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4Licensing Corp 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31
  3. Ex-31
  4. Ex-32
  5. Ex-32



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
FORM 10-Q

|X|     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE           SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

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 number 0-7843

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

New York
(State or other jurisdiction of
incorporation or organization)
13-2691380
(I.R.S. Employer
Identification No.)

1414 Avenue of the Americas
New York, New York 10019
(212) 758-7666

(Address, including zip code, and telephone number, including area code,
of Registrant’s principal executive offices)


      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes |X|    No |_|        


        Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

  Large accelerated filer                        Accelerated filer    X                   Non-accelerated filer        

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

      At November 9, 2006, the number of shares outstanding of the Registrant’s common stock, par value $.01 per share, was 13,134,368.







4Kids Entertainment, Inc. and Subsidiaries

Table of Contents


Page #

Part I—FINANCIAL INFORMATION


        Item 1.

Financial Statements

 

     

 

Consolidated Balance Sheets as of September 30, 2006
(Unaudited) and December 31, 2005

2

     

 

Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 (Unaudited)

3

     

 

Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the nine months ended
September 30, 2006 (Unaudited) and the year ended December 31, 2005

4

     

 

Consolidated Statements of Cash Flows for the nine months
ended September 30, 2006 and 2005 (Unaudited)

5

     

 

Notes to Consolidated Financial Statements (Unaudited)

6

     

        Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

17

     

        Item 3.

Quantitative and Qualitative Disclosures about Market Risk

29

     

        Item 4.

Controls and Procedures

29

     

Part II—OTHER INFORMATION

        Item 1.

Legal Proceedings

29

     

        Item 1A.

Risk Factors

29

     

        Item 6.

Exhibits

30


        Signatures

 

31





Part I - FINANCIAL INFORMATION
Item 1. Financial Statements

4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
(In thousands of dollars, except share data)


Assets 2006
2005
Current assets: (Unaudited)
     Cash and cash equivalents   $  18,666   $  35,142  
     Investments  97,600   78,383  


     Total cash and investments  116,266   113,525  
 
     Accounts receivable - net  24,699   32,193  
     Prepaid 4Kids TV broadcast fee, net of accumulated amortization 
       of $105,886 and $90,714 in 2006 and 2005, respectively  --   6,606  
     Prepaid income taxes  4,135   2,312  
     Prepaid expenses and other current assets  4,838   1,683  
     Current assets from discontinued operations  1,667   2,316  
     Deferred income taxes  610   466  


     Total current assets  152,215   159,101  
 
Property and equipment - net  2,057   2,853  
 
Other assets: 
     Accounts receivable - noncurrent, net  528   891  
     Film and television costs - net  16,103   12,208  
     Deferred income taxes - noncurrent  1,024   1,971  
     Other assets - net  7,685   6,914  


Total assets  $179,612   $183,938  


Liabilities and Stockholders’ Equity 
 
Current liabilities: 
     Due to licensors  $    6,839   $  13,503  
     Accounts payable and accrued expenses  10,750   9,239  
     Current liabilities from discontinued operations  150   1,486  
     Deferred revenue  4,975   5,297  


     Total current liabilities  22,714   29,525  
 
Deferred rent  835   1,016  


     Total liabilities  23,549   30,541  


Commitments and contingencies (Note 9) 
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, 14,884,368 and 14,826,643 shares; outstanding 13,134,368 and 
         13,076,643 shares in 2006 and 2005, respectively  149   148  
Additional paid-in capital  62,185   61,415  
     Accumulated other comprehensive income  1,006   428  
     Retained earnings  125,972   124,655  


   189,312   186,646  
     Less- cost of 1,750,000 treasury shares in 2006 and 2005  33,249   33,249  


   156,063   153,397  


Total liabilities and stockholders’ equity  $179,612   $183,938  



See notes to consolidated financial statements.


2


4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(In thousands of dollars, except share data)



Three Months Ended
September 30,
Nine Months Ended
September 30,
2006
2005
2006
2005
Net revenues     $ 17,562   $ 19,492   $ 53,487   $ 57,100  




Costs and expenses:  
  Selling, general and administrative    9,278    8,117    27,840    24,610  
  Production service costs    3,225    2,093    9,256    6,215  
  Amortization of television and film costs    1,759    2,144    4,776    5,989  
  Amortization of 4Kids TV broadcast fee    5,490    5,104    15,172    15,662  




           Total costs and expenses    19,752    17,458    57,044    52,476  




(Loss) income from operations    (2,190 )  2,034    (3,557 )  4,624  
 
Interest income    1,114    654    3,010    2,054  




(Loss) income before income taxes    (1,076 )  2,688    (547 )  6,678  
 
(Benefit) provision for income taxes    (845 )  890    (1,322 )  2,464  




(Loss) income from continuing operations   $ (231 ) $ 1,798   $ 775   $ 4,214  
 
Loss income from discontinued operations   $ (34 ) $ 180   $ 542   $ 359  




Net (loss) income   $ (265 ) $ 1,978   $ 1,317   $ 4,573  




Per share amounts:  
  Basic (loss) earnings per common share  
             Continuing Operations   $ (0.02 ) $ 0.14   $ 0.06   $ 0.32  
             Discontinued Operations   $ 0.00   $ 0.01   $ 0.04   $ 0.03  




Basic (loss) earnings per common share   $ (0.02 ) $ 0.15   $ 0.10   $ 0.35  




  Diluted (loss) earnings per common share  
             Continuing Operations   $ (0.02 ) $ 0.14   $ 0.06   $ 0.31  
             Discontinued Operations   $ 0.00   $ 0.01   $ 0.04   $ 0.02  




Diluted (loss) earnings per common share   $ (0.02 ) $ 0.15   $ 0.10   $ 0.33  




  Weighted average common shares  
      outstanding - basic    13,100,477    13,000,418    13,089,511    13,209,094  




  Weighted average common shares  
      outstanding - diluted    13,100,477    13,424,913    13,373,422    13,651,572  




See notes to consolidated financial statements.

3


4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2006 (UNAUDITED) AND YEAR ENDED DECEMBER 31, 2005
(In thousands of dollars and shares)



Common
Shares

Stock
Amount

Additional
Paid-in
Capital

Retained
Earnings

Accumulated
Other
Comprehensive
Income


Less:
Treasury
Stock

Total
BALANCE, DECEMBER 31, 2004  14,411   $144   $58,068   $119,586   $   1,124   $  (14,944)  $ 163,978  
Proceeds from exercise of stock options  416   4   1,345   --   --   --  1,349  
Tax benefit from exercise of stock 
options  --   --   2,002   --   --   --  2,002  
Acquisition of treasury stock, at cost  --   --   --   --   --   (18,305) (18,305 )
Comprehensive income: 
Net income  --   --   --   5,069   --   --  5,069  
Translation adjustment  --   --   --   --   (696 ) --  (696 )

Total comprehensive income  --   --   --   --   --   --  4,373  







BALANCE, DECEMBER 31, 2005  14,827   $148   $61,415   $124,655   $428   $(33,249) $ 153,397  
Proceeds from exercise of stock options  57   1   681   --   --   --  682  
Tax benefit from exercise of stock 
options  --   --   89   --   --   --  89  
Comprehensive income: 
Net income  --   --   --   1,317   --   --  1,317  
Translation adjustment  --   --   --   --   578   --  578  

Total comprehensive income  --   --   --   --   --   --  1,895  







BALANCE, SEPTEMBER 30, 2006  14,884   $149   $62,185   $125,972   $1,006   $(33,249) $ 156,063  








See notes to consolidated financial statements.

4


4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(In thousands of dollars)



2006
2005
Cash flows from operating activities:      
     Net income  $     1,317   $     4,573  
     Adjustments to reconcile net income to net cash 
       provided by (used in) operating activities - continuing operations: 
     Depreciation and amortization  779   872  
     Amortization of television and film costs  4,776   5,989  
     Amortization of 4Kids TV broadcast fee  15,172   15,662  
     Provision for doubtful accounts  382   15  
     Deferred income taxes  803   1,359  
     Tax benefit on exercise of stock options  --   130  
     Changes in operating assets and liabilities: 
     Accounts receivable  7,756   11,909  
     Film and television costs  (8,671 ) (8,503 )
     Prepaid income taxes  (1,823 ) 1,135  
     Prepaid 4Kids TV broadcast fee  (8,566 ) (22,616 )
     Prepaid expenses and other current assets  (3,155 ) (857 )
     Other assets - net  (771 ) (844 )
     Due to licensors  (6,664 ) (8,930 )
     Accounts payable and accrued expenses  1,450   (2,211 )
     Deferred revenue  (322 ) (1,291 )
     Deferred rent  (181 ) 82  


     Net cash provided by (used in) operating activities - continuing operations  2,282   (3,526 )
     Net cash used in operating activities - discontinued operations  (687 ) (2,677 )


     Net cash provided by (used in) operating activities  1,595   (6,203 )
 
Cash flows from investing activities: 
     Proceeds from maturities of investments  127,607   42,423  
     Purchase of investments  (146,824 ) (45,904 )
     Purchase of property and equipment  (508 ) (593 )
     Loss from disposal of property, plant and equipment  525   6  


     Net cash used in investing activities  (19,200 ) (4,068 )


Cash flows from financing activities: 
     Proceeds from exercise of stock options  682   441  
     Purchase of treasury shares  --   (16,971 )
     Tax benefit on exercise of stock options  89   --  


     Net cash provided by (used in) financing activities  771   (16,530 )


Effects of exchange rate changes on cash and cash equivalents  358   (507 )


Net decrease in cash and cash equivalents  (16,476 ) (27,308 )
 
Cash and cash equivalents, beginning of period  35,142   111,759  


Cash and cash equivalents, end of period  $   18,666   $   84,451  


Supplemental disclosure of cash flow information: 
Cash paid during period for: 
     Income Taxes  $        112   $          169  



See notes to consolidated financial statements.

5


4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands of dollars, except share and per share data)



1. DESCRIPTION OF BUSINESS

General Development and Narrative Description of Business — 4Kids Entertainment, Inc., together with the subsidiaries through which the Company’s 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, and (iii) Television and Film Production/Distribution.

Licensing — The Company’s wholly-owned subsidiary, 4Kids Entertainment Licensing, Inc. (“4Kids Licensing”), is engaged in the business of licensing the merchandising rights to popular children’s television series, properties and product concepts (collectively the “Properties” or individually the “Property”). 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. 4Kids Entertainment International, Ltd. (“4Kids International”), the Company’s wholly-owned subsidiary based in London, manages the Properties represented by the Company in the United Kingdom and European marketplaces.

4Kids Technology, Inc., a wholly-owned subsidiary, develops ideas and concepts for licensing which integrate new and existing technologies with traditional game and toy play patterns. 4Sight Licensing Solutions, Inc. (“4Sight Licensing”), a wholly-owned subsidiary, is engaged in the business of licensing properties and product concepts to adults, teens and “tweens”. 4Sight Licensing focuses on brand building through licensing.

Advertising Media and Broadcast — The Company, through a multi-year agreement with Fox Broadcasting Corporation (“Fox”), leases Fox’s Saturday morning programming block from 8am to 12pm eastern/pacific time (7am to 11am central time). In January 2005, the Company changed the name of the Saturday morning programming block from “Fox Box” to “4Kids TV”. The Company provides substantially all programming content to be broadcast on 4Kids TV. 4Kids Ad Sales, Inc. (“4Kids Ad Sales”), a wholly-owned subsidiary, retains all of the revenue from its sale of network advertising time for the four-hour time period leased from Fox.

Effective June 30, 2006, the Company’s wholly-owned subsidiary, The Summit Media Group, Inc. (“Summit Media”), which previously provided print and broadcast media planning and buying services for clients principally in the children’s toy and game business, terminated its operations. The closing of the media buying business will enable the Company to further reduce costs and focus on its core businesses. The Company has reallocated capital previously devoted to Summit Media to other business initiatives. As a consequence of the termination of its operations, Summit Media no longer serves as a media buying agency for third parties.

Television and Film Production/Distribution — The Company’s wholly-owned subsidiary, 4Kids Productions, Inc. (“4Kids Productions”), produces and acquires animated and live-action television programs and theatrical motion pictures for distribution to the television, home video and theatrical markets. 4Kids Productions also adapts foreign programming for the U.S. market and produces original animated television programming for domestic and international broadcast. Additionally, 4Kids Productions produce original music compositions for use with its television and film production activities.

The Company’s wholly-owned subsidiary, 4Kids Entertainment Music, Inc. (“4Kids Music”), markets and manages the Company’s musical operations. 4Kids Music composes original music for incorporation into television programming produced by 4Kids Productions. 4Kids Entertainment Home Video, Inc. (“4Kids Home Video”), another wholly-owned subsidiary, distributes home videos associated with television programming produced by 4Kids Productions.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation — The consolidated financial statements, except for the December 31, 2005 consolidated balance sheet and the consolidated statement of stockholders’ equity and comprehensive income for the year ended December 31, 2005, are unaudited. In the opinion of management, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of September 30, 2006 and December 31, 2005 and the results of operations for the three and nine months ended September 30, 2006 and 2005, and stockholders’ equity and comprehensive income for the nine months ended September 30, 2006 and the year ended December 31, 2005, and cash flows for the nine months ended September 30, 2006 and 2005. Because of the inherent seasonality and changing trends of the toy, game, entertainment and advertising industries, operating results for the Company on a quarterly basis may not be indicative of operating results for the full year.


6


In connection with the termination of the operations of Summit Media, the media buying operations, has been classified as a discontinued operation. As further discussed in Notes 6 and 10, the consolidated financial statements have been reclassified to reflect the reporting of this business as a discontinued operation.

The consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2005, which are included in the Company’s Annual Report on Form 10-K with respect to such period that has been filed with the Securities and Exchange Commission. All significant intercompany accounts and transactions have been eliminated. The December 31, 2005 consolidated balance sheet amounts are derived from the Company’s audited consolidated financial statements.

Revenue RecognitionMerchandise licensing revenues: Licensing revenues, net of licensor participations, are recognized when the underlying royalties from the sales of the related products are earned. The Company recognizes guaranteed royalties, net of licensor participations, at the time the arrangement becomes effective if the Company has no significant direct continuing involvement with the underlying Property or obligation to the licensee. 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.

Broadcast advertising revenues: Advertising revenues 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. Commission income from the discontinued media planning and buying operations of Summit Media, from both print and broadcast media, were recognized at the time the related media was run.

Episodic television series revenues: Television series initially produced for networks and first-run syndication are generally licensed to domestic and foreign markets concurrently. 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 television license agreements, net of licensor participations, are recognized in the period that the films or episodic television series are available for telecast.

Production and adaptation costs charged to the licensor are included in net revenues and the corresponding costs are included in production service costs in the accompanying consolidated statements of income. Production service costs included in net revenues amounted to $2,875 and $8,301 for the three and nine months ended September 30, 2006, respectively, and $2,093 and $6,215 for the three and nine months ended September 30, 2005, respectively.

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.

Prepaid 4Kids TV Broadcast Fee — The Company capitalized the broadcast fee paid to Fox and amortized the amount of such fee over the broadcast season based on estimated advertising revenue. During the nine months ended September 30, 2006, the Company paid Fox and certain affiliates $6,808 and $222 attributable to the fourth and fifth year’s broadcast fees, respectively, and during calendar year 2005, the Company paid Fox and certain affiliates $6,768 and $19,255 attributable to the third and fourth year’s broadcast fees, respectively. The unamortized portion of these fees of $0 and $6,606, are included in “Prepaid 4Kids TV broadcast fee” on the accompanying consolidated balance sheets as of September 30, 2006 and December 31, 2005, respectively.


7


Film and Television Costs – The Company accounts for its film and television costs pursuant to American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 00-2, Accounting by Producers or Distributors of Films. The cost of production for television programming, including overhead, participations and talent residuals is capitalized and amortized using the individual-film-forecast method under which such costs are amortized for each television program in the ratio that revenue earned in the current period for such program bears to management’s estimate of the ultimate revenues to be realized from all media and markets for such program. Management regularly reviews, and revises when necessary, its ultimate revenue estimates on a title-by-title basis, which may result in a change in the rate of amortization applicable to such title and/or a write-down of the value of such title to estimated fair value. These revisions can result in significant quarter-to-quarter and year-to-year fluctuations in film write-downs and rates of amortization. If a total net loss is projected for a particular title, the associated film and television costs are written down to estimated fair value. All exploitation costs, including advertising and marketing costs are expensed as incurred. Television adaptation and production costs that are adapted and/or produced are stated at the lower of cost, less accumulated amortization, or fair value.

Translation of Foreign Currency — In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 130, Reporting Comprehensive Income, the Company classifies items of 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. Comprehensive (loss) income for the three and nine months ended September 30, 2006, was $(181) and $1,895, respectively, which included translation adjustments of $84 and $578 for the respective periods. Comprehensive income for the three and nine months ended September 30, 2005, was $1,893 and $4,066, respectively, which included translation adjustments of $(85) and $(507) for the respective periods.

Recently Issued Accounting PronouncementsShare-Based Payments – In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payments (“SFAS No. 123-R”). SFAS No. 123-R is a revision of SFAS No. 123, as amended, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees. SFAS No.123-R eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS No. 123, which generally resulted in no compensation expense recorded in the financial statements related to the issuance of equity awards to employees. SFAS No. 123-R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123-R establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all companies to apply a fair-value-based measurement method generally in accounting for all share-based payment transactions with employees.

SFAS No. 123-R is effective for fiscal years beginning after June 15, 2005. The Company adopted SFAS No. 123-R effective January 1, 2006, using a modified prospective application. This application requires the Company to record compensation expense for all awards granted after January 1, 2006 and for the unvested portion of previously granted awards that remain outstanding as of such date. The Company’s adoption of SFAS No. 123-R did not result in the recording of compensation expense in 2006 with respect to options previously granted, since all of the Company’s outstanding options were fully vested at December 31, 2005. The adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.

Accounting Changes and Error Corrections – In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”). SFAS No. 154 replaces APB No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for, and reporting of, a change in accounting principles.  SFAS No. 154 applies to all voluntary changes in accounting principles and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions.  SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.

Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination – In June 2005, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination (“EITF No. 05-6”). EITF No. 05-6 provides that leasehold improvements that are placed in service significantly after, and not contemplated at or near the beginning of the lease term should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. Leasehold improvements acquired in a business combination should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date of acquisition. The Company is required to apply EITF No. 05-6 to leasehold improvements that are purchased or acquired in reporting periods beginning after June 30, 2005. The adoption of this Issue did not have a material effect on the Company’s consolidated financial position or results of operations.


8


Accounting for Uncertainty in Income Taxes — In June 2006, the FASB issued SFAS Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of SFAS No. 109 Accounting for Income Taxes (“SFAS No. 109”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax provision taken or expected to be taken in a tax return. FIN 48 also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 will be effective for fiscal periods beginning after December 15, 2006. Earlier application of the interpretation is encouraged if the enterprise has not yet issued financial statements, including interim financial statements, in the period the interpretation is adopted. The Company does not expect that the adoption of FIN 48 will a have a material effect on the Company’s consolidated financial position or results of operations.

Fair Value Measurements - In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning November 15, 2007. The Company is currently evaluating the adoption of SFAS 157 and its impact on the consolidated financial position and results of operation.

3. STOCK-BASED EMPLOYEE COMPENSATION

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, restricted stock shares, and other stock-based awards. The plans are administered by the Compensation Committee of the Board of Directors, consisting of non-employee directors.

Effective January 1, 2006, the Company adopted SFAS No. 123-R (revised 2004), Share-Based Payments, utilizing the modified prospective method whereby prior periods are not restated for comparability. SFAS 123-R requires recognition of stock-based compensation expense in the statement of operations over the vesting period based on the fair value of the award at the grant date. Previously, the Company used the intrinsic value method under APB No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), as amended by related interpretations of the FASB. Under APB No. 25, no compensation cost was recognized for stock options because the quoted market price of the stock at the grant date was equal to the amount per share the employee had to pay to acquire the stock after fulfilling the vesting period. SFAS 123-R supersedes APB No. 25 as well as SFAS 123, Accounting for Stock-Based Compensation, which permitted pro forma footnote disclosures to report the difference between the fair value method and the intrinsic value method. For the nine months ended September 30, 2006, the Company did not grant any stock options and at January 1, 2006, all of the Company’s outstanding options were fully vested and; therefore, the adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.


9


Stock Options

The following table provides the pro forma effect on net earnings as if the fair-value-based measurement method had been applied to all stock-based compensation for the three and nine months ended September 30, 2005:


Three Months Ended
September 30,
2005

Nine Months Ended
September 30,
2005

Net income as reported   $1,978   $4,573  
 
Deduct stock-based employee compensation 
 expense determined under fair value based 
 method for all awards, net of tax  762   2,860  


Pro forma net income  $1,216   $1,713  


Net income per share: 
Reported 
   Basic  $   0.15   $   0.35  


   Diluted  $   0.15   $   0.33  


Pro forma 
   Basic  $   0.09   $   0.13  


   Diluted  $   0.09   $   0.13  



The Company issued stock option grants on April 25, 2005 and September 1, 2005 for approximately 651,000 and 125,000 underlying shares, respectively. The options were granted to certain employees, including officers and members of the Board of Directors, at an exercise price of $20.56 and $17.00, respectively (the average of the high and low stock price from the previous day of trading). Each of the stock option grants has a (i) five year life; (ii) is immediately vested and exercisable with respect to 50 percent of the underlying shares; and (iii) became vested and exercisable with respect to the remaining 50 percent on December 30, 2005 and December 31, 2005, respectively.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions used for options granted in 2005 included no dividend yield for the period, expected volatility of approximately 38%, a risk-free interest rate of approximately 3.76%, and an estimated option duration of 3.6 years for 2005. The weighted average fair value of options granted in fiscal 2005 is $6.56.

The following table summarizes activity under our stock option plans for the nine months ended September 30, 2006:


Nine Months Ended September 30, 2006
Shares
(In thousands)

Weighted
Average
Exercise
Price

Remaining
Contractual
Life
(in years)

Aggregate
Intrinsic
Value

Outstanding at beginning of period      2,682   $ 17.79          
Grants    --    --     
Exercised    (57 ) 11.80 
Forfeited    (268 ) 18.97 

Outstanding at end of period    2,357   $ 17.80   2.57   $ 5,720  




Exercisable at end of period    2,357   $ 17.80   2.57   $ 5,720  





The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for those awards that have an exercise price currently below the closing price. As of September 30, 2006, we had options outstanding to purchase an aggregate of 709 shares with an exercise price below the quoted price of our stock, resulting in an aggregate intrinsic value of $5,720. During the nine months ended September 30, 2006 and 2005, the aggregate intrinsic value of options exercised under our stock option plans was $261 and $319, respectively, determined as of the date of exercise.


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Restricted Stock Awards

Pursuant to its Long-term Incentive Compensation Plan, the Company granted restricted stock awards on May 23, 2006 and June 15, 2006 for approximately 145,000 and 4,000 underlying shares, respectively. The restricted stock awards were granted to certain employees, including officers and members of the Board of Directors, at a grant price of $16.52 and $15.78, respectively (the average of the high and low stock price from the previous day of trading). The restricted stock awards vest annually from the date of grant over a period of four years. During the restriction period, award holders do not have the rights of stockholders and cannot transfer ownership and nonvested shares 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.

A summary of restricted stock award activity under the Plans as of September 30, 2006 and changes during the nine months then ended is presented as follows:


Number of
Shares

Weighted-Average
Grant Date Fair
Value

Outstanding at January 1, 2006      --   $--  
  Granted    149,298    16.50  
  Vested    --    --  
  Forfeited    (1,000 )  16.52  
  Converted    --    --  


Outstanding at September 30, 2006    148,298   $ 16.50  



The restricted stock awards vest annually from the date of grant over a period of four years. However, vesting can be accelerated in the event of a change of control of the Company as defined in the Plan. As of September 30, 2006, there was approximately $2,100 of unrecognized compensation cost related to restricted stock awards granted under the Plan. That cost is expected to be recognized over a remaining weighted-average period of 3.6 years. There were no shares that vested during the three and nine months ended September 30, 2006.

4. DEFERRED REVENUE

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

The Company has deferred all amounts received under the contract, and recognizes revenue as the Current Music Assets and Future Music Assets generate revenue over the contract term. Notwithstanding the foregoing, as of the date the Company has delivered all of the Future Music Assets required under the contract, any portion of the $5,000 that remains deferred and not recognized, will be recognized as revenue. Pursuant to the above, the Company recognized revenues of $125 and $485 for the three and nine months ended September 30, 2006, respectively, and $132 and $414 for the three and nine months ended September 30, 2005, respectively. The Company has included $2,635 and $3,120 as deferred revenue on the accompanying consolidated balance sheets as of September 30, 2006 and December 31, 2005, 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 cumulative advances of $3,920 against 4Kids Home Video’s share of the distribution and service fee proceeds to be realized by 4Kids Home Video from such titles, $75 of which were received by the Company during the nine months ended September 30, 2006. Pursuant to the above, the Company recognized revenue of $62 and $132 for the three and nine months ended September 30, 2006, respectively, and $23 and $67 for the three and nine months ended September 30, 2005, respectively. The Company has included $461 as deferred revenue on both accompanying consolidated balance sheets as of September 30, 2006 and December 31, 2005.


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Other Agreements — In addition, the Company entered into other agreements for various Properties and advertising time on 4Kids TV in which the Company has received certain advances and/or minimum guarantees. As of September 30, 2006 and December 31, 2005, the unearned portion of these advances and guaranteed payments was $1,879 and $1,716, respectively, and is included in deferred revenue on the accompanying consolidated balance sheets.

5. STOCKHOLDERS’ EQUITY


  a. Stock Purchases – In November 2005, the Board of Directors authorized the Company to purchase up to 1,000,000 shares of the Company’s common stock from time to time through December 31, 2006 in the open market or through negotiated prices. Such purchases are to be made out of the Company’s surplus. Through November 9, 2006, no purchases relating to this 1,000,000 share authorization have been made by the Company.

  b. Stock Options — Pursuant to its stock option plans, the Company granted stock options on April 25, 2005 and September 1, 2005 for approximately 651,000 and 125,000 underlying shares, respectively. The options were granted to certain employees, including officers and members of the Board of Directors, at an exercise price of $20.56 and $17.00, respectively (the average of the high and low stock price from the previous day of trading). Each of the stock option grants (i) have a five year life; (ii) is immediately vested and exercisable with respect to 50 percent of the underlying shares; and (iii) became vested and exercisable with respect to the remaining 50 percent on December 30, 2005 and December 31, 2005, respectively.

  c. Restricted Stock Awards – Pursuant to its Long-term Incentive Compensation Plan, the Company granted restricted stock awards on May 23, 2006 and June 15, 2006 for approximately 145,000 and 4,000 underlying shares, respectively. The restricted stock was granted to certain employees, including officers and members of the Board of Directors, at a grant price of $16.52 and $15.78, respectively (the average of the high and low stock price from the previous day of trading). The restricted stock awards vest annually from the date of grant over a period of four years.

6. SEVERANCE AND EXIT COSTS

In connection with the termination of the Company’s media buying operations, the Company recorded charges for severance and termination benefits in the amount of approximately $333 during the nine months ended September 30, 2006. The charges were attributable to the elimination of 10 positions, primarily representing sales and related support functions in addition to certain other management positions. There were no amounts attributable to the scheduled termination of employees under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, plans whereby employees are required to provide transitional services through their termination dates.

A summary of the actions taken in 2006 for severance and other exit-costs have been recorded in (loss) income from discontinued operations and is provided as follows:


Amount
Professional fees     $ 51  
Severance    333  

    Total   $ 384  


The following is a reconciliation of activity with respect to the liabilities for the severance and exit costs:

Amount
Balance, January 1, 2006     $ --  
   Severance and related costs recognized    333  
   Other    51  
   Cash payments    (239 )

Balance, September 30, 2006   $ 145  


The liability for severance and exit costs will be paid in accordance with the provisions of the severance agreements and payments are expected to be completed at various times through 2006.


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7. LEGAL PROCEEDINGS

On June 19, 2006, Summit Media entered into a Settlement Agreement and Mutual General Release (the “Settlement Agreement”) with The Beacon Media Group L.L.C. (“Beacon”), and various officers and employees of Beacon, collectively (the “Beacon Defendants”) to settle the lawsuit filed by Summit Media in Supreme Court, New York County, against Beacon and the Beacon Defendants. Under the terms of the Settlement Agreement, Summit Media will receive $2,000, in regularly scheduled payments through 2010, in exchange for Summit Media discontinuing the lawsuit. The present value of this settlement amount is included in net income from discontinued operations, see Note 10. As part of the Settlement Agreement, Summit has discontinued its media buying business and effective July 1, 2006, no longer serves as a media buying agency for third parties.

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 property is the subject will, individually or in the aggregate, have a material adverse effect on the Company’s financial position or the results of its operations.

8. RELATED PARTY

The Company’s Chairman and Chief Executive Officer is the founder and Chairman 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 who have lost their lives in the line of duty. The Foundation also works with law enforcement and firefighting organizations to provide children with valuable social and life skill programs. The Company contributed approximately $20 and $70 to the foundation for the three and nine months ended September 30, 2006, respectively, and $30 and $90 to the foundation for the three and nine months ended September 30, 2005, respectively.

Brian Lacey has been Executive Vice President of International for the Company since July 2003. Prior to joining the Company, Mr. Lacey was the President and founder of Lacey Entertainment, a New York-based worldwide television marketing, production and distribution company (“Lacey”). Until July 2003 (when the agreement was terminated), Lacey provided consulting services to the Company under a fee-based agreement pursuant to which the Company agreed to pay Lacey a percentage of all programming sales placed by Lacey in the international marketplace as the cash payments for such programming sales were received. During the nine months ended September 30, 2006, Lacey was paid $341 for all remaining obligations with respect to this agreement. As of September 30, 2006 and December 31, 2005, the Company has included $0 and $233, respectively, in accounts payable and accrued expenses on its accompanying consolidated balance sheets for remaining obligations due to Lacey under the former agreement.


9. COMMITMENTS AND CONTINGENCIES

  a. 4Kids TV Broadcast Agreement — In January 2002, the Company entered into a multi-year agreement with Fox to lease Fox’s Saturday morning programming block which airs principally on Saturday mornings from 8am to 12pm eastern/pacific time (7am to 11am central time), and which was originally called the “Fox Box”. In January 2005, the Company re-branded the Fox Box as “4Kids TV.” The Company provides substantially all programming content to be broadcast on 4Kids TV and retains all of the revenue from network advertising sales for the four-hour time period. 4Kids Ad Sales, Inc., a wholly-owned subsidiary, manages and accounts for the ad revenue and costs associated with 4Kids TV.

  In March 2006, the multi-year agreement was extended for two broadcast years through the 2007-2008 broadcast season. As of September 30, 2006, no amounts remain to be paid for the 2005-2006 broadcast season under the original agreement. The time-buy fee for each of the 2006-2007 and 2007-2008 broadcast seasons will be $20,000 as compared to the $25,312 paid for each broadcast year during the initial term of the multi-year agreement. The fee is payable in quarterly installments of $5,000 each year beginning in October 2006. The extended agreement also provides Fox with the option to further extend the agreement through the 2008-2009 broadcast season under the same terms and conditions by providing notice to the Company no later than August 31, 2007.

  The costs of 4Kids TV is capitalized and amortized over each broadcast year based on estimated advertising revenue for the related broadcast year. The Company recorded amortization expenses of $5,490 and $15,172 for the three and nine months ended September 30, 2006, respectively, and $5,104 and $15,662 for the three and nine months ended September 30, 2005, respectively. During the nine months ended September 30, 2006, the Company paid Fox and certain Fox affiliates $6,808 and $222 attributable to the fourth and fifth years’ broadcast fees, respectively, and during calendar year 2005, the Company paid Fox and certain Fox affiliates $6,768 and $19,255 attributable to the third and fourth years’ broadcast fees, respectively. The unamortized portion of these fees of $0 and $6,606 are included in “Prepaid 4Kids TV broadcast fee” on the accompanying consolidated balance sheets as of September 30, 2006 and December 31, 2005, respectively.


13



  In addition to the time-buy fee paid to Fox, the Company incurs additional costs to program the four-hour 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 four-hour block as well as additional indirect expenses of advertising sales, promotion and administration.

  As of September 30, 2006, the minimum guaranteed payment obligations under the 4Kids TV Broadcast Agreement are as follows:

Year ending
December 31,

Amount
                                                      2006               $5,000  
                                                      2007              20,000  
                                                      2008              15,000  

                                                     Total            $40,000  


  The Company’s ability to recover the cost of its fee payable to Fox will depend on the popularity of the television programs the Company broadcasts on 4Kids TV and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such programs impacts audience levels and the level of the network advertising rates that the Company can charge. Additionally, the success of the merchandise licensing programs and home video sales based on such television programs broadcast on 4Kids TV 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 Fox, the Company would record a charge to earnings to reflect an expected loss on the Fox agreement 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 4Kids TV fee. Such estimates and assumptions are subject to market forces and factors beyond the control of the Company and are inherently subject to change. There can be no assurance that the Company will be able to recover the full cost of the 4Kids TV fee and in the event it cannot, it would record the resulting charge to earnings to reflect an expected loss on the 4Kids TV fee, which could be significant.

  b. Contractual Arrangements — During the normal course of business, the Company may enter into various agreements with third parties to license, acquire, distribute, broadcast, develop and/or promote properties. The terms of these agreements will vary based on the services and/or properties included within the agreement, as well as the other terms and conditions set forth therein.

10. DISCONTINUED OPERATION

In June 2006, the Company announced that the business of its media buying subsidiary, Summit Media, would be terminated as of June 30, 2006. The results of operations for Summit Media are reported as a discontinued operation for the three and nine months ended September 30, 2006, and accordingly, the accompanying consolidated financial statements have been reclassified separately to report the assets, liabilities and operating results of this business.

The following are the summarized results of discontinued operations for the media buying business:


Three Months Ended
September 30,
Nine Months Ended
September 30,
2006
2005
2006
2005
Net revenues   $ 12   $1,030   $2,862   $2,685  




(Loss) income before income taxes  (76 ) 345   1,084   689  
(Benefit) provision for income taxes  (42 ) 165   542   330  




(Loss) income from discontinued operations  $(34 ) $   180   $   542   $   359  






14


The Company has included approximately $1,800 in net revenues for the nine months ended September 30, 2006 relating to the Settlement Agreement, see Note 7.

The major classes of assets and liabilities of the discontinued operation in the balance sheet are as follows:


September 30,
2006

December 31,
2005

Accounts receivable   $     67   $2,315  
Prepaid expense and other current assets  1,600   1  


Current assets of discontinued operation  $1,667   $2,316  


Media payable  $      --   $1,450  
Accounts payable and accrued expenses  150   36  


Current liabilities of discontinued operation  $   150   $1,486  



11. SEGMENT AND RELATED INFORMATION

The Company applies SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The Company has three reportable segments: (i) Licensing; (ii) Advertising, Media and Broadcast; and (iii) Television and Film Production/Distribution. The Company’s reportable segments are strategic business units, which, while managed separately, work together as a vertically integrated entertainment company. The Company’s management regularly evaluates the performance of each segment based 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 recorded inter-segment revenues and the Company’s Advertising, Media and Broadcast segment recorded inter-segment charges related to the estimated acquisition costs of episodic television series for broadcast. In the opinion of management, such acquisition costs represent the estimated fair value which would have been incurred in a transaction between unaffiliated third parties on an arms length basis. All inter-segment transactions have been eliminated in consolidation.


Licensing Advertising
Media and
Broadcast
TV and Film
Production/
Distribution
Total
Three Months Ended September 30,          
2006: 
     Net revenues from external customers  $    6,937   $   3,578   $  7,047   $   17,562  
     Amortization of television and film cost  --   --   1,759   1,759  
        Amortization of 4Kids TV broadcast fee  --   5,490   --   5,490  
     Segment profit (loss)  2,661   (3,910 ) 173   (1,076 )
     Interest income  1,097   17   --   1,114  
 
2005: 
     Net revenues from external customers  $    9,149   $   4,004   $  6,339   $   19,492  
     Amortization of television and film cost  --   --   2,144   2,144  
        Amortization of 4Kids TV broadcast fee  --   5,104   --   5,104  
     Segment profit (loss)  5,087   (3,290 ) 891   2,688  
     Interest income  629   25   --   654  
 
Nine Months Ended September 30, 
2006: 
     Net revenues from external customers  $  23,468   $ 10,615   $19,404   $   53,487  
     Amortization of television and film cost  --   --   4,776   4,776  
        Amortization of 4Kids TV broadcast fee  --   15,172   --   15,172  
     Segment profit (loss)  8,969   (10,300 ) 784   (547 )
     Interest income  2,987   23   --   3,010  
     Segment assets  144,407   5,408   29,797   179,612  
 
2005: 
     Net revenues from external customers  $  28,021   $ 11,387   $17,692   $   57,100  
     Amortization of television and film cost  --   --   5,989   5,989  
        Amortization of 4Kids TV broadcast fee  --   15,662   --   15,662  
     Segment profit (loss)  15,519   (9,996 ) 1,155   6,678  
     Interest income  1,979   73   2   2,054  
     Segment assets  129,992   20,926   26,121   177,039  

15



Net revenues from external customers and segment profit from discontinued operations have been excluded from the Advertising, Media and Broadcast segment and are disclosed in Notes 6 and 10. Conversely, discontinued operations relating to segment assets have been included in segment reporting.

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 merchandise licensing revenues from international sources, primarily in Europe, of $3,803 and $8,980 for the three and nine months ended September 30, 2006, respectively, and $3,060 and $8,209 for the three and nine months ended September 30, 2005, respectively. At September 30, 2006 and 2005, net assets of the Company’s London office were $7,602 and $7,050, respectively.

_________________


16



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

Overview

The Company’s operating results for the nine months ended September 30, 2006, reflect a decrease in licensing revenues from the “Teenage Mutant Ninja Turtles”, “Yu-Gi-Oh!” and “American Kennel Club” properties, partially offset by increased revenues from the production of the “Viva Piñata” and “Chaotic” properties, as compared to the same period in 2005.

General

The Company receives revenues from its three business segments: (i) Licensing; (ii) Advertising, Media and Broadcasting; and (iii) Television and Film Production/Distribution. The Company typically derives a substantial portion of its licensing revenues from a small number of Properties, which usually generate revenues only for a limited period of time. Since the Company’s licensing revenues are highly subject to changing trends in the toy, game and entertainment businesses, the Company’s licensing revenues from year-to-year from particular properties are subject to dramatic increases and decreases. It is not possible to accurately predict the length of time a property will be commercially successful 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 revenue from the sale of advertising time on 4Kids TV as more fully described in Note 2 to the Company’s consolidated financial statements. The Company’s advertising sales subsidiary, 4Kids Ad Sales, sells advertising time on 4Kids TV 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.

The Company’s media buying subsidiary, Summit Media, which previously provided print and broadcast media planning and buying services for clients principally in the children’s toy and game business has terminated its operations. In connection with the closing of Summit Media, the media buying operations have been classified as a discontinued operation. As further discussed in Notes 6 and 10, the consolidated financial statements have been reclassified to accommodate the reporting of this business as a discontinued operation.

Critical Accounting Policies

The Company’s accounting policies are more 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 Statement of Position No. 00-2, Accounting by Producers and Distributors of Film (“SOP No. 00-2”).

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.


17


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 home video markets as well as provisions for uncollectible receivables. In determining the estimate of 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 home video inventory. The Company estimates the amount of uncollectible receivables for licensing and advertising 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 three 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 broadcasts certain of its Properties on 4Kids TV, the Saturday morning programming block that the Company leases from Fox. The cost of 4Kids TV has been and will continue to be capitalized and amortized over each broadcast year based on estimated advertising revenue. In developing future estimated revenues, the Company has made certain assumptions with regard to the anticipated popularity of the television series the Company broadcasts on 4Kids TV and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such series impacts audience levels and the level of the network advertising rates that the Company can charge. These estimates are based on historical trends, as well as the Company’s subjective judgment of future customer demand and acceptance of its television programming. Differences may result in the amount and timing of revenue for any period if actual performance varies from the Company’s estimates. See Note 9 of the Notes to the Company’s consolidated financial statements for additional information.

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 the Company 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 Issued Accounting PronouncementsShare-Based Payments – In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payments (“SFAS No. 123-R”). SFAS No. 123-R is a revision of SFAS No. 123, as amended, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees. SFAS No.123-R eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS No. 123, which generally resulted in no compensation expense recorded in the financial statements related to the issuance of equity awards to employees. SFAS No. 123-R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123-R establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all companies to apply a fair-value-based measurement method generally in accounting for all share-based payment transactions with employees.


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SFAS No. 123-R is effective for fiscal years beginning after June 15, 2005. The Company adopted SFAS No. 123-R effective January 1, 2006, using a modified prospective application. This application requires the Company to record compensation expense for all awards granted after January 1, 2006 and for the unvested portion of previously granted awards that remain outstanding as of such date. The Company’s adoption of SFAS No. 123-R did not result in the recording of compensation expense in 2006 with respect to options previously granted, since all of the Company’s outstanding options were fully vested at December 31, 2005. The adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.

Accounting Changes and Error Corrections – In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”). SFAS No. 154 replaces APB No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for, and reporting of, a change in accounting principles.  SFAS No. 154 applies to all voluntary changes in accounting principles and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions.  SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.

Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination – In June 2005, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination (“EITF No. 05-6”). EITF No. 05-6 provides that leasehold improvements that are placed in service significantly after, and not contemplated at or near the beginning of the lease term should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. Leasehold improvements acquired in a business combination should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date of acquisition. The Company is required to apply EITF No. 05-6 to leasehold improvements that are purchased or acquired in reporting periods beginning after June 30, 2005. The adoption of this Issue did not have a material effect on the Company’s consolidated financial position or results of operations.

Accounting for Uncertainty in Income Taxes — In June 2006, FASB issued SFAS Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109 Accounting for Income Taxes (“SFAS No. 109”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax provision taken or expected to be taken in a tax return. FIN 48 also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 will be effective for fiscal periods beginning after December 15, 2006. Earlier application of the interpretation is encouraged if the enterprise has not yet issued financial statements, including interim financial statements, in the period the interpretation is adopted. The Company does not expect that the adoption of FIN 48 will a have a material effect on the Company’s consolidated financial position or results of operations.

Fair Value Measurements - In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning November 15, 2007. The Company is currently evaluating the adoption of SFAS 157 and its impact on the consolidated financial position and results of operation.


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Results of Operations

The following table sets forth our results of operations expressed as a percentage of total net revenues for the three and nine months ended September 30, 2006 and 2005:


Three Months Ended
September 30,
Nine months Ended
September 30,
2006
2005
2006
2005
Net revenues   100 % 100 % 100 % 100 %




Selling, general & administrative  53 % 41 % 52 % 43 %
Production service costs  18 % 11 % 18 % 11 %
Amortization of television and film costs  10 % 11 % 9 % 11 %
Amortization of 4Kids TV broadcast fee  31 % 26 % 28 % 27 %




Total Costs and Expenses  112 % 89 % 107 % 92 %




(Loss) income from Operations  (12 %) 11 % (7 %) 8 %
 
Interest income  6 % 3 % 6 % 4 %




(Loss) income before income taxes  (6 %) 14 % (1 %) 12 %
 
(Benefit) provision for income taxes  (5 %) 5 % (2 %) 5 %




(Loss) income from continuing operations  (1 %) 9 % 1 % 7 %
 
Income from discontinued operations  -- % 1 % 1 % 1 %




Net (loss) income  (1 %) 10 % 2 % 8 %





Three and nine months ended September 30, 2006 as compared to three and nine months ended September 30, 2005

Continuing Operations

Revenues

Revenues by reportable segment and for the Company as a whole were as follows:

For the three months ended September 30, 2006 and 2005

2006
2005
$ Change
% Change
Licensing   $  6,937   $  9,149   $ (2,212 ) (24 %)
Advertising Media and Broadcast  3,578   4,004   (426 ) (11 %)
Television and Film Production/Distribution  7,047   6,339   708   11 %



Total  $17,562   $19,492   $ (1,930 ) (10 %)




For the nine months ended September 30, 2006 and 2005

2006
2005
$ Change
% Change
Licensing   $23,468   $28,021   $(4,553 ) (16 %)
Advertising Media and Broadcast  10,615   11,387   (772 ) (7 %)
Television and Film Production/Distribution  19,404   17,692   1,712   10 %



Total  $53,487   $57,100   $(3,613 ) (6 %)





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The decrease in consolidated net revenues for the three months and nine months ended September 30, 2006 as compared to the same periods in 2005, was due to a number of factors.

In the Licensing segment, decreased revenues for the three months ended September 30, 2006 were primarily attributable to:


  (i) reduced licensing revenues on the “Yu-Gi-Oh!", “Teenage Mutant Ninja Turtles” and “Cabbage Patch” properties; partially offset by
  (ii) increased revenues attributable to the “GI Joe” property domestically, and the “Teenage Mutant Ninja Turtles” and “Winx Club” properties internationally,

and decreased revenue for the nine months ended September 30, 2006 were primarily attributable to:

  (i) reduced licensing revenues on the “Teenage Mutant Ninja Turtles”, “Yu-Gi-Oh!", “American Kennel Club” and “Winx Club” properties domestically; partially offset by
  (ii) increased revenues attributable to the “GI Joe” property domestically, and the “Winx Club” property internationally.

The “Yu-Gi-Oh!” property continues to be the largest contributor to the Company’s revenues in this business segment. The Company recorded additional revenues of approximately $2,800 for the “Yu-Gi-Oh!” property during the nine months ended September 30, 2006, resulting from changes in the manner in which sales are calculated by a licensee for purposes of computing the amount of certain marketing fees due to the Company from such licensee. In addition, revenues for the “Teenage Mutant Ninja Turtles” property, despite lower licensing revenues along with the “Cabbage Patch” property, are also amongst the largest contributors in this segment.

In the Advertising Media and Broadcasting segment, revenues decreased for the three and nine months ended September 30, 2006, when compared to the same periods in 2005, resulting from lower network advertising revenues.

In the Television and Film Production/Distribution segment, the increased revenue for the three and nine months ended September 30, 2006, when compared to the same periods in 2005 primarily resulted from:


  (i) increased domestic production service revenue from the “Viva Piñata” and “Chaotic” television series; and
  (ii) increased international broadcast sales of the “Yu-Gi-Oh!” television series; partially offset by
  (iii) decreased domestic broadcast sales from the “Yu-Gi-Oh!” and “Pokémon” television series.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 14%, or $1,161, to $9,278 for the three months ended September 30, 2006, when compared to the same period in 2005. The increase was primarily attributable to:

  (i) increased bad debts, trade shows and international sales expenses;
  (ii) increased compensation costs related to the issuance of restricted stock awards; and
  (iii) increased various state taxes; partially offset by
  (iv) decreased professional fees.

Selling, general and administrative expenses increased 13%, or $3,230, to $27,840 for the nine months ended September 30, 2006, when compared to the same period in 2005. The increase was primarily attributable to:


  (i) severance expenses for a former officer of the Company and various other terminated employees of approximately $1,800;
  (ii) the write-off of developmental software totaling approximately $525;
  (iii) increased bad debts, trade shows and international sales expenses; and
  (iv) increased compensation costs related to the issuance of restricted stock awards; partially offset by
  (v) decreased professional fees.


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Production Service and Capitalized Film Costs

For the three months ended September 30, 2006 and 2005


2006
2005
$ Change
% Change
Production Service Costs   $3,225   $2,093   $ 1,132   54 %
Amortization of Television and Film Costs  1,759   2,144   (385 ) (18 %)

For the nine months ended September 30, 2006 and 2005

2006
2005
$ Change
% Change
Production Service Costs   $9,256   $6,215   $ 3,041   49 %
Amortization of Television and Film Costs  4,776   5,989   (1,213 ) (20 %)

The significant increase in production service costs during the three and nine months ended September 30, 2006, as compared to the same periods in 2005, was primarily due to increased production costs for the work performed on the “Viva Piñata” and “Chaotic” television series, partially offset by decreased costs for the “Pokémon”, “Kirby” and “Teenage Mutant Ninja Turtles” television series. When the Company is entitled to be paid for such production costs, the Company categorizes them as production service costs and reflects a corresponding amount in revenue for the amount billed back to the property owners.

The decrease in the amortization of television and film costs is principally due to a reduction in the realized revenue on the “Teenage Mutant Ninja Turtles”, “One Piece” and “Shaman King” television series; partially offset by the increased amortization of the new “GI Joe”, “Magical Doremi”, and “Viva Piñata” television series during 2006.

As of September 30, 2006, there were $16,103 of capitalized film production costs recorded in the Company’s consolidated balance sheet relating primarily to various stages of production on 368 episodes of animated programming. Based on management’s ultimate revenue estimates as of September 30, 2006, approximately 41% 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

For the three months ended September 30, 2006 and 2005

2006
2005
$ Change
% Change
Amortization of 4Kids TV Broadcast Fee   $5,490   $5,104   $386   8 %

For the nine months ended September 30, 2006 and 2005

2006
2005
$ Change
%Change
Amortization of 4Kids TV Broadcast Fee   $15,172   $15,662   $(490 ) (3 %)

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 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.

Based on the increased and decreased percentage of advertising revenue recognized by the Company during the three and nine months ended September 30, 2006, respectively, as compared to the same periods in 2005 and the percentage of the total advertising revenues already recognized, the Company’s amortization of the 4Kids TV broadcast fee increased $386, to $5,490, and decreased $490, to $15,172, for the three and nine months ended September 30, 2006, respectively, as compared to same periods in 2005. Through September 30, 2006 and 2005, the Company had amortized 100% of the 4Kids TV broadcast fee for the third and fourth broadcast years.


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


  (i) revenues generated from merchandise licensing, home videos and music publishing of 4Kids TV Properties; and
  (ii) production and acquisition costs associated with the television programs broadcast on 4Kids TV.

The ability of the Company to further develop its merchandising, and to a lesser extent, home video and music publishing revenue streams were significant components of its evaluation process which resulted in the decision to lease the 4Kids TV Saturday morning programming block.

Interest Income

Interest income increased 70%, or $460, to $1,114 and 47%, or $956, to $3,010 for the three and nine months ended September 30, 2006, as compared to the same periods in 2005, primarily as a result of the increasing interest rate environment and higher average cash balances invested.

Income Tax (Benefit) Expense

Income taxes decreased 195%, or $1,735, to a benefit of $845 from a provision of $890 and 154%, or $3,786 to a benefit of $1,322 from a provision of $2,464 for the three and nine months ended September 30, 2006, respectively, as compared to the same periods in 2005, due primarily to decreased income from continuing operations and a shift in the Company’s investment strategy toward tax-exempt and tax-advantaged securities during 2006.

Net Income

As a result of the above, the Company had net (loss) income for the three and nine months ended September 30, 2006, of $(265) and $1,317, respectively, as compared to $1,978 and $4,573 for the same periods in 2005.

Discontinued Operations

Effective June 30, 2006, the Company’s wholly-owned subsidiary, The Summit Media Group, Inc. (“Summit Media”), which previously provided print and broadcast media planning and buying services for clients principally in the children’s toy and game business, terminated its operations. The closing of the media buying business will enable the Company to further reduce costs and focus on its core businesses. The Company has reallocated capital previously devoted to Summit Media to other business initiatives. As a consequence of the termination of its operations, Summit Media no longer serves as a media buying agency for third parties.

The results of operations for Summit Media are reported as a discontinued operation for the three and nine months ended September 30, 2006, and accordingly, the accompanying consolidated financial statements have been reclassified separately to report the assets, liabilities and operating results of this business.

The following are the summarized results of discontinued operations for the media buying business:


Three Months Ended
September 30,
Nine Months Ended
September 30,
2006
2005
2006
2005
Net Revenues   $ 12   $1,030   $2,862   $2,685  




(Loss) income before income taxes  (76 ) 345   1,084   689  
(Benefit) provision for income taxes  (42 ) 165   542   330  




Net (loss) income from discontinued operations  $(34 ) $   180   $   542   $   359  





Under the terms of the Settlement Agreement, Summit Media will receive $2,000, in regularly scheduled payments through 2010, in exchange for Summit Media discontinuing the lawsuit. The Company has included approximately $1,800 in net revenues for the nine months ended September 30, 2006 relating to this agreement. In connection with the termination the Company’s media buying operations, the Company recorded charges for severance and termination benefits in the amount of approximately $333 during the nine months ended September 30, 2006. The charges were attributable to the elimination of 10 positions, primarily representing sales and related support functions in addition to certain other management positions. There were no amounts attributable to the scheduled termination of employees under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, plans whereby employees are required to provide transitional services through their termination dates.


23


Liquidity and Capital Resources

Financial Position

Cash and cash equivalents and short-term investments as of September 30, 2006 and December 31, 2005 were as follows:


2006
2005
$ Change
Cash and cash equivalents   $  18,666   $  35,142   $(16,476 )
Investments  97,600   78,383   19,217  



   $116,266   $113,525   $   2,741  




During the nine months ended September 30, 2006, the Company’s cash and cash equivalents and short-term investment balances remained consistent, primarily as a result of an increase in investment income and cash collections of seasonally high fourth quarter accounts receivable, substantially offset by payments made to licensors, Fox and certain affiliates for the 4Kids TV broadcast agreement.

Sources and Uses of Cash

Cash flows for the nine months ended September 30, 2006 and 2005 were as follows:


Sources (Uses)
2006
2005
$ Changes
Operating Activities   $   1,595   $(6,203 ) $   7,798  
Investing Activities  (19,200 ) (4,068 ) (15,132 )
Financing Activities  771   (16,530 ) 17,301  

Working capital, consisting of current assets less current liabilities, was $129,501 as of September 30, 2006, and $129,576 as of December 31, 2005. The decrease in cash flows used in operating activities is principally due to lower 4Kids TV broadcast fees paid to Fox, partially offset by decreased cash collections attributable to fourth quarter accounts receivable for the nine months ended September 30, 2006, as compared to the same period in 2005.

As of September 30, 2006, the Company had $97,600 invested in tax-exempt and tax-advantaged auction-rate securities and short-term government obligations. The 2006 decrease in cash flows from investing activities is primarily due to the Company’s purchase of auction-rate securities as an investment strategy for its excess cash balances. During 2006, the Company purchased property and equipment of $508, which was comprised primarily of computer equipment, as compared to purchases of property and equipment of $593 in 2005. Additionally, the Company had a write-off of developmental software of approximately $525 during 2006. Funds required for the purchase of property and equipment in 2006 are expected to be similar to that of 2005.

The 2006 increase in cash flows from financing activities was primarily due to the fact that there were no treasury stock purchases during the 2006 period.

During the nine months ended September 30, 2006, the Company’s cash flows from operations were negatively impacted by reduced consumer demand for licensed products featuring Properties represented by the Company.  Due to changing trends in the toy, game and entertainment business and the difficulty in predicting the length of time a property will be commercially successful, the Company’s revenues, operating results and cash flow from operations may fluctuate significantly from year to year and present operating results that are not necessarily indicative of future performance.

Historically, the majority of the television-based Properties the Company represented were existing episodes of foreign produced programming that the Company adapted for the United States and other markets.  The Company is now seeking to increase the number of new animated television programs that the Company will be producing and which will be owned in whole or in part by the Company. The cost of producing new programs is substantially more than the cost of producing adaptations of existing animated programs. Accordingly, the production costs associated with developing original animated programming will likely result in increased capitalized film and television costs for the Company.  If a Property consisting of new animated programs produced by the Company performs at a level less than the Company’s expectations, the Company may have to amortize substantially higher production costs related to such Property over a shorter period of time. This increased amortization of the higher production costs of new animated programs produced by the Company could materially and adversely affect the Company’s financial performance. While the Company expects that the revenues associated with such newly produced programs will be sufficient to maintain its historical operating margins, there can be no assurance that such revenues will be realized.


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4Kids TV Broadcast Agreement

In January 2002, the Company entered into a multi-year agreement with Fox to lease Fox’s Saturday morning programming block. In January 2005, the Company rebranded the “Fox Box” to “4Kids TV”. The Company provides substantially all programming content to be broadcast on 4Kids TV, which principally airs on Saturday mornings from 8 am to 12 pm eastern/pacific time (7 am to 11 am central time) and retains all of the revenue from network advertising sales for the four-hour time period. 4Kids Ad Sales, Inc., a wholly-owned subsidiary, manages and accounts for the ad revenue and costs associated with 4Kids TV.

In March 2006, the multi-year agreement was extended for two broadcast years through the 2007-2008 broadcast season. As of September 30, 2006, no amounts remain to be paid for the 2005-2006 broadcast season under the original agreement. The time-buy fee for each of the 2006-2007 and 2007-2008 broadcast seasons will be $20,000 as compared to the $25,312 paid for each broadcast year during the initial term of the multi-year agreement. The fee is payable in quarterly installments of $5,000 each year beginning in October 2006. The extended agreement also provides Fox with the option to further extend the agreement through the 2008-2009 broadcast season under the same terms and conditions by providing notice to the Company no later than August 31, 2007.

In addition to the time-buy fee paid to Fox, the Company will incur additional costs to program the four-hour block and sell the related network advertising time. These costs will include direct programming costs to acquire, adapt and deliver programming for the broadcast during the weekly four-hour block as well as additional indirect expenses of advertising sales, promotion and administration.

Contractual Commitments

The Company’s contractual obligations and commitments are detailed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. As of September 30, 2006, the Company’s contractual obligations and commitments have not materially changed since December 31, 2005, except for severance and other exit costs associated with discontinued operations of the Company’s media buying entity. Contractual obligations of approximately $125 will be paid out during the remainder of 2006 in conjunction with this discontinued operation.

Related Party Transactions

The Company’s Chairman and Chief Executive Officer is the founder and Chairman 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 who have lost their lives in the line of duty. The Foundation also works with law enforcement and firefighting organizations to provide children with valuable social and life skill programs. The Company contributed approximately $20 and $70 to the foundation for the three and nine months ended September 30, 2006, respectively, and $30 and $90 to the foundation for the three and nine months ended September 30, 2005, respectively.

Brian Lacey has been Executive Vice President of International for the Company since July 2003. Prior to joining the Company, Mr. Lacey was the President and founder of Lacey Entertainment, a New York-based worldwide television marketing, production and distribution company (“Lacey”). Until July 2003 (when the agreement was terminated), Lacey provided consulting services to the Company under a fee-based agreement pursuant to which the Company agreed to pay Lacey a percentage of all programming sales placed by Lacey in the international marketplace as the cash payments for such programming sales were received. During the nine months ended September 30, 2006, Lacey was paid $341 for all remaining obligations with respect to this agreement. As of September 30, 2006 and December 31, 2005, the Company has included $0 and $233, respectively, in accounts payable and accrued expenses on its accompanying consolidated balance sheets for remaining obligations due to Lacey under the former agreement.


25


Forward Looking Information and Risk Factors That May Affect Future Results

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company. We may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our stockholders. These “forward-looking” statements may relate to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities, liquidity, and similar matters or to developments beyond our control, including changes in domestic or global economic conditions. Forward-looking statements are inherently subject to risks and uncertainties and are made on the basis of management’s views and assumptions as of the time the statements are made. There can be no assurance, however, that our expectations will necessarily come to pass. A variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed or anticipated in our forward-looking statements. The factors listed below are illustrative and other risks and uncertainties may arise as are or may be detailed from time to time in our public announcements and filings with the Securities and Exchange Commission. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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’s 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:


  (1) our current Properties, product concepts or programming will continue to be popular for any significant period of time;

  (2) new Properties, product concepts or programming we represent or produce will achieve and sustain popularity in the marketplace;

  (3) a Property’s life cycle will be sufficient to permit us to recover revenues in excess of the costs of advance payments, guarantees, development, marketing, royalties and other costs relating to such Property; or

  (4) we will successfully anticipate, identify and react to consumer preferences.

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.

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 three and nine months ended September 30, 2006, the Company derived approximately 56% of its revenues from two Properties and 79% from three Properties, respectively. In addition, our control over the timing of the licensing royalty payments we receive is limited and some of these payments are based on quarterly royalty payments reported by our licensees. 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. A significant decrease in our licensing revenues could have a significant adverse effect on our financial condition and results of operations.

Revenues from our licensing segment are directly impacted by third party sales of licensed products based on our Properties.

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


26


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

Historically, the majority of the television-based Properties we represented were existing episodes of foreign programming that we adapted for the United States and other markets. Our strategic focus has shifted toward Properties where we are joint copyright owners of the newly produced episodes. The investment required to produce such original animated programming is substantially in excess of the historical cost of adapting existing animated programming. Following the commercial release of a Property, its overall market acceptance and resulting revenues will directly impact our amortization of the costs incurred to develop such Property. To the extent a Property performs at a level less than our expectations, the ratio of amortization expense to revenues realized will increase. This increase will adversely impact our operating margins 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 generated by 4Kids Ad Sales occur during the fourth fiscal quarter. The financial results of 4Kids TV are also 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 4Kids TV during the holiday season could have a material adverse effect on our financial condition and results of operations.

We operate in a highly competitive marketplace.

Licensing.     Our principal competitors in the Licensing segment are large media companies with theatrical distribution and television broadcast distribution (e.g., Disney, Time-Warner, Viacom), 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. However, the ultimate success of a new entrant in the field would depend on its access to toy and other manufacturers, access to distribution of television based properties, access to properties to be licensed, retail market acceptance of properties and its know-how in the negotiation and subsequent administration of licenses.

Advertising Media and Broadcast. Our Advertising Media and Broadcast segment also operates in a highly competitive marketplace against companies with substantially greater resources and distribution networks than we have. Our ability to derive advertising revenue from the sale of commercial time on 4Kids TV depends, in substantial part, on the popularity of the television shows that we broadcast on 4Kids TV. We also face significant competition from other television broadcasters and cable networks, including competition from a successful television program that we previously produced (i.e., “Pokémon”), which is broadcast on Saturday mornings on a competing network.

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 the Company and its subsidiaries.


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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 dependant on the amount of advertising revenues generated from sales of network advertising on 4Kids TV. Recently, there has been increased scrutiny of food advertising directed at children as a result of childhood obesity concerns. In response to these concerns, several 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 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 4Kids TV programming.

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 many 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 the senior management personnel and 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 or our licensors’ 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 there are adequate remedies for any infringement. Any such failure to successfully protect our intellectual property rights may have a material adverse effect on our competitive position.

We may 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 and in the future may be, impacted by changes in such conditions. Softening global economies, stock market uncertainty and wavering consumer confidence caused by the threat or occurrence of terrorist attacks, war or other factors generally affecting economic conditions may adversely affect our business, financial condition and results of operations.

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 dependant 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.

Readers are cautioned that other factors discussed in this report, although not listed here, also could materially affect our future earnings.


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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Rate Fluctuations

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and procedures, as defined in Securities and Exchange Act of 1934, as amended (the “Exchange Act”) Rule 13a-15(e),which is designed to provide reasonable assurance that information which is required to be disclosed in our reports filed pursuant to the Exchange Act, is accumulated and communicated to management in a timely manner. At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the 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 pursuant to Exchange Act Rule 13a-15(b). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the date of such evaluation, our disclosure controls and procedures were effective in timely alerting them to information relating to us that is required to be included in our reports filed under the Exchange Act.

Changes in Internal Control Over Financial Reporting

During the third quarter of 2006, there were no significant changes in our internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II -OTHER INFORMATION

Item 1. Legal Proceedings

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 property is the subject will, individually or in the aggregate, have a material adverse effect on the Company’s financial position or the results of its operations.

Item 1A. Risk Factors

Information regarding risk factors is set forth under the heading “Forward Looking Information and Risk Factors That May Affect Future Results” appearing at the end of Part I — Item 2: “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005.


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Item 6. Exhibits

(a) Exhibits


31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
32.1 Joint Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18
  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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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.

Dated: November 9, 2006

By: /s/ Alfred R. Kahn

         Alfred R. Kahn
   Chairman of the Board,
Chief Executive Officer and
               Director

By: /s/ Bruce R. Foster

          Bruce R. Foster
      Executive Vice President,
Treasurer, Chief Financial Officer,
Principal Accounting Officer


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