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Form 10-Q Grom Social Enterprises, For: Mar 31

May 16, 2022 5:00 PM EDT
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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2022

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, par value $0.001 GROM The Nasdaq Capital Market
Warrants to purchase shares of Common Stock, par value $0.001 per share GROMW The Nasdaq Capital Market

 

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 ☒     No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒     No ☐

 

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 Accelerated filer
Non-accelerated filer Smaller reporting company
    Emerging growth company

 

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

 

As of May 13, 2022, 18,760,403 shares of the registrant’s common stock were outstanding.

 

 

   

 

 

GROM SOCIAL ENTERPRISES, INC.

 

Table of Contents

 

Part I – FINANCIAL INFORMATION Page
     
Item 1. Financial Statements 4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 32
     
Part II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 33
Item 1A. Risk Factors 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
Item 3. Defaults upon Senior Securities 33
Item 4. Mine Safety Disclosures 33
Item 5. Other Information 33
Item 6. Exhibits 33

 

 

 

 

 

 

 

 

 

 

 

 

 2 

 

 

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:

 

  · adverse economic conditions;

 

  · the Company’s ability to raise capital to fund 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 Company’s ability to attract and retain qualified senior management and technical personnel;

 

  · the continued effect of the Covid-19 pandemic on the Company’s operations; and

 

  · other risks and uncertainties related to the social media, animation services, nutritional products, and web filtering services marketplace and our business strategy.

 

These forward-looking statements represent our intentions, plans, expectations, assumptions, and beliefs about future events and are subject to risks, uncertainties and other factors. Considering these risks, uncertainties, and assumptions, the events described in the forward-looking statements may not occur or may occur to a different extent or at a different time than we have described.

 

All forward-looking statements speak only as of the date of this Report. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, or other information contained herein, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise. We caution you therefore that you should not rely on any of these forward-looking statements as statements of historical fact or as guarantees or assurances of future performance.

 

 

 

 

 

 

 

 3 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

GROM SOCIAL ENTERPRISES INC.

Condensed Consolidated Balance Sheets (Unaudited)

 

         
  March 31,   December 31, 
   2022   2021 
         
ASSETS          
Current assets:          
Cash and cash equivalents  $6,271,328   $6,530,161 
Accounts receivable, net   766,747    968,579 
Inventory, net   95,533    91,361 
Prepaid expenses and other current assets   503,823    457,578 
Total current assets   7,637,431    8,047,679 
Operating lease right of use assets   583,414    593,405 
Property and equipment, net   518,729    577,988 
Goodwill   22,376,025    22,376,025 
Intangible assets, net   5,034,917    5,073,074 
Deferred tax assets, net -- noncurrent   465,632    465,632 
Other assets   839,754    721,160 
Total assets  $37,455,902   $37,854,963 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current liabilities:          
Accounts payable  $399,597   $467,711 
Accrued liabilities   439,578    400,329 
Dividend payable   176,844    459,068 
Advanced payments and deferred revenues   396,155    404,428 
Convertible notes, net -- current   873,896    2,604,346 
Loans payable -- current   5,324    36,834 
Related party payables   50,000    50,000 
Lease liabilities -- current   344,492    333,020 
Total current liabilities   2,685,886    4,755,736 
Convertible notes, net of loan discounts   987,718    716,252 
Lease liabilities   251,908    284,848 
Contingent purchase consideration   5,586,493    5,586,493 
Other noncurrent liabilities   387,742    390,833 
Total liabilities   9,899,747    11,734,162 
           
Commitments and contingencies (Note 15)        
           
Stockholders' Equity:          
Series A preferred stock, $0.001 par value. 2,000,000 shares authorized; 0 zero shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively        
Series B preferred stock, $0.001 par value. 10,000,000 shares authorized; 0 zero shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively        
Series C preferred stock, $0.001 par value. 10,000,000 shares authorized; 9,360,759 and 9,400,259 shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively   9,361    9,400 
Common stock, $0.001 par value. 500,000,000 shares authorized; 18,725,967 and 12,698,192 shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively   18,726    12,698 
Additional paid-in capital   94,917,681    89,851,309 
Accumulated deficit   (69,957,641)   (66,404,190)
Accumulated other comprehensive loss   (34,473)   (30,755)
Total Grom Social Enterprises, Inc. stockholders' equity   24,953,654    23,438,462 
Noncontrolling interests   2,602,501    2,682,339 
Total stockholders' equity   27,556,155    26,120,801 
Total liabilities and equity  $37,455,902   $37,854,963 

  

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

 

 4 

 

 

GROM SOCIAL ENTERPRISES INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

 

 

         
   Three Months Ended March 31,   Three Months Ended March 31, 
   2022   2021 
         
Sales  $1,231,125   $1,875,284 
Cost of goods sold   916,949    1,018,121 
Gross profit   314,176    857,163 
Operating expenses:          
Depreciation and amortization   64,450    148,638 
Selling, general and administrative   1,694,819    1,262,265 
Professional fees   404,066    187,109 
Total operating expenses   2,163,335    1,568,012 
Loss from operations   (1,849,159)   (710,849)
Other income (expense)          
Interest expense, net   (1,631,022)   (648,846)
Loss on settlement of debt       (947,179)
Other gains (losses)   23,736    (8,701)
Total other expense   (1,607,286)   (1,604,726)
Loss before income taxes   (3,456,445)   (2,315,575)
Provision for income taxes (benefit)        
Net loss   (3,456,445)   (2,315,575)
Loss attributable to noncontrolling interest   (79,838)    
Net loss attributable to Grom Social Enterprises, Inc. stockholders   (3,376,607)   (2,315,575)
Preferred stock dividend payable on Series C convertible preferred stock   (176,844)    
Net loss attributable to Grom Social Enterprises, Inc. common stockholders  $(3,553,451)  $(2,315,575)
           
Basic and diluted loss per common share  $(0.25)  $(0.39)
           
Weighted-average number of common shares outstanding:          
Basic and diluted   14,053,731    5,936,750 
           
Comprehensive loss:          
Net loss  $(3,456,445)  $(2,315,575)
Foreign currency translation adjustment   (3,718)   18,369 
Comprehensive loss   (3,460,163)   (2,297,206)
Comprehensive loss attributable to noncontrolling interests   (79,838)    
Comprehensive loss attributable to Grom Social Enterprises, Inc. common stockholders  $(3,380,325)  $(2,297,206)

 

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

 

 

 

 5 

 

 

GROM SOCIAL ENTERPRISES INC.

Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

 

 

                               
   Series A Preferred Stock   Series B Preferred Stock   Series C Preferred Stock 
   Shares   Value   Shares   Value   Shares   Value 
                         
Balance, December 31, 2020      $    5,625,884   $5,626       $ 
                               
Net loss                        
Change in foreign currency translation                        
Issuance of Series B preferred stock with common stock in connection with sales made under private offerings           950,000    950         
Issuance of Series B preferred stock in exchange for consulting, professional and other services           75,000    75         
Exchange of convertible notes and accrued interest for Series B preferred stock           2,564,175    2,564         
Issuance of common stock in exchange for consulting, professional and other services                        
Issuance of common stock in connection with the issuance of convertible note(s)                        
Issuance of common stock warrants in connection with the issuance of convertible note(s)                        
Recognition of beneficial conversion features related to convertible note(s)                        
Stock based compensation expense related to stock options                        
                               
Balance, March 31, 2021      $    9,215,059   $9,215       $ 

 

 

   Series A Preferred Stock   Series B Preferred Stock   Series C Preferred Stock 
   Shares   Value   Shares   Value   Shares   Value 
                         
Balance, December 31, 2021      $       $    9,400,259   $9,400 
                               
Net loss                        
Change in foreign currency translation                        
Preferred stock dividend payable on Series C preferred stock                        
Issuance of common stock in connection with Series C preferred stock dividend                        
Conversion of Series C preferred stock into common stock                   (39,500)   (39)
Issuance of common stock in exchange for consulting, professional and other services                        
Issuance of common stock in connection with the issuance of convertible note(s)                        
Conversion of convertible note(s) and accrued interest into common stock                        
Recognition of beneficial conversion features related to convertible note(s)                        
Stock based compensation expense related to stock options                        
                               
Balance, March 31, 2022      $       $    9,360,759   $9,361 

(continued)

 

 6 

 

 

GROM SOCIAL ENTERPRISES INC.

Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

(Continued)

 

                             
                   Accumulated         
           Additional       Other       Total 
   Common Stock   Paid-in   Accumulated   Comprehensive   Noncontrolling   Stockholders' 
   Shares   Value   Capital   Deficit   Loss   Interest   Equity 
                             
Balance, December 31, 2020   5,886,073   $5,886   $64,417,218   $(55,791,914)  $(39,334)  $   $8,597,482 
                                    
Net loss               (2,315,575)           (2,315,575)
Change in foreign currency translation                   18,369        18,369 
Issuance of Series B preferred stock with common stock in connection with sales made under private offerings           949,050                950,000 
Issuance of Series B preferred stock in exchange for consulting, professional and other services           74,925                75,000 
Exchange of convertible notes and accrued interest for Series B preferred stock           2,561,611                2,564,175 
Issuance of common stock in exchange for consulting, professional and other services   16,782    17    80,113                80,130 
Issuance of common stock in connection with the issuance of convertible note(s)   13,282    13    29,737                29,750 
Issuance of common stock warrants in connection with the issuance of convertible note(s)           489,313                489,313 
Recognition of beneficial conversion features related to convertible note(s)           249,095                249,095 
Stock based compensation expense related to stock options                            
                                    
Balance, March 31, 2021   5,916,137   $5,916   $68,851,062   $(58,107,489)  $(20,965)  $   $10,737,739 

 

 

                   Accumulated         
           Additional       Other       Total 
   Common Stock   Paid-in   Accumulated   Comprehensive   Noncontrolling   Stockholders' 
   Shares   Value   Capital   Deficit   Loss   Interest   Equity 
                             
Balance, December 31, 2021   12,698,192   $12,698   $89,851,309   $(66,404,190)  $(30,755)  $2,682,339   $26,120,801 
                                    
Net loss               (3,376,607)       (79,838)   (3,456,445)
Change in foreign currency translation                   (3,718)        (3,718)
Preferred stock dividend payable on Series C preferred stock               (176,844)           (176,067)
Issuance of common stock in connection with Series C preferred stock dividend   175,253    175    458,893                459,068 
Conversion of Series C preferred stock into common stock   20,573    21    18                 
Issuance of common stock in exchange for consulting, professional and other services   74,584    75    76,747                76,822 
Issuance of common stock in connection with the issuance of convertible note(s)                            
Conversion of convertible note(s) and accrued interest into common stock   5,757,365    5,757    4,119,243                4,125,000 
Recognition of beneficial conversion features related to convertible note(s)           363,329                363,329 
Stock based compensation expense related to stock options           48,142                48,142 
                                    
Balance, March 31, 2022   18,725,967   $18,726   $94,917,681   $(69,957,641)  $(34,473)  $2,602,501   $27,556,155 

  

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

 

 

 7 

 

 

GROM SOCIAL ENTERPRISES INC.

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

 

         
   Three Months Ended March 31,   Three Months Ended March 31, 
   2022   2021 
Cash flows from operating activities of continuing operations:          
Net loss  $(3,456,445)  $(2,315,575)
Adjustments to reconcile net loss to cash used in operating activities:          
Depreciation and amortization   130,830    217,515 
Amortization of debt discount   1,621,313    441,986 
Common stock issued in exchange for fees and services   76,822    155,130 
Stock based compensation   48,142     
Loss on extinguishment of debt       947,179 
Changes in operating assets and liabilities:          
Accounts receivable   201,832    (137,717)
Inventory   (4,172)   20,859 
Prepaid expenses and other current assets   (46,245)   42,911 
Operating lease right of use assets   (11,523)   (1,671)
Other assets   (118,594)    
Accounts payable   (70,542)   (348,794)
Accrued liabilities   39,250    261,402 
Advanced payments and deferred revenues   (8,273)   (272,315)
Income taxes payable and other noncurrent liabilities   (3,091)   1,742 
Related party payables       (1,225)
Net cash used in operating activities   (1,600,696)   (988,573)
           
Cash flows from investing activities:          
Purchase of fixed assets   (25,825)   (2,391)
Net cash used in investing activities   (25,825)   (2,391)
           
Cash flows from financing activities:          
Proceeds from issuance of preferred stock, net of issuance costs       950,000 
Net proceeds from issuance of convertible notes   1,444,000    666,500 
Repayments of convertible notes   (35,968)   (157,141)
Repayments of loans payable   (31,510)   (25,921)
Net cash provided by financing activities   1,376,522    1,433,438 
           
Effect of exchange rates on cash and cash equivalents   (8,834)   19,176 
Net increase (decrease) in cash and cash equivalents   (258,833)   461,650 
Cash and cash equivalents at beginning of period   6,530,161    120,300 
Cash and cash equivalents at end of period  $6,271,328   $581,950 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $11,796   $74,299 
           
Supplemental disclosure of non-cash investing and financing activities:          
Common stock issued for financing costs incurred in connection with convertible and promissory notes  $   $29,750 
Common stock warrants issued in connection with convertible promissory notes  $363,329   $489,313 
Conversion of convertible debentures and accrued interest into common stock  $4,125,000   $ 
Conversion of convertible debentures and accrued interest into preferred stock  $   $1,616,996 
Discount for beneficial conversion features on convertible notes  $   $249,095 
Preferred stock dividend payable on convertible preferred stock  $176,844   $ 

 

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

 

 

 

 8 

 

 

GROM SOCIAL ENTERPRISES, INC.

Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited)

 

 

1. NATURE OF OPERATIONS

 

Grom Social Enterprises, Inc. (the “Company”, “Grom” “we”, “us” or “our”), a Florida corporation f/k/a Illumination America, Inc. (“Illumination”), is a media, technology and entertainment company. The Company is focused on (i) delivering content to children under the age of 13 years in a safe secure platform that is compliant with the Children’s Online Privacy Protection Act (“COPPA”) and can be monitored by parents or guardians, (ii) creating, acquiring, and developing the commercial potential of Kids & Family entertainment properties and associated business opportunities, (iii) providing world class animation services, and (iv) offering protective web filtering solutions to block unwanted or inappropriate content.

 

The Company operates its business through the following five operating subsidiaries:

 

  · Grom Social, Inc. (“Grom Social”) was incorporated in the State of Florida on March 5, 2012 and operates the Company’s social media network designed for children under the age of 13 years.

 

  · TD Holdings Limited (“TD Holdings”) was incorporated in Hong Kong on September 15, 2005. TD Holdings operates through its two subsidiary companies: (i) Top Draw Animation Hong Kong Limited (“TDAHK”), a Hong Kong corporation and (ii) Top Draw Animation, Inc. (“Top Draw” or “TDA”), a Philippines corporation. The group’s principal service-based activities are the production of animated films and televisions series.

 

  · Grom Educational Services, Inc. (“GES”) was incorporated in the State of Florida on January 17, 2017. GES operates the Company’s web filtering services provided to schools and government agencies.

 

  · Grom Nutritional Services, Inc. (“GNS”) was incorporated in the State of Florida on April 19, 2017. GNS intends to market and distribute nutritional supplements to children. GNS has been nonoperational since its inception.

 

  · Curiosity Ink Media, LLC (“Curiosity”) was incorporated in the State of Delaware on January 9, 2017, creates, acquires and develops the commercial potential of Kids & Family entertainment properties and associated business opportunities.

 

The Company owns 100% of each of Grom Social, TD Holdings, GES and GNS, and 80% of Curiosity. The Company is headquartered in Boca Raton, Florida with offices in Los Angeles, California; Salt Lake City, Utah; Norcross, Georgia; and Manila, Philippines.

 

2. BASIS OF PRESENTATION and SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Impact of COVID-19

 

On January 30, 2020, the World Health Organization announced a global health emergency because of the spread of a new strain of the novel coronavirus (“COVID-19”). On March 11, 2020, the World Health Organization declared the outbreak of COVID-19, a global pandemic. COVID-19 has and continues to significantly affect the United States and global economies.

  

The Company has experienced significant disruptions to its business and operations due to circumstances related to COVID-19, and delays caused government-imposed quarantines, office closings and travel restrictions, which affect both the Company’s and its service providers. The Company has significant operations in Manila, Philippines, which was locked down by the government on March 12, 2020 due to concerns related to the spread of COVID-19. As a result of the Philippines government’s call to contain COVID-19, the Company’s animation studio, located in Manila, Philippines, which accounts for approximately 85.2% of the Company’s total revenues on a consolidated basis, was forced to close its offices for significant periods of time from March 2020 through December 2021.

 

 

 

 

 9 

 

 

In response to the outbreak and business disruption, the Company has instituted employee safety protocols to contain the spread, including domestic and international travel restrictions, work-from-home practices, extensive cleaning protocols, social distancing and various temporary closures of its administrative offices and production studio. The Company has implemented a range of actions aimed at temporarily reducing costs and preserving liquidity. In January 2022, the Company started to recall artist and employees to return to the studio which is currently operating at 50% seat capacity.

 

The outbreak has and may continue to spread, which could materially impact the Company’s business. The full extent of potential impacts on the Company’s business, financing activities and the global economy will depend on future developments, which cannot be predicted due to the uncertain nature of the continued COVID-19 pandemic, government mandated shut downs, and its adverse effects, including new information which may emerge concerning the severity of COVID-19 and the actions to contain COVID-19 or treat its impact, among others. These effects could have a material adverse impact on the Company’s business, operations, financial condition and results of operations.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conjunction with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted. For the three months ended March 31, 2022, the condensed consolidated financial statements include the accounts of the Company and its operating subsidiaries Grom Social, TD Holdings, GES, GNS, and Curiosity. The Company recognizes noncontrolling interest related to its less-than-wholly-owned subsidiary, Curiosity, as equity in the consolidated financial statements separate from the parent entity’s equity. The net income (loss) attributable to noncontrolling interest is included in net income (loss) in the condensed consolidated statements of operations and comprehensive loss.

 

These condensed 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, which includes intercompany balances and transactions are of a normal and recurring nature. Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto at December 31, 2021, as presented in the Company’s Annual Report on Form 10-K filed on April 15, 2022 with the SEC.

 

Certain prior period statement of operations captions and balances have been reclassified to conform with the current year presentation, including the allocation of $98,877 from depreciation and amortization and $118,810 in certain fixed overhead costs from selling, general, and administrative expenses previously presented under operating expenses to cost of goods sold during the three months ended March 31, 2021. The changes do not have a financial impact on the Company’s reported revenue, reported net loss, or cash flows from operations.

  

Use of Estimates

 

We have made estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates. The results of operations for the three months ended March 31, 2022, are not necessarily indicative of the operating results for the full year.

 

Update to Significant Accounting Policies

 

There have been no new or material changes to the significant accounting policies discussed in the Company’s audited financial statements in its Annual Report on Form 10-K for the fiscal year ended December 31, 2021 as filed with the SEC on April 15, 2022, that are of significance, or potential significance, to the Company.

 

Recent Accounting Pronouncements – Issued, not yet Adopted

 

There were no new accounting pronouncements issued in the first quarter of fiscal year 2022 which could impact the Company.

 

 

 

 10 

 

 

Recent Accounting Pronouncements – Adopted

 

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entitys Own Equity (Subtopic 815-40): Issuers Accounting for Certain Modification or Exchanges of Freestanding Equity-Classified Written Call Options (“ASU 2021-04”), which clarifies and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options due to a lack of explicit guidance in the FASB Codification. ASU 2021-04 provides guidance on modifications or exchanges of freestanding equity-classified written call options that are not within the scope of another Topic. Entities should treat a modification of the terms or conditions, or an exchange of a freestanding equity-classified written call option that remains equity-classified after modification or exchange, as an exchange of the original instrument for a new instrument. ASU 2021-04 provides further guidance on measuring the effect of such modifications or exchanges, and also provides guidance on the recognition of such modifications or exchanges on the basis of the substance of the transaction, in the same manner as if cash had been paid as consideration. ASU 2021-04 is effective for all entities for fiscal years beginning after December 15, 2021, and early adoption is permitted. The Company adopted this ASU on January 1, 2022, which did not result in a material impact to the condensed consolidated financial statements and disclosures.

 

3.

REVENUES

 

The Company’s main types of revenue contracts consists of the following, which are disaggregated from the condensed consolidated statements of operations.

 

Animation Revenue

 

Animation revenue is primarily generated from contracts with customers for preproduction and production services related to the development of animated movies and television series. Preproduction activities include producing storyboards, location design, model and props design, background color and color styling. Production focuses on library creation, digital asset management, background layout scene assembly, posing, animation and aftereffects. The Company provides services under fixed-price contracts. Under fixed-price contracts, the Company agrees to perform the specified work for a pre-determined price. To the extent actual costs vary from estimated costs, the Company’s profit may increase, decrease, or result in a loss.

 

Web Filtering Revenue

  

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

 

Produced and Licensed Content Revenue

 

Produced and licensed content revenues are generated from the licensing of internally-produced films and television programs.

 

Licensed internally-produced films and television programming, each individual film or episode delivered represents a separate performance obligation and revenues are recognized when the episode is made available to the licensee for exhibition. For license agreements containing multiple deliverables, revenues are allocated based on the relative standalone selling price of each film or episode of a television series, which is based on licenses for comparable films or series within the marketplace. Agreements to license programming are often long term, with collection terms ranging from one to five years.

 

 

 

 

 11 

 

 

The advanced billing component for licensed content is initially recorded as deferred revenue and subsequently recognized as revenue upon completion of the performance obligation in accordance with the terms of licensing agreement.

 

Publishing Revenue

 

Publishing revenues are recognized when merchandise is shipped or electronically delivered to the consumer. Consumer print books are generally sold with a right of return. The Company records a returns reserve and corresponding decrease in revenue at the time of sale based upon historical trends. For publishing revenues, payments are due shortly after shipment or electronic delivery.

 

Other Revenue

 

Other revenue corresponds to subscription and advertising revenue from the Grom Social website and mobile application.

 

All revenue recognized in the condensed consolidated statements of operations is considered to be revenue from contracts with customers. The following table depicts the disaggregated revenue listed above within the Sales caption in the condensed consolidated statements of operations:

        
  

Three Months Ended

March 31, 2022

  

Three Months Ended

March 31, 2021

 
Animation  $1,048,613   $1,713,658 
Web Filtering   182,244    161,241 
Produced and Licensed Content        
Publishing   268    385 
Total Sales  $1,231,125   $1,875,284 

 

The following table sets forth the components of the Company’s accounts receivable and advanced payments and deferred revenues at March 31, 2022, and December 31, 2021:

        
  

March 31,

2022

  

December 31,

2021

 
         
Billed accounts receivable  $660,232   $822,536 
Unbilled accounts receivable   147,477    187,751 
Allowance for doubtful accounts   (40,962)   (41,708)
Total accounts receivable, net  $766,747   $968,579 
Total advanced payments and deferred revenues  $396,155   $404,428 

 

During the three months ended March 31, 2022, the Company had three customers that accounted for 65.9% of revenues and three customers that accounted for 61.7% of accounts receivable. During the year ended December 31, 2021, the Company had four customers that accounted for 69.1% of revenues and two customers that accounted for 61.3% of accounts receivable.

 

Animation revenue contracts vary with movie contracts typically allowing for progress billings over the contract term while other episodic development activities are typically billable upon delivery of the performance obligation for an episode. These episodic activities typically create unbilled contract assets between episode delivery dates while movies can create contract assets or liabilities based on the progress of activities versus the arranged billing schedule. Revenues from web filtering contracts are all billed in advance and therefore represent contract liabilities until fully recognized on a ratable basis over the contract life.

 

 

 

 

 12 

 

 

 

4. INVENTORY

 

Inventory consists of costs incurred to produce animated content for third parties customers. Costs incurred to produce the animated content to customers, which include direct production costs, production overhead and supplies are recognized as work-in-progress inventory. As animated content is completed in accordance with the terms stated by the customer, inventory is classified as finished products and subsequently recognized as cost of services as animated content is accepted by and available to the customer. Carrying amounts of animated content are recorded at the lower of cost or net realizable value. Cost is determined using a weighted average cost method for direct production costs, productions overhead and supplies used for completing animation projects.

 

As of March 31, 2022 and December 31, 2021, the Company’s inventory totaled $95,533 and $91,361, respectively, and was comprised of work-in-progress of $81,673 and $77,501, respectively, and finished goods of $13,860.

 

5. PROPERTY AND EQUIPMENT

 

The following table sets forth the components of the Company’s property and equipment at March 31, 2022 and December 31, 2021:

                              
   March 31, 2022   December 31, 2021 
   Cost   Accumulated Depreciation   Net Book Value   Cost   Accumulated Depreciation   Net Book Value 
Capital assets subject to depreciation:                              
Computers, software and office equipment  $2,655,372   $(2,409,116)  $246,256   $2,698,172   $(2,399,978)  $298,194 
Machinery and equipment   183,400    (164,201)   19,199    183,618    (162,647)   20,971 
Vehicles   99,856    (80,950)   18,906    101,674    (76,497)   25,177 
Furniture and fixtures   398,532    (364,230)   34,302    401,862    (365,075)   36,787 
Leasehold improvements   1,138,039    (962,786)   175,253    1,086,518    (955,547)   130,971 
Total fixed assets   4,475,199    (3,981,283)   493,916    4,471,844    (3,959,744)   512,100 
Capital assets not subject to depreciation:                              
Construction in progress   24,813        24,813    65,888        65,888 
Total fixed assets  $4,500,012   $(3,981,283)  $518,729   $4,537,732   $(3,959,744)  $577,988 

 

For the three months ended March 31, 2022 and 2021, the Company recorded depreciation expense of $92,674 and $120,786, respectively.

 

6. OTHER ASSETS

 

The following table sets forth the components of the Company’s other assets at March 31, 2022 and December 31, 2021:

        
   March 31, 2022   December 31, 2021 
         
Capitalized website development costs   424,224    411,800 
Prepublication costs   154,786    152,286 
Produced and licensed content costs   186,052    76,701 
Deposits   74,692    76,052 
Other noncurrent assets       4,321 
Total other assets   839,754    721,160 

 

No amortization expense has yet to be recognized for website development costs, prepublication costs and produced and licensed content costs as these properties were still in development as of March 31, 2022.

 

 

 

 

 13 

 

 

 

7. LEASES

 

The Company has entered into operating leases primarily for office space. These leases have terms which range from two years to six years, and often include one or more options to renew or in the case of equipment rental, to purchase the equipment. During the three months ended March 31, 2022, the Company recorded an additional $80,478 of right of use (“ROU”) assets and lease liabilities related to new operating leases.

 

In January 2022, the Company signed a new lease agreement to extend the term until March 2024 of the Company’s office space in Boca Raton, Florida. The total legally binding minimum lease payments for this agreement is approximately $94,898.

 

Based on the present value of the lease payments for the remaining lease term of the Company's existing leases, the Company recognized $583,414 in noncurrent ROU assets, $344,492 in current lease liabilities and $251,908 in noncurrent lease liabilities from operating leases as of March 31, 2022.

 

Because the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments.

 

Information related to the Company's operating ROU assets and related lease liabilities are as follows:

    
   Three Months Ended
March 31, 2022
 
Cash paid for operating lease liabilities  $110,274 
Weighted-average remaining lease term   1.5 
Weighted-average discount rate   10% 

    

For the three months ended March 31, 2022 and 2021, the Company recorded rent expenses related to lease obligations of $105,340 and $90,993, respectively. Rent expenses related to lease obligations are allocated between cost of goods sold and selling, general and administrative expenses in the Company’s condensed consolidated statement of operations.

 

The maturities of the lease liabilities are as follows as of March 31, 2022:

     
Remainder of 2022  $320,246 
2023   116,606 
2024   52,430 
2025   42,596 
2026   44,726 
Thereafter   42,962 
Total future lease payments   623,566 
Less: Imputed interest   (27,166)
Present value of lease liabilities  $596,400 

 

 

 

 14 

 

 

 

8. BUSINESS COMBINATIONS

 

Acquisition of Curiosity Ink Media, LLC

 

On July 29, 2021, the Company entered into a membership interest purchase agreement (the “Purchase Agreement”) with Curiosity Ink Media LLC, a Delaware limited liability company (“Curiosity”) and the holders of all of Curiosity’s outstanding membership interests (the “Sellers”), for the purchase of 80% of Curiosity’s outstanding membership interests (the “Purchased Interests”) from the Sellers (the “Acquisition).

 

On August 19, 2021, pursuant to the terms of the Purchase Agreement, the Company consummated the Acquisition and acquired the Purchased Interests in consideration for the issuance to the Sellers of an aggregate of 1,771,883 shares of the Company’s common stock to the Sellers, pro rata to their membership interests immediately prior to the closing of the Acquisition. The shares were valued at $2.82 per share which represents to the 20-day volume-weighted average price of the Company’s common stock on August 19, 2021.

 

Pursuant to the Purchase Agreement, the Company also paid $400,000 and issued an 8% eighteen-month convertible promissory note in the principal amount $278,000 (the “Note”) to pay-down and refinance certain outstanding loans and advances previously made to Curiosity by Russell Hicks and Brett Watts.

 

The Note is convertible into shares of common stock of the Company at a conversion price of $3.28 per share but may not be converted if, after giving effect to such conversion, the noteholder and its affiliates would beneficially own in excess of 9.99% of the Company’s outstanding common stock. The Note may be prepaid at any time, in whole or in part. The Note is subordinate to the Company’s senior indebtedness.

 

The Sellers also have the ability to earn up to $17,500,000 (payable 50% in cash and 50% in stock) upon the achievement of certain performance milestones as of December 31, 2025.

 

In addition to the tangible assets, goodwill totaling $14,271,969 was recorded in connection with the acquisition. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents potential future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Goodwill is not expected to be deductible for tax purposes.

    
Consideration Paid:    
Cash consideration  $400,000 
Common stock issued   5,421,962 
Convertible notes   278,000 
Contingent purchase consideration   5,586,493 
Total consideration  $11,686,455 

 

The amounts in the table below represent the allocation of the purchase price. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

     
Cash and cash equivalents  $26,408 
Inventory   65,734 
Produced and licensed content cost   187,920 
Goodwill and intangible assets   14,271,969 
Accounts payable   (113,462)
Noncontrolling interest   (2,752,114)
Total identifiable assets acquired, and liabilities assumed  $11,686,455 

 

 

 

 

 15 

 

 

As of March 31, 2022, the initial accounting for the acquisition remains incomplete as the Company expects to finalize the purchase price allocation and valuations by June 30, 2022 to conclude its fair value assessment of the assets acquired and liabilities assumed, including any separately identifiable intangible assets.

 

The Company’s results of operations for the three months ended March 31, 2022 include results of operations for Curiosity. No pro forma information is presented for the Company’s results of operations as if the acquisition of Curiosity had occurred on January 1, 2021 as results of its operations are not considered material to the condensed consolidated financial statements as of and for the three months ended March 31, 2021.

 

9. 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. At March 31, 2022 and December 31, 2021, the carrying amount of the Company’s goodwill was $22,376,025.

 

The following table sets forth the components of the Company’s intangible assets at March 31, 2022 and December 31, 2021:

                                    
   Current Year Period   Prior Year End 
   Amortization Period (Years)   Gross Carrying Amount   Accumulated Amortization   Accumulated Impairment   Net Book Value   Gross Carrying Amount   Accumulated Amortization   Accumulated Impairment   Net Book Value 
Intangible assets subject to amortization:                                             
Customer relationships   10.00    1,526,282    (877,612)       648,670    1,600,286    (876,457)   (37,002)   686,827 
Mobile software applications   2.00                    282,500    (282,500)        
NetSpective webfiltering software   2.00                    1,134,435    (1,134,435)        
Noncompete agreements   1.50                    846,638    (846,638)        
Subtotal       1,526,282    (877,612)       648,670    3,863,859    (3,140,030)   (37,002)   686,827 
Intangible assets not subject to amortization:                                             
Trade names       4,386,247            4,386,247    4,455,595        (69,348)   4,386,247 
Total intangible assets       5,912,529    (877,612)       5,034,917    8,319,454    (3,140,030)   (106,350)   5,073,074 

 

For the three months ended March 31, 2022 and 2021, the Company recorded amortization expense of $38,157 and $96,728, respectively.

 

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

     
Remainder of 2022  $114,471 
2023   152,628 
2024   152,628 
2025   152,628 
2026   76,314 
Total remaining intangible assets subject to amortization   $648,670 

  

 

 

 

 16 

 

 

 

10.  ACCRUED LIABILITIES

 

The following table sets forth the components of the Company’s accrued liabilities at March 31, 2022 and December 31, 2021:

        
  

March 31,

2022

  

December 31,

2021

 
         
Executive and employee compensation  $231,390   $238,669 
Interest on convertible notes and promissory notes   30,079    31,997 
Other accrued expenses and liabilities   178,109    129,663 
Total accrued liabilities  $439,578   $400,329 

  

11.  RELATED PARTY PAYABLES

 

Darren Marks’s Family

 

The Company has engaged the family of Darren Marks, its Chief Executive Officer, to assist in the development of the Grom Social website and mobile application. These individuals create and produce original short form content focusing on social responsibility, anti-bullying, digital citizenship, unique blogs, and special events. Sarah Marks, the wife of Mr. Marks, and Zach Marks, Luke Marks, Jack Marks, Dawson Marks, Caroline Marks and Victoria Marks, each Mr. Marks’s children, are, or have been, employed by or independently contracted with the Company.

 

For the three months ended March 31, 2022 and 2021, the Marks family was paid a total of $7,500, respectively.

 

Effective January 1, 2021, the Company entered into a marketing agreement with Caroline Marks, daughter of Mr. Marks, for a period of 60 months in exchange for 52,084 shares of the Company’s common stock. On March 2, 2022, the Board of Directors of the Company approved the issuance the shares of common stock at a fair market value of $53,647.

 

Compensation for services provided by the Marks family is expected to continue for the foreseeable future.

 

Liabilities Due to Executive Officers and Directors

 

On July 11, 2018, our director Dr. Thomas Rutherford loaned the Company $50,000. The loan bears interest at a rate of 10% per annum and was due on August 11, 2018. No notice of default or demand for payment has been received by the Company.

 

As of March 31, 2022 and December 31, 2021, the aggregate related party payables balance was $50,000, respectively.

  

 

 

 

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12. CONVERTIBLE NOTES

 

The following tables set forth the components of the Company’s convertible notes as of March 31, 2022 and December 31, 2021:

        
  

March 31,

2022

   December 31,
2021
 
8% Unsecured Convertible Note (Curiosity)  $278,000   $278,000 
10% Senior Secured Convertible Note with Original Issuance Discount (L1 Capital Global Master Fund or “L1”)       4,125,000 
10% Senior Secured Convertible Note with Original Issuance Discount (L1 – Second Tranche)   1,750,000     
12% Senior Convertible Notes with Original Issuance Discounts (OID Notes)   75,000    75,000 
12% Senior Secured Convertible Notes (TDH Secured Notes)   300,143    330,039 
12% Senior Secured Convertible Notes (Additional Secured Notes)   56,636    63,099 
Loan discounts   (598,165)   (1,550,540)
Total convertible notes, net   1,861,614    3,320,598 
Less: current portion of convertible notes, net   (873,896)   (2,604,346)
Convertible notes, net  $987,718   $716,252 

 

8% Unsecured Convertible Notes – Curiosity

 

On July 29, 2021, the Company entered into a membership interest purchase agreement with Curiosity and the holders of all of Curiosity’s outstanding membership interests, for the purchase of 80% of Curiosity’s outstanding membership interests from the sellers. Pursuant to the purchase agreement, the Company issued 8% eighteen-month convertible promissory notes in the aggregate principal amount $278,000 to pay-down and refinance certain outstanding loans and advances previously made by certain of its principals. The notes are convertible into shares of common stock of the Company at a conversion price of $3.28 per share but may not be converted if, after giving effect to such conversion, the noteholder and its affiliates would beneficially own in excess of 9.99% of the Company’s outstanding common stock. The notes may be prepaid at any time, in whole or in part. The notes are subordinate to the Company’s senior indebtedness. 

 

As of March 31, 2022, the principal balance of the Curiosity note was $278,000.

 

10% Senior Secured Convertible Note with Original Issuance Discount (L1)

 

On September 14, 2021, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with L1 Capital Global Master Fund (“L1”) pursuant to which it issued (i) a 10% original issue discount senior secured convertible note in the principal amount of $4,400,000 to L1 (the “L1 Note”) and (ii) a 5 five-year warrant to purchase 813,278 shares of the Company’s common stock at an exercise price of $4.20 per share (“Warrant Shares”) in exchange for $3,960,000 (the “First Tranche Financing”). The Purchase Agreement also provided, subject to shareholder approval, for the issuance, subject to certain conditions, of an additional $1,500,000 of notes and warrants to purchase 277,777 shares of common stock (the “Second Tranche Financing”) on the same terms.

 

The L1 Note is convertible by L1 into common stock of the Company at a price of $4.20 per share, or approximately 1,047,619 shares. It is repayable in equal monthly installments of $275,000 with certain deferments or an acceleration of up to three months' payments. The Company may repay the L1 Note in cash or shares of common stock at a price equal to the lesser of the then conversion price or 95% of the lowest daily VWAP during the ten consecutive trading days immediately preceding the monthly payment date, but in no event less than $1.92. In the event that VWAP drops below $1.92, the Company will have the right to pay at such VWAP with any shortfall paid in cash. The L1 Note is senior to all other Company indebtedness and the Company’s obligations under the note are secured by all of the assets of the Company’s subsidiaries.

 

 

 

 

 18 

 

 

The Company estimated the fair value of the warrant at date of grant using the Black-Scholes option pricing model using the following inputs: (i) stock price on the date of grant of $2.70, (ii) the contractual term of the warrant of 5 years, (iii) a risk-free interest rate of 0.79% and (iv) an expected volatility of the price of the underlying common stock of 299.8%. As a result, the Company allocated a fair value of $1,200,434 to the stock warrants and recorded debt discount to be amortized as interest expense over the term of the related convertible note.

 

On October 20, 2021, the Company and L1 entered into an amended and restated purchase agreement which increased the amount of the Second Tranche Financing from $1,500,000 to $6,000,000 and provides (i) for an amended and restated 10% original issue discount senior secured convertible note to be issued in exchange for the L1 Note pursuant to the Purchase Agreement and (ii) for the issuance of a five-year warrant to purchase 1,041,194 shares of the Company’s common stock at an exercise price of $4.20 per share.

 

In the event the principal amount of the L1 Note issued in the First Tranche Financing, when aggregated with the L1 Note to be issued in the Second Tranche Financing, exceeds 25% of the market capitalization of the Company’s common stock as reported by Bloomberg L.P, then the principal amount to be issued in the Second Tranche Financing will be limited to 25%, in the aggregate of both L1 Notes, unless waived in the sole discretion of the Purchaser.

 

During the three months ended March 31, 2022, the Company issued an aggregate 5,757,365 shares of common stock to L1 upon the conversion of $4,125,000 of outstanding principal. As of March 31, 2022, the principal balance was $0 and all associated loan discounts were fully amortized.

 

10% Senior Secured Convertible Note with Original Issuance Discount (L1– Second Tranche)

 

On January 20, 2022 (the “Second Tranche Closing”), the Company and LI Capital closed on the Second Tranche of the offering, resulting in the issuance of (i) a $1,750,000 10% Original Issue Discount Senior Secured Convertible Note, due July 20, 2023, (the “Second Tranche Note”); and (ii) a five year warrant to purchase 303,682 shares of Common Stock of the Company at an exercise price of $4.20 per share (the “Second Tranche Warrants”), in exchange for consideration of $1,575,000 (i.e. the face amount less the 10% Original Issue Discount of $175,000).

 

In connection with the Second Tranche Closing, the Company paid to EF Hutton a fee of $126,000.

 

The Second Tranche Note is convertible into common stock of the Company at a rate of $4.20 per share (the “Conversion Price”) into 416,667 shares of common stock (the “Second Tranche Conversion Shares”) and, is repayable in equal monthly installments of $111,563 commencing on the date that the SEC declares a registration statement with respect to the resale of such shares effective, with all remaining amounts due on July 20, 2023. The Second Tranche Note is repayable by payment of cash, or, at the discretion of the Company and if the below listed “Equity Conditions” are met, by issuance of shares of the common stock at a price of 95% of the lowest daily VWAP during the ten-trading day period prior to the respective monthly redemption dates (with a floor of $1.92) multiplied by 102% of the amount due on such date. In the event that the ten-trading day VWAP drops below $1.92 the Company will have the right to pay in stock at such ten-trading day VWAP with any shortfall paid in cash. The Conversion Price may be adjusted in the event of dilutive issuances but in no event to less than $0.54 (the “Monthly Conversion Price”).

 

The Company’s right to make monthly payments in stock in lieu of cash for the Second Tranche Note is conditioned on certain conditions (the “Equity Conditions”). The Equity Conditions required to be met each month in order to redeem the Second Tranche Note with stock in lieu of a monthly cash payment, among other conditions set forth therein, include without limitation, that a registration statement be in effect with respect to the resale of the shares issuable upon conversion or redemption of the Second Tranche Note (or, that an exemption under Rule 144 is available), that no default be in effect, that the average daily trading volume of the Company’s common stock would have to be at least $550,000 during the five trading days prior to the respective monthly redemption and that the outstanding principal amounts of the First Tranche Note and Second Tranche Note combined, shall not exceed 30% of the market capitalization of the Company’s Common Stock as reported on Bloomberg L.P., which percentage is subject to increase by LI Capital at its sole discretion.

 

 

 

 

 19 

 

 

Other provisions of the Second Tranche Note, which is similar in terms to the First Tranche Note, include that the Second Tranche Note Conversion Price is subject to full anti-dilution price protections in the event of financings that are below the Conversion Price with a floor of $0.54.

 

In the event of an Event of Default as defined in the notes, if the stock price is below the Conversion Price at the time of default and only for so long as a default is continuing, the Second Tranche Notes would be convertible at a rate of 80% of the lowest VWAP in the ten prior trading days, provided, that if the default is cured the default conversion rate elevates back to the normal Conversion Price

 

As part of the Second Tranche Closing, the Company issued Second Tranche Warrants exercisable for five years from the date of issuance, at $4.20 per share which carry the same anti-dilution protection as the Second Tranche Notes, subject to the same adjustment floor. The Second Tranche Warrants are exercisable via cashless exercise only for so long as no registration statement covering resale of the shares is in effect.

 

The Second Tranche Note continues to be subject to (i) the repayment and performance guarantees by the subsidiaries of the Company pursuant to a subsidiary guaranty and, (ii) the Security Agreement pursuant to which the LI Capital was granted a security interest in all of the assets of the Company and certain of its subsidiaries, each as entered into in connection with the First Tranche closing on September 14, 2021.

 

As of March 31, 2022, the principal balance of these notes was $1,750,000 and remaining balance on the associated loan discounts was $557,774.

 

10% Secured Convertible Notes with Original Issuance Discounts (“OID Notes”)

 

On August 6, 2020, the Company entered into debt exchange agreements with certain holders of these 10% convertible notes pursuant to which an aggregate of 647,954 shares of the Company’s Series B preferred stock (“Series B Stock”) were issued to noteholders for an aggregate of $411,223 of outstanding principal and accrued and unpaid interest.

 

On November 30, 2020, the Company entered into a debt exchange agreement with the remaining holder of these 10% convertible notes pursuant to which an aggregate of 158,000 shares of Series B Stock were issued to the noteholder for an aggregate of $111,250 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $46,750 as a result of the exchange.

 

On July 19, 2021, the Company repaid $6,329 of outstanding principal and accrued and unpaid interest to a 10% secured convertible noteholder.

 

As of March 31, 2022, the principal balance of these notes was $75,000 and all associated loan discounts were fully amortized. No notices of default or demands for payment have been received by the Company.

  

12% Senior Secured Convertible Notes (“TDH Secured Notes”)

 

On March 16, 2020, the Company sold (the “TDH Secured Notes Offering”) an aggregate $3,000,000 of its 12% senior secured convertible notes (the “TDH Secured Notes”), to eleven accredited investors (the “TDH Secured Note Lenders”), pursuant to a subscription agreement with the TDH Secured Note Lenders. Interest on the TDH Secured Notes accrues on the outstanding principal amount at the rate of 12% per annum. Principal and interest on the TDH Secured Notes are payable monthly, on an amortized basis over 48 months, with the last payment due on March 16, 2024. Pursuant to the TDH Secured Notes, TD Holdings will pay amounts due under the TDH Secured Notes. Prepayment of amounts due under TDH Secured Notes is subject to a prepayment penalty in an amount equal to 4% of the amount prepaid.

 

The TDH Secured Notes are convertible at the option of the holders at 75% of the average sales price of the Company’s common stock over the 60 trading days immediately preceding conversion provided that the conversion price shall not be less than $3.20 per share.

 

 

 

 

 20 

 

 

The Company’s obligations under the TDH Secured Notes, are secured by Grom Holdings’ shares of stock of TDH, and of its wholly owned subsidiary, TDAHK. The TDH Secured Notes rank equally and ratably on a pari passu basis with (i) the other TDH Secured Notes and (ii) the Original TDH Notes issued by the Company pursuant to TDH Share Sale Agreement.

 

If the Company sells the animation studio located in Manila, Philippines, which is currently owned by TDH through TDAHK (the “Animation Studio”), for more than $12,000,000, and so long as any amount of principal is outstanding under the TDH Secured Notes, the Company will pay the TDH Secured Notes holders from the proceeds of the sale (i) all amounts of principal outstanding under the TDH Secured Notes, (ii) such amount of interest which would be due and payable assuming the TDH Secured Notes were held to maturity (minus any amounts of interest previously paid hereunder), and (iii) an additional 10% of the amount of principal outstanding under the TDH Secured Notes within five days of the closing of such sale.

 

In connection with the issuance of the TDH Secured Notes, the Company issued to each TDH Secured Note holder shares of common stock equal to 20% of the principal amount of such holder’s TDH Secured Note, divided by $3.20. Accordingly, an aggregate of 187,500 shares of common stock were issued to the TDH Secured Note holders on March 16, 2020. These shares were valued at $420,000, or $2.24 per share, which represents fair market value. The Company recorded the value of these shares as a loan discount to be amortized as interest expense over the term of the notes.

 

On August 6, 2020, the Company entered into debt exchange agreements with certain holders of these 12% TDH Secured Notes pursuant to which an aggregate of 1,739,580 shares of the Company’s Series B Stock were issued to noteholders for an aggregate of $1,101,000 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $598,042 as a result of the exchange.

 

On November 30, 2020, the Company entered into a debt exchange agreement with another holder of these 12% TDH Secured Notes pursuant to which an aggregate of 158,000 shares of Series B Stock were issued to the noteholder for an aggregate of $99,633 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $58,367 as a result of the exchange.

 

On February 17, 2021, the Company entered into debt exchange agreements with certain holders of these 12% TDH Secured Notes pursuant to which an aggregate of 2,106,825 shares of the Company’s Series B Stock were issued to noteholders for an aggregate of $1,256,722 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $850,103 as a result of the exchange.

 

As of March 31, 2022, the principal balance of these notes was $300,143 and the remaining balance on the associated loan discounts was $34,271.

  

12% Senior Secured Convertible Notes (Additional Secured Notes)

 

On March 16, 2020, the Company issued to seven accredited investors (the “Additional Secured Note Lenders”) an aggregate of $1,060,000 of its 12% senior secured convertible notes (the “Additional Secured Notes”) in a private offering pursuant to a subscription agreement with substantially the same terms as the TDH Secured Notes except that the Additional Secured Notes are secured by all of the assets of the Company other than the shares and other assets of TDH and TDAHK, pursuant to a security agreement by and among the Company and the Additional Secured Note Lenders.

 

Interest on the Additional Secured Notes accrues on the outstanding principal amount at the rate of 12% per annum. Principal and interest on the Additional Secured Notes are payable monthly, on an amortized basis over 48 months, with the last payment due on March 16, 2024. Prepayment of the amounts due under the Additional Secured Notes is subject to a prepayment penalty of 4% of the amount prepaid.

 

The Additional Secured Notes are convertible at the option of the holders at 75% of the average sales price of the Company’s common stock over the 60 trading days immediately preceding conversion provided that the conversion price shall not be less than $3.20 per share.

 

 

 

 

 21 

 

 

In connection with the issuance of the Additional Secured Notes, the Company issued to each Additional Secured Note Lender shares of common stock equal to 20% of the principal amount of such holder’s Additional Secured Note, divided by $3.20. Accordingly, an aggregate of 66,250 shares of common stock were issued. These shares were valued at $148,000, or $2.24 per share, which represents fair market value. 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 notes.

 

On August 6, 2020, the Company entered into debt exchange agreements with certain holders of these 12% Additional Secured Notes pursuant to which an aggregate of 1,236,350 shares of the Company’s Series B Stock were issued to noteholders for an aggregate of $782,500 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $424,375 as a result of the exchange.

 

On February 17, 2021, the Company entered into debt exchange agreements with certain holders of these 12% Additional Secured Notes pursuant to which an aggregate of 288,350 shares of the Company’s Series B Stock were issued to noteholders for an aggregate of $182,500 of outstanding principal and accrued and unpaid interest. The Company recognized an extinguishment loss of $97,077 as a result of the exchange.

 

As of March 31, 2022, the principal balance of these notes was $56,636 and the remaining balance on the associated loan discounts was $6,511.

 

Future Minimum Principal Payments

 

The remaining principal repayments based upon the maturity dates of the Company’s borrowings for each of the next five years are as follows:

     
Remainder of 2022  $1,340,940 
2023   1,042,793 
2024   76,046 
2025 and thereafter    
Total Convertible notes principal amount payable.  $2,459,779 

 

13. INCOME TAXES

 

In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon currently known facts and circumstances and applies that rate to its year-to-date earnings or losses. The Company’s effective tax rate is based on expected income and statutory tax rates and takes into consideration permanent differences between financial statement and tax return income applicable to the Company in the various jurisdictions in which the Company operates. The effect of discrete items, such as changes in estimates, changes in rates or tax status, and unusual or infrequently occurring events, is recognized in the interim period in which the discrete item occurs. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the result of new judicial interpretations or regulatory or tax law changes.

 

The Company’s interim effective tax rate, inclusive of discrete items, for the three-month periods ended March 31, 2022 and 2021 was 0%, respectively. The decrease in the interim effective tax rate for the three months ended March 31, 2022 is primarily due to recurrent net losses for the periods presented.

 

14.

STOCKHOLDERS’ EQUITY

 

Preferred Stock

 

The Company is authorized to issue 25,000,000 shares of preferred stock, par value of $0.001 per share.

 

 

 

 

 22 

 

 

Series A Preferred Stock

 

As of March 31, 2022 and December 31, 2021, the Company had no shares of Series A Stock issued and outstanding.

 

Series B Preferred Stock

 

On February 17, 2021, the Company entered into debt exchange agreements with holders of three of the Company’s convertible promissory notes in the aggregate amount of $1,700,905 of outstanding principal and accrued and unpaid interest. Pursuant to the terms of the debt exchange agreements, the holders exchanged the outstanding notes, and all amounts owed by the Company thereunder, for an aggregate of 2,564,175 shares of the Company’s Series B Stock. At the time of the exchange, all amounts due under the notes were deemed to be paid in full and the notes were cancelled.

 

On February 17, 2021, the Company entered into subscription agreements with two accredited investors, pursuant to which the Company sold the investors an aggregate of 300,000 shares of Series B Stock for aggregate gross proceeds of $300,000.

 

On March 31, 2021, the Company entered into subscription agreements with two accredited investors, pursuant to which the Company sold the investors an aggregate of 650,000 shares of Series B Stock for aggregate gross proceeds of $650,000.

 

On May 20, 2021, the Company entered into exchange agreements with all of the holders of Series B Stock (the “Series B Holders”), pursuant to which the Series B Holders agreed to exchange all of the issued and outstanding shares of Series B Stock for shares of the Company’s newly designated Series C Stock, on a one for one basis. As a result of the exchange, all 9,215,059 issued and outstanding shares of Series B Stock was exchanged for 9,215,059 shares of Series C Stock, and all of the exchanged shares of Series B Stock were cancelled.

  

As of March 31, 2022 and December 31, 2021, the Company had no shares of Series B Stock issued and outstanding, respectively.

 

Series C Preferred Stock

 

On May 20, 2021, the Company filed with the Secretary of State of the State of Florida a Certificate of Designation of Preferences, Rights and Limitations of Series C Stock designating 10,000,000 shares as Series C Preferred Stock (the “Series C Stock”). The Series C Stock ranks senior and prior to all other classes or series of the Company’s preferred stock and common stock.

 

The holder may, at any time after the 6-month anniversary of the issuance of the shares of Series C Preferred Stock, convert such shares into common stock at a conversion rate of $1.92 per share. In addition, the Company may, at any time after the issuance of the shares, convert any or all of the outstanding shares of Series C Preferred Stock at a conversion rate of $1.92 per share.

 

Each share of Series C Stock entitles the holder to 1.5625 votes for each share of Series C Stock. The consent of the holders of at least two-thirds of the shares of Series C Stock is required for the amendment to any of the terms of the Series C Stock, to create any additional class of stock unless the stock ranks junior to the Series C Stock, to make any distribution or dividend on any securities ranking junior to the Series C Stock, to merge or sell all or substantially all of the assets of the Company or acquire another business or effectuate any liquidation of the Company.

 

Cumulative dividends accrue on each share of Series C Stock at the rate of 8% per annum of the stated value of $1.00 per share and are payable in arrears quarterly commencing 90 days from issuance. The dividend shall be payable in shares of common stock (a “PIK Dividend”) and are be due and payable on the date on which such PIK Dividend was declared.

 

 

 

 

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Upon a liquidation, dissolution or winding up of the Company, the holders of the Series C Stock are entitled to $1.00 per share plus all accrued and unpaid dividends. No distribution may be made to holders of shares of capital stock ranking junior to the Series C Stock upon a liquidation until Series C stockholders receive their liquidation preference. The holders of 66 2/3% of the then outstanding shares of Series C Stock, may elect to deem a merger, reorganization or consolidation of the Company into or with another corporation, not affiliated with said majority, or other similar transaction or series of related transactions in which more than 50% of the voting power of the Company is disposed of in exchange for property, rights or securities distributed to holders thereof by the acquiring person, firm or other entity, or the sale of all or substantially all of the assets of the Company.

 

On May 20, 2021, the Company entered into exchange agreements with all of the holders of Series B Stock (the “Series B Holders”), pursuant to which the Series B Holders agreed to exchange all of the issued and outstanding shares of Series B Stock for shares of Series C Stock, on a one for one basis. As a result of the exchange, all 9,215,059 issued and outstanding shares of Series B Stock was exchanged for 9,215,059 shares of the Company’s Series C Stock, and all of the exchanged shares of Series B Stock were cancelled.

 

On June 11, 2021, the Company entered into subscription agreements with an accredited investor, pursuant to which the Company sold the investor an aggregate of 100,000 shares of Series C Stock for aggregate gross proceeds of $100,000.

 

On September 10, 2021, the Company entered into a debt exchange agreement with a holder of a 10% convertible note pursuant to which 85,250 shares of the Company’s Series C Stock was issued for $85,250 of outstanding principal and accrued and unpaid interest.

 

On January 24, 2022, the Company issued 20,573 shares of common stock to a stockholder upon the conversion of 39,500 shares of Series C preferred stock.

 

As of March 31, 2022 and December 31, 2021, the Company had 9,360,759 and 9,400,259 shares of Series C Stock issued and outstanding, respectively.

 

For the three months ended March 31, 2022, the Company declared cumulative dividends totaling $176,844 for amounts accrued on its Series C Stock.

 

Common Stock

 

The Company is authorized to issue 500,000,000 shares of common stock, par value of $0.001 per share and had 18,725,967 and 12,698,192 shares of common stock issued and outstanding as of March 31, 2022 and December 31, 2021, respectively.

 

Reverse Stock Split

 

On April 7, 2021, the board of directors of the Company approved, and on April 8, 2021, the Company’s shareholders approved, an increase to the range of the ratio for a reverse stock split to a ratio of no less than 1-for-2 and no more than 1-for-50. On May 6, 2021, the board fixed the ratio for a reverse stock split at 1-for-32 and, on May 7, 2021, the Company filed a certificate of amendment to its articles of incorporation with the Secretary of State of the State of Florida to effect the reverse stock split which became effective as of May 13, 2021. The Company’s common stock began being quoted on the OTCQB on a post-reverse split basis beginning on May 19, 2021.

 

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

 

During the three months ended March 31, 2022, the Company issued 74,584 shares of common stock with a fair market value of $76,822 to contractors for services rendered.

 

During the three months ended March 31, 2021, the Company issued 16,782 shares of common stock with a fair market value of $80,130 to contractors for services rendered.

 

 

 

 

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Common Stock Issued in Connection with the Conversion of Convertible Note Principal and Accrued Interest

 

During the three months ended March 31 2022, the Company issued 5,757,365 shares of common stock upon the conversion of $4,125,000 in convertible note principal and accrued interest.

 

Common Stock Issued in Connection with the Issuance of Convertible Notes

  

During the three months ended March 31, 2021, the Company issued 13,282 shares of common stock valued at $29,750 in connection with the issuance of convertible notes.

 

Common Stock Issued in Connection with Series C Stock Dividends

 

During the three months ended March 31, 2022, the Company issued 175,253 shares of common stock valued at $459,068 for cumulative dividends declared as of December 31, 2021 on its Series C Stock.

 

Stock Purchase Warrants

 

Stock purchase warrants are accounted for as equity in accordance with 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 March 31, 2022 and December 31, 2021. All warrants are exercisable for a period of three to five years from the date of issuance:

            
   Number of Warrants Outstanding   Weighted Average Exercise Price   Weighted Average Remaining Contractual Life (Yrs.) 
             
Balance January 1, 2021   229,628   $7.34    1.66 
Warrants issued   4,273,733    4.18      
Warrants exercised   (249,480)         
Warrants forfeited   (6,711)         
December 31, 2021   4,247,170   $4.40    1.75 
Warrants issued   303,682   $4.20      
Warrants exercised             
Warrants forfeited             
Balance March 31, 2022   4,550,852   $4.39    1.61 

  

As of March 31, 2022, the outstanding stock purchase warrants had an aggregate intrinsic value of $7,395.

 

 

 

 

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Stock Options

 

The following table represents all outstanding and exercisable stock options as of March 31, 2022.

                        
Year Issued  Options
Issued
   Options
Forfeited
   Options
Outstanding
   Vested
Options
   Weighted Average Exercise Price   Weighted Average Remaining Life (Yrs.) 
                         
2013   241,730    (26,063)   215,667    215,667   $7.68    1.47 
2018   1,875        1,875    1,875    24.96    1.08 
2021   208,500        208,500    208,500   $2.98    4.33 
Total   452,105    (26,063)   426,042    426,042   $5.46    1.98 

 

During the three months ended March 31, 2022, the Company recorded $48,142 in stock-based compensation costs related to stock options. No stock-based compensation costs related to stock options was recorded during the three months ended March 31, 2021.

 

As of March 31, 2022, there were $454,675 in total unrecognized stock-based compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 2.3 years.

 

As of March 31, 2022, the outstanding stock options had an aggregate intrinsic value of $0.

  

15. COMMITMENTS AND CONTINGENCIES

 

In the ordinary course of business, the Company and its subsidiaries are subject to various pending and potential legal actions, arbitration proceedings, claims, investigations, examinations, regulatory proceedings, information gathering requests, subpoenas, inquiries and matters relating to compliance with laws and regulations (collectively, legal proceedings).

 

Based on the Company’s current knowledge, and taking into consideration its legal expenses, the Company does not believe it is a party to, nor are any of its subsidiaries the subject of, any legal proceeding that would have a material adverse effect on the Company’s consolidated financial condition or liquidity.

 

See also Note 7 (“Leases”).

 

See also Note 13 (“Income Taxes”).

  

16. SUBSEQUENT EVENTS

 

Executive Separation Agreement and Departure of Director

 

On April 22, 2022, Grom Social Enterprises, Inc. (the “Company”), Grom Social, Inc. and Melvin Leiner entered into an Executive Separation Agreement (the “Separation Agreement”), pursuant to which Mr. Leiner retired from his positions as the Company’s Executive Vice President and Chief Operating Officer. Pursuant to the Separation Agreement, Mr. Leiner’s employment with the Company ended on April 22, 2022 and Mr. Leiner is to receive separation payments over a nine (9) month period equal to his base salary, as well as certain limited health benefits.

 

In accordance with the Separation Agreement, the Company will pay to Mr. Leiner the sum of $236,250 in biweekly installments over the nine (9) month period beginning on the first regular Company pay period after April 22, 2022 and ending on January 13, 2023. The Separation Agreement also contains non-disparagement covenants and a mutual release of claims by the parties thereto.

 

On the same day, Mr. Leiner resigned from the Company’s Board of Directors, effectively immediately. Mr. Leiner did not resign as a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices.

 

 

 

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

 

The following discussion and analysis should be read in conjunction with our financial statements and the related notes thereto. The management's discussion and analysis contain forward-looking statements, such as statements of our plans, objectives, expectations, and intentions. Any statements that are not statements of historical fact are forward-looking statements. When used, the words "believe," "plan," "intend," "anticipate," "target," "estimate," "expect" and the like, and/or future tense or conditional constructions ("will," "may," "could," "should," etc.), or similar expressions, identify certain of these forward-looking statements. These forward-looking statements are subject to risks and uncertainties, including those under "Risk Factors," which appear in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, which we filed with the Securities and Exchange Commission on April 15, 2022, that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements. Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of several factors. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report.

 

The share and per share information in the following discussion reflects a reverse stock split of our outstanding common stock at a 1-for-32 ratio, effective as of May 13, 2021.

 

Overview

 

We are a media, technology and entertainment company that focuses on (i) delivering content to children under the age of 13 years in a safe secure platform that is compliant with Children’s Online Privacy Protection Act (“COPPA”) and can be monitored by parents or guardians, (ii) creating, acquiring, and developing the commercial potential of Kids & Family entertainment properties and associated business opportunities, (iii) providing world class animation services, and (iv) offering protective web filtering solutions to block unwanted or inappropriate content. We operate our business through the following subsidiaries:

 

  · Grom Social, Inc. was incorporated in the State of Florida on March 5, 2012 and operates our social media network designed for children under the age of 13 years.

 

  · TD Holdings Limited (“TD Holdings”) was incorporated in Hong Kong on September 15, 2005. TD Holdings operates through its two subsidiary companies: (i) Top Draw Animation Hong Kong Limited, a Hong Kong corporation and (ii) Top Draw Animation, Inc., a Philippines corporation. The group’s principal activities are the production of animated films and televisions series.

 

  · Grom Educational Services, Inc. (“GES”) was incorporated in the State of Florida on January 17, 2017. GES operates our web filtering services provided to schools and government agencies.

 

  · Grom Nutritional Services, Inc. (“GNS”) was incorporated in the State of Florida on April 19, 2017. GNS intends to market and distribute nutritional supplements to children. GNS has been nonoperational since its inception.

 

  · Curiosity Ink Media, LLC (“Curiosity”) was incorporated in the State of Delaware on January 9, 2017, creates, acquires, and develops the commercial potential of Kids & Family entertainment properties and associated business opportunities.

 

We own 100% of each of Grom Social, TD Holdings, GES and GNS, and 80% of Curiosity. We are headquartered in Boca Raton, Florida with offices in Los Angeles, California; Salt Lake City, Utah; Norcross, Georgia; and Manila, Philippines.

 

Impact of COVID-19

 

We have experienced significant disruptions to our and operations due to circumstances related to COVID-19, and delays as a result of government-imposed quarantines, office closings and travel restrictions, which affect both us and our service providers. We have significant operations in Manila, Philippines, which was locked down by the government on March 12, 2020 due to concerns related to the spread of COVID-19. As a result of the Philippines government’s call to contain COVID-19, our animation studio, located in Manila, Philippines, which accounts for approximately 89% of our total revenues on a consolidated basis, was forced to close its offices for significant periods of time from March 2020 through December 2021. In January 2022, we started to recall artist and employees to return to the studio which is currently operating at 50% seat capacity.

 

 

 

 

 

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In response to the outbreak and business disruption, hawse have instituted employee safety protocols to contain the spread, including domestic and international travel restrictions, work-from-home practices, extensive cleaning protocols, social distancing and various temporary closures of our administrative offices and production studio. has Additionally, we have implemented a range of actions aimed at temporarily reducing costs and preserving liquidity.

 

Recent Events

 

L1 Capital Financing

 

Closing of Second Tranche

 

The Purchase Agreement, as amended on October 20, 2021, with L1 Capital contemplated a closing of a second tranche of the offering (the “Second Tranche”) of up to an additional $6,000,000 principal amount of Notes identical to the First Tranche Note, and warrants exercisable for five years to purchase up to 1,041,194 shares at an exercise price of $4.20 per share.

 

On January 20, 2022 (the “Second Tranche Closing”), we closed on the Second Tranche of the offering with L1 Capital, resulting in the issuance of (i) a $1,750,000 10% original issue discount senior secured convertible note, due July 20, 2023, (the “Second Tranche Note”); and (ii) a five year warrant to purchase 303,682 shares of our common stock at an exercise price of $4.20 per share (the “Second Tranche Warrants”), in exchange for consideration of $1,575,000 (i.e. the face amount less the 10% original issue discount of $175,000).

 

In connection with the Second Tranche Closing, we paid to EF Hutton a fee of $126,000. 

 

The Second Tranche Note is convertible into our common stock at a rate of $4.20 per share (the “Conversion Price”) into 416,667 shares of common stock (the “Second Tranche Conversion Shares”) and, is repayable in equal monthly installments of $111,563 commencing on the date that the SEC declares a registration statement with respect to the resale of such shares effective, with all remaining amounts due on July 20, 2023. The Second Tranche Note is repayable by payment of cash, or, at our discretion and if the below listed “Equity Conditions” are met, by issuance of shares of our common stock at a price of 95% of the lowest daily VWAP during the ten-trading day period prior to the respective monthly redemption dates (with a floor of $1.92) multiplied by 102% of the amount due on such date. In the event that the ten-trading day VWAP drops below $1.92 we will have the right to pay in stock at such ten-trading day VWAP with any shortfall paid in cash. The Conversion Price may be adjusted in the event of dilutive issuances but in no event to less than $0.54 (the “Monthly Conversion Price”).

 

Our right to make monthly payments in stock in lieu of cash for the Second Tranche Note is conditioned on certain conditions (the “Equity Conditions”). The Equity Conditions required to be met each month in order to redeem the Second Tranche Note with stock in lieu of a monthly cash payment, among other conditions set forth therein, include without limitation, that a registration statement be in effect with respect to the resale of the shares issuable upon conversion or redemption of the Second Tranche Note (or, that an exemption under Rule 144 is available), that no default be in effect, that the average daily trading volume of our common stock would have to be at least $550,000 during the five trading days prior to the respective monthly redemption and that the outstanding principal amounts of the First Tranche Note and Second Tranche Note combined, shall not exceed 30% of the market capitalization of our common stock as reported on Bloomberg L.P., which percentage is subject to increase by the investor at its sole discretion.

 

Other provisions of the Second Tranche Note, which is similar in terms to the First Tranche Note, include that the Second Tranche Note Conversion Price is subject to full anti-dilution price protections in the event of financings that are below the Conversion Price with a floor of $0.54.

 

 

 

 

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In the event of an Event of Default as defined in the notes, if the stock price is below the Conversion Price at the time of default and only for so long as a default is continuing, the Second Tranche Notes would be convertible at a rate of 80% of the lowest VWAP in the ten prior trading days, provided, that if the default is cured the default conversion rate elevates back to the normal Conversion Price.

 

As part of the Second Tranche Closing, we issued Second Tranche Warrants exercisable for five years from the date of issuance, at $4.20 per share which carry the same anti-dilution protection as the Second Tranche Notes, subject to the same adjustment floor. The Second Tranche Warrants are exercisable via cashless exercise only for so long as no registration statement covering resale of the shares is in effect.

 

The Second Tranche Note continues to be subject to (i) the repayment and performance guarantees by our subsidiaries pursuant to a subsidiary guaranty and, (ii) the security agreement pursuant to which the LI Capital was granted a security interest in all of our assets and certain of our subsidiaries, each as entered into in connection with the First Tranche closing on September 14, 2021.

 

Executive Separation Agreement and Departure of Director

 

On April 22, 2022, we entered into an Executive Separation Agreement with Melvin Leiner (the “Separation Agreement”), pursuant to which Mr. Leiner retired from his positions as our Executive Vice President and Chief Operating Officer. Pursuant to the Separation Agreement, Mr. Leiner’s employment with us ended on April 22, 2022 and Mr. Leiner is to receive separation payments over a nine (9) month period equal to his base salary, as well as certain limited health benefits.

 

In accordance with the Separation Agreement, we will pay to Mr. Leiner the sum of $236,250 in biweekly installments over the nine (9) month period beginning on our first regular pay period after April 22, 2022 and ending on January 13, 2023. The Separation Agreement also contains non-disparagement covenants and a mutual release of claims by the parties thereto.

On the same day, Mr. Leiner resigned from our Board of Directors, effectively immediately. Mr. Leiner did not resign as a result of any disagreement with us on any matter relating to our operations, policies or practices.

 

Results of Operations

 

Comparison of Results of Operations for the Three Months Ended March 31, 2022 and 2021

 

Revenue

 

Revenue for the three months ended March 31, 2022 was $1,231,125, compared to revenue of $1,875,284 during the three months ended March 31, 2021, representing a decrease of $644,159 or 34.4%.

  

Animation revenue for the three months ended March 31, 2022 was $1,048,613, compared to animation revenue of $1,713,958 during the three months ended March 31, 2021, representing a decrease of $665,045 or 38.8%. The decrease in animation revenue is primarily attributable to client delays in providing us with necessary productions materials and content and in the execution and commencement of previously negotiated contracts.

 

Web filtering revenue for the three months ended March 31, 2022 was $182,244, compared to web filtering revenue of $161,241 during the three months ended March 31, 2021, representing an increase of $21,003 or 13.0%. The increase is primarily due to an increase in organic sales growth, and the timing of multi-year contract renewals.

 

 

 

 

 

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Subscription and advertising revenue from our Grom Social mobile application has been nominal. Subscription and advertising revenue for the three months ended March 31, 2022 was $268 compared to subscription and advertising revenue of $384 during the three months ended March 31, 2021, representing a decrease of $116 or 30.2%, primarily attributable to a decrease in marketing and promotion activities.

 

No revenue was generated from produced and licensed content and publications during the three months ended March 31, 2022 and 2021.

 

Gross Profit

 

Our gross profits vary significantly by subsidiary. Historically, our animation business has realized gross profits between 45% and 55%, while our web filtering business has realized gross profits between 75% and 90%. Additionally, our gross profits may vary from period to period due to the nature of the business of each subsidiary, and the timing and volume of customer contracts and projects. Current gross margins percentages may not be indicative of future gross margin performance.

 

Gross profit for the three months ended March 31, 2022 and 2021 were $314,1750, or 25.5%, and $857,163, or 45.7%, respectively. The decrease in gross profit is primarily attributable to lower contract margins in our animation business due to the absorption of fixed overhead expenses against reduced revenue levels and certain projects exceeding budgeted costs.

 

Operating Expenses

 

Operating expenses for the three months ended March 31, 2022 were $2,163,335, compared to operating expenses of $1,568,012 during the three months ended March 31, 2021, representing an increase of $595,323 or 38.0%. The increase is primarily attributable to an increase in selling, general and administrative costs and fees for professional services rendered during the three months ended March 31, 2022 due to the change and transition to new professional service providers, our debt financing transactions and related registered offerings, an increase in employee headcount, compensation and benefits from the acquisition of Curiosity, and stock-based compensation from the grant of stock and stock option awards.

 

Selling, general and administrative (“SG&A”) are comprised of selling, marketing and promotional expenses, compensation and benefits, insurance, rent and related facility costs, research and development, and other general expenses. SG&A expenses were $1,694,819 for the three months ended March 31, 2022, compared to $1,262,265 for the three months ended March 31, 2021, representing an increase of $432,554 or 34.3%.

 

Stock-based compensation, a non-cash component of our SG&A, was $48,142 for the three months ended March 31, 2022, compared to $0 for the three months ended March 31, 2021. The increase is attributable to options to purchase shares of our common stock in connection with certain employment agreements entered into in connection with our acquisition of Curiosity.

 

Professional fees are comprised of accounting and compliance services, legal services, investor relations and other advisory fees. Professional fees were $404,066 for the three months ended March 31, 2022, compared to $187,109 for the three months ended March 31, 2021, representing an increase of $216,957 or 116.0%.

 

Depreciation and amortization included in operating expenses was $64,450 for the three months ended March 31, 2022, compared to $118,638 for the three months ended March 31, 2021, representing a decrease of $54,188 or 45.7%.

 

Other Income (Expense)

 

Net other expense for the three months ended March 31, 2022 was $1,607,286, compared to a net other expense of $1,604,726 for the three months ended March 31, 2021, representing an increase of $2,560 or 0.2%. The nominal increase in other income (expense) is primarily attributable to increased interest expense related to the amortization and write off of debt discounts on convertible notes due to conversions.

 

Interest expense is comprised of interest accrued and paid on our convertible notes and recorded from the amortization of note discounts. Interest expense was $1,631,022 for the three months ended March 31, 2022, compared to $648,846 during the three months ended March 31, 2021, representing an increase of $982,176 or 151.4%. For the three months ended March 31, 2021, a one-time extinguishment loss of $947,179 was recognized related to the exchange of $1,447,996 in principal and interest accrued under certain convertible notes for 2,395,175 shares of our Series B Stock.

  

Net Loss Attributable to Common Stockholders

 

We realized a net loss attributable to common stockholders of $3,553,451, or $0.25 per share, for the three months ended March 31, 2022, compared to a net loss attributable to common stockholders of $2,315,575, or $0.39 per share, during the three months ended March 31, 2021, representing an increase in net loss attributable to common stockholders of $1,237,876 or 53.5%.

 

 

 

 

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Liquidity and Capital Resources

 

At March 31, 2022, we had cash and cash equivalents of $6,271,328.

 

Net cash used in operating activities for the three months ended March 31, 2022 was $1,600,696, compared to net cash used in operating activities of $988,573 during the three months ended March 31, 2021, representing an increase in cash used of $612,123, primarily due to the increase in our net loss, change in our operating assets and liabilities, and amortization of debt discounts.

 

Net cash used in investing activities for the three months ended March 31, 2022 was $25,825, compared to net cash used in investing activities of $2,391 during the three months ended March 31, 2021 representing an increase in cash used of $23,434. This change is attributable to an increase in the amount of fixed assets purchased and/or leasehold improvements made by our animation studio in Manilla, Philippines during the three months ended March 31, 2022.

 

Net cash provided by financing activities for the three months ended March 31, 2022 was $1,376,522, compared to net cash provided by financing activities of $1,433,438 for the three months ended March 31, 2021, representing a decrease in cash provided of $56,916. Our primary sources of cash from financing activities during the three months ended March 31, 2022 were attributable to $1,444,000 in proceeds from second tranche of convertible notes issued to L1 Capital, as compared to $666,500 in proceeds from the sale of 12% senior secured convertible notes during the three months ended March 31, 2021. These increases were offset, in part, by the repayment of convertible notes and loans payable of $67,478 during the three months ended March 31, 2022, as compared to repayments of convertible notes and loans for $183,062 during the three months ended March 31, 2021.

  

We believe we have adequate working capital to meet our operational needs for the next twelve months.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements.

 

Critical Accounting Estimates

 

Our consolidated financial statements and accompanying notes have been prepared in accordance with GAAP. The preparation of these consolidated 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 consolidated 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.

 

In the three months ended March 31, 2022, there were no significant changes to our critical accounting estimates from those disclosed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Annual Report on Form 10-K.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

We are a smaller reporting company and are not required to provide this information.

 

 

 

 

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Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officer and principal financial officer has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of March 31, 2022, the end of the period covered by this Quarterly Report.

 

These controls are designed to ensure that information required to be disclosed in the reports we file or submit pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial, as appropriate officer to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and the principal financial officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2022.

 

The Company’s assessment identified certain material weaknesses which are set forth below:

 

Functional Controls and Segregation of Duties

 

Because of the Company’s limited resources, there are limited controls over information processing. Additionally, there is inadequate segregation of duties consistent with control objectives. Our Company’s management is composed of a small number of individuals resulting in a situation where limitations on segregation of duties exist. In order to remedy this situation, we will need to hire additional staff to provide greater segregation of duties.

 

Accordingly, as the result of identifying the above material weakness we have concluded that these control deficiencies resulted in a reasonable possibility that a material misstatement of the annual or interim financial statements may not be prevented or detected on a timely basis by the Company’s internal controls.

 

Management believes that the material weaknesses set forth above were the result of the scale of our operations and are intrinsic to our small size. Management continues to take actions to remedy these weaknesses, including the process of hiring additional staff to create the necessary segregation of duties to improve controls over information processing. Additionally, management has initiated the process of building a risk management framework with plans to embed the principles of this framework across all aspects of the business.

 

Remediation Plan

 

Management has implemented remediation steps to address the material weakness and to improve our internal control over financial reporting. Specifically, we (i) expanded and improved our review process for complex transactions and related accounting standards, including the identification of third-party professionals with whom to consult regarding the application of complex accounting matters, (ii) hired qualified personnel to improve the oversight of our accounting operations, and (iii) established new processes and policies. While we believe that these remediation actions will improve the effectiveness of our internal control over financial reporting, the material weakness identified will not be considered remediated until the controls operate for a sufficient period of time, and we cannot assure you that the measures we have taken to date, or any measures we may take in the future will be sufficient to remediate the material weakness we have identified or avoid potential future material weaknesses. 

 

Changes in Internal Control over Financial Reporting

 

Other than the remediation efforts described above, there were no changes in our internal controls over financial reporting during our first fiscal quarter, that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

 

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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

There are no pending legal proceedings to which the Company is a party or in which any director, officer or affiliate of the Company, any owner of record or beneficially of more than 5% of any class of voting securities of the Company, or security holder is a party adverse to the Company or has a material interest adverse to the Company. The Company's property is not the subject of any pending legal proceedings.

 

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, filed with the SEC on April 15, 2022.

 

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

 

Except as set forth below, there were no sales of equity securities sold during the period covered by this Report that were not registered under the Securities Act and were not previously reported in a Current Report on Form 8-K filed by the Company.

 

On January 24, 2022, the Company issued 20,573 shares of common stock to a stockholder upon the conversion of 39,500 shares of Series C preferred stock.

 

On March 3, 2022, the Company issued 52,085 shares of common stock to a related party for marketing and promotional services provided to the Company.

 

On March 3, 2022, the Company issued 22,500 shares of common stock to an investor and public relations firm for services provided to the Company.

 

On March 18, 2022, the Company issued 2,000,001 shares of common stock to a noteholder upon the conversion of $1,300,000 in convertible note principal.

 

On March 21, 2022, the Company issued 1,384,616 shares of common stock to a noteholder upon the conversion of $900,000 in convertible note principal.

 

On March 23, 2022, the Company issued 307,693 shares of common stock to a noteholder upon the conversion of $200,000 in convertible note principal.

 

The above issuances did not involve any underwriters, underwriting discounts or commissions, or any public offering and we believe is exempt from the registration requirements of the Securities Act of 1933 by virtue of Section 4(2) thereof.

 

Item 3. Defaults upon Senior Securities.

 

None.

  

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

Exhibit No.   Description
10.1   10% Original Issue Discount Promissory Note dated January 20, 2022, between Grom Social Enterprises, Inc. and L1 Global Capital Master Fund (“L1 Global”) (incorporated by reference to Exhibit 10.1 to the Company’s report on Form 8-K filed with the SEC on January 26, 2022).
10.2   Common Stock Purchase Warrant to purchase 303,682 shares of the Company’s Common Stock issued to L1 Global, dated January 20, 2022 (incorporated by reference to Exhibit 10.2 to the Company’s report on Form 8-K filed with the SEC on January 26, 2022).
10.3   Registration Rights Agreement, dated as of January 20, 2022, between the Company L1 Global (incorporated by reference to Exhibit 10.3 to the Company’s report on Form 8-K filed with the SEC on January 26, 2022).
10.4   Executive Separation Agreement, dated April 22, 2022, by and among Grom Social Enterprises, Inc. and Melvin Leiner (incorporated by reference to Exhibit 10.1 to the Company’s report on Form 8-K filed with the SEC on April 28, 2022).
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

 

 

 

 33 

 

 

SIGNATURES

 

Pursuant to the requirements 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: May 16, 2022 By: /s/ Darren Marks
    Darren Marks
   

Chief Executive Officer and President

(Principal Executive Officer)

     
     
Date: May 16, 2022 By: /s/ Jason Williams
    Jason Williams
    Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 34 



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