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 September 30, 2017
 
OR
 
  ☐
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                     
 
Commission file number 000-50621
 
DOLPHIN ENTERTAINMENT, INC.
(Exact name of registrant as specified in its' charter)
 
Florida
 
86-0787790
(State of incorporation)
 
(I.R.S. employer identification no.)
 
2151 LeJeune Road, Suite 150 – Mezzanine, Coral Gables, Florida 33134
(Address of principal executive offices, including zip code)
 
(305) 774-0407
(Registrant’s telephone number)
 
_________________________________________________________________ 
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑  No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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. (Check one):
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
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 a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ☐ No ☑
 
The number of shares of common stock outstanding was 9,367,057 as of November 16, 2017.
 

 
 
 
DOLPHIN ENTERTAINMENT, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
PAGE
 
 
 
PART I — FINANCIAL INFORMATION
 
 3
 
 
 
ITEM 1. FINANCIAL STATEMENTS
 
 3
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2017 (unaudited) and December 31, 2016
 
3
 
 
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016 (unaudited)
 
4
 
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016 (unaudited)
 
5
 
 
 
Consolidated Statements of Changes in Stockholders' Earnings (Deficit) for the nine months ended September 30, 2017 (unaudited)
 
6
 
 
 
Notes to Unaudited Condensed Consolidated Financial Statements
 
7
 
 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
47
 
 
 
ITEM 4. CONTROLS AND PROCEDURES
 
68
 
 
 
PART II — OTHER INFORMATION
 
70
 
 
 
ITEM 1. LEGAL PROCEEDINGS
 
      70
 
 
 
ITEM 1A. RISK FACTORS
 
70
 
 
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
72
 
 
 
ITEM 6. EXHIBITS
 
74
 
 
 
SIGNATURES
 
75
 
 
2
 
PART I – FINANCIAL INFORMATION
ITEM I – FINANCIAL STATEMENTS      
DOLPHIN ENTERTAINMENT, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(unaudited)
 
ASSETS
 
As of
September 30,
2017
 
 
As of
December 31,
2016
 
Current
 
 
 
 
 
 
Cash and cash equivalents
  $ 1,957,235  
  $ 662,546  
Restricted cash
    -  
    1,250,000  
Accounts receivable, net of $164,000 of allowance for doubtful accounts
    3,978,865  
    3,668,646  
Other current assets
  450,648
    2,665,781  
Total current assets
    6,386,748
    8,246,973  
Capitalized production costs
    2,437,163  
    4,654,013  
Intangible assets, net of $498,666 of amortization
    8,611,334  
    -  
Goodwill
    14,351,368
    -  
Property, equipment and leasehold improvements
    1,111,899  
    35,188  
Investments
    220,000  
    -  
Deposits
    643,708  
    1,261,067  
Total Assets
  $ 33,762,220
  $ 14,197,241  
LIABILITIES
       
       
Current
       
       
Accounts payable
  $ 1,423,213  
  $ 677,249  
Other current liabilities
    5,659,214  
    2,958,523  
Line of credit
    750,000  
    -  
Put rights
    947,515  
    -  
Warrant liability
    -  
    14,011,254  
Accrued compensation
    2,437,500  
    2,250,000  
Debt
    5,063,846  
    18,743,069  
Loan from related party
    1,734,867  
    684,326  
Deferred revenue
    20,303  
    46,681  
Note payable
    1,800,000  
    300,000  
Total current liabilities
    19,836,458  
    39,671,102  
Noncurrent
       
       
Warrant liability
    2,774,583  
    6,393,936  
Put rights
    2,752,485  
    -  
Contingent consideration
    3,973,000  
    -  
Note payable
    475,000  
    -  
Other noncurrent liabilities
    1,217,000  
    -  
Total noncurrent liabilities
    11,192,068  
    6,393,936  
Total Liabilities
    31,028,526  
    46,065,038  
STOCKHOLDERS' EQUITY (DEFICIT)
       
       
Common stock, $0.015 par value, 200,000,000 shares authorized, 9,367,057 and 7,197,761 shares, respectively, issued and outstanding at September 30, 2017 and December 31, 2016.
    140,506  
    215,933  
Preferred Stock, Series C, $0.001 par value, 50,000 shares authorized, 50,000 shares issued and outstanding at each of September 30, 2017 and December 31, 2016
    1,000  
    1,000  
Additional paid in capital
  92,829,088
    67,727,474  
Accumulated deficit
    (90,236,900 )
    (99,812,204 )
Total Stockholders' Equity (Deficit)
  $ 2,733,694
  $ (31,867,797 )
Total Liabilities and Stockholders' Equity (Deficit)
  $ 33,762,220
  $ 14,197,241  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
3
 
 
DOLPHIN ENTERTAINMENT INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
 
For the three months ended
 
 
For the nine months ended
 
 
 
September 30,
 
 
September 30,
 
 
 
2017
 
 
2016
 
 
2017
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Entertainment publicity  
    5,409,175
 
    -
 
    10,546,716  
    -
 
Production and distribution
  $ 1,398,839  
  $ 1,140,000  
  $ 4,625,801  
  $ 1,144,157  
Membership
    -  
    6,225  
    -  
    27,253  
Total revenues
    6,808,014  
    1,146,225  
    15,172,517  
    1,171,410  
 
       
       
       
       
Expenses:
       
       
       
       
Direct costs
    427,926  
    1,375,734  
    2,927,817  
    1,378,173  
Distribution and marketing
    320,439  
    9,237,873  
    950,812  
    9,237,873  
Selling, general and administrative
    628,564  
    370,984  
    1,871,258  
    1,019,641  
Legal and professional
    208,637  
    689,523  
    1,098,728  
    1,576,963  
Payroll
    3,482,246  
    350,264  
    7,284,734  
    1,101,465  
Total expenses
    5,067,812  
    12,024,378  
    14,133,349  
    14,314,115  
Income (Loss) before other expenses
    1,740,202  
    (10,878,153 )
    1,039,168  
    (13,142,705 )
 
       
       
       
       
Other Income (Expenses):
       
       
       
       
Other income
    -  
    -  
    -  
    9,660  
Amortization and Depreciation
    (321,538 )
    (47,369 )
    (648,848 )
    (47,369 )
Extinguishment of debt
    3,881,444  
    -  
    3,877,277  
    (5,843,811 )
Acquisition costs
    -  
    -  
    (745,272 )
    -  
Bad debt
    (69,437 )
    -  
    (85,437 )
    -  
Loss on disposal of furniture, office equipment and leasehold improvements
    -  
    -  
    (28,025 )
    -  
Change in fair value of warrant liability
    1,396,094  
    -  
    7,685,607  
    -  
Change in fair value of put rights and contingent consideration
    (30,000 )
    -  
    (246,000 )
    -  
Interest expense
    (424,187 )
    (613,651 )
    (1,273,166 )
    (3,768,727 )
Net Income (Loss)
    6,172,578  
    (11,539,173 )
    9,575,304  
    (22,792,952 )
 
       
       
       
       
Net income attributable to noncontrolling interest
  $ -  
  $ 1,556  
  $ -  
  $ 6,813  
Net income (loss) attributable to Dolphin Entertainment, Inc.
    6,172,578  
    (11,540,729 )
    9,575,304  
    (22,799,765 )
Net Income (Loss)
  $ 6,172,578  
  $ (11,539,173 )
  $ 9,575,304  
  $ (22,792,952 )
 
       
       
       
       
Income (Loss) per Share:
       
       
       
       
Basic
  $ 0.66
 
  $ (2.16 )
  $ 1.11
 
  $ (7.37 )
Diluted
  $ 0.44
 
  $ (2.16 )
  $ 0.20
 
  $ (7.37 )
Weighted average number of shares used in per share calculation
       
       
       
       
Basic
    9,336,826  
    5,337,108  
  8,640,543
 
    3,801,626  
Diluted
  10,382,818
    5,337,108  
    9,479,840
 
    3,801,626  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4
 
 
DOLPHIN ENTERTAINMENT, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
For the nine months ended
September 30,
 
 
 
2017
 
 
2016
 
 
 
 
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
Net income (loss)
  $ 9,575,304  
  $ (22,792,952 )
 
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
       
Depreciation and amortization
    648,848  
    15,996  
Amortization of capitalized production costs
    2,256,711  
    1,108,668  
Bad debt
    85,437  
    -  
Loss on extinguishment of debt
    4,167  
    5,843,811  
Loss on disposal of fixed assets
    28,025
 
    -  
Change in fair value of warrant liability
    (7,685,607 )
    -  
Change in fair value of put rights and contingent consideration
    246,000  
    -  
Gain on extinguishment of debt
    (4,500,000 )
    -
 
Compensation paid with shares of common stock
    103,740
 
    -
 
Changes in operating assets and liabilities:
       
       
Accounts receivable
    1,310,988  
    (1,142,727 )
Other current assets
    2,215,132
 
    -
 
Prepaid expenses
    -  
    69,766  
Related party receivable
    -  
    (67,690 )
Capitalized production costs
    (39,861 )
    (256,714 )
Deposits
    662,922  
    (1,200,000 )
Deferred revenue
    (26,378 )
    (74,736 )
Accrued compensation
    187,500  
    122,500  
Accounts payable
    706,284  
    (1,323,714 )
Other current liabilities
    434,920  
    4,121,106  
Other noncurrent liabilities
    456,814
 
    -  
Net Cash Provided by (Used in) Operating Activities
    6,670,946
 
    (15,576,686 )
CASH FLOWS FROM INVESTING ACTIVITIES:
       
       
Restricted cash
    1,250,000  
    -  
Payment of working capital adjustment (42West)
    (185,031 )
    -  
Purchase of fixed assets
    (166,956 )
    -  
Acquisition of 42West, net of cash acquired
    13,626  
    -  
Net Cash Provided by Investing Activities
    911,639  
    -  
CASH FLOWS FROM FINANCING ACTIVITIES:
       
       
Proceeds from loan and security agreements
    -  
    10,569,744  
Repayment of loan and security agreements
    -  
    (410,000 )
Sale of common stock
    500,000  
    6,225,000  
Restricted cash
    -  
    (1,250,000 )
Proceeds from line of credit
    750,000  
    -  
Proceeds from note payable
    1,975,000  
    -  
Repayment of debt
    (9,179,223 )
    -  
Proceeds from the exercise of warrants
    35,100  
    -  
Exercise of put rights
    (1,075,000 )
    -  
Advances from related party
    1,388,000  
    320,000  
Repayment to related party
    (681,773 )
    (1,288,383 )
Net Cash Provided by (Used in) Financing Activities
    (6,287,896 )
    14,166,361  
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    1,294,689  
    (1,410,325 )
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    662,546  
    2,392,685  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 1,957,235  
  $ 982,360  
 
       
       
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
       
       
 
       
       
Interest paid
  $ 26,459  
  $ 749,249  
 
SUPPLEMENTAL DISCLOSURES OF NON CASH FLOW INFORMATION:
 
       
Conversion of related party debt and interest to shares of common stock
  $ -  
  $ 3,073,410  
Conversion of debt into shares of common stock
  $ -  
  $ 3,164,000  
Conversion of loan and security agreements, including interest, into shares of common stock
  $ -  
  $ 20,434,858  
Loan commitment fee and interest reserve
  $ -  
  $ 1,531,871  
Liability for contingent consideration for the 42West Acquisition (see note 4)
  $ 3,973,000
 
  $ -
 
Liability for put rights to the Sellers of 42West (see note 4)
  $ 3,700,000
 
  $ -
 
Liabilities assumed in the 42West Acquisition (see note 4)
  $ 1,011,000
 
  $ -
 
Payment of certain accounts payable with shares of common stock
  $ 58,885  
  $ -  
Issuance of shares of Common Stock pursuant to 2017 Plan
  $ 486,424  
  $ -  
Issuance of shares of Common Stock related to the 42West Acquisition (see note 4)
  $ 15,030,767  
  $ -  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
5
 
 
DOLPHIN ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
 
 
 
 
Total
 
 
 
Preferred Stock
 
 
Common Stock
 
 
Paid-in
 
 
Accumulated
 
 
Stockholders
 
 
 
Shares
 
 
Amount
 
 
Shares
 
 
Amount
 
 
Capital
 
 
Deficit
 
 
Equity (Deficit)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Balance December 31, 2016
    50,000  
  $ 1,000  
    7,197,761  
  $ 215,933  
  $ 67,727,474  
  $ (99,812,204 )
  $ (31,867,797 )
 Net income for the nine months ended September 30, 2017
    -  
    -  
    -  
    -  
    -  
    9,575,304  
    9,575,304  
Sale of common stock during the nine months ended September 30, 2017
    -  
    -  
    50,000  
    750  
    499,250  
    -  
    500,000  
Issuance of shares from partial exercise of Warrant E and exercise of Warrants J and K
    -  
    -  
    1,332,885  
    19,993  
    9,960,107  
    -  
    9,980,100  
Issuance of shares for payment of services
       
       
    6,140  
    92  
    61,487  
       
    61,579  
Issuance of shares related to acquisition of 42West
    -  
    -  
    837,415  
    12,562  
    15,443,206
    -  
    15,455,768
Shares issued per equity compensation plan
    -  
    -  
    59,320  
    890  
  102,850
    -  
  103,740
Shares retired from exercise of puts
    -  
    -  
    (116,591 )
    (1,749 )
    (1,073,251 )
    -  
    (1,075,000 )
Effect of reverse stock split on cumulative amount of par value
    -  
    -  
    127  
    (107,965 )
    107,965  
    -  
    -  
 Balance September 30, 2017
    50,000  
  $ 1,000  
    9,367,057  
  $ 140,506  
  $ 92,829,088
  $ (90,236,900 )
  $ 2,733,694
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6
 
 
DOLPHIN ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
 
NOTE 1 – GENERAL
 
Dolphin Entertainment, Inc. (the “Company,” “Dolphin,” “we,” “us” or “our”), formerly Dolphin Digital Media, Inc., is a leading independent entertainment marketing and premium content development company. Through its recent acquisition of 42 West, LLC (“42West”), the Company provides expert strategic marketing and publicity services to all of the major film studios, and many of the leading independent and digital content providers, as well as for hundreds of A-­list celebrity talent, including actors, directors, producers, recording artists, athletes and authors. The strategic acquisition of 42West brings together premium marketing services with premium content production, creating significant opportunities to serve respective constituents more strategically and to grow and diversify the Company’s business. Dolphin’s content production business is a long established, leading independent producer, committed to distributing premium, best-­in­-class film and digital entertainment. Dolphin produces original feature films and digital programming primarily aimed at family and young adult markets. Dolphin also currently operates online kids clubs; however it intends to discontinue the online kids clubs at the end of 2017 to dedicate its time and resources to the entertainment publicity business and the production of feature films and digital content.
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the accounts of Dolphin, and all of its wholly-owned and majority-owned and controlled subsidiaries, including Dolphin Films, Inc., Dolphin Kids Clubs, LLC, Cybergeddon Productions, LLC, Dolphin SB Productions LLC, Dolphin Max Steel Holdings LLC, Dolphin JB Believe Financing, LLC, Dolphin JOAT Productions, LLC and 42West.
 
Effective March 7, 2016, the Company acquired Dolphin Films, Inc. ("Dolphin Films") from Dolphin Entertainment, LLC. (“DE LLC”), a company wholly owned by William O’Dowd, CEO, President and Chairman of the Board of Dolphin. At the time of the acquisition, Mr. O’Dowd was also the majority shareholder of Dolphin. The acquisition from DE LLC was a transfer between entities under common control. As such, the Company recorded the assets, liabilities and deficit of Dolphin Films on its consolidated balance sheets at DE LLC’s historical basis instead of fair value. Transfers of businesses between entities under common control require prior periods to be retrospectively adjusted to furnish comparative information. Accordingly, the accompanying financial statements and related notes of the Company have been retrospectively adjusted to include the historical balances of DE LLC’s prior to the effective date of the acquisition.
 
On May 9, 2016, the Company filed an amendment to its Articles of Incorporation with the Secretary of State of the State of Florida to effectuate a 1-to-20 reverse stock split. The reverse stock split was approved by the Board of Directors and a majority of the Company’s shareholders and became effective May 10, 2016. The number of shares of common stock in the accompanying unaudited condensed consolidated financial statements and all related footnotes has been adjusted to retrospectively reflect the reverse stock split.
 
On March 30, 2017, the Company entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”), by and among the Company and Leslee Dart, Amanda Lundberg, Allan Mayer and the Beatrice B. Trust (the “Sellers”). Pursuant to the Purchase Agreement, the Company acquired from the Sellers 100% of the membership interests of 42West and 42West became a wholly-owned subsidiary of the Company (the “42West Acquisition”). The consideration paid by the Company in connection with the 42West Acquisition was approximately $18.7 million in shares of common stock of the Company, par value $0.015 (the “Common Stock”), based on the Company’s 30-trading-day average stock price prior to the closing date of $9.22 per share (less certain working capital and closing adjustments, transaction expenses and payments of indebtedness), plus the potential to earn up to an additional $9.3 million in shares of Common Stock based on achieving certain financial targets. See note 4 for additional information regarding the acquisition.
 
 
7
 
 
On June 29, 2017, the shareholders approved a change in the name of the Company to Dolphin Entertainment, Inc. Effective July 6, 2017, the Company amended its Articles of Incorporation to (i) change the Company’s name to Dolphin Entertainment, Inc.; (ii) cancel previous designations of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock; (iii) reduce the number of Series C Convertible Preferred Stock outstanding in light of the 1-to-20 reverse stock split from 1,000,000 to 50,000 shares; and (iv) clarify the voting rights of the Series C Convertible Preferred Stock that, except as required by law, holders of Series C Convertible Preferred Stock will only have voting rights once the independent directors of the Board determine that an optional conversion threshold has occurred.
 
On September 13, 2017, the Company filed with the Florida Department of State Articles of Amendment to the Company’s Amended and Restated Articles of Incorporation to effectuate a reverse stock split of the Company’s Common Stock, on a two (2) old for one (1) new basis (the “Reverse Stock Split”), providing that the Reverse Stock Split would become effective under Florida law on September 14, 2017. Immediately after the Reverse Stock Split, the number of authorized shares of Common Stock was reduced from 400,000,000 shares to 200,000,000. As a result, each shareholder’s percentage ownership interest in the Company and proportional voting power remained unchanged. Any fractional shares resulting from the Reverse Stock Split were rounded up to the nearest whole share of Common Stock. Shareholder approval of the Reverse Stock Split was not required. All consolidated financial statements and per share amounts have been retroactively adjusted for the above amendment to authorized shares and the reverse stock split.
 
The Company enters into relationships or investments with other entities, and in certain instances, the entity in which the Company has a relationship or investment may qualify as a variable interest entity (“VIE”). A VIE is consolidated in the financial statements if the Company is deemed to be the primary beneficiary of the VIE. The primary beneficiary is the party that has the power to direct activities that most significantly impact the activities of the VIE and has the obligation to absorb losses or the right to benefits from the VIE that could potentially be significant to the VIE. The Company has included Max Steel Productions, LLC formed on July 8, 2013 in the State of Florida and JB Believe, LLC formed on December 4, 2012 in the State of Florida in its combined financial statements as VIE’s.
 
The unaudited condensed consolidated financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to quarterly report on Form 10-Q under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of the Company’s management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been reflected in these unaudited condensed consolidated financial statements. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017. The balance sheet at December 31, 2016 has been derived from the audited financial statements at that date, but does not include all the information and footnotes required by U.S. GAAP for complete financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. The most significant estimates made by management in the preparation of the financial statements relate to ultimate revenue and costs for investment in digital and feature film projects; estimates of sales returns and other allowances and provisions for doubtful accounts and impairment assessments for investment in digital and feature film projects. Actual results could differ from such estimates.
 
 
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Recent Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 —Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which provides guidance for revenue recognition. This ASU will supersede the revenue recognition requirements in ASC Topic 605, and most industry specific guidance, and replace it with a new Accounting Standards Codification (“ASC”) Topic 606. The FASB has also issued several subsequent ASUs which amend ASU 2014-09. The amendments do not change the core principle of the guidance in ASC 606.
 
The core principle of ASC 606 is that revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps:
 
Step 1: Identify the contract(s) with a customer
 
Step 2: Identify the performance obligations in the contract.
 
Step 3: Determine the transaction price.
 
Step 4: Allocate the transaction price to the performance obligations in the contract.
 
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
 
The guidance in ASU 2014-09 also specifies the accounting for some costs to obtain or fulfill a contract with a customer. ASC 606 will require the Company to make significant judgments and estimates. ASC 606 also requires more extensive disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
 
Public business entities are required to apply the guidance of ASC 606 to annual reporting periods beginning after December 15, 2017 (2018 for the Company), including interim reporting periods within that reporting period. Accordingly, the Company will adopt ASU 606 in the first quarter of 2018.
 
ASC 606 requires an entity to apply ASC 606 using one of the following two transition methods:
 
1. 
Retrospective approach: Retrospectively to each prior reporting period presented and the entity may elect certain practical expedients.
 
2. 
Modified retrospective approach: Retrospectively with the cumulative effect of initially applying ASC 606 recognized at the date of initial application. If an entity elects this transition method it also is required to provide the additional disclosures in reporting periods that include the date of initial application of (a) the amount by which each financial statement line item is affected in the current reporting period by the application ASU 606 as compared to the guidance that was in effect before the change, and (b) an explanation of the reasons for significant changes.
 
The Company expects that it will adopt ASC 606 following the modified retrospective approach. The Company is currently evaluating the impact that the adoption of this new guidance. While there may be additional areas impacted by the new standard, the Company has identified certain areas that may be impacted as follows:
 
Variable Consideration: The Company is entitled to royalties from certain international distributors based on the sales made by these distributors after recoupment of a minimum guarantee. The Company is also entitled to certain bonus payments if certain of their clients receive awards as specified in the engagement contracts. Under the new revenue recognition rules, revenues will be recorded based on best estimates available in the period of sales or usage. The Company is evaluating the impact, if any, of recognizing the variable consideration.
 
 
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Principal vs. Agent: The new standard includes new guidance as to how to determine whether the Company is acting as a principal, in which case revenue would be recognized on a gross basis, or whether the Company is acting as an agent, in which case revenues would be recognized on a net basis. The Company is currently evaluating whether the new principal versus agent guidance will have an impact (i.e., changing from gross to net recognition or from net to gross recognition) under certain of its distribution arrangements.
 
The Company is continuing to evaluate the impact of the new standard on its consolidated financial statements for the above areas and other areas of revenue recognition, particularly as it pertains to its new subsidiary, 42West.
 
In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740) regarding balance sheet classification of deferred income taxes. ASU 2015-17 simplifies the presentation of deferred taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. ASU 2015-17 is effective for public companies for annual reporting periods beginning after December 15, 2016 (2017 for the Company), and interim periods within those fiscal years. The guidance may be adopted prospectively or retrospectively and early adoption is permitted. Adoption of ASU 2015-17 did not have an impact on the Company’s financial position, results of operations or cash flows.
 
In February 2016, The FASB issued ASU 2016-02, Leases (Topic 642) intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment. The ASU will require organizations that lease assets—referred to as “lessees”—to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Under the new guidance, a lease will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP—which requires only capital leases to be recognized on the balance sheet –the new ASU will require both types of leases to be recognized on the balance sheet. The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.
 
ASU 2016-02 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (2019 for the Company). For all other organizations, the ASU on leases will take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. Early application will be permitted for all organizations. The Company is currently reviewing the impact that implementing this ASU will have.
 
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU will be effective on a retrospective or modified retrospective basis for annual reporting periods beginning after December 15, 2017 (2018 for the Company), and interim periods within those years, with early adoption permitted. The Company does not believe that adoption of this new guidance will have a material effect on our consolidated financial statements.
 
In October 2016, the FASB issued ASU 2016-17 —Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control. The update amends the consolidation guidance on how VIE’s should treat indirect interest in the entity held through related parties. The ASU will be effective on a retrospective or modified retrospective basis for annual reporting periods beginning after December 15, 2016 (2017 for the Company), and interim periods within those years, with early adoption permitted. The adoption of ASU 2016-17 did not have an effect on the Company’s condensed consolidated financial statements.
 
 
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In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-18 provides guidance on the classification of restricted cash and cash equivalents in the statement of cash flows. Although it does not provide a definition of restricted cash or restricted cash equivalents, it states that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for interim and annual reporting periods beginning after December 15, 2017. The Company does not currently expect the adoption of this new standard to have a material impact on its consolidated financial statements.
 
In January 2017, the FASB issued guidance to simplify the accounting for goodwill impairment. The guidance removes the second step of the goodwill impairment test, which requires that a hypothetical purchase price allocation be performed to determine the amount of impairment, if any. Under this new guidance, a goodwill impairment charge will be based on the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance is effective for the Company’s fiscal year beginning April 1, 2020, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company adopted the new guidance effective January 1, 2017, with no material impact on the Company’s consolidated financial statements.
 
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718). This update mandates that entities will apply the modification accounting guidance if the value, vesting conditions or classification of a stock-based award changes. Entities will have to make all of the disclosures about modifications that are required today, in addition to disclosing that compensation expense has not changed. Additionally, the new guidance also clarifies that a modification to an award could be significant and therefore requires disclosure, even if the modification accounting is not required. The guidance will be applied prospectively to awards modified on or after the adoption date and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company is currently evaluating the impact of the provisions of this new standard on its consolidated financial statements.
 
In July 2017, FASB issued ASU No. 2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). ASU 2017-11 consists of two parts. The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this Update re-characterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect The Company is currently reviewing the impact that implementing this ASU will have.
 
 
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NOTE 2 — GOING CONCERN
 
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the U.S. which contemplate the continuation of the Company as a going concern. Although the Company has net income of $6,172,578 and $9,575,304, respectively for the three and nine months ended September 30, 2017, it has recorded accumulated deficit of $90,236,900 as of September 30, 2017. The Company has a working capital deficit of $13,449,710 and therefore does not have adequate capital to fund its obligations as they come due or to maintain or develop its operations. The Company is dependent upon funds from private investors, proceeds from debt securities, securities convertible into shares of its Common Stock and support of certain stockholders. If the Company is unable to obtain funding from these sources within the next 12 months, it could be forced to liquidate.
 
These factors raise substantial doubt about the ability of the Company to continue as a going concern. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. In this regard, management is planning to raise any necessary additional funds through loans and additional issuance of its Common Stock, securities convertible into the Company’s Common Stock, debt securities or a combination of such financing alternatives. There is no assurance that the Company will be successful in raising additional capital. Such issuances of additional securities would further dilute the equity interests of our existing shareholders, perhaps substantially. The Company currently has the rights to several scripts that it intends to obtain financing to produce during 2018 and release starting in early 2019. It expects to earn a producer and overhead fee for each of these productions. There can be no assurances that such productions will be released or fees will be realized in future periods. With the acquisition of 42West, the Company is currently exploring opportunities to expand the services currently being offered by 42West to the entertainment community and reducing expenses by identifying certain costs that can be combined with the Company’s. There can be no assurance that the Company will be successful in selling these services to clients or reducing expenses.
 
NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Accounts Receivable and Allowance for Doubtful Accounts
 
The Company’s trade accounts receivable are recorded at amounts billed to customers, and presented on the balance sheet net of the allowance for doubtful accounts. The allowance is determined by various factors, including the age of the receivables, current economic conditions, historical losses and other information management obtains regarding the financial condition of customers. The policy for determining the past due status of receivables is based on how recently payments have been received. Receivables are charged off when they are deemed uncollectible.
 
Revenue Recognition
 
Entertainment Publicity revenue consists of fees from the performance of professional services and billings for direct costs reimbursed by clients. Fees are generally recognized on a straight-line or monthly basis which approximates the proportional performance on such contracts. Direct costs reimbursed by clients are billed as pass-through revenue with no mark-up.
 
Revenue from motion pictures and web series are recognized in accordance with guidance of FASB Accounting Standard Codification (“ASC”) 926-60 “Revenue Recognition – Entertainment-Films”. Revenue is recorded when a distribution contract, domestic or international, exists, the movie or web series is complete in accordance with the terms of the contract, the customer can begin exhibiting or selling the movie or web series, the fee is determinable and collection of the fee is reasonable. On occasion, the Company may enter into agreements with third parties for the co-production or distribution of a movie or web series. Revenue from these agreements will be recognized when the movie is complete and ready to be exploited. Cash received and amounts billed in advance of meeting the criteria for revenue recognition is classified as deferred revenue.
 
 
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Additionally, because third parties are the principal distributors of the Company’s movies, the amount of revenue that is recognized from films in any given period is dependent on the timing, accuracy and sufficiency of the information received from its distributors. As is typical in the film industry, the Company’s distributors may make adjustments in future periods to information previously provided to the Company that could have a material impact on the Company’s operating results in later periods. Furthermore, management may, in its judgment, make material adjustments to the information reported by its distributors in future periods to ensure that revenues are accurately reflected in the Company’s financial statements. To date, the distributors have not made, nor has the Company made, subsequent material adjustments to information provided by the distributors and used in the preparation of the Company’s historical financial statements.
 
Investment
 
Investment represents an investment in equity securities of The Virtual Reality Company (“VRC”). The Company’s $220,000 investment in VRC represents less than 1% noncontrolling ownership interest in VRC. Accordingly, the Company accounts for its investment under the cost method. Under the cost method, the investor’s share of earnings or losses is not included in the balance sheet or statement of operations. The net accumulated earnings of the investee subsequent to the date of investment are recognized by the investor only to the extent distributed by the investee as dividends. However, impairment charges are recognized in the statement of operations, if factors come to our attention that indicate that a decrease in value of the investment has occurred that is other than temporary.
 
Property, Equipment and Leasehold Improvements
 
Property and equipment is recorded at cost and depreciated over the estimated useful lives of the assets using the straight-line method. The Company recorded depreciation expense of $72,205 and $150,182, respectively for the three and nine months ended September 30, 2017 and $4,681 and $15,996, respectively, for the three and nine months ended September 30, 2016. When items are retired or otherwise disposed of, income is charged or credited for the difference between net book value and proceeds realized thereon. Ordinary maintenance and repairs are charged to expense as incurred, and replacements and betterments are capitalized. Leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful lives of the assets. The range of estimated useful lives to be used to calculate depreciation and amortization for principal items of property and equipment are as follow:
 
Asset Category
 
Depreciation/   Amortization Period
(Years)
Furniture and fixtures 
 
5 - 7
Computer and office equipment 
 
3 - 5
Leasehold improvements 
 
5 - 8, not to exceed the lease terms
 
Deferred Landlord Reimbursement
 
Deferred landlord reimbursement represents the landlord’s reimbursement for tenant improvements of one of the Company’s office spaces. Such amount is amortized on a straight-line basis over the term of the lease.
 
Deferred Rent
 
Deferred rent consists of the excess of the rent expense recognized on the straight-line basis over the payments required under certain office leases.
 
 
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Intangible assets
 
In connection with the acquisition of 42West that occurred on March 30, 2017, the Company acquired an estimated $9,110,000 of intangible assets with finite useful lives initially estimated to range from 3 to 10 years. As indicated in note 4, the purchase price allocation and related consideration are provisional and subject to completion and adjustment. Intangible assets are initially recorded at fair value and are amortized over their respective estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
 
Goodwill
 
In connection with the acquisition of 42West that occurred on March 30, 2017 (note 4), the Company recorded $13,996,337 of goodwill, which management has assigned to the Entertainment Publicity reporting unit. As indicated in note 4, the purchase price allocation and related consideration are provisional and subject to completion and adjustment.  During the six months between the date of acquisition and September 30, 2017, the Company adjusted goodwill in the amount of $355,031 to record a working capital adjustment, as provided for in the 42West purchase agreement and adjust the preliminary fair value of certain liabilities as of the acquisition date. The Company accounts for goodwill in accordance with FASB Accounting Standards Codification No. 350, Intangibles—Goodwill and Other (“ASC 350”). ASC 350 requires goodwill to be reviewed for impairment annually, or more frequently if circumstances indicate a possible impairment. The Company evaluates goodwill in the fourth quarter or more frequently if management believes indicators of impairment exist. Such indicators could include, but are not limited to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator.
 
The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount, including goodwill. If management concludes that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, management conducts a two-step quantitative goodwill impairment test. The first step of the impairment test involves comparing the fair value of the reporting unit with its carrying value (including goodwill). The Company estimates the fair values of its reporting units using a combination of the income, or discounted cash flows approach and the market approach, which utilizes comparable companies’ data. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. If the estimated fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit, and the Company must perform step two of the impairment test (measurement).
 
Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation in acquisition accounting. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. To the extent that the carrying amount of goodwill exceeds its implied fair value, an impairment loss would be recorded.
 
Warrants
 
When the Company issues warrants, it evaluates the proper balance sheet classification of the warrant to determine whether the warrant should be classified as equity or as a derivative liability on the consolidated balance sheets. In accordance with ASC 815-40, Derivatives and Hedging-Contracts in the Entity’s Own Equity (ASC 815-40), the Company classifies a warrant as equity so long as it is “indexed to the Company’s equity” and several specific conditions for equity classification are met.  A warrant is not considered indexed to the Company’s equity, in general, when it contains certain types of exercise contingencies or contains certain provisions that may alter either the number of shares issuable under the warrant or the exercise price of the warrant, including, among other things, a provision that could require a reduction to the then current exercise price each time the Company subsequently issues equity or convertible instruments at a per share price that is less than the current conversion price (also known as a “full ratchet down round provision”). If a warrant is not indexed to the Company’s equity, it is classified as a derivative liability which is carried on the consolidated balance sheet at fair value with any changes in its fair value recognized currently in the statement of operations.
 
 
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The Company has outstanding warrants at September 30, 2017 and December 31, 2016 accounted for as derivative liabilities, because they contain full-ratchet down round provisions (see notes 11 and 17). The Company also has equity classified warrants outstanding at September 30, 2017 and December 31, 2016 (see note 17).
 
Fair Value Measurements
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are categorized based on whether the inputs are observable in the market and the degree that the inputs are observable. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Observable inputs are based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s own assumptions based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels, defined as follows:
 
 
Level 1
 
 
Inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date.
 
 
Level 2
 
 
Inputs other than quoted prices included within Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated with observable market data.
 
 
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies, and similar techniques that use significant unobservable inputs. Unobservable inputs for the asset or liability that reflect management’s own assumptions about the assumptions that market participants would use in pricing the asset or liability as of the reporting date.
 
To account for the acquisition of 42West that occurred on March 30, 2017, the Company made a number of fair value measurements related to the different forms of consideration paid for 42West and of the identified assets acquired and liabilities assumed. In addition, the Company makes fair value measurements of its Put Rights and Contingent Consideration. See Note 4 and 11 for further discussion and disclosures.
 
Certain warrants issued in 2016 are measured and carried at fair value on a recurring basis in the condensed consolidated financial statements. See note 11 for disclosures regarding those fair value measurements.
 
As of September 30, 2016, and for the three and nine months then ended, the Company had no assets or liabilities measured at fair value, on a recurring or nonrecurring basis.
 
Business Segments
 
Through March 30, 2017 (the date the Company acquired 42West) (see Note 4), the Company operated the following business segments:
 
1) 
Dolphin Digital Media (USA): The Company created online kids clubs and derives revenue from annual membership fees.
 
2) 
Dolphin Digital Studios: Dolphin Digital Studios creates original programming that premieres online, with an initial focus on content geared toward tweens and teens.
 
3) 
Dolphin Films: Dolphin Films produces motion pictures, with an initial focus on family content. The motion pictures are distributed, through third parties, in the domestic and international markets. The Company derived a majority of its revenues from this segment during the three and nine months ended September 30, 2016.
 
 
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Based on an analysis of the Company’s operating segments and the provisions of ASC 280, Segment Reporting (ASC 280), the Company believes it meets the criteria for aggregating these operating segments into a single reporting segment because they have similar economic characteristics, similar nature of product sold, (content), similar production process (the Company uses the same labor force, and content) and similar type of customer (children, teens, tweens and family).
 
With the acquisition of 42West, the Company has identified an additional operating segment meeting the criteria in ASC 280 for a separate reporting segment. The new segment is Entertainment Publicity and primarily provides talent, entertainment and targeted marketing, and strategic communications services. See Note 19 for Segment reporting for the three and nine months ended September 30, 2017.
 
NOTE 4 ACQUISITION OF 42WEST
 
On March 30, 2017, the “Company entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”), by and among the Company and the Sellers. Pursuant to the Purchase Agreement, the Company acquired from the Sellers 100% of the membership interests of 42West and 42West became a wholly-owned subsidiary of the Company. 42West is an entertainment public relations agency offering talent, entertainment and targeted marketing and strategic communications services.
 
The consideration paid by the Company in connection with the 42West Acquisition was $18,666,666 (less, the amount of 42West’s transaction expenses paid by the Company and payments by the Company of certain 42West indebtedness) in shares of Common Stock, determined based on the Company’s 30-trading-day average stock price prior to the closing date of $9.22 per share, plus the potential to earn up to an additional $9.3 million (less payment of certain taxes) in shares of Common Stock, determined based on $9.22 per share. As a result, the Company (i) issued 615,140 shares of Common Stock to the Sellers on the closing date (the “Initial Consideration”), (ii) (a) issued 172,275 shares of Common Stock to certain current 42West employees and a former 42West employee on April 13, 2017, to settle change in control provisions in their pre-existing employment and termination agreements (the “Change in Control Provisions”), (b) issued 59,320 shares of restricted stock as employee stock bonuses (the “Employee Bonus Shares”) under the Company's 2017 equity Incentive Plan, and (c) will issue approximately 767,563 shares of Common Stock to the Sellers, and 213,348 shares of Common Stock to certain current and former 42West employees to settle the Change in Control Provisions, on January 2, 2018 (the “Post-Closing Consideration”), and (iii) potentially may issue up to approximately 856,414 shares of Common Stock to the Sellers, and 125,149 shares to certain current and former 42West employees in accordance with the Change in Control Provisions, based on the achievement of specified 42West financial performance targets over a three-year period beginning January 1, 2017 and ending December 31, 2019 as set forth in the Purchase Agreement (the “Earn-Out Consideration”, and together with the Initial Consideration and the Post-Closing Consideration, (the “Stock Consideration”). The Purchase Agreement allows for a working capital adjustment to be calculated within 30 days of the closing of the transaction. On April 13, 2017, the Company issued 50,000 shares of Common Stock to the Sellers as a provisional working capital adjustment, and on August 30, 2017 the Company made a final cash payment to the Sellers of $185,031 to settle the working capital adjustment once all information was agreed to between the Sellers and the Company. None of the Common Stock included in the Stock Consideration have been registered under the Securities Act except for the Employee Bonus Shares.
 
The Company also agreed to pay the Sellers’ transaction costs and assumed certain tax liabilities incurred or to be incurred by the Sellers based on the proceeds they receive.
 
The issuance of 59,320 Employee Bonus Shares and the potential issuance of 117,788 shares as part of the Earn-Out Consideration to current employees (the “Employee Earn-Out Shares”) are conditioned on the employees remaining employed by the Company up to the date the shares become issuable. If an employee does not remain employed for the requisite service period, the shares they forfeit will be allocated among and issued to the Sellers. The Employee Bonus Shares and Employee Earnout Shares are not considered part of the accounting consideration transferred to acquire 42West. The Employee Bonus Shares will be accounted for under ASC 718,  Compensation Stock-Compensation , which will result in compensation expense in the Company’s consolidated statements of operations. On August 21, 2017, the Company granted 59,320 of nonvested restricted stock to current 42West employees, of which 58,205 shares remain outstanding at September 30, 2017.
 
The Purchase Agreement contains customary representations, warranties, covenants and indemnifications.
 
 
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Also in connection with the 42West Acquisition, on March 30, 2017, the Company entered into put agreements (the “Put Agreements”) with each of the Sellers. Pursuant to the terms and subject to the conditions set forth in the Put Agreements, the Company has granted the Sellers the right, but not obligation, to cause the Company to purchase up to an aggregate of 1,187,094 of their shares of Common Stock received as Stock Consideration for a purchase price equal to $9.22 per share during certain specified exercise periods set forth in the Put Agreements up until December 2020 (the “Put Rights”). During the three months ended September 30, 2017, the Sellers, in accordance with the Put Agreements, caused the Company to purchase 40,672 shares of Common Stock for an aggregate amount of $375,000.
 
Each of Leslee Dart, Amanda Lundberg and Allan Mayer (the “Principal Sellers”) has entered into employment agreements with the Company to continue as employees of the Company for a three-year term after the closing of the 42West Acquisition. Each of the employment agreements of the Principal Sellers contains lock-up provisions pursuant to which each Principal Seller has agreed not to transfer any shares of Common Stock in the first year, except pursuant to an effective registration statement on Form S-1 or Form S-3 promulgated under the Securities Act (an “Effective Registration Statement”) or upon exercise of the Put Rights pursuant to the Put Agreement, and, except pursuant to an Effective Registration Statement, no more than 1/3 of the Initial Consideration and Post-Closing Consideration received by such Principal Seller in the second year and no more than an additional 1/3 of the Initial Consideration and Post-Closing Consideration received by such Principal Seller in the third year, following the closing date. The non-executive employees of 42West were retained as well.
 
In addition, in connection with the 42West Acquisition, on March 30, 2017, the Company entered into a registration rights agreement with the Sellers (the “Registration Rights Agreement”) pursuant to which the Sellers are entitled to rights with respect to the registration under the Securities Act. All fees, costs and expenses of underwritten registrations under the Registration Rights Agreement will be borne by the Company. At any time after the one-year anniversary of the Registration Rights Agreement, the Company will be required, upon the request of such Sellers holding at least a majority of the Stock Consideration received by the Sellers, to file a registration statement on Form S-1 and use its reasonable efforts to affect a registration covering up to 25% of the Stock Consideration received by the Sellers. In addition, if the Company iseligible to file a registration statement on Form S-3, upon the request of such Sellers holding at least a majority of the Stock Consideration received by the Sellers, the Company will be required to use its reasonable efforts to affect a registration of such shares on Form S-3 covering up to an additional 25% of the Stock Consideration received by the Sellers. The Company is required to effect only one registration on Form S-1 and one registration statement on Form S-3, if eligible. The right to have the Stock Consideration received by the Sellers registered on Form S-1 or Form S-3 is subject to other specified conditions and limitations.
 
The provisional acquisition-date fair value of the consideration transferred totaled $24,113,798, which consisted of the following:
 
Common Stock issued at closing and in April 2017 (787,415 shares) 
  $ 6,693,028  
Common Stock issuable on January 2, 2018 (980,911 shares) 
    8,337,739  
Contingent Consideration 
    3,627,000  
Put Rights 
    3,800,000  
Sellers’ transaction costs paid at closing 
    260,000  
Sellers’ tax liabilities assumed 
    786,000  
Working capital adjustment (50,000 shares issued in April 2017 plus paid $185,031 in cash in August 2017)
    610,031
 
  $ 24,113,798
 
The fair values of the 787,415 shares of Common Stock issued at closing and in April 2017, the 50,000 share of Common Stock issued on April 13, 2917 and the 980,911 shares of Common Stock to be issued on January 2, 2018 were determined based on the closing market price of the Company’s Common Stock on the acquisition date of $8.50 per share.
 
 
17
 
 
The Earn-Out Consideration arrangement requires the Company to pay up to 863,776 shares of Common Stock to the Sellers and one former employee of 42West to settle a Change in Control Provision (the “Contingent Consideration”), on achievement of adjusted EBITDA targets based on the operations of 42West over the three-year period beginning January 1, 2017. The provisional fair value of the Contingent Consideration was estimated using a Monte Carlo Simulation model, which incorporated significant inputs that are not observable in the market, and thus represents a Level 3 measurement as defined in ASC 820. The unobservable inputs utilized for measuring the fair value of the Contingent Consideration reflect management’s own assumptions about the assumptions that market participants would use in valuing the Contingent Consideration as of the acquisition date. The key assumptions as of the acquisition date used in applying the Monte Carlo Simulation model are as follows: estimated risk-adjusted EBITDA figures ranging between $3,750,000 and $3,900,000; discount rates ranging between 11.75% and 12.25% applied to the risk-adjusted EBITDA estimates to derive risk-neutral EBITDA estimates; risk-free discount rates ranging from 1.03% to 1.55%, based on U.S. government treasury obligations with terms similar to those of the Contingent Consideration arrangement, applied to the risk-neutral EBITDA estimates; and an annual asset volatility estimate of 72.5%.
 
The provisional fair value of the Put Rights at the acquisition date was estimated using Black-Scholes Option Pricing Model, which incorporates significant inputs that are not observable in the market, and thus represents a Level 3 measurement as defined in ASC 820. The unobservable inputs utilized for measuring the fair value of the Put Rights reflect management’s own assumptions about the assumptions that market participants would use in valuing the Put Rights as of the acquisition date. The key assumptions in applying the Black Scholes Option Pricing Model are as follows: a discount rate range of 0.12% to 1.70% based on U.S Treasury obligations with a term similar to the exercise period for each of the rights to put shares to the Company as set forth in the Put Option agreements, and an equity volatility estimate of 75% based on the stock price volatility of the Company and certain publicly traded companies operating in the advertising services industry.
 
The Sellers’ tax liabilities assumed relates to the New York City Unincorporated Business Tax the Sellers will incur on the Initial Consideration, Post-Closing Consideration and potential Earn-Out Consideration received or to be received by them in connection with the 42West Acquisition. The Company’s obligation to pay the Sellers’ tax liabilities is a mutually agreed upon amount of $786,000, which was based on the Sellers’ estimates at the closing date of the 42West Acquisition of the amount of taxes to be owed, based on a 4% tax rate and the Sellers’ estimated taxable income. The estimated fair value of the Sellers’ tax liabilities assumed may change during the measurement period, pending receipt by the Company from the Sellers of an updated tax liability accrual, and ultimately the Sellers’ preparation of the related income tax returns related to the Initial Consideration. Therefore, the estimated fair value of the Sellers’ tax liabilities assumed is provisional.
 
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date, March 30, 2017. Amounts in the table are provisional estimates that may change, as described below.
 
Cash 
  $ 273,625  
Accounts receivable 
    1,706,644  
Property, equipment and leasehold improvements 
    1,087,962  
Other assets 
    265,563  
Indemnification asset 
    300,000  
Intangible assets 
    9,110,000  
Total identifiable assets acquired 
    12,743,794  
 
       
Accounts payable and accrued expenses 
    (731,475 )
Line of credit and note payable 
    (1,025,000 )
Settlement liability 
    (300,000 )
Other liabilities 
    (902,889 )
Tax liabilities 
    (22,000 )
Total liabilities assumed 
    (2,981,364 )
Net identifiable assets acquired 
    9,762,430  
Goodwill 
    14,351,368
Net assets acquired 
  $ 24,113,798
 
 
18
 
 
Of the provisional fair value of the $9,110,000 of acquired identifiable intangible assets, $5,980,000 was assigned to customer relationships (10-year useful life), $2,760,000 was assigned to the trade name (10-year useful life), and $370,000 was assigned to non-competition agreements (3-year useful life), that were recognized at fair value on the acquisition date.
 
The estimated fair value of accounts receivable acquired is $1,706,644, with the gross contractual amount being $1,941,644. The Company expects $235,000 to be uncollectible. The estimated fair value of accounts receivable is provisional, pending the Company obtaining additional evidence of the actual amounts which will be collected.
 
The fair values of property and equipment and leasehold improvements of $1,087,962, and other assets of $265,563, are based on 42West’s carrying values prior to the acquisition, which approximate their fair values.
 
The estimated fair value of the settlement liability of $300,000 relates to 42West’s contingent liability to the Motion Picture Industry Pension Individual Account and Health Plans (collectively the “Plans”), two multiemployer pension funds and one multiemployer welfare fund, respectively, that are governed by the Employee Retirement Income Security Act of 1974, as amended (the “Guild Dispute”). The Plans intend to conduct an audit of 42West’s books and records for the period June 7, 2011 through August 20, 2016 in connection with the alleged contribution obligations of 42West to the Plans. Based on a recent audit for periods prior to June 7, 2011, the Company estimates that the probable amount the Plan may seek to collect from 42West is approximately $300,000, as of the acquisition date, in pension plan contributions, health and welfare plan contributions and union dues once the audit is completed. Accordingly, the Company has recorded a $300,000 settlement accrual liability for the probable amount of the liability it may incur due to the Motion Picture Industry Pension audit of the period from March 25, 2012 through August 20, 2016 (see Note 20). The Company has not recorded a liability as of the acquisition date for any exposure for additional settlement obligations related to the period from August 20, 2016 through March 30, 2017, as the Company has not reached a conclusion that a loss for that period is probable. Therefore, the ultimate amount related to the settlement liability as of March 30, 2017 may vary from the amount recorded, and as such, the estimated fair value of the settlement liability is provisional.
 
In accordance with the terms of the Purchase Agreement, the Sellers indemnified the Company with respect to the Guild Dispute for losses incurred related to the Company’s alleged contribution obligations to the Plans for the period between March 25, 2012 through March 26, 2016. The Company has recorded an indemnification asset related to the recorded settlement liability, measured at fair value on the same basis as the settlement liability. The indemnification asset represents the estimated fair value of the indemnification payment expected to be received from Sellers, related to the indemnification by the Sellers of the estimated settlement liability. As the estimated fair value of the settlement liability is provisional, so too is the estimated fair value of the indemnification asset.
 
The deferred tax liability related to 42West is a provisional estimate pending the completion of an analysis of deferred income taxes.
 
Based on the provisional fair values related to certain assets acquired and liabilities assumed discussed above, the $14,351,368 of goodwill is also provisional. The goodwill was assigned to the Entertainment Publicity reporting unit, which is at the same level as the Entertainment Publicity segment (see Note 19). The goodwill recognized is attributable primarily to expectations of continued successful efforts to obtain new customers, buyer specific synergies and the assembled workforce of 42West. The goodwill is expected to be deductible for income tax purposes.
 
The Company expensed $0 and $745,272 of acquisition related costs in the three and nine months ended September 30, 2017, respectively. These costs are included in the condensed consolidated statements of operations in the line item entitled “acquisition costs.”
 
 
19
 
 
The revenue and net income of 42West included in the consolidated amounts reported in the condensed consolidated statements of operations for the three and nine months ended September 30, 2017 are as follows:
 
 
 
For the three months ended September 30, 2017
 
 
For the nine months ended September 30, 2017
 
Revenue 
  $ 5,409,166  
  $ 15,236,278  
Net income 
  $ 247,247  
  $ 1,612,589  
 
The following represents the pro forma consolidated operations for the three and nine months ended September 30, 2017 and September 30, 2016, respectively, as if 42West had been acquired on January 1, 2016 and its results had been included in the consolidated results of the Company beginning on that date:
 
Pro Forma Consolidated Statements of Operations
 
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2017  
 
 
2016
 
 
2017
 
 
2016
 
Revenues 
  $ 6,808,014
  $ 5,588,495
  $ 19,862,073
  $ 15,064,851
Net income (loss) 
  5,923,245  
    (11,617,330 )
  10,297,757
    (22,205,725 )
 
The pro forma amounts have been calculated after applying the Company’s accounting policies to the financial statements of 42West and adjusting the combined results of the Company and 42West to reflect (a) the amortization that would have been charged assuming the intangible assets had been recorded on January 1, 2006, (b) the reversal of 42West’s income taxes as if 42West had filed a consolidated income tax return with the Company beginning January 1, 2016, and (c) to exclude $207,564 and $795,272 of acquisition related costs that were originally expensed by the Company during the three months ended June 30, 2017 and by the Company and 42West on a combined basis during the six months ended June 30, 2017, respectively.
 
 
20
 
 
The following table summarizes the original and revised estimated fair values of the assets acquired and liabilities assumed at the acquisition date of March 30, 2017 and the related measurement period adjustments to the fair values recorded through September 30, 2017:
 

 
    March 31, 2017 (As initially reported)
 
 
Measurement Period Adjustments
 
 
September 30, 2017(As adjusted)
 
Cash 
  $ 273,625  
  $  
  $ 273,625  
Accounts receivable 
    1,706,644  
     
    1,706,644  
Property, equipment and leasehold improvements 
    1,087,962  
     
    1,087,962  
Other assets 
    265,563  
     
    265,563  
Indemnification asset 
     
    300,000  
    300,000  
Intangible assets 
    9,110,000  
     
    9,110,000  
Total identifiable assets acquired 
    12,443,794  
    300,000  
    12,743,794  
 
       
       
       
Accounts payable and accrued expenses 
    (731,475 )
     
    (731,475 )
Line of credit and note payable 
    (1,025,000 )
     
    (1,025,000 )
Settlement liability 
    (300,000 )
     
    (300,000 )
Other liabilities 
    (902,889 )
     
    (902,889 )
Tax liabilities 
    (22,000 )
     
    (22,000 )
Total liabilities assumed 
    (2,981,364 )
     
    (2,981,364 )
Net identifiable assets acquired 
    9,462,430  
     
    9,762,430  
Goodwill 
    13,996,337  
    355,031
    14,351,368
Net assets acquired 
  $ 23,458,767  
  $ 655,031
  $ 24,113,798
 
The above estimated fair values of assets acquired and liabilities assumed are based on the information that was available as of the acquisition date to estimate the fair value of assets acquired and liabilities assumed. As of March 31, 2017, the Company recorded the identifiable net assets acquired of $9,462,430 as shown in the table above in its condensed consolidated balance sheet. During the period from March 31, 2017 through September 30, 2017, the Company’s measurement period adjustments of $655,031 were made based on new information obtained after the acquisition date about facts and circumstances that existed as of the acquisition date, and, accordingly, the Company recognized these adjustments in its September 30, 2017 condensed consolidated balance sheet to reflect the adjusted identifiable net assets acquired of $9,762,430 as shown in the table above. The changes to the provisional amounts did not result in changes to the Company’s previously reported condensed consolidated income statement for the three months ended March 31, 2017.
 
The following is a reconciliation of the initially reported fair value to the adjusted fair value of goodwill:
 
Goodwill originally reported at March 31, 2017 
  $ 13,996,337  
Changes to estimated fair values:
       
Contingent Consideration 
    86,000  
Put Rights 
    (200,000 )
Sellers’ tax liabilities assumed 
    159,000  
Working capital adjustment 
    610,031
Indemnification asset 
    (300,000 )
 
    355,031
Adjusted goodwill 
  $ 14,351,368
 
The provisional estimated fair value of Contingent Consideration increased from the originally reported amount primarily due to changes in the estimated risk-adjusted EBITDA figures expected to be achieved during the earn-out period, changes to the risk-free discount rates and recalibration of the asset volatility estimate, which are inputs to the Monte Carlo simulation model used to calculate the fair value.
 
The provisional estimated fair value of the Put Rights decreased from the originally reported amount primarily due to a decrease in the annual asset volatility assumption.
 
The final working capital adjustment and provisional indemnification asset were initially determined subsequent to the issuance by the Company of its condensed consolidated financial statements for the three months ended March 31, 2017.
 
NOTE 5 — CAPITALIZED PRODUCTION COSTS, ACCOUNTS RECEIVABLES AND OTHER CURRENT ASSETS
 
Capitalized Production Costs
 
Capitalized production costs include the unamortized costs of completed motion pictures and digital projects which have been produced by the Company, costs of scripts for projects that have not been developed or produced and costs for projects that are in production. These costs include direct production costs and production overhead and are amortized using the individual-film-forecast method, whereby these costs are amortized and participations and residuals costs are accrued in the proportion that current year’s revenue bears to management’s estimate of ultimate revenue at the beginning of the current year expected to be recognized from the exploitation, exhibition or sale of the motion picture or web series.
 
 
21
 
 
Motion Pictures
 
For the three and nine months ended September 30, 2017, revenues earned from motion pictures were $1,398,839 and $4,625,801, respectively, mainly attributable to Max Steel , the motion picture released on October 14, 2016 and international sales of Believe , the motion picture released in December 2013. During the three and nine months ended September 30, 2016, the Company earned revenues of $1,140,000 and $1,144,157, respectively from the international sales of Max Steel and Believe. The Company amortized capitalized production costs (included as direct costs) in the condensed consolidated statements of operations using the individual film forecast computation method in the amount of $206,798 and $2,256,711, respectively during the three and nine months ended September 30, 2017 and $1,106,229 for each of the three and nine months ended September 30, 2016, related to Max Steel . All capitalized production costs for Believe were either amortized or impaired in prior years. Subsequent to the release of Max Steel , the Company used a discounted cash flow model and determined that the fair value of the capitalized production costs should be impaired by $2,000,000 due to a lower than expected domestic box office performance. As of September 30, 2017, and December 31, 2016, the Company had a balance of $1,933,219, and $4,189,930, respectively recorded as capitalized production costs related to Max Steel .
 
The Company has purchased scripts, including one from a related party, for other motion picture productions and has capitalized $237,500 and $215,000 in capitalized production costs as of September 30, 2017 and December 31, 2016 associated with these scripts. The Company intends to produce these projects but they were not yet in production as of September 30, 2017.
 
On November 17, 2015, the Company entered into a quitclaim agreement with a distributor for rights to a script owned by the Company. As part of the agreement the Company will receive $221,223 plus interest and a profit participation if the distributor decides to produce the motion picture within 24 months after the execution of the agreement. If the motion picture is not produced within the 24 months, all rights revert back to the Company. As per the terms of the agreement, the Company is entitled to co-finance the motion picture. As of September 30, 2017, the Company had not been notified by the distributor that it intends to produce the motion picture.
 
As of September 30, 2017, and December 31, 2016, respectively, the Company has total capitalized production costs of $2,170,719 and $4,404,930, net of accumulated amortization, tax incentives and impairment charges, recorded on its condensed consolidated balance sheets related to motion pictures.
 
Digital Productions
 
During the year ended December 31, 2016, the Company produced a new digital project showcasing favorite restaurants of NFL players throughout the country. The Company entered into a co-production agreement and was responsible for financing 50% of the project’s budget. Per the terms of the agreement, the Company is entitled to 50% of the profits of the project, net of any distribution fees. The show was produced throughout several cities in the U.S. The show was released on Destination America, a digital cable and satellite television channel, on September 9, 2017 and the Company does not expect to derive any revenues from this initial release.
 
During the three and nine months ended September 30, 2017 and 2016, the Company did not earn any revenues related to digital productions. During the nine months ended September 30, 2016, the Company impaired $2,439 of capitalized production costs related to digital productions.
 
As of September 30, 2017, and December 31, 2016, respectively, the Company has total capitalized production costs of $266,444 and $249,083, recorded on its condensed consolidated balance sheet related to the digital productions discussed above.
 
The Company has assessed events and changes in circumstances that would indicate that the Company should assess whether the fair value of the productions are less than the unamortized costs capitalized and did not identify indicators of impairment, other than those noted above.
 
 
22
 
 
Accounts Receivables
 
The Company entered into various agreements with foreign distributors for the licensing rights of our motion picture, Max Steel , in certain international territories. The motion picture was delivered to the distributors and other stipulations, as required by the contracts were met. As of September 30, 2017 and December 31, 2016, the Company had a balance of $2,025,160 and $3,668,646, respectively, in accounts receivable related to the revenues of Max Steel .
 
The Company’s trade accounts receivable related to its entertainment publicity business are recorded at amounts billed to customers, and presented on the balance sheet, net of the allowance for doubtful accounts. The allowance is determined by various factors, including the age of the receivables, current economic conditions, historical losses and other information management obtains regarding the financial condition of customers. As of September 30, 2017, the Company had a balance of $1,951,504, net of $164,000 of allowance for doubtful accounts of accounts receivable related to the entertainment publicity business. (note 4)
 
Other Current Assets
 
The Company had a balance of $450,648 and $2,665,781 in other current assets on its condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017, these amounts were primarily comprised of deferred offering costs and an indemnification asset related to the 42West Acquisition. (See note 4 for further discussion). As of December 31, 2016, these amounts were primarily comprised of tax incentive receivables and prepaid loan interest.
 
Indemnification asset – The Company recorded in other current assets on its condensed consolidated balance sheet, $300,000 related to certain indemnifications associated with the 42West Acquisition.
 
Tax Incentives The Company has access to government programs that are designed to promote film production in the jurisdiction. As of September 30, 2017, and December 31, 2016, respectively, the Company had a balance of $0 and $2,060,883 from these tax incentives. Tax incentives earned with respect to expenditures on qualifying film productions are included as an offset to capitalized production costs when the qualifying expenditures have been incurred provided that there is reasonable assurance that the credits will be realized.
 
Deferred offering costs The Company incurred legal and professional fees in the amount of $116,204 related to the filing of its S-1 Registration Statement. These costs have been deferred until the final S-1 is filed.
   
Prepaid Interest – The Company entered into a loan and security agreement to finance the distribution and marketing costs of Max Steel and prepaid interest related to the agreement. As of September 30, 2017, and December 31, 2016, there was a balance of $0 and $602,697 of prepaid interest.
 
 
23
 
 
NOTE 6 — PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
 
Property, equipment and leasehold improvement consists of:
 
 
 
September 30,
2017
 
 
December 31,
2016
 
Furniture and fixtures 
  $ 539,715  
  $ 65,311  
Computers and equipment 
    408,058  
    41,656  
Leasehold improvements 
    356,946  
    7,649  
 
    1,304,719  
    114,616  
Less: accumulated depreciation 
    (192,820 )
    (79,428 )
 
  $ 1,111,899  
  $ 35,188  
 
The Company depreciates furniture and fixtures over a useful life of between five and seven years, computer and equipment over a useful life of between three and five years and leasehold improvements over the remaining term of the related leases. On June 1, 2017, the Company entered into a sublease agreement for one of its offices in Los Angeles. As part of the sublease agreement, the Company agreed to allow the subtenant to acquire the fixed assets in the office. As a result, the Company wrote off $64,814 of property, equipment and leasehold improvements and $36,789 of accumulated depreciation. This resulted in a loss in the amount of $28,025 that was recorded on the condensed consolidated statement of operations for the nine months ended September 30, 2017 as loss on disposal of furniture, office equipment and leasehold improvements. The balances as of September 30, 2017 include the provisional amounts of the Company’s newly acquired subsidiary 42West. (See note 4)
 
NOTE 7 — INVESTMENT
 
Investments, at cost, consist of 344,980 shares of common stock of VRC. In exchange for services rendered by 42West to VRC during 2015, 42West received both cash consideration and a promissory note that was convertible into shares of common stock of VRC. On April 7, 2016, VRC closed an equity financing round resulting in common stock being issued to a third-party investor. This transaction triggered the conversion of all outstanding promissory notes into shares of common stock of VRC. The Company’s investment in VRC represents less than 1% noncontrolling ownership interest in VRC. The Company had a balance of $220,000 on its condensed consolidated balance sheet as of September 30, 2017, related to this investment.
 
 
24
 
 
NOTE 8 — DEBT
 
Loan and Security Agreements
 
First Group Film Funding
 
During the years ended December 31, 2013 and 2014, the Company entered into various loan and security agreements with individual noteholders (the “First Loan and Security Noteholders”) for notes with an aggregate principal amount of $11,945,219 to finance future motion picture projects (the “First Loan and Security Agreements”). During the year ended December 31, 2015, one of the First Loan and Security Noteholders increased its funding under its respective First Loan and Security Agreement for an additional $500,000 note and the Company used the proceeds to repay $405,219 to another First Loan and Security Noteholder. Pursuant to the terms of the First Loan and Security Agreements, the notes accrued interest at rates ranging from 11.25% to 12% per annum, payable monthly through June 30, 2015. During 2015, the Company exercised its option under the First Loan and Security Agreements, to extend the maturity date of these notes until December 31, 2016. In consideration for the Company’s exercise of the option to extend the maturity date, the Company was required to pay a higher interest rate, increasing by 1.25% resulting in rates ranging from 12.50% to 13.25%. The First Loan and Security Noteholders, as a group, were to receive the Company’s entire share of the proceeds from the motion picture productions funded under the First Loan and Security Agreements, on a prorata basis, until the principal investment was repaid. Thereafter, the First Loan and Security Noteholders, as a group, would have the right to participate in 15% of the Company’s future profits from these projects (defined as the Company’s gross revenues of such projects less the aggregate amount of principal and interest paid for the financing of such projects) on a prorata basis based on each First Loan and Security Noteholder’s loan commitment as a percentage of the total loan commitments received to fund specific motion picture productions.
 
On May 31, 2016 and June 30, 2016, the Company entered into debt exchange agreements with certain First Loan and Security Noteholders on substantially similar terms to convert an aggregate of $11,340,000 of principal and $1,811,490 of accrued interest into shares of Common Stock. Pursuant to the terms of such debt exchange agreements, the Company agreed to convert the debt owed to certain First Loan and Security Noteholders into Common Stock at an exchange rate of $10.00 per share and issued 1,315,149 shares of Common Stock. On May 31, 2016, the market price of a share of Common Stock was $13.98 and on June 30, 2016 it was $12.16. As a result, the Company recorded losses on the extinguishment of debt on its consolidated statement of operations of $3,328,366 for the nine months ended September 30, 2016 based on the difference between the fair value of the Common Stock issued and the carrying amount of outstanding balance of the exchanged notes on the date of the exchange. On December 29, 2016, as part of a global settlement agreement with an investor that was a noteholder under each of a First Loan and Security Agreement, a Web Series Agreement and a Second Loan and Security Agreement, the Company entered into a debt exchange agreement whereby the Company issued Warrant “J” that entitles the warrant holder to purchase shares of Common Stock at a price of $0.03 per share in settlement of $1,160,000 of debt from the note under the First Loan and Security Agreement.   See Note 17 for further discussion of Warrant “J”.
 
The Company did not expense any interest during the three and nine months ended September 30, 2017 and expensed $38,741 and $1,358,585, respectively, in interest during the three and nine months ended September 30 2016, related to the First Loan and Security Agreements. The Company did not have any debt outstanding or accrued interest as of September 30, 2017 and December 31, 2016 related to the First Loan and Security Agreements on its condensed consolidated balance sheets.
 
Web Series Funding
 
During the years ended December 31, 2014 and 2015, the Company entered into various loan and security agreements with individual noteholders (the “Web Series Noteholders”) for an aggregate principal amount of notes of $4,090,000 which the Company used to finance production of its 2015 web series (the “Web Series Loan and Security Agreements”). Under the Web Series Loan and Security Agreements, the Company issued promissory notes that accrued interest at rates ranging from 10% to 12% per annum payable monthly through August 31, 2015, with the exception of one note that accrued interest through February 29, 2016. During 2015, the Company exercised its option under the Web Series Loan and Security Agreements to extend the maturity date of these notes to August 31, 2016. In consideration for the Company’s exercise of the option to extend the maturity date, the Company was required to pay a higher interest rate, increasing 1.25% resulting in interest rates ranging from 11.25% to 13.25%. Pursuant to the terms of the Web Series Loan and Security Agreements, the Web Series Noteholders, as a group, would have had the right to participate in 15% of the Company’s future profits generated by the series (defined as the Company’s gross revenues of such series less the aggregate amount of principal and interest paid for the financing of such series) on a prorata basis based on each Web Series Noteholder’s loan commitment as a percentage of the total loan commitments received to fund the series.
 
 
25
 
 
During the nine months ended September 30, 2016, the Company entered into thirteen individual debt exchange agreements (the “Web Series Debt Exchange Agreements”) on substantially similar terms with the Web Series Noteholders. Pursuant to the terms of the Web Series Debt Exchange Agreements, the Company and each Web Series Noteholder agreed to convert an aggregate of $4,204,547 of principal and accrued interest under the Web Series Loan and Security Agreements into an aggregate of 420,455 shares of Common Stock at an exchange price of $10.00 per share as payment in full of each of the notes issued under the Web Series Loan and Security Agreements. Mr. Nicholas Stanham, director of the Company, was one of the Web Series Noteholders that converted his note into shares of Common Stock. For the nine months ended September 30, 2016, the Company recorded a loss on extinguishment of debt in the amount of $ $588,694 due to the market price of the Common Stock being between $12.00 and $12.16 per share on the dates of the exchange.
 
During 2016, the Company also entered into (i) substantially identical Subscription Agreements with two Web Series Noteholders to convert $1,265,530 of principal and interest into an aggregate of 126,554 shares of Common Stock at an exchange price of $10.00 per share as payment in full of each of the notes issued under the Web Series Loan and Security Agreements and (ii) a global settlement agreement with another investor that was a Noteholder of a First Loan and Security Agreement, a Web Series Agreement and a Second Loan and Security Agreement. As part of the global settlement agreement, the Company entered into a debt exchange agreement whereby the Company issued Warrant “J” that entitles the warrant holder to purchase shares of Common Stock at a price of $0.03 per share in settlement of $340,000 of debt from the Web Series Loan and Security Agreement. See Note 17 for further discussion of Warrant “J”.
 
The Company did not expense any interest during the three and nine months ended September 30, 2017 and expensed $39,091 and $323,670 respectively, in interest during the three and nine months ended September 30, 2016, related to the Web Series Loan and Security Agreements. The Company did not have any debt outstanding or accrued interest as of September 30, 2017 and December 31, 2016 related to the Web Series Loan and Security Agreements on its condensed consolidated balance sheets.
 
Second Group Film Funding
 
During the year ended December 31, 2015, the Company entered into various loan and security agreements with individual noteholders (the “Second Loan and Security Noteholders”) for notes with an aggregate principal amount of $9,274,327 to fund a new group of film projects (the “Second Loan and Security Agreements”). Of this total aggregate amount, notes with an aggregate principal amount of $8,774,327 were issued in exchange for debt that had originally been incurred by DE LLC, primarily related to the production and distribution of the motion picture, “ Believe ”. The remaining $500,000 of principal amount was related to a note issued in exchange for cash. The notes issued pursuant to the Second Loan and Security Agreements accrue interest at rates ranging from 11.25% to 12% per annum, payable monthly through December 31, 2016. The Company did not exercise its option to extend the maturity date of these notes until July 31, 2018. The Second Loan and Security Noteholders, as a group, were to receive the Company’s entire share of the proceeds from the related group of film projects, on a prorata basis, until the principal balance was repaid. Thereafter, the Second Loan and Security Noteholders, as a group, would have the right to participate in 15% of the Company’s future profits from such projects (defined as the Company’s gross revenues of such projects less the aggregate amount of principal and interest paid for the financing of such projects) on a prorata basis based on each Second Loan and Security Noteholder’s loan principal as a percentage of the total loan proceeds received to fund the specific motion picture productions.
 
 
26
 
 
On May 31 and June 30, 2016, the Company entered into various debt exchange agreements on substantially similar terms with certain of the Second Loan and Security Noteholders to convert an aggregate of $4,344,350 of principal and accrued interest into shares of Common Stock. Pursuant to such debt exchange agreements, the Company agreed to convert the debt at an exchange price of $10.00 per share and issued 434,435 shares of Common Stock. On May 31, 2016, the market price of a share of the Common Stock was $13.98 and on June 30, 2016, it was $12.16. As a result, the Company recorded a loss on the extinguishment of debt of $1,312,059 on its consolidated statement of operations for nine months ended September 30, 2016, due to the difference between the exchange price and the market price of the Common Stock on the dates of exchange. During 2016, the Company repaid one of the Second Loan and Security Noteholders its principal investment of $300,000. On December 29, 2016, as part of a global settlement agreement with an investor that was a noteholder under each of a First Loan and Security Agreement, a Web Series Agreement and a Second Loan and Security Agreement, the Company entered into a debt exchange agreement whereby the Company issued Warrant “J” that entitles the warrant holder to purchase shares of Common Stock at a price of $0.03 per share in settlement of $4,970,990 of debt from the note under the Second Loan and Security Agreement. See Note 17 for further discussion of Warrant “J”.
 
During the three and nine months ended September 30, 2017, the Company did not record any interest expense related to the Second Loan and Security Agreements. The Company recorded $140,958 and $921,366, respectively during the three and nine months ended September 30, 2016 of interest expense related to the Second Loan and Security Agreements. The Company did not have any debt outstanding or accrued interest as of September 30, 2017 and December 31, 2016 related to the Second Loan and Security Agreements on its condensed consolidated balance sheets.
 
The Company accounts for the above agreements in accordance with ASC 470-10-25-2, which requires that cash received from an investor in exchange for the future payment of a specified percentage or amount of future revenue, shall be classified as debt.
 
Prints and Advertising Loan
 
During 2016, Dolphin Max Steel Holding, LLC, a Florida limited liability company (“Max Steel Holding”) and a wholly owned subsidiary of Dolphin Films, entered into a loan and security agreement (the “P&A Loan”) providing for up to $14,500,000 non-revolving credit facility that matures on August 25, 2017. Proceeds of the credit facility in the aggregate amount of $12,500,000 were used to pay a portion of the print and advertising expenses of the domestic distribution of Max Steel . To secure Max Steel Holding’s obligations under the P&A Loan, the Company granted to the lender a security interest in bank account funds totaling $1,250,000 pledged as collateral and recorded as restricted cash in the condensed consolidated balance sheet as of December 31, 2016, and rights to the assets of Max Steel Holdings. Repayment of the loan was intended to be made from revenues generated by Max Steel in the U.S. Max Steel did not generate sufficient funds to repay the loan prior to the maturity date. As a result, if the lender forecloses on the collateral securing the loan, the Company’s subsidiary will lose the copyright for Max Steel and, consequently, will no longer receive any revenues from the domestic distribution of Max Steel . In addition, the Company would impair the entire capitalized production costs of Max Steel included as an asset on its balance sheet, which as of September 30, 2017 was $1,933,219. The P&A Loan is also partially secured by a $4,500,000 corporate guaranty from a party associated with the film, of which Dolphin has backstopped $620,000. The lender had retained a reserve of $1,531,871 for loan fees and interest. Amounts borrowed under the credit facility accrue interest at either (i) a fluctuating per annum rate equal to the 5.5% plus a base rate or (ii) a per annum rate equal to 6.5% plus the LIBOR determined for the applicable interest period.
 
 During the nine months ended September 30, 2017, the Company agreed to allow the lender to apply the balance held as restricted cash to the loan balance.   On September 18, 2017, the party associated with the film paid the lender the guaranty of $4,500,000 and the Company recorded the $620,000 backstop in other current liabilities. As September 30, 2017 and December 31, 2016, the Company had an outstanding balance of $2,366,689 and $12,500,000, respectively, related to this agreement recorded on the condensed consolidated balance sheets.  On its condensed consolidated statement of operations for the three and nine months ended September 30, 2017, the Company recorded (i) interest expense of $177,225 and $602,697, respectively, related to the P&A Loan and (ii) $500,000 in direct costs from loan proceeds that were not used by the distributor for the marketing of the film and returned to the lender.
 
 
27
 
 
Production Service Agreement
 
During the year ended December 31, 2014, Dolphin Films entered into a financing agreement for the production of one of the Company’s feature films, Max Steel (the “Production Service Agreement”). The Production Service Agreement was for a total amount of $10,419,009 with the lender taking an $892,619 producer fee. The Production Service Agreement contained repayment milestones to be made during the year ended December 31, 2015, that if not met, accrued interest at a default rate of 8.5% per annum above the published base rate of HSBC Private Bank (UK) Limited until the maturity on January 31, 2016 or the release of the movie. Due to a delay in the release of Max Steel , the Company did not make the repayments as prescribed in the Production Service Agreement. As a result, the Company recorded accrued interest of $1,425,146 and $1,147,520, respectively, as of September 30, 2017 and December 31, 2016 in other current liabilities on the Company’s condensed consolidated balance sheets. The loan was partially secured by international distribution agreements entered into by the Company prior to the commencement of principal photography and the receipt of tax incentives. As a condition to the Production Service Agreement, the Company acquired a completion guarantee from a bond company for the production of the motion picture. The funds for the loan were held by the bond company and disbursed as needed to complete the production in accordance with the approved production budget. The Company recorded debt as funds were transferred from the bond company for the production.
 
As of September 30, 2017, and December 31, 2016 the Company had outstanding balances of $2,697,157 and $6,243,069, respectively, related to this debt on its condensed consolidated balance sheets.
 
Line of Credit
 
The Company’s subsidiary, 42West had a revolving line of credit with City National Bank under a revolving note, which matured on November 1, 2017.  The revolving note was not renewed and the Company is seeking to establish a new credit facility. The note bears interest at the prime rate of City National Bank plus 0.875% per annum and is payable monthly.  Amounts outstanding under the note are secured by substantially all of 42West’s assets and are guaranteed by the Principal Sellers of 42West.   The maximum amount that could be drawn on the line of credit was $1,750,000 prior to its expiration; however, upon maturity of the note the Company no longer has the ability to borrow additional amounts under the line of credit.  Upon closing of the acquisition of 42West, the line of credit had a balance of $500,000.  On April 27, 2017, the Company drew an additional $250,000 from the line of credit to be used for working capital.  As a result, the balance as of September 30, 2017 was $750,000. As of the date of this filing, City National Bank has not called the outstanding principal of the revolving note; however, the Company has sufficient liquidity to satisfy all of its outstanding obligations under the revolving note in such event.  Under the revolving note, an event of default will occur if we fail to pay any principal when due after five days’ notice and an opportunity to cure. 
 
Payable to Former Member of 42West
 
During 2011, 42West entered into an agreement to purchase the membership interest of one of its members. Pursuant to the agreement, the outstanding principal shall be payable immediately if 42West sells, assigns, transfers, or otherwise disposes all or substantially all of its assets and/or business prior to December 31, 2018. In connection with the Company’s acquisition of 42West, (note 4), payment of this redemption was accelerated, with $300,000 paid during April 2017, and the remaining $225,000 to be paid in January 2018. The outstanding balance at September 30, 2017 of $225,000 has been included in other current liabilities on the accompanying condensed consolidated balance sheet.
 
 
28
 
 
NOTE 9 — NOTES PAYABLE
 
Convertible Notes
 
2015 Convertible Debt
 
On December 7, 2015, the Company entered into a subscription agreement with an investor to sell up to $7,000,000 in convertible promissory notes of the Company. The promissory note would bear interest on the unpaid balance at a rate of 10% per annum, and became due and payable on December 7, 2016. The promissory note could have been prepaid at any time without a penalty. Pursuant to the subscription agreement, the Company issued a convertible note to the investor in the amount of $3,164,000. At any time prior to the maturity date, the investor had the right, at its option, to convert some or the entire convertible note into Common Stock. The convertible note had a conversion price of $10.00 per share. The outstanding principal amount and all accrued interest were mandatorily and automatically converted into Common Stock, at the conversion price, upon the average market price per share of Common Stock being greater than or equal to the conversion price for twenty trading days.
 
During the three months ended March 31, 2016, a triggering event occurred pursuant to the convertible note agreement. As such 316,400 shares of Common Stock were issued in satisfaction of the convertible note payable. For the nine months ended September 30, 2016, the Company recorded interest expense of $31,207 on its condensed consolidated statements of operations. No interest expense was recorded for the nine months ended September 30, 2017.
 
2017 Convertible Debt
 
On July 18, July 26, July 27, July 31, August 30, September 6, September 8 and September 22, 2017, the Company entered into subscription agreements pursuant to which it issued convertible promissory notes, each with substantially similar terms, for an aggregate principal amount of $875,000.  Each of the convertible promissory notes bears interest at a rate of 10% per annum and matures one year from the date of issue, with the exception of one note in the amount of $75,000 which matures two years from the date of issue.  The principal and any accrued interest of each of the convertible promissory notes are convertible by the respective holder at a price equal to either (i) the 90-trading day average price per share of common stock as of the date the holder submits a notice of conversion or (ii) if an Eligible Offering (as similarly defined in each of the convertible promissory notes) of common stock is made, 95% of the Public Offering Share price (as similarly defined in each of the convertible promissory notes).  
 
Nonconvertible Notes
 
 On September 20, 2017, the Company signed a promissory note in the amount of $150,000 with a maturity date of September 20, 2018. The promissory note bears interest at 10% per annum and may be repaid at any time without a penalty. The promissory note is held by an entity of which Allan Mayer, a director, shareholder and employee of the Company, is the trustee.
 
On June 14, 2017, the Company signed a promissory note in the amount of $400,000 with a two year term, expiring on June 14, 2019. The promissory note bears interest of 10% per annum and can be prepaid without a penalty after the initial six months.
 
On April 18, 2017, the Company signed a promissory note in the amount of $250,000 with an initial maturity date of October 18, 2017, bearing interest at 10% per annum. The maturity date of the promissory note has been extended to December 15, 2017 with an interest rate of 12%.
 
On April 10, 2017, the Company signed two promissory notes with an aggregate principal amount of $300,000 on substantially identical terms. Both promissory notes are held by one noteholder, and had an initial maturity date of October 10, 2017, bearing interest at 10% per annum. The maturity date of the promissory note has been extended to December 15, 2017 on substantially identical terms.
 
On July 5, 2012, the Company signed an unsecured promissory note in the amount of $300,000 bearing 10% interest per annum and payable on demand.
 
 
29
 
 
No principal payments were made on the promissory notes during the three and nine months ended September 30, 2017. The Company made interest payments in the aggregate amount of $26,459 and had a balance of $181,146 and $134,794 as of September 30, 2017 and December 31, 2016, respectively, of accrued interest recorded in other current liabilities in its condensed consolidated balance sheets, related to these promissory notes. The Company recorded interest expense for the three and nine months ended September 30, 2017 of $41,989 and $68,088, respectively, and $7,562 and $22,521 for the three and nine months ended September 30, 2016, respectively, related to these promissory notes. As of September 30, 2017 and December 31, 2016, the Company had a balance of $1,800,000 and $300,000, respectively, on its consolidated balance sheets in current liabilities and $475,000 and $0, respectively, in noncurrent liabilities relating to these notes payable.
 
NOTE 10 — LOANS FROM RELATED PARTY
 
On December 31, 2011, the Company issued an unsecured revolving promissory note (the “DE Note”) to DE LLC, an entity wholly owned by the Company’s CEO. The DE Note accrued interest at a rate of 10% per annum. DE LLC had the right at any time to demand that all outstanding principal and accrued interest be repaid with a ten-day notice to the Company. On March 4, 2016, the Company entered into a subscription agreement (the “Subscription Agreement”) with DE LLC. Pursuant to the terms of the Subscription Agreement, the Company and DE LLC agreed to convert the $3,073,410 aggregate amount of principal and interest outstanding under the DE Note into 307,341 shares of Common Stock. The shares were converted at a price of $10.00 per share. On the date of the conversion that market price of the shares was $12.00 and as a result the Company recorded a loss on the extinguishment of the debt of $614,682 on the condensed consolidated statement of operations for the nine months ended September 30, 2016. During the nine months ended September 30, 2016, the Company recorded interest expense in the amount of $32,008 on its condensed consolidated statement of operations.
 
In addition, DE LLC has previously advanced funds for working capital to Dolphin Films. During the year ended December 31, 2015, Dolphin Films agreed to enter into second Loan and Security Agreements with certain of DE LLC’s debtholders, pursuant to which the debtholders exchanged their DE Notes for notes issued by Dolphin Films totaling $8,774,327. See note 8 for more details. The amount of debt assumed by Dolphin Films was applied against amounts owed to DE LLC by Dolphin Films. During 2016, Dolphin Films entered into a promissory note with DE LLC (the “New DE Note”) in the principal amount of $1,009,624. The New DE Note is payable on demand and bears interest at 10% per annum. During the nine months ended September 30, 2017, the Company agreed to include certain script costs and other payables totaling $594,315 that were owed to DE LLC as part of the New DE Note. During the nine months ended September 30, 2017, the Company received proceeds related to the New DE Note from DE LLC in the amount of $1,388,000 and repaid DE LLC $681,773. As of September 30, 2017, and December 31, 2016, Dolphin Films owed DE LLC $1,734,867 and $684,326, respectively, that was recorded on the condensed consolidated balance sheets. Dolphin Films recorded interest expense of $45,055 and $112,473 for the three and nine months ended September 30, 2017.
 
As discussed in Note 9, the Company signed a promissory note and received $150,000 from an entity, of which Allan Mayer, director, shareholder and employee of the Company, is the trustee.
 
NOTE 11 — FAIR VALUE MEASUREMENTS
 
Warrants
 
During 2016, the Company issued Series G, H, I, J and K Common Stock warrants (the “Warrants”) for which the Company determined that the Warrants should be accounted for as derivatives (see Note 17), for which a liability is recorded in the aggregate and measured at fair value in the consolidated balance sheets on a recurring basis, and the change in fair value from one reporting period to the next is reported as income or expense in the consolidated statements of operations. On March 31, 2017, Warrants J and K were exercised.
 
 
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The Company records the fair value of the liability in the condensed consolidated balance sheets under the caption “Warrant liability” and records changes to the liability against earnings or loss under the caption “Changes in fair value of warrant liability” in the condensed consolidated statements of operations. The carrying amount at fair value of the aggregate liability for the Warrants recorded on the condensed consolidated balance sheet at September 30, 2017 and December 31, 2016 is $2,774,583 and $20,405,190. Due to the change in the fair value of the Warrant Liability for the period in which the Warrants were outstanding during the three and nine months ended September 30, 2017, the Company recorded a gain on the change in fair value of the warrant liability of $1,396,094 and $7,685,607, respectively, for the three and nine months ended September 30, 2017, in the condensed consolidated statement of operations.
 
The Warrants outstanding at September 30, 2017 have the following terms:
 
 
 
Issuance Date
 
Number of Common Shares
 
 
Per Share Exercise Price
 
 
Remaining Term (Months)
 
Expiration Date
Series G Warrants 
 
November 4, 2016
    750,000  
  $ 9.22  
    4  
January 31, 2018
Series H Warrants 
 
November 4, 2016
    250,000  
  $ 9.22  
    16  
January 31, 2019
Series I Warrants 
 
November 4, 2016
    250,000  
  $ 9.22  
    28  
January 31, 2020
 
The Warrants have an adjustable exercise price due to a full ratchet down round provision, which would result in a downward adjustment to the exercise price in the event the Company completes a financing in which the price per share of the financing is lower than the exercise price of the Warrants in effect immediately prior to the financing.
 
Due to the existence of the full ratchet down round provision, which creates a path-dependent nature of the exercise prices of the Warrants, the Company concluded it is necessary to measure the fair value of the Warrants using a Monte Carlo Simulation model, which incorporates inputs classified as “level 3” according to the fair value hierarchy in ASC 820, Fair Value. In general, level 3 assumptions utilize unobservable inputs that are supported by little or no market activity in the subject instrument and that are significant to the fair value of the liabilities. The unobservable inputs the Company utilizes for measuring the fair value of the Warrant liability reflects management’s own assumptions about the assumptions that market participants would use in pricing the asset or liability as of the reporting date.
 
The Company determined the fair values of the Warrants by using the following key inputs to the Monte Carlo Simulation model at September 30, 2017:
 
 
 
As of September 30, 2017
 
Inputs
 
Series G
 
 
Series H
 
 
Series I
 
Volatility (1)  
    71.2 %
    67.0 %
    76.3 %
Expected term (years) 
    0.33  
    1.33  
    2.33  
Risk free interest rate 
    1.107 %
    1.363 %
    1.520 %
Common stock price 
  $ 8.40  
  $ 8.40  
  $ 8.44  
Exercise price 
  $ 9.22  
  $ 9.22  
  $ 9.22  
 
(1) “Level 3” input.
 
The stock volatility assumption represents the range of the volatility curves used in the valuation analysis that the Company has determined market participants would use based on comparison with similar entities. The risk-free interest rate is interpolated where appropriate, and is based on treasury yields. The valuation model also included a level 3 assumption as to dates of potential future financings by the Company that may cause a reset of the exercise price.
 
Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s income or loss will reflect the volatility in changes to these estimates and assumptions. The fair value is most sensitive to changes at each valuation date in the Company’s Common Stock price, the volatility rate assumption, and the exercise price, which could change if the Company were to do a dilutive future financing.
 
 
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For the Warrants, which measured at fair value categorized within Level 3 of the fair value hierarchy, the following is a reconciliation of the fair values from December 31, 2016 to September 30, 2017:
 
 
 
Warrants
“G”, “H” and “I”
 
 
Warrants
“J” and “K”
 
 
Total
 
Beginning fair value balance reported in the consolidated balance sheet at December 31, 2016
  $ 6,393,936  
  $ 14,011,254  
  $ 20,405,190  
Change in fair value (gain) reported in the statements of operations
    (3,619,353 )
    (4,066,254 )
    (7,685,607 )
Exercise of “J” and “K” Warrants 
     
    (9,945,000 )
    (9,945,000 )
Ending fair value balance reported in the condensed consolidated balance sheet at September 30, 2017
  $ 2,774,583  
  $  
  $ 2,774,583  
 
Put Rights
 
In connection with the 42West Acquisition (note 4), on March 30, 2017, the Company entered into Put Agreements with each of the Sellers. Pursuant to the terms and subject to the conditions set forth in the Put Agreements, the Company has granted the Sellers the right, but not obligation, to cause the Company to purchase up to an aggregate of 1,187,094 of their shares of Common Stock received as Stock Consideration for a purchase price equal to $9.22 per share during certain specified exercise periods set forth in the Put Agreements up until December 2020 (the “Put Rights”). During the nine months ended September 30, 2017, the Sellers, in accordance with the Put Agreements, caused the Company to purchase 116,591 shares of Common Stock for an aggregate amount of $1,075,000.
 
The Company records the fair value of the liability in the condensed consolidated balance sheets under the caption “Put Rights” and records changes to the liability against earnings or loss under the caption “Changes in fair value of put rights and contingent consideration” in the condensed consolidated statements of operations. The fair value of the Put Rights on the date of acquisition was $3,800,000. The carrying amount at fair value of the aggregate liability for the Put Rights recorded on the condensed consolidated balance sheet at September 30, 2017 is $3,700,000. Due to the change in the fair value of the Put Rights for the period in which the Put Rights were outstanding during the three and nine months ended September 30, 2017, the Company recorded a gain on the put rights of $200,000 and $100,000, respectively, in the condensed consolidated statement of operations. The Company measured the fair value of the Put Rights as of the date of the acquisition.
 
The Company utilized the Black-Scholes Option Pricing Model, which incorporates significant inputs that are not observable in the market, and thus represents a Level 3 measurement as defined in ASC 820. The unobservable inputs utilized for measuring the fair value of the Put Rights reflect management’s own assumptions about the assumptions that market participants would use in valuing the Put Rights as of the acquisition date and September 30, 2017.
 
The Company determined the fair value by using the following key inputs to the Black-Scholes Option Pricing Model:
 
  Inputs
 
  On the date of Acquisition
(March 30, 2017)
 
 
As of
September 30,
2017
 
  Equity Volatility estimate
    75 %
    82.5 %
  Discount rate based on US Treasury obligations
    0.12%-1.70 %
    1.04%-1.62 %
 
 
 
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For the Put Rights, which measured at fair value categorized within Level 3 of the fair value hierarchy, the following is a reconciliation of the fair values from the date of acquisition (March 30, 2017) to September 30, 2017:
 
Beginning fair value balance on the Acquisition Date (March 30, 2017) 
  $ 3,800,000  
Change in fair value (loss) reported in the statements of operations 
    (100,000 )
Ending fair value balance reported in the condensed consolidated balance sheet at September 30, 2017
  $ 3,700,000  
 
Contingent Consideration
 
In connection with the 42West acquisition (note 4), the Sellers have the potential to earn up to $9,333,333 (1,727,551 shares of Common Stock) on achievement of adjusted EBITDA targets based on the operations of 42West over the three-year period beginning January 1, 2017 (the “Contingent Consideration”).
 
The Company records the fair value of the liability in the condensed consolidated balance sheets under the caption “Contingent Consideration” and records changes to the liability against earnings or loss under the caption “Changes in fair value of put rights and contingent consideration” in the condensed consolidated statements of operations. The fair value of the Contingent Consideration on the date of acquisition was $3,627,000. The carrying amount at fair value of the aggregate liability for the Contingent Consideration recorded on the condensed consolidated balance sheet at September 30, 2017 is $3,973,000. Due to the change in the fair value of the Contingent Consideration for the period in which the Contingent Consideration was outstanding during the three and nine months ended September 30, 2017, the Company recorded a loss on the contingent consideration of $230,000 and $346,000, respectively in the condensed consolidated statement of operations. The Company measured the fair value of the Contingent Consideration as of the date of the acquisition.
 
The Company utilized a Monte Carlo Simulation model, which incorporates significant inputs that are not observable in the market, and thus represents a Level 3 measurement as defined in ASC 820. The unobservable inputs utilized for measuring the fair value of the Contingent Consideration reflect management’s own assumptions about the assumptions that market participants would use in valuing the Contingent Consideration as of the acquisition date.
 
The Company determined the fair value by using the following key inputs to the Monte Carlo Simulation Model:
 
Inputs
 
On the date of Acquisition
(March 30, 2017)
 
 
As of
September 30,
2017
 
Risk Free Discount Rate (based on US government treasury obligation with a term similar to that of the Contingent Consideration)
    1.03 %-1.55%
    1.31 % -1.62%
Annual Asset Volatility Estimate 
    72.5 %
    80 %
Estimated EBITDA 
  $ 3,600,000- $3,900,000  
  $ 3,600,000- $3,900,000  
 
For the Contingent Consideration, which measured at fair value categorized within Level 3 of the fair value hierarchy, the following is a reconciliation of the fair values from the date of acquisition (March 30, 2017) to September 30, 2017:
 
Beginning fair value balance on the Acquisition Date (March 30, 2017) 
  $ 3,627,000  
Change in fair value reported in the statements of operations 
    346,000  
Ending fair value balance reported in the condensed consolidated balance sheet at September 30, 2017
  $ 3,973,000  
 
There were no assets or liabilities carried at fair value on a recurring basis at September 30, 2016.
 
 
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NOTE 12 — LICENSING AGREEMENT - RELATED PARTY
 
During 2008, the Company entered into a ten-year licensing agreement with DE LLC, a related party. Under the license, the Company is authorized to use DE LLC’s brand properties in connection with the creation, promotion and operation of subscription based Internet social networking websites for children and young adults. The license requires that the Company pays to DE LLC royalties at the rate of fifteen percent of net sales from performance of the licensed activities. The Company did not use any of the brand properties related to this agreement and as such, there was no royalty expense for the three and nine months ended September 30, 2017 and 2016.
 
NOTE 13 — DEFERRED REVENUE
 
During the year ended December 31, 2014, the Company entered into agreements with various entities for the international distribution rights of a motion picture that was in production. As required by the distribution agreements, the Company received $1,418,368 of deposits for these rights that was recorded as deferred revenue on its condensed consolidated balance sheet. During the year ended December 31, 2016, the Company delivered the motion picture to various international distributors and recorded $1,371,687 of revenue from production from these deposits. As of September 30, 2017 and December 31, 2016, respectively, the Company has a balance of $20,303 and $46,681 as deferred revenue on its condensed consolidated balance sheets.
 
NOTE 14 — VARIABLE INTEREST ENTITIES
 
VIEs are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make significant decisions relating to the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses or the right to receive the residual returns of the entity. The most common type of VIE is a special-purpose entity (“SPE”). SPEs are commonly used in securitization transactions in order to isolate certain assets, and distribute the cash flows from those assets to investors. The legal documents that govern the transaction specify how the cash earned on the assets must be allocated to the SPE’s investors and other parties that have rights to those cash flows. SPEs are generally structured to insulate investors from claims on the SPE’s, assets by creditors of other entities, including the creditors of the seller of the assets.
 
The primary beneficiary of a VIE is required to consolidate the assets and liabilities of the VIE. The primary beneficiary is the party that has both (1) the power to direct the activities of an entity that most significantly impact the VIE’s economic performance; and (2) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, the Company considers all the facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities.
 
To assess whether the Company has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE, the Company considers all of its economic interests, including debt and equity investments, servicing fees, and derivative or other arrangements deemed to be variable interests in the VIE. This assessment requires that the Company apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE.
 
The Company performs ongoing reassessments of (1) whether entities previously evaluated under the majority voting-interest framework have become VIEs, based on certain triggering events, and therefore would be subject to the VIE consolidation framework, and (2) whether changes in the facts and circumstances regarding the Company’s involvement with a VIE cause the Company’s consolidation conclusion to change. The consolidation status of the VIEs with which the Company is involved may change as a result of such reassessments. Changes in consolidation status are applied prospectively with assets and liabilities of a newly consolidated VIE initially recorded at fair value unless the VIE is an entity which was previously under common control, which in that case is consolidated based historical cost. A gain or loss may be recognized upon deconsolidation of a VIE depending on the carrying amounts of deconsolidated assets and liabilities compared to the fair value of retained interests and ongoing contractual arrangements.
 
 
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The Company evaluated certain entities of which it did not have a majority voting interest and determined that it had (1) the power to direct the activities of the entities that most significantly impact their economic performance and (2) had the obligation to absorb losses or the right to receive benefits from these entities. As such the financial statements of Max Steel Productions, LLC and JB Believe, LLC are consolidated in the balance sheets as of September 30, 2017 and December 31, 2016, and in the statements of operations and statements of cash flows presented herein for the three and nine months ended September 30, 2017 and 2016. These entities were previously under common control and have been accounted for at historical costs for all periods presented.
 
Following is summary financial information for the VIE’s:
 
 
 
Max Steel Productions LLC
 
 
JB Believe LLC
 
(in USD)
 
As of and for the nine months ended September 30, 2017
 
 
As of and for the three months ended September 30, 2017
 
 
As of December 31,2016
 
 
As of and for the nine months ended September 30, 2016
 
 
As of and for the three months ended September 30, 2016
 
 
As of and for the nine months ended September 30, 2017
 
 
As of and for the three months ended September 30, 2017
 
 
As of December 31,2016
 
 
As of and for the nine months ended September 30, 2016
 
 
As of and for the three months ended September 30, 2016
 
Assets 
    9,597,807  
    9,597,807  
    12,327,887  
    n/a  
    n/a  
     
     
    240,269  
    n/a  
    n/a  
Liabilities 
    (12,578,388 )
    (12,578,411 )
    (15,922,552 )
    n/a  
    n/a  
    (6,752,271 )
    (6,752,271 )
    (7,014,098 )
    n/a  
    n/a  
Revenues 
    4,572,665  
    1,398,839  
    n/a  
    1,140,000  
    1,140,000  
    53,136  
     
    n/a  
    3,786  
     
Expenses 
    (3,958,581 )
    (575,366 )
    n/a  
    (2,253,056 )
    (1,711,325 )
    (31,578 )
    (27,786 )
    n/a  
    (392,416 )
    (131,825 )
 
 
35
 
 
NOTE 15 — STOCKHOLDERS’ EQUITY (DEFICIT)
 
A. 
Preferred Stock
 
The Company’s Amended and Restated Articles of Incorporation authorize the issuance of 10,000,000 shares of preferred stock. The Board of Directors has the power to designate the rights and preferences of the preferred stock and issue the preferred stock in one or more series.
 
On February 23, 2016, the Company amended its Articles of Incorporation to designate 1,000,000 preferred shares as “Series C Convertible Preferred Stock” with a $0.001 par value which may be issued only to an “Eligible Series C Preferred Stock Holder”. On May 9, 2017, the Board of Directors of the Company approved the amendment of the Company’s articles of incorporation to reduce the designation of Series C Convertible Preferred Stock to 50,000 shares with a $0.001 par value. The amendment was approved by the Company’s shareholders on June 29, 2017 and the Company filed Amended and Restated Articles of Incorporation with the State of Florida (‘the Second Amended and Restated Articles of Incorporation”) on July 6, 2017. Pursuant to the Second Amended and Restated Articles of Incorporation, each share of Series C Convertible Preferred Stock will be convertible into one share of common stock (one half of a share post-split), subject to adjustment for each issuance of common stock (but not upon issuance of common stock equivalents) that occurred, or occurs, from the date of issuance of the Series C Convertible Preferred Stock (the “issue date”) until the fifth (5th) anniversary of the issue date (i) upon the conversion or exercise of any instrument issued on the issued date or thereafter issued (but not upon the conversion of the Series C Convertible Preferred Stock), (ii) upon the exchange of debt for shares of common stock, or (iii) in a private placement, such that the total number of shares of common stock held by an “Eligible Class C Preferred Stock Holder” (based on the number of shares of common stock held as of the date of issuance) will be preserved at the same percentage of shares of common stock outstanding held by such Eligible Class C Preferred Stock Holder on such date. An Eligible Class C Preferred Stock Holder means any of (i) DE LLC for so long as Mr. O’Dowd continues to beneficially own at least 90% and serves on the board of directors or other governing entity, (ii) any other entity in which Mr. O’Dowd beneficially owns more than 90%, or a trust for the benefit of others, for which Mr. O’Dowd serves as trustee and (iii) Mr. O’Dowd individually. Series C Convertible Preferred Stock will only be convertible by the Eligible Class C Preferred Stock Holder upon the Company satisfying one of the “optional conversion thresholds”. Specifically, a majority of the independent directors of the Board, in its sole discretion, must have determined that the Company accomplished any of the following (i) EBITDA of more than $3.0 million in any calendar year, (ii) production of two feature films, (iii) production and distribution of at least three web series, (iv) theatrical distribution in the United States of one feature film, or (v) any combination thereof that is subsequently approved by a majority of the independent directors of the Board based on the strategic plan approved by the Board. While certain events may have occurred that could be deemed to have satisfied this criteria, the independent directors of the Board have not yet determined that an optional conversion threshold has occurred.   Except as required by law, holders of Series C Convertible Preferred Stock will only have voting rights once the independent directors of the Board determine that an optional conversion threshold has occurred. Only upon such determination, will the Series C Convertible Preferred Stock be entitled or permitted to vote on all matters required or permitted to be voted on by the holders of common stock and will be entitled to that number of votes equal to three votes for the number of Conversion Shares (as defined in the Certificate of Designation) into which such Holder’s shares of the Series C Convertible Preferred Stock could then be converted.
 
The Certificate of Designation also provides for a liquidation value of $0.001 per share and dividend rights of the Series C Convertible Preferred Stock on parity with the Company’s Common Stock.
 
Effective July 6, 2017, the Company amended its Articles of Incorporation to among other things cancel previous designations of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock.
 
 
36
 
 
B. 
Common Stock
 
The Company’s Articles of Incorporation previously authorized the issuance of 200,000,000 shares of Common Stock. 250,000 shares had been designated for the 2012 Omnibus Incentive Compensation Plan (the “2012 Plan”). Shares issuable under the 2012 Plan were not registered pursuant to a registration statement on Form S-8 and, consequently, no awards were granted under the 2012 Plan. On June 29, 2017, the shareholders of the Company approved the 2017 Plan that replaced the 2012 Plan. On August 7, 2017, the Company filed a registration statement on Form S-8 to register 1,000,000 shares of Common Stock issuable under the Plan. As of September 30, 2017, 59,320 shares of restricted stock were issued under the 2017 Plan. The shares of restricted stock were issued on August 21, 2017 and have a vesting period of six months (February 21, 2018). Employees that received the awards must remain employed by the Company until the vesting date or they risk the forfeiture of the award.
 
Effective February 23, 2016, the Company amended its Amended Articles of Incorporation to increase the number of authorized shares of its Common Stock from 200,000,000 to 400,000,000. Effective September 14, 2017, the Company amended its Amended and Restated Articles of Incorporation to effectuate a 1:2 reverse stock split. As a result, the number of authorized shares of Common Stock was reduced from 400,000,000 to 200,000,000 shares.
 
On February 16, 2017, the Company entered into a subscription agreement pursuant to which the Company issued and sold to an investor 50,000 shares of Common Stock at a price of $10.00 per share. This transaction provided $500,000 in proceeds for the Company.
 
On March 30, 2017, the Company entered into a Membership Interest Purchase Agreement to acquire a 100% membership interest in 42West. The Company issued 615,140 shares of Common Stock at a price of $9.22 per share related to this transaction. See note 4 for further details on the acquisition.
 
On March 30, 2017, KCF Investments LLC and BBCF 2011 LLC exercised Warrants J and K to purchase 1,085,000 and 85,000, respectively, of shares of Common Stock at a purchase price of $0.03 per share. This transaction provided $35,100 in proceeds for the Company. See note 17 for further discussion.
 
On March 30, 2017, the Principal Sellers of 42West, exercised put options in the aggregate amount of 43,381 shares of Common Stock and were paid an aggregate total of $400,000 on April 10, 2017.
 
On April 13, 2017, the Company issued the following shares of Common Stock as per the 42West Acquisition agreement; (i) 172,275 to certain designated employees and (ii) 50,000 shares as an estimate for the Purchase Consideration withheld on the date of closing related to the working capital.
 
On April 13, 2017, the Company issued 3,254 shares of Common Stock to a consultant for services rendered during the month ended March 31, 2017. The shares were issued at a purchase price of $9.22 per share.
 
On April 13, 2017, T Squared partially exercised Class E Warrants and acquired 162,885 shares of our common stock pursuant to the cashless exercise provision in the related warrant agreement. T Squared had previously paid down $1,675,000 for these shares.
 
On May 5, 2017, the Principal Sellers of 42West exercised put options in the aggregate amount of 32,538 shares of Common Stock and were paid an aggregate total of $300,000 on June 2, 2017.
 
On June 22, 2017, one of the Principal Sellers of 42West exercised a put option for 8,134 shares of Common Stock and was paid $75,000 on July 10, 2017.
 
On August 2, 2017, the Company issued 2,886 shares of Common Stock to a consultant for services rendered during the second quarter of 2017. The shares were issued at a purchase price of $10.00 per share.
 
On August 12 and August 15, 2017 the Principal Sellers of 42West exercised put options in the aggregate amount of 32,538 shares of Common Stock and were paid an aggregate total of $300,000 on September 1, 2017.
 
On August 21, 2017, the Company issued 59,320 shares of restricted stock to certain employees pursuant to the 2017 Plan (see further discussion of the 2017 Plan above).
 
 
37
 
 
On September 19 and September 20, 2017, two of the Principal Sellers of 42West exercised put options in the aggregate amount of 16,268 shares of Common Stock and were paid an aggregate of $150,000 on October 10, 2017.
 
As of September 30, 2017, and December 31, 2016, the Company had 9,367,057 and 7,197,761 shares of Common Stock issued and outstanding, respectively.
 
C. 
Noncontrolling Interest
 
On May 21, 2012, the Company entered into an agreement with a note holder to form Dolphin Kids Clubs, LLC (“Dolphin Kids Clubs”). Under the terms of the agreement, Dolphin converted an aggregate amount of $1,500,000 in notes payable and received an additional $1,500,000 during the year ended December 31, 2012 for a 25% membership interest in the newly formed entity. The Company holds the remaining 75% and thus controlling interest in Dolphin Kids Clubs. The purpose of Dolphin Kids Clubs is to create and operate online kids clubs for selected charitable, educational and civic organizations. The agreement encompasses kids clubs created between January 1, 2012 and December 31, 2016. It was a “gross revenue agreement” and the Company was responsible for paying all associated operating expenses. On December 29, 2016, as part of a global agreement with the 25% member of Dolphin Kids Clubs, the Company entered into a Purchase Agreement and acquired the 25% noncontrolling interest of Dolphin Kids Clubs. In exchange for the 25% interest, the Company issued Warrant “J” that entitles the warrant holder to purchase shares of common stock at a price of $0.03 per share. See notes 11 and 17 for further discussion of Warrant “J”.
 
NOTE 16 — EARNINGS (LOSS) PER SHARE
 
The following table sets forth the computation of basic and diluted income (loss) per share:
 
 
 
 
 
  Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
 
 
  2017
 
 
    2016
 
 
2017
 
 
  2016
 
Numerator:
 
   
 
 
   
 
 
 
 
 
   
 
Net income (loss) 
  $ 6,172,578  
  $ (11,540,729 )
  $ 9,575,304  
  $ (22,799,765 )
Preferred stock deemed dividend 
     
     
     
    (5,227,247 )
Numerator for basic income (loss) per share 
    6,172,578  
    (11,540,729 )
    9,575,304  
    (28,027,012 )
Change in fair value of Warrants “J” and “K” (note 11)
    (1,396,094 )
     
    (7,685,607 )
     
Change in fair value of Put rights
    (200,000 )
     
     
     
Numerator for diluted income (loss) per share
  $ 4,576,484  
  $ (11,540,729 )
  $ 1,889,697
  $ (28,027,012 )
Denominator:
       
       
       
       
Denominator for basic EPS — weighted–average shares
    9,336,826  
    5,337,108  
    8,640,543  
    3,801,626  
Effect of dilutive securities:
       
       
       
       
Warrants 
    3,704  
     
    501,918  
     
Employee nonvested stock awards
    25,556  
     
    8,612  
     
Shares issuable in January 2018 in connection with the 42West acquisition (Note 4)
    980,911  
     
    328,767  
     
Put rights in connection with the 42West acquisition (Note 4)
  35,821
     
     
     
Denominator for diluted EPS — adjusted weighted-average shares assuming exercise of warrants
  10,382,818
    5,337,108  
    9,479,840  
    3,801,626  
Basic income (loss) per share 
  $ 0.66  
  $ (2.16 )
  $ 1.11  
  $ (7.37 )
Diluted Income (loss) per share 
  $ 0.44
  $ (2.16 )
  $ 0.20  
  $ (7.37 )
 
Basic income (loss) per share is computed by dividing income or loss attributable to the shareholders of Common Stock (the numerator) by the weighted-average number of shares of Common Stock outstanding (the denominator) for the period. The denominator for diluted income per share assumes that any instruments convertible into Common Stock such as warrants, convertible securities, and any other Common Stock equivalents, if dilutive, were exercised and included outstanding shares during the period. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share, as the inclusion of any other potential shares outstanding would be anti-dilutive.
 
The denominator for calculating diluted income per share for the three and nine months ended September 30, 2017 assumes that dilutive warrants were exercised at the beginning of the period and that nonvested stock granted to employees had been included in outstanding shares since the beginning of the period, or the grant date if later. The denominator for diluted income per share for the three and nine months ended September 30, 2017 assumes that the shares issuable in January 2018 in connection with the 42West acquisition had been outstanding since the beginning of the periods, and for the three months ended September 30, 2017 the denominator assumes that dilutive put rights issued to the Sellers in connection with the 42West acquisition had been settled by the Company at the beginning of the period.
 
 
38
 

For warrants that are carried as liabilities at fair value, when exercise is assumed in the denominator for diluted earnings per share, the related change in the fair value of the warrants recognized in the consolidated statements of operations for the period, is added back or subtracted from net income during the period. For the three and nine months ended September 30, 2017, dilutive warrant shares outstanding were assumed to have been exercised and included in the denominator for diluted loss per share, and the related gains recorded in the condensed consolidated statements of operations due to recording the decrease in fair value of the warrant liabilities during the three- and nine-month periods was subtracted from net income to arrive at the numerator for basic and diluted income (loss) per share.
 
In periods when the put rights are assumed to have been settled at the beginning of the period in calculating the denominator for diluted income per share, the related change in the fair value of put right liability recognized in the consolidated statements of operations for the period, is added back or subtracted from net income during the period. The denominator for calculating diluted income per share for the three months ended September 30, 2016 assumes the put rights had been settled at the beginning of the period, and therefore, the related income due to the decrease in the fair value of the put right liability during the three months ended September 30, 2017 is subtracted from net income. The put rights were not assumed to have been settled during the nine months ended September 30, 2017, as the effect on diluted income per share would have been antidilutive.
 
For the three and nine months ended September 30, 2017, the Common Stock that is issuable in January 2018 in connection with the 42West Acquisition was assumed to have been issued during the period in arriving at the denominator for diluted loss per share.
 
Due to the net losses reported for the three and nine months ended September 30, 2016, common equivalent shares such as warrants were excluded from the computation of diluted loss per share, as inclusion would be anti-dilutive for the periods presented.
 
For the nine months ended September 30, 2016, the Company reflected the preferred stock deemed dividend of $5,227,247 (note 15) related to exchange of Series A for Series B Preferred Stock in the numerator for calculating basic and diluted loss per share, as the loss for holders of Common Stock would be increased by that amount. Due to the net losses reported, dilutive common equivalent shares were excluded from the computation of diluted loss per share.
 
NOTE 17 — WARRANTS
 
A summary of warrants outstanding at December 31, 2016 and issued exercised and expired during the nine months ended September 30, 2017 is as follows:
 
Warrants:
 
Shares
 
 
Weighted Avg. Exercise Price
 
Balance at December 31, 2016 
    2,945,000  
  $ 5.98  
Issued 
     
     
Exercised 
    1,332,885  
    1.28  
Expired 
     
     
Balance at September 30, 2017 
    1,612,115  
  $ 9.28  
 
On March 10, 2010, T Squared Investments, LLC (“T Squared”) was issued Warrant “E” for 175,000 shares of the Company at an exercise price of $10.00 per share with an expiration date of December 31, 2012. T Squared can continually pay the Company an amount of money to reduce the exercise price of Warrant “E” until such time as the exercise price of Warrant “E” is effectively $0.004 per share. Each time a payment by T Squared is made to Dolphin, a side letter will be executed by both parties that state the new effective exercise price of Warrant “E” at that time. At such time when T Squared has paid down Warrant “E” to an exercise price of $0.004 per share or less, T Squared shall have the right to exercise Warrant “E” via a cashless provision and hold for six months to remove the legend under Rule 144 of the Securities Act. During the years ended December 31, 2010 and 2011, T Squared paid down a total of $1,625,000. During the year ended December 31, 2016, T Squared paid $50,000 for the issuance of Warrants G, H and I as described below. Per the provisions of the Warrant Purchase Agreement, the $50,000 was to reduce the exercise price of Warrant “E”. On April 13, 2017, T Squared exercised 162,885 warrants using the cashless exercise provision, in the warrant agreement and received 162,885 shares of the Common Stock. Since T Squared applied the $1,675,000 that it had previously paid the Company to pay down the exercise price of the warrants, the exercise price for the remaining 12,115 warrants was recalculated and is currently $6.20 per share of Common Stock. T Squared did not make any payments during the nine months ended September 30, 2017 to reduce the exercise price of the warrants.
 
During the year ended December 31, 2012, T Squared agreed to amend a provision in a preferred stock purchase agreement (the “Preferred Stock Purchase Agreement”) dated May 2011 that required the Company to obtain consent from T Squared before issuing any Common Stock below the existing conversion price as defined in the Preferred Stock Purchase Agreement. As a result, the Company has extended the expiration date of Warrant “E” (described above) to September 13, 2015 and on September 13, 2012, the Company issued 175,000 warrants to T Squared (“Warrant “F”) with an exercise price of $10.00 per share. Under the terms of Warrant “F”, T Squared has the option to continually pay the Company an amount of money to reduce the exercise price of Warrant “F” until such time as the exercise price of Warrant “F” is effectively $0.004 per share. At such time, T Squared will have the right to exercise Warrant “F” via a cashless provision and hold for six months to remove the legend under Rule 144 of the Securities Act. The Company agreed to extend both warrants until December 31, 2018 with substantially the same terms as herein discussed. T Squared did not make any payments during the nine months ended September 30, 2017 to reduce the exercise price of the warrants.
 
 
39
 
 
On September 13, 2012, the Company sold 175,000 warrants with an exercise price of $10.00 per share and an expiration date of September 13, 2015 for $35,000. Under the terms of these warrants, the holder has the option to continually pay the Company an amount of money to reduce the exercise price of the warrants until such time as the exercise price is effectively $0.004 per share. At such time, the holder will have the right to exercise the warrants via a cashless provision and hold for six months to remove the legend under Rule 144 of the Securities Act. The Company recorded the $35,000 as additional paid in capital. The Company agreed to extend the warrants until December 31, 2018 with substantially the same terms as herein discussed. The holder of the warrants did not make any payments during the nine months ended September 30, 2017 to reduce the exercise price of the warrants.
 
On November 4, 2016, the Company issued a Warrant “G”, a Warrant “H” and a Warrant “I” to T Squared (“Warrants “G”, “H” and “I”). A summary of Warrants “G”, “H” and “I” issued to T Squared is as follows:
 
Warrants :
 
Number of Shares
 
 
Exercise price at September 30, 2017
 
 
Original Exercise Price
 
 
Fair Value as of September 30, 2017
 
 
Fair Value as of December 31, 2016
 
Expiration Date
Warrant “G” 
    750,000  
  $ 9.22  
  $ 10.00  
  $ 1,043,761  
  $ 3,300,671  
January 31, 2018
Warrant “H” 
    250,000  
  $ 9.22  
  $ 12.00  
    715,215  
    1,524,805  
January 31, 2019
Warrant “I” 
    250,000  
  $ 9.22  
  $ 14.00  
    1,015,607  
    1,568,460  
January 31, 2020
 
    1,250,000  
       
       
  $ 2,774,583  
  $ 6,393,936  
 
 
The Warrants “G”, “H” and “I” each contain an antidilution provision which in the event the Company sells grants or issues any shares, options, warrants, or any instrument convertible into shares or equity in any form below the then current exercise price per share of the Warrants “G”, “H” and “I”, then the then current exercise price per share for the warrants that are outstanding will be reduced to such lower price per share. Under the terms of the Warrants “G”, “H” and “I”, T Squared has the option to continually pay the Company an amount of money to reduce the exercise price of any of Warrants “G”, “H” and “I” until such time as the exercise price of Warrant “G”, “H” and/or “I” is effectively $0.02 per share. The Common Stock issuable upon exercise of Warrants “G”, “H” and “I” are not registered and will contain a restrictive legend as required by the Securities Act. At such time when the T Squared has paid down the warrants to an exercise price of $0.02 per share or less T Squared will have the right to exercise the Warrants “G”, “H” and “I” via a cashless provision and hold for six months to remove the legend under Rule 144 of the Securities Act.
 
On March 30, 2016, the Company issued shares of Common Stock at a purchase price of $9.22 per share related to the acquisition of 42West (note 4). As a result, the exercise price of each of Warrants “G”, “H” and “I” were reduced to $9.22.
 
Due to the existence of the antidilution provision, the Warrants “G”, “H” and “I” are carried in the condensed consolidated financial statements as of September 30, 2017 and December 31, 2016 as derivative liabilities at fair value (see note 11).
 
On December 29, 2016, in connection with the purchase by the Company of 25% of the outstanding membership interests of Dolphin Kids Club, LLC, the termination of an Equity Finance Agreement and the debt exchange of First Loan and Security Notes, Web Series Notes and Second Loan and Security Notes (See note 8), the Company issued Warrant “J” and Warrant “K” (Warrants “J” and “K”) to the seller. Each of the Warrants “J” and “K” had an exercise price of $0.03 per share and an expiration date of December 29, 2020.
 
The Warrants “J” and “K” each contained an antidilution provision that in the event the Company sells grants or issues any shares, options, warrants, or any instrument convertible into shares or equity in any form below the current exercise price per share of Warrants “J” and “K”, then the current exercise price per share for the Warrants “J” and “K” that are outstanding will be reduced to such lower price per share. The Common Stock issuable upon exercise of Warrants “J” and “K” are not registered and will contain a restrictive legend as required by the Securities Act. At such time as the exercise price is $0.01 per share or less, the holder will have the right to exercise the Warrants “J” and “K” via a cashless provision and hold for six months to remove the legend under Rule 144 of the Securities Act.
 
 
40
 
 
Due to the existence of the antidilution provision, the Warrants “J” and “K” were carried in the condensed consolidated balance sheet as of December 31, 2016 as derivative liabilities at a fair value of $12,993,342 for Warrant “J” and $1,017,912 for Warrant “K” (see note 11). On March 30, 2017, the holders of Warrants J and K exercised their warrants and were issued 1,170,000 shares of Common Stock. The Company received $35,100 of proceeds from the transaction.
 
NOTE 18 — OTHER RELATED PARTY TRANSACTIONS
 
On December 31, 2014, the Company and its CEO renewed his employment agreement for a period of two years commencing January 1, 2015. The agreement stated that the CEO was to receive annual compensation of $250,000 plus bonus. In addition, the CEO was entitled to an annual discretionary bonus as determined by the Company’s Board of Directors. The CEO was eligible to participate in all of the Company’s benefit plans offered to its employees. As part of his agreement, he received a $1,000,000 signing bonus in 2012 that is recorded in accrued compensation on the condensed consolidated balance sheets. Any unpaid and accrued compensation due to the CEO under this agreement will accrue interest on the principal amount at a rate of 10% per annum from the date of this agreement until it is paid. The agreement included provisions for disability, termination for cause and without cause by the Company, voluntary termination by executive and a non-compete clause. The Company accrued $2,437,500 and $2,250,000 of compensation as accrued compensation and $909,834 and $735,211 of interest in other current liabilities on its condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016, respectively, in relation to Mr. O’Dowd’s employment. The Company recorded interest expense related to accrued compensation of $60,388 and $174,623, respectively, for the three and nine months ended September 30, 2017 and $54,081 and $156,404, respectively, for the three and nine months ended September 30, 2016, on the condensed consolidated statements of operations.
 
On October 14, 2015, the Company and Merger Subsidiary, a wholly owned subsidiary of the Company, entered into a merger agreement with Dolphin Films and DE LLC, both entities owned by a related party. Pursuant to the Merger Agreement, Merger Subsidiary agreed to merge with and into Dolphin Films with Dolphin Films surviving the Merger. As a result, during the nine months ended September 30, 2016, the Company acquired Dolphin Films. As consideration for the Merger, the Company issued 2,300,000 shares of Series B Convertible Preferred Stock (“Series B”), par value $0.10 per share, and 50,000 shares of Series C Convertible Preferred Stock, par value $0.001 per share to DE LLC.
 
On March 30, 2017, in connection with the 42West Acquisition, the Company and Mr. O’Dowd, as personal guarantor, entered into four separate Put Agreements with each of the Sellers of 42West, pursuant to which the Company has granted each of the Sellers the right to cause the Company to purchase up to an aggregate of 1,187,094 of their shares of Common Stock received as Consideration for a purchase price equal to $9.22 per share during certain specified exercise periods up until December 2020. Pursuant to the terms of one such Put Agreement between Mr. Allan Mayer, a member of the board of directors of the Company, and the Company, Mr. Mayer exercised Put Rights and caused the Company to purchase 32,537 shares of Common Stock at a purchase price of $9.22 for an aggregate amount of $300,000, during the period between March 30, 2017 (42West Acquisition date) and September 30, 2017.
 
On March 30, 2017, KCF Investments LLC and BBCF 2011 LLC, entities under the common control of Mr. Stephen L Perrone, an affiliate of the Company, exercised Warrants “J” and “K” and were issued an aggregate of 1,170,000 shares of the Company’s Common Stock at an exercise price of $0.03 per share.
 
NOTE 19 — SEGMENT INFORMATION
 
As a result of the 42West Acquisition (note 4), the Company has determined that as of the second quarter of 2017, it operates two reportable segments, the Entertainment Publicity Division (“EPD”) and the Content Production Division (“CPD”). The EPD segment is comprised of 42West and provides clients with diversified services, including public relations, entertainment content marketing and strategic marketing consulting. CPD is comprised of Dolphin Entertainment, Dolphin Films, and Dolphin Digital Studios and specializes in the production and distribution of digital content and feature films.
 
The profitability measure employed by our chief operating decision maker for allocating resources to operating divisions and assessing operating division performance is operating income (loss). All segments follow the same accounting policies as those described in Note 3.
 
 
41
 
 
Salaries and related expenses include salaries, bonus, commission and other incentive related expenses. Legal and professional expenses primarily include professional fees related to financial statement audits, legal, investor relations and other consulting services, which are engaged and managed by each of the segments. In addition, general and administrative expenses include rental expense and depreciation of property, equipment and leasehold improvements for properties occupied by corporate office employees.
 
In connection with the 42West Acquisition, the Company assigned $9,110,000 of intangible assets, less the amortization during the six months between the 42West Acquisition date (March 30, 2017) and September 30, 2017 of $498,666, and Goodwill of $14,351,368 to the EPD segment. Information presented for the EPD segment is for the period between the 42West Acquisition date (March 30, 2017) and September 30, 2017.
 
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2017
 
Revenue:
 
 
 
 
 
 
EPD
  $ 5,409,175  
  $ 10,546,716  
CPD
    1,398,839  
    4,625,801  
Total
  $ 6,808,014  
  $ 15,172,517  
Segment operating income (loss):
       
       
EPD
  $ 1,432,148  
  $ 2,200,996  
CPD
    308,054  
    (1,161,828 )
Total
    1,740,202  
    1,039,168  
Interest expense
    (424,187 )
    (1,273,166 )
Other income, net
    4,856,563  
    9,809,302  
Income before income taxes
  $ 6,172,578
  $ 9,575,304  
 
 
 
As of
September 30,
2017
 
Total assets:
 
 
 
EPD
  $ 27,682,381
CPD
  6,079,839
Total
  $ 33,762,220
 
NOTE 20 — COMMITMENTS AND CONTINGENCIES
 
Litigation
 
On or about January 25, 2010, an action was filed by Tom David against Winterman Group Limited, Dolphin Digital Media (Canada) Ltd., Malcolm Stockdale and Sara Stockdale in the Superior Court of Justice in Ontario (Canada) alleging breach of a commercial lease and breach of a personal guaranty. On or about March 18, 2010, Winterman Group Limited, Malcolm Stockdale and Sara Stockdale filed a Statement of Defense and Crossclaim. In the Statement of Defense, Winterman Group Limited, Malcolm Stockdale and Sara Stockdale denied any liability under the lease and guaranty. In the Crossclaim filed against Dolphin Digital Media (Canada) Ltd., Winterman Group Limited, Malcolm Stockdale and Sara Stockdale seek contribution or indemnity against Dolphin Digital Media (Canada) Ltd. alleging that Dolphin Digital Media (Canada) agreed to relieve Winterman Group Limited, Malcolm Stockdale and Sara Stockdale from any and all liability with respect to the lease or the guaranty. On or about March 19, 2010, Winterman Group Limited, Malcolm Stockdale and Sara Stockdale filed a Third-Party Claim against the Company seeking contribution or indemnity against the Company, formerly known as Logica Holdings, Inc., alleging that the Company agreed to relieve Winterman Group Limited, Malcolm Stockdale and Sara Stockdale from any and all liability with respect to the lease or the guaranty. The Third-Party Claim was served on the Company on April 6, 2010. On or about April 1, 2010, Dolphin Digital Media (Canada) filed a Statement of Defense and Crossclaim. In the Statement of Defense, Dolphin Digital Media (Canada) denied any liability under the lease and in the Crossclaim against Winterman Group Limited, Malcolm Stockdale and Sara Stockdale, Dolphin Digital Media (Canada) seeks contribution or indemnity against Winterman Group Limited, Malcolm Stockdale and Sara Stockdale alleging that the leased premises were used by Winterman Group Limited, Malcolm Stockdale and Sara Stockdale for their own use. On or about April 1, 2010, Dolphin Digital Media (Canada) also filed a Statement of Defense to the Crossclaim denying any liability to indemnify Winterman Group Limited, Malcolm Stockdale and Sara Stockdale. The ultimate results of these proceedings against the Company cannot be predicted with certainty. On or about March 12, 2012, the Court served a Status Notice on all the parties indicating that since more than (2) years had passed since a defense in the action had been filed, the case had not been set for trial and the case had not been terminated, the case would be dismissed for delay unless action was taken within ninety (90) days of the date of service of the notice. The Company has not filed for a motion to dismiss and no further action has been taken in the case. The ultimate results of these proceedings against the Company could result in a loss ranging from 0 to $325,000. On March 23, 2012, Dolphin Digital Media (Canada) Ltd filed for bankruptcy in Canada. The bankruptcy will not protect the Company from the Third-Party Claim filed against it. However, the Company has not accrued for this loss because it believes that the claims against it are without substance and it is not probable that they will result in loss. As of September 30, 2017, the Company has not received any other notifications related to this action.
 
 
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A putative class action was filed on May 5, 2017, in the United States District Court for the Southern District of Florida by Kenneth and Emily Reel on behalf of a purported nationwide class of individuals who attended the Fyre Music Festival, or the Fyre Festival, in the Bahamas on April 28-30, 2017. The complaint names several defendants, including 42West, along with the organizers of the Fyre Festival, Fyre Media Inc. and Fyre Festival LLC, individuals related to Fyre and another entity called Matte Projects LLC. The complaint alleges that the Fyre Festival was promoted by Fyre as a luxurious experience through an extensive marketing campaign orchestrated by Fyre and executed with the assistance of outside marketing companies, 42West and Matte, but that the reality of the festival did not live up to the luxury experience that it was represented to be. The plaintiffs assert claims for fraud, negligent misrepresentation and for violation of several states’ consumer protection laws. The plaintiffs seek to certify a nationwide class action comprised of “All persons or entities that purchased a Fyre Festival 2017 ticket or package or that attended, or planned to attend, Fyre Festival 2017” and seek damages in excess of $5,000,000 on behalf of themselves and the class. The plaintiffs sought to consolidate this action with five other class actions also arising out of the Fyre Festival (to which 42West is not a party) in a Multi District Litigation proceeding, which request was denied by the panel. We believe the claims against 42West are without merit and that we have strong defenses to the claims.
 
Tax Filings
 
The Company accrued $120,000 for estimated penalties associated with not filing certain information returns. The penalties per return are $10,000 per entity per year. The Company received notification from the Internal Revenue Service concerning information returns for the year ended December 31, 2009. The Company responded with a letter stating reasonable cause for the noncompliance and requested that penalties be abated. During 2012, the Company received a notice stating that the reasonable cause had been denied. The Company decided to pay the penalties and not appeal the decision for the 2009 Internal Revenue Service notification. There is no associated interest expense as the tax filings are for information purposes only and would not result in further income taxes to be paid by the Company. The Company made payments in the amount of $40,000 during the year ended December 31, 2012 related to these penalties. At each of September 30, 2017 and December 31, 2016, the Company had a remainder of $40,000 in accruals related to these late filing penalties which is presented as a component of other current liabilities.
 
Kids Club
 
Effective February 1, 2017, the Company notified US Youth Soccer Association, Inc., with whom it had entered into an agreement to create, design and host the US Youth Soccer Clubhouse website, that it would not renew the agreement. The Company did not record any revenues or expenses related to this website for the three and nine months ended September 30, 2017 and 2016.
 
On July 1, 2016, the Company and United Way Worldwide mutually agreed to terminate the agreement and agreement create and host an online kids club to promote United Way’s philanthropic philosophy and encourage literacy programs. Pursuant to the terms of the agreement the Company was responsible for the creation and marketing of the website, developing and managing the sponsorship package, and hiring of certain employees to administer the program. Each school sponsorship package was $10,000 with the Company earning $1,250. The remaining funds were used for program materials and the costs of other partners. During the nine months ended September 30, 2017, management decided to discontinue the online kids clubs at the end of 2017.
 
The Company recorded revenues of $6,225 and $27,253 related to the online kids clubs during the three and nine months ended September 30, 2016. There were no revenues generated by the online kids clubs during the three and nine months ended September 30, 2017.
 
 
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Incentive Compensation Plan
 
On June 29, 2017, the shareholders of the Company approved the 2017 Plan which replaced the 2012 Plan. The 2017 Plan was adopted as a flexible incentive compensation plan that would allow us to use different forms of compensation awards to attract new employees, executives and directors, to further the goal of retaining and motivating existing personnel and directors and to further align such individuals’ interests with those of the Company’s shareholders. Under the 2017 Plan, the total number of shares of Common Stock reserved and available for delivery under the 2017 Plan (the “Awards”), at any time during the term of the 2017 Plan, will be 1,000,000 shares of Common Stock. The 2017 Plan imposes individual limitations on the amount of certain Awards, in part with the intention to comply with Section 162(m) of the Code. Under these limitations, in any fiscal year of the Company during any part of which the 2017 Plan is in effect, no participant may be granted (i) stock options or stock appreciation rights with respect to more than 300,000 Shares, or (ii) performance shares (including shares of restricted stock, restricted stock units, and other stock based-awards that are subject to satisfaction of performance goals) that the Committee intends to be exempt from the deduction limitations under Section 162(m) of the Code, with respect to more than 300,000 Shares, in each case, subject to adjustment in certain circumstances. The maximum amount that may be paid out to any one participant as performance units that the Committee intends to be exempt from the deduction limitations under Section 162(m) of the Code, with respect to any 12-month performance period is $1,000,000 (pro-rated for any performance period that is less than 12 months), and with respect to any performance period that is more than 12 months, $2,000,000. Through August 21, 2017, the Company issued 59,320 Shares as Awards to certain employees. There is a vesting period of six months. Through September 30, 2017, the Company recorded compensation expense of $103,760 on its condensed consolidated statement of operations.
 
Employee Benefit Plan
 
The Company’s wholly owned subsidiary, 42West, has a 401(K) profit sharing plan that covers substantially all employees of 42West.  Contributions to the plan are at discretion of management. The Company’s contributions were approximately $58,848 and $206,916 for the three and nine months ended September 30, 2017, respectively.
 
Employment Contracts
 
During 2015, 42West entered into seven separate three-year employment contracts with senior level management employees. The contracts define each individual’s compensation, along with specific salary increases mid-way through the term of each contract. Each individual was also guaranteed a percentage of proceeds if 42West was sold during the term of their contract. The percentages vary by executive. Termination for cause, death or by the employee would terminate the Company’s commitment on each of the contracts. During the six months between the 42West Acquisition date (March 30, 2017) and September 30, 2017, one of the seven senior level management employees left the Company. On July 11, 2017, the Company entered into a three-year employment agreement with a senior level management employee. Per the terms of the employment agreement, the employee is entitled to a base salary with a guaranteed increase of at least 7.5% of the base salary after 18 months of employment and periodic reviews throughout the term of the employment agreement. The employment agreement contains provisions for termination as a result of death or disability and entitles the employee to bonuses, commission, vacations and to participate in all employee benefit plans offered by the Company.
 
 
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As a condition to the closing of the 42West Acquisition described in note 4, each of the three Principal Sellers has entered into employment agreements (the “Employment Agreements”) with the Company and will continue as employees of the Company for a three-year term. Each of the Employment Agreements provides for a base salary with annual increases and bonuses if certain performance targets are met. In addition, the Employment Agreements grant each Principal Seller an annual stock bonus of $200,000 to be calculated using the 30-day trading average of the Company’s Common Stock. The Employment Agreements also contain provisions for termination and as a result of death or disability. During the term of the Employment Agreement, the Principal Sellers shall be entitled to participate in all employee benefit plans, practices and programs maintained by the Company as well as are entitled to paid vacation in accordance with the Company’s policy. Each of the Employment Agreements contains lock-up provisions pursuant to which each Principal Seller has agreed not to transfer any shares of Common Stock in the first year, no more than 1/3 of the Initial Consideration and Post-Closing Consideration received by such Seller in the second year and no more than an additional 1/3 of the Initial Consideration and Post-Closing Consideration received by such Seller in the third year, following the closing date of the 42West Acquisition.