4Licensing Corp 10-Q 2008
4Kids Entertainment, Inc. and Subsidiaries
Table of Contents
Part I – FINANCIAL INFORMATION
Item 1. Financial Statements
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2008 and DECEMBER 31, 2007
(In thousands of dollars, except share data)
See notes to consolidated financial statements.
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(In thousands of dollars, except share data)
See notes to consolidated financial statements.
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
THREE MONTHS ENDED MARCH 31, 2008 (UNAUDITED) AND YEAR ENDED DECEMBER 31, 2007
(In thousands of dollars and shares)
See notes to consolidated financial statements.
4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
See notes to consolidated financial statements.
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 its businesses are conducted (the “Company”), is a diversified entertainment and media company specializing in the youth oriented market with operations in the following business segments: (i) Licensing; (ii) Advertising Media and Broadcast; (iii) Television and Film Production/Distribution; and (iv) Trading Card and Game Distribution. The Company was organized as a New York corporation in 1970.
Licensing - The Licensing business segment consists of the results of operations of the following wholly-owned subsidiaries of the Company: 4Kids Entertainment Licensing, Inc. (“4Kids Licensing”); 4Sight Licensing Solutions, Inc. (“4Sight Licensing”); 4Kids Entertainment International, Ltd. (“4Kids International”); and 4Kids Technology, Inc. (“4Kids Technology”). 4Kids Licensing is engaged in the business of licensing the merchandising rights to popular children’s television series, properties and product concepts (individually, the “Property” or collectively the “Properties”). 4Kids Licensing typically acts as exclusive merchandising agent in connection with the grant to third parties of licenses to manufacture and sell all types of merchandise, including toys, videogames, trading cards, apparel, housewares, footwear, books and other published materials, based on such Properties. 4Sight Licensing is engaged in the business of licensing properties and product concepts to adults, teens and “tweens”. 4Sight Licensing focuses on brand building through licensing. 4Kids International, based in London, manages Properties represented by the Company in the United Kingdom and European marketplaces. 4Kids Technology develops ideas and concepts for licensing which integrate new and existing technologies with traditional game and toy play patterns.
Advertising Media and Broadcast - The Company, through a multi-year agreement with Fox Broadcasting Corporation (“Fox”), leases Fox’s Saturday morning programming block (“4Kids TV”) from 8am to 12pm eastern/pacific time (7am to 11am central time). The Company provides substantially all programming content to be broadcast on 4Kids TV. 4Kids Ad Sales, Inc. (“4Kids Ad Sales”), a wholly-owned subsidiary of the Company, retains all of the revenue from its sale of network advertising time for the four-hour time period leased from Fox.
On October 1, 2007, the Company and The CW Network, LLC ("The CW") entered into an agreement (the "CW Agreement"), under which The CW granted to the Company the exclusive right to program The CW's Saturday morning children's programming block that is broadcast in most markets between 7am and 12pm ("The CW Kids Block") for an initial term of five years beginning with The CW's 2008-2009 broadcast season.
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. As a consequence of the termination of its operations, Summit Media no longer serves as a media buying agency for third parties and is classified as a discontinued operation.
Television and Film Production/Distribution - The Television and Film Production/Distribution business segment consists of the results of operations of the following wholly-owned subsidiaries of the Company: 4Kids Productions, Inc. (“4Kids Productions”); 4Kids Entertainment Music, Inc. (“4Kids Music”); and 4Kids Entertainment Home Video, Inc. (“4Kids Home Video”). 4Kids Productions produces and adapts animated and live-action television programs and theatrical motion pictures for distribution to the domestic and international television, home video and theatrical markets. 4Kids Music composes original music for incorporation into television programming produced by 4Kids Productions and markets and manages such music. 4Kids Home Video distributes home videos associated with television programming produced by 4Kids Productions.
Trading Card and Game Distribution - Through its wholly-owned subsidiary, 4Kids Digital Games, Inc. (“4Kids Digital”), the Company owns 55% of TC Digital Games LLC, a Delaware limited liability company (“TC Digital”) that produces, markets and distributes the “Chaotic” trading card game. In December 2006, 4Kids Digital acquired a 53% ownership interest in TC Digital and entered into TC Digital’s operating agreement (the “TCD Agreement”) with Chaotic USA Digital Games LLC (“CUSA LLC”), a wholly-owned subsidiary of Chaotic USA Entertainment Group, Inc. (“CUSA”). The TCD Agreement contains terms and conditions governing the operations of TC Digital, and entitles 4Kids Digital and CUSA to elect two managers to the entity’s Management Committee with 4Kids Digital having the right to break any dead-locks. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA increasing 4Kids Digital’s ownership percentage to 55%. The consideration for the purchase of the additional membership interest
was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites LLC, a Delaware limited liability company and subsidiary of the Company (“TC Websites”) under its operating agreement (the “TCW Agreement”).
Through its wholly-owned subsidiary, 4Kids Websites, Inc. (“4Kids Websites”), the Company owns 55% of TC Websites, a company that owns and operates www.chaoticgame.com, the companion website for the “Chaotic” trading card game which was launched as a public beta version on October 24, 2007. In December 2006, 4Kids Websites purchased a 50% membership interest in TC Websites from CUSA and entered into the TCW Agreement. The TCW Agreement contains terms and conditions governing TC Websites’ operations and entitles 4Kids Websites and CUSA to elect two managers to its Management Committee. On December 18, 2007, 4Kids Websites entered into an agreement pursuant to which it acquired an additional 5% ownership interest in TC Websites from CUSA, and the TCW Agreement was concurrently amended to provide 4Kids Websites with the right to break any deadlocks on TC Websites’ Management Committee, including with respect to operational matters. The consideration for the purchase of the additional membership interest was paid through the settlement of certain capital contributions required to be made by CUSA to TC Websites under the TCW Agreement. Prior to the acquisition by 4Kids Websites of the additional 5% ownership interest and amendment of the TCW Agreement, the Company used the equity method to account for its investment in TC Websites, where it did not have control but had significant influence. As a result of 4Kids Websites’ increased ownership and operational control, TC Websites is consolidated in the Company’s financial statements, subject to a minority interest.
TC Digital and TC Websites are the exclusive licensees of certain patents covering the uploading of coded trading cards to a website where online game play and community activities occur. The www.chaoticgame.com website provides full access to all of its content and is free of charge for all users. No purchase of trading cards is necessary to play the online version where virtual playing decks are available to users who register on the website. These two businesses enable the Company to offer traditional trading card game play with an online digital play experience. In addition, it is anticipated that TC Digital and TC Websites will diversify their product lines and will ultimately distribute and sell, and create websites for other trading card games. The Company believes that its ownership interests in TC Digital and TC Websites represent a potentially significant addition to its business strategy.
Certain of the Company’s executive officers have interests in CUSA, CUSA LLC and certain other entities with which TC Digital and TC Websites have engaged in transactions since their formation. Information regarding these relationships can be found in Note 9.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements, except for the December 31, 2007 consolidated balance sheet and the consolidated statement of stockholders’ equity and comprehensive loss for the year ended December 31, 2007, are unaudited and should be read in conjunction with audited consolidated financial statements and notes thereto for the year ended December 31, 2007 as presented in our Annual Report on Form 10-K. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, which are of a normal and recurring nature, necessary to present fairly the financial position of the Company as of March 31, 2008 and December 31, 2007, and the results of operations for the three months ended March 31, 2008 and 2007, and stockholders’ equity and comprehensive loss for the three months ended March 31, 2008 and the year ended December 31, 2007, and cash flows for the three months ended March 31, 2008 and 2007. 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.
In connection with the termination of the operations of Summit Media, the media buying operations have been classified as a discontinued operation. As further discussed in Note 12, the consolidated financial statements have been reclassified to reflect the reporting of this business as a discontinued operation.
Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (the “FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 prescribes the financial statement recognition and measurement criteria for a tax position taken or expected to be taken in a tax return. FIN 48 also requires additional disclosures related to uncertain income tax positions. See Note 6, “Income Taxes”, for further information.
Revenue Recognition – Merchandise licensing revenues: Licensing revenues, net of licensor participations, are recognized when the underlying royalties from the sales of the related products are earned. 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 licensors of television rights to Properties represented by the Company are included in net revenues and the corresponding costs are included in production service costs in the accompanying consolidated statements of operations. Production service costs included in net revenues amounted to $1,480 and $1,717 for the three months ended March 31, 2008 and 2007, 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.
Trading card revenues: Emerging Issue Task Force (“EITF”) Issue No. 00-21 - Accounting for Revenue Arrangements with Multiple Deliverables, provides guidance on how and when to recognize revenues for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. Revenue arrangements with multiple deliverables are required to be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration must be allocated among the separate units of accounting based on their relative fair values. The Company has determined that because its trading card game is provided with a web component, there is a multiple deliverable arrangement. However, since no purchase of trading cards is necessary to access the website and cards are available free of charge to users who register on the website, the Company has determined that the selling price of the trading cards should be fully attributable to the cards. Revenues from trading card sales, net of a reserve for returns and allowances, are recognized on the date cards are shipped by the Company’s distributor to wholesalers/retailers as reported to the Company.
Fair Value Measurements - The fair values of the Company’s financial instruments reflect the estimates of amounts that would be received from selling an asset in an orderly transaction between market participants at the measurement date. The fair value estimates presented in this report are based on information available to the Company as of March 31, 2008 and December 31, 2007.
The carrying values of cash and cash equivalents approximate fair value. The Company has estimated the fair value of its investment in auction rate securities (“ARS”) using significant unobservable inputs at March 31, 2008.
In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 157, Fair Value Measurements (“SFAS No. 157”), the Company applies a fair value hierarchy based on three levels of inputs, the first two of which are considered
observable and the last of which is considered unobservable, that may be used to measure fair value. The three levels are the following:
Investments – The Company’s short-term investments principally consist of ARS and other debt securities. ARS are generally rated A or better by one or more national rating agencies and have contractual maturities of up to 30 years. The Company classifies its investments in auction rate securities as “available for sale.” The auction rate securities that the Company invests in generally have interest reset dates that occur every 7 or 35 days and despite the long-term nature of their stated contractual maturity, the historical operation of the auction rate security market has given the Company the ability to quickly liquidate these securities at ongoing auctions every 35 days or less.
During 2007, liquidity issues began to affect the global credit and capital markets. As a result, ARS, which historically have had a liquid market and had their interest rates reset periodically (e.g. monthly) through Dutch auctions, began to fail at auction. These auction failures have caused ARS to become illiquid, which in turn has caused the fair market values for these securities to decline.
As of March 31, 2008, the Company held ARS having an aggregate principal amount of approximately $52,000. The ARS currently held by the Company are private placement debt securities with long-term nominal maturities and interest rates that typically reset monthly. The Company’s investments in ARS represent interests in debt obligations issued by banks and insurance companies that had at least an “A” credit rating at the time of purchase by the Company, including bond insurers and re-insurers such as MBIA, AMBAC, FGIC, FSA, RAM and Radian.
Many of the ARS held by the Company as of March 31, 2008, have experienced failed auctions due to the liquidity issues described above. As of March 31, 2008, the estimated fair market value of the ARS held by the Company declined by $13,180 ($3,993 during 2007 and $9,187 during the first quarter of 2008) based upon an analysis of the current market conditions of the Company’s securities held made by the Company in accordance with SFAS No. 157. Although all of the ARS invested in by the Company have continued to pay interest according to their stated terms and substantially all of the ARS invested in by the Company continue to be a rated “A” or above, the Company recorded an unrealized loss of $9,187 during the first quarter of 2008 resulting in a reduction in stockholders’ equity. Since the Company has the ability and the intent to hold these investments until recovery of their fair value, which may not be prior to the maturity of the applicable security, the Company does not consider these investments to be other-than-temporarily impaired.
The credit and capital markets, including the market for ARS have remained illiquid in 2008, and as a result, there continues to be failed auctions affecting ARS owned by the Company. Although all of the Company’s investments in ARS have continued to pay interest according to their stated terms and substantially all of the ARS invested in by the Company continue to be a rated “A” or above, the Company’s unrealized loss on its ARS had subsequently increased by $1,005, to a cumulative unrealized loss of $14,185 as of April 30, 2008, based upon statements provided by the investment bank through which the Company holds such securities.
Given the failed auctions, many of the Company’s ARS are currently illiquid. Accordingly, the Company has reclassified $9,021 (face amount of $20,350 less estimated devaluations of $11,329), in ARS from current to non-current assets on its balance sheet due to the fact that the Company believes that the liquidity of these ARS is unlikely to be restored in a period less than twelve months from such date.
If uncertainties in the credit and capital markets continue or the Company experiences any rating downgrades on any investments in its ARS portfolio or the value of such investments declines further, the Company may incur impairment charges to its investment portfolio, which could negatively affect the Company’s financial condition and cash flow. If in the reasonable judgment of the Company, the value of any ARS should be permanently impaired, the Company would record an expense which would negatively impact reported earnings. As a result of the current market issues, the Company has invested its surplus cash solely in U.S. Treasury securities.
The Company believes that based on the Company’s current cash, cash equivalents and marketable securities, the current lack of liquidity affecting a significant portion of its portfolio of ARS will not have a material impact on the Company’s liquidity or its ability to fund its operations.
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 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 SFAS No. 130, Reporting Comprehensive Income (“SFAS No. 130”), 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 for the three months ended March 31, 2008 and 2007, was $15,582 and $172, respectively, which included translation adjustments of $4 and $33 for the respective periods.
Recently Issued Accounting Pronouncements– In November 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS No. 141R”), which continues to require that all business combinations be accounted for by applying the acquisition method. Under the acquisition method, the acquirer recognizes and measures the identifiable assets acquired, the liabilities assumed, and any contingent consideration and contractual contingencies, as a whole, at their fair value as of the acquisition date. Under SFAS No. 141R, all transaction costs are expensed as incurred. SFAS No. 141R rescinds EITF Issue No. 93-7 (“EITF 93-7). Under EITF 93-7, the effect of any subsequent adjustments to uncertain tax positions were generally applied to goodwill, except for post-acquisition interest on uncertain tax positions, which was recognized as an adjustment to income tax expense. Under SFAS No. 141R, all subsequent adjustments to these uncertain tax positions that otherwise would have impacted goodwill will be recognized in the income statement. SFAS No. 141R will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB No. 87, 88, 106 and 132(R) (“SFAS 158”). SFAS 158 requires that the funded status of defined benefit postretirement plans be recognized on companies’ balance sheets and that changes in the funded status be reflected in comprehensive income, effective for fiscal years ending after December 15, 2006. SFAS 158 also requires companies to measure the funded status of each such plan as of the date of its fiscal year-end, effective for fiscal years ending after December 15, 2008. Since the Company does not currently have a defined benefit postretirement plan, the adoption of SFAS 158 will not have any impact on its consolidated financial position and results of operations.
In November 2007, the FASB issued SFAS No. 160, Accounting and Reporting of Noncontrolling Interest (“SFAS No. 160”). SFAS No. 160 requires that a noncontrolling interest (previously referred to as a minority interest) be separately reported in the equity section of the consolidated entity’s balance sheet. SFAS No. 160 also established accounting and reporting standards for: (i) ownership interests in subsidiaries held by parties other than the parent, (ii) the amount of consolidated net income attributable to the parent and to the noncontrolling interest, (iii) changes in a parent’s ownership interest and (iv) the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS No. 160 is effective for us beginning January 1, 2009. The Company is currently evaluating the impact the adoption of SFAS No. 160 will have on its consolidated financial position and results of operations.
In March 2008, the FASB issued SFAS No. 161 (“SFAS 161”), Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No.133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). SFAS No. 161 requires companies to provide enhanced disclosures regarding derivative instruments and hedging
activities in order to better convey the purpose of derivative use in terms of risk management. Disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect a company's financial position, financial performance, and cash flows, are required. This Statement retains the same scope as SFAS No. 133 and is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact, if any, that the adoption of SFAS No. 161 will have on its consolidated financial position and results of operations.
In December 2007, the FASB ratified EITF Issue No. 07-1, Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property. The EITF concluded that a collaborative arrangement is one in which the participants are actively involved and are exposed to significant risks and rewards that depend on the ultimate commercial success of the endeavor. Revenues and costs incurred with third parties in connection with collaborative arrangements would be presented gross or net based on the criteria in EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, and other accounting literature. Payments to or from collaborators would be evaluated and presented based on the nature of the arrangement and its terms, the nature of the entity’s business, and whether those payments are within the scope of other accounting literature. The nature and purpose of collaborative arrangements are to be disclosed along with the accounting policies and the classification and amounts of significant financial statement amounts related to the arrangements. Activities in the arrangement conducted in a separate legal entity should be accounted for under other accounting literature; however required disclosure under EITF 07-1 applies to the entire collaborative agreement. This Issue is effective for fiscal years beginning after December 15, 2008, and is to be applied retrospectively to all periods presented for all collaborative arrangements existing as of the effective date. The Company is currently evaluating the impact that this pronouncement may have on its consolidated financial position and results of operations.
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values and estimated fair values of the Company’s financial instruments for the periods presented are as follows:
Level 1- The Company’s Level 1 assets consist of cash, US Treasury securities with original maturities of three months or less and Corporate bonds.
Level 2 - At March 31, 2008 and December 31, 2007, the Company had no investments which were considered to be Level 2 assets.
Level 3 – The Company’s Level 3 assets consist of the Company’s investment in ARS. The recent uncertainties in the credit markets have prevented the Company and other investors from liquidating their holdings of ARS in auctions for these securities during the three months ended March 31, 2008, because the amount of securities submitted for sale has exceeded the amount of purchase orders.
The carrying value of the Company’s investments in ARS as of March 31, 2008 represents the Company’s best estimate of the fair value of these investments based on currently available information. The estimation process included consideration of such factors as issuer and insurer credit rating, comparable market data, if available, the credit quality of the ARS, the rate of interest received since the date the auctions began, yields of securities similar to the underlying ARS and input from broker-dealers. Due to the uncertainty in the credit markets, it is reasonably possible the fair value of these investments may change in the near term. If the issuers are unable to successfully close future auctions and their credit ratings deteriorate, the Company may be required to further adjust the carrying value of its investment in ARS through additional devaluations.
The table below provides a summary of changes in fair value for the Company's investments:
4. 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, shares of restricted stock, and other stock-based awards. The plans are administered by the Compensation Committee of the Board of Directors, consisting of non-employee directors.
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. The Company did not grant any stock options during the three months ended March 31, 2008 and at January 1, 2006, all of the Company’s outstanding options were fully vested. Consequently, the adoption of this pronouncement did not have a material effect on the Company’s consolidated financial position or results of operations.
The following table summarizes activity under our stock option plans for the three months ended March 31, 2008:
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 March 31, 2008, there were options outstanding to purchase an aggregate of approximately 225,000 shares with an exercise price below the quoted price of our stock, resulting in an aggregate intrinsic value of $625. During the three months ended March 31, 2008 and 2007, the aggregate intrinsic value of options exercised under our stock option plans was $0 and $4, respectively, determined as of the date of exercise.
Restricted Stock Awards
The Company granted restricted stock awards of approximately 162,000 shares on May 25, 2007 under its 2006 long-term incentive compensation plan and 145,000 and 4,000 shares on May 23, 2006 and June 15, 2006, respectively, under its 2005 long-term incentive compensation plan. The restricted stock awards were granted to certain employees, including officers and members of the Board of Directors, at grant prices of $16.79, $16.52 and $15.78 (in each case, the average of the high and low stock price from the previous day of trading) for the May 25, 2007, the May 23, 2006 and the June 15, 2006 grants, respectively. The restricted stock awards vest annually over a period of four years from the date of grant with accelerated vesting upon a change of control of the Company (as defined in the applicable plan). During the restriction period, award holders do not have the rights of stockholders and cannot transfer ownership. Additionally, nonvested shares of award holders are subject to forfeiture. These awards are forfeited and revert to the Company in the event of employment termination, except in the case of death, disability, retirement or other specified events.
A summary of restricted stock award activity under the Company’s long-term incentive compensation plans as of March 31, 2008 and changes during the three months then ended is presented as follows:
As of March 31, 2008 and 2007, the Company recognized $298 and $137 of compensation costs related to the long-term incentive compensation plans. Additionally, as of March 31, 2008, there was approximately $2,232 and $1,155 of unrecognized compensation cost related to restricted stock awards granted under the Company’s 2006 and 2005 long-term incentive compensation plans, respectively. The cost is expected to be recognized over a remaining weighted-average period of 3.2 and 2.1 years under the 2006 and 2005 plans, respectively. There were no shares of restricted stock that vested during the three months ended March 31, 2008.
Availability for Future Issuance - As of the three months ended March 31, 2008, (i) options to purchase approximately 803,000 shares of the Company’s common stock were available for future issuance under the Company’s stock option plans and (ii) options to purchase a maximum of approximately 845,000 shares of the Company’s common stock were available for future issuance under the Company’s long-term incentive compensation plans, reduced by four shares for each share of restricted stock awarded under the 2006 and 2005 plans, for which an aggregate of 45,000 shares were available for issuance as options, and reduced by two shares for each share of restricted stock awarded under the 2007 plan for which 800,000 shares were available for issuance as options. Additionally, approximately 8,205 shares of restricted stock, repurchased in May 2007 to discharge withholding tax obligations upon the vesting of certain employees’ restricted shares, were also available for issuance under the 2005 plan.
5. DEFERRED REVENUE
Music - Music Publishing - 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 its television programs (“Current Music Assets”) to an unaffiliated third party in an arms length transaction for $3,000 (the “Music Agreement”). 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 (“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. The Company expects and continues to produce additional new music which, based on the success of the administrative service, continues to supply the unaffiliated third party with this content. Since the Company continues to deliver more than the amount of music required to be delivered under the Music Agreement, there is no way to appropriately record the fair value of the future amounts to be delivered. Based on EITF 00-21, the Company’s inability to fair value the future portion of the music deliverables results in the entire amount to be recorded as deferred revenue. The most appropriate and systematic method of accounting for this revenue relating to the deferred portion would be to reduce this deferred amount dollar for dollar based on the actual music earnings of the Company. Pursuant to the above, the Company recognized revenues of $90 and $74 for the three months ended March 31, 2008 and 2007, respectively. The Company has included $1,904 and $1,994 as deferred revenue on the accompanying consolidated balance sheets as of March 31, 2008 and December 31, 2007, 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 $4,119 against 4Kids Home Video’s share of the distribution and service fee proceeds to be realized by 4Kids Home Video from such titles. Pursuant to the above, the Company recognized revenue of $171 and $36 for the three months
ended March 31, 2008 and 2007, respectively. The Company has included $248 and $419 as deferred revenue on the accompanying consolidated balance sheets as of March 31, 2008 and December 31, 2007, respectively.
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 March 31, 2008 and December 31, 2007, the unearned portion of these advances and guaranteed payments was $298 and $571, respectively, and is included in deferred revenue on the accompanying consolidated balance sheets.
6. INCOME TAXES
The (provision for) benefit from income taxes consisted of the following:
The Company adopted the provisions of FIN 48, effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position 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 this interpretation did not have a material effect on the Company’s consolidated financial position or results of operations.
The Company and its consolidated subsidiaries file income tax returns in the United States and in the United Kingdom. The Company is no longer subject to examinations by income tax authorities in most jurisdictions for years prior to 2003.
7. EARNINGS PER SHARE
The Company applies SFAS No. 128, Earnings per Share, which requires the computation and presentation of earnings per share (“EPS”) to include basic and diluted EPS. Basic EPS is computed based solely on the weighted average number of common shares outstanding during the period. Diluted EPS reflects all potential dilution of common stock. The following table reconciles Basic EPS with Diluted EPS for the three months ended March 31, 2008 and 2007:
For the three months ended March 31, 2008 and 2007, 1,460,425, and 1,250,750 shares, respectively, attributable to the exercise of outstanding options, were excluded from the calculation of diluted EPS because the effect was antidilutive.
8. 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 Properties is the subject will, individually or in the aggregate, have a material adverse affect on the Company’s financial position or the results of its operations.
9. RELATED PARTY
National Law Enforcement and Firefighters Children’s Foundation - The Company’s Chairman and Chief Executive Officer is the founder and President of The National Law Enforcement and Firefighters Children’s Foundation (the “Foundation”). The Foundation is a not-for-profit organization dedicated to helping the children of law enforcement and firefighting personnel and working with law enforcement and firefighting organizations to provide all children with valuable social and life skill programs. During the three months ended March 31, 2008 and 2007, the Company contributed approximately $31 and $30, respectively, to the Foundation.
Chaotic USA Entertainment Group, Inc. (“CUSA”) - On December 11, 2006, 4Kids Digital and CUSA LLC, entered into the TCD Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47% of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA LLC increasing 4Kids Digital’s ownership percentage to 55%. TC Digital is treated as a consolidated subsidiary of the Company as a result of its majority ownership in TC Digital and its right to break any dead-locks within the TC Digital Management Committee. Bryan Gannon (“Gannon”), President and Chief Executive Officer of CUSA and John Milito (“Milito”), Executive Vice President and Chief Operating Officer of CUSA, each own an interest of approximately 32% in CUSA. Additionally, on December 11, 2006, Gannon and Milito became officers of TC Digital.
As of March 31, 2008, the Company has entered into the following transactions with CUSA and CUSA LLC, or parties related to Gannon and Milito that are summarized below:
and $64 for each such entity, for the three months ended March 31, 2008. On September 10, 2007, the Company purchased a 25% interest in such patents from Cornerstone for $750. For the three months ended March 31, 2008, the Company earned royalties of $42 related to its portion of the patents relating to the sales of “Chaotic” trading cards which is eliminated in the Company’s consolidated financial statements.
4Kids Digital is required under the terms of the TCD Agreement and the related loan and line of credit agreements to provide loans to TC Digital from time to time in an aggregate amount up to $8,000 with a maturity date of December 31, 2010 and an interest rate of 12%. Any transaction resulting in the sale of more than 50% of TC Digital’s membership interests or in the sale of all or substantially all of TC Digital’s assets occurring while there is no debt owed from TC Digital to 4Kids Digital under the loan and line of credit or occurring prior to August 31, 2009 requires the consent of members of TC Digital holding two-thirds of its membership interests (as opposed to a majority of its membership interests).
10. COMMITMENTS AND CONTINGENCIES
a. Broadcast Agreements - In January 2002, the Company entered into a multi-year agreement with Fox to lease Fox’s Saturday morning programming block (“4Kids TV”) which airs principally on Saturday mornings from 8am to 12pm eastern/pacific time (7am to 11am central time). 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 manages and accounts for the ad revenue and costs associated with 4Kids TV. The broadcast fee for the 2007-2008 broadcast season is $20,000 payable in quarterly installments of $5,000 commencing in October 2007. Fox has exercised its option to extend this agreement through its 2008-2009 broadcast season under the same terms and conditions as in effect for the 2007-2008 broadcast season.
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 $5,203 and $4,419 for the three months ended March 31, 2008 and 2007, respectively. During the three months ended March 31, 2008, the Company paid Fox and certain Fox affiliates $5,266, attributable to the 2007-2008 broadcast season fees and during calendar year 2007, the Company paid Fox and certain Fox affiliates $15,525 and $5,263, attributable to the 2006-2007 and 2007-2008 broadcast seasons fees, respectively.
As of March 31, 2008, the minimum guaranteed payment obligations under the 4Kids TV Broadcast Agreement are as follows:
On October 1, 2007, the Company and The CW entered into the CW Agreement, under which The CW granted to the Company the exclusive right to program The CW's Saturday morning children's programming block that is broadcast in most markets between 7am and 12pm for an initial term of five years beginning with The CW's 2008-2009 broadcast season.
Under the CW Agreement, the Company is obligated to make quarterly minimum guaranteed payments which are subject to reduction under certain circumstances. The Company and The CW will share advertising revenues earned from the sale of national commercial time during The CW Kids Block with The CW's share to be applied against such quarterly guarantee payments. In addition, The CW will be entitled under the CW Agreement to participate in the Company's merchandising revenue from certain content broadcast on The CW Kids Block if such merchandising revenues exceed a certain annual minimum.
As of March 31, 2008, the minimum guaranteed payment obligations under the CW Agreement are as follows:
The Company’s ability to recover the cost of its fee payable to Fox and the minimum guarantee due to The CW will depend on the popularity of the television programs which are broadcast on 4Kids TV and The CW Kids Block and the general market demand and pricing of advertising time for Saturday morning children’s broadcast television. The popularity of such programs, broadcast on 4Kids TV and beginning in September 2008 on The
CW Kids Block, 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 and The CW Kids Block 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 and/or The CW, the Company would record a charge to earnings to reflect an expected loss on the Fox and The CW agreements in the period in which the factors negatively affecting the recoverability of the fee payable become known. The Company will be required to make certain assumptions and estimates about future events such as advertising rates and audience viewing levels in evaluating its ability to recover the cost of the broadcast fees. Such estimates and assumptions are subject to market forces and factors beyond the control of the Company and are inherently subject to change. There can be no assurance that the Company will be able to recover the full cost of the broadcast fees and in the event it cannot, it would record the resulting charge to earnings to reflect an expected loss on the broadcast fee, which could be significant.
In addition to the broadcast fee paid to Fox and minimum guarantee to be paid to The CW, commencing with the 2008-2009 broadcast season, the Company incurs additional costs to program each broadcast block and sell the related network advertising time. These costs include direct programming costs to acquire, adapt and deliver programming for the broadcast during the weekly broadcast blocks, as well as additional indirect expenses of advertising sales, promotion and administration.
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, geographic restrictions, duration, property and exploitation condition and results of operation.
c. Stock Purchases - On December 4, 2007, the Company announced that 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, 2008 in the open market or through negotiated prices. The Company purchased 235,484 shares at an average price of $11.65 per share for the three months ended March 31, 2008 under this authorization. As of May 9, 2008, no shares of the Company’s common stock were subsequently purchased by the Company under this authorization.
11. MINORITY INTEREST
a) TC Digital Games LLC - On December 11, 2006, 4Kids Digital and CUSA LLC entered into the TCD Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47% of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital purchased an additional 2% membership interest in TC Digital from CUSA for approximately $200, increasing 4Kids Digital’s ownership percentage to 55%. The consideration for the purchase of this additional membership interest was paid through the settlement of capital contributions required to be made by CUSA to TC Websites under the TCW Agreement. TC Digital is treated as a consolidated subsidiary of the Company as a result of its majority ownership and its right to break any dead-locks within the TC Digital Management Committee.
Minority interest of membership units in TC Digital represents the minority members’ proportionate share of the equity in the entity. Income is allocated to the membership units minority interest based on the ownership percentage throughout the year. At December 18, 2007, the minority members’ proportionate share of the equity in the entity decreased by 2% to 45% and at March 31, 2008, the minority member continued to hold 45% of the equity in the entity. The following table summarizes the minority interest loss attributable to the minority equity interest in TC Digital: