KDE 4Kids Entertainment Common Stock

Large accelerated filer ___

Accelerated filer ___

Non-accelerated filer X

Smaller reporting company ___

4Kids Entertainment,   Inc. and Subsidiaries

 

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements.

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

MARCH 31, 2010 and DECEMBER 31, 2009

(In thousands of dollars, except share data)

 

 

 

See notes to consolidated financial statements.

2

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2010 AND 2009

(In thousands of dollars, except share data)

 

 

See notes to consolidated financial statements.

 

3

 

 

 

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE LOSS

THREE MONTHS ENDED MARCH 31, 2010 (UNAUDITED) AND THE YEAR ENDED DECEMBER 31, 2009

(In thousands of dollars and shares)

 

 

 

(1) Cumulative effect adjustment to opening retained earnings as of January 1, 2009, related to the adoption of new accounting standards on investments in debt and equity securities (see Note 2).

 

See notes to consolidated financial statements.

 

 

 

 

 

 

 

4

 

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2010 AND 2009

 

See notes to consolidated financial statements.

 

 

5

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands of dollars, except share and per share data)

 

1. DESCRIPTION OF BUSINESS

 

General Development and Narrative Description of Business - 4Kids Entertainment, Inc., together with the subsidiaries through which its businesses are conducted (the “Company”), is a diversified entertainment and media company specializing in the youth oriented market with operations in the following business segments: (i) Licensing; (ii) Advertising Media and Broadcast; (iii) Television and Film Production/Distribution; and (iv) Trading Card and Game Distribution. The Company was organized as a New York corporation in 1970.

 

Licensing - The Licensing business segment consists of the results of operations of the following wholly-owned subsidiaries of the Company: 4Kids Entertainment Licensing, Inc. (“4Kids Licensing”); 4Sight Licensing Solutions, Inc. (“4Sight Licensing”); 4Kids Entertainment International, Ltd. (“4Kids International”); and 4Kids Technology, Inc. (“4Kids Technology”). 4Kids Licensing is engaged in the business of licensing the merchandising rights to popular children’s television series, properties and product concepts (individually, the “Property” or collectively the “Properties”). 4Kids Licensing typically acts as exclusive merchandising agent in connection with the grant to third parties of licenses to manufacture and sell all types of merchandise, including toys, videogames, trading cards, apparel, housewares, footwear, books and other published materials, based on such Properties. 4Sight Licensing is engaged in the business of licensing properties and product concepts to adults, teens and “tweens”. 4Sight Licensing focuses on brand building through licensing. 4Kids International, based in London, manages Properties represented by the Company in the United Kingdom and European marketplaces. 4Kids Technology develops ideas and concepts for licensing which integrate new and existing technologies with traditional game and toy play patterns.

 

Advertising Media and Broadcast - The Company, through a multi-year agreement with The CW Network, LLC (“The CW”), leases The CW’s Saturday morning programming block (“The CW4Kids”) which broadcasts in most markets from 7am to 12pm for an initial term of five years beginning with The CW's 2008-2009 broadcast season. The Company provides substantially all programming content to be broadcast on The CW4Kids. 4Kids Ad Sales, Inc. (“4Kids Ad Sales”), a wholly-owned subsidiary of the Company, retains a portion of the revenue from its sale of network advertising time for the five-hour time period.

 

The Advertising Media and Broadcast segment also generates revenues from the sale of advertising on the Company’s multiple websites. These websites also showcase and promote The CW4Kids, as well as its many Properties.

 

Television and Film Production/Distribution - The Television and Film Production/Distribution business segment consists of the results of operations of the following wholly-owned subsidiaries of the Company: 4Kids Productions, Inc. (“4Kids Productions”); 4Kids Entertainment Music, Inc. (“4Kids Music”); and 4Kids Entertainment Home Video, Inc. (“4Kids Home Video”). 4Kids Productions produces and adapts animated and live-action television programs and theatrical motion pictures for distribution to the domestic and international television, home video and theatrical markets. 4Kids Music composes original music for incorporation into television programming produced by 4Kids Productions and markets and manages such music. 4Kids Home Video distributes home videos associated with television programming produced by 4Kids Productions.

 

Trading Card and Game Distribution - Through its wholly-owned subsidiary, 4Kids Digital Games, Inc. (“4Kids Digital”), the Company owns 55% of TC Digital Games LLC, a Delaware limited liability company (“TC Digital”) that produces, markets and distributes the “Chaotic” trading card game. In December 2006, 4Kids Digital acquired a 53% ownership interest in TC Digital and entered into TC Digital’s operating agreement (the “TCD Agreement”) with Chaotic USA Digital Games LLC (“CUSA LLC”), a wholly-owned subsidiary of Chaotic USA Entertainment Group, Inc. (“CUSA”). The TCD Agreement contains terms and conditions governing the operations of TC Digital, and entitles 4Kids Digital and CUSA to elect two managers to the entity’s Management Committee with 4Kids Digital having the right to break any dead-locks. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA increasing 4Kids Digital’s ownership percentage to 55%. The consideration for the purchase of the additional membership interest was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites LLC, a Delaware limited liability company and subsidiary of the Company (“TC Websites”) under TC Websites’ operating agreement (the “TCW Agreement”). TC Digital is consolidated in the Company’s consolidated financial statements, subject to a noncontrolling interest.

 

 

Through its wholly-owned subsidiary, 4Kids Websites, Inc. (“4Kids Websites”), the Company owns 55% of TC Websites, a company that owns and operates www.chaoticgame.com , the companion website for the “Chaotic” trading card game which was launched as a public beta version on October 24, 2007. In December 2006, 4Kids Websites purchased a 50% membership interest in TC Websites from CUSA and entered into the TCW Agreement. The TCW Agreement contains terms and conditions governing TC Websites’ operations and entitles 4Kids Websites and CUSA to elect two managers to its Management Committee. On December 18, 2007, 4Kids Websites entered into an agreement pursuant to which it acquired an additional 5% ownership interest in TC Websites from CUSA, and the TCW Agreement was concurrently amended to provide 4Kids Websites with the right to break any deadlocks on TC Websites’ Management Committee, including with respect to operational matters. The consideration for the purchase of the additional membership interest was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites under the TCW Agreement. Prior to the acquisition by 4Kids Websites of the additional 5% ownership interest and amendment of the TCW Agreement, the Company used the equity method to account for its investment in TC Websites, where it did not have control but had significant influence. As a result of 4Kids Websites’ increased ownership and operational control, TC Websites is consolidated in the Company’s financial statements, subject to a noncontrolling interest.

 

Additionally, in March 2009, TC Digital, the Company and Home Focus entered into various agreements pursuant to which TC Digital and Home Focus agreed to form TC Digital International, Ltd. (“TDI”), an Irish Private Corporation, for the purpose of distributing “Chaotic” trading cards principally in Europe and the Middle East (“TDI Territory”) and the Company agreed to purchase a 25% interest in TDI from Home Focus (the "TDI Interest"). As a result, TDI is owned 50% by TC Digital, 25% by the Company and 25% by Home Focus. As permitted by authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) and based on the Company’s controlling interest and operational control, TDI’s financial statements are included in the Company’s consolidated financial statements for the three month period ended March, 31, 2010.

 

TC Digital and TC Websites are the exclusive licensees of certain patents covering the uploading of coded trading cards to a website where online game play and community activities occur. The www.chaoticgame.com website provides full access to all of its content and is free of charge for all users. No purchase of trading cards is necessary to play the online version where virtual playing decks are available to users who register on the website. These two businesses enable the Company to offer traditional trading card game play with an online digital play experience.

 

Certain of the Company’s current and former executive officers have interests in CUSA, CUSA LLC and certain other entities with which TC Digital and TC Websites have engaged in transactions since their formation. Information regarding these relationships can be found in Note 8.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation - The consolidated financial statements, except for the December 31, 2009 consolidated balance sheet and the consolidated statement of changes in equity and comprehensive loss for the year ended December 31, 2009, are unaudited and should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2009 presented in our Annual Report on Form 10-K. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, which are of a normal and recurring nature, necessary to present fairly the financial position of the Company as of March 31, 2010 and December 31, 2009, and the results of operations for the three months ended March 31, 2010 and 2009, and changes in equity and comprehensive loss for the three months ended March 31, 2010 and the year ended December 31, 2009, and cash flows for the three months ended March 31, 2010 and 2009. Because of the inherent seasonality and changing trends of the toy, game, entertainment and advertising industries, operating results for the Company on a quarterly basis may not be indicative of operating results for the full year.

 

Revenue Recognition – Merchandise licensing revenues : Licensing revenues, net of licensor participations, are recognized when the underlying royalties from the sales of the related products are earned. If the Company has no significant direct continuing involvement with the underlying Property or obligation to the licensee, the Company recognizes guaranteed royalties, net of licensor participations, at the time the arrangement becomes effective as long as the license period has commenced. Where the Company has significant continuing direct involvement with the underlying Property or obligation to the licensee, guaranteed minimum royalties, net of licensor participations, are recognized ratably over the term of the license or based on sales of the related products, if greater. Licensing advances and guaranteed payments collected but not yet earned by the Company are classified as deferred revenue in the accompanying consolidated balance sheets.

 

 

Broadcast advertising revenues : Advertising revenues, net of network participations, are recognized when the related commercials are aired and are recorded net of agency commissions and net of an appropriate reserve when advertising is sold together with a guaranteed audience delivery. Internet advertising revenues are recognized on the basis of impression views in the period the advertising is displayed.

 

Episodic television series revenues : Television series initially produced for networks and first-run syndication are generally licensed to domestic and foreign markets concurrently or licensed to foreign markets with a one year lag from the domestic broadcast of the series. The length of the revenue cycle for episodic television varies depending on the number of seasons a series remains in active exploitation. Revenues arising from executed television license agreements, net of licensor participations, are recognized in the period that the films or episodic television series are available for telecast.

 

Home video revenues : Revenues from home video and DVD sales, net of a reserve for returns, are recognized, net of licensor participations, on the date that video and DVD units are shipped by the Company’s distributor to wholesalers/retailers. Consistent with the practice in the home video industry, the Company estimates the reserve for returns based upon its review of historical returns rates and expected future performance.

 

Music revenues : Revenues from music sales, net of licensor participations, and net of a reserve for returns, are recognized on the date units are shipped by the Company’s distributor to wholesalers/retailers as reported to the Company. In the case of musical performance revenues, the revenue is recognized when the musical recordings are broadcast and/or performed.

 

Trading card revenues : The FASB provides guidance on how and when to recognize revenues for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. Revenue arrangements with multiple deliverables are required to be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration must be allocated among the separate units of accounting based on their relative fair values. The Company has determined that because its trading card game is provided with a web component, there is a multiple deliverable arrangement. However, since no purchase of trading cards is necessary to access the website and virtual cards are available free of charge to users who register on the website, the Company has determined that the selling price of the trading cards should be fully attributable to the cards. Certain of the Company’s trading card distributors, have contractually changed to a point-of-sale (“POS”) model in response to the demands from retailers. Under the POS model, sales are recorded once the sales are made to the ultimate consumer. Distributors and retailers not under the POS model remain under the FOB shipping point model in which sales are recorded, net of a reserve for returns and allowance, upon shipment to distributors.

 

Revenue generated from merchandise licensing, broadcast advertising, episodic television series, home video, and music are classified as service revenue on the consolidated statement of operations while revenue generated from the sale of trading cards is classified as product revenue.

 

Fair Value Measurements - The fair values of the Company’s financial instruments reflect the estimates of amounts that would be received from selling an asset in an orderly transaction between market participants at the measurement date. The fair value estimates presented in this report are based on information available to the Company as of March 31, 2010 and December 31, 2009.

 

The carrying values of cash and cash equivalents, accounts receivable, due to licensors, accounts payable, accrued expenses and deferred revenue approximate fair value. The Company has estimated the fair value of its investment in auction rate securities (“ARS”) and other long-term investments using unobservable inputs at March 31, 2010. The authoritative guidance issued by the FASB includes a fair value hierarchy based on three levels of inputs, the first two of which are considered observable and the last of which is considered unobservable, that may be used to measure fair value. The three levels are the following:

 

 

 

 

 

 

Investments - The Company’s long-term investments principally consist of ARS, corporate bonds and preferred shares. ARS are generally rated “BBB” or better by one or more national rating agencies and have contractual maturities of up to 80 years. Of the aggregate principal amount of $26,850 in investment securities held by the Company as of March 31, 2010, 31% mature within the next 30 years, 57% mature through 2087 and the remaining 43% have no maturity date. The Company classifies these investments as “available for sale”, for certain investments in debt and equity securities. The ARS that the Company invests in generally had interest reset dates that occurred every 7 or 35 days and despite the long-term nature of their stated contractual maturity, the historical operation of the ARS market had given the Company the ability to quickly liquidate these securities at ongoing auctions every 35 days or less.

 

During 2007, liquidity issues began to affect the global credit and capital markets. In addition, certain individual ARS experienced liquidity issues specific to such securities. As a result, ARS, which historically have had a liquid market and had their interest rates reset periodically (e.g. monthly) through Dutch auctions, began to fail at auction. These auction failures have caused ARS to become illiquid, which in turn has caused the fair market values of these securities to decline.

 

The ARS currently held by the Company are private placement debt securities with long-term nominal maturities and interest rates that typically reset monthly. The Company’s investments in ARS represent interests in debt obligations issued by banks and insurance companies that originally had at least an “A” credit rating at the time of purchase, including JP Morgan Chase, bond insurers and re-insurers such as MBIA, AMBAC, FGIC, and FSA. The collateral underlying these securities consists primarily of commercial paper, but also includes asset-backed and mortgage-backed securities, corporate debt, government holdings, money market funds and other ARS.

 

As of March 31, 2010, the Company held investment securities having an aggregate principal amount of $26,850. The estimated fair market value of these securities as determined by the Company had declined by $15,137 (a decline of $15,245 prior to 2010, partially offset by an increase in value of $108 during 2010) to $11,713, as of March 31, 2010. During the first quarter of 2010, the Company sold investment securities with a par value of $8,700 for $2,575. No additional impairment charges were recorded in the first quarter of 2010 since the Company had previously recorded in earnings an unrealized loss on these securities of $6,125. Additionally, the Company did not incur any impairment charges in 2010 due to credit losses.

 

Since the Company has the ability, and presently expects, to hold its remaining investment securities until recovery of their face value, which may not be prior to the maturity of the applicable security (to the extent such security has a specified maturity date) and based on consideration of all of the factors described above, the Company considered certain of these investments to be temporarily impaired as such term is defined in the accounting literature. Accordingly, the entire balance of unrealized loss in accumulated other comprehensive income at March 31, 2010 relates to securities which the Company considers temporarily impaired. Additionally, these remaining investment securities held by the Company have continued to pay interest according to their stated terms, which the Company believes may create an incentive for the issuers to redeem these securities once the current liquidity problems in the credit market substantially improve.

 

The Company continues to monitor the market for ARS and considers its impact (if any) on the fair value of its investments. If the current market conditions deteriorate further, the Company may be required to record additional impairment charges to non-operating expense in future periods.

 

The credit and capital markets, including the market for ARS, have remained illiquid, and as a result of this and other factors specific to certain investment securities, the Company’s unrealized loss on its investment securities may subsequently increase. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; and yields of securities similar to the underlying investment securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its evaluation on the mid-point of that range. Specifically, the Company considers the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying these securities in our overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looks at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period.

 

 

 

Due to the sensitivity of the methodologies and considerations used, the Company continually re-evaluates the investment securities and although the valuation methodologies have remained consistent for each quarter in which these securities were valued, certain inputs may have changed. The changes in these inputs primarily relate to the changes in the economic environment and the market for such securities.

 

Given the failed auctions, the Company’s investment securities are currently illiquid.  Accordingly, the Company has classified all of its investment in ARS and the securities into which certain of the ARS have been exchanged, as non-current assets as of March 31, 2010 on its balance sheet due to the fact that the Company believes that the liquidity of these securities is unlikely to be restored in a period less than twelve months from such date.

 

If uncertainties in the credit and capital markets continue or the Company’s investments experience any rating downgrades on any investments in its portfolio or the value of such investments declines further, the Company may incur additional impairment charges to its investment portfolio, which could negatively affect the Company’s financial condition, results of operations and cash flow. As a result of the current market issues, the Company’s surplus cash is invested solely in government securities with a maturity of 90 days or less.

 

Based on the Company’s cash position as of March 31, 2010, the anticipated effects of the significant cost cutting initiatives implemented by the Company during 2009 and continuing into 2010, and the Company’s belief that economic conditions have become more stable, the Company expects its overall cash position to provide adequate liquidity to fund its day-to-day operations for the next twelve months. However, the illiquidity affecting a significant portion of the Company’s portfolio of investment securities is impacting the Company’s ability to make capital investments or expand its operations.

 

If the Company determines that it is necessary to generate additional cash to fund its operations, the Company will consider all alternatives available to it, including, but not limited to sales of assets, issuance of equity or debt securities and third party arrangements. There can be no assurance, however, that the Company would be able to generate such additional cash in a timely manner or that such additional cash could be obtained on terms acceptable to the Company.

 

Film and Television Costs – The Company's cost of production for television programming, including overhead, participations and talent residuals is capitalized and amortized in accordance with authoritative guidance issued by the FASB using the individual-film-forecast method under which such costs are amortized for each television program in the ratio that revenue earned in the current period for such program bears to management’s estimate of the ultimate revenues to be realized from all media and markets for such program. Management regularly reviews, and revises when necessary, its ultimate revenue estimates on a title-by-title basis, which may result in a change in the rate of amortization applicable to such title and/or a write-down of the value of such title to estimated fair value. These revisions can result in significant quarter-to-quarter and year-to-year fluctuations in film write-downs and rates of amortization. If a total net loss is projected for a particular title, the associated film and television costs are written down to estimated fair value. All exploitation costs, including advertising and marketing costs are expensed as incurred. Television adaptation and production costs that are adapted and/or produced are stated at the lower of cost, less accumulated amortization, or fair value.

 

Deferred Revenue - The Company enters into various agreements for Properties under which the Company has received certain advances and/or minimum guarantees. The unearned portion of these advances and guaranteed payments are included in deferred revenue.

 

Reclassifications - Certain reclassifications have been made to prior year amounts to conform to 2010 presentation.

 

Translation of Foreign Currency - In accordance with authoritative guidance issued by the FASB, the Company classifies items as other comprehensive income by their nature in the financial statements and displays the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the consolidated balance sheet. The assets and liabilities of the Company’s foreign subsidiary, 4Kids International have been recorded in their local currency and translated to U.S. dollars using period-end exchange rates. Income and expense items have been translated at the average rate of exchange prevailing during the period. Any adjustment resulting from translating the financial statements of the foreign subsidiary is reflected as “other comprehensive income”, net of related tax. Comprehensive loss for the three months ended March 31, 2010 and 2009 was $4,523 and $6,262, respectively, which included translation adjustments of $(154) and $(108) for the respective periods.

 

 

Recently Adopted Accounting Standards – In August 2009, the FASB issued authoritative guidance regarding the measurement of liabilities at fair value when a quoted price in an active market is not available.  In these circumstances, a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance, such as an income approach or a market approach.  The guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  This guidance is currently effective and the adoption of this guidance did not have an impact on the Company’s consolidated financial position and results of operations.

 

In June 2009, the FASB issued authoritative guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial statements about a transfer of financial assets, the effects of a transfer on its financial position, financial performance and cash flows, and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective as of the beginning of the first interim period within a reporting entity’s first annual reporting period that begins after November 15, 2009. The adoption of this guidance did not have an impact on the Company’s consolidated financial position and results of operations.

 

In May 2009, the FASB issued authoritative guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance sets forth (1) the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which events or transactions occurring after the balance sheet date should be recognized in its financial statements and (3) the disclosures that should be made about events or transactions that occurred after the balance sheet date. In February 2010, the FASB amended this new standard to eliminate the requirement to disclose the date through which subsequent events have been evaluated. As the new standard was not intended to significantly change the current practice of reporting subsequent events, it did not have an impact on the Company’s consolidated financial position and results of operations.

 

In April 2009, the FASB issued authoritative guidance related to investments in debt and equity securities. The objective of the new guidance is to make impairment guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) of debt and equity securities in financial statements.  The guidance revises the OTTI evaluation methodology. Under the guidance, the security is analyzed for credit loss, (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the statement of earnings, while the balance of impairment related to other factors will be recognized in other comprehensive income. This guidance was effective for all interim and annual periods ending after June 15, 2009. The Company adopted this authoritative guidance issued by the FASB as of January 1, 2009 and recorded a cumulative-effect adjustment of $2,130 to its opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive loss. The Company did not incur any impairment charges in 2010 due to credit losses.

 

Recently Issued Accounting Standards - In October 2009, the FASB issued authoritative guidance which will allow companies to allocate arrangement consideration to multiple deliverables. The guidance provides principles and application guidance on whether multiple deliverables exist, how an arrangement should be separated, and the consideration allocated. The guidance requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of the selling price. The guidance eliminates the use of the residual method, requires entities to allocate revenue using the relative-selling-price method and significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. The guidance requires new and expanded disclosures and is applied prospectively to revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 or retrospectively for all periods presented. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

 

 

 

 

 

 

 

3. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The carrying values and estimated fair values of the Company’s financial instruments for the periods presented are as follows:

 

Level 1- The Company’s Level 1 assets consist of cash and U.S. Treasury securities with original maturities of three months or less.

 

Level 2 - At March 31, 2010 and December 31, 2009, the Company had no investments which were considered to be Level 2 assets.

 

Level 3 – The Company’s Level 3 assets consist of the Company’s investment in ARS, corporate obligations, and preferred shares. The recent uncertainties in the credit markets have made it more difficult for the Company and other investors to liquidate their holdings of these securities for the three months ended March 31, 2010 and the year ended December 31, 2009, because the amount of securities submitted for sale has exceeded the amount of purchase orders.

 

The carrying value of the Company’s investments in its Level 3 assets, as of March 31, 2010 and December 31, 2009, represent the Company’s best estimate of the fair value of these investments based on currently available information. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; and yields of securities similar to the underlying investment securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its evaluation on the mid-point of that range. Specifically, the Company considered the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying the ARS in its overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looked at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period. If the issuers are unable to successfully close future auctions and their credit ratings

 

 

deteriorate, the Company may be required to further adjust the carrying value of its investment securities through additional devaluations.

 

The table below provides a summary of changes in fair value for the Company’s available for sale investments:

 

 

The following table presents additional information about assets measured at fair value using Level 3 inputs for the three months ended March 31, 2010: 

 

 

 

 

 

 

 

 

 

 

 

 

 

4. STOCK-BASED EMPLOYEE COMPENSATION

 

The Company has stock-based compensation plans for employees and non-employee members of the Board of Directors. The plans provide for discretionary grants of stock options, shares of restricted stock, and other stock-based awards. The plans are administered by the Compensation Committee of the Board of Directors, consisting of non-employee directors. The Company’s recognition of stock-based compensation expense in the statement of operations over the vesting period is based on the fair value of the award at the grant date.

 

The following table summarizes activity under our stock option plans for the three months ended March 31, 2010:

 

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of our common stock on the date of determination for those awards that have an exercise price currently below the closing price. As of March 31, 2010, there were no options outstanding to purchase shares with an exercise price below the quoted price of our common stock. During the three months ended March 31, 2010 and 2009, the aggregate intrinsic value of options exercised under the Company’s stock option plans was $0, determined as of the date of exercise.

 

Restricted Stock Awards

 

The Company granted restricted stock awards of approximately 378,000 shares on May 22, 2009 under its 2008 long-term incentive compensation plan (“LTICP”), 311,000 shares on May 23, 2008 under its 2007 LTICP, 162,000 shares on May 25, 2007 under its 2006 LTICP and 145,000 and 4,000 shares on May 23, 2006 and June 15, 2006, respectively, under its 2005 LTICP. The restricted stock awards were granted to certain employees, including officers and members of the Board of Directors, at grant prices of $1.46, $7.85, $16.79, $16.52 and $15.78 (in each case, the average of the high and low stock price from the previous day of trading) for the May 22, 2009, May 23, 2008, May 25, 2007, the May 23, 2006 and the June 15, 2006 grants, respectively. The restricted stock awards vest annually over a period of three years from the date of grant for the awards made under the 2008 and 2007 LTICPs and over a period of four years for the awards made under the 2006 and 2005 LTICPs, with accelerated vesting upon a change of control of the Company (as defined in the applicable plan). During the restriction period, award holders do not have the rights of stockholders and cannot transfer ownership. Additionally, nonvested shares of award holders are subject to forfeiture. These awards are forfeited and revert to the Company in the event of employment termination, except in the case of death, disability, retirement or other specified events.

 

A summary of restricted stock award activity under the Company’s LTICPs as of March 31, 2010 and changes during the three months then ended is presented as follows:

 

 

During the three months ended March 31, 2010 and 2009, the Company recognized $389 and $462, respectively, of compensation costs related to the LTICPs. Additionally, as of March 31, 2010, there was approximately $331, $716, $593 and $64 of unrecognized compensation cost related to restricted stock awards granted under the Company’s 2008, 2007, 2006 and 2005 LTICPs, respectively. The cost is expected to be recognized over a remaining weighted-average period of 2.1, 1.1, 1.1 and 0.1 years under the 2008, 2007, 2006 and 2005 LTICPs, respectively. There were no shares that vested during the three months ended March 31, 2010.

 

Availability for Future Issuance - As of March 31, 2010, (i) options to purchase approximately 1,515,000 shares of the Company’s common stock were available for future issuance under the Company’s stock option plans and (ii) options to purchase a maximum of approximately 473,000 shares of the Company’s common stock were available for future issuance under the Company’s LTICPs, reduced by four shares for each share of restricted stock awarded under the 2006 and 2005 LTICPs, under which an aggregate of 147,000 shares of the 473,000 total shares were available for issuance as options, and reduced by two shares for each share of restricted stock awarded under the 2008 and 2007 LTICPs, under which an aggregate of 326,000 of the 473,000 total shares were available for issuance as options.

 

5. INCOME TAXES

 

The benefit from income taxes consisted of the following:

 

 

The Company and its wholly-owned subsidiaries file income tax returns in the United States and in the United Kingdom. Income tax expense (benefit) is determined using the asset and liability method provided for in the authoritative guidance issued by the FASB. Deferred income taxes are recognized at currently enacted tax rates for the expected future tax consequences attributable to temporary differences between amounts reported for income tax purposes and financial reporting purposes. Deferred taxes are provided for the undistributed earnings as if they were to be distributed. The Company records a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has not recorded any liability for unrecognized tax benefits.

 

The Company is no longer subject to examinations by income tax authorities in most jurisdictions for years prior to 2006. As of March 31, 2010, there were no outstanding tax audits.

 

6. EARNINGS PER SHARE

 

The Company computes basic EPS based solely on the weighted average number of common shares outstanding during the period in accordance with authoritative guidance issued by the FASB. Diluted EPS reflects all potential dilution of common stock. The following table reconciles Basic EPS with Diluted EPS for the three months ended March 31, 2010 and 2009:

 

 

 

 

 

For the three months ended March 31, 2010 and 2009, 703,250 and 1,265,000 shares, respectively, attributable to the exercise of outstanding options, were excluded from the calculation of diluted EPS because the effect was antidilutive.

 

7. LEGAL PROCEEDINGS

 

On February 12, 2010, Home Focus Development, LTD, a British Virgin Islands Corporation, ("Home Focus") filed suit against the Company in the United States District Court for the Southern District of New York. In the lawsuit, Home Focus alleges that the Company owes it $1,075 under an Interest Purchase Agreement among the Company, Home Focus and TC Digital entered into on March 2, 2009, pursuant to which the Company acquired a 25% ownership interest in TDI. As further described in Note 8, the Company withheld payments in an aggregate amount of $725 from Home Focus otherwise due under the Interest Purchase Agreement as a result of Home Focus’s failure to make required capital contributions to TDI. On April 26, 2010, the Company answered the complaint and asserted various counterclaims against Home Focus and its owners, in their individual capacities. The Company intends to vigorously defend this litigation.

 

The Company, from time to time, is involved in litigation arising in the ordinary course of its business. The Company does not believe that such litigation to which the Company or any subsidiary of the Company is a party or of which any of their Properties is the subject will, individually or in the aggregate, have a material adverse effect on the Company’s financial position or the results of its operations.

 

8. RELATED PARTY TRANSACTIONS

 

National Law Enforcement and Firefighters Children’s Foundation - The Company’s Chairman and Chief Executive Officer is the founder and President of The National Law Enforcement and Firefighters Children’s Foundation (the “Foundation”). The Foundation is a not-for-profit organization dedicated to helping the children of law enforcement and firefighting personnel and working with law enforcement and firefighting organizations to provide all children with valuable social and life skill programs. The Company made no contributions to the Foundation for the three months ended March 31, 2010 and 2009.

 

Chaotic USA Entertainment Group, Inc. (“CUSA”) - On December 11, 2006, 4Kids Digital and CUSA LLC, entered into the TCD Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47% of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA LLC increasing 4Kids Digital’s ownership percentage to 55%. TC Digital is treated as a consolidated subsidiary of the Company as a result of its majority ownership in TC Digital and its right to break any dead-locks within the TC Digital Management Committee. Bryan Gannon (“Gannon”), President and Chief Executive Officer of CUSA and John Milito (“Milito”), Executive Vice President and Chief Operating Officer of CUSA, each own an interest of approximately 32% in CUSA and became officers of TC Digital in 2006. Milito’s employment with TC Digital was terminated on December 31, 2009.

 

As of March 31, 2010, the Company has entered into the following transactions with CUSA and CUSA LLC, or parties related to Gannon and Milito that are summarized below:

 

 

 

Agreement (“CPRA”) replacing the original Chaotic Property Representation Agreement entered into by the parties in April 2005. Under the terms of the CPRA, 4Kids Licensing is granted exclusive television broadcast and production, merchandising licensing, and home video rights to the “Chaotic” Property worldwide in perpetuity, subject to certain limited exceptions. Under the terms of the CPRA, all “Chaotic” related income less approved merchandising and other expenses shall be distributed 50% to the Company and 50% to CUSA and Apex, excluding trading card royalties which are distributed 55% to 4Kids Digital and 45% to CUSA. Additionally, all approved production expenses for television episodes based on the “Chaotic” property are allocated 50% to 4Kids Licensing and 50% to CUSA and Apex. As of March 31, 2010 and 2009 there were no distributions and approximately $8,717 and $7,604, respectively, of production, merchandising and other general expenses were owed to 4Kids Licensing by CUSA and Apex, collectively.

 

 

 

4Kids Digital is required under the terms of the TCD Agreement and the related loan and line of credit agreements to provide loans to TC Digital from time to time with a maturity date of December 31, 2010. On September 15, 2008, 4Kids Digital and TC Digital agreed to reduce the interest payable on any such loans from 12% to 9% retroactive to December 11, 2006.

 

 

 

 

$100 for services as a senior executive; and (iii) Milito equal to $100 for services as a senior executive. Under the terms of the TCW Agreement, each member of TC Websites is obligated to make capital contributions on a pro-rata basis to the extent determined by its Management Committee to be necessary to fund the operation of the Website. Any transaction resulting in the sale of more than 50% of TC Websites’ membership interests or in the sale of all or substantially all of TC Digital’s assets requires the consent of members of TC Websites holding two-thirds of its membership interests (as opposed to a majority of its membership interests).

 

 

 

9. ACCOUNTING CHANGE AND RECLASSIFICATION

 

Certain of the Company’s representation contracts contain provisions for the production of animated television episodes based on the licensor’s property. These contracts typically contain provisions for the licensor to reimburse the Company for costs incurred in the production of the television programming. The reimbursement may be in the form of reduced royalty fees owed the licensor under other provisions of the contract or in the form of direct cash reimbursement. The Company has historically accounted for this reimbursement as reduction of its film costs capitalized. Additionally, the Company has historically recorded the reimbursement as service revenue with an equal amount as cost of production.

 

These reimbursements are contained under overall representation contracts with licensors. Under these contracts, the Company will generate royalty revenue from third party licensees. Since the primary licensor (property owner) will also benefit from the increased awareness of the property, they are willing to contribute to the cost of the production of the programming. The Company believes that it is appropriate to account for the partial reimbursement of production costs as a reduction of its capitalized film costs which is amortized into the cost of revenue.

 

 

 

 

 

 

 

 

The Company has reassessed the accounting treatment for reimbursements of its production costs under representation contracts and will no longer record these amounts in the Television and Film Production/Distribution segment as revenue with a corresponding charge to production service costs. The Company has retroactively adjusted revenue and production service costs for all periods presented. The Company considered the qualitative aspect of these adjustments, as well as the impact on the Company’s operating losses and earnings per share calculations in determining that no further restatement of the Company’s financial statements is necessitated by this accounting change. The following table shows the summary impact in the consolidated statements of operations for the three months ended March 31, 2009:

 

 

10. COMMITMENTS AND CONTINGENCIES

 

a . Broadcast Agreement - On October 1, 2007, the Company and The CW entered into the CW Agreement, under which The CW granted to the Company the exclusive right to program The CW's Saturday morning children's programming block (“The CW4Kids”) that is broadcast in most markets between 7am and 12pm for an initial term of five years beginning with The CW's 2008-2009 broadcast season.

 

Under the CW Agreement, the Company is obligated to make quarterly minimum guaranteed payments which are subject to reduction under certain circumstances. The Company and The CW share advertising revenues earned from the sale of national commercial time during The CW4Kids with The CW's share to be applied against such quarterly guarantee payments. In addition, The CW is entitled under the CW Agreement to participate in the Company's merchandising revenue from certain content broadcast on The CW4Kids, if such merchandising revenues exceed a certain annual minimum. 4Kids Ad Sales, Inc. manages and accounts for the ad revenue and costs associated with The CW4Kids.

 

In December 2009, the Company notified The CW that it believed it was entitled to a reduction in the total guarantee for the broadcast year as well as a change in the split of the national advertising proceeds derived from The CW4Kids block from 80% - 20% in favor of The CW to 65% - 35% in favor of The CW as a result of industry action taken by most of the leading food advertisers reducing or otherwise limiting categories of permitted advertising in response to public concern about childhood obesity. Such a reduction and adjustment in the share of advertising proceeds is provided for under The CW Agreement if any federal, state or other governmental law, regulation or rule or any industry action bans, reduces or otherwise limits the categories of permitted advertising that can be broadcast in children's programming. The Company has supplied The CW with evidence supporting its position including a copy of the October 2009 report of the Children's Food and Beverage Advertising Initiative set up under the auspices of the Council of Better Business Bureaus which describes the effect of the industry action undertaken by leading food advertisers as well as children's food advertising spending statistics documenting the reduction in children's food advertising. In December 2009 and March 2010, the Company paid The CW installments of $4,275 and $1,900, respectively as payment of the quarterly guarantees for the 2009 - 2010 broadcast season rather than $6,750 and $3,000, respectively, the original amount required under The CW Agreement.

 

The CW has disputed the Company’s position by claiming that there has been no industry action reducing or otherwise limiting the categories of permitted advertising and believes that the Company is in breach of The CW Agreement by having paid the reduced amount in respect of the quarterly guarantee. The Company and The CW are currently in discussions regarding the contractual dispute. If they are unable to resolve the dispute through negotiation, the dispute between the Company and The CW will be resolved through arbitration. If the Company prevails through negotiation or arbitration, the $15,000 guarantee will be reduced and the split of advertising revenues will be adjusted. There can be no assurance, however, that the Company will prevail or of the amount of any reduction or adjustment in the event the Company is successful. If the Company is

 

 

unsuccessful, it will be required to pay $3,575 to The CW, representing the difference between the original amount required under The CW Agreement and the amount paid by the Company through March 2010.

 

As of March 31, 2010, the minimum guaranteed payment obligations under the CW Agreement, assuming full payment is required, are as follows:

 

 

The Company’s ability to recover the cost of its minimum guarantee due to The CW will depend on the popularity of the television programs the Company broadcasts on The CW4Kids and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such programs, broadcast by the Company on The CW4Kids, impacts audience levels and the level of the network advertising rates that the Company can charge. Additionally, the success of the merchandise licensing programs and home video sales based on such television programs broadcast on The CW4Kids is dependent on consumer acceptance of such television programs. If the Company estimates that it will be unable to generate sufficient future revenue from advertising sales, home video sales and merchandising licensing at levels to cover the cost of its contractual obligation to The CW, the Company would record a charge to earnings to reflect an expected loss on The CW agreements in the period in which the factors negatively affecting the recoverability of the fee payable become known. The Company will be required to make certain assumptions and estimates about future events such as advertising rates and audience viewing levels in evaluating its ability to recover the cost of the minimum guaranteed payments. Such estimates and assumptions are subject to market forces and factors beyond the control of the Company and are inherently subject to change. There can be no assurance that the Company will be able to recover the full cost of the minimum guaranteed payments and in the event it cannot, it would record the resulting charge to earnings to reflect an expected loss on the minimum guaranteed payments, which could be significant.

 

In addition to the minimum guarantee paid to The CW, the Company incurs additional costs to program the broadcast block and sell the related network advertising time. These costs include direct programming costs to acquire, adapt and deliver programming for the broadcast block as well as additional indirect expenses of advertising sales, promotion and administration.

 

b. Contractual Arrangements - During the normal course of business, the Company may enter into various agreements with third parties to license, acquire, distribute, broadcast, develop and/or promote Properties. The terms of these agreements will vary based on the services and/or Properties included within the agreements, as each of these agreements also have specific provisions relating to rights granted, territory and contractual term.

 

11. NONCONTROLLING INTEREST

 

Effective January 1, 2009, all earnings and losses of a subsidiary are attributed to both the parent and the noncontrolling interests, even if the losses attributable to the noncontrolling interest result in a deficit noncontrolling interest balance. Previously, any losses exceeding the noncontrolling interests’ investment in the subsidiaries were attributed to the parent.

 

a) TC Digital Games LLC - On December 11, 2006, 4Kids Digital and CUSA LLC entered into the TCD Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47% of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA for approximately $200, increasing 4Kids Digital’s ownership percentage to 55%. The consideration for the purchase of this additional membership interest was paid through the settlement of capital contributions required to be made by CUSA to TC Websites under the TCW Agreement. TC Digital is treated as a consolidated subsidiary of the Company as a result of its majority ownership and its right to break any dead-locks within the TC Digital Management Committee.

 

 

 

 

Noncontrolling interest of membership units in TC Digital represents the noncontrolling members’ proportionate share of the equity in the entity. Income is allocated to the membership units noncontrolling interest based on the ownership percentage throughout the year. As of March 31, 2010, the noncontrolling member continued to hold 45% of the equity in the entity. The following table summarizes the noncontrolling interest loss attributable to the noncontrolling equity interest in TC Digital:

 

 

Included in the TC Digital net loss is $33 related to the operations of TDI, a joint venture owned 50% by TC Digital, 25% by the Company and 25% by Home Focus Development Ltd. (“Home Focus”), see Note 8 for further details.  As of March 31, 2010, Home Focus has not made a required capital contribution to TDI.

 

As of March 31, 2010, the loss in excess of noncontrolling interest for TC Digital absorbed by 4Kids Digital, in the aggregate, since the formation of such entity is $17,129.

 

b) TC Websites LLC - Under the terms of the TCW Agreement, 4Kids Websites and CUSA are each entitled to elect two managers to TC Websites’ Management Committee. On December 18, 2007, 4Kids Websites entered into an agreement with CUSA and TC Websites pursuant to which 4Kids acquired an additional 5% ownership interest in TC Websites from CUSA for approximately $650 and the TCW Agreement was amended to provide 4Kids Websites with the right to break any deadlocks on TC Websites' Management Committee with respect to operational matters. The consideration for the purchase of this additional membership interest was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites under the TCW Agreement. TC Websites is treated as a consolidated subsidiary of the Company as a result of its majority ownership and its right to break any dead-locks within the TC Websites Management Committee.

 

As of March 31, 2010, the noncontrolling member continued to hold 45% of the equity in the entity. The following table summarizes the noncontrolling interest loss attributable to the noncontrolling equity interest in TC Websites:

 

 

As of March 31, 2010, the loss in excess of noncontrolling interest for TC Websites absorbed by 4Kids Websites in the aggregate since the formation of such entity is $5,586.

 

12. SUBSEQUENT EVENTS

 

Subsequent events were evaluated by the Company through the date the financial statements were issued. There were no events that occurred subsequent to March 31, 2010 that would require recognition in the Company’s consolidated financial statements.

 

 

 

 

 

13. SEGMENT AND RELATED INFORMATION

 

The Company has four reportable segments: (i) Licensing; (ii) Advertising Media and Broadcast; (iii) Television and Film Production/Distribution; and (iv) Trading Card and Game Distribution. The Company’s reportable segments are strategic business units, which, while managed separately, work together as a vertically integrated entertainment company. The Company’s management regularly evaluates the performance of each segment based on its net revenues, profit and loss after all expenses, including amortized film and television costs and the 4Kids TV broadcast fee and interest income. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company’s Television and Film Production/Distribution segment records inter-segment revenues and the Company’s Advertising Media and Broadcast segment records inter-segment charges related to the estimated acquisition costs of episodic television series for broadcast. All inter-segment transactions have been eliminated in consolidation.

 

 

Through the Company’s London office and network of international subagents, which allow it to license its Properties throughout the world, the Company recognized net revenues from international sources primarily in Europe, of approximately $800 and $2,370 for the three months ended March 31, 2010 and 2009, respectively. As of March 31, 2010 and 2009, net assets of the Company’s London office were $2,309 and $4,972, respectively.

 

******

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

(In thousands of dollars unless otherwise specified)

 

Overview

 

The Company’s operating results for the three months ended March 31, 2010 were negatively impacted by the decline in licensing revenue from the “Monster Jam”, “American Kennel Club” and “Teenage Mutant Ninja Turtles” Properties. Accordingly, the Company experienced an overall significant decrease in licensing revenues worldwide as compared with the comparable period last year. Based on the diminished popularity of the “Chaotic” Property, the Company’s Trading Card and Game Distribution segment experienced a reduction in orders from TC Digital’s distributors during the first quarter of 2010 as compared with 2009 and overall sales of “Chaotic” trading cards during the first quarter of 2010 were below expectations. During 2009 and continuing in 2010, the Company implemented significant cost-cutting initiatives, primarily pertaining to personnel related costs and advertising and marketing expenses, in an effort to offset its poor operating results; however, these initiatives failed to offset lower revenues and other charges.

 

General

 

The Company receives revenues from the following four business segments: (i) Licensing; (ii) Advertising, Media and Broadcasting; (iii) Television and Film Production/Distribution; and (iv) Trading Card and Game Distribution. The Company typically derives a substantial portion of its licensing revenues from a small number of Properties, which usually generate revenues for only a limited period of time. The Company’s revenues are highly subject to changing trends in the toy, game and entertainment businesses, potentially causing dramatic increases and decreases from year to year due to the popularity of particular Properties. It is not possible to accurately predict the length of time a Property will be commercially successful and/or if a Property will be commercially successful at all. Popularity of Properties can vary from months to years. As a result, the Company’s revenues from particular Properties may fluctuate significantly between comparable periods.

 

The Company’s licensing revenues have historically been derived primarily from the licensing of toy and game concepts. As a result, a substantial portion of the Company’s revenues and net income are subject to the seasonal variations of the toy and game industry. Typically, a majority of toy orders are shipped in the third and fourth calendar quarters resulting in increased royalties earned by the Company during such calendar quarters. The Company recognizes revenues from the sale of advertising time on the leased Saturday morning programming block from The CW (“The CW4Kids”), as more fully described in Note 2 of the notes to the Company’s consolidated financial statements. The Company’s advertising sales subsidiary, 4Kids Ad Sales, sells advertising time on The CW4Kids at higher rates in the fourth quarter due to the increased demand for commercial time by children’s advertisers during the holiday season. As a result, much of the revenues of 4Kids Ad Sales are earned in the fourth quarter when the majority of toy and video game advertising occurs. As a result of the foregoing, the Company has historically experienced greater revenues during the second half of the year than during the first half of the year.

 

Critical Accounting Policies

 

The Company’s accounting policies are fully described in Note 2 of the notes to the Company’s consolidated financial statements. Below is a summary of the critical accounting policies, among others, that management believes involve significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Accounting for Film and Television Costs - The Company amortizes the costs of production for film and television programming using the individual-film-forecast method under which such costs are amortized for each film or television program in the ratio that revenue earned in the current period for such title bears to management’s estimate of the total revenues to be realized from all media and markets for such title. All exploitation costs, including advertising and marketing costs, are expensed as incurred.

 

Management regularly reviews, and revises when necessary, its total revenue estimates on a title-by-title basis, which may result in a change in the rate of amortization and/or a write-down of the film or television asset to estimated fair value. The Company determines the estimated fair value for individual film and television Properties based on the estimated future ultimate revenues and costs.

 

Any revisions to ultimate revenues can result in significant quarter-to-quarter and year-to-year fluctuations in film and television write-downs and amortization. A typical film or television series recognizes a substantial portion of its ultimate

 

 

revenues within the first three years of release. By then, the film or television series has been exploited in the domestic and international television (network and cable) and home video markets. In addition, a significant portion of licensing revenues associated with the film or television series will have been realized. A similar portion of the film’s or television series’ capitalized costs should be expected to be amortized accordingly, assuming the film or television series is profitable.

 

The commercial potential of individual films and television programming varies dramatically, and is not directly correlated with production or acquisition costs. Therefore, it is difficult to predict or project the impact that individual films or television programming will have on the Company’s results of operations. However, the likelihood that the Company will report losses, particularly in the year of a television series initial release, is increased as the applicable accounting literature requires the immediate recognition of all of the production or acquisition costs (through increased amortization) in instances where it is estimated that the ultimate revenues of a film or television series will not recover those costs. Conversely, the profit from a film or television series must be deferred and recognized over the entire revenue stream generated by that film or television series. As a result, significant fluctuations in reported income or loss can occur, particularly on a quarterly basis, depending on release schedules and broadcast dates, the timing of advertising campaigns and the relative performance of individual film or television series.

 

Other Estimates   -   The Company estimates reserves for future returns of product in the trading card and home video markets as well as provisions for uncollectible receivables. In determining the estimate of trading card and home video product sales that will be returned, the Company performs an analysis that considers historical returns, changes in customer demand and current economic trends. Based on this information, a percentage of each sale is reserved provided that the customer has the right to return unsold trading card and home video inventory. The Company estimates the amount of uncollectible receivables from its business segments by monitoring delinquent accounts and estimating a reserve based on contractual terms and other customer specific issues.

 

Revenue Recognition - The Company’s revenue recognition policies for its four business segments are appropriate to the circumstances of each segment’s business. See Note 2 of the notes to the Company’s consolidated financial statements for a discussion of these revenue recognition policies.

 

Accounting Changes - The Company has reassessed the accounting treatment for reimbursements of its production costs under representation contracts and will no longer record these amounts as revenue with a corresponding charge to production service costs. In accordance with authoritative guidance issued by the FASB, the Company has retroactively adjusted revenue and production service costs for all periods presented. The Company considered the qualitative aspect of these adjustments, as well as the impact on the Company’s operating losses and earnings per share calculations in determining that no further restatement of the Company’s consolidated financial statements is necessitated by this accounting change. See Note 9 of the notes to the Company’s consolidated financial statements for a discussion of these changes.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company continually evaluates the policies and estimates that it uses to prepare its consolidated financial statements. In general, management’s estimates and assumptions are based on historical experience, known trends or events, information from third-party professionals and other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

 

Recently Adopted Accounting Standards – In August 2009, the FASB issued authoritative guidance regarding the measurement of liabilities at fair value when a quoted price in an active market is not available.  In these circumstances, a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance, such as an income approach or a market approach.  The guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  This guidance is currently effective and the adoption of this guidance did not have an impact on the Company’s consolidated financial position and results of operations.

 

 

In June 2009, the FASB issued authoritative guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial statements about a transfer of financial assets, the effects of a transfer on its financial position, financial performance and cash flows, and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective as of the beginning of the first interim period within a reporting entity’s first annual reporting period that begins after November 15, 2009. The adoption of this guidance did not have an impact on the Company’s consolidated financial position and results of operations.

 

In May 2009, the FASB issued authoritative guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance sets forth (1) the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which events or transactions occurring after the balance sheet date should be recognized in its financial statements and (3) the disclosures that should be made about events or transactions that occurred after the balance sheet date. In February 2010, the FASB amended this new standard to eliminate the requirement to disclose the date through which subsequent events have been evaluated. As the new standard was not intended to significantly change the current practice of reporting subsequent events, it did not have an impact on the Company’s consolidated financial position and results of operations.

 

In April 2009, the FASB issued authoritative guidance related to investments in debt and equity securities. The objective of the new guidance is to make impairment guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) of debt and equity securities in financial statements.  The guidance revises the OTTI evaluation methodology. Under the guidance, the security is analyzed for credit loss, (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the statement of earnings, while the balance of impairment related to other factors will be recognized in other comprehensive income. This guidance was effective for all interim and annual periods ending after June 15, 2009. The Company adopted this authoritative guidance issued by the FASB as of January 1, 2009 and recorded a cumulative-effect adjustment of $2,130 to its opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive loss. The Company did not incur any impairment charges in 2010 due to credit losses.

 

Recently Issued Accounting Standards - In October 2009, the FASB issued authoritative guidance which will allow companies to allocate arrangement consideration to multiple deliverables. The guidance provides principles and application guidance on whether multiple deliverables exist, how an arrangement should be separated, and the consideration allocated. The guidance requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of the selling price. The guidance eliminates the use of the residual method, requires entities to allocate revenue using the relative-selling-price method and significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. The guidance requires new and expanded disclosures and is applied prospectively to revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 or retrospectively for all periods presented. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

 

 

 

 

 

 

 

 

 

 

 

 

Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of total net revenues for the three months ended March 31, 2010 and 2009:

 

 

 

Three months ended March 31, 2010 as compared to three ended March 31, 2009.

 

Revenues

 

Revenues by reportable segment and for the Company as a whole were as follows:

 

 

The decrease in consolidated net revenues for the three months ended March 31, 2010, as compared to the same period in 2009, was due to a number of factors.

 

In the Licensing segment, decreased revenues for the three months ended March 31, 2010 were primarily attributable to:

 

 

 

 

 

The “Yu-Gi-Oh!” and “Cabbage Patch Kids” Properties are the largest contributors with approximately 70% of the Company’s revenues in this business segment for the three months ended March 31, 2010.

 

In the Advertising Media and Broadcast segment, the significant decrease in revenues for the three months ended March 31, 2010, as compared to the same period in 2009, was primarily attributable to a decline in ratings which caused a decrease in the sale of network advertising time on The CW4Kids of approximately $340, as well as decreased revenue from the sale of internet advertising on the Company’s websites of approximately $480.

 

In the Television and Film Production/Distribution segment, the decrease in revenues for the three months ended March 31, 2010, as compared to the same period in 2009, was primarily attributable to:

 

 

The decrease in the Trading Card and Game Distribution segment for the three months ended March 31, 2010 when compared to the same period in 2009 was primarily attributable to decreased retail sales which were negatively impacted by diminished popularity of the “Chaotic” property, as well as continued weakness in the global economic climate. As a result, many retailers maintained reduced inventory levels, and the Company’s Trading Card and Game Distribution segment was negatively impacted by the resulting cut back by the Company’s distributors on orders placed with TC Digital. Additionally, due to the overall lack of demand for the “Chaotic” Property, the Company has granted allowances and promotional markdowns to these distributors equal to approximately $310 for the three months ended March 31, 2010.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased 41%, or $4,934, to $7,097 for the three months ended March 31, 2010, when compared to the same period in 2009. The decrease was attributable to broad cost-cutting initiatives implemented throughout the Company and included:

 

 

Cost of Sales of Trading Cards

 

Cost of sales of trading cards represents finished goods inventory costs relating to the “Chaotic” trading card game. Cost of sales decreased 27%, or $138, to $364 for the three months ended March 31, 2010, when compared to the same period in 2009. The decrease was primarily attributable to the overall decrease in trading card revenue. Based on the diminished popularity of the “Chaotic” Property, the Company’s Trading Card and Game Distribution segment experienced a reduction in orders from TC Digital’s distributors.

 

Capitalized Film Costs

 

For the three months ended March 31, 2010 and 2009

 

 

The increase in amortization of television and film costs for the three months ended March 31, 2010 when compared to the same period in 2009, was primarily due to the increased amortization of the “Chaotic” television series offset by decreased amortization of the “Teenage Mutant Ninja Turtles” and “Yu-Gi-Oh!” television series.

 

 

 

 

 

As of March 31, 2010, there were $6,381 of capitalized film production costs in the Company’s consolidated balance sheet relating primarily to various stages of production on 226 episodes of animated programming. Based on management’s ultimate revenue estimates as of March 31, 2010, approximately 59% of the total completed and unamortized film and television costs are expected to be amortized during the next year, and over 90% of the total completed and unamortized film and television costs are expected to be amortized during the next three years.

 

Interest Income

 

Interest income decreased 74%, or $296, to $105 for the three months ended March 31, 2010, as compared to the same period in 2009, primarily as a result of lower cash balances and the Company’s investments yielding lower interest rates than the prior period.

 

Income (Loss) Before Income Taxes

 

 

In the Licensing segment, the decrease in segment income for the three months ended March 31, 2010, as compared to the same period in 2009, was primarily attributable to lower licensing revenues and lower interest income allocated to this segment, partially offset by a decrease in licensing expenses.

 

In the Advertising Media and Broadcast segment, the increase in segment loss for the three months ended March 31, 2010, as compared to the same period in 2009, resulted from the decline in ratings which caused a decrease in the sale of network advertising time on The CW4Kids, as well as decreased revenue from the sale of internet advertising on the Company’s websites, partially offset by a decrease in segment expenses.

 

In the Television and Film Production/Distribution segment, the increase in segment loss for the three months ended March 31, 2010, as compared to the same period in 2009, was primarily due to increased amortization of television and film costs, as well as an overall decrease in production revenues partially offset by a decrease in international sales expense and personnel related costs.

 

In the Trading Card and Game Distribution segment, the decrease in segment loss for the three months ended March 31, 2010, as compared to the same period in 2009, was primarily attributable to the overall decrease in segment expenses, partially offset by an overall decrease in trading card revenue.

 

Income Taxes

 

The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. The Company records a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In view of the level of deferred tax assets as of March 31, 2010 and the Company’s historical losses from operations, the Company has determined that it should record a full valuation allowance against its net deferred tax assets.

 

As a result of the valuation allowance, the Company did not record a benefit from income taxes for the three months ended March 31, 2010 and 2009.

 

In the event that the Company earns pre-tax income in the future such that it will be able to use some or all of its deferred tax assets, the Company may reduce or eliminate the valuation allowance. If the Company were to reverse the valuation allowance, in whole or in part, the Company’s income statement for such reporting period would record a reduction in income tax expense and an increase in net income, to the extent of the reversal of the valuation allowance.

 

 

The Company’s effective tax rate for the three months ended March 31, 2010 was 31.4%, which differs from the statutory rate of 35% primarily due to the mix of income and losses, which have tax rates that differ from the statutory rate, and due to permanent differences and tax rate differences on subsidiaries.

 

Net Loss

 

As a result of the above, the Company had a net loss for the three months ended March 31, 2010 of $4,477, as compared to a net loss of $4,080 for the same period in 2009.

 

Liquidity and Capital Resources

 

 

Cash and cash equivalents as of March 31, 2010 and December 31, 2009 were as follows:

 

 

 

Long-term investments as of March 31, 2010 and December 31, 2009 were as follows:

 

 

The Company’s long-term investments principally consist of ARS, corporate bonds and preferred shares. ARS are generally rated “BBB” or better by one or more national rating agencies and have contractual maturities of up to 80 years. Of the aggregate principal amount of $26,850 in investment securities held by the Company as of March 31, 2010, 31% mature within the next 30 years, 57% mature through 2087 and the remaining 43% have no maturity date. The Company classifies these investments as “available for sale”, for certain investments in debt and equity securities. The ARS that the Company invests in generally had interest reset dates that occurred every 7 or 35 days and despite the long-term nature of their stated contractual maturity, the historical operation of the ARS market had given the Company the ability to quickly liquidate these securities at ongoing auctions every 35 days or less.

 

During 2007, liquidity issues began to affect the global credit and capital markets. In addition, certain individual ARS experienced liquidity issues specific to such securities. As a result, ARS, which historically have had a liquid market and had their interest rates reset periodically (e.g. monthly) through Dutch auctions, began to fail at auction. These auction failures have caused ARS to become illiquid, which in turn has caused the fair market values of these securities to decline.

 

The ARS currently held by the Company are private placement debt securities with long-term nominal maturities and interest rates that typically reset monthly. The Company’s investments in ARS represent interests in debt obligations issued by banks and insurance companies that originally had at least an “A” credit rating at the time of purchase, including JP Morgan Chase, bond insurers and re-insurers such as MBIA, AMBAC, FGIC, and FSA. The collateral underlying these securities consists primarily of commercial paper, but also includes asset-backed and mortgage-backed securities, corporate debt, government holdings, money market funds and other ARS.

 

As of March 31, 2010, the Company held investment securities having an aggregate principal amount of $26,850. The estimated fair market value of these securities as determined by the Company had declined by $15,137 (a decline of $15,245 prior to 2010, partially offset by an increase in value of $108 during 2010) to $11,713, as of March 31, 2010. During the first quarter of 2010, the Company sold investment securities with a par value of $8,700 for $2,575. No additional impairment charges were recorded in the first quarter of 2010 since the Company had previously recorded in earnings an unrealized loss on these securities of $6,125. Additionally, the Company did not incur any impairment charges in 2010 due to credit losses.

 

 

 

Since the Company has the ability, and presently expects, to hold its remaining investment securities until recovery of their face value, which may not be prior to the maturity of the applicable security (to the extent such security has a specified maturity date) and based on consideration of all of the factors described above, the Company considered certain of these investments to be temporarily impaired as such term is defined in the accounting literature. Accordingly, the entire balance of unrealized loss in accumulated other comprehensive income at March 31, 2010 relates to securities which the Company considers temporarily impaired. Additionally, these remaining investment securities held by the Company have continued to pay interest according to their stated terms, which the Company believes may create an incentive for the issuers to redeem these securities once the current liquidity problems in the credit market substantially improve.

 

The Company continues to monitor the market for ARS and considers its impact (if any) on the fair value of its investments. If the current market conditions deteriorate further, the Company may be required to record additional impairment charges to non-operating expense in future periods.

 

The credit and capital markets, including the market for ARS, have remained illiquid, and as a result of this and other factors specific to certain investment securities, the Company’s unrealized loss on its investment securities may subsequently increase. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; and yields of securities similar to the underlying investment securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its evaluation on the mid-point of that range. Specifically, the Company considers the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying these securities in our overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looks at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period.

 

Due to the sensitivity of the methodologies and considerations used, the Company continually re-evaluates the investment securities and although the valuation methodologies have remained consistent for each quarter in which these securities were valued, certain inputs may have changed. The changes in these inputs primarily relate to the changes in the economic environment and the market for such securities.

 

Given the failed auctions, the Company’s investment securities are currently illiquid.  Accordingly, the Company has classified all of its investment in ARS and the securities into which certain of the ARS have been exchanged, as non-current assets as of March 31, 2010 on its balance sheet due to the fact that the Company believes that the liquidity of these securities is unlikely to be restored in a period less than twelve months from such date.

 

If uncertainties in the credit and capital markets continue or the Company’s investments experience any rating downgrades on any investments in its portfolio or the value of such investments declines further, the Company may incur additional impairment charges to its investment portfolio, which could negatively affect the Company’s financial condition, results of operations and cash flow. As a result of the current market issues, the Company’s surplus cash is invested solely in government securities with a maturity of 90 days or less.

 

Based on the Company’s cash position as of March 31, 2010, the anticipated effects of the significant cost cutting initiatives implemented by the Company during 2009 and continuing into 2010, and the Company’s belief that economic conditions have become more stable, the Company expects its overall cash position to provide adequate liquidity to fund its day-to-day operations for the next twelve months. However, the illiquidity affecting a significant portion of the Company’s portfolio of investment securities is impacting the Company’s ability to make capital investments or expand its operations.

 

If the Company determines that it is necessary to generate additional cash to fund its operations, the Company will consider all alternatives available to it, including, but not limited to sales of assets, issuance of equity or debt securities and third party arrangements. There can be no assurance, however, that the Company would be able to generate such additional cash in a timely manner or that such additional cash could be obtained on terms acceptable to the Company.

 

 

 

 

 

Sources and Uses of Cash

 

Cash flows for the three months ended March 31, 2010 and 2009 were as follows:

 

 

Working capital, consisting of current assets less current liabilities, was $4,058 as of March 31, 2010 and $4,859 as of December 31, 2009.

 

Operating Activities

2010

Net cash provided by operating activities for the three months ended March 31, 2010 of $3,161 primarily reflects an increase in cash collections of the Company’s trade and income tax receivables, including a tax refund in an amount of $3,567 relating to extended net operating loss carrybacks. This increase was offset by a decrease in the Company’s business performance.

 

2009

Net cash used in operating activities for the three months ended March 31, 2009 of $4,449 primarily reflects a decrease in the Company’s overall business performance.

 

Investing Activities

2010

Net cash provided by investing activities for the three months ended March 31, 2010 of $2,555 reflects proceeds from the sale of the Company’s investment securities for $2,575, partially offset by purchases of property and equipment.

 

2009

Net cash used in investing activities for the three months ended March 31, 2009 of $73 reflects the Company’s purchase of property and equipment.

 

Financing Activities

2010

Net cash provided by financing activities for the three months ended March 31, 2010 of $4 reflects cash contributions from noncontrolling interests.

 

2009

Net cash provided by financing activities for the three months ended March 31, 2009 of $31 reflects cash contributions from noncontrolling interests.

 

During the first quarter of 2010, the Company's cash flow from operations was impacted by an overall decrease in consumer spending due to the diminished popularity of its Properties, as well as the current economic conditions.  While the Company strives to further diversify its revenue streams, management remains cognizant of changing trends in the toy, game and entertainment business and the difficulty in predicting the length of time a property will be commercially successful.  As a result, the Company's revenues, operating results and cash flow from operations may fluctuate significantly from year to year and present operating results are not necessarily indicative of future performance.

 

Broadcast Agreements

 

The CW Broadcast Agreement - On October 1, 2007, the Company and The CW entered into the CW Agreement, under which The CW granted to the Company the exclusive right to program The CW's Saturday morning children's programming block (“The CW4Kids”) that is broadcast in most markets between 7am and 12pm for an initial term of five years beginning with The CW's 2008-2009 broadcast season.

 

Under the CW Agreement, the Company is obligated to make quarterly minimum guaranteed payments which are subject to reduction under certain circumstances. The Company and The CW share advertising revenues earned from the sale of national commercial time during The CW4Kids with The CW's share to be applied against such quarterly guarantee payments. In addition, The CW is entitled under the CW Agreement to participate in the Company's merchandising revenue

 

 

from certain content broadcast on The CW4Kids, if such merchandising revenues exceed a certain annual minimum. 4Kids Ad Sales, Inc. manages and accounts for the ad revenue and costs associated with The CW4Kids.

 

In December 2009, the Company notified The CW that it believed it was entitled to a reduction in the total guarantee for the broadcast year as well as a change in the split of the national advertising proceeds derived from The CW4Kids block from 80% - 20% in favor of The CW to 65% - 35% in favor of The CW as a result of industry action taken by most of the leading food advertisers reducing or otherwise limiting categories of permitted advertising in response to public concern about childhood obesity. Such a reduction and adjustment in the share of advertising proceeds is provided for under The CW Agreement if any federal, state or other governmental law, regulation or rule or any industry action bans, reduces or otherwise limits the categories of permitted advertising that can be broadcast in children's programming. The Company has supplied The CW with evidence supporting its position including a copy of the October 2009 report of the Children's Food and Beverage Advertising Initiative set up under the auspices of the Council of Better Business Bureaus which describes the effect of the industry action undertaken by leading food advertisers as well as children's food advertising spending statistics documenting the reduction in children's food advertising. In December 2009 and March 2010, the Company paid The CW installments of $4,275 and $1,900, respectively as payment for the quarterly guarantees for the 2009 - 2010 broadcast season rather than $6,750 and $3,000, respectively, the original amount required under The CW Agreement.

 

The CW has disputed the Company’s position by claiming that there has been no industry action reducing or otherwise limiting the categories of permitted advertising and believes that the Company is in breach of The CW Agreement by having paid the reduced amount in respect of the quarterly guarantee. The Company and The CW are currently in discussions regarding the contractual dispute. If they are unable to resolve the dispute through negotiation, the dispute between the Company and The CW will be resolved through arbitration. If the Company prevails through negotiation or arbitration, the $15,000 guarantee will be reduced and the split of advertising revenues will be adjusted. There can be no assurance, however, that the Company will prevail or of the amount of any reduction or adjustment in the event the Company is successful. If the Company is unsuccessful, it will be required to pay $3,575 to The CW, representing the difference between the original amount required under The CW Agreement and the amount paid by the Company through March 2010.

 

Contractual Commitments

 

The Company’s contractual obligations and commitments are detailed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. As of March 31, 2010, the Company’s remaining contractual obligations and commitments have not materially changed since December 31, 2009.

 

Forward Looking Information and Risk Factors That May Affect Future Results

 

This Quarterly Report on Form 10-Q, including the section titled “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements that relate to future events or our future financial performance. We may also make written and oral forward-looking statements in our Securities and Exchange Commission (“SEC”) filings and otherwise. We have tried, where possible, to identify such statements by using words such as “believe,” “expect,” “intend,” “estimate,” “anticipate,” “will,” “project,” “plan” and similar expressions in connection with any discussion of future operating or financial performance. Any forward-looking statements are and will be based upon our then-current expectations, estimates and assumptions regarding future events and are applicable only as of the dates of such statements. By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated in any forward-looking statements. Such risks and uncertainties include those described in this Quarterly Report on Form 10-Q and in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC, as well as other factors. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Foreign Currency Exchange Rate Fluctuations

 

From time to time, the Company may be exposed to the risk of future currency exchange rate fluctuations, which is accounted for as an adjustment to stockholders’ equity and changes in the exchange rates between various foreign currencies and the U.S. dollar may, as a result, have an impact on the accumulated other comprehensive loss component of stockholders’ equity reported by the Company, and such effect may be material in any individual reporting period. The Company is currently not a party to any market risk sensitive instruments, or any derivative contracts or other arrangements that may reduce such market risk.

 

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

(a) We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) that are designed to provide reasonable assurance that information required to be disclosed in our filings and submissions under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

We completed an evaluation under the supervision and with participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the first quarter, such disclosure controls and procedures were effective to provide the reasonable assurance described above.

 

(b) There have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934) during the period covered by this report that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

Part II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

On February 12, 2010, Home Focus Development, LTD, a British Virgin Islands Corporation, ("Home Focus") filed suit against the Company in the United States District Court for the Southern District of New York. In the lawsuit, Home Focus alleges that the Company owes it $1,075 under an Interest Purchase Agreement among the Company, Home Focus and TC Digital entered into on March 2, 2009, pursuant to which the Company acquired a 25% ownership interest in TDI. As further described in Note 8 to the Company’s consolidated financial statements, the Company withheld payments in an aggregate amount of $725 from Home Focus otherwise due under the Interest Purchase Agreement as a result of Home Focus’s failure to make required capital contributions to TDI. On April 26, 2010, the Company answered the complaint and asserted various counterclaims against Home Focus and its owners, in their individual capacities. The Company intends to vigorously defend this litigation.

 

The Company, from time to time, is involved in litigation arising in the ordinary course of its business. The Company does not believe that such litigation to which the Company or any subsidiary of the Company is a party or of which any of their Properties is the subject will, individually or in the aggregate, have a material adverse affect on the Company’s financial position or the results of its operations.

 

Item 1A. Risk Factors.

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” of the Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Annual Report”), which could materially affect our business, financial condition or future results. The risks described in the 2009 Annual Report are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently do not consider material also may materially adversely affect our business, financial condition and/or operating results. There have been no material changes from the risk factors disclosed in the 2009 Annual Report except for the following:

 

The New York Stock Exchange (“NYSE”) may delist our common stock which could have an adverse impact on the liquidity and market price of our common stock.  

 

Our common stock is currently listed on the NYSE. As previously reported by us, on March 23, 2010, we received written notice from NYSE Regulation, Inc. that we had fallen below the NYSE’s continued listing standards because over a 30 trading-day period our total market capitalization was less than $50 million and, at the same time our stockholders’ equity was less than $50 million. In its notice, the NYSE informed us that it is prepared to proceed with its normal business plan procedures, under which we had 45 calendar days from receipt of the notice to submit a plan demonstrating our ability to achieve compliance with the continued listing standard within 18 months.

 

 

 

In its letter, the NYSE noted that we were at risk of falling below the $15 million minimum average 30 trading day market capitalization threshold which would pre-empt the plan/cure process described above, and were also at risk of falling below the $1.00 per share minimum price criteria, where we would be required to bring our share price and average share price back above $1.00 per share by six months following receipt of the applicable notification. Based on our recent market capitalization, we have fallen below the $15 million minimum average 30 trading day market capitalization threshold and have been in contact with the NYSE regarding this event. However, we have not been notified by the NYSE of the initiation of suspension and delisting procedures.

 

Provided that the NYSE does not initiate suspension and delisting procedures due to the Company’s failure to maintain the $15 million minimum average 30 trading day market capitalization listing requirement, we intend to submit a business plan to the NYSE during the week of May 10, 2010. The business plan will be reviewed by the Listings and Compliance Committee of the NYSE (the “Committee”). The Committee will either accept the plan, at which time we will be subject to quarterly monitoring for compliance with the business plan, or the Committee will not accept the business plan and we will be subject to suspension and delisting procedures.

 

A delisting of our common stock, whether due to our failure to maintain the $15 million average 30 trading day market capitalization or $50 million stockholders’ equity threshold could negatively impact us by reducing the liquidity and market price of our common stock and reducing the number of investors willing to hold or acquire our common stock, which could negatively impact our ability to raise equity financing.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SIGNATURES

 

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

 

4KIDS ENTERTAINMENT, INC.

 

Date: May 10, 2010

 

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