Business Context and Reporting Period
Genius Brands International, Inc. (now identified in the request as Kartoon Studios, Inc.) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company develops, licenses, distributes, and monetizes children’s multimedia content and related consumer products, including Llama Llama, SpacePop, Rainbow Rangers, Thomas Edison’s Secret Lab, and the Kid Genius Cartoon Channel.
The company reported 7,610,794 common shares outstanding as of November 13, 2017. Its principal activities included content production, licensing and royalties, television and home entertainment distribution, advertising, and product sales.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Total revenue | $256,501, versus $120,486 in 2016 | $650,723, versus $648,711 in 2016 |
| Operating loss | $(1,166,587), versus $(1,533,721) | $(3,737,924), versus $(4,616,257) |
| Net loss | $(1,164,406), versus $(1,530,900) | $(3,732,183), versus $(4,363,567) |
| Loss per common share | $(0.20), versus $(0.38) | $(0.67), versus $(1.12) |
| Operating expenses | $1,423,088, versus $1,654,207 | $4,388,647, versus $5,264,968 |
Operating loss margins were approximately (455%) for the quarter and (574%) for the nine-month period. The filing does not present a conventional gross profit or gross margin.
- Quarterly revenue increased 113%, led by television and home entertainment revenue of $155,003, up 345%, and licensing and royalties of $94,430, up 10%. Advertising revenue was $7,008, compared with none in the prior-year quarter.
- Nine-month revenue was essentially flat. Licensing and royalties increased 5% to $365,993, while television and home entertainment declined 8% to $263,142 and product sales declined 47% to $8,561. Advertising revenue was $13,027, compared with none in the prior-year period.
- Nine-month operating expenses decreased 17%, primarily from lower marketing and sales expenses and lower share-based compensation within general and administrative costs.
- Film and television costs, net, increased to $4,232,632 from $2,260,964 at December 31, 2016, reflecting production and development of SpacePop, Llama Llama, and Rainbow Rangers.
- Cash and cash equivalents were $2,247,402, and restricted cash was $1,000,000, for total cash, cash equivalents, and restricted cash of $3,247,402 at September 30, 2017.
- Working capital was $1,863,056, compared with a deficit of $479,404 at December 31, 2016. Current assets were $3,989,900 and current liabilities were $2,126,844.
- Net cash used in operating activities was $5,029,810, compared with $1,885,328 in the prior-year period. Cash used in investing activities was $47,361.
- Financing activities provided $5,436,652, including $3,401,924 of net proceeds from a warrant exchange and $2,034,728 of net proceeds from the production facility.
- The production facility had gross borrowings of $3,624,263 and net borrowings of $3,495,524 after financing costs. It bears interest at Prime plus 1% or LIBOR plus 3.25%, is secured by Llama Llama license fees and copyrights, and had a $1,000,000 restricted-cash requirement.
- Deferred revenue increased to $5,072,849 from $3,106,608 at December 31, 2016, including Sony advances and amounts associated with expanded distribution rights.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue growth substantially reduced the operating and net loss, although the company remained materially unprofitable.
- Nine-month revenue was approximately unchanged, while the net loss improved by $631,384 and the operating loss improved by $878,333.
- Operating cash consumption increased by $3,144,482 year over year, largely reflecting increased investment in film and television production and development.
- Marketing and sales expense declined 47% for the nine-month period, and general and administrative expense declined 13%. Share-based compensation expense declined to $514,108 from $1,236,880.
- During the first quarter, Sony paid $1,489,583 owed to Sony DADC on the company’s behalf in exchange for 301,231 common shares, worldwide home entertainment distribution rights, and increased recoupment rights against future royalties.
- In February 2017, the company issued 1,171,689 shares upon warrant exercise and received $3,866,573 of gross proceeds, while issuing replacement and additional warrants.
- Common shares outstanding increased to 5,938,103 at September 30, 2017 from 4,010,649 at December 31, 2016, creating dilution risk.
Outlook, Risks, Contingencies, and Unusual Items
Management stated that anticipated cash balances, working capital, the production facility, and the deal pipeline were expected to fund operations for the next twelve months, but cautioned that additional financing could be required if profitable operations and positive operating cash flow are not achieved. Potential responses include additional financing, reducing development and production plans, or reducing operations.
- On October 3, 2017, after quarter-end, the company sold 1,647,691 common shares at $3.90 per share and issued warrants for an equal number of shares. Gross proceeds were approximately $6,425,995 before fees and expenses.
- The October offering warrants were immediately exercisable at $3.90 per share and expire five years after issuance. The placement agent fee was 9% of gross proceeds, plus reimbursable expenses of up to $35,000.
- The company anticipated delivering 15 half-hour episodes of Llama Llama to Netflix in the fourth quarter of 2017. The associated production facility is secured by Netflix license fees and the series copyright.
- The company reported a disputed trade payable of $925,000. Management believes the applicable statute of limitations has expired and is working with the counterparty to extinguish the liability.
- Goodwill of $10,365,805 and indefinite-lived artistic-related intangible assets of $1,740,000 had not been impaired through September 30, 2017. Future impairment testing depends on estimates of projected cash flows, growth rates, and discount rates.
- The company planned to adopt the new revenue standard effective January 1, 2018, expected to use the modified retrospective method, and was still evaluating the potential impact and related internal-control changes.
- Key risks include recurring losses, significant operating cash burn, dependence on additional financing, dilution from equity and warrant issuances, reliance on key personnel, concentrated ownership, content-production execution, and recoupment obligations under the Sony distribution arrangement.
- Management reported no material pending legal proceedings, no defaults upon senior securities, no material off-balance-sheet arrangements, and effective disclosure controls as of September 30, 2017.
Important Facts for Investors to Verify
- Confirm the registrant’s current corporate name and whether the filing remains applicable to Kartoon Studios, Inc., since the filing identifies the company as Genius Brands International, Inc.
- Verify the timing, net proceeds, fees, share issuance, and warrant terms of the October 2017 financing.
- Assess whether production spending, especially for Llama Llama, SpacePop, and Rainbow Rangers, is producing contracted revenue and sufficient cash returns.
- Review the production facility’s outstanding balance, interest-rate exposure, collateral, covenants, and Netflix delivery obligations.
- Evaluate the company’s ability to fund operations given $5.0 million of nine-month operating cash burn and continued net losses.
- Review potential dilution from 1.77 million outstanding warrants, 1.30 million outstanding options, Series A preferred stock, and the October 2017 warrant issuance.
- Monitor the $925,000 disputed payable, Sony’s royalty recoupment rights, deferred revenue recognition, and possible impairment of goodwill and capitalized content costs.