Quarterly Report (10-q)

Date : 08/14/2018 @ 10:20PM
Source : Edgar (US Regulatory)
Stock : Grom Social Enterprises, Inc. (QB) (GRMM)
Quote : 0.2  0.0 (0.00%) @ 8:59PM

Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

 

For the transition period from ________ to _________

 

Commission File Number:  000-55585

 

Grom Social Enterprises, Inc.

(Exact name of registrant as specified in its charter)

 

Florida   46-5542401
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

2060 NW Boca Raton Blvd. #6, Boca Raton, Florida   33431
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: ( 561) 287-5776

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ     No   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company þ
    Emerging growth company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨      No  þ

 

The number of shares of the registrant’s only class of common stock issued and outstanding was 127,495,399 shares as of August 14, 2018.

 

 

 

 

     
 

  

Grom Social Enterprises

 

Table of Contents

 

Part I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements 2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 3
Item 3. Quantitative and Qualitative Disclosures about Market Risk 6
Item 4. Controls and Procedures 7
     
Part II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 8
Item 1A. Risk Factors 8
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 8
Item 3. Defaults upon Senior Securities 8
Item 4. Mine Safety Disclosures 8
Item 5. Other Information 8
Item 6. Exhibits 8

 

 

 

  i  
 

 

CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

 

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon our current assumptions, expectations and beliefs concerning future developments and their potential effect on our business. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “approximately,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing,” or the negative of these terms or other comparable terminology, although the absence of these words does not necessarily mean that a statement is not forward-looking. This information may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from the future results, performance or achievements expressed or implied by any forward-looking statements.

 

Factors that may cause or contribute actual results to differ from these forward-looking statements include, but are not limited to, for example:

 

  · adverse economic conditions;
     
  · the Company’s ability to raise capital to fund a portion of its operations
     
  · the Company’s ability to monetize its gromsocial.com database of users
     
  · industry competition
     
  · the Company’s ability to integrate its acquisitions
     
  · the inability to attract and retain qualified senior management and technical personnel; and
     
  · other risks and uncertainties related to the social media, animation services, nutritional products and web filtering services marketplace and our business strategy.

 

All forward-looking statements speak only as of the date of this Report. We undertake no obligation to update any forward-looking statements or other information contained herein. Stockholders and potential investors should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements in this report are reasonable, we cannot assure stockholders and potential investors that these plans, intentions or expectations will be achieved.

 

These forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors. Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. Considering these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of the Quarterly Report on Form 10-Q. All subsequent written and oral forward-looking statements concerning other matters addressed in this Quarterly Report on Form 10-Q and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Quarterly Report on Form 10-Q.

 

Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise.

 

 

 

 

  1  
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Our unaudited consolidated financial statements included in this Form 10-Q are as follows:
 
F-1 Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017
   
F-2 Interim Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017
   
F-3 Interim Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017
   
F-4 Notes to Interim Unaudited Financial Statements

 

 

 

 

  2  
 

 

GROM SOCIAL ENTERPRISES INC.

Consolidated Balance Sheets

                   

 

    June 30,     December 31,  
    2018     2017  
    (Unaudited)     (Audited)  
ASSETS                
Current assets:                
Cash and cash equivalents   $ 392,005     $ 436,869  
Accounts receivable     556,167       445,388  
Inventory     522,926       426,998  
Prepaid expenses and other current assets     980,240       1,035,379  
Total current assets     2,451,338       2,344,634  
Property and equipment, net     924,286       849,893  
Goodwill     8,853,261       8,800,761  
Intangible assets, net     6,538,629       6,768,857  
Deferred tax assets     189,513       201,290  
Other assets     69,106       81,345  
Total assets   $ 19,026,133     $ 19,046,780  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY                
Current liabilities:                
Accounts payable   $ 567,506     $ 882,504  
Accrued liabilities     1,652,152       1,592,726  
Advanced payments and deferred revenues     1,465,283       1,184,624  
Convertible debentures, net -- current           75,000  
Related party payables     2,294,257       2,076,640  
Income taxes payable           46,963  
Total current liabilities     5,979,198       5,858,457  
Convertible debentures, net of loan discounts     2,529,627       1,463,273  
Senior secured promissory notes, net of loan discounts     3,720,000       3,953,661  
Contingent purchase consideration     429,000       429,000  
Other noncurrent liabilities     223,601       237,495  
Total liabilities     12,881,426       11,941,886  
                 
Commitments and contingencies (Note 14)            
                 
Stockholders' Equity:                
Preferred stock, $0.001 par value. 10,000,000 shares authorized; zero shares issued and outstanding            
Common stock, $0.001 par value. 200,000,000 shares authorized; 127,328,822 and 124,273,548 shares issued and outstanding as of June 30, 2018 and December 31, 2017, respectively     127,329       124,274  
Additional paid-in capital     49,493,776       47,901,532  
Accumulated earnings (deficit)     (43,288,577 )     (40,843,568 )
Accumulated other comprehensive income     (187,821 )     (77,344 )
Total stockholders' equity     6,144,707       7,104,894  
Total liabilities and equity   $ 19,026,133     $ 19,046,780  

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  F- 1  
 

 

GROM SOCIAL ENTERPRISES INC.

Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

 

 

    Three Months Ended June 30,     Three Months Ended June 30,     Six Months Ended June 30,     Six Months Ended June 30,  
    2018     2017     2018     2017  
                         
Sales   $ 1,778,633     $ 1,776,875     $ 3,811,305     $ 3,485,556  
Cost of goods sold     668,386       876,511       1,446,125       1,614,374  
Gross margin     1,110,247       900,364       2,365,180       1,871,182  
Operating expenses:                                
Depreciation and amortization     204,986       277,995       405,087       561,546  
Selling and marketing     55,442       72,501       111,354       112,971  
General and administrative     1,575,698       969,557       2,944,244       2,157,525  
Professional fees     300,424       292,473       682,979       1,027,661  
Stock based compensation     92,970       408,529       169,163       1,963,360  
Total operating expenses     2,229,520       2,021,055       4,312,827       5,823,063  
Income (loss) from operations     (1,119,273 )     (1,120,691 )     (1,947,647 )     (3,951,881 )
Other income (expense)                                
Interest income (expense), net     (245,366 )     (104,843 )     (508,459 )     (207,581 )
Other gains (losses)     34,161       13,695       34,506       25,389  
Total other income (expense)     (211,205 )     (91,148 )     (473,953 )     (182,192 )
Income (loss) before income taxes     (1,330,478 )     (1,211,839 )     (2,421,600 )     (4,134,073 )
Provision for income taxes     23,409             23,409        
Net income (loss)   $ (1,353,887 )   $ (1,211,839 )   $ (2,445,009 )   $ (4,134,073 )
                                 
Basic and diluted earnings (loss) per common share   $ (0.01 )   $ (0.01 )   $ (0.02 )   $ (0.04 )
                                 
Weighted-average number of common shares outstanding:                                
Basic and diluted     126,387,518       104,128,845       126,017,416       103,445,162  
                                 
Comprehensive loss:                                
Net income (loss)   $ (1,353,887 )   $ (1,211,839 )   $ (2,445,009 )   $ (4,134,073 )
Foreign currency translation adjustment     (110,477 )     (3,919 )     (110,477 )     (3,919 )
Comprehensive income (loss)   $ (1,464,364 )   $ (1,215,758 )   $ (2,555,486 )   $ (4,137,992 )

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  F- 2  
 

 

GROM SOCIAL ENTERPRISES INC.

Consolidated Statements of Cash Flows (Unaudited)

 

 

    Six Months Ended June 30,     Six Months Ended June 30,  
    2018     2017  
Cash flows from operating activities of continuing operations:                
Net income (loss)   $ (2,445,009 )   $ (4,134,073 )
Adjustments to reconcile net loss to cash used in operating activities:                
Depreciation and amortization     405,087       561,546  
Amortization of debt discount     325,619       92,289  
Common stock issued for financing costs     2,250        
Common stock issued in exchange for fees and services     263,250       907,955  
Deferred taxes     11,776       (4,619 )
Stock based compensation     293,363       1,963,360  
Changes in operating assets and liabilities:                
Accounts receivable     (110,778 )     (74,570 )
Inventory     (95,927 )     (30,469 )
Prepaid expenses and other current assets     127,138       (116,711 )
Other assets     12,239       (19,876 )
Accounts payable     (143,522 )     (217,559 )
Accrued liabilities     59,426       33,838  
Advanced payments and deferred revenues     280,659       547,055  
Income taxes payable and other noncurrent liabilities     (60,857 )     (33,102 )
Related party payables     217,616       450,724  
Net cash provided by (used in) operating activities     (857,670 )     (74,212 )
                 
Cash flows from investing activities:                
Purchase of fixed assets     (249,252 )     (119,403 )
Net cash provided by (used in) investing activities     (249,252 )     (119,403 )
                 
Cash flows from financing activities:                
Proceeds from exercise of common stock purchase warrants, net of issuance costs     61,500       1,038,000  
Proceeds from issuance of convertible debentures     1,186,135        
Proceeds from issuance of senior, secured promissory notes           32,000  
Repayments of convertible debentures     (75,000 )     (75,000 )
Net cash provided by (used in) financing activities     1,172,635       995,000  
                 
Effect of exchange rates on cash and cash equivalents     (110,577 )     (15,069 )
Net increase (decrease) in cash and cash equivalents     (44,864 )     786,316  
Cash and cash equivalents at beginning of period     436,869       443,494  
Cash and cash equivalents at end of period   $ 392,005     $ 1,229,810  
                 
Supplemental disclosure of cash flow information:                
Cash paid for interest   $ 70,253     $  
Cash paid for income taxes   $     $  
                 
Supplemental disclosure of non-cash investing and financing activities:                
Common stock issued related to acquisition of business   $ 52,500     $ 32,500  
Common stock issued with letter of intent to acquire a business            
Common stock issued related to acquisition of intangible assets   $     $ 60,000  
Common stock issued for financing costs incurred in connection with convertible and promissory notes   $ 678,259     $  
Common stock issued in connection with long term service contracts   $ 72,000     $  
Common stock issued to reduce accounts payable and other accrued liabilities   $ 171,376     $ 33,000  
Contingent purchase consideration   $     $ 362,500  
Debt issued related to acquisition of a business   $     $ 1,000,000  
Discount for beneficial conversion features on convertible debentures   $ 801     $  

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  F- 3  
 

 

GROM SOCIAL ENTERPRISES, INC.

Notes to Consolidated Unaudited Financial Statements

For the Three and Six-Month Interim Periods Ended June 30, 2018 and 2017

 

1. NATURE OF OPERATIONS

 

Effective August 17, 2017, Grom Social Enterprises, Inc. (the “Company,” “Grom,” “we,” “us,” or “our”), a Florida corporation f/k/a Illumination America, Inc. (“Illumination”), consummated the acquisition of Grom Holdings, Inc. (“Grom Holdings”). Pursuant to the terms of the Share Exchange Agreement (“Share Exchange”) that was entered into on May 15, 2017, the Company amended its Articles of Incorporation to increase its authorized capital to 200,000,000 shares of common stock, as well as to change its name to “Grom Social Enterprises, Inc.” At the closing of the Share Exchange, the Company issued an aggregate of 110,853,883 shares of its common stock to the Grom Holdings shareholders, pro rata to their respective ownership percentage. Each share of Grom Holdings was exchanged for 4.17 shares of Illumination common stock. As a result, the stockholders of Grom Holdings are now stockholders of the Company and own approximately 92% of the Company’s issued and outstanding shares of common stock.

  

As a result of the acquisition of Grom Holdings, Inc. the Company now operates its business through five wholly-owned subsidiaries, including:

 

  · Grom Social, Inc. (“Grom Social”), incorporated in the State of Florida in March 2012, operates our social media network designed for children.

 

  · TD Holdings Limited (“TD Holdings”), which was acquired in July 2016, is incorporated in Hong Kong. Its operations are conducted through its subsidiary companies, Top Draw Animation Hong Kong Limited (“TDAHK”) and Top Draw Animation, Inc (“Top Draw” or “TDA”). The group’s principal activities, based in Manila, Philippines, are the production of animated films.

 

  · Grom Educational Services, Inc. (“GES”), formed in February 2017, is a Florida corporation through which we operate our NetSpective Webfilter (“NetSpective”) services that we provide to schools and libraries.

 

  · Grom Nutritional Services, Inc. (“GNS”) is a Florida corporation formed in April 2017 through which we intend to market and distribute four flavors of a nutritional supplement to children.

 

  · Illumination America Lighting, Inc. (“IAL”), which operates our LED lighting business that was formerly Illumination, was our principal business prior to the Grom Holdings acquisition.

 

Retroactive Application of the Share Exchange Ratio

 

All references to share totals or values in this Form 10-Q, unless otherwise stated, have been adjusted, retroactively, to reflect the Share Exchange ratio of 4.17 as of August 17, 2017.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Going Concern

 

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business for the twelve-month period following the date of these financial statements. On a consolidated basis, the Company has incurred significant operating losses since inception.

   

Because the Company does not expect that existing operational cash flow will be sufficient to fund presently anticipated operations, this raises substantial doubt about the Company’s ability to continue as a going concern. Therefore, the Company will need to raise additional funds and is currently exploring alternative sources of financing. Historically, the Company has raised capital through private placements, convertible debentures and officer loans as an interim measure to finance working capital needs and may continue to raise additional capital through sale of Common Stock or other securities and obtaining some short-term loans. The Company will be required to continue to so until its consolidated operations become profitable. Also, the Company has, in the past, paid for consulting services with its Common Stock to maximize working capital, and intends to continue this practice where feasible.

 

 

 

 

  F- 4  
 

 

Management’s Representation of Interim Financial Statements

 

The accompanying unaudited consolidated financial statements have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted as allowed by such rules and regulations, and management believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements include all of the adjustments, which in the opinion of management are necessary to a fair presentation of financial position and results of operations. All such adjustments are of a normal and recurring nature. Interim results are not necessarily indicative of results for a full year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements at December 31, 2017 and 2016, as presented in the Company’s Form 10-K filed on April 17, 2018 with the SEC.

 

Basis of Presentation

 

The Company has deemed the transfer of net assets to be a reverse acquisition in accordance with FASB ASC 805-40,  "Reverse Acquisitions" . The legal acquirer is Illumination America and the legal acquiree is Grom Holdings, Inc. However, the transaction was accounted for as a recapitalization effected by a share exchange, wherein Grom Holdings is considered the acquirer for accounting and financial reporting purposes. The assets and liabilities of the acquired entity have been brought forward at their book value and no goodwill has been recognized.

 

The consolidated financial statements of the Company have been prepared in accordance with GAAP and are expressed in United States dollars. For the six month period ended June 30, 2018, the consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Grom Social, TD Holdings, GES, Illumination, GNS and IAL. TD Holdings was acquired on July 1, 2016; and GES was formed in January 2017 to house the NetSpective assets and business which was acquired on January 1, 2017.

 

GNS, which was formed in April 2017, had not recorded any material activity through the date of this report.

 

All intercompany accounts and transactions are eliminated in consolidation.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates relate to revenue recognition, valuation of accounts receivable and inventories, purchase price allocation of acquired businesses, impairment of long lived assets and goodwill, valuation of financial instruments, income taxes, and contingencies. The Company bases its estimates on historical experience, known or expected trends and various other assumptions that are believed to be reasonable given the quality of information available as of the date of these financial statements. The results of these assumptions provide the basis for making estimates about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.

 

Revenue Recognition

 

On January 1, 2018, we adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 605. As of and for the three month and six-month periods ended June 30, 2018, the consolidated financial statements were not materially impacted as a result of the application of Topic 606 compared to Topic 605.

 

Revenue from the production of animated films is recognized based upon substantial completion and delivery of the Company’s produced animated films on a per episodic basis. Substantial means that the animated films are 100% complete and is usually termed as a “first take”. In certain animation contracts, a certain percentage of the total contract price are withheld by the Company’s client for possible retakes and rejects over the finished products and are not recognized as revenue. A certain percentage of the episode price is required in advance as a down payment upon every inception of the animation of an episode and is initially recorded by the Company as deferred revenue.

 

Revenue is measured by reference to the fair value of consideration received or receivable by the Company for services provided, excluding value-added tax (VAT), if any, and trade discounts. Cost and expenses are recognized in the consolidated statements of comprehensive income upon utilization of the service or at the date they are incurred.

 

 

 

 

 

  F- 5  
 

 

Revenue from subscription sales are recognized on a pro-rata basis over the subscription period. Typically, a subscriber purchases computer hardware and a service license for a period of use between one year to five years for software and support. The subscriber is billed in full at the time of the sale. The Company immediately recognizes any revenue attributable to the computer hardware as it is non-refundable. The advanced billing for software and service is initially recorded as deferred revenue and subsequently recognized as revenue evenly throughout the subscription period.

 

Fair Value Measurements

 

The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820 “Fair Value Measurements and Disclosures” (“ASC 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1  - Quoted prices in active markets for identical assets or liabilities.

 

Level 2  - Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable.

 

Level 3  - Unobservable inputs that are supported by little or no market activity, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.

 

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of June 30, 2018 and December 31, 2017. The Company uses the market approach to measure fair value for its Level 1 financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The respective carrying value of certain balance sheet financial instruments approximates its fair value. These financial instruments include cash, trade receivables, related party payables, accounts payable, accrued liabilities and short-term borrowings. Fair values were estimated to approximate carrying values for these financial instruments since they are short term in nature and they are receivable or payable on demand.

 

The estimated fair value of assets and liabilities acquired in business combinations and reporting units and long-lived assets used in the related asset impairment tests utilize inputs classified as Level 3 in the fair value hierarchy.

 

The Company determines the fair value of contingent consideration based on a probability-weighted discounted cash flow analysis. The fair value remeasurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement as defined in the fair value hierarchy. In each period, the Company reassesses its current estimates of performance relative to the stated targets and adjusts the liability to fair value. Any such adjustments are included as a component of Other Income (Expense) in the Consolidated Statements of Operations and Comprehensive Loss.

 

    Level 1     Level 2     Level 3  
Earnout liability   $     $     $ 429,000  

 

The following table summarizes the change in the Company’s financial assets and liabilities measured at fair value as of June 30, 2018 and December 31, 2017.

 

Fair value, January 1, 2017   $ 1,931,707  
Fair value of contingent consideration issued during the period     362,500  
Change in fair value     (1,865,207 )
Fair value, December 31, 2017     429,000  
Fair value of contingent consideration issued during the period      
Change in fair value      
Fair Value, June 30, 2018   $ 429,000  

 

Derivative Financial Instruments

 

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risk. Terms of convertible and other promissory notes are reviewed to determine whether they contain embedded derivative instruments that are required to be accounted for separately from the host contract and recorded on the balance sheet at fair value. The fair value of derivative liabilities is required to be revalued at each reporting date, with corresponding changes in fair value recorded in current period operating results.

 

 

 

 

  F- 6  
 

 

Beneficial Conversion Features

 

In accordance with FASB ASC 470-20, “Debt with Conversion and Other Options” the Company records a beneficial conversion feature (“BCF”) related to the issuance of convertible debt or preferred stock instruments that have conversion features at fixed rates that are in-the-money when issued. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital. The intrinsic value is generally calculated at the commitment date as the difference between the conversion price and the fair value of the common stock or other securities into which the security is convertible, multiplied by the number of shares into which the security is convertible. If certain other securities are issued with the convertible security, the proceeds are allocated among the different components. The portion of the proceeds allocated to the convertible security is divided by the contractual number of the conversion shares to determine the effective conversion price, which is used to measure the BCF. The effective conversion price is used to compute the intrinsic value. The value of the BCF is limited to the basis that is initially allocated to the convertible security.

 

Stock Purchase Warrants

 

The Company accounts for warrants issued to purchase shares of its common stock as equity in accordance with FASB ASC 480,  Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, Distinguishing Liabilities from Equity.

 

Cash and cash equivalents

 

The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks and money market funds, the fair value of which approximates cost. The Company maintains its cash balances with a high-credit-quality financial institution. At times, such cash may be in excess of the Federal Deposit Insurance Corporation-insured limit of $250,000. The Company has not experienced any losses in such accounts, and management believes the Company is not exposed to any significant credit risk on its cash and cash equivalents.

 

Accounts receivable

 

Accounts receivable are customer obligations due under normal trade terms which are recorded at net realizable value. The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of trade receivables. A considerable amount of judgment is required in assessing the amount of the allowance. The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be required.

 

Recovery of bad debt amounts previously written off is recorded as a reduction of bad debt expense in the period the payment is collected. If the Company’s actual collection experience changes, revisions to its allowance may be required. After all attempts to collect a receivable have failed, the receivable is written off against the allowance.

 

Inventory

 

Materials are recorded at cost, determined using the first-in, first-out method. Work-in-process inventories are valued at the actual cost incurred for a specific project. The cost of work-in-process includes materials, direct labor, other direct costs and related production overheads.

 

Inventories are measured at the lower of cost or net realizable value. Historically, costs are generally lower in the case of the Company’s inventories since all animation projects are contract based with guaranteed payments from its customers. Materials-in-transit, if any, are stated at invoice cost plus any importation or other incidental charges.

 

The Company may record a write-down against cost for inventory if necessary, based on a review of the movement and current condition of raw materials. The Company does not believe that any obsolescence exists on work in process. In the event of a dispute with a client regarding quality or specifications, the Company may incur additional costs because of retakes and editing in an effort to achieve customer satisfaction.

 

The Company believes that no write-down for obsolete inventory is necessary as of June 30, 2018 and December 31, 2017.

 

 

 

 

  F- 7  
 

 

Property and equipment

 

Property and equipment are stated at cost or fair value if acquired as part of a business combination. Depreciation is computed by the straight-line method and is charged to operations over the estimated useful lives of the assets. Maintenance and repairs are charged to expense as incurred. The carrying amount and accumulated depreciation of assets sold or retired are removed from the accounts in the year of disposal and any resulting gain or loss is included in results of operations. The estimated useful lives of property and equipment are as follows:

 

Computers, software and office equipment 1 – 5 years
Machinery and equipment 3 – 5 years
Vehicles 5 years
Furniture and fixtures 5 – 10 years
Leasehold improvements Lesser of lease term or estimated useful life

 

Construction in process is not depreciated until the construction is completed and the asset is placed into service.

 

Goodwill and Intangible Assets

 

Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the Company’s acquisitions is attributable to the value of the potential expanded market opportunity with new customers. Intangible assets have either an identifiable or indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever is shorter. The Company’s amortizable intangible assets consist of customer relationships and non-compete agreements. Their useful lives range from 1.5 to 10 years. The Company’s indefinite-lived intangible assets consist of trade names.

 

Goodwill and indefinite-lived assets are not amortized but are subject to annual impairment testing unless circumstances dictate more frequent assessments. The Company performs an annual impairment assessment for goodwill during the fourth quarter of each year and more frequently whenever events or changes in circumstances indicate that the fair value of the asset may be less than the carrying amount. Goodwill impairment testing is a two-step process performed at the reporting unit level. Step one compares the fair value of the reporting unit to its carrying amount. The fair value of the reporting unit is determined by considering both the income approach and market approaches. The fair values calculated under the income approach and market approaches are weighted based on circumstances surrounding the reporting unit. Under the income approach, the Company determines fair value based on estimated future cash flows of the reporting unit, which are discounted to the present value using discount factors that consider the timing and risk of cash flows. For the discount rate, the Company relies on the capital asset pricing model approach, which includes an assessment of the risk-free interest rate, the rate of return from publicly traded stocks, the Company’s risk relative to the overall market, the Company’s size and industry and other Company specific risks. Other significant assumptions used in the income approach include the terminal value, growth rates, future capital expenditures and changes in future working capital requirements. The market approaches use key multiples from guideline businesses that are comparable and are traded on a public market. If the fair value of the reporting unit is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying amount exceeds its fair value, then the second step must be completed to measure the amount of impairment, if any. Step two calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets of the reporting unit from the fair value of the reporting unit as calculated in step one. In this step, the fair value of the reporting unit is allocated to all of the reporting unit’s assets and liabilities in a hypothetical purchase price allocation as if the reporting unit had been acquired on that date. If the carrying amount of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized in an amount equal to the excess.

 

Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates, strategic plans and future market conditions, among others. There can be no assurance that the Company’s estimates and assumptions made for purposes of the goodwill impairment testing will prove to be accurate predictions of the future. Changes in assumptions and estimates could cause the Company to perform impairment test prior to scheduled annual impairment tests.

 

The Company performed its annual fair value assessment at December 31, 2017 and 2016 on its subsidiaries with material goodwill and intangible asset amounts on their respective balance sheets and determined that no impairment exists.

 

Long-Lived Assets

 

The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances have indicated that an asset may not be recoverable. The long-lived asset is grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. If the sum of the projected undiscounted cash flows is less than the carrying value of the assets, the assets are written down to the estimated fair value.

 

 

 

  F- 8  
 

 

The Company evaluated the recoverability of its long-lived assets on June 30, 2018 and at December 31, 2017, respectively on its subsidiaries with material amounts on their respective balance sheets and determined that no impairment exists.

  

Income taxes

 

The Company accounts for income taxes under FASB ASC 740,  “Accounting for Income Taxes” . Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. FASB ASC 740-10-05,  “Accounting for Uncertainty in Income Taxes”  prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.

 

The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company assesses the validity of its conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause it to change its judgment regarding the likelihood of a tax position’s sustainability under audit.

 

Foreign Currency Translation

 

The functional and reporting currency of TD Holdings and TDAHK is the Hong Kong Dollar. The functional and reporting currency of Top Draw is the Philippine Peso. Management has adopted ASC 830 “Foreign Currency Matters” for transactions that occur in foreign currencies. Monetary assets denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Average monthly rates are used to translate revenues and expenses.

 

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

 

Assets and liabilities of the Company’s operations are translated into the reporting currency, United States dollars, at the exchange rate in effect at the balance sheet dates. Revenue and expenses are translated at average rates in effect during the reporting periods. Equity transactions are recorded at the historical rate when the transaction occurred. The resulting translation adjustment is reflected as accumulated other comprehensive income, a separate component of stockholders' equity in the statement of stockholders' equity.

 

Differences may arise in the amount of bad debt expense, depreciation expense and amortization expense reported in the Company's operating results as compared to the corresponding change in allowance for doubtful accounts, accumulated depreciation and accumulated amortization, respectively, due to foreign currency translation. These translation adjustments are reflected in accumulated other comprehensive income, a separate component of the Company's stockholders' equity.

 

Comprehensive Gain or Loss

 

ASC 220 “Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. As of June 30, 2018, and December 31, 2017, the Company determined that it had items that represented components of comprehensive income and, therefore, has included a statement of comprehensive income in the financial statements.

 

Shipping and handling costs

 

Shipping and handling costs related to the acquisition of goods from vendors are included in cost of sales.

 

 

 

 

  F- 9  
 

 

Basic and Diluted Net Income (Loss) Per Share

 

The Company computes net income (loss) per share in accordance with ASC 260,  “Earnings per Share” . ASC 260 requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.

 

Recent accounting pronouncements

 

Under the Jumpstart Our Business Startups Act, or the JOBS Act, we meet the definition of an “emerging growth company.” We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non- emerging growth companies.

 

FASB ASU 2016-02, Leases (Topic 842) - ASU 2016-02 requires that a lessee recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right FASB ASU No. 2014-15, “Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern, to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities and all nonpublic business entities upon issuance. The adoption of this standard is not expected to have a material impact on our financial position and results of operations.

 

The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new pronouncements that have been issued that might have a material impact on its financial position or results of operations.

  

3. ACCOUNTS RECEIVABLE

 

The following table sets forth the components of the Company’s accounts receivable at June 30, 2018 and December 31, 2017:

 

   

June 30 ,

2018

   

December 31,

2017

 
             
Total accounts receivable   $ 556,167     $ 445,388  

 

As of June 30, 2018, and December 31, 2017, the Company evaluated its outstanding accounts receivables and determined that no allowance for bad debts was necessary. No bad debt expense was recorded during the six-month period ended June 30, 2018 and the year ended December 31, 2017.

 

During the six-month ended June 30, 2018, the Company had four customers that accounted for 79.5% of revenues and four customers that accounted for 55.2% of accounts receivable.

 

During the year ended December 31, 2017, the Company had four customers that accounted for approximately 71.6% of consolidated revenues and three customers that accounted for 77.3% of accounts receivable.

 

 

 

 

  F- 10  
 

 

4.  PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

The following table sets forth the components of the Company’s prepaid expenses and other current assets at June 30, 2018 and December 31, 2017:

  

   

June 30,

2018

   

December 31,

2017

 
             
Collaborative development agreement   $ 143,649     $ 191,531  
Vendor advances     93,718       43,219  
Prepaid service agreements     421,023       578,732  
Other prepaid expenses and current assets     321,850       221,897  
Total   $ 980,240     $ 1,035,379  

 

Prepaid expenses and other assets represent prepayments made in the normal course and in which the economic benefit is expected to be realized within twelve months.

 

5. PROPERTY AND EQUIPMENT, NET

 

The following table sets forth the components of the Company’s property and equipment at June 30, 2018 and December 31, 2017:

 

    June 30, 2018     December 31, 2017  
    Gross Carrying Amount     Accumulated Depreciation     Net Book Value     Gross Carrying Amount     Accumulated Depreciation     Net Book Value  
Capital assets subject to depreciation:                                                
Computers, software and office equipment   $ 1,846,459     $ (1,368,943 )   $ 477,516     $ 1,792,499     $ (1,319,388 )   $ 473,111  
Machinery and equipment     152,369       (88,421 )     63,948       95,356       (88,342 )     7,015  
Vehicles     153,409       (116,191 )     37,218       159,431       (110,098 )     49,333  
Furniture and fixtures     354,268       (265,954 )     88,314       305,855       (273,768 )     32,086  
Leasehold improvements     833,490       (576,200 )     257,290       654,309       (585,808 )     68,502  
Total fixed assets     3,339,995       ( 2,415,709 )     924,286       3,007,450       (2,377,404 )     630,046  
Fixed assets not subject to depreciation:                                                
Construction in progress                       219,847             219,847  
Total fixed assets   $ 3,339,995     $ ( 2,415,709   $ 924,286     $ 3,227,297     $ (2,377,404 )   $ 849,893  

 

For the six-month period ended June 30, 2018 and the year ended December 31, 2017, the Company recorded depreciation expense of $170,668 and $277,047, respectively.

 

6. BUSINESS COMBINATIONS

 

Acquisition of TD Holdings Limited

 

On February 6, 2016, Grom Holdings entered into a letter of intent to acquire all of the stock of TD Holdings. Grom Holdings issued 417,000 shares of its common stock valued at $0.58 per share, or $240,000, in return for a period of exclusivity through May 31, 2016.

 

On June 20, 2016, Grom Holdings executed a share sale agreement with TD Holdings. Under the terms of the agreement, Grom Holdings paid $12.0 million in consideration including $3.5 million in cash, the issuance of $4.0 million of its common stock and the issuance of $4.5 million in 5% senior, secured promissory notes in exchange to the selling shareholders of TDA (“TDA Sellers”) for all of the equity of TD Holdings. The 7,367,001 shares of the Company’s common stock issued were subject to a twelve-month restrictive period from the date of the transaction closing. The transaction closed effective July 1, 2016.

 

The TDA Sellers were also entitled to receive $329,644 in post-closing cash payments for the excess working capital, as defined by the agreement, on TD Holdings’ closing balance sheet. These amounts were subject to certain adjustments, and payable on demand after the transaction closing date. As of December 31, 2016, the excess working capital obligation was fully satisfied.

 

Additionally, the former stockholders will have the opportunity for contingent, earn-out payments of up to $5.0 million if certain revenue and EBITDA thresholds are achieved over the three-year post-closing period. The earn-out payments, if made, shall be payable 25% in cash and 75% in common stock. For the years ended December 31, 2017 and 2016 respectively no earn-out thresholds were achieved. -see Note 12, Debt, “Amendment of TDA Sellers Note”.

 

 

  F- 11  
 

 

Fair Value of Consideration Transferred and Recording of Assets Acquired

 

The following table summarizes the acquisition date fair value of the consideration paid, identifiable assets acquired, and liabilities assumed including an amount for goodwill:

 

Consideration Paid:      
Cash and cash equivalents   $ 3,500,000  
Common stock, 7,367,001 shares of Grom common stock (includes the 417,000 Letter of Intent shares)     4,240,000  
Senior, secured promissory notes, net of discount of $309,049     4,190,951  
Working capital adjustment payable to sellers     329,644  
Contingent purchase consideration     3,987,602  
Fair value of total consideration   $ 16,248,197  

 

Recognized amount of identifiable assets acquired, and liabilities assumed:      
Financial assets:        
Cash and cash equivalents   $ 1,024,424  
Accounts receivables     693,406  
Inventory     350,769  
Prepaid and other assets     148,079  
Property and equipment     405,191  
Deferred tax assets     180,735  
Identifiable intangible assets:        
Customer relationships     1,526,282  
Non-compete agreements     846,638  
Trade name     4,386,247  
Financial liabilities:        
Accounts payable and accrued liabilities     (465,247 )
Advance payments and deferred revenues     (697,752 )
Other noncurrent liabilities     (254,631 )
Total identifiable net assets     8,144,141  
Goodwill     8,104,056  
    $ 16,248,197  

   

In estimating the fair value of the common stock issued, the Company considered, among other factors, the recent volume and pricing of capital raise activities. The Company valued the common stock shares at $0.58 per share, which represents a 26% discount to the most recent issue price prior to the measurement date. The Company believes the discount represents a market participant perspective due to the large block and minimum six month holding period.

 

In determining the fair value of the promissory notes issued, the Company considered, among other factors, the market yields on debt securities depending on the time horizon and level of perceived risk of the specific investment. The Company arrived at an estimated market rate of 9.4% and calculated the present value of the $4.0 million promissory note and its related interest to be $3,690,951. As a result, the Company recorded a discount against the promissory notes of $309,049. The discount is being amortized using the effective interest method over the life of the notes. For the year ended December 31, 2017, the Company recorded $202,667 in interest expense related to the note discount.

 

On January 3, 2018, we entered into an amendment to the acquisition agreement with the TDA Sellers -see Note 12 Debt, “Senior Secured Promissory Notes”. As part of the terms of the agreement, we issued an additional 800,000 restricted shares valued at $480,000 of our common stock to the TDA Sellers, which was recorded as an additional note discount. For the three-month period ended June 30, 2018 the Company recorded $80,000 in interest expense related to the note discount. The remaining discount balance at June 30, 2018 was $320,000.

 

The fair value of the contingent consideration was estimated using a lattice model. The forecast future up and down movements were estimated based on historical EBITDA volatility of 22.2% which includes the years 2013-2015 and the trailing twelve months ended June 30, 2016. The weighted average probability of each scenario was calculated and discounted to present value at the weighted average cost of capital to arrive at $3,987,602.

 

 

 

 

  F- 12  
 

 

Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the acquisition is attributable to the value of the potential expanded market opportunity with new customers. The goodwill is not expected to be deductible for tax purposes.

 

In determining the purchase price allocation, the Company considered, among other factors, how a market participant would likely use the acquired assets. The estimated fair value of intangible assets was based on the income approach. The income approach requires a projection of the cash flow that the asset is expected to generate in the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate, which accounts for the time value of money and the degree of risk inherent in the asset. The expected future cash flow that is projected should include all of the economic benefits attributable to the asset, including the tax savings associated with the amortization of the intangible asset value over the tax life of the asset. The income approach may take the form of a “relief-from-royalty” methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending on the specific asset under consideration.

 

The “relief-from-royalty” method was used to value the trade names acquired from TD Holdings. The “relief-from-royalty” method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be required to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the intangible asset. The key assumptions in the prospective cash flows include an 11% compound annual sales growth rate over the five years period subsequent to the acquisition. The royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the existing trade names acquired were as follows: royalty rate of 7.0%, discount rate of 13.8%, and a tax rate of 40.0%. The trade names are expected to be used indefinitely and the value includes a terminal value, based on a long-term sustainable growth rate of 2.0%, of the after-tax royalty savings determined using a form of the Gordon Growth model.

 

The fair value of customer relationships was valued using an income method. Net Operating Profit After Tax (“NOPAT”) per customer is a function of the gross profit margin of the Company, applicable contributory assets (i.e., working capital, fixed capital, work force, brand, IPR&D) charges, and the discount rate reflecting the riskiness of the asset under valuation. NOPAT per customer was used to estimate the value of the customer relationships. The key assumptions used include a revenue attrition rate of 35%, an income tax rate of 40%, and a discount rate of 13.8%.

 

The “with and without” method was used to value the non-compete agreement which will be amortized over three years. The key assumptions used include an income tax rate of 40%, and a discount rate of 13.8%.

 

Acquisition of NetSpective Webfiltering

 

On January 1, 2017, Grom Holdings acquired the assets of NetSpective, a division of TeleMate.net Software (the “TeleMate”). Under the terms of the agreement, Grom Holdings paid $1.0 million in consideration in the form of a $1.0 million redeemable, convertible promissory note. The note bears interest at 0.68% per annum. All note principal and accrued interest is payable January 1, 2020. The note is convertible at the election of the sellers (the “Telemate Sellers”) into the Company’s common stock at a conversion rate of $0.78 per share. Furthermore, if not previously converted by the Telemate Sellers, the note may be converted by the Company into shares of the Company’s common stock at a rate of $0.48 per share commencing on November 1, 2019.

 

The Telemate Sellers had the opportunity for contingent, earn-out payments of up to $362,500 if certain net cash flow thresholds are achieved during the one-year post-closing period. The earn-out payments, if made, shall be payable entirely in common stock.

  

Consideration Paid:      
Cash and cash equivalents   $  
Common stock, 41,700 shares paid with letter of intent     32,500  
Senior, secured promissory notes     1,000,000  
Financial liabilities assumed     521,735  
Contingent purchase consideration     362,500  
Fair value of total consideration   $ 1,916,735  

 

Recognized amount of identifiable assets acquired, and liabilities assumed:      
Financial assets:        
Intangible asset        
Brand name   $ 69,348  
Software     1,134,435  
Customer relationships     74,004  
Financial liabilities:        
Deferred revenues     (521,735 )
Write-down of purchase consideration     463,978  
Goodwill     696,705  
    $ 1,916,735  

 

 

 

  F- 13  
 

 

Additionally, since the valuation report reflected that the earnout threshold would not be reached, and the earnout was achieved, the Company recorded an additional expense of $362,500 related to the acquisition of Netspective.

 

In determining the fair value of the convertible promissory note issued, the Company considered, among other factors, the market yields on debt securities for similar time horizons and level of perceived risk of the investment. Based on the conversion factors and interest rate contained in the note, the Company believes the note represents fair value.

 

We used a lattice model to estimate the fair value of the contingent consideration. We forecast future up and down movements based on the 9.7% historical volatility of “Net Cash Flow” which includes the years 2014-2016. The weighted average probability of each scenario was calculated and since it did not reach the earnout threshold, we did not record any contingent consideration provision.

 

The fair value of the internally developed software was estimated using a replacement cost approach similar to the Constructive Cost Model (“COCOMO”) II.  The model is an algorithmic software cost estimation tool that estimates the cost, effort, and schedule of a hypothetical software project. We estimated costs based on total lines of code in the program and labor cost rates for the required personnel, in addition to a profit component.  Although this is a replacement cost model, we believe it represents fair value from a market participant perspective. The key assumptions used include average labor rates, total estimated labor hours, and an income tax rate of 40%.

   

In determining the purchase price allocation, the Company considered, among other factors, how a market participant would likely use the acquired assets. The estimated fair value of intangible assets was based on the income approach for customer relationships and tradename and a replacement cost method for the software programs. The income approach requires a projection of the cash flow that the asset is expected to generate in the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate, which accounts for the time value of money and the degree of risk inherent in the asset. The expected future cash flow that is projected should include all of the economic benefits attributable to the asset, including the tax savings associated with the amortization of the intangible asset value over the tax life of the asset. The income approach may take the form of a “relief-from-royalty” methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending on the specific asset under consideration. The replacement cost model uses estimated current costs at the Measurement Date, plus a profit component.

 

The “relief-from-royalty” method was used to value the trade names acquired from TeleMate. The “relief-from-royalty” method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be required to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the intangible asset. The key assumptions in the prospective cash flows include a 15% compound annual sales growth rate over the five years period subsequent to the acquisition. The royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the existing trade names acquired were as follows: royalty rate of 1.0%, discount rate of 17.1%, and a tax rate of 40.0%. The trade names are expected to be used indefinitely and the value includes a terminal value, based on a long-term sustainable growth rate of 2.0%, of the after-tax royalty savings determined using a form of the Gordon Growth model.

 

The fair value of customer relationships was valued using an income method. Net Operating Profit After Tax (“NOPAT”) per customer is a function of the gross profit margin of the Company, applicable contributory assets (i.e., working capital, fixed capital, work force, brand, IPR&D) charges, and the discount rate reflecting the riskiness of the asset under valuation. NOPAT per customer was used to estimate the value of the customer relationships. The key assumptions used include a revenue attrition rate of 10%, an income tax rate of 40%, and a discount rate of 17.1%.

 

7.  GOODWILL AND INTANGIBLE ASSETS

 

The following table sets forth the changes in the carrying amount of the Company’s goodwill at June 30, 2018 and December 31, 2017:

 

Fair value, January 1, 2017   $ 8,104,056  
Acquisition of NetSpective Webfiltering     696,705  
Balance, December 31, 2017     8,800,761  
Acquisition of Bonnie Boat     52,500  
Fair Value, June 30, 2018   $ 8,853,261  

 

 

 

 

  F- 14  
 

 

The following table sets forth the components of the Company’s intangible assets at June 30, 2018 and December 31, 2017:

 

    June 30, 2018     December 31, 2017  
    Amortization Period (Years)     Gross Carrying Amount     Accumulated Amortization     Net Book Value     Gross Carrying Amount     Accumulated Amortization     Net Book Value  
Intangible assets subject to amortization:                                                        
Customer relationships     10.00     $ 1,600,286       (316,356 )     1,283,930     $ 1,600,286     $ (236,343 )   $ 1,363,943  
Mobile software applications     2.00       282,500       (277,500 )     5,000       282,500       (240,729 )     41,771  
NetSpective webfiltering software     2.00       1,134,435       (340,331 )     794,104       1,134,435       (226,887 )     907,548  
Noncompete agreements     1.50       846,638       (846,638 )           846,638       (846,638 )      
Subtotal             3,863,859       (1,780,825 )     2,083,034       3,863,859       (1,550,597 )     2,313,262  
Intangible assets not subject to amortization:                                                        
Trade names           4,455,595               4,455,595       4,455,595             4,455,595  
Total intangible assets           $ 8,319,454     $ (1,780,825 )   $ 6,538,629     $ 8,319,454     $ (1,550,597 )   $ 6,768,857  

 

The Company recorded amortization expense for intangible assets subject to amortization of $230,239 for the six-month period ended June 30, 2018, and $1,092,592 for the year ended December 31, 2017.

 

The following table provides information regarding estimated amortization expense for intangible assets subject to amortization for each of the following years ending December 31:

 

  2018     $ 198 ,547  
  2019       386,916  
  2020       386,916  
  2021       386,916  
  2022       160,029  
  Thereafter       563,710  
        $ 2,083,034  

 

8. OTHER ASSETS

 

Other assets are comprised solely of guarantee deposits at TDA which are refundable upon termination of contract or delivery of subject matter of the contract. These are initially recorded at cost which is the fair value at the time of transaction and are subsequently measured at amortized cost.

 

9.  ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

 

Accounts payables are recognized initially at the transaction price and subsequently measured at the undiscounted amount of cash or other consideration expected to be paid. Accrued expenses are recognized based on expected amount required to settle the obligation or liability.

 

The following table sets forth the components of the Company’s accrued liabilities at June 30, 2018 and December 31, 2017.

 

   

June 30,

2018

   

December 31,

2017

 
             
Earnout consideration payable in connection with Netspective acquisition   $ 362,500     $ 362,500  
Executive and employee compensation     783,300       838,689  
Interest on convertible debentures and promissory notes     458,440       356,599  
Other accrued expenses and liabilities     47,912       34,938  
Total accrued liabilities   $ 1,652,152     $ 1,592,726  

 

 

 

 

  F- 15  
 

 

10.  RELATED PARTY PAYABLES

 

Messrs. Darren Marks and Melvin Leiner, both officers of the Company, have made numerous loans to Grom to help fund operations. These loans are non-interest bearing and callable on demand. Neither Mr. Marks nor Mr. Leiner have any intention of calling these loans at present. The loan balances are classified as short-term obligations under Related Party Payables on the Company’s balance sheet. During the three-month period ended March 31, 2018, Wayne Dearing, the managing director of TDH and his wife Stella Dearing made loans to the Company amounting to $259,433 as of June 30, 2018. These loans were made to assist TDH’s liquidity and helping to fund the capital expenditures to build out new office space at its facilities in Manila. These short-term demand loans are non-interest.

 

On December 29, 2017, Messrs. Marks and Leiner agreed to convert an aggregate of $500,000 of their combined loan balances into shares of our Common Stock, at a conversion price of $0.50 per share, which was above the closing price of the Company’s common stock of $0.30 on December 29, 2017. Mr. Marks converted $333,333 of his loan into 666,666 shares; and Mr. Leiner converted $166,667 into 333,334 shares. As a result of the transaction, Mr. Marks and Mr. Leiner’s loan balances were reduced to $1,291,018 and $842,468, respectively. Mr. Marks and Mr. Leiner now beneficially own 15,204,731 and 9,313,136 shares of our Common Stock, respectively.

 

As of June 30, 2018, and December 31, 2017, the loan balances, respectively $1,194,283 and $1,215,442 for Mr. Marks; and $840,540 and $861,198, respectively, for Mr. Leiner.

 

On January 4, 2018, Mr. Marks and Mr. Leiner voluntarily agreed to defer a large portion of their demand loans until July 1, 2019. Mr. Marks agreed to defer $915,442 of his loan balance, and Mr. Leiner agreed to defer $561,198, leaving each individual with a current principal balance due of $300,000.

 

Mr. Marks’ son Zach and his wife Sarah are employees of Grom. Their annual salaries are $90,000 and $35,000, respectively. His sons Luke and Jack, and daughter Caroline are also employed by Grom as independent contractors. Their annual fees are $18,000, $7,200 and $15,000, respectively. The Company believes that the services provided by members of the Marks family are integral to the success of the Company and are valued significantly below market for the comparable level of services provided.

 

During the years ended December 31, 2017 and 2016, the Company’s two officers and Zach Marks each voluntarily agreed to defer portion of their salaries. As of June 30, 2018, and December 31, 2017 the group was collectively owed $635,643 and $617,213 respectively, in accrued salaries. See Note 9 – Accounts Payable and Accrued Liabilities.

 

11.  OTHER NONCURRENT LIABILITIES

 

Other noncurrent liabilities are comprised solely of retirement benefit costs. The Philippine Republic Act (RA) No. 7641, mandates all private employers to provide retirement benefits to employees who upon reaching the age of sixty years or more, but not beyond sixty-five years, have served at least five years in the said establishment. The amount of retirement benefit was defined as “at least one-half month salary for every year of service, a fraction of at least six months being considered as one whole year”.

 

The balance of the accrued retirement benefit cost as of June 30, 2018 and December 31, 2017 amounted to $223,601 and $237,495 respectively.

 

12. DEBT

 

Convertible Debentures

 

The following tables set forth the components of the Company’s, convertible debentures as of June 30, 2018 and December 31, 2017:

 

    June 30,
2018
    December 31,
2017
 
Redeemable unsecured convertible note -TeleMate   $ 1,000,000       1,000,000  
Principal value of secured convertible notes     1,914,708       676,223  
Loan discounts     (385,081 )     (137,950 )
Less: Current portion           (75,000 )
Total convertible notes, net   $ 2,529,627     $ 1,463,273  

 

Redeemable unsecured convertible note -TeleMate

 

On January 1, 2017, the Company issued a three-year 0.68% redeemable convertible note for $1,000,000 to TeleMate in connection with the acquisition of the NetSpective webfiltering assets from them. All note principal and accrued interest is payable January 1, 2020. The note is convertible at the election of the noteholders into the Company’s’ common stock at a conversion rate of $0.78 per share. Furthermore, if not previously converted by the noteholders, the note may be converted by the Company into shares of the Company’s common stock at a rate of $0.48 per share commencing on November 1, 2019.

 

 

 

  F- 16  
 

 

Under the terms of the asset purchase agreement in which TeleMate had the obligation to collect certain monies on behalf of the Company, TeleMate failed to remit $146,882 it had collected on the Company’s behalf from NetSpective customers. As a result of TeleMate’s non-payment, and to avoid litigation, on January 12, 2018 we entered into a First Modification to the Purchase and Sale Agreement (the “Modification”).

 

Under the terms of the Modification, the TeleMate Sellers agreed to the following terms:

 

  · To pay the Company $10,000 per month against their outstanding balance of $146,822. To date they have paid the Company $30,000 and are current on their monthly payment obligations.
     
  · They cannot exercise the conversion feature of their $1.0 million promissory note, nor will any of the $362,500 Earnout shares (464,744) until all payments are made in full.

 

  · The December 31, 2019 maturity date of the $1,000,000 convertible note is extended indefinitely, until all payments are made in full.

 

  · All interest payments ($6,800 annually) due from the Company to the TeleMate Sellers were suspended indefinitely until all payments are made in full.

 

Finally, assuming all payments are made and the TeleMate Sellers decide to exercise the conversion feature of their promissory note, they are now bound by a leakout agreement which will limit for a one-year period the amount of shares they can register for sale on a monthly basis.

 

Secured Convertible Notes - 2018

 

During the six-month period ended June 30, 2018, the Company privately placed a series of secured, convertible, original issue discount (OID) notes with accredited investors for gross proceeds of $1,186,135. The Notes were issued with an OID discounts of 10.0%, or $127,348. The debentures carried an interest rate of 10% per annum, payable semiannually in cash, for a two-year term with fixed conversion at a price per share if converted within the first year of issuance or fixed conversion price at $0.78 converted during the two-year following issuance.

 

In connection with the issuance of these convertible debentures, the Company issued to its noteholders an aggregate of 328,371 shares of common stock as an inducement to lend. These shares were valued at $198,260 or approximately $0.60 per share. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the related convertible debentures. The related amortization expense was $79,280 for the six months ended June 30, 2018.

 

Secured Convertible Notes - 2017

 

During the year ended December 31, 2017, the Company privately placed a series of secured, convertible, original issue discount (OID) notes with accredited investors for gross proceeds of $601,223. The Notes were issued with an OID discounts of 10.0%, or $60,122. The debentures carried an interest rate of 10% per annum, payable semiannually in cash, for a two-year term with fixed conversion at a price per share if converted within the first year of issuance or fixed conversion price at $0.78 converted during the two-year following issuance.

 

In connection with the issuance of these convertible debentures, the Company issued to its noteholders an aggregate of 150,305 shares of common stock as an inducement to lend. These shares were valued at $78,321 with share prices ranging between $0.38 and $0.54 per share. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the related convertible debentures. The related amortization expense was $4,543 for the year ended December 31, 2017.

 

Additionally, at the end of 2017, there were two convertible notes outstanding amounting to $75,000 that had been issued in 2016 with a fixed conversion price of $1.19.

 

Secured Convertible Notes - 2016 activity

 

During the year ended December 31, 2016, the Company privately placed a series of secured, convertible debentures with accredited investors for gross proceeds of $2,705,600. The debentures carried an interest rate of 9% per annum, payable semiannually in cash, for a two-year term with fixed conversion prices ranging from $0.72 to $0.96 per share if converted within the first year of issuance or fixed conversion prices ranging from $1.20 to $1.44 if converted during the year following issuance.

 

 

 

 

  F- 17  
 

 

In connection with the issuance of these convertible debentures, the Company issued to its noteholders an aggregate of 884,244 shares of common stock as an inducement to lend. These shares were valued at $667,332, with share prices ranging between $0.72 and $0.96 per share. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the related convertible debentures.

 

All of the convertible debentures were analyzed at the time of their issuance for a beneficial conversion feature. In some instances, the Company concluded that a beneficial conversion feature existed. The beneficial conversion features were measured using the commitment-date stock price and were determined to aggregate $67,917. This amount is recorded as a debt discount and is amortized as interest expense over the term of the related convertible debentures.

 

The Company has analyzed the convertible debentures for derivative accounting consideration and determined that derivative accounting does not apply.

 

Senior Secured Promissory Notes

 

The following tables set forth the components of the Company’s senior, secured promissory notes at June 30, 2018 and December 31, 2017:

 

    June 30,
2018
    December 31,
2017
 
Principal value of promissory notes   $ 4,040,000     $ 4,040,000  
Loan discounts     (320,000 )     (86,339 )
                 
Total promissory notes, net   $ 3,720,000     $ 3,953,661  

 

Amendment of TDA Sellers Note

 

On January 3, 2018, we entered into an amendment to the acquisition agreement with the TDA Sellers (the “Amendment”):

 

  · The TDA Sellers agreed to extend the maturity date of the $4.0 million secured promissory note one year until July 1, 2019 (see 2016 description below);

 

  · The interest rate on the note during the one-year extension period from July 2, 2018 to July 1, 2019 was changed to 10%. The interest rate on the Note remained at 5%, payable annually in arrears, until June 30, 2018;

 

  · During the one-year extension period, the interest will be paid quarterly in arrears, instead of annually in arrears. The first such quarterly interest payment of $100,000 is due on September 30, 2018; and

 

  · Under the terms of the terms acquisition agreement, the TDA Sellers had an opportunity to earn up to $5.0 million in contingent Earnout Payments (as describe above). The original Earn out measurement period ended on December 31, 2018.  As part of the consideration for the TDA Sellers agreeing to enter the Amendment, we agreed to extend the Earnout Period, one year, to December 31, 2019.

 

Also, as additional consideration, we issued an additional 800,000 restricted shares valued at $480,000 of our common stock to the TDA Sellers. The amortization of this $480,000 in additional discount amount to $160,000 in interest during the six-month period ended June 30, 2018.

 

As a result of the amendment, the Company has classified the promissory note as a long-term obligation on our balance sheet for the period ended December 31, 2017.

  

On June 20, 2016, the Company issued a secured promissory note to the shareholders of TD Holdings in connection with the share sale agreement. The note totaled $4.0 million, bears interest at 5.0% per annum and is due on the earlier of (i) June 20, 2018 or (ii) the date on which the Company successfully completes a qualified initial public offering as defined in the agreement. The note is collateralized by all of the assets of TD Holdings. See amendment to the TDH Seller’s Note (above).

 

 

 

 

  F- 18  
 

 

Maturities of the Company’s borrowings for each of the next five years are as follows:

 

2018   $ 40,000  
2019   $ 5,701,223  
2020   $ 1,213,485  
2021   $  
2022   $  

 

13. STOCKHOLDERS’ EQUITY

 

Preferred Stock

 

The Company is authorized to issue 25,000,000 shares of Preferred Stock at a par value of $0.001. No shares of Preferred Stock were issued and outstanding as of either June 30, 2018 or December 31, 2017.

 

Common stock

 

The Company is authorized to issue 200,000,000 shares of common stock at a par value of $0.001 and had 127,328,822 and 124,273,548 shares of common stock issued and outstanding as of June 30, 2018 and December 31, 2017, respectively.

 

Common Stock Issued in Private Placements

 

During the six-month period ended June 30, 2018 and the year ended December 31, 2017, the Company did not issue any shares of stock in private placements.

 

Common Stock Issued in Connection with the Exercise of Warrants

 

During the six months ended June 30, 2018, the Company issued 256,455 shares of common stock for proceeds of $61,244 under a series of stock warrant exercises with a share price of approximately $0.24 per share.

 

During the year ended December 31, 2017, the Company issued 6,530,220 shares of common stock for proceeds of $1,566,000 under a series of stock warrant exercises with a share price of approximately $0.24 per share.

 

Common Stock Issued in Exchange for Consulting, Professional and Other Services

 

During the six months ended June 30, 2018, the Company issued 595,321 shares of common stock with a fair market value of $292,443 to employees, officers and directors in lieu of cash payment. Additionally, the Company issued 634,500 shares of common stock with a fair value of $335,250 to consultants and other professionals in lieu of cash payments.

  

During the year ended December 31, 2017, the Company issued 1,156,931 shares of common stock with a fair market value of $835,225 to employees, officers and directors in lieu of cash payment. Additionally, the Company issued 3,264,965 shares of common stock with a fair value of $1,892,735 to consultants and other professionals in lieu of cash payments.

  

Each share issuance made in exchange for services was valued based upon the trading price of the Company’s common stock on the OTC markets.

 

Common Stock Issued In lieu of Cash for Loans Payable and Other Accrued Obligations

 

During the six months ended June 30, 2018, the Company issued 285,627 shares of common stock with a fair market value of $171,376 to satisfy loans payable and other accrued obligations.

 

During the year ended December 31, 2017, the Company issued 1,045,870 shares of common stock with a fair market value of $533,000 to satisfy loans payable and other accrued obligations.

 

Common Stock Issued in Connection with the Issuance of Convertible Debentures

 

During the six months ended June 30, 2018 the Company issued 328,371 shares of common stock with a fair market value of $198,260 to investors as an inducement to lend in connection with the issuance of its unsecured, convertible notes. The fair value of the shares was recorded as interest expense in the Company’s consolidated financial statements. See Note 12 – Debt.

 

 

 

  F- 19  
 

 

During the year ended December 31, 2017 the Company issued 150,305 shares of common stock with a fair market value of $78,322 to investors as an inducement to lend in connection with the issuance of its unsecured, convertible notes. The fair value of the shares was recorded as interest expense in the Company’s consolidated financial statements. See Note 12 – Debt.

 

Common Stock Issued in the Acquisition of a Business

 

During the six months ended June 30, 2018 the Company issued 150,000 shares valued at $52,000 with the acquisition of Bonnie Boat.

 

During the year ended December 31, 2017, the Company issued 300,000 shares valued at $147,000 with the acquisition of Fyoosion marketing technology.

 

Common Stock Issued in the Acquisition of Intangible Assets

 

During the year ended December 31, 2017 the company issued 83,400 shares in connection with the acquisition of certain intangible assets valued at $60,000.

 

Common Stock issued in Connection with the Amendment of the Terms of a Promissory note

 

During the six months ended June 30, 2018, we issued 800,000 shares valued at $480,000 in connection with the amendment we negotiated to the $4.0 million-dollar TDA Sellers Note -see Note 11. Additionally, we issued 5,000 shares valued at $2,250 to amend the terms of a promissory note.

 

Stock Purchase Warrants

 

The stock purchase warrants have been accounted for as equity in accordance with FASB ASC 480, Accounting for Derivative Financial Instruments indexed to, and potentially settled in, a company’s own stock, distinguishing liabilities from equity.

 

The following table reflects all outstanding and exercisable warrants at June 30, 2018 and December 31, 2017. All stock warrants are exercisable for a period between three and five years from the date of issuance.

 

    Number of Warrants Outstanding     Weighted Avg. Exercise Price     Weighted Avg. Contractual Life (Yrs.)  
Balance January 1, 2017     7,608,154     $ 0.26       0.75  
Warrants issued     567,166     $ 1.50       2.25  
Less: Warrants exercised     (7,107,765 )   $ 0.24          
Warrants forfeited     (29,190 )   $ 0.24          
Balance December 31, 2017     1,038,365     $ 1.36       2.38  
Warrants issued                      
Less: Warrants exercised     (256,455 )                
Balance June 30, 2018     781,910     $ 1.36       1.88  

 

Stock Options

 

The following table represents all outstanding and exercisable stock options as of June 30, 2018.

    

    Options
issued
    Options
forfeited
    Options
outstanding
    Vested
options
    Strike Price     Weighted Average Remaining Life In Years
                                   
      7,735,350             7,735,350       7,735,350     $ 0.24     4.77
      9,695,250       417,000       9,278,250       9,278,250     $ 0.36     .95
      938,250       938,250                 $ 0.48      
      13,135,500       3,544,500       9,591,000       9,591,000     $ 0.72     1.76
      5,481,000       1,042,500       4,438,500       4,340,406     $ 0.78     2.62
Total     36,985,350       (5,942,250 )     31,043,100       30,945,006             2.39

 

  F- 20  
 

 

On May 1, 2018 the Company granted 60,000 stock options to a new employee at a strike price of $0.78, vesting over a five-year period. Using the Black Sholes model with a volatility of 520.58%, with no dividends paid since inception and a risk-free interest rate of 2.86%; resulted in stock-based compensation expense of $27,600 which will amortized over a 60 month period, or $460 per month. 

 

For the three months ended June 30, 2018 and the year ended December 31, 2017, the Company recorded $920 and $1,823,408 in stock-based compensation expense, respectively related to these stock options.

 

14. COMMITMENTS AND CONTINGENCIES

 

In the United States we lease approximately 1,000 square feet of office space in Boca Raton, Florida at the rate of $2,000 per month pursuant to a three-year lease expiring in October 2018. Our Florida office houses our corporate headquarters and administrative staff.

 

Our animation business leases portions of 3 floors comprising in the aggregate approximately 28,800 square feet in the West Tower of the Philippine Stock Exchange Centre in Pasig City, Manila. The space is used for administration and production purposes and we pay approximately $22,533 per month in the aggregate for such space (which increases by approximately 5% per year. These leases expire in December 2022.

 

We opened a new 1,400 square foot office in Norcross, Georgia on January 1, 2018 to house our NetSpective division.  The monthly rent pursuant to a five-year lease which expires in December 2023, is $2,055 per month which increases by approximately 3% annually.

 

15. SUBSEQUENT EVENTS

 

Subsequent to June 30, 2018 the Company has issued $110,000 in two-year convertible 20% OID notes at 10% interest to four accredited investors.

 

 

 

 

 

 

 

  F- 21  
 

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our financial statements and notes thereto included herein. In connection with, and because we desire to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward-looking statements in the following discussion and elsewhere in this Quarterly Report and in any other statement made by, or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on our behalf. We disclaim any obligation to update forward looking statements.

 

Overview

 

Effective August 17, 2017 (the “Effective Date”), we consummated the acquisition of Grom Holdings. Pursuant to the terms of the Share Exchange, we amended our Articles of Incorporation to increase our capitalization to 200,000,000 shares of common stock authorized, as well as to change our name to “Grom Social Enterprises, Inc.” On the Effective Date, we issued an aggregate of 110,853,883 shares of our common stock to the Grom Holdings shareholders, pro rata to their respective ownership. Each share of Grom Holdings was exchanged for 4.17 shares of Illumination common stock. As a result, the stockholders of Grom Holdings are now stockholders of the Company and the Grom Holdings shareholders own approximately 92% of our issued and outstanding shares of common stock.

  

As a result of the acquisition of Grom Holdings we now operate our business through five wholly-owned subsidiaries, including:

 

  · Grom Social which operates the Company’s social media network designed for children.

 

  · TD Holdings whose operations are conducted through its subsidiary companies, TDAHK and TDA. TD Holdings principal activities, based in Manila, Philippines, are the production of animated films.

 

  · GES which the Company operates its NetSpective webfiltering services that is provided to schools.

 

  · GNS through which the Company intends to market and distribute four flavors of a nutritional supplement to children.
     
  · IAL, which operates the LED business that was Illumination America’s principal business prior to the Grom Holdings acquisition.

 

As described above,  we deemed the transfer of net assets to be a reverse acquisition in accordance with FASB ASC 805-40,  "Reverse Acquisitions" . The legal acquirer is Illumination America and the legal acquiree is Grom Holdings, Inc. However, the transaction was accounted for as a recapitalization effected by a share exchange, wherein Grom Holdings is considered the acquirer for accounting and financial reporting purposes. The assets and liabilities of the acquired entity have been brought forward at their book value and no goodwill has been recognized.

 

Results of operations for the three and six months ended June 30, 2018 and 2017 include the operations of Grom and its five wholly-owned subsidiaries. It does not include the operating results of Illumination America.

 

Retroactive Application of the Share Exchange Ratio

 

All references to common stock totals or values in this Quarterly Report, unless otherwise stated have been adjusted, retroactively, to reflect the Share Exchange ratio of 4.17 as of August 17, 2017.

  

 

 

 

  3  
 

 

Results of Operations

 

Comparison of Results of Operations for the three months ended June 30, 2018 and June 30, 2017

 

Revenue

 

During the three months ended June 30, 2018 we generated revenues of $1,778,633 compared to revenues of $1,776,875 during the three-month period ended June 30, 2017, an increase of $1,758 or an increase of approximately 0.1%. The increase is due to increase revenues at TDH offset by a decline in revenues at Netspective webfiltering. Since both businesses are contract based the timing of revenues from quarter to quarter may change.

 

Subscription and advertising revenue generated by our gromsocial.com website and from our “MamaBear” mobile software safety application for the period ended June 30, 2018 was nominal. We expect to start generating increasing revenue from these sources in the second half of 2018. Additionally, we expect generate revenues from our new nutritional product supplement for children that we also expect to launch in the fourth quarter of 2018. However, there can be no assurances we will be successful in generating increasing revenue from these sources.

 

Gross margin

 

Gross margin is calculated by subtracting cost of sales from revenue. Gross margin percentage is calculated by dividing gross margins by revenue. Our gross margins vary significantly by subsidiary. Margins at our largest subsidiary, TDA are approximately 45-60%, margins for our web filtering revenues are typically in the 75-78% range, and margins at our lighting business have historically been between 12-18% Additionally, margins within subsidiary vary from quarter to quarter and from year to year due to the nature of the business of each subsidiary. Therefore, our consolidated blended gross margin will be subject to significant fluctuation form period to period until we increase our revenue to higher levels. Current gross margins percentages may not be indicative of future gross margin performance.

 

Gross margin for the periods ended June 30, 2018 and 2017 were 62.4% and 50.7 %, respectively. The increase in gross margin for the three months ended June 30, 2018 compared to June 30, 2017, is primarily attributable to improved margins at both our animation and webfiltering divisions.

 

Operating expenses

 

Operating expenses were $2,229,521 for the three-month period ended June 30, 2018, compared to $2,021,056 for same period ended in 2017, or an increase of $208,465. The increase in 2018 is primarily attributable to an increase in general and administrative expenses (G&A) of approximately $606,000 offset by a reduction of approximately $315,500 in stock-based compensation, and due to a reduction of approximately $73,000 in depreciation and amortization. The additional G&A expense were incurred across all phases of our business including with the intention of increasing future revenue. There can be no assurance that these expenditures will result in increased future revenues.

 

Interest Expense

 

Interest expense is comprised of cash interest payable on the Note due to the TDA Sellers, as well as interest payable on convertible notes, and amortization of note discounts. Interest expense was $245,366 for the three-month period ended June 30, 2018 compared to 104,843 the same period in 2017. The significant increase is attributable to an increase in debt, the amortization of note discounts including the note discount of $480,000($80,000 per quarter) related to the amendment of the note due to the TDA Sellers -see Note 12 Debt.

 

Other Income

 

Other income for the three-month periods ended June 30, 2018 and 2017 was $34,161 and $13,695, respectively, and was comprised of royalty income earned on film projects at TD Holdings.

 

Net loss

 

Net loss for the three-month period ended June 30, 2018 was ($1,353,887) or ($0.01) per share compared to a net loss of ($1,211,839) or ($0.01) per share during the same period ended June 30, 2017. The increase in operating losses of $142,048 in the 2018 period compared to 2017 is primarily attributable to increased gross margin of approximately $210,000; offset by an increase in operating expenses of approximately $208,000 and an increase in interest expense by approximately $120,000.

 

 

  4  
 

 

 

Comparison of Results of Operations for the six months ended June 30, 2018 and June 30, 2017

 

Revenue

 

During the six months ended June 30, 2018 we generated revenues of $3,811,305 compared to revenues of $3,485,556 during the six-month period ended June 30, 2017. The increase in revenues of approximately $326,000 is primarily due to increased revenues at TDH of $363,000 offset by a decline in revenues at Netspective webfiltering of approximately $40,000. Since both businesses are contract based the timing of revenues from quarter to quarter may change.

 

Subscription and advertising revenue generated by our gromsocial.com website and from our “MamaBear” mobile software safety application for the six-month period ended June 30, 2018 was approximately $15,000. We expect to start generating increasing revenue from these sources in the second half of 2018. Additionally, we expect generate revenues from our new nutritional product supplement for children “Just Brilliant” that we also expect to launch in the fourth quarter of 2018. However, there can be no assurances we will be successful in generating increasing revenue from these sources.

 

Gross margin

 

Gross margin is calculated by subtracting cost of sales from revenue. Gross margin percentage is calculated by dividing gross margins by revenue. Our gross margins vary significantly by subsidiary. Margins at our largest subsidiary, TDA are approximately 45-55%, margins for our web filtering revenues are typically in the 75-78% range, and margins at our lighting business have historically been between 12-18% Additionally, margins within subsidiary vary from quarter to quarter and from year to year due to the nature of the business of each subsidiary. Therefore, our consolidated blended gross margin will be subject to significant fluctuation form period to period until we increase our revenue to higher levels. Current gross margins percentages may not be indicative of future gross margin performance.

 

Gross margin for the six-month periods ended June 30, 2018 and 2017 were 62.1% and 53.7%, respectively. The increase in gross margin for the six-month period ended 2018 compared to the same six-month period ended June 30, 2017, is primarily attributable to improved margins at both our animation and webfiltering divisions.

 

Operating expenses

 

Operating expenses were $4,312,827 for the six-month period ended June 30, 2018, compared to $5,823,063 for same period ended in 2017, or a decrease of approximately $1,510,000. The decrease in 2018 is primarily attributable to a reduction of approximately $1,795,000 in stock-based compensation, and due to a reduction of approximately $345,000 in professional fees; a decrease of approximately $156,000 in depreciation and amortization; offset by an increase in general and administrative expense of approximately $787,000.

 

Interest Expense

 

Interest expense is comprised of cash interest payable on the Note due to the TDA Sellers, as well as interest payable on convertible notes, and amortization of note discounts. Interest expense was $508,459 for the six-month period ended June 30, 2018 compared to 207,581 the same period in 2017. The significant increase is attributable to an increase in debt, the amortization of note discounts including the note discount of $480,000(160,000 in expense in 2018) related to the amendment of the note due to the TDA Sellers -see Note 12 Debt.

 

Other Income

 

Other income for the six-month periods ended June 30, 2018 and 2017 was $34,506 and $25,389 respectively and was comprised of royalty income earned on film projects at TD Holdings.

 

Net loss

 

Net loss for the six-month period ended June 30, 2018 was $2,445,009 or ($0.02) per share compared to a net loss of $4,134,073 during the same period ended June 30, 2017. The reduction in the operating losses is primarily due to increased gross margin of approximately $494,000, a decrease in operating expenses of approximately $1,510,000, offset by an increase in interest expense by approximately $301,000.

 

 

 

 

  5  
 

 

Liquidity and Capital Resources

 

At June 30, 2018, we had $392,005 in cash.

 

During the six months ended June 30, 2018, net cash used in operating activities was $(857,670) compared to net cash used of $(74,212) during the same period in 2017. The increase of $783,458 in net cash used in operating activities is primarily attributable changes in operating assets of approximately $253,000 and a reduction of approximately $645,000 in common stock and fees exchanged for services.

 

Net cash used in investing activities during the period ended June 30, 2018 increased approximately $130,000 compared to the same period in 2017 and is directly attributable to an increase in the purchase of fixed assets in the same amount.

 

Net cash provided by financing activities was $1,172,635 for the three months ended June 30, 2018 compared to $995,000 for the same period in 2017. The increase in net cash provided by financing activities of $177,635 is primarily due to $1,186,135 in proceeds from convertible notes in 2018 compared to zero in the same period in 2017, offset by proceeds from warrant exercises of $1,038.000 in 2017 compared to $61,500 in 2018.

 

Our consolidated financial statements have been prepared assuming we will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business for the twelve-month period following the date of these financial statements. We have incurred annual losses since inception and expect we may incur additional losses in future periods. Additionally, as of June 30, 2018, excluding related party payables to our officers and principal shareholders which are not anticipated to be paid for the foreseeable future, we had a working capital deficit of $1,233,603.

 

We currently have a monthly consolidated cash operating loss of approximately $150,000 to $180,000, or approximately $2,000,000 per year. In order to fund our operations, we believe we will be required to raise approximately $2,000,000. As of the date of this Form 10-Q we have no commitment from any investment banker or other traditional funding sources and, while we have had discussions with various potential funding sources, we have no definitive agreement with any third party to provide us with financing, either debt or equity. The failure to obtain the financing necessary to allow us to continue to implement our business plan will have a significant negative impact on our anticipated results of operations.

 

We expect to reduce our monthly cash operating loss through improved profitability. There can be no assurance we will be successful. Historically we have successfully funded our losses through equity issuances, debt issuance and through officer loans. We expect to be able to continue to fund our operating losses in a similar manner and believe that we can secure capital on reasonable terms although there can be no assurances.

 

Off-Balance Sheet Arrangements

 

We had no off-balance sheet arrangements as of June 30, 2018 and December 31, 2017.

 

Critical Accounting Estimates

 

Our financial statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect reported amounts of assets, liabilities, revenues and expenses. We continually evaluate the accounting policies and estimates used to prepare the financial statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are discussed in our Form 10-K for the year ended December 31, 2017, Critical Accounting Policies section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk .

 

Not applicable

 

 

 

 

  6  
 

 

Item 4.  Controls and Procedures .

 

Evaluation of Disclosure Controls and Procedures

 

Pursuant to Rules 13a-15(b) and 15-d-15(b) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. The term “disclosure controls and procedures”, as defined under Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

Inherent Limitations  – Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdown can occur because of simple error or mistake. In particular, many of our current processes rely upon manual reviews and processes to ensure that neither human error nor system weakness has resulted in erroneous reporting of financial data.

 

We believe that our financial statements presented in this quarterly report on Form 10-Q fairly present, in all material respects, our financial position, results of operations, and cash flows for the period presented herein.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the last quarterly period covered by this report that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

 

  

 

 

 

 

 

 

 

 

  7  
 

 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings.

 

We are not a party to any legal proceeding that we believe will have a material adverse effect upon our business or financial position and no such action has been threatened.

 

Item 1A.  Risk Factors.

 

There have been no material changes to the risk factors disclosed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on April 17, 2018.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

 

During the six months ended June 30, 2018, we issued 800,000 shares valued at $480,000 in connection with the amendment we negotiated to the $4.0 million-dollar TDA Sellers Note -see Note 11. Additionally, during the six-month period ended June 30, 2018 we issued 328,371 shares in connection with issuance of $1,186,135 in convertible notes. See Note 12.

 

Item 3.  Defaults upon Senior Securities.

 

None.

 

Item 4.  Mine Safety Disclosures.

 

Not applicable.

 

Item 5.  Other Information.

 

None.

 

Item 6.  Exhibits.

 

31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32   Chief Executive Officer and Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Labels Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

 

 

 

 

 

 

  8  
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: August 14, 2018 By: /s/ Darren Marks
    Darren Marks
   

Chief Executive Officer, President and Chairman

(Principal Executive Officer)

     
     
Date: August 14, 2018 By: /s/ Melvin Leiner
    Melvin Leiner
    Chief Operating Officer, Executive Vice President, Chief Financial Officer, Director and Secretary (Principal Financial and Accounting Officer)

 

 

 

 

 

 

 

 

 

  9  

Grom Social Enterprises, Inc. (USOTC:GRMM)
Historical Stock Chart

1 Year : From Jul 2018 to Jul 2019

Click Here for more Grom Social Enterprises, Inc. Charts.

Grom Social Enterprises, Inc. (USOTC:GRMM)
Intraday Stock Chart

Today : Tuesday 16 July 2019

Click Here for more Grom Social Enterprises, Inc. Charts.

Latest GRMM Messages

{{bbMessage.M_Alias}} {{bbMessage.MSG_Date}} {{bbMessage.HowLongAgo}} {{bbMessage.MSG_ID}} {{bbMessage.MSG_Subject}}

Loading Messages....


No posts yet, be the first! No {{symbol}} Message Board. Create One! See More Posts on {{symbol}} Message Board See More Message Board Posts


Your Recent History
LSE
GKP
Gulf Keyst..
LSE
QPP
Quindell
FTSE
UKX
FTSE 100
LSE
IOF
Iofina
FX
GBPUSD
UK Sterlin..
Stocks you've viewed will appear in this box, letting you easily return to quotes you've seen previously.

Register now to create your own custom streaming stock watchlist.


NYSE, AMEX, and ASX quotes are delayed by at least 20 minutes.
All other quotes are delayed by at least 15 minutes unless otherwise stated.