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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Ended June 30, 2002
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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COMMISSION FILE NO. 0-7843
4KIDS ENTERTAINMENT, INC.
(Exact name of registrant as specified in its Charter)
NEW YORK
--------
(State of Incorporation)
13-2691380
----------
(I.R.S. Employer Identification Number)
1414 Avenue of the Americas, New York, New York
-----------------------------------------------
(Address of Principal Executive Offices)
10019
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(Zip Code)
(212) 758-7666
--------------
(Registrant's Telephone Number, Including Area Code)
NOT APPLICABLE
--------------
(Former Name, Former Address and Former Fiscal
Year if changed since last report)
Indicate by a check mark whether the registrant: (1) has filed all annual,
quarterly and other reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or 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 the number of shares outstanding of each of the Registrant's classes of
common stock, as of the close of the latest practicable date.
Class Outstanding at August 14, 2002
----- ------------------------------
Common Stock, $.01 Par Value 12,596,008
4KIDS ENTERTAINMENT, INC.
AND SUBSIDIARIES
INDEX
PAGE NUMBER
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 1
June 30, 2002(Unaudited) and December 31, 2001
Consolidated Statements of Income for the Three and 2
Six Months Ended June 30, 2002 and 2001(Unaudited)
Consolidated Statements of Cash Flows for the 3
Six Months Ended June 30, 2002 and 2001(Unaudited)
Notes to Consolidated Financial 4
Statements (Unaudited)
Item 2: Management's Discussion and Analysis 11
of Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures 15
About Market Risk
PART II: OTHER INFORMATION 16
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
------------ ------------
ASSETS (UNAUDITED)
CURRENT ASSETS
Cash and cash equivalents $ 71,713,275 $104,445,499
Investments 19,806,158 9,154,504
Accounts receivable - net 13,891,449 9,652,554
Prepaid/refundable income taxes 2,405,329 3,584,392
Prepaid expenses and other
current assets 16,051,331 4,042,835
------------ ------------
Total current assets 123,867,542 130,879,784
------------ ------------
FURNITURE, EQUIPMENT AND
LEASEHOLD IMPROVEMENTS -
Net of accumulated depreciation
and amortization of $1,934,864 and
$1,469,858 in 2002 and 2001,
respectively 2,742,614 2,098,758
ACCOUNTS RECEIVABLE - noncurrent, net 5,433,524 4,662,130
INVESTMENT IN EQUITY SECURITIES 725,631 725,631
FILM INVENTORY - noncurrent, net 4,933,521 4,182,372
OTHER ASSETS, NET 1,279,379 1,190,362
------------ ------------
TOTAL ASSETS $138,982,211 $143,739,037
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Due to licensors $ 7,560,851 $ 16,911,596
Media payable 1,079,853 1,588,162
Accounts payable and accrued expenses 4,801,685 4,455,011
Deferred revenue 1,451,880 96,889
Deferred income taxes 1,497,806 1,497,806
------------ ------------
Total current liabilities 16,392,075 24,549,464
DEFERRED INCOME TAXES - Noncurrent 731,447 731,447
------------ ------------
Total liabilities 17,123,522 25,280,911
------------ ------------
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, 12,595,758 and
12,546,708 shares in
2002 and 2001 125,958 125,467
Additional paid-in capital 33,884,471 33,265,412
Retained earnings 87,848,260 85,067,247
------------ ------------
Total stockholders' equity 121,858,689 118,458,126
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $138,982,211 $143,739,037
============ ============
See notes to consolidated financial statements.
1
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
NET REVENUES $8,178,372 $9,148,269 $15,139,208 $21,411,977
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Selling, general and administrative costs 5,018,038 4,497,406 9,486,247 8,589,262
Amortization of capitalized film costs 1,516,083 359,484 1,858,681 1,130,220
----------- ----------- ----------- -----------
TOTAL COSTS AND EXPENSES 6,534,121 4,856,890 11,344,928 9,719,482
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 1,644,251 4,291,379 3,794,280 11,692,495
INTEREST INCOME 315,081 1,260,080 791,733 2,903,457
----------- ----------- ----------- -----------
INCOME BEFORE INCOME
TAX PROVISION 1,959,332 5,551,459 4,586,013 14,595,952
INCOME TAX PROVISION 732,000 2,292,000 1,805,000 6,047,000
----------- ----------- ----------- -----------
NET INCOME $1,227,332 $3,259,459 $2,781,013 $8,548,952
=========== =========== =========== ===========
PER SHARE AMOUNTS
Basic Earnings per share $0.10 $0.27 $0.22 $0.71
=========== =========== =========== ===========
Diluted Earnings per share $0.09 $0.24 $0.20 $0.64
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 12,590,791 12,104,694 12,583,566 12,092,594
=========== =========== =========== ===========
Weighted average common share
outstanding - diluted 13,653,166 13,326,392 13,646,168 13,279,593
=========== =========== =========== ===========
See notes to consolidated financial statements.
2
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,781,013 $ 8,548,952
Adjustments to reconcile net
income to net cash used in
operating activities:
Depreciation and amortization 465,006 257,848
Amortization of capitalized
film costs 1,858,681 1,130,220
Changes in operating assets
and liabilities:
Accounts receivable - net (5,010,289) 5,867,527
Prepaid/refundable income
taxes 1,179,063 4,524,131
Prepaid expenses and other
current assets (12,008,496) (731,379)
Film inventory - net (2,609,830) (2,203,897)
Other assets (89,017) (323,844)
Due to licensors (9,350,745) (36,267,318)
Media payable (508,309) (1,732,111)
Accounts payable and
accrued expenses 346,674 (2,804,632)
Income taxes payable 0 (689,337)
Deferred revenue 1,354,991 (2,432,023)
------------ ------------
Net cash used in operating
activities (21,591,258) (26,855,863)
------------ ------------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from maturities of
commercial paper 9,154,504 46,756,096
Purchases of commercial paper (19,806,158) (26,134,926)
Purchases of property
and equipment (1,108,862) (509,445)
------------ ------------
Net cash (used in) provided
by investing activities (11,760,516) 20,111,725
------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from exercise of
stock options and related
tax benefit 619,550 627,298
------------ ------------
Net cash provided by
financing activities 619,550 627,298
------------ ------------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (32,732,224) (6,116,840)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 104,445,499 117,749,331
------------ ------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 71,713,275 $111,632,491
============ ============
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR:
Income Taxes $ -- $ 1,105,033
============ ============
See notes to consolidated financial statements.
3
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2002
Note 1
BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes as required by accounting principles generally
accepted in the United States of America for complete financial statements. In
the opinion of management, all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation of the interim
financial information have been included. Operating results for the six months
ended June 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002. For further information, refer
to the consolidated financial statements and footnotes thereto included in 4Kids
Entertainment, Inc.'s (the "Company") annual report Form 10-K for the year ended
December 31, 2001.
Note 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
For a summary of significant accounting policies, reference is made to the
Company's annual report on Form 10-K previously filed for the year ended
December 31, 2001.
New Accounting Pronouncements - In July 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" (effective July 1,
2001) and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No.
141 prohibits pooling-of-interests accounting for acquisitions initiated
after June 30, 2001. SFAS No. 142 specifies that goodwill and some
intangible assets will no longer be amortized but instead will be subject
to periodic impairment testing. The Company's adoption of SFAS No. 141 and
SFAS No. 142 did not have a significant impact on its results of
operations or financial position.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires entities to record the fair
value of a liability for an asset retirement obligation in the period in
which it is incurred. The provisions of SFAS No. 143 are effective for
fiscal years beginning after June 15, 2002.
4
The Company will adopt SFAS No. 143 beginning in the first fiscal quarter
of fiscal 2003. The Company believes that the adoption of SFAS No. 143
will not have a material impact on its results of operations or financial
position.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". The primary objectives of SFAS No.
144 were to develop one accounting model based on the framework
established in SFAS No. 121, and to address significant implementation
issues. The provisions of SFAS No. 144 are effective for fiscal years
beginning after December 15, 2001. The Company adopted SFAS No. 144 in the
first fiscal quarter of fiscal 2002. The Company's adoption of SFAS No.
144 did not have a material impact on its results of operations or
financial position.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145
rescinds the provisions of SFAS No. 4 that requires companies to classify
certain gains and losses from debt extinguishments as extraordinary items,
eliminates the provisions of SFAS No. 44 regarding the Motor Carrier Act
of 1980 and amends the provisions of SFAS No. 13 to require that certain
lease modifications be treated as sale leaseback transactions. The
provisions of SFAS 145 related to classification of debt extinguishment is
effective for fiscal years beginning after May 15, 2002. Earlier
application is encouraged. The adoption of SFAS 145 is not expected to
have a material impact in the financial position or results of operation
of the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues 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)." SFAS No. 146 requires that a liability for
a cost associated with an exit or disposal activity be recognized when the
liability is incurred. This statement also established that fair value is
the objective for initial measurement of the liability. The provisions of
SFAS No. 146 are effective for exit or disposal activities that are
initiated after December 31, 2002. The Company is currently evaluating the
impact of SFAS No. 146 on its consolidated financial statements.
Reclassifications - Certain amounts have been reclassified in year 2001 to
conform to the current year's presentation.
5
Note 3
COMMITMENTS AND CONTINGENCIES:
A. LITIGATION:
(i) Imber v. Nintendo, et al. In September 1999, the Company was named as a
defendant in a lawsuit filed in the United States District Court for the
Southern District of California. Also named as defendants in this lawsuit are
Nintendo of America Inc. and Wizards of the Coast, Inc. The lawsuit, purportedly
brought on behalf of a class of all persons who purchased a package of Pokemon
trading cards, seeks to challenge longstanding practices in the trading card
industry, including the practice of randomly inserting premium cards in packages
of Pokemon cards.
The lawsuit claims that these practices constitute illegal gambling activity in
violation of California and federal law, including the Federal Racketeer
Influenced and Corrupt Organization Act, and seeks an award of treble damages.
The lawsuit has not specified the amount of damages sought. On April 18, 2000,
the United States District Court issued an Order to Show Cause in the
lawsuit(and in a number of other lawsuits making similar allegations concerning
other types of trading cards) requiring the plaintiffs in all of the cases to
show cause why the cases should not be dismissed for lack of standing. On June
21, 2000, the United States District Court dismissed the RICO claims with
prejudice and all other claims without prejudice. Plaintiffs filed a notice of
appeal on July 24, 2000 from the District Court's June 21, 2000 dismissal, and
the appeal is pending.
(ii) Morrison v. Nintendo, et al. On March 29, 2000, Morrison Entertainment
Group, Inc., filed suit in the United States District Court for the Central
District of California against Nintendo of America Inc., 4Kids Entertainment,
Inc., and Leisure Concepts, Inc. The suit alleges that the Pokemon trademark
infringes upon the Plaintiff's "Monster in my Pocket" trademark. The complaint
also alleges trademark dilution, unfair competition, and a breach of implied
contract. The complaint seeks injunctive relief as well as monetary damages. On
August 6, 2001, the United States District Court granted summary judgement
dismissing the suit. Plaintiff has filed a notice of appeal from the District
Court's dismissal. In the first quarter of 2002 the parties filed their briefs
on appeal.
While it is impossible to predict the eventual outcome of the litigation
discussed in sub-paragraphs (i) and (ii) above, the Company believes these
litigations will not have a material adverse effect on the Company's financial
condition and results of operations.
B. KEY MAN CLAUSE - Under the terms of the Company's representation agreements
(the "Agreements") with Pokemon USA, Inc. "PUI" with respect to the Pokemon
property and Nintendo of
6
America Inc. "NOA" with respect to the Nintendo properties, in the event that
Mr. Alfred Kahn, Chairman and CEO of the Company, becomes unavailable due to
death, disability, termination or a major change of duties and an acceptable
replacement for Mr. Kahn is not found within a specified period of time, or
there is a change in control of the Company resulting in a major change of
duties for Mr. Kahn, PUI and NOA have the option to terminate their respective
agreements. The Company would however, continue to be paid on license agreements
in place at the time such options were exercised.
Note 4
FOX LEASE AGREEMENT
In January 2002, The Company entered into a multi-year agreement with Fox
Broadcasting Company ("Fox") to lease the television network's Saturday morning
programming block. Beginning with the September 2002 broadcast year, the Company
will provide all programming content for Fox's Saturday morning broadcast block,
which airs from 8am to 12pm ET/PT (7am to 11am CT). Under the terms of the
agreement, the Company will also have the right to retain all revenue from the
network advertising sales during the four-hour time period.
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 license fee of $25,312,500 for each broadcast year during the
initial term of the agreement.
The agreement provides for 50% of the fee for the first broadcast season to be
paid within ten days of the execution of the Agreement, with the balance of the
fee for the first broadcast season to be paid in four equal installments in
September, December, February and April of the broadcast year.
Accordingly, on January 28, 2002, the Company paid $12,656,250, representing 50%
of the first year's fee, to Fox which is included in "Prepaid expenses and other
current assets" on the accompanying balance sheet as of March 31, 2002. Fees for
each subsequent broadcast year are payable 50% in the June preceding the
beginning of the broadcast year (which is 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 $25,000,000 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.
The agreement further provides that, at the Company's option, up to $10,300,000
of each year's fee may be paid in the Company's common stock. Over the initial
four year term of the agreement, the Company will pay Fox aggregate license fees
of $101,200,000.
The Company's ability to recover the cost of its license fees payable to Fox
will depend on the popularity of the television
7
programs the Company runs 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 the Company can charge. Additionally, the success of
merchandise licensing programs and home video sales based on such television
programs is dependent on consumer acceptance of the properties. If the Company
is 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 Broadcasting, it would record a charge to earnings
to reflect a write down in the future value of the Fox license agreement in the
period in which the deficiency or factors affecting the recoverability of the
license 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
license fee. Such estimates and assumptions are subject to market forces and
factors beyond the control of the Company and inherently subject to change.
There can be no assurance that the Company will be able to recover the full cost
of the Fox license fee and in the event it cannot, the resulting charges to
reflect a write down in the future value of the Fox license fee could be
significant.
Note 5
DEFERRED REVENUE
Master Toy Licensee - 4Kids Entertainment Licensing, Incorporated, a wholly
owned subsidiary of the Company, is the exclusive Merchandise Licensing Agent
for the "Pokemon" property outside Asia. The master toy licensee ("Licensee")
for the "Pokemon" property and The Pokemon Company LLC (the assignee of certain
rights and obligations of Nintendo of America Inc. with respect to the "Pokemon"
property) have entered into a new agreement (the "Agreement") effective January
1, 2001.
The Agreement supersedes the original Merchandise License Agreement, dated as of
May 14, 1998 as amended in September 1999.
Under the revised terms of the Agreement, the parties have agreed, inter alia,
that Licensee will pay a minimum royalty for the period starting January 1, 2001
and ending December 31, 2003. If all of the conditions under the Agreement are
met and the full amount of the minimum guaranteed royalties are paid by
Licensee, the Company's share would be not less than $7,500,000 over the period
of the Agreement. Through March 31, 2002, the Company has recognized $5,000,000
($2,500,000 in each of fiscal 2001 and 2002) of its share of minimum guaranteed
royalties based on annual minimums under the Agreement.
Additionally, Licensee has agreed that any amounts paid by the Licensee under
the original Merchandise License Agreement, including the advance paid in April
2000 are non-refundable and
8
non-recoupable against any future royalties. Accordingly, approximately
$2,300,000 of deferred revenue at December 31, 2000 relating to the original
Merchandise License Agreement was recognized as revenue in the quarter ended
March 31, 2001.
The Company has also created a new subsidiary, 4Kids Entertainment Home Video,
Inc. ("4KHV"). 4KHV has entered into an agreement with its home video
distributor Funimation pursuant to which 4KHV is providing ongoing advertising,
marketing and promotional services with respect to home video titles of Company
represented properties distributed by Funimation. Funimation has paid the
Company an advance against 4KHV's share of the distribution proceeds to be
realized by 4KHV from such titles. Such advance has been recorded in the
Company's deferred revenue account. As 4KHV earns its share of the distribution
proceeds from its distributor Funimation, such deferred revenue will be
recognized as revenue.
Note 6
INVESTMENT IN THE POKEMON COMPANY
During the quarter ended September 30, 2001, the Company completed its purchase
of a 3% equity interest in the Pokemon Company, a closely held Japanese company,
which was organized in 1998 by Nintendo Co. Ltd, Creatures, Inc. and Game Freak,
Inc., the creators of Pokemon, to manage and control all rights throughout the
world to Pokemon. The Company accounts for this investment on the cost basis and
has classified it as "Investment in equity securities", a non-current asset on
the accompanying balance sheet.
Note 7
SUBSEQUENT EVENT: MUSIC PUBLISHING
In July 2002, the Company granted a right 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 Pokemon) ("Current Music
Assets") to a third party for $3 million which was and received by the Company
in July, 2002. Further, the Company agreed to grant a right to receive a 50%
interest in the Company's net share of future music revenues from music to be
produced by the Company for its television programs (excluding Pokemon)("Future
Music Assets") to the same third party for $2 million. In connection with the
grant of Future Music Assets, the Company will receive $750,000 in each of June
2003 and 2004 and $500,000 in June 2005.
As a result of the above transactions, the Company will recognize revenue of $3
million for granting the rights to a 50% interest in its Current Music Assets in
the quarter ending September 30, 2002. The Company will recognize revenue from
granting the rights to a 50% interest in Future Music Assets over the period of
time it produces the related music.
9
Note 8
SEGMENT AND RELATED INFORMATION
The Company applies Statement of Financial Accounting Standards No. 131 ("SFAS
No. 131"), "Disclosures About Segments of an Enterprise and Related
Information". The Company has three reportable segments; Licensing, Media
Buying, Planning and Television Distribution and Television and Film Production.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company does not have any
inter-segment sales or transfers.
The Company's reportable segments are strategic business units which, while
managed separately, work together as a vertically integrated entertainment
company.
MEDIA & TV & FILM
LICENSING TV DISTRIBUTION PRODUCTION TOTAL
--------- --------------- ---------- -----
Six Months Ended
June 30,
2002
Revenues $ 10,114,915 $1,419,310 $ 3,604,983 $ 15,139,208
Segment Profit (Loss) 3,511,798 (42,122) 1,116,337 4,586,013
Segment Assets 126,072,272 2,566,833 10,343,106 138,982,211
2001
Revenues $ 15,783,545 $1,197,869 $ 4,430,563 $ 21,411,977
Segment Profit 12,249,520 43,022 2,303,410 14,595,952
Segment Assets 129,852,420 7,718,582 3,824,166 141,395,168
Three Months Ended
June 30,
2002
Revenues $ 5,518,036 $ 645,082 $ 2,015,254 $ 8,178,372
Segment Profit (Loss) 2,097,370 (175,444) 37,406 1,959,332
Segment Assets 126,072,272 2,566,833 10,343,106 138,982,211
2001
Revenues $ 7,635,398 $ 543,948 $ 968,923 $ 9,148,269
Segment Profit (Loss) 5,463,884 (22,728) 110,303 5,551,459
Segment Assets 129,852,420 7,718,582 3,824,166 141,395,168
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS:
The Company receives revenues from a number of sources, principally licensing,
media buying and television distribution. Additionally, beginning in September
2002, the Company will begin to recognize revenue from the sale of advertising
time related to its lease of the Fox Saturday morning television block more
fully described in Note 4 to the Financial Statements. The Company typically
derives a substantial portion of its licensing revenues from a small number of
properties, which properties usually generate revenues only for a limited period
of time. Because the Company's licensing revenues are highly subject to changing
fashion in the toy and entertainment business, its licensing revenues from year
to year from particular sources are subject to dramatic increases and decreases.
It is not possible to precisely anticipate the length of time a project will be
commercially successful, if at all. Popularity of properties can vary from
months to years. As a result, the Company's revenues and net income may
fluctuate significantly between comparable periods. The Company's revenues have
historically been primarily derived from the license of toy and game concepts.
Thus, 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. In
addition, the Company's media buying subsidiary concentrates its activities on
the youth oriented market. As a result, most of its revenue is earned in the
fourth quarter when the majority of toy and video game advertising occurs. In
the Company's usual experience, its revenues during the second half of the year
have generally been greater than during the first half of the year. However, the
Company's revenues in the most recent fiscal years were influenced more by
popularity trends and movie and home video release dates of "Pokemon" than the
historical seasonal trends of toy and game sales. Further, the Company has
little control over the timing of guarantee and minimum royalty payments, some
of which are made upon the execution and delivery of license agreements.
Three and Six Months Ended June 30, 2002 Compared to the Three and Six Months
Ended June 30, 2001
Consolidated net revenues decreased 11% or $969,897 to $8,178,372 for the three
month period ended June 30, 2002 as compared to the same period in 2001.
Consolidated net revenues for the six month period decreased 30% or $6,272,769
to $15,139,208 as compared to the six month period ended June 30, 2001. The
decrease in consolidated net revenues for the three and six month periods was
due primarily to decreased merchandise licensing and movie related revenues for
the Pokemon property.
11
Additionally, revenues related to the World Championship Wrestling ("WCW")
property decreased by approximately $950,000 from the first quarter of 2001. The
Company's representation of the WCW property terminated in the first quarter of
2001. Offsetting a portion of the decreased revenues for the three months and
six ended June 30, 2002 were revenues earned on the Yu-Gi-OH! Property for
merchandise licensing and television license fees.
In April 2002, Yu-Gi-OH! began running on the Kids WB! television network six
days a week, thereby triggering an additional minimum guaranteed royalty
obligation generating licensing revenues for the Company. Video games from
Konami and a card game from The Upper Deck Company all began shipping into the
US market during the quarter ended June 30, 2002, generating marketing fee
revenues for the Company from the initial three months of sales.
Selling, general and administrative expenses increased 12% or $520,632 to
$5,018,038 and 10% or $896,985 to $9,486,247 for the three and six month periods
ended June 30, 2002 when compared to the year ago periods. These increases were
primarily attributable to bonus accruals of approximately $292,000 recorded in
the first quarter of 2002 and approximately $218,000 recorded in the second
quarter of 2002. For the first two fiscal quarters ended June 30, 2002, the
Chairman and CEO of the Company has voluntarily reduced the amount of his bonus
compensation by approximately $225,000. Additionally, selling general and
administrative expenses increased as a result of payroll costs from the
Company's expanded operations in advertising sales for selling the commercial
time obtained by the Company in leasing the Fox Saturday morning television
block.
Amortization of capitalized film cost increased $1,156,599 and $728,461 for the
three and six months ended June 30, 2002 when compared to the prior year
periods. The increase was primarily attributable to increased amortization of
the Cubix, Yu-Gi-OH! and Tama television series. At June 30, 2002, there were
$4,933,521 of capitalized film production costs which primarily relate to the
production of twenty-six episodes of Cubix, forty-eight episodes of the
Yu-Gi-Oh!, 26 episodes of Tama and Friends, 52 episodes of Ultra Man 52 episodes
of Kinnikuman- Ultimate Muscle, 52 episodes of Kirby and 52 episodes of the
Fighting Foodons television series. Cubix is a computer animated television
series owned in part by the Company which premiered on The Kids' WB television
network in August 2001. Kids WB! has renewed the series for broadcast during the
upcoming 2002-2003 new television season. Yu-Gi-Oh! premiered on the Kids' WB
television network in September 2001. Kids WB! has renewed the series for
broadcast in the 2002-2003 television season. Tama and Friends is a television
series broadcast in first run syndication which began in September 2001.
Ultra Man, Kinnikuman Ultimate Muscle, Kirby and Fighting Foodons are being
prepared for broadcast beginning in September 2002 on the Company's Saturday
morning Fox network television block. At June 30, 2002, the percentage of total
unamortized film costs
12
expected to be amortized within the next three years exceeded 80%.
The Company periodically evaluates its anticipated revenue from film production
and, consequently, amortization rates may change as a result of such estimates.
Interest income decreased by $944,999 to $315,081 and $2,111,724 to $791,733 for
the three and six month periods ended June 30, 2002 as compared to the same
periods in 2001. These decreases are due primarily to substantially lower
interest rates obtained on the Company's invested cash during 2002 as compared
to the same periods in 2001 and to a reduced amount of invested cash.
LIQUIDITY AND CAPITAL RESOURCES:
At June 30, 2002, the Company had working capital of $107,475,467 as compared to
working capital of $106,330,320 at December 31, 2001, an increase in working
capital of $1,145,147. Cash and cash equivalents and investments decreased by
$22,080,570 to $91,519,433 from December 31, 2001. The decrease in cash
equivalents is primarily due to decreased levels of royalty collections on the
Pokemon property and the paydown of royalties collected on behalf of licensors.
Accordingly, there is a corresponding decrease in the current liability "Due to
Licensors" of $9,350,745. Additionally, in January 2002, the Company paid the
first installment of $12,656,250 to Fox Broadcasting for the network lease more
fully described in Note 4 to the financial statements. This prepaid fee is
reflected in "Prepaid expenses and other current assets" on the accompanying
balance sheet at June 30, 2002.
Accounts receivable, net (current and non-current) increased to $19,324,973 at
June 30, 2002 from $14,314,684 at December 31, 2001. The increase was primarily
due to increased royalty income receivable on the Yu-Gi-OH! property.
Amounts due to licensors, which represents the owners' share of royalties
collected at June 30, 2002, decreased by $9,350,745 to $7,560,851 from December
31, 2001. Beginning in 2002, Pokemon USA, Inc., the U.S. subsidiary of The
Pokemon Company, became the collection agent for Pokemon royalties. Accordingly,
the Company no longer collects and accounts for 100% of royalties on Pokemon in
"Cash and cash equivalents" with a corresponding current liability "Due to
Licensors" for the licensor's share of such royalties. Beginning in 2002, the
Company began recording its share of Pokemon revenue due from Pokemon USA, Inc.
as a receivable. This receivable is settled quarterly with a payment from
Pokemon USA, Inc.
The Company's new license agreement with Fox to program the network's four hour
Saturday morning children's block beginning in September 2002, will require the
Company to pay an annual fee of $25,312,500. Under the terms of the agreement,
on January 28, 2002, the Company paid $12,656,250 which represents 50% of the
first year's fee to Fox. Fees for each subsequent broadcast year
13
are 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 $25,000,000
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. The
agreement further provides that, at 4Kids option, up to $10,300,000 of each
year's fee may be paid in the Company's common stock. Further, 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.
The Company's contractual cash obligations for leases and the Fox license
agreement are as follows (in thousands):
Year ending Fox
December 31, Leases License Total
------- -------- --------
July 1 - Dec. 31, 2002 $ 597 $ 6,328 $ 6,925
2003 1,225 25,312 26,537
2004 1,402 25,312 26,714
2005 1,522 25,312 26,834
2006 1,557 6,328 7,885
2007 and thereafter 3,468 -- 3,468
------- -------- --------
Total $9,771 $88,592 $98,363
======= ======== ========
The Company has allocated significant resources to the acquisition, programming
and marketing of the Fox Box. The Company's ability to recover these resources
will be dependant on successful delivery and audience acceptance of the
programming and on the success of merchandise licensing programs and home video
sales based on such television programs. The launch of the Fox Box is on
schedule and the Company has experienced better than expected upfront orders for
the advertising time available during the four hour block. If the trend
continues for the orders for advertising time, the Company believes it will
cover the lease fee to Fox Broadcasting with the advertising sales generated
during the four hour Fox Box. However, the Company's ability to retain the full
value of the advertising time sold will be dependent on the audience ratings
delivered by the programs in the Fox Box. There can no assurance that the demand
for advertising time will continue or that the programs will achieve the minimum
rating performance necessary to retain the full value of the advertising time
sold.
The Company anticipates it will be able to meet its payment obligations
under the license agreement and will be able to finance its business as
currently conducted from its working capital. Accordingly, in March 2001, it
terminated its $5,000,000 credit facility with JPMorgan Chase Bank. However, as
the Company explores new and expanded opportunities in the children's
entertainment market, it may seek additional financing alternatives.
14
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS:
Not Applicable
Forward-looking Statements
Sections of this Quarterly Report contain forward-looking statements, including,
without limitation, statements concerning possible or assumed future results of
operations of the Company preceded by, followed by or that include the words
"believes," "expects," "anticipates," "estimates," "intends," "plans" or similar
expressions. For those statements, we claim the protection of the safe harbor
for forward-looking statements contained in the U.S. Private Securities
Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance. They
involve risks, uncertainties and assumptions. Due to the fact that the Company
faces competition from toy companies, motion picture studios and other licensing
companies, and the uncertainty of the public's response to the Company's
properties, actual results or outcomes may differ materially from any such
forward-looking statements.
15
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of the Company was held on May 23, 2002. The
matters voted upon, including the number or votes cast for, against or withheld,
as well as the number of abstentions and broker non-votes, as to each such
matter were as follows:
Proposal 1: All five of management's nominees for directors as listed in the
proxy statement were elected with the number of votes cast for each nominee as
follows:
Shares Voted Shares Voted Shares Broker Non-Votes Votes
"FOR" "AGAINST" "ABSTAINING" Withheld
Joel I. Cohen 9,957,718 37,825
Jay Emmett 9,957,718 37,825
Joseph P. Garrity 9,957,718 37,825
Steven M. Grossman 9,957,718 37,825
Alfred R. Kahn 9,957,718 37,825
Proposal 2: The proposal to appoint Deloitte & Touche LLP as independent
auditors to examine the Company's financial statements for the fiscal year
ending December 31, 2002, was ratified by the following vote:
Shares Voted Shares Voted Shares Broker Votes
"FOR" "AGAINST" "ABSTAINING" Non-Votes Withheld
9,931,075 58,830 5,638
Proposal 3: The proposal to approve the 4Kids Entertainment, Inc. 2002 Stock
Option Plan, which authorizes the issuance of options to purchase up to 600,000
shares of the Company's common stock, was ratified by the following vote:
Shares Voted Shares Voted Shares Broker Votes
"FOR" "AGAINST" "ABSTAINING" Non-Votes Withheld
8,707,708 582,992 704,843
16
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
99.1 Certification 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
None
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: August 14, 2002
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
Chief Financial Officer
17