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DOLPHIN DIGITAL MEDIA INC - 10-Q - MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Note Regarding Forward Looking Statements(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements in this Form 10-Q under "Management's Discussion and Analysis" constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such statements are indicated by words or phrases such as "anticipates," "projects," "believes," "intends," "expects," and similar words or phrases. Such factors include, among others, the following: competition; seasonality; success of operating initiatives; new product development and introduction schedules; acceptance of new product offerings; advertising and promotional efforts; adverse publicity; availability, changes in business strategy or development plans; availability and terms of capital; labor and employee benefit costs; changes in government regulations; and other factors particular to the Company. Should one or more of these risks, uncertainties or other factors materialize, or should underlying assumptions prove incorrect, actual results, performance, or achievements of the Company may vary materially from any future results, performance or achievements expressed or implied by such forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this paragraph. The Company disclaims any obligation to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. References in this Form 10-Q to "Company," "we," "us," and "our," are references to Dolphin Digital Media, Inc. and its consolidated subsidiaries, Hiding Digital Productions, LLC, Cybergeddon Productions, LLC and Dolphin Kids Clubs LLC. Business Summary Dolphin Digital Media, Inc. is dedicated to the production of high-quality digital content. Dolphin Digital Studios is committed to consistently delivering premium, best-in-class entertainment and securing premiere distribution partners to maximize audience reach and commercial advertising potential. The growth of online video viewing is well-documented. While all major demographics have experienced an increase in online video viewing for several years in a row, it is worth mentioning the potential of the "tween" and "teen/young adult" space online. According to a study by the Kaiser Family Foundation, 8-18 year-olds devote an average of 7 hours and 38 minutes across a typical day, or more than 53 hours per week, to using entertainment media. This creates a huge opportunity for quality content for this audience, which increasingly turns to the internet to source its entertainment options. Advertisers have taken notice, with leading digital-marketing research firm eMarketer estimating that online video ad spending (the fastest-growing advertising segment) will surpass $5 billion in the United States of America alone by 2014. Management sees an opportunity for Dolphin Digital Media to become a "market leader" digital studio. Dolphin Digital Media has also announced its entry into "Kids Clubs," or online websites to serve as destinations for entertainment and information. Management seeks to partner with established "brands" in the children's space, and to expand each brand's existing online audience through the promotion of original content supplied and/or sourced by Dolphin Digital Studios. Premium entertainment offerings, such as original web series, will serve to both increase audience through positive word-of-mouth and to increase engagement, or length of time on site. Furthermore, the Kids Clubs will serve as the platform for sponsorships and other marketing opportunities, such as contests and sweepstakes. In addition, the Kids Clubs are tremendous marketing vehicles for the respective brands, as they keep the brands "top of mind" for the youngest generation, and in a space (the online world) where they increasingly go. 17 --------------------------------------------------------------------------------Dolphin Digital Media partnered with the University of Miami to launch its first kids club, the Coca-Cola Junior Canes Club, in September, 2011. In February 2012, the Company entered into an agreement with United States Youth Soccer Association, Inc. to launch a Kids Club in this upcoming back-to-school season. During 2013, Dolphin Digital Media, Inc. partnered with a worldwide philanthropic organization to create a Kids Club to promote the organization's philanthropic philosophy and encourage literacy programs. Donors can sponsor membership for all children in a particular school and that donation entitles the school to receive a Reading Oasis from Scholastic Books. The Company did not record any revenues related to this arrangement and incurred $22,500 and $67,500 in expenses for the three and nine months ended September 30, 2013. Dolphin Digital Studios During the nine months ended September 30, 2013, the Company's focus has primarily been devoted to Dolphin Digital Studios, which creates original content to premiere online. Substantially all of the Company's operating income and expenses during the nine months ended September 30, 2013 were incurred related to Dolphin Digital Studios. Dolphin Digital Studios is a natural fit and progression in the core business of Dolphin Digital Media -entertaining its customers through high-quality digital programming. Premium online video is the largest growth sector for online advertising, with market leaders such as Yahoo!, Hulu, Netflix, YouTube and AOL making major initiatives around original programming. Dolphin Digital Media foresees 3 distinct demographics for its upcoming "web series": ? Tweens (roughly 9-14 years old); ? Teens and Young Adults (roughly 14-24 years old); and ? General Market (roughly 14-49 years old). Each of these demographics will be served with different content, and the Company may have different distribution partners for each of these demographics. Dolphin Digital Studios earns revenue from the online distribution of its web series in three different ways: Producer's Fees: Dolphin Digital Studios will earn fees for producing each web series, as included in the production budget for each project; Advertising Revenue: typically, Dolphin Digital Studios will be entitled to between 50-60% of all advertising revenue generated by its distribution partner from the online distribution of any particular web series; and Sponsorship Revenue: Dolphin Digital Studios will generally retain between 70-100% of any product integration fees, or sponsorship revenues, associated with any of its web series. During the nine months ended September 30, 2013, Dolphin Digital Studios concentrated its efforts in identifying and acquiring the rights to certain properties that it intends to produce for online distribution. Dolphin Digital Studios expects to produce several web series a year. Some projects may be self-financed, while some projects currently under development will feature strategic and financial partnerships. This will allow Dolphin Digital Studios to have attractive project financing alternatives while developing its slate of programming. The Company secured financing for a slate of projects through Equity Finance Agreements in the amount of $1,000,000 that were entered into during 2011 and 2012. Funding received through these investments is meant to help finance the costs of the web series. Per the agreements, the Company invests in projects through January 1, 2013. Investors are then entitled to share in the future revenues of any productions for which the funds invested were used. Investors share in the producers' revenues up to 115% of their investment and afterwards, as a group, will receive 50% of the revenues derived from these web series. Per the Equity Finance Agreements, the Company is entitled to a producer's fee, not to exceed $250,000, for each web series before calculating the share of revenues owed to the investors. Based on the gross producers' revenues to date, the Company is not required to pay the investors any amount in excess of the existing liability already recorded as of September 30, 2013 and December 31, 2012. The Company has invested these funds in eleven projects. Only one of the productions was completed as of September 30, 2013 and there was no producer gross revenue generated as defined in the Equity Finance Agreements as of September 30, 2013. The Company expects to generate gross producer revenues during 2014 at which time the investors will receive their pro rata share of the revenue. 18 --------------------------------------------------------------------------------Furthermore, the web series from Dolphin Digital Studios can be repackaged for distribution into "traditional media," such as television and home video, on a worldwide scale, which will significantly increase the revenue potential for any particular web series. Web series that migrate to traditional media outlets will also benefit from having a pre-established track record and viewer base. For distribution into such outlets, Dolphin Digital Studios will capitalize on its existing relationship with Dolphin Entertainment, one of the top independent television producers and distributors in the world, with a specialty in quality children's and teen programming. Founded in 1996, Dolphin Entertainment is an Emmy-nominated production and distribution company that has produced programming for Nickelodeon, Cartoon Network, and Canada's Family Channel. Dolphin Entertainment currently distributes its children's and teen programming into 300 million homes in over 100 countries. Furthermore, Dolphin Entertainment has great experience with "general market" programming, as well, having distributed television movies from U.S. partners that include Lifetime, Anchor Bay, and Starz, to name a few. The Company recognized $793,130 and $3,097,082 of revenues from online content for the nine months ended September 30, 2013 and 2012, respectively and $5,950 and $2,098,500 for the three months ended September 30, 2013 and 2012, respectively. These were derived from online productions that premiered in 2012. The revenues in 2013 were mainly derived from product integration and the sale foreign licensing rights of the productions. Cybergeddon During 2012, the Company announced its project Cybergeddon. Anthony Zuiker, the visionary creator of the CSI franchise and his production company Dare to Pass, and Yahoo, Inc. the premier digital media company partnered with Dolphin Digital Studios for this ground breaking motion picture event which brings to life the growing threat of cybercrime. True to his storytelling form, Zuiker engaged Norton by Symantec to leverage its technical credibility and security insights to help inform and guide the narrative. Cybergeddon was released September 25, 2012, through Yahoo's global online distribution. During 2012, the Company incorporated Cybergeddon Productions, LLC as a wholly owned subsidiary. The Company entered into agreements with certain vendors and in accordance with these agreements was responsible for creating 6-12 digital episodes of approximately eight to fifteen minutes in length. The Company completed the web series during the third quarter of 2012 and began to amortize the capitalized production costs using the individual film forecast computation method. During the three and nine months ended September 30, 2013, the Company amortized approximately $6,000 and $511,000 related to this production. The Company amortized approximately $1,344,000 for the three and nine months ended September 30, 2012. On April 9, 2012, the Company entered into an agreement with a vendor to create a universal (iPhone and iPad) iOS app and an Android app for the series and expensed $320,000 as advertising costs related to this app during the third quarter of 2012. The Company did not generate any revenues or incur any expenses related to these app's for the three and nine months ended September 30, 2013. During 2013, the production was nominated for three Streamy Awards and Missy Peregrym (Rookie Blue), the lead actress, won for Best Female Performance in a Drama. Management expects future announcements relating to distribution partners for the tween and general market demographics. Cambio Distribution Partnership Cambio and Dolphin Digital Media have entered into an exclusive content deal, in which 4-6 original web series will be financed per year. In this deal, Dolphin Digital Media and Cambio will collaborate to identify original material to produce, with an emphasis on established screenwriters, actors, directors and producers. Cambio holds exclusive rights to distribute the content online in the United States. Dolphin Digital Media holds the underlying copyright in each production, as well as worldwide distribution rights outside of the online rights in the United States. As of September 30, 2013, no productions associated with this partnership have been completed. 19 --------------------------------------------------------------------------------Kids Clubs Dolphin Digital Media sees opportunity from the combination of the following two consumer trends: 1) a greater number of children under 18 have access to the internet in their lives (and most "own" their own devices - i.e. laptop computers, tablets, smartphones, etc.); and 2) those children who do have access to the internet spend an increasingly greater amount of time "online." Simply put, the internet has become the next generation's "go to" destination for both entertainment and information. "Offline" brands need to engage with their participants "online" or risk losing them altogether. It is a tremendous lost opportunity to build successful engagement with children and teenagers in the "real world" and offer them nothing (let alone an equivalent engagement opportunity) in the digital world. For example, Little Leagues may exist for the enjoyment of children, but their websites are overwhelmingly only used by parents. Similarly, non-profits may exist to provide enrichment and cultural opportunities for children, but their websites are seldom visited by the children they cater to. Dolphin Digital Media recognizes that it is uniquely positioned to offer such children's organizations a real alternative. Management has tremendous experience building engaging websites for children, in creating best-in-class premium original online entertainment content, and in coordinating large-scale sweepstakes and promotional contests. Management believes that Dolphin Digital Media will quickly become the preferred partner for a variety of children's organizations that have neither the time, financial resources or experience to provide online engagement for their participants, but who see the value in doing so. In September, 2011, Dolphin Digital Media partnered with the University of Miami to launch the Coca-Cola Junior Canes Club. The Company will share equally revenues from net membership fees with the University of Miami. For the quarters ended September 30, 2013 and 2012, the Company did not generate any significant revenues from this partnership with the University of Miami and decided to discontinue the program subsequent to quarter end. In February 2012, Dolphin Digital Media entered into an agreement with U.S. Youth Soccer to create the "US Soccer Clubhouse" website. During the quarter ended March 31, 2012, the Company hired a third party to begin building the US Soccer Clubhouse website at an initial cost of $125,000. The first installment of $25,000 was paid during the first quarter of 2012, the second $25,000 installment was paid during the second quarter of 2012 and the remaining payments are being made monthly over a period of two years upon receipt of the completed site. . On May 21, 2012, Dolphin Digital Media, Inc. entered into an agreement with a note holder to form Dolphin Kids Club LLC. Under the terms of the agreement, the parties agreed to convert $1,500,000 of notes payable into equity of Dolphin Kids Club, LLC and the Company received additional capital contributions of $1,500,000 during the year ended December 31, 2012 for a 25% member interest in the newly formed entity. Dolphin holds the remaining 75% and thus controlling interest in the entity. The purpose of this entity is to create and operate online Kids Clubs for selected charitable, educational and civic organizations. The agreement encompasses Kids Clubs created between January 1, 2012 and December 31, 2016. It is a "gross revenue agreement" and Dolphin Digital Media, Inc. will be responsible for paying all associated operating expenses. Net income will be attributable to each member based on the thresholds established in the operating agreement of the entity. Dolphin Kids Clubs, LLC has been consolidated in these financial statements with amounts attributable to the noncontrolling interest presented as a separate component of shareholders' equity. As of September 30, 2013 and December 31, 2012, the Company recorded a noncontrolling interest of $3,000,000 for the 25% interest in Dolphin Kids Clubs LLC. In 2013, the Company entered into an agreement with a worldwide philanthropic organization to create Club Connect. Club Connect is a kids club that promotes the organization's philanthropic philosophy and encourages literacy in elementary school age children. High School drop-out rates have a direct, proportional correlation to 3rd grade reading proficiency. If a child is already behind in their reading proficiency after 3rd grade, they are over 4x more likely to drop-out of high school (a rate which increases to 10x for minority children). In the US, nearly 60% of fourth graders are not reading at their grade level. Club Connect is an online site that offers reading activities, articles and games. It also promotes parent engagement by emailing parents and continuously messaging the importance of reading and parent involvement to achieve reading proficiency. Club Connect has also partnered with Scholastic Books to provide a Reading Oasis to schools that are sponsored by a donor. Donors may sponsor a school for $10,000 which entitles each child in the school to receive an annual Club Connect membership and a Reading Oasis for the school. A Reading Oasis is a location in a school that is transformed into a reading room. Scholastic will provide the Reading Oasis with hundreds of books (K-3), listening library, colorful bean bag chairs, a reading themed carpet, book cases, and a stereo listening center with four headphones. 20 --------------------------------------------------------------------------------During 2013, the Company hired a third party to create the website. As per the terms of the agreement, the Company will share revenues derived from net memberships to Club Connect with the philanthropic organization. For the three and nine months ended September 30, 2013, no revenues related to this agreement were derived and approximately $30,000 and $67,500 in expenses were incurred. Dolphin Secure During 2013, the Company decided that it would no longer pursue any sales or marketing of its internet safety product, Dolphin Secure. As a result, during the nine months ended September 30, 2013, the Company wrote off approximately $8,000 of finger print readers that were recorded as inventory. On February 8, 2011, the Company entered into a licensing agreement with Dolphin Media Germany, an unrelated party, for the licensing rights of Dolphin Secure. Under the deal terms, Dolphin Digital Media will receive a royalty from all customer licenses and sales, once royalty payments due to the Company exceed the initial license fee of $275,000. In turn, Dolphin Media Germany has retained the German-language rights to Dolphin Secure, as well as a right of first negotiation to launch the product in other European territories. During the three and nine months ended September 30, 2013 and 2012, the Company did not receive any royalties in relation to the licensing agreement. Management Expertise The launch of Dolphin Digital Studios leverages our management expertise in creating high-quality entertainment, especially for children and young adults. Dolphin Entertainment, founded in 1996 by our Chairman, C.E.O. and President, Bill O'Dowd, is one of the world's leading entertainment companies specializing in children's and young adult live-action programming, with divisions dedicated to Television Production, Feature Film Production, International Distribution and Merchandising and Licensing. Dolphin Entertainment served as Executive Producer to Nickelodeon's Emmy™-nominated hit series Zoey 101 and Ned's Declassified School Survival Guide, as well as eight different television movies that have premiered on Nickelodeon in the past ten years. Dolphin Entertainment distributes its programs worldwide, with sales in over 100 countries (reaching almost 300 million homes) for its current children's properties, including Mexico, Italy, France, Spain, the United Kingdom, Germany, Canada, Australia, New Zealand, Brazil, and South Africa, among many others. Dolphin Entertainment has successfully launched international merchandising lines for its children's properties in nearly every consumer category, including publishing, apparel, sleepwear, accessories, and cosmetics. Dolphin Digital Media holds a multiyear exclusive licensing agreement with Dolphin Entertainment, Inc., a related party, currently set to expire in June, 2018. Under the license, Dolphin Digital Media is authorized to use Dolphin Entertainment's brand properties in connection with social networking sites. The license requires that Dolphin Digital Media pays Dolphin Entertainment royalties at the rate of fifteen percent of the net sales from performance of the licensed activities. As of September 30, 2013 and December 31, 2012, the Company had not used Dolphin Entertainment's brand properties and therefore no royalties were payable under the licensing agreement. 21 --------------------------------------------------------------------------------Results for the three and nine months ended September 30, 2013 and September 30, 2012 The Company recognized revenues of $1,793,130 and $3,097,082 for the nine months ended September 30, 2013 and 2012, respectively and $505,950 and $2,098,500 for the three months ended September 30, 2013 and 2012, respectively. Revenues for the three and nine months ended September 30, 2013 are primarily derived from an agreement with a related party to provide management and back office services at an annual fee of $2,000,000. For the three and nine months ended September 30, 2013, the Company recognized $500,000 and $1,000,000 respectively, related to this contract. For the three and nine months ended September 30, 2012, the Company recognized revenues from its productions in the amount of $3,097,082 and $2,098,500, respectively. Revenues from production for the three and nine months ended September 30, 2013 were $5,950 and $793,130, respectively and were mainly related to the sale licensing rights for foreign territories for its productions and product integration revenues. The Company incurred direct costs primarily related to the amortization of capitalized production costs of approximately $511,000 and $2,305,000 for the nine months ended September 30, 2013 and 2012 and $5,600 and $1,344,000 for the three months ended September 30, 2013 and 2012. Payroll costs decreased by $895,234 from $1,689,492 to $794,258 for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2013, mostly due to $1,000,000 of accrued bonus for our CEO offset by additional headcount in 2013. General and administrative costs increased from $1,627,524 for the nine months ended September 30, 2012 to $1,950,865 for the nine months ended September 30, 2013 mostly due to consulting fee for the digital projects in the amount of $177,000, a license agreement of $58,000, public relations consultants in the amount of $78,000, approximately $45,000 in investor relations, $8,000 of inventory write off and legal fees and consulting fees in the amount of $130,000 for a project that the Company decided not to pursue. In addition, we purchased membership cards in the amount of $60,000 for kids clubs which we decided not to use and expensed. Travel costs for the nine months ended September 30, 2013 increased by approximately $112,000 as compared to the nine months ended September 30, 2012 mostly due to additional travel to Los Angeles to source projects and provide services to the related party. The Company increased its accounting and audit fees by approximately $45,000 for the nine months ended September 30 2013 as compared to September 30, 2012 due to fees related to the accounting for the derivative liability. The Company leased new office space in Los Angeles and as a result rent increased by about $20,000 for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012. This was offset by approximately $380,000 of advertising expenses incurred for one of its productions for the nine months ended September 30, 2012. General and administrative costs decreased by approximately $333,000 for the three months ended September 30, 2013 as compared to September 30, 2012, mainly due to advertising costs incurred in connection with the App's for "Cybergeddon". Interest expense increased by approximately $181,000 for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 and by approximately $75,000 for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012 mostly due to an increase in the principal balance of the note from our CEO and interest accruing on his compensation. The net loss was $441,430 or $(.01) per share and $1,986,711 or $(.02) per share based on 81,892,352 weighted average shares outstanding for the three and nine months ended September 30, 2013 as compared to a net loss of $1,230,511 or $(.02) per share and $2,577,259 or $(.03) per share based on 81,892,352 weighted average shares outstanding for the three and nine months ended September 30, 2012. The increase in net loss was a result of the factors described above. Liquidity and Capital Resources Cash flows used in operating activities decreased from $2,492,805 for the nine months ended September 30, 2012 to $2,444,777 for the nine months ended September 30, 2013. This decrease is mostly due to the Company capitalizing $2,240,298 in production costs during the nine months ended September 30, 2012 as compared to $289,206 for the nine months ended September 30, 2013. In addition during 2012, the Company reduced its other current liabilities by $861,766 by applying the production tax credits of Cybergeddon and Hiding against the production liabilities These increases in uses of cash are offset by the Company using several consultants during the nine months ended September 30, 2013 to assist in developing partnerships for digital projects, sourcing integration partners, and website development for kids clubs. For the nine months ended September 30, 2013, the Company decreased the cash derived from receivable and other current assets by approximately $711,000 mostly due to a receivable from the service contract and increased uses of cash in other current liabilities mainly due to an increase in the notes payable resulting in increased interest on these notes. During the nine months ended September 30, 2013, cash flows from investing activities were minimal and did not significantly change. 22 -------------------------------------------------------------------------------- Cash flows from financing activities decreased by $682,000 from $3,065,000 for the nine months ended September 30 2012 to $2,383,000 for nine months ended September 30, 2013. This decrease is mostly due to the Company receiving $1,325,000 as a capital contribution and $1,350,000 in notes payable that were later converted into capital during the nine months ended September 30, 2012 as partial payment for a 25% interest in the Company's subsidiary, Dolphin Kids Clubs, LLC (The total investment was $3,000,000 of which $150,000 was received during 2011). During nine months ended September 30, 2012, the Company also received $250,000 from the sale of common stock, $35,000 from the sale of warrants and $105,000 for a revenue sharing agreement accounted for as debt. For the nine months ended September 30, 2013, financing cash flows included a net of $2,428,000 received as loans from our CEO and repayment of a note payable in the amount of $45,000. Our independent auditors issued an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern based upon our net loss for the year ended December 31, 2012, our accumulated deficit as of December 31, 2012, and our level of working capital. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. Management is planning to raise any necessary additional funds through loans, financing at the subsidiary level and additional sales of its common stock; however, there can be no assurance that the Company will be successful in raising any necessary additional loans or capital. During the first two quarters of 2014, the Company generated some insignificant revenues from its kids club business and believes it will increase revenues from this source during the third and fourth quarters of 2014. The Company is currently negotiating a deal for a variety of web series that it believes will generate revenues during the first quarter of 2015. The Company intends to finance these productions through project-specific financing. Critical Accounting Policies See "Summary of Significant Accounting Policies" in the Notes to the unaudited condensed consolidated financial statements and our current annual report on Form 10-K for the year ended December 31, 2012, for discussion of significant accounting policies, recent accounting pronouncements and their effect, if any, on the Company. These policies have been followed for the nine months ended September 30, 2013. Recent Accounting Pronouncements Recent accounting pronouncements that the Company has adopted or will be required to adopt in the future are summarized below. In May 2014, the FASB issued an accounting standard update relating to the recognition of revenue from contracts with customers, which will supersede most current U.S. GAAP revenue recognition guidance, including industry-specific guidance. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The guidance will be effective for our fiscal year beginning January 1, 2017, and can be applied either retrospectively or under a cumulative-effect transition method. We are currently evaluating the impact that the adoption of this new guidance will have on our consolidated financial statements. Other recent Accounting Standards Updates not effective until after September 30, 2013 are not expected to have a significant effect on the Company's consolidated financial position or results of operations. 23 --------------------------------------------------------------------------------Off-Balance Sheet Arrangements As of September 30, 2013, we did not have any off-balance sheet arrangements. |