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Marvel Entertainment, Inc. – ‘10-K’ for 12/31/08

On:  Friday, 2/27/09, at 5:16pm ET   ·   For:  12/31/08   ·   Accession #:  1362310-9-2976   ·   File #:  1-13638

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 2/27/09  Marvel Entertainment, Inc.        10-K       12/31/08   10:1.1M                                   Bowne - BPC/FA

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                       HTML    766K 
 2: EX-10.2     2005 Stock Incentive Plan                           HTML    129K 
 4: EX-10.33    Ambac Amendment No. 7                               HTML     27K 
 5: EX-10.34    Ambac Amendment No. 8                               HTML     44K 
 3: EX-10.7     2005 Cash Incentive Compensation Plan               HTML     59K 
 6: EX-21       List of Subsidiaries                                HTML     11K 
 7: EX-23       Consent of Pwc                                      HTML      7K 
 8: EX-31.1     Section 302 Certification of CEO                    HTML     13K 
 9: EX-31.2     Section 302 Certification of CFO                    HTML     13K 
10: EX-32       Section 906 Certification of CEO and CFO            HTML     10K 


10-K   —   Annual Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Item 1 Business
"Item 1A Risk Factors
"Item 1B Unresolved Staff Comments
"Item 2 Properties
"Item 3 Legal Proceedings
"Item 4 Submission of Matters to A Vote of Security Holders
"Part Ii
"Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
"Item 6 Selected Financial Data
"Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 7A Quantitative and Qualitative Disclosures About Market Risk
"Item 8 Financial Statements and Supplementary Data
"Item 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
"Item 9A Controls and Procedures
"Item 9B Other Information
"Part Iii
"Item 10 Directors, Executive Officers and Corporate Governance
"Item 11 Executive Compensation
"Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
"Item 13 Certain Relationships and Related Transactions, and Director Independence
"Item 14 Principal Accountant Fees and Services
"Part Iv
"Item 15 Exhibits and Financial Statement Schedules
"Signatures
"Consolidated Financial Statements and Consolidated Financial Statement Schedule
"Report of Independent Registered Public Accounting Firm
"Consolidated Balance Sheets as of December 31, 2008 and 2007
"Consolidated Statements of Net Income for the years ended December 31, 2008, 2007 and 2006
"Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006
"Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007, and 2006
"Notes to Consolidated Financial Statements
"Schedule II-Valuation and Qualifying Accounts

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  Filed by Bowne Pure Compliance  

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
or
     
o   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 1-13638
MARVEL ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   13-3711775
     
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer Identification No.)
     
417 Fifth Avenue, New York, NY   10016
     
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (212)-576-4000
Securities registered pursuant to Section 12(b) of the Act:
     
Title of each class   Name of each exchange on which registered
Common Stock, par value $.01 per share   New York Stock Exchange
Preferred Share Purchase Rights   New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes þ     No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o     No þ
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 þ     No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-Accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o     No þ
The approximate aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant as of June 30, 2008, the last business day of the Registrant’s most recently completed second fiscal quarter, was $1.588 billion based on a price of $32.14 per share, the closing sales price for the Registrant’s common stock as reported in the New York Stock Exchange Composite Transaction Tape on that date.
As of February 24, 2009, there were 78,800,177 outstanding shares of the Registrant’s common stock, including 674,680 shares of restricted stock.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12, 13 and 14) is incorporated by reference from the Registrant’s definitive proxy statement, which the Registrant intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Report.
 
 

 

 



 

TABLE OF CONTENTS
         
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i



 

ITEM 1. BUSINESS
Unless the context otherwise requires, the term “we,” “us,” “our,” “Marvel” or the Company each refer to Marvel Entertainment, Inc., a Delaware corporation, and its subsidiaries. Some of the characters and properties referred to in this report are subject to copyright and/or trademark protection.
General
Marvel Entertainment, Inc. and its subsidiaries constitute one of the world’s most prominent character-based entertainment companies, with a proprietary library of over 5,000 characters. Our library of characters is one of the oldest and most recognizable collections of characters in the entertainment industry, and includes Spider-Man, Iron Man, The Incredible Hulk, Captain America, Thor, The Avengers, Ghost Rider, The Fantastic Four, X-Men (including Wolverine), Blade, Daredevil, The Punisher, Namor the Sub-Mariner, Nick Fury, Silver Surfer and Ant-Man.
We operate in three integrated and complementary operating segments: Licensing, Publishing and Film Production.
The expansion of our studio operations to include feature films that we produce ourselves began in late 2005 with our entering into a $525 million film facility (the “Film Facility”) to fund the production of our films. This expansion resulted in the creation of a new segment, the Film Production segment, during 2006. Previously, Marvel Studios’ operations related solely to the licensing of our characters to third-party motion picture and television producers. Those licensing activities were, and still are, included in the Licensing segment. The operations of developing and producing our own theatrical releases are reported in our Film Production segment.
We are party to a joint venture with Sony Pictures Entertainment Inc., called Spider-Man Merchandising L.P. (the “Joint Venture”), for pursuing licensing opportunities, relating to characters based upon movies or television shows featuring Spider-Man and produced by Sony. The Joint Venture is consolidated in our financial statements as a result of our having control of all significant decisions relating to the ordinary course of business of the Joint Venture and our receiving the majority of the financial interest of the Joint Venture. The operations of the Joint Venture are included in our Licensing segment.
Our Licensing, Publishing and Film Production segments are described below. For further information about our segments, see Note 11 to our consolidated financial statements.
Licensing
Our Licensing segment, which includes the operations of the Joint Venture, licenses our characters for use in a wide variety of products and media, the most significant of which are described below. In addition, as part of our efforts to build demand for our licensed consumer products, the Licensing segment has begun producing animated television programming featuring Marvel characters. The animated programming is expected to begin airing in 2009. By controlling the content and distribution of the animation, we hope to increase our consumer products licensing activities more than is possible through animation whose content and distribution is under the control of our animation licensees.
Consumer Products
We license our characters for use in a wide variety of consumer products, including toys, apparel, interactive games, electronics, homewares, stationery, gifts and novelties, footwear, food and beverages and collectibles.

 

1



 

Studio Licensing
Feature Films. We have licensed some of our characters to major motion picture studios for use in motion pictures. For example, we currently have a license with Sony to produce motion pictures featuring the Spider-Man family of characters. We also have outstanding licenses with studios for a number of our other characters, including The Fantastic Four, X-Men (including Wolverine), Daredevil/Elektra, Ghost Rider, Namor the Sub-Mariner and The Punisher. Under these licenses, we retain control over merchandising rights and retain more than 50% of merchandising-based royalty revenue. We intend to self-produce, rather than license, all future films based on our characters that have not been licensed to third parties.
Television Programs. We license our characters for use in television programs. Several television shows based on our characters are in various stages of development, including animated programming based on Iron Man, X-Men (including Wolverine), the Incredible Hulk and Black Panther. Since January 2009, the new animated series “Wolverine and the X-Men” has been airing on Nicktoons Network.
Made-for-DVD Animated Feature Films. We have licensed some of our characters to an entity controlled by Lions Gate Entertainment Corp. to produce up to ten feature-length animated films for distribution directly to the home video market. To date, six titles have been produced and distributed under this arrangement.
Destination-Based Entertainment
We license our characters for use at theme parks, shopping malls and special events. For example, we have licensed some of our characters for use at Marvel Super Hero Island, part of the Islands of Adventure theme park at Universal Orlando in Orlando, Florida, and for use in a Spider-Man attraction at the Universal Studios theme park in Osaka, Japan. We have also licensed our characters for the development of theme parks in Dubai and in South Korea.
Promotions
We license our characters for use in short-term promotions of other companies’ products and services.
Publications
Our Licensing segment licenses our characters to publishers located outside the United States for use in foreign-language comic books and trade paperbacks and to publishers worldwide for novelizations and a range of coloring and activity books.
Publishing
The Publishing segment creates and publishes comic books and trade paperbacks principally in North America. Marvel has been publishing comic books since 1939 and has developed a roster of more than 5,000 Marvel Characters. Our titles include Spider-Man, X-Men, Fantastic Four, Iron Man, the Incredible Hulk, Captain America, the Avengers, and Thor. In addition to revenues from the sale of comic books and trade paperbacks, the Publishing segment derives revenues from sales of advertising and subscriptions and from other publishing activities, such as custom comics and digital media activities.

 

2



 

Our digital media activities have had a small but growing impact on our Publishing segment revenues, mostly through online advertising and comic subscription sales. Our website, www.marvel.com, has also proven to be an effective means to market various Marvel products and events. In 2007, we launched a digital comic subscription service and we currently have over 5,000 previously published Marvel comic books available for viewing online in a proprietary viewer. We have added more content to our website, including videos, casual games, news and character biographies. In early 2008, we launched a separate website, www.marvelkids.com, featuring Marvel characters and content for children aged 6-11. During 2008, we expanded our distribution of digital media content through arrangements with third-party websites such as YouTube and iTunes. We expect continued growth and diversification in Marvel Online revenues as we continue to increase our online presence. We are planning on further development in the digital space in 2009 with a broader offering in casual games, video and digital comics as well as further expansion of our distribution arrangements through third-party websites.
The Publishing segment’s approach to our characters is to present a contemporary drama suggestive of real people with real problems. This enables the characters to evolve, remain fresh, and, therefore, attract new and retain old readers in each succeeding generation. Our characters exist in the “Marvel Universe,” a fictitious universe that provides a unifying historical and contextual background for the characters and storylines. The “Marvel Universe” concept permits us to use the popularity of our better-known characters to more fully develop existing but lesser-known characters. In this manner, formerly lesser-known characters such as Ghost Rider, Black Panther and Wolverine have been developed and are now popular characters in their own right and are featured in their own comic books. The “Marvel Universe” concept also allows us to use our more popular characters to make “guest appearances” in the comic books of lesser-known characters to attempt to increase the circulation of a particular issue or series.
Customers, Marketing and Distribution
Our comic book and trade paperback publications are distributed through three channels: (i) to comic book specialty stores on a non-returnable basis (the “direct market”), (ii) to traditional retail outlets, including bookstores and newsstands, on a returnable basis (the “mass market”) and (iii) on a subscription sales basis.
In 2008, the Publishing segment continued to be the domestic comic industry leader, with 41% of the dollar share and 46% of the unit share of the direct market channel. Approximately 69% of the Publishing segment’s net sales in 2008 were derived from sales to the direct market. We distribute our publications to the direct market through Diamond Comic Distributors, Inc., an unaffiliated entity. We print periodicals to order for the direct market, thus minimizing the cost of printing and marketing excess inventory.
For the year ended December 31, 2008, approximately 17% of the Publishing segment’s net sales were derived from sales to the mass market.
In addition to revenues from the sale of comic books and trade paperbacks to the direct market and the mass market, the Publishing segment derives revenues from sales of advertising and subscriptions and from other publishing activities, such as custom comics and digital media. For the year ended December 31, 2008, approximately, 14% of the Publishing segment’s net sales were derived from these sources. In most of our comic publications, three cover pages and ten interior pages are allocated for advertising. We permit advertisers to advertise in a broad range of our comic book publications or to advertise in specific groups of titles whose readership’s age is suited to the advertiser.
Film Production
Until we began producing our own films, our growth strategy was to increase exposure of our characters by licensing them to third parties for development as movies and television shows. The increased exposure creates revenue opportunities for us through increased sales of toys and other licensed merchandise. Our self-produced movies, the first two of which were released in 2008, represent an expansion of that strategy that also increases our level of control in developing and launching character brands. Our self-produced movies also offer us an opportunity to participate in the films’ financial performance to a greater extent than we could as a licensor.

 

3



 

As a film development company, MVL Productions LLC, a wholly-owned consolidated subsidiary of ours, engages in a broad range of pre-production services. Those services include developing film concepts and screenplays, preparing budgets and production schedules, obtaining production insurance and completion bonds and forming special-purpose, bankruptcy-remote subsidiaries to produce each film as a work-made-for-hire for MVL Film Finance LLC. MVL Productions LLC has also entered into a studio distribution agreement with Paramount Pictures Corporation and, solely with respect to The Incredible Hulk theatrical release, with Universal Pictures, a division of Universal City Studios, LLP.
MVL Productions LLC’s studio distribution agreement with Paramount requires Paramount to distribute five of our future films and to provide advertising and marketing efforts for each film. Included in Paramount’s distribution rights are exclusive theatrical and non-theatrical (e.g., exhibition on airplanes, schools and military installations), home video, pay television and international television distribution rights. Excluded are all distribution rights with respect to free television distribution in the United States and Canada. As compensation for its services under the studio distribution agreement, after remitting to us 5% of the film’s gross receipts (that is, the producer fee payable to Marvel), Paramount is permitted to recoup its distribution costs and expenses (including print and advertising costs and payments of residuals and participation costs owed to talent) for each film from the gross receipts of each film and to receive its distribution fee before we receive our share of gross receipts.
Paramount distributes Iron Man and Universal Studios distributes The Incredible Hulk on terms similar to those described above, except that the Reserved Territories, as defined below, are excluded.
Our Film Production segment includes our self-produced feature films. Those films are financed primarily with our $525 million film facility, which is described below. The first two films produced by the Film Production segment were Iron Man, which was released on May 2, 2008, and The Incredible Hulk, which was released on June 13, 2008. We are currently developing four films for release in 2010 and 2011: Iron Man 2, Thor, The First Avenger: Captain America and The Avengers. The scheduled release dates of those films are, respectively, May 7, 2010, July 16, 2010, May 6, 2011 and July 15, 2011.
The film facility enables us to independently finance the development and production costs of up to ten feature films, including films that may feature the following Marvel characters, whose theatrical film rights are pledged as collateral to secure the film facility:
    Ant-Man
    Black Panther
    Captain America
    Cloak & Dagger
    Doctor Strange
    Hawkeye
    Iron Man
    Nick Fury
    Power Pack
    Shang-Chi
    The Avengers
    The Incredible Hulk
Also included as collateral for the film facility are the theatrical film rights to many of the supporting characters that would be most closely associated with the featured characters and character families. For example, the theatrical film rights to The Incredible Hulk’s girlfriend, Betty Ross, and his nemesis, Abomination, are both pledged as collateral to the film facility.
We are currently developing a movie based on the character Thor and expect to obtain the consent of the film facility lenders to finance and produce that film through the film facility, in which case we will pledge the theatrical film rights to Thor and various related characters as additional collateral to secure the film facility.

 

4



 

While theatrical films featuring the characters listed above may be financed and produced by us only through the film facility, we retain all other rights associated with those characters. In addition, we may continue to license our other characters for movie productions by third parties, obtain financing to produce movies based on those other characters ourselves or with others or, with the consent of the film facility lenders, finance and produce films based on those other characters through the film facility.
We fund, from working capital and other sources, the incremental overhead expenses and costs of developing each film to the stage at which the conditions for an initial borrowing for the film are met under the film facility. If the film’s initial funding conditions are met under the film facility, we are able to borrow up to 67% of our budgeted production costs including an amount equal to our incremental overhead expenses related to that film, but not exceeding 2% of the film’s budget. If the initial funding conditions are not met, we will be unable to borrow these amounts under the film facility. Beginning with our third film, upon meeting the film’s initial funding conditions, we will be responsible to immediately fund 33% of that film’s budget using our own funds.
In connection with the film facility, we have formed the following wholly-owned subsidiaries: Assembled Productions LLC, MVL Rights LLC, MVL Productions LLC, Incredible Productions LLC, Iron Works Productions LLC, Iron Works Productions II LLC, MVL Iron Works Productions Canada, Inc., Vita-Ray Productions LLC, MVL Incredible Productions Canada, Inc. and MVL Film Finance LLC (collectively, the “Film Slate Subsidiaries). The assets of MVL Film Finance LLC have been pledged as collateral to secure our film facility debt. The assets of the other Film Slate Subsidiaries, other than MVL Productions LLC, are not available to satisfy debts or other obligations of any of our other subsidiaries or any other persons.
Terms of the Film Facility
Financing Available; Rate of Interest; Borrowings Outstanding
MVL Film Finance LLC maintains a $525 million credit facility for producing theatrical motion pictures based on our characters. MVL Film Finance LLC’s ability to borrow under the film facility expires on September 1, 2012. The film facility expires on September 1, 2016, subject to extension by up to ten months under certain circumstances. The expiration date and final date for borrowings under the film facility occur sooner if the films produced under the facility fail to meet certain defined performance measures. The film facility consists of $465 million in revolving senior bank debt and $60 million in mezzanine debt, which is subordinated to the senior bank debt and, as discussed below, was repurchased by us. Both Standard & Poor’s, a division of the McGraw-Hill Companies, Inc., and Moody’s Investor Rating Service, Inc. have given the senior bank debt investment grade ratings. In addition, Ambac Assurance Corporation has insured repayment of the senior bank debt. In exchange for the repayment insurance, we pay Ambac a fee calculated as a percentage of senior bank debt, but in no event less than $3.4 million per year. The interest rates for outstanding senior bank debt, and the fees payable on unused senior bank debt capacity, both described below, include the percentage fee owed to Ambac (assuming the minimum has been reached). During the second and third quarters of 2008, our wholly-owned subsidiary, MVL International C.V., repurchased all $60 million of the mezzanine debt for $58.1 million. The mezzanine debt remains outstanding and MVL International C.V. receives the interest payments made by MVL Film Finance LLC with respect to this debt. The interest expense and interest income related to the mezzanine debt are therefore eliminated in our consolidated results and our consolidated financial position does not include the mezzanine debt.
All future interest payable under the film facility must now be paid from the films’ net collections, rather than from any of our other sources of cash. Effective December 31, 2008, the film facility requires us to maintain a liquidity reserve of $25 million, included in restricted cash, to cover future interest payments in the event that the films’ net collections are not sufficient to make these payments. If we do not release a film in 2010, 2011 and 2012 or our sixth film under the facility by August 26, 2012, the liquidity reserve requirement will be increased to $45 million.
The film facility also requires us to maintain an interest reserve equal to the subsequent quarter’s estimated interest. As of December 31, 2008, this reserve was $6.4 million, and is included in restricted cash.

 

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The interest rate for outstanding senior bank debt is LIBOR (1.43% at December 31, 2008) or the commercial paper rate, as applicable, plus 2.935%. The LIBOR rate on our outstanding senior bank debt resets to the quoted LIBOR rate two business days preceding the commencement of each calendar quarter. The commercial paper rate resets periodically depending on how often our lenders issue commercial paper to fund their portion of our outstanding debt. The weighted average interest rate of our senior bank debt was 5.78% at December 31, 2008. The interest rate for the mezzanine debt is LIBOR plus 7.0%. As noted above, we have repurchased the mezzanine debt and, accordingly, interest expense, from the dates of repurchase, related to the mezzanine debt is no longer reflected in our consolidated operating results.
The film facility requires us to pay a fee on any senior bank debt capacity that we are not using. This fee is currently 0.90%, and is applied on $465 million reduced by the amount of any outstanding senior bank debt.
In June 2008, Ambac’s rating was downgraded by S&P from AAA to AA. The downgrade caused an increase of 1.30% in our interest rate for outstanding senior bank debt and an increase of 0.30% in the fee payable on our unused senior bank debt capacity. These increases are reflected in the rates noted above. Any further downgrades of Ambac’s rating, such as the one by Moody’s on November 5, 2008 (to Baa1), do not affect our rate of interest or fees under the film facility.
If the senior bank debt’s rating (without giving effect to Ambac’s insurance) by either S&P or Moody’s were to fall below investment grade, the interest rate for the outstanding senior bank debt would increase by up to an additional 0.815%. In addition, if the ratio of our indebtedness, excluding the film facility, to our total capital, defined as our consolidated equity plus indebtedness excluding film facility indebtedness, were to exceed 0.4 to 1.0, then the interest rate for outstanding senior bank debt could increase by up to an additional 0.50%. In light of recent adverse developments in the credit markets, we have assessed the economic impact on our film production activities from the actual and potential increases in interest rates described above. We do not believe the actual or potential impact from these rate increases to be material.
Proceeds derived from our films must be used to pay amounts due under the film facility. Although the principal under our film facility is not due until September 1, 2016 at the earliest, interest and facility fees are due on a quarterly basis. The excess funds remaining after payment of all amounts due under the film facility are deposited into a “borrower-blocked” account. Amounts in the borrower-blocked account are applied to fund required reserves (discussed above) and pay amounts that become due under the film facility (such as interest and Ambac fees). If the reserves are fully funded and all amounts due have been paid, additional amounts may, at Marvel’s discretion, be retained in the borrower-blocked account, used to fund future production costs or used to repay film facility debt. Upon our completion of three films, amounts in the borrower blocked account may also, at our discretion, be distributed to us on an unrestricted basis, provided that these funds exceed certain thresholds.
During the year ended December 31, 2008, in addition to the repurchase of the mezzanine debt, we funded the required reserves described above and repaid $62.8 million of film facility debt, using a combination of net collections from our films and our own funds.
The film facility requires the maintenance of a minimum tangible net worth, a prospective cash coverage test, an historical cash coverage test and an asset coverage ratio, each measured quarterly, and compliance with various administrative covenants. We have maintained compliance with all required provisions of the film facility since its inception.
We entered into an interest rate cap agreement in connection with the film facility whereby LIBOR is capped at 6.0% for debt outstanding under the film facility up to certain stipulated notional amounts, which vary over the term of the film facility. The notional amount of debt associated with the interest rate cap agreement at December 31, 2008 was $300 million. The interest rate cap is recorded at its fair value of $0.1 million at December 31, 2008 and is included in other assets in the accompanying consolidated balance sheets. Fair value of the interest rate cap at December 31, 2007 was $1.1 million. Gains and losses from changes in the fair value of the interest rate cap are recorded within Other Income in the accompanying consolidated statements of net income. The interest rate cap expires on October 15, 2014.

 

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As of December 31, 2008, MVL Film Finance LLC had $213.0 million in outstanding senior bank debt under the film facility. Of these borrowings, $204.8 million are classified as current in the accompanying consolidated balance sheets, which represents the amount we estimate to be repaid over the twelve-month period beginning on January 1, 2009. Borrowings have been used to fund direct production costs of our Iron Man and The Incredible Hulk feature films, to fund the interest payments and liquidity reserve of the film facility, to fund the finance transaction costs related to the closing of the facility and to purchase the interest rate cap. We repaid $127.6 million of our film facility debt in early 2009, using a combination of net collections from Iron Man and our own funds. We expect to borrow approximately $150 million under our film facility during 2009.
Limitations on Recourse under Film Facility
The borrowings under the film facility are non-recourse to us and our affiliates, other than MVL Film Finance LLC. In other words, only MVL Film Finance LLC, and not our other affiliated companies, will be responsible for paying back amounts borrowed under the film facility. MVL Film Finance LLC has pledged all of its assets, principally consisting of the theatrical film rights to the characters included in the film facility and the rights to completed films or films in production, as collateral for the borrowings. While the borrowings are non-recourse to us, we have agreed to instruct our subsidiaries involved in the film facility to maintain operational covenants. If those covenants are not maintained, we may be liable for any actual damages caused by the failure, although our liability would be subject to limitations, including the exclusion of consequential damages.
Use of Funds
Funds under the film facility may be used for the production of up to ten films featuring characters included in the film facility. Funds may be used to produce more than one film based on a single character or character family, so even if ten films are produced using the funds from the film facility, not all characters and character families included in the facility will necessarily be the subject of a film financed under the facility.
Initial Funding Conditions
For any film included in the film facility, an initial funding may be made only if certain conditions are met. The conditions include obtaining a satisfactory completion bond and production insurance for the film, and compliance with representations, warranties and covenants. To obtain a completion bond, we will need to have in place the main operational pieces to producing a film, including approved production, cash flow and delivery schedules, an approved budget, an approved screenplay and the key members of the production crew, including the director. As a condition to the initial funding of the fifth film to be produced under the film facility and each film thereafter, we will have to satisfy an interim asset test, which is the asset coverage ratio, discussed above, calculated at the time of this initial funding request. Until recently, we would also have been required, before the fifth film’s funding, either to obtain a cumulative, minimum budget percentage (33%) from our pre-sales of film distribution rights in Australia and New Zealand, Japan, Germany, France and Spain (the “Reserved Territories”), together with the proceeds of any government rebate, subsidy or tax incentive and any other source of co-financing, or to fund that budget percentage with our own cash (the “Pre-Sales Test”). The Pre-Sale Test has now been effectively subsumed by other terms of the film facility, as explained below. Future distribution in the Reserved Territories will be handled by Paramount, with limited exceptions.
The film facility requires us to fund 33% of the budget of each film distributed under the distribution agreement with Paramount that we entered into in the third quarter of 2008. The film facility will provide up to 67% of the budget (reduced by the proceeds of any co-financing). After deduction of Paramount’s distribution fees and expenses in the Reserved Territories, we will be entitled to recoup our 33% contribution from all film proceeds from the Reserved Territories. Our recoupment will be crossed among all films distributed under the distribution agreement with Paramount and among all Reserved Territories. After recoupment of our 33% contribution, all additional film proceeds from the Reserved Territories will be used to pay down borrowings under the film facility.

 

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In January 2009, we repaid $16.3 of film facility borrowings with our own cash. That payment, combined with the pre-sales of distribution rights in the Reserved Territories and other co-financing proceeds for Iron Man and The Incredible Hulk, equals 33% of those films’ budgets. Because of the requirement that we fund 33% of future films, we therefore expect to be in compliance, without any further action on our part, with the Pre-Sale Test when it is first applied (upon funding of the fifth film) and at all relevant times thereafter.
Unrestricted Proceeds of the Film Facility
In connection with each film released under the film facility, we are entitled to retain a producer fee of five percent of any gross receipts and of any amounts received in connection with the sale of the Reserved Territories or other co-financing sources. We will also retain, after the payment of miscellaneous third party agency fees and participations, all film-related merchandising revenues, such as revenues from toy sales and product licensing based on the movies. These merchandising revenues and the producer fee are neither pledged as collateral nor subject to cash restrictions under the film facility. We have agreed, however, to make available to the film facility the proceeds of our producer fee on Iron Man 2, which are available to reimburse the film facility for amounts expended by the facility on Iron Man 2 in excess of the maximum budget cap under the facility.
Restricted Proceeds of the Film Facility
MVL Film Finance LLC will receive and retain funds from revenue streams such as our share of box office receipts, home video sales and television. Any sums remaining after payments of residuals and participations to talent, distribution fees and expenses (including marketing costs), interest expense and production costs will be placed into a blocked account maintained by MVL Film Finance LLC. Sums in that account may be used only for the production of films and repayment of indebtedness under the film facility. After the release of the third film, funds may be withdrawn from the blocked account for our general corporate purposes if we have met conditions including compliance with financial coverage tests and a minimum balance requirement. After three films, funds may be withdrawn for general purposes only if the balance in the blocked account is at least $350 million. For each film thereafter until film nine, the balance requirement is reduced by $50 million.
Ability to Refinance or Discontinue Film Facility
The film facility allows MVL Film Finance LLC to either refinance or simply discontinue the financing at any time without penalty by prepaying all outstanding indebtedness.
Former Toy Segment
We no longer have a Toy segment. During early 2008, we completed our exit from toy manufacturing activities. We also completed a change in the focus of the support that we provide to Hasbro, Inc., which resulted in changes to our internal organizational structure and staff reductions. These events altered our internal reporting of segment performance, with the result that we are including revenues earned from Hasbro (associated with toys manufactured and sold by Hasbro) and related expenses (associated with royalties that we owe to third parties, such as movie studios, on our Hasbro revenue) within our Licensing segment. Those revenues and expenses were formerly included in our Toy segment. Our remaining activities related to our terminated toy manufacturing business are included with Corporate overhead in “All Other”. We have reclassified prior-period segment information to conform to the current-year presentation.

 

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Intellectual Property
Our most valuable assets are our library of proprietary characters, the stories we have published for decades, the associated copyrights, trademarks and goodwill and our “Marvel” and “Marvel Comics” trade names. We believe that our library of characters and stories could not easily be replicated. We conduct an active program of maintaining and protecting our intellectual property rights in the United States and abroad. Our principal trademarks have been registered in the United States and in certain of the countries in Western Europe, Latin America, Asia (including many Pacific Rim countries), the Middle East and Africa. While we have registered numerous trademarks in these countries, and expect that our rights will be protected there, certain countries do not have laws that protect United States holders of intellectual property as strongly as laws in the United States, and what rights we have in those countries can be difficult to enforce. There can be no assurance that our rights will not be violated or our characters “pirated.”
Competition
The industries in which we compete are highly competitive.
The Licensing segment competes with a diverse range of entities that own intellectual property rights in characters. These include DC Comics (a subsidiary of Time Warner, Inc.), The Walt Disney Company, NBC Universal, Inc. (a subsidiary of General Electric Company), DreamWorks Animation SKG, Inc. and other entertainment-related entities. Many of these competitors have greater financial and other resources than we do.
The Publishing segment competes with numerous publishers in the United States. Some of the Publishing segment’s competitors, such as DC Comics, are part of integrated entertainment companies and have greater financial and other resources than we do. The Publishing segment also faces competition from other entertainment media, such as movies and television.
The Film Production segment competes with other film producers, including major studios such as Twentieth Century Fox and Sony Pictures (which also produce films licensed by our Licensing segment). Many of these producers are part of integrated entertainment companies and have greater financial and other resources than we do. Paramount and Universal (with respect solely to The Incredible Hulk), who have agreed to distribute the Film Production segment’s films, are also competitors of the Film Production segment in their capacity as film producers.
Employees
As of December 31, 2008, Marvel employed approximately 300 people. We also contract for creative work on an as-needed basis with over 700 active freelance writers and artists. Our employees are not subject to any collective bargaining agreements. In addition, we utilize the services of personnel employed by payroll services companies on a project-by-project basis in connection with our film production activities. We believe that our relationship with our employees is good.

 

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Financial Information about Geographic Areas
The following table sets forth revenues from external customers by geographic area:
Revenue by Geographic Area
(in millions)
                                                 
    2008     2007     2006  
    U.S.     Foreign     U.S.     Foreign     U.S.     Foreign  
 
                                               
Licensing (1)
  $ 170.3     $ 122.5     $ 217.0     $ 126.6     $ 88.3     $ 44.1  
Publishing
    111.7       13.7       113.4       12.3       96.7       11.8  
Film Production
    157.9       96.7                          
All Other (2)
    2.6       0.8       14.6       1.9       77.8       33.1  
 
                                   
Total
  $ 442.5     $ 233.7     $ 345.0     $ 140.8     $ 262.8     $ 89.0  
 
                                   
     
(1)   Includes U.S. revenue derived from the Joint Venture of $20.8 million, $70.8 million and $3.4 million for 2008, 2007, and 2006, respectively. Includes foreign revenue derived from the Joint Venture of $36.5 million, $51.2 million and $0.7 million for 2008, 2007, and 2006, respectively.
 
(2)   Represents toy sales, associated with our toy manufacturing operations, which ceased during early 2008.
Available Information
Our Internet address is www.marvel.com. Through our website, we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission. We also make available on our website our Code of Business Conduct and Ethics, our Code of Ethics for the Chief Executive Officer and Senior Financial Officers, our Corporate Governance Guidelines and the charters of the following committees of our Board of Directors: the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee. We are providing our Internet address here solely for the information of investors. We do not intend to incorporate the contents of the website into this report. Printed copies of the information referred to in this paragraph are also available on written request sent to: Corporate Secretary, Marvel Entertainment, Inc., 417 Fifth Avenue, New York, New York 10016.
Certification with the New York Stock Exchange
On May 30, 2008, our chief executive officer filed, with the New York Stock Exchange, the CEO certification regarding our compliance with the exchange’s corporate governance listing standards as required by Listed Company Manual Rule 303A.12.

 

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ITEM 1A. RISK FACTORS
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements that Marvel or its representatives make. Statements that are not statements of historical fact, including comments about our business strategies and objectives, growth prospects and future financial performance, are forward-looking statements. The words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “guidance,” “forecast,” “plan,” “outlook” and similar expressions, in filings with the SEC, in our press releases and in oral statements made by our representatives, also identify forward-looking statements. The forward-looking statements in this report speak only as of the date of this report. We do not intend to update or revise any forward-looking statements to reflect events or circumstances after the date on which the statements are made, even if new information becomes available.
The risk factors listed below, among others, could cause our actual results to differ significantly from what is expressed in our forward-looking statements.
Risk Factors
Exposure to economic downturn. Recent turmoil in the financial markets has adversely affected economic activity in the United States and other regions of the world in which we do business. There is evidence that this is affecting demand for some of our products and our licensees’ products, and a continued decline in economic activity could adversely affect demand for any of our businesses, thus reducing our revenue. A sustained decline in economic conditions could negatively impact the performance of our theatrical and home entertainment releases, the royalties we receive on sales of licensed consumer products and the sales of our trade paperbacks, comic books and advertising. These conditions could also impair the ability of those with whom we do business to satisfy their obligations to us, which could also harm our business.
Exposure to tightening of credit markets. U.S. and global credit markets have recently undergone significant disruption, making it difficult for many businesses to obtain financing on acceptable terms. If these conditions continue or worsen, our costs of borrowing may increase, our existing corporate and/or film facility lenders might violate their commitments to lend, and we might be unable to obtain other financing. Our licensees and publishing retailers may also have increased cost of borrowings and more difficulties in obtaining financing for their operations. Our $100 million corporate line of credit is scheduled to expire on March 31, 2010. While we expect to be able to extend this line of credit, and have used it only on occasion, our inability to extend or replace this line of credit could harm our business.
Dependence on a single distributor to the direct market. Sales of our publications to the direct market represent most of our Publishing segment’s net sales. We distribute our publications to the direct market solely through Diamond Comic Distributors, Inc. Diamond handles the vast majority of all publishers’ direct market distribution. If Diamond were to fail to perform under our distribution agreement or if it were to experience financial difficulties, our distribution to the direct market could be severely disrupted and we might be unable to find an adequate replacement distributor.
Financial difficulties of licensees. We have licensed to other parties the exclusive right to manufacture and sell various character families in important merchandise categories such as footwear, costumes and interactive games. Our revenues could be adversely affected if those licensees or any of our other significant non-exclusive licensees, many of whom have significant future payment obligations to us, experience financial difficulties or bankruptcy.
A decrease in the level of media exposure or popularity of our characters. If movies or television programs based on Marvel characters are not successful, or if certain Marvel characters lose some of their popularity, our ability to interest potential licensees in the use of Marvel characters in general could be substantially diminished, as could the royalties we receive from licensees.

 

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Changing consumer preferences. Our products (and those of our licensees) are subject to changing consumer preferences. In particular, products based on feature films are, in general, successfully marketed for only a limited period of time following the film’s release. Existing product lines might not retain their current popularity or new products developed by us or our licensees might not meet with the same success as current products. Our licensees and we might not accurately anticipate future trends or be able to successfully develop, produce and market products to take advantage of market opportunities presented by those trends. Part of our strategy (and the strategy of many of our licensees) is to make products based on the anticipated success of feature film releases and TV broadcasts. If these releases and broadcasts are not successful, these products may not be sold profitably or even at all. In addition, demand for Marvel-branded merchandise could decrease in the event of safety problems in products produced and sold by our licensees.
Movie- and television-production delays and cancellations. We do not control the decision to proceed with the production of films and television programs based on characters that we license to studios, and we do not control the timing of the releases of those films and programs. Delays or cancellations of proposed films and television programs could have an adverse effect on our business. Dates we express for the anticipated release of films and launch dates for television programs are anticipated dates only and those events could be delayed or, in some instances, even cancelled.
Concentration of toy licensing in one licensee. Most of our toy licensing revenue is generated under a license with Hasbro. Disruption to our relationship with Hasbro or financial difficulties of Hasbro could adversely affect our licensing revenues. In addition, the retail toy business is highly concentrated, and an adverse change in the relationship between Hasbro and one or more of its major customers could have a material adverse effect on us. The bankruptcy or other lack of success of one or more significant toy retailers could materially decrease our earnings under the Hasbro license. The current economic turmoil increases the likelihood of those retailers’ suffering financial difficulties.
Uncertainties in the film production business. We have only recently entered into the film-production business, with the release in 2008 of our first two self-produced films. We have to make significant up-front investments in film development costs and will not be able to borrow those amounts from the film facility if for some reason the film in development does not meet the lenders’ conditions for funding. If the lenders’ conditions are met, repayment of their loan will depend on the films’ financial success and, with respect to all of our future self-produced films, we will be responsible for funding 33% of the budget ourselves. Should proceeds from the films be insufficient to repay the loan, we could lose the film rights to some important Marvel characters. In addition, our accompanying consolidated statements of net income (also known as our “income statement” or “profit and loss statement”) will reflect any losses suffered by the film facility even if we do not have to fund those losses, and as a result, the volatility of our consolidated financial results could increase. Among the factors that might cause the developments described above, or other material adverse developments concerning our film-production operations, are the following:
    We might be unable to attract and retain creative talent. The success of our film-production activities depends to a degree on our ability to hire, retain and motivate top creative talent. Making movies is an activity that requires the services of individuals, such as actors, directors and producers, who have unusual creative talents. Individuals with those talents may be more difficult to identify, hire and retain than are individuals with general business management skills. We have to hire and retain creative talent to assist us in making our movies. If we experience difficulty in hiring, retaining or motivating creative talent, the production of our films could be delayed or the success of our films could be adversely affected.
    We will be exposed to changes in fortune on the part of key talent. We may find ourselves partially dependent on key talent (actors, writers, directors) in our most successful movie franchises. A key actor’s incapacitation or damaged reputation, for instance, could impair our ability to profit from that actor’s performance in future films.

 

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    Our films might be less successful economically than we anticipate. We cannot predict the economic success of any of our films because the revenue derived from the distribution of a film depends primarily upon its acceptance by the public, which cannot be accurately predicted. The economic success of a film also depends upon the public’s acceptance of competing films, critical reviews, the availability of alternative forms of entertainment and leisure time activities, piracy and unauthorized recording, transmission and distribution of films, general economic conditions, weather conditions and other tangible and intangible factors, none of which can be predicted with certainty. We expect to release a limited number of films per year as part of the film facility. The commercial failure of just one of those films could have a material adverse effect on our results of operations in both the year of release and in the future.
    Our films might be more expensive to make than we anticipate. We expect that the film facility will provide the capital required to produce our films. Expenses associated with producing the films could increase beyond the facility’s limit, however, because of a range of things such as an escalation in compensation rates of talent and crews working on the films or in the number of personnel required to work on films, or because of creative problems or difficulties with technology, special effects and equipment. In addition, unexpected circumstances sometimes cause film productions to exceed budget.
    Our film productions might be disrupted or delayed. Our movies productions are subject to long and inflexible schedules. Disruptions or delays to those schedules, by a union strike (such as the one currently threatened by the Screen Actors Guild for the spring of 2009) or by any other event, could cause us to incur additional costs, miss an anticipated release date or go for long periods without releasing a movie, and could hurt our associated licensing and toy programs.
    We might be disadvantaged by changes or disruptions in the way films are distributed. The manner in which consumers access film content has undergone rapid and dramatic changes. Some ancillary means of distribution, such as the DVD market, have gained importance, while others have faded. We cannot assure that new distribution channels will be as profitable for the film industry as are today’s channels or that we will successfully exploit any new channels. We can also not assure that current distribution channels, such as the DVD market, will maintain their profitability. In addition, films and related products are distributed internationally and are subject to risks inherent in international trade including war and acts of terrorism, instability of foreign governments or economies, fluctuating foreign exchange rates and changes in laws and policies affecting the trade of movies and related products.
    We might lose potential sales because of piracy of films and related products. With technological advances, the piracy of films and related products has increased. Unauthorized and pirated copies of our films will reduce the revenue generated by those films and related products.
    We will be primarily dependent on a single distributor for each film. If our studio distributor (Paramount or, in the case of The Incredible Hulk and its sequels, Universal) were to fail to perform under its distribution agreement or if it were to experience financial difficulties, our ability to distribute our films and to receive proceeds from our films could be impaired.
    We will depend on our studio distributors for revenue and certain expense information related to the accounting for film-production activities. Because of Paramount’s and Universal’s role as distributor and paymaster of the film facility films, we will depend on them to have internal controls over financial reporting related to the films they distribute and to provide us with timely and accurate financial and other information related to our films. Paramount’s and Universal’s internal controls might not remain sufficient to allow us to meet our internal control obligations. We may be unable to effectively create compensating controls to detect and prevent errors or irregularities in Paramount’s and Universal’s accounting to us and others.

 

13



 

    We might fail to meet the conditions set by the lenders for the funding of films. An initial funding of films by the film facility will be made only if the lenders’ conditions are met. Those conditions include our obtaining a completion bond and production insurance. To obtain a completion bond we will need to have in place the main operational pieces to producing a film, including approved schedules for production, cash flow and delivery, an approved budget, an approved screenplay and the key members of the production crew, including the director and producer. We might not be able to satisfy those conditions and obtain a completion bond. In addition, there are very few companies that provide completion bonds in the amounts that we will require, and if the one company with which we have so far made arrangements were to exit the business, we might be unable to obtain a completion bond under any circumstances. If the lenders’ conditions are not met, the film in question will not be funded and we will be forced to absorb the up-front film development costs, which could be material, by using our own funds.
    We might fail to meet the tests imposed by the lenders for the funding of films beyond the first four. In order for more than four films to be funded by the film facility, we will have to pass an interim asset test. If the interim asset test is not passed, the film facility may be cut short and, because fewer films will be available to repay the lenders, our risk of losing film rights to some of our characters will increase.
    Cash flows from our films might be insufficient to pay our interest costs under the film facility. Future interest on film facility borrowings must be paid from the films’ net collections, rather than from any of our other sources of cash. If cash flow from the films were to dip, even temporarily, below the point required to pay interest under the facility, and below the interest and liquidity reserves that are required to be maintained ($31.4 million at December 31, 2008), then we would be in default and we could be barred by the film facility lenders from making any future borrowings under the facility.
    The film facility’s lenders might default. If one or more of the banks in our film facility’s lending consortium were to default in making a required funding and if we were unable to arrange for a replacement bank, the amount available to us under the film facility would drop by the amount of the defaulting bank’s unused commitment and our film productions could be disrupted as a result.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Marvel has the following principal properties:
                 
Facility   Location   Square Feet     Owned/Leased
Office (1)
  New York, New York     65,253     Leased
Office (2)
  Beverly Hills, California     18,418     Leased
Office (3)
  London, England     1,700     Leased
Office (2)
  Manhattan Beach, California     156,537     Leased
     
(1)   Used by our Publishing and corporate offices.
 
(2)   Used by our Licensing and Film Production segments.
 
(3)   Used by our Licensing segment.
Our Licensing segment also leases office space in West Palm Beach, Florida and in the Netherlands.
ITEM 3. LEGAL PROCEEDINGS
The information required by Part I, Item 3 is incorporated herein by reference to the information appearing under the caption “Commitments and Contingencies” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in Part II hereof. The caption can be found on page 43, below.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2008, no matters were submitted to a vote of Marvel’s security holders.

 

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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Price of and Dividends on our Common Stock
The principal United States market in which our common stock is traded is the New York Stock Exchange. Our common stock is not listed for trading on any other securities exchange registered under the Securities Exchange Act of 1934. The following table sets forth, for each fiscal quarter indicated, the high and low closing prices for our common stock as reported in the New York Stock Exchange Composite Transaction Tape.
                 
Fiscal Year   High     Low  
 
               
2008
               
First Quarter
  $ 28.73     $ 23.62  
Second Quarter
  $ 36.82     $ 26.36  
Third Quarter
  $ 36.65     $ 30.32  
Fourth Quarter
  $ 34.34     $ 23.70  
 
               
2007
               
First Quarter
  $ 30.91     $ 26.44  
Second Quarter
  $ 30.00     $ 25.48  
Third Quarter
  $ 26.81     $ 22.03  
Fourth Quarter
  $ 29.08     $ 22.75  
As of February 24, 2009, the number of holders of record of our common stock was approximately 4,000.
We have not declared any dividends on our common stock.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
                                 
                    Total number of        
                    shares     Approximate dollar  
                    purchased as     value of shares that  
            Average     part of publicly     may yet be  
    Total number of shares     price paid     announced plans     purchased under the  
Period   purchased(a)     per share     or programs(b)     plans or programs  
 
                               
October 2008
    8,299     $ 26.25       8,299          
November 2008
    18,500       23.74       12,200          
December 2008
          N/A                
 
                           
 
                               
Total
    26,799     $ 24.52       20,499     $ 127.7 million (c)
 
                           
     
(a)   This column’s figures include 6,300 shares purchased by the Fleer/Skybox defined benefit pension plan, as described in Note 10 to the accompanying consolidated financial statements.
 
(b)   This column represents the number of shares repurchased through our common stock repurchase program announced on February 19, 2008.
 
(c)   As of December 31, 2008.

 

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Performance Graph
The following graph compares the cumulative total stockholder return on shares of our common stock with that of the New York Stock Exchange Composite Index and the Amex Media (Communications) Index.
The comparison assumes that, immediately after the close of business on December 31, 2003, $100 was invested in shares of our common stock and in the stocks included in the NYSE Composite Index and the Amex Media (Communications) Index, and that all dividends were reinvested. These indexes, which reflect formulas for dividend reinvestment and weighting of individual stocks, do not necessarily reflect returns that could be achieved by individual investors.
(PERFORMANCE GRAPH)
Value of $100 Invested Over Period Presented:
                                                 
    12/31/03     12/31/04     12/31/05     12/31/06     12/31/07     12/31/08  
 
       
Marvel Entertainment, Inc.
  $ 100.00     $ 105.53     $ 84.40     $ 138.66     $ 137.63     $ 158.45  
NYSE Composite
  $ 100.00     $ 114.97     $ 125.73     $ 151.46     $ 164.89     $ 100.16  
AMEX Media (Communications)
  $ 100.00     $ 83.67     $ 89.73     $ 95.05     $ 66.47     $ 13.62  

 

17



 

ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data, derived from our audited financial statements, for the five-year period ended December 31, 2008. We have not declared dividends on our common stock during any of the periods presented below.
                                         
    Year Ended December 31,  
    2008     2007     2006     2005     2004  
    (in thousands, except per share amounts)  
Statements of Net Income Data:
                                       
Net sales
  $ 676,177     $ 485,807     $ 351,798     $ 390,507     $ 513,468  
Operating income
    367,974       274,429       112,560       171,167       224,413  
Income before income tax expense and minority interest
    354,498       263,232       98,800       171,048       206,872  
Net Income
    205,535       139,823       58,704       102,819       124,877  
Net Income per common share
    2.63       1.75       0.71       1.03       1.17  
Diluted net income per common share
    2.61       1.70       0.67       0.97       1.10  
                                         
    December 31,  
    2008     2007     2006     2005     2004  
    (in thousands)  
Balance sheet data:
                                       
Working capital (deficit)
  $ (26,333 )   $ (108,483 )   $ (58,559 )   $ 2,532     $ 142,231  
Total assets
    937,584       817,358       623,865       573,546       714,814  
Borrowings
    213,001       246,862       50,200       25,800        
Other non-current debt
                             
Stockholders’ equity
    396,691       181,503       254,891       360,600       546,500  
Treasury stock
    905,293       894,940       682,886       395,536       91,001  

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our financial statements and the related notes thereto, and the other financial information included elsewhere in this Report.
Set forth below is a discussion of our financial condition and our results of operations for the three fiscal years in the period ended December 31, 2008.
Overview
Management Overview of Business Trends
We operate in three integrated and complementary operating segments: Licensing, Publishing and Film Production. During early 2008, we completed our exit from toy manufacturing activities as planned. We also completed a change in the focus of the support that we provide to Hasbro, which resulted in changes to our internal organizational structure and staff reductions. As a result of these events, we no longer have a Toy segment and have altered our internal reporting of segment performance, with the result that we are including revenues earned from Hasbro (associated with toys manufactured and sold by Hasbro) and related expenses (associated with royalties that we owe to third parties, such as movie studios, on our Hasbro revenue) within our Licensing segment. Those revenues and expenses were formerly included in our Toy segment. Our remaining activities related to our terminated toy manufacturing business are included with Corporate overhead in “All Other”. We have reclassified prior-period segment information to conform to the current-year presentation. As a result of these changes, segment information for the years ended December 31, 2007 and 2006 has been reclassified as follows:
                                                 
    Year Ended December 31, 2007     Year Ended December 31, 2006  
    Previously             As     Previously             As  
    Reported     Adjustment     Reclassified     Reported     Adjustment     Reclassified  
    (in millions)  
Net Sales
                                               
Licensing
  $ 272.7     $ 70.9     $ 343.6     $ 127.2     $ 5.2     $ 132.4  
Toys
    87.4       (87.4 )           116.1       (116.1 )      
All Other
          16.5       16.5             110.9       110.9  
 
                                               
Cost of Revenues
                                               
Toys
    8.7       (8.7 )           56.4       (56.4 )      
All Other
          8.7       8.7             56.4       56.4  
 
                                               
Selling, General and Administrative
                                               
Licensing
    75.7       11.6       87.3       49.2       0.7       49.9  
Toys
    20.8       (20.8 )           28.0       (28.0 )      
All Other
    22.0       9.2       31.2       22.7       27.3       50.0  
 
                                               
Operating Income(Loss)
                                               
Licensing
    196.1       59.4       255.5       77.6       4.5       82.1  
Toys
    54.7       (54.7 )           21.1       (21.1 )      
All Other
    (22.4 )     (4.7 )     (27.1 )     (22.7 )     16.6       (6.1 )

 

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The increased exposure of Marvel characters in movies and television shows can create revenue opportunities for us through increased sales of licensed merchandise. Producing films ourselves provides us with more control of our film projects, gives us greater flexibility to coordinate the timing of licensing programs around Marvel-branded theatrical releases and provides us with the opportunity for a meaningful source of profits. The operations of developing and producing our own theatrical releases are reported in our Film Production segment, the funding for which comes primarily from our $525 million film facility. We intend to self-produce all future films based on our characters that have not already been licensed to third parties.
Our operating results were stronger in 2008 than in 2007, due largely to the 2008 release of our first two self-produced films, Iron Man and The Incredible Hulk. As discussed below, we will not release any self-produced films in 2009 and our only licensed film scheduled for release in 2009 is X-Men Origins: Wolverine. As a result, we expect our operating results to be lower in 2009 than in 2008 or 2007, when Spider-Man 3 was released. Our next self-produced films, Iron Man 2 and Thor, are scheduled for release in 2010.
Licensing
Our Licensing segment is responsible for the licensing, promotion and brand management for all of our characters worldwide. We pursue a strategy, where feasible, of concentrating our licensee relationships with fewer, larger licensees who demonstrate the financial and merchandising capability to manage our portfolio of both classic and movie properties. A key focus is negotiating strong minimum guarantees while keeping royalty rates competitive.
Another strategy of the Licensing segment’s consumer products program is to create new revenue opportunities by further segmenting our properties to appeal to new demographic profiles. Initiatives such as Marvel Super Hero Squad, Marvel Extreme, Marvel Heroes and Marvel Comics (the retro depiction of our characters) have all helped the licensing business expand beyond its traditional classic and event-driven properties.
Major entertainment events play an important role in driving sales of our licensed products. In 2007, our Licensing segment revenue reflected the benefit of the May 2007 release of the movie Spider-Man 3. The Licensing segment’s 2007 initiatives were focused on merchandising our self-produced movies: Iron Man, which was released on May 2, 2008, and The Incredible Hulk, which was released on June 13, 2008. Our 2008 Licensing segment revenue benefited from the release of those movies, but not as significantly as 2007 Licensing segment revenue benefited from the release of Spider-Man 3. We expect that our 2009 Licensing segment revenue will be lower than in 2008 as there will only be one major entertainment event in 2009, X-Men Origins: Wolverine, expected to be domestically released on May 1, 2009 by Twentieth Century Fox. In addition, although we have many licensees that are large companies, the majority of our consumer product licensees are small to medium sized companies, located throughout the world, that rely on access to credit to produce and distribute their products. As a result of world-wide tightening of credit markets, some of our licensees may have difficulties producing and distributing goods. In addition, due to the lessening of consumer demand resulting from the global recessionary environment, some of our licensees may have difficulties obtaining sufficient sales orders. These macro-economic factors (see “Item 1A — Risk Factors”) are another reason for our expectation that 2009 Licensing segment revenue will be lower than in 2008. We believe the negative impact of these macro-economic factors on the Licensing segment may be partially mitigated as a result of the non-durable nature of the products sold by most of our licensees and the low prices at which the majority of these products are sold.
We typically enter into multi-year merchandise license agreements that specify minimum royalty payments and include a significant down payment upon signing. We recognize license revenue when the earnings process is complete, including, for instance, the determination that the credit-worthiness of the licensee reasonably assures collectibility of any outstanding minimum royalty payments. If the earnings process is complete with respect to all required minimum royalty payments, then we record as revenue the present value of those payments.

 

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The earnings process is not complete if, among other things, we have significant continuing involvement under the license, we have placed restrictions on the licensee’s ability to exploit the rights conveyed under the contract or we owe a performance obligation to the licensee. In the case where we have significant continuing involvement or where any restrictions remain on the licensee’s rights (e.g., no sales of products based on a specific character allowed until a future date), we recognize revenue as the licensee reports its sales and corresponding royalty obligation to us. Where we have a performance obligation, minimum royalty collections are not recognized until our performance obligation has been satisfied. Minimum payments collected in advance of recognition are recorded as deferred revenue. In any case where we are unable to determine that the licensee is sufficiently creditworthy, we recognize revenue only to the extent of cash collections. When cumulative reported royalties exceed the minimum royalty payments, the excess royalties are recorded as revenue when collected and are referred to as “overages”.
As discussed above, beginning in 2008 we are including revenues earned from Hasbro, and related expenses, in our Licensing segment.
Publishing
The Publishing segment is focused on strengthening its Super Hero graphic fiction presence in its primary distribution channels such as the direct and mass market, and expanding its reach to a broader demographic by providing all ages and new reader products in the book market and online. In 2008, Marvel launched a major comic book crossover series, Secret Invasion, which involves many of the Marvel characters and features tie-ins to many other Marvel publications, similar to the Civil War series that was a top-selling comic book in 2007. Secret Invasion ran from April through December 2008. The third volume of the Dark Tower series and the first volume of The Stand series were released in October 2008. The momentum of these efforts will take us into and through the Dark Reign and Ultimatum publishing events that will occur in the first half of 2009, which will be supplemented with a variety of Wolverine product to be distributed around the X-Men Origins: Wolverine movie expected to be domestically released on May 1, 2009 by Twentieth Century Fox. We will also see the first collections for The Stand and the Ender’s Game series along with the continued publication of the Dark Tower. However, due to the macro-economic factors discussed above, we believe that Publishing segment revenue in 2009 will be lower than in 2008 as consumer spending will be down, retailers look to reduce inventory and advertising budgets remain constrained. The current economic climate may also lead to a reduction in the number of large book retailers and direct-market retailers. Direct-market retailers are generally small business entities, many of which rely on access to credit that may be more difficult to obtain.
The Publishing segment has continued its development and investment in digital media, resulting in increased content on our Marvel Digital Comics Unlimited service, where we currently have over 5,000 previously published Marvel comic books available for viewing online in a proprietary viewer. We have also added more content to our websites, including videos, casual games, news and character biographies. In early 2008, we launched a separate website, www.marvelkids.com, featuring Marvel characters and content developed for children ages 6-11. During 2008, we also expanded our distribution of digital media content through arrangements with third-party websites such as YouTube and iTunes. We expect continued growth and diversification in Marvel Online revenues as we continue to increase our online presence. However, our expectations for online revenue growth, expected in large part to be achieved through increased advertising revenues, have been reduced because of the macro-economic factors discussed above, which have had a negative impact on industry-wide online advertising. For the years ended December 31, 2008, 2007 and 2006, the revenue of our digital media group was $2.5 million, $1.0 million and $0.3 million, respectively, and the expenses of our digital media group were $4.5 million, $1.6 million and $0.1 million, respectively.
Film Production
In 2008, we released our first two self-produced films: Iron Man on May 2 and The Incredible Hulk on June 13. We are currently developing four films for release in 2010 and 2011: Iron Man 2, Thor, The First Avenger: Captain America and The Avengers. The scheduled release dates of those films are, respectively, May 7, 2010, July 16, 2010, May 6, 2011 and July 15, 2011. After the release of each film, we begin to recognize revenue and to amortize our film inventory as described below.

 

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Film Inventory
In general, we are responsible for all of the costs of developing and producing our feature films. The film’s distributor is responsible for the out-of-pocket costs, charges and expenses (including contingent compensation and residual costs, to a defined limit) incurred in the distribution, manufacturing, printing and advertising, marketing, publicizing and promotion of the film in all media (referred to in the aggregate as the distributor’s costs). The distributor’s costs are not included in film inventory.
We account for our film inventory under the guidance provided by AICPA Statement of Position 00-2, “Accounting by Producers or Distributors of Films” (“SOP 00-2”). We capitalize all direct film production costs, such as labor costs, visual effects and set construction. Those capitalized costs, along with capitalized production overhead and capitalized interest costs, appear on our balance sheet as an asset called film inventory. Production overhead includes allocable costs, including cash and stock compensation and benefits, of individuals or departments with exclusive or significant responsibility for the production of films. Capitalization of production overhead and interest costs commences upon completion of the requirements for funding the production under the film facility and ceases upon completion of the production.
We also capitalize the costs of projects in development into film inventory. Those costs consist primarily of script development. In the event that a film does not begin pre-production within three years from the time of the first capitalized transaction, or if an earlier decision is made to abandon the project, all capitalized costs related to these projects are expensed. During 2008 and 2007, $1.7 and $1.3 million, respectively, of film development costs were written off and included in selling, general and administrative expenses in the accompanying consolidated statements of net income.
Once a film is released, using the individual-film-forecast computation method, the amount of film inventory relating to that film is amortized and included in each period’s costs of revenue in the proportion that the film’s revenue during the period bears to the film’s then-estimated total revenue, net of the distributor’s costs, over a period not to exceed ten years (ultimate revenues). Estimates of ultimate revenues for each film are regularly reviewed and revised as necessary based on the latest available information. Reductions in those revenue estimates could result in the write-off, or the acceleration of the amortization, of film inventory in that reporting period; increases in those revenue estimates could result in reduced amortization in that period.
As of December 31, 2008, our Film Production segment had film inventory of $181.6 million, primarily for the Iron Man and The Incredible Hulk productions.
Film Revenue
The amount of revenue recognized from our films in any given period depends on the timing, accuracy and sufficiency of the information we receive from our distributors.
After remitting to us five percent of the film’s gross receipts, the distributor is entitled to retain a fee based upon the film’s gross receipts and to recoup all of its costs on a film-by-film basis prior to our receiving any additional share of film receipts. Any of the distributor’s costs for a film that are not recouped against receipts for that film are borne by the distributor. Our share of the film’s receipts, as described above, is recognized as revenue when reported due to us by the distributor. We received minimum guarantees from local distributors in five territories in connection with the release of Iron Man and The Incredible Hulk. In those territories, we began to recognize revenue when the film was made available for exhibition in theaters.
Revenue from the sale of home video units is recognized when our distributors report as due to us the home video sale proceeds that they have collected from retailers. We provide for future mark-downs and returns of home entertainment product at the time the related revenue is recognized, using estimates. Our estimates are calculated by analyzing a combination of our distributors’ historical returns and mark-down practices, our distributors’ estimates of returns of our home video units, current economic trends, projections of consumer demand for our home video units and point-of-sale data available from retailers. We periodically review our estimates using the latest information available.

 

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Revenue from both free and pay television licensing agreements is recognized at the time the production is made available for exhibition in those markets.
Film Facility
The film facility enables us to independently finance the development and production costs of up to ten feature films, including films that may feature the following Marvel characters, whose theatrical film rights are pledged as collateral to secure the film facility.
    Ant-Man
    Black Panther
    Captain America
    Cloak & Dagger
    Doctor Strange
    Hawkeye
    Iron Man
    Nick Fury
    Power Pack
    Shang-Chi
    The Avengers
    The Incredible Hulk
Also included as collateral for the film facility are the theatrical film rights to many of the supporting characters that would be most closely associated with the featured characters and character families. For example, the theatrical film rights to The Incredible Hulk’s girlfriend, Betty Ross, and his nemesis, Abomination, are both pledged as collateral to the film facility.
We are currently developing a movie based on the character Thor and expect to obtain the consent of the film facility lenders to finance and produce that film through the film facility, in which case we will pledge the theatrical film rights to Thor and various related characters as additional collateral to secure the film facility.
While theatrical films featuring the characters listed above may be financed and produced by us only through the film facility, we retain all other rights associated with those characters. In addition, we may continue to license our other characters for movie productions by third parties, obtain financing to produce movies based on those other characters ourselves or with others or, with the consent of the film facility lenders, finance and produce films based on those other characters through the film facility.
We fund, from working capital and other sources, the incremental overhead expenses and costs of developing each film to the stage at which the conditions for an initial borrowing for the film are met under the film facility. If the film’s initial funding conditions are met under the film facility, we are able to borrow up to 67% of our budgeted production costs including an amount equal to our incremental overhead expenses related to that film, but not exceeding 2% of the film’s budget. If the initial funding conditions are not met, we will be unable to borrow these amounts under the film facility. Beginning with our third film, upon meeting the film’s initial funding conditions, we will be responsible to immediately fund 33% of that film’s budget using our own funds.
We recorded interest expense related to the film facility, net of interest capitalized, of $19.0 million, $13.7 million and $12.8 million during the years ended December 31, 2008, 2007 and 2006, respectively. Interest charges associated with borrowings to fund the productions were capitalized, rather than expensed, until the completion of production. The productions of Iron Man and The Incredible Hulk were completed in the second quarter of 2008. Starting in the second quarter of 2008, therefore, our interest expense began to increase significantly, as we began to expense, rather than capitalize, interest on the amounts borrowed to fund the Iron Man and The Incredible Hulk productions. In 2008, 2007 and 2006, we capitalized interest costs of $5.1 million, $8.4 million and $0.2 million, respectively and those amounts were included in film inventory.

 

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Our Results of Operations
Year ended December 31, 2008 compared with the year ended December 31, 2007
Net Sales
                         
    Years ended December 31,          
    2008     2007     % Change  
    (dollars in millions)          
 
                       
Licensing
  $ 292.8     $ 343.6       (15 %)
Publishing
    125.4       125.7        
Film Production
    254.6             N/A  
All Other
    3.4       16.5       (79 %)
 
                   
Total
  $ 676.2     $ 485.8       39 %
 
                   
                 
    Years ended December 31,  
    2008     2007  
 
               
Sales Mix by Segment:
               
Licensing
    43 %     71 %
Publishing
    19 %     26 %
Film Production
    38 %      
All Other
          3 %
 
           
Net Sales
    100 %     100 %
 
           
Our consolidated net sales of $676.2 million for 2008 were $190.4 million higher than net sales in 2007. The increase primarily reflects the $254.6 million increase in Film Production net sales related to the theatrical releases during 2008 of Iron Man and The Incredible Hulk. This increase was partially offset by a 15% decline in licensing net sales and, within All Other, a decline in sales due to our exit from toy manufacturing operations.
Licensing segment net sales decreased $50.8 million during 2008, reflecting a $64.6 million decrease in Joint Venture revenue (to $57.4 million, primarily overages) related to the May 2007 release of Spider-Man 3 and a $14.8 million decrease in licensing audit claim settlements, resulting from an unusually high amount of settlement revenue in 2007. These decreases were partially offset by increases of $13.0 million and $11.1 million, respectively, in domestic and foreign licensing revenue, excluding the Joint Venture. The increases in domestic and foreign licensing were primarily due to amounts that were previously recorded as deferred revenue until the second quarter of 2008, when most licensees were first permitted to begin selling merchandise relating to Iron Man and The Incredible Hulk, partially offset by a decrease in overages that primarily resulted from increased licensing contract renewal activity. The increase in Film Production revenue and the significant decrease in Joint Venture revenue caused 2008 Licensing segment net sales to decrease as a percentage of consolidated net sales from 71% in 2007 to 43% in 2008.

 

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Net sales from the Publishing segment were consistent from 2007 to 2008 with a decrease of $0.3 million to $125.4 million in 2008. This decrease reflects a $2.2 million reduction in our custom comic book sales due to a decrease in the scale and number of projects, a $1.3 million reduction in advertising revenue, resulting from decreased spending of advertising dollars by larger corporate advertisers and a $0.6 million reduction in sales of trade paperbacks. These reductions were offset by an increase of $0.8 million in our online comic subscription revenue and a $0.7 million increase in our online advertisement sales, both due to the growth of our digital media business in 2008, and by a $2.4 million increase in our comic book sales related to limited-edition comic book series events. Comic book sales in 2008 benefited from strong unit sales of Secret Invasion, a limited-edition comic book series. Comic book sales in 2007 benefited from strong unit sales of the final two comic-book issues of the Civil War series; The Death of Captain America; the Stephen King series, Dark Tower: The Gunslinger Born; and the World War Hulk series. Publishing segment net sales decreased as a percentage of consolidated net sales from 26% in 2007 to 19% in 2008, primarily because of film production revenues in 2008.
Net sales from the Film Production segment were $254.6 million in 2008, related to the theatrical releases of Iron Man and The Incredible Hulk. There were no Film Production segment revenues in 2007.
Net sales included in All Other represent our former toy manufacturing operations, which we exited in 2008.
Cost of Revenues
                                 
    Years ended December 31,  
    2008     2007  
            % of Net             % of Net  
            Segment             Segment  
    Amount     Sales     Amount     Sales  
    (dollars in millions)  
 
                               
Licensing
  $       N/A     $       N/A  
Publishing
    55.2       44 %     52.2       42 %
Film Production
    135.3       53 %           N/A  
All Other
    1.0       29 %     8.7       53 %
 
                           
Total
  $ 191.5       28 %   $ 60.9       13 %
 
                           
Consolidated cost of revenues increased $130.6 million to $191.5 million during 2008 compared with 2007, primarily reflecting the amortization of film inventory in our Film Production segment. This increase was partially offset by the reduction of toy-production costs resulting from our exit from the toy business. Consequently, our consolidated cost of revenues as a percentage of sales increased to 28% during 2008, as compared to 13% in 2007.
Publishing segment cost of revenues for comic book and trade paperback publishing consists of art, editorial, and printing costs. The $3.0 million increase in Publishing segment cost of revenues is primarily associated with the increase in comic titles published (1,128 in 2008 vs. 974 in 2007). Publishing segment cost of revenues as a percentage of Publishing segment net sales increased from 42% in 2007 to 44% in 2008, primarily reflecting the impact of rising costs of talent combined with a reduction in the size of print runs and, to a lesser extent, an increase in paper costs.
Film Production segment cost of revenues during the 2008 period consisted of the amortization of film inventory as revenue was generated from the Iron Man and The Incredible Hulk feature films.
Cost of revenues included in All Other primarily consists of our former toy production activities.

 

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Selling, General and Administrative Expenses
                                 
    Years ended December 31,  
    2008     2007  
            % of Net             % of Net  
            Segment             Segment  
    Amount     Sales     Amount     Sales  
    (dollars in millions)  
 
       
Licensing
  $ 70.9       24 %   $ 87.3       25 %
Publishing
    22.8       18 %     19.9       16 %
Film Production
    15.7       6 %     8.7       N/A  
All Other
    29.1       N/A       31.2       N/A  
 
                           
Total
  $ 138.5       20 %   $ 147.1       30 %
 
                           
Consolidated selling, general and administrative (“SG&A”) expenses of $138.5 million in 2008 were $8.6 million lower than SG&A expenses in 2007, primarily reflecting decreases in SG&A expenses in the Licensing segment, which were partially offset by increases in SG&A expenses in the Film Production and Publishing segments. Consolidated SG&A as a percentage of net sales during 2008 decreased to 20%, from 30% in 2007, primarily reflecting increased revenue from the Film Production segment and the impact of items in the Licensing segment.
Licensing segment SG&A expenses consist primarily of payroll, agents’ foreign-sales commissions and royalties owed to movie studios and talent for their share of license royalty income, which are variable expenses based on licensing revenues. We pay movie studio licensees up to 50% of merchandising-based royalty revenue (after certain contractually agreed-upon deductions) from the licensing of both “classic” and “movie” versions of characters featured in the films. Licensing segment SG&A expenses of $70.9 million for 2008 were $16.4 million less than in 2007. The decrease was primarily because of changes in information that we received from Sony Pictures. In particular, on the basis of information that Sony Pictures provided late in 2007, we accrued an expense of $11.5 million in that year for royalties payable to actors starring in the Spider-Man movies for the use of their likenesses in licensed products. That accrual increased our 2007 Licensing segment SG&A. Sony Pictures then retracted that information and replaced it with new information in 2008, and on the basis of the new information we reduced the accrual by $8.3 million. That reduction decreased our 2008 Licensing segment SG&A. The accrual and the reduction together produced a $19.8 million downward effect on our year-over-year change in Licensing segment SG&A. Another downward effect was created by a $4.7 million non-recurring charge recorded in 2007 related to a contractual obligation. These decreases were partially offset by increases of $2.6 million in foreign sales commissions attributable to higher commission-based foreign revenues, $2.6 million in royalties primarily owed to movie studios and $2.5 million in promotions and other selling expenses. The increase in royalties is primarily due to the change in sales-mix resulting in an increase in non-Joint Venture net sales and a decrease in Joint Venture Licensing segment net sales, of which Sony Pictures’ share of royalty income is reflected as minority interest expense rather than SG&A, whereas other studios’ shares of license royalty income is recorded within SG&A expense. As a percentage of Licensing segment net sales, Licensing segment SG&A was consistent at 24% during 2008 compared with 25% in 2007.
Publishing segment SG&A expenses consist primarily of payroll, distribution fees and other miscellaneous overhead costs. Publishing segment SG&A expenses increased $2.9 million during 2008 over 2007, principally due to increased employee compensation of $1.9 million as a result of increased headcount to service the growth of our digital media business. In addition, this increase also reflects an increase of $0.6 million in the consulting and hosting fees related to the digital media web infrastructure.

 

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SG&A expenses for our Film Production segment consist primarily of employee compensation and the allocated expenses associated with our California office. The costs of marketing and promoting our films are borne by our distributors. Film Production SG&A expenses increased $7.0 million during 2008 over 2007, partially due to $5.1 million of higher compensation resulting primarily from bonuses tied to the successful release of Iron Man and The Incredible Hulk, and increased employee headcount. SG&A in 2008 also reflects an increase of $0.7 million in the advertisement and promotion costs utilized to increase awareness of the Iron Man character.
SG&A expenses included in All Other for 2008 decreased $2.1 million over 2007, principally reflecting a decline in the SG&A of our former toy manufacturing activities, which amounted to $0.7 million in 2008 and $9.2 million in 2007. This $8.5 million decrease was partially offset by a $4.5 million increase in employee compensation expense.
Depreciation and Amortization
Depreciation and amortization expense decreased $4.4 million to $1.6 million in 2008 (from $6.0 million in 2007) as a result of decreased tooling costs due to the cessation of our toy production activities.
We account for our goodwill under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Accordingly, goodwill is not amortized but is subject to annual impairment tests. Our most recent annual impairment review did not result in an impairment charge.
Other Income
Other income increased $20.8 million to $23.4 million in 2008 (from $2.6 million in 2007). During 2008, we received settlement payments from two interactive licensees in connection with the early termination of their agreements, which resulted in $19.0 million of income, and settlement payments of $2.0 million from a licensee in connection with a contractual violation.
Operating Income
                                 
    Years ended December 31,  
    2008     2007  
    Amount     Margin     Amount     Margin  
    (dollars in millions)  
 
                               
Licensing
  $ 242.3       83 %   $ 255.5       74 %
Publishing
    47.3       38 %     53.5       43 %
Film Production
    102.7       40 %     (7.5 )     N/A  
All Other
    (24.3 )     N/A       (27.1 )     N/A  
 
                           
Total
  $ 368.0       54 %   $ 274.4       56 %
 
                           
Consolidated operating income increased $93.6 million to $368.0 million during 2008, primarily reflecting a $119.3 million contribution from the gross profit of the Film Production segment related to the theatrical releases of Iron Man and The Incredible Hulk and the benefits of $21.0 million of licensing settlement payments and decreases in SG&A expenses. These increases were partially offset by a $50.8 million decrease in net sales from the Licensing segment, which generates the highest margin, which resulted in our consolidated operating margin declining from 56% in 2007 to 54% in 2008.

 

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Operating income in the Licensing segment decreased $13.2 million, primarily because of the $50.8 million reduction in Licensing segment net sales resulting from the decrease in Joint Venture revenue related to the May 2007 release of Spider-Man 3, partially offset by the $21.0 million in licensing settlement payments and the decrease in SG&A discussed above. The operating margin in the Licensing segment during 2008 increased to 83%, compared with 74% in 2007, primarily resulting from the licensing settlement payments and the non-recurring SG&A items.
Operating income in the Publishing segment decreased $6.2 million, and margins declined from 43% during 2007 to 38% during 2008, primarily due to a $2.9 million increase in expenses related to our digital media initiatives in 2008 compared with 2007. In addition, there was a decrease in 2008 in net sales of custom comic books and advertising, both of which have high margins, combined with an increase in cost of sales associated with talent costs and paper costs.
In 2008, operating income in the Film Production segment reflects a $119.3 million gross profit contribution from our self-produced films. This was partially offset by $15.7 million in SG&A expenses of the Film Production segment. During 2007, the Film Production operating loss reflects the SG&A costs noted above and a charge of $0.9 million for the decrease in the fair value of the interest rate cap associated with our film facility, offset by a $2.1 million increase in the fair value of forward contracts for the Canadian dollar. The forward contracts were entered into during 2007 in connection with the production of The Incredible Hulk.
All Other operating costs primarily represent corporate overhead expenses, partially offset by our toy manufacturing operations, which ceased during early 2008.
Interest Expense
                 
    Years ended December 31,  
    2008     2007  
    (dollars in millions)  
 
               
Interest incurred, HSBC line of credit
  $     $ 0.1  
Interest incurred, film facilities
    24.1       22.1  
 
           
Total Interest incurred
    24.1       22.2  
Less: Interest capitalized
    (5.1 )     (8.4 )
 
           
Total
  $ 19.0     $ 13.8  
 
           
From 2007 to 2008, there was an increase in the amount of interest we incurred as a result of increased outstanding borrowings associated with the Iron Man and The Incredible Hulk productions. In addition, we capitalized less interest in 2008 than in 2007 because of the completion, early in 2008, of these productions. The result was a $5.2 million increase in interest expense in 2008 compared to 2007. We expect that our 2009 interest expense will be lower than in 2008 as our average outstanding borrowings decrease and we once again begin to capitalize interest.
Interest Income
Interest income reflects amounts earned on cash equivalents and short-term investments. Interest income increased $1.0 million to $3.6 million in 2008 as compared to 2007, due to higher average cash and investment balances partially offset by a decrease in interest rates.
Gain on Repurchase of Debt
During 2008, our subsidiary, MVL International C.V repurchased all $60.0 million of our mezzanine debt related to the film facility for $58.1 million, which resulted in a net gain of $1.9 million.

 

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Income Taxes
Our annual effective tax rate differs from the federal statutory rate due to the effects of state and local taxes and elimination of the minority share of Joint Venture earnings from reported income before income tax expense. Our effective tax rates for the years ended December 31, 2008 and 2007 were both 37.6%. While the rates are consistent from year to year, there were offsetting components. The principal offsetting items were a decrease in state taxes (2.1%) partially offset by a reduction in the benefit from Joint Venture income (1.7%).
We are not responsible for the income taxes related to the minority share of the Joint Venture’s earnings. The tax liability associated with the minority share of the Joint Venture’s earnings is therefore not reported in our income tax expense, even though the Joint Venture’s entire income is consolidated in our reported income before income tax expense. Joint Venture earnings therefore have the effect of lowering our effective tax rate. This effect is more pronounced in periods in which Joint Venture earnings are higher relative to our other earnings.
We retain various state and local net operating loss carryforwards of $316 million, which will expire in various jurisdictions in the years 2009 through 2026. As of December 31, 2008, there is a valuation allowance of $0.3 million against capital loss carryforwards, as we believe it is more likely than not that those assets will not be realized in the future.
We file income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. We are no longer subject to tax examinations by taxing authorities in any jurisdiction for 2002 and prior tax years. The Internal Revenue Service (“IRS”) is examining our 2003 through 2006 tax years. As of December 31, 2008, the IRS has proposed certain adjustments, which are fully reserved for and, if accepted, would not result in a material change to our financial position. We are also under examination by various state and local jurisdictions.
Minority Interest
Minority interest related to the Joint Venture amounted to $15.8 million in 2008 and $24.5 million in 2007. This $8.7 million decrease reflects decreased operations in 2008 from licensing associated with Spider-Man 3, which was released in May 2007.
Earnings per Share
Diluted earnings per share increased to $2.61 in 2008 from $1.70 in 2007 reflecting a 47% increase in net income and a 5% reduction in the weighted average number of shares outstanding due to treasury share repurchases. We repurchased 0.4 million shares during 2008.
Year ended December 31, 2007 compared with the year ended December 31, 2006
Net Sales
                         
    Years ended December 31,        
    2007     2006     % Change  
    (dollars in millions)        
 
       
Licensing
  $ 343.6     $ 132.4       160 %
Publishing
    125.7       108.5       16 %
All Other
    16.5       110.9       (85 )%
 
                   
Total
  $ 485.8     $ 351.8       38 %
 
                   

 

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    Years ended December 31,  
    2007     2006  
 
               
Sales Mix by Segment:
               
Licensing
    71 %     38 %
Publishing
    26 %     31 %
All Other
    3 %     31 %
 
           
Net Sales
    100 %     100 %
 
           
Our consolidated net sales of $485.8 million for 2007 were $134.0 million higher than net sales in 2006. This was principally due to the160% increase in Licensing segment net sales, which was mostly attributable to revenue related to Spider-Man 3 merchandising through the joint venture with Sony Pictures, called Spider-Man Merchandising L.P. (the “Joint Venture”). In addition, Publishing segment net sales increased 16%. These increases were partially offset by an 85% decline in sales within All Other due to our exit from toy manufacturing operations.
Licensing segment net sales increased $211.2 million during 2007, mostly due to a $117.9 million increase in Joint Venture revenue related to the May 2007 release of Spider-Man 3. There was no merchandise licensing revenue recorded for Spider-Man 3 until the first quarter of 2007, when licensees were first permitted to begin exploiting merchandise relating to Spider-Man 3. In addition, $70.9 million of royalty and service fee revenue was recorded in 2007, associated with Hasbro’s sales to retailers, compared to $5.2 million in 2006, which represents the initial sales under the Hasbro license agreement during the fourth quarter of 2006. Licensing segment net sales also benefited during 2007 from $18.3 million received in settlements of audit claims, an unusually high amount, and a $4.0 million increase in overages revenue. Studio licensing revenue increased $5.8 million, principally due to revenues associated with the Spider-Man movie properties. The significant increase in Joint Venture revenue and royalty and service revenue from Hasbro caused 2007 Licensing segment net sales to increase as a percentage of consolidated net sales from 38% in 2006 to 71% in 2007.
Net sales from the Publishing segment increased $17.2 million to $125.7 million in 2007, primarily due to an increase of $10.0 million in sales of trade paperbacks and hard cover books and an increase of $3.9 million in comic book sales. The increase in trade paperbacks and hard covers is attributable to an increase in the sale of Civil War and Dark Tower trade paperbacks. The growth also reflects an increase in trade titles published. Comic book sales in 2007 benefited from strong unit sales of the final two comic-book issues of the Civil War series; The Death of Captain America; the Stephen King series, Dark Tower: The Gunslinger Born; and the World War Hulk series. Custom publishing also increased $2.3 million due to an increase in the scale and number of projects. Although Publishing segment net sales increased from 2006 to 2007, because of the larger relative increases in Licensing segment net sales, Publishing segment net sales decreased as a percentage of consolidated net sales from 31% in 2006 to 26% in 2007.
Net sales included in All Other represent our former toy manufacturing operations. Net sales related to these operations in 2007 were principally sales of licensed-in properties manufactured by us, and in 2006, were principally sales of Marvel character-based toys manufactured by us.

 

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Cost of Revenues
                                 
    Years ended December 31,  
    2007     2006  
            % of Net             % of Net  
            Segment             Segment  
    Amount     Sales     Amount     Sales  
    (dollars in millions)  
 
                               
Licensing
  $       N/A     $       N/A  
Publishing
    52.2       42 %     47.2       44 %
All Other
    8.7       53 %     56.4       51 %
 
                           
Total
  $ 60.9       13 %   $ 103.6       29 %
 
                           
Consolidated cost of revenues decreased $42.7 million to $60.9 million during 2007 compared with 2006, primarily due to the reduction of toy-production costs resulting from our cessation of the manufacture and sale of Marvel-branded toys. Consequently, our consolidated cost of revenues as a percentage of sales decreased to 13% during 2007, as compared to 29% in 2006.
Publishing segment cost of revenues as a percentage of Publishing segment net sales decreased from 44% during 2006 to 42% during 2007. Rising costs of talent, ink and paper in 2007 were absorbed by higher unit sales of comic and trade books. In addition, larger print runs in 2007 resulted in lower unit costs and generated higher margins. The increase in cost of revenue of $5.0 million is primarily associated with increased sales.
Cost of revenues included in All Other primarily consisted of our former toy production activities. These cost of revenues consisted of product and package manufacturing, shipping and buying agents’ commissions. The most significant portion of these cost of revenues was product and package manufacturing. The decrease in these cost of revenues from $56.4 million in 2006 to $8.7 million in 2007 reflected the elimination of manufacturing costs to produce Marvel-branded toys.
Selling, General and Administrative Expenses
                                 
    Years ended December 31,  
    2007     2006  
            % of Net             % of Net  
            Segment             Segment  
    Amount     Sales     Amount     Sales  
    (dollars in millions)  
 
                               
Licensing
  $ 87.3       25 %   $ 49.9       38 %
Publishing
    19.9       16 %     17.2       16 %
Film Production
    8.7       N/A       6.0       N/A  
All Other
    31.2       N/A       50.0       N/A  
 
                           
Total
  $ 147.1       30 %   $ 123.1       35 %
 
                           
Consolidated SG&A expenses of $147.1 million in 2007 were $24.0 million greater than SG&A expenses in 2006, primarily due to increases in the Licensing segment. Consolidated SG&A as a percentage of net sales decreased to 30% in 2007 from 35% during 2006, primarily due to the significant increase in Joint Venture Licensing segment net sales.

 

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Licensing segment SG&A expenses in 2007 reflected increases of $10.0 million in royalties payable to movie studios, $7.2 million in agents’ foreign sales commissions and $11.8 million in royalties payable to actors for use of their likeness in licensed products. There were also increases in connection with licensing promotion expense related to the Joint Venture and increased professional fees as we pursued audits of our licensees. In addition, during 2007, we recorded a non-recurring charge of $4.7 million related to a contractual obligation. As a percentage of Licensing segment net sales, Licensing segment SG&A decreased significantly from 38% to 25%. This resulted from the significant increase in licensing revenue derived from the activities of the Joint Venture, of which Sony Pictures’ share is reflected as minority interest expense rather than SG&A.
Publishing segment SG&A expenses increased $2.7 million during 2007 over 2006, principally due to increased employee compensation and increased distribution fees associated with increased sales. Publishing segment SG&A expenses as a percentage of Publishing segment net sales during 2007 remained consistent with the percentage in 2006.
The $2.7 million increase in Film Production SG&A expenses in 2007 compared to 2006 reflects the ramp-up of our film production business, which was partially offset by the capitalization of overhead costs related to The Incredible Hulk and Iron Man film productions aggregating $1.0 million during 2007.
SG&A expenses included in All Other for 2007 decreased $18.8 million over 2006, principally reflecting a $18.1 million decline in the SG&A of our former toy manufacturing activities, from $27.3 million in 2006 to $9.2 million in 2007. This decrease was principally the result of the establishment of additional reserves in 2006 for estimated uncollectible amounts due from Toy Biz Worldwide, Ltd. (“TBW”) in the amount of $2.6 million, which were reduced by $1.4 million in 2007 upon settling with TBW. This caused a decrease of $4.0 million in SG&A in 2007 compared with the prior year. As a result of the shift to Hasbro , SG&A of our former toy manufacturing activities also declined due to decreases in general selling expenses of $3.1 million, royalties payable to studios of $3.7 million and payroll of $5.3 million. Decreases related to corporate overhead were primarily due to a non-recurring credit in 2007 associated with pension accounting for the Fleer/Skybox International Retirement Plan and a $0.4 million decrease in consulting and payroll related expenses. This was partially offset by a $1.8 million increase in legal fees.
Depreciation and Amortization
Depreciation and amortization expense decreased $8.3 million to $6.0 million in 2007 (from $14.3 million in 2006) as a result of decreased tooling costs due to the cessation of our production of Marvel-branded toys.
We account for our goodwill under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Accordingly, goodwill is not amortized but is subject to annual impairment tests. Our most recent annual impairment review did not result in an impairment charge.
Other Income
Other income increased $0.8 million to $2.6 million in 2007 (from $1.8 million in 2006). During 2007, other income primarily resulted from $2.1 million in realized gains generated from forward contracts entered into during 2007 to mitigate our risk of fluctuations in the Canadian dollar related to the Canadian filming of The Incredible Hulk. Other income also benefited from $0.6 million in sales of fully depreciated tooling used by our former Toy segment. These increases were partially offset by a $0.9 million decrease in the fair value of the interest rate cap associated with the film facility.
During 2006, other income consisted principally of $1.6 million of non-recurring income resulting from payments received for our agreement to vacate leased property earlier than provided for in a lease and our agreement to allow our tenant to vacate property earlier than provided for in its lease and $0.8 million in sales of fully depreciated tooling used by our former Toy segment. These increases were offset by a $1.5 million decrease in the fair value of the interest rate cap associated with the film facility.

 

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Operating Income
                                 
    Years ended December 31,  
    2007     2006  
    Amount     Margin     Amount     Margin  
    (dollars in millions)  
 
                               
Licensing
  $ 255.5       74 %   $ 82.1       62 %
Publishing
    53.5       43 %     44.1       41 %
Film Production
    (7.5 )     N/A       (7.5 )     N/A  
All Other
    (27.1 )     N/A       (6.1 )     N/A  
 
                           
Total
  $ 274.4       56 %   $ 112.6       32 %
 
                           
Consolidated operating income increased $161.8 million to $274.4 million during 2007, primarily due to a $211.2 million increase in net sales from the Licensing segment, which generates the highest margins. This increase was partially offset by an 85% decline in sales within All Other due to our exit from toy manufacturing operations. This also caused consolidated operating margins to increase significantly, from 32% during 2006 to 56% during 2007.
Operating income in the Licensing segment increased $173.4 million, which caused operating margins to increase from 62% to 74%, primarily due to the increase in merchandise licensing revenue from the Joint Venture. The margins of Joint Venture merchandise licensing are higher than most other merchandise licensing because Sony Pictures’ share of the Joint Venture’s operating results is classified as minority interest expense, whereas other studios’ shares of license royalty income is recorded within SG&A expense.
Operating income in the Publishing segment increased $9.4 million and margins improved from 41% in 2006 to 43% in 2007 due to the increase in net sales volume with improved gross margins resulting from larger print runs of more successful titles.
During 2007, the Film Production operating loss reflects the SG&A costs noted above and a charge of $0.9 million for the decrease in the fair value of the interest rate cap associated with our film facility, offset by a $2.1 million increase in the fair value of forward contracts for the Canadian dollar. The forward contracts were entered into during 2007 in connection with the production of The Incredible Hulk. During 2006, the Film Production operating loss reflects the SG&A costs noted above and a charge of $1.5 million for the decrease in the fair value of the interest rate cap.
All Other operating costs primarily represent corporate overhead expenses, and the operating loss of our former toy manufacturing operations of $4.7 million in 2007 and the operating income for these operations of $16.6 million in 2006. The $21.0 million increase in operating costs is the result of the $21.3 million decrease in the operating income of our former toy manufacturing operations.
Interest Expense
                 
    Years ended December 31,  
    2007     2006  
    (dollars in millions)  
 
               
Interest incurred, HSBC line of credit
  $ 0.1     $ 2.4  
Interest incurred, film facilities
    22.1       13.0  
 
           
Total Interest incurred
    22.2       15.4  
Less: Interest capitalized
    (8.4 )     (0.2 )
 
           
Total
  $ 13.8     $ 15.2  
 
           

 

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From 2006 to 2007, there was a $6.8 million increase for interest we incurred. The increase was primarily the result of borrowings for the movie productions Iron Man (beginning in the first quarter of 2007) and The Incredible Hulk (beginning in the second quarter of 2007), offset by a decrease in our short-term borrowings under our HSBC line of credit to finance repurchases of our common stock. During 2007, $8.4 million of interest cost related to movie production borrowings was capitalized into film inventory, an increase of $8.2 million over the 2006 amount. This led to a $1.4 million net reduction in interest expense from 2006 to 2007.
Interest Income
Interest income reflects amounts earned on our cash equivalents and short-term investments. Interest income increased $1.1 million to $2.6 million in 2007 as compared to 2006, due to higher levels of cash equivalents and short-term investments in 2007 than in 2006.
Income Taxes
Our annual effective tax rate differs from the federal statutory rate due to the effects of state and local taxes and elimination of the minority share of Joint Venture earnings from reported income before income tax expense. Our effective tax rates for the years ended December 31, 2007 and 2006 were 37.6% and 39.5%, respectively. The 1.9% reduction in the effective tax rate was principally caused by higher Joint Venture income, partially offset by state and local income taxes.
As of December 31, 2007, we retained various state and local net operating loss carryforwards of $354 million. As of December 31, 2007, there was a valuation allowance of $1.2 million against capital loss carryforwards and state and foreign net operating loss carryforwards.
Minority Interest
Minority interest expense, related to the Joint Venture, amounted to $24.5 million in 2007 and $1.0 million in 2006. This increase of $23.5 million reflects the increased operations from licensing associated with the Spider-Man films, the most recent of which was the May 2007 release of Spider-Man 3.
Earnings per Share
Diluted earnings per share increased to $1.70 in 2007 from $0.67 in 2006 reflecting a 138% increase in net income and a 5.5% reduction in the weighted average number of shares outstanding due to the effect of treasury share repurchases (8.5 million shares acquired in 2007).
Liquidity and Capital Resources
Our primary sources of liquidity are cash, cash equivalents, cash flows from operations, our film credit facilities and the HSBC line of credit, described below. We anticipate that our primary uses for liquidity will be to conduct our business, including our obligation to fund 33% of the budget of each of our prospective self-produced films commencing with Iron Man 2 and Thor in 2009, and to repurchase our common stock.
During 2008, our cash and cash equivalents increased by $75.2 million as a result of the $181.3 million of net cash provided by operating activities, which represents an increase of $187.9 million over the $6.6 million of cash used in operating activities during 2007. The increase is principally the result of strong cash collections from our Licensing segment and a $197.9 million reduction in film expenditures in 2008 over 2007. Our film-production expenditures, including expenditures funded by draw-downs from our film facilities, appear on our accompanying consolidated statements of cash flows as cash used in operating activities. The related draw-downs appear on our accompanying consolidated statements of cash flows as cash provided by financing activities.

 

34



 

Our working capital deficiency decreased $82.2 million from $108.5 million at December 31, 2007 to $26.3 million at December 31, 2008, primarily reflecting a $115.8 million increase in accounts receivable, which primarily relates to fourth quarter Iron Man revenue that we received from our distributor in February 2009, and the $181.3 million of cash generated through operations noted above. These improvements in working capital were partially offset by the repurchase of $60 million of long-term mezzanine debt using cash from operations and a $162.5 million increase in short-term borrowings principally representing the amount of borrowings under our film facility that we estimate to be repaid over the twelve-month period beginning on January 1, 2009.
Net cash flows used in investing activities for the year ended December 31, 2008 reflects the use of restricted cash to fund production expenses and distribute cash to our Joint Venture partner, and the purchase of short-term investments using cash from operations. Cash equivalents at December 31, 2008 consist principally of U.S. Treasury Bills and short-term bank CD’s (covered by the U.S. Government’s Temporary Liquidity Guarantee Program). Net cash flows used in investing activities for the year ended December 31, 2007 reflect the purchase of short-term investments using our excess cash and the use of restricted cash to fund production expenses and obligations under the film facility.
Net cash used in financing activities during the year ended December 31, 2008 reflects $180.5 million in repayments of our film facility borrowings, including our repurchase of all $60.0 million of long-term mezzanine debt for $58.1 million using cash from operations, partially offset by $106.3 million in borrowings under our film facility during that period. In addition, we repurchased 0.4 million shares of our common stock at a cost of $10.5 million. During the year ended December 31, 2007, we repurchased 8.5 million shares of our common stock at a cost of $212.0 million. Repurchases were financed through cash generated from operations. At December 31, 2008, the remaining amount authorized and available for stock repurchases was $127.7 million.
MVL Film Finance LLC maintains a $525 million credit facility for producing theatrical motion pictures based on our characters. MVL Film Finance LLC’s ability to borrow under the film facility expires on September 1, 2012. The film facility expires on September 1, 2016, subject to extension by up to ten months under certain circumstances. The expiration date and final date for borrowings under the film facility occur sooner if the films produced under the facility fail to meet certain defined performance measures. The film facility consists of $465 million in revolving senior bank debt and $60 million in mezzanine debt, which is subordinated to the senior bank debt and, as discussed below, was repurchased by us. Both Standard & Poor’s, a division of the McGraw-Hill Companies, Inc., and Moody’s Investor Rating Service, Inc. have given the senior bank debt investment grade ratings. In addition, Ambac Assurance Corporation has insured repayment of the senior bank debt. In exchange for the repayment insurance, we pay Ambac a fee calculated as a percentage of senior bank debt, but in no event less than $3.4 million per year. The interest rates for outstanding senior bank debt, and the fees payable on unused senior bank debt capacity, both described below, include the percentage fee owed to Ambac (assuming the minimum has been reached). During 2008, our wholly-owned subsidiary, MVL International C.V. repurchased all $60 million of the mezzanine debt for $58.1 million. The mezzanine debt remains outstanding and MVL International C.V. receives the interest payments made by MVL Film Finance LLC with respect to this debt. The interest expense and interest income related to the mezzanine debt are therefore eliminated in our consolidated results and our consolidated financial position does not include the mezzanine debt.
All future interest payable under the film facility must now be paid from the films’ net collections, rather than from any of our other sources of cash. Effective December 31, 2008, the film facility requires us to maintain a liquidity reserve of $25 million, included in restricted cash, to cover future interest payments in the event that the films’ net collections are not sufficient to make these payments. If we do not release a film in 2010, 2011 and 2012 or our sixth film under the facility by August 26, 2012, the liquidity reserve requirement will be increased to $45 million.
The film facility also requires us to maintain an interest reserve equal to the subsequent quarter’s estimated interest. As of December 31, 2008, this reserve was $6.4 million, and is included in restricted cash.
In February 2009, we repaid $109 million of our film facility debt using net collections from Iron Man.

 

35



 

The interest rate for the mezzanine debt is LIBOR plus 7.0%. As noted above, we repurchased the mezzanine debt and, accordingly, interest expense, from the dates of repurchase, related to the mezzanine debt is not reflected in our consolidated operating results.
The interest rate for outstanding senior bank debt is currently LIBOR (1.43% at December 31, 2008) or the commercial paper rate, as applicable, plus 2.935%. The LIBOR rate on our outstanding senior bank debt resets to the quoted LIBOR rate two business days preceding the commencement of each calendar quarter. The commercial paper rate resets periodically depending on how often our lenders issue commercial paper to fund their portion of our outstanding debt. The weighted average interest rate of our senior bank debt was 5.78% at December 31, 2008.
The film facility requires us to pay a fee on any senior bank debt capacity that we are not using. This fee is currently 0.90%, and is applied on $465 million reduced by the amount of any outstanding senior bank debt.
In June 2008, Ambac’s rating was downgraded by S&P from AAA to AA. The downgrade caused an increase of 1.30% in our interest rate for outstanding senior bank debt and an increase of 0.30% in the fee payable on our unused senior bank debt capacity. These increases are reflected in the rates noted above. Any further downgrades of Ambac’s rating, such as the one by Moody’s on November 5, 2008 (to Baa1), do not affect our rate of interest or fees under the film facility.
If the senior bank debt’s rating (without giving effect to Ambac’s insurance) by either S&P or Moody’s were to fall below investment grade, the interest rate for the outstanding senior bank debt would increase by up to an additional 0.815%. In addition, if the ratio of our indebtedness, excluding the film facility, to our total capital, defined as our consolidated equity plus indebtedness excluding film facility indebtedness, were to exceed 0.4 to 1.0, then the interest rate for outstanding senior bank debt could increase by up to an additional 0.50%. In light of recent adverse developments in the credit markets, we have assessed the economic impact on our film production activities from the actual and potential increases in interest rates described above. We do not believe the actual or potential impact from these rate increases to be material.
The film facility requires the maintenance of a minimum tangible net worth, a prospective cash coverage test, an historical cash coverage test and an asset coverage ratio, each measured quarterly, and compliance with various administrative covenants. We have maintained compliance with all required provisions of the film facility since its inception.
Until recently, we would also have been required, before our fifth film’s funding, either to obtain a cumulative, minimum budget percentage (33%) from our pre-sales of film distribution rights in Australia and New Zealand, Japan, Germany, France and Spain (the “Reserved Territories”), together with the proceeds of any government rebate, subsidy or tax incentive and any other source of co-financing, or to fund that budget percentage with our own cash (the “Pre-Sales Test”). The Pre-Sale Test has now been effectively subsumed by other terms of the film facility, as explained below. Future distribution in the Reserved Territories will be handled by Paramount, with limited exceptions.
The film facility requires us to fund 33% of the budget of each film distributed under the distribution agreement with Paramount that we entered into in the third quarter of 2008. The film facility will provide up to 67% of the budget (reduced by the proceeds of any co-financing). After deduction of Paramount’s distribution fees and expenses in the Reserved Territories, we will be entitled to recoup our 33% contribution from all film proceeds from the Reserved Territories. Our recoupment will be crossed among all films distributed under the distribution agreement with Paramount and among all Reserved Territories. After recoupment of our 33% contribution, all additional film proceeds from the Reserved Territories will be used to pay down borrowings under the film facility.
In January 2009, we repaid $16.3 of film facility borrowings with our own cash. That payment, combined with the pre-sales of distribution rights in the Reserved Territories and other co-financing proceeds for Iron Man and The Incredible Hulk, equals 33% of those films’ budgets. Because of the requirement that we fund 33% of future films, we therefore expect to be in compliance, without any further action on our part, with the Pre-Sale Test when it is first applied (upon funding of the fifth film) and at all relevant times thereafter.

 

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In the first quarter of 2009, we amended the film facility to allow us, at our option, to utilize a lower cost completion bond structure. In order to take advantage of this lower cost completion bond structure for a picture, we will need to escrow approximately $26 million ($31.5 million for Iron Man 2) for the duration of production. Upon completion of the film, the escrowed funds will be returned to us. However, the amount of escrowed funds returned to us will be reduced to the extent that the cost of the film exceeds 110% of its budget.
If one of the banks in our film facility’s lending consortium were to default in making a required funding and if we were unable to arrange for a replacement bank, the amount available to us under the film facility would drop by the amount of the defaulting bank’s unused commitment and our film productions could be disrupted as a result.
We maintain a $100 million revolving line of credit with HSBC Bank USA, National Association (the “HSBC Line of Credit”) with a sub-limit for the issuance of letters of credit. The HSBC Line of Credit expires on March 31, 2010. Borrowings under the HSBC Line of Credit may be used for working capital and other general corporate purposes and for repurchases of our common stock. The HSBC Line of Credit contains customary event-of-default provisions and a default provision based on our market capitalization. We are in compliance with the covenants of the facility, which include net income, leverage and free cash flow, as of December 31, 2008 and continue to be in compliance. The HSBC Line of Credit is secured by a lien in (a) our accounts receivable, (b) our rights under our license with Hasbro and (c) all of our treasury stock repurchased by us after November 9, 2005. Borrowings under the HSBC Line of Credit bear interest at HSBC’s prime rate or, at our option, at LIBOR plus 1.25% per annum. As of December 31, 2008, we had no borrowings outstanding under the HSBC Line of Credit.
Our capital expenditures for the years ended December 31, 2008 and 2007 were $2.4 million and $2.7 million, respectively. We do not expect to have significant capital expenditures in 2009. Capital expenditures do not include film costs that we capitalize into film inventory.
In September 2008, we entered into a lease for the rental of sound stages where we intend to film our next four self-produced films, and for Marvel Studios’ new production and corporate office space, located in Manhattan Beach, California. The lease has an initial term of three years, with four successive one-year extension options. We anticipate making aggregate rental payments under this lease of approximately $14 million over the three-year period beginning January 1, 2009.
In February 2009, we repurchased 0.3 million shares of our common stock for $6.5 million.
We believe that our cash and cash equivalents, cash flows from operations, the film facilities, and the HSBC line of credit will be sufficient for us to conduct our business, including our obligation to fund 33% of the budget of each of our prospective self-produced films, and to make repurchases, if any, under our current stock repurchase program.
The following table sets forth our contractual obligations as of December 31, 2008:
                                         
    Payments Due By Period  
            Less than                     More Than  
Contractual Obligations   Total     1 Year     1-3 Years     3-5 Years     5 Years  
(Amounts in thousands)                              
Animated television production obligations
  $ 15,870     $ 15,359     $ 511     $     $  
Long-term debt obligations*
  $ 213,001     $ 204,800     $ 8,201              
Capital lease obligations
                             
Operating lease obligations
    21,242       7,381       13,452       409        
Licensed-in toy royalty obligations
    1,200       1,200                    
Other long-term liabilities reflected on the registrant’s balance sheet under GAAP
    6,710       1,000       2,000       1,850       1,860  
Expected pension benefit payments
    15,303       1,365       2,866       3,026       8,046  
 
                             
Total
  $ 273,326     $ 231,105     $ 27,030     $ 5,285     $ 9,906  
 
                             
     
*   Scheduled repayment based on the minimum expected term of the film facility. Such amount may be repaid earlier depending on the success of theatrical releases under the film facility.

 

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Our balance sheet includes $59.3 million of non-current tax reserves (including estimated interest and penalties of $5.5 million) for uncertain tax positions under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). However, it is not possible to predict or estimate the timing of payments for these obligations. We do not expect to make any significant payments for these uncertain tax positions within the next twelve months.
We believe that our financial condition is strong and that our cash balances, other liquid assets, operating cash flows, access to debt and equity capital markets and borrowing capacity, taken together, provide adequate resources to fund ongoing operating requirements and future capital expenditures related to the expansion of existing businesses and development of new projects. However, our operating cash flow and access to the capital markets can be affected by macroeconomic factors outside of our control. See “Item 1A — Risk Factors”. In addition to macroeconomic factors, our borrowing costs can be affected by short and long-term debt ratings assigned by independent rating agencies, which are based, in significant part, on our performance as measured by certain financial covenants in our debt arrangements discussed above.
Critical Accounting Policies and Estimates
General
Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We review the accounting policies used by us in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates. Our estimates include amounts related to the estimate of ultimate revenues for each of our films, the realizability of film inventory, valuation allowances for deferred income tax assets, reserves for uncertain tax positions, character allocation in computing studio share of royalties payable, the reserve for uncollected minimum royalty guarantees, provisions for returns, pension plan assumptions, the realizability of goodwill, the realizability of inventories, other sales allowances and doubtful accounts, depreciation and amortization periods for equipment, litigation related accruals, and forfeiture rates related to employee stock compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis and by the Audit Committee at the end of each quarter prior to the public release of our financial results. Management believes that the following critical accounting policies affect its more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Book Sales, Sales Returns and Customer Allowances
Trade paperback and hardcover book sales, returnable comic books and custom publishing, are recorded when title and risk of ownership have passed to the buyer. Provisions for future returns and other sales allowances are established based upon historical experience, adjusting for current economic and other factors affecting the customer. We regularly review and revise, when considered necessary, our estimates of sales returns based primarily upon actual returns, and estimated sell-through at the retail level. No provision for sales returns is provided when the terms of the underlying sales do not permit the customer to return product to us. Return rates for returnable comic book sales, traditionally sold at newsstands and bookstores, are typically higher than those related to trade paperback and hardcover book sales.

 

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Comic book revenues — non-returnable and other
Sales of comic books to the direct market, our largest channel of comic book distribution, are made on a non-returnable basis and related revenues are recognized in the period the comic books are made available for sale (on-sale date established by us). Revenue from advertising in our comic books is also recognized in the period that the comic books are made available for sale. Subscription revenues related to our comic book business are generally collected in advance for a one-year subscription and are recognized as income on a pro rata basis over the subscription period as the comic books are delivered.
License Revenues
Revenue from licensing our characters is recorded in accordance with guidance provided in Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition” (an amendment of Staff Accounting Bulletin No. 101 “Revenue Recognition”) (“SAB 104”). Under the SAB 104 guidelines, revenue is recognized when the earnings process is complete. This is considered to have occurred when persuasive evidence of an agreement between us and the customer exists, when the characters are freely and immediately exploitable by the licensee and we have satisfied our obligations under the agreement, when the amount of revenue is fixed or determinable and when collection of unpaid revenue amounts is reasonably assured.
For licenses that contain non-refundable minimum payment obligations to us, we recognize such non-refundable minimum payments as revenue at the inception of the license, prior to the collection of all amounts ultimately due, provided all the criteria for revenue recognition under SAB 104 have been met. Receivables from licensees due more than one year beyond the balance sheet date are discounted to their present value.
The earnings process is not complete if, among other things, we have significant continuing involvement under the license, we have placed restrictions on the licensee’s ability to exploit the rights conveyed under the contract or we owe a performance obligation to the licensee. In the case where we have significant continuing involvement or where any restrictions remain on the licensee’s rights (e.g., no sales of products based on a specific character allowed until a future date), we recognize revenue as the licensee reports its sales and corresponding royalty obligation to us. Where we have a performance obligation, minimum royalty collections are not recognized until our performance obligation has been satisfied. Minimum payments collected in advance of recognition are recorded as deferred revenue. In any case where we are unable to determine that the licensee is sufficiently creditworthy, we recognize revenue only to the extent of cash collections. When cumulative reported royalties exceed the minimum royalty payments, the excess royalties are recorded as revenue when collected and are referred to as “overages”.
As discussed above, beginning in 2008, revenues earned from Hasbro, and related expenses, are included in our Licensing segment.
Revenues related to the licensing of animation are recognized when persuasive evidence of a sale or licensing arrangement with a customer exists, when an episode is delivered in accordance with the terms of the arrangement, when the license period of the arrangement has begun and the customer can begin its exhibition, when the arrangement fee is fixed or determinable, and when collection of the arrangement fee is reasonably assured.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In evaluating the collectibility of accounts receivable, we consider a number of factors, including the age of the accounts, changes in status of the customers’ financial condition and other relevant factors. Estimates of uncollectible amounts are revised each period, and changes are recorded in the period they become known.

 

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Excess and Obsolete Inventory
We write down excess and obsolete inventory to its estimated realizable value based upon assumptions about future product demand, consumer trends, the success of related feature films, the availability of alternate distribution channels and overall market conditions. If actual product demands, consumer trends and market conditions are less favorable than those projected by us, additional inventory write-downs could be required.
Fixed Assets
Fixed assets are stated at cost less accumulated depreciation and amortization. For financial reporting purposes, depreciation and amortization is computed using the straight-line method generally over a three to five-year life for furniture and fixtures and office equipment, and over the shorter of the life of the underlying lease or estimated useful life for leasehold improvements. Expenditures for major software purchases and software developed for internal use are capitalized and depreciated using the straight-line method over the estimated useful lives of the related assets, which is generally 3 years. For software developed for internal use, all external direct costs for materials and services are capitalized in accordance with AICPA Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Total capitalized internal use software costs were $5.5 million and $3.5 million at December 31, 2008 and 2007, respectively. Accumulated depreciation and amortization for fixed assets was $4.7 million and $3.2 million at December 31, 2008 and 2007, respectively, of which $3.0 million and $2.0 million related to internal use software. Amortization expense for internal use software was $1.0 million, $1.0 million and $0.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
Film Production Operations
Film Inventory
In general, we are responsible for all of the costs of developing and producing our feature films. The film’s distributor is responsible for the out-of-pocket costs, charges and expenses (including contingent compensation and residual costs, to a defined limit) incurred in the distribution, manufacturing, printing and advertising, marketing, publicizing and promotion of the film in all media (referred to in the aggregate as the distributor’s costs). The distributor’s costs are not included in film inventory.
We account for our film inventory under the guidance provided by AICPA Statement of Position 00-2, “Accounting by Producers or Distributors of Films” (“SOP 00-2”). We capitalize all direct film production costs, such as labor costs, visual effects and set construction. Those capitalized costs, along with capitalized production overhead and capitalized interest costs, appear on our balance sheet as an asset called film inventory. Production overhead includes allocable costs, including cash and stock compensation and benefits, of individuals or departments with exclusive or significant responsibility for the production of films. Capitalization of production overhead and interest costs commences upon completion of the requirements for funding the production under the film facility and ceases upon completion of the production. In 2008, 2007 and 2006, we capitalized interest costs of $5.1 million, $8.4 million and $0.2 million, respectively and those amounts were included in film inventory.
We also capitalize the costs of projects in development into film inventory. Those costs consist primarily of script development. In the event that a film does not begin pre-production within three years from the time of the first capitalized transaction, or if an earlier decision is made to abandon the project, all capitalized costs related to these projects are expensed. During 2008 and 2007, $1.7 and $1.3 million, respectively, of film development costs were written off and included in selling, general and administrative expenses in the accompanying consolidated statements of net income.

 

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Once a film is released, using the individual-film-forecast computation method, the amount of film inventory relating to that film is amortized and included in each period’s costs of revenue in the proportion that the film’s revenue during the period bears to the film’s then-estimated total revenue, net of the distributor’s costs, over a period not to exceed ten years (ultimate revenues). Estimates of ultimate revenues for each film are regularly reviewed and revised as necessary based on the latest available information. Reductions in those revenue estimates could result in the write-off, or the acceleration of the amortization, of film inventory in that reporting period; increases in those revenue estimates could result in reduced amortization in that period.
As of December 31, 2008, our Film Production segment had film inventory, net of amortization, of $181.6 million, primarily for the Iron Man and The Incredible Hulk productions.
Film Revenue
The amount of revenue recognized from our films in any given period depends on the timing, accuracy and sufficiency of the information we receive from our distributors.
After remitting to us five percent of the film’s gross receipts, the distributor is entitled to retain a fee based upon the film’s gross receipts and to recoup all of its costs on a film-by-film basis prior to our receiving any additional share of film receipts. Any of the distributor’s costs for a film that are not recouped against receipts for that film are borne by the distributor. Our share of the film’s receipts, as described above, is recognized as revenue when reported due to us by the distributor. We have also received minimum guarantees from local distributors in five territories. In those territories, we began to recognize revenue when the film was made available for exhibition in theaters.
Revenue from the sale of home video units is recognized when our distributors report as due to us the home video sale proceeds that they have collected from retailers. We provide for future mark-downs and returns of home entertainment product at the time the related revenue is recognized, using estimates. Our estimates are calculated by analyzing a combination of our distributors’ historical returns and mark-down practices, our distributors’ estimates of returns of our home video units, current economic trends, projections of consumer demand for our home video units and point-of-sale data available from retailers. We periodically review our estimates using the latest information available.
Revenue from both free and pay television licensing agreements is recognized at the time the production is made available for exhibition in those markets.
Goodwill
We have significant goodwill on our balance sheet, which resulted from the acquisition of Marvel Entertainment Group, Inc. in 1998. Goodwill is accounted for under the guidance provided by Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible Assets” (“SFAS 142”). As required by SFAS 142, goodwill is allocated to various operating segments (see Note 11).
To determine if there is potential goodwill impairment, SFAS 142 requires us to compare the fair value of each of our reporting units (which are our operating segments) to its carrying amount on an annual basis. To determine the fair value of our reporting units, we generally use a present value technique (forecasted discounted cash flow) corroborated by market multiples when available and as appropriate. If the fair value of our reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than the carrying value of its goodwill. As of December 31, 2008, our goodwill was not impaired.
Long-Lived Assets
We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets.

 

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Studio and Talent Share of Royalties
We share merchandise licensing revenues with movie studio licensees for Marvel characters portrayed in theatrical releases. Typically, the studio is paid up to 50% of the total license income derived from licensing for a specific character, in most cases net of a distribution fee retained by us, and in some instances with adjustments for characters that have generated sales prior to the theatrical release. In accounting for amounts payable to studios under multi-character licensing agreements, we make an initial estimate of how minimum guarantees recognized as revenue will be shared among the various studios. This estimate is subsequently adjusted based on actual royalties reported to us by our licensees. We also share merchandise licensing revenue with talent for the use of their likeness in licensed products. We accrue our obligation to talent based upon the talent’s contractual participation rate. In the case of licensed films, we depend on the licensee to provide that information to us. In 2008, 2007 and 2006, we provided for $27.2 million, $42.8 million and $23.6 million, respectively, for the share of royalties due to movie studios and talent. The 2008 expense reflects an $8.3 million reduction to our estimate of royalties payable to talent.
Accounting for Joint Venture
The operations of the Joint Venture have been consolidated in our consolidated financial statements, including revenues of $57.4 million, $122.0 million and $4.1 million for the years ended December 31, 2008, 2007 and 2006, respectively. The Joint Venture distributes to us and to Sony Pictures all cash received, proportionate to each party’s interest, on at least a quarterly basis. At December 31, 2008, advances to joint venture partner of $0.9 million reflects distributions made to Sony Pictures in connection with cash received by the Joint Venture from minimum royalty advances on Spider-Man 4 licensing contracts for which the Joint Venture has not yet recognized revenue and earnings thereon. These advances or payments due are classified as current or non-current consistent with the classification of deferred revenue related to such advances, which is based on when the underlying deferred revenue is scheduled to be recognized. At December 31, 2007, we had $0.6 million in minority interest distributions due to Sony Pictures.
Pension
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and recognize changes in the funded status in the year in which the changes occur. SFAS 158 also eliminates the option to use an early measurement date effective for fiscal years ending after December 15, 2008. We adopted the recognition provisions of SFAS 158 effective December 31, 2006 and early adopted the measurement provision in the first quarter of 2007. The impact of this adoption was minimal as a result of our already reporting our unfunded obligation related to the Fleer/Skybox Plan (as defined in Note 10), a frozen plan, as a liability in the statement of financial position.
Accounting for Stock-Based Compensation
We account for stock-based compensation cost under the provisions SFAS No. 123(R) “Share-Based Payment” (“SFAS 123R”), which establishes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS 123R, stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant). SFAS No. 123R also requires the related excess tax benefit received upon exercise of stock options or vesting of restricted stock, to be reflected in the statement of cash flows as a financing activity rather than an operating activity. In connection with the implementation of SFAS No. 123R, we elected the short-cut method in determining our additional paid-in capital pool of windfall benefits and the graded vesting method to amortize compensation expense over the service period.

 

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We did not grant any stock option awards during 2008, 2007 or 2006. As of December 31, 2007, all of our issued stock options have vested and, accordingly, we have no remaining unrecognized compensation cost related to nonvested stock option awards. During the years ended December 31, 2007 and 2006, we recognized $2.3 million and $5.9 million, respectively, of compensation expense associated with previously granted stock options, which was classified in selling, general and administrative expense. The charge for the years ended December 31, 2007 and 2006, net of income tax benefit of $0.9 million and $2.3 million, respectively, has reduced basic and diluted earnings per share by $0.02 and $0.04, respectively. The tax benefit realized from stock-based compensation totaled $8.7 million, $2.5 million and $64.8 million (due to higher than usual stock option exercises) for the years ended December 31, 2008, 2007 and 2006, respectively.
We used the Black-Scholes option pricing model to value the compensation expense associated with our stock option awards under SFAS 123R. In addition, we estimated forfeitures when recognizing compensation expense associated with our stock options, and adjusted our estimate of forfeitures when they were expected to differ. Key input assumptions used to estimate the fair value of stock options included the market value of the underlying shares at the date of grant, the exercise price of the award, the expected option term, the expected volatility (based on historical volatility) of our stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and our expected annual dividend yield.
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, the option valuation model requires the input of highly subjective assumptions. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing model does not necessarily provide a reliable measure of the fair value of our employee stock options.
Commitments and Contingencies
Legal Matters
On January 26, 2009, in the United States District Court for the Southern District of New York, four purported shareholders of Stan Lee Media, Inc. (“SLM”), individually and on behalf of all SLM shareholders, filed a derivative action against Marvel, Isaac Perlmutter (our President and Chief Executive Officer), Avi Arad (a former officer and director), Stan Lee, Joan C. Lee, Joan Lee and Arthur Lieberman. The complaint alleges that SLM is the owner of rights in characters co-created by Mr. Lee while he was employed by our predecessors, the Marvel name and trademark, and Mr. Lee’s name and likeness (collectively, the “Intellectual Property”). The plaintiffs allege that prior to the date Mr. Lee entered into a new employment agreement with us in 1998, Mr. Lee transferred his interest in the Intellectual Property to a predecessor of SLM. Mr. Lee has denied that he had any ownership interest in the Intellectual Property and that any transfer of those rights to SLM ever took place. The complaint in the plaintiffs’ lawsuit also alleges that all defendants committed fraud, were involved in a conspiracy to deprive SLM of its ownership of the Intellectual Property, wrongfully failed to disclose the terms of a 2005 settlement of litigation brought against Marvel by Mr. Lee and wrongfully exploited claimed rights of SLM in the Intellectual Property. The relief sought by the complaint includes a declaration of SLM’s rights in the Intellectual Property, compensatory and punitive damages of $750 million based on alleged breaches of fiduciary duty, unspecified damages for fraud, inducing a breach of fiduciary duty and civil conspiracy, an accounting of profits and the imposition of a constructive trust, unspecified treble damages for violations of SLM’s Lanham Act rights, SLM’s rights of publicity and for unfair business practices. We believe all claims in the complaint are without merit.
On March 30, 2007, in the United States District Court for the Southern District of Illinois, Gary Friedrich and Gary Friedrich Enterprises, Inc. (“Friedrich”) filed a lawsuit against us, and numerous other defendants including Sony Pictures Entertainment, Inc., Columbia Pictures Industries, Inc., Hasbro, Inc. and Take-Two Interactive Software, Inc. That suit has been transferred to the Southern District of New York. The complaint alleges that Friedrich is the owner of intellectual property rights in the character Ghost Rider and that we and other defendants have exploited the Ghost Rider character in a motion picture and merchandise without Friedrich’s consent. Friedrich has asserted numerous claims including copyright infringement, negligence, waste, state law misappropriation, conversion, trespass to chattels, unjust enrichment, tortious interference with right of publicity, and for an accounting. We believe Friedrich’s claims to be without merit.

 

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We are also involved in various other legal proceedings and claims incident to the normal conduct of our business. Although it is impossible to predict the outcome of any legal proceeding and there can be no assurances, we believe that our legal proceedings and claims, individually and in the aggregate, are not likely to have a material adverse effect on our financial condition, results of operations or cash flows.
We regularly evaluate our litigation claims to provide assurance that all losses and disclosures are provided for in accordance with SFAS No. 5 “Accounting for Contingencies” (“SFAS 5”). Our evaluation of legal matters involves considerable judgment by us. We engage internal and outside legal counsel to assist in the evaluation of these matters. Accruals for estimated losses, if any, are determined in accordance with the guidance provided by SFAS 5.
Income Taxes
We use the liability method of accounting for income taxes as prescribed by Financial Accounting Standard No. 109, Accounting for Income Taxes (SFAS 109). Under this method, income tax expense is based on reported income before income taxes, and deferred income taxes are recorded as a result of temporary differences between the amounts of assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes, measured using enacted tax rates and laws that are expected to be in effect when the differences reverse.
Income tax expense includes U.S. federal, state and local, and foreign income taxes, including U.S. federal taxes on undistributed earnings of foreign subsidiaries to the extent that such earnings are not permanently reinvested.
We are not responsible for the income taxes related to the minority share of the Joint Venture’s earnings. The tax liability associated with the minority share of the Joint Venture’s earnings is therefore not reported in our income tax expense, even though all of the Joint Venture’s revenues and expenses are consolidated in our reported income before income tax expense. Joint Venture earnings therefore have the effect of lowering our effective tax rate. This effect is more pronounced in periods in which Joint Venture earnings are higher relative to our other earnings.
We consider future taxable income and potential tax planning strategies in assessing the potential need for valuation allowances against deferred tax assets. If actual results differ from estimates or if we adjust these assumptions in the future, we may need to adjust our deferred tax assets or liabilities, which could impact our effective tax rate in future periods.
On January 1, 2007, we adopted the provisions of FIN 48, which clarifies accounting for uncertain income tax positions. This interpretation requires us to recognize in the consolidated financial statements only those tax positions we determine to be more likely than not of being sustainable upon examination, based on the technical merits of the positions, under the presumption that the taxing authorities have full knowledge of all relevant facts (see Note 8). The determination of which tax positions are more likely than not sustainable requires us to use significant judgments and estimates, which may or may not be borne out by actual results.

 

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Recent Accounting Standards Adopted in 2008
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a common definition for fair value to be applied to GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS 157 is effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007. FSP FAS No. 157-2 “Partial Deferral of the Effective Date of Statement 157” (“FSP 157-2”), deferred the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. We do not expect the adoption of FSP 157-2 to have a material impact on our consolidated financial statements. In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS 157 when the market for a financial asset is not active. FSP 157-3 was effective upon issuance, including reporting for prior periods for which financial statements have not been issued. The adoption of FSP 157-3 for reporting as of December 31, 2008 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 became effective for the fiscal year beginning January 1, 2008. We did not elect the fair value option for any items under SFAS 159.
Recent Accounting Standards Not Yet Adopted
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, the goodwill acquired and any noncontrolling interest in the acquiree. This statement also establishes disclosure requirements to enable the evaluation of the nature and financial effect of the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008. We do not expect the adoption of this statement to have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. We do not expect the adoption of this statement to have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 expands quarterly disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We do not expect the adoption of this statement to have a material impact on disclosures in our consolidated financial statements.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we hold bank deposits denominated in various currencies, which subjects us to currency rate fluctuation risk. A substantial portion of our international licenses are denominated in U.S. dollars, which insulates us from currency rate fluctuation risk on the minimum payments under those licenses. Currency fluctuations do affect, however, the value in U.S. dollars of sales of underlying licensed products in local currencies and therefore affect the rate at which minimum guarantees are earned out and the extent to which we receive overages on those licenses. Further, our international licenses that are denominated in foreign currencies subject us to currency rate fluctuation risk with respect to both minimum payments and overages. We believe that the impact of currency rate fluctuations do not represent a significant risk in the context of our current international operations.
In connection with our film facility, to mitigate our exposure to rising interest rates based on LIBOR, we entered into an interest rate cap to cover a majority of the notional amount of anticipated borrowings under this facility. We do not generally enter into any other types of derivative financial instruments in the normal course of business to mitigate our interest rate risk, nor are such instruments used for speculative purposes. In light of recent adverse developments in the credit markets, we have assessed the economic impact on our film production activities from the actual and potential increases in our film facility interest rates because of downgrades by S&P or Moody’s. We do not believe the impact of these actual or potential increases to be material.
The current volatility and disruption to the capital and credit markets are causing contraction in the availability of business and consumer credit and has lead to a global recession. This current decrease and any future decreases in economic activity in the United States or other regions in the world in which we do business could significantly and adversely affect our future results of operations and financial condition in a number of ways. These economic conditions could reduce the performance of our theatrical and home entertainment releases and the ability of licensees to produce and sell our licensed consumer products and reduce demand for our publications, thereby reducing our revenues and earnings, and could cause our licensees to be unable or to refuse to make required payments to us under their license agreements.
Additional information relating to our outstanding financial instruments is included in Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this item, the reports of the independent registered public accounting firm on those financial statements and the related required financial statement schedule appear on pages F-2 and following. See the accompanying Index to Financial Statements and Financial Statement Schedule on page F-1. The supplementary financial data required by Item 302 of Regulation S-K appears in Note 13 to the December 31, 2008 Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Marvel’s management has evaluated, with the participation of Marvel’s chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures as of the end of 2008, the fiscal year covered by this report. Based on that evaluation, our chief executive officer and chief financial officer have concluded that those controls and procedures were effective as of the end of 2008.

 

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Internal Control Over Financial Reporting
Management’s Annual Report on Internal Control Over Financial Reporting
(1) Marvel’s management is responsible for establishing and maintaining adequate internal control over financial reporting for Marvel, as that term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
(2) The framework used by management to evaluate the effectiveness of our internal control over financial reporting as required by paragraph (c) of Rule 13a-15 under the Securities Exchange Act of 1934 is the framework described in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
(3) Marvel management’s assessment is that our internal control over financial reporting was effective as of December 31, 2008, the fiscal year covered by this report.
(4) PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the consolidated financial statements and financial statement schedule included in this annual report, has also audited the effectiveness of our internal control over financial reporting as of December 31, 2008, as stated in their report included in this annual report.
Attestation Report of the Independent Registered Public Accounting Firm
The report of PricewaterhouseCoopers LLP referred to immediately above is provided on page F-2 below.
Changes in Internal Controls Over Financial Reporting
There were no changes in our internal control over financial reporting identified by Marvel that occurred during the fourth quarter of 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
On December 5, 2008, our subsidiaries Marvel Studios, Inc., MVL Productions LLC and MVL Film Finance LLC entered into Amendment No. 7 to Transaction Documents by and among such subsidiaries and Ambac Assurance Corporation, in its capacity as Control Party (“Amendment No. 7”). Amendment No. 7 reduces, effective December 31, 2008, the funding requirement for a liquidity reserve that we are required to keep for the film facility from $45 million to $25 million. In the event that we do not release a film in 2010, 2011 and 2012 or our sixth film under the film facility by August 26, 2012, the liquidity reserve will be increased to $45 million. The above description of the terms of Amendment No. 7 is qualified in its entirety by reference to the full text of Amendment No. 7, which is filed as Exhibit 10.33 to this Annual Report on Form 10-K and is incorporated herein by reference.

 

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On February 17, 2009, the Company and its subsidiaries Marvel Studios, Inc., MVL Productions LLC and MVL Film Finance LLC entered into Amendment No. 8 to Transaction Documents by and among the Company, such subsidiaries, Ambac Assurance Corporation, in its capacity as Control Party and HSBC Bank USA, National Association, it its capacity as Collateral Agent and Collection Account Bank (“Amendment No. 8”). Amendment No. 8 permits Marvel to set a budget for Iron Man 2 that exceeds the maximum budget under our film facility. The film facility will fund the same percentage (i.e., 67%) of any amounts in excess of the cap and will be reimbursed for any such additional amounts out of Marvel’s 5% producer fee on Iron Man 2. Amendment No. 8 also allows Marvel, at its option, to utilize a lower cost completion bond structure. In order to take advantage of this lower cost completion bond structure for a picture, Marvel will need to escrow funds for the duration of production. The escrowed funds on a picture would be at risk in the event that: (i) the picture is abandoned after over $100 million has been expended; or (ii) spending on the picture exceeds 110% of its budget. In addition, Amendment No. 8 technically amends the permitted investments for funds in the film facility’s accounts. The above description of the terms of Amendment No. 8 is qualified in its entirety by reference to the full text of Amendment No. 8, which is filed as Exhibit 10.34 to this Annual Report on Form 10-K and is incorporated herein by reference.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is incorporated in this annual report by reference to the information appearing under the captions “Corporate Governance,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement, which we intend to file not later than April 30, 2009, with the Securities and Exchange Commission.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated in this annual report by reference to the information appearing under the caption “Executive Compensation” in our definitive proxy statement, which we intend to file not later than April 30, 2009, with the Securities and Exchange Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated in this annual report by reference to the information appearing under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance Under Equity Compensation Plans” in our definitive proxy statement, which we intend to file not later than April 30, 2009, with the Securities and Exchange Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated in this annual report by reference to the information appearing under the caption “Transactions with Related Persons, Promoters and Certain Control Persons” and “Corporate Governance” in our definitive proxy statement, which we intend to file not later than April 30, 2009, with the Securities and Exchange Commission.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated in this annual report by reference to the information appearing under the caption “Independent Registered Public Accounting Firm” in our definitive proxy statement, which we intend to file not later than April 30, 2009, with the Securities and Exchange Commission.

 

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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
All financial statements and financial statement schedules filed with this report are listed on page F-1. All required exhibits are listed on the Exhibit Index immediately below.
EXHIBIT INDEX
         
Exhibit No.
       
 
  3 (i)  
Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3(i) of the Company’s Current Report on Form 8-K dated February 23, 2006 and filed with the Securities and Exchange Commission on March 1, 2006.)
       
 
  3 (ii)  
Amended and Restated Bylaws, as amended through the date hereof. (Incorporated by reference to Exhibit 3(ii) of the Company’s Current Report on Form 8-K dated October 23, 2008 and filed with the Securities and Exchange Commission on October 29, 2008.)
       
 
  4.1    
Article V of the Restated Certificate of Incorporation (see Exhibit 3(i), above), defining the rights of holders of Common Stock.
       
 
  4.2    
Rights Agreement, dated as of August 22, 2000, between the Company and American Stock Transfer & Trust Company as Rights Agent, defining the rights of holders of Preferred Share Purchase Rights. (Incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K dated August 22, 2000 and filed with the Securities and Exchange Commission on September 12, 2000.)
       
 
  4.3    
Amendment to Rights Agreement, dated as of November 30, 2001, by and between the Company and American Stock Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 10.9 of the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on December 4, 2001.)
       
 
  4.4    
Amendment No. 2 to Rights Agreement, dated as of October 7, 2002, by and between the Company and American Stock Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated October 4, 2002 and filed with the Securities and Exchange Commission on October 7, 2002.)
       
 
  10.1    
1998 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10.1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.)*
       
 
  10.2    
2005 Stock Incentive Plan, as amended. (Filed herewith.)*
       
 
  10.3    
Form of Stock Option Agreement under the 2005 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on May 4, 2005.)*
       
 
  10.4    
Form of Restricted Stock Agreement under the 2005 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on May 4, 2005.)*
       
 
  10.5    
Form of Performance-Based Restricted Stock Agreement under the 2005 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on May 4, 2005.)*

 

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Exhibit No.
       
 
  10.6    
Form of Performance-Based Phantom Stock Agreement under the Company’s 2005 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and filed with the Securities and Exchange Commission on November 9, 2005.)*
       
 
  10.7    
2005 Cash Incentive Compensation Plan, as amended. (Filed herewith.)*
       
 
  10.8    
Form of Performance-Based Award Letter under the Company’s 2005 Cash Incentive Plan. (Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and filed with the Securities and Exchange Commission on November 9, 2005.)*
       
 
  10.9    
Nonqualified Stock Option Agreement, dated as of November 30, 2001, by and between the Company and Isaac Perlmutter. (Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on December 4, 2001.)*
       
 
  10.10    
Registration Rights Agreement, dated as of October 1, 1998, by and among the Company, Dickstein & Co., L.P., Dickstein Focus Fund L.P., Dickstein International Limited, Elyssa Dickstein, Jeffrey Schwarz and Alan Cooper as Trustees U/T/A/D 12/27/88, Mark Dickstein, Grantor, Mark Dickstein and Elyssa Dickstein, as Trustees of the Mark and Elyssa Dickstein Foundation, Elyssa Dickstein, Object Trading Corp., Whippoorwill/Marvel Obligations Trust — 1997, and Whippoorwill Associates, Incorporated. (Incorporated by reference to Exhibit 99.5 to the Company’s Current Report on Form 8-K/A dated and filed with the Securities and Exchange Commission on October 16, 1998.)*
       
 
  10.11    
Registration Rights Agreement, dated as of December 8, 1998, by and among the Company, Marvel Entertainment Group, Inc., Avi Arad, Isaac Perlmutter, Isaac Perlmutter T.A., The Laura & Isaac Perlmutter Foundation Inc., and Zib Inc. (Incorporated by reference to Exhibit 10.4 of the Company’s Annual Report on Form 10-K for the year ended December 31, 1998.)*
       
 
  10.12    
Warrant Shares Registration Right Agreement, dated as of November 30, 2001, by and between the Company and Isaac Perlmutter. (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on December 4, 2001.)*
       
 
  10.13    
Agreement of Sublease dated as of August 5, 2004, by and between CIBC World Markets Corp. and the Company. (Incorporated by reference to Exhibit 10.16 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and filed with the Securities and Exchange Commission on March 9, 2005.)
       
 
  10.14    
Amendment to Agreement of Sublease dated as of February 17, 2005, by and between CIBC World Markets Corp. and the Company. (Incorporated by reference to Exhibit 10.17 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and filed with the Securities and Exchange Commission on March 9, 2005.)
       
 
  10.15    
Lease Agreement, dated as of February 15, 2005, by and between 417 Fifth Avenue LLC and the Company (Incorporated by reference to Exhibit 10.18 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and filed with the Securities and Exchange Commission on March 9, 2005.)
       
 
  10.16    
Lease, dated as of September 22, 2008, between MVL Productions LLC, as tenant, and CRP MB Studios, L.L.C., as landlord. (Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008.)
       
 
  10.17    
Credit Agreement, dated as of November 9, 2005 among Marvel Entertainment, Inc. and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and filed with the Securities and Exchange Commission on November 9, 2005.)

 

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Exhibit No.
       
 
  10.18    
Amendment No. 1 and Reaffirmation Agreement dated as of January 18, 2006 to Credit Agreement dated as of November 9, 2005, among the Company and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 and filed with the Securities and Exchange Commission on August 8, 2006.)
       
 
  10.19    
Amendment No. 2 and Reaffirmation Agreement dated as of June 28, 2006 to Credit Agreement dated as of November 9, 2005, among the Company and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 and filed with the Securities and Exchange Commission on August 8, 2006.)
       
 
  10.20    
Amendment No. 3 and Reaffirmation Agreement dated as of June 30, 2006 to Credit Agreement dated as of November 9, 2005, among the Company and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 and filed with the Securities and Exchange Commission on August 8, 2006.)
       
 
  10.21    
Amendment No. 4 and Reaffirmation Agreement dated as of May 7, 2007 to Credit Agreement dated as of November 9, 2005, between Marvel Entertainment, Inc. and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 and filed with the Securities and Exchange Commission on May 9, 2007.)
       
 
  10.22    
Amendment No. 5 and Reaffirmation Agreement dated as of August 21, 2007 by and among the Registrant, Marvel Characters, Inc. and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated August 21, 2007 and filed with the Securities and Exchange Commission on August 27, 2007.)
       
 
  10.23    
Pledge and Security Agreement, dated as of November 9, 2005, by Marvel Entertainment, Inc. and Marvel Characters, Inc. in favor of HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.6 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and filed with the Securities and Exchange Commission on November 9, 2005.)
       
 
  10.24    
Guaranty, dated as of November 9, 2005 by Marvel Characters, Inc. in favor of and for the benefit of HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.7 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and filed with the Securities and Exchange Commission on November 9, 2005.)
       
 
  10.25    
Credit and Security Agreement, dated as of August 31, 2005, by and among MVL Film Finance LLC, as Borrower, the Financial Institutions and Conduit Lenders identified therein, as Lenders, HSBC Bank USA, National Association, as the Collateral Agent and General Electric Capital Corporation, as Administrative Agent. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.26    
Insurance and Indemnity Agreement, dated as of August 31, 2005, by and between the Company, MVL Film Finance LLC, MVL Productions LLC, MVL Rights LLC, Marvel Studios, Inc., the Collateral Agent and Ambac Assurance Corporation. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.27    
Amendment No. 1 dated as of September 29, 2006 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc., Marvel Characters, Inc., MVL Rights LLC, Ambac Assurance Corporation and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated September 29, 2006 and filed with the Securities and Exchange Commission on October 5, 2006.)

 

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Exhibit No.
       
 
  10.28    
Amendment No. 2 dated as of February 21, 2007 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc., Marvel Characters, Inc., MVL Rights LLC, Ambac Assurance Corporation and HSBC Bank USA, National Association. (Incorporated by reference to Exhibit 10.26 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.)
       
 
  10.29    
Amendment No. 3 to Transaction Documents dated as of April 13, 2007 by and among HSBC Bank USA, National Association, in its capacity as Collateral Agent, Ambac Assurance Corporation, in its capacity as Control Party, MVL Productions LLC, Marvel Studios, Inc. and MVL Film Finance LLC. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated April 16, 2007 and filed with the Securities and Exchange Commission on April 19, 2007.)
       
 
  10.30    
Amendment No. 4 dated as of January 15, 2008 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc. and Ambac Assurance Corporation, in its capacity as Control Party. (Incorporated by reference to Exhibit 10.30 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.)
       
 
  10.31    
Amendment No. 5 dated as of May 30, 2008 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc. and Ambac Assurance Corporation, in its capacity as Control Party. (Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008.)
       
 
  10.32    
Amendment No. 6 dated as of September 17, 2008 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc. , Marvel Entertainment, Inc , Ambac Assurance Corporation, in its capacity as Control Party and HSBC Bank USA, National Association, in its capacities as Collateral Agent and Collection Account Bank. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated September 25, 2008 and filed with the Securities and Exchange Commission on September 29, 2008.)
       
 
  10.33    
Amendment No. 7 dated as of December 5, 2008 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, Marvel Studios, Inc. and Ambac Assurance Corporation, in its capacity as Control Party. (Filed herewith.)
       
 
  10.34    
Amendment No. 8 dated as of February 17, 2009 to Transaction Documents by and among MVL Film Finance LLC, MVL Productions LLC, the Company, Marvel Studios, Inc., HSBC Bank USA, N.A., in its capacities as Collateral Agent and Collection Account Bank, and Ambac Assurance Corporation, in its capacity as Control Party. (Filed herewith.)
       
 
  10.35    
Master Development and Distribution Agreement, dated as of August 31, 2005, by and among MVL Film Finance LLC, MVL Productions LLC and Marvel Studios, Inc. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.36    
Assignment Agreement, dated as of August 31, 2005, by and between Marvel Characters, Inc. and MVL Rights LLC. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.37    
Exclusive Cross License Agreement, dated as of August 31, 2005, by and between MVL Rights LLC and MVL Film Finance LLC. (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.38    
Hulk Exclusive Cross License Agreement dated as of September 29, 2006 by and between MVL Rights LLC and MVL Film Finance LLC. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated September 29, 2006 and filed with the Securities and Exchange Commission on October 5, 2006.)

 

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Exhibit No.
       
 
  10.39    
Iron Man Exclusive Cross License Agreement dated as of September 29, 2006 by and between MVL Rights LLC and MVL Film Finance LLC. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K dated September 29, 2006 and filed with the Securities and Exchange Commission on October 5, 2006.)
       
 
  10.40    
Exclusive License Agreement, dated as of August 31, 2005, by and between MVL Rights LLC and Marvel Characters, Inc. (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.41    
Letter Agreement, dated as of August 31, 2005, by Marvel and agreed and acknowledged by Marvel Studios, Inc., MVL Rights LLC, MVL Productions LLC and Marvel Characters, Inc. (Incorporated by reference to Exhibit 10.7 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.42    
Assignment Agreement dated as of August 30, 2005, by and between Marvel, Marvel Entertainment Group, Inc. and Marvel Characters, Inc. (Incorporated by reference to Exhibit 10.8 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 6, 2005.)
       
 
  10.43    
License Agreement dated January 6, 2006 by and between Marvel Characters, Inc. and Spider-Man Merchandising L.P. on the one hand and Hasbro, Inc. on the other. (Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 and filed with the Securities and Exchange Commission on May 8, 2006.)
       
 
  10.44    
Amendment dated as of February 8, 2006 to License Agreement dated January 6, 2006 by and between Marvel Characters, Inc. and Spider-Man Merchandising L.P. on the one hand, and Hasbro, Inc. on the other. (Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 and filed with the Securities and Exchange Commission on May 8, 2006.)
       
 
  10.45    
Employment Agreement, dated as of November 30, 1998, between the Company and Stan Lee. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002.)*
       
 
  10.46    
Employment Agreement dated May 31, 2007 between the Company and Alan Fine. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.)*
       
 
  10.47    
Amendment No. 1, dated as of August 6, 2007, to Employment Agreement between the Company and Alan Fine. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.)*
       
 
  10.48    
Amendment No. 2, dated March 19, 2008, to Employment Agreement between the Company and Alan Fine. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 19, 2008 and filed with the Securities and Exchange Commission on March 25, 2008.)*
       
 
  10.49    
Amended and Restated Employment Agreement, dated March 21, 2008, by and between the Company and John Turitzin. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated March 19, 2008 and filed with the Securities and Exchange Commission on March 25, 2008.)*
       
 
  10.50    
Amended and Restated Employment Agreement, dated May 2, 2008, by and between the Company and David Maisel. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated May 2, 2008 and filed with the Securities and Exchange Commission on May 8, 2008.)*
       
 
  10.51    
Employment Agreement dated June 20, 2007 between the Company and Kenneth P. West. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.)*

 

53



 

         
Exhibit No.
       
 
  10.52    
Employment Agreement, dated as of November 30, 2001, by and between the Company and Isaac Perlmutter. (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K dated and filed with the Securities and Exchange Commission on December 4, 2001.)*
       
 
  10.53    
Amendment to Employment Agreement with Isaac Perlmutter dated as of May 1, 2004. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.)*
       
 
  10.54    
Second Amendment to Employment Agreement with Isaac Perlmutter dated as of October 15, 2004. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.)*
       
 
  10.55    
Third Amendment to Employment Agreement with Isaac Perlmutter dated as of May 8, 2006. (Incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 and filed with the Securities and Exchange Commission on May 8, 2006.)*
       
 
  10.56    
Share Disposition Agreement, dated as of May 20, 2007 by and between Marvel Entertainment, Inc. and Isaac Perlmutter. (Incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.)*
       
 
  10.57    
Share Disposition Agreement, dated as of February 13, 2008 by and between Marvel Entertainment, Inc. and Isaac Perlmutter. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated February 19, 2008 and filed with the Securities and Exchange Commission on February 25, 2008.)*
       
 
  21    
       
 
  23    
       
 
  24    
Power of attorney (included below the signature hereto).
       
 
  31.1    
Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act. (Filed herewith.)
       
 
  31.2    
Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act. (Filed herewith.)
       
 
  32    
Certification pursuant to Section 906 of the Sarbanes-Oxley Act. (Furnished herewith.)
     
*   Management contract or compensatory plan or arrangement.
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.
         
  MARVEL ENTERTAINMENT, INC.
 
 
  By:   /s/ John Turitzin    
    John Turitzin   
    Executive Vice President   
February 27, 2009

 

54



 

POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints John Turitzin his true and lawful attorney-in-fact with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report and to cause the same to be filed, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby granting to said attorney-in-fact and agent full power and authority to do and perform each and every act and thing whatsoever requisite or desirable to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things that said attorney-in-fact and agent, or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
         
Signature   Title   Date
 
       
  Chief Executive Officer and
Vice Chairman of the Board of Directors
(principal executive officer)
  February 27, 2009
 
       
  Chief Financial Officer
(principal financial officer) 
  February 27, 2009
 
       
  Chief Accounting Officer
(principal accounting officer) 
  February 27, 2009
 
       
  Chairman of the Board of Directors    February 27, 2009
       
 
       
  Vice Chairman of the Board of Directors    February 27, 2009
       
 
       
  Director    February 27, 2009
       
 
       
  Director    February 27, 2009
       
 
       
/s/ Sid Ganis
 
  Director    February 27, 2009
       
 
       
  Director    February 27, 2009
       
 
       
  Director    February 27, 2009
       

 

55



 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
     
Marvel Entertainment, Inc.
   
 
   
  F-2
 
   
  F-3
 
   
  F-4
 
   
  F-5
 
   
  F-6
 
   
  F-7
 
   
Consolidated Financial Statement Schedule
   
 
   
  F-39
All other schedules prescribed by the accounting regulations of the Commission are not required or are inapplicable and therefore have been omitted.

 

F-1



 

Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Marvel Entertainment, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of net income, of stockholders’ equity and comprehensive income and of cash flows present fairly, in all material respects, the financial position of Marvel Entertainment, Inc. and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the accompanying financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain tax positions in 2007.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 27, 2009

 

F-2



 

MARVEL ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
                 
    December 31,  
    2008     2007  
    (in thousands, except share data)  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 105,335     $ 30,153  
Restricted cash
    43,647       20,836  
Short-term investments
    32,975       21,016  
Accounts receivable, net
    144,487       28,679  
Inventories, net
    11,362       10,647  
Income tax receivable
    2,029       10,882  
Deferred income taxes, net
    34,072       21,256  
Prepaid expenses and other current assets
    5,135       4,245  
 
           
Total current assets
    379,042       147,714  
 
               
Fixed assets, net
    3,432       2,612  
Film inventory
    181,564       264,817  
Goodwill
    346,152       346,152  
Accounts receivable, non-current portion
    1,321       1,300  
Income tax receivable, non-current portion
    5,906       4,998  
Deferred income taxes, net
    13,032       37,116  
Deferred financing costs
    5,810       11,400  
Advances to joint venture partner
    870        
Other assets
    455       1,249  
 
           
Total assets
  $ 937,584     $ 817,358  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 2,025     $ 3,054  
Accrued royalties
    76,580       84,694  
Accrued expenses and other current liabilities
    40,635       37,012  
Deferred revenue
    81,335       88,617  
Film facilities
    204,800       42,264  
Minority interest to be distributed
          556  
 
           
Total current liabilities
    405,375       256,197  
Accrued royalties, non-current portion
    10,499       10,273  
Deferred revenue, non-current portion
    48,939       58,166  
Film facilities, non-current portion
    8,201       246,862  
Income tax payable, non-current portion
    59,267       54,066  
Other liabilities
    8,612       10,291  
 
           
Total liabilities
    540,893       635,855  
 
           
 
               
Commitments and contingencies
               
 
               
Stockholders’ equity:
               
Preferred stock, $.01 par value, 100,000,000 shares authorized, none issued
           
Common stock, $.01 par value, 250,000,000 shares authorized, 134,397,258 issued and 78,408,082 outstanding in 2008 and 133,179,310 issued and 77,624,842 outstanding in 2007
    1,344       1,333  
Additional paid-in capital
    750,132       728,815  
Retained earnings
    555,125       349,590  
Accumulated other comprehensive loss
    (4,617 )     (3,395 )
 
           
Total stockholders’ equity before treasury stock
    1,301,984       1,076,343  
Treasury stock, at cost, 55,989,176 shares in 2008 and 55,554,468 shares in 2007
    (905,293 )     (894,840 )
 
           
Total stockholders’ equity
    396,691       181,503  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 937,584     $ 817,358  
 
           
See Notes to Consolidated Financial Statements.

 

F-3



 

MARVEL ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF NET INCOME
                         
    Years Ended December 31,  
    2008     2007     2006  
    (in thousands, except per share data)  
 
                       
Net sales
  $ 676,177     $ 485,807     $ 351,798  
 
                 
 
                       
Costs and expenses:
                       
Cost of revenues (excluding depreciation expense)
    191,519       60,933       103,584  
Selling, general and administrative
    138,506       147,118       123,130  
Depreciation and amortization
    1,559       5,970       14,322  
 
                 
Total costs and expenses
    331,584       214,021       241,036  
Other income, net
    23,381       2,643       1,798  
 
                 
Operating income
    367,974       274,429       112,560  
Interest expense
    18,984       13,756       15,225  
Interest income
    3,592       2,559       1,465  
Gain on repurchase of debt
    1,916              
 
                 
Income before income tax expense and minority interest
    354,498       263,232       98,800  
Income tax expense
    (133,180 )     (98,908 )     (39,071 )
Minority interest in consolidated joint venture
    (15,783 )     (24,501 )     (1,025 )
 
                 
Net income
  $ 205,535     $ 139,823     $ 58,704  
 
                 
 
                       
Basic and diluted net earnings per share:
                       
Weighted average shares outstanding:
                       
Weighted average shares for basic earnings per share
    78,062       79,751       82,161  
Effect of dilutive stock options, warrants and restricted stock
    602       2,716       5,069  
 
                 
Weighted average shares for diluted earnings per share
    78,664       82,467       87,230  
Earnings per share:
                       
Basic
  $ 2.63     $ 1.75     $ 0.71  
 
                 
 
       
Diluted
  $ 2.61     $ 1.70     $ 0.67  
 
                 
See Notes to Consolidated Financial Statements.

 

F-4



 

MARVEL ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
                                                                         
                                            Accumulated Other              
    Common     Common     Deferred     Additional             Comprehensive Loss              
    Stock     Stock     Stock     Paid-In     Retained     Foreign     Pension     Treasury        
    Shares     Amount     Compensation     Capital     Earnings     Currency     Liability     Stock     Total  
    (in thousands)  
 
                                                                       
    90,206     $ 1,217     $ (6,242 )   $ 594,873     $ 169,762     $ 45     $ (3,519 )   $ (395,536 )   $ 360,600  
 
       
Impact of adoption of SFAS 123R
    (502 )     (4 )     6,242       (6,238 )                              
Employee stock options exercised
    7,075       70             46,812                               46,882  
Tax benefit of stock options exercised, net
                      64,802                               64,802  
Restricted stock vesting
    152       1             (1 )                              
Common stock retired
    (46 )                 (828 )                             (828 )
Treasury stock, at cost
    (15,558 )                                         (287,350 )     (287,350 )
Compensatory stock expense
                      11,040                               11,040  
Net income
                            58,704                         58,704  
Other comprehensive income
                                  147       894             1,041  
 
                                                                     
Comprehensive income
                                                    59,745  
 
                                                     
 
                                                                       
    81,327       1,284             710,460       228,466       192       (2,625 )     (682,886 )     254,891  
 
                                                                       
Impact of adoption of FIN 48
                      265       (18,699 )                       (18,434 )
Employee stock options exercised
    676       8             12,052                               12,060  
Tax benefit of stock options exercised, net
                      (604 )                             (604 )
Restricted stock vesting
    4,109       41             (41 )                              
Common stock retired
    (47 )                 (1,243 )                             (1,243 )
Treasury stock, at cost
    (8,460 )                                         (211,954 )     (211,954 )
Compensatory stock expense
                      7,926                               7,926  
Warrants issued for services
    20                                                  
Net income
                            139,823                         139,823  
Other comprehensive income (loss)
                                  150       (1,112 )           (962 )
 
                                                                     
Comprehensive income
                                                    138,861  
 
                                                     
 
                                                                       
    77,625       1,333             728,815       349,590       342       (3,737 )     (894,840 )     181,503  
 
       
Employee stock options exercised
    982       8             8,564                               8,572  
Tax benefit of stock options exercised, net
                      8,734                               8,734  
Restricted stock vesting
    320       3             (3 )                              
Common stock retired
    (84 )                   (2,170 )                             (2,170 )
Treasury stock, at cost
    (435 )                                         (10,453 )     (10,453 )
Compensatory stock expense
                      6,192                               6,192  
Net income
                            205,535                         205,535  
Other comprehensive loss
                                  (1,154 )     (68 )           (1,222 )
 
                                                                     
Comprehensive income
                                                    204,313  
 
                                                     
 
                                                                       
    78,408     $ 1,344     $     $ 750,132     $ 555,125     $ (812 )   $ (3,805 )   $ (905,293 )   $ 396,691  
 
                                                     
See Notes to Consolidated Financial Statements.

 

F-5



 

MARVEL ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
                         
    Years Ended December 31,  
    2008     2007     2006  
    (in thousands)  
 
                       
Cash flows from operating activities:
                       
Net income
  $ 205,535     $ 139,823     $ 58,704  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
                       
Depreciation and amortization
    1,559       5,970       14,322  
Amortization of film inventory
    135,339              
Gain on repurchase of debt
    (1,916 )            
Amortization of deferred financing costs
    4,981       4,980       4,980  
Unrealized loss on interest rate cap and foreign currency forward contracts
    1,008       915       1,504  
Non-cash charge for stock based compensation
    6,192       7,926       11,040  
Excess tax benefit from stock-based compensation
    (8,734 )     (2,454 )     (45,569 )
Gain on sales of equipment
                (133 )
Impairment of long term assets
    1,663       1,301       962  
Deferred income taxes
    11,500       1,161       (300 )
Minority interest of joint venture (net of distributions of $16,743 in 2008 and $14,751 in 2007)
    (960 )     9,750       (5,046 )
Changes in operating assets and liabilities:
                       
Accounts receivable
    (115,829 )     42,292       7,127  
Inventories
    (715 )     (423 )     (1,047 )
Income tax receivable
          30,963        
Prepaid expenses and other current assets
    (890 )     2,986       (2,446 )
Film inventory
    (53,135 )     (251,045 )     (15,055 )
Other assets
    (214 )     (46 )     172  
Deferred revenue
    (16,509 )     (28,956 )     140,087  
Income taxes payable
    21,151       17,820       (1,296 )
Accounts payable, accrued expenses and other current liabilities
    (8,738 )     10,431       (9,831 )
 
                 
Net cash provided by (used in) operating activities
    181,288       (6,606 )     158,175  
 
                 
 
                       
Cash flow (used in) provided by investing activities:
                       
Purchases of fixed assets
    (2,384 )     (2,169 )     (10,034 )
Expenditures for product and package design
          (490 )     (6,252 )
Proceeds from sales of equipment
                1,876  
Sales of short-term investments
    66,055       333,380       80,671  
Purchases of short-term investments
    (78,014 )     (354,396 )     (65,532 )
Change in restricted cash
    (22,811 )     (12,309 )     (144 )
 
                 
Net cash (used in) provided by investing activities
    (37,154 )     (35,984 )     585  
 
                 
 
                       
Cash flow (used in) provided by financing activities:
                       
Borrowings from film facilities
    106,300       255,926       7,400  
Repayments of film facilities
    (180,509 )            
Borrowings from line of credit
          2,000       169,200  
Repayments of line of credit
          (19,000 )     (152,200 )
Deferred financing costs
          (609 )      
Purchase of treasury stock
    (10,453 )     (211,954 )     (287,350 )
Exercise of stock options
    8,572       12,060       46,882  
Excess tax benefit from stock-based compensation
    8,734       2,454       64,802  
 
                 
Net cash (used in) provided by financing activities
    (67,356 )     40,877       (151,266 )
 
                 
 
                       
Effect of exchange rates on cash
    (1,596 )     (79 )     224  
 
                 
Net increase (decrease) in cash and cash equivalents
    75,182       (1,792 )     7,718  
Cash and cash equivalents, at beginning of year
    30,153       31,945       24,227  
 
                 
Cash and cash equivalents, at end of year
  $ 105,335     $ 30,153     $ 31,945  
 
                 
 
                       
Supplemental disclosure of cash flow information:
                       
Interest paid
  $ 18,028     $ 4,564     $ 10,009  
Income taxes paid
    100,862       91,476       38,174  
Income tax refund
          42,064       12,180  
See Notes to Consolidated Financial Statements.

 

F-6



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008
1. Description of Business and Basis of Presentation
Marvel Entertainment, Inc. and its subsidiaries are one of the world’s most prominent character-based entertainment companies, with a proprietary library of over 5,000 characters.
We operate in three integrated and complementary operating segments: Licensing, Publishing and Film Production. We no longer have a Toy segment. During early 2008, we completed our exit from toy manufacturing activities. We also completed a change in the focus of the support that we provide to Hasbro, Inc. (“Hasbro”), which resulted in changes to our internal organizational structure and staff reductions. These events altered our internal reporting of segment performance, with the result that we are including revenues earned from Hasbro (associated with toys manufactured and sold by Hasbro) and related expenses (associated with royalties that we owe to third parties, such as movie studios, on our Hasbro revenue) within our Licensing segment. Those revenues and expenses were formerly included in our Toy segment. Our remaining activities related to our terminated toy manufacturing business are included with Corporate overhead in “All Other”. We have reclassified prior-period segment information to conform to the current-year presentation.
The expansion of our studio operations to include feature films that we produce ourselves began in late 2005 with our entering into a $525 million film facility (the “Film Facility”) to fund the production of our films. This expansion resulted in the creation of a new segment, the Film Production segment, during 2006. Previously, Marvel Studios’ operations related solely to the licensing of our characters to third-party motion picture and television producers. Those licensing activities were, and still are, included in the Licensing segment. The operations of developing and producing our own theatrical releases are reported in our Film Production segment.
In connection with the film facility, we have formed the following wholly-owned subsidiaries: Assembled Productions LLC, MVL Rights LLC, MVL Productions LLC, Incredible Productions LLC, Iron Works Productions LLC, Iron Works Productions II LLC, MVL Iron Works Productions Canada, Inc., Vita-Ray Productions LLC, MVL Incredible Productions Canada, Inc. and MVL Film Finance LLC (collectively, the “Film Slate Subsidiaries). The assets of MVL Film Finance LLC have been pledged as collateral to secure our film facility debt. The assets of the other Film Slate Subsidiaries, other than MVL Productions LLC, are not available to satisfy debts or other obligations of any of our other subsidiaries or any other persons.
We are party to a joint venture with Sony Pictures Entertainment Inc., called Spider-Man Merchandising L.P. (the “Joint Venture”), for pursuing licensing opportunities, relating to characters based upon movies or television shows featuring Spider-Man and produced by Sony. The Joint Venture is consolidated in our consolidated financial statements as a result of our having control of all significant decisions relating to the ordinary course of business of the Joint Venture and our receiving the majority of the financial interest of the Joint Venture. The operations of the Joint Venture are included in our Licensing segment.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include our accounts and those of our subsidiaries, including the Film Slate Subsidiaries and the Joint Venture. Upon consolidation, all inter-company accounts and transactions are eliminated.

 

F-7



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The principal areas of judgment in our consolidated financial statements relate to the estimate of ultimate revenues for each of our films, the realizability of film inventory, valuation allowances for deferred income tax assets, reserves for uncertain tax positions, character allocation in computing studio share of royalties payable, the reserve for uncollected minimum royalty guarantees, provisions for returns, pension plan assumptions, the realizability of goodwill, the realizability of inventories, other sales allowances and doubtful accounts, depreciation and amortization periods for equipment, litigation related accruals, and forfeiture rates related to employee stock compensation. Actual results could differ from these estimates.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. We place our investments with high quality financial institutions. At times, such investments may be in excess of federally insured limits. Cash equivalents at December 31, 2008 consist principally of U.S. Treasury Bills (with an original maturity of three months or less) and short-term bank CD’s (covered by the U.S. Government’s Temporary Liquidity Guarantee Program). Cash equivalents at December 31, 2007 consisted principally of U.S. Treasury Bills (with an original maturity of three months or less).
Restricted Cash
Restricted cash primarily consists of cash that has been pledged to secure the film facility and is not available for our general corporate purposes (see Note 5).
Restricted cash also includes cash balances of the Joint Venture that are not freely available to either Sony Pictures or us until distributed. Distributions are made no less than on a quarterly basis.
Accounting for Joint Venture
The operations of the Joint Venture have been consolidated in our consolidated financial statements, including revenues of $57.4 million, $122.0 million and $4.1 million for the years ended December 31, 2008, 2007 and 2006, respectively. The Joint Venture distributes to us and to Sony Pictures all cash received, proportionate to each party’s interest, on at least a quarterly basis. At December 31, 2008, advances to joint venture partner of $0.9 million reflects distributions made to Sony Pictures in connection with cash received by the Joint Venture from minimum royalty advances on licensing contracts for which the Joint Venture has not yet recognized revenue and earnings thereon. These advances or payments due are classified as current or non-current consistent with the classification of deferred revenue related to such advances, which is based on when the underlying deferred revenue is scheduled to be recognized. At December 31, 2007, we had $0.6 million in minority interest distributions due to Sony Pictures.
Inventories
Inventories are valued at the lower of cost (first-in, first-out method) or market (see Note 3).

 

F-8



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Fixed Assets
Fixed assets are stated at cost less accumulated depreciation and amortization. For financial reporting purposes, depreciation and amortization is computed using the straight-line method generally over a three to five-year life for furniture and fixtures and office equipment, and over the shorter of the life of the underlying lease or estimated useful life for leasehold improvements. Expenditures for major software purchases and software developed for internal use are capitalized and depreciated using the straight-line method over the estimated useful lives of the related assets, which is generally 3 years. For software developed for internal use, all external direct costs for materials and services are capitalized in accordance with AICPA Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Total capitalized internal use software costs were $5.5 million and $3.5 million at December 31, 2008 and 2007, respectively. Accumulated depreciation and amortization for fixed assets was $4.7 million and $3.2 million at December 31, 2008 and 2007, respectively, of which $3.0 million and $2.0 million related to internal use software. Amortization expense for internal use software was $1.0 million, $1.0 million and $0.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
Goodwill
We have significant goodwill on our balance sheet, which resulted from the acquisition of Marvel Entertainment Group, Inc. in 1998. Goodwill is accounted for under the guidance provided by Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible Assets” (“SFAS 142”). As required by SFAS 142, goodwill is allocated to various operating segments (see Note 11).
To determine if there is potential goodwill impairment, SFAS 142 requires us to compare the fair value of each of our reporting units (which are our operating segments) to its carrying amount on an annual basis. To determine the fair value of our reporting units, we generally use a present value technique (forecasted discounted cash flow) corroborated by market multiples when available and as appropriate. If the fair value of our reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than the carrying value of its goodwill. As of December 31, 2008, our goodwill was not impaired.
Long-Lived Assets
We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets.
Film Production Operations
As a film development company, MVL Productions LLC, a wholly-owned consolidated subsidiary of ours, engages in a broad range of pre-production services. Those services include developing film concepts and screenplays, preparing budgets and production schedules, obtaining production insurance and completion bonds and forming special-purpose, bankruptcy-remote subsidiaries to produce each film as a work-made-for-hire for MVL Film Finance LLC. MVL Productions LLC has also entered into a studio distribution agreement with Paramount Pictures Corporation and, solely with respect to The Incredible Hulk theatrical release, with Universal Pictures, a division of Universal City Studios, LLP.

 

F-9



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Film Inventory
In general, we are responsible for all of the costs of developing and producing our feature films. The film’s distributor is responsible for the out-of-pocket costs, charges and expenses (including contingent compensation and residual costs, to a defined limit) incurred in the distribution, manufacturing, printing and advertising, marketing, publicizing and promotion of the film in all media (referred to in the aggregate as the distributor’s costs). The distributor’s costs are not included in film inventory.
We account for our film inventory under the guidance provided by AICPA Statement of Position 00-2, “Accounting by Producers or Distributors of Films” (“SOP 00-2”). We capitalize all direct film production costs, such as labor costs, visual effects and set construction. Those capitalized costs, along with capitalized production overhead and capitalized interest costs, appear on our balance sheet as an asset called film inventory. Production overhead includes allocable costs, including cash and stock compensation and benefits, of individuals or departments with exclusive or significant responsibility for the production of films. Capitalization of production overhead and interest costs commences upon completion of the requirements for funding the production under the film facility and ceases upon completion of the production. In 2008, 2007 and 2006, we capitalized interest costs of $5.1 million, $8.4 million and $0.2 million, respectively.
We also capitalize the costs of projects in development into film inventory. Those costs consist primarily of script development. In the event that a film does not begin pre-production within three years from the time of the first capitalized transaction, or if an earlier decision is made to abandon the project, all capitalized costs related to these projects are expensed. During 2008 and 2007, $1.7 and $1.3 million, respectively, of film development costs were written off and included in selling, general and administrative expenses in the accompanying consolidated statements of net income.
Once a film is released, using the individual-film-forecast computation method, the amount of film inventory relating to that film is amortized and included in each period’s costs of revenue in the proportion that the film’s revenue during the period bears to the film’s then-estimated total revenue, net of the distributor’s costs, over a period not to exceed ten years (ultimate revenues). Estimates of ultimate revenues for each film are regularly reviewed and revised as necessary based on the latest available information. Reductions in those revenue estimates could result in the write-off, or the acceleration of the amortization, of film inventory in that reporting period; increases in those revenue estimates could result in reduced amortization in that period.
As of December 31, 2008, film inventory, net of amortization, primarily relates to the Iron Man and The Incredible Hulk productions.
Film Revenue
The amount of revenue recognized from our films in any given period depends on the timing, accuracy and sufficiency of the information we receive from our distributors.
After remitting to us five percent of the film’s gross receipts, the distributor is entitled to retain a fee based upon the film’s gross receipts and to recoup all of its costs on a film-by-film basis prior to our receiving any additional share of film receipts. Any of the distributor’s costs for a film that are not recouped against receipts for that film are borne by the distributor. Our share of the film’s receipts, as described above, is recognized as revenue when reported due to us by the distributor, and as noted above, will not occur until the distributor has recovered their costs. We have also received minimum guarantees from local distributors in five territories. In those territories, we began to recognize revenue when the film was made available for exhibition in theaters.

 

F-10



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Revenue from the sale of home video units is recognized when our distributors report as due to us the home video sale proceeds that they have collected from retailers. We provide for future mark-downs and returns of home entertainment product at the time the related revenue is recognized, using estimates. Our estimates are calculated by analyzing a combination of our distributors’ historical returns and mark-down practices, our distributors’ estimates of returns of our home video units, current economic trends, projections of consumer demand for our home video units and point-of-sale data available from retailers. We periodically review our estimates using the latest information available.
As of December 31, 2008, we recorded a receivable of $119.5 million due from a distributor, primarily related to net collected revenue from the Iron Man film. This receivable was collected in full on February 17, 2009.
Revenue from both free and pay television licensing agreements is recognized at the time the production is made available for exhibition in those markets.
Deferred Financing Costs
Deferred financing costs relate to our film facility (see Note 4) and are being amortized over the minimum expected term of the facility, which approximates 4.5 years. Amortization for each of the years ended December 31, 2008, 2007 and 2006 was $5.0 million.
Treasury Shares
We account for treasury shares using the cost method. During the year ended December 31, 2008, we repurchased 0.4 million shares of our common stock at a cost of $10.5 million. During 2007, we repurchased 8.5 million shares of our common stock at a cost of $212.0 million under two stock repurchase programs. As of December 31, 2008, 31.4 million of our shares held in treasury are pledged as collateral under the HSBC Line of Credit, as defined in Note 4 below.
Comprehensive Income
We follow the provisions of SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), which established standards for reporting and display of comprehensive income or loss and its components. Comprehensive income or loss reflects the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. For us, comprehensive income represents net income adjusted for the unrecognized loss related to the minimum pension liability of a former subsidiary and cumulative foreign currency translation adjustments associated with our foreign subsidiary. In accordance with SFAS 130, we have chosen to disclose comprehensive income in our accompanying Consolidated Statements of Stockholders’ Equity and Comprehensive Income. Other comprehensive loss is reflected net of income tax benefit (expense) of ($0.1) million in 2008, $0.7 million in 2007 and ($0.2) million in 2006.

 

F-11



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Revenue Recognition
Book Sales, Sales Returns and Customer Allowances
Trade paperback and hardcover book sales, returnable comic books and custom publishing, are recorded when title and risk of ownership have passed to the buyer. Provisions for future returns and other sales allowances are established based upon historical experience, adjusting for current economic and other factors affecting the customer. We regularly review and revise, when considered necessary, our estimates of sales returns based primarily upon actual returns, and estimated sell-through at the retail level. No provision for sales returns is provided when the terms of the underlying sales do not permit the customer to return product to us. Return rates for returnable comic book sales, traditionally sold at newsstands and bookstores, are typically higher than those related to trade paperback and hardcover book sales.
Comic book revenues — non-returnable and other
Sales of comic books to the direct market, our largest channel of comic book distribution, are made on a non-returnable basis and related revenues are recognized in the period the comic books are made available for sale (on-sale date established by us). Revenue from advertising in our comic books is also recognized in the period that the comic books are made available for sale. Subscription revenues related to our comic book business are generally collected in advance for a one-year subscription and are recognized as income on a pro rata basis over the subscription period as the comic books are delivered. Online advertising revenue is recognized in the period the advertisements are delivered. Subscription revenues related to our digital comic book business are generally collected in advance and are recognized as income on a pro rata basis over the subscription period, which ranges from one month to one year.
License Revenues
Revenue from licensing our characters is recorded in accordance with guidance provided in Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition” (an amendment of Staff Accounting Bulletin No. 101 “Revenue Recognition”) (“SAB 104”). Under the SAB 104 guidelines, revenue is recognized when the earnings process is complete. This is considered to have occurred when persuasive evidence of an agreement between us and the customer exists, when the characters are freely and immediately exploitable by the licensee and we have satisfied our obligations under the agreement, when the amount of revenue is fixed or determinable and when collection of unpaid revenue amounts is reasonably assured.
For licenses that contain non-refundable minimum payment obligations to us, we recognize such non-refundable minimum payments as revenue at the inception of the license, prior to the collection of all amounts ultimately due, provided all the criteria for revenue recognition under SAB 104 have been met. Receivables from licensees due more than one year beyond the balance sheet date are discounted to their present value.
The earnings process is not complete if, among other things, we have significant continuing involvement under the license, we have placed restrictions on the licensee’s ability to exploit the rights conveyed under the contract or we owe a performance obligation to the licensee. In the case where we have significant continuing involvement or where any restrictions remain on the licensee’s rights (e.g., no sales of products based on a specific character allowed until a future date), we recognize revenue as the licensee reports its sales and corresponding royalty obligation to us. Where we have a performance obligation, minimum royalty collections are not recognized until our performance obligation has been satisfied. Minimum payments collected in advance of recognition are recorded as deferred revenue. In any case where we are unable to determine that the licensee is sufficiently creditworthy, we recognize revenue only to the extent of cash collections. When cumulative reported royalties exceed the minimum royalty payments, the excess royalties are recorded as revenue when collected and are referred to as “overages”.

 

F-12



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
As discussed in Note 1, beginning in 2008 we are including revenues earned from Hasbro, and related expenses, in our Licensing segment.
Revenues related to the licensing of animation are recognized when persuasive evidence of a sale or licensing arrangement with a customer exists, when an episode is delivered in accordance with the terms of the arrangement, when the license period of the arrangement has begun and the customer can begin its exhibition, when the arrangement fee is fixed or determinable, and when collection of the arrangement fee is reasonably assured.
Advertising Costs
Advertising production and media costs are expensed when the advertisement is first run. For the years ended December 31, 2008, 2007, and 2006, advertising expenses were $1.4 million, $1.7 million and $3.0 million, respectively. As noted above, advertising costs for our self-produced films are borne by our distributors.
Studio and Talent Share of Royalties
We share merchandise licensing revenues with movie studio licensees for Marvel characters portrayed in theatrical releases. Typically, the studio is paid up to 50% of the total license income derived from licensing for a specific character, in most cases net of a distribution fee retained by us, and in some instances with adjustments for characters that have generated sales prior to the theatrical release. In accounting for amounts payable to studios under multi-character licensing agreements, we make an initial estimate of how minimum guarantees recognized as revenue will be shared among the various studios. This estimate is subsequently adjusted based on actual royalties reported to us by our licensees. We also share merchandise licensing revenue with talent for the use of their likeness in licensed products. We accrue our obligation to talent based upon the talent’s contractual participation rate. In the case of licensed films, we depend on the licensee to provide that information to us. In 2008, 2007 and 2006, we provided $27.2 million, $42.8 million and $23.6 million, respectively, for the share of royalties due to movie studios and talent. The 2008 expense reflects an $8.3 million reduction to our estimate of royalties payable to talent.
Income Taxes
We use the liability method of accounting for income taxes as prescribed by Financial Accounting Standard No. 109, Accounting for Income Taxes (“SFAS 109”). Under this method, income tax expense is based on reported income before income taxes, and deferred income taxes are recorded as a result of temporary differences between the amounts of assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes, measured using enacted tax rates and laws that are expected to be in effect when the differences reverse.
Income tax expense includes U.S. federal, state and local, and foreign income taxes, including U.S. federal taxes on undistributed earnings of foreign subsidiaries to the extent that such earnings are not permanently reinvested.
We consider future taxable income and potential tax planning strategies in assessing the potential need for valuation allowances against our deferred tax assets. If actual results differ from estimates or if we adjust these assumptions in the future, we may need to adjust our deferred tax assets or liabilities, which could impact our effective tax rate in future periods.

 

F-13



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
On January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertain income tax positions. This interpretation requires us to recognize in the consolidated financial statements only those tax positions which we have determined to be more likely than not sustainable upon examination, based on the technical merits of the positions under the presumption that the taxing authorities have full knowledge of all relevant facts (see Note 9). The determination of which tax positions are more likely than not sustainable requires us to use significant judgments and estimates, which may or may not be borne out by actual results.
Foreign Currency Translation
The financial position and results of all of our foreign operations are measured using the local currency as the functional currency. Assets and liabilities of foreign subsidiaries are translated at the exchange rate in effect at year-end. Income statement accounts and cash flows of foreign subsidiaries are translated at the average rate of exchange prevailing during the period.
Pension
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and recognize changes in the funded status in the year in which the changes occur. SFAS 158 also eliminates the option to use an early measurement date effective for fiscal years ending after December 15, 2008. We adopted the recognition provisions of SFAS 158 effective December 31, 2006, and early adopted the measurement provision in the first quarter of 2007. The impact of this adoption was minimal as a result of our already reporting our unfunded obligation related to the Fleer/Skybox Plan (as defined in Note 10), a frozen plan, as a liability in the statement of financial position.
Stock-Based Compensation
We account for stock-based compensation cost under the provisions of SFAS No. 123(R) “Share-Based Payment” (“SFAS 123R”), which establishes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS 123R, stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant). SFAS No. 123R also requires the related excess tax benefit received upon exercise of stock options or vesting of restricted stock to be reflected in the statement of cash flows as a financing activity rather than an operating activity. In connection with the implementation of SFAS No. 123R, we elected the short-cut method in determining our additional paid-in capital pool of windfall benefits and the graded vesting method to amortize compensation expense over the service period.
We did not grant any stock option awards during 2008, 2007 or 2006. As of December 31, 2007, all of our issued stock options have vested and, accordingly, we have no remaining unrecognized compensation cost related to nonvested stock option awards and therefore, there was no compensation expense related to previously granted stock options in 2008. During the years ended December 31, 2007 and 2006, we recognized $2.3 million and $5.9 million, respectively, of compensation expense associated with previously granted stock options, which was classified in selling, general and administrative expense. The charge for the years ended December 31, 2007 and 2006, net of income tax benefit of $0.9 million and $2.3 million, respectively, has reduced basic and diluted earnings per share by $0.02 and $0.04, respectively. The tax benefit realized from stock-based compensation totals $8.7 million, $2.5 million and $64.8 million (due to higher than usual stock option exercises) for the years ended December 31, 2008, 2007 and 2006, respectively.

 

F-14



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
We used the Black-Scholes option pricing model to value the compensation expense associated with our stock option awards under SFAS 123R. In addition, we estimated forfeitures when recognizing compensation expense associated with our stock options, and adjusted our estimate of forfeitures when they were expected to differ. Key input assumptions used to estimate the fair value of stock options include the market value of the underlying shares at the date of grant, the exercise price of the award, the expected option term, the expected volatility (based on historical volatility) of our stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and our expected annual dividend yield.
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, the option valuation model requires the input of highly subjective assumptions. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing model does not necessarily provide a reliable measure of the fair value of our employee stock options.
Concentration of Risk
Our publishing and licensing activities generally do not require collateral or other security with regard to balances due from customers. We extend credit to our customers in the normal course of business and perform periodic credit evaluations of our customers, maintaining allowances for potential credit losses. We consider concentrations of credit risk in establishing the allowance for doubtful accounts and believe the recorded allowance amount is adequate.
We distribute our comic books to the direct market through Diamond Comic Distributors, Inc., which handles the vast majority of all publishers’ direct market distribution. Termination of this distribution agreement, or Diamond’s inability to perform under it, could significantly disrupt our publishing operations.
In the third quarter of 2008, we entered into a distribution agreement with Paramount Pictures Corporation and Viacom Overseas Holdings C.V. (collectively, “Paramount”). Pursuant to this, Paramount has agreed to distribute our next four self-produced feature films. Termination of this distribution agreement could significantly disrupt our film production operations.
Earnings Per Share
In accordance with SFAS No. 128 “Earnings Per Share”, basic income per share is computed by dividing net income attributable to common stock by the weighted average number of shares of common stock outstanding during the periods. The computation of diluted income per share is similar to the computation of basic income per share, except the number of shares is increased assuming the vesting of restricted stock and the exercise of dilutive stock options and warrants, using the treasury stock method, unless the effect is anti-dilutive. For the years ended December 31, 2008, 2007 and 2006, 333,333, 375,000 and 948,508 of stock options, respectively, with exercise prices greater than the average fair market price for the period, were anti-dilutive and not included in the diluted earnings per share calculations because of their anti-dilutive effect. In addition, a warrant, issued in 2005, to purchase 260,417 shares of our common stock with an exercise price greater than the average fair market price for a period, was anti-dilutive and not included in the diluted earnings per share calculations because of its anti-dilutive effect during the first three quarters of 2006. In the fourth quarter of 2006 through the third quarter of 2007, this warrant was in the money, and included in the diluted earnings per share calculation. In September 2007, these warrants were exercised in a cashless exercise that resulted in the issuance of 19,830 shares of common stock.

 

F-15



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
2. Summary of Significant Accounting Policies (continued)
Recent Accounting Standards Adopted in 2008
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a common definition for fair value to be applied to GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS 157 is effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007. FSP FAS No. 157-2, “Partial Deferral of the Effective Date of Statement 157” (“FSP 157-2”), deferred the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. We do not expect the adoption of FSP 157-2 to have a material impact on our consolidated financial statements. In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP 157-3). FSP 157-3 clarifies the application of SFAS 157 when the market for a financial asset is not active. FSP 157-3 was effective upon issuance, including reporting for prior periods for which financial statements have not been issued. The adoption of FSP 157-3 for reporting as of December 31, 2008 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 became effective for the fiscal year beginning January 1, 2008. We did not elect the fair value option for any items under SFAS 159.
Recent Accounting Standards Not Yet Adopted
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, the goodwill acquired and any noncontrolling interest in the acquiree. This statement also establishes disclosure requirements to enable the evaluation of the nature and financial effect of the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008. We do not expect the adoption of this statement to have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. We do not expect the adoption of this statement to have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 expands quarterly disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We do not expect the adoption of this statement to have a material impact on disclosures in our consolidated financial statements.

 

F-16



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
3. Details of Certain Balance Sheet Accounts
                 
    December 31,  
    2008     2007  
    (in thousands)  
Accounts receivable, net, consists of the following:
               
Licensing:
               
Accounts receivable
  $ 9,434     $ 13,330  
Less allowances for doubtful accounts
    (278 )     (626 )
 
           
Total licensing
    9,156       12,704  
 
           
Publishing:
               
Accounts receivable
    30,474       29,345  
Less allowances for:
               
Doubtful accounts
    (266 )     (175 )
Allowance for returns
    (14,460 )     (15,019 )
 
           
Total publishing
    15,748       14,151  
 
           
Film Production
               
Accounts receivable (See Note 2)
    119,459        
 
           
All Other:
               
Accounts receivable
    124       2,124  
Less allowances for doubtful accounts
          (300 )
 
           
Total All Other
    124       1,824  
 
           
Total
  $ 144,487     $ 28,679  
 
           
Inventories, net, consists of the following:
               
Publishing:
               
Finished goods
  $ 5,734     $ 5,264  
Editorial and raw materials
    5,628       4,904  
 
           
Total publishing
    11,362       10,168  
 
           
All Other:
               
Finished goods
          479  
 
           
Total
  $ 11,362     $ 10,647  
 
           
Accounts receivable — licensing, non-current portion are due as follows:
               
2009
  $     $ 1,370  
2010
    1,381        
Discounting
    (60 )     (70 )
 
           
Total
  $ 1,321     $ 1,300  
 
           
Film inventory, net, consist of the following:
               
Theatrical Films
               
Released, net of amortization
  $ 172,224     $  
In Production
          261,826  
In development or pre-production
    7,257       2,991  
 
           
Total
    179,481       264,817  
 
           
Animated television productions
               
In development or pre-production
    2,083        
 
           
 
               
Total film inventory, net
  $ 181,564     $ 264,817  
 
           

 

F-17



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
3. Details of Certain Balance Sheet Accounts (continued)
                 
    December 31,  
    2008     2007  
    (in thousands)  
Accrued royalties consists of the following:
               
Merchandise royalty obligations
  $ 1,556     $ 2,796  
Freelance talent
    4,005       4,570  
Studio and talent share of royalties
    71,019       77,328  
 
           
Total
  $ 76,580     $ 84,694  
 
           
Accrued expenses and other current liabilities consist of the following:
               
Inventory purchases
  $ 2,030     $ 2,327  
Bonuses
    12,860       8,059  
Legal fees and litigation accruals
    2,111       1,625  
Licensing common marketing fund
    9,441       7,498  
Interest
    3,675       5,639  
Other accrued expenses
    10,518       11,864  
 
           
Total
  $ 40,635     $ 37,012  
 
           
Based on our current estimates, approximately $93.3 million of film inventory for our released films is expected to be amortized during the twelve-month period beginning on January 1, 2009 using the individual-film-forecast computation method. In addition, based on our current estimates of ultimate revenue from our released feature films, we expect to amortize approximately 84% of unamortized film inventory of released films at December 31, 2008 during the three-year period beginning January 1, 2009.
4. Debt Financing
Our debt facilities, used in connection with our film-production activities, and our general corporate credit line are described below.
Film Facilities
Film Facility
MVL Film Finance LLC maintains a $525 million credit facility for producing theatrical motion pictures based on some of our specified characters. MVL Film Finance LLC’s ability to borrow under the film facility expires on September 1, 2012. The film facility expires on September 1, 2016, subject to extension by up to ten months under certain circumstances. The expiration date and final date for borrowings under the film facility occur sooner if the films produced under the facility fail to meet certain defined performance measures. The film facility consists of $465 million in revolving senior bank debt and $60 million in mezzanine debt, which is subordinated to the senior bank debt and, as discussed below, was repurchased by us. Both Standard & Poor’s, a division of the McGraw-Hill Companies, Inc., and Moody’s Investor Rating Service, Inc. have given the senior bank debt investment grade ratings. In addition, Ambac Assurance Corporation has insured repayment of the senior bank debt. In exchange for the repayment insurance, we pay Ambac a fee calculated as a percentage of senior bank debt but in no event less than $3.4 million per year. The interest rates for outstanding senior bank debt, and the fees payable on unused senior bank debt capacity, both described below, include the percentage fee owed to Ambac (assuming the minimum has been reached).

 

F-18



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
4. Debt Financing (continued)
During 2008, our wholly-owned subsidiary, MVL International C.V. repurchased all $60 million of the mezzanine debt for $58.1 million, which resulted in a gain of $1.9 million that is included in other income in the accompanying consolidated statement of net income. The mezzanine debt remains outstanding and MVL International C.V. receives the interest payments made by MVL Film Finance LLC with respect to this debt. The interest expense and interest income related to the mezzanine debt are therefore eliminated in our consolidated results and our consolidated financial position does not include the mezzanine debt.
All future interest payable under the film facility must now be paid from the films’ net collections, rather than from any of our other sources of cash. Effective December 31, 2008, the film facility requires us to maintain a liquidity reserve of $25 million, included in restricted cash, to cover future interest payments in the event that the films’ net collections are not sufficient to make these payments. If we do not release a film in 2010, 2011 and 2012 or our sixth film under the facility by August 26, 2012, the liquidity reserve requirement will be increased to $45 million.
The film facility also requires us to maintain an interest reserve equal to the subsequent quarter’s estimated interest. As of December 31, 2008, this reserve was $6.4 million and is included in restricted cash.
The interest rate for outstanding senior bank debt is currently LIBOR (1.43% at December 31, 2008) or the commercial paper rate, as applicable, plus 2.935%. The LIBOR rate on our outstanding senior bank debt resets to the quoted LIBOR rate two business days preceding the commencement of each calendar quarter. The commercial paper rate resets periodically depending on how often our lenders issue commercial paper to fund their portion of our outstanding debt. The weighted average interest rate of our senior bank debt was 5.78% at December 31, 2008. The interest rate for the mezzanine debt is LIBOR plus 7.0%. As noted above, we have repurchased the mezzanine debt and, accordingly, interest expense, from the dates of repurchase, related to the mezzanine debt is no longer reflected in our consolidated operating results.
The film facility requires us to pay a fee on any senior bank debt capacity that we are not using. This fee is currently 0.90%, and is applied on $465 million reduced by the amount of any outstanding senior bank debt.
On June 5, 2008, Ambac’s rating was downgraded by S&P from AAA to AA. The downgrade caused an increase of 1.30% in our interest rate for outstanding senior bank debt and an increase of 0.30% in the fee payable on our unused senior bank debt capacity. These increases are reflected in the rates noted above. Any further downgrades of Ambac’s rating, such as the one by Moody’s on November 5, 2008 (to Baa1), do not affect our rate of interest or fees under the film facility.
If the senior bank debt’s rating (without giving effect to Ambac’s insurance) by either S&P or Moody’s were to fall below investment grade, the interest rate for the outstanding senior bank debt would increase by up to an additional 0.815%. In addition, if the ratio of our indebtedness, excluding the film facility, to our total capital, defined as our consolidated equity plus indebtedness excluding film facility indebtedness, were to exceed 0.4 to 1.0, then the interest rate for outstanding senior bank debt could increase by up to an additional 0.50%. In light of recent adverse developments in the credit markets, we have assessed the economic impact on our film production activities from the actual and potential increases in interest rates described above. We do not believe the actual or potential impact from these rate increases to be material.

 

F-19



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
4. Debt Financing (continued)
Proceeds from our films must be used to pay amounts due under the film facility. Although the principal under our film facility is not due until September 1, 2016, at the earliest, interest and facility fees are due on a quarterly basis. The excess funds remaining after payment of all amounts due under the film facility are deposited into a “borrower-blocked” account. Amounts in the borrower-blocked account are applied to fund required reserves (discussed above) and pay amounts that become due under the film facility (such as interest and Ambac fees). If the reserves are fully funded and all amounts due have been paid, additional amounts may, at Marvel’s discretion, either be retained in the borrower-blocked account, used to fund future production costs, or used to repay film facility debt. Upon our completion of three films, amounts in the borrower blocked account may also, at our discretion, be distributed to us on an unrestricted basis, provided that these funds exceed certain thresholds. During the year ended December 31, 2008, in addition to the repurchase of the mezzanine debt, we funded the required reserves described above and repaid $62.8 million of film facility debt, using a combination of net collections from our films and our own funds.
The borrowings under the film facility are non-recourse to us and our affiliates, other than MVL Film Finance LLC. In other words, only MVL Film Finance LLC, and not our other affiliated companies, will be responsible for paying back amounts borrowed under the film facility. MVL Film Finance LLC has pledged all of its assets, principally consisting of the theatrical film rights to the characters included in the film facility and the rights to completed films or films in production, as collateral for the borrowings. The film facility requires the maintenance of a minimum tangible net worth, a prospective cash coverage test, an historical cash coverage test and an asset coverage ratio, each measured quarterly, and compliance with various administrative covenants. We have maintained compliance with all required provisions of the film facility since its inception.
For any film included in the film facility, an initial funding may be made only if certain conditions are met. The conditions include obtaining a satisfactory completion bond and production insurance for the film, and compliance with representations, warranties and covenants. To obtain a completion bond, we will need to have in place the main operational pieces to producing a film, including approved production, cash flow and delivery schedules, an approved budget, an approved screenplay and the key members of the production crew, including the director. As a condition to the initial funding of the fifth film to be produced under the film facility and each film thereafter, we will have to satisfy an interim asset, which is the asset coverage ratio, discussed above, calculated at the time of this initial funding request. Until recently, we would also have been required, before the fifth film’s funding, either to obtain a cumulative, minimum budget percentage (33%) from our pre-sales of film distribution rights in Australia and New Zealand, Japan, Germany, France and Spain (the “Reserved Territories”), together with the proceeds of any government rebate, subsidy or tax incentive and any other source of co-financing, or to fund that budget percentage with our own cash (the “Pre-Sales Test”). The Pre-Sale Test has now been effectively subsumed by other terms of the film facility, as explained below. Future distribution in the Reserved Territories will be handled by Paramount, with limited exceptions.
The film facility requires us to fund 33% of the budget of each film distributed under the distribution agreement with Paramount that we entered into in the third quarter of 2008. The film facility will provide up to 67% of the budget (reduced by the proceeds of any co-financing). After deduction of Paramount’s distribution fees and expenses in the Reserved Territories, we will be entitled to recoup our 33% contribution from all film proceeds from the Reserved Territories. Our recoupment will be crossed among all films distributed under the new distribution agreement with Paramount and among all Reserved Territories. After recoupment of our 33% contribution, all additional film proceeds from the Reserved Territories will be used to pay down borrowings under the film facility.

 

F-20



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
4. Debt Financing (continued)
In January 2009, we repaid $16.3 of film facility borrowings with our own cash. That payment, combined with the pre-sales of distribution rights in the Reserved Territories and other co-financing proceeds for Iron Man and The Incredible Hulk, equals 33% of those films’ budgets. Because of the requirement that we fund 33% of future films, we therefore expect to be in compliance, without any further action on our part, with the Pre-Sale Test when it is first applied (upon funding of the fifth film) and at all relevant times thereafter.
We entered into an interest rate cap agreement in connection with the film facility whereby LIBOR is capped at 6.0% for debt outstanding under the film facility up to certain stipulated notional amounts, which vary over the term of the film facility. The notional amount of debt associated with the interest rate cap agreement at December 31, 2008 was $300 million. The interest rate cap is recorded at its fair value of $0.1 million at December 31, 2008 and is included in other assets in the accompanying consolidated balance sheets. Fair value of the interest rate cap at December 31, 2007 was $1.1 million. Gains and losses from changes in the fair value of the interest rate cap are recorded within Other Income in the accompanying consolidated statements of net income. The interest rate cap expires on October 15, 2014.
As of December 31, 2008, MVL Film Finance LLC had $213.0 million ($246.9 million as of December 31, 2007) in outstanding senior bank debt under the film facility. Of these borrowings, $204.8 million are classified as current in the accompanying consolidated balance sheets, which represents the amount we estimate to be repaid over the twelve-month period beginning on January 1, 2009. Borrowings have been used to fund direct production costs of our Iron Man and The Incredible Hulk feature films, to fund the interest payments and liquidity reserve of the film facility, to fund the finance transaction costs related to the closing of the facility and to purchase the interest rate cap. We repaid $127.6 million of our film facility debt in early 2009, using a combination of net collections from Iron Man and our own funds. We expect to borrow approximately $150 million under our film facility during 2009.
Iron Man Facility
On February 27, 2007, we closed a $32.0 million financing with Comerica Bank (the “Iron Man Facility”) through our wholly-owned consolidated subsidiary, Iron Works Productions LLC. The proceeds of this financing were used solely to fund the production of our Iron Man feature film and were collateralized by minimum guarantees related to distributors’ rights to distribute Iron Man in the Reserved Territories. During 2008, the Iron Man Facility was repaid in full using the funds received from these minimum guarantees.
Hulk Facility
On June 29, 2007, we closed a $32.0 million financing with HSBC Bank USA, National Association (the “Hulk Facility”) through our wholly-owned consolidated subsidiary, Incredible Productions LLC. The proceeds of this financing were used solely to fund the production of our The Incredible Hulk feature film and were collateralized by minimum guarantees related to distributors’ rights to distribute The Incredible Hulk in the Reserved Territories. During 2008, the Hulk Facility was repaid in full using the funds received from these minimum guarantees.

 

F-21



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
4. Debt Financing (continued)
Corporate Line of Credit
We maintain a $100 million revolving line of credit with HSBC Bank USA, National Association (the “HSBC Line of Credit”) with a sub-limit for the issuance of letters of credit. The HSBC Line of Credit expires on March 31, 2010. Borrowings under the HSBC Line of Credit may be used for working capital and other general corporate purposes and for repurchases of our common stock. During the quarter ended September 30, 2007, the HSBC Line of Credit was amended to replace the minimum net worth covenant with a net income covenant and a minimum market capitalization requirement. The HSBC Line of Credit, as amended, contains customary event-of-default provisions and a default provision based on our market capitalization. We continue to be in compliance with the covenants of the facility, which include net income, leverage and free cash flow. The HSBC Line of Credit is secured by a lien in (a) our accounts receivable, (b) our rights under our toy license with Hasbro and (c) all of our treasury stock repurchased by us after November 9, 2005. Borrowings under the HSBC Line of Credit bear interest at HSBC’s prime rate or, at our option, at LIBOR plus 1.25% per annum. As of December 31, 2008, we had no borrowings outstanding under the HSBC Line of Credit.
5. Stock-Based Compensation
On April 28, 2005, our stockholders approved our 2005 Stock Incentive Plan (the “2005 Plan”). Since that date, new awards can no longer be made under our 1998 Stock Incentive Plan (the “1998 Plan”) (together with the 2005 Plan, the “Plans”), but all outstanding awards under the 1998 Plan continue in accordance with their terms. The 2005 Plan authorizes a range of awards including stock options, stock appreciation rights, restricted stock, other awards based on common stock, dividend equivalents, performance shares or other stock-based performance awards, and shares issuable in lieu of rights to cash compensation. Eligible recipients of awards under the 2005 Plan include officers, employees, consultants and directors. Under the 2005 Plan, 4.0 million shares plus the approximately 2.6 million shares unused (out of 24 million authorized) under the 1998 Plan at the time of the 2005 Plan’s inception, along with shares subject to awards under the 1998 Plan that are not delivered to the award’s recipient (e.g., because the recipient’s employment ends before the award vests), may be the subject of future awards. Under the 2005 Plan, no more than 2.0 million shares plus any unused portion of the preceding year’s limit may be the subject of awards to any one person during a calendar year as “performance-based” compensation intended to qualify under Section 162(m) of the Internal Revenue Code. During any five-year period, no more than 250,000 shares may be the subject of awards under the 2005 Plan to any one non-employee director. Options granted under the 2005 Plan may not be “repriced” (as defined in the rules of the New York Stock Exchange) without stockholder approval. Our practice has been to provide newly issued shares upon exercise of stock options and for granting of restricted stock.
Information with respect to options issued under the Plans is as follows:
                 
            Weighted  
            Average  
            Exercise  
    Shares     Price  
 
               
Outstanding at January 1, 2008
    2,204,539     $ 14.83  
Canceled
    (88,475 )     16.05  
Exercised
    (982,046 )     8.73  
 
             
Outstanding at December 31, 2008
    1,134,018     $ 20.01  
 
             

 

F-22



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
5. Stock-Based Compensation (continued)
Stock options outstanding at December 31, 2008 are summarized as follows:
                         
    Outstanding and     Weighted Average     Weighted  
    Exercisable     Remaining     Average  
    Options at     Contractual Life —     Exercise  
Range of Exercise Prices   December 31, 2008     (Years)     Price  
 
       
$1.67 – $3.29
    33,038       2.51     $ 2.01  
$3.73 – $6.61
    203,130       3.76     $ 5.10  
$11.23 – $17.32
    286,100       2.95     $ 15.45  
$19.41 – $21.50
    111,750       4.91     $ 19.45  
$25.00 – $35.00
    500,000       0.34     $ 30.00  
At December 31, 2008, 2007 and 2006, there were 1,134,018, 2,204,539 and 2,668,810 exercisable options with a weighted average exercise price of $20.01, $14.83 and $15.26, respectively.
Options granted under the 1998 Plan generally vested in three equal annual installments beginning twelve months after the date of grant. No options have been granted during 2008, 2006 or 2007 under the 2005 Plan. At December 31, 2008, the weighted average remaining contractual life of the options outstanding is 2.12 years, and all of the options are fully vested.
The aggregate intrinsic value of outstanding and vested stock options as of December 31, 2008 was $12.9 million, of which all were vested. The intrinsic value of options exercised during the year ended December 31, 2008 was $23.5 million. The intrinsic value of options exercised during the years ended December 31, 2007 and 2006 was $7.7 million and $173.3 million, respectively.
Restricted Stock
Restricted stock grants generally vest over a three or four-year period. The aggregate market value of restricted stock at the dates of issuance was $9.4 million, $9.6 million and $5.9 million for the years ended December 31, 2008, 2007 and 2006, respectively, and is being recognized over the vesting period (the period over which restrictions lapse). In addition, when recognizing compensation expense associated with our restricted stock, we estimate forfeitures, based on historical trends, and adjust estimates of forfeitures when they are expected to differ. At December 31, 2008, we estimate that 8% of restricted stock grants will be forfeited within the first year of the date granted, an additional 5% within the second year of the date granted and insignificant amount after the second year of the date granted.
For the years ended December 31, 2008, 2007 and 2006, we recognized $6.2 million, $5.5 million and $4.3 million, respectively, of compensation expense associated with restricted stock, which was classified in selling, general and administrative expense.

 

F-23



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
5. Stock-Based Compensation (continued)
The following table summarizes the status of our restricted shares during the year ended December 31, 2008:
                 
            Weighted  
            Average  
            Fair Value at  
    Shares     Grant Date  
 
       
Outstanding at January 1, 2008
    672,968     $ 22.30  
Granted during 2008
    379,901       24.25  
Vested during 2008
    (311,270 )     20.84  
Forfeited during 2008
    (35,602 )     21.25  
 
             
Outstanding at December 31, 2008
    705,997     $ 24.34  
 
             
The total remaining unrecognized compensation cost related to restricted stock awards is $10.4 million as of December 31, 2008. The weighted average period over which this cost is expected to be recognized is 2.3 years. The total fair value of restricted stock vested during the year ended December 31, 2008 was $6.5 million.
As of December 31, 2008, we had reserved a total of 7.0 million shares of our common stock for issuance under the Plans, including 4.0 million shares that are available for future grants under the 2005 Plan.
Stock Units
Each of our stock units provides its holder with the right to receive a share of our common stock as soon as we reasonably anticipate that our U.S. federal income tax deduction for the compensation resulting from the issuance of the stock will not be limited or eliminated by application of Section 162(m) of the Internal Revenue Code. The units were granted in exchange for restricted shares of our common stock, and were subject to forfeiture until the vesting date of the stock exchanged. All of the units are vested. As of December 31, 2008, 35,966 stock units remain outstanding and subject to settlement.
6. Fair Value Measurements
SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS 157 classifies the inputs used to measure fair value into the following hierarchy:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities
Level 2: Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability
Level 3: Unobservable inputs for the asset or liability

 

F-24



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
6. Fair Value Measurements (continued)
We endeavor to utilize the best available information in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth our financial assets and liabilities that were accounted for, at fair value, on a recurring basis as of December 31, 2008:
                                 
    Recurring Fair Value Measurements Using  
    Total Fair
Value
    Level 1     Level 2     Level 3  
    (in thousands)  
Financial Assets:
                               
Investment securities
  $ 32,975     $ 32,975     $     $  
Interest rate cap
    100             100        
At December 31, 2008, we held $33.0 million of short-term investment securities, which consists of US Treasury Bills with an original maturity of more than three months. Our short-term investments are classified as available-for-sale securities.
We are exposed to market risks from changes in interest rates, which may adversely affect our operating results and financial position. When deemed appropriate, we minimize our risks from interest rate fluctuations using derivative financial instruments. Derivative financial instruments are used to manage risk and are not used for trading or other speculative purposes. We do not use leveraged derivative financial instruments. The interest rate cap is valued using broker quotations, or market transactions either in the listed or over-the counter markets. As such, these derivative instruments are classified within level 2. Gains and losses from changes in the fair value of the interest rate cap are recorded within other income in the accompanying consolidated statements of net income.
The estimated fair value of certain of our financial instruments, including cash and cash equivalents, current portion of accounts receivable, accounts payable and accrued expenses approximate their carrying amounts due to their short term maturities. The non-current portion of accounts receivable have been discounted to their net present value, which approximates fair value. The carrying value of our film facility debt approximates its fair value because the interest rates applicable to such debt are based on floating rates identified by reference to market rates.
7. Sales to Major Customers
Credit is extended based on an evaluation of the customer’s financial condition and generally, collateral is not required. Credit losses are provided for in the financial statements and have been consistently within our expectations.
During the years ended December 31, 2008 and 2007, Hasbro accounted for 16% and 21%, respectively, of Licensing segment net sales.
We distribute our comic books and trade paperbacks to the direct market through Diamond. During the years ended December 31, 2008, 2007 and 2006, net sales made through Diamond to the direct market accounted for 69%, 68% and 70%, respectively, of Publishing segment net sales. Diamond also distributes our trade paperbacks to mass bookstore merchandisers. Total net sales made through Diamond during the years ended December 31, 2008, 2007 and 2006 accounted for 81%, 81% and 80%, respectively, of Publishing segment net sales and 15%, 21% and 25%, respectively, of our consolidated net sales. Diamond also accounted for 7% and 34% of total consolidated accounts receivable at December 31, 2008 and 2007, respectively.

 

F-25



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
8. Income Taxes
The provision (benefit) for income taxes is based upon income (loss) before taxes as follows:
                         
    Years ended December 31,  
    2008     2007     2006  
    (in thousands)  
United States
  $ 350,554     $ 266,363     $ 88,327  
Foreign jurisdictions
    3,944       (3,131 )     10,473  
 
                 
Total
  $ 354,498     $ 263,232     $ 98,800  
 
                 
The provision (benefit) for income taxes is summarized as follows:
                         
    Years ended December 31,  
    2008     2007     2006  
    (in thousands)  
Current:
                       
Federal
  $ 100,785     $ 76,253     $ 33,016  
State and local
    14,989       17,518       803  
Foreign (1)
    5,906       3,976       5,552  
 
                 
 
    121,680       97,747       39,371  
 
                 
 
                       
Deferred:
                       
Federal
    4,581       (3,562 )     (2,663 )
State and local
    6,958       4,815       2,381  
Foreign
    (39 )     (92 )     (18 )
 
                 
 
    11,500       1,161       (300 )
 
                 
 
                       
Income tax expense
  $ 133,180     $ 98,908     $ 39,071  
 
                 
     
(1)   Current foreign taxes include foreign withholding taxes in the amount of $5.4 million, $4.4 million, and $3.1 million for 2008, 2007, and 2006, respectively.
The differences between the statutory federal income tax rate and the effective tax rate are attributable to the following:
                         
    Years ended December 31,  
    2008     2007     2006  
Federal income tax provision computed at the statutory rate
    35.0 %     35.0 %     35.0 %
State and local taxes, net of federal income tax benefit
    4.0 %     6.1 %     3.2 %
Joint venture minority interest
    (1.6 )%     (3.3 )%     (0.4 )%
Foreign taxes
          0.2 %     0.7 %
Other
    0.2 %     (0.4 )%     1.0 %
 
                 
Total provision for income taxes
    37.6 %     37.6 %     39.5 %
 
                 
We are not responsible for the income taxes related to the minority share of the Joint Venture’s earnings. The tax liability associated with the minority share of the Joint Venture’s earnings is therefore not reported in our income tax expense, even though the Joint Venture’s entire income is consolidated in our reported income before income tax expense. Joint Venture earnings therefore have the effect of lowering our effective tax rate. This effect is more pronounced in periods in which Joint Venture earnings are higher relative to our other earnings.

 

F-26



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
8. Income Taxes (continued)
We retain various state and local net operating loss carryforwards of $316 million, which will expire in various jurisdictions in the years 2009 through 2026. The tax benefit on $93 million of this amount will be recorded as additional paid-in capital when realized, consistent with SFAS 123R, as it is attributable to tax deductions from exercises of stock options. As of December 31, 2008, there is a valuation allowance of $0.3 million against capital loss carryforwards, as we believe it is more likely than not that such assets will not be realized in the future.
For financial statement purposes, we record income taxes using the liability approach of SFAS 109, which results in the recognition and measurement of deferred tax assets based on the likelihood of realization of tax benefits in future years. Deferred taxes result from temporary differences between the recognition of income and expenses for financial reporting purposes and on income tax returns. The significant components of our deferred tax assets and liabilities are as follows:
                 
    December 31,  
    2008     2007  
    (in thousands)  
Deferred tax assets:
               
Accounts receivable
  $ 204     $ 398  
Inventory
    1,147       867  
Depreciation/ amortization
    180       103  
Sales reserves
    3,504       4,202  
Employment reserves
    4,613       5,767  
Minimum pension liability
    1,744       1,932  
Other reserves
    1,109       1,084  
Loss carryforwards
    8,564       12,448  
Deferred revenue
    26,600       18,260  
Federal benefit of reserves
    20,258       14,545  
Tax credits
    887        
 
           
Total gross deferred tax assets
    68,810       59,606  
Less valuation allowance
    (322 )     (1,234 )
 
           
Net deferred tax assets
    68,488       58,372  
 
           
Deferred tax liabilities:
               
Unremitted foreign earnings
    (186 )      
Film revenue
    (21,198 )      
 
           
Total gross deferred tax liabilities
    (21,384 )      
 
           
Net deferred tax assets
  $ 47,104     $ 58,372  
 
           
We adopted the provisions of FIN 48 on January 1, 2007 and, as a result, we recognized an increase in reserves for uncertain tax positions of approximately $26 million, including interest (net of tax benefit) and penalties, resulting in a total liability for unrecognized tax benefits (“UTBs”) under FIN 48 of $36 million. The increase in reserves for uncertain tax positions was partially offset by deferred tax assets established to recognize the correlative impact of federal, state and local, and foreign uncertain tax positions. As a result of FIN 48’s adoption, we recorded a net reduction of approximately $19 million to our January 1, 2007 retained earnings balance.

 

F-27



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
8. Income Taxes (continued)
A reconciliation of the beginning and ending amounts of UTBs is as follows:
                 
    December 31,  
    2008     2007  
    (in thousands)  
 
       
Balance at January 1
  $ 51,900     $ 36,000  
Additions based on tax positions related to the current year
    13,000       14,500  
Reductions based on tax positions related to the current year
           
Additions for tax positions of prior years
    3,300       1,600  
Reductions for tax positions of prior years
    (9,400 )      
Settlements with taxing authorities
    (1,100 )      
Expirations of statutes of limitations
    (600 )     (200 )
 
           
Balance at December 31
  $ 57,100     $ 51,900  
 
           
If the December 31, 2008 total amount of UTBs were recognized in the future, the effective tax rate in future periods would be favorably affected by $38.7 million.
The $13.0 million increase to UTBs for the year ended December 31, 2008 resulted from current tax positions claimed in various jurisdictions in which we operate. UTBs decreased by $10.0 million in the current year due to the resolution of certain state and local and foreign tax examinations, and expiring statutes of limitations for the assessment of additional tax liabilities. UTBs also decreased by $1.1 million in the current year due to the settlement of a state tax examination in October 2008. Except for increases attributable to earnings in subsequent periods, we do not expect the remaining UTBs to significantly increase or decrease over the next twelve months.
We file income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. We are no longer subject to examination by U.S. federal, state and local, or foreign tax authorities for years through 2002. New York State has completed examinations of our tax returns through 2007 with no material adjustments. Federal income tax returns for 2003 through 2006 are currently under examination by the Internal Revenue Service (“IRS”). As of December 31, 2008, the IRS has proposed certain adjustments, which are fully reserved for and, if we were to agree to them, would not result in a material change to our financial position.
We record interest and penalties that may be incurred on UTBs as part of income tax expense. During the years ended December 31, 2008 and 2007, interest and penalties totaled $2.8 million and $1.2 million, respectively. At December 31, 2008, we maintained $5.2 million of accrued interest and $0.3 million of accrued penalties on UTBs. At December 31, 2007, we maintained $2.4 million of accrued interest and $0.3 million of accrued penalties on UTBs.
9. Commitments and Contingencies
We have commitments under various operating leases, primarily for office space, certain of which extend through January 31, 2012.
Rent expense related to non-cancelable operating leases amounted to $2.1 million, $2.2 million and $2.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
On September 23, 2008, we entered into a non-cancellable operating lease for the rental of sound stages where we intend to film our next four self-produced films, and for Marvel Studios’ new production and corporate office space, located in Manhattan Beach, California. The lease has an initial term of three years, with four successive one-year extension options. We anticipate making aggregate rental payments under this lease of approximately $14 million over the three-year period beginning January 1, 2009.

 

F-28



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
9. Commitments and Contingencies (continued)
Future minimum rental payments under non-cancelable operating leases as of December 31, 2008 are as follows (in thousands):
         
Year ending December 31:
       
2009
  $ 7,381  
2010
    7,425  
2011
    6,027  
2012
    409  
 
     
Total
  $ 21,242  
 
     
Legal Matters
On January 26, 2009, in the United States District Court for the Southern District of New York, four purported shareholders of Stan Lee Media, Inc. (“SLM”), individually and on behalf of all SLM shareholders, filed a derivative action against Marvel, Isaac Perlmutter (our President and Chief Executive Officer), Avi Arad (a former officer and director), Stan Lee, Joan C. Lee, Joan Lee and Arthur Lieberman. The complaint alleges that SLM is the owner of rights in characters co-created by Mr. Lee while he was employed by our predecessors, the Marvel name and trademark, and Mr. Lee’s name and likeness (collectively, the “Intellectual Property”). The plaintiffs allege that prior to the date Mr. Lee entered into a new employment agreement with us in 1998, Mr. Lee transferred his interest in the Intellectual Property to a predecessor of SLM. Mr. Lee has denied that he had any ownership interest in the Intellectual Property and that any transfer of those rights to SLM ever took place. The complaint in the plaintiffs’ lawsuit also alleges that all defendants committed fraud, were involved in a conspiracy to deprive SLM of its ownership of the Intellectual Property, wrongfully failed to disclose the terms of a 2005 settlement of litigation brought against Marvel by Mr. Lee and wrongfully exploited claimed rights of SLM in the Intellectual Property. The relief sought by the complaint includes a declaration of SLM’s rights in the Intellectual Property, compensatory and punitive damages of $750 million based on alleged breaches of fiduciary duty, unspecified damages for fraud, inducing a breach of fiduciary duty and civil conspiracy, an accounting of profits and the imposition of a constructive trust, unspecified treble damages for violations of SLM’s Lanham Act rights, SLM’s rights of publicity and for unfair business practices. We believe all claims in the complaint are without merit.
On March 30, 2007, in the United States District Court for the Southern District of Illinois, Gary Friedrich and Gary Friedrich Enterprises, Inc. (“Friedrich”) filed a lawsuit against us, and numerous other defendants including Sony Pictures Entertainment, Inc., Columbia Pictures Industries, Inc., Hasbro, Inc. and Take-Two Interactive Software, Inc. That suit has been transferred to the Southern District of New York. The complaint alleges that Friedrich is the owner of intellectual property rights in the character Ghost Rider and that we and other defendants have exploited the Ghost Rider character in a motion picture and merchandise without Friedrich’s consent. Friedrich has asserted numerous claims including copyright infringement, negligence, waste, state law misappropriation, conversion, trespass to chattels, unjust enrichment, tortious interference with right of publicity, and for an accounting. We believe Friedrich’s claims to be without merit.
We are also involved in various other legal proceedings and claims incident to the normal conduct of our business. Although it is impossible to predict the outcome of any legal proceeding and there can be no assurances, we believe that our legal proceedings and claims, individually and in the aggregate, are not likely to have a material adverse effect on our financial condition, results of operations or cash flows.

 

F-29



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
9. Commitments and Contingencies (continued)
We regularly evaluate our litigation claims to provide assurance that all losses and disclosures are provided for in accordance with SFAS No. 5 “Accounting for Contingencies” (“SFAS 5”). Our evaluation of legal matters involves considerable judgment by us. We engage internal and outside legal counsel to assist in the evaluation of these matters. Accruals for estimated losses, if any, are determined in accordance with the guidance provided by SFAS 5.
10. Benefit Plans
We have a 401(k) plan covering substantially all of our employees. We may make discretionary contributions to this plan. No contributions were made during any of the years ended December 31, 2008, 2007 and 2006.
In addition, in connection with the 1999 sale of the assets of our Fleer and Skybox International subsidiaries, we retained certain liabilities related to the Fleer/Skybox International Retirement Plan (the “Qualified Plan”) and the Skybox Nonqualified Defined Benefit Plan (the “Nonqualifed Plan”), both of which are defined benefit pension plans for employees of those subsidiaries (collectively, the “Fleer/Skybox Plan”). These plans have been amended to freeze the accumulation of benefits and to prohibit new participants. Based on our assumptions, the accumulated benefit obligation was $20.8 million at December 31, 2008 ($20.4 million at December 31, 2007) which exceeded assets by $4.2 million at December 31, 2008 ($4.6 million at December 31, 2007). The Nonqualified Plan is unfunded and has a net liability of $1.0 million at December 31, 2008 and 2007. The current liability, which equals $0.1 million, relates only to the Nonqualified Plan and represents the benefits expected to be paid in the next 12 months from the Nonqualified Plan. The remainder of the Nonqualified Plan’s liability is non-current. The Qualified Plan is underfunded and has a net liability of $3.2 million ($3.6 million at December 31, 2007). Because the Qualified Plan’s assets are sufficient to cover the expected benefits to be paid from this plan in the next twelve months, its liabilities are non-current.
During the first quarter of 2007, we changed our measurement date from September 30 to December 31 for the Fleer/Skybox Plan. In accordance with the measurement date transition provisions of SFAS 158, we remeasured benefit obligations and plan assets as of January 1, 2007. This remeasurement did not have a material impact on the unfunded accumulated benefit obligation or accumulated other comprehensive income.
Plan administrative expenses for the years ended December 31, 2008, 2007 and 2006 were not significant. Pension costs are funded based on the recommendations of independent actuaries, and amounted to $1.1 million, $1.4 million and $1.0 million during 2008, 2007 and 2006, respectively. We expect contributions for our pension plan in 2009 to be approximately $0.7 million. Expected benefit payments are based on the same assumptions used to measure the year-end benefit obligations.

 

F-30



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
10. Benefit Plans (continued)
We target approximately 85% of our pension plan assets to be invested in a combination of commercial paper, a stable return fund and an intermediate government securities fund, based on the risk tolerance characteristic of the plan, which may be adjusted in the future to achieve our overall investment objective. The balance of the plan assets are invested in various common stocks, including, from time to time, our shares. We develop our expected long-term rate of return assumption based on the historical experience of our portfolio and the review of projected returns by asset class. The discount rate, determined at each measurement date, is based on the Moody’s Aa Corporate Bond Index yield, a commonly used index for determining pension obligations. This index is an average of the Utilities and Industrial bond indices. The plan provides for the payment of benefits at any time.
Our plan asset allocations (at the measurement dates) and target allocations are summarized as follows:
                                 
    Percentage of     Percentage of     Percentage of        
    Plan Assets     Plan Assets     Plan Assets     % Target  
    at September 30,     at December 31,     at December 31,     Allocation in  
    2006     2007     2008     2009  
 
                               
Equity securities
    25 %     11 %     1 %     15 %
Debt securities
    75 %     89 %     99 %     85 %

 

F-31



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
10. Benefit Plans (continued)
The following table reconciles the projected benefit obligation, plan assets, funded status, and net pension liability for the Fleer/Skybox Plan. The 2008 and 2007 column includes the twelve months period from January 1 to December 31. The remeasure column includes the three-month period from October 1, 2006 to December 31, 2006, which reflects the change in measurement date from September 30 to December 31. The 2006 column includes the twelve month period from October 1, 2005 to September 30, 2006.
                                 
    2008     2007     Remeasure     2006  
    (in thousands)  
 
                               
Accumulated Benefit Obligation, End of Period
  $ 20,818     $ 20,432     $ 20,645     $ 20,680  
 
                       
 
                               
Change in Projected Benefit Obligation
                               
Projected benefit obligation, beginning of period
  $ 20,432     $ 20,645     $ 20,680     $ 21,711  
Service cost
                       
Interest cost
    1,162       1,152       285       1,141  
Plan amendments
                       
Assumption changes
                       
Actuarial (gain)/loss
    580       (31 )           (595 )
Benefits paid
    (1,356 )     (1,334 )     (320 )     (1,577 )
 
                       
Projected benefit obligation, end of period
  $ 20,818     $ 20,432     $ 20,645     $ 20,680  
 
                       
 
                               
Change in plan assets
                               
Plan assets at fair value, beginning of period
  $ 15,840     $ 14,891     $ 14,777     $ 14,414  
Actual return on plan assets
    1,049       837       212       976  
Company contributions
    1,089       1,446       222       964  
Benefits paid
    (1,356 )     (1,334 )     (320 )     (1,577 )
 
                       
Plan assets at fair value, end of period
  $ 16,622     $ 15,840     $ 14,891     $ 14,777  
 
                       
 
       
Funded status
  $ (4,196 )   $ (4,592 )   $ (5,754 )   $ (5,903 )
Contributions between measurement date and fiscal year-end
                      223  
 
                       
Net pension (liability) at end of period
  $ (4,196 )   $ (4,592 )   $ (5,754 )   $ (5,680 )
 
                       
 
                               
Amounts recognized in the statement of financial position
                               
Non-current assets
  $     $     $     $  
Current liabilities
    (105 )     (105 )     (103 )     (103 )
Non-current liabilities
    (4,091 )     (4,487 )     (5,651 )     (5,577 )
 
                       
Net pension (liability) at end of period
  $ (4,196 )   $ (4,592 )   $ (5,754 )   $ (5,680 )
 
                       
 
                               
Amounts recognized in accumulated other comprehensive income
                               
Net transition obligation
  $     $     $     $  
Prior service cost (credit)
    (312 )     (365 )     (419 )     (433 )
Net actuarial loss
    6,871       6,722       6,833       6,860  
 
                       
 
  $ 6,559     $ 6,357     $ 6,414     $ 6,427  
 
                       

 

F-32



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
10. Benefit Plans (continued)
The components of net periodic pension costs and the significant assumptions used are summarized below:
                         
    2008     2007     2006  
    (dollars in thousands)  
 
                       
Total cost for plan year
                       
Service cost
  $     $     $  
Interest cost
    1,162       1,152       1,141  
Expected return on plan assets
    (828 )     (972 )     (922 )
Amortization of:
                       
Unrecognized net loss
    210       215       244  
Unrecognized prior service cost
    (54 )     (54 )     (54 )
Unrecognized net asset obligation
                 
 
                 
Net periodic pension cost
  $ 490     $ 341     $ 409  
 
                 
 
                       
Measurement date
    12/31/2008       12/31/2007       9/30/2006  
 
                       
Assumptions used for annual expense:
                       
Discount rate
    5.88 %     5.70 %     5.40 %
Expected return on plan assets
    5.25 %     6.50 %     6.50 %
Rate of compensation increase
    N/A       N/A       N/A  
 
       
Assumptions used for year-end disclosure:
                       
Discount rate
    5.62 %     5.88 %     5.70 %
Rate of consumption increase
    N/A       N/A       N/A  
We expect to contribute $0.7 million to the plan in 2009.
Annual expected benefit payments are as follows (in thousands):
         
2009
  $ 1,365  
2010
    1,426  
2011
    1,440  
2012
    1,499  
2013
    1,527  
2014-2018
    8,046  
The estimated net actuarial loss and prior service cost for the plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost during the 2009 fiscal year are $0.2 million and ($0.1 million), respectively. There is no transition obligation to be amortized in 2009.
The amortization of any prior service cost and gains and losses is determined using a straight-line amortization of the cost over the expected lifetime of inactive participants in the plan, since the plan has mostly inactive participants.

 

F-33



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
11. Segment Information
We operate our businesses in three segments: Licensing, Publishing and Film Production.
                                         
                    Film              
    Licensing     Publishing     Production     All Other     Total  
    (in thousands)  
                                       
Net sales
  $ 292,817     $ 125,389     $ 254,571     $ 3,400     $ 676,177  
Operating income (loss)
    242,262       47,315       102,656       (24,259 )     367,974  
 
                                       
Total capital expenditures(1)
    1       1,533       206       644       2,384  
Total identifiable assets
    363,954       74,319       365,414       133,897       937,584  
 
                                       
                                       
Net sales
  $ 343,655     $ 125,657     $     $ 16,495     $ 485,807  
Operating income (loss)
    255,505       53,524       (7,537 )     (27,063 )     274,429  
 
                                       
Total capital expenditures(1)
    142             220       2,297       2,659  
Total identifiable assets
    351,788       71,409       278,887       115,274       817,358  
 
                                       
                                       
Net sales
  $ 132,448     $ 108,464     $     $ 110,886     $ 351,798  
Operating income (loss)
    82,014       44,077       (7,464 )     (6,067 )     112,560  
 
                                       
Total capital expenditures(1)
    1,492                   14,794       16,286  
Total identifiable assets
    366,454       69,710       39,006       148,695       623,865  
     
(1)   Excludes film costs capitalized into film inventory
During early 2008, we completed our exit from toy manufacturing activities as planned. We also completed a change in the focus of the support that we provide to Hasbro, which resulted in changes to our internal organizational structure and staff reductions. These events altered our internal reporting of segment performance, with the result that we are including revenues earned from Hasbro (associated with toys manufactured and sold by Hasbro) and related expenses (associated with royalties that we owe on our Hasbro revenue) within our Licensing segment. Those revenues and expenses were formerly included in our Toy segment. Our remaining activities related to our terminated toy manufacturing business are included with Corporate overhead in “All Other”. We have reclassified prior-period segment information to conform to the current-year presentation. As a result of these changes, segment information for the years ended December 31, 2007 and 2006 has been reclassified as follows:
                                                 
    Year Ended December 31, 2007     Year Ended December 31, 2006  
    Previously             As     Previously             As  
    Reported     Adjustment     Reclassified     Reported     Adjustment     Reclassified  
    (in thousands)  
Net Sales
                                               
Licensing
  $ 272,722     $ 70,933     $ 343,655     $ 127,261     $ 5,187     $ 132,448  
Toys
    87,428       (87,428 )           116,073       (116,073 )      
All Other
          16,495       16,495             110,886       110,886  
 
                                               
Cost of Revenues
                                               
Toys
    8,680       (8,680 )           56,384       (56,384 )      
All Other
          8,680       8,680             56,384       56,384  
 
                                               
Selling, General and Administrative
                                               
Licensing
    75,736       11,564       87,300       49,288       714       50,002  
Toys
    20,806       (20,806 )           27,979       (27,979 )      
All Other
    21,994       9,242       31,236       22,698       27,265       49,963  
 
                                               
Operating Income(Loss)
                                               
Licensing
    196,136       59,369       255,505       77,541       4,473       82,014  
Toys
    54,725       (54,725 )           21,098       (21,098 )      
All Other
    (22,419 )     (4,644 )     (27,063 )     (22,692 )     16,625       (6,067 )

 

F-34



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
11. Segment Information (continued)
Licensing Segment
Our Licensing segment, which includes the operations of the Joint Venture, licenses our characters for use in a wide variety of products and media, the most significant of which are described below. In addition, as part of our efforts to build demand for our licensed consumer products, the Licensing segment has begun producing animated television programming featuring Marvel characters. The animated programming is expected to begin airing in 2009. By controlling the content and distribution of the animation, we hope to increase our consumer products licensing activities more than is possible through animation whose content and distribution is under the control of our animation licensees. Identifiable assets for the Licensing segment as of December 31, 2008 and 2007 include goodwill of $298.4 million.
Consumer Products
We license our characters for use in a wide variety of consumer products, including toys, apparel, interactive games, electronics, homewares, stationery, gifts and novelties, footwear, food and beverages and collectibles.
Studio Licensing
Feature Films. We have licensed some of our characters to major motion picture studios for use in motion pictures. For example, we currently have a license with Sony to produce motion pictures featuring the Spider-Man family of characters. We also have outstanding licenses with studios for a number of our other characters, including The Fantastic Four, X-Men (including Wolverine), Daredevil/Elektra, Ghost Rider, Namor the Sub-Mariner and The Punisher. Under these licenses, we retain control over merchandising rights and retain more than 50% of merchandising-based royalty revenue. We intend to self-produce, rather than license, all future films based on our characters that have not been licensed to third parties.
Television Programs. We license our characters for use in television programs. Several television shows based on our characters are in various stages of development including animated programming based on Iron Man, X-Men (including Wolverine), the Incredible Hulk and Black Panther. Since January 2009, the new animated series “Wolverine and the X-Men” has been airing on Nicktoons Network.
Made-for-DVD Animated Feature Films. We have licensed some of our characters to an entity controlled by Lions Gate Entertainment Corp. to produce up to ten feature-length animated films for distribution directly to the home video market. To date, six titles have been distributed under this arrangement.
Destination-Based Entertainment
We license our characters for use at theme parks, shopping malls and special events. For example, we have licensed some of our characters for use at Marvel Super Hero Island, part of the Islands of Adventure theme park at Universal Orlando in Orlando, Florida, and for use in a Spider-Man attraction at the Universal Studios theme park in Osaka, Japan. We have also licensed our characters for the development of theme parks in Dubai and in South Korea.
Promotions
We license our characters for use in short-term promotions of other companies’ products and services.

 

F-35



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
11. Segment Information (continued)
Publications
Our Licensing segment licenses our characters to publishers located outside the United States for use in foreign-language comic books and trade paperbacks and to publishers worldwide for novelizations and a range of coloring and activity books.
Publishing Segment
The Publishing segment creates and publishes comic books and trade paperbacks principally in North America. Marvel has been publishing comic books since 1939 and has developed a roster of more than 5,000. Our titles include Spider-Man, X-Men, Fantastic Four, Iron Man, the Incredible Hulk, Captain America, the Avengers, and Thor. In addition to revenues from the sale of comic books and trade paperbacks, the Publishing segment derives revenues from sales of advertising and subscriptions and from other publishing activities, such as custom comics and digital media activities. Our digital media activities have had a small but growing impact on our Publishing segment revenues, mostly through online advertising and digital comic subscription sales. We expect continued growth and diversification in Marvel Online revenues as we continue to increase our online presence. Identifiable assets for the Publishing segment as of December 31, 2008 and 2007 include goodwill of $42.5 million.
Film Production Segment
Until we began producing our own films, our growth strategy was to increase exposure of our characters by licensing them to third parties for development as movies and television shows. The increased exposure creates revenue opportunities for us through increased sales of toys and other licensed merchandise. Our self-produced movies, the first two of which were released in 2008, represent an expansion of that strategy that also increases our level of control in developing and launching character brands. Our self-produced movies also offer us an opportunity to participate in the films’ financial performance to a greater extent than we could as a licensor.
Our Film Production segment includes our self-produced feature films. Those films are financed primarily with our $525 million film facility. The first two films produced by the Film Production segment were Iron Man, which was released on May 2, 2008, and The Incredible Hulk, which was released on June 13, 2008. We are currently developing four films for release in 2010 and 2011: Iron Man 2, Thor, The First Avenger: Captain America and The Avengers. The scheduled release dates of those films are, respectively, May 7, 2010, July 16, 2010, May 6, 2011 and July 15, 2011. Identifiable assets for the Film Production segment as of December 31, 2008 and 2007 include goodwill of $5.3 million.

 

F-36



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
11. Segment Information (continued)
Revenue by Geographic Area
(in thousands)
                                                 
    2008     2007     2006  
    U.S.     Foreign     U.S.     Foreign     U.S.     Foreign  
 
                                               
Licensing (1)
  $ 170,336     $ 122,482     $ 217,077     $ 126,579     $ 88,336     $ 44,112  
Publishing
    111,737       13,651       113,399       12,258       96,722       11,742  
Film Production
    157,900       96,671                          
All Other (2)
    2,562       838       14,557       1,937       77,790       33,096  
 
                                   
Total
  $ 442,535     $ 233,642     $ 345,033     $ 140,774     $ 262,848     $ 88,950  
 
                                   
     
(1)   Includes U.S. revenue derived from the Joint Venture of $20.8 million, $70.8 million and $3.4 million for 2008, 2007, and 2006, respectively. Includes foreign revenue derived from the Joint Venture of $36.5 million, $51.2 million and $0.7 million for 2008, 2007, and 2006, respectively.
 
(2)   Represents toy sales, associated with our toy manufacturing operations, which ceased during early 2008.
12. Other Income
During January 2008, we received settlement payments in connection with the early termination of two interactive license agreements. We recorded $19.0 million of other income from these settlement payments.
13. Subsequent Event
On February 17, 2009, we amended the film facility to allow us, at our option, to utilize a lower cost completion bond structure. In order to take advantage of this lower cost completion bond structure for a picture, we will need to escrow approximately $26 million ($31.5 million on Iron Man 2) for the duration of production. Upon completion of the film, the escrowed funds will be returned to us. However, the amount of escrowed funds returned to us will be reduced to the extent that the cost of the film exceeds 110% of its budget.
In February 2009, we repurchased 0.3 million shares of our common stock for $6.5 million.

 

F-37



 

MARVEL ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2008
14. Quarterly Financial Data (Unaudited)
Summarized quarterly financial information for the years ended December 31, 2008 and 2007 is as follows:
                                                                 
    2008     2007  
Quarter Ended   March 31     June 30     September 30     December 31     March 31     June 30     September 30     December 31  
    (1)     (2)                     (5)             (4)     (3)  
    (in thousands, except per share data)  
 
       
Net sales
  $ 112,567     $ 156,859     $ 182,499     $ 224,252     $ 151,402     $ 101,475     $ 123,642     $ 109,288  
Net income
    45,231       46,671       50,626       63,007       46,842       29,087       36,268       27,626  
Basic net income per common share
  $ 0.58     $ 0.60     $ 0.65     $ 0.80     $ 0.56     $ 0.35     $ 0.47     $ 0.36  
Dilutive net income per common share
  $ 0.58     $ 0.59     $ 0.64     $ 0.80     $ 0.54     $ 0.34     $ 0.45     $ 0.35  
     
(1)   The quarterly financial data for the quarter ended March 31, 2008 includes settlement payments of $19.0 million, included in other income, received in connection with the early termination of two interactive licensing agreements and are reflected in net income.
 
(2)   The quarterly financial data for the quarter ended June 30, 2008 includes a credit of $8.3 million in selling, general and administrative expense to reflect a reduction in our estimate of royalties payable to actors starring in the Spider-Man movies for the use of their likeness in licensed products.
 
(3)   Quarterly financial data for the quarter ended December 31, 2007 includes out-of-period adjustments of $2.8 million in additional selling, general and administrative expense to correct the estimated amount of royalties payable to actors for the use of their likeness in products over the period 2004 to 2006. The quarterly financial data also includes $1.9 million in additional selling, general and administrative expense to correct the estimated amount of royalties payable to actors for the use of their likeness in products in the first and third quarters of 2007. We do not believe these adjustments are material to this quarter or any previously reported periods.
 
(4)   The quarterly financial data for the quarter ended September 30, 2007 includes unusually high amounts ($16.8 million) received in settlements of licensing audit claims that are reflected in net sales. The quarterly financial data also includes a discrete tax benefit of $1.7 million, primarily due to a reduction of deferred tax liabilities related to our Hong Kong subsidiary, which we do not believe is material to this quarter or any previously reported periods.
 
(5)   The quarterly financial data for the quarter ended March 31, 2007 includes an adjustment to beginning of the year deferred tax assets, which resulted in a discrete income tax charge of $2.6 million, a $3.1 million decrease to additional paid-in-capital and a $4.4 million increase to goodwill. The adjustment to additional paid-in-capital is presented on the accompanying statement of stockholders’ equity and comprehensive income within tax benefit of stock options exercised, net. The net income for the quarter ended March 31, 2007 also includes an adjustment to record a $1.9 million non-recurring credit to selling, general and administrative expenses associated with pension accounting for the Fleer/Skybox Plan. Diluted net income per common share in the first quarter of 2007 incorporates a correction to our weighted average number of diluted shares outstanding that was announced on May 24, 2007. We do not believe that any of these adjustments are material to this quarter or any previously reported periods.
The income per common share computation for each quarter and year are separate calculations. Accordingly, the sum of the quarterly income per common share amounts may not equal the net income per common share for the year.

 

F-38



 

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
                                         
    Balance At     Charged to     Charged to             Balance at  
    Beginning of     Sales or Costs     Other     Deductions     End of  
Description   Period     and Expenses     Accounts     (3)     Period  
    (in thousands)  
                                       
Allowances included in Accounts Receivable, Net:
                                       
Doubtful accounts-current
  $ 1,101     $ (522 )(2)   $     $ 35     $ 544  
Doubtful accounts-non-current
                             
Advertising, markdowns, volume discounts and other
    15,019       20,329 (1)           20,888       14,460  
 
                                       
Valuation allowances against deferred taxes
    1,234                   912       322  
 
                                       
                                       
Allowances included in Accounts Receivable, Net:
                                       
Doubtful accounts-current
    2,107       (453 )(2)           553       1,101  
Doubtful accounts-non-current
                             
Advertising, markdowns, volume discounts and other
    18,504       21,414 (1)     (1,981 )     22,918       15,019  
 
                                       
Valuation allowances against deferred taxes
    1,067       167                   1,234  
 
                                       
                                       
Allowances included in Accounts Receivable, Net:
                                       
Doubtful accounts-current
    3,993       (1,877 )(2)           9       2,107  
Doubtful accounts-non-current
                             
Advertising, markdowns, volume discounts and other
    12,216       23,366 (1)           17,078       18,504  
 
                                       
Valuation allowances against deferred taxes
    2,610       150       (1,693 )           1,067  
     
(1)   Charged to sales.
 
(2)   Charged to (recovery of) costs and expenses.
 
(3)   Allowances utilized and/or paid.

 

F-39


Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-K’ Filing    Date    Other Filings
9/1/16
10/15/14
9/1/12
8/26/12
1/31/12
7/15/11
5/6/11
7/16/10
5/7/10
3/31/10
5/1/09
4/30/094
Filed on:2/27/09
2/24/098-K
2/17/098-K,  SC 13G/A
1/26/09
1/1/09
For Period End:12/31/0810-K/A
12/15/08
12/5/08
11/15/08
11/5/084
10/29/088-K
10/23/083,  8-K
9/30/0810-Q
9/29/088-K
9/25/088-K
9/23/08
9/22/08
9/17/08
6/30/08
6/13/08
6/5/08
5/30/08
5/8/084,  8-K
5/2/084,  8-K
3/31/0810-Q
3/25/088-K,  DEF 14A,  DEFA14A
3/21/08
3/19/088-K
2/25/084,  8-K
2/19/088-K
2/13/08SC 13G/A
1/15/08
1/1/08
12/31/0710-K
11/15/07
9/30/0710-Q
8/27/078-K
8/21/078-K
8/6/07
6/30/0710-Q
6/29/07
6/20/078-K
5/31/078-K,  SC 13D/A
5/24/07
5/20/07
5/9/0710-Q
5/7/07
4/19/078-K
4/16/078-K
4/13/07
3/31/0710-Q
3/30/07DEF 14A
2/27/07
2/21/07
1/1/07
12/31/0610-K
10/5/063,  8-K
10/1/06
9/30/0610-Q
9/29/068-K
8/8/0610-Q
6/30/0610-Q,  10-Q/A
6/28/06
5/8/0610-Q
3/31/0610-Q
3/1/068-K
2/23/068-K
2/8/064
1/18/06
1/6/068-K
12/31/0510-K
11/9/0510-Q,  8-K
10/1/05
9/30/0510-Q
9/6/058-K
8/31/05
8/30/05
5/4/058-K
4/28/0510-Q,  8-K,  DEF 14A
3/9/0510-K,  4
2/17/05
2/15/05
12/31/0410-K
10/15/048-K
9/30/0410-Q
8/5/04
5/1/04
12/31/0310-K,  10-K/A
10/7/028-K,  SC TO-I
10/4/02
9/30/0210-Q
12/4/018-K
11/30/01
9/12/008-K
8/22/008-K,  PRE 14A
12/31/9810-K,  10-K/A,  4,  S-3/A
12/8/98
11/30/984
10/16/988-K/A
10/1/983,  8-K
 List all Filings 


2 Subsequent Filings that Reference this Filing

  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

10/01/09  SEC                               UPLOAD9/25/17    1:15K  Marvel Entertainment, Inc.
 3/30/09  SEC                               UPLOAD9/25/17    1:35K  Marvel Entertainment, Inc.
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