**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-K/A**

**(Amendment No. 1)**

 

**ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE**

**ACT OF 1934**

**For thefiscal year ended December 31, 2004**

**OR**

**oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGEACT OF 1934**

**For thetransition period from                to                 **

 

**Commission File No. 0-7843**

 

**4Kids Entertainment, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

| **1414  Avenue of the Americas, New York, New York** | **10019**  |
|------------------------------------------------------|------------|
| (Address of  principal executive offices)            | (Zip Code) |

 

Registrant’stelephone number, including area code:**(212) 758-7666**

 

Securities registered pursuant to Section 12(b) ofthe Act:**None**

 

Securities registered pursuant to Section 12(g) ofthe Act:

**CommonStock, $.01 par value**

(Title of Class)

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) hasbeen subject to the filing requirements for the past 90 days. Yes ýNo o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the Registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Act) Yes ý No o

 

The aggregate market value of the voting stock held bynon-affiliates of the Registrant, based on the closing price of the CommonStock on June 30, 2004 as reported on the New York Stock Exchange Market,was approximately $299,947,000. Shares of Common Stock held by each officer anddirector and by each person who owns 5% or more of the outstanding Common Stockhave been excluded from this computation in that such persons may be deemed tobe affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

 

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

 

| **Common  Stock, $.01 Par Value** | ** ** | **13,311,768**                                           |
|-----------------------------------|------------|----------------------------------------------------------|
| (Title of Class)                  |       | (No. of Shares  Outstanding at March 15, 2005) |

 

**Portionsof the Registrant’s Proxy Statement for the Annual Meeting of Stockholders tobe held on May 26, 2005 are incorporated by reference into Part IIIof this Annual Report  on Form 10-K**

 

 

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**ExplanatoryNote:**

 

This Form 10-K/Ais being filed to include the correct Report of Independent Registered PublicAccounting Firm on Consolidated Financial Statements in Item 8 FinancialStatements and Supplementary Data.  On March 17,2005, the Company was informed by its auditors, that they had inadvertentlyprovided an incorrect version of their Report of Independent Registered PublicAccounting Firm included in the Form 10-K filed on March 16,2005. The Report of Independent Registered Public Accounting Firm that wasfiled with the Form 10-K on March 16, 2005, included languagein the second paragraph relating to internal control over financial reportingand language in the third paragraph relating to financial statementschedules.  That language has beendeleted from the Report being filed with this Form 10-K/A.

 

**Item8.    Financial Statements and Supplementary Data**

 

The Report of Registered Public IndependentAccounting Firm, our Consolidated Financial Statements and Notes thereto appearin a separate section of this Form 10-K/A (beginning on Page F-1following Part IV). The index to our Consolidated Financial Statements isincluded in Item 15 in the Form 10-K filed on March 16, 2005.

 

2

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated.

 

Date: March 18, 2005

 
| /s/ Joseph P. Garrity          |   |
|--------------------------------|--------|
| Joseph P. Garrity,             |   |
| Executive Vice President,      |   |
| Treasurer, Principal Financial |   |
| Officer, Principal Accounting  |   |
| Officer and Director           |   |

 

3

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**INDEX OF EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                   | ** ** | **Page  Number** |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
|                |       |                                                                                                                                                                                              |       |             |
| 23.1                |       | Consent of  Deloitte & Touche LLP, Independent Registered Public Accounting  Firm.                                                                                                       |       |             |
|                |       |                                                                                                                                                                                              |       |             |
| 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. |       |             |

 

4

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM ON CONSOLIDATED FINANCIAL STATEMENTS**

 

To the Board of Directorsand Stockholders of4Kids Entertainment, Inc. and Subsidiaries

 

We have audited the accompanying consolidatedbalance sheets of 4Kids Entertainment, Inc. and Subsidiaries (the “Company”)as of December 31, 2004 and 2003, and the related consolidated statementsof income, stockholders’ equity and comprehensive income and cash flows foreach of the three years in the period ended December 31, 2004. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

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

 

In our opinion, such consolidated financialstatements present fairly, in all material respects, the financial position ofthe Company as of December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2004, in conformity with accounting principles generallyaccepted in the United States of America.

 
| /s/ Deloitte & Touche LLP |   |
|-------------------------------|--------|
|                          |
| New York, NY                  |
| March 16, 2005           |

 

F-1

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**Part I– FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

**4KIDS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**DECEMBER 31, 2004 and 2003**

(In thousands of dollars, except share data)

 
| ** **                                                                                                                                                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ASSETS                                                                                                                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| CURRENT ASSETS:                                                                                                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                                              |       | $          | 111,759    |       | $          | 95,136 |   |
| Investments                                                                                                                                                                            |       | 16,067     |       | 24,443     |       |
| Total cash and investments                                                                                                                                                             |       | 127,826    |       | 119,579    |       |
| Accounts receivable - net                                                                                                                                                              |       | 39,917     |       | 37,143     |       |
| Prepaid 4Kids TV broadcast fee, net of accumulated  amortization of $64,306 and $36,447 in 2004 and 2003, respectively                                                                 |       | 6,991      |       | 8,688      |       |
| Prepaid income taxes                                                                                                                                                                   |       | 3,074      |       | 2,670      |       |
| Prepaid expenses and other current assets                                                                                                                                              |       | 1,759      |       | 1,690      |       |
| Deferred income taxes                                                                                                                                                                  |       | 158        |       | —     |       |
| Total current assets                                                                                                                                                                   |       | 179,725    |       | 169,770    |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| PROPERTY AND EQUIPMENT - NET                                                                                                                                                           |       | 2,821      |       | 3,350      |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| OTHER ASSETS:                                                                                                                                                                          |       |       |       |       |       |
| Accounts receivable - noncurrent, net                                                                                                                                                  |       | 901        |       | 2,662      |       |
| Investment in equity securities                                                                                                                                                        |       | 726        |       | 726        |       |
| Film and television costs - net                                                                                                                                                        |       | 10,518     |       | 8,183      |       |
| Deferred income taxes - noncurrent                                                                                                                                                     |       | 2,241      |       | 2,575      |       |
| Other assets – net                                                                                                                                                                |       | 8,083      |       | 6,014      |       |
| TOTAL ASSETS                                                                                                                                                                           |       | $          | 205,015    |       | $          | 193,280 |   |
|                                                                                                                                                                                   |       |       |       |       |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                              |       |       |       |       |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| CURRENT LIABILITIES:                                                                                                                                                                   |       |       |       |       |       |
| Due to licensors                                                                                                                                                                       |       | $          | 16,859     |       | $          | 11,835 |   |
| Media payable                                                                                                                                                                          |       | 3,723      |       | 2,178      |       |
| Accounts payable and accrued expenses                                                                                                                                                  |       | 12,589     |       | 9,706      |       |
| Deferred revenue                                                                                                                                                                       |       | 6,855      |       | 8,070      |       |
| Deferred income taxes                                                                                                                                                                  |       | —     |       | 52         |       |
| Total current liabilities                                                                                                                                                              |       | 40,026     |       | 31,841     |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| DEFERRED RENT                                                                                                                                                                          |       | 1,011      |       | 952        |       |
| Total liabilities                                                                                                                                                                      |       | 41,037     |       | 32,793     |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                          |       |       |       |       |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| 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, 14,411,768 and 13,965,343 shares; outstanding 13,661,768 and 13,965,343  shares in 2004 and 2003, respectively |       | 144        |       | 140        |       |
| Additional paid-in capital                                                                                                                                                             |       | 58,068     |       | 52,798     |       |
| Accumulated other comprehensive income                                                                                                                                                 |       | 1,124      |       | 693        |       |
| Retained earnings                                                                                                                                                                      |       | 119,586    |       | 106,856    |       |
|                                                                                                                                                                                   |       | 178,922    |       | 160,487    |       |
| Less- cost of 750,000 treasury shares                                                                                                                                                  |       | 14,944     |       | —     |       |
|                                                                                                                                                                                   |       | 163,978    |       | 160,487    |       |
|                                                                                                                                                                                   |       |       |       |       |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                        |       | $          | 205,015    |       | $          | 193,280 |   |

 

See notes to consolidated financial statements.

 

F-2

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**4KIDS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**

(In thousands of dollars, except share data)

 
| ** **                                                            | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                                  |       |       |       |       |       |       |       |
| NET REVENUES                                                          |       | $          | 103,306    |       | $          | 102,079    |       | $ | 53,140 |   |
|                                                                  |       |       |       |       |       |       |       |
| COSTS AND EXPENSES:                                                   |       |       |       |       |       |       |       |
| Selling, general and administrative                                   |       | 36,755     |       | 33,743     |       | 25,374     |       |
| Production service costs                                              |       | 10,029     |       | 7,819      |       | 3,375      |       |
| Amortization of television and film costs and 4Kids  TV broadcast fee |       | 36,669     |       | 36,946     |       | 14,355     |       |
| Total costs and expenses                                              |       | 83,453     |       | 78,508     |       | 43,104     |       |
|                                                                  |       |       |       |       |       |       |       |
| INCOME FROM OPERATIONS                                                |       | 19,853     |       | 23,571     |       | 10,036     |       |
|                                                                  |       |       |       |       |       |       |       |
| INTEREST INCOME                                                       |       | 1,469      |       | 1,112      |       | 1,656      |       |
|                                                                  |       |       |       |       |       |       |       |
| INCOME BEFORE INCOME TAXES                                            |       | 21,322     |       | 24,683     |       | 11,692     |       |
|                                                                  |       |       |       |       |       |       |       |
| INCOME TAXES                                                          |       | 8,592      |       | 9,884      |       | 4,702      |       |
| NET INCOME                                                            |       | $          | 12,730     |       | $          | 14,799     |       | $ | 6,990 |   |
|                                                                  |       |       |       |       |       |       |       |
| PER SHARE AMOUNTS:                                                    |       |       |       |       |       |       |       |
| Basic earnings per common share                                       |       | $          | 0.93       |       | $          | 1.11       |       | $ | 0.55 |   |
|                                                                  |       |       |       |       |       |       |       |
| Diluted earnings per common share                                     |       | $          | 0.89       |       | $          | 1.05       |       | $ | 0.51 |   |
|                                                                  |       |       |       |       |       |       |       |
| Weighted average common shares outstanding - basic                    |       | 13,683,756 |       | 13,292,852 |       | 12,653,102 |       |
|                                                                  |       |       |       |       |       |       |       |
| Weighted average common shares outstanding - diluted                  |       | 14,335,343 |       | 14,156,291 |       | 13,726,642 |       |

 

See notes to consolidated financial statements.

 

F-3

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**4KIDS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**

**YEARS ENDED DECEMBER 31, 2004,2003 AND 2002**

(In thousands of dollars and shares)

 
| ** **                                 | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-------------------|------------|-----------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **        | ** ** | **Other**       | ** ** | **Less:**  | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained**   | ** ** | **Comprehensive** | ** ** | **Treasury**    | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Earnings**      | ** ** | **Income**      | ** ** | **Stock**  | ** ** | **Total**  | ** ** |
| ** **                                 | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
| BALANCE, DECEMBER 31, 2001            |       | 12,547           |       | $           | 125        |           | $          | 33,266            |       | $               | 85,067     |       | $          | —     |       | $ | — |   | $ | 118,458 |   |
| Proceeds from exercise of stock options    |       | 588              |       | 6           |       | 2,062          |       | —            |       | —          |       | —     |       | 2,068      |       |
| Tax benefit from exercise of stock options |       | —           |       | —      |       | 5,083          |       | —            |       | —          |       | —     |       | 5,083      |       |
| Comprehensive income:                      |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| Net income                                 |       | —           |       | —      |       | —         |       | 6,990             |       | —          |       | —     |       | 6,990      |       |
| Translation adjustment                     |       | —           |       | —      |       | —         |       | —            |       | 72              |       | —     |       | 72         |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| Total comprehensive income                 |       | —           |       | —      |       | —         |       | —            |       | —          |       | —     |       | 7,062      |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| BALANCE, DECEMBER 31, 2002            |       | 13,135           |       | $           | 131        |           | $          | 40,411            |       | $               | 92,057     |       | $          | 72         |       | $ | — |   | $ | 132,671 |   |
| Proceeds from exercise of stock options    |       | 830              |       | 9           |       | 6,399          |       | —            |       | —          |       | —     |       | 6,408      |       |
| Tax benefit from exercise of stock options |       | —           |       | —      |       | 5,988          |       | —            |       | —          |       | —     |       | 5,988      |       |
| Comprehensive income:                      |       |             |       |        |       |           |       |              |       |            |       | —     |       |       |       |
| Net income                                 |       | —           |       | —      |       | —         |       | 14,799            |       | —          |       | —     |       | 14,799     |       |
| Translation adjustment                     |       | —           |       | —      |       | —         |       | —            |       | 621             |       | —     |       | 621        |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| Total comprehensive income                 |       | —           |       | —      |       | —         |       | —            |       | —          |       | —     |       | 15,420     |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| BALANCE, DECEMBER 31, 2003            |       | 13,965           |       | $           | 140        |           | $          | 52,798            |       | $               | 106,856    |       | $          | 693        |       | $ | — |   | $ | 160,487 |   |
| Proceeds from exercise of stock options    |       | 446              |       | 4           |       | 2,295          |       | —            |       | —          |       | —     |       | 2,299      |       |
| Tax benefit from exercise of stock options |       | —           |       | —      |       | 2,975          |       | —            |       | —          |       | —     |       | 2,975      |       |
| Acquisition of treasury stock, at cost     |       | —           |       | —      |       | —         |       | —            |       | —          |       | (14,944    | )          | (14,944    | )          |
| Comprehensive income:                      |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| Net income                                 |       | —           |       | —      |       | —         |       | 12,730            |       | —          |       | —     |       | 12,730     |       |
| Translation adjustment                     |       | —           |       | —      |       | —         |       | —            |       | 431             |       | —     |       | 431        |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| Total comprehensive income                 |       | —           |       | —      |       | —         |       | —            |       | —          |       | —     |       | 13,161     |       |
|                                       |       |             |       |        |       |           |       |              |       |            |       |       |       |       |       |
| BALANCE, DECEMBER 31, 2004            |       | 14,411           |       | $           | 144        |           | $          | 58,068            |       | $               | 119,586    |       | $          | 1,124      |       | $ | (14,944 | ) | $ | 163,978 |   |

 

See notes to consolidated financial statements.

 

F-4

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**4KIDS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2004,2003 AND 2002**

(In thousands of dollars)

 
| ** **                                                                                   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                        |       |       |       |       |       |       |       |
| Net income                                                                                   |       | $          | 12,730     |       | $          | 14,799     |       | $ | 6,990 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |       |       |       |       |       |       |
| Depreciation and amortization                                                                |       | 1,385      |       | 1,855      |       | 865        |       |
| Amortization of television and film costs and 4Kids  TV broadcast fee                        |       | 36,669     |       | 36,946     |       | 14,355     |       |
| Provision for (recovery of) doubtful accounts                                                |       | (354       | )          | 120        |       | 901        |       |
| Deferred income taxes                                                                        |       | 124        |       | (2,589     | )          | (2,163     | )          |
| Tax benefit on exercise of stock options                                                     |       | 2,975      |       | 5,988      |       | 5,083      |       |
| Changes in operating assets and liabilities:                                                 |       |       |       |       |       |       |       |
| Accounts receivable                                                                          |       | (659       | )          | 4,655      |       | (31,166    | )          |
| Film and television costs                                                                    |       | (11,145    | )          | (12,473    | )          | (6,382     | )          |
| Prepaid income taxes                                                                         |       | (404       | )          | (1,035     | )          | 1,949      |       |
| Prepaid Fox broadcast fee                                                                    |       | (26,162    | )          | (25,834    | )          | (19,301    | )          |
| Prepaid expenses and other current assets                                                    |       | (69        | )          | 2,181      |       | 172        |       |
| Other assets - net                                                                           |       | (2,069     | )          | (4,369     | )          | (1,058     | )          |
| Due to licensors                                                                             |       | 5,024      |       | 2,772      |       | (7,849     | )          |
| Media payable                                                                                |       | 1,545      |       | (3,435     | )          | 4,025      |       |
| Accounts payable and accrued expenses                                                        |       | 2,883      |       | (70        | )          | 5,561      |       |
| Deferred revenue                                                                             |       | (1,215     | )          | 4,094      |       | 3,879      |       |
| Deferred rent                                                                                |       | 59         |       | 195        |       | 517        |       |
|                                                                                         |       |       |       |       |       |       |       |
| Net cash provided by (used in) operating activities                                          |       | 21,317     |       | 23,800     |       | (23,622    | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                        |       |       |       |       |       |       |       |
| Proceeds from maturities of investments                                                      |       | 54,529     |       | 57,706     |       | 41,366     |       |
| Purchase of investments                                                                      |       | (46,153    | )          | (71,362    | )          | (42,998    | )          |
| Purchase of property and equipment                                                           |       | (856       | )          | (749       | )          | (2,619     | )          |
|                                                                                         |       |       |       |       |       |       |       |
| Net cash provided by (used in) investing activities                                          |       | 7,520      |       | (14,405    | )          | (4,251     | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES -                                                       |       |       |       |       |       |       |       |
| Proceeds from exercise of stock options                                                      |       | 2,299      |       | 6,408      |       | 2,068      |       |
| Purchase of treasury shares                                                                  |       | (14,944    | )          | —     |       | —     |       |
|                                                                                         |       |       |       |       |       |       |       |
| Net cash (used in) provided by financing activities                                          |       | (12,645    | )          | 6,408      |       | 2,068      |       |
| EFFECTS OF EXCHANGE RATE CHANGES ON CASH AND CASH  EQUIVALENTS                               |       | 431        |       | 621        |       | 72         |       |
|                                                                                         |       |       |       |       |       |       |       |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                         |       | 16,623     |       | 16,424     |       | (25,733    | )          |
|                                                                                         |       |       |       |       |       |       |       |
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                                 |       | 95,136     |       | 78,712     |       | 104,445    |       |
|                                                                                         |       |       |       |       |       |       |       |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                                       |       | $          | 111,759    |       | $          | 95,136     |       | $ | 78,712 |   |
|                                                                                         |       |       |       |       |       |       |       |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                            |       |       |       |       |       |       |       |
|                                                                                         |       |       |       |       |       |       |       |
| CASH PAID DURING THE YEAR FOR:                                                               |       |       |       |       |       |       |       |
| Income Taxes                                                                                 |       | $          | 5,941      |       | $          | 7,874      |       | $ | 1,874 |   |

 

See notes to consolidated financial statements.

 

F-5

----

 

**4KIDS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**

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

 

**1. DESCRIPTION OF BUSINESS**

 

4Kids Entertainment, Inc. (the “Company”),together with the subsidiaries through which the Company’s businesses areconducted (the “Company”), is a diversified entertainment and media companyspecializing in the youth oriented market with operations in the followingbusiness segments: Licensing, Advertising Media and Broadcast, Television andFilm Production/Distribution.

 

***Licensing*** -The Company’s wholly-owned subsidiary, 4Kids Entertainment Licensing, Inc.(“4Kids Licensing”), is engaged in the business of licensing the merchandisingrights to popular children’s television series, properties and product concepts(collectively the “Properties”). 4Kids Licensing typically acts as exclusivemerchandising agent in connection with the grant to third parties of licensesto manufacture and sell all types of merchandise, including toys, videogames,trading cards, apparel, housewares, footwear, books and other publishedmaterials, based on such Properties. 4Kids Entertainment International, Ltd. (“4Kids International”), theCompany’s wholly-owned subsidiary based in London, manages the Propertiesrepresented by the Company in the United Kingdom and Europeanmarketplaces.  Licensing revenuesaccounted for approximately 49%, 54% and 54% of consolidated net revenues forthe years ended December 31, 2004, 2003 and 2002, respectively.

 

4Kids Technology, Inc., a wholly-ownedsubsidiary, develops ideas and concepts for licensing which integrate new andexisting technologies with traditional game and toy play patterns. Websites4Kids, Inc., a wholly-owned subsidiary, specializes in website developmentby creating websites designed to enhance and support the marketing of children’sproperties represented by the Company.

 

***Advertising Media and Broadcast***- The Company, through a multi-year agreement with Fox leases Fox’s Saturdaymorning programming block from 8am to 12pm eastern/pacific time (7am to 11amcentral time).  In January, 2005, theCompany changed the name of the Saturday morning programming block from Fox Boxto 4Kids TV.  The Company providessubstantially all programming content to be broadcast on 4Kids TV. 4Kids AdSales, Inc., a wholly-owned subsidiary of the Company, retains all of therevenue from its sale of network advertising time for the four-hour timeperiod.

 

The Company’s wholly-owned subsidiary, The Summit MediaGroup, Inc. (“Summit Media”), provides print and broadcast media planningand buying services for clients which are principally in the children’s toy andgame business. Summit Media is compensated by receiving a percentage of thecost of the media it places.

 

***Television and FilmProduction/Distribution*** - The Company’s wholly-ownedsubsidiary, 4Kids Productions, Inc. (“4Kids Productions”), produces andacquires animated and live-action television programs and theatrical motionpictures for distribution to the television, home video and theatrical markets.4Kids Productions also adapts foreign programming for the U.S. market andproduces original animated television programming for domestic andinternational broadcast. Additionally, 4Kids Productions produces originalmusic compositions for use with its television and film production activities.

 

4Kids Entertainment Music, Inc. (“4Kids Music”),a wholly-owned subsidiary, markets and manages the musical operations for theCompany on certain existing and newly created music associated with itstelevision programming. 4Kids Entertainment Home Video, Inc. (“4Kids HomeVideo”), a wholly-owned subsidiary, distributes home videos associated withtelevision programming produced by 4Kids Productions.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Principles of Consolidation***- The accompanying consolidated financial statements include the accounts of4Kids Entertainment, Inc. and its wholly-owned subsidiaries afterelimination of significant intercompany transactions and balances. Theseconsolidated financial statements reflect the use of significant accountingpolicies, as described below and elsewhere in the notes to the consolidatedfinancial statements. These financial statements are prepared in accordancewith accounting principles generally accepted in the United States of America.

 

F-6

----

 

***Revenue Recognition***– *Merchandising licensing revenues*:Merchandise licensing revenues are recognized when the underlying royaltiesfrom the sales of the related products are earned. The Company recognizesguaranteed royalties at the time the arrangement becomes effective if theCompany has no significant direct continuing involvement with the underlyingproperty or obligation to the licensee. Where the Company has significantcontinuing direct involvement with the underlying property or obligation to thelicensee, guaranteed minimum royalties are recognized ratably over the term ofthe license or based on sales of the related products, if greater. Licensingadvances and guaranteed payments collected, but not yet earned by the Company,are classified as deferred revenue in the accompanying consolidated balancesheets.

 

*Broadcast advertising revenues*:Advertising revenues are recognized when the related commercials are aired andare recorded net of agency commissions and an appropriate reserve whenadvertising is sold together with a guaranteed audience delivery. Internetadvertising revenues are recognized on the basis of impression views in theperiod the advertising is displayed. Fee-based commissions for media planningand buying services, for clients in both print and broadcast media, arerecognized at the time the related media runs.

 

*Episodic television series revenue*:Television series initially produced for networks and first-run syndication aregenerally licensed to domestic and foreign markets concurrently. The length ofthe revenue cycle for episodic television varies depending on the number ofseasons a series remains in active exploitation. Revenues arising fromtelevision license agreements are recognized in the period that the films orepisodic television series are available for telecast.

 

Production and adaptation costs charged to thelicensor are included in net revenues and the corresponding costs are includedin production service costs in the accompanying consolidated statements ofincome. Production service costs included in net revenues amounted to $9,629,$7,005 and $3,375 in 2004, 2003 and 2002, respectively.

 

*Home video revenues*: Revenuesfrom home video and DVD sales, net of a reserve for returns, are recognized onthe date that video and DVD units are shipped by the Company’s distributor towholesalers/retailers. Consistent with the practice in the home video industry,the Company estimates the reserve for returns based upon its review ofhistorical returns rates and expected future performance.

 

*Music revenues*: Revenues frommusic sales, net of a reserve for returns, are recognized on the date units areshipped by the Company’s distributor to wholesalers/retailers as reported tothe Company. In the case of musical performance revenues, the revenue isrecognized when the musical recordings are broadcast and/or performed.

 

***Advertising Expense***- Advertising costs are expensed as incurred, except for costs related to thedevelopment of a property and/or animated or live-action television programcommercial or media campaign which are expensed in the period in which thecommercial or campaign is first presented. Advertising expenses are included inselling, general and administrative expenses on the accompanying consolidatedstatements of income.

 

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

 

***Impairment Of Long-Lived AndIntangible Assets*** - As required by Statement of FinancialAccounting Standards (“SFAS”) No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets,* (which the Companyadopted on January 2, 2002), the Company assesses the recoverability oflong-lived assets for which an indicator of impairment exists. Therecoverability of assets to be held and used is measured by comparing thecarrying amount of an asset to the future undiscounted net cash flows expectedto be generated by the asset. If an asset is considered to be impaired, theimpairment to be recognized is measured as the amount by which the carryingamount of the asset exceeds its fair value. Fair value of long-lived assets isdetermined using the expected cash flows discounted at a rate commensurate withthe risk involved. The Company believes that the future cash flows to be receivedfrom our long-lived assets will exceed the respective assets’ carrying value,and accordingly has not recorded any impairment losses through December 31,2004.

 

***Cash and Cash Equivalents***- All highly liquid investments with original maturities of three months orless are classified as cash and cash equivalents. The fair value of cash andcash equivalents approximates the amounts shown on the financial statements.Cash and cash equivalents consist of unrestricted cash and short-terminvestments. Included in cash and cash equivalents are accounts in variousbanks which maintain balances in excess of the Federal Deposit InsuranceCorporation (FDIC) insured limit of $100 per bank. At December 31, 2004and 2003, the excess cash amounted to a total of $58,913 and $46,177,respectively.

 

F-7

----

 

***Prepaid4Kids TV Broadcast Fee*** - The Company has capitalized thebroadcast fee paid to Fox and amortized the amount over the broadcast seasonbased on estimated advertising revenue. During 2004, the Company had paid Fox and certain affiliates $6,934 and$19,228 attributable to the second and third year’s broadcast fees,respectively, and during 2003, the Company had paid Fox and certain affiliates$6,328 and $19,506 attributable to the first and second year’s broadcast fee,respectively. The unamortized portion of these fees of $6,991 and $8,688, areincluded in “Prepaid 4Kids TV broadcast fee” on the accompanying consolidatedbalance sheets as of December 31, 2004 and 2003, respectively.

 

***Investments***- Management determines the appropriate classification of its debt securitiesat the time of purchase and re-evaluates such designation as of each balancesheet date. Debt securities for which the Company has both the intent and abilityto hold to maturity are classified as held-to-maturity and are recorded atamortized cost. At December 31, 2004 and 2003, the Company had noinvestments that qualified as trading or available for sale.

 

At December 31, 2004 and 2003, the Company’s investmentsin debt securities were classified as short-term investments. The Companymaintains these balances principally in money market funds and commercial paperwith various financial institutions. These financial institutions are locatedin different areas of the U.S. and Company policy is designed to limit exposureto any one institution. The Company performs periodic evaluations of therelative standing of those financial institutions that participate in theCompany’s investment strategy.

 

***Investment in Equity Securities***- During the quarter ended September 30, 2001, the Company completed itspurchase of a 3% equity interest in the Pokémon Company, a closely heldJapanese company, which was organized in 1998 by Nintendo Co. Ltd, Creatures, Inc.and Game Freak, Inc., the creators of “Pokémon”, to manage and control allrights to “Pokémon” throughout the world. The Company accounts for thisinvestment on the cost basis and has classified it as a noncurrent asset on theaccompanying consolidated balance sheets.

 

***Film and Television Costs***- The Company accounts for its film and television costs pursuant to AICPAStatement of Position (“SOP”) No. 00-2, *Accountingby Producers or Distributors of Films*. The cost of production fortelevision programming, including overhead, participations and talent residualsis capitalized and amortized using the individual-film-forecast method underwhich such costs are amortized for each television program in the ratio thatrevenue earned in the current period for such program bears to management’sestimate of the ultimate revenues to be realized from all media and markets forsuch program. Management regularly reviews, and revises when necessary, itsultimate revenue estimates on a title-by-title basis, which may result in a changein the rate of amortization applicable to such title and/or a write-down of thevalue of such title to estimated fair value. These revisions can result insignificant quarter-to-quarter and year-to-year fluctuations in filmwrite-downs and rates of amortization. If a total net loss is projected for aparticular title, the associated film and television costs are written down toestimated fair value. All exploitation costs, including advertising andmarketing costs, are expensed as incurred. Television adaptation and productioncosts that are adapted and/or produced are stated at the lower of cost, lessaccumulated amortization, or fair value.

 

***Fair Value of FinancialInstruments*** - The carrying amounts of cash and cashequivalents, accounts receivable, investments, prepaid expenses and othercurrent assets, due to licensors, media payable, accounts payable and accruedexpenses, and other liabilities approximate their fair values principallybecause of the short-term maturities of these instruments.

 

***Use of Estimates***- The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differmaterially from those estimates.

 

***Translation of Foreign Currency —***In accordance with SFAS No. 130, *Reporting Comprehensive Income* (“SFAS No. 130”), theCompany classifies items of other comprehensive income by their nature in thefinancial statements and displays the accumulated balance of other comprehensiveincome separately from retained earnings and additional paid-in capital in theequity section of the consolidated balance sheet. The assets andliabilities of the Company’s foreign subsidiary, 4Kids International have beenrecorded in their local currency and translated to U.S. dollars usingperiod-end exchange rates. Income and expense items have been translated at theaverage rate of exchange prevailing during the period. Any adjustment resultingfrom translating the financial statements of the foreign subsidiary isreflected as “other comprehensive income”, net of related tax. Comprehensiveincome for the years ended December 31, 2004, 2003 and 2002 was $13,161,$15,420 and $7,062  respectively, whichincluded translation adjustments of $431, $621and $72 for the respectiveperiods.

 

F-8

----

 

***Concentration Of Credit Risk***- Financial instruments, which potentially subject the Company to concentrationof credit risk, consist primarily of temporary cash investments and accountsreceivable. The majority of the cash and cash equivalents are maintained withmajor financial institutions in the United States of America. Thecounterparties to the agreements relating to investment instruments consist ofvarious United States governmental units and financial institutions of highcredit standing. Credit risk on accounts receivable is minimized by the Companyby performing ongoing credit evaluations of its customers’ financial conditionand monitoring its exposure for credit losses and maintaining allowances foranticipated losses.

 

***Income Taxes***- Deferred income taxes are recorded for the temporary differences between thefinancial statement and tax bases of assets and liabilities using current taxrates. Valuation allowances are established against deferred tax assetswhenever circumstances indicate that it is more likely than not that suchassets will not be realized in future periods.

 

***Stock-Based Employee Compensation:***Stock-basedcompensation is accounted for using the intrinsic value-based method inaccordance with Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*. Under APB No. 25,because the exercise price of a company’s employee stock options equals themarket price of the underlying stock on the date of the grant, no compensationexpense is recognized.

 

SFAS No. 123, *Accounting for Stock-Based Compensation*, establishes a fairvalue-based method of accounting for employee stock-based compensation plansand encourages companies to adopt that method. However, it also allowscompanies to continue to apply the intrinsic value-based method currentlyprescribed under APB No. 25. The Company has chosen to continue to reportstock-based compensation in accordance with APB No. 25, and provides thefollowing pro forma disclosure of the effects of applying the fair value methodto all applicable awards granted. Under APB No. 25 and relatedinterpretations, no compensation cost has been recognized for the Company’sstock options. Had compensation cost for the Company’s stock options beendetermined based on the fair value at the grant date for those awards aspermitted (but not required) under the alternative method of SFAS No. 123,the Company’s results of operations and related per share amounts would havebeen reduced to the pro forma amounts indicated below.

 
| ** **                                                                                                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                                                      |       |     |       |     |       |     |       |
| **Net income as reported**                                                                                                                |       | $        | 12,730     |     | $          | 14,799   |       | $ | 6,990 |   |
|                                                                                                                                      |       |     |       |     |       |     |       |
| Deduct stock-based employee compensation expense  determined under fair value based method for all applicable awards granted,  net of tax |       | 3,453    |       | 1,726    |       | 2,795    |       |
| **Pro forma net income**                                                                                                                  |       | $        | 9,277      |     | $          | 13,073   |       | $ | 4,195 |   |
|                                                                                                                                      |       |     |       |     |       |     |       |
| **Net income per share:**                                                                                                                 |       |     |       |     |       |     |       |
| Reported                                                                                                                                  |       |     |       |     |       |     |       |
| Basic                                                                                                                                     |       | $        | 0.93       |     | $          | 1.11     |       | $ | 0.55 |   |
| Diluted                                                                                                                                   |       | $        | 0.89       |     | $          | 1.05     |       | $ | 0.51 |   |
|                                                                                                                                      |       |     |       |     |       |     |       |
| Pro forma                                                                                                                                 |       |     |       |     |       |     |       |
| Basic                                                                                                                                     |       | $        | 0.68       |     | $          | 0.98     |       | $ | 0.33 |   |
| Diluted                                                                                                                                   |       | $        | 0.65       |     | $          | 0.92     |       | $ | 0.31 |   |

 

The Company issued stockoption grants for underlying shares of 596, 624 and 596, at exercise prices of$22.37, $11.80 and $19.97, in 2004, 2003 and 2002, respectively.  Each of the stock option grants has a (i) fiveyear life; (ii) is immediately exercisable with respect to 50 percent ofthe underlying shares; and (iii) becomes exercisable with respect to theremaining 50 percent on the first anniversary date of the grant.

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesoption-pricing model. The weighted average assumptions used for options grantedin 2004, 2003 and 2002 included no dividend yield for the periods, expectedvolatility of approximately 58%, 60% and 48% for 2004, 2003 and 2002,respectively, a risk-free interest rate of approximately 2.06%, 1.92% and3.62%  for 2004, 2003 and 2002, respectively,and an option duration of 3.7, 3.5 and 4.1 years for 2004, 2003 and 2002,respectively.

 

**RecentlyIssued Accounting Pronouncements** - *Consolidationof Variable Interest Entities* — On January 2003, the FinancialAccounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 46*, Consolidation of Variable Interest Entities.* In December 2003,the FASB issued FIN No. 46 (Revised) (“FIN No. 46-R”) toaddress certain FIN implementation issues. This interpretation clarifies the application of Accounting ResearchBulletin No. 51,

 

F-9

----

 

Consolidated FinancialStatements for companies that have interests in entities that are VariableInterest Entities (“VIE”) as defined under FIN No. 46.  According to this interpretation, if acompany has an interest in a VIE and is at risk for a majority of the VIE’slosses or receives a majority of the VIE’s expected gains it shall consolidatethe VIE.  FIN No. 46-R alsorequires additional disclosures by primary beneficiaries and other significantvariable interest holders.  For entitiesacquired or created before February 1, 2003, this interpretation waseffective no later than the end of the first interim or reporting period ended March 31,2004, except for those VIE’s that are considered to be special purposeentities, for which the effective date is no later than the end of the firstinterim period or reporting period ended after December 15, 2003. As of December 31,2004, the Company did not have an interest in any VIE’s, and accordingly, theadoption of the provisions of this interpretation by the Company did not have amaterial effect on its consolidated financial position or results ofoperations.

 

In December 2004,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123(revised 2004), *Share-Based Payment* (“SFAS No. 123-R”).SFAS No.123-R is a revision of SFAS No. 123, as amended, *Accounting for Stock-Based Compensation*, and supersedesAccounting Principles Board Opinion No. 25*, Accountingfor Stock Issued to Employees*. SFAS No.123-R eliminatesthe alternative to use the intrinsic value method of accounting that wasprovided in SFAS No. 123, which generally resulted in no compensationexpense recorded in the financial statements related to the issuance of equityawards to employees. SFAS No. 123-R requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements. SFAS No. 123-R establishes fair value asthe measurement objective in accounting for share-based payment arrangementsand requires all companies to apply a fair-value-based measurement method inaccounting for generally all share-based payment transactions with employees.

 

The Company will adoptSFAS No. 123-R, effective with the beginning of its 2005 thirdquarter, using a modified prospective application.  This application will require the Company torecord compensation expense for all awards granted after the required effectivedate and for the unvested portion of previously granted awards that remainoutstanding at the date of adoption. The provisions of SFAS No. 123-Rare effective as of the beginning of the first interim or annual reportingperiod that begins after June 15, 2005, but early adoption is encouraged.The Company currently expects that the adoption of SFAS No. 123-Rwill not result in the recording of compensation expense in 2005 related tounvested stock options outstanding on July 1, 2005.

 

**3. INVESTMENTS**

 

Short-term investments consisted of the following asof:

 
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                               | ** ** | **Amortized Cost**    | ** ** | **Fair Value** | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
|                                     |       |                  |       |   |   |   |   |   |   |
| Held-to-maturity – Government Bonds |       | $                     | 16,067     |   | $ | 16,060 |   | $ | 24,443 |   | $ | 24,443 |   |
|                                          |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

**4. ACCOUNTS RECEIVABLE AND MEDIA PAYABLE/DUE TOLICENSORS**

 

Generally, licensing contracts provide for the Companyto collect, on behalf of the licensor, royalties from the licensees. TheCompany records as accounts receivable only its proportionate share of suchearned royalties.

 

Due to licensors represents amounts collected by theCompany on behalf of licensors, which are generally payable to such licensorsafter the close of each calendar quarter.

 

Additionally, accounts receivable include amounts duefrom customers for advertising revenue earned from airing commercial spots onthe 4Kids TV, as well as amounts due from clients for earned commissions andthe cost of related media placed on their behalf in circumstances where theCompany is assuming the liability for the client for such media. In suchcircumstances, the Company will record a corresponding liability for mediapayable.

 

F-10

----

 

Accountsreceivable consisted of the following as of:

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                            |       |                  |       |   |   |
| Gross accounts receivable       |       | $                     | 42,006     |   | $ | 41,347 |   |
| Allowance for doubtful accounts |       | (1,188                | )          | (1,542 | ) |
|                            |       | 40,818                |       | 39,805 |   |
| Less long-term portion          |       | 901                   |       | 2,662 |   |
|                            |       | $                     | 39,917     |   | $ | 37,143 |   |

 

**5. FILM AND TELEVISION COSTS**

 

Film and television costs consisted of the followingas of:

 
| ** **                | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                      |       |                  |       |   |   |
| Opening balance           |       | $                     | 8,183      |   | $ | 5,653 |   |
| Additions                 |       | 11,145                |       | 12,473 |   |
|                      |       | 19,328                |       | 18,126 |   |
| Amortization              |       | (8,810                | )          | (9,943 | ) |
| Ending Balance            |       | $                     | 10,518     |   | $ | 8,183 |   |
|                      |       |                  |       |   |   |
| Development/Preproduction |       | $                     | 671        |   | $ | 353 |   |
| Production                |       | 894                   |       | 3,306 |   |
| Completed not released    |       | 3,643                 |       | 1,772 |   |
| Completed released        |       | 5,310                 |       | 2,752 |   |
|                      |       | $                     | 10,518     |   | $ | 8,183 |   |

 

Amortization of capitalized film and television costswere $8,810, $9,943 and $4,991 in 2004, 2003 and 2002, respectively.Amortization expense for 2004, 2003 and 2002 includes write-downs of certainfilm and television costs of $132, $483 and $462, respectively. Based onmanagement’s ultimate revenue estimates as of December 31, 2004,approximately 69% of the total completed and unamortized film and televisioncosts are expected to be amortized during 2005, and over 90% of the totalcompleted and unamortized film and television costs are expected to beamortized during the next three years.

 

**6. PROPERTY AND EQUIPMENT**

 

Property and equipment consisted of the following asof:

 
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                           |       |                  |       |   |   |
| Computer equipment and software                |       | $                     | 1,489      |   | $ | 1,586 |   |
| Machinery and equipment                        |       | 2,231                 |       | 1,481 |   |
| Office furniture and fixtures                  |       | 833                   |       | 644 |   |
| Leasehold improvements                         |       | 2,807                 |       | 2,793 |   |
| Office equipment                               |       | 190                   |       | 190 |   |
|                                           |       | 7,550                 |       | 6,694 |   |
|                                           |       |                  |       |   |   |
| Less accumulated depreciation and amortization |       | 4,729                 |       | 3,344 |   |
|                                           |       |                  |       |   |   |
|                                           |       | $                     | 2,821      |   | $ | 3,350 |   |

 

F-11

----

 

**7. REVENUES/MAJOR CUSTOMERS**

 

Net revenues included in the accompanying consolidatedstatements of income are net of licensor participations of $72,531, $54,237 and$29,337 in 2004, 2003 and 2002, respectively.

 

The percentages of revenue from major properties andcustomers/licensees are as follows:

 
| ** **                                                                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                       | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                             |       |                              |       |   |   |   |   |
| Percentage of revenue derived from major properties  (revenue in excess of 10 percent of total revenue)          |       | 55                                | %          | 69 | % | 64 | % |
|                                                                                                             |       |                              |       |   |   |   |   |
| Number of major properties                                                                                       |       | 2                                 |       | 3 |   | 2 |   |
|                                                                                                             |       |                              |       |   |   |   |   |
| Percentage of revenue derived from major  customers/licensees (revenue in excess of 10 percent of total revenue) |       | 18                                | %          | 29 | % | 40 | % |
|                                                                                                             |       |                              |       |   |   |   |   |
| Number of major customers/licensees                                                                              |       | 1                                 |       | 1 |   | 2 |   |

 

As of December 31, 2004 and 2003, accountsreceivable due from major customers/licensees listed above represented 14% and23% of the Company’s total accounts receivable, respectively.

 

**8. INCOME TAXES**

 

The Company has provided for deferred income taxes inaccordance with SFAS No. 109, *Accounting for IncomeTaxes*, whereby deferred income taxes are determined based upon theenacted income tax rates for the years in which these taxes are estimated to bepayable or recoverable. Deferred income taxes arise from temporary differencesresulting from a difference between the tax basis of an asset or liability andits reported amount in the financial statements.

 

The provision for incometaxes consisted of the following: 

 
| ** **                           | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                 |       |                              |       |   |   |   |   |
| Current tax expense:                 |       |                              |       |   |   |   |   |
| Federal                              |       | $                                 | 6,500      |   | $ | 8,747 |   | $ | 5,141 |   |
| State and local                      |       | 2,340                             |       | 3,231 |   | 1,714 |   |
| Foreign                              |       | (372                              | )          | 495 |   | 10 |   |
|                                 |       |                              |       |   |   |   |   |
| Total current tax expense            |       | 8,468                             |       | 12,473 |   | 6,865 |   |
|                                 |       |                              |       |   |   |   |   |
| Deferred tax expense/ (benefit):     |       |                              |       |   |   |   |   |
| Federal                              |       | 114                               |       | (1,898 | ) | (1,738 | ) |
| State and local                      |       | 18                                |       | (691 | ) | (425 | ) |
| Foreign                              |       | (8                                | )          | — |   | — |   |
|                                 |       |                              |       |   |   |   |   |
| Total deferred tax (benefit) expense |       | 124                               |       | (2,589 | ) | (2,163 | ) |
|                                 |       |                              |       |   |   |   |   |
| Income tax expense                   |       | $                                 | 8,592      |   | $ | 9,884 |   | $ | 4,702 |   |

 

F-12

----

 

The following is a summary reconciliation of the U.S.Federal statutory income tax rate to the Company’s effective income tax rate:

 
| ** **                    | ** ** | **2004** | ** ** | **% of  Pretax** | ** ** | **2003** | ** ** | **% of  Pretax** | ** ** | **2002** | ** ** | **% of  Pretax** | ** ** |
|-------------------------------|------------|----------|------------|------------------|------------|----------|------------|------------------|------------|----------|------------|------------------|------------|
|                          |       |     |       |             |       |     |       |             |       |     |       |             |       |
| Tax at Federal statutory rate |       | $        | 7,463      |             | 35.0       | %        | $          | 8,639            |       | 35.0     | %          | $                | 4,092      |   | 35.0 | % |
| Increase (decrease) in:       |       |     |       |             |       |     |       |             |       |     |       |             |       |
| State and local taxes - net   |       | 1,546    |       | 7.2              |       | 1,651    |       | 6.7              |       | 773      |       | 6.6              |       |
| Other - net                   |       | (417     | )          | (2.0             | )          | (406     | )          | (1.7             | )          | (163     | )          | (1.4             | )          |
|                          |       |     |       |             |       |     |       |             |       |     |       |             |       |
| Income tax expense            |       | $        | 8,592      |             | 40.2       | %        | $          | 9,884            |       | 40.0     | %          | $                | 4,702      |   | 40.2 | % |

 

The income tax effects of temporary differences thatgive rise to deferred tax assets and liabilities are as follows:

 
| ** **                                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                |       |     |       |     |       |
| Deferred Tax Assets:                                                |       |     |       |     |       |
| Film and television costs                                           |       | $        | 1,436      |     | $          | 1,949 |   |
| Accounts receivable allowances                                      |       | 448      |       | 627      |       |
| Deferred rent                                                       |       | 458      |       | 347      |       |
| Property and Equipment                                              |       | 375      |       | 279      |       |
| Gross deferred tax assets                                           |       | $        | 2,717      |     | $          | 3,202 |   |
|                                                                |       |     |       |     |       |
| Deferred Tax Liability:                                             |       |     |       |     |       |
| Accrued minimum guarantees                                          |       | $        | 318        |     | $          | 679 |   |
| Gross deferred tax liability                                        |       | 318      |       | 679      |       |
| Net deferred tax asset                                              |       | $        | 2,399      |     | $          | 2,523 |   |
|                                                                |       |     |       |     |       |
| Amounts recognized in the Consolidated Balance  Sheets consists of: |       |     |       |     |       |
| Deferred tax asset (liability) – current                       |       | $        | 158        |     | $          | (52 | ) |
| Deferred tax asset – long term                                 |       | 2,241    |       | 2,575    |       |
|                                                                |       |     |       |     |       |
| Net deferred tax asset                                              |       | $        | 2,399      |     | $          | 2,523 |   |

 

Income tax benefitsrelated to the exercise of stock options reduced current taxes payable andincreased additional paid-in capital by $2,975, $5,988 and $5,083 in 2004, 2003and 2002, respectively.

 

In accordance with SFAS No. 109,we have performed an evaluation of the recoverability of our deferred taxassets.  It is our opinion that it ismore likely than not that the deferred tax assets will be realized and shouldnot be reduced by a valuation allowance.

 

The Company hasdetermined that earnings through 2004 of approximately $5,415 from its foreignsubsidiary will remain invested overseas for the indefinite future and,accordingly, no deferred tax liability has been recognized.  If such earnings were to be repatriated, theincome tax liability is estimated to be approximately $275.

 

**9. STOCK OPTIONS**

 

The Company has variousstock option plans (the “Plans”). Options may be exercised for a period of notmore than ten years after the date of grant. Unless otherwise determined by theCompany’s Compensation Committee or by contract with the recipient of the stockoption grant, each option is immediately exercisable with respect to 50 percentof the shares subject to the option and becomes exercisable with respect to theother 50 percent on the first anniversary of the date of grant. Certain of thePlans permit the Committee to grant nonqualified options, with an exerciseprice of not less than 85 percent of the fair market value of the common stock;all other options must be at 100 percent of the fair market value.  The

 

F-13

----

 

Company’s options haveall been granted at an exercise price per share equal to the fair market valueof the common stock as of the grant date.

 

Changes in the Company’s  stock options for the three year period endedDecember 31, 2004 were as follows:

 
| ** **                             | ** ** | **2004**                | ** ** | **2003**                              | ** ** | **2002**                | ** ** |
|----------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|-------------------------|------------|
| **(Shares in thousands)**              | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                                   |       |                    |       |                                  |       |                    |       |   |   |   |   |   |   |
| Options outstanding, beginning of year |       | 2,378                   |       | $                                     | 11.89      |                    | 2,597      |   | $ | 10.56 |   | 2,624 |   | $ | 7.05 |   |
| Granted                                |       | 596                     |       | 22.37                                 |       | 624                     |       | 11.80 |   | 596 |   | 19.97 |   |
| Exercised                              |       | (447                    | )          | 5.15                                  |       | (830                    | )          | 7.72 |   | (588 | ) | 3.52 |   |
| Cancelled                              |       | (131                    | )          | 29.92                                 |       | (13                     | )          | 8.14 |   | (35 | ) | 31.35 |   |
|                                   |       |                    |       |                                  |       |                    |       |   |   |   |   |   |   |
| Options outstanding, end of year       |       | 2,396                   |       | $                                     | 14.81      |                    | 2,378      |   | $ | 11.89 |   | 2,597 |   | $ | 10.56 |   |
|                                   |       |                    |       |                                  |       |                    |       |   |   |   |   |   |   |
| Options exercisable, end of year       |       | 2,104                   |       | $                                     | 13.76      |                    | 2,072      |   | $ | 11.91 |   | 2,376 |   | $ | 9.69 |   |

 

Under the Company’s stock option plans, options topurchase 735 shares of the Company’s common stock were available at December 31,2004 for future issuance.

 
| ** **                | ** ** | **Options Outstanding**   | ** ** | **Options Exercisable** | ** ** |
|---------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                | ** ** | ** **                | ** ** | ** **              | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                | ** ** | **Number**                | ** ** | **Weighted Average**    | ** ** | **Average** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of**              | ** ** | **Outstanding**           | ** ** | **Remaining**           | ** ** | **Exercise** | ** ** | **Exercisable** | ** ** | **Exercise** | ** ** |
| **Exercise Prices**       | ** ** | **at 12/31/04**           | ** ** | **Contractual Life**    | ** ** | **Price** | ** ** | **at 12/31/04** | ** ** | **Price** | ** ** |
|                      |       |                      |       |                    |       |   |   |   |   |   |   |
| $   0.7710 | -          | $   1.1565 |       | 420                     |       | 1.6 |   | $ | 0.8125 |   | 420 |   | $ | 0.8125 |   |
| $   3.1042 | -          | $   4.6563 |       | 75                      |       | 3.9 |   | $ | 3.1042 |   | 75 |   | $ | 3.1042 |   |
| $   8.9375 | -          | $ 13.4060            |       | 688                     |       | 3.6 |   | $ | 10.8247 |   | 688 |   | $ | 10.8247 |   |
| $ 13.4061            | -          | $ 20.1090            |       | 454                     |       | 3.5 |   | $ | 19.8745 |   | 454 |   | $ | 19.8745 |   |
| $ 20.1091            | -          | $ 30.1635            |       | 659                     |       | 3.9 |   | $ | 22.9346 |   | 367 |   | $ | 23.3849 |   |
| $ 30.1636            | -          | $ 33.2813            |       | 100                     |       | 5.0 |   | $ | 33.2813 |   | 100 |   | $ | 33.2813 |   |
|                      |       | 2,396                     |       | 3.4                     |       | $ | 14.8105 |   | 2,104 |   | $ | 13.7600 |   |

 

**10. EARNINGS PER SHARE**

 

The Company applies SFAS No. 128, *Earnings per Share,* which requires the computation andpresentation of earnings per share (“EPS”) to include basic and diluted EPS.Basic EPS is computed based solely on the weighted average number of commonshares outstanding during the period. Diluted EPS reflects all potentialdilution of common stock. The following table reconciles Basic EPS with DilutedEPS for the three years ended December 31, 2004.

 
| ** **                              | ** ** | **Year Ended 2004** | ** ** |
|-----------------------------------------|------------|---------------------|------------|
| ** **                              | ** ** | **Net Income**      | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic earnings per share -              |       |                |       |   |   |   |   |
| Income available to common shareholders |       | $                   | 12,730     |   | 13,683,756 |   | $ | 0.93 |   |
|                                    |       |                |       |   |   |   |   |
| Effect of dilutive security -           |       |                |       |   |   |   |   |
| Stock options                           |       |                |       | 651,587 |   | (0.04 | ) |
|                                    |       |                |       |   |   |   |   |
| Diluted earnings per share              |       | $                   | 12,730     |   | 14,335,343 |   | $ | 0.89 |   |

 

F-14

----

 
| ** **                              | ** ** | **Year Ended 2003** | ** ** |
|-----------------------------------------|------------|---------------------|------------|
| ** **                              | ** ** | **Net Income**      | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic earnings per share -              |       |                |       |   |   |   |   |
| Income available to common shareholders |       | $                   | 14,799     |   | 13,292,852 |   | $ | 1.11 |   |
|                                    |       |                |       |   |   |   |   |
| Effect of dilutive security -           |       |                |       |   |   |   |   |
| Stock options                           |       |                |       | 863,439 |   | (0.06 | ) |
|                                    |       |                |       |   |   |   |   |
| Diluted earnings per share              |       | $                   | 14,799     |   | 14,156,291 |   | $ | 1.05 |   |

 
| ** **                              | ** ** | **Year Ended 2002** | ** ** |
|-----------------------------------------|------------|---------------------|------------|
| ** **                              | ** ** | **Net Income**      | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic earnings per share -              |       |                |       |   |   |   |   |
| Income available to common shareholders |       | $                   | 6,990      |   | 12,653,102 |   | $ | 0.55 |   |
|                                    |       |                |       |   |   |   |   |
| Effect of dilutive security -           |       |                |       |   |   |   |   |
| Stock options                           |       |                |       | 1,073,540 |   | (0.04 | ) |
|                                    |       |                |       |   |   |   |   |
| Diluted earnings per share              |       | $                   | 6,990      |   | 13,726,642 |   | $ | 0.51 |   |

 

For the years ended December 31, 2004, 2003 and2002, approximately 1,168,100, 247,500 and 256,000 shares, respectively,attributable to the exercise of outstanding options, were excluded from thecalculation of diluted EPS because the effect was antidilutive.

 

**11. DEFINED CONTRIBUTION PLAN**

 

The Company participates in a 401(k) plan coveringsubstantially all employees. Benefits vest based on number of years of service.The Company’s policy is to match 25% of the first 6% of the covered employee’sannual salary, as defined by the plan. Contributions to the plan by the Companyamounted to $158, $124 and $89 for the years ended December 31, 2004, 2003and 2002, respectively.

 

**12. COMMITMENTS AND CONTINGENCIES**

 

*a.**                          BonusPlan* - Bonuses under the Company’s Bonus Plan are based upon an amount ofup to 10 percent of pretax profits. Key officers and employees, as designatedby the Board of Directors, can be included in the Bonus Plan.    For 2004, 2003 and 2002, the Board ofDirectors, under the Bonus Plan, awarded the Chairman and CEO of the Companyapproximately $900, $1,275 and $0, respectively. An additional amount ofapproximately $1,469, $1,466 and $0 under the Bonus Plan was granted toemployees in 2004, 2003 and 2002, respectively.

 

*b.**                          Leases*- The Company leases certain office, administration and production facilities.Commitments for minimum rentals, not including common charges, undernon-cancellable leases at the end of 2004 are as follows:

 

| **Year Ending**       | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| **December 31,** | ** ** | **Amount** | ** ** |
|                  |       |       |       |
| 2005                  |       | $          | 1,754      |   |
| 2006                  |       | 2,008      |       |
| 2007                  |       | 1,310      |       |
| 2008                  |       | 1,279      |       |
| 2009 and thereafter   |       | 1,558      |       |
|                  |       | $          | 7,909      |   |

 

Rentexpense for all operating leases charged against earnings amounted to $1,936,$1,611, and $1,497 in 2004, 2003 and 2002, respectively.

 

F-15

----

 

*c.*               *Litigation* (i) DSIToys. During 2003, the Company’s subsidiary, Summit Media served as the mediabuying agency for DSI Toys, Inc. (“DSI”). On October 17, 2003, DSIfiled a voluntary petition under Chapter 7 of the Bankruptcy Code in the UnitedStates Bankruptcy Court for the Southern District of Texas.  In January 2004, the Trustee for thebankruptcy estate of DSI (the “Trustee”) sent a letter to Summit Media allegingthat DSI made payments to Summit Media totaling $1,159 (the “Amount”) duringthe ninety (90) day period prior to DSI’s bankruptcy filing and asserting thatsuch payments constituted avoidable preference payments, and the Trustee formallydemanded that Summit Media repay the Amount. The Company and the Trustee have entered into a settlement agreementpertaining to this matter which provides for the payment by the Company of $5and a full release in favor of the Company, which has been approved by theBankruptcy Court.  A motion by theTrustee to dismiss the formal action against the Company is pending in theBankruptcy Court.

 

(ii) Telamerica Cable Connect.  During 2002,Summit Media entered into three (3) agreements with Telamerica CableConnect (“TCC”) for the purchase of certain advertising units for broadcast useon the ABC Family, Cartoon Network and Nickelodeon cable stations.  The agreements between Summit Media and TCCprovided for a “ratings and Cost per Thousand (“CPM”) guarantee” for the mediabuys and required TCC to provide Summit Media with a summary affidavit analysisof the media buys. Summit Media paid TCC for the advertising units with respectto which TCC has provided confirmation of the delivery of the ratings and CPMguarantee set forth in the agreements. To date, TCC has been unable to provideSummit Media with appropriate documentation confirming the delivery of theratings and CPM guarantee for the remainder of advertising units purchased bySummit Media.  Summit Media has,therefore, refused to pay TCC for the advertising units with respect to whichTCC has not provided confirmation of the ratings and CPM guarantee.

 

On September 27,2004, TCC filed a Demand for Arbitration claiming that Summit Media owes approximately$234 plus interest for advertising purchased by Summit Media from TCC.  Summit Media has denied the claim by TCC andasserted a counterclaim against TCC for up to $150.  The Company believes that it has meritoriousdefenses to the claim asserted by TCC. The arbitration hearing has beenscheduled for May 2005.

 

TheCompany from time to time is involved in litigation arising in the ordinarycourse of its business. The Company does not believe that such litigation towhich the Company or any subsidiary of the Company is a party or of which anyof their property is the subject will, individually or in the aggregate, have amaterial adverse effect on the Company’s financial position or the results ofits operations.

 

*d.*              *Key Man Clause*- Under the terms of the Company’s representation agreements (the “Agreements”)with Pokémon USA, Inc. (“PUI”) with respect to the Pokémon property andNintendo of America, Inc. (“NOA”) with respect to the Nintendo properties,in the event that Alfred Kahn, the Chairman and CEO becomes unavailable due todeath, disability, termination or a major change of duties and an acceptablereplacement for Mr. Kahn is not found within a specified period of time,or there is a change in control of the Company resulting in a major change ofduties for Mr. Kahn, PUI and NOA have the option to terminate theirrespective agreements with the Company. The Company would, however, continue tobe paid on license agreements in place at the time such options were exercised.

 

*e.*               *Employment Contracts*-The Company has employment agreements and arrangements with its executiveofficers and certain management personnel. The agreements generally continueuntil terminated by the executive or the Company, and provide for severancepayments under certain circumstances. The majority of the agreements andarrangements provide the employees with certain additional rights after aChange of Control (as defined) of the Company occurs. The agreements include acovenant against competition with the Company which extends for a period oftime after termination for any reason. As of December 31, 2004, if all ofthe employees under contract were terminated by the Company without good causeor following a Change of Control, (as defined) under these contracts, theCompany’s liability would be approximately $6,965 or $12,119, respectively.

 

Theseemployment agreements provide for an aggregate minimum annual base compensationof $3,143 expiring on various dates through 2009.

 

*f.**                  DeferredRevenue* - Music Publishing - In July 2002, 4Kids Music granted a rightto receive a 50% interest in the Company’s net share of the music revenues fromcurrently existing music produced by the Company for its television programs(excluding Pokémon)(“Current Music Assets”) to an unaffiliated third party inan arms length transaction for $3,000. Further, the Company agreed to grant aright to receive a 50% interest in the Company’s net share of music revenuesfrom future music to be produced by the Company for its television

 

F-16

----

 

programs(excluding Pokémon) (“ Future Music Assets”) to the same third party for$2,000. In consideration of the grant of Future Music Assets, the Companyreceived $750 in June 2003 and $750 in June 2004 and will receive$500 in June 2005.

 

TheCompany has deferred all amounts received under the contract, and recognizesrevenue as the Current Music Assets and Future Music Assets generate revenueover the contract term.  Notwithstandingthe foregoing, as of the date the Company has delivered all of the FutureMusic Assets required under the contract, any portion of the $5,000 thatremains deferred and not recognized, will be recognized asrevenue. Pursuant to the above, the Company recognized revenues of $632 and$390 for the years ended December 31, 2004 and 2003, respectively.  The Company has included $3,164 and $3,046 asdeferred revenue on the accompanying consolidated balance sheets as of December 31,2004 and 2003, respectively.

 

HomeVideo – At various dates since May 2002, 4Kids Home Video, entered intovarious agreements with an unaffiliated third party home video distributor (the“Video Distributor”), pursuant to which 4Kids Home Video provides ongoingadvertising, marketing and promotional services with respect to certain homevideo titles, that are owned or controlled by the Company and which aredistributed by the Video Distributor. The Video Distributor has paid theCompany advances of $3,670 ($370 during the year ended December 31, 2004)against 4Kids Home Video’s share of the distribution and service fee proceedsto be realized by 4Kids Home Video from such titles. Pursuant to the above, theCompany recognized revenue of $337 and $2,187 for the years ended December 31,2004 and 2003, respectively.  The Companyhas included $433 and $400 as deferred revenue on the accompanying consolidatedbalance sheets as of December 31, 2004 and 2003, respectively.

 

OtherAgreements - In addition, the Company entered into other agreements for variousproperties and advertising time on the 4Kids TV in which the Company hasreceived certain advances and/or minimum guarantees. Accordingly, as of December 31,2004 and 2003 the unearned portion of these advances and guaranteed paymentswere $3,258 and $4,624, respectively, and are included in deferred revenue onthe accompanying consolidated balance sheets.

 

*g.*              *Master Toy Licensee*- 4Kids Licensing, a wholly-owned subsidiary of the Company, is the exclusiveMerchandise Licensing Agent for the “Pokémon” property outside Asia. The mastertoy licensee (“Licensee”) for the “Pokémon” property and The Pokémon CompanyLLC, (the assignee of certain rights and obligations of Nintendo of AmericaInc. with respect to the “Pokémon” property) entered into an agreement (the “Agreement”)effective January 1, 2001.

 

Underthe terms of the Agreement, Licensee was required to pay a minimum royalty forthe period from January 1, 2001 to December 31, 2003. Since all ofthe conditions under the Agreement were met and the full amount of the minimumguaranteed royalties were payable by the Licensee, the Company earned $7,500over the period of the Agreement.  TheCompany earned royalties relating to the Agreement of $2,500 in each of theyears ended December 31, 2003 and 2002. During 2003, the Agreement was amended extending the term to December 31,2006.

 

*h.**              4KidsTV  Broadcast Agreement* - In January 2002,the Company entered into a multi-year agreement with Fox to lease Fox’sSaturday morning programming block (the “Fox Box”).  In December 2004, the Company rebrandedthe Fox Box to 4Kids TV.  The Companyprovides substantially all programming content to be broadcast on 4Kids TV,which airs on Saturday mornings from 8am to 12pm eastern/pacific time (7am to11am central time): and retains all of the revenue from network advertisingsales for the four-hour time period. 4Kids Ad Sales, Inc., a wholly-owned subsidiary of the Companymanages and accounts for the ad revenue and costs associated with 4KidsTV.  The agreement has an initial term offour broadcast years beginning with the September 2002 broadcast year,with the Company having the option to extend the term for up to two additionalbroadcast years. 4Kids will pay a fee of $25,312 for each broadcast year duringthe initial term of the agreement.

 

The agreement providedfor 50% of the fee for the first broadcast season to be paid within ten days ofthe execution of the short form agreement in February 2002, with thebalance of the fee for the first broadcast year payable in four equalinstallments in September 2002, December 2002, February 2003 andApril 2003.  The fee for eachsubsequent broadcast year is payable 50% in the June preceding thebeginning of the broadcast year (which begins in September) with the balance ofthe fee for the broadcast year payable in four equal installments in September,December, February and April.  Allpayments required to be made on or prior to March 15, 2004 have beenmade.  Additionally, the agreementrequires the Company to establish a $25,000 letter of credit for the benefit ofFox, which letter of credit may be reduced by the Company as installments of

 

F-17

----

 

the final year’s fee arepaid. As of December 31, 2004, the Company had received a commitment froma bank for the letter of credit, but the letter of credit had not been issuedpending completion of the long form agreement with Fox.  Upon the issuance of the letter of credit,the Company will grant a security interest in its cash balances to the issuingbank to secure the amount of such letter of credit and will appropriatelydisclose these amounts as restricted cash in its consolidated financialstatements.

 

Thecost of 4Kids TV is capitalized and amortized over each broadcast year based onestimated advertising revenue for the related broadcast year.  The Company recorded amortization expense of$27,859 and $27,003 for the years ended December 31, 2004 and 2003,respectively.  During 2004, the Companyhad paid Fox and certain Fox affiliates $6,934 and $19,228 attributable to thesecond and third year’s broadcast fees, respectively, and during 2003, theCompany had paid Fox and certain Fox affiliates $6,328 and $19,506 attributableto the first and second year’s broadcast fee, respectively. The unamortizedportion of these fees of $6,991 and $8,688, are included in “Prepaid 4Kids TVbroadcast fee” on the accompanying consolidated balance sheets as of December 31,2004 and 2003, respectively.

 

The agreement furtherprovides that, at the Company’s option, up to $10,300 of each year’s fee may bepaid by delivering shares of the Company’s common stock. Over the initial fouryear term of the agreement, the Company will pay Fox an aggregate fee of$101,250. The Company will incur additional costs to program the four hourblock and to sell the related network advertising time.  These costs will include direct programmingcosts to acquire, adapt and deliver programming for broadcast during the weeklyfour hour block as well as additional indirect expenses of advertising sales,promotion and administration.

 

As of December 31,2004, the minimum guaranteed payment obligations under the 4Kids TV BroadcastAgreement are as follows:

 

| **Year ending**       | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| **December 31,** | ** ** | **Amount** | ** ** |
| 2005                  |       | $          | 25,312     |   |
| 2006                  |       | 6,326      |       |
| Total                 |       | $          | 31,638     |   |

 

The Company’s ability torecover the cost of its fee payable to Fox will depend on the popularity of thetelevision programs the Company broadcasts on 4Kids TV and the general marketdemand and pricing of advertising time for Saturday morning children’sbroadcast television. The popularity of such programs impacts audience levelsand the level of the network advertising rates that the Company can charge.Additionally, the success of merchandise licensing programs and home videosales based on such television programs broadcast on 4Kids TV is dependent onconsumer acceptance of the properties. If the Company estimates that it will beunable to generate sufficient future revenue from advertising sales, home videosales and merchandising licensing at levels to cover the cost of itscontractual obligation to Fox, the Company would record a charge to earnings toreflect an expected loss on the Fox agreement in the period in which thedeficiency or factors affecting the recoverability of the fee payable becomeknown. The Company will be required to make certain assumptions and estimatesabout future events such as advertising rates and audience viewing levels inevaluating its ability to recover the cost of the 4Kids TV fee.  Such estimates and assumptions are subject tomarket forces and factors beyond the control of the Company and are inherentlysubject to change.  There can be noassurance that the Company will be able to recover the full cost of the 4KidsTV fee and in the event it cannot, it would record the resulting charge toearnings to reflect an expected loss on the 4Kids TV fee, which could besignificant.

 

*i.**                 ContractualArrangements* - During the normal course of business, the Company may enterinto various agreements with third parties to license, acquire, distribute,broadcast, develop and/or promote properties. The terms of these agreementswill vary based on the services and/or properties included within theagreement, as well as, geographic restrictions, duration, property andexploitation condition and results of operations.

 

*j.**                  StockPurchases* - In the third quarter of 2004, the Company completed thepurchase of 750,000 shares of the Company’s stock at an average price of $19.93per share that had previously been authorized by the Board of Directors in November 2003.In November 2004, the Board of Directors authorized the Company topurchase up to 1,000,000 additional shares of the Company’s common stock fromtime to time through December 31, 2005 in the open market or throughnegotiated prices.  Such purchases are tobe made out of the Company’s surplus. No such purchases relating to theadditional 1,000,000 shares were made by the Company during 2004.  Subsequent to December 31, 2004, 350,000additional shares were purchased at an average price of $19.00 per share.

 

F-18

----

 

**13. SEGMENT AND RELATED INFORMATION**

 

The Company applies SFAS No. 131, DisclosuresAbout Segments of an Enterprise and Related Information. The Company has threereportable segments; (i) Licensing, (ii) Advertising Media andBroadcast, and (iii) Television and Film Production/Distribution. TheCompany’s reportable segments are strategic business units, which, whilemanaged separately, work together as a vertically integrated entertainmentcompany.   The Company’s managementregularly evaluates the performance of each segment based on its net revenues,profit and loss after all expenses, including amortized film, television costsand the 4Kids TV broadcast fee and interest income.

 

The accounting policies of the segments are the sameas those described in the summary of significant accounting policies.Commencing in 2003, the Company’s Television and Film Production/ Distributionsegment recorded inter-segment revenues and the Company’s Advertising Media andBroadcast segment recorded inter-segment charges related to the estimatedacquisition costs of episodic television series for broadcast.  In the opinion of management, suchacquisition costs represent the estimated fair value which would have been incurredin a transaction between unaffiliated third parties on an arm lengthbasis.  All inter-segment transactionshave been eliminated in consolidation.

 
| ** **                                                            | ** ** | **Licensing** | ** ** | **Advertising  Media and  Broadcast** | ** ** | **TV and Film  Production/  Distribution** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------|------------|---------------|------------|---------------------------------------|------------|--------------------------------------------|------------|-----------|------------|
|                                                                  |       |          |       |                                  |       |                                       |       |      |       |
| 2004:                                                                 |       |          |       |                                  |       |                                       |       |      |       |
| Net revenues from external customers                                  |       | $             | 49,903     |                                  | $          | 24,113                                     |       | $         | 29,290     |   | $ | 103,306 |   |
| Amortization of televsion and film costs and 4Kids  TV broadcast fee  |       | —        |       | 27,859                                |       | 8,810                                      |       | 36,669    |       |
| Segment profit (loss)                                                 |       | 31,268        |       | (13,235                               | )          | 3,289                                      |       | 21,322    |       |
| Segment assets                                                        |       | 160,114       |       | 21,089                                |       | 23,812                                     |       | 205,015   |       |
| Interest income                                                       |       | 1,444         |       | 25                                    |       | —                                     |       | 1,469     |       |
|                                                                  |       |          |       |                                  |       |                                       |       |      |       |
| 2003:                                                                 |       |          |       |                                  |       |                                       |       |      |       |
| Net revenues from external customers                                  |       | $             | 54,842     |                                  | $          | 22,544                                     |       | $         | 24,693     |   | $ | 102,079 |   |
| Amortization of television and film costs and 4Kids  TV broadcast fee |       | —        |       | 27,003                                |       | 9,943                                      |       | 36,946    |       |
| Segment profit (loss)                                                 |       | 37,085        |       | (14,583                               | )          | 2,181                                      |       | 24,683    |       |
| Segment assets                                                        |       | 152,117       |       | 20,366                                |       | 20,797                                     |       | 193,280   |       |
| Interest income                                                       |       | 1,094         |       | 18                                    |       | —                                     |       | 1,112     |       |
|                                                                  |       |          |       |                                  |       |                                       |       |      |       |
| 2002:                                                                 |       |          |       |                                  |       |                                       |       |      |       |
| Net revenues from external customers                                  |       | $             | 28,937     |                                  | $          | 11,200                                     |       | $         | 13,003     |   | $ | 53,140 |   |
| Amortization of television and film costs and 4Kids  TV broadcast fee |       | —        |       | 9,444                                 |       | 4,911                                      |       | 14,355    |       |
| Segment profit (loss)                                                 |       | 16,862        |       | (6,613                                | )          | 1,443                                      |       | 11,692    |       |
| Segment assets                                                        |       | 121,442       |       | 26,417                                |       | 14,980                                     |       | 162,839   |       |
| Interest income                                                       |       | 1,619         |       | 37                                    |       | —                                     |       | 1,656     |       |

 

Additionally, through the Company’s London office andnetwork of international subagents, which allow it to license its propertiesthroughout the world, the Company recognized net revenues from internationalsources primarily in Europe, of $8,949, $10,315 and $3,161 for the years ended2004, 2003 and 2002, respectively.

 

F-19

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**14. SUMMARIZED QUARTERLY DATA (UNAUDITED):**

 

Following is a summary of the quarterly results ofoperations for the years ended December 31, 2004 and 2003:

 
| ** **                 | ** ** | **Fiscal Quarter** | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **First**          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total** | ** ** |
| 2004:                      |       |               |       |   |   |   |   |   |   |   |   |
| Net revenues               |       | $                  | 22,467     |   | $ | 22,097 |   | $ | 24,682 |   | $ | 34,060 |   | $ | 103,306 |   |
| Income from operations     |       | 4,996              |       | 3,080 |   | 3,860 |   | 7,917 |   | 19,853 |   |
| Net income                 |       | 3,167              |       | 2,043 |   | 2,531 |   | 4,989 |   | 12,730 |   |
| Basic earnings per share   |       | $                  | 0.23       |   | $ | 0.15 |   | $ | 0.19 |   | $ | 0.37 |   | $ | 0.93 |   |
| Diluted earnings per share |       | $                  | 0.22       |   | $ | 0.14 |   | $ | 0.18 |   | $ | 0.36 |   | $ | 0.89 |   |
|                       |       |               |       |   |   |   |   |   |   |   |   |
| 2003:                      |       |               |       |   |   |   |   |   |   |   |   |
| Net revenues               |       | $                  | 20,978     |   | $ | 23,369 |   | $ | 25,334 |   | $ | 32,398 |   | $ | 102,079 |   |
| Income from operations     |       | 4,626              |       | 5,818 |   | 4,481 |   | 8,646 |   | 23,571 |   |
| Net income                 |       | 2,970              |       | 3,645 |   | 2,867 |   | 5,317 |   | 14,799 |   |
| Basic earnings per share   |       | $                  | 0.23       |   | $ | 0.28 |   | $ | 0.22 |   | $ | 0.39 |   | $ | 1.11 |   |
| Diluted earnings per share |       | $                  | 0.21       |   | $ | 0.26 |   | $ | 0.20 |   | $ | 0.36 |   | $ | 1.05 |   |

 

Quarterly amounts for earnings per share may not agreeto annual amount due to rounding.

 

******

 

F-20

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