24 million of 42West revenue. The filing text does not provide a clear reconciliation.
Confirm the definition and composition of management’s approximately $13.52 million total-debt figure, including how acquisition-related put and contingent-consideration obligations are treated.
Check the status of the expired 42West credit facility, the extended short-term notes, the remaining Max Steel obligations, and the company’s ability to meet near-term cash needs.
Assess financing availability and potential dilution from convertible notes, acquisition shares, earn-outs, and any further equity issuance.
Monitor the Fyre Festival litigation, pension-fund audit, seller put exercises, and completion of the provisional 42West purchase-price allocation.
Evaluate whether reported earnings and cash generation are sustainable after excluding significant fair-value movements and the debt-extinguishment gain, and whether material control weaknesses are remediated.