UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the fiscal year ended December 31, 2009

OR

oTRANSITION 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

(Exact name of registrant as specified in its charter)

                  (State or other jurisdiction of                                                                                          (I.R.S. Employer

                 incorporation or organization)                                                                                             Identification No.)

 

                                   (Address of principal executive offices)                                                        (Zip Code)

 

Registrant’s telephone number, including area code: (212) 758-7666

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __ NoX  

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes___ No X

 

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 the filing requirements for the past 90 days. Yes X No ___

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

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

 

(Do not check if a smaller reporting company)

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

 

The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing price of the Common Stock on June 30, 2009 as reported on the New York Stock Exchange Market, was approximately $16,348,415. The calculation of the aggregate market value of voting stock excludes shares of Common Stock held by current executive officers, directors, and stockholders that the registrant has concluded are affiliates of the registrant. Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant or that such person is controlled by or under common control with the registrant.

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Portions of the registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held on May 28, 2010 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

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FORM 10-K REPORT INDEX

 

 

 

PART I

 

Throughout this Annual Report on Form 10-K, we “incorporate by reference” certain information in parts of other documents filed with the Securities and Exchange Commission (the “SEC”). The SEC allows us to disclose important information by referring to it in that manner. Please refer to such information.

 

This Annual Report on Form 10-K, including the sections titled "Item 1A. Risk Factors" and "Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements that relate to future events or our future financial performance. We may also make written and oral forward-looking statements in our Securities and Exchange Commission ("SEC") filings and otherwise. We have tried, where possible, to identify such statements by using words such as "believe," "expect," "intend," "estimate," "anticipate," "will," "project," "plan" and similar expressions in connection with any discussion of future operating or financial performance. Any forward-looking statements are and will be based upon our then-current expectations, estimates and assumptions regarding future events and are applicable only as of the dates of such statements. By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated in any forward-looking statements. Such risks and uncertainties include those described in "Item 1A. Risk Factors" below as well as other factors. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Throughout this Annual Report on Form 10-K, all dollar amounts are reported in thousands unless otherwise specified.

 

Item 1. Business.

 

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

 

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

 

The Licensing segment accounted for approximately 65%, 30% and 46% of consolidated net revenues for the years ended December 31, 2009, 2008 and 2007, respectively. The “Yu-Gi-Oh!” Property continues to be the largest contributor in this business segment exclusive of a one-time payment of $9,786 received by the Company in October 2009 in consideration of its agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of its representation agreement with Mirage Group in 2012.

 

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

 

The Company, through a multi-year agreement (the “Fox Agreement”) with Fox Broadcasting Corporation (“Fox”), leased Fox’s Saturday morning programming block (“4Kids TV”) from 8am to 12pm eastern/pacific time (7am to 11am central time) which was terminated on December 31, 2008. The Company provided substantially all programming content to be broadcast on 4Kids TV and 4Kids Ad Sales retained all of the revenue from its sale of network advertising time for the four-hour programming block.

 

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

 

The Advertising Media and Broadcast segment accounted for 8%, 29% and 33% of consolidated net revenues for the years ended December 31, 2009, 2008 and 2007, respectively.

 

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

 

The Television and Film Production/Distribution segment accounted for 20%, 15% and 19% of consolidated net revenues for the years ended December 31, 2009, 2008 and 2007, respectively.

 

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

 

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

 

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

 

Certain of the Company’s executive officers have interests in CUSA, CUSA LLC and certain other entities with which TC Digital and TC Websites have engaged in transactions since their formation. Information regarding these relationships can be found in Notes 15 and 17 of the notes to the Company’s consolidated financial statements.

 

The Trading Card and Game Distribution segment accounted for 7%, 27% and 2% of consolidated net revenues for the years ended December 31, 2009, 2008 and 2007, respectively.

 

Financial Information About Industry Segments - Financial information regarding the Company’s industry segments and non-U.S. sales and assets can be found in Note 19 of the notes to the Company’s consolidated financial statements.

 

Dependence on a Few Sources of Revenues - The Company typically derives a substantial portion of its revenues from a small number of Properties, which usually generate revenues for only a limited period of time. The Company’s revenues are highly subject to changing trends in the toy, game and entertainment businesses, causing dramatic increases and decreases from year to year due to the popularity of particular Properties. It is not possible to accurately predict the length of time that a Property will be commercially successful and/or if a Property will be commercially successful at all. Due to these factors, the Company must continually seek new properties from which it can derive revenues. In addition, the Company also does not control the timing of the release of products by licensees which can affect both the amount of licensing revenues earned and the periods during which such revenues are recognized.

 

Two Properties, “Teenage Mutant Ninja Turtles” and “Yu-Gi-Oh!” represented 33% and 24%, respectively, for a total of 57%, of consolidated net revenues for fiscal 2009, or $21,031, of which $9,786, or 27% of consolidated net revenues, represented a one-time payment received by the Company in October 2009 in consideration of its agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of its representation agreement with Mirage Group in 2012. One licensee, Konami Corporation, represented 17% of consolidated net revenues for fiscal 2009. For more information on the Company’s Revenues/Major Customers, please see Note 9 of the notes to the Company’s consolidated financial statements.

 

Trademarks and Copyrights - Except as provided below, the Company generally does not own any trademarks or copyrights in Properties which the Company represents as a merchandising agent. The trademarks and copyrights are typically owned by the creators of the Properties or by other entities, which may have expended substantial amounts of resources in developing or promoting the Properties.

 

The Company owns the copyrights and trademarks to “Charlie Chan” and the “WMAC Masters” live action television series. The Company is also a joint copyright holder of the “Cubix” CGI television series and the “Teenage Mutant Ninja Turtles” and “Chaotic” animated television series produced by 4Kids Productions.  On October 21, 2009, the Company received a payment of $9,786 in consideration of its agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of its representation agreement with Mirage Group in 2012. The Company continues to have the right to broadcast these co-produced “Teenage Mutant Ninja Turtles” episodes through the end of the 2009-2010 broadcast season. Additionally, the Company is a joint copyright holder of the “Chaotic” trading card artwork for the “Chaotic” trading card game. The Company also jointly owns the copyright to the “Chaotic” trading card game as it relates to revisions to the original “Chaotic” trading card game previously sold in Denmark.  The Company, through its 55% ownership interest in TC Websites, jointly owns the intellectual property rights to the website, including certain proprietary software contained in the website which enables “Chaotic” website visitors to play the “Chaotic” trading card game online at www.chaoticgame.com.

 

Seasonal Aspects - A substantial portion of the Company’s revenues and net income are subject to the seasonal and trend variations of the toy and game industry. Typically, a majority of toy orders are shipped in the third and fourth calendar quarters. Historically, the Company’s net revenues from toy and game royalties during the second half of the year have generally been greater than during the first half of the year. Additionally, advertising revenues derived from the sale of commercial time on The CW4Kids is generally higher in the fourth quarter due to higher advertising rates typically charged to children’s advertisers for advertising during the holiday season.

 

Competition - The Company’s principal competitors in the area of merchandise licensing are the large media companies (e.g., Disney, Time Warner and Nickelodeon, which is owned by Viacom) with consumer products/merchandise licensing divisions, toy companies, other licensing companies, and numerous individuals who act as merchandising agents. There are also many independent product development firms with which the Company competes. Many of these companies have substantially greater resources than the Company and represent properties which have been commercially successful for longer periods than the Properties represented by the Company. The Company believes it would be relatively easy for a potential competitor to enter its market in light of the relatively small investment required to commence operations as a merchandising agent.

 

The Company’s Advertising Media and Broadcast segment also operates in a highly competitive marketplace against large media companies (e.g., Disney, Time Warner, CBS, NBC and Nickelodeon, which is owned by Viacom) with substantially greater resources and distribution networks than the Company. The Company’s ability to derive advertising revenue from the sale of commercial time on The CW4Kids as well as internet advertising on its websites, substantially depends on the popularity of the television shows that the Company broadcasts. The Company also faces significant competition from other television broadcasters and cable networks, which also broadcast children’s television shows on Saturday mornings and sell advertising on their related websites.

 

 

The Company’s Television and Film Production/Distribution segment competes with all forms of entertainment directed at children. There are a significant number of companies that produce and/or broadcast television programming, distribute theatrical motion pictures and home videos for the children’s audience and program websites directed to children. The Company also competes with these companies to obtain creative talent to write, adapt, score, provide voice-overs and produce the television programs and theatrical motion pictures marketed by the Company and its subsidiaries.

 

The Company’s Trading Card and Game Distribution segment also operates in a highly competitive market against strong competition such as: (i)Wizards of the Coast, which is owned by Hasbro and distributes the popular “Magic the Gathering” trading card game; (ii) Konami, a company that distributes “Yu-Gi-Oh!” trading cards in the U.S.; (iii) Upper Deck, a company that distributes “Yu-Gi-Oh!” trading cards in Europe and sports cards; (iv) Topps, a company that distributes sports cards; and (v) Nintendo of America and Pokémon USA, Inc., the companies that distribute the “Pokémon” trading card game. The “Chaotic” website which is part of the Company’s Trading Card and Game Distribution segment also competes with popular online multiplayer game websites such as “World of Warcraft”, the website run by Blizzard Entertainment, a subsidiary of Vivendi.

 

Employees - As of March 15, 2010, the Company had a total of 111 full-time employees in its domestic and international operations. Of the total, 59 employees were primarily rendering services for the Licensing segment, 20 were primarily rendering services for the Advertising Media and Broadcasting segment, 25 were primarily rendering services for the Television and Film Production/Distribution segment and 7 were primarily rendering services for the Trading Card and Game Distribution segment. The Company also hires additional employees on a program-by-program basis whose compensation is typically allocated to the capitalized cost of the related programming.

 

Available Information - The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and the Proxy Statement for its Annual Meeting of Stockholders are made available, free of charge, through its website, www.4kidsentertainment.com, as soon as reasonably practicable after such reports have been filed with or furnished to the Securities and Exchange Commission (the “SEC”). In addition, you may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site, www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

 

Executive Officers of the Company

 

 

 

The following significant factors, as well as others of which we are unaware or deem to be immaterial at this time, could materially adversely affect our business, financial condition or operating results in the future. Therefore, the following information should be considered carefully together with other information contained in this report. Past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

 

 

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

 

Our common stock is currently listed on the NYSE. On April 14, 2009, we announced that we were not in compliance with the NYSE’s continued listing standards with respect to global market capitalization and stockholders’ equity as a result of our stockholders’ equity for the year ended December 31, 2008 being equal to $74,991, or approximately $9, below the minimum NYSE stockholders’ equity requirement in effect at that time. In accordance with NYSE rules, on May 21, 2009, we submitted a plan that we believed demonstrated our ability to achieve compliance with the continued listing standard within 18 months which was subject to the review of the Listings and Compliance Committee of the NYSE.

 

The NYSE subsequently implemented a pilot program to amend its listing criteria such that a NYSE listed company that originally qualified to list under the “earnings test” such as 4Kids would be considered to be not in compliance with the NYSE’s continued listing standards if its average global market capitalization over a consecutive 30-day trading period is less than $50,000, and at the same time, its stockholders’ equity is less than $50,000 (the “Program”). The NYSE made a rule filing on March 1, 2010 with the SEC to extend the Program through June 30, 2010, and on February 26, 2010 submitted a proposed rule change to the SEC to make the Program permanent.

 

On June 1, 2009, we received a notice from NYSE Regulation, Inc. (“NYSE Regulation”) indicating that we were deemed to be back in compliance with the NYSE’s stockholders’ equity requirement and informing us that if we do not meet the continued listing standards within 12 months of the date we were deemed in compliance, we would receive a formal notification letter from NYSE Regulation. The staff of NYSE Regulation would then examine the relationship between the two incidents of falling below continued listing standards and reevaluate our method of financial recovery from the first incident. The staff of NYSE Regulation would at that point take such action as it believes is appropriate, which, depending upon the circumstances could include truncating the procedures that would otherwise be applicable, or immediately initiating suspension and delisting procedures.

 

As of December 31, 2009, our 30-day trading average market capitalization was approximately $19,200 and our shareholders’ equity was $35,117. Consequently, we believe that it is likely that we will receive a formal notification from NYSE Regulation regarding our failure to meet the NYSE’s continued listing standards.

 

In addition, based on our recent market capitalization, we may fall below the $15 million minimum average market capitalization threshold for continued listing set forth in Section 802.01B of the NYSE Listed Corporation Manual, which pre-empts the NYSE’s plan/cure process applicable to other failures to meet its listing standards, and would result in immediate initiation of suspension and delisting procedures.

 

A delisting of our common stock could negatively impact us by reducing the liquidity and market price of our common stock and reducing the number of investors willing to hold or acquire our common stock, which could negatively impact our ability to raise equity financing.

 

We have been and may continue to be negatively affected by adverse general economic and other conditions.

 

Conditions in the domestic and global economies are extremely unpredictable and our business has been impacted by changes in such conditions. Softening global economies, stock market uncertainty and wavering consumer confidence caused by economic weakness, the decline in the housing market, the threat or occurrence of terrorist attacks, war or other factors generally affecting economic conditions have adversely affected our business, financial condition and results of operations and may continue to do so in the future.

 

Recent turmoil in U.S. and foreign credit markets, equity markets, and in the global financial services industry, including the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the U.S. and foreign governments, have continued to place pressure on the global economy and affect overall consumer spending, spending by advertisers and the availability of credit to us, our clients, and our customers. If conditions in the global economy, U.S. economy or other key vertical or geographic markets remain uncertain or weaken further, they may have a further material adverse effect on our business, financial condition and results of operations.

 

The changing entertainment preferences of consumers could adversely affect our business.

 

Our business and operating results depend upon the appeal of our Properties, product concepts and programming to consumers. Consumer entertainment preferences, as well as industry trends and demands are continuously changing and are difficult to predict as they vary over time. In addition, as entertainment properties often have short life cycles, there can be no assurances that:

 

 

 

Our failure to accomplish any of these events could result in reduced overall revenues, which could have a material adverse effect on our business, financial condition and results of operations. In addition, the volatility of consumer preferences could cause our revenues and net income to vary significantly between comparable periods.

 

We have experienced operating losses and negative cash flows from operations during recent years and may continue to do so in the future.  

 

We have experienced net losses, as well as negative cash flows from operations, over each of the past four fiscal years. If we do not become profitable and generate positive cash flows from operations, we could require additional sources of cash to fund continued operations. If additional sources of cash is required to support our business, we may not be able to generate such additional cash in a timely manner, on terms acceptable to us, or at all. We cannot be certain that we will achieve profitability or positive cash flows from operations at any point in time.

 

Revenues from our Licensing segment are largely derived from a small number of Properties and are subject to changing industry trends.

 

We have historically derived a substantial portion of our licensing revenues from a small number of Properties which usually generate revenues only for a limited period of time. For the year ended December 31, 2009, we derived approximately 74%, or $17,755 of our licensing revenues from two Properties, of which 41%, or $9,786 represented a one-time payment received by the Company in October 2009 in consideration of its agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of its representation agreement with Mirage Group in 2012. In 2010, we are likely to receive only small amounts of licensing revenue from the “Teenage Mutant Ninja Turtles” Property during the first six months of the year after which our receipts of revenue shall terminate. Our licensing revenues are also subject to the changing trends in the toy, game and entertainment industries. Consequently, our licensing revenues may be subject to dramatic increases and decreases from particular sources over time. In addition, we do not control the timing of the release of products by licensees which can affect both the amount of licensing revenues earned and the periods during which such revenues are recognized. A significant decrease in our licensing revenues could have a material adverse impact on our financial condition and results of operations. Additionally, due to the expiration or termination in 2010 of representation agreements between the Company and various licensors and the expiration of certain license agreements, the Company is likely to receive its final share of merchandise licensing revenues in 2010 from the following long-standing Properties: “Teenage Mutant Ninja Turtles”, “Monster Jam” and “Cabbage Patch Kids”. There can be no assurance that the Company will be able to license new properties to replace the substantial revenue streams contributed by the “Teenage Mutant Ninja Turtles”, “Monster Jam” and “Cabbage Patch Kids” Properties to the Company in previous years.

 

Revenues from our Licensing segment are directly impacted by the amount of retail shelf space dedicated to our Properties.

 

As an exclusive merchandising agent, we grant licenses to third parties to manufacture and sell all types of merchandise based on the Properties that we represent. The ability of these third parties to design, manufacture, and ultimately market and sell this merchandise through various distribution channels has a direct impact on our revenues. If these third parties are not successful in obtaining distribution or placement for this merchandise at retail, the performance of certain Properties could suffer which could have a material adverse impact on our financial condition and results of operations.

 

Our operating margins could be adversely impacted by the mix of Properties we represent.

 

Historically, the majority of the television episodes produced by our production studio were English language dubbed versions of previously produced foreign language programming. We were able to license television broadcast rights, home video rights and merchandising rights to such foreign language programming for rights fees that were substantially below the cost of producing original programming. Over the past several years, we have begun shifting our strategic focus toward the production of more original animated programming in an effort to obtain a higher percentage of revenues and build the value of our programming library. The investment required to produce original animated programming is substantially

 

greater than our historical cost of dubbing and adapting existing foreign language animated programming. Our production of original programming funded in whole or in part by us has resulted in a substantial increase in capitalized film costs that will be amortized based on overall market acceptance and projected revenues. To the extent that a Property performs at a level lower than our expectations, the ratio of amortization expense will increase and may adversely impact our operating margins and results of operations. If our original programming is not successful, we may be required to write-down capitalized film costs associated with the unsuccessful series, which will have a material adverse impact on our financial condition and results of operations.

 

We must continually seek new Properties from which we can derive revenues.

 

It is difficult to predict whether a Property will be successful, and if so, for how long. Because of this, we are constantly seeking new Properties that are already successful or that we believe are likely to become successful in the future. If we are unable to identify and acquire the rights to successful new Properties, our revenues, financial condition and results of operations could be adversely affected.

 

Our business is seasonal and highly dependent on our performance during the holiday season.

 

A high percentage of our annual operating results have historically depended on our performance during the holiday season. Sales of our licensed toy and game concepts are seasonal and most retail sales of these products occur during the third and fourth fiscal quarters. Also, as a result of the increased demand for commercial time by children’s advertisers during the holiday season, a significant portion of the revenues of 4Kids Ad Sales is generated during the fourth fiscal quarter. The financial results of The CW4Kids will be affected by how successful it is in attracting viewers during the holiday season. As a result of the seasonal nature of our business, we would be significantly and adversely affected by unfavorable economic conditions and other unforeseen events during the holiday season, such as a terrorist attack or a military engagement, that negatively affect the retail environment or consumer buying patterns. In addition, a failure by us to supply programming to The CW4Kids during the holiday season could have a material adverse impact on our financial condition and results of operations.

 

We operate in a highly competitive marketplace.

 

Licensing. Our principal competitors in the area of merchandise licensing are the large media companies (e.g., Disney, Time Warner and Nickelodeon, which is owned by Viacom) with consumer products/merchandise licensing divisions, toy companies, other licensing companies, and numerous individuals who act as merchandising agents. There are also many independent product development firms with which we compete. Many of these companies have substantially greater resources than we do and represent properties which have been commercially successful for longer periods than our Properties. We believe that it would be relatively easy for a potential competitor to enter into this market in light of the relatively small investment required to commence operations as a merchandising agent.

 

Advertising Media and Broadcast. Our Advertising Media and Broadcast segment also operates in a highly competitive marketplace against large media companies (e.g., Disney, Time Warner, CBS, NBC and Nickelodeon, which is owned by Viacom) with substantially greater resources and distribution networks than we have. Our ability to derive advertising revenues from the sale of commercial time on The CW4Kids, substantially depends on the popularity of the television shows that we broadcast. We also face significant competition from other television broadcasters and cable networks, which also broadcast children’s television shows on Saturday mornings. Saturday morning broadcast television for children has been losing popularity over the last few years to the children’s cable television channels such as Nickelodeon, Cartoon Network and the Disney Channel. In addition, the popularity of the internet, video on demand, digital video recording of programming and other trends have caused a fragmentation of the audience. Both of these trends have resulted in lower advertising revenues from the sale of advertising time on The CW4Kids. The continued reduction of advertising revenues, as a result of these and other trends, has adversely affected our business and the results of operations.

 

Television and Film Production/Distribution. Our Television and Film Production/Distribution segment competes with all forms of entertainment directed at children. There are a significant number of companies that produce and/or broadcast television programming and distribute theatrical motion pictures and home videos for the children’s audience. We also compete with these companies to obtain creative talent to write, adapt, score, provide voice-overs and produce the television programs and theatrical motion pictures marketed by us.

 

 

 

 

 

Trading Card and Game Distribution. Our Trading Card and Game Distribution segment operates in a highly competitive market against strong competition such as: (i)Wizards of the Coast, which is owned by Hasbro and distributes the popular “Magic the Gathering” trading card game; (ii) Konami, a company that distributes “Yu-Gi-Oh!” trading cards in the U.S.; (iii) Upper Deck, a company that distributes “Yu-Gi-Oh!” trading cards in Europe and sports cards; (iv) Topps, a company that distributes sports cards; and (v) Nintendo of America and Pokémon USA, Inc., the companies that distribute the “Pokémon” trading card game. The “Chaotic” website which is part of the Company’s Trading Card and Game Distribution segment also competes with popular online multiplayer game websites such as “World of Warcraft”, the website run by Blizzard Entertainment, a subsidiary of Vivendi.

 

Our broadcasting costs may increase or our advertising revenues may decrease due to events beyond our control.

 

The success of our Advertising Media and Broadcast segment is largely dependent on the amount of advertising revenues generated from sales of network advertising on The CW4Kids. Recently, there has been increased scrutiny of food advertising directed at children as a result of childhood obesity concerns. In response to these concerns, many significant food advertisers have reduced or eliminated advertising of food products directed toward children resulting in a reduction in the advertising dollars spent in the children’s television and internet advertising marketplace. In addition, international, political and military developments may result in increases in broadcasting costs or loss of advertising revenue due to, among other things, the preemption of our programming.

 

Our Trading Card and Game Distribution segment presents certain risks.

 

Card inventory risk. A portion of our card sales are subject to returns. Although the Company maintains return provisions, returns considerably in excess of the Company’s provisions could materially and adversely affect our future plans and results.

 

There may be issues with the functionality of the “Chaotic” website. Each “Chaotic” trading card has a unique code which enables the “Chaotic” card collector to enter or upload the “Chaotic” trading card codes to the companion website, www.chaoticgame.com. The “Chaotic” website enables each “Chaotic” card collector to battle online using the “Chaotic” cards that have been uploaded to the card collector’s online account. The “Chaotic” website is currently operated as a public beta version and is being developed and tested continually in such environment. There can be no assurance that the “Chaotic” website will not have operational issues which can be resolved in a timely manner. If the “Chaotic” website were not to operate properly, the success of the trading card game would be adversely affected. Such circumstances could require us to make additional substantial investments in order to support, enhance or upgrade the “Chaotic” trading game companion website beyond our current expectations.

 

Failure by the Company to protect its proprietary intellectual property and information could have a material adverse effect on our business, financial condition and results of operations. The value of the “Chaotic” website depends, in part, on our ability to protect patents licensed by TC Digital and TC Websites covering the uploading of coded trading cards to a website where online game play and community activities occur. The failure by the Company to be able to protect successfully its proprietary intellectual property and information could have a material adverse effect on our business, financial condition and results of operations.

 

Our future success is dependent on certain key employees.

 

The success of our business depends to a significant extent upon the skills, experience and efforts of a number of senior management personnel and other key employees. In certain instances, we have employment agreements in place as a method of retaining the services of these key employees. The loss of the services of any of our senior management personnel or other key employees could have a material adverse effect on our business, results of operations or financial condition.

 

We may not be able to successfully protect our intellectual property rights.

 

We rely on a combination of copyright, trademark, patent and other proprietary rights laws to protect the intellectual property rights that we own or license. It is possible that third parties may challenge our rights to such intellectual property. In addition, there is a risk of third parties infringing upon our licensors’ or our intellectual property rights and producing counterfeit products. These events may result in lost revenue as well as litigation, which may be expensive and time-consuming even if a favorable outcome is obtained. There can be no assurance that adequate remedies would be available for any infringement of the intellectual property rights owned or licensed by the Company. Any such failure to successfully protect our intellectual property rights may have a material adverse effect on our competitive position.

 

We must be able to respond to rapidly changing technology occurring within our industry.

 

Our success will depend, in part, on our ability to anticipate and adapt to numerous changes in our industry resulting from technological developments such as the internet, broadband distribution of entertainment content and the adoption of digital television standards. These new distribution technologies may diminish the size of the audience watching broadcast television and require us to fundamentally change the way we market and distribute our Properties. For example, digital technology is likely to accelerate the convergence of broadcast, telecommunications, internet and other media and could result in material changes in the regulations, intellectual property usage and technical platforms on which our business relies. These changes could significantly decrease our revenues or require us to incur significant capital expenditures.

 

Potential labor disputes may lead to increased costs or disrupt the operation of our business.

 

The success of our business is dependent on our employees who are involved with our domestic and international operations. Any labor dispute may adversely affect one or more of our business segments through increased costs of operating such segment or disruption of the operations of such segment which could adversely affect our results of operations.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

The following table sets forth, with respect to properties leased (none are owned) by the Company at December 31, 2009, the location of the property, the date on which the lease expires and the use which the Company makes of such facilities:

 

 

The executive, marketing, sales and administrative offices are utilized by the Licensing, Advertising Media and Broadcast and Trading Card and Game Distribution segments. The international sales office is utilized primarily by the Licensing Segment. The production and the website development facilities are primarily utilized by the Television and Film Production/Distribution segment.

 

Item 3. Legal Proceedings.

 

On November 9, 2008, the Company entered into an agreement with Fox to settle the lawsuit brought by the Company against Fox for alleged breaches of the Fox Agreement (the “Settlement Agreement”). Under the terms of the Settlement Agreement, the Fox Agreement terminated on December 31, 2008 rather than at the end of the 2008-2009 broadcast season in September 2009. The Company’s remaining financial obligations to Fox for the first three quarters of 2009 also terminated. During the year ended December 31, 2009, the Company paid Fox $6,250 in respect of its remaining obligation under the Settlement Agreement.

 

 

 

On July 29, 2009, The Upper Deck Company, LLC (“Upper Deck”) filed suit in Superior Court of the State of California, County of San Diego, North County Division, against Bryan C. Gannon (“Gannon”) and TC Digital Games LLC (“TC Digital”) alleging that Gannon misappropriated and used confidential information and trade secrets of Upper Deck in connection with the “Chaotic” trading card game. The complaint alleges that Gannon became privy to the Upper Deck confidential information and trade secrets during the course of Gannon’s service to Upper Deck during the July 1, 2002 through January 1, 2003 period as an independent contractor and during the January 2, 2003 through May 23, 2003 period during which Gannon was an employee of Upper Deck. The complaint seeks unspecified monetary damages to be determined at trial. On October 5, 2009, Upper Deck voluntarily dismissed the complaint without prejudice.

 

On February 12, 2010, Home Focus Development, LTD, a British Virgin Islands Corporation, (“Home Focus”) filed suit against the Company in the United States District Court for the Southern District of New York. In the lawsuit, Home Focus alleges that the Company owes it $1,075 under an Interest Purchase Agreement among the Company, Home Focus and TC Digital entered into on March 2, 2009, pursuant to which the Company acquired a 25% ownership interest in TC Digital International Ltd. As further described in Note 17 of the notes to the Company’s consolidated financial statements, the Company withheld payments in an aggregate amount of $575 from Home Focus otherwise due under the Interest Purchase Agreement as a result of Home Focus’s failure to make required capital contributions to TC Digital International, Ltd, (“TDI”) the joint venture formed by the Company and Home Focus. The Company intends to vigorously defend this litigation.

 

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

 

PART II

 

Item 4. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

 

(a) Market Information - The Company’s Common Stock is listed for trading on the New York Stock Exchange under the symbol “KDE”. The following table indicates high and low sales quotations for the periods indicated based upon information supplied by the New York Stock Exchange.

 

 

(b) Holders - The approximate number of holders of record of the Company’s Common Stock on March 15, 2010 was 5,349.

 

(c) Dividends - There were no dividends or other distributions made by the Company during 2009 or 2008. Future dividend policies will be determined by the Board of Directors based on the Company’s earnings, financial condition, capital requirements and other existing conditions. It is anticipated that cash dividends will not be paid to the holders of the Company’s Common Stock in the foreseeable future.

 

(d) Equity Compensation Plan Information - Information regarding the Company’s equity compensation plans is incorporated by reference to Item 11 in Part III of this Form 10-K.

 

 

 

 

(e) Performance Graph - The following graph compares the cumulative total shareholders return of our common stock with the cumulative return of the Standard & Poor’s Small Cap 600 Index (“S&P 600”), the Russell 2000 Index (“Russell 2000”) and a group of companies, consisting of The Walt Disney Company, Time Warner, Inc., World Wrestling Entertainment, Inc., Marvel Entertainment, Inc. and Mattel, Inc. (“Peer Group”) for the period beginning December 31, 2004 and ending December 31, 2009. The graph assumes that $100 was invested on December 31, 2004, and that any dividends were reinvested.

 

 

 

 

Item 5. Selected Consolidated Financial Data.

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

 

Our selected consolidated financial data presented below has been derived from our audited consolidated financial statements and should be read in conjunction with the notes to the Company’s consolidated financial statements and “Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

 

 

 

* Included as a reduction of selling, general and administrative expenses for 2006 and 2005 is income of $722 and $2,040, respectively, reclassified from income from discontinued operations to conform to 2009 presentation.

 

 

 

 

The Company did not declare or pay any cash dividends during the five-year period ended December 31, 2009.

 

Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following is a discussion and analysis of our financial position and results of operations for each of the three years in the period ended December 31, 2009. This commentary should be read in conjunction with our consolidated financial statements and the notes to the Company’s consolidated financial statements, which begin on page F-1 under “Item 7. Financial Statements and Supplementary Data”.

 

Overview

 

The Company’s operating results for the year ended December 31, 2009 were negatively impacted by the continuing decline in the popularity of its significant Properties. Accordingly, the Company experienced an overall decrease in revenues worldwide. Based on the diminished popularity of the “Chaotic” Property, the Company’s Trading Card and Game Distribution segment experienced a reduction in orders from TC Digital’s distributors. Consequently, overall sales of “Chaotic” trading cards during fiscal 2009 were below expectations. In addition, these reduced sales caused (i) an overall surplus of trading card inventory forcing the Company to record significant reserves on this slower moving inventory; (ii) a reduction of the Company’s film inventory through amortization based on a change in the overall expected future revenues of the “Chaotic” Property; and (iii) an impairment charge for a portion of the carrying amount of many of the Company’s “Chaotic” related assets. The Company was also impacted by an other than temporary impairment of certain of the Company’s investment securities. During 2009, the Company implemented significant cost-cutting initiatives, primarily pertaining to personnel related costs and advertising and marketing expenses, in an effort to offset its poor operating results; however, these initiatives failed to offset lower revenues and other charges.

 

General

 

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

 

The Company’s licensing revenues have historically been derived primarily from the licensing of toy and game concepts. As a result, a substantial portion of the Company’s revenues and net income are subject to the seasonal variations of the toy and game industry. Typically, a majority of toy orders are shipped in the third and fourth calendar quarters resulting in increased royalties earned by the Company during such calendar quarters. The Company recognizes revenues from the sale

 

 

of advertising time on the leased Saturday morning programming block from The CW (“The CW4Kids”), as more fully described in Note 2 of the notes to the Company’s consolidated financial statements. The Company’s advertising sales subsidiary, 4Kids Ad Sales, sells advertising time on The CW4Kids at higher rates in the fourth quarter due to the increased demand for commercial time by children’s advertisers during the holiday season. As a result, much of the revenues of 4Kids Ad Sales are earned in the fourth quarter when the majority of toy and video game advertising occurs. As a result of the foregoing, the Company has historically experienced greater revenues during the second half of the year than during the first half of the year.

 

Critical Accounting Policies

 

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

 

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

 

Management regularly reviews, and revises when necessary, its total revenue estimates on a title-by-title basis, which may result in a change in the rate of amortization and/or a write-down of the film or television asset to estimated fair value. The Company determines the estimated fair value for individual film and television Properties based on the estimated future ultimate revenues and costs in accordance with authoritative guidance issued by the Financial Accounting Standards Board (“FASB”).

 

Any revisions to ultimate revenues can result in significant quarter-to-quarter and year-to-year fluctuations in film and television write-downs and amortization. A typical film or television series recognizes a substantial portion of its ultimate revenues within the first three years of release. By then, the film or television series has been exploited in the domestic and international television (network and cable) and home video markets. In addition, a significant portion of licensing revenues associated with the film or television series will have been realized. A similar portion of the film’s or television series’ capitalized costs should be expected to be amortized accordingly, assuming the film or television series is profitable.

 

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

 

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

 

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

 

4Kids TV Broadcast Agreement - The Company broadcasted certain of its Properties on 4Kids TV, the Saturday morning programming block that the Company leased from Fox, under the Fox Agreement, until December 31, 2008. The cost of 4Kids TV has been capitalized and amortized over each broadcast year based on estimated advertising revenue up until the termination of the Fox Agreement on December 31, 2008, at which time the cost to lease 4Kids TV was fully amortized.

Accounting Changes - The Company has reassessed the accounting treatment for reimbursements of its production costs under representation contracts and will no longer record these amounts as revenue with a corresponding charge to production service costs. In accordance with authoritative guidance issued by the FASB, the Company has retroactively adjusted revenue and production service costs for all periods presented. The Company considered the qualitative aspect of these adjustments, as well as the impact on the Company’s operating losses and earnings per share calculations in determining that no further restatement of the Company’s consolidated financial statements is necessitated by this accounting change. See Note 12 of the notes to the Company’s consolidated financial statements for a discussion of these changes.

 

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

 

Recently Adopted Accounting Standards - In June 2009, the FASB established the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants.  The adoption of the Codification by the Company did not have a material impact on its consolidated financial statements or results of operations.  In accordance with the FASB’s guidance, the Company’s notes to consolidated financial statements will explain accounting concepts rather than cite the topics of specific U.S. GAAP.

 

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

 

In April 2009, the FASB issued authoritative guidance related to investments in debt and equity securities. The objective of the new guidance is to make impairment guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) of debt and equity securities in financial statements.  The guidance revises the OTTI evaluation methodology. Further, the security is analyzed for credit loss, (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the statement of earnings, while the balance of impairment related to other factors will be recognized in other comprehensive income. This guidance was effective for all interim and annual periods ending after June 15, 2009. The Company adopted this authoritative guidance issued by the FASB as of January 1, 2009 and recorded a cumulative-effect adjustment of $2,130 to its opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive loss.

 

In April 2009, the FASB issued authoritative guidance that principally requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. This guidance is currently effective and its adoption did not have an impact on the Company’s consolidated financial position and results of operations.

 

Recently Issued Accounting Standards - In June 2009, the FASB issued authoritative guidance that is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

In August 2009, the FASB issued authoritative guidance regarding the measurement of liabilities at fair value when a quoted price in an active market is not available.  In these circumstances, a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance, such as an income approach or a market approach.  The guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  This guidance is effective for interim periods beginning on or after June 15, 2010. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

 

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

 

Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of total net revenues for the three years ended December 31, 2009, 2008 and 2007.

                

 

 

Year Ended December 31, 2009 as compared to Year Ended December 31, 2008

 

Revenues

 

Revenues for the years ended December 31, 2009 and 2008, by reportable segment and for the Company as a whole, were as follows:

 

 

The decrease in consolidated net revenues for 2009, as compared to 2008, was due to a number of factors.

In the Licensing segment, increased revenues were primarily attributable to:

 

 

The “Yu-Gi-Oh!”, “Monster Jam”, “Teenage Mutant Ninja Turtles” and “Cabbage Patch Kids” Properties were the largest contributors with approximately 77% of the Company’s revenues in this business segment for 2009, exclusive of the one-time “Teenage Mutant Ninja Turtles” payment. Exclusive of the one-time payment, “Teenage Mutant Ninja Turtles” revenue approximated 12% of consolidated net revenues during 2009. Revenues associated with the “Teenage Mutant Ninja Turtles” Property will cease as of June 30, 2010 along with the Company’s right to serve as merchandise licensing agent.

 

In the Advertising Media and Broadcast segment, the significant decrease in revenues for 2009 compared with 2008 primarily results from the different accounting treatment with regard to advertising revenue under our agreement with The CW as compared with the accounting treatment for advertising revenue received under the agreement that the Company had with Fox. Under The CW Network Agreement, the CW’s minimum guaranteed revenue share for The CW4Kids is offset against the Company’s network advertising revenues. Under the accounting treatment for the Fox Agreement, the Company recorded the full amount of the advertising revenue received with respect to advertising sales on Fox while at the same time amortizing the Fox broadcast fee as an expense rather than as an offset to network advertising revenue. For the year ended December 31, 2009, the Company recognized $450 of net advertising revenue attributable to The CW as compared to 2008 where the Company recognized $335 of advertising revenue attributable to The CW. Additionally in 2008, the Company recorded $13,446 of net advertising revenue attributable to Fox and $16,022 of the Fox broadcast fee for 4Kids TV which was amortized and classified as an expense rather than as an offset to network advertising revenue.

 

In the Television and Film Production/Distribution segment, the decrease in revenues for 2009, as compared to 2008, was primarily attributable to:

 

 

The Trading Card and Game Distribution segment began to record significant revenues in 2008 as a result of the launch of the “Chaotic” trading card game to retail and mass market distribution. For the year ended December 31, 2009, retail sales were negatively impacted by diminished popularity of the “Chaotic” property accompanied by the continued global economic downturn. As a result, many retailers maintained reduced inventory levels, and the Company’s Trading Card and Game Distribution segment was negatively impacted by the resulting cut back by the Company’s distributors on orders placed with TC Digital. These reductions resulted in the Company recording lower revenues and higher inventory levels for the year ended December 31, 2009. Additionally, due to the overall lack of demand for the “Chaotic” Property, the Company has granted allowances and promotional markdowns to these distributors equal to approximately $2,295 for the year ended December 31, 2009.

 

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased 12%, or $6,374 to $48,190 for the year ended December 31, 2009, when compared to the same period in 2008. The decrease was attributable to broad cost-cutting initiatives implemented throughout the Company and included:

 

 

Additionally, in 2009, the Company recorded nonrecurring severance expenses for terminated employees of approximately $2,410 which is included in personnel related costs.

 

Cost of Sales of Trading Cards

 

Cost of sales of trading cards represents finished goods inventory costs relating to the “Chaotic” trading card game. Cost of sales decreased 23%, or $2,458, to $8,167 for the year ended December 31, 2009, when compared to the same period in 2008. The decrease was primarily attributable to the overall decrease in trading card revenue. Based on the diminished popularity of the “Chaotic” Property, the Company’s Trading Card and Game Distribution segment experienced a reduction in orders from TC Digital’s distributors. These reduced sales caused an overall surplus of trading card inventory forcing the Company to record significant reserves on this slower moving inventory of approximately $3,829 based on the value of expected future trading card sales;

 

Capitalized Film Costs

 

 

The increase in amortization of television and film costs for the year ended December 31, 2009, as compared to the same period in 2008 is primarily due to increased amortization relating to the “Chaotic” television series based on significant reductions of estimated future revenues. In addition, increased amortization was recorded for the “Teenage Mutant Ninja Turtles” Property due to an increase in revenue from a one-time payment to the Company relating to the termination of the Company’s right to serve as the merchandise licensing agent for the Property, prior to the scheduled expiration of the representation agreement in 2012.

 

As of December 31, 2009, there was $6,832 of capitalized film production costs recorded in the Company’s consolidated balance sheet relating primarily to various stages of production on 229 episodes of animated programming. Based on management’s ultimate revenue estimates as of December 31, 2009, approximately 56% of the total completed and unamortized film and television costs are expected to be amortized during the next year, and over 90% of the total completed and unamortized film and television costs are expected to be amortized during the next three years.

 

4Kids TV Broadcast Fee

 

 

Due to the termination of the Fox Agreement on December 31, 2008, the 4Kids TV broadcast fee has been fully amortized. The minimum guaranteed payment obligations under the CW Agreement are offset against the Company’s revenues from the sale of network advertising time on The CW4Kids rather than being amortized as a broadcast fee.

 

Impairment of Investment in International Trading Card Subsidiary

 

The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of certain assets may not be recoverable. When such events or changes in circumstances are present, the Company assesses the recoverability of these assets by determining whether the carrying value will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the value of the assets.

 

 

 

During the fourth quarter of 2009, the Company recorded $20,195 of charges to reduce the carrying value of certain “Chaotic” assets based on their revised estimated fair values. Such amounts include: (i) a reduction of the Company’s film inventory of $12,637 through amortization based on a change in the overall expected future revenues of the Property, including approximately $6,943 owed to the Company by CUSA and Apex, collectively, for their share of production costs for television episodes of the “Chaotic” Property under their representation agreement with 4Kids Licensing; (ii) a reduction of the Company’s trading card inventory of $3,829, based on the value of expected future trading card sales; (iii) an impairment charge with respect to the Company’s investment in TDI of $2,430 to reflect the decreased value of this non-performing international joint venture of the “Chaotic” trading card business; and (iv) an impairment charge of $1,299 relating to the decreased value of the Company’s international subsidiary’s investment in a percentage of domestic “Chaotic” trading card sales.

 

Interest Income

 

Interest income decreased 60%, or $1,646, to $1,076 for the year ended December 31, 2009, as compared to the same period in 2008, primarily as a result of lower cash balances and the Company‘s investments yielding lower interest rates than the prior period.

 

Impairment of Investment Securities

 

As of December 31, 2009, the Company held investment securities having an aggregate principal amount of $35,550. The estimated fair market value of the investment securities held by the Company had declined by $21,370 (a decline of $22,125 prior to 2009, with an increase in value of $755 during 2009) to $14,180, based upon an analysis of the current market conditions of the Company’s securities made by the Company in accordance with authoritative guidance issued by the FASB. The Company concluded in 2009, that $6,175 of the decline in the fair value of the investment securities held by the Company were now other than temporarily impaired. The Company’s determination that certain of its long-term investments were other than temporarily impaired was based upon the fact that: (i) two of the Company’s securities with an aggregate par value of $8,700 were sold subsequent to December 31, 2009 for $2,575 resulting in a realized loss of $6,125, of which $5,383 had been recorded in other comprehensive loss in 2008; and (ii) certain of the Company’s other ARS ceased to pay interest according to their stated terms and that the underlying bond insurers of such securities elected to exercise their put right against the trusts, thereby exchanging the investment grade collateral in the trust with preferred stock. The Company did not incur any impairment charges in 2009 due to credit losses under the new authoritative guidance issued by the FASB in 2009. The Company continues to monitor the market for ARS and consider its impact (if any) on the fair value of its investments. If the current market conditions deteriorate further, the Company may be required to record additional impairment charges to non-operating expense in future periods.

 

Loss on Sale of Investment Securities

 

During 2009, the Company sold securities with a par value of $11,380 for $3,733 causing the Company to record a loss on the sale of investment securities of $7,647.

 

Loss Before Income Taxes

 

In the Licensing segment, the increase in segment loss for the year ended December 31, 2009, as compared to the same period in 2008, was primarily attributable to a loss on the sale of investment securities of $7,647, as well as lower licensing revenues and lower interest income allocated to this segment, partially offset by a decrease in licensing expenses.

 

In the Advertising Media and Broadcast segment, the decrease in segment loss for the year ended December 31, 2009, as compared to the same period in 2008, resulted from the amortization of the 4Kids TV broadcast fee during 2008 which was greater than the minimum guaranteed payment made for The CW4Kids broadcast block in 2009. Stronger ratings for the Company’s Properties broadcast on its programming block during the year also contributed to the improvement in segment performance.

In the Television and Film Production/Distribution segment, the increase in segment loss for the year ended December 31, 2009, as compared to the same period in 2008, was primarily due to increased amortization of television and film costs resulting from a significantly revised downward outlook for the “Chaotic” Property and the termination of the “Teenage Mutant Ninja Turtle” representation rights as well as an overall decrease in production revenues partially offset by a decrease in international sales expense.

 

In the Trading Card and Game Distribution segment, the increase in segment loss for the year ended December 31, 2009, as compared to the same period in 2008, was primarily attributable to the overall decrease in trading card revenue as well as a reduction in carrying value of the Company’s trading card inventory of $3,829, based on the value of expected future trading card sales.

 

Income Tax Expense

 

The net tax benefit of $3,805 for the year ended December 31, 2009 reflected a current tax benefit related to the utilization of the Company’s net operating loss carrybacks. The net tax provision for the year ended December 31, 2008 reflected a deferred tax expense of $300 related to taxable income from the Company’s foreign subsidiary. 

 

The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. Authoritative guidance issued by the FASB requires the Company to record a valuation allowance when it is more likely than not that all or some portion of the deferred tax assets will not be realized. In view of the level of deferred tax assets as of December 31, 2009, and the Company’s historical losses from operations, the Company has determined that a full valuation allowance against its net deferred tax assets is required.

 

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

 

The Company files in multiple tax jurisdictions and from time to time is subject to audit in certain tax jurisdictions. As of December 31, 2009, there were no outstanding tax audits.

 

Net Loss

 

As a result of the above, the Company had a net loss for the year ended December 31, 2009 of $52,456, as compared to a net loss in 2008 of $36,819.

 

Year Ended December 31, 2008 as compared to Year Ended December 31, 2007

 

Revenues

 

Revenues for the years ended December 31, 2008 and 2007, by reportable segment and for the Company as a whole, were as follows:

 

 

The increase in consolidated net revenues for 2008, as compared to 2007, was due to a number of factors.

In the Licensing segment, decreased revenues were primarily attributable to:

 

 

 

The “Yu-Gi-Oh!” and “Teenage Mutant Ninja Turtles” Properties, despite lower licensing revenues as compared to 2007, continued to be the largest contributors to the Company’s revenues in this business segment in 2008.

 

In the Advertising Media and Broadcast segment, revenues for 2008 remained relatively consistent when compared to 2007, primarily resulting from:

 

 

In the Television and Film Production/Distribution segment, the revenue decline for 2008, as compared to 2007, primarily resulting from:

 

 

The Trading Card and Game Distribution segment began to record revenues in the fourth quarter of 2007 as a result of the October launch of the “Chaotic” trading card game to comic and hobby stores. For the year ended December 31, 2008, revenues were $15,276, as a result of sales to mass market distribution channels as well as to comic and hobby stores. During the fourth quarter of 2008, retail sales were negatively impacted by the global economic downturn. As a result of the downturn, many retailers decided to reduce inventory on hand for the holiday selling season, and the Company’s Trading Card and Game Distribution segment was negatively impacted by the resulting cut back by the Company’s distributors on their own holiday orders placed with TC Digital. Consequently, overall sales of “Chaotic” trading cards during the fourth quarter of 2008 were below expectations. In addition, these reduced sales caused an overall surplus of trading card inventory forcing the Company to record a reserve of $3,000 on its slower moving inventory.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased 21%, or $9,594 to $54,564 for the year ended December 31, 2008, when compared to 2007. The increase was primarily due to the following:

 

 

Cost of Sales of Trading Cards

 

Cost of sales of trading cards represents finished goods inventory costs relating to the “Chaotic” trading card game which was released to comic and hobby stores in October 2007. The Company’s production of cards to meet anticipated retailer demand followed by a decrease in overall consumer spending caused an inventory surplus and resulted in the Company recording a reserve of $3,000 associated with its slower moving inventory, as of December 31, 2008.

 

Capitalized Film Costs

 

 

The decrease in amortization of television and film costs for the year ended December 31, 2008 when compared to the same period in 2007, was primarily due to the decreased amortization of “Viva Piñata” and “Teenage Mutant Ninja Turtles” television series as well as decreased amortization of various older properties which were fully amortized in 2007. These decreases were offset by increased amortization of the “Chaotic” and “Yu-Gi-Oh!” television series.

As of December 31, 2008, there were $16,661 of capitalized film production costs in the Company’s consolidated balance sheet relating primarily to various stages of production on 461 episodes of animated programming. Based on management’s ultimate revenue estimates as of December 31, 2008, approximately 42% of the total completed and unamortized film and television costs are expected to be amortized during the next year, and over 90% of the total completed and unamortized film and television costs are expected to be amortized during the next three years.

 

4Kids TV Broadcast Fee

 

As a result of the broadcast year (ending each year in September) being different than the Company’s fiscal year (ending each year in December), the amount of the amortization of the broadcast fee recognized from period to period will vary based upon: (i) the amount of advertising revenue recognized during the period; and (ii) the amount of advertising revenue already recognized for the broadcast year as a percentage of the total amount expected to be recognized for the full broadcast year.

 

The decrease in amortization of the 4Kids TV broadcast fee for the year ended December 31, 2008 when compared to the same period in 2007, resulted from the agreement to terminate the Fox Agreement on December 31, 2008. The Fox Agreement was originally scheduled to terminate in September 2009.

 

Interest Income

 

Interest income decreased 48%, or $2,559 to $2,722 for the year ended December 31, 2008, as compared to 2007, primarily as a result of lower cash balances and the Company investing its surplus cash in U.S. Treasury securities typically bearing lower interest rates than other investments.

 

Impairment of Investment Securities

 

As of December 31, 2008, the Company held investment securities having an aggregate principal amount of $46,930. As of December 31, 2008, the estimated fair market value of the investment securities held by the Company had declined by $25,313 ($3,993 during 2007 and $21,320 during 2008) to $21,617, based upon an analysis of the current market conditions of the Company’s investment securities made by the Company in accordance with authoritative guidance issued by the FASB. The Company concluded that a portion of the 2008 decline in fair value of $6,262, as well as $1,572 of the long-term investment decline during 2007 previously deemed to be temporarily impaired and recorded to other comprehensive income in 2007, were now other than temporarily impaired. The Company’s determination that certain of its long-term investments were other than temporarily impaired was based upon the fact that certain of the Company’s auction rate securities (“ARS”) ceased to pay interest according to their stated terms and that the underlying bond insurers of such securities elected to exercise their put right against the trusts, thereby exchanging the investment grade collateral in the trust with preferred stock. Accordingly, the Company recorded $7,834 of impairment charges to non-operating expense, in the Licensing segment, related to the other than temporary impairment of its ARS. The Company continues to monitor the market for ARS and considers its impact (if any) on the fair value of its investments. If the current market conditions deteriorate further, the Company may be required to record additional impairment charges to non-operating expense in future periods.

 

(Loss) Income Before Income Taxes

 

 

The loss in the Licensing segment for the year ended December 31, 2008, as compared to income for the same period in 2007, was primarily attributable to an other than temporary impairment of certain of the Company’s investment securities, lower revenues from licensed Properties as well as a decrease in interest income allocated to this segment.

 

 

 

In the Advertising Media and Broadcast segment, the decrease in segment loss for the year ended December 31, 2008, as compared to the same period in 2007, was due to a decrease in amortization of the 4Kids TV broadcast fee in conjunction with the termination of the Fox Agreement, as well as a decrease in advertising and promotional expenses.

 

In the Television and Film Production/Distribution segment, the increase in segment loss for the year ended December 31, 2008 as compared to the same period in 2007, was primarily due to an increase in international selling expenses as well as a decrease in domestic broadcast sales, partially offset by decreased amortization of television and film costs.

 

In the Trading Card and Game Distribution segment, the increase in segment loss for the year ended December 31, 2008 when compared to the same period in 2007, was primarily attributable to increased cost of goods sold and selling, general and administrative expenses partially offset by increased revenues.

 

Income Tax Expense

 

The net tax provision for the year ended December 31, 2008 reflected a deferred tax expense of $300 related to taxable income from the Company’s foreign subsidiary. The deferred tax expense of $2,436 for the year ended December 31, 2007, related to an increase in the Company’s valuation reserve.

 

The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. The authoritative guidance issued by the FASB requires the Company to record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In view of the level of deferred tax assets as of December 31, 2008, and the Company’s historical losses from operations, the Company has determined that the application of the authoritative guidance issued by the FASB requires the Company to record a full valuation allowance against its net deferred tax assets.

 

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

 

The Company's effective tax rate for 2008 would have been a benefit of 38.1%. This rate differs from the Federal statutory rate of 35% primarily due to the mix of income and losses, which have tax rates that differ from the statutory rate, and due to permanent differences and tax rate differences on subsidiaries.

 

The Company files in multiple tax jurisdictions and from time to time is subject to audit in certain tax jurisdictions. As of December 31, 2008, the Company is in the process of undergoing an audit of its 2006 federal return. Management does not anticipate any adjustments.

 

Net Loss

 

As a result of the above, the Company had a net loss for the year ended December 31, 2008 of $36,819, as compared to a net loss of $23,326 for the same period in 2007.

 

Liquidity and Capital Resources

 

 

Cash and cash equivalents for the years ended December 31, 2009 and 2008 were as follows:

 

 

 

Long-term investments for the years ended December 31, 2009 and 2008 were as follows:

 

 

 

The Company’s long-term investments principally consist of ARS, corporate bonds and preferred shares. ARS are generally rated “BBB” or better by one or more national rating agencies and have contractual maturities of up to 80 years. Of the aggregate principal amount of $35,550 in investment securities held by the Company as of December 31, 2009, 23% mature within the next 30 years, 43% mature through 2087 and the remaining 57% have no maturity date. The Company classifies these investments as “available for sale”, in accordance with the authoritative guidance issued by the FASB for certain investments in debt and equity securities. The ARS that the Company invests in generally had interest reset dates that occurred every 7 or 35 days and despite the long-term nature of their stated contractual maturity, the historical operation of the ARS market had given the Company the ability to quickly liquidate these securities at ongoing auctions every 35 days or less.

 

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

 

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

 

As of December 31, 2009, the Company held investment securities having an aggregate principal amount of $35,550. The estimated fair market value of the investment securities held by the Company had declined by $21,370 (a decline of $22,125 prior to 2009, with an increase in value of $755 during 2009) to $14,180, including $2,130 related to credit losses recorded in accordance with new authoritative guidance issued by the FASB and adopted in 2009 based upon an analysis of the current market conditions of the Company’s securities made by the Company. The Company concluded in 2009, that $6,175 of the decline in the fair value of the investment securities held by the Company were now other than temporarily impaired. The Company’s determination that certain of its long-term investments were other than temporarily impaired was based upon the fact that: (i) two of the Company’s securities with an aggregate par value of $8,700 were sold subsequent to December 31, 2009 for $2,575 resulting in a realized loss of $6,125, of which $5,383 had been recorded in other comprehensive loss in 2008; and (ii) certain of the Company’s other ARS ceased to pay interest according to their stated terms and that the underlying bond insurers of such securities elected to exercise their put right against the trusts, thereby exchanging the investment grade collateral in the trust with preferred stock. The Company did not incur any impairment charges in 2009 as a result of credit losses under the new authoritative guidance issued by the FASB in 2009.

 

Since the Company has the ability, and presently expects, to hold its remaining investment securities until recovery of their face value, which may not be prior to the maturity of the applicable security (to the extent such security has a specified maturity date) and based on consideration of all of the factors described above, the Company considered certain of these investments to be temporarily impaired as such term is defined in the accounting literature. Accordingly, the entire balance of unrealized loss in accumulated other comprehensive income at December 31, 2009 relates to securities which the Company considers temporarily impaired. Additionally, these remaining investment securities held by the Company have continued to pay interest according to their stated terms, which the Company believes may create an incentive for the issuers to redeem these securities once the current liquidity problems in the credit market substantially improve.

 

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

 

During 2009, the Company sold investment securities with a par value of $11,380 for $3,733 causing the Company to record a loss on the sale of investments of $7,647. The Company had previously recorded an unrealized loss on these securities of $3,081, which was reclassified due to the sale of the investment.

 

The credit and capital markets, including the market for ARS, have remained illiquid, and as a result of this and other factors specific to certain investment securities, the Company’s unrealized loss on its investment securities may subsequently increase. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; yields of securities similar to the underlying investment securities; and, until September 2008, input from broker-dealers’ statements provided by the investment bank through which the Company held such securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its

 

evaluation on the mid-point of that range. Specifically, the Company considers the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying these securities in our overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looks at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period.

 

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

 

Given the failed auctions, the Company’s investment securities are currently illiquid.  Accordingly, the Company has classified $14,180 of its investment in ARS and the securities into which certain of the ARS have been exchanged, as non-current assets as of December 31, 2009 on its balance sheet due to the fact that the Company believes that the liquidity of these securities is unlikely to be restored in a period less than twelve months from such date.

 

The Company believes that Lehman Brothers, Inc., the securities broker-dealer that purchased the ARS on behalf of the Company that have been classified as other than temporarily impaired based on discretion afforded to it, has violated its legal obligations to the Company. As a result, the Company has taken various measures to obtain appropriate legal relief, including initiating an arbitration with the Financial Industry Regulatory Authority. On September 15, 2008, Lehman Brothers Holdings, Inc., the parent company of Lehman Brothers, Inc., filed for bankruptcy. On September 16, 2008, Barclays PLC announced that it had reached an agreement to purchase the assets of Lehman Brothers Holdings, Inc.’s North American operations, including substantial assets of Lehman Brothers, Inc. The Lehman-Barclays transaction was approved by the United States Bankruptcy Court for the Southern District of New York on September 20, 2008. On September 19, 2008, the Securities Investor Protection Corporation (“SIPC”) filed a proceeding, placing Lehman Brothers, Inc. in liquidation under the Securities Investor Protection Act (“SIPA”). SIPC, pursuant to its authority under SIPA, has acted to facilitate the transfer of Lehman Brothers, Inc.’s customer accounts (including the Company’s accounts) to Barclays, PLC. In view of the bankruptcy of Lehman Brothers Holdings, Inc. and the liquidation of Lehman Brothers, Inc., the Company is currently assessing what additional steps, if any, to take to pursue legal redress.

 

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

 

During the first quarter of 2010, the Company realized cash proceeds from the sale of two of its investment securities in an amount equal to approximately $2,575 and received tax refunds relating to extended net operating loss carrybacks of approximately $3,567. Based on the Company’s receipt of such cash proceeds, its cash position as of December 31, 2009, the anticipated effects of the significant cost cutting initiatives implemented by the Company during 2009 and continuing into 2010, and the Company’s belief that economic conditions have become more stable, the Company expects its overall cash position to provide adequate liquidity to fund its day-to-day operations for the next twelve months. However, the illiquidity affecting a significant portion of the Company’s portfolio of investment securities is impacting the Company’s ability to make capital investments or expand its operations.

 

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

 

Sources and Uses of Cash

 

Cash flows for the three years ended December 31, 2009, 2008 and 2007 were as follows:

 

 

 

Working capital, consisting of current assets less current liabilities, was $4,859 as of December 31, 2009 and $17,579 as of December 31, 2008.

 

Operating Activities

2009

Net cash used in operating activities of $13,673 in 2009 primarily reflects a decrease in the Company’s business performance, as well as additional costs related to the purchase of film and television inventory, partially offset by increased collections of the Company’s accounts receivable.

 

2008

Net cash used in operating activities of $32,310 in 2008 primarily reflects a decrease in the Company’s business performance as well as additional costs related to the purchase of film and television inventory, payment of the Fox broadcast fee and purchase of trading card inventory. This decrease was partially offset by amortization of television and film costs and the 4Kids TV broadcast fee as well as the impairment of a portion of the Company’s investment securities

 

2007

Net cash used in operating activities of $13,821 in 2007, primarily reflected a decrease in the Company’s business performance. This decrease was partially offset by a reduction of the Company’s tax assets attributable to a valuation allowance being established against net operating loss carryforwards.

 

Investing Activities

2009

Net cash provided by investing activities of $3,522 in 2009, reflects proceeds from the sale of certain of the Company’s investment securities for $3,733, partially offset by purchases of property and equipment.

 

2008

Net cash provided by investing activities of $23,408 in 2008, reflects a shift in the Company’s investments for the period from auction rate securities to U.S. Treasury securities, which are short in duration and are classified as cash and cash equivalents.

 

2007

Net cash provided by investing activities of $20,576 in 2007, reflected a shift in the Company’s investment strategy, implemented during 2007, to purchase taxable investments with longer maturities to minimize the risk of short-term interest rate fluctuations, partially offset by increased capitalized website costs related to the development of the “Chaotic” website.

 

Financing Activities

2009

Net cash provided by financing activities of $74 in 2009, reflects the capital contributions from the Company’s noncontrolling interests, partially offset by the Company’s purchase of shares of its common stock classified as treasury stock on the consolidated financial statements.

 

2008

Net cash used in financing activities of $2,641 in 2008, reflects the Company’s purchase of shares of its common stock classified as treasury stock on the consolidated financial statements.

 

2007

Net cash provided by financing activities of $2 in 2007, reflected proceeds from the exercise of stock options, substantially offset by the purchase of treasury shares.

 

During 2009, the Company's cash flow from operations was impacted by an overall decrease in consumer spending due to the diminished popularity of its Properties, as well as the current economic conditions.  While the Company strives to further diversify its revenue streams, management remains cognizant of changing trends in the toy, game and entertainment business and the difficulty in predicting the length of time a property will be commercially successful.  As a result, the Company's revenues, operating results and cash flow from operations may fluctuate significantly from year to year and present operating results are not necessarily indicative of future performance.

 

 

 

 

 

Broadcast Agreements

 

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

 

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

 

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

 

The CW has disputed the Company’s position by claiming that there has been no industry action reducing or otherwise limiting the categories of permitted advertising and believes that the Company is in breach of The CW Agreement by having paid the reduced amount in respect of the quarterly guarantee. The Company and The CW are currently in discussions regarding the contractual dispute. If they are unable to resolve the dispute through negotiation, the dispute between the Company and The CW will be resolved through arbitration. If the Company prevails through negotiation or arbitration, the $15,000 guarantee will be reduced and the split of advertising revenues will be adjusted. There can be no assurance, however, that the Company will prevail or of the amount of any reduction or adjustment in the event the Company is successful. If the Company is unsuccessful, it will be required to pay $2,475 to The CW, representing the difference between the original amount required under The CW Agreement and the amount paid by the Company in December 2009.

 

The Company broadcasted certain of its Properties on 4Kids TV, the Saturday morning programming block that the Company leased from Fox, under the Fox Agreement. On November 9, 2008, the Company entered into an agreement with Fox to settle the lawsuit brought by the Company against Fox for alleged breaches of the Fox Agreement. Under the terms of the Settlement Agreement, the Fox Agreement terminated on December 31, 2008 rather than at the end of the 2008-2009 broadcast season in September 2009. The Company’s remaining financial obligations to Fox for the first three quarters of 2009 also terminated. During the year ended December 31, 2009, the Company paid Fox $6,250 in respect of its remaining obligation under the Settlement Agreement. The cost of 4Kids TV has been capitalized and amortized over each broadcast year based on estimated advertising revenue until the termination of the Fox Agreement on December 31, 2008, at which time the cost to lease 4Kids TV was fully amortized.

 

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

 

 

 

 

 

 

Contractual Commitments

 

The Company has commitments under certain firm contractual arrangements (“firm commitments”) to make future payments for goods and services. These firm commitments secure the future rights to various assets and services to be used in the normal course of operations. The following table summarizes the Company’s material firm commitments as of December 31, 2009 and the impact that such obligations are expected to have on the Company’s liquidity and cash flows in future periods. The Company expects to fund these commitments primarily with operating cash flows generated in the normal course of business.

 

 

The Company’s contractual obligations and commitments are detailed in the Company’s consolidated financial statements. For additional information see Note 14 of the notes to the Company’s consolidated financial statements.

 

Item 6A. Quantitative and Qualitative Disclosures About Market Risk.

 

Foreign Currency Exchange Rate Fluctuations.

 

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

 

 

The Reports of Registered Public Independent Accounting Firms, the Company’s consolidated financial statements and notes to the Company’s consolidated financial statements appear in a separate section of this Form 10-K (beginning on Page F-1 following Part IV). The index to the Company’s consolidated financial statements is included in Item 14.

 

 

None.

 

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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

 

 

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

 

Management's Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), is a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

• Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

• Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

• Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The scope of management's assessment of the effectiveness of internal control over financial reporting includes all of our Company's consolidated subsidiaries.

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control-Integrated Framework." Based on this assessment, management believes that, as of December 31, 2009, our internal control over financial reporting was effective based on those criteria.

 

Eisner LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, has issued an auditors' report on our internal control over financial reporting.

 

Item 8B.  Other Information.

 

None.

 

PART III

 

Item 9. Directors and Executive Officers of the Registrant.

 

Information concerning directors and officers of the Company is incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A to be filed with the Securities and Exchange Commission within 120 days after the end of the Company’s fiscal year.

 

On May 29, 2009, the Company filed with the New York Stock Exchange the Annual CEO Certification regarding the Company’s compliance with the NYSE’s Corporate Governance listing standards as required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual.  

 

Item 10. Executive Compensation.

 

Information concerning executive and director compensation is incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A to be filed with the Securities and Exchange Commission within 120 days after the end of the Company’s fiscal year.

 

Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

Information concerning security ownership of each person known by the Company to own beneficially more than 5% of the outstanding shares of Common Stock, of each director of the Company and all officers and directors as a group and of the Company’s equity compensation plans is incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A to be filed with the Securities and Exchange Commission within 120 days after the end of the Company’s fiscal year.

 

Item 12. Certain Relationships and Related Transactions.

 

Information concerning certain relationships and related transactions is incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A to be filed with the Securities and Exchange Commission within 120 days after the end of the Company’s fiscal year.

 

Item 13. Principal Accountant Fees and Services.

 

Information concerning principal accountant fees and services is incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A to be filed with the Securities and Exchange Commission within 120 days after the end of the Company’s fiscal year.

 

PART IV

 

Item 14. Exhibits and Financial Statement Schedules.

 

(a)(1) Financial Statements:

The following consolidated financial statements of 4Kids Entertainment, Inc. and Subsidiaries are included in Item 8:

 

(a)(2) Financial Statement Schedules

 

All schedules have been omitted because they are inapplicable, not required, or the information is included in the Company’s consolidated financial statements or the notes to the Company’s consolidated financial statements.

 

(a)(3) and (b) Exhibits.

See Index of Exhibits annexed hereto.

 

 

 

 

 

 

SIGNATURES

 

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

 

4KIDS ENTERTAINMENT, INC.

 

Date: March 15, 2010

___________________________

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

Date: March 15, 2010

___________________________

 

 

 

 

 

 

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders

4Kids Entertainment, Inc.

 

We have audited the accompanying consolidated balance sheets of 4Kids Entertainment, Inc. and Subsidiaries (the “Company”) as of December 31, 2009 and 2008 and the related consolidated statements of operations, stockholders' equity and comprehensive loss, and cash flows for each of the years in the three year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2009 and 2008 and the consolidated results of their operations and their consolidated cash flows for each of the years in the three year period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 15, 2010 expressed an unqualified opinion thereon.

 

/s/ Eisner LLP

 

New York, New York

March 15, 2010

 

 

 

 

 

 

 

 

 

 

 

 

F-1

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

4Kids Entertainment, Inc.

 

We have audited 4Kids Entertainment, Inc. internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). 4Kids Entertainment, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, 4Kids Entertainment, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of 4Kids Entertainment, Inc. and subsidiaries as of December 31, 2009, and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three year period ended December 31, 2009, and our report dated March 15, 2010 expressed an unqualified opinion on those financial statements.

 

/s/ Eisner LLP

 

New York, New York

March 15, 2010

 

 

 

 

 

F-2

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2009 AND 2008

(In thousands of dollars, except share data)

                                                                                                                                                                                                                              

 

 

See notes to consolidated financial statements.

F-3

 

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

(In thousands of dollars, except share data)

 

 

See notes to consolidated financial statements.

 

F-4

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS

YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

(In thousands of dollars and shares)

 

 

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

 

See notes to consolidated financial statements.

F-5

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

 

See notes to consolidated financial statements.

 

F-6

 

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007

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

 

1. DESCRIPTION OF BUSINESS

 

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

 

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

 

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

 

The Company, through a multi-year agreement (the “Fox Agreement”) with Fox Broadcasting Corporation (“Fox”), leased Fox’s Saturday morning programming block (“4Kids TV”) from 8am to 12pm eastern/pacific time (7am to 11am central time) which was terminated on December 31, 2008. The Company provided substantially all programming content to be broadcast on 4Kids TV and 4Kids Ad Sales retained all of the revenue from its sale of network advertising time for the four-hour programming block.

 

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

 

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

 

Trading Card and Game Distribution - Through its wholly-owned subsidiary, 4Kids Digital Games, Inc. (“4Kids Digital”), the Company owns 55% of TC Digital Games LLC, a Delaware limited liability company (“TC Digital”) that produces, markets and distributes the “Chaotic” trading card game. In December 2006, 4Kids Digital acquired a 53% ownership interest in TC Digital and entered into TC Digital’s operating agreement (the “TCD Agreement”) with Chaotic USA Digital Games LLC (“CUSA LLC”), a wholly-owned subsidiary of Chaotic USA Entertainment Group, Inc. (“CUSA”). The TCD Agreement contains terms and conditions governing the operations of TC Digital, and entitles 4Kids Digital and CUSA to

 

F-7

 

elect two managers to the entity’s Management Committee with 4Kids Digital having the right to break any dead-locks. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA increasing 4Kids Digital’s ownership percentage to 55%. The consideration for the purchase of the additional membership interest was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites LLC, a Delaware limited liability company and subsidiary of the Company (“TC Websites”) under TC Websites’ operating agreement (the “TCW Agreement”). TC Digital is consolidated in the Company’s consolidated financial statements, subject to a noncontrolling interest.

 

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

 

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

 

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

 

Certain of the Company’s executive officers have interests in CUSA, CUSA LLC and certain other entities with which TC Digital and TC Websites have engaged in transactions since their formation. Information regarding these relationships can be found in Note 15 and 17.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation – The accompanying consolidated financial statements include the accounts of 4Kids Entertainment, Inc. and its wholly-owned subsidiaries and investments of more than 50% in subsidiaries and other entities after elimination of significant intercompany transactions and balances. While the Company maintained a 50% ownership interest in TC Websites and did not control, but had significant influence, over such entity, the Company’s investment in TC Websites was accounted for using the equity method in 2006. As a result of the acquisition by the Company of an additional 5% ownership interest in such entity and increased operational control, TC Websites has been included in the Company’s consolidated financial statements in fiscal years 2009, 2008 and 2007 as further discussed in Note 15. These consolidated financial statements reflect the use of significant accounting policies, as described below and elsewhere in the notes to the consolidated financial statements.

 

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

F-8

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

 

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

 

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

 

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

 

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

 

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

 

Advertising Expense - Advertising costs are expensed as incurred, except for costs related to the development of a Property and/or animated or live-action television commercial or media campaign which are expensed in the period in which the commercial or campaign is first presented. Advertising expense included in selling, general and administrative expenses on the accompanying consolidated statements of income was $4,108, $5,272 and $1,794 during fiscal years 2009, 2008 and 2007, respectively.

 

Inventories - Inventories consist of raw materials and finished goods inventory of trading cards and are valued at the lower of cost or net realizable value. The cost of the Company’s inventory is computed using the first-in, first-out method.

 

Property and Equipment - Property and equipment are carried at cost, net of accumulated depreciation and amortization. Depreciation is calculated on the straight-line method based on the estimated useful lives of the assets, which range from 3 to 10 years. Amortization of leasehold improvements is computed using the straight-line method over the estimated useful lives of the related assets or, if shorter, the lease term. Costs associated with the repair and maintenance of property are expensed as incurred.

 

Website Development Costs - The Company capitalizes its website development costs for the www.chaoticgame.com website consistent with the authoritative guidance issued by the FASB. Costs incurred during the preliminary project stage are expensed as incurred, while application stage projects are capitalized. The costs capitalized during the application stage are generally related to employee and/or consulting services directly associated with the development of the website. Website costs are included in property and equipment in the Company’s consolidated balance sheet. Amortization commenced on October 24, 2007, once the website went live and is amortized using the straight-line method over the estimated useful life of three years.

 

F-9

 

Impairment Of Long-Lived And Intangible Assets - As required by authoritative guidance issued by the FASB, the Company assesses the recoverability of long-lived assets for which an indication of impairment exists. The recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the future undiscounted net cash flows expected to be generated by the asset. If an asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds its fair value. Fair value of long-lived assets is determined using the expected cash flows discounted at a rate commensurate with the risk involved. At December 31, 2009, the Company recorded an impairment charge with respect to its investment in TDI of $2,430 to reflect the decreased value of the non-performing international joint venture of the Company’s “Chaotic” trading card business for the purpose of distributing “Chaotic” trading cards principally in Europe and the Middle East. The Company believes that the future cash flows to be received from the remaining long-lived assets will exceed the respective assets’ carrying value, and accordingly has not recorded any additional impairment losses.

 

Cash and Cash Equivalents - All highly liquid investments with original maturities of three months or less are classified as cash and cash equivalents. The fair value of cash and cash equivalents approximates the amounts shown on the financial statements. Cash and cash equivalents consist of unrestricted cash in various banks in which the Company maintains balances in excess of the Federal Deposit Insurance Corporation (FDIC) insured limit of $250 per interest bearing account as of December 31, 2009 and, 2008. At December 31, 2009 and 2008, the cash and cash equivalents in excess of the insured limit aggregated $2,139 and $8,880, respectively. The standard amount of $250 per depositor is in effect through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100 per depositor for all account categories except IRA’s and other certain retirement accounts, which will remain at $250 per depositor.

 

Fair Value Measurements - The fair values of the Company’s financial instruments reflect the estimates of amounts that would be received from selling an asset in an orderly transaction between market participants at the measurement date. The fair value estimates presented in this report are based on information available to the Company as of December 31, 2009 and December 31, 2008.

 

The carrying values of cash and cash equivalents approximate fair value. The Company has estimated the fair value of its investment in auction rate securities (“ARS”) and other long-term investments using unobservable inputs at December 31, 2009. The authoritative guidance issued by the FASB includes a fair value hierarchy based on three levels of inputs, the first two of which are considered observable and the last of which is considered unobservable, that may be used to measure fair value. The three levels are the following:

 

 

 

 

Investments - The Company’s long-term investments principally consist of ARS, corporate bonds and preferred shares. ARS are generally rated “BBB” or better by one or more national rating agencies and have contractual maturities of up to 80 years. Of the aggregate principal amount of $35,550 in investment securities held by the Company as of December 31, 2009, 23% mature within the next 30 years, 43% mature through 2087 and the remaining 57% have no maturity date. The Company classifies these investments as “available for sale”, in accordance with the authoritative guidance issued by the FASB for certain investments in debt and equity securities. The ARS that the Company invests in generally had interest reset dates that occurred every 7 or 35 days and despite the long-term nature of their stated contractual maturity, the historical operation of the ARS market had given the Company the ability to quickly liquidate these securities at ongoing auctions every 35 days or less.

 

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

 

 

F-10

 

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

 

As of December 31, 2009, the Company held investment securities having an aggregate principal amount of $35,550. The estimated fair market value of the investment securities held by the Company had declined by $21,370 (a decline of $22,125 prior to 2009, with an increase in value of $755 during 2009) to $14,180, including $2,130 related to credit losses recorded in accordance with new authoritative guidance issued by the FASB and adopted in 2009 based upon an analysis of the current market conditions of the Company’s securities made by the Company. The Company concluded in 2009, that $6,175 of the decline in the fair value of the investment securities held by the Company were now other than temporarily impaired. The Company’s determination that certain of its long-term investments were other than temporarily impaired was based upon the fact that: (i) two of the Company’s securities with an aggregate par value of $8,700 were sold subsequent to December 31, 2009 for $2,575 resulting in a realized loss of $6,125, of which $5,383 had been recorded in other comprehensive loss in 2008; and (ii) certain of the Company’s other ARS ceased to pay interest according to their stated terms and that the underlying bond insurers of such securities elected to exercise their put right against the trusts, thereby exchanging the investment grade collateral in the trust with preferred stock. The Company did not incur any impairment charges in 2009 as a result of credit losses under the new authoritative guidance issued by the FASB in 2009.

 

Since the Company has the ability, and presently expects, to hold its remaining investment securities until recovery of their face value, which may not be prior to the maturity of the applicable security (to the extent such security has a specified maturity date) and based on consideration of all of the factors described above, the Company considered certain of these investments to be temporarily impaired as such term is defined in the accounting literature. Accordingly, the entire balance of unrealized loss in accumulated other comprehensive income at December 31, 2009 relates to securities which the Company considers temporarily impaired. Additionally, these remaining investment securities held by the Company have continued to pay interest according to their stated terms, which the Company believes may create an incentive for the issuers to redeem these securities once the current liquidity problems in the credit market substantially improve.

 

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

 

During 2009, the Company sold investment securities with a par value of $11,380 for $3,733 causing the Company to record a loss on the sale of investments of $7,647. The Company had previously recorded an unrealized loss on these securities of $3,081 which was reclassified due to the sale of the investment.

 

The credit and capital markets, including the market for ARS, have remained illiquid, and as a result of this and other factors specific to certain investment securities, the Company’s unrealized loss on its investment securities may subsequently increase. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; yields of securities similar to the underlying investment securities; and, until September 2008, input from broker-dealers’ statements provided by the investment bank through which the Company held such securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its evaluation on the mid-point of that range. Specifically, the Company considers the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying these securities in our overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looks at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period.

 

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

 

F-11

Given the failed auctions, the Company’s investment securities are currently illiquid.  Accordingly, the Company has classified $14,180 of its investment in ARS and the securities into which certain of the ARS have been exchanged, as non-current assets as of December 31, 2009 on its balance sheet due to the fact that the Company believes that the liquidity of these securities is unlikely to be restored in a period less than twelve months from such date.

 

The Company believes that Lehman Brothers, Inc., the securities broker-dealer that purchased the ARS on behalf of the Company that have been classified as other than temporarily impaired based on discretion afforded to it, has violated its legal obligations to the Company. As a result, the Company has taken various measures to obtain appropriate legal relief, including initiating an arbitration with the Financial Industry Regulatory Authority. On September 15, 2008, Lehman Brothers Holdings, Inc., the parent company of Lehman Brothers, Inc., filed for bankruptcy. On September 16, 2008, Barclays PLC announced that it had reached an agreement to purchase the assets of Lehman Brothers Holdings, Inc.’s North American operations, including substantial assets of Lehman Brothers, Inc. The Lehman-Barclays transaction was approved by the United States Bankruptcy Court for the Southern District of New York on September 20, 2008. On September 19, 2008, the Securities Investor Protection Corporation (“SIPC”) filed a proceeding, placing Lehman Brothers, Inc. in liquidation under the Securities Investor Protection Act (“SIPA”). SIPC, pursuant to its authority under SIPA, has acted to facilitate the transfer of Lehman Brothers, Inc.’s customer accounts (including the Company’s accounts) to Barclays, PLC. In view of the bankruptcy of Lehman Brothers Holdings, Inc. and the liquidation of Lehman Brothers, Inc., the Company is currently assessing what additional steps, if any, to take to pursue legal redress.

 

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

 

During the first quarter of 2010, the Company realized cash proceeds from the sale of two of its investment securities in an amount equal to approximately $2,575 and received tax refunds relating to extended net operating loss carrybacks of approximately $3,567. Based on the Company’s receipt of such cash proceeds, its cash position as of December 31, 2009, the anticipated effects of the significant cost cutting initiatives implemented by the Company during 2009 and continuing into 2010, and the Company’s belief that economic conditions have become more stable, the Company expects its overall cash position to provide adequate liquidity to fund its day-to-day operations for the next twelve months. However, the illiquidity affecting a significant portion of the Company’s portfolio of investment securities is impacting the Company’s ability to make capital investments or expand its operations.

 

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

 

Operating Leases - The Company accounts for all operating leases on a straight-line basis over the term of the lease. In accordance with authoritative guidance issued by the FASB, any incentives or rent escalations are recorded as deferred rent and are included as a component of rent expense over the respective lease term.

 

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are used in, but not limited to, certain areas of revenue recognition, the amortization of televisions and film costs, the amortization of 4Kids TV broadcast fees, valuation of our investment securities and inventory reserves. Actual results could differ materially from those estimates.

 

Reclassifications - Certain reclassifications have been made to prior year amounts to conform to the 2009 presentation.

 

Translation of Foreign Currency - In accordance with authoritative guidance issued by the FASB, the Company classifies items as other comprehensive income by their nature in the financial statements and displays the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the consolidated balance sheet. The assets and liabilities of the Company’s foreign subsidiary, 4Kids International have been recorded in their local currency and translated to U.S. dollars using period-end exchange rates. Income and expense items have been translated at the average rate of exchange prevailing during the period. Any adjustment resulting from translating the financial statements of the foreign subsidiary is reflected as “other comprehensive income”, net of related tax.

F-12

Comprehensive loss for the years ended December 31, 2009, 2008 and 2007 was $(40,024), $(51,653) and $(27,217), respectively, which included translation adjustments of $504, $(1,348) and $102 for the respective periods.

 

Concentration Of Credit Risk - Financial instruments, which potentially subject the Company to concentration of credit risk, consist primarily of long-term investment securities, temporary cash investments and accounts receivable. The investment securities held by the Company are generally rated “BBB” or above. The Company evaluates the fair values of these investment securities quarterly to determine its exposure for credit loss. The majority of the cash and cash equivalents are maintained with major financial institutions in the United States of America. The counterparties to the agreements relating to investment instruments consist of various United States governmental units and financial institutions of high credit standing. Credit risk on accounts receivable is minimized by the Company by performing ongoing credit evaluations of its customers’ financial condition and monitoring its exposure for credit losses and maintaining allowances for anticipated losses.

 

Income Taxes - The Company is subject to income taxes in both the United States and the United Kingdom. Income tax expense (benefit) is provided for using the asset and liability method. Deferred income taxes are recognized at currently enacted tax rates for the expected future tax consequences attributable to temporary differences between amounts reported for income tax purposes and financial reporting purposes. Deferred taxes are provided for the undistributed earnings as if they were to be distributed. The tax rate for the year ended December 31, 2009 is affected by the estimated valuation allowance against the Company’s deferred tax assets. The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as recurring operating losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. The authoritative guidance issued by the FASB requires the Company to record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Based on the level of deferred tax assets as of December 31, 2009 and the level of historical losses realized, the Company has determined that the uncertainty regarding the realization of these assets is sufficient to warrant the establishment of a full valuation allowance against the Company’s net deferred tax assets.

 

Our assessment of the valuation allowance on the deferred tax assets could change in the future based on our levels of pre-tax income and other tax-related adjustments. A change in estimate of the valuation allowance, in whole or in part, would result in a non-cash reduction in income tax expense during the period of the change. To the extent there is a reversal of some or all of the valuation allowance, future financial statements would reflect a decrease in non-cash income tax expense until such time as our deferred tax assets are all used to reduce current taxes payable.

 

TC Digital and TC Websites are limited liability companies and have elected to be treated as partnerships for income tax purposes. As such, U.S. federal and state income taxes (in the states which tax limited liability companies as partnerships) are the direct responsibility of its members. We own 55% of the membership interests in both entities. Thus, our respective portion of their activity is reported in our consolidated tax returns.

 

Recently Adopted Accounting Standards - In June 2009, the FASB established the FASB ASC as the single source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the United States Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants.  The adoption of the ASC by the Company did not have a material impact on its consolidated financial statements or results of operations.  In accordance with the FASB’s guidance, the Company’s notes to consolidated financial statements will explain accounting concepts rather than cite the topics of specific U.S. GAAP.

 

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

 

 

F-13

 

In April 2009, the FASB issued authoritative guidance related to investments in debt and equity securities. The objective of the new guidance is to make impairment guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments (“OTTI”) of debt and equity securities in financial statements.  The guidance revises the OTTI evaluation methodology. Further, the security is analyzed for credit loss, (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the statement of earnings, while the balance of impairment related to other factors will be recognized in other comprehensive income. This guidance was effective for all interim and annual periods ending after June 15, 2009. The Company adopted this authoritative guidance issued by the FASB as of January 1, 2009 and recorded a cumulative-effect adjustment of $2,130 to its opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive loss.

 

In April 2009, the FASB issued authoritative guidance that principally requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. This guidance is currently effective and its adoption did not have an impact on the Company’s consolidated financial position and results of operations.

 

Recently Issued Accounting Standards - In June 2009, the FASB issued authoritative guidance that is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

 

In August 2009, the FASB issued authoritative guidance regarding the measurement of liabilities at fair value when a quoted price in an active market is not available.  In these circumstances, a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance, such as an income approach or a market approach.  The guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  This guidance is effective for interim periods beginning on or after June 15, 2010. The Company is evaluating the impact the adoption of this guidance will have on its consolidated financial position and results of operations.

 

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

 

 

 

 

 

 

 

 

 

 

 

F-14

 

3. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

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

 

 

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

 

Level 2 - At December 31, 2009 and December 31, 2008, the Company had no investments which were considered to be Level 2 assets.

 

Level 3 – The Company’s Level 3 assets consist of the Company’s investment in ARS, corporate obligations, and preferred shares. The recent uncertainties in the credit markets have hindered the Company and other investors from liquidating their holdings of these securities for the years ended December 31, 2009 and 2008, because the amount of securities submitted for sale has exceeded the amount of purchase orders.

 

The carrying value of the Company’s investments in its Level 3 assets, as of the years ended December 31, 2009 and 2008, represent the Company’s best estimate of the fair value of these investments based on currently available information. The Company estimates the fair values of the investment securities quarterly based upon consideration of such factors as: issuer and insurer credit rating; comparable market data, if available; current market conditions; the credit quality of the investment securities; the rate of interest received since the date the auctions began; yields of securities similar to the underlying investment securities; and, until September 2008, broker-dealers’ statements provided by the investment bank through which the Company held such securities. These considerations are used to determine a range of values for each security from moderate to highly conservative. The Company has based its evaluation on the mid-point of that range. Specifically, the Company considered the composition of the collateral supporting the investment securities and the default probabilities of the collateral underlying the ARS in its overall valuation of each security. The Company has also researched the secondary market, and while such a market may be available, there is no guarantee that such a market will exist at any particular point in time. Additionally, the Company looked at the probabilities of default, probabilities of successful auctions and probabilities of earning the maximum (failed auction) rate for each period. If the issuers are unable

 

F-15

 

to successfully close future auctions and their credit ratings deteriorate, the Company may be required to further adjust the carrying value of its investment securities through additional devaluations.

 

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

 

 

The following table presents additional information about assets measured at fair value using Level 3 inputs for the year ended December 31, 2009: 

 

 

4. ACCOUNTS RECEIVABLE/DUE TO LICENSORS

 

Generally, licensing contracts provide for the Company to collect, on behalf of the licensor, royalties from the licensees. The Company records as accounts receivable only its proportionate share of such earned royalties.

 

Due to licensors represents amounts collected by the Company on behalf of licensors, which are generally payable to such licensors after the close of each calendar quarter. Additionally, accounts receivable include amounts due from customers for advertising revenue earned from airing commercial spots on The CW4Kids and 4Kids TV and from trading cards sold by TC Digital.

 

 

 

 

Accounts receivable consisted of the following as of:

 

 

5. INVENTORIES

 

Inventories consisted of the following as of:

 

        

 

As of December 31, 2009, 2008 and 2007, the reserve for slow-moving inventory was $6,038, $3,000 and $0, respectively. During 2009, this reserve was reduced by $370 based on the reduction of inventory for trading card sales made by the Company. Based on the overall surplus of trading card inventory in 2009, the Company recorded an additional inventory reserve of $3,408.

 

6. FILM AND TELEVISION COSTS

 

Film and television costs consisted of the following as of:

 

        

        

 

Amortization of capitalized film and television costs were $21,511, $7,707 and $8,179 during fiscal years 2009, 2008 and 2007, respectively. Based on management’s ultimate revenue estimates as of December 31, 2009, approximately 56% of the total completed and unamortized film and television costs are expected to be amortized during 2009, and over 90% of the total completed and unamortized film and television costs are expected to be amortized during the next three years.

 

 

 

 

 

F-17

 

7. PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following as of:

 

        

 

8. STOCKHOLDERS’ EQUITY

 

The Company has stock-based compensation plans for employees and non-employee members of the Board of Directors. The plans provide for discretionary grants of stock options, shares of restricted stock, and other stock-based awards. The plans are administered by the Compensation Committee of the Board of Directors, consisting of non-employee directors.

 

The Company records stock compensation utilizing the modified prospective method provided in the definitive guidance by the SEC whereby prior periods are not restated for comparability. The Company’s recognition of stock-based compensation expense in the statement of operations over the vesting period is based on the fair value of the award at the grant date. All of the Company’s outstanding options were fully vested at the time the Company adopted this guidance and the Company has not subsequently granted any such options.

 

The following table summarizes activity under the Company’s stock option plans for the years ended December 31, 2009, 2008 and 2007:

 

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing price of the Company’s common stock on the date of determination for those awards that have an exercise price currently below the closing price. As of December 31, 2009, there were no options outstanding to purchase shares with an exercise price below the quoted price of its common stock. During the years ended December 31, 2009, 2008 and 2007, the aggregate intrinsic value of options exercised under its stock option plans was $0, $281 and $1,328, respectively, determined as of the date of exercise.

 

F-18

 

 

 

Restricted Stock Awards

 

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

 

The following table summarizes restricted stock activity under the Company’s long-term incentive compensation plans for the years ended December 31, 2009, 2008 and 2007:

 

 

The Company recognized $1,826, $1,621 and $942 of compensation costs related to the LTICPs during the years ended December 31, 2009, 2008 and 2007, respectively. Additionally, as of the year ended December 31, 2009, there was approximately $386, $910, $750 and $173 of unrecognized compensation cost related to restricted stock awards granted under the Company’s 2008, 2007, 2006 and 2005 LTICPs, respectively. The cost is expected to be recognized over a remaining weighted-average period of 2.4, 1.4, 1.4 and 0.4 years under the 2008, 2007, 2006 and 2005 LTICPs, respectively. There were approximately 97,000, 37,000 and 31,000 shares of restricted stock that vested during the year ended December 31, 2009 that had been granted under the 2007, 2006 and 2005 LTICPs, respectively.

 

F-19

 

 

Availability for Future Issuance – As of December 31, 2009, (i) options to purchase approximately 1,482,000 shares of the Company’s common stock were available for future issuance under the Company’s stock option plans and (ii) options to purchase a maximum of approximately 443,000 shares of the Company’s common stock were available for future issuance under the Company’s LTICPs, reduced by four shares for each share of restricted stock awarded under the 2006 and 2005 LTICPs, under which an aggregate of approximately 143,000 shares of the 443,000 total shares were available for issuance as options, and reduced by two shares for each share of restricted stock awarded under the 2008 and 2007 LTICPs, under which an aggregate of approximately 300,000 of the 443,000 total shares were available for issuance as options.

 

9. REVENUES/MAJOR CUSTOMERS

 

Net revenues included in the accompanying consolidated statements of operations are net of licensor participations of $30,945, $29,378 and $29,150 during fiscal years 2009, 2008 and 2007, respectively. The percentages of revenue from major Properties and customers/licensees are as follows:

 

 

Two Properties, “Teenage Mutant Ninja Turtles” and “Yu-Gi-Oh!” represented 33% and 24%, respectively, for a total of 57%, of consolidated net revenues for fiscal 2009, or $21,031, of which $9,786, or 27% of consolidated net revenues, represented a one-time payment received by the Company in October 2009 in consideration of its agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of its representation agreement with Mirage Group in 2012. Two Properties, “Chaotic” and “Yu-Gi-Oh!” represented 43% of consolidated net revenues for fiscal 2008 and two Properties, “Yu-Gi-Oh!” and “Teenage Mutant Ninja Turtles” represented 37% of consolidated net revenues for fiscal 2007. One licensee, Konami, represented 17%, 11% and 14% of consolidated net revenues for fiscal 2009, 2008 and 2007, respectively. As of December 31, 2009 and 2008, accounts receivable due from these major customers/licensees discussed above represented 6% of the Company’s gross accounts receivable for each such year.

 

10. INCOME TAXES

 

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

 

The Company is no longer subject to examinations by income tax authorities in most jurisdictions for years prior to 2006. As of December 31, 2009, there were no outstanding tax audits.

 

 

 

F-20

 

 

The (benefit from) provision for income taxes consisted of the following:

 

 

The domestic and foreign components of pre-tax (loss) income are as follows:

 

 

 

 

 

 

 

 

 

 

F-21

 

 

The components of the net deferred tax assets (liabilities) are as follows:

 

 

A reconciliation of activity for the Company’s deferred tax asset valuation allowance is provided as follows:

 

 

 

 

 

 

 

 

 

F-22

 

The expiration terms and amounts for which an allowance has been provided with respect to the loss and credit carryforwards reflected in the gross deferred tax assets above are comprised as follows:

 

 

The Company records U.S. taxes on undistributed earnings of subsidiaries to the extent such earnings are planned to be remitted and not permanently reinvested. During 2009, the Company found it necessary to repatriate earnings from its foreign subsidiary. The Company has no current plans to repatriate more earnings from its foreign subsidiary. The Company, however, has decided to provide U.S. taxes on the undistributed earnings, as if they were to be distributed. The Company has provided $1,210 of U.S. taxes on undistributed earnings of $3,025. The taxes were calculated assuming a deduction for foreign taxes, even though foreign tax credits may be available.

 

There were no income tax benefits related to the exercise of stock options for the years ended December 31, 2009, 2008 and 2007.

 

The Company has no unrecognized tax benefits recorded for the years ended December 31, 2009 and 2008.

 

When and if the Company were to recognize interest or penalties related to unrecognized tax benefits, they would be reported net of federal tax benefit in tax expense.

 

It is difficult to predict what would occur to change the Company’s unrecognized tax benefits over the next twelve months. The Company believes, however, that there should be no change during the next twelve months.

 

11. EARNINGS PER SHARE

 

The Company computes basic EPS based solely on the weighted average number of common shares outstanding during the period in accordance with authoritative guidance issued by the FASB. Diluted EPS reflects all potential dilution of common stock. The following table reconciles Basic EPS with Diluted EPS for the years ended December 31, 2009, 2008 and 2007:

 

 

 

F-23

 

 

For the years ended December 31, 2009, 2008 and 2007, 770,250, 1,301,000 and 1,189,000 shares, respectively, attributable to the exercise of outstanding options, were excluded from the calculation of diluted EPS because the effect was antidilutive.

 

12. ACCOUNTING CHANGE AND RECLASSIFICATION

 

Certain of the Company’s representation contracts contain provisions for the production of animated television episodes based on the licensor’s property. These contracts typically contain provisions for the licensor to reimburse the Company for costs incurred in the production of the television programming. The reimbursement may be in the form of reduced royalty fees owed the licensor under other provisions of the contract or in the form of direct cash reimbursement. The Company has historically accounted for this reimbursement as reduction of its film costs capitalized in accordance with ASC 926-20. Additionally, the Company has historically recorded the reimbursement as service revenue with an equal amount as cost of production.

 

These reimbursements are contained under overall representation contracts with licensors. Under these contracts, the Company will generate royalty revenue from third party licensees. Since the primary licensor (property owner) will also benefit from the increased awareness of the property, they are willing to contribute to the cost of the production of the programming. The Company believes that it is appropriate to account for the partial reimbursement of production costs as a reduction of its capitalized film costs which is amortized into the cost of revenue in accordance with ASC 926-20.

 

The Company has reassessed the accounting treatment for reimbursements of its production costs under representation contracts and will no longer record these amounts in the Television and Film Production/Distribution segment as revenue with a corresponding charge to production service costs. In accordance with authoritative guidance issued by the FASB, the Company has retroactively adjusted revenue and production service costs for all periods presented. The Company considered the qualitative aspect of these adjustments, as well as the impact on the Company’s operating losses and earnings per share calculations in determining that no further restatement of the Company’s financial statements is necessitated by this accounting change. The following table shows the summary impact in the consolidated statements of operations for the years ended December 31, 2009, 2008 and 2007.

 

 

 

 

 

F-24

 

 

13. DEFINED CONTRIBUTION PLAN

 

The Company participates in a 401(k) plan covering substantially all employees. Benefits vest based on number of years of service. The Company’s policy is to match 25% of the first 6% of the covered employee’s annual salary, as defined by the plan. Contributions to the plan by the Company amounted to $159, $198 and $170 for the years ended December 31, 2009, 2008 and 2007, respectively.

 

14. COMMITMENTS AND CONTINGENCIES

 

 

 

        

 

Rent expense for all operating leases charged against earnings amounted to $2,694, $2,771 and $2,365 during fiscal years 2009, 2008 and 2007, respectively.     

 

Litigation - On November 9, 2008, the Company entered into an agreement with Fox to settle the lawsuit brought by the Company against Fox for alleged breaches of the Fox Agreement (the “Settlement Agreement”). Under the terms of the Settlement Agreement, the Fox Agreement terminated on December 31, 2008 rather than at the end of the 2008-2009 broadcast season in September 2009. The Company’s remaining financial obligations to Fox for the first three quarters of 2009 also terminated. During the year ended December 31, 2009, the Company paid Fox $6,250 in respect of its remaining obligation under the Settlement Agreement.

 

On July 29, 2009, The Upper Deck Company, LLC ("Upper Deck") filed suit in Superior Court of the State of California, County of San Diego, North County Division, against Bryan C. Gannon ("Gannon") and TC Digital Games LLC ("TC Digital") alleging that Gannon misappropriated and used confidential information and trade secrets of Upper Deck in connection with the “Chaotic” trading card game. The complaint alleges that Gannon became privy to the Upper Deck confidential information and trade secrets during the course of Gannon's service to Upper Deck during the July 1, 2002 through January 1, 2003 period as an independent contractor and during the January 2, 2003 through May 23, 2003 period during which Gannon was an employee of Upper Deck. The complaint seeks unspecified monetary damages to be determined at trial. On October 5, 2009, Upper Deck voluntarily dismissed the complaint without prejudice.

 

On February 12, 2010, Home Focus Development, LTD, a British Virgin Islands Corporation, ("Home Focus") filed suit against the Company in the United States District Court for the Southern District of New York. In the lawsuit, Home Focus alleges that the Company owes it $1,075 under an Interest Purchase Agreement among the Company, Home Focus and TC Digital entered into on March 2, 2009, pursuant to which the Company acquired a 25% ownership interest in TDI. As further described in Note 17, the Company withheld payments in an aggregate amount of $575 from Home Focus otherwise due under the Interest Purchase Agreement as a result of Home Focus’s failure to make required capital contributions to TDI. The Company intends to vigorously defend this litigation.

F-25

 

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

 

 

 

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. The Company expects and continues to produce additional new music which, based on the success of the administrative service, continues to supply the unaffiliated third party with this content. Since the Company continues to deliver more than the amount of music required to be delivered under the Music Agreement, there is no way to appropriately record the fair value of the future amounts to be delivered. Based on authoritative guidance issued by the FASB, the Company’s inability to fair value the future portion of the music deliverables results in the entire amount recorded as deferred revenue. The most appropriate and systematic method of accounting for this revenue relating to the deferred portion would be to reduce this deferred amount dollar for dollar based on the actual music earnings of the Company. Pursuant to the above, the Company recognized revenues of $517, $634 and $461 for the years ended December 31, 2009, 2008 and 2007, respectively. The Company has included $843 and $1,360 as deferred revenue on the accompanying consolidated balance sheets as of December 31, 2009 and 2008, respectively. 

 

Home Video - At various dates since May 2002, 4Kids Home Video, entered into various agreements 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 advances of $4,119 against 4Kids Home Video’s share of the distribution and service fee proceeds to be realized by 4Kids Home Video from such titles. Pursuant to the above, the Company recognized revenue of $131, $208 and $122 for the years ended December 31, 2009, 2008 and 2007, respectively. The Company has included $80 and $211 as deferred revenue on the accompanying consolidated balance sheets as of December 31, 2009 and 2008, respectively.

 

Other Agreements - In addition, the Company entered into other agreements for various Properties and advertising time on The CW4Kids in which the Company has received certain advances and/or minimum guarantees. Accordingly, as of December 31, 2009 and 2008 the unearned portion of these advances and guaranteed payments were $1,356 and $1,699, respectively, and are included in deferred revenue on the accompanying consolidated balance sheets.

 

 

F-26

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

 

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

 

The CW has disputed the Company’s position by claiming that there has been no industry action reducing or otherwise limiting the categories of permitted advertising and believes that the Company is in breach of The CW Agreement by having paid the reduced amount in respect of the quarterly guarantee. The Company and The CW are currently in discussions regarding the contractual dispute. If they are unable to resolve the dispute through negotiation, the dispute between the Company and The CW will be resolved through arbitration. If the Company prevails through negotiation or arbitration, the $15,000 guarantee will be reduced and the split of advertising revenues will be adjusted. There can be no assurance, however, that the Company will prevail or of the amount of any reduction or adjustment in the event the Company is successful. If the Company is unsuccessful, it will be required to pay $2,475 to The CW, representing the difference between the original amount required under The CW Agreement and the amount paid by the Company in December 2009.

 

As of December 31, 2009, the minimum guaranteed payment obligations under the CW Agreement are as follows:

 

 

The Company broadcasted certain of its Properties on 4Kids TV, the Saturday morning programming block that the Company leased from Fox, under the Fox Agreement, until December 31, 2008. The cost of 4Kids TV has been capitalized and amortized over each broadcast year based on estimated advertising revenue up until the termination of the Fox Agreement on December 31, 2008, at which time the cost to lease 4Kids TV was fully amortized.

 

The costs of 4Kids TV was capitalized and amortized over each broadcast year based on estimated advertising revenue for the related broadcast year. The Company recorded amortization expenses of $16,022 and $21,472 for the years ended December 31, 2008 and 2007, respectively. During the year ended December 31, 2008, the Company paid Fox and certain Fox affiliates $5,741 and $2,273, attributable to the 2007-2008 and 2008-2009 broadcast seasons fees, respectively.

 

F-27

 

 

The Company’s ability to recover the cost of its minimum guarantee due to The CW will depend on the popularity of the television programs the Company broadcasts on The CW4Kids and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such programs, broadcast by the Company on The CW4Kids, impacts audience levels and the level of the network advertising rates that the Company can charge. Additionally, the success of the merchandise licensing programs and home video sales based on such television programs broadcast on The CW4Kids is dependent on consumer acceptance of such television programs. If the Company estimates that it will be unable to generate sufficient future revenue from advertising sales, home video sales and merchandising licensing at levels to cover the cost of its contractual obligation to The CW, the Company would record a charge to earnings to reflect an expected loss on The CW agreements in the period in which the factors negatively affecting the recoverability of the fee payable become known. The Company will be required to make certain assumptions and estimates about future events such as advertising rates and audience viewing levels in evaluating its ability to recover the cost of the broadcast fees. 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 broadcast fees and in the event it cannot, it would record the resulting charge to earnings to reflect an expected loss on the broadcast fee, which could be significant.

 

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

 

 

15. NONCONTROLLING INTEREST

 

The Company adopted the authoritative guidance issued by the FASB which provides that all earnings and losses of a subsidiary should be attributed to the parent and the noncontrolling interests, even if the losses attributable to the noncontrolling interest result in a deficit noncontrolling interest balance. Previously, any losses exceeding the noncontrolling interests’ investment in the subsidiaries were attributed to the parent. This guidance was applied prospectively as of January 1, 2009.

 

The following table reflects the Company’s net loss and loss per share had the Company not attributed the losses of the subsidiary to the noncontrolling interest and remained under the previous accounting guidance.

 

 

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

 

F-28

 

Noncontrolling interest of membership units in TC Digital represents the noncontrolling members’ proportionate share of the equity in the entity. Income is allocated to the membership units noncontrolling interest based on the ownership percentage throughout the year. As of December 31, 2009 and 2008, the noncontrolling member held 45% of the equity in the entity. The following table summarizes the noncontrolling interest loss attributable to the noncontrolling equity interest in TC Digital:

 

 

Included in the TC Digital net loss is $1,288 related to the operations of TC Digital International Ltd. (“TDI”), a joint venture owned 50% by TC Digital, 25% by the Company and 25% by Home Focus Development Ltd. (“Home Focus”), see Note 17 for further details. As of December 31, 2009, Home Focus has not made a capital contribution to TDI.

 

As of December 31, 2009, the loss in excess of noncontrolling interest for TC Digital absorbed by 4Kids Digital, in the aggregate, since the formation of such entity is $16,291.

 

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

 

While the Company maintained a 50% ownership interest in TC Websites and did not control, but had significant influence, over such entity, the Company’s investment in TC Websites had been accounted for using the equity method in accordance with authoritative guidance issued by the FASB. Due to the increased membership interest and the additional operational control, TC Websites’ financial statements are included in the Company’s consolidated financial statements for the years ended December 31, 2009 and 2008.

 

As of December 31, 2009, the noncontrolling member of TC Websites held 45% of the equity in the entity. The following table summarizes the noncontrolling interest loss attributable to the noncontrolling equity interest in TC Websites:

 

 

As of December 31, 2009, the loss in excess of noncontrolling interest for TC Websites absorbed by 4Kids Websites in the aggregate since the formation of such entity is $5,430.

 

16. IMPAIRMENT OF CHAOTIC RELATED ASSETS

 

The Company continually monitors events and changes in circumstances that could indicate carrying amounts of certain assets may not be recoverable. When such events or changes in circumstances are present, the Company assesses the recoverability of these assets by determining whether the carrying value will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the value of the assets.

 

F-29

During the fourth quarter of 2009, the Company recorded $20,195 of charges to reduce the carrying value of certain “Chaotic” assets based on their revised estimated fair values. Such amounts include: (i) a reduction of the Company’s film inventory of $12,637 through amortization based on a change in the overall expected future revenues of the Property, including approximately $6,943 owed to the Company by CUSA and Apex, collectively, for their share of production costs for television episodes of the “Chaotic” Property under their representation agreement with 4Kids Licensing; (ii) a reduction of the Company’s trading card inventory of $3,829, based on the value of expected future trading card sales; (iii) an impairment charge with respect to the Company’s investment in TDI of $2,430 to reflect the decreased value of this non-performing international joint venture of the “Chaotic” trading card business; and (iv) an impairment charge of $1,299 relating to the decreased value of the Company’s international subsidiary’s investment in a percentage of domestic “Chaotic” trading card sales.

 

17. RELATED PARTY TRANSACTIONS

 

National Law Enforcement and Firefighters Children’s Foundation - The Company’s Chairman and Chief Executive Officer is the founder and President of The National Law Enforcement and Firefighters Children’s Foundation (the “Foundation”). The Foundation is a not-for-profit organization dedicated to helping the children of law enforcement and firefighting personnel and working with law enforcement and firefighting organizations to provide all children with valuable social and life skill programs. During the years ended December 31, 2009, 2008 and 2007, the Company contributed approximately $66, $110 and $120, respectively, to the Foundation.

 

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

 

As of December 31, 2009, the Company has entered into the following transactions with CUSA and CUSA LLC, or parties related to Gannon and Milito that are summarized below:

 

 

 

F-30

 

 

 

 

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

 

 

 

 

 

F-31

 

 

 

18. SUBSEQUENT EVENTS

Subsequent events were evaluated by the Company through the date the financial statements were issued. There were no events that occurred subsequent to December 31, 2009 that would require recognition in the Company’s consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

F-32

 

 

19. SEGMENT AND RELATED INFORMATION

 

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

 

 

As of December 31, 2009, included in segment loss for the Licensing segment is an impairment charge of $6,175 related to the Company’s investment securities, as disclosed in Note 3.

 

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 revenues from international sources primarily in Europe, of approximately $7,130, $11,684 and $7,374 during fiscal years 2009, 2008 and 2007, respectively. As of December 31, 2009 and 2008, net assets of the Company’s London office were $3,094 and $5,420, respectively.

 

 

 

 

 

F-33

 

 

20. SUMMARIZED QUARTERLY DATA (UNAUDITED)

 

Following is a summary of the quarterly results of operations for the years ended December 31, 2009 and 2008:

 

 

 

Quarterly amounts for loss per share may not agree to annual amount due to rounding.

 

During the fourth quarter of 2009, the Company recorded $20,195 of charges to reduce the carrying value of certain “Chaotic” assets based on their revised estimated fair values. Such amounts include: (i) a reduction of the Company’s film inventory of $12,637 through amortization based on a change in the overall expected future revenues of the Property, including approximately $6,943 owed to the Company by CUSA and Apex, collectively, for their share of production costs for television episodes of the “Chaotic” Property under their representation agreement with 4Kids Licensing; (ii) a reduction of the Company’s trading card inventory of $3,829, based on the value of expected future trading card sales; (iii) an impairment charge with respect to the Company’s investment in TDI of $2,430 to reflect the decreased value of this non-performing international joint venture of the “Chaotic” trading card business; and (iv) an impairment charge of $1,299 relating to the decreased value of the Company’s international subsidiary’s investment in a percentage of domestic “Chaotic” trading card sales. The Company also recorded an impairment charge of $6,006 in non-operating expense relating to securities which were now other than temporarily impaired. In addition to these charges, the Company recorded revenue of $9,786 which represented a one-time payment received in consideration of the Company’s agreement to terminate its right to serve as the merchandise licensing agent for the “Teenage Mutant Ninja Turtles” Property prior to the scheduled expiration of the representation agreement with the Mirage Group in 2012.

 

******

 

 

 

 

 

 

 

F-34