[table][TR][TD][/TD][/TR][/table]Form 10-Q for 4 KIDS ENTERTAINMENT INC
[hr][/hr]15-May-2012 Quarterly Report
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 three months ended March 31, 2012 were primarily impacted by the receipt of a payment to 4Kids in the amount of $8,000 based upon the order of the Bankruptcy Court approving the Settlement Agreement becoming a final order which resulted in the Company recognizing a gain on litigation settlement of $8,000. The Company continues to experience declining popularity of its existing Properties combined with the failure of new Properties to achieve satisfactory popularity levels. In addition, the Company continues to incur costs associated with the Bankruptcy Cases, which costs the Company expects to continue to incur throughout the Bankruptcy proceedings.
Chapter 11 Bankruptcy Proceedings - On April 6, 2011 (the "Petition Date"), the Company and all of its domestic wholly-owned subsidiaries (the "Debtors") filed voluntary petitions for relief (the "Bankruptcy Cases") under Title 11 of Chapter 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"), which Bankruptcy Cases are jointly administered under Case No. 11-11607. The Company will continue to operate itself and its subsidiaries as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. In general, as debtors-in-possession, we are authorized under Chapter 11 of the Bankruptcy Code to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the prior approval of the Bankruptcy Court. 4Kids Entertainment International, Ltd., the Company's subsidiary based in London, England, and TC Digital Games LLC and TC Websites LLC, two domestic subsidiaries in each of which the Company holds a majority ownership, were not included in the filing and will continue to operate outside the Bankruptcy Cases.
Shortly after the Petition Date, the Debtors began notifying all known current or potential creditors of the Debtors regarding the commencement of the Bankruptcy Cases. Subject to certain exceptions under the Bankruptcy Code, the commencement of the Bankruptcy Cases automatically enjoined, or stayed, the continuation of any judicial or administrative proceedings or other actions against the Debtors or their property to recover on, collect or secure a claim arising prior to the Petition Date. Thus, for example, most creditor actions to obtain possession of property from the Debtors, or to create, perfect or enforce any lien against the property of the Debtors, or to collect on monies owed or otherwise exercise rights or remedies with respect to a pre-petition claim are enjoined unless and until the Bankruptcy Court lifts the automatic stay.
After the filing of the Bankruptcy Cases, the United States Trustee for the Southern District of New York appointed an official committee of unsecured creditors (the "Creditors' Committee"). The Creditors' Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court with respect to the Debtors. There can be no assurance that the Creditors' Committee will support the Debtors' positions on matters to be presented to the Bankruptcy Court in the future or on any bankruptcy plan, once proposed. Disagreements between the Debtors and the Creditors' Committee could protract the Bankruptcy Cases, negatively impact the Debtors' ability to operate and delay the Debtors' emergence from Chapter 11. Under Section 365 and other relevant sections of the Bankruptcy Code, we may assume, assume and assign, or reject certain executory contracts and unexpired leases, including, without limitation, leases of real property and equipment, subject to the approval of the Bankruptcy Court and certain other conditions. Any description of an executory contract or unexpired lease in this report, including, where applicable, our express termination rights or a quantification of our obligations, must be read in conjunction with, and is qualified by, any overriding rejection rights we have under Section 365 of the Bankruptcy Code.
On February 29, 2012, 4Kids and the Licensors entered into a Settlement Agreement, dated as of February 27, 2012 (the "Settlement Agreement"), settling all claims brought by Licensors against 4Kids and all counterclaims brought by 4Kids against the Licensors in the Yu-Gi-Oh! Litigation. The Settlement Agreement provides, among other things, for the Licensors to make a payment to 4Kids in the amount of $8,000 upon the order of the Bankruptcy Court approving the Settlement Agreement becoming a final order. On March 9, 2012, the Bankruptcy Court issued an order approving the Settlement Agreement and, accordingly, the Company recognized a gain on litigation settlement of $8,000. Under the Settlement Agreement, the Licensors acknowledged that the Yu-Gi-Oh! Agreement remained valid, binding and legally enforceable with 4Kids continuing to serve as the exclusive licensing agent for the merchandise licensing, television broadcast and home video rights to the Yu-Gi-Oh! Property throughout the world outside of Asia. The Settlement Agreement further provided for each of 4Kids and the Licensors to release each other from all claims they may have against each other, other than certain indemnification claims and claims that may arise under the Settlement Agreement. The Settlement Agreement also provided that the agreement does not constitute an admission by any party of any violation of any agreement or law. On March 27, 2012, 4Kids received the payment in the amount of $8,000 pursuant to the Settlement Agreement.
[hr][/hr]On April 26, 2012, 4Kids, and its subsidiaries which are debtors in the cases pending in the Bankruptcy Court, (4Kids and such subsidiaries, collectively, "Seller"), entered into an Asset Purchase Agreement (the "Asset Purchase Agreement"), which contemplates the sale of substantially all of its assets to Kidsco Media Ventures LLC, a Delaware limited liability company, and an affiliate of Saban Capital Group ("Kidsco" or "Purchaser") for a purchase price of $10,000, subject to certain adjustments (the "Purchase Price"). The transaction is proposed under section 363 of the Bankruptcy Code. The transaction is subject to, among other things, (i) competitive bidding pursuant to such sale procedures which was approved by the Bankruptcy Court at a hearing on April 27, 2012, and (ii) approval of the transaction by the Bankruptcy Court.
While the consummation of the Settlement Agreement and the execution of the Asset Purchase Agreement represent significant steps in the process of resolving the Bankruptcy Cases, the timing of any resolution of the Bankruptcy Cases will depend on the timing and outcome of numerous other ongoing matters therein, and it is not possible at this time to accurately predict when such other matters will be resolved. We have incurred and will continue to incur significant costs associated with the Bankruptcy Cases. The amount of these costs, which began in April 2011 and are being expensed as incurred, are expected to significantly affect our results of operations, financial position and liquidity. The Bankruptcy Cases have also presented challenges to our ability to generate additional revenues in all of our business segments especially as it relates to the sales of commercial advertising.
The Company will consider all alternatives available to generate additional cash to fund its operations, including, but not limited to sales of assets, issuance of equity or debt securities, and third party arrangements subject to any limitations and procedures arising from the Bankruptcy Cases.
Our ability to achieve and maintain profitability and positive cash flow is dependent upon the success of our reorganizational efforts and a number of other factors, including our ability to generate additional revenues. The Company's financial statements have been prepared assuming that the Company will continue as a going concern and do not contain any adjustments that may result from the outcome of this uncertainty.
4Kids historical recurring losses and negative cash flows from operations has caused 4Kids' independent registered public accounting firm, in the Company's annual report for the year ended December 31, 2011, to include an explanatory paragraph in their report dated March 22, 2012, expressing substantial doubt about 4Kids' ability to continue as a going concern.
The Company receives revenues from the following 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 for only a limited period of time. The Company's revenues are highly subject to changing trends in the toy, game and entertainment businesses, potentially causing dramatic increases and decreases from year to year due to the popularity of particular Properties. It is not possible to accurately predict the length of time a Property will be commercially successful and/or if a Property will be commercially successful at all. Popularity of Properties can vary from months to years. As a result, the Company's revenues from particular Properties may fluctuate significantly between comparable periods.
The Company's licensing revenues have historically been derived primarily from the licensing of toy and game concepts. As a result, a substantial portion of the Company's revenues and net income are subject to the seasonal variations of the toy and game industry. Typically, a majority of toy orders are shipped in the third and fourth calendar quarters resulting in increased royalties earned by the Company during such calendar quarters. The Company recognizes revenues from the sale of advertising time on the leased Saturday morning programming block from The CW ("The CW4Kids"), as more fully described in Note 2 of the notes to the Company's consolidated financial statements. The Company's advertising sales subsidiary, 4Kids Ad Sales, sells advertising time on The CW4Kids at higher rates in the fourth quarter due to the increased demand for commercial time by children's advertisers during the holiday season. As a result, much of the revenues of 4Kids Ad Sales are earned in the fourth quarter when the majority of toy and video game advertising occurs. As a result of the foregoing, the Company has historically experienced greater revenues during the second half of the year than during the first half of the year.
[hr][/hr]Effective September 30, 2010, the Company terminated the operations of TC Digital Games LLC ("TC Digital"), the joint venture which produced, marketed and distributed the "Chaotic" trading card game, and TC Websites LLC ("TC Websites"), the joint venture that owns and operates www.chaoticgame.com, the companion website for the "Chaotic" trading card game. The Company owns 55% of each of TC Digital and TC Websites. The closing of these companies enabled the Company to further reduce costs and focus on its core businesses. As a consequence of the termination of their operations, TC Digital and TC Websites ceased supporting the Chaotic trading card game and website, effective October 1, 2010. TC Digital and TC Websites are included in discontinued operations in the Company's consolidated financial statements, subject to a noncontrolling interest.
Critical Accounting Policies
The Company's accounting policies are fully described in Note 2 of the notes to the Company's consolidated financial statements. Below is a summary of the critical accounting policies, among others, that management believes involve significant judgments and estimates used in the preparation of its consolidated financial statements.
Accounting for Film and Television Costs - 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.
Any revisions to ultimate revenues can result in significant quarter-to-quarter and year-to-year fluctuations in film and television write-downs and amortization. A typical film or television series recognizes a substantial portion of its ultimate revenues within the first three years of release. By then, the film or television series has been exploited in the domestic and international television (network and cable) and home video markets. In addition, a significant portion of licensing revenues associated with the film or television series will have been realized. A similar portion of the film's or television series' capitalized costs should be expected to be amortized accordingly, assuming the film or television series is profitable.
The commercial potential of individual films and television programming varies dramatically, and is not directly correlated with production or acquisition costs. Therefore, it is difficult to predict or project the impact that individual films or television programming will have on the Company's results of operations. However, the likelihood that the Company will report losses, particularly in the year of a television series initial release, is increased as the applicable accounting literature requires the immediate recognition of all of the production or acquisition costs (through increased amortization) in instances where it is estimated that the ultimate revenues of a film or television series will not recover those costs. Conversely, the profit from a film or television series must be deferred and recognized over the entire revenue stream generated by that film or television series. As a result, significant fluctuations in reported income or loss can occur, particularly on a quarterly basis, depending on release schedules and broadcast dates, the timing of advertising campaigns and the relative performance of individual film or television series.
Reorganization Items - The Company's costs relate to professional, consulting and trustee fees in conjunction with the filing of the Bankruptcy Cases. These types of expenditures are expensed as incurred and reported as reorganization items.
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 trading card and home video inventory. The Company estimates the amount of uncollectible receivables from its business segments by monitoring delinquent accounts and estimating a reserve based on contractual terms and other customer specific issues.
Revenue Recognition - The Company's revenue recognition policies for its 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.
[hr][/hr]Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company continually evaluates the policies and estimates that it uses to prepare its consolidated financial statements. In general, management's estimates and assumptions are based on historical experience, known trends or events, information from third-party professionals and other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.
Recently Issued Accounting Standards - There have been no recent accounting pronouncements expected to have a material impact on the Company's financial condition or results of operations and cash flow.
Recently Adopted Accounting Standards - In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The objective of ASU 2011-05 is to improve the comparability, consistency, and transparency of financial reporting, to increase the prominence of items reported in other comprehensive income, and to facilitate convergence of U.S. GAAP and International Financial Reporting Standards. To achieve this, the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in ASU 2011-05 require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. Finally, current GAAP does not require an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income, which is required by the guidance in ASU 2011-05. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company's adoption of this guidance did not have any effect on the Company's consolidated financial position and results of operations.
The "Yu-Gi-Oh!" Property was the largest contributor to this business segment for the three months ended March 31, 2012, with approximately 81% of the Company's revenues.