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For the transition period from _____________ to _____________

Commission file number 0-7843

4Kids Entertainment, Inc. (Exact name of Registrant as specified in its charter)

New York (State or other jurisdiction of incorporation or organization)

13-2691380 (I.R.S. Employer Identification No.)

1414 Avenue of the Americas New York, New York 10019 (212) 758-7666 (Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes |X|    No |_|               Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X|    No |_|       At November 13, 2003, the number of shares outstanding of the Registrant’s common stock, par value $.01 per share, was 13,419,068. 4Kids Entertainment, Inc. and Subsidiaries Table of Contents

Page # Part I--FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2003    (Unaudited) and December 31, 2002	2
	Consolidated Statements of Income for the three and nine    months ended September 30, 2003 and 2002 (Unaudited)	3
	Consolidated Statements of Cash Flows for the nine    months ended September 30, 2003 and 2002 (Unaudited)	4
	Notes to Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial    Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	21
Part II—OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K	22
Signatures		23

Part I-FINANCIAL INFORMATION

Item 1. Financial Statements

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share data)

			September 30,			December 31,
			2003			2002
ASSETS			(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents			$	63,491		$	78,712
Investments				35,988			10,787
Accounts receivable - net				30,031			38,847
Prepaid Fox broadcast fee - net				14,170			9,857
Prepaid/refundable income taxes				1,665			1,635
Advances to licensors				1,279			1,617
Prepaid expenses and other current assets				2,585			2,254
Total current assets				149,209			143,709
PROPERTY AND EQUIPMENT - net				3,450			3,853
ACCOUNTS RECEIVABLE - net				3,560			5,733
INVESTMENT IN EQUITY SECURITIES				726			726
FILM AND TELEVISION COSTS - net				8,400			5,653
DEFERRED INCOME TAXES				1,369			917
OTHER ASSETS - net				4,780			2,248
TOTAL ASSETS			$	171,494		$	162,839
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Due to licensors			$	8,942		$	9,063
Media payable				2,043			5,613
Accounts payable and accrued expenses				8,153			9,776
Deferred revenue				5,136			3,976
Deferred income taxes				651			983
Total current liabilities				24,925			29,411
DEFERRED RENT				928			757
Total liabilities				25,853			30,168
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value - authorized, 3,000,000 shares;
none issued				--			--
Common stock, $.01 par value - authorized, 40,000,000 shares;
issued, 13,403,568 and 13,135,008 shares in 2003 and
2002, respectively				134			131
Additional paid-in capital				43,809			40,411
Accumulated other comprehensive income				159			72
Retained earnings				101,539			92,057
Total stockholders' equity				145,641			132,671
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY			$	171,494		$	162,839

See notes to consolidated financial statements. -2-

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands of dollars, except share data)

			Three Months Ended						Nine Months Ended
			September 30,						September 30,
			2003			2002			2003			2002
NET REVENUES			$	25,334		$	12,099		$	69,681		$	27,238
COSTS AND EXPENSES:
Selling, general and administrative				8,579			6,842			23,996			16,328
Production service costs				2,574			327			6,556			804
Amortization of television and film costs and
Fox broadcast fee				9,700			1,919			24,204			3,301
Total costs and expenses				20,853			9,088			54,756			20,433
INCOME FROM OPERATIONS				4,481			3,011			14,925			6,805
INTEREST INCOME				252			388			835			1,180
INCOME BEFORE INCOME TAX
PROVISION				4,733			3,399			15,760			7,985
INCOME TAX PROVISION				1,866			1,436			6,278			3,241
NET INCOME			$	2,867		$	1,963		$	9,482		$	4,744
PER SHARE AMOUNTS:
Basic earnings per common share			$	0.22		$	0.16		$	0.72		$	0.38
Diluted earnings per common share			$	0.20		$	0.14		$	0.68		$	0.35
Weighted average common shares
outstanding - basic				13,247,459			12,597,355			13,174,119			12,588,162
Weighted average common shares
outstanding - diluted				14,169,729			13,678,026			14,018,995			13,656,787

See notes to consolidated financial statements. -3-

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands of dollars)

			Nine Months Ended
			September 30,			September 30,
			2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income			$	9,482		$	4,744
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization				928			722
Amortization of television and film costs and Fox broadcast fee				24,204			3,301
Provision for doubtful accounts				253			--
Deferred income taxes				(784	)		--
Tax benefit on exercise of stock options				1,569			292
Changes in operating assets and liabilities:
Accounts receivable				10,736			(11,125	)
Film and television costs				(9,115	)		(4,163	)
Prepaid/refundable income taxes				(30	)		3,584
Prepaid Fox broadcast fee				(22,149	)		(14,427	)
Advances to licensors				338			--
Prepaid expenses and other current assets				(331	)		(4,060	)
Other assets - net				(2,532	)		(176	)
Due to licensors				(121	)		(9,049	)
Media payable				(3,570	)		292
Accounts payable and accrued expenses				(1,623	)		589
Income taxes payable				--			680
Deferred revenue				1,160			4,155
Deferred rent				171			424
Net cash provided by (used in) operating activities				8,586			(24,217	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investments				63,242			20,047
Purchase of investments				(88,443	)		(19,806	)
Purchase of property and equipment				(525	)		(2,274	)
Net cash used in investing activities				(25,726	)		(2,033	)
CASH FLOWS FROM FINANCING ACTIVITIES -
Proceeds from exercise of stock options				1,832			525
EFFECTS OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS				87			--
NET DECREASE IN CASH AND CASH EQUIVALENTS				(15,221	)		(25,725	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD				78,712			104,445
CASH AND CASH EQUIVALENTS, END OF PERIOD			$	63,491		$	78,720
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR:
Income Taxes			$	5,600		$	--

See notes to consolidated financial statements. -4-

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

 

4Kids Entertainment Music, Inc. ("4Kids Music"), a wholly-owned subsidiary, markets and administers the musical operations for the Company on certain existing and newly created music associated with its television programming. 4Kids Entertainment Home Video, Inc. ("4Kids Home Video"), a wholly-owned subsidiary, markets and administers the Company’s home video operations associated with its television programming.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Home video revenues: Revenues from home video and DVD sales, net of a reserve for returns, are recognized 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 a reserve for returns, are recognized based 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.

Film and Television Costs — The Company accounts for its film and television costs pursuant to AICPA Statement of Position (“SOP”) No. 00-2, Accounting by Producers or Distributors of Films. The cost of production for television programming, including overhead, participations and talent residuals is capitalized and amortized 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 total revenues to be realized from all media and markets for such program. 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 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.

Reclassifications —Certain amounts reported for the prior period have been reclassified to conform to the current period’s presentation.

Translation of Foreign Currency —The assets and liabilities of the Company's foreign subsidiary 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; which is a component of stockholders’ equity. Comprehensive income for the three and nine months ended September 30, 2003 was $2,916 and $9,569, respectively, which included translation adjustments of $49 and $87 for the respective periods. Comprehensive income for the three and nine months ended September 30, 2002 is the same as net income for the periods.

Earnings Per Share — The Company applies SFAS No. 128, Earnings per share, which requires the computation and presentation of earnings per share (“EPS”) to include basic and diluted EPS. Basic EPS is computed solely on the weighted average number of common share outstanding during the period. Diluted EPS reflects all potential dilution of common stock. Total dilution was due to stock options and increased the weighted average common shares outstanding by 922 shares and 845 shares for the three and nine months ended September 30, 2003, respectively, and 1,081 shares and 1,069 shares for the three and nine months ended September 30, 2002, respectively.

Stock-Based Compensation —The Company accounts for stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). Under FASB Interpretation 44, Accounting for Certain Transactions involving Stock Compensation, an Interpretation of APB No. 25, outside directors are considered employees for purposes of applying APB No. 25 if they are elected by shareholders. Consequently, no compensation expense for employees and directors is recognized.

-7-

 

The following table illustrates the pro forma effect on net income and net income per basic and diluted shares had the Company applied the fair value recognition provisions of SFAS No. 123 for the three and nine months ended September 30, 2003 and 2002.

			Three Months Ended						Nine Months Ended
			September 30,						September 30,
			2003			2002			2003			2002
Net income as reported			$	2,867		$	1,963		$	9,482		$	4,744
Deduct stock-based employee compensation
expense determined under fair value based
method for all awards, net of tax				251			314			1,486			2,481
Pro forma net income			$	2,616		$	1,649		$	7,996		$	2,263
Net income per share:
Reported
Basic			$	0.22		$	0.16		$	0.72		$	0.38
Diluted			$	0.20		$	0.14		$	0.68		$	0.35
Pro forma
Basic			$	0.20		$	0.13		$	0.61		$	0.18
Diluted			$	0.18		$	0.12		$	0.57		$	0.17

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions used for options granted in 2003 and 2002 included no dividend yield for both periods, expected volatility of approximately 55.3% and 47.9% for 2003 and 2002, respectively, a risk-free interest rate of approximately 1.4% and 2.2% for 2003 and 2002, respectively, and an option duration of 4 years for both periods.

Recently Issued Accounting Pronouncements – Costs Associated with Exit or Disposal Activities -   In June 2002, Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”). Such standard requires costs associated with exit or disposal activities (including restructurings) to be recognized when the costs are incurred, rather than at a date of commitment to an exit or disposal plan. SFAS No. 146 nullifies Emerging Issue Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under SFAS No. 146, a liability related to an exit or disposal activity is not recognized until such liability has actually been incurred whereas under EITF Issue No. 94-3 a liability was recognized at the time of a commitment to an exit or disposal plan. The provisions of this standard are effective for exit or disposal activities initiated after December 31, 2002. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

-8-

 

Guarantees — In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. Such Interpretation elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation apply to guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of this Interpretation in its financial statements as of and for the year ending after December 31, 2002. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

Consolidation of Variable Interest Entities — On January 17, 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. Such Interpretation addresses consolidation of entities that are not controllable through voting interests or in which the equity investors do not bear the residual economic risks and rewards. These entities have been commonly referred to as special purpose entities. The Interpretation provides guidance related to identifying variable interest entities and determining whether such entities should be consolidated. It also provides guidance related to the initial and subsequent measurement of assets, liabilities and noncontrolling interests in newly consolidated variable interest entities and requires disclosures for both the primary beneficiary of a variable interest entity and other beneficiaries of the entity. Such Interpretation is effective for newly created variable interest entities beginning February 1, 2003 and for existing variable interest entities as of the third quarter of 2003. However, in October 2003, the FASB permitted companies to defer the third quarter 2003 effective date to December 31, 2003, in whole or in part, and indicated that it would provide further clarification of this Interpretation before December 31, 2003. The Company is currently evaluating the provisions of this Interpretation.

Derivative Instruments and Hedging Activities — In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated in the statement for hedging relationships designated after June 30, 2003. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

-9-

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities.  The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock.  SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and to all other instruments that exist as of the beginning of the first interim financial reporting period after June 15, 2003.  The Company adopted the provisions of SFAS 150 on July 1, 2003. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

3. COMMITMENTS AND CONTINGENCIES

a.

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 any 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 consolidated financial position or the results of its operations.

b.

Deferred Revenue — Music Publishing — In July 2002, 4Kids Music granted a right through 2011 to receive a 50% interest in the Company’s net share of the music revenues from currently existing music produced by the Company for its television programs (excluding “Pokémon”) (“Current Music Assets”) to an unaffiliated third party in an arms length transaction for $3,000. Further, the Company granted a right to receive a 50% interest in the Company’s net share of music revenues from future music to be produced by the Company for its television programs (excluding “Pokémon”) (“Future Music Assets”) to the same third party for $2,000.  In consideration of the grant of Future Music Assets, the Company received $750 in June 2003 and will receive $750 in June 2004 and $500 in June 2005.

The Company has deferred all amounts received under the contract, and recognizes revenue as the Current Music Assets and Future Music Assets generate revenue over the contract term. Notwithstanding the foregoing, as of the date the Company has delivered all of the Future Music Assets required under the contract, any portion of the $5,000 that remains deferred and not recognized, will be recognized as revenue. Pursuant to the above, the Company recognized revenue of $68 and $347 for the three and nine months ended September 30, 2003, respectively and $314 for both the three and nine months ended September 30, 2002. The Company has included $3,089 and $2,686 as deferred revenue on the accompanying consolidated balance sheets as of September 30, 2003 and December 31, 2002, respectively.

Home Video — In May 2002, 4Kids Home Video entered into an agreement with an unaffiliated third party home video distributor (the “Video Distributor”), pursuant to which 4Kids Home Video provides ongoing advertising, marketing and promotional services with respect to certain home video titles that are owned or controlled by the Company and which are distributed by the Video Distributor. The Video Distributor has paid the Company an advance of $1,300 against 4Kids Home Video’s share of the service fee proceeds to be realized by 4Kids Home Video from such titles. Pursuant to the above, the Company recognized revenue of $0 and $587 for the three and nine months ended September 30, 2003, respectively and $713 for both the three and nine months ended September 30, 2002. The Company has included $587 as deferred revenue on the accompanying consolidated balance sheets as of December 31, 2002. As of September 30, 2003, the advance has been fully recognized as revenue.

Other Agreements – In addition, the Company has entered into other agreements for various properties in which the Company has received certain advances and/or minimum guarantees. Accordingly, as of September 30, 2003 and December 31, 2002, the unearned portion of these advances and guaranteed payments received was $2,047 and $703, respectively, and are included as deferred revenue on the accompanying consolidated balance sheets.

-10-

 

c.

Master Toy License – 4Kids Licensing is the exclusive Merchandise Licensing Agent for the “Pokémon” property outside Asia. The master toy licensee (“Licensee”) for the “Pokémon” property and The Pokémon Company LLC (the assignee of certain rights and obligations of Nintendo of America Inc. with respect to the “Pokémon” property) entered into an agreement (the “Agreement”) effective January 1, 2001.

Under the terms of the Agreement, Licensee is required to pay a minimum royalty for the period starting January 1, 2001 and ending December 31, 2003. Since all of the conditions under the Agreement were met and the full amount of the minimum guaranteed royalties were payable by the Licensee, the Company earned $7,500 over the period of the Agreement. For each of the nine months ended September 30, 2003 and 2002, the Company earned royalties relating to the Agreement of $2,500. During 2003, the Agreement was amended extending the term to December 31, 2006.

d.

Fox Broadcast Agreement — In January 2002, the Company entered into a multi-year agreement with Fox to lease the Fox Box. The Company is providing all programming content for the Fox Box and commenced doing so with the broadcast year beginning in September of 2002. The agreement has an initial term of four broadcast years, with the Company having the option to extend the term for up to two additional broadcast years. 4Kids will pay a fee of $25,312 for each broadcast year during the initial term of the agreement.

The agreement provided for 50% of the fee for the first broadcast season to be paid within ten days of the execution of the short form agreement in February 2002, with the balance of the fee for the first broadcast season payable in four equal installments in September 2002, December 2002, February 2003 and April 2003. The fee for each subsequent broadcast year is payable 50% in the June preceding the beginning of the broadcast year (which begins in September) with the balance of the fee for the broadcast year payable in four equal installments in September, December, February and April. All payments required to be made on or prior to September 30, 2003 have been made. Additionally, the agreement requires the Company to establish a $25,000 letter of credit for the benefit of Fox, which letter of credit may be reduced by the Company as installments of the final year’s fee are paid. As of September 30, 2003, the Company had received a commitment from a bank for the letter of credit, but the letter of credit had not been issued pending completion of the long form agreement with Fox. Upon the issuance of the letter of credit, the Company will grant a security interest in its cash balances to the issuing bank to secure the amount of such letter of credit and will appropriately disclose these amounts as restricted cash in its consolidated financial statements.

The cost of the Fox Box is capitalized and amortized over each broadcast season based on estimated advertising revenue. The Company recorded amortization expense of $7,167 and $17,836 for the three and nine months ended September 30, 2003, respectively, and $1,393 for both the three and nine months ended September 30, 2002. As of September 30, 2003, the Company paid Fox and certain affiliates $15,820 attributed to the second year’s broadcast fee, and as of December 31, 2002, the Company paid $19,301 attributed to the first year’s broadcast fee. The unamortized portion of these fees of $14,170 and $9,857, are included in “Prepaid Fox broadcast fee” on the accompanying consolidated balance sheets as of September 30, 2003 and December 31, 2002, respectively.

-11-

 

The agreement further provides that, at the Company’s option, up to $10,300 of each year’s fee may be paid by delivering shares of the Company’s common stock. Over the initial four year term of the agreement, the Company will pay Fox an aggregate fee of $101,250. The Company will incur additional costs to program the four hour block and to sell the related network advertising time. These costs will include direct programming costs to acquire, adapt and deliver programming for broadcast during the weekly four hour block as well as additional indirect expenses of advertising sales, promotion and administration.

As of September 30, 2003, the minimum guaranteed payment obligations under the Fox Broadcast Agreement are as follows:

Year ending December 31,						Amount
October 1, - December 31, 2003						$	3,164
2004							25,312
2005							25,312
2006							6,328
Total						$	60,116

The Company’s ability to recover the cost of its fee payable to Fox will depend on the popularity of the television programs the Company broadcasts on the Fox Box and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such programs impacts audience levels and the level of the network advertising rates that the Company can charge. Additionally, the success of merchandise licensing programs and home video sales based on such television programs broadcast on the Fox Box is dependent on consumer acceptance of the properties. 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 Fox, the Company would record a charge to earnings to reflect an expected loss on the Fox agreement in the period in which the deficiency or factors 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 Fox fee. 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 Fox fee and in the event it cannot, it would record the resulting charge to earnings to reflect an expected loss on the Fox fee, which could be significant.

4. SEGMENT AND RELATED INFORMATION

The Company applies SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The Company has three reportable segments; (i) Licensing, (ii) Advertising Media and Broadcast, and (iii) Television and Film Production/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 upon its net revenues, profit and loss after all expenses, including amortized film, television costs and the Fox broadcast fee and interest income.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Commencing in 2003, the Company’s Television and Film Production/Distribution segment recorded inter-segment revenues and the Company’s Advertising Media and Broadcast segment recorded inter-segment charges related to the estimated acquisition costs of episodic television series for broadcast. In the opinion of management, such acquisition costs represent the estimated fair value which would have been incurred in a transaction between unaffiliated third parties on an arm’s length basis. All inter-segment transactions have been eliminated in consolidation.

-12-

 

			Licensing			Advertising Media and Broadcast			Television and Film Production/ Distribution			Total
Three Months Ended
September 30,
2003
Net revenues from external customers		$	13,046			$	5,543		$	6,745		$	25,334
Amortization of television and film costs
and Fox broadcast fee		$	--			$	7,167		$	2,533		$	9,700
Segment profit (loss)		$	9,091			$	(4,843	)	$	485		$	4,733
Interest income		$	249			$	3		$	--		$	252
2002
Net revenues from external customers		$	7,440			$	1,997		$	2,662		$	12,099
Amortization of television and film costs
and Fox broadcast fee		$	--			$	1,393		$	526		$	1,919
Segment profit (loss)		$	4,580			$	(2,356	)	$	1,175		$	3,399
Interest income		$	381			$	7		$	--		$	388
Nine Months Ended
September 30,
2003
Net revenues from external customers		$	37,112			$	13,774		$	18,795		$	69,681
Amortization of television and film costs
and Fox broadcast fee		$	--			$	17,836		$	6,368		$	24,204
Segment profit (loss)		$	24,950			$	(12,024	)	$	2,834		$	15,760
Segment assets		$	128,948			$	21,098		$	21,448		$	171,494
Interest income		$	820			$	15		$	--		$	835
2002
Net revenues from external customers		$	17,555			$	3,011		$	6,672		$	27,238
Amortization of television and film costs
and Fox broadcast fee		$	--			$	1,393		$	1,908		$	3,301
Segment profit (loss)		$	8,799			$	(3,127	)	$	2,313		$	7,985
Segment assets		$	110,940			$	19,230		$	16,221		$	146,391
Interest income		$	1,149			$	31		$	--		$	1,180

Additionally, 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 revenue from international sources primarily in Europe, of $3,808 and $7,528 for the three and nine months ended September 30, 2003, respectively, and $1,272 and $4,017 for the three and nine months ended September 30, 2002, respectively.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(In thousands of dollars unless otherwise specified)

 

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

Film and Television Costs

The Company accounts for its film and television costs pursuant to AICPA Statement of Position (“SOP”) No. 00-2, Accounting by Producers or Distributors of Films. The cost of production for television programming, including overhead, participations and talent residuals is capitalized and amortized 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 total revenues to be realized from all media and markets for such program. 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 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.

Recently Issued Accounting Pronouncements

Costs Associated with Exit or Disposal Activities -   In June 2002, Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities(“SFAS No. 146”). Such standard requires costs associated with exit or disposal activities (including restructurings) to be recognized when the costs are incurred, rather than at a date of commitment to an exit or disposal plan. SFAS No. 146 nullifies Emerging Issue Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under SFAS No. 146, a liability related to an exit or disposal activity is not recognized until such liability has actually been incurred whereas under EITF Issue No. 94-3 a liability was recognized at the time of a commitment to an exit or disposal plan. The provisions of this standard are effective for exit or disposal activities initiated after December 31, 2002. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

Guarantees — In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. Such Interpretation elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation apply to guarantees issued or modified after December 31, 2002. The disclosure provisions of this Interpretation are effective for financial statements as of and for the year ending after December 31, 2002. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

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Stock-Based Compensation — On December 31, 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure(“SFAS No. 148”). This standard amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method (expense treatment) of accounting for stock-based employee compensation. This standard also requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure requirements of this statement as of December 31, 2002. Should the Company elect to utilize the fair value based method for its stock-based compensation in the future, it must adopt the remaining provisions of SFAS No. 148.

Consolidation of Variable Interest Entities — On January 17, 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. Such Interpretation addresses consolidation of entities that are not controllable through voting interests or in which the equity investors do not bear the residual economic risks and rewards. These entities have been commonly referred to as special purpose entities. The Interpretation provides guidance related to identifying variable interest entities and determining whether such entities should be consolidated. It also provides guidance related to the initial and subsequent measurement of assets, liabilities and noncontrolling interests in newly consolidated variable interest entities and requires disclosures for both the primary beneficiary of a variable interest entity and other beneficiaries of the entity. Such Interpretation is effective for newly created variable interest entities beginning February 1, 2003 and for existing variable interest entities as of the third quarter of 2003. However, in October of 2003, the FASB permitted companies to defer the third quarter 2003 effective date to December 31, 2003, in whole or in part, and indicated that it would provide further clarification of this Interpretation before December 31, 2003. The Company is currently evaluating the provisions of this Interpretation.

Derivative Instruments and Hedging Activities — In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated in the statement for hedging relationships designated after June 30, 2003. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities.  The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock.  SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and to all other instruments that exist as of the beginning of the first interim financial reporting period after June 15, 2003. The Company adopted the provisions of SFAS No. 150 on July 1, 2003. The adoption of this standard by the Company did not have a material effect on its consolidated financial position or results of operations.

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Three and nine months ended September 30, 2003 as compared to three and nine months ended September 30, 2002.

Consolidated net revenues increased 109%, or $13,235, to $25,334, and 156%, or $42,443, to $69,681 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. The increase was due to a number of factors. In the Licensing segment, net revenue increased 75%, or $5,606, to $13,046 and 111%, or $19,557, to $37,112 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. Licensing and fee revenue, primarily from the “Yu-Gi-Oh!” and “Teenage Mutant Ninja Turtles” properties, increased significantly in the current periods as compared to the same periods in 2002. Net revenue in the Advertising Media and Broadcast segment increased 178% or $3,546 to $5,543 and 357%, or $10,763, to $13,774 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002 primarily due to sales of advertising time on the Fox Box which began broadcast operations in September 2002. Net revenue for the Television and Film Production/Distribution segment increased 154%, or $4,083, to $6,745 and 182%, or $12,123, to $18,795 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. In this segment, increased production service revenue was earned for work performed on the “Teenage Mutant Ninja Turtles”, “Kirby”, and “Pokémon” television programs when compared to the same period in 2002. Additionally, revenue for the nine months ended September 30, 2003 increased from the “Pokémon” movies and international broadcast agreements for the “Yu-Gi-Oh!”, “Teenage Mutant Ninja Turtles” and “Pokémon” television programs.

Selling, general and administrative expenses increased 25%, or $1,737, to $8,579 and 47%, or $7,668, to $23,996 for the three and nine months ended September 30, 2003, respectively, when compared to the same periods in 2002, primarily due to increased marketing and advertising costs for the expanded property line-up, home video operations, payroll and employee benefits resulting from higher staffing levels in advertising sales; the operation, marketing and promotion relating to the Fox Box and the Company’s Fox Box TV website; all of which commenced significant operations in September 2002. These increased payroll and employee benefits costs include bonus accruals which are based on pre-tax earnings. In addition, the Company incurred additional infrastructure costs to support the aforementioned new operations.

Production service costs increased 687%, or $2,247, to $2,574 and 715%, or $5,752, to $6,556 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. This increase was attributable to certain television production costs related to the “Teenage Mutant Ninja Turtles”, “Kirby”, and “Pokémon” television programs for which the Company incurs production costs that will be reimbursed. When the Company expects to be reimbursed, it categorizes them as production service costs and reflects a corresponding amount in revenue for the amount of the reimbursement.

As of September 30, 2003, there was $8,400 of capitalized film production costs relating primarily to various stages of production on 660 episodes of animated programming. Amortization of capitalized film costs increased 382%, or $2,007, to $2,533 and 234%, or $4,460, to $6,368 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, primarily due to increased amortization of programs broadcast on the Fox Box and the “Yu-Gi-Oh!” television programs.

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Amortization of the Fox broadcasting fee was $7,167 and $17,836 for the three and nine months ended September 30, 2003, respectively. The Fox Box commenced operations in September 2002. The fee payable to Fox is capitalized and amortized each broadcast season based on estimated advertising revenue. As of September 30, 2003, the Company paid Fox and certain affiliates $15,820 attributed to the second year’s broadcast fee, and as of December 31, 2002, the Company paid $19,301 attributed to the first year’s broadcast fee. The unamortized portion of these fees of $14,170 and $9,857, are included in “Prepaid Fox broadcast fee” on the accompanying consolidated balance sheets as of September 30, 2003 and December 31, 2002, respectively.

In addition to advertising revenues, the operating costs of 4Kids Ad Sales, Inc. and the amortization of the Fox broadcast fee, the overall impact of the Fox Box on the Company’s results of operations includes:

i)	revenues generated from merchandise licensing, home video and music publishing of Fox Box        properties, and

ii)	production and acquisition costs associated with the television programs broadcast on the Fox        Box.

The ability of the Company to further develop its merchandising, home video and music publishing revenue streams was a significant component of its evaluation to lease the Fox Box programming block.

Interest income decreased 35%, or $136, to $252 and 29%, or $345, to $835 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, as a result of the declining interest rate environment, partially offset by higher average cash balances invested.

Income tax expense increased 30%, or $430, to $1,866 and 94%, or $3,037, to $6,278 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, due to higher pre-tax income. The Company’s effective tax rate remained relatively consistent at approximately 40% for both 2003 and 2002.

As a result of the above, the Company had net income for the three and nine months ended September 30, 2003 of $2,867 and $9,482, respectively, as compared to net income for the same periods in 2002 of $1,963 and $4,744, respectively.

Liquidity and Capital Resources

For the nine months ended September 30, 2003, the Company’s cash and cash equivalents and short-term investment balances increased by $9,980 to $99,479, primarily as a result of increased royalty collections on the “Yu-Gi-Oh!” and “Teenage Mutant Ninja Turtles” properties and a decrease in accounts receivable, offset by contractual payments made for the Fox Box broadcast rights and other film rights and decreases in media payable.

Cash flows provided by (used in) operating activities for the nine months ended September 30, 2003 and 2002, were $8,586 and ($24,217), respectively. Working capital, consisting of current assets less current liabilities, was $124,284 as of September 30, 2003 and $114,298 as of December 31, 2002.

Cash flows used in investing activities for the nine months ended September 30, 2003, and 2002 were ($25,726), and ($2,033), respectively. As of September 30, 2003 and December 31, 2002, the Company had approximately $35,988 and $10,787, respectively, invested primarily in government obligations. For the nine months ended September 30, 2003, the Company purchased property and equipment of $525, which was comprised primarily of leasehold improvements and computer equipment, as compared to purchases of property and equipment of $2,274 for the same period in 2002.

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Cash flows provided by financing activities for the nine months ended September 30, 2003 and 2002 were $1,832 and $525, respectively. Cash flows from financing activities for the nine months ended September 30, 2003 and 2002 were generated by proceeds from the exercise of stock options by the Company’s employees.

The Company’s license agreement with Fox to program the network’s four hour Saturday morning children’s block which began in September 2002, requires the Company to pay an annual fee of $25,312. Under the terms of the agreement, through September 30, 2003, the Company paid Fox and certain affiliates a total of $41,450, representing the entire first broadcast year’s fee of $25,630, and a portion of the second broadcast year’s fee of $15,820, with the balance of the second year’s fee payable in three equal installments of $3,164 due in December 2003, February 2004 and April 2004. The fee for each subsequent broadcast year is payable 50% in the June preceding the beginning of the broadcast year (which begins in September) with the balance of the fee for the broadcast year payable in four equal installments in September, December, February and April. Additionally, the Agreement requires the Company to establish a $25,000 Letter of Credit for the benefit of Fox, which Letter of Credit may be reduced by the Company as installments of the final year’s license fee are paid. As of September 30, 2003, the Company had received a commitment for the letter of credit, but the letter of credit had not been issued pending completion of the long form agreement with Fox. Upon the issuance of the letter of credit, the Company will grant a security interest in its cash balances to the issuing bank to secure the amount of such letter of credit and will appropriately disclose these amounts as restricted cash in its financial statements.

The agreement further provides that, at the Company’s option, up to $10,300 of each year’s fee may be paid by delivering shares of the Company’s common stock. The Company will incur additional costs to program the four-hour block and to sell the related network advertising time. These costs will include direct programming costs to acquire, adapt and deliver programming for broadcast during the weekly four hour block as well as additional indirect costs of advertising sales, promotion and administration.

Our aggregate minimum payment obligations under various operating leases related to certain office, administrative and production facilities and the Fox Broadcast fee are as follows:

Year ending December 31,			Leases			Fox Broadcast Fee			Total
October 1, - December 31, 2003			$	302		$	3,164		$	3,466
2004				1,402			25,312			26,714
2005				1,522			25,312			26,834
2006				1,557			6,328			7,885
2007				1,557			--			1,557
2008 and thereafter				1,911			--			1,911
Total			$	8,251		$	60,116		$	68,367

The Company believes that existing cash and short-term investments and anticipated cash to be generated from future operations will be sufficient to meet our cash needs over the next twelve months for working capital, capital expenditures and strategic investments. However, during such period or thereafter, depending on the size and number of the projects and investments undertaken by the Company, the Company may seek additional financing alternatives.

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Forward-looking Statements

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company. We may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our stockholders. Such statements may, for example, express expectations or projections about future actions that we may take, including restructuring or strategic initiatives or about developments beyond our control including changes in domestic or global economic conditions. These statements are made on the basis of management’s views and assumptions as of the time the statements are made. There can be no assurance, however, that our expectations will come to pass.

Factors that may affect forward-looking statements. For the Company, a wide range of factors could materially affect future developments and performance, including the following:

Changes in Company-wide or business-unit strategies, which may result in changes in the types or mix of businesses in which the Company is involved or chooses to invest;

Changes in U.S., global or regional economic conditions, which may affect purchases of Company-licensed consumer products, the advertising market for broadcast and television programming and the performance of the Company’s theatrical, music and home entertainment releases;

Increased competitive pressures, both domestically and internationally, which may, among other things, lead to increased expenses in such areas as television programming acquisition and motion picture production and marketing;

Technological developments that may affect the distribution of the Company’s creative products or create new risks to the Company’s ability to protect its intellectual property;

Labor disputes, which may lead to increased costs or disruption of operations in any of the Company’s business units;

Changing public and consumer taste, which may among other things, affect the Company’s entertainment, broadcasting and consumer products businesses generally or result in increases in broadcasting losses or loss of advertising revenue; and

International, political and military developments that may, among other things, result in increases in broadcasting costs or loss of advertising revenue.

This list of factors that may affect future performance and the accuracy of forward-looking statements are illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

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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 income (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

The Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures under the supervision of and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is included in such reports.

There have not been any changes in the Company’s internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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Part II -OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a)     Exhibits

31.1        Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted                     pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2        Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted                     pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1        Joint Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18                     U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of                     2002.

(b)     Reports on Form 8-K

(1)        The Registrant filed a Current Report on Form 8-K on August 13, 2003 in connection with                  the issuance of its press release announcing the results for the quarterly period ended                  June 30, 2003.

(2)        The Registrant filed a Current Report on Form 8-K on November 13, 2003 in connection                  with the issuance of its press release announcing the results for the quarterly period ended                  September 30, 2003.

-22- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: November 14, 2003 4KIDS ENTERTAINMENT, INC. By: /s/ Alfred R. Kahn Alfred R. Kahn Chairman of the Board and Chief Executive Officer By: /s/ Joseph P. Garrity Joseph P. Garrity Executive Vice President and Chief Financial Officer -23-