Business Context and Reporting Period
Genius Brands International, Inc. (now Kartoon Studios, Inc.) filed its Form 10-K for the fiscal year ended December 31, 2017. The company creates, distributes, and licenses children’s and family multimedia content and related consumer products, including Llama Llama, Rainbow Rangers, SpacePop, Baby Genius, and Thomas Edison’s Secret Lab. The filing is an annual report; fourth-quarter activity was significant because the company delivered the first season of Llama Llama to Netflix in December 2017.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $5.336 million | $0.867 million | Up 516% |
| Television and home entertainment revenue | $4.815 million | $0.356 million | Up 1,252% |
| Licensing and royalties | $0.472 million | $0.463 million | Up 2% |
| Genius Brands Network revenue | $0.039 million | $0.034 million | Up 15% |
| Net loss | $4.909 million | $6.213 million | Loss narrowed 21% |
| Loss from operations | $4.914 million | $6.465 million | Loss narrowed 24% |
| Basic and diluted loss per share | $0.81 | $1.59 | Improved |
| Cash used in operating activities | $7.187 million | $3.716 million | Use increased |
| Cash, cash equivalents, and restricted cash | $7.498 million | $2.888 million | Up $4.610 million |
Based on reported revenue and operating loss, the operating margin was approximately negative 92.1%; the net margin was approximately negative 92.0%. Direct operating costs increased to $4.257 million from $0.279 million, primarily because of film amortization, participation expense, dubbing costs, and other costs associated with Llama Llama. Total operating expenses were $10.250 million, up 40% year over year.
At December 31, 2017, current assets were $10.835 million and current liabilities were $3.719 million, producing working capital of $7.116 million, compared with a working-capital deficit of $0.479 million in 2016. Accounts receivable totaled $4.581 million, including $1.688 million classified as long term.
Net production-loan-facility borrowings were $4.323 million, against gross borrowings of $4.437 million. The secured, non-recourse facility bears interest at Prime plus 1% or LIBOR plus 3.25%, matures in December 2019, and is secured by Netflix license fees and the Llama Llama copyright. Restricted cash was $0.569 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was overwhelmingly attributable to recognition of $4.815 million from television and home entertainment distribution, principally the December 2017 delivery of Llama Llama to Netflix. The filing states that one customer, identified elsewhere as Netflix, represented 84% of 2017 revenue and 98% of accounts receivable.
- Net loss narrowed by $1.304 million, despite substantially higher direct operating costs, because revenue growth exceeded the increase in operating expenses.
- Marketing and sales expense declined 36% to $0.662 million, and general and administrative expense declined 11% to $5.330 million, partly because share-based compensation decreased by $0.918 million.
- Operating cash use increased materially to $7.187 million, reflecting a $2.825 million investment in film and television costs and a $4.527 million increase in accounts receivable.
- Financing activities provided $11.904 million, including $3.402 million from a warrant exercise transaction, $5.700 million from an October registered direct offering, and $2.803 million from the production facility.
- Common shares outstanding increased to 7.611 million at December 31, 2017 from 4.011 million at December 31, 2016, before subsequent 2018 issuances. The company also had 3.414 million warrants outstanding at year-end.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide formal numerical revenue or earnings guidance. Management stated that anticipated cash balances, working capital, and the deal pipeline were expected to fund operations for the next twelve months, but warned that additional financing, reduced production plans, or reduced operations could be required if profitability and positive operating cash flow are not achieved.
- The company has incurred net losses in every fiscal quarter since inception and had an accumulated deficit of $41.551 million at year-end.
- Revenue is highly concentrated and timing-dependent. The 2017 results benefited from a major Netflix delivery and may not be representative of future periods.
- The company disputes a $0.925 million trade payable assumed in the A Squared transaction and believes the applicable statute of limitations has expired.
- The company’s operating model requires significant investment in content before licensing and consumer-product revenue is realized. Delays, production-cost overruns, weak audience reception, or reduced licensing demand could impair results.
- Competition includes substantially larger companies such as Disney, Nickelodeon, and Cartoon Network. The company also depends on third-party production and animation studios, licensees, distributors, and broadcasters.
- The company had $6.472 million of uninsured cash balances at year-end, exceeding FDIC insurance limits.
- The company held approximately $23.363 million of federal net operating loss carryforwards, but the related deferred tax asset was fully offset by a valuation allowance.
- Subsequent to year-end, the company completed an approximately $1.8 million private placement of common stock and warrants, entered into a substantially larger Beverly Hills office lease, and announced changes in its CFO and COO positions.
- The filing reports that management assessed internal control over financial reporting and disclosure controls as effective as of December 31, 2017. The independent auditor audited the financial statements but was not engaged to express an opinion on internal control effectiveness.
- The MD&A cash-flow summary lists cash used in operations as $7.153 million, while the audited statement of cash flows reports $7.187 million. Investors should reconcile this apparent filing inconsistency.
Most Important Facts for Investors to Verify
- Whether Netflix-related revenue and receivables were collected as expected and how much future revenue remains subject to customer concentration.
- The repayment schedule, collateral, covenants, and effective interest cost of the $4.323 million net production facility.
- The company’s cash runway after considering recurring operating cash burn, production commitments, restricted cash, and the 2018 office lease.
- The potential cash or dilution impact of approximately 3.414 million outstanding warrants, 1.294 million options, Series A preferred stock, and subsequent 2018 securities issuances.
- The status and potential resolution of the disputed $0.925 million trade payable.
- The recoverability of $2.777 million of capitalized film and television costs and $10.366 million of goodwill, given the company’s continuing losses.
- The effect of adopting ASC 606 revenue recognition in 2018, including the transition adjustment and changes to the timing of licensing and royalty revenue.
- Whether management can reduce dependence on large, irregular content deliveries and achieve sustained positive operating cash flow.