Kartoon Studios, Inc. (formerly Genius Brands International, Inc.) — Q2 2014 Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014; filed August 14, 2014. The filing reports the consolidated results of Genius Brands International and wholly owned subsidiary A Squared Entertainment. The A Squared merger closed November 15, 2013, so prior-period comparisons are not fully comparable.
Business Context
The company develops, produces, distributes and licenses children’s entertainment and related consumer products, including television, home entertainment, music, books, digital applications and merchandise. During the second quarter, management began shifting away from direct sales of physical DVDs and CDs toward licensing and merchandising. A one-for-one-hundred reverse stock split became effective April 7, 2014.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 |
|---|---|---|
| Revenue | $217,196 | $393,478 |
| Gross profit | $112,084 | $152,331 |
| Gross margin | 51.6% | 38.7% |
| Operating loss | $(858,282) | $(1,746,331) |
| Operating margin | (395.1%) | (443.9%) |
| Net loss | $(1,140,629) | $(1,994,792) |
| Net loss per common share | $(0.18) | $(0.33) |
| Cash used in operating activities | Not separately provided | $(1,234,446) |
Second-quarter revenue consisted of product sales of $118,495, television and home entertainment revenue of $36,814, and licensing and royalties of $61,887. Six-month revenue consisted of product sales of $204,636, television and home entertainment revenue of $87,275, and licensing and royalties of $101,567.
| Balance Sheet Metric | June 30, 2014 | December 31, 2013 |
|---|---|---|
| Cash and cash equivalents | $5,576,206 | $527,110 |
| Current assets | $6,467,938 | $2,227,343 |
| Current liabilities | $2,726,956 | $3,096,075 |
| Working capital | $3,740,982 | Not provided in the filing text |
| Total liabilities | $3,468,714 | $3,096,075 |
| Stockholders’ equity | $15,441,583 | $11,496,102 |
| Accumulated deficit | $(19,418,847) | $(17,424,055) |
Current liabilities included $412,893 of interest-free related-party advances with no stated maturity, a disputed trade payable of $925,000, and $741,758 of services advances. The filing reports no material capital expenditure commitments and no off-balance-sheet arrangements.
Material Changes Versus Prior Comparable Period
- Second-quarter revenue declined 65% from $622,324 to $217,196; six-month revenue declined 71% from $1,356,563 to $393,478.
- Product sales decreased 70% in the quarter and 81% year to date, reflecting weaker demand for CDs and DVDs and the move away from physical-product distribution.
- Licensing and royalty revenue decreased 73% in the quarter and 61% year to date as the company shifted away from third-party off-brand products.
- Television and home entertainment revenue contributed $36,814 in the quarter and $87,275 year to date, with no comparable 2013 revenue because of the A Squared merger.
- Second-quarter operating loss increased 77% to $858,282, while six-month operating loss increased 49% to $1,746,331.
- Second-quarter net loss increased from $543,249 to $1,140,629; six-month net loss increased from $1,489,114 to $1,994,792.
- Professional services and other general and administrative costs increased substantially, while salaries, stock compensation, marketing and cost of sales declined.
- Interest expense fell sharply because legacy debenture balances were converted into common stock in connection with the merger.
- Cash increased by $5,049,096 during the first six months, primarily from financing activities rather than operations.
Cash Flow, Financing and Liquidity
- Operating cash use was $1,234,446, compared with $85,918 used in the first six months of 2013.
- Investing cash use was $89,481, including investment in film and television costs, intangible assets and fixed assets.
- Financing activities provided $6,373,023, including $5,379,915 of net proceeds from Series A convertible preferred stock, $355,116 from common stock, and $750,000 from a supply-chain services agreement, partially offset by related-party debt repayments.
- The company received a $250,000 music advance during the second quarter. It also had $750,000 remaining due under the Sony DADC supply-chain agreement by January 17, 2015.
- Management stated that existing sales, operating cash, financing proceeds and contractual advances were expected to fund planned operations for the next twelve months. Management also warned that additional funding, reduced development activity, or a reduction or termination of operations could be required if profitability and positive operating cash flow are not achieved.
Guidance, Outlook, Risks and Unusual Items
- The strategic outlook emphasized transitioning from physical-product sales to licensing, consumer products and merchandising. Stone Newman was hired effective July 14, 2014 as President—Worldwide Consumer Products at an annual salary of $275,000 plus participation for certain customers.
- The company recorded a $174,963 inventory loss, increasing the inventory reserve to $274,241, because a portion of physical inventory might not be saleable.
- The company recorded a $70,905 loss on disposition of assets after ceasing development of its e-commerce website and web-based streaming services.
- The company recorded a $50,000 loss on distribution contracts and a $52,447 gain on extinguishment of debt during the first six months.
- Film and television costs increased to $112,575 as production began on the second installment of Stan Lee and the Mighty 7 and episodes of Thomas Edison: Secret Lab.
- The company raised $6 million gross through 6,000 shares of 0% Series A convertible preferred stock. Each share had a $1,000 stated value and an initial conversion price of $2.00 per common share, subject to adjustment provisions. The financing also resulted in 300,000 warrants exercisable at $2.00 per share for five years.
- The preferred financing triggered the issuance of 305,562 additional common shares to earlier investors under a purchase-price adjustment provision.
- The company reported $10.4 million of goodwill from the A Squared merger and $1.9 million of net intangible assets. Goodwill and certain artistic-related intangible assets are subject to impairment testing.
- Management identified disclosure controls and procedures as ineffective for the period ended June 30, 2014 and continued to address previously reported material weaknesses in internal control over financial reporting.
- Key stated risks include recurring losses, dependence on financing, uncertain consumer demand, seasonal sales fluctuations, dependence on strategic partners and limited customers, competition, production delays and costs, intellectual-property protection, and the ability to service obligations.
Most Important Facts to Verify
- Whether the licensing and merchandising transition can replace declining physical-product revenue and produce positive operating cash flow.
- The terms, conversion impact and potential dilution from the Series A preferred stock, 300,000 warrants and other outstanding equity rights.
- The sustainability of the $5.6 million cash balance given six-month operating cash burn of $1.2 million and recurring net losses.
- The collectability and timing of the remaining $750,000 Sony DADC advance and other music or services advances.
- The status and potential resolution of the $925,000 disputed trade payable and $412,893 related-party advance.
- Potential impairment of the $10.4 million goodwill balance and other intangible assets if expected content revenues do not materialize.
- Remediation and independent verification of the company’s ineffective disclosure controls and previously reported material weaknesses.
- Comparability of future results, given the 2013 A Squared merger, the reverse stock split, changes in revenue strategy and significant nonrecurring inventory and asset charges.