Dolphin Digital Media, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The filing is by Dolphin Digital Media, Inc.; the company’s entertainment PR acquisition target is 42West, LLC.
Business context and reporting period
Dolphin produced and distributed digital content and motion pictures, and operated online kids clubs. On March 30, 2017, it acquired 42West, an entertainment public relations agency, expanding the business into talent publicity, strategic communications, and content marketing. 42West’s results contributed only one day to reported Q1 results and were described as immaterial.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $532,866 | $17,278 |
| Operating loss before other income and expense | $871,692 | $985,185 |
| Net income (loss) | $4,961,788 | $(3,448,848) |
| Operating cash flow | $3,751,228 provided | $570,769 used |
| Cash and cash equivalents, March 31 | $585,343 | $2,763,711 at March 31, 2016 |
| Working capital | $(19,795,860) deficit | $(31.4) million deficit, per MD&A |
Reported revenue was primarily from domestic and international distribution of Max Steel; the prior-year quarter’s revenue was from kids-club memberships. Direct costs were $500,526, primarily production-cost amortization. The filing does not provide a meaningful consolidated operating margin; the reported operating loss before other items was $871,692.
Net income was primarily driven by a $6,823,325 gain from a decline in the fair value of warrant liabilities, not by operating performance. Interest expense was $452,137, versus $1,281,965 a year earlier. Basic and diluted EPS were reported as $0.34 and $0.05, respectively. The EPS note also presents income available to common shareholders of $895,534 after adjustments for warrant gains, so investors should review the EPS calculation.
Operating cash flow benefited from collections on receivables and tax-incentive proceeds. Financing cash outflow was $5,092,057, including $5,842,827 of debt repayments; cash declined $77,203 during the quarter. At quarter-end, current assets were $4.39 million and current liabilities were $24.19 million.
Current debt included approximately $9.69 million under the Max Steel prints-and-advertising loan and $3.21 million under its production-service financing. The company also reported a $500,000 line-of-credit balance, an $825,000 note payable, and $1.24 million owed to a related party. Total liabilities were $35.67 million.
Material changes and acquisition
- 42West was acquired for provisional consideration of $23.46 million, including issued and issuable shares, contingent consideration, put rights, transaction costs, and assumed seller tax liabilities. The agreement also provides for up to approximately $9.3 million of additional stock consideration tied to performance targets.
- The acquisition added provisional intangible assets of $9.11 million and goodwill of $14.00 million. Purchase-price allocation and several fair-value estimates were not final.
- Acquisition consideration includes put rights allowing sellers to require repurchase of up to 2,374,187 shares at $4.61 per share through December 2020. Sellers exercised put options for 86,764 shares, receiving $400,000 on April 14, 2017.
- Common shares outstanding increased to 18,065,801 at March 31, from 14,395,521 at year-end, including shares issued for the acquisition and warrant exercises. The filing reports 18,755,865 shares outstanding as of May 22, 2017.
- Cash used to repay debt and application of $1.25 million of restricted cash reduced the Max Steel loan balance. The company also reported a $2.0 million impairment of Max Steel production costs in 2016; Q1 2017 included $517,303 of amortization for the film.
Outlook, risks, and unusual items
- Going concern: Management disclosed substantial doubt about the company’s ability to continue as a going concern, citing a $19.8 million working-capital deficit, $94.85 million accumulated deficit, and insufficient capital to meet obligations. It plans to seek loans and/or issue equity or other securities; funding is not assured and equity financing could substantially dilute shareholders.
- Near-term liquidity: The company may have to repurchase up to 455,531 42West sellers’ shares during 2017 for up to approximately $3.1 million. After quarter-end it borrowed $550,000 under short-term 10% notes and drew additional funds from the 42West credit line for working capital.
- Business outlook: Management expected to seek distribution for a digital project and pursue scripts for future productions, while exploring expanded services at 42West. The timing of releases, revenue, and fees is uncertain; no quantified earnings or revenue guidance was provided.
- Accounting and reporting: Warrant liabilities are valued using Level 3 models with significant unobservable assumptions, creating earnings volatility. The company said disclosure controls were ineffective because material weaknesses identified previously had not been fully remediated.
- Contingencies: The company accrued approximately $300,000 for a 42West multiemployer pension and benefit-plan audit exposure. It disclosed an unresolved Canadian lease-related claim with a possible loss range of $0–$325,000, but did not accrue it because management considered a loss not probable.
- Acquisition accounting: 42West’s provisional consideration and purchase-price allocation remain subject to valuation and closing adjustments. The filing’s acquisition-cost figures differ: the statements report $537,708 of acquisition-related costs, while the acquisition note identifies $287,708 as costs expensed; investors should reconcile the amounts.
Important facts for investors to verify
- Available liquidity, debt maturities, covenant compliance, and the company’s ability to obtain financing sufficient to address the going-concern risk.
- The cash and dilution impact of the 42West put rights, scheduled stock issuances, employee awards, and performance-based earn-out.
- Final 42West purchase-price allocation, including goodwill, intangible-asset valuations, contingent consideration, and put-right valuation.
- The quality and sustainability of earnings: reported net income depended heavily on the noncash warrant fair-value gain; reconcile reported EPS with the adjusted common-shareholder numerator in the notes.
- The acquisition-related-cost discrepancy and the status of remediation of material weaknesses in disclosure controls and financial reporting.
- Collections and remaining recoverability of Max Steel receivables and production costs, and the timing and economics of planned digital and film releases.