|  |
|--|

| **UNITED                    STATES                    SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****FORM 10-Q**

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

For the                    quarterly period ended March 31, 2008

OR

**|   |                         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15                    (d) OF THE                               SECURITIES                    EXCHANGE ACT OF 1934** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| For the transition period from _____________ to                _____________ |
|------------------------------------------------------------------------------|

| **Commission file number 0-7843** |
|-----------------------------------|

| **4Kids Entertainment, Inc.**(Exact name of registrant as specified in its charter) |
|-------------------------------------------------------------------------------------|

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

| **1414 Avenue of the Americas                    New York, New York 10019                    (212) 758-7666****(**Address, including zip code, and telephone number,                    including area code,                    of registrant’s principal executive offices) |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

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

 

| Large accelerated filer ___ | Accelerated filerX | Non-accelerated filer ___ | Smaller reporting company ___ |
|-----------------------------|--------------------|---------------------------|-------------------------------|

| (Do not check if a smaller reporting company)

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

      As                    of May 9, 2008, the number of shares outstanding of the registrant’s                    common stock, par value $.01 per share, was 13,096,723. |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**4Kids Entertainment,** **Inc. and Subsidiaries**

 

**Table of Contents**

 

|                                   |            |                                                                                                                                                                                                                          |                                                                                                                   | **Page #**

                              |
|----------------------------------------|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------|------------------------------------------------|
| **Part I—FINANCIAL INFORMATION** |            |                                                                                                                                                                                                                          |
|                                   | Item 1.         |                                                                                                                                                                                                                          | Financial Statements                                                                                                   |                                           |   |
|                                   |            | Consolidated Balance Sheets as of March 31, 2008                            (Unaudited) and December 31, 2007                                                                                                                 |                                                                                                                   | 2                                              |
|                                   |            | Consolidated Statements of Operations (Unaudited) for                            the three months ended March 31, 2008 and 2007                                                                                               |                                                                                                                   | 3                                              |
|                                   |            | Consolidated Statements of Stockholders’ Equity                            and Comprehensive Loss for the three months ended March 31, 2008                            (Unaudited) and the year ended December 31, 2007 |                                                                                                                   | 4                                              |
|                                   |            | Consolidated Statements of Cash Flows (Unaudited) for                            the three months ended March 31, 2008 and 2007                                                                                               |                                                                                                                   | 5                                              |
|                                   |            | Notes to Consolidated Financial Statements                            (Unaudited)                                                                                                                                             |                                                                                                                   | 6                                              |
|                                   | Item 2.         |                                                                                                                                                                                                                          | Management’s Discussion and Analysis of Financial                            Condition and Results of Operations |                                           | 22 |
|                                   | Item 3.         |                                                                                                                                                                                                                          | Quantitative and Qualitative Disclosures about Market                            Risk                                  |                                           | 31 |
|                                   | Item 4.         |                                                                                                                                                                                                                          | Controls and Procedures                                                                                                |                                           | 32 |
| **Part II—OTHER INFORMATION**    |            |                                                                                                                                                                                                                               |
|                                   | Item 1.         |                                                                                                                                                                                                                          | Legal Proceedings                                                                                                      |                                           | 32 |
|                                   |  

Item 1A |                                                                                                                                                                                                                          |  

Risk Factors                                                                                                   |                                           |  

32 |
|                                   | Item 2.         |                                                                                                                                                                                                                          | Unregistered Sales of Equity Securities and Use of                            Proceeds                                 |                                           | 32 |
|                                   |  

Item 6. |                                                                                                                                                                                                                          |  

Exhibits                                                                                                       |  

                                  |  

33 |
| Signatures                             |            | 34                                                                                                                                                                                                                            |
|                                   |            |                                                                                                                                                                                                                          |                                                                                                                   |                                           |   |

             

             

             

             

 

 

 

 

 

----

**Part I – FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

**MARCH 31, 2008 and DECEMBER 31, 2007**

(In            thousands of dollars, except share data)

 

| **ASSETS:**                                                                                                                                                                                                                                                                                                                                      |   | **2008**   |    | **2007** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|---------|----------|--------|
| Current assets:                                                                                                                                                                                                                                                                                                                                  |   | (Unaudited | )       |     |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                        |   | $          | 32,870  |     | $      | 24,872 |   |
| Investments                                                                                                                                                                                                                                                                                                                                      |   |       | 25,005  |     |   | 36,106 |   |
| Total cash, cash equivalents and investments                                                                                                                                                                                                                                                                                                     |   |       | 57,875  |     |   | 60,978 |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| Accounts receivable - net                                                                                                                                                                                                                                                                                                                        |   |       | 18,429  |     |   | 21,403 |   |
| Inventories                                                                                                                                                                                                                                                                                                                                      |   |       | 250     |     |   | 611 |   |
| Prepaid income taxes                                                                                                                                                                                                                                                                                                                             |   |       | 872     |     |   | 1,159 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                        |   |       | 1,871   |     |   | 2,985 |   |
| Current assets from discontinued operations                                                                                                                                                                                                                                                                                                      |   |       | 823     |     |   | 372 |   |
| Total current assets                                                                                                                                                                                                                                                                                                                             |   |       | 80,120  |     |   | 87,508 |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| Property and equipment - net                                                                                                                                                                                                                                                                                                                     |   |       | 4,236   |     |   | 4,255 |   |
| Long-term investments                                                                                                                                                                                                                                                                                                                            |   |       | 18,695  |     |   | 31,806 |   |
| Accounts receivable - non-current, net                                                                                                                                                                                                                                                                                                           |   |       | 319     |     |   | 208 |   |
| Film and television costs - net                                                                                                                                                                                                                                                                                                                  |   |       | 14,276  |     |   | 14,352 |   |
| Non-current assets from discontinued                            operations                                                                                                                                                                                                                                                                       |   |       | 475     |     |   | 926 |   |
| Other assets - net (includes related party amounts of                            $4,914 and $4,265, respectively)                                                                                                                                                                                                                                |   |       | 14,210  |     |   | 12,024 |   |
| Total assets                                                                                                                                                                                                                                                                                                                                     |   | $          | 132,331 |     | $      | 151,079 |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’                            EQUITY:**                                                                                                                                                                                                                                                                       |   |       |    |     |   |   |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| Current liabilities:                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| Due to licensors                                                                                                                                                                                                                                                                                                                                 |   | $          | 5,131   |     | $      | 4,420 |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                                            |   |       | 14,408  |     |   | 14,969 |   |
| Deferred revenue                                                                                                                                                                                                                                                                                                                                 |   |       | 2,450   |     |   | 2,984 |   |
| Total current liabilities                                                                                                                                                                                                                                                                                                                        |   |       | 21,989  |     |   | 22,373 |   |
| Deferred rent                                                                                                                                                                                                                                                                                                                                    |   |       | 578     |     |   | 618 |   |
| Total liabilities                                                                                                                                                                                                                                                                                                                                |   |       | 22,567  |     |   | 22,991 |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       |    |     |   |   |   |
| Commitments and contingencies (Note 10)                                                                                                                                                                                                                                                                                                          |   |       |    |     |   |   |   |
| 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, 15,099,812 and 15,099,812 shares; outstanding                            13,096,723 and                                    13,332,207 shares in                            2008 and 2007, respectively |   |       | 151     |     |   | 151 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                       |   |       | 63,679  |     |   | 63,679 |   |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                                                                             |   |       | (11,745 | )        |   | (2,562 | ) |
| Retained earnings                                                                                                                                                                                                                                                                                                                                |   |       | 93,924  |     |   | 100,323 |   |
|                                                                                                                                                                                                                                                                                                                                                  |   |       | 146,009 |     |   | 161,591 |   |
| Less cost of 2,003,089 and 1,767,605 treasury shares in                            2008 and 2007, respectively                                                                                                                                                                                                                                   |   |       | 36,245  |     |   | 33,503 |   |
|                                                                                                                                                                                                                                                                                                                                             |   |       | 109,764 |     |   | 128,088 |   |
| Total liabilities and stockholders’                            equity                                                                                                                                                                                                                                                                      |   | $          | 132,331 |     | $      | 151,079 |   |

 

See            notes to consolidated financial statements.

2

             

----

             

**4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**THREE MONTHS ENDED MARCH 31, 2008 AND 2007**

(In            thousands of dollars, except share data)

 

|                                        |   | **Three Months Ended** |   |
|---------------------------------------------|--------|------------------------|--------|
|                                        |   | **March 31,**          |   |
|                                        |   | **2008**               |   |   | **2007** |   |
| Net revenues:                               |   |                   |   |   |   |   |
| Service revenue                             | $      | 12,611                 |   | $ | 14,931 |   |
| Product revenue                             |   | 2,428                  |   |   | — |   |
| Total net revenues                          |   | 15,039                 |   |   | 14,931 |   |
|                                        |   |                   |   |   |   |   |
| Costs and expenses:                         |   |                   |   |   |   |   |
| Selling, general and administrative         |   | 12,608                 |   |   | 8,963 |   |
| Production service costs                    |   | 1,545                  |   |   | 1,780 |   |
| Cost of sales of trading cards              |   | 1,016                  |   |   | — |   |
| Amortization of television and film costs   |   | 1,708                  |   |   | 1,687 |   |
| Amortization of 4Kids TV broadcast fee      |   | 5,203                  |   |   | 4,419 |   |
| Total costs and expenses                    |   | 22,080                 |   |   | 16,849 |   |
|                                        |   |                   |   |   |   |   |
| Loss from operations                        |   | (7,041                 | )      |   | (1,918 | ) |
|                                        |   |                   |   |   |   |   |
| Interest income                             |   | 670                    |   |   | 1,087 |   |
|                                        |   |                   |   |   |   |   |
| Loss before income taxes                    |   | (6,371                 | )      |   | (831 | ) |
|                                        |   |                   |   |   |   |   |
| (Provision for) benefit from income taxes   |   | (28                    | )      |   | 677 |   |
|                                        |   |                   |   |   |   |   |
| Loss from unconsolidated operations – |   |                   |   |   |   |   |
| net of a tax benefit                        |   | —                |   |   | (51 | ) |
|                                        |   |                   |   |   |   |   |
| Net loss                                    | $      | (6,399                 | )      | $ | (205 | ) |
|                                        |   |                   |   |   |   |   |
| Per share amounts:                          |   |                   |   |   |   |   |
| Basic loss per common share                 | $      | (0.48                  | )      | $ | (0.02 | ) |
|                                        |   |                   |   |   |   |   |
| Diluted loss per common share               | $      | (0.48                  | )      | $ | (0.02 | ) |
|                                        |   |                   |   |   |   |   |
| Weighted average common shares              |   |                   |   |   |   |   |
| outstanding - basic                         |   | 13,226,618             |   |   | 13,183,279 |   |
|                                        |   |                   |   |   |   |   |
| Weighted average common shares              |   |                   |   |   |   |   |
| outstanding - diluted                       |   | 13,226,618             |   |   | 13,183,279 |   |
|                                        |   |                   |   |   |   |   |

 

 

 

 

 

 

See            notes to consolidated financial statements.

 

3

 

----

 

**4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND            COMPREHENSIVE LOSS**

**THREE MONTHS ENDED MARCH 31, 2008 (UNAUDITED) AND YEAR ENDED DECEMBER            31, 2007**

(In            thousands of dollars and shares)

|                                                                            | **Common Stock** |       | **Additional****Paid-In****Capital** |    | **Retained Earnings** |   | **Accumulated****Other****Comprehensive****Income/Loss** |   | **Less Treasury Stock** |    | **Total****Stockholders’****Equity** |   |
|---------------------------------------------------------------------------------|------------------|------------|--------------------------------------|---------|-----------------------|--------|----------------------------------------------------------|--------|-------------------------|---------|--------------------------------------------|--------|
| **Shares**                                                                      |             | **Amount** |
|                                                                            |             |       |                                 |    |                  |   |                                                     |   |                    |    |                                       |   |   |   |   |   |   |   |   |   |
| BALANCE, DECEMBER 31, 2006                                                      | 14,933           |       | $                                    | 149     |                  | $      | 62,859                                                   |   | $                       | 123,649 |                                       | $      | 1,329 |   | $ | (33,249 | ) | $ | 154,737 |   |
| Issuance of common stock and stock options                            exercised | 167              |       |                                 | 2       |                  |   | 820                                                      |   |                    | — |                                       |   | — |   |   | — |   |   | 822 |   |
| Acquisition of treasury stock, at cost                                          | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | — |   |   | (254 | ) |   | (254 | ) |
| Comprehensive loss:                                                             |             |       |                                 |    |                  |   |                                                     |   |                    |    |                                       |   |   |   |   |   |   |   |   |   |
| Net loss                                                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | (23,326 | )                                          |   | — |   |   | — |   |   | (23,326 | ) |
| Translation adjustment                                                          | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | 102 |   |   | — |   |   | 102 |   |
| Unrealized loss on marketable securities                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | (3,993 | ) |   | — |   |   | (3,993 | ) |
| Total comprehensive loss                                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | — |   |   | — |   |   | (27,217 | ) |
|                                                                            |             |       |                                 |    |                  |   |                                                     |   |                    |    |                                       |   |   |   |   |   |   |   |   |   |
| BALANCE, DECEMBER 31, 2007                                                      | 15,100           |       | $                                    | 151     |                  | $      | 63,679                                                   |   | $                       | 100,323 |                                       | $      | (2,562 | ) | $ | (33,503 | ) | $ | 128,088 |   |
| Acquisition of treasury stock, at cost                                          | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | — |   |   | (2,742 | ) |   | (2,742 | ) |
| Comprehensive loss:                                                             |             |       |                                 |    |                  |   |                                                     |   |                    |    |                                       |   |   |   |   |   |   |   |   |   |
| Net loss                                                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | (6,399  | )                                          |   | — |   |   | — |   |   | (6,399 | ) |
| Translation adjustment                                                          | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | 4 |   |   | — |   |   | 4 |   |
| Unrealized loss on marketable securities                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | (9,187 | ) |   | — |   |   | (9,187 | ) |
| Total comprehensive loss                                                        | —          |       |                                 | — |                  |   | —                                                  |   |                    | — |                                       |   | — |   |   | — |   |   | (15,582 | ) |
|                                                                            |             |       |                                 |    |                  |   |                                                     |   |                    |    |                                       |   |   |   |   |   |   |   |   |   |
| BALANCE, MARCH 31, 2008                                                         | 15,100           |       | $                                    | 151     |                  | $      | 63,679                                                   |   | $                       | 93,924  |                                       | $      | (11,745 | ) | $ | (36,245 | ) | $ | 109,764 |   |

 

 

 

 

 

See            notes to consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

4

 

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**4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**THREE MONTHS ENDED MARCH 31, 2008 AND 2007**

|   | (In thousands of dollars) |
|--------|---------------------------|

 

|                                                                                                              |   | **2008** |   |   | **2007** |   |
|--------------------------------------------------------------------------------------------------------------|--------|----------|--------|--------|----------|--------|
| Cash flows from operating activities:                                                                        |   |     |   |   |     |   |
| Net loss                                                                                                     | $      | (6,399   | )      | $      | (205     | )      |
| Adjustments to reconcile net loss to net cash                                                                |   |     |   |   |     |   |
| (used in) provided by operating activities –                            continuing operations:         |   |     |   |   |     |   |
| Depreciation and amortization                                                                                |   | 357      |   |   | 236      |   |
| Amortization of television and film costs                                                                    |   | 1,708    |   |   | 1,687    |   |
| Amortization of 4Kids TV broadcast fee                                                                       |   | 5,203    |   |   | 4,419    |   |
| Provision for (recovery of) doubtful accounts                                                                |   | 216      |   |   | (23      | )      |
| Deferred income taxes                                                                                        |   | —  |   |   | 264      |   |
| Loss on investment in unconsolidated                            affiliate                                    |   | —  |   |   | 93       |   |
| Changes in operating assets and liabilities:                                                                 |   |     |   |   |     |   |
| Inventory                                                                                                    |   | 361      |   |   | —  |   |
| Accounts receivable                                                                                          |   | 2,647    |   |   | 6,036    |   |
| Film and television costs                                                                                    |   | (1,632   | )      |   | (2,166   | )      |
| Prepaid income taxes                                                                                         |   | 287      |   |   | (701     | )      |
| Prepaid 4Kids TV broadcast fee                                                                               |   | (5,266   | )      |   | (4,419   | )      |
| Prepaid expenses and other current assets                                                                    |   | 1,114    |   |   | (1,234   | )      |
| Other assets - net                                                                                           |   | (2,186   | )      |   | (1,720   | )      |
| Due to licensors                                                                                             |   | 711      |   |   | 1,288    |   |
| Accounts payable and accrued expenses                                                                        |   | (498     | )      |   | (1,438   | )      |
| Deferred revenue                                                                                             |   | (534     | )      |   | (1,051   | )      |
| Deferred rent                                                                                                |   | (40      | )      |   | (67      | )      |
|                                                                                                         |   |     |   |   |     |   |
| Net cash (used in) provided by operating activities                            – continuing operations |   | (3,951   | )      |   | 999      |   |
| Net cash provided by operating activities –                            discontinued operations         |   | —  |   |   | 7        |   |
| Net cash (used in) provided by operating                            activities                               |   | (3,951   | )      |   | 1,006    |   |
|                                                                                                         |   |     |   |   |     |   |
| Cash flows from investing activities:                                                                        |   |     |   |   |     |   |
| Proceeds from maturities of investments                                                                      |   | 15,025   |   |   | 24,320   |   |
| Purchase of investments                                                                                      |   | —  |   |   | (25,730  | )      |
| Purchase of property and equipment                                                                           |   | (338     | )      |   | (217     | )      |
| Purchase of investment in unconsolidated                            affiliate                                |   | —  |   |   | (132     | )      |
| Net cash provided by (used in) investing                            activities                               |   | 14,687   |   |   | (1,759   | )      |
|                                                                                                         |   |     |   |   |     |   |
| Cash flows from financing activities:                                                                        |   |     |   |   |     |   |
| Proceeds from exercise of stock options                                                                      |   | —  |   |   | 6        |   |
| Purchase of treasury shares                                                                                  |   | (2,742   | )      |   | —  |   |
| Net cash (used in) provided by financing                            activities                               |   | (2,742   | )      |   | 6        |   |
|                                                                                                         |   |     |   |   |     |   |
| Effects of exchange rate changes on cash and cash                            equivalents                     |   | 4        |   |   | 22       |   |
|                                                                                                         |   |     |   |   |     |   |
| Net increase (decrease) in cash and cash                            equivalents                              |   | 7,998    |   |   | (725     | )      |
|                                                                                                         |   |     |   |   |     |   |
| Cash and cash equivalents, beginning of                            period                                    |   | 24,872   |   |   | 18,066   |   |
|                                                                                                         |   |     |   |   |     |   |
| Cash and cash equivalents, end of period                                                                     | $      | 32,870   |   | $      | 17,341   |   |
|                                                                                                         |   |     |   |   |     |   |
| *Supplemental disclosure of cash flow                            information:*                               |   |     |   |   |     |   |
| Cash paid during period for Income Taxes                                                                     | $      | 37       |   | $      | —  |   |
| *Supplemental schedule of non-cash investing and                            financing activities*            |   |     |   |   |     |   |
| Unrealized loss on marketable securities                                                                     | $      | 9,187    |   | $      | —  |   |

 

See            notes to consolidated financial statements.

5

----

**4KIDS ENTERTAINMENT, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

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

 

**1.            DESCRIPTION OF BUSINESS**

 

*General**Development and Narrative            Description of Business*- 4Kids Entertainment, Inc., together            with the subsidiaries through which its businesses are conducted (the            “Company”), is a diversified entertainment and media company specializing            in the youth oriented market with operations in the following business segments: (i)            Licensing; (ii) Advertising Media and Broadcast; (iii) Television and Film            Production/Distribution; and (iv) Trading Card and Game Distribution. The Company was            organized as a New York corporation in 1970.

 

***Licensing***- The Licensing business            segment consists of the results of operations of the following wholly-owned            subsidiaries of the Company: 4Kids Entertainment Licensing, Inc. (“4Kids            Licensing”); 4Sight Licensing Solutions, Inc. (“4Sight Licensing”);            4Kids Entertainment International, Ltd. (“4Kids International”); and 4Kids            Technology, Inc. (“4Kids Technology”). 4Kids Licensing is engaged in the            business of licensing the merchandising rights to popular children’s television            series, properties and product concepts (individually, the “Property” or            collectively the “Properties”). 4Kids Licensing typically acts as exclusive            merchandising agent in connection with the grant to third parties of licenses to            manufacture and sell all types of merchandise, including toys, videogames, trading            cards, apparel, housewares, footwear, books and other published materials, based on            such Properties. 4Sight Licensing is engaged in the business of licensing properties            and product concepts to adults, teens and “tweens”. 4Sight Licensing            focuses on brand building through licensing. 4Kids International, based in London,            manages Properties represented by the Company in the United Kingdom and European            marketplaces. 4Kids Technology develops ideas and concepts for licensing which            integrate new and existing technologies with traditional game and toy play            patterns.

 

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

 

On            October 1, 2007, the Company and The CW Network, LLC ("The CW") entered into an            agreement (the "CW Agreement"), under which The CW granted to the Company the exclusive            right to program The CW's Saturday morning children's programming block that is            broadcast in most markets between 7am and 12pm ("The CW Kids Block") for an initial            term of five years beginning with The CW's 2008-2009 broadcast season.

 

Effective June 30, 2006, the Company’s wholly-owned subsidiary,            The Summit Media Group, Inc. (“Summit Media”), which previously provided            print and broadcast media planning and buying services for clients principally in the            children’s toy and game business, terminated its operations. As a consequence of            the termination of its operations, Summit Media no longer serves as a media buying            agency for third parties and is classified as a discontinued operation.

 

***Television and Film Production/Distribution***- The Television and Film Production/Distribution business segment            consists of the results of operations of the following wholly-owned subsidiaries of the            Company: 4Kids Productions, Inc. (“4Kids Productions”); 4Kids Entertainment            Music, Inc. (“4Kids Music”); and 4Kids Entertainment Home Video, Inc.            (“4Kids Home Video”). 4Kids Productions produces and adapts animated and            live-action television programs and theatrical motion pictures for distribution to the            domestic and international television, home video and theatrical markets. 4Kids Music            composes original music for incorporation into television programming produced by 4Kids            Productions and markets and manages such music. 4Kids Home Video distributes home            videos associated with television programming produced by 4Kids Productions.

 

***Trading Card and Game Distribution***-            Through its wholly-owned subsidiary, 4Kids Digital Games, Inc. (“4Kids            Digital”), the Company owns 55% of TC Digital Games LLC, a Delaware limited            liability company (“TC Digital”) that produces, markets and distributes the            “Chaotic” trading card game. In December 2006, 4Kids Digital acquired a 53%            ownership interest in TC Digital and entered into TC Digital’s operating            agreement (the “TCD Agreement”) with Chaotic USA Digital Games LLC            (“CUSA LLC”), a wholly-owned subsidiary of Chaotic USA Entertainment Group,            Inc. (“CUSA”). The TCD Agreement contains terms and conditions governing            the operations of TC Digital, and entitles 4Kids Digital and CUSA to elect two managers            to the entity’s Management Committee with 4Kids Digital having the right to break            any dead-locks. On December 18, 2007, 4Kids Digital purchased an additional 2%            membership interest in TC Digital from CUSA increasing 4Kids Digital’s ownership            percentage to 55%. The consideration for the purchase of the additional membership            interest

6

 

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was            paid through the settlement of certain capital contributions required to be made by            CUSA to TC Websites LLC, a Delaware limited liability company and subsidiary of the            Company (“TC Websites”) under its operating agreement (the “TCW            Agreement”).

 

Through its wholly-owned subsidiary, 4Kids Websites, Inc. (“4Kids            Websites”), the Company owns 55% of TC Websites, a company that owns and            operates*www.chaoticgame.com*,            the companion website for the “Chaotic” trading card game which was            launched as a public beta version on October 24, 2007. In December 2006, 4Kids Websites            purchased a 50% membership interest in TC Websites from CUSA and entered into the TCW            Agreement. The TCW Agreement contains terms and conditions governing TC Websites’            operations and entitles 4Kids Websites and CUSA to elect two managers to its Management            Committee. On December 18, 2007, 4Kids Websites entered into an agreement pursuant to            which it acquired an additional 5% ownership interest in TC Websites from CUSA, and the            TCW Agreement was concurrently amended to provide 4Kids Websites with the right to            break any deadlocks on TC Websites’ Management Committee, including with respect            to operational matters. The consideration for the purchase of the additional membership            interest was paid through the settlement of certain capital contributions required to            be made by CUSA to TC Websites under the TCW Agreement. Prior to the acquisition by            4Kids Websites of the additional 5% ownership interest and amendment of the TCW            Agreement, the Company used the equity method to account for its investment in TC            Websites, where it did not have control but had significant influence. As a result of            4Kids Websites’ increased ownership and operational control, TC Websites is            consolidated in the Company’s financial statements, subject to a minority            interest.

TC            Digital and TC Websites are the exclusive licensees of certain patents covering the            uploading of coded trading cards to a website where online game play and community            activities occur. The*www.chaoticgame.com*website provides full access to all of its content and is free of charge            for all users. No purchase of trading cards is necessary to play the online version            where virtual playing decks are available to users who register on the website. These            two businesses enable the Company to offer traditional trading card game play with an            online digital play experience. In addition, it is anticipated that TC Digital and TC            Websites will diversify their product lines and will ultimately distribute and sell,            and create websites for other trading card games. The Company believes that its            ownership interests in TC Digital and TC Websites represent a potentially significant            addition to its business strategy.

Certain of the Company’s executive officers have interests in            CUSA, CUSA LLC and certain other entities with which TC Digital and TC Websites have            engaged in transactions since their formation. Information regarding these            relationships can be found in Note 9.

 

**2.            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Basis of Presentation***- The            consolidated financial statements, except for the December 31, 2007 consolidated            balance sheet and the consolidated statement of stockholders’ equity and            comprehensive loss for the year ended December 31, 2007, are unaudited and should be            read in conjunction with audited consolidated financial statements and notes thereto            for the year ended December 31, 2007 as presented in our Annual Report on Form 10-K.            All significant intercompany accounts and transactions have been eliminated. In the            opinion of management, the accompanying consolidated financial statements contain all            adjustments, which are of a normal and recurring nature, necessary to present fairly            the financial position of the Company as of March 31, 2008 and December 31, 2007, and            the results of operations for the three months ended March 31, 2008 and 2007, and            stockholders’ equity and comprehensive loss for the three months ended March 31,            2008 and the year ended December 31, 2007, and cash flows for the three months ended            March 31, 2008 and 2007. Because of the inherent seasonality and changing trends of the            toy, game, entertainment and advertising industries, operating results for the Company            on a quarterly basis may not be indicative of operating results for the full            year.

In            connection with the termination of the operations of Summit Media, the media buying            operations have been classified as a discontinued operation. As further discussed in            Note 12, the consolidated financial statements have been reclassified to reflect the            reporting of this business as a discontinued operation.

Effective January 1, 2007, the Company adopted the provisions of            Financial Accounting Standards Board (the “FASB”) Interpretation            No. 48,*Accounting for Uncertainty in Income            Taxes*(“FIN 48”). FIN 48 prescribes the financial            statement recognition and measurement criteria for a tax position taken or expected to            be taken in a tax return. FIN 48 also requires additional disclosures related to            uncertain income tax positions. See Note 6, “Income Taxes”, for further            information.

 

7

 

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***Revenue Recognition***–*Merchandise licensing revenues*:            Licensing revenues, net of licensor participations, are recognized when the underlying            royalties from the sales of the related products are earned. The Company recognizes            guaranteed royalties, net of licensor participations, at the time the arrangement            becomes effective if the Company has no significant direct continuing involvement with            the underlying Property or obligation to the licensee. Where the Company has            significant continuing direct involvement with the underlying Property or obligation to            the licensee, guaranteed minimum royalties, net of licensor participations, are            recognized ratably over the term of the license or based on sales of the related            products, if greater. Licensing advances and guaranteed payments collected but not yet            earned by the Company are classified as deferred revenue in the accompanying            consolidated balance sheets.

 

*Broadcast advertising revenues*:            Advertising revenues are recognized when the related commercials are aired and are            recorded net of agency commissions and net of an appropriate reserve when advertising            is sold together with a guaranteed audience delivery. Internet advertising revenues are            recognized on the basis of impression views in the period the advertising is displayed.            Commission income from the discontinued media planning and buying operations of Summit            Media, from both print and broadcast media, were recognized at the time the related            media was run.

 

*Episodic television series revenues*:            Television series initially produced for networks and first-run syndication are            generally licensed to domestic and foreign markets concurrently. The length of the            revenue cycle for episodic television varies depending on the number of seasons a            series remains in active exploitation. Revenues arising from television license            agreements, net of licensor participations, are recognized in the period that the films            or episodic television series are available for telecast.

 

Production and adaptation costs charged to the licensors of television            rights to Properties represented by the Company are included in net revenues and the            corresponding costs are included in production service costs in the accompanying            consolidated statements of operations. Production service costs included in net            revenues amounted to $1,480 and $1,717 for the three months ended March 31, 2008 and            2007, respectively.

 

*Home video revenues*: Revenues from            home video and DVD sales, net of a reserve for returns, are recognized, net of licensor            participations, on the date that video and DVD units are shipped by the Company’s            distributor to wholesalers/retailers. Consistent with the practice in the home video            industry, the Company estimates the reserve for returns based upon its review of            historical returns rates and expected future performance.

 

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

 

*Trading card revenues*: Emerging            Issue Task Force (“EITF”) Issue No. 00-21 -*Accounting for Revenue Arrangements with Multiple            Deliverables*, provides guidance on how and when to recognize            revenues for arrangements that may involve the delivery or performance of multiple            products, services and/or rights to use assets. Revenue arrangements with multiple            deliverables are required to be divided into separate units of accounting if the            deliverables in the arrangement meet certain criteria. Arrangement consideration must            be allocated among the separate units of accounting based on their relative fair            values. The Company has determined that because its trading card game is provided with            a web component, there is a multiple deliverable arrangement. However, since no            purchase of trading cards is necessary to access the website and cards are available            free of charge to users who register on the website, the Company has determined that            the selling price of the trading cards should be fully attributable to the cards.            Revenues from trading card sales, net of a reserve for returns and allowances, are            recognized on the date cards are shipped by the Company’s distributor to            wholesalers/retailers as reported to the Company.

 

***Fair Value Measurements-***The fair values of the Company’s financial instruments reflect the            estimates of amounts that would be received from selling an asset in an orderly            transaction between market participants at the measurement date. The fair value            estimates presented in this report are based on information available to the Company as            of March 31, 2008 and December 31, 2007.

 

The            carrying values of cash and cash equivalents approximate fair value. The Company has            estimated the fair value of its investment in auction rate securities            (“ARS”) using significant unobservable inputs at March 31,            2008.

 

In            accordance with Statement of Financial Accounting Standards            (“SFAS”)No. 157,*Fair Value            Measurements*(“SFAS No. 157”), the Company            applies a fair value hierarchy based on three levels of inputs, the first two of which            are considered

 

8

 

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observable and the last of which is considered unobservable, that may be            used to measure fair value. The three levels are the following:

 

|   | **•** | Level 1 - Quoted prices in active markets for identical                            assets or liabilities. |
|--------|------------|-----------------------------------------------------------------------------------------------------------|

 

|   | **•** | Level 2 - Inputs other than Level 1 that are observable,                            either directly or indirectly, such as quoted prices for similar assets                            or liabilities, quoted prices in markets that are not active, or other                            inputs that are observable or can be corroborated by observable market                            data for substantially the full term of the assets or                            liabilities. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Level 3 - Unobservable inputs that are supported by                            little or no market activity and that are significant to the fair value                            of the assets or liabilities. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

***Investments***– The            Company’s short-term investments principally consist of ARS and other debt            securities. ARS are generally rated A or better by one or more national rating agencies            and have contractual maturities of up to 30 years. The Company classifies its            investments in auction rate securities as “available for sale.” The auction            rate securities that the Company invests in generally have interest reset dates that            occur every 7 or 35 days and despite the long-term nature of their stated contractual            maturity, the historical operation of the auction rate security market has given the            Company the ability to quickly liquidate these securities at ongoing auctions every 35            days or less.

During 2007, liquidity issues began to affect the global credit and            capital markets. As a result, ARS, which historically have had a liquid market and had            their interest rates reset periodically (e.g. monthly) through Dutch auctions, began to            fail at auction. These auction failures have caused ARS to become illiquid, which in            turn has caused the fair market values for these securities to decline.

As            of March 31, 2008, the Company held ARS having an aggregate principal amount of            approximately $52,000. The ARS currently held by the Company are private placement debt            securities with long-term nominal maturities and interest rates that typically reset            monthly. The Company’s investments in ARS represent interests in debt obligations            issued by banks and insurance companies that had at least an “A” credit            rating at the time of purchase by the Company, including bond insurers and re-insurers            such as MBIA, AMBAC, FGIC, FSA, RAM and Radian.

Many            of the ARS held by the Company as of March 31, 2008, have experienced failed            auctions due to the liquidity issues described above. As of March 31, 2008, the            estimated fair market value of the ARS held by the Company declined by $13,180 ($3,993            during 2007 and $9,187 during the first quarter of 2008) based upon an analysis of the            current market conditions of the Company’s securities held made by the Company in            accordance with SFAS No. 157. Although all of the ARS invested in by the Company have            continued to pay interest according to their stated terms and substantially all of the            ARS invested in by the Company continue to be a rated “A” or above, the            Company recorded an unrealized loss of $9,187 during the first quarter of 2008            resulting in a reduction in stockholders’ equity. Since the Company has the            ability and the intent to hold these investments until recovery of their fair value,            which may not be prior to the maturity of the applicable security, the Company does not            consider these investments to be other-than-temporarily impaired.

 

The            credit and capital markets, including the market for ARS have remained illiquid in            2008, and as a result, there continues to be failed auctions affecting ARS owned by the            Company. Although all of the Company’s investments in ARS have continued to pay            interest according to their stated terms and substantially all of the ARS invested in            by the Company continue to be a rated “A” or above, the Company’s            unrealized loss on its ARS had subsequently increased by $1,005, to a cumulative            unrealized loss of $14,185 as of April 30, 2008, based upon statements provided by the            investment bank through which the Company holds such securities.

Given the failed auctions, many of the Company’s ARS are currently            illiquid.  Accordingly, the Company has reclassified $9,021 (face amount of            $20,350 less estimated devaluations of $11,329), in ARS from current to non-current            assets on its balance sheet due to the fact that the Company believes that the            liquidity of these ARS is unlikely to be restored in a period less than twelve months            from such date.

 

If            uncertainties in the credit and capital markets continue or the Company experiences any            rating downgrades on any investments in its ARS portfolio or the value of such            investments declines further, the Company may incur impairment charges to its            investment portfolio, which could negatively affect the Company’s financial            condition and cash flow. If in the reasonable judgment of the Company, the value of any            ARS should be permanently impaired, the Company would record an expense which would            negatively impact reported earnings. As a result of the current market issues, the            Company has invested its surplus cash solely in U.S. Treasury securities.

 

9

 

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The            Company believes that based on the Company’s current cash, cash equivalents and            marketable securities, the current lack of liquidity affecting a significant portion of            its portfolio of ARS will not have a material impact on the Company’s liquidity            or its ability to fund its operations.

 

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

 

***Translation of Foreign Currency —***In accordance with SFAS No. 130,*Reporting            Comprehensive Income*(“SFAS No. 130”), the            Company classifies items of other comprehensive income by their nature in the financial            statements and displays the accumulated balance of other comprehensive income            separately from retained earnings and additional paid-in capital in the equity section            of the consolidated balance sheet. The assets and liabilities of the Company’s            foreign subsidiary, 4Kids International have been recorded in their local currency and            translated to U.S. dollars using period-end exchange rates. Income and expense items            have been translated at the average rate of exchange prevailing during the period. Any            adjustment resulting from translating the financial statements of the foreign            subsidiary is reflected as “other comprehensive income”, net of related            tax. Comprehensive loss for the three months ended March 31, 2008 and 2007, was $15,582            and $172, respectively, which included translation adjustments of $4 and $33 for the            respective periods.

 

***Recently Issued Accounting            Pronouncements*****–**In            November 2007, the FASB issued SFAS No. 141R,*Business            Combinations*(“SFAS No. 141R”), which continues            to require that all business combinations be accounted for by applying the acquisition            method. Under the acquisition method, the acquirer recognizes and measures the            identifiable assets acquired, the liabilities assumed, and any contingent consideration            and contractual contingencies, as a whole, at their fair value as of the acquisition            date. Under SFAS No. 141R, all transaction costs are expensed as incurred. SFAS No.            141R rescinds EITF Issue No. 93-7 (“EITF 93-7). Under EITF 93-7, the effect of            any subsequent adjustments to uncertain tax positions were generally applied to            goodwill, except for post-acquisition interest on uncertain tax positions, which was            recognized as an adjustment to income tax expense. Under SFAS No. 141R, all subsequent            adjustments to these uncertain tax positions that otherwise would have impacted            goodwill will be recognized in the income statement. SFAS No. 141R will be applied            prospectively to business combinations for which the acquisition date is on or after            the beginning of the first annual reporting period beginning after December 15,            2008.

In            September 2006, the FASB issued SFAS No. 158,*Employers’ Accounting for Defined Benefit Pension and Other            Postretirement Plans—An Amendment of FASB            No.* *87, 88, 106 and            132(R)*(“SFAS 158”). SFAS 158 requires            that the funded status of defined benefit postretirement plans be recognized on            companies’ balance sheets and that changes in the funded status be reflected in            comprehensive income, effective for fiscal years ending after December 15, 2006.            SFAS 158 also requires companies to measure the funded status of each such plan as of            the date of its fiscal year-end, effective for fiscal years ending after            December 15, 2008. Since the Company does not currently have a defined benefit            postretirement plan, the adoption of SFAS 158 will not have any impact on its            consolidated financial position and results of operations.

In            November 2007, the FASB issued SFAS No. 160,*Accounting and            Reporting of Noncontrolling Interest*(“SFAS No.            160”). SFAS No. 160 requires that a noncontrolling interest (previously referred            to as a minority interest) be separately reported in the equity section of the            consolidated entity’s balance sheet. SFAS No. 160 also established accounting and            reporting standards for: (i) ownership interests in subsidiaries held by parties other            than the parent, (ii) the amount of consolidated net income attributable to the parent            and to the noncontrolling interest, (iii) changes in a parent’s ownership            interest and (iv) the valuation of retained noncontrolling equity investments when a            subsidiary is deconsolidated. SFAS No. 160 is effective for us beginning January 1,            2009. The Company is currently evaluating the impact the adoption of SFAS No. 160 will            have on its consolidated financial position and results of operations.

 

In            March 2008, the FASB issued SFAS No. 161 (“SFAS 161”),*Disclosures about Derivative Instruments and Hedging            Activities—an amendment of FASB Statement No.133, Accounting for Derivative            Instruments and Hedging Activities*(“SFAS No.            133”)*.*SFAS No. 161 requires            companies to provide enhanced disclosures regarding derivative instruments and            hedging

 

10

 

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activities in order to better convey the purpose of derivative use in            terms of risk management. Disclosures about (i) how and why an entity uses derivative            instruments, (ii) how derivative instruments and related hedged items are accounted for            under SFAS No. 133 and its related interpretations, and (iii) how derivative            instruments and related hedged items affect a company's financial position, financial            performance, and cash flows, are required. This Statement retains the same scope as            SFAS No. 133 and is effective for fiscal years and interim periods beginning after            November 15, 2008. The Company is currently evaluating the impact, if any, that the            adoption of SFAS No. 161 will have on its consolidated financial position and results            of operations.

 

In            December 2007, the FASB ratified EITF Issue No. 07-1,*Accounting for Collaborative Arrangements Related to the Development            and Commercialization of Intellectual Property*. The EITF            concluded that a collaborative arrangement is one in which the participants are            actively involved and are exposed to significant risks and rewards that depend on the            ultimate commercial success of the endeavor. Revenues and costs incurred with third            parties in connection with collaborative arrangements would be presented gross or net            based on the criteria in EITF Issue No. 99-19,*Reporting            Revenue Gross as a Principal versus Net as an Agent*, and            other accounting literature. Payments to or from collaborators would be evaluated and            presented based on the nature of the arrangement and its terms, the nature of the            entity’s business, and whether those payments are within the scope of other            accounting literature. The nature and purpose of collaborative arrangements are to be            disclosed along with the accounting policies and the classification and amounts of            significant financial statement amounts related to the arrangements. Activities in the            arrangement conducted in a separate legal entity should be accounted for under other            accounting literature; however required disclosure under EITF 07-1 applies to the            entire collaborative agreement. This Issue is effective for fiscal years beginning            after December 15, 2008, and is to be applied retrospectively to all periods presented            for all collaborative arrangements existing as of the effective date. The Company is            currently evaluating the impact that this pronouncement may have on its consolidated            financial position and results of operations.

 

**3.            FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The            carrying values and estimated fair values of the Company’s financial instruments            for the periods presented are as follows:

|                                |         |                                  |         |                                                                                |         |                                                                           |         |                                                                  |    |         |   |          |   |
|-------------------------------------|--------------|---------------------------------------|--------------|-------------------------------------------------------------------------------------|--------------|--------------------------------------------------------------------------------|--------------|-----------------------------------------------------------------------|---------|--------------|--------|---------------|--------|
|                                |    | **Estimated Fair Value Measurements** |
|                                |    | **Carrying** **Value**           |    | **Quoted**

**Prices** **in**

**Active**

**Markets**

**(Level** **1)** |    | **Significant**

**Other**

**Observable**

**Inputs**

**(Level** **2)** |    | **Significant**

**Unobservable**

**Inputs**

**(Level** **3)** |    |
| ***March*** ***31, 2008:***    |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Financial Assets                    |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Cash and cash equivalents           |    | $                                     | 32,870       |                                                                           | $            | 32,870                                                                         |    | $                                                                     | — |    | $      | —  |   |
| Auction rate securities             |         |                                  | 20,042       |                                                                                |         | —                                                                        |         |                                                                  | — |         |   | 20,042        |   |
| Corporate obligations               |    |                                  | 4,963        |                                                                           |         | —                                                                        |    |                                                                  | — |    |   | 4,963         |   |
| Total short-term investments        |         | $                                     | 57,875       |                                                                                | $            | 32,870                                                                         |         | $                                                                     | — |         |   | 25,005        |   |
|                                |         |                                  |         |                                                                                |         |                                                                           |         |                                                                  |    |         |   |          |   |
| Auction rate securities             |         | $                                     | 18,695       |                                                                                | $            | —                                                                        |         | $                                                                     | — |         | $      | 18,695        |   |
| Total long-term investments         |         | $                                     | 18,695       |                                                                                | $            | —                                                                        |         | $                                                                     | — |         | $      | 18,695        |   |
|                                |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Total Financial Assets              |    | $                                     | 76,570       |                                                                           | $            | 32,870                                                                         |    | $                                                                     | — |    | $      | 43,700        |   |
|                                |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| ***December*** ***31, 2007:*** |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Financial Assets                    |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Cash and cash equivalents           |    | $                                     | 24,872       |                                                                           | $            | 24,872                                                                         |    | $                                                                     | — |    | $      | —       |   |
| Auction rate securities             |         |                                  | 31,170       |                                                                                |         | —                                                                        |         |                                                                  | — |         |   | 31,170        |   |
| Corporate obligations               |         |                                  | 4,936        |                                                                                |         | —                                                                        |         |                                                                  | — |         |   | 4,936         |   |
| Total short-term investments        |         | $                                     | 60,978       |                                                                                | $            | 24,872                                                                         |         | $                                                                     | — |         | $      | 36,106        |   |
|                                |         |                                  |         |                                                                                |         |                                                                           |         |                                                                  |    |         |   |          |   |
| Auction rate securities             |         | $                                     | 26,806       |                                                                                | $            | —                                                                        |         | $                                                                     | — |         | $      | 26,806        |   |
| Corporate obligations               |         |                                  | 5,000        |                                                                                |         | 5,000                                                                          |         |                                                                  | — |         |   | —       |   |
| Total long-term investments         |         | $                                     | 31,806       |                                                                                | $            | 5,000                                                                          |         | $                                                                     | — |         | $      | 26,806        |   |
|                                |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
| Total Financial Assets              |    | $                                     | 92,784       |                                                                           | $            | 29,872                                                                         |    | $                                                                     | — |    | $      | 62,912        |   |
|                                |    |                                  |         |                                                                           |         |                                                                           |    |                                                                  |    |    |   |          |   |
|                                     |              |                                       |              |                                                                                     |              |                                                                                |              |                                                                       |         |              |        |               |        |  |  |  |  |  |

 

 

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Level 1- The Company’s Level 1 assets consist of cash, US Treasury            securities with original maturities of three months or less and Corporate            bonds.

 

Level 2 - At March 31, 2008 and December 31, 2007, the Company had            no investments which were considered to be Level 2 assets.

 

Level 3 – The Company’s Level 3 assets consist of the            Company’s investment in ARS. The recent uncertainties in the credit markets have            prevented the Company and other investors from liquidating their holdings of ARS in            auctions for these securities during the three months ended March 31, 2008,            because the amount of securities submitted for sale has exceeded the amount of purchase            orders.

 

The            carrying value of the Company’s investments in ARS as of March 31, 2008            represents the Company’s best estimate of the fair value of these investments            based on currently available information. The estimation process included consideration            of such factors as issuer and insurer credit rating, comparable market data, if            available, the credit quality of the ARS, the rate of interest received since the date            the auctions began, yields of securities similar to the underlying ARS and input from            broker-dealers. Due to the uncertainty in the credit markets, it is reasonably possible            the fair value of these investments may change in the near term. If the issuers are            unable to successfully close future auctions and their credit ratings deteriorate, the            Company may be required to further adjust the carrying value of its investment in ARS            through additional devaluations.

 

The            table below provides a summary of changes in fair value for the Company's investments:

 

|                                      |   | **March 31, 2008** |
|-------------------------------------------|--------|--------------------|
|                                      |   | **Amortized Cost** |   | **Unrealized Loss** |   | **Estimated**

**Fair Value** |
|                                      |   |               |   |   |   |   |   |   |
| Auction-Rate securities                   |   |               | $21,530 |   | $ (1,488 | ) |   | $20,042 |
| Corporate obligations                     |   |               | 5,000 |   | (37 | ) |   | 4,963 |
| Total short-term investments              |   |               | $26,530 |   | $ (1,525 | ) |   | $25,005 |
|                                      |   |               |   |   |   |   |   |   |
|                                      |   |               |   |   |   |   |   |   |
| Auction-Rate securities – long-term |   |               | $30,350 |   | $(11,655 | ) |   | $18,695 |
| Total long-term investments               |   |               | $30,350 |   | $(11,655 | ) |   | $18,695 |
|                                      |   |               |   |   |   |   |   |   |

 

|                                      |   | **December 31, 2007** |
|-------------------------------------------|--------|-----------------------|
|                                      |   | **Amortized Cost**    |   | **Unrealized Loss** |   | **Estimated**

**Fair Value** |
|                                      |   |                  |   |   |   |   |   |   |
| Auction-Rate securities                   |   |                  | $31,555 |   | $ (385 | ) |   | $31,170 |
| Corporate obligations                     |   |                  | 5,000 |   | (64 | ) |   | 4,936 |
| Total short-term investments              |   |                  | $36,555 |   | $ (449 | ) |   | $36,106 |
|                                      |   |                  |   |   |   |   |   |   |
|                                      |   |                  |   |   |   |   |   |   |
| Auction-Rate securities – long-term |   |                  | $30,350 |   | $(3,544 | ) |   | $26,806 |
| Corporate obligations                     |   |                  | 5,000 |   | — |   |   | 5,000 |
| Total long-term investments               |   |                  | $35,350 |   | $(3,544 | ) |   | $31,806 |

 

**4.            STOCK-BASED EMPLOYEE COMPENSATION**

 

The            Company has stock-based compensation plans for employees and non-employee members of            the Board of Directors. The plans provide for discretionary grants of stock options,            shares of restricted stock, and other stock-based awards. The plans are administered by            the Compensation Committee of the Board of Directors, consisting of non-employee            directors.

 

12

 

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Effective January 1, 2006, the Company adopted SFAS No. 123-R (revised            2004),*Share-Based Payment*s,            utilizing the modified prospective method whereby prior periods are not restated for            comparability. SFAS 123-R requires recognition of stock-based compensation expense in            the statement of operations over the vesting period based on the fair value of the            award at the grant date. Previously, the Company used the intrinsic value method under            APB No. 25,*Accounting for Stock Issued to            Employees*(‘‘APB No. 25’’), as            amended by related interpretations of the FASB. Under APB No. 25, no compensation cost            was recognized for stock options because the quoted market price of the stock at the            grant date was equal to the amount per share the employee had to pay to acquire the            stock after fulfilling the vesting period. SFAS 123-R supersedes APB No. 25 as well as            SFAS 123,*Accounting for Stock-Based            Compensation*, which permitted pro forma footnote disclosures            to report the difference between the fair value method and the intrinsic value method.            The Company did not grant any stock options during the three months ended March 31,            2008 and at January 1, 2006, all of the Company’s outstanding options were fully            vested. Consequently, the adoption of this pronouncement did not have a material effect            on the Company’s consolidated financial position or results of            operations.

 

The            following table summarizes activity under our stock option plans for the three months            ended March 31, 2008:

 

|                               |   | **Shares**

**(In thousands)** |    | **Weighted****Average****Exercise****Price** |   | **Remaining**

**Contractual**

**Life**

**(in years)** |   | **Aggregate****Intrinsic****Value** |   |
|------------------------------------|--------|--------------------------------|---------|----------------------------------------------|--------|----------------------------------------------------------|--------|-------------------------------------|--------|
| Outstanding at beginning of period |   |                           | 1,715   |                                         | $      | 18.43                                                    |   |                                |   |   |   |   |   |
| Grants                             |   |                           | — |                                         |   | —                                                  |   |                                |   |   |   |   |   |
| Exercised                          |   |                           | — |                                         |   | —                                                  |   |                                |   |   |   |   |   |
| Forfeited                          |   |                           | (30     | )                                            |   | 19.70                                                    |   |                                |   |   |   |   |   |
| Outstanding at end of period       |   |                           | 1,685   |                                         | $      | 18.41                                                    |   |                                | 1.57   |   | $ | 625 |   |
|                               |   |                           |    |                                         |   |                                                     |   |                                |   |   |   |   |   |
| Exercisable at end of period       |   |                           | 1,685   |                                         | $      | 18.41                                                    |   |                                | 1.57   |   | $ | 625 |   |

 

The            aggregate intrinsic value is calculated as the difference between the exercise price of            the underlying awards and the quoted price of our common stock for those awards that            have an exercise price currently below the closing price. As of March 31, 2008, there            were options outstanding to purchase an aggregate of approximately 225,000 shares with            an exercise price below the quoted price of our stock, resulting in an aggregate            intrinsic value of $625. During the three months ended March 31, 2008 and 2007, the            aggregate intrinsic value of options exercised under our stock option plans was $0 and            $4, respectively, determined as of the date of exercise.

 

*Restricted Stock Awards*

 

The            Company granted restricted stock awards of approximately 162,000 shares on May 25, 2007            under its 2006 long-term incentive compensation plan and 145,000 and 4,000 shares on            May 23, 2006 and June 15, 2006, respectively, under its 2005 long-term incentive            compensation plan. The restricted stock awards were granted to certain employees,            including officers and members of the Board of Directors, at grant prices of $16.79,            $16.52 and $15.78 (in each case, the average of the high and low stock price from the            previous day of trading) for the May 25, 2007, the May 23, 2006 and the June 15, 2006            grants, respectively. The restricted stock awards vest annually over a period of four            years from the date of grant with accelerated vesting upon a change of control of the            Company (as defined in the applicable plan). During the restriction period, award            holders do not have the rights of stockholders and cannot transfer ownership.            Additionally, nonvested shares of award holders are subject to forfeiture. These awards            are forfeited and revert to the Company in the event of employment termination, except            in the case of death, disability, retirement or other specified events.

 

 

 

 

 

 

13

 

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A            summary of restricted stock award activity under the Company’s long-term            incentive compensation plans as of March 31, 2008 and changes during the three months            then ended is presented as follows:

 

|                           |   | **Number of Shares**

**(in thousands)** |    | **Weighted- Average Grant Date Fair                            Value** |   |
|--------------------------------|--------|------------------------------------------|---------|------------------------------------------------------------------------|--------|
| Outstanding at January 1, 2008 |   |                                     | 254     |                                                                   | $      | 16.68 |   |
| Granted                        |   |                                     | — |                                                                   |   | — |   |
| Vested                         |   |                                     | — |                                                                   |   | — |   |
| Forfeited                      |   |                                     | — |                                                                   |   | — |   |
| Outstanding at March 31, 2008  |   |                                     | 254     |                                                                   | $      | 16.68 |   |
|                                |        |                                          |         |                                                                        |        |  |  |  |  |  |  |  |

 

As            of March 31, 2008 and 2007, the Company recognized $298 and $137 of compensation costs            related to the long-term incentive compensation plans. Additionally, as of March 31,            2008, there was approximately $2,232 and $1,155 of unrecognized compensation cost            related to restricted stock awards granted under the Company’s 2006 and 2005            long-term incentive compensation plans, respectively. The cost is expected to be            recognized over a remaining weighted-average period of 3.2 and 2.1 years under the 2006            and 2005 plans, respectively. There were no shares of restricted stock that vested            during the three months ended March 31, 2008.

 

*Availability for Future Issuance -*As of            the three months ended March 31, 2008, (i) options to purchase approximately 803,000            shares of the Company’s common stock were available for future issuance under the            Company’s stock option plans and (ii) options to purchase a maximum of            approximately 845,000 shares of the Company’s common stock were available for            future issuance under the Company’s long-term incentive compensation plans,            reduced by four shares for each share of restricted stock awarded under the 2006 and            2005 plans, for which an aggregate of 45,000 shares were available for issuance as            options, and reduced by two shares for each share of restricted stock awarded under the            2007 plan for which 800,000 shares were available for issuance as options.            Additionally, approximately 8,205 shares of restricted stock, repurchased in May 2007            to discharge withholding tax obligations upon the vesting of certain employees’            restricted shares, were also available for issuance under the 2005 plan.

 

**5.            DEFERRED REVENUE**

 

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

 

The            Company has deferred all amounts received under the contract, and recognizes revenue as            the Current Music Assets and Future Music Assets generate revenue over the contract            term. The Company expects and continues to produce additional new music which, based on            the success of the administrative service, continues to supply the unaffiliated third            party with this content. Since the Company continues to deliver more than the amount of            music required to be delivered under the Music Agreement, there is no way to            appropriately record the fair value of the future amounts to be delivered. Based on            EITF 00-21, the Company’s inability to fair value the future portion of the music            deliverables results in the entire amount to be recorded as deferred revenue. The most            appropriate and systematic method of accounting for this revenue relating to the            deferred portion would be to reduce this deferred amount dollar for dollar based on the            actual music earnings of the Company.  Pursuant to the above, the Company            recognized revenues of $90 and $74 for the three months ended March 31, 2008 and 2007,            respectively. The Company has included $1,904 and $1,994 as deferred revenue on the            accompanying consolidated balance sheets as of March 31, 2008 and December 31, 2007,            respectively. 

             

*Home Video*- At various dates since May            2002, 4Kids Home Video entered into various agreements with an unaffiliated third party            home video distributor (the “Video Distributor”) pursuant to which 4Kids            Home Video provides ongoing advertising, marketing and promotional services with            respect to certain home video titles that are owned or controlled by the Company and            which are distributed by the Video Distributor. The Video Distributor has paid the            Company cumulative advances of $4,119 against 4Kids Home Video’s share of the            distribution and service fee proceeds to be realized by 4Kids Home Video from such            titles. Pursuant to the above, the Company recognized revenue of $171 and $36 for the            three months

 

14

 

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ended March 31, 2008 and 2007, respectively. The Company has included            $248 and $419 as deferred revenue on the accompanying consolidated balance sheets as of            March 31, 2008 and December 31, 2007, respectively.

 

*Other Agreements*- In addition, the Company            entered into other agreements for various Properties and advertising time on 4Kids TV            in which the Company has received certain advances and/or minimum guarantees. As of            March 31, 2008 and December 31, 2007, the unearned portion of these advances and            guaranteed payments was $298 and $571, respectively, and is included in deferred            revenue on the accompanying consolidated balance sheets.

 

**6.            INCOME TAXES**

 

The            (provision for) benefit from income taxes consisted of the following:

 

|                       |   | **Three Months Ended** |   |     |
|----------------------------|--------|------------------------|--------|----------|
|                       |   | **March 31,**          |   |     |
|                       |   | **2008**               |   | **2007** |   |   |
| Current                    |   | $                      | 2,352  |     | $ | 941 |   |   |
| Deferred                   |   |                   | (70    | )        |   | (264 | ) |   |
|                       |   | $                      | 2,282  |     | $ | 677 |   |   |
| Less:  Valuation allowance |   |                   | (2,310 | )        |   | — |   |   |
| Total                      |   | $                      | (28    | )        | $ | 677 |   |   |

 

 

The            Company adopted the provisions of FIN 48, effective January 1, 2007. FIN 48            clarifies the accounting for uncertainty in income taxes recognized in an            enterprise’s financial statements in accordance with SFAS No. 109,*Accounting for Income Taxes*(“SFAS            No. 109”). FIN 48 prescribes a recognition threshold and measurement attribute            for financial statement recognition and measurement of a tax position taken or expected            to be taken in a tax return. FIN 48 also provides guidance on the derecognition,            classification, interest and penalties, accounting in interim periods, disclosure and            transition. The adoption of this interpretation did not have a material effect on the            Company’s consolidated financial position or results of operations.

 

The            Company and its consolidated subsidiaries file income tax returns in the United States            and in the United Kingdom. The Company is no longer subject to examinations by income            tax authorities in most jurisdictions for years prior to 2003.

 

**7.            EARNINGS PER SHARE**

 

The            Company applies SFAS No. 128,*Earnings per Share,*which requires the computation and presentation of earnings per share            (“EPS”) to include basic and diluted EPS. Basic EPS is computed based            solely on the weighted average number of common shares outstanding during the period.            Diluted EPS reflects all potential dilution of common stock. The following table            reconciles Basic EPS with Diluted EPS for the three months ended March 31, 2008 and            2007:

 

| **Three Months Ended March 31, 2008**                                                        |   | **Net Loss** |   | **Weighted Average Shares** |   | **Per Share** |   |
|----------------------------------------------------------------------------------------------|--------|--------------|--------|-----------------------------|--------|---------------|--------|
| Basic loss per share –Loss available to common                            shareholders | $      | (6,399       | )      | 13,226,618                  | $      | (0.48         | )      |
|                                                                                         |   |         |   |                        |   |          |   |
| Effect dilutive security – Stock                            options                    |   | —      |   | —                     |   | —       |   |
|                                                                                         |   |         |   |                        |   |          |   |
| Diluted loss per share                                                                       | $      | (6,399       | )      | 13,226,618                  | $      | (0.48         | )      |

 

| **Three Months Ended March 31, 2007**                                                        |   | **Net Loss** |   | **Weighted Average Shares** |   | **Per Share** |   |
|----------------------------------------------------------------------------------------------|--------|--------------|--------|-----------------------------|--------|---------------|--------|
| Basic loss per share –Loss available to common                            shareholders | $      | (205         | )      | 13,183,279                  | $      | (0.02         | )      |
|                                                                                         |   |         |   |                        |   |          |   |
| Effect dilutive security – Stock                            options                    |   | —      |   | —                     |   | —       |   |
|                                                                                         |   |         |   |                        |   |          |   |
| Diluted loss per share                                                                       | $      | (205         | )      | 13,183,279                  | $      | (0.02         | )      |

 

For            the three months ended March 31, 2008 and 2007, 1,460,425, and 1,250,750 shares,            respectively, attributable to the exercise of outstanding options, were excluded from            the calculation of diluted EPS because the effect was antidilutive.

 

15

 

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**8.            LEGAL PROCEEDINGS**

 

The            Company, from time to time, is involved in litigation arising in the ordinary course of            its business. The Company does not believe that such litigation to which the Company or            any subsidiary of the Company is a party or of which any of their Properties is the            subject will, individually or in the aggregate, have a material adverse affect on the            Company’s financial position or the results of its operations.

 

**9. RELATED PARTY**

 

*National Law Enforcement and Firefighters Children’s            Foundation*- The Company’s Chairman and Chief Executive            Officer is the founder and President of The National Law Enforcement and Firefighters            Children’s Foundation (the “Foundation”). The Foundation is a            not-for-profit organization dedicated to helping the children of law enforcement and            firefighting personnel and working with law enforcement and firefighting organizations            to provide all children with valuable social and life skill programs. During the three            months ended March 31, 2008 and 2007, the Company contributed approximately $31 and            $30, respectively, to the Foundation.

*Chaotic USA Entertainment Group, Inc. (“CUSA”)*- On December 11, 2006, 4Kids Digital and CUSA LLC, entered into the TCD            Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids            Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47%            of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital            purchased an additional 2% membership interest in TC Digital from CUSA LLC increasing            4Kids Digital’s ownership percentage to 55%. TC Digital is treated as a            consolidated subsidiary of the Company as a result of its majority ownership in TC            Digital and its right to break any dead-locks within the TC Digital Management            Committee. Bryan Gannon (“Gannon”), President and Chief Executive Officer            of CUSA and John Milito (“Milito”), Executive Vice President and Chief            Operating Officer of CUSA, each own an interest of approximately 32% in CUSA.            Additionally, on December 11, 2006, Gannon and Milito became officers of TC            Digital.

As            of March 31, 2008, the Company has entered into the following transactions with CUSA            and CUSA LLC, or parties related to Gannon and Milito that are summarized            below:

|   | ° | *Employment Agreements –*On December 11, 2006, TC Digital entered into employment                            agreements through December 31, 2009, with Bryan Gannon, to serve as                            its President and Chief Executive Officer and John Milito, to serve as                            its Executive Vice President. Under the terms of the employment                            agreements, each of Gannon and Milito will receive an annual base                            salary of $350 and are eligible to receive additional bonuses at the                            sole discretion of TC Digital’s Management Committee, on which                            they serve with minority voting rights. Gannon and Milito are each                            entitled to receive a minimum bonus of $200 in 2008 if TC Digital                            attains 60% of the projected revenues for the year approved by TC                            Digital’s Management Committee. As of March 31, 2008, no bonus                            had been earned with respect to 2008 under the employment agreements                            since their bonus is based on annual targets. |
|--------|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ° | *Chaotic Property Representation Agreement                            –*On December 11, 2006, 4Kids                            Licensing, CUSA and Apex Marketing, Inc. (“Apex”), a                            corporation in which Gannon holds 60% of the outstanding capital stock                            and Milito owns 39% of the outstanding capital stock, entered into an                            amended and restated Chaotic property representation agreement                            (“CPRA”) replacing the original Chaotic property                            representation agreement entered into by the parties in April 2005.                            Under the terms of the CPRA, 4Kids Licensing is granted exclusive                            television broadcast and production, merchandising licensing, and home                            video rights to the “Chaotic” Property worldwide in                            perpetuity, subject to certain limited exceptions. Under the terms of                            the CPRA, all “Chaotic” related income less approved                            merchandising and other expenses shall be distributed 50% to the                            Company and 50% to CUSA and Apex, excluding trading card royalties                            which are distributed 55% to 4Kids Digital and 45% to CUSA.                            Additionally, all approved production expenses for television episodes                            based on the “Chaotic” property are allocated 50% to 4Kids                            Licensing and 50% to CUSA and Apex. As of March 31, 2008, there were                            approximately $4,914 of production and merchandising expenses owed to                            4Kids Licensing by CUSA and Apex, collectively. |
|--------|-------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ° | *Patent License Agreements –*On December 11, 2006, TC Digital and TC Websites each                            entered into an agreement (the “Patent License Agreements”)                            with Cornerstone Patent Technologies, LLC (“Cornerstone”),                            a limited liability company, in which Gannon and Milito each hold a 25%                            membership interest. Pursuant to the Patent License Agreements, TC                            Digital and TC Websites obtained exclusive licenses (subject to certain                            exceptions) to use certain patent rights in connection with                            “Chaotic” and other trading card games which are uploaded                            to websites owned and operated by the combined entities. Additionally,                            each of TC Digital and TC Websites agreed to pay Cornerstone a royalty                            of 1.5% of the Manufacturers Suggested Retail Price for the sale of                            trading cards, which amounted to $64 |
|--------|-------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

16

 

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and $64 for each such entity, for the three months ended March 31, 2008.            On September 10, 2007, the Company purchased a 25% interest in such patents from            Cornerstone for $750. For the three months ended March 31, 2008, the Company earned            royalties of $42 related to its portion of the patents relating to the sales of            “Chaotic” trading cards which is eliminated in the Company’s            consolidated financial statements.

|   | ° | *TCD Agreement –*Under                            the terms of the TCD Agreement, TC Digital is obligated to pay the                            following fees and/or royalties to: (i) 4Kids Digital equal to 3% of TC                            Digital’s gross revenues up to $350 per year for management                            services performed; (ii) 4Kids Digital and CUSA equal to 3% of net                            sales of each pack of trading cards sold; and (iii) the Company equal                            to (x) 10% of the net sales of “Chaotic” trading cards and                            (y) an additional 1% of net sales of “Chaotic” trading                            cards above $50 million during a calendar year. The Company acquired                            its rights to receive royalties of 10% in respect to net sales of                            “Chaotic” trading cards under the TCD Agreement through                            purchases from Dracco Company Ltd. (“Dracco”) of a 5%                            royalty stream on October 17, 2007, a 1% royalty stream, previously                            allocated to CUSA from Dracco, on December 18, 2007, a 4% royalty                            stream on March 17, 2008 in exchange for one-time payments of $2,250,                            $450 and $1,100, respectively. The consideration for the purchase of                            the 1% royalty stream for $450 was satisfied through the settlement of                            certain capital contributions required to be made by CUSA to TC                            Websites under the TCW Agreement. During the three months ended March                            31, 2008, the Company and CUSA earned royalties of $286 and $76                            relating to the sales of “Chaotic” trading cards under the                            TCD agreement, respectively. The Company’s portion of royalties                            and its management fee were eliminated in its consolidated financial                            statements. |
|--------|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

4Kids Digital is required under the terms of the TCD Agreement and the            related loan and line of credit agreements to provide loans to TC Digital from time to            time in an aggregate amount up to $8,000 with a maturity date of December 31, 2010 and            an interest rate of 12%. Any transaction resulting in the sale of more than 50% of TC            Digital’s membership interests or in the sale of all or substantially all of TC            Digital’s assets occurring while there is no debt owed from TC Digital to 4Kids            Digital under the loan and line of credit or occurring prior to August 31, 2009            requires the consent of members of TC Digital holding two-thirds of its membership            interests (as opposed to a majority of its membership interests).

|   | ° | *Chaotic Merchandise License Agreement                            –*On December 11, 2006, 4Kids                            Licensing, CUSA and TC Digital entered into a merchandise licensing                            agreement pursuant to which 4Kids Licensing and CUSA granted TC Digital                            exclusive rights to manufacture, produce and license                            “Chaotic” trading cards and related accessories through                            December 31, 2016. Under the terms of the agreement, TC Digital is                            obligated to pay a royalty on trading cards and all related accessories                            equal to (i) 4% of net sales to 4Kids Licensing while any amounts are                            outstanding to 4Kids Digital under the loan agreement or line of credit                            agreement or (ii) 8% of net sales of such cards and accessories, 55% of                            which will be paid to 4Kids Licensing and 45% of which will be paid to                            CUSA. During the three months ended March 31, 2008, no royalties had                            been earned under this agreement. |
|--------|-------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ° | *Operating Agreement of TC Websites LLC                            –*On December 11, 2006, 4Kids Websites                            entered into the TCW agreement with CUSA to purchase a 50% membership                            interest in TC Websites, which was amended on December 18, 2007 in                            connection with 4Kids Websites’ acquisition of an additional 5%                            ownership interest in TC Websites. Under the terms of the TCW                            Agreement, TC Websites is obligated to pay fees to: (i) 4Kids Websites                            equal to 3% of gross revenues of TC Websites with a minimum fee of $100                            and a maximum fee of $200 per year for management services; (ii) Gannon                            equal to $100 for services as a senior executive; and (iii) Milito                            equal to $100 for services as a senior executive. Each member of TC                            Websites is obligated to make capital contributions on a pro-rata basis                            to the extent determined by its Management Committee to be necessary to                            fund the operation of the Website. Any transaction resulting in the                            sale of more than 50% of TC Websites’ membership interests or in                            the sale of all or substantially all of TC Digital’s assets                            requires the consent of members of TC Websites holding two-thirds of                            its membership interests (as opposed to a majority of its membership                            interests). |
|--------|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | ° | *Right of First Negotiation Agreement**–*On December 11,                            2006, the Company entered into a letter agreement with TC Digital                            providing TC Digital with a right of first negotiation for the license                            of trading card rights represented by the Company as merchandise                            licensing agent for any third party property and for any property                            developed and wholly owned by the Company, through December 31, 2009,                            subject to the terms of the Company’s obligations to third                            parties and to other limitations. If the Company and TC Digital are                            unable to reach an agreement with respect to trading card rights within                            a specified period, the Company will be free to license such trading                            card rights to third parties on terms no less favorable to the Company                            as the last offer made to TC Digital during such                            negotiations. |
|--------|-------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**10.            COMMITMENTS AND CONTINGENCIES**

             

*a.*   *Broadcast Agreements*- In January 2002, the            Company entered into a multi-year agreement with Fox to lease Fox’s Saturday            morning programming block (“4Kids TV”) which airs principally on Saturday            mornings from 8am to 12pm eastern/pacific time (7am to 11am central time). The Company            provides substantially all programming content to be broadcast on 4Kids TV and retains            all of the revenue from network advertising sales for the four-hour time period. 4Kids            Ad Sales manages and accounts for the ad revenue and costs associated with 4Kids TV.            The broadcast fee for the 2007-2008 broadcast season is $20,000 payable in quarterly            installments of $5,000 commencing in October 2007. Fox has exercised its option to            extend this agreement through its 2008-2009 broadcast season under the same terms and            conditions as in effect for the 2007-2008 broadcast season.

             

The costs of 4Kids TV is capitalized and amortized over each broadcast            year based on estimated advertising revenue for the related broadcast year. The Company            recorded amortization expenses of $5,203 and $4,419 for the three months ended March            31, 2008 and 2007, respectively. During the three months ended March 31, 2008, the            Company paid Fox and certain Fox affiliates $5,266, attributable to the 2007-2008            broadcast season fees and during calendar year 2007, the Company paid Fox and certain            Fox affiliates $15,525 and $5,263, attributable to the 2006-2007 and 2007-2008            broadcast seasons fees, respectively.

             

As of March 31, 2008, the minimum guaranteed payment obligations under            the 4Kids TV Broadcast Agreement are as follows:

 

| **Year Ending**

**December 31,** |   | **Amount** |   |
|-----------------------------------|--------|------------|--------|
| 2008                              | $      | 15,000     |   |
| 2009                              |   | 15,000     |   |
| Total                             | $      | 30,000     |   |

             

On October 1, 2007, the Company and The CW entered into the CW            Agreement, under which The CW granted to the Company the exclusive right to program The            CW's Saturday morning children's programming block that is broadcast in most markets            between 7am and 12pm for an initial term of five years beginning with The CW's            2008-2009 broadcast season.

Under the CW Agreement, the Company is obligated to make quarterly            minimum guaranteed payments which are subject to reduction under certain circumstances.            The Company and The CW will share advertising revenues earned from the sale of national            commercial time during The CW Kids Block with The CW's share to be applied against such            quarterly guarantee payments. In addition, The CW will be entitled under the CW            Agreement to participate in the Company's merchandising revenue from certain content            broadcast on The CW Kids Block if such merchandising revenues exceed a certain annual            minimum.

As of March 31, 2008, the minimum guaranteed payment obligations under            the CW Agreement are as follows:

| **Year Ending**

**December 31,** |   | **Amount** |   |
|-----------------------------------|--------|------------|--------|
| 2008                              | $      | 6,750      |   |
| 2009                              |   | 15,000     |   |
| 2010                              |   | 15,000     |   |
| 2011                              |   | 15,000     |   |
| 2012                              |   | 15,000     |   |
| 2013                              |   | 8,250      |   |
| Total                             | $      | 75,000     |   |

             

The Company’s ability to recover the cost of its fee payable to            Fox and the minimum guarantee due to The CW will depend on the popularity of the            television programs which are broadcast on 4Kids TV and The CW Kids Block and the            general market demand and pricing of advertising time for Saturday morning            children’s broadcast television. The popularity of such programs, broadcast on            4Kids TV and beginning in September 2008 on The

             

18

 

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CW Kids Block, impacts audience levels and the level of the network            advertising rates that the Company can charge. Additionally, the success of the            merchandise licensing programs and home video sales based on such television programs            broadcast on 4Kids TV and The CW Kids Block is dependent on consumer acceptance of such            television programs. If the Company estimates that it will be unable to generate            sufficient future revenue from advertising sales, home video sales and merchandising            licensing at levels to cover the cost of its contractual obligation to Fox and/or The            CW, the Company would record a charge to earnings to reflect an expected loss on the            Fox and The CW agreements in the period in which the factors negatively affecting the            recoverability of the fee payable become known. The Company will be required to make            certain assumptions and estimates about future events such as advertising rates and            audience viewing levels in evaluating its ability to recover the cost of the broadcast            fees. Such estimates and assumptions are subject to market forces and factors beyond            the control of the Company and are inherently subject to change. There can be no            assurance that the Company will be able to recover the full cost of the broadcast fees            and in the event it cannot, it would record the resulting charge to earnings to reflect            an expected loss on the broadcast fee, which could be significant.

             

In addition to the broadcast fee paid to Fox and minimum guarantee to be            paid to The CW, commencing with the 2008-2009 broadcast season, the Company incurs            additional costs to program each broadcast block and sell the related network            advertising time. These costs include direct programming costs to acquire, adapt and            deliver programming for the broadcast during the weekly broadcast blocks, as well as            additional indirect expenses of advertising sales, promotion and            administration.

             

*b.*  *Contractual Arrangements*- During the            normal course of business, the Company may enter into various agreements with third            parties to license, acquire, distribute, broadcast, develop and/or promote Properties.            The terms of these agreements will vary based on the services and/or Properties            included within the agreement, as well as, geographic restrictions, duration, property            and exploitation condition and results of operation.

             

*c.*   *Stock Purchases*- On December 4, 2007, the            Company announced that the Board of Directors authorized the Company to purchase up to            1,000,000 shares of the Company’s common stock from time to time through December            31, 2008 in the open market or through negotiated prices. The Company purchased 235,484            shares at an average price of $11.65 per share for the three months ended March 31,            2008 under this authorization. As of May 9, 2008, no shares of the Company’s            common stock were subsequently purchased by the Company under this            authorization.

             

**11.            MINORITY INTEREST**

 

a)*TC Digital Games LLC -*On December 11, 2006, 4Kids Digital and CUSA LLC entered into the TCD            Agreement with respect to the operation of TC Digital as a joint venture, with 4Kids            Digital owning 53% of TC Digital’s membership interests and CUSA LLC owning 47%            of TC Digital’s membership interests. On December 18, 2007, 4Kids Digital            purchased an additional 2% membership interest in TC Digital from CUSA for            approximately $200, increasing 4Kids Digital’s ownership percentage to 55%. The            consideration for the purchase of this additional membership interest was paid through            the settlement of capital contributions required to be made by CUSA to TC Websites            under the TCW Agreement. TC Digital is treated as a consolidated subsidiary of the            Company as a result of its majority ownership and its right to break any dead-locks            within the TC Digital Management Committee.

Minority interest of membership units in TC Digital represents the            minority members’ proportionate share of the equity in the entity. Income is            allocated to the membership units minority interest based on the ownership percentage            throughout the year. At December 18, 2007, the minority members’ proportionate            share of the equity in the entity decreased by 2% to 45% and at March 31, 2008,            the minority member continued to hold 45% of the equity in the entity. The following            table summarizes the minority interest loss attributable to the minority equity            interest in TC Digital:

 

|                                                                                     | **Three Months Ended** |    |
|------------------------------------------------------------------------------------------|------------------------|---------|
|                                                                                     | **March 31,**          |    |
|                                                                                     | **2008**               |    | **2007** |   |
| TC Digital net loss before common units minority                            interest     | $                      | (2,395  | ) | $ | (558 | ) |
| Minority interest percentage                                                             |                   | 45      | % |   | 47 | % |
| Minority interest loss allocation                                                        |                   | (1,078  | ) |   | (262 | ) |
| Less: Minority member capital contribution                                               |                   | — |   |   | — |   |
| Loss in excess of minority interest absorbed by 4Kids                            Digital | $                      | (1,078  | ) | $ | (262 | ) |

 

 

19

 

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b)*TC Websites LLC -*Under the terms of the TCW Agreement, 4Kids Websites and CUSA are each            entitled to elect two managers to TC Websites’ Management Committee. On December            18, 2007, 4Kids Websites entered into an agreement with CUSA and TC Websites pursuant            to which 4Kids acquired an additional 5% ownership interest in TC Websites from CUSA            for approximately $650 and the TCW Agreement was amended to provide 4Kids Websites with            the right to break any deadlocks on TC Websites' Management Committee with respect to            operational matters. The consideration for the purchase of this additional membership            interest was paid through the settlement of certain capital contributions required to            be made by CUSA to TC Websites under the TCW Agreement.

 

While the Company maintained a 50% ownership interest in TC Websites and            did not control, but had significant influence, over such entity, the Company’s            investment in TC Websites was accounted for using the equity method. As permitted by            Accounting Research Bulletin No. 51,*Consolidated Financial            Statements*, due to the increased membership interest and the            additional operational control, TC Websites’ financial statements are now            included in the Company’s consolidated financial statements for the three months            ended March 31, 2008 and for the year ended December 31, 2007 as though it has been            acquired by the Company at the beginning of such year, and accordingly, revenues and            expenses are included for the three months ended March 31, 2008.

At            December 18, 2007, the minority members’ proportionate share of the equity in the            entity decreased by 5% to 45%. The following table summarizes the minority interest            loss attributable to the minority equity interest in TC Websites:

 

|                                                                                      | **Three Months Ended** |    |
|-------------------------------------------------------------------------------------------|------------------------|---------|
|                                                                                      | **March 31,**          |    |
|                                                                                      | **2008**               |    | **2007** |   |
| TC Websites net loss before common units minority                            interest     | $                      | (848    | ) | $ | (185 | ) |
| Minority interest percentage                                                              |                   | 45      | % |   | 50 | % |
| Minority interest loss allocation                                                         |                   | (382    | ) |   | (93 | ) |
| Less: Minority member capital contribution                                                |                   | — |   |   | — |   |
| Loss in excess of minority interest absorbed by 4Kids                            Websites | $                      | (382    | ) | $ | (93 | ) |

 

**12. DISCONTINUED OPERATIONS**

 

In June            2006, the Company announced that the business of its media buying subsidiary, Summit            Media, would be terminated effective June 30, 2006. The results of discontinued            operations for the media buying business had no effect on the Company’s results            of operations for the three months ended March 31, 2008 and 2007, however, the            accompanying consolidated financial statements have been reclassified separately to            report the assets and liabilities.

 

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

 

|                                                                       |   | **March 31,** |    | **December 31,** |
|----------------------------------------------------------------------------|--------|---------------|---------|------------------|
|                                                                       |   | **2008**      |    | **2007**         |
| Accounts receivable                                                        |   | $             | — |             | $ | — |
| Prepaid expense and other current assets                                   |   |          | 823     |             |   | 372 |
| Current assets from discontinued operations                                |   | $             | 823     |             | $ | 372 |
|                                                                       |   |          |    |             |   |   |
| Other receivable – non-current                                       |   |          | 475     |             |   | 926 |
|                                                                       |   |          |    |             |   |   |
| Non-current assets from discontinued                            operations |   | $             | 475     |             | $ | 926 |

 

Under the terms of the Settlement Agreement entered into by Summit Media            with The Beacon Media Group LLC (“Beacon”), Sheldon Hirsch, Tom Horner and            Paul Caldera (the “Beacon Defendants”) on June 19, 2006, relating to the            lawsuit filed by Summit Media in Supreme Court, New York County against Beacon and the            Beacon Defendants, Summit Media will receive $2,000, in regularly scheduled payments            through 2010, in exchange for Summit Media’s discontinuation of the lawsuit. The            Company has included approximately $1,800 in net revenues for the year ended December            31, 2006, relating to this agreement. Through March 31, 2008, the Company had received            $500 of the scheduled payments related to the lawsuit.

 

**13.            SEGMENT AND RELATED INFORMATION**

 

The            Company applies SFAS No. 131,*Disclosures about Segments of an            Enterprise and Related Information.*The Company has four            reportable segments: (i) Licensing; (ii) Advertising Media and Broadcast; (iii)            Television and Film

 

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Production/Distribution; and (iv) Trading Card and Game Distribution.            The Company’s reportable segments are strategic business units, which, while            managed separately, work together as a vertically integrated entertainment company. The            Company’s management regularly evaluates the performance of each segment based on            its net revenues, profit and loss after all expenses, including amortized film and            television costs and the 4Kids TV broadcast fee and interest income.

 

The            accounting policies of the segments are the same as those described in the summary of            significant accounting policies. The Company’s Television and Film            Production/Distribution segment records inter-segment revenues and the Company’s            Advertising Media and Broadcast segment records inter-segment charges related to the            estimated acquisition costs of episodic television series for broadcast. In the opinion            of management, such acquisition costs represent the estimated fair value which would            have been incurred in a transaction between unaffiliated third parties on an arms            length basis. All inter-segment transactions have been eliminated in            consolidation.

 

|                                      |   | **Licensing** |    | **Advertising Media and Broadcast** |   | **TV and Film Production/ Distribution** |   | **Trading Card and Game Distribution** |    | **Total** |   |
|-------------------------------------------|--------|---------------|---------|-------------------------------------|--------|------------------------------------------|--------|----------------------------------------|---------|-----------|--------|
| **Three Months Ended March 31,****2008:** |   |          |    |                                |   |                                     |   |                                   |    |      |   |   |   |   |   |   |
| Net revenues from external customers      |   | $             | 5,573   |                                | $      | 3,568                                    |   | $                                      | 3,470   |      | $      | 2,428 |   | $ | 15,039 |   |
| Amortization of television and film costs |   |          | — |                                |   | —                                  |   |                                   | 1,708   |      |   | — |   |   | 1,708 |   |
| Amortization of 4Kids TV broadcast fee    |   |          | — |                                |   | 5,203                                    |   |                                   | — |      |   | — |   |   | 5,203 |   |
| Segment profit (loss)                     |   |          | 1,735   |                                |   | (3,572                                   | )      |                                   | (1,621  | )         |   | (2,913 | ) |   | (6,371 | ) |
| Interest income                           |   |          | 645     |                                |   | 19                                       |   |                                   | 6       |      |   | — |   |   | 670 |   |
| Segment assets                            |   |          | 87,780  |                                |   | 8,457                                    |   |                                   | 25,218  |      |   | 10,876 |   |   | 132,331 |   |
|                                      |   |          |    |                                |   |                                     |   |                                   |    |      |   |   |   |   |   |   |
| **2007:**                                 |   |          |    |                                |   |                                     |   |                                   |    |      |   |   |   |   |   |   |
| Net revenues from external customers      |   | $             | 7,930   |                                | $      | 3,415                                    |   | $                                      | 3,586   |      | $      | — |   | $ | 14,931 |   |
| Amortization of television and film costs |   |          | — |                                |   | —                                  |   |                                   | 1,687   |      |   | — |   |   | 1,687 |   |
| Amortization of 4Kids TV broadcast fee    |   |          | — |                                |   | 4,419                                    |   |                                   | — |      |   | — |   |   | 4,419 |   |
| Segment profit (loss)                     |   |          | 4,218   |                                |   | (3,840                                   | )      |                                   | (419    | )         |   | (790 | ) |   | (831 | ) |
| Interest income                           |   |          | 1,033   |                                |   | 18                                       |   |                                   | 36      |      |   | — |   |   | 1,087 |   |
| Segment assets                            |   |          | 137,998 |                                |   | 5,920                                    |   |                                   | 31,970  |      |   | 4,080 |   |   | 179,968 |   |

 

Discontinued operations relating to segment assets have been included in            segment reporting from the Advertising, Media and Broadcast segment and are disclosed            in Note 12.

 

Additionally, through the Company’s London office and network of            international subagents, which allow it to license its Properties throughout the world,            the Company recognized net merchandise licensing revenues from international sources,            primarily in Europe, of $2,608 and $2,471 for the three months ended March 31, 2008 and            2007. As of March 31, 2008 and 2007, net assets of the Company’s London office            were $6,669 and $7,387, respectively.

 

******

 

 

 

 

 

 

 

 

 

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**Item            2. Management’s Discussion and Analysis of Financial Condition and Results of            Operations**

(In            thousands of dollars unless otherwise specified)

 

**Overview**

 

The            Company’s operating results for the three months ended March 31, 2008 were            negatively impacted by increased selling, general and administrative expenses            associated with the operations of the Company’s newly formed Trading Card and            Game Distribution companies. The Company’s results also reflect an overall            decrease in licensing revenues resulting primarily from reduced revenue on the            “Teenage Mutant Ninja Turtles” and “Nintendo” Properties and an            overall reduction in its licensing revenues worldwide. These decreases were partially            offset by revenues generated from the Trading Card and Game Distribution segment            resulting from the October 2007 launch of the “Chaotic” trading card            game.

 

**General**

 

The            Company receives revenues from the following four business segments: (i) Licensing;            (ii) Advertising, Media and Broadcasting; (iii) Television and Film            Production/Distribution; and (iv) Trading Card and Game Distribution. The Company            typically derives a substantial portion of its licensing revenues from a small number            of Properties, which usually generate revenues for only a limited period of time. The            Company’s revenues are highly subject to changing trends in the toy, game and            entertainment businesses, potentially causing dramatic increases and decreases from            year to year due to the popularity of particular Properties. It is not possible to            accurately predict the length of time a Property will be commercially successful and/or            if a Property will be commercially successful at all. Popularity of Properties can vary            from months to years. As a result, the Company’s revenues from particular            Properties may fluctuate significantly between comparable periods.

 

The            Company’s licensing revenues have historically been derived primarily from the            licensing of toy and game concepts. As a result, a substantial portion of the            Company’s revenues and net income are subject to the seasonal variations of the            toy and game industry. Typically, a majority of toy orders are shipped in the third and            fourth calendar quarters resulting in increased royalties earned by the Company during            such calendar quarters. The Company recognizes revenues from the sale of advertising            time on 4Kids TV as more fully described in Note 2 of the Notes to the Company’s            consolidated financial statements. The Company’s advertising sales subsidiary,            4Kids Ad Sales, sells advertising time on 4Kids TV at higher rates in the fourth            quarter due to the increased demand for commercial time by children’s advertisers            during the holiday season. As a result, much of the revenues of 4Kids Ad Sales are            earned in the fourth quarter when the majority of toy and video game advertising            occurs. As a result of the foregoing, the Company has historically experienced greater            revenues during the second half of the year than during the first half of the            year.

 

The            Company’s media buying subsidiary, Summit Media, which previously provided print            and broadcast media planning and buying services for clients principally in the            children’s toy and game business, terminated its operations effective June 30,            2006. In connection with the closing of Summit Media, the media buying operations have            been classified as a discontinued operation. As further discussed in Note 12 of the            Notes to the Company’s consolidated financial statements, the consolidated            financial statements have been reclassified to accommodate the reporting of this            business as a discontinued operation.

 

**Critical Accounting Policies**

 

The            Company’s accounting policies are fully described in Note 2 of the Notes to the            Company’s consolidated financial statements. Below is a summary of the critical            accounting policies, among others, that management believes involve significant            judgments and estimates used in the preparation of its consolidated financial            statements.

 

*Accounting for Film and Television Costs*-  In accordance with accounting principles generally accepted            in the United States and industry practice, the Company amortizes the costs of            production for film and television programming using the individual-film-forecast            method under which such costs are amortized for each film or television program in the            ratio that revenue earned in the current period for such title bears to            management’s estimate of the total revenues to be realized from all media and            markets for such title. All exploitation costs, including advertising and marketing            costs, are expensed as incurred.

 

Management regularly reviews, and revises when necessary, its total            revenue estimates on a title-by-title basis, which may result in a change in the rate            of amortization and/or a write-down of the film or television asset to estimated fair            value. The Company determines the estimated fair value for individual film and            television Properties based on the estimated future ultimate revenues and costs in            accordance with Statement of Position No. 00-2,*Accounting by            Producers and Distributors of Film*(“SOP No.            00-2”)*.*

 

22

 

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Any            revisions to ultimate revenues can result in significant quarter-to-quarter and            year-to-year fluctuations in film and television write-downs and amortization. A            typical film or television series recognizes a substantial portion of its ultimate            revenues within the first three years of release. By then, the film or television            series has been exploited in the domestic and international television (network and            cable) and home video markets. In addition, a significant portion of licensing revenues            associated with the film or television series will have been realized. A similar            portion of the film’s or television series’ capitalized costs should be            expected to be amortized accordingly, assuming the film or television series is            profitable.

 

The            commercial potential of individual films and television programming varies            dramatically, and is not directly correlated with production or acquisition costs.            Therefore, it is difficult to predict or project the impact that individual films or            television programming will have on the Company’s results of operations. However,            the likelihood that the Company will report losses, particularly in the year of a            television series initial release, is increased as the applicable accounting literature            requires the immediate recognition of all of the production or acquisition costs            (through increased amortization) in instances where it is estimated that the ultimate            revenues of a film or television series will not recover those costs. Conversely, the            profit from a film or television series must be deferred and recognized over the entire            revenue stream generated by that film or television series. As a result, significant            fluctuations in reported income or loss can occur, particularly on a quarterly basis,            depending on release schedules and broadcast dates, the timing of advertising campaigns            and the relative performance of individual film or television series.

 

*Other Estimates* -   The Company estimates reserves for future returns of            product in the trading card and home video markets as well as provisions for            uncollectible receivables. In determining the estimate of trading card and home video            product sales that will be returned, the Company performs an analysis that considers            historical returns, changes in customer demand and current economic trends. Based on            this information, a percentage of each sale is reserved provided that the customer has            the right to return unsold trading card and home video inventory. The Company estimates            the amount of uncollectible receivables for licensing and advertising by monitoring            delinquent accounts and estimating a reserve based on contractual terms and other            customer specific issues.

 

*Revenue Recognition*- The Company’s            revenue recognition policies for its four business segments are appropriate to the            circumstances of each segment’s business. See Note 2 of the Notes to the            Company’s consolidated financial statements for a discussion of these revenue            recognition policies.

 

*4Kids TV Broadcast Agreement*- The Company            broadcasts certain of its Properties on 4Kids TV, the Saturday morning programming            block that the Company leases from Fox. The cost of 4Kids TV has been and will continue            to be capitalized and amortized over each broadcast year based on estimated advertising            revenue. In developing estimated future revenues, the Company has made certain            assumptions with regard to the anticipated popularity of the television series that the            Company broadcasts on 4Kids TV and the general market demand and pricing of advertising            time for Saturday morning children’s broadcast television. The popularity of such            series impacts audience levels and the level of the network advertising rates that the            Company can charge. These estimates are based on historical trends, as well as the            Company’s subjective judgment of future customer demand and acceptance of its            television programming. Differences may result in the amount and timing of revenue for            any period if actual performance varies from the Company’s estimates. See Note 10            of the Notes to the Company’s consolidated financial statements for additional            information.

 

Management’s Discussion and Analysis of Financial Condition and            Results of Operations discusses the Company’s consolidated financial statements,            which have been prepared in accordance with accounting principles generally accepted in            the United States. The preparation of these financial statements requires management to            make estimates and assumptions that affect the reported amounts of assets and            liabilities and the disclosure of contingent assets and liabilities as of the date of            the financial statements and the reported amounts of revenues and expenses during the            reporting period. The Company continually evaluates the policies and estimates that it            uses to prepare its consolidated financial statements. In general, management’s            estimates and assumptions are based on historical experience, known trends or events,            information from third-party professionals and other factors that are believed to be            reasonable under the circumstances, the results of which form the basis for making the            judgments about carrying values of assets and liabilities that are not readily apparent            from other sources. Actual results may differ from these estimates under different            assumptions and conditions.

 

**Recently Issued Accounting Pronouncements –**In November 2007, the Financial Accounting Standards Board (the            “FASB”) issued Statement of Financial Accounting Standards            (“SFAS”) No. 141R,*Business            Combinations*(“SFAS No. 141R”), which continues            to require that all business combinations be accounted for by applying the acquisition            method. Under the acquisition method, the acquirer recognizes and measures the            identifiable assets acquired, the liabilities assumed, and any contingent consideration            and contractual contingencies, as a whole, at their fair value as of the acquisition            date.

 

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Under SFAS No. 141R, all transaction costs are expensed as incurred.            SFAS No. 141R rescinds EITF Issue No. 93-7 (“EITF 93-7”). Under EITF 93-7,            the effect of any subsequent adjustments to uncertain tax positions were generally            applied to goodwill, except for post-acquisition interest on uncertain tax positions,            which was recognized as an adjustment to income tax expense. Under SFAS No. 141R, all            subsequent adjustments to these uncertain tax positions that otherwise would have            impacted goodwill will be recognized in the income statement. SFAS No. 141R will be            applied prospectively to business combinations for which the acquisition date is on or            after the beginning of the first annual reporting period beginning after December 15,            2008.

In            September 2006, the FASB issued SFAS No. 158,*Employers’ Accounting for Defined Benefit Pension and Other            Postretirement Plans—An Amendment of FASB            No.* *87, 88, 106 and            132(R)*(“SFAS 158”). SFAS 158 requires            that the funded status of defined benefit postretirement plans be recognized on            companies’ balance sheets and that changes in the funded status be reflected in            comprehensive income, effective for fiscal years ending after December 15, 2006.            SFAS 158 also requires companies to measure the funded status of each such plan as of            the date of its fiscal year-end, effective for fiscal years ending after            December 15, 2008. Since the Company does not currently have a defined benefit            postretirement plan, the adoption of SFAS 158 will not have any impact on its            consolidated financial position and results of operations.

In            November 2007, the FASB issued SFAS No. 160,*Accounting and            Reporting of Noncontrolling Interest*(“SFAS No.            160”). SFAS No. 160 requires that a noncontrolling interest (previously referred            to as a minority interest) be separately reported in the equity section of the            consolidated entity’s balance sheet. SFAS No. 160 also established accounting and            reporting standards for: (i) ownership interests in subsidiaries held by parties other            than the parent, (ii) the amount of consolidated net income attributable to the parent            and to the noncontrolling interest, (iii) changes in a parent’s ownership            interest and (iv) the valuation of retained noncontrolling equity investments when a            subsidiary is deconsolidated. SFAS No. 160 is effective for the Company beginning            January 1, 2009. The Company is currently evaluating the impact the adoption of SFAS            No. 160 will have on its consolidated financial position and results of            operations.

 

In            March 2008, the FASB issued SFAS No. 161*)*(“SFAS 161”),*Disclosures            about Derivative Instruments and Hedging Activities—an amendment of FASB            Statement No.133, Accounting for Derivative Instruments and Hedging Activities (SFAS            No. 133”).*SFAS No. 161 requires companies to provide            enhanced disclosures regarding derivative instruments and hedging activities in order            to better convey the purpose of derivative use in terms of risk management. Disclosures            about (i) how and why an entity uses derivative instruments, (ii) how derivative            instruments and related hedged items are accounted for under SFAS No. 133 and its            related interpretations, and (iii) how derivative instruments and related hedged items            affect a company's financial position, financial performance, and cash flows, are            required. This Statement retains the same scope as SFAS No. 133 and is effective for            fiscal years and interim periods beginning after November 15, 2008. The Company is            currently evaluating the impact, if any, that the adoption of SFAS No. 161 will have on            its consolidated financial position and results of operations.

 

In            December 2007, the FASB ratified EITF Issue No. 07-1,*Accounting for Collaborative Arrangements Related to the Development            and Commercialization of Intellectual Property*(“EITF            07-1”). The EITF concluded that a collaborative arrangement is one in which the            participants are actively involved and are exposed to significant risks and rewards            that depend on the ultimate commercial success of the endeavor. Revenues and costs            incurred with third parties in connection with collaborative arrangements would be            presented gross or net based on the criteria in EITF Issue No. 99-19,*Reporting Revenue Gross as a Principal versus Net as an            Agent*, and other accounting literature. Payments to or from            collaborators would be evaluated and presented based on the nature of the arrangement            and its terms, the nature of the entity’s business, and whether those payments            are within the scope of other accounting literature. The nature and purpose of            collaborative arrangements are to be disclosed along with the accounting policies and            the classification and amounts of significant financial statement amounts related to            the arrangements. Activities in the arrangement conducted in a separate legal entity            should be accounted for under other accounting literature; however required disclosure            under EITF 07-1 applies to the entire collaborative agreement. This Issue is effective            for fiscal years beginning after December 15, 2008, and is to be applied            retrospectively to all periods presented for all collaborative arrangements existing as            of the effective date. The Company is currently evaluating the impact that this            pronouncement may have on its consolidated financial position and results of            operations.

 

 

 

 

 

24

 

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**Results of Operations**

 

The            following table sets forth our results of operations expressed as a percentage of total            net revenues for the three months ended March 31, 2008 and 2007:

 

|                                                                                      | **Three Months March 31,** |    |
|-------------------------------------------------------------------------------------------|----------------------------|---------|
|                                                                                      | **2008**                   |    | **2007** |   |
| Net revenues                                                                              |                       | 100     | % |   | 100 | % |
|                                                                                      |                       |    |   |   |   |   |
| Costs and expenses:                                                                       |                       |    |   |   |   |   |
| Selling, general and administrative                                                       |                       | 84      |   |   | 60 |   |
| Production service costs                                                                  |                       | 10      |   |   | 12 |   |
| Cost of sales of trading cards                                                            |                       | 7       |   |   | — |   |
| Amortization of television and film costs                                                 |                       | 11      |   |   | 11 |   |
| Amortization of 4Kids TV broadcast fee                                                    |                       | 35      |   |   | 30 |   |
| Total costs and expenses                                                                  |                       | 147     |   |   | 113 |   |
|                                                                                      |                       |    |   |   |   |   |
| Loss from operations                                                                      |                       | (47     | ) |   | (13 | ) |
|                                                                                      |                       |    |   |   |   |   |
| Interest income                                                                           |                       | 4       |   |   | 7 |   |
|                                                                                      |                       |    |   |   |   |   |
| Loss before income taxes                                                                  |                       | (43     | ) |   | (6 | ) |
|                                                                                      |                       |    |   |   |   |   |
| (Provision for) benefit from income taxes                                                 |                       | — |   |   | 5 |   |
|                                                                                      |                       |    |   |   |   |   |
| Loss from unconsolidated operations – net of tax                            benefit |                       | — |   |   | — |   |
|                                                                                      |                       |    |   |   |   |   |
| Net loss                                                                                  |                       | (43     | )% |   | (1 | )% |

 

**Three months ended March 31, 2008 as compared to three months ended            March 31, 2007.**

 

***Continuing Operations***

 

**Revenues**

 

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

 

| **For the three months ended March 31, 2008 and                            2007** |   |
|-----------------------------------------------------------------------------------|--------|
|                                                                              |   | **2008** |   | **2007** |   | **$ Change** |   | **% Change** |   |
| Licensing                                                                         |   | $ | 5,573 |   | $ | 7,930 |   | $ | (2,357 | ) | (30 | )% |   |
| Advertising, Media and Broadcast                                                  |   |   | 3,568 |   |   | 3,415 |   |   | 153 |   | 4 |   |   |
| Television and Film Production/Distribution                                       |   |   | 3,470 |   |   | 3,586 |   |   | (116 | ) | (3 | ) |   |
| Trading Card and Game Distribution                                                |   |   | 2,428 |   |   | — |   |   | 2,428 |   | n/a |   |   |
| Total                                                                             |   | $ | 15,039 |   | $ | 14,931 |   | $ | 108 |   | 1 | % |   |

 

The            decrease in consolidated net revenues for the three months ended March 31, 2008, as            compared to the same period in 2007, was due to a number of factors.

 

In            the Licensing segment, decreased revenues for the three months ended March 31, 2008            were primarily attributable to:

 

| (i) | reduced licensing revenues on the “Teenage Mutant                            Ninja Turtles” and“Nintendo”                            Properties, worldwide and the “Cabbage Patch Kids”                            Property, domestically; partially offset by |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (ii) | increased revenues attributable to the “Shaman                            King” Property, worldwide. |
|------|------------------------------------------------------------------------------------------------------------------|

The            “Yu-Gi-Oh!”, “Cabbage Patch Kids” and “Teenage Mutant            Ninja Turtles” Properties continue to be the largest contributors to the            Company’s revenues in this business segment.

 

25

 

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In the            Advertising Media and Broadcast segment, revenues increased slightly for the three            months ended March 31, 2008 as a result of increased revenues from the sale of network            advertising time on 4Kids TV and from the sale of internet advertising on the*www.4kids.tv*website.

In            the Television and Film Production/Distribution segment, the revenue decline for the            three months ended March 31, 2008, as compared to same period in 2007, primarily            resulted from:

| (i) | decreased domestic broadcast sales from the                            “Yu-Gi-Oh!” television series; as well as |
|-----|------------------------------------------------------------------------------------------------------------------------------|

| (ii) | decreased international broadcast sales from the                            “Teenage Mutant Ninja Turtles” television series; partially                            offset by |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (iii) | increased international broadcast sales from the                            “Viva Piñata” and “Chaotic” television                            series; as well as |
|-------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (iv) | increased production service revenue from the                            “Viva Piñata” and “Dinosaur King”                            television series. |
|------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

The            Trading Card and Game Distribution segment began to record revenues in the fourth            quarter 2007 as a result of the October launch of the “Chaotic” trading            card game to comic and hobby stores. For the three months ended March 31, 2008,            revenues were $2,428 as a result of sales to comic and hobby stores, as well as mass            market distribution channels.

**Selling, General and Administrative Expenses**

 

Selling, general and administrative expenses increased 41%, or $3,645,            to $12,608 for the three months ended March 31, 2008, when compared to the same period            in 2007. The increase was primarily attributable to:

| (i) | increased costs of approximately $2,600 and $600 related                            to the operations of the Company’s recently formed ventures, TC                            Digital and TC Websites, respectively; |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (ii) | increased international selling expenses of                            approximately $650; |
|------|--------------------------------------------------------------------------------------------|

| (iii) | increased bad debt expense of approximately $240; as                            well as |
|-------|-----------------------------------------------------------------------------------------|

| (iv) | increased website costs of approximately $200 primarily                            related to the redesign and upgrade of                            the* www.4Kids.tv*website; partially offset by |
|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (v) | decreased advertising and marketing costs of                            approximately $510. |
|-----|---------------------------------------------------------------------------------------------|

 

**Cost of Sales of Trading Cards**

 

Cost            of sales of trading cards represents finished goods inventory costs relating to the            “Chaotic” trading card game which launched as a public beta version in            October 2007.

 

**Production Service and Capitalized Film Costs**

 

Production service and capitalized film costs were as            follows:

 

**For the three months ended March 31, 2008 and            2007**

 

|                                      |   | **2008** |   | **2007** |   | **$ Change** |   | **% Change** |
|-------------------------------------------|--------|----------|--------|----------|--------|--------------|--------|--------------|
| Production Service Costs                  |   | $        | 1,545  |     | $      | 1,780        |   | $            | (235 | ) | (13) | % |
| Amortization of Television and Film Costs |   |     | 1,708  |     |   | 1,687        |   |         | 21 |   | 1 |   |

 

The            decrease in production service costs during the three months ended March 31, 2008, as            compared to the same period in 2007, was primarily due to decreased production costs            for the “Chaotic” television series, partially offset by increased            production costs for the work performed on the “Dinosaur King” television            series. When the Company is entitled to be paid for such production costs, the Company            categorizes them as production service costs and reflects a corresponding amount in            revenue for the amount billed back to the property owners.

 

Amortization of television and film costs remained relatively consistent            for the three months ended March 31, 2008 when compared to the same period in            2007.

 

As            of March 31, 2008, there were $14,276 of capitalized film production costs recorded in            the Company’s consolidated balance sheet relating primarily to various stages of            production on 284 episodes of animated programming. Based on management’s            ultimate revenue estimates as of March 31, 2008, approximately 46% of the total            completed and unamortized film and television costs are expected to be amortized during            the next year, and over 90% of the total completed and unamortized film and television            costs are expected to be amortized during the next three years.

26

 

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**4Kids TV Broadcast Fee**

 

| **For the three months ended March 31, 2008 and                            2007** |   |
|-----------------------------------------------------------------------------------|--------|
|                                                                              |   |   |   |   |   |
|                                                                              |   | **2008** |   | **2007** |   | **$ Change** |   | **% Change** |   |
| Amortization of 4Kids TV Broadcast Fee                                            |   | $ | 5,203 |   | $ | 4,419 |   | $ | 784 |   | 18 | % |   |
|                                                                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

As a            result of the broadcast year (ending each year in September) being different than the            Company’s fiscal year (ending each year in December), the amount of the            amortization of the broadcast fee recognized from period to period will vary based            upon: (i) the amount of advertising revenue recognized during the period; and (ii) the            amount of advertising revenue already recognized for the broadcast year as a percentage            of the total amount expected to be recognized for the full broadcast year. The            Company’s amortization of the 4Kids TV broadcast fee increased by $784 from            $4,419 in 2007 to $5,203 in 2008 in conjunction with the increased advertising revenues            recognized by the Company for the three months ended March 31, 2008 when compared to            the same period in 2007.

 

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

 

| (i) | revenues generated from merchandise licensing, home                            videos and music publishing of 4Kids TV Properties; and |
|-----|----------------------------------------------------------------------------------------------------------------------------------------|

| (ii) | production and acquisition costs associated with the                            television programs broadcast on 4Kids TV. |
|------|----------------------------------------------------------------------------------------------------------------------------|

 

The            ability of the Company to further develop its merchandising and, to a lesser extent,            home video and music publishing revenue streams were significant components of its            evaluation process which resulted in the decision to lease an additional Saturday            morning children’s programming block from The CW, as described in Note 10 of the            Notes to the Company’s consolidated financial statements under “Broadcast            Agreements”. Other factors, such as lower guaranteed payments associated with the            five-hour broadcast period, additional units allocated to the Company for sale during            the CW Kids Block, an anticipated increase in network support due to a revenue sharing            arrangement, along with the availability of the CW Kids Block, also contributed to the            decision to lease another Saturday morning children’s block which will overlap            with our current 4Kids TV block during the same Saturday morning time period for the            2008-2009 broadcast season.

 

**Interest Income**

 

Interest income decreased 38%, or $417, to $670 for the three months            ended March 31, 2008, as compared to the same period in 2007, primarily as a result of            the Company investing its surplus cash in U.S. Treasury securities typically yielding            lower interest rates.

 

**Income (Loss) Before Income Taxes**

 

| **For the three months ended March 31, 2008 and                            2007** |   |     |   |     |
|-----------------------------------------------------------------------------------|--------|----------|--------|----------|
|                                                                              |   | **2008** |   | **2007** |   | **$ Change** |   | **% Change** |
| Licensing                                                                         |   | $        | 1,735  |     | $ | 4,218 |   | $ | (2,483 | ) | (59 | )% |
| Advertising, Media and Broadcast                                                  |   |     | (3,572 | )        |   | (3,840 | ) |   | 268 |   | 7 |   |
| Television and Film Production/Distribution                                       |   |     | (1,621 | )        |   | (419 | ) |   | (1,202 | ) | (287 | ) |
| Trading Card and Game Distribution                                                |   |     | (2,913 | )        |   | (790 | ) |   | (2,123 | ) | (269 | ) |
| Total                                                                             |   | $        | (6,371 | )        | $ | (831 | ) | $ | (5,540 | ) | (667 | )% |

 

The            decrease in the Licensing segment profit for the three months ended March 31, 2008, as            compared to the same period in 2007, is primarily attributable to lower revenues from            licensed Properties, and decreased selling, general and administrative expenses as well            as a decrease in interest income allocated to this segment.

 

In            the Advertising Media and Broadcast segment, the segment loss for the three months            ended March 31, 2008 remained relatively consistent as compared to the same period in            2007.

 

In            the Television and Film Production/Distribution segment, the increase in segment loss            for the three months ended March 31, 2008 as compared to the same period in 2007 was            primarily due to decreased production service revenue.

 

27

 

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In            the Trading Card and Game Distribution segment, the increase in segment loss was            attributable to the fact that the majority of the start-up costs for this segment were            incurred late in 2007 and early 2008.

 

**Income Taxes**

 

The            Company recorded a provision for income taxes of $28 for the three months ended March            31, 2008, as compared to a benefit from income taxes of $677 for the same period in            2007.

 

The            Company regularly reviews its deferred tax assets for recoverability taking into            consideration such factors as historical losses, projected future taxable income and            the expected timing of the reversals of existing temporary differences. SFAS No.            109,* Accounting for Income Taxes*(SFAS No. 109), requires the Company to record a valuation allowance            when it is more likely than not that some portion or all of the deferred tax assets            will not be realized. In view of the level of deferred tax assets as of March 31, 2008            and the Company’s historical losses from operations, the Company has determined            that the application of SFAS No. 109 requires the Company to record a full valuation            allowance against its net deferred tax assets.

 

If            the Company had not taken any valuation allowance, but rather recorded its 2008 loss            after giving effect to the tax benefit from such loss, the Company’s loss in 2008            would have decreased by $2,310 or $0.17 per share to a net loss of $4,089 or $0.31 per            share.

 

In            the event that the Company earns pre-tax income in the future such that it will be able            to use some or all of its deferred tax assets, SFAS No. 109 permits the Company to            reduce or eliminate the valuation allowance. If the Company were to reverse the            valuation allowance, in whole or in part, the Company’s income statement for such            reporting period would record a reduction in income tax expense and an increase in net            income, to the extent of the reversal of the valuation allowance.

 

Our            effective tax rate for 2008 would have been a benefit of 35.8% had the Company not            taken a valuation allowance. This rate differs slightly from the Federal statutory rate            of 35% primarily due to the mix of income and losses, which have tax rates that differ            from the statutory rate, and due to permanent differences and tax rate differences on            subsidiaries.

 

**Net Loss**

 

As a            result of the above, the Company had a net loss for the three months ended March 31,            2008, of $6,399 compared to a net loss of $205, for the same period in 2007.

 

**Liquidity and Capital Resources**

 

**Financial Position**

 

Cash            and cash equivalents and short-term investments as of March 31, 2008 and December 31,            2007 were as follows:

|                      |   | **2008** |   | **2007** |   | **$ Change** |   |
|---------------------------|--------|----------|--------|----------|--------|--------------|--------|
|                      |   |     |   |     |   |         |   |   |   |   |
| Cash and cash equivalents |   | $        | 32,870 |     | $      | 24,872       |   | $ | 7,998 |   |
| Investments               |   |     | 25,005 |     |   | 36,106       |   |   | (11,101 | ) |
|                      |   | $        | 57,875 |     | $      | 60,978       |   | $ | (3,103 | ) |
|                           |        |          |        |          |        |              |        |  |  |  |  |

 

Long-term investments as of March 31, 2008 and December 31, 2007 were as            follows:

 

|        |   | **2008** |   | **2007** |   | **$ Change** |   |
|-------------|--------|----------|--------|----------|--------|--------------|--------|
|        |   |     |   |     |   |         |   |   |   |   |
| Investments |   | $        | 18,695 |     | $      | 31,806       |   | $ | (13,111 | ) |
|             |        |          |        |          |        |              |        |  |  |  |  |

During 2007, liquidity issues began to affect the global credit and            capital markets. As a result, ARS, which historically have had a liquid market and had            their interest rates reset periodically (e.g. monthly) through Dutch auctions, began to            fail at auction. These auction failures have caused ARS to become illiquid, which in            turn has caused the fair market values for these securities to decline.

 

28

 

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As            of March 31, 2008, the Company held ARS having an aggregate principal amount of            approximately $52,000. The ARS held by the Company are private placement debt            securities with long-term nominal maturities and interest rates that typically reset            monthly. The Company’s investments in ARS represent interests in debt obligations            issued by banks and insurance companies that had at least an “A” credit            rating at the time of purchase by the Company, including bond insurers and re-insurers            such as MBIA, AMBAC, FGIC, FSA, RAM and Radian.

Many            of the ARS held by the Company as of March 31, 2008, have experienced failed            auctions due to the liquidity issues described above. As of March 31, 2008, the            estimated fair market value of the ARS held by the Company declined by $13,180 ($3,993            during 2007 and $9,187 during the first quarter of 2008) based upon an analysis of the            current market conditions of the Company’s securities held made by the Company in            accordance with SFAS No. 157. Although all of the ARS invested in by the Company have            continued to pay interest according to their stated terms and substantially all of the            ARS invested in by the Company continue to be a rated “A” or above, the            Company recorded an unrealized loss of $9,187 during the first quarter of 2008            resulting in a reduction in stockholders’ equity. Since the Company has the            ability and the intent to hold these investments until recovery of their fair value,            which may not be prior to the maturity of the applicable security, the Company does not            consider these investments to be other-than-temporarily impaired.

 

The            credit and capital markets, including the market for ARS have remained illiquid in            2008, and as a result, there continues to be failed auctions affecting ARS owned by the            Company. Although all of the Company’s investments in ARS have continued to pay            interest according to their stated terms and substantially all of the ARS invested in            by the Company continue to be a rated “A” or above, the Company’s            unrealized loss on its ARS had subsequently increased by $1,005, to a cumulative            unrealized loss of $14,185 as of April 30, 2008, based upon statements provided by the            investment bank through which the Company holds such securities.

Given the failed auctions, many of the Company’s ARS are currently            illiquid.  Accordingly, the Company has reclassified $9,021 (face amount of            $20,350 less estimated devaluations of $11,329), in ARS from current to non-current            assets on its balance sheet due to the fact that the Company believes that the            liquidity of these ARS is unlikely to be restored in a period less than twelve months            from such date.

 

If            uncertainties in the credit and capital markets continue or the Company experiences any            rating downgrades on any investments in its ARS portfolio or the value of such            investments as reflected in monthly statements declines further, the Company may incur            impairment charges to its investment portfolio, which could negatively affect the            Company’s financial condition and cash flow. If in the reasonable judgment of the            Company, the value of any ARS should be permanently impaired, the Company would record            an expense which would negatively impact reported earnings. As a result of the current            market issues, the Company has invested its surplus cash solely in U.S. Treasury            securities.

The            Company believes that based on the Company’s current cash, cash equivalents and            marketable securities, the current lack of liquidity affecting a significant portion of            its portfolio of ARS will not have a material impact on the Company’s liquidity            or its ability to fund its operations.

 

**Sources and Uses of Cash**

 

Cash            flows for the three months ended March 31, 2008 and 2007 were as follows:

 

| ***Sources (Uses)*** |   | **2008** |   | **2007** |   |   |
|----------------------|--------|----------|--------|----------|--------|--------|
| Operating Activities |   | $        | (3,951 | )        | $      | 1,006  |   |   |
| Investing Activities |   |     | 14,687 |     |   | (1,759 | ) |   |

| Financing Activities |   |   | (2,742 | ) |   | 6 |   |   |
|----------------------|--------|--------|--------|---|--------|---|--------|--------|

 

Working capital, consisting of current assets less current liabilities,            was $58,131 as of March 31, 2008 and $65,135 as of December 31, 2007.

 

***Operating Activities***

*2008*

Net            cash used in operating activities for the three months ended March 31, 2008 of $3,951            primarily reflects a decrease in the Company’s business performance. This            decrease was partially offset by amortization of television and film costs.

 

29

 

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*2007*

Net            cash provided by operating activities for the three months ended March 31, 2007 of            $1,006 primarily reflected amortization of television and film costs, partially offset            by a decrease in the Company’s business performance.

 

***Investing Activities***

*2008*

Net            cash provided by investing activities for the three months ended March 31, 2008 of            $14,687 reflects a shift in the Company’s investments for the period, from            auction-rate securities to U.S. Treasury securities which are short in duration and are            classified as cash and cash equivalents.

 

*2007*

Net            cash used in investing activities for the three months ended March 31, 2007 of $1,759            reflected the purchase of auction-rate securities for its excess cash balances            partially offset by the proceeds received on the maturity of these            investments.

 

***Financing Activities***

*2008*

Net            cash used in financing activities for the three months ended March 31, 2008 of $2,742            reflects the Company’s purchase of shares of its common stock classified as            treasury stock on the consolidated financial statements.

 

*2007*

Net            cash provided by financing activities for the three months ended March 31, 2007 of $6            reflected the Company’s proceeds from the exercise of stock options by the            Company’s employees.

 

During 2008, the Company's cash flow from operations was impacted by            consumer demand for a limited number of its licensed Properties.  While the            Company strives to further diversify its revenue streams, management remains cognizant            of changing trends in the toy, game and entertainment business and the difficulty in            predicting the length of time a property will be commercially successful.  As a            result, the Company's revenues, operating results and cash flow from operations may            fluctuate significantly from year to year and present operating results are not            necessarily indicative of future performance.

 

Historically, the majority of the television-based Properties that the            Company represented were existing episodes of foreign programming that were adapted for            the United States and other markets. The Company’s strategic focus has shifted            toward Properties like “Chaotic” and “Teenage Mutant Ninja            Turtles”, where the Company is a joint copyright owner of the episodes.            Therefore, it is the Company’s intention to allocate a larger portion of its            capital resources to the production costs associated with developing original animated            programming resulting in increased capitalized film and television costs. Following the            commercial release of a Property, its overall market acceptance and resulting revenues            will directly impact the Company’s amortization of these capitalized film and            television costs. To the extent a Property performs at a level lower than the            Company’s expectations, the ratio of amortization expense to revenues realized            will increase. While the Company expects that the revenues associated with such            Properties will be sufficient to maintain its historical operating margins, there can            be no assurance that the marketing plans designed to achieve those revenues can be            executed in a manner to achieve its objectives.

 

**Broadcast Agreements**

 

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

 

In            March 2006, the Fox agreement was extended for two broadcast years through the            2007-2008 broadcast season. The broadcast fee for the 2007-2008 broadcast season is            $20,000 payable in quarterly installments of $5,000 commencing in October 2007. Fox has            exercised its option to extend this agreement through its 2008-2009 broadcast season            under the same terms and conditions as in effect for the 2007-2008 broadcast            season.

 

30

 

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*The CW Broadcast Agreement*- On October 1,            2007, the Company and The CW entered into the CW Agreement, under which The CW granted            to the Company the exclusive right to program The CW's Saturday morning children's            programming block that is broadcast in most markets between 7am and 12pm for an initial            term of five years beginning with The CW's 2008-2009 broadcast season.

 

Under the CW Agreement, the Company is obligated to make quarterly            minimum guaranteed payments which are subject to reduction under certain circumstances.            The Company and The CW will share advertising revenues earned from the sale of national            commercial time during The CW Kids Block with The CW's share to be applied against such            quarterly guarantee payments. In addition, The CW will be entitled under the CW            Agreement to participate in the Company's merchandising revenue from certain content            broadcast on The CW Kids Block, if such merchandising revenues exceed a certain annual            minimum.

 

In            addition to the broadcast fee paid to Fox and the minimum guarantee to be paid to The            CW, commencing with the 2008-2009 broadcast season, the Company incurs additional costs            to program each broadcast block and sell the related network advertising time. These            costs include direct programming costs to acquire, adapt and deliver programming for            the broadcast during the weekly broadcast blocks as well as additional indirect            expenses of advertising sales, promotion and administration.

 

The            ability of the Company to further develop its merchandising and, to a lesser extent,            home video and music publishing revenue streams were significant components of its            evaluation process which resulted in the decision to lease an additional Saturday            morning children’s programming block from The CW, as described in Note 10 of the            Notes to the Company’s consolidated financial statements under “Broadcast            Agreements”. Other factors, such as lower guaranteed payments associated with the            five-hour broadcast period, additional units allocated to the Company for sale during            the CW Kids Block, and an anticipated increase in network support due to a revenue            sharing arrangement, also contributed to the decision to lease another Saturday morning            children’s block.

 

**Contractual Commitments**

The            Company’s contractual obligations and commitments are detailed in the            Company’s Annual Report on Form 10-K for the year ended December 31, 2007. As of            March 31, 2008, the Company’s contractual obligations and commitments have not            materially changed since December 31, 2007.

**Forward Looking Information and Risk Factors That May Affect Future            Results**

 

This            Quarterly Report on Form 10-Q, including the section titled “Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of            Operations” contains forward-looking statements that relate to future events or            our future financial performance. We may also make written and oral forward-looking            statements in our Securities and Exchange Commission (“SEC”) filings and            otherwise. We have tried, where possible, to identify such statements by using words            such as “believe,” “expect,” “intend,”            “estimate,” “anticipate,” “will,”            “project,” “plan” and similar expressions in connection with            any discussion of future operating or financial performance. Any forward-looking            statements are and will be based upon our then-current expectations, estimates and            assumptions regarding future events and are applicable only as of the dates of such            statements. By their nature, forward-looking statements involve risks and uncertainties            that could cause actual results to differ materially from those anticipated in any            forward-looking statements. Such risks and uncertainties include those described in            this Quarterly Report on Form 10-Q and in “Item 1A. Risk Factors” of our            Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC, as            well as other factors. We undertake no obligation to update or revise any            forward-looking statements, whether as a result of new information, future events or            otherwise.

 

**Item            3. Quantitative and Qualitative Disclosures About Market Risk**

 

**Foreign Currency Exchange Rate Fluctuations**

 

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

 

31

 

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**Item            4. Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

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

 

**Changes in Internal Control over Financial Reporting**

 

During the first quarter of 2008, there were no significant changes in            our internal control over financial reporting or in other factors that have materially            affected, or are reasonably likely to materially affect, our internal control over            financial reporting.

 

**Part II -****OTHER            INFORMATION**

 

**Item 1. Legal Proceedings**

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

 

**Item            1A. Risk Factors**

 

There            have been no material changes from the risk factors previously disclosed in our Annual            Report on Form 10-K for the year ended December 31, 2007.

 

**Item 2. Unregistered Sales of Equity Securities and Use of            Proceeds**

(a)            Purchases of Equity Securities by the Issuer

**ISSUER PURCHASES OF EQUITY SECURITIES**

             

|  

                             

Period During 2008 |  

Total Number of SharesPurchased |  

Average PricePaid Per                            Share | Total Number of Shares Purchased as Part of Publicly                            Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under                            the Plans or Programs(1) |
|----------------------------------------------------------------|-----------------------------------------|----------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|
| Jan. 1 – Jan. 31                                         | 93,979                                  | $11.85                                                         | 93,979                                                                                                      | 896,621                                                                                                      |
| Feb. 1 – Feb. 29                                         | 15,300                                  | 12.24                                                          | 109,279                                                                                                     | 881,321                                                                                                      |
| Mar. 1 – Mar. 31                                         | 126,205                                 | 11.42                                                          | 235,484                                                                                                     | 755,116                                                                                                      |
| **Total**                                                      | **235,484**                             | **$11.65**                                                     | **235,484**                                                                                                 | **755,116**                                                                                                  |

             

(1) On December 4, 2007, the Company announced that the Board of            Directors authorized the Company to purchase up to 1,000,000 shares of the            Company’s common stock from time to time through December 31, 2008 in the open            market or through negotiated prices. The Company purchased 235,484 shares at an average            price of $11.65 per share for the three months ended March 31, 2008 under this            authorization. As of May 9, 2008, no shares of the Company’s common stock were            subsequently purchased by the Company under this authorization.

 

32

 

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|   | **Item 6.** | **Exhibits** |
|--------|-------------|--------------|

             

|   | (a) | Exhibits |
|--------|-----|----------|

             

|   | 31.1 | Certification of Chief Executive Officer pursuant to 18                            U.S.C. Section 1350, as adopted pursuant to Section 302 of the                            Sarbanes-Oxley Act of 2002. |
|--------|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | 31.2 | Certification of Chief Financial Officer pursuant to 18                            U.S.C. Section 1350, as adopted pursuant to Section 302 of the                            Sarbanes-Oxley Act of 2002. |
|--------|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

             

 

 

 

 

 

 

 

 

 

 

 

 

 

 

33

 

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities            Exchange Act of 1934, the Registrant has duly caused this report to be signed on its            behalf by the undersigned, thereunto duly authorized.

 

4KIDS            ENTERTAINMENT, INC.

 

Date:            May 12, 2008

 

|   | By: | /s/*Alfred R.                            Kahn* |
|--------|-----|------------------------------------------------|

___________________________

|   | Alfred R. Kahn, |
|--------|-----------------|

|   | Chairman of the Board, |
|--------|------------------------|

|   | Chief Executive Officer and |
|--------|-----------------------------|

|   | Director |
|--------|----------|

 

 

|   | By: | /s/*Bruce R.                            Foster* |
|--------|-----|-------------------------------------------------|

___________________________

|   | Bruce R. Foster, |
|--------|------------------|

|   | Executive Vice President, |
|--------|---------------------------|

|   | Treasurer, Chief Financial |
|--------|----------------------------|

|   | Officer and Principal Accounting |
|--------|----------------------------------|

|   | Officer |
|--------|---------|

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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