Business Context and Reporting Period
Genius Brands International, Inc. (the filing entity associated with Kartoon Studios, Inc.) filed this unaudited Form 10-Q for the quarter ended March 31, 2013. The company develops, distributes, and licenses children’s videos, music, books, toys, digital applications, and related intellectual property under brands including Baby Genius, Little Genius, Kid Genius, 123 Favorite Music, and Wee Worship.
Revenue is generated through product sales, licensed and distributed products, and licensing and royalty arrangements. The company identified seasonal sales patterns, with historically higher activity in the third and fourth quarters.
Key Financial Metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $734,239 | $1,030,947 | Down 28.8% |
| Gross profit | $86,930 | $296,816 | Down 70.7% |
| Gross margin | 11.8% | 28.8% | Down approximately 17.0 percentage points |
| Loss from operations | $(691,036) | $(567,171) | Loss increased 21.8% |
| Operating margin | (94.1%) | (55.0%) | Worsened |
| Net loss attributable to the company | $(945,865) | $(605,667) | Loss increased 56.2% |
| Net loss per share | $(0.01) | $(0.01) | Unchanged as reported |
| Net cash used in operating activities | $(226,163) | $51,201 | Decrease of $277,364 |
Product sales were $702,812, including $216,523 from company-owned products and $486,290 from licensed and distributed products. Licensing and royalty revenue was $31,427. Operating expenses totaled $777,966, including $471,147 of salaries and related expenses and $58,279 of stock compensation expense.
Cash was $179,835 at March 31, 2013, compared with $447,548 at December 31, 2012 and $428,771 at March 31, 2012. Total current assets were $1,192,571 and current liabilities were $2,305,374, producing a working capital deficit of $1,112,803. Total stockholders’ deficit was $1,092,829, and accumulated deficit was $11,153,889.
Investing activities used $73,689, primarily for intangible assets. Financing activities provided $32,139 from debenture issuance costs. The filing reports total liabilities of $3,105,963 and total assets of $2,013,134.
Debt, Liquidity, and Capitalization
- The company had a $1.0 million senior secured convertible debenture bearing 16% annual interest and due June 27, 2014. Its carrying amount, net of discount, was $595,975, with $250,000 classified as current at March 31, 2013.
- Mandatory principal redemptions were scheduled to total $250,000 in 2013 and $750,000 in 2014.
- Related-party notes payable and accrued interest totaled $454,614, generally due in 2015.
- The company recorded a $161,824 derivative liability related to the convertible debenture and warrants, compared with $68,962 at December 31, 2012.
- The derivative revaluation produced a $92,862 loss during the quarter and contributed to the increase in other expense.
- Management stated that revenue, anticipated operating cash flow, deferred officer salaries, and short-term financing were expected to fund planned operations for the next twelve months, but acknowledged that additional financing could be required.
- Shares outstanding increased to 72,383,205 from 71,912,617 at December 31, 2012. In February 2013, 470,588 shares were issued to satisfy $40,000 of debenture interest.
Material Changes Versus the Prior Comparable Period
- Total revenue declined $296,708, primarily because company-owned product sales fell $305,500, or 58.5%, due to lower wholesale and direct-to-consumer sales and distributor returns.
- Licensed and distributed product revenue increased 1.5%, while royalty revenue increased 5.8%.
- Gross margin contracted substantially because gross profit declined faster than revenue.
- Cost of sales decreased 11.8%, and marketing and sales expense decreased 71.1%; however, general and administrative expense increased 4.3%, including higher salary-related costs.
- Interest expense increased to $161,983 from $33,215, primarily reflecting the 16% debenture and related amortization of debt discount.
- The company moved from $51,201 of operating cash inflow in Q1 2012 to $226,163 of operating cash outflow in Q1 2013.
- The company discontinued sales of unrelated overstock products at the end of the first quarter and planned to phase out those products over the following six months.
- Product development spending increased to $26,991 from $5,680, while $320,306 of product development costs remained capitalized in process.
Guidance, Outlook, Risks, and Unusual Items
Management anticipated growth from improved existing products, competitive pricing, additional catalog content, licensing opportunities, and digital products. A Ready!Play!Learn! program and an application featuring digital video, music, games, and puzzles were expected to become available in the second quarter of 2013. The filing does not provide quantitative revenue or earnings guidance.
The company reported that the Tollytots toy line had generated no royalty revenue beyond guaranteed minimum payments following its third-quarter 2012 retail launch, and there was no assurance of additional future revenue. Management also noted that sales could be affected by consumer preferences, economic and retail conditions, competition, customer concentration, seasonal fluctuations, production delays, intellectual-property protection, and the availability of financing.
Liquidity remains a significant risk because the company has recurring losses, negative working capital, negative stockholders’ equity, limited cash, scheduled debt redemptions, and negative operating cash flow. The filing states that failure to achieve profitable operations and sufficient operating cash flow could require additional equity or related-party financing, reduced development activity, or a significant reduction or termination of operations.
The company reported no material pending legal proceedings, no reportable defaults on senior securities, and no material subsequent events. Management concluded that disclosure controls and procedures were effective as of March 31, 2013, and reported no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Verify the company’s current legal name and corporate history, because the filing is under Genius Brands International, Inc., while the request identifies Kartoon Studios, Inc.
- Assess the company’s ability to fund operations and meet the $250,000 2013 debenture redemption and subsequent 2014 obligations.
- Review the terms, conversion features, anti-dilution provisions, and potential dilution from the convertible debenture, 5,852,060 warrants, and 15,725,000 outstanding stock options.
- Evaluate whether the company can reverse the sharp decline in company-owned product sales and improve the 11.8% gross margin.
- Confirm the collectability of $557,332 of accounts receivable and the valuation and saleability of $344,946 of inventory.
- Monitor deferred officer salaries, related-party debt, and the company’s reliance on future financing.
- Verify the commercial launch and revenue contribution of the planned digital application and Ready!Play!Learn! program.