10-Q 1 e13750_10q.txt 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the Quarterly Period Ended June 30, 2002 ------------- OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- --------- COMMISSION FILE NO. 0-7843 4KIDS ENTERTAINMENT, INC. (Exact name of registrant as specified in its Charter) NEW YORK -------- (State of Incorporation) 13-2691380 ---------- (I.R.S. Employer Identification Number) 1414 Avenue of the Americas, New York, New York ----------------------------------------------- (Address of Principal Executive Offices) 10019 ----- (Zip Code) (212) 758-7666 -------------- (Registrant's Telephone Number, Including Area Code) NOT APPLICABLE -------------- (Former Name, Former Address and Former Fiscal Year if changed since last report) Indicate by a check mark whether the registrant: (1) has filed all annual, quarterly and other reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_| Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the close of the latest practicable date. Class Outstanding at August 14, 2002 ----- ------------------------------ Common Stock, $.01 Par Value 12,596,008 4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES INDEX PAGE NUMBER PART I: FINANCIAL INFORMATION Item 1: Financial Statements Consolidated Balance Sheets as of 1 June 30, 2002(Unaudited) and December 31, 2001 Consolidated Statements of Income for the Three and 2 Six Months Ended June 30, 2002 and 2001(Unaudited) Consolidated Statements of Cash Flows for the 3 Six Months Ended June 30, 2002 and 2001(Unaudited) Notes to Consolidated Financial 4 Statements (Unaudited) Item 2: Management's Discussion and Analysis 11 of Financial Condition and Results of Operations Item 3: Quantitative and Qualitative Disclosures 15 About Market Risk PART II: OTHER INFORMATION 16 4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, DECEMBER 31, 2002 2001 ------------ ------------ ASSETS (UNAUDITED) CURRENT ASSETS Cash and cash equivalents $ 71,713,275 $104,445,499 Investments 19,806,158 9,154,504 Accounts receivable - net 13,891,449 9,652,554 Prepaid/refundable income taxes 2,405,329 3,584,392 Prepaid expenses and other current assets 16,051,331 4,042,835 ------------ ------------ Total current assets 123,867,542 130,879,784 ------------ ------------ FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS - Net of accumulated depreciation and amortization of $1,934,864 and $1,469,858 in 2002 and 2001, respectively 2,742,614 2,098,758 ACCOUNTS RECEIVABLE - noncurrent, net 5,433,524 4,662,130 INVESTMENT IN EQUITY SECURITIES 725,631 725,631 FILM INVENTORY - noncurrent, net 4,933,521 4,182,372 OTHER ASSETS, NET 1,279,379 1,190,362 ------------ ------------ TOTAL ASSETS $138,982,211 $143,739,037 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Due to licensors $ 7,560,851 $ 16,911,596 Media payable 1,079,853 1,588,162 Accounts payable and accrued expenses 4,801,685 4,455,011 Deferred revenue 1,451,880 96,889 Deferred income taxes 1,497,806 1,497,806 ------------ ------------ Total current liabilities 16,392,075 24,549,464 DEFERRED INCOME TAXES - Noncurrent 731,447 731,447 ------------ ------------ Total liabilities 17,123,522 25,280,911 ------------ ------------ STOCKHOLDERS' EQUITY Preferred stock, $.01 par value - authorized, 3,000,000 shares; none issued Common stock, $.01 par value - authorized, 40,000,000 shares; issued, 12,595,758 and 12,546,708 shares in 2002 and 2001 125,958 125,467 Additional paid-in capital 33,884,471 33,265,412 Retained earnings 87,848,260 85,067,247 ------------ ------------ Total stockholders' equity 121,858,689 118,458,126 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $138,982,211 $143,739,037 ============ ============ See notes to consolidated financial statements. 1 4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2002 2001 2002 2001 ----------- ----------- ----------- ----------- NET REVENUES $8,178,372 $9,148,269 $15,139,208 $21,411,977 ----------- ----------- ----------- ----------- COSTS AND EXPENSES: Selling, general and administrative costs 5,018,038 4,497,406 9,486,247 8,589,262 Amortization of capitalized film costs 1,516,083 359,484 1,858,681 1,130,220 ----------- ----------- ----------- ----------- TOTAL COSTS AND EXPENSES 6,534,121 4,856,890 11,344,928 9,719,482 ----------- ----------- ----------- ----------- INCOME FROM OPERATIONS 1,644,251 4,291,379 3,794,280 11,692,495 INTEREST INCOME 315,081 1,260,080 791,733 2,903,457 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAX PROVISION 1,959,332 5,551,459 4,586,013 14,595,952 INCOME TAX PROVISION 732,000 2,292,000 1,805,000 6,047,000 ----------- ----------- ----------- ----------- NET INCOME $1,227,332 $3,259,459 $2,781,013 $8,548,952 =========== =========== =========== =========== PER SHARE AMOUNTS Basic Earnings per share $0.10 $0.27 $0.22 $0.71 =========== =========== =========== =========== Diluted Earnings per share $0.09 $0.24 $0.20 $0.64 =========== =========== =========== =========== Weighted average common shares outstanding - basic 12,590,791 12,104,694 12,583,566 12,092,594 =========== =========== =========== =========== Weighted average common share outstanding - diluted 13,653,166 13,326,392 13,646,168 13,279,593 =========== =========== =========== ===========
See notes to consolidated financial statements. 2 4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) SIX SIX MONTHS ENDED MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,781,013 $ 8,548,952 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 465,006 257,848 Amortization of capitalized film costs 1,858,681 1,130,220 Changes in operating assets and liabilities: Accounts receivable - net (5,010,289) 5,867,527 Prepaid/refundable income taxes 1,179,063 4,524,131 Prepaid expenses and other current assets (12,008,496) (731,379) Film inventory - net (2,609,830) (2,203,897) Other assets (89,017) (323,844) Due to licensors (9,350,745) (36,267,318) Media payable (508,309) (1,732,111) Accounts payable and accrued expenses 346,674 (2,804,632) Income taxes payable 0 (689,337) Deferred revenue 1,354,991 (2,432,023) ------------ ------------ Net cash used in operating activities (21,591,258) (26,855,863) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of commercial paper 9,154,504 46,756,096 Purchases of commercial paper (19,806,158) (26,134,926) Purchases of property and equipment (1,108,862) (509,445) ------------ ------------ Net cash (used in) provided by investing activities (11,760,516) 20,111,725 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options and related tax benefit 619,550 627,298 ------------ ------------ Net cash provided by financing activities 619,550 627,298 ------------ ------------ NET DECREASE IN CASH AND CASH EQUIVALENTS (32,732,224) (6,116,840) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 104,445,499 117,749,331 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 71,713,275 $111,632,491 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: CASH PAID DURING THE PERIOD FOR: Income Taxes $ -- $ 1,105,033 ============ ============ See notes to consolidated financial statements. 3 4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) June 30, 2002 Note 1 BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes as required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the interim financial information have been included. Operating results for the six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in 4Kids Entertainment, Inc.'s (the "Company") annual report Form 10-K for the year ended December 31, 2001. Note 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: For a summary of significant accounting policies, reference is made to the Company's annual report on Form 10-K previously filed for the year ended December 31, 2001. New Accounting Pronouncements - In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" (effective July 1, 2001) and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 prohibits pooling-of-interests accounting for acquisitions initiated after June 30, 2001. SFAS No. 142 specifies that goodwill and some intangible assets will no longer be amortized but instead will be subject to periodic impairment testing. The Company's adoption of SFAS No. 141 and SFAS No. 142 did not have a significant impact on its results of operations or financial position. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. 4 The Company will adopt SFAS No. 143 beginning in the first fiscal quarter of fiscal 2003. The Company believes that the adoption of SFAS No. 143 will not have a material impact on its results of operations or financial position. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The primary objectives of SFAS No. 144 were to develop one accounting model based on the framework established in SFAS No. 121, and to address significant implementation issues. The provisions of SFAS No. 144 are effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 in the first fiscal quarter of fiscal 2002. The Company's adoption of SFAS No. 144 did not have a material impact on its results of operations or financial position. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44 regarding the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS 145 related to classification of debt extinguishment is effective for fiscal years beginning after May 15, 2002. Earlier application is encouraged. The adoption of SFAS 145 is not expected to have a material impact in the financial position or results of operation of the Company. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This statement also established that fair value is the objective for initial measurement of the liability. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company is currently evaluating the impact of SFAS No. 146 on its consolidated financial statements. Reclassifications - Certain amounts have been reclassified in year 2001 to conform to the current year's presentation. 5 Note 3 COMMITMENTS AND CONTINGENCIES: A. LITIGATION: (i) Imber v. Nintendo, et al. In September 1999, the Company was named as a defendant in a lawsuit filed in the United States District Court for the Southern District of California. Also named as defendants in this lawsuit are Nintendo of America Inc. and Wizards of the Coast, Inc. The lawsuit, purportedly brought on behalf of a class of all persons who purchased a package of Pokemon trading cards, seeks to challenge longstanding practices in the trading card industry, including the practice of randomly inserting premium cards in packages of Pokemon cards. The lawsuit claims that these practices constitute illegal gambling activity in violation of California and federal law, including the Federal Racketeer Influenced and Corrupt Organization Act, and seeks an award of treble damages. The lawsuit has not specified the amount of damages sought. On April 18, 2000, the United States District Court issued an Order to Show Cause in the lawsuit(and in a number of other lawsuits making similar allegations concerning other types of trading cards) requiring the plaintiffs in all of the cases to show cause why the cases should not be dismissed for lack of standing. On June 21, 2000, the United States District Court dismissed the RICO claims with prejudice and all other claims without prejudice. Plaintiffs filed a notice of appeal on July 24, 2000 from the District Court's June 21, 2000 dismissal, and the appeal is pending. (ii) Morrison v. Nintendo, et al. On March 29, 2000, Morrison Entertainment Group, Inc., filed suit in the United States District Court for the Central District of California against Nintendo of America Inc., 4Kids Entertainment, Inc., and Leisure Concepts, Inc. The suit alleges that the Pokemon trademark infringes upon the Plaintiff's "Monster in my Pocket" trademark. The complaint also alleges trademark dilution, unfair competition, and a breach of implied contract. The complaint seeks injunctive relief as well as monetary damages. On August 6, 2001, the United States District Court granted summary judgement dismissing the suit. Plaintiff has filed a notice of appeal from the District Court's dismissal. In the first quarter of 2002 the parties filed their briefs on appeal. While it is impossible to predict the eventual outcome of the litigation discussed in sub-paragraphs (i) and (ii) above, the Company believes these litigations will not have a material adverse effect on the Company's financial condition and results of operations. B. KEY MAN CLAUSE - Under the terms of the Company's representation agreements (the "Agreements") with Pokemon USA, Inc. "PUI" with respect to the Pokemon property and Nintendo of 6 America Inc. "NOA" with respect to the Nintendo properties, in the event that Mr. Alfred Kahn, Chairman and CEO of the Company, becomes unavailable due to death, disability, termination or a major change of duties and an acceptable replacement for Mr. Kahn is not found within a specified period of time, or there is a change in control of the Company resulting in a major change of duties for Mr. Kahn, PUI and NOA have the option to terminate their respective agreements. The Company would however, continue to be paid on license agreements in place at the time such options were exercised. Note 4 FOX LEASE AGREEMENT In January 2002, The Company entered into a multi-year agreement with Fox Broadcasting Company ("Fox") to lease the television network's Saturday morning programming block. Beginning with the September 2002 broadcast year, the Company will provide all programming content for Fox's Saturday morning broadcast block, which airs from 8am to 12pm ET/PT (7am to 11am CT). Under the terms of the agreement, the Company will also have the right to retain all revenue from the network advertising sales during the four-hour time period. The agreement has an initial term of four broadcast years, with the Company having the option to extend the term for up to two additional broadcast years. 4Kids will pay a license fee of $25,312,500 for each broadcast year during the initial term of the agreement. The agreement provides for 50% of the fee for the first broadcast season to be paid within ten days of the execution of the Agreement, with the balance of the fee for the first broadcast season to be paid in four equal installments in September, December, February and April of the broadcast year. Accordingly, on January 28, 2002, the Company paid $12,656,250, representing 50% of the first year's fee, to Fox which is included in "Prepaid expenses and other current assets" on the accompanying balance sheet as of March 31, 2002. Fees for each subsequent broadcast year are payable 50% in the June preceding the beginning of the broadcast year (which is September) with the balance of the fee for the broadcast year payable in four equal installments in September, December, February and April. Additionally, the Agreement requires the Company to establish a $25,000,000 Letter of Credit for the benefit of Fox, which Letter of Credit may be reduced by the Company as installments of the final year's license fee are paid. The agreement further provides that, at the Company's option, up to $10,300,000 of each year's fee may be paid in the Company's common stock. Over the initial four year term of the agreement, the Company will pay Fox aggregate license fees of $101,200,000. The Company's ability to recover the cost of its license fees payable to Fox will depend on the popularity of the television 7 programs the Company runs and the general market demand and pricing of advertising time for Saturday morning children's broadcast television. The popularity of such programs impacts audience levels and the level of the network advertising rates the Company can charge. Additionally, the success of merchandise licensing programs and home video sales based on such television programs is dependent on consumer acceptance of the properties. If the Company is unable to generate sufficient future revenue from advertising sales, home video sales and merchandising licensing at levels to cover the cost of its contractual obligation to Fox Broadcasting, it would record a charge to earnings to reflect a write down in the future value of the Fox license agreement in the period in which the deficiency or factors affecting the recoverability of the license fee payable become known. The Company will be required to make certain assumptions and estimates about future events such as advertising rates and audience viewing levels in evaluating its ability to recover the cost of the Fox license fee. Such estimates and assumptions are subject to market forces and factors beyond the control of the Company and inherently subject to change. There can be no assurance that the Company will be able to recover the full cost of the Fox license fee and in the event it cannot, the resulting charges to reflect a write down in the future value of the Fox license fee could be significant. Note 5 DEFERRED REVENUE Master Toy Licensee - 4Kids Entertainment Licensing, Incorporated, a wholly owned subsidiary of the Company, is the exclusive Merchandise Licensing Agent for the "Pokemon" property outside Asia. The master toy licensee ("Licensee") for the "Pokemon" property and The Pokemon Company LLC (the assignee of certain rights and obligations of Nintendo of America Inc. with respect to the "Pokemon" property) have entered into a new agreement (the "Agreement") effective January 1, 2001. The Agreement supersedes the original Merchandise License Agreement, dated as of May 14, 1998 as amended in September 1999. Under the revised terms of the Agreement, the parties have agreed, inter alia, that Licensee will pay a minimum royalty for the period starting January 1, 2001 and ending December 31, 2003. If all of the conditions under the Agreement are met and the full amount of the minimum guaranteed royalties are paid by Licensee, the Company's share would be not less than $7,500,000 over the period of the Agreement. Through March 31, 2002, the Company has recognized $5,000,000 ($2,500,000 in each of fiscal 2001 and 2002) of its share of minimum guaranteed royalties based on annual minimums under the Agreement. Additionally, Licensee has agreed that any amounts paid by the Licensee under the original Merchandise License Agreement, including the advance paid in April 2000 are non-refundable and 8 non-recoupable against any future royalties. Accordingly, approximately $2,300,000 of deferred revenue at December 31, 2000 relating to the original Merchandise License Agreement was recognized as revenue in the quarter ended March 31, 2001. The Company has also created a new subsidiary, 4Kids Entertainment Home Video, Inc. ("4KHV"). 4KHV has entered into an agreement with its home video distributor Funimation pursuant to which 4KHV is providing ongoing advertising, marketing and promotional services with respect to home video titles of Company represented properties distributed by Funimation. Funimation has paid the Company an advance against 4KHV's share of the distribution proceeds to be realized by 4KHV from such titles. Such advance has been recorded in the Company's deferred revenue account. As 4KHV earns its share of the distribution proceeds from its distributor Funimation, such deferred revenue will be recognized as revenue. Note 6 INVESTMENT IN THE POKEMON COMPANY During the quarter ended September 30, 2001, the Company completed its purchase of a 3% equity interest in the Pokemon Company, a closely held Japanese company, which was organized in 1998 by Nintendo Co. Ltd, Creatures, Inc. and Game Freak, Inc., the creators of Pokemon, to manage and control all rights throughout the world to Pokemon. The Company accounts for this investment on the cost basis and has classified it as "Investment in equity securities", a non-current asset on the accompanying balance sheet. Note 7 SUBSEQUENT EVENT: MUSIC PUBLISHING In July 2002, the Company granted a right to receive a 50% interest in the Company's net share of the music revenues from currently existing music produced by the Company for its television programs (excluding Pokemon) ("Current Music Assets") to a third party for $3 million which was and received by the Company in July, 2002. Further, the Company agreed to grant a right to receive a 50% interest in the Company's net share of future music revenues from music to be produced by the Company for its television programs (excluding Pokemon)("Future Music Assets") to the same third party for $2 million. In connection with the grant of Future Music Assets, the Company will receive $750,000 in each of June 2003 and 2004 and $500,000 in June 2005. As a result of the above transactions, the Company will recognize revenue of $3 million for granting the rights to a 50% interest in its Current Music Assets in the quarter ending September 30, 2002. The Company will recognize revenue from granting the rights to a 50% interest in Future Music Assets over the period of time it produces the related music. 9 Note 8 SEGMENT AND RELATED INFORMATION The Company applies Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures About Segments of an Enterprise and Related Information". The Company has three reportable segments; Licensing, Media Buying, Planning and Television Distribution and Television and Film Production. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company does not have any inter-segment sales or transfers. The Company's reportable segments are strategic business units which, while managed separately, work together as a vertically integrated entertainment company.
MEDIA & TV & FILM LICENSING TV DISTRIBUTION PRODUCTION TOTAL --------- --------------- ---------- ----- Six Months Ended June 30, 2002 Revenues $ 10,114,915 $1,419,310 $ 3,604,983 $ 15,139,208 Segment Profit (Loss) 3,511,798 (42,122) 1,116,337 4,586,013 Segment Assets 126,072,272 2,566,833 10,343,106 138,982,211 2001 Revenues $ 15,783,545 $1,197,869 $ 4,430,563 $ 21,411,977 Segment Profit 12,249,520 43,022 2,303,410 14,595,952 Segment Assets 129,852,420 7,718,582 3,824,166 141,395,168 Three Months Ended June 30, 2002 Revenues $ 5,518,036 $ 645,082 $ 2,015,254 $ 8,178,372 Segment Profit (Loss) 2,097,370 (175,444) 37,406 1,959,332 Segment Assets 126,072,272 2,566,833 10,343,106 138,982,211 2001 Revenues $ 7,635,398 $ 543,948 $ 968,923 $ 9,148,269 Segment Profit (Loss) 5,463,884 (22,728) 110,303 5,551,459 Segment Assets 129,852,420 7,718,582 3,824,166 141,395,168
10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: The Company receives revenues from a number of sources, principally licensing, media buying and television distribution. Additionally, beginning in September 2002, the Company will begin to recognize revenue from the sale of advertising time related to its lease of the Fox Saturday morning television block more fully described in Note 4 to the Financial Statements. The Company typically derives a substantial portion of its licensing revenues from a small number of properties, which properties usually generate revenues only for a limited period of time. Because the Company's licensing revenues are highly subject to changing fashion in the toy and entertainment business, its licensing revenues from year to year from particular sources are subject to dramatic increases and decreases. It is not possible to precisely anticipate the length of time a project will be commercially successful, if at all. Popularity of properties can vary from months to years. As a result, the Company's revenues and net income may fluctuate significantly between comparable periods. The Company's revenues have historically been primarily derived from the license of toy and game concepts. Thus, a substantial portion of the Company's revenues and net income are subject to the seasonal variations of the toy and game industry. Typically, a majority of toy orders are shipped in the third and fourth calendar quarters. In addition, the Company's media buying subsidiary concentrates its activities on the youth oriented market. As a result, most of its revenue is earned in the fourth quarter when the majority of toy and video game advertising occurs. In the Company's usual experience, its revenues during the second half of the year have generally been greater than during the first half of the year. However, the Company's revenues in the most recent fiscal years were influenced more by popularity trends and movie and home video release dates of "Pokemon" than the historical seasonal trends of toy and game sales. Further, the Company has little control over the timing of guarantee and minimum royalty payments, some of which are made upon the execution and delivery of license agreements. Three and Six Months Ended June 30, 2002 Compared to the Three and Six Months Ended June 30, 2001 Consolidated net revenues decreased 11% or $969,897 to $8,178,372 for the three month period ended June 30, 2002 as compared to the same period in 2001. Consolidated net revenues for the six month period decreased 30% or $6,272,769 to $15,139,208 as compared to the six month period ended June 30, 2001. The decrease in consolidated net revenues for the three and six month periods was due primarily to decreased merchandise licensing and movie related revenues for the Pokemon property. 11 Additionally, revenues related to the World Championship Wrestling ("WCW") property decreased by approximately $950,000 from the first quarter of 2001. The Company's representation of the WCW property terminated in the first quarter of 2001. Offsetting a portion of the decreased revenues for the three months and six ended June 30, 2002 were revenues earned on the Yu-Gi-OH! Property for merchandise licensing and television license fees. In April 2002, Yu-Gi-OH! began running on the Kids WB! television network six days a week, thereby triggering an additional minimum guaranteed royalty obligation generating licensing revenues for the Company. Video games from Konami and a card game from The Upper Deck Company all began shipping into the US market during the quarter ended June 30, 2002, generating marketing fee revenues for the Company from the initial three months of sales. Selling, general and administrative expenses increased 12% or $520,632 to $5,018,038 and 10% or $896,985 to $9,486,247 for the three and six month periods ended June 30, 2002 when compared to the year ago periods. These increases were primarily attributable to bonus accruals of approximately $292,000 recorded in the first quarter of 2002 and approximately $218,000 recorded in the second quarter of 2002. For the first two fiscal quarters ended June 30, 2002, the Chairman and CEO of the Company has voluntarily reduced the amount of his bonus compensation by approximately $225,000. Additionally, selling general and administrative expenses increased as a result of payroll costs from the Company's expanded operations in advertising sales for selling the commercial time obtained by the Company in leasing the Fox Saturday morning television block. Amortization of capitalized film cost increased $1,156,599 and $728,461 for the three and six months ended June 30, 2002 when compared to the prior year periods. The increase was primarily attributable to increased amortization of the Cubix, Yu-Gi-OH! and Tama television series. At June 30, 2002, there were $4,933,521 of capitalized film production costs which primarily relate to the production of twenty-six episodes of Cubix, forty-eight episodes of the Yu-Gi-Oh!, 26 episodes of Tama and Friends, 52 episodes of Ultra Man 52 episodes of Kinnikuman- Ultimate Muscle, 52 episodes of Kirby and 52 episodes of the Fighting Foodons television series. Cubix is a computer animated television series owned in part by the Company which premiered on The Kids' WB television network in August 2001. Kids WB! has renewed the series for broadcast during the upcoming 2002-2003 new television season. Yu-Gi-Oh! premiered on the Kids' WB television network in September 2001. Kids WB! has renewed the series for broadcast in the 2002-2003 television season. Tama and Friends is a television series broadcast in first run syndication which began in September 2001. Ultra Man, Kinnikuman Ultimate Muscle, Kirby and Fighting Foodons are being prepared for broadcast beginning in September 2002 on the Company's Saturday morning Fox network television block. At June 30, 2002, the percentage of total unamortized film costs 12 expected to be amortized within the next three years exceeded 80%. The Company periodically evaluates its anticipated revenue from film production and, consequently, amortization rates may change as a result of such estimates. Interest income decreased by $944,999 to $315,081 and $2,111,724 to $791,733 for the three and six month periods ended June 30, 2002 as compared to the same periods in 2001. These decreases are due primarily to substantially lower interest rates obtained on the Company's invested cash during 2002 as compared to the same periods in 2001 and to a reduced amount of invested cash. LIQUIDITY AND CAPITAL RESOURCES: At June 30, 2002, the Company had working capital of $107,475,467 as compared to working capital of $106,330,320 at December 31, 2001, an increase in working capital of $1,145,147. Cash and cash equivalents and investments decreased by $22,080,570 to $91,519,433 from December 31, 2001. The decrease in cash equivalents is primarily due to decreased levels of royalty collections on the Pokemon property and the paydown of royalties collected on behalf of licensors. Accordingly, there is a corresponding decrease in the current liability "Due to Licensors" of $9,350,745. Additionally, in January 2002, the Company paid the first installment of $12,656,250 to Fox Broadcasting for the network lease more fully described in Note 4 to the financial statements. This prepaid fee is reflected in "Prepaid expenses and other current assets" on the accompanying balance sheet at June 30, 2002. Accounts receivable, net (current and non-current) increased to $19,324,973 at June 30, 2002 from $14,314,684 at December 31, 2001. The increase was primarily due to increased royalty income receivable on the Yu-Gi-OH! property. Amounts due to licensors, which represents the owners' share of royalties collected at June 30, 2002, decreased by $9,350,745 to $7,560,851 from December 31, 2001. Beginning in 2002, Pokemon USA, Inc., the U.S. subsidiary of The Pokemon Company, became the collection agent for Pokemon royalties. Accordingly, the Company no longer collects and accounts for 100% of royalties on Pokemon in "Cash and cash equivalents" with a corresponding current liability "Due to Licensors" for the licensor's share of such royalties. Beginning in 2002, the Company began recording its share of Pokemon revenue due from Pokemon USA, Inc. as a receivable. This receivable is settled quarterly with a payment from Pokemon USA, Inc. The Company's new license agreement with Fox to program the network's four hour Saturday morning children's block beginning in September 2002, will require the Company to pay an annual fee of $25,312,500. Under the terms of the agreement, on January 28, 2002, the Company paid $12,656,250 which represents 50% of the first year's fee to Fox. Fees for each subsequent broadcast year 13 are payable 50% in the June preceding the beginning of the broadcast year (which begins in September) with the balance of the fee for the broadcast year payable in four equal installments in September, December, February and April. Additionally, the Agreement requires the Company to establish a $25,000,000 Letter of Credit for the benefit of Fox, which Letter of Credit may be reduced by the Company as installments of the final year's license fee are paid. The agreement further provides that, at 4Kids option, up to $10,300,000 of each year's fee may be paid in the Company's common stock. Further, the Company will incur additional costs to program the four hour block and to sell the related network advertising time. These costs will include direct programming costs to acquire, adapt and deliver programming for broadcast during the weekly four hour block as well as additional indirect costs of advertising sales, promotion and administration. The Company's contractual cash obligations for leases and the Fox license agreement are as follows (in thousands): Year ending Fox December 31, Leases License Total ------- -------- -------- July 1 - Dec. 31, 2002 $ 597 $ 6,328 $ 6,925 2003 1,225 25,312 26,537 2004 1,402 25,312 26,714 2005 1,522 25,312 26,834 2006 1,557 6,328 7,885 2007 and thereafter 3,468 -- 3,468 ------- -------- -------- Total $9,771 $88,592 $98,363 ======= ======== ======== The Company has allocated significant resources to the acquisition, programming and marketing of the Fox Box. The Company's ability to recover these resources will be dependant on successful delivery and audience acceptance of the programming and on the success of merchandise licensing programs and home video sales based on such television programs. The launch of the Fox Box is on schedule and the Company has experienced better than expected upfront orders for the advertising time available during the four hour block. If the trend continues for the orders for advertising time, the Company believes it will cover the lease fee to Fox Broadcasting with the advertising sales generated during the four hour Fox Box. However, the Company's ability to retain the full value of the advertising time sold will be dependent on the audience ratings delivered by the programs in the Fox Box. There can no assurance that the demand for advertising time will continue or that the programs will achieve the minimum rating performance necessary to retain the full value of the advertising time sold. The Company anticipates it will be able to meet its payment obligations under the license agreement and will be able to finance its business as currently conducted from its working capital. Accordingly, in March 2001, it terminated its $5,000,000 credit facility with JPMorgan Chase Bank. However, as the Company explores new and expanded opportunities in the children's entertainment market, it may seek additional financing alternatives. 14 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS: Not Applicable Forward-looking Statements Sections of this Quarterly Report contain forward-looking statements, including, without limitation, statements concerning possible or assumed future results of operations of the Company preceded by, followed by or that include the words "believes," "expects," "anticipates," "estimates," "intends," "plans" or similar expressions. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions. Due to the fact that the Company faces competition from toy companies, motion picture studios and other licensing companies, and the uncertainty of the public's response to the Company's properties, actual results or outcomes may differ materially from any such forward-looking statements. 15 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Shareholders of the Company was held on May 23, 2002. The matters voted upon, including the number or votes cast for, against or withheld, as well as the number of abstentions and broker non-votes, as to each such matter were as follows: Proposal 1: All five of management's nominees for directors as listed in the proxy statement were elected with the number of votes cast for each nominee as follows:
Shares Voted Shares Voted Shares Broker Non-Votes Votes "FOR" "AGAINST" "ABSTAINING" Withheld Joel I. Cohen 9,957,718 37,825 Jay Emmett 9,957,718 37,825 Joseph P. Garrity 9,957,718 37,825 Steven M. Grossman 9,957,718 37,825 Alfred R. Kahn 9,957,718 37,825
Proposal 2: The proposal to appoint Deloitte & Touche LLP as independent auditors to examine the Company's financial statements for the fiscal year ending December 31, 2002, was ratified by the following vote: Shares Voted Shares Voted Shares Broker Votes "FOR" "AGAINST" "ABSTAINING" Non-Votes Withheld 9,931,075 58,830 5,638 Proposal 3: The proposal to approve the 4Kids Entertainment, Inc. 2002 Stock Option Plan, which authorizes the issuance of options to purchase up to 600,000 shares of the Company's common stock, was ratified by the following vote: Shares Voted Shares Voted Shares Broker Votes "FOR" "AGAINST" "ABSTAINING" Non-Votes Withheld 8,707,708 582,992 704,843 16 Item 6. Exhibits and Reports on Form 8-K a. Exhibits 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b. Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: August 14, 2002 4KIDS ENTERTAINMENT, INC. By: /s/ Alfred R. Kahn ------------------------- Alfred R. Kahn Chairman of the Board and Chief Executive Officer By: /s/ Joseph P. Garrity ------------------------- Joseph P. Garrity Executive Vice President Chief Financial Officer 17