UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2013March 31, 2014

For the transition period from ___________to ___________

Commission file number: 000-54389

GENIUS BRANDS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

(858) 450-2900310-273-4222

(Registrant’s telephone number, including area code)

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. Yesx 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 (§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 x No¨

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 99,715,5666,077,707 shares of common stock, par value $0.001, were outstanding as of November 14, 2013.May 16, 2014.

GENIUS BRANDS INTERNATIONAL, INC.

FORM 10-Q

For the Quarterly Period Ended September 30, 2013March 31, 2014

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited).Statements.

Genius Brands International, Inc.

Consolidated Balance Sheets

September 30, 2013March 31, 2014 (unaudited) and December 31, 20122013 (audited)

See

The accompanying notes to financial statements.

Genius Brands International, Inc.

Consolidated Statementsare an integral part of Operations

Periods Ending September 30, 2013 and 2012 (unaudited)

See accompanying notes tothese consolidated financial statements.

Genius Brands International, Inc.

Consolidated Statements of Stockholders’ Equity (Deficit)Operations

Three Month Period Ending March 31, 2014 and 2013 (unaudited)

SeeThe accompanying notes toare an integral part of these consolidated financial statements.

Genius Brands International, Inc.

Consolidated Statements of Cash Flows (unaudited)Stockholders' Equity (Deficit)

SeeThe accompanying notes toare an integral part of these consolidated financial statements.

Genius Brands International, Inc.

Consolidated Statements of Cash Flows

Three Month Period Ending March 31, 2014 and 2013 (unaudited)

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

Genius Brands International, Inc.

Notes to Financial Statements

September 30, 2013March 31, 2014 (unaudited)

Note 1: The CompanyOrganization and Significant Accounting PoliciesBusiness

Organization and Nature of Business

Genius Brands International, Inc. (“we”, “us”, “our” or the “Company”),f/k/a Pacific Entertainment Corporation, creates, produces and distributes music-based products whichoriginal “content with a purpose” for kids, meaning multi-media, multi-format content for kids that we believe is as entertaining as it is enriching. In most cases, the Company wholly owns the original content it produces, and works with a variety of partners who are entertaining, educationalexperts in their respective categories, to develop and beneficial todistribute it in multiple formats around the well-being of infants and young children, under our brands, including Baby Genius and Little Genius. We create, market and sell children’s videos, music, books and other products in the United States by distribution at wholesale to retail stores and distributors, direct to consumers through various “deal for a day” sites and through digital platforms using intellectual property developed and owned by us. We license the use of our intellectual property, both domestically and internationally, to others to manufacture, market and sell products based on our characters and brands, whereby we receive advances and royalties.world. The Company also obtains rightsowns and is developing a portfolio of original children’s entertainment to the content of other studios for distribution through our warehouse facilityappeal to our customers, for which we either pay royalty fees or earn distribution fees. We have licensing agreements with other companies under which we produce music-based products using their characters and brands and for which we pay a royalty.toddlers to teens.

The Company commenced operations in January 2006, assuming all of the rights and obligations of its then Chief Executive Officer, Klaus Moeller, under an Asset Purchase Agreement between the Company and Genius Products, Inc., in which wethe Company obtained all rights, copyrights, and trademarks to the brands “Baby Genius,” “Little Genius,” “Kid Genius,” “123 Favorite Music” and “Wee Worship,” and all then existing productions under those titles. On October 17, 2011 and October 18, 2011, Genius Brands International, Inc.,the Company filed Articles of Merger with the Secretary of State of the State of Nevada and with the Secretary of State of the State of California, respectively. As previously described on the Company’s Schedule 14C Information Statement, filed with the Securities and Exchange Commission on September 21, 2011, by filing the Articles of Merger, the Company (i) changed its domicilestate of incorporation to Nevada from California, and (ii) changed its name to Genius Brands International, Inc. from Pacific Entertainment Corporation (the “Reincorporation”). Pursuant to the Articles of Merger, Pacific Entertainment Corporation, a California corporation, merged into Genius Brands International, Inc., a Nevada corporation that, prior to the Reincorporation, was the wholly owned subsidiary of Pacific Entertainment Corporation. Genius Brands International, the Nevada corporation, is the surviving corporation. In connection with the Reincorporation, on October 12, 2011, the Company filed an Issuer Company-Related Action Notification Form with the Financial Industry Regulatory Authority (“FINRA”) and on November 29, 2011 our trading symbol changed from “PENT” to “GNUS”.

On January 11, 2011, the Company signed a five-year, world-wide license agreement with Tollytots® for a new toy line. The agreement included a broad range of exclusive categories including learning and developmental toys, most plush toys, and musical toys which Tollytots® had the sole right to manufacture, market and distribute on a world-wide basis.  It also allowed Tollytots® a non-exclusive right to manufacture, market and distribute products in several non-exclusive categories, including board games, puzzles, electronic learning aids and amusement plush toys.  The agreement was subject to early termination by the Company in specified territories in the event minimum sales requirements in those territories were not met in any contract year. On June 6,November 15, 2013, the Company and Tollytots® agreed to terminate the agreement in its entirety. The Company will receive no further payments for this license beyond September 30, 2013.

The Company also obtains licenses for other select brands we feel we can market and sell through our distribution channels.   

On September 20, 2010, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with A Squared Entertainment LLC, a joint venture agreement with Dr. Shulamit Ritblatt to form Circle of Education,Delaware limited liability company (“A Squared”), A Squared Holdings LLC, (“COE”), a California limited liability company forand sole member of A Squared (the “Member”) and A2E Acquisition LLC, our newly formed, wholly-owned Delaware subsidiary (“Acquisition Sub”). Upon closing of the purpose of creation and distribution of a music-based curriculum to promote school readiness for children ages 2-5 years.  The Company actively participated in a research studytransactions contemplated under the Merger Agreement (the “Merger”), which occurred concurrently with entering into the useMerger Agreement, our Acquisition Sub merged with and into A Squared, and A Squared, as the surviving entity, became a wholly-owned subsidiary of the curriculum throughCompany. As a major university for three years based on certain unregistered copyrights and trademarks, confidential information, designs, ideas, discoveries, inventions, processes, research results and work product it had developed. In March 2012,result of the Merger, the Company acquired the business and Dr. Ritblatt agreedoperations of A Squared.  A Squared creates, produces and distributes original “content with a purpose” for kids 6-11, whereas Genius Brands previously focused on toddlers. Today the merged company is focused on providing “content with a purpose” for toddlers to terminatetweens, in all media formats, relevant consumer products categories, in territories around the joint venture agreement. COE transferred equal rightworld.

On April 2, 2014, we filed a certificate of ownershipamendment to our Articles of Incorporation to affect a reverse split of our issued and outstanding common stock on a one-for-one hundred basis. The reverse stock split was effective with FINRA on April 7, 2014. All common stock share and per share information in this Quarterly Report, including the intellectual property developed asaccompanying consolidated financial statements and notes thereto, have been adjusted to reflect retrospective application of the date of termination (“IP”) to each of the Company and Dr. Ritblatt, and in exchange for the rights to the IP, Dr. Ritblatt transferred her units of COE to the Company. Each party will have the right to continue development of the IP and products based on the IP with no further obligation to the other party. Subject to certain limitations for specific channels of distribution reserved for each party for a period of twelve months from the execution of the agreements, both parties have non-exclusive and non-restrictive rights to the use, sublicense or sale of the IP and products created based on the IP.

The Company has developed the Ready!Play!Learn!™ program based partially on the intellectual property discussed above, which we anticipate will be available for distribution in 2014. The program includes a curriculum book and music aimed at parents and caregivers of preschool aged children to assist them in preparing their children for kindergarten.

In 2012, the Company began development of an application based on our content and characters. The initial application includes digital video and music delivery, with games and puzzles based on our characters, which is scheduled to be available in the fourth quarter of 2013. Future enhancements include a variety of tools, including lesson plans, curriculum and songs designed to assist parents teach academic subjects and socialization skills to their children ages 2-5 years in preparation for attending kindergarten.

The Company believes that the distribution of products is changing from the traditional brick and mortar retail store to an increasing emphasis on digital delivery whereby the owners of content will be able to reach customers directly through a digital delivery platform. In 2013, we began creation of a digital streaming application that will be available at www.babygenius.com and the conversion of all our content to digital format. We anticipate the initial completion date in the fourth quarter of 2013.

The Company’s Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America.  These require the use of estimates and assumptions that affect the assets, liabilities, revenues and expenses reported in the financial statements, as well as amounts included in the notes thereto, including discussion and disclosure of contingent liabilities.  Although the Company uses its best estimates and judgments, actual results could differ from these estimates as future confirming events occur.reverse split, unless otherwise indicated.

Liquidity

Historically, the Company has incurred net losses. As of September 30, 2013,March 31, 2014, the Company had an accumulated deficit of $14,494,074$18,278,217 and a total stockholders’ deficitequity of $3,412,073.$11,099,791. At September 30, 2013,March 31, 2014, the Company had current assets of $893,315,$2,159,340, including cash of $234,211,$992,753 and current liabilities of $4,500,134,$2,802,119, including short-term debt to related parties which bears no interest and has no stated maturity of $415,787 and certain disputed trade payables of $925,000 to which the Company disputes the claim, resulting in a working capital deficit of $3,606,819.$642,779. For the nine monthsquarter ended September 30, 2013,March 31, 2014, the Company reported a net loss of $4,286,050$854,162 and net cash used by operating activities of $467,579.$476,146. Management believes that its sales and cash provided by operations, together with funds available from deferredthe issuance of common stock in the first quarter of 2014, and reduced officers’ salaries and short term financing,proceeds from a long-term, exclusive supply chain services agreement for which it received $750,000 during the first quarter of 2014 will be sufficient to fund planned operations for the next twelve months. However, there can be no assurance that operations and operating cash flows will continue at the current levels or improve in the near future. If the Company is unable to obtain profitable operations and positive operating cash flows, sufficient to meet scheduled debt obligations, it may need to seek additional funding or be forced to scale back its development plans or to significantly reduce or terminate operations. Subsequent to March 31, 2014, the Company sold 6,000 Series A Convertible Preferred Shares to accredited investors at a price of $1,000 per share for which it received gross proceeds of $6,000,000 and paid offering costs of $535,000. Additionally, the Company entered into an agreement for musical composition administration services with a third party for which the Company received an advance of $250,000.

Note 2: Summary of Significant Accounting Policies

Cash Equivalents

The Company considers all highly liquid debt instruments with initial maturities of three months or less to be cash equivalents. 

Reverse Stock Split

On April 2, 2014, we filed a certificate of amendment to our Articles of Incorporation to affect a reverse split of our issued and outstanding common stock on a one-for-one hundred basis. The reverse stock split was effective with FINRA on April 7, 2014. All common stock share and per share information in this Form 10-Q, including the accompanying consolidated financial statements and notes thereto, have been adjusted to reflect retrospective application of the reverse split, unless otherwise indicated.

Business Combination

On November 15, 2013, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with A Squared Entertainment LLC, a Delaware limited liability company (“A Squared”), A Squared Holdings LLC, a California limited liability company and sole member of A Squared (the “Parent Member”) and A2E Acquisition LLC, our newly formed, wholly-owned Delaware subsidiary (“Acquisition Sub”). Upon closing of the transactions contemplated under the Merger Agreement (the “Merger”), which occurred concurrently with entering into the Merger Agreement, our Acquisition Sub merged with and into A Squared, and A Squared, as the surviving entity, became a wholly-owned subsidiary of the Company.  As a result of the Merger, the Company acquired the business and operations of A Squared.  

The audited financial statements have been prepared using the acquisition method of accounting in accordance with FASB Accounting Standards Codification (“ASC”) 805, Business Combinations.

See Note 3 - Business Combination for additional information.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Genius Brands International, Inc. and its wholly owned subsidiary A Squared Entertainment, LLC. All significant inter-company balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

Cash EquivalentsFinancial Statement Reclassification

The Company considers all highly liquid debt instruments with initial maturities of three months or lessCertain account balances from prior periods have been reclassified in these unaudited consolidated financial statements so as to be cash equivalents.conform to current period classifications.

Significant Accounting Policies

Revenue RecognitionAllowance for Sales Returns -The Company recognized revenue related to product sales when (i) the seller’s price An Allowance for Sales Returns is substantially fixed, (ii) shipment has occurred causing the buyer to be obligated to pay for product, (iii) the buyer has economic substance apart from the seller, and (iv) there is no significant obligation for future performance to directly bring about the resale of the product by the buyer as required by FASB Accounting Standards Codification (“ASC”) Topic 605 - Revenue Recognition.

 Revenues associated with the sale of products, are recorded when shipped to customers pursuant to approved customer purchase orders resulting in the transfer of title and risk of loss.  Cost of sales, rebates and discounts are recorded at the time of revenue recognition or at each financial reporting date.

The Company’s licensing and royalty revenue represent variable paymentsestimated based on netaverage sales from brand licensees for content distribution rights.  These license agreements are held in conjunction with third parties that are responsible for collecting fees dueduring the previous year.  Based on experience, sales growth, and remitting toour customer base, the Company its share after expenses. Revenue from licensed products is recognized when realized or realizable based on royalty reporting received from licensees.

Shippingconcluded that the allowance for sales returns at March 31, 2014 and Handling -The Company records shippingDecember 31, 2013 should be $43,000 and handling expenses in the period in which they are incurred and are included in the Cost of Goods Sold.$43,000, respectively.

Inventories -Inventories are stated at the lower of cost (average) or market and consist of finished goods such as DVDs, CDs and other products. A reserve for slow-moving and obsolete inventory is established for all inventory deemed potentially non-saleable by management in the period in which it is determined to be potentially non-saleable. The current inventory is considered properly valued and saleable. The Company concluded that there was an appropriate reserve for slow moving and obsolete inventory of $84,671$99,278 and $57,305$93,607 established as of September 30, 2013March 31, 2014 and December 31, 2012,2013, respectively.

Property and Equipment -Property and equipment are recorded at cost. Depreciation on property and equipment is computed using the straight-line method over the estimated useful lives of the assets, which range from 5 to 39 years. Maintenance, repairs, and renewals, which neither materially add to the value of the assets nor appreciably prolong their lives, are charged to expense as incurred. Gains and losses from dispositions of property and equipment are reflected in the statement of operations.

Intangible Assets –-Intangible Assets acquired, either individually or with a group of other assets, are initially recognized and measured based on fair value.  In the 2005 acquisition of the assets from Genius Products, fair value was calculated using a discounted cash flow analysis of the revenue streams for the estimated life of the assets. In the 2013 acquisition of the identifiable artistic-related assets from A Squared, fair value was determined through an independent appraisal. The Company determined that these assets are indefinite-lived. Additionally, the Merger transaction with A Squared gave rise to goodwill representing the future economic benefits arising from the assets of A Squared that could not be individually identified and recognized.

The Company develops new video, music, books and digital applications, in addition to adding content, improved animation and songs/features to their existing productions.  The costs of new product development and significant improvement to existing products are capitalized while routine and periodic alterations to existing products are expensed as incurred.  The Company begins amortization of new products when it is available for general release.  Annual amortization cost of intangible assets are computed based on the straight-line method over the remaining economic life of the product, generally such deferred costs are amortized over five years.

The Company reviews all intangible assets periodically to determine if the value has been impaired following the guidance of ASC 350-20 - Goodwill and ASC 350-30 - General Intangibles Other Than Goodwill.

Capitalized Production Cost - The Company capitalizes production costs for episodic series produced in accordance with ASC 926-20, Entertainment-Films - Other Assets - Film Costs. Accordingly, production costs are capitalized at actual cost and then charged against revenue based on the initial market revenue evidenced by recent financial transactions usinga firm commitment over the discounted cash flow analysisperiod of commitment. The Company expenses all capitalized costs that exceed the initial market firm commitment revenue in the period of delivery of the episodes.

The Company capitalizes production costs for films produced in accordance with ASC 926-20, Entertainment-Films - Other Assets - Film Costs. Accordingly, production costs are capitalized at actual cost and then charged against revenue quarterly as a cost of production based on the relative fair value of the film(s) delivered and recognized as revenue. The Company evaluates their capitalized production costs annually and limits recorded amounts by their ability to recover such costs through expected future sales.

The Company also develops new videos, music, books and digital applications in addition to adding content, improved animation and bonus songs/features to its existing product catalog. In accordance with ASC 350 - Intangible Assets and ASC 730 - Research and Development, the costs of new product development and significant improvement to existing products are capitalized while routine and periodic alterations to existing products are expensed as incurred.

Revenue Recognition - The Company recognized revenue related to product sales when (i) the seller’s price is substantially fixed, (ii) shipment has occurred causing the buyer to be obligated to pay for product, (iii) the buyer has economic substance apart from the seller, and (iv) there is no significant obligation for future performance to directly bring about the resale of the product by the buyer as required by ASC 605 - Revenue Recognition.

Revenues associated with the sale of products, are recorded when shipped to customers pursuant to approved customer purchase orders resulting in the transfer of title and risk of loss.  Cost of sales, rebates and discounts are recorded at the time of revenue streamrecognition or at each financial reporting date.

The Company recognizes revenue in accordance with ASC 926-605, Entertainment-Films - Revenue Recognition. Accordingly, the Company recognizes revenue when (i) persuasive evidence of a sale with customer exists, (ii) the film is complete and has been delivered or is available for delivery, (iii) the estimated lifelicense period of the assets.arrangement has begun and the customer can begin its exploitation, exhibition, or sale, (iv) the arrangement fee is fixed or determinable, and (v) collection of the arrangement fee is reasonably assured.

For its distribution, TV, and home entertainment income the Company generally enters in to flat fee arrangements to deliver multiple films or episodes. The Company allocates revenue to each film or episode based on their relative fair market values and recognizes revenue as each film or episode is complete and available for delivery.

The Company’s licensing and royalty revenue represents both (a) variable payments based on net sales from brand licensees for content distribution rights.  These license agreements are held in conjunction with third parties that are responsible for collecting fees due and remitting to the Company its share after expenses. Revenue from licensed products is recognized when realized or realizable based on royalty reporting received from licensees and (b) licensing income the Company recognizes revenue as an agent in accordance with ASC 605-45, Revenue Recognition - Principal Agent. Accordingly, the Company’s revenue is its gross billings to its customers less the amounts it pays to suppliers for their products and services.

Shipping and Handling - The Company records shipping and handling expenses in the period in which they are incurred and are included in the Cost of Goods Sold.

Stock Based Compensation -As required by ASC 718 - Stock Compensation, the Company recognizes an expense related to the fair value of our stock-compensationstock-based compensation awards, including stock options, using the Black-Scholes calculation as of the date of grant.

Advertising Costs -The Company’s marketing and sales costs are primarily related to advertising, trade shows, public relation fees and production and distribution of collateral materials.  In accordance with ASC 720 regarding Advertising Costs, the Company expenses advertising costs in the period in which the expense is incurred.  Marketing and Sales costs incurred by licensees are borne fully by the licensee and are not the responsibility of the Company. Advertising expense for the ninethree months ended September 30,March 31, 2014 and 2013 was $27,406 and September 30, 2012 was $14,915 and $32,412,$13,500, respectively.

AllowanceEarnings Per Share - Basic earnings (loss) per common share (“EPS”) is calculated by dividing net loss by the weighted average number of common shares outstanding for Sales Returns -An Allowance for Sales Returnsthe period. Diluted EPS is estimatedcalculated by dividing net loss by the weighted average number of common shares outstanding, plus the assumed exercise of all dilutive securities using the treasury stock or “as converted” method, as appropriate. During periods of net loss, all common stock equivalents are excluded from the diluted EPS calculation because they are antidilutive. Stock options to purchase 37,150 shares of common stock at March 31, 2014 have not been included as they would be anti-dilutive.

Income Taxes- Deferred income tax assets and liabilities are recognized based on average sales duringdifferences between the previous year.  Based on experience, sales growth,financial statement and our customer base,tax basis of assets and liabilities using presently enacted tax rates. At each balance sheet date, the Company concludedevaluates the available evidence about future taxable income and other possible sources of realization of deferred tax assets, and records a valuation allowance that reduces the allowance for sales returns at September 30, 2013 and December 31, 2012 shoulddeferred tax assets to an amount that represents management’s best estimate of the amount of such deferred tax assets that more likely than not will be $43,000 and $53,000, respectively.realized.

Fair value of financial instruments -The carrying amounts of cash, receivables and accrued liabilities approximate fair value due to the short-term maturity of the instruments.

Note 2: Plant, Property,We adopted ASC 820 as of January 1, 2008 for financial instruments measured at fair value on a recurring basis. ASC Topic 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and Equipment and Intangible Assetsexpands disclosures about fair value measurements.

The Company has plant, property and equipment and other intangible assetsFair 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. ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the creationhighest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

Recent Accounting Pronouncements

In July 2013, the FASB issued Accounting Standards Update No. 2013-11, “Presentation of revenuean Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU No. 2013-11”). ASU No. 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as follows as of September 30,a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with limited exceptions. ASU No. 2013-11 is effective for interim and annual periods beginning after December 15, 2013 and December 31, 2012:may be applied retrospectively.

Pursuant to FASB Accounting Standards Codification regarding Topic 350, Intangible Assets, intangible asset(s) acquired, either individually or withManagement does not believe that any other recently issued, but not effective, accounting standards if currently adopted would have a group of other assets shall be initially recognized and measured basedmaterial effect on fair value.  In the acquisition of the assets from Genius Products, fair value was calculated using a discounted cash flow analysis of the revenue streams for the estimated life of the assets.  As this resulted in a fair market value in excess of the purchase price, the assets were recorded at $2,489,082, the total purchase price discounted with the imputed interest rate of 10%.

The Company reviews all intangible assets periodically to determine if the value has been impaired by recentaccompanying consolidated financial transactions using the discounted cash flow analysis of revenue stream for the estimated life of the assets.  At September 30, 2013 and December 31, 2012, it was determined that no impairment existed.

The Company continues to develop new videos, music, books and digital applications in addition to adding content, improved animation and bonus songs/features to its existing product catalog.  In accordance with FASB Accounting Standards Codification regarding ASC 350 - Intangible Assets and ASC 730 - Research and Development,the costs of new product development and significant improvement to existing products are capitalized while routine and periodic alterations to existing products are expensed as incurred.As of September 30, 2013, the Company has $397,749 in Capitalized Product Development in Process representing video, music, website, digital application and preschool preparation program development projects not yet completed.statements.

Note 3: Business Combination

Overview

On November 15, 2013, the Company entered into the Merger Agreement with A Squared and Acquisition Sub. Upon closing of the Merger, which occurred concurrently with entering into the Merger Agreement, our Acquisition Sub merged with and into A Squared, and A Squared, as the surviving entity, became a wholly-owned subsidiary of the Company. As a result of the Merger, the Company acquired the business and operations of A Squared. A Squared is a children’s entertainment production company that produces original content for children and families that provide entertaining and educational media experiences. A Squared also creates comprehensive consumer product programs in the forms of toys, books and electronics. A Squared works with broadcasters, digital and online distributors and retailers worldwide as well as major toy companies, video game companies and top licensees in the kids and family arena.

Immediately following the Merger, the Company’s pre-Merger shareholders and option holders owned approximately 50% of the Company’s common stock on a fully-diluted basis, and former A Squared members owned approximately 50% of the Company’s common stock on a fully diluted basis.

Pursuant to the terms and conditions of the Merger:

Accounting Treatment

Although the transaction has been structured as a merger of equals, the merger will be treated as a business combination for accounting purposes. The audited financial statements have been prepared using the acquisition method of accounting in accordance with ASC 805, Business Combinations. Genius Brands is the deemed accounting acquirer, and A Squared is the deemed accounting acquiree based on the following factors: the transfer of the Company’s equity as consideration for the merger, the relative size of the pre-merger assets and revenue bases with the Company holding a significantly larger asset and revenue base as compared to A Squared, and the fact that the Company paid a premium over the pre-combination fair value of A Squared.

Purchase Price Allocation

The following table summarizes the final purchase accounting for the fair value of the assets acquired and liabilities assumed at the date of the Merger:

Proforma

Included in the consolidated statement of operations for three months ended March 31, 2014 are revenues of $60,461 and net loss of $255,947 attributed to A Squared Entertainment LLC from the date of acquisition.

The table below presents the proforma revenue and net loss for the quarters ended March 31, 2014 and 2013, assuming the Merger had occurred on January 1, 2013, pursuant to ASC 805-10-50. Thisproformainformation does not purport to represent what the actual results of operations of the Company would have been had Merger occurred on this date nor does it purport to predict the results of operations for future periods.

Note 4: Investment in Stan Lee Comics LLC

In November 2009, A Squared formed a joint venture, Stan Lee Comics, LLC, with POW Entertainment Inc. (“POW”), a California corporation, and Archie Comic Publications, Inc. (“Archie”), a New York corporation, to create, distribute, and exploit comic books and other intellectual property based on exclusive properties created by Stan Lee and owned by POW Entertainment, Inc. Each of A Squared, POW, and Archie own one-third of Stan Lee Comics, LLC.

Upon formation, the parties agreed that POW would contribute certain properties to Stan Lee Comics, LLC as consideration for its ownership interest. Similarly, A Squared would contribute certain creative development functions and be entitled to the exercise of all audio-visual development, production and distribution rights in all media, as well as all merchandising rights, in and to the contributed properties as consideration for its ownership interest. Finally, Archie would be entitled to all comic book publication and distribution rights in and to the contributed properties as consideration for its ownership interest. Each party would be entitled to one-third of any net proceeds derived from the contributed properties or their derivative works after recoupment of production cost and fees. Stan Lee Comics, LLC is the owner of the Stan Lee and the Mighty 7 property.

Upon closing of the Merger, the Company assumed the rights to Stan Lee Comics, LLC held by A Squared.

Pursuant to ASC 323-30, as of March 31, 2014, the Company has recorded the Investment in Stan Lee Comics LLC at $0 as no monetary consideration was paid by A Squared, or assumed by the Company in the Merger, for the ownership interest in Stan Lee Comics, LLC.

Note 5:  Property and Equipment, Net

The Company has property and equipment as follows as of March 31, 2014 and December 31, 2013:

During the three months ended March 31, 2014 and 2013, the Company recorded depreciation expense of $12,470 and $2,595, respectively.

Note 6:  Film and Television Costs and Capitalized Product Development in Process

 As of March 31, 2014, the Company had Film and Television Costs of $89,819 compared to $0 at December 31, 2013. The increase relates to the commencement of production of the second installment of the feature filmStan Lee and the Mighty 7 and episodes of theThomas Edison: Secret Lab.

As of March 31, 2014, the Company had Capitalized Product Development in Process of $67,030 compared to $54,575 as of December 31, 2013. These assets relate to the ongoing development of the Company’s e-commerce website and web-based streaming services.

Note 7: Goodwill and Intangible Assets, Net

Goodwill

In association with the Merger, the Company recognized $10,365,806 in Goodwill, representing the excess of the fair value of the consideration for the Merger over net identifiable assets acquired (See Note 3 - Business Combination for additional information). Pursuant to ASC 350-20, Goodwill is not subject to amortization but is subject to annual review to determine if certain events warrant impairment to the Goodwill asset. As of December 31, 2013, no impairment was warranted or recognized.

Intangible Assets, Net

The Company had following intangible assets as of March 31, 2014 and December 31, 2013:

Note 3:8: Accrued Liabilities

Accrued but unpaid salaries and vacation benefits total $746,377 and $516,083 asAs of September 30, 2013March 31, 2014 and December 31, 2012, respectively.   Debenture Interest2013, the Company has the following accrued and unpaid is $40,663 and $45,716 at September 30, 2013 and December 31, 2012, respectively.  Other accrued liabilities totaling $199,633 and $496,662 as of September 30, 2013 and December 31, 2102 are as follows:liabilities:

Note 9: Short Term Debt - Related Parties

The Company recognized a derivative liability for the conversion feature and warrants for the $1.0 million senior secured debenture issued to Hillair on June 27, 2012 as an embedded derivative. It was valued on the respective transaction dates of June 27, 2012 for issuance of the debentures and August 30, 2013, the date on which it was assigned to other holders, using a Black-Scholes pricing model. Warrants to purchase 5,000,000 shares of common stock were issued to Hillair asAs part of the debenture, and were exchanged pursuant to an agreement between Hillair andMerger, the Company on August 29, 2013 on a one for one basis with no receiptacquired certain liabilities from A Squared. From time to time, A Squared required short-term advances to fund its operations and provide working capital from its founder, the Company’s current Chief Executive Officer, Andrew Heyward. As of cash. 380,952 warrantsMarch 31, 2014, these advances totaled $415,787, compared to purchase shares$516,659 as of common stock were issued toNational Securities Corporation and several of its employees, who acted as placement agent toDecember 31, 2013. On March 3, 2014, the Company in connection with the Debenture. These warrants haverepaid a cashless exercise provision effective six months after the issuance date. In accordance with ASC 815-10-25, we measured the subsequent derivative valuation using a Black-Scholes pricing model on December 31, 2012 and recorded the additional derivative liability as of that date. See Note 6: Stockholders’ Equity for additional information on the warrants issued.

On August 29, 2013, pursuant to an agreement between the Company, Hillair and four new holders, the original debenture was assigned and exchanged for an aggregate of $1,163,333 in new notes with the same provisions. The additional value represented an increase of $150,000 in prepayment fees and $13,333 in accrued but unpaid interest. The interest rate and maturity date were not changed.

On September 6, 2013, a holderportion of the reissued debenture issued a notice of voluntary conversion for $75,000 of the issuance price reducing the aggregate amount of the outstanding debenturesMember Advances to $1,088,333. 6,188,119 shares of common stock were issued. A loss on the conversion was recordedits Chief Executive Officer, Andrew Heyward, in the amount of $67,376.$100,000.

At the end of each quarterly reporting date the valuesThese advances are evaluatedinterest free and adjusted to current market value. The amount recorded as of September 30, 2013 and December 31, 2012 was $2,040,240 and $68,962, respectively.

Derivative liability activity for the nine months ending September 30, 2013 was as follows:

Fair market values of the Company's derivatives as of September 30, 2013 were based on the Black Scholes valuation using the following assumptions:

The conversion feature may be exercised at any time and are thus reported as current liabilities.

have no stated maturity. The Company recorded a loss on the derivative valuation for the debenture in the amount of $1,051,034 for the nine months ended September 30, 2013 and a gain on the derivative valuation in the amount of $46,257 for the nine months ended September 30, 2012.

Note 4: Notes Payable

On June 27, 2012, the Company entered into a Securities Purchase Agreement with Hillair Capital Investments L.P. ("Hillair") whereby the Company issued and sold (i) a $1,000,000 16% senior secured convertible debenture due June 27, 2014 (the “Debenture”), and (ii) a common stock purchase warrant (the “Debenture Warrant”) to purchase up to 5,000,000 shares of the Company’s common stock. The initial closing of the Debenture and Warrant Transaction occurred on June 27, 2012 (“Original Issue Date”). The Company issued to Hillair the Debenture and the Debenture Warrant for the purchase price of $1,000,000. The Debenture is convertible, in whole or in part, into shares of Common Stock upon notice by the holder to the Company, subject to certain conversion limitations set forth in the Debenture. The conversion price for the Debenture is $0.21 per share, subject to adjustments. Interest on the Debenture accrues at thehas applied an imputed interest rate of 16% annually and is payable quarterly on February 1, May 1, August 1 and November 1, beginning on November 1, 2012, on any redemption, conversion and at maturity. Interest is payable in cash or at the Company’s option in shares of the Company’s common stock; provided certain conditions are met. On August 29, 2013, pursuant to an agreement between the Company, Hillair and four new holders, the original debenture was assigned and exchanged for an aggregate of $1,163,333 in new notes with the same provisions. The additional value is due to an increase of $150,000 in prepayment fees and $13,333 in accrued but unpaid interest at the time of the exchange. The interest rate and maturity date were not changed. Commencing on December 27, 2013, the Company will be obligated to redeem a certain amount under the reissued Debentures on a quarterly basis, in an amount equal to $300,000 on each of December 27, 2013 and March 27, 2014 and $488,033 on June 27, 2014. On September 6, 2013, a holder of the reissued debenture issued notice of voluntary conversion for $75,000 of the issuance price reducing the aggregate amount of the outstanding debentures to $1,088,333.

Accrued interest was recorded as of September 30, 2013 and December 31, 2012 in the amounts of $40,663 and $45,716, respectively.

Debt Discount was recorded in the aggregate amount of $648,972 for the issuance of warrants and the derivative value of the convertible feature of the debenture at inception of the issuance to Hillair. The unamortized discount amount of $322,903 for the Hillair debenture was recorded as interest expense in the period ended September 30, 2013.

The warrants were valued in the amount of $379,688, based on the Black-Scholes valuation using the following assumptions:

Debt Discount for the convertible feature of the debenture was valued in the amount of $269,284 using the Black-Scholes calculation with the following assumptions:

Debt Discount was recorded in the aggregate amount of $1,163,333 for the derivative value of the convertible feature of the reissued debenture on the exchange date using the Black-Scholes calculation with the following assumptions:

Interest expense for the amortization of the debt discount for the warrants and convertible feature of the debenture is calculated on a straight-line basis over the remaining life of the debenture. For the periods ended September 30, 2013 and December 31, 2012, amortization of the debt discount was recorded in the amounts of $278,577 and $163,825, respectively, for a debt discount balance of $979,499 and $485,147, respectively.

To secure the Company’s obligations under the Debenture, the Company granted a security interest in certain of its property to secure the prompt payment, performance and discharge in full of all of the Company’s obligations under the Debenture.

National Securities Corporation acted as placement agent to the Company in connection with the Debenture and Warrant Transaction and received commissions of 8% of the gross proceeds and a five year warrant to purchase up to 380,952 shares of the company’s common stock at a price of $0.33 per share, which warrant contained terms substantially similar to the Debenture Warrants.

Additional information regarding the Debenture may be found in the Form 8-K filed by the Company on July 2, 2012.

On August 30, 2013, the Company issued 12% convertible notes to several parties with a maturity date of October 21, 2013 for an aggregate of $530,000. The notes have a stated conversion rate of $0.01212 and can be voluntarily converted at any time by the holder and mandatorily by the Company upon certain conditions. Cash was received in the aggregate of $309,000. Four officers and directors of the Company converted outstanding salaries payable to the new notes in the aggregate of $221,000. Additional information regarding the notes payable may be found on the Form 8-K filed by the Company on September 4, 2013.

Debenture Interest accrued and unpaid for the 2006 issuance of $2.5 million is $19,049 as of September 30, 2013 and December 31, 2012. Interest on this series of debentures was terminated effective July 24, 20096% in accordance with ASC 835-30-45. During the conversion agreement upon establishment of a secondary trading market for our common stock.

As of September 30, 2013 and Decemberquarter ended March 31, 2012,2014, the Company had the following notes payable and accruedrecognized imputed interest balances outstanding:expense of $7,163.

Maturities requirements on notes payable subject to mandatory redemption at September 30, 2013, are as follow:

Note 5: Notes Payable and Accrued Interest - Related Parties

As of September 30, 2013 and December 31, 2012, the Company had the following notes payable and accrued interest balances outstanding:

Throughout 2009, 2008 and 2007, the Company borrowed funds from Messrs. Moeller, Meader, Larry Balaban and Howard Balaban in the aggregate principal amounts of $4,000, $280,000 and $444,500, respectively.  The proceeds from all officer loans were used to pay operating obligations of the Company.  Subsequent agreements amended the stated interest rate to 6% per annum and extended the maturity to January 15, 2015. Repayments were made on February 2, 2011 and April 27, 2011 in the aggregate amounts of $66,000 and $30,000, respectively. For the three months ended September 30, 2013 compared to the same period of 2012, interest expenses for these loans were recorded in amounts of $3,779 and $3,559, respectively. For the nine months ended September 30, 2013 and 2012, the interest expenses for these loans were $11,166 and $10,519, respectively.

On February 1, 2008, Isabel Moeller, sister of our Chief Executive Officer, Klaus Moeller, loaned $310,000 to the Company at an interest rate equal to 8% per annum. The funds were borrowed from Ms. Moeller in order to reduce outstanding obligations due to Genius Products, Inc. at that time. Subsequent agreements extended the maturity date to January 15, 2015 and reduced the stated interest rate to six (6%) percent per annum. Repayments on the principal balance were made in the aggregate of $24,000 during February and April 2011. On April 1, 2011, Ms. Moeller agreed to convert $200,000 of the outstanding balance to shares of common stock of the Company. On March 31, 2012, Ms. Moeller agreed to convert the remaining balance of outstanding principal and interest, in the amount of $173,385, to shares of common stock of the Company. There was no interest expense recorded for the three months ended September 30, 2013 or 2012. Interest expense nine months ended September 30, 2013 and September 30, 2012 was $0 and $2,562, respectively. The note is paid in full.

On March 31, 2011, four of the Company’s officers agreed to convert accrued but unpaid salaries through December 31, 2010 to subordinated long term notes payable. In February 2011, as a result of an agreement by each of the four officers to retroactively decrease the amount of the annual salary for 2010 from $125,000 per annum per officer to $80,000, the amount of the notes were reduced to an aggregate of $1,620,137. In March 2012, the officers agreed to convert the aggregate sum of $1,572,161 to shares of common stock of the Company. The remaining note, with a principal balance of $159,753, has a maturity of January 15, 2015 and a stated interest rate of six percent (6%) per annum. For the three months ended September 30, 2013 and 2012, the interest recorded for this notes was $4,185 and $2,508, respectively. For the nine month periods ended September 30, 2013 and 2012, interest expense was recorded in the amounts $10,331 and $31,019, respectively. The decrease in expense was due to conversion of a majority of the outstanding balance to common stock on March 31, 2012.

Maturities requirements on notes payable - related party subject to mandatory redemption at September 30, 2013, are as follow:

Note 6:10: Stockholders’ Equity

As part of the Reincorporation, the total number of authorized shares of common stock was changed to 250,000,000 shares, of $0.001 par value.value per share. The common stock and additional paid in capital accounts were restated as of December 31, 2012, and for the years then ended, to recognize the change from no par common stock to a par value of $0.001 per share. The Company conducted a consent solicitation of its stockholders of record as of September 3, 2013 (the “Record Date”) to approve certain corporation actions. Stockholders, representing at least a majority of outstanding shares of the Company’s voting capital as of the Record Date voted by written consent to approve an amendment to the company’s Article of Incorporation in order to increase the number of common stock authorized to 700,000,000 from 250,000,000. As of September 30, 2013March 31, 2014 and December 31, 2012,2013, the total number of authorized shares of common stock was 700,000,000.

As part of the aforementioned consent solicitation, stockholders, representing at least a majority of outstanding shares of the Company’s voting capital as of the Record Date, also voted by written consent to approve a proposal to effect a reverse split of the Company’s common stock in a ratio to be determined by the Board which would not be less than One for Ten (1:10) and not more than One for One-Hundred (1:100), which was to be effective no later than September 30, 2014, at the sole discretion of the Board and in lieu of issuing any fractional shares resulting from the reverse split, to issue the next whole share (the “Reverse Split”).

On April 2, 2014, we filed a certificate of amendment to our Articles of Incorporation to affect a reverse split of our issued and outstanding common stock on a one-for-one hundred basis. The reverse stock split was effective with FINRA on April 7, 2014. All common stock share and per share information in this Form 10-Q, including the accompanying consolidated financial statements and notes thereto, have been adjusted to reflect retrospective application of the reverse split, unless otherwise indicated. The total number of authorized shares of common stock was not adjusted in conjunction with the reverse split.

As of March 31, 2014 and December 31, 2013, there were 87,512,0076,047,707 and 71,912,6175,918,704 shares of common stock outstanding, respectively.

The Company has 10,000,000 shares of preferred stock authorized with a par value of $0.001.$0.001 per share. The Board of Directors is authorized, subject to any limitations prescribed by law, without further vote or action by our stockholders, to issue from time to time shares of preferred stock in one or more series. Each series of preferred stock will have such number of shares, designations, preferences, voting powers, qualifications and special or relative rights or privileges as shall be determined by our board of directors, which may include, among others, dividend rights, voting rights, liquidation preferences, conversion rights and preemptive rights. As of September 30, 2013March 31, 2014 and December 31, 2012,2013, no shares were outstanding, and the Board of Directors has not authorized issuance of preferred shares.

On February 1, 2013,January 10, 2014, the Company issued 470,588102,860 shares of the Company’s common stock in a private placement to certain investors at $3.50 per share. The Company received gross proceeds of $360,000 and paid related offering costs of $4,884.

On January 10, 2014, the Company issued 8,143 shares of common stock as an extinguishment of a $28,500 accounts payable balance for services rendered in exchange for interest payablerelation to the private placement. The shares were valued at the market price of $4.00 per share giving rise to a loss on the debenture due on that date in the amountextinguishment of $40,000, or $0.085 per share. Hillair agreed to waive any anti-dilutive provisions contained in the debenture for this transaction.accounts payable of $4,072.

On May 1, 2013,January 29, 2014, the Company issued 278,183 shares of common stock in exchange for services valued at $16,134 to Pacific Media Digital Services, LLC, or $0.06 per share.

On May 1, 2013, the Company issued 62,50018,000 shares of common stock to Direct Action Group, LLCa third party for prepaid investor relations services at $3.50 per share for a six month period beginning in January 2014.

Note 11: Stock Options

The Company has adopted the provisions of ASC 718 - Compensation which requires companies to measure the cost of employee services received in exchange for services valued at $3,125, or $0.05 per share.equity instruments based on the grant date fair value of those awards and to recognize the compensation expense over the requisite service period during which the awards are expected to vest.

On May 26, 2013,December 29, 2008, the Company issued 400,000adopted the Pacific Entertainment Corporation 2008 Stock Option Plan (the “Plan”), which provides for the issuance of qualified and non-qualified stock options to officers, directors, employees and other qualified persons. The Plan is administered by the Board of Directors of the Company or a committee appointed by the Board of Directors. The number of shares of the Company’s common stock initially reserved for issuance under the Plan was 110,000. On September 2, 2011, the shareholders holding a majority of the Company’s outstanding common stock adopted an amendment to the Company’s 2008 Stock Option Plan to increase the number of shares of common stock issuable under the plan to ROAR, LLC in exchange for services valued at $20,000, or $0.05 per share.500,000.

On August 30, 2013, 5,000,000 warrants to purchaseThe following schedule summarizes the changes in the Company’s common stock held by Hillair were exchanged on a one for one basis with no receipt of cash andoption plan during the warrants were cancelled. The shares were valued at market price of $0.05 and there was a reduction in a derivative liability of $30,964, a reduction in debt issuance cost of $14,464, and a loss on the exchange of warrants recognized in the amount of $308,500.three months ended March 31, 2014:

On September 6, 2013, a holder of the reissued debenture issued notice of voluntary conversion for $75,000 of the issuance price reducing the aggregate amount of the outstanding debentures to $1,088,333. 6,188,119 shares were issued and were valued at a market price of $0.05. In conjunction with this issuance there was a reduction in the derivative liability of $200,495, a reduction in the debt discount of $67,500, and a loss on the conversion was recorded in the amount of $67,376.

On September 13, 2013, 2,800,000 shares of common stock were issued in exchange for services valued $112,000 to New Castle LLC, or $0.04 per share.

On September 19, 2013, pursuant to an agreement to cancel a consulting agreement, 400,000 shares of common stock were issued to ROAR, LLC. The shares were valued at $0.04 per share, or $16,000.

On September 23, 2013, pursuant to a private placement memorandum,During the Company received $100,000 for purchase of common stock. The subscription documents were not receivedthree months ended March 31, 2014 and no shares were issued.

On June 27, 2012, a senior secured convertible debenture was issued in the face value of $1,000,000 with a stated conversion price of $0.21, subject to certain adjustments, and 5,000,000 warrants, which is equal to the total face value divided by the stated warrant conversion price of $0.20. The debenture warrants may be exercised at any time on or after June 27, 2012 and on or prior to the close of business on June 27, 2017, at an exercise price of $0.33 per share, subject to adjustments upon certain events.  The warrants contain full anti-dilution protection and do not limit the amount the Company would be required to pay or the number of shares the Company could be required to issue. The Company is required to reserve shares equal to the total outstanding debentures divided by seventy-five percent (75%) of the conversion price plus the outstanding warrants.

On August 29, 2013, pursuant to an agreement between the Company, Hillair and four new holders, the original debenture was assigned and exchanged for an aggregate of $1,163,333 in new notes with the same provisions. The additional value represented an increase of $150,000 in prepayment fees and $13,333 in accrued but unpaid interest. The interest rate and maturity date were not changed. On September 6, 2013, a holder of the reissued debenture issued notice of voluntary conversion for $75,000 of the issuance price reducing the aggregate amount of the outstanding debentures to $1,088,333. As of September 30, 2013, we have reserved 119,728,603 shares of common stock for the debenture conversion provision issued to the holders.

On August 30, 2013, the Company issued 12% convertible notes to several parties with a maturity daterecognized stock based compensation expense of October 21, 2013 for an aggregate of $530,000. The notes have a stated conversion rate of $0.01212$0 and can be voluntarily converted at any time by the holder and mandatorily by the Company upon certain conditions. Cash was received in the aggregate of $309,000. Four officers and directors of the Company converted outstanding salaries payable to the new notes in the aggregate of $221,000. As of September 30, 2013, we have reserved 43,729,373 shares of common stock for the conversion provision issued to the holders. See Note 4: Notes Payable for additional information.$58,279, respectively.

Note 7:12: Income Taxes

The Company accounts for income taxes in accordance with Accounting Standards Codification Topic 740, Income Taxes (“Topic 740”), which requires the recognition of deferred tax liabilities and assets at currently enacted tax rates for the expected future tax consequences of events that have been included in the financial statements or tax returns.  A valuation allowance is recognized to reduce the net deferred tax asset to an amount that is more likely than not to be realized.

Topic 740 provides guidance on the accounting for uncertainty in income taxes recognized in a company’s financial statements.  Topic 740 requires a company to determine whether it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position.  If the more-likely-than-not threshold is met, a company must measure the tax position to determine the amount to recognize in the financial statements.

At the adoption date of January 1, 2008, the Company had no unrecognized tax benefit which would affect the effective tax rate if recognized.

The Company includes interest and penalties arising from the underpayment of income taxes in the statements of operation in the provision for income taxes.  As of September 30, 2013March 31, 2014 and December 31, 2012,2013, the Company had no accrued interest or penalties related to uncertain tax positions.

The Company files income tax returns in the U.S. federal jurisdiction and in the state of California.  The Company is currently subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities since inception of the Company.

Note 8: Lease Commitments

The Company has no capital leases subject to the Capital Lease guidelines in the FASB Accounting Standards Codification.  Rental expenses incurred for operating leases during the three months ended September 30, 2013 and 2012 were $0 and $9,432, respectively, and for the nine months ended September 30, 2013 and September 30, 2012 were $8,201 and $28,295, respectively.  Warehouse space of approximately 2,000 square feet in Rogers, Minnesota was rented on a month to month basis and was vacated as of October 31, 2013. In November 2012, the Company signed a nine month lease to occupy three offices in San Diego, California, which terminated as of April 30, 2013.

Note 9: Recent Accounting Pronouncements

The Company reviews all of the Financial Accounting Standard Board’s updates periodically to ensure the Company’s compliance of its accounting policies and disclosure requirements to the Codification Topics. The Company has determined there were no new accounting pronouncements issued during the nine months ended September 30, 2013 that the Company believes are applicable or would have a material impact on the financial statements of the Company.

Note 10: Stock Options

The Company has adopted the provisions of ASC 718 – Compensation which requires companies to measure the cost of employee services received in exchange for equity instruments based on the grant date fair value of those awards and to recognize the compensation expense over the requisite service period during which the awards are expected to vest.

On December 29, 2008, the Company adopted the Pacific Entertainment Corporation 2008 Stock  Option Plan (the “Plan”), which provides for the issuance of qualified and non-qualified stock options to officers, directors, employees and other qualified persons. The Plan is administered by the Board of Directors of the Company or a committee appointed by the Board of Directors. The number of shares of the Company’s common stock initially reserved for issuance under the Plan was 11 million. On September 2, 2011, the shareholders holding a majority of the Company’s outstanding common stock adopted an amendment to the Company’s 2008 Stock Option Plan to increase the number of shares of common stock issuable under the plan to 50 million.  

As of September 30, 2013, options to purchase up to 8,390,000 shares of the Company’s common stock previously issued in 2009 through 2012 expired or were cancelled.

On May 15, 2013, Stock Option Grant Notices were issued to each of five officers to purchase up to 750,000 shares of common stock, vesting on the grant date, at an exercise price of $0.20 per share. The options have expiration dates five years from the grant date.

On May 15, 2013, options to purchase up to 250,000 shares of common stock were issued to an employee, vesting on the date of grant, at an exercise price of $0.20 per share. The options have an expiration date five years from the date of the grant notice.

On May 15, 2013, pursuant to amendments to employment agreements with Messrs. Moeller, Meader, Larry Balaban and Howard Balaban, Stock Option Grant Notices previously granted to each employee to purchase up to two million shares of common stock expiring on January 20, 2014 were cancelled effective immediately.

On September 10, 2013 Stock Option Grant Notice was issued to an employee to purchase up to 100,000 shares of common stock, vesting on the grant date, at an exercise price of $0.44. The options have an expiration date five years from the date of the grant notice.

The following schedule summarizes the changes in the Company’s stock option plan for the nine months ended September 30, 2013:

Note 11: Warrants

The Company has warrants outstanding to purchase up to 543,452 and 5,852,060 shares of our common stock at September 30, 2013 and December 31, 2012, respectively.

In connection with the sale of shares of its common stock in 2010 the Company issued warrants to purchase a total of 471,108 shares of its common stock at $0.40 per share exercisable for a three-year period. As of September 30, 2013, 5,308,608 of these warrants have expired or were cancelled, 5,000,000 of which were cancelled in exchange for 5,000,000 shares of the Company’s common stock (See Note 6).

 Either the exercise price or the number of shares purchasable under the warrant may be adjusted in the event of any split of the common stock, reclassification, capital reorganization or change in the outstanding common stock, or declaration of a common stock dividend.  In the event of any such adjustment, the Company will notify the holders of the warrants of the exercise price and number of shares purchasable under the warrant following adjustment, the facts requiring the adjustment and the method of calculation of any increase or decrease in price or purchasable shares. No adjustment will be required, however, unless the adjustment would require an increase or decrease in the exercise price of at least 1%.

The following schedule summarizes the changes in the Company’s warrants during the nine months ended September 30, 2013:

The following schedule summarizes the outstanding warrants at September 30, 2013:

Note 12: Fair Value Measurements

We adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) as of January 1, 2008 for financial instruments measured at fair value on a recurring basis. ASC Topic 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about 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. ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at September 30, 2013:

Note 13: Employment Agreements

On April 26, 2011,November 15, 2013, as a closing condition to the Merger, the Company and each of Messrs. Moeller, Meader, Larry Balaban and Howard Balaban (the “Executives”) agreed to terminate all then existing employment agreements for the Executives and enterentered into new five-year employment agreements unless written termination is provided by either party. Each employment agreement provides for a graduated base salary beginning at $165,000 per annum retroactivewith Andrew Heyward, to March 20, 2011, continuingserve as Chief Executive Officer, and Amy Moynihan Heyward, to December 31, 2011, increasing to $195,000 for 2012 and $225,000 for 2013. After 2013, the agreement provides for base salary increases at the discretionserve as President of the Board of Directors, with a minimum 5% increase.  In addition to base salary,Company, for which each Executive will receive an annual car allowancebase salary of $11,400,$200,000 and four weeks paid vacation per annum.$180,000, respectively.

On January 10, 2013, Messrs. Moeller, Meader and Howard Balaban agreed to reduce the amount of payments for salary effective January 1, 2013 through January 19, 2013 to $165,000 and a further reduction to $140,000 commencing January 20, 2013, continuing until further notice by each one to the Board of Directors. The agreements with each of Messrs. Moeller, Meader and Howard Balaban include the accrual of unpaid salary, the right to convert any or all of the accrued but unpaid salary to common stock of the Company at a conversion price of $0.21 per share and an amendment to all outstanding stock option grant notices to allow each to retain all rights until the expiration date upon termination unless for cause, as defined in the employment agreement.Note 14: Lease Commitments

On March 28, 2013, Mr. Meader voluntarily resigned his position as President effective April 1, 2013. The Company agreed to the retention of all stock options granted to Mr. Meader as of the date of termination, vesting and expiration dates in accordance with the original grant notices in exchange for a general release of all claims against the Company. The Company has entered into a consulting agreement with Mr. Meaderno capital leases subject to provide continued services for an initial period of twelve months.the Capital Lease guidelines in the FASB Accounting Standards Codification.

On May 2,Rental expenses incurred for operating leases during the three months ended March 31, 2014 and 2013 were $35,815 and $6,947, respectively.  

Warehouse space of approximately 2,000 square feet in Rogers, Minnesota was rented on a month to month basis and was vacated as of October 31, 2013. In November 2012, the Company entered intosigned a five-year “at will” employment agreement with Jeanene Morgannine month lease to serveoccupy three offices in San Diego, California, which terminated as of April 30, 2013.

Currently, the Company’s Chief Financial Officer.Company leases approximately 2,807 square feet of office space at 9401 Wilshire Boulevard, Beverly Hills, California pursuant to a standard office lease dated February 3, 2012. The agreement provideslease has a base salaryterm of $165,000 per annum3 years, from JanuaryMay 1, 2012 through April 30, 2015. The monthly rent is $10,807 which is to December 31, 2012, increasing to $190,000be adjusted upward 3% each year on January 1, 2013 and $215,000 on January 1, 2014. After 2014, the agreement provides for base salary increases at the discretionanniversary of the Board of Directors with a minimum 5% increase. The board of directors, in its sole discretion, may grant Ms. Morgan a year-end bonus with a value of no less than 2% of EBITDA of the Company (assuming a positive figure) and up to 100% of Ms. Morgan’s base salary. Ms. Morgan shall be granted an option to purchase 200,000 shares of the Company’s common stock. Ms. Morgan shall be permitted to participate in all benefit plans of the Company and receive 4 weeks paid vacation.

On January 10, 2013, Ms. Morgan agreed to defer the payment of the salary increase which would have become effective January 1, 2013. The deferral will continue until further notice by Ms. Morgan to the Board of Directors. The agreement includes the accrual of unpaid salary, the right to convert any or all of the accrued but unpaid salary to common stock of the Company at a conversion price of $0.21 per share and an amendment to all outstanding stock option grant notices to allow Ms. Morgan to retain all rights until the expiration date upon termination unless for cause, as defined in the employment agreement.lease.

The following is a schedule by year of the future minimum salarylease payments related to these employment agreements:required by the non-cancelable operating lease agreement:

Note 14:  Restatement

The Company has restated its financial statements for the three and nine month periods ended September 30, 2012. The Company determined that a derivative liability should have been recognized for the conversion feature and warrants for the $1.0 million senior secured debenture issued to Hillair on June 27, 2012 as an embedded derivative.  All of the issues were non-cash items.  The audited financial statements as of December 31, 2012 correctly recorded and presented the derivative liability.

The impact of the restatements of the Statement of Operations accounts for the periods ended September 30, 2012 are as follows: