Kartoon Studios, Inc. (formerly Genius Brands International, Inc.) — 2018 Q3 Form 10-Q
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2018. The company develops, licenses, distributes and manages multimedia content and consumer brands, including Llama Llama, Rainbow Rangers, Baby Genius, SpacePop and Thomas Edison’s Secret Lab. The filing was signed November 14, 2018, when the registrant was named Genius Brands International, Inc.
Financial performance and liquidity
| Metric | Three months ended Sept. 30, 2018 | Three months ended Sept. 30, 2017 | Nine months ended Sept. 30, 2018 | Nine months ended Sept. 30, 2017 |
|---|---|---|---|---|
| Revenue | $523,175 | $256,501 | $692,799 | $650,723 |
| Loss from operations | $(1,253,864) | $(1,166,587) | $(4,706,300) | $(3,737,924) |
| Net loss | $(1,821,852) | $(1,164,406) | $(5,275,101) | $(3,732,183) |
| Net loss applicable to common shareholders | $(2,175,185) | $(1,164,406) | $(5,628,434) | $(3,732,183) |
| Basic and diluted loss per share | $(0.24) | $(0.20) | $(0.66) | $(0.67) |
| Cash used in operating activities | Not separately provided | Not separately provided | $(5,486,708) | $(5,029,810) |
- Third-quarter revenue increased 104%, driven by higher licensing and royalties, television and home entertainment, and advertising revenue. Nine-month revenue increased 6% despite declines in licensing, television and product sales.
- Approximate operating margins were negative 240% for the quarter and negative 679% for the nine-month period. Approximate net margins were negative 348% and negative 761%, respectively, based on net loss rather than net loss applicable to common shareholders.
- Direct operating costs increased 156% in the quarter and 374% for the nine-month period, primarily from film and television cost amortization, participation expenses and the SpacePop property write-down. Nine-month film and television cost amortization was $1,033,392, including a $549,117 SpacePop write-down.
- At September 30, 2018, cash and cash equivalents were $5,074,026, current assets were $8,098,644, current liabilities were $3,742,989, and working capital was $4,355,655, down from $8,041,279 at December 31, 2017.
- Total assets were $26,815,227 and total stockholders’ equity was $16,275,962. Accumulated deficit was $46,973,682.
- Net secured convertible notes payable were $1,552,955 at September 30, 2018. The production facility had net borrowings of $1,645,895; gross outstanding borrowings were $1,726,572. The filing also reports a new production loan commitment of up to $4,231,989, with no amounts outstanding under that new facility at quarter-end.
- Cash, cash equivalents and restricted cash declined by $2,424,047 during the first nine months, to $5,074,025. Financing inflows of $3,105,647 did not offset operating cash use and investing outflows.
Material changes versus the prior comparable period
- Third-quarter revenue rose $266,673, or 104%, while the nine-month increase was $42,076, or 6%.
- Third-quarter net loss increased from $1,164,406 to $1,821,852. Nine-month net loss increased from $3,732,183 to $5,275,101.
- Interest expense increased substantially, from $794 to $577,477 for the quarter and from $2,827 to $578,570 for the nine-month period, primarily reflecting the secured convertible notes.
- Advertising revenue increased to $115,628 for the quarter and $154,563 for the nine-month period, compared with $7,008 and $13,027, respectively, in the prior-year periods.
- The company adopted ASC 606 on January 1, 2018 using the modified retrospective method. The adoption reduced beginning accumulated deficit by $206,247 and reduced 2018 nine-month revenue by $162,551, partially offset by a $42,952 reduction in costs.
- Common shares outstanding increased to 9,272,000 from 7,610,794 at December 31, 2017. The company issued 599,205 shares to a vendor for animation services during the first nine months, valued at $1,563,002.
Guidance, outlook, risks and unusual items
- Management stated that cash, working capital, the production facility and the deal pipeline were expected to fund operations for the next twelve months, but cautioned that operating cash flows may not improve. If profitability and positive operating cash flow are not achieved, the company may need additional financing, reduced production and development, or operational reductions.
- In August 2018, the company issued $4.5 million of senior secured convertible notes bearing 10% annual interest, convertible at $2.50 per share and due August 20, 2019 unless converted or redeemed. The notes are secured by company assets and include restrictive covenants and default provisions.
- The related financing included warrants to purchase 1.8 million common shares at $3.00 per share. Total warrants outstanding increased to 5,899,389, creating potential dilution.
- In September 2018, Llama Productions entered into a secured facility of up to $4,231,989 to fund production of the second season of Llama Llama for initial exhibition on Netflix. The facility matures March 31, 2021 and is secured by Llama assets, including the series.
- The company disclosed a potential material weakness in internal control over financial reporting related to the timely evaluation of the accounting treatment for warrants issued with the convertible notes. Management replaced its Controller and was reviewing controls for complex accounting matters. Disclosure controls and procedures were deemed ineffective for the period.
- Customer concentration was significant: one customer represented 89% of accounts receivable at September 30, 2018, and two customers represented more than 10% of third-quarter revenue.
- The company had $4,574,026 of uninsured cash balances at September 30, 2018. It also reported a $925,000 disputed trade payable, which management believes is uncollectible due to expiration of the applicable statute of limitations.
- The company had no material pending legal proceedings reported, but was scheduled for mediation with a co-producer regarding the definition of “Net Receipts.” Management expected any adverse amount to be immaterial.
- Subsequent to quarter-end, the company issued 102,711 shares valued at $243,705 for vendor and marketing services and entered into a new five-year CEO employment agreement effective November 16, 2018.
Important facts for investors to verify
- Reconcile the company’s continuing operating cash burn with management’s assertion that available liquidity will fund the next twelve months.
- Review the August 2018 secured convertible notes, maturity and repayment terms, collateral, covenants, conversion provisions and potential equity dilution.
- Assess the production financing and completion risk for Llama Llama season two and the recoverability of $6.1 million in capitalized film and television costs.
- Evaluate the disclosed internal-control material weakness and any subsequent remediation or restatement developments.
- Review revenue concentration, accounts receivable collectability and dependence on major distribution and licensing partners.
- Consider the effects of ASC 606 adoption, the SpacePop write-down, share-based payments, vendor stock issuance and outstanding warrants on reported results and dilution.