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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 September 30, 2002
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ________________
COMMISSION FILE 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
-----
(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 November 14, 2002
- ---------------------------- --------------------------------
Common Stock, $.01 Par Value 12,612,508
4KIDS ENTERTAINMENT, INC.
AND SUBSIDIARIES
INDEX
PAGE NUMBER
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of 1
September 30, 2002(Unaudited) and December 31, 2001
Consolidated Statements of Income for the Three and 2
Nine Months Ended September 30, 2002 and 2001(Unaudited)
Consolidated Statements of Cash Flows for the 3
Nine Months Ended September 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 16
About Market Risk
Item 4: Controls and Procedures 16
PART II: OTHER INFORMATION 17
Item 6: Exhibits and Reports on Form 8-K 17
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
ASSETS (UNAUDITED)
- ------
CURRENT ASSETS
Cash and cash equivalents $ 78,720,434 $104,445,499
Investments 8,913,469 9,154,504
Accounts receivable - net 19,978,485 9,652,554
Prepaid/refundable income taxes -- 3,584,392
Prepaid expenses and other current assets 21,137,768 4,042,835
------------ ------------
Total current assets 128,750,156 130,879,784
------------ ------------
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS -
Net of accumulated depreciation and amortization
of $1,835,129 and $1,469,858 in 2002 and 2001, respectively 3,650,934 2,098,758
ACCOUNTS RECEIVABLE - noncurrent, net 5,460,735 4,662,130
INVESTMENT IN EQUITY SECURITIES 725,631 725,631
FILM INVENTORY - noncurrent, net 6,437,684 4,182,372
OTHER ASSETS, NET 1,366,129 1,190,362
------------ ------------
TOTAL ASSETS $146,391,269 $143,739,037
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Due to licensors $ 7,862,349 $ 16,911,596
Media payable 1,880,335 1,588,162
Accounts payable and accrued expenses 5,044,070 4,455,011
Income taxes payable 679,980 --
Deferred revenue 4,252,138 96,889
Deferred income taxes 1,497,806 1,497,806
------------ ------------
Total current liabilities 21,216,678 24,549,464
DEFERRED RENT AND OTHER LONG-TERM LIABILITY 424,131 --
DEFERRED INCOME TAXES - Noncurrent 731,447 731,447
------------ ------------
Total liabilities 22,372,256 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, 12,610,008 and 12,546,708 shares in 2002 and 2001 126,100 125,467
Additional paid-in capital 34,081,417 33,265,412
Retained earnings 89,811,496 85,067,247
------------ ------------
Total stockholders' equity 124,019,013 118,458,126
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $146,391,269 $143,739,037
============ ============
See notes to consolidated financial statements.
1
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
NET REVENUES $12,099,483 $ 9,875,681 $27,238,691 $31,287,658
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Selling, general and administrative costs 6,841,632 8,155,909 16,327,879 17,444,661
Amortization of capitalized film costs and
Fox broascast fee 2,246,571 268,726 4,105,252 699,456
----------- ----------- ----------- -----------
TOTAL COSTS AND EXPENSES 9,088,203 8,424,635 20,433,131 18,144,117
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 3,011,280 1,451,046 6,805,560 13,143,541
INTEREST INCOME 387,956 992,666 1,179,689 3,896,123
----------- ----------- ----------- -----------
INCOME BEFORE INCOME
TAX PROVISION 3,399,236 2,443,712 7,985,249 17,039,664
INCOME TAX PROVISION 1,436,000 949,000 3,241,000 6,996,000
----------- ----------- ----------- -----------
NET INCOME $ 1,963,236 $ 1,494,712 $ 4,744,249 $10,043,664
=========== =========== =========== ===========
PER SHARE AMOUNTS
Basic Earnings per share $0.16 $0.12 $0.38 $0.83
=========== =========== =========== ===========
Diluted Earnings per share $0.14 $0.11 $0.35 $0.75
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 12,597,355 12,161,371 12,588,162 12,115,519
=========== =========== =========== ===========
Weighted average common share
outstanding - diluted 13,678,026 13,468,957 13,656,787 13,342,714
=========== =========== =========== ===========
See notes to consolidated financial statements.
2
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,744,249 $ 10,043,664
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 721,929 447,100
Amortization of capitalized film costs and Fox broadcast fee 4,105,252 699,456
Changes in operating assets and liabilities:
Accounts receivable - net (11,124,536) 3,262,592
Prepaid/refundable income taxes 3,584,392 4,524,131
Prepaid expenses and other current assets (18,487,794) 19,543
Film inventory - net (4,967,703) (4,894,843)
Other assets (175,767) (322,819)
Due to licensors (9,049,247) (37,284,901)
Media payable 292,173 (1,955,645)
Accounts payable and accrued expenses 589,059 (367,000)
Income taxes payable 679,980 (3,210)
Tax benefit on exercise of stock options 291,728 862,000
Deferred revenue 4,155,249 (2,208,421)
Deferred rent and other long-term liability 424,131 --
------------- -------------
Net cash used in operating activities (24,216,905) (27,178,353)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of commercial paper 20,047,193 57,146,327
Purchases of commercial paper (19,806,158) (40,240,903)
Investment in The Pokemon Company -- (725,631)
Purchases of property and equipment (2,274,105) (1,063,842)
------------- -------------
Net cash (used in) provided by investing activities (2,033,070) 15,115,951
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 524,910 360,309
------------- -------------
Net cash provided by financing activities 524,910 360,309
------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (25,725,065) (11,702,093)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 104,445,499 117,749,331
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 78,720,434 $ 106,047,238
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR:
Income Taxes $ 134,255 $ 1,105,033
============= =============
See notes to consolidated financial statements.
3
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 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 nine months
ended September 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 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 No. 145 related to
classification of debt extinguishment is effective for fiscal years
beginning after May 15, 2002. The Company's adoption of SFAS 145 beginning
in the first quarter of fiscal 2003 is not expected to have an impact on
its results of operations or financial position.
4
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 adoption of SFAS 146 is not
expected to have a material impact in the financial position or results of
operation of the Company.
Reclassifications - Certain amounts have been reclassified in year 2001 to
conform to the current year's presentation.
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 ("RICO"), 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.
On August 20, 2002 the United States Court of Appeals for the Ninth Circuit
affirmed the United States District Court's
5
dismissal of the RICO claims with prejudice, and all other state law claims
without prejudice.
(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, which is still pending.
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 operation.
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 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 with third parties in place at the time such
options were exercised.
C. CONTRACTUAL ARRANGEMENTS - During the normal course of business, the Company
may enter into various agreements with third-parties to license, acquire,
distribute, broadcast, develop and/or promote properties. The terms of these
agreements will vary based on the services and/or properties included within the
agreement, as well as, geographic restrictions, duration, property and
exploitation rights, and various other terms. The effect of these agreements
could be material to the Company's financial condition and results of
operations.
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
6
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 network advertising sales during the
four-hour time period. In June 2002, the Company created a new subsidiary, 4Kids
Ad Sales, Inc. ("4KAS"). 4KAS was established to account for the revenue and
costs associated with the Fox programming block.
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 $25,312,500 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 the
following September, December, February and April of the broadcast year.
The cost of the Saturday morning program block has been and will be capitalized
and amortized over the broadcast season based on estimated advertising revenue
earned. The Company paid Fox $15,820,313, representing a portion of the first
year fee. The remaining unamortized portion of the first year's fee to Fox of
$14,427,452 is included in "Prepaid expenses and other current assets" on the
accompanying balance sheet as of September 30, 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 the following September,
December, February and April. Additionally, the agreement will require 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 fee are paid. As of September 30, 2002, the Company is in the
process of, but has not yet executed the required letter of credit. Upon the
execution of the letter of credit, the Company will secure the amount of such
letter of credit against its cash balances 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 $10,300,000
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 an aggregate fee of
$101,250,000.
The Company's ability to recover the cost of its fees payable to Fox will depend
on the popularity of the television 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
7
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, it
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 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.
Note 5
DEFERRED REVENUE
Music Publishing - In July 2002, the Company created a new subsidiary, 4Kids
Entertainment Music, Inc. ("4KM"). Also in July 2002, 4KM 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 an unaffiliated third party in an
arms length transaction for $3 million which was 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 music revenues from future 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.
The Company initially expected to recognize revenue of $3 million for granting
the rights to a 50% interest in its Current Music Assets in the quarter ended
September 30, 2002 and to recognize revenue from granting the rights to a 50%
interest in Future Music Assets over the period of time during which it produces
the related music. Given the evolving literature regarding revenue recognition,
including the modifications to Emerging Issues Task Force 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables", in October 2002, the Company
has determined that it will defer all amounts received or to be received under
the contract. Therefore, the Company will recognize revenue as the Current Music
Assets and Future Music Assets generate revenue over the contract term.
Notwithstanding the foregoing, when the
8
Company delivers all of the Future Music Assets required under the contract, any
portion of the $5 million that remains deferred and has not been recognized as
of the date all required Future Music Assets have been delivered will be
recognized as revenue. Pursuant to the above, the Company recognized revenue of
$114,829 for the quarter ended September 30, 2002.
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 and 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 September 30, 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 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.
In May 2002, the Company created a new subsidiary, 4Kids Entertainment Home
Video, Inc. ("4KHV"). 4KHV has entered into an agreement with its home video
distributor, Funimation Productions, Ltd ("Funimation"), pursuant to which 4KHV
is providing ongoing advertising, marketing and promotional services with
respect to certain home video titles, the rights to which are owned or
controlled by the Company and which are distributed by Funimation. Funimation
has paid the Company an advance against 4KHV's share of the service fee proceeds
to be realized by 4KHV from such titles. Such advance has been recorded in the
Company's deferred revenue account and will be recognized as the service fees
are earned through the sales of home videos by Funimation.
9
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
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; (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 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.
The Company periodically reviews its operating segments, and as such, evaluates
the relevance and appropriateness of each of its reportable segments. During the
quarter ended September 30, 2002, management reviewed the Company's operating
segments, as they relate to current operations and in accordance with the
Company's internal management structure. In response to this evaluation, the
Company has revised its operating segments to reflect a more appropriate measure
of evaluating the operating performance of its reportable segments. These
revisions have been reflected in the current quarter's disclosure, with all
previously reported amounts reclassified to conform to the current presentation.
10
ADVERTISING TV & FILM
MEDIA & PRODUCTION/
LICENSING BROADCAST DISTRIBUTION TOTAL
--------- ----------- ------------ -----
Nine Months Ended
September 30,
2002
Revenues $ 17,554,696 $ 3,011,413 $ 6,672,582 $ 27,238,691
Interest Income 1,149,018 30,671 - 1,179,689
Segment Profit (Loss) 8,799,111 (3,127,270) 2,313,408 7,985,249
Segment Assets 110,940,160 19,229,554 16,221,555 146,391,269
2001
Revenues $ 22,673,693 $ 1,528,656 $ 7,085,309 $ 31,287,658
Interest Income 3,747,026 149,097 - 3,896,123
Segment Profit (Loss) 15,415,647 (666,184) 2,290,201 17,039,664
Segment Assets 130,299,867 8,226,529 7,064,739 145,591,135
Three Months Ended
September 30,
2002
Revenues $ 7,439,781 $ 1,997,103 $ 2,662,599 $ 12,099,483
Interest Income 381,188 6,768 - 387,956
Segment Profit (Loss) 4,580,679 (2,356,270) 1,174,827 3,399,236
Segment Assets 110,940,160 19,229,554 16,221,555 146,391,269
2001
Revenues $ 6,890,148 $ 510,787 $ 2,474,746 $ 9,875,681
Interest Income 941,598 51,068 - 992,666
Segment Profit (Loss) 2,479,946 (219,976) 183,742 2,443,712
Segment Assets 130,299,867 8,226,529 7,064,739 145,591,135
Item 2: 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,
advertising, media buying and television distribution. Additionally, beginning
in September 2002, the Company began 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 the 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
11
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 and advertising sales subsidiaries provides services primarily to
toy and video game companies. 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" and
"Yu-Gi-Oh!" than the historical seasonal trends of toy and game sales. Further,
guarantee and minimum royalty payments may occur throughout the year, some of
which are made upon the execution and delivery of license agreements.
Three and Nine Months Ended September 30, 2002 Compared to the Three and Nine
Months Ended September 30, 2001
Consolidated net revenues increased 23% or $2,223,802 to $12,099,483 for the
three month period ended September 30, 2002 as compared to the same period in
2001. Consolidated net revenues for the nine month period decreased 13% or
$4,048,967 to $27,238,691 as compared to the nine month period ended September
30, 2001. The increase in consolidated net revenues for the three month period
was due primarily to increased revenue for the "Yu-Gi-Oh" property for
merchandise licensing and television license fees, and the advertising revenue
associated with the Fox programming block. 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 nine months ended
September 30, 2002, generating marketing fee revenues for the Company. The
decrease in consolidated net revenue for the nine month period was due to
decreased merchandise licensing and movie related revenues for the Pokemon
property.
Selling, general and administrative expenses decreased 16% or $1,314,277 to
$6,841,632 and 6% or $1,116,782 to $16,327,879 for the three and nine month
periods ended September 30, 2002, respectively, as compared to the comparables
of the prior year periods. These decreases were primarily attributable to
reduced marketing and promotion costs of approximately $2,200,000, associated
with two properties introduced during 2001. These reductions in costs were
partially offset by increased selling, general and administrative expenses
associated with the Company's
12
expanded operations in leasing and operating the Fox Saturday morning television
block.
Amortization of capitalized film costs and the Fox broadcast fee increased
$1,977,845 and $3,405,796 for the three and nine months ended September 30,
2002, respectively, when compared to the prior year periods. The increase was
primarily attributable to the initial period of amortization of the costs for
the Fox Saturday morning television block, as well as, increased amortization of
the Cubix, Yu-Gi-OH! and Tama television series. At September 30, 2002, there
were $6,437,684 of unamortized capitalized film production costs which primarily
relate to the production of 26 episodes of Cubix, 100 episodes of the Yu-Gi-Oh!,
26 episodes of Tama and Friends, 52 episodes of Ultraman, 52 episodes of
Kinnikuman-Ultimate Muscle, 52 episodes of Kirby and 26 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
2003-2004 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
2003-2004 television season. Tama and Friends is a television series broadcast
in first run syndication which began in September 2001.
Ultraman, Kinnikuman-Ultimate Muscle, Kirby and Fighting Foodons began
broadcasting in September 2002 on the Company's Saturday morning Fox network
television block. At September 30, 2002, the percentage of total unamortized
film costs expected to be amortized within the next three years exceeded 80%.
Additionally, at September 30, 2002, there were $14,457,452 of unamortized Fox
Saturday morning television block fees. The cost of this television block has
been and will be capitalized and amortized over the broadcast season based on
estimated advertising revenue earned. All unamortized costs of the Fox Saturday
morning television block will be completely amortized by the end of each
broadcast season.
The Company periodically evaluates its anticipated revenue from film production
and estimated advertising sales associated with the Fox Saturday morning
broadcast block. Consequently, amortization rates may change as a result of such
estimates.
Interest income decreased by $604,710 to $387,956 and $2,716,434 to $1,179,689
for the three and nine month periods ended September 30, 2002, respectively, 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
13
during 2002 as compared to the same periods in 2001 and to a reduced amount of
invested cash.
The Company's effective income tax rate was 42% and 41% for the three and nine
months ended September 30, 2002, respectively, as compared to 39% and 41% for
the three and nine months, respectively, of the prior year. The differences in
effective rates are caused primarily by the fluctuating income levels of the
Company's wholly-owned foreign subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, the Company had working capital of $107,533,478 as
compared to working capital of $106,330,320 at December 31, 2001, an increase in
working capital of $1,203,158. Cash and cash equivalents and investments
decreased by $25,725,065 to $78,720,434 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 $9,049,247. Additionally, in January through
September 2002, the Company paid installments totaling 15,820,313 to Fox
Broadcasting for the network block more fully described in Note 4 to the
financial statements. This prepaid fee is shown net of amortization of
$1,392,861 and is reflected in "Prepaid expenses and other current assets" on
the accompanying balance sheet at September 30, 2002.
Accounts receivable, net (current and non-current) increased to $25,439,220 at
September 30, 2002 from $14,314,684 at December 31, 2001. The increase was
primarily due to increased royalty and marketing fee income receivable on the
Yu-Gi-OH! property and advertising revenue associated with the Fox Saturday
morning children's block.
Amounts due to licensors, which represents the owners' share of royalties
collected at September 30, 2002, decreased by $9,049,247 to $7,862,349 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 on its balance sheet. 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 to the Company from Pokemon USA,
Inc.
The Company's new 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, as of
September 30, 2002, the Company paid $15,820,313, which represents approximately
63% of the first broadcast year (which begins in September) fee to Fox. The
remaining unamortized portion of the
14
first year's fee to Fox of $14,427,252 is included in "Prepaid expenses and
other current assets" on the accompanying balance sheet as of September 30,
2002. Fees for each subsequent broadcast year are payable 50% in the June
preceding the beginning of the broadcast year with the balance of the fee for
the broadcast year payable in four equal installments in the following
September, December, February and April. Additionally, the Agreement will
require 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 fee are paid. As of September 30, 2002, the Company is in the
process of, but has not yet executed the required letter of credit. Upon the
execution of the letter of credit, the Company will secure the amount of such
letter of credit against its cash balances, and will appropriately disclose
these amounts as restricted cash in its financial statements.
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 Fox Saturday morning four hour television
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 agreement are
as follows (in thousands):
Year ending Fox
December 31, Leases Fee Total
-------- -------- -------
Oct. 1 - Dec. 31, 2002 $ 299 $ 3,164 $ 3,463
2003 1,206 25,312 26,518
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 $9,454 $85,428 $94,882
====== ======= =======
The Company has allocated significant resources to the acquisition, programming
and marketing of the Fox Saturday morning four hour television block. The
Company's ability to recover these resources will be dependent 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 Company launched its Fox Saturday morning television block as
scheduled. The Company believes it will cover the fee to Fox Broadcasting with
the advertising sales generated during the four hour television block. However,
the Company's ability to retain sufficient value of the advertising time sold
will be dependant on the audience ratings delivered by the programs in the
television block. There can be no assurance that the demand for advertising time
will continue or that the programs will achieve the minimum rating performance
necessary to retain sufficient value of the advertising time sold.
15
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 the JPMorgan Chase Bank. However, as the
Company explores new and expanded opportunities in the children's entertainment
market, it may seek additional financing alternatives.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to the consolidated financial statements.
Item 3: 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.
Item 4: CONTROLS AND PROCEDURES
4Kids maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed by the Company in the reports it files
under the Securities Exchange Act of 1934, as amended ("Exchange Act") is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. Within the 90 days prior to the date of this
report, 4Kids carried out an evaluation, under the supervision and with the
participation of its management, including 4Kids' Chairman and Chief Executive
Officer and Executive Vice President and Chief Financial Officer of the
effectiveness of 4Kids' disclosure controls and procedures pursuant to Rule
13a-14 of the Exchange Act. Based on that evaluation, 4Kids' Chairman of the
Board and Chief Executive
16
Officer and Executive Vice President and Chief Financial Officer have concluded
that 4Kids' disclosure controls and procedures are effective.
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
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: November 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
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Alfred R. Kahn, Chairman of the Board and Chief Executive Officer of 4Kids
Entertainment, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of 4Kids
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
18
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Alfred R. Kahn
---------------------
Alfred R. Kahn
Chairman of the Board and
Chief Executive Officer
19
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
I, Joseph P. Garrity, Executive Vice President and Chief Financial Officer of
4Kids Entertainment, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of 4Kids
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
20
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Joseph P. Garrity
-------------------------
Joseph P. Garrity
Executive Vice President
Chief Financial Officer
21