4Kids Entertainment, Inc. Q3 2008 Earnings Call Transcript

4Kids Entertainment, Inc. (KDE)

Q3 2008 Earnings Call

November 10, 2008 9:00 am ET

Executives

Todd Fromer - KCSA Strategic Communications

Bruce R. Foster - Chief Financial Officer, Executive Vice President

Alfred R. Kahn - Chairman of the Board, Chief Executive Officer

Analysts

[Walter Rensley - Walrus Partners]

Presentation

Operator

My name is Kerri and I’ll be your conference operator today. At this time I would like to welcome everyone to the third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) Mr. Fromer, you may begin your conference.

Todd Fromer

Welcome to the 4Kids Entertainment third quarter earnings conference call. Before we begin I must state that the information contained in this conference call other than historical information consists of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may involve risks and uncertainties that could cause actual results to differ materially from those described in such statements. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors beyond the company’s control including general economic conditions, consumer spending levels, competition from toy companies, motion picture studios and other licensing companies, the uncertainty of public response to the company’s properties and other factors could cause actual results to differ materially from the company’s expectations.

At this time I would now like to turn the call over to Mr. Bruce Foster, Chief Financial Officer of 4Kids Entertainment.

Bruce R. Foster

I’d like to spend a few minutes reviewing with you the company’s third quarter of 2008 financial results. Revenues by reportable segment and as the company as a whole were as follows.

In the licensing segment revenue for the three months ended 9/30/08 was approximately $4.2 million as compared to $4.3 million in ’07, a decrease of approximately $0.1 million. Revenue for the nine months ended September 30, 2008 was approximately $12.7 million as compared to $16.3 million in ’07, a decrease of approximately $3.6 million.

These decreased revenues for the three and nine months ended September 30 were primarily attributable to decreased licensing revenue in the Teenage Mutant Ninja Turtles, Nintendo and Cabbage Patch Kids properties domestically and the Viva Piñata property worldwide partially offset by increased revenues attributable to the Shaman King and Dinosaur King properties worldwide.

In the advertising media and broadcast segment revenue for the three months ended September 30, 2008 was approximately $2.7 million as compared to $3.5 million in 07, a decrease of approximately $0.8 million. Revenue for the nine months ended September 30, ’08 was approximately $10.4 million as compared to $10.2 million in ’07, an increase of approximately $0.2 million.

These decreased revenues for the three months ended September 30, ’08 resulted from reduced revenues from the sale of network advertising time on for 4Kids TV. Revenues remained relatively consistent for the nine months ended September 30, ’08 as compared to the same period in ’07.

In the television and film production and distribution segment revenues from the three months ended September 30, ’08 was approximately $3.6 million as compared to $4.4 million in ’07, a decrease of approximately $0.8 million. Revenue for the nine months ended September 30 was approximately $11.5 million as compared to $12.6 million in ’07, a decrease of approximately $1.1 million.

These decreased revenues for the three months ended September 30, ’08 as compared to the same period in ’07 were primarily attributable to decreased broadcast sales from the Yu-Gi-Oh! television series worldwide and Chaotic television series domestically as well as decreased production service revenue from the Viva Piñata television series partially offset by increased production service revenue from the Teenage Mutant Ninja Turtles and Chaotic television series as well as increased broadcast sales from the Dinosaur King television series internationally.

The decreased revenues for the nine months ended September 30, ’08 were primarily attributable to decreased broadcast sales from the Yu-Gi-Oh! television series worldwide, decreased production service revenue from the Viva Piñata television series, decreased broadcast sales from the Pokémon television series internationally as well as decreased home video sales from the Teenage Mutant Ninja Turtles television series partially offset by increased production service revenue from the Teenage Mutant Ninja Turtles, Dinosaur King and Chaotic television series’ as well as increased international broadcast sales from the Dinosaur King television series.

The trading card and game distribution segment began to record revenues in the fourth quarter of ’07 as a result of the October launch of the Chaotic trading card game to comic and hobby stores. For the three and nine months ended September 30, ’08 revenues were $7.2 million and $14.7 million respectively as a result of sales to mass market distribution channels as well as the comic and hobby stores.

On a consolidated basis net revenue for the third quarter of ’08 was approximately $17.8 million as compared to $12.2 million in ’07, an increase of approximately $5.6 million. On a consolidated basis net revenue for the nine months ended September 30, ’08 was $49.4 million as compared to $39.1 million in ’07, an increase of approximately $10.3 million.

Now turning to the expense side selling, general and administration expenses increased approximately $3.5 million to approximately $13.9 million for the three months ended September 30, ’08 when compared to the same period in 2007.

The increase was primarily attributable to increased costs of approximately $2.4 million related to the operations of TC Digital along with costs of approximately $0.8 million related to the operation of TC websites which was not consolidated in the prior years, increased foreign exchange losses associated with the currency fluctuations of $0.5 million, increased production service expenses of approximately $0.3 million as well as increased costs relating to the grant of restricted shares of approximately $0.2 million which were partially offset by decreased professional fees of $0.2 million as well as decreased website costs of $0.2 million.

Selling, general and administrative expenses increased approximately $2.3 million to $39.9 million for the nine months ended September 30, ’08 when compared to the same period in ’07.

The increase was primarily attributable to increased costs of approximately $6.5 million related to the operation of TC Digital along with costs of $2.7 million related to the operations of TC websites, again which were not consolidated in the prior year, increased international selling expenses of approximately $1.1 million, increased costs related to the grant of restricted shares of approximately $0.5 million as well as increased foreign exchange loss associated with currency fluctuations of approximately $0.5 million which were partially offset by decreased advertising and marketing costs of approximately $0.8 million as well as increased bad debt expense of approximately $0.3 million.

Production service costs for the three months ended September 30, ’08 were approximately $1.7 million as compared to approximately $1.5 million in ’07, an increase of approximately $0.2 million. Production service costs for the nine months ended September 30, ’08 were approximately $5.2 million as compared to $5.1 million in ’07, an increase of approximately $0.1 million.

The increase in production service costs during the three months ended September 30, ’08 as compared to the same period in ’07 was primarily due to increased production costs for the Teenage Mutant Ninja Turtles and Chaotic television series’ partially offset by decreased production costs for the work performed on the Viva Piñata television series. The production service costs increased for the nine months ended September 30, ’08 when compared to the same period in ’07 primarily due to increased production costs for the Teenage Mutant Ninja Turtles, Dinosaur King and Chaotic television series’ partially offset by decreased production costs for work performed on the Viva Piñata television series.

Amortization of film and television costs for the three months ended September 30, ’08 were approximately $1.9 million as compared to $1.5 million in ’07, an increase of approximately $0.4 million. Amortization of film and television costs for the nine months ended September 30, ’08 were approximately $5.3 million as compared to approximately $4.7 million in ’07, an increase of approximately $0.6 million. The increase in amortization was related to the Yu-Gi-Oh! and Chaotic television series’ which were partially offset by decreased amortization related to the various other older televisions series’.

Amortization of the 4Kids TV broadcast fees for the three months ended September 30, ’08 was approximately $3 million as compared to $5.5 million in ’07, a decrease of approximately $2.5 million. Amortization of the 4Kids TV broadcast fees for the nine months ended September 30, ’08 was approximately $12.2 million as compared to $13.7 million in ’07, a decrease of approximately $1.5 million. The decrease in amortization of the 4Kids TV broadcast fees resulted from lower 4Kids TV advertising revenues recognized by the company for the three and nine months ended September 30, ’08 when compared to the same period in ’07.

Interest income decreased $0.6 million to $0.7 million and $1.7 million to $2.1 million for the three and nine months ended September 30, ’08 as compared to the same period in ’07 primarily as a result of the company investing in surplus cash in US Treasury securities typically yielding lower interest rates than other investments as well as lower average cash balances invested during the current year.

The company did not record a benefit from income taxes for the three months ended September 30, ’08 but the company did have a benefit from income taxes of approximately $1 million and $1.1 million for the same period in ’07.

As a result of the above, the company had a net loss for the three and nine months ended September 30, ’08 of approximately $5.3 million and $17.2 million respectively compared to a net loss of approximately $4.2 million and $6.6 million for the same periods in ’07. Loss per share on a fully diluted basis was $0.40 per share and $1.31 per share for the three and nine months ended September 30, ’08 respectively as compared to a loss of $0.31 per share and $0.50 per share for the same periods in ’07. Diluted shares were approximately 13.2 million for the three and nine months ended September ’08 and ’07.

Now turning to the balance sheet. As of September 30 the company’s cash and cash equivalents as well as short- and long-term investment balance was approximately $67.7 million. Of that total amount the company had approximately $46.9 million in auction rate securities which had been written down from equity on the balance sheet to approximately $26.8 million.

Working capital consisting of current assets less current liabilities was approximately $28.3 million as of September 30, ’08 as compared to $65.1 million as of 12/31/07. A portion of the decreased working capital was attributed to the reclass of $11.7 million in auction rate securities from short to long-term assets.

On November 9, 2008 the company entered into an agreement with Fox to settle the Fox litigation. Under the terms of the settlement agreement the Fox agreement will terminate on December 31, ’08 rather than the end of the ‘08/’09 broadcast season in September of 2009. The company’s remaining financial obligation to Fox for the ¾ of 2009 will also terminate. Under the terms of the settlement agreement the company will pay Fox $12.2 million of the $13 million of the 2008 time buy fees owed to Fox withheld by the company as set-off payments to Fox for the second, third and fourth quarters of ’08.

Under the terms of the settlement agreement the company will record approximately $3.8 million of broadcast fee amortization in the fourth quarter of ’08 with no amortization being recorded in 2009. For comparative purposes amortization for the fourth quarter of 2007 was $7.7 million and the amortization for the first three quarters of ’08 was $11.5 million.

In December 2007 the Board of Directors authorized the company to purchase up to 1 million shares of the company’s common stock from time to time through 12/31/08 in the open market or through negotiated prices. The company purchased 235,485 shares at an average price of approximately $11.65 per share for the nine months ended September 30 under this authorization. As of November 7, 2008 no shares of the company’s stocks were subsequently purchased by the company under this authorization.

Now I’d like to turn the call over to our CEO and Chairman, Mr. Al Kahn.

Alfred R. Kahn

Even though those results obviously are not good, there was a tremendous amount of excitement and a tremendous amount of opportunity that are in those results which I want to amplify on and make sure we’re all clear on where we’re going and how we’re going to get there.

In the third quarter, as Bruce mentioned, the company had a $0.40 per share loss compared to a $0.42 per share loss in the second quarter. Obviously this loss is not taking into account any tax benefits. Had the loss been adjusted for the tax benefits the company would have reported a loss of $0.24 in the third quarter which still obviously is not satisfactory or acceptable.

I am pleased to report though that based upon our projections, I expect the company to be profitable in the fourth quarter of ’08. I also believe that assuming reasonable worldwide economic conditions the company will be profitable for the total of ’09.

The company’s results for the fourth quarter of ’08 and continuing to ’09 will begin to reflect the financial benefits and the various steps we have taken over the past two years to reinvent 4Kids, not only as a merchandise licensing company but also the trading card company with multiple Internet platforms ready to compete in the digital age.

Let me add an important caveat to what I said. The company will of course be negatively impacted should current conditions worsen. We would then expect advertisers to cut back ad spending, retailers to cut back their purchases of licensed merchandise and toys and consumers to cut back substantially on spending. We’re seeing some of this in the fourth quarter.

Let me review our most important results during the third quarter. First, Chaotic. First and foremost, our Chaotic trading card sales increased almost 50% in the third quarter ’08 to $7.2 million as compared to sales of $5.1 million in the second quarter of ’08. We are on plan to achieve the projected $20 million to $30 million of Chaotic trading card sales in ’08 but given retail and consumer caution, I expect our Chaotic sales will be in the low $20s.

We are hopeful however that the low price points of Chaotic trading cards with booster packs typically costing about $3.99, retail starter packs typically $14.99 and holiday tins have an MSRP of $19.99. We’ll label our trading card sales to be less adversely impacted by possible declines in consumer spending than higher priced toys and games.

The real issue is the retailers’ inventory position. Generally speaking retailers carry a certain number of weeks of inventory. We generally expect them to carry between 30 and 40 weeks of inventory at any given point in time. That number is being reduced by retailers who are running very, very scared and nervous about what the fourth quarter might bring. So that reduction in the average amount of weeks that the retailer will carry will certain impact us in terms of what we’ve suggested in Chaotic.

We also know that our price points will enable us to hopefully have a better percentage of holiday sales because we believe that the real impact of the recession will be on higher priced goods.

With sales projected to receive $20 million we have established Chaotic in its first year as the third most important successful trading card game in the US after Pokémon and Yu-Gi-Oh!. Given the intense competition of the trading card space, this is a considerable achievement and sets us up well for 2009 and beyond.

I am also pleased to report that the two releases of the Chaotic trading card game successfully debuted in late September and early October. The new starter deck called M’arrillian Invasion and related booster cards are selling well at the over 25,000 locations in the US and Canada selling Chaotic trading cards. Chaotic trading cards are available at mass market retailers such as Wal-Mart, Target, Toys R Us, Kmart, comic and hobbies stores, specialty retailers such as Game Stop and Best Buy which began carrying Chaotic cards in July, and drugstore chains such as Rite Aid, [inaudible] and Walgreens.

In view of the Chaotic sales performance we are receiving more facings or pegs for the Chaotic trading card game in a number of retail chains. At several mass market retailers Chaotic trading cards are also being offered both in the trading card section and in the toy section as well.

We have begun shipping our Chaotic holiday tins to mass market retailers such as Wal-Mart, Target, Toys R Us and Best Buy. The holiday tins as I said have an MSRP of $19.99. Both the [new millennium] starter pack release and the holiday tins are being supported by a massive television advertising campaign.

We’re also supporting Chaotic with new television episodes. On September 13 we began broadcasting a new Chaotic series called M’arrillian Invasion at 10 a.m. on Fox. The new Chaotic episodes produced in richer 2D animation as opposed to the Flash animation of the original episodes are among the top rated shows on Fox.

We have also taken a number of steps to enhance the experience at the Chaotic website. We’ve bought back to the Chaotic website the popular basic one creature versus one creature game. This one versus one game should enable new players to begin a player in the Chaotic trading card game online.

We also are able to port this one-on-one game to other websites so that kids who are not into Chaotic can try the game on other sites and if they like it can certainly then go to Chaoticgame.com to register and receive their own obvious digital cards. In the interim of course the idea of being able to test the game, let’s say it be on 4Kids.tv or other sites, without having to purchase cards or register is a very good sampling device for getting kids into the game.

All these changes to the Chaotic website have been well received by the growing Chaotic online community. We now have more than 1 million registered users from approximately 750,000 this summer. There have been a total of 42.5 million Chaotic trading card codes uploaded to the website. We have seen more games being played on a daily basis and more time being spent on this site by Chaotic fans. In short, we are seeing improving matrix on the Chaoticgame.com sites mirroring the increasing sales of the trading card game.

As sales of Chaotic trading cards continue to grow, we expect traffic on the Chaoticgame.com website to increase substantially. Although it’s interesting, I would guess that during the fourth quarter a lot of the cards that will be bought will be bought for gifts so maybe a lot of those cards will not be uploaded in the fourth quarter because they’ll be given as holiday presents where the codes won’t be revealed to their purchasers until Christmas.

While we are not monetizing the Chaoticgame site at this time, I believe that the increasing popularity of the Chaoticgame.com website is creating an ever more valuable asset for your company, and of course it also enables us to use the card management system we developed for Chaotic for other game engines.

We are currently exploring other opportunities for the management system in other games and in other categories, the idea being to broaden the offerings from TC Digital so that we can amortize the cost of the website and the cost of the obvious card matching system over other opportunities and also obviously garner more shelf space and more revenues and more profits in the foreseeable future. It’s interesting that our market capitalization is not ascribed any value to the Chaoticgame.com websites or frankly to probably TC Digital in general.

The Chaotic trading card game continues to do very well in Canada where for a number of months it had either been the best-selling trading card game or in the top two. The broadcast of the Chaotic television show on Teletoon Canada has been very successful and we’re in the process of concluding negotiations with Teletoon for the new season of the Chaotic episodes.

We are also in the process of negotiating very significant merchandise license agreements for Chaotic in several major categories. As our company practice, these deals will be announced when they are completed; however I can tell you that two categories that we are most anxious to sign are the toy area and the video game area in which we are currently negotiating and expect to finalize these particularly deals in the fourth quarter.

In addition to the Chaotic licensing initiatives, the developing story for Chaotic in 2009 will be the European rollout. We have begun a soft launch of the Chaotic trading card game in England and we are scheduled to rollout the Chaotic trading card game in Europe in ’09. We’ll be coordinating the trading card game’s release with the broadcast of the Chaotic series in key markets.

We are in the process of translating Chaotic trading cards on the Chaotic website into the major European languages of Spanish, French and German and negotiating the final details of broadcast licenses and distribution deals in a number of these European markets. We believe the sales of the Chaotic trading card game in Europe will begin contributing to revenue in the second quarter of ’09.

Bringing the Chaotic trading card game to market has been a long process but I believe that we have succeeded in creating a terrific trading card game, a judgment that has been validated by the first nine months of results of Chaotic trading card game sales. Even this past weekend in monitoring the site and monitoring sales at retail, we believe that we’re starting to see some Christmas action and we believe that this will accelerate over the next couple of weeks.

We’ve also spent a substantial amount of money creating the infrastructure of our trading card company and website company that can support other trading card properties as I mentioned. While these expenditures have re-depressed our results over the last number of years, I believe they are essential steps to ultimately building shareholder value and profitability for the long haul.

The other major piece of news that I’d like to describe to you has been the settlement of our Fox litigation. Last April as you’ll remember, we commenced litigation against Fox. Our contract with Fox provides that for each broadcast season 4Kids television programming needs to be broadcast by Fox on Saturday mornings between the hours of 8 a.m. and 12 p.m. on the East and West Coast times and between the hours of 7 a.m. and 11 a.m. in the Central and Mountain time zones in at least 90% of the country.

Our Fox agreement further provides that if 90% broadcast clearance is not maintained in any broadcast season, 4Kids is entitled to a refund of a portion of the time buy being paid to Fox for that broadcast season. Our Fox contract also provides that 4Kids is entitled to set off the refund against installment for the time buy fee to Fox. We computed the average clearances that Fox has provided to us for the preceding broadcast seasons of our deal and based on our calculations we believe that Fox owed 4Kids a substantial revenue refund of approximately $13 million.

Fox disputed our calculation and denied that 4Kids was entitled to any refund. 4Kids exercised the set-off right and did not pay Fox the $5 million fee due on April 1, 2008 and then later that month we sued Fox. 4Kids did not pay the $5 million fee due July 1, 2008 and the $3 million of the $5 million which was due on October 1, 2008. The $13 million not paid to Fox has been expensed on our P&L in accordance with the way we amortized the Fox fee.

In the settlement agreement that we concluded yesterday, Fox and 4Kids has agreed that the 4Kids Fox agreement will terminate on December 31, 2008 rather than at the end of the 2008/2009 broadcast season in September ’09. As a result of the early termination, 4Kids will now have to pay the $15 million broadcast fee which is payable in three installments of $5 million due January 1, ’09, April 1, ’09 and July 1, ’09. Under the terms of the settlement however we will be paying Fox $12.25 million out of the $13 million we previously set off, an amount that we already amortized and will be eligible to retain $750,000 in cash.

Historically our fourth quarter ad sales, representing almost 50% of the overall ad sales for each broadcast year. The early termination should save us about $5 million on the amortization of broadcast fees in the fourth quarter of ’08 as Bruce has discussed. By not having to pay the $15 million of broadcast fees to Fox until ’09 we estimate that the net savings of the amortized fees less estimated ad revenues in the fourth quarter will be about another $5 million or $6 million and possibly more should the advertising market weaken further next year.

We’ve therefore received compensation for substantially all of the amount that we have claimed but I think there’s a more important angle. If ad revenues as we believe will be very soft in the first and second quarters, that would have put a very, very big drain on our profits because we’d be paying Fox that $15 million and really not necessarily getting any fourth quarter ad revenues. So we conceivably could have had a loss that would be very substantial. Maybe that loss could have been maybe $10 million.

With this deal we will have no loss on Fox and obviously we will have less inventory to sell on our CW block. We then also can take our best programming from Fox and our best programming from CW and the new programming that has been scheduled to be added in January, such as Rollbots, such as Cayman Riders, such as Huntechs, and really create one very, very powerful block which can be promoted solely by 4Kids and that can be sold by our ad subsidiaries both online and also for regular advertising.

So this deal really can save us in the $15 million range in terms of expense and more importantly it also saves us the $15 million in cash that we will not have to pay out next year to Fox. I want to thank Bruce Foster and Sam Newborn and all of our people who have worked tirelessly to get this deal done and get it done in a timely fashion so that not only could we report it for this conference call but also that it has a positive impact on our fourth quarter and going forward in 2009.

As I mentioned we believe the advertising market will be very, very tough in the first two quarters and that this reduction of 64 advertising units per week on Fox will make us much more viable in terms of selling the ad time on CW and also take another competitor out of the kids broadcast network because Fox has alluded to us that the time will no longer be used for kids programming but for other programming that has yet to be determined.

Now for an update on some of our other core brands which also I think is good news for us. Yu-Gi-Oh! had a solid quarter for us with our Yu-Gi-Oh! revenues up nicely from the third quarter of ’07 and obviously in the second quarter of ’08. We also just signed a five-year extension to our Yu-Gi-Oh! representation agreement. Our Yu-Gi-Oh! Rights now expire at the end of 2015 rather than August 31, 2010. So we obviously have another seven years of Yu-Gi-Oh! which certainly is some good news for your company.

We also during the third quarter signed a new master toy license deal with Playmates that will start in ’09. Playmates will have US rights to manufacture and distribute toys based on the new Yu-Gi-Oh! series entitled Yu-Gi-Oh! 5Ds. Playmates has also been granted manufacturing rights to supply Yu-Gi-Oh! 5Ds toys to the European market. We are in the process of making distribution deals for the Yu-Gi-Oh! 5Ds toys with various distributors in Europe.

Dinosaur King has started to perform for us especially in Europe. Dinosaur King has terrific television placement on some top free TV broadcasters in Europe: TV network France 3, RTL 2 in Germany and Mediaset in Italy.

Upper Deck is the trading card partner. They will be distributing the dinosaur video game in the US this holiday season. We’ve also made a deal with Playmates similar to the Yu-Gi-Oh! 5Ds deal. Playmates will be manufacturing and distributing the dinosaur toys in the US. Playmates also has been granted manufacturing rights to supply Dinosaur King toys to distributors in the European market. We’re also in the process of making distribution deals for the Dinosaur King toys with different distributors in Europe.

Teenage Mutant Ninja Turtles faced a tough comparison with the third quarter of ’07. The feature film TMNT was released in late March of ’07 in the US and the movie DVD was released in August ’07. Both events were drivers for Turtles merchandise sales last year. We are also working on the 25^th anniversary of the Turtles brand in ’09 and have many celebrations and promotions in the pipeline for next year.

We’ve also closed a theme park rights deal for Turtles in Korea we’re hoping to serve as a template for more theme park deals for Turtles and some other properties around the world.

We continue to receive revenue contributions in such brands as the American Kennel Club, the Cat Fanciers’ Association, The Dog, Cabbage Patch Kids, Monster Jam and other brands.

While licensing revenue was one of the things that I mentioned that was very disappointing to us where the third quarter was basically flat year-over-year compared to licensing revenue from the third quarter of ’07, licensing revenue for the nine months of ’08 is down $3.5 million from the first three quarters of ’07. We recognize this is one of the major areas that we need to improve upon to increase licensing revenues to show better financial results.

Based on the number of deals in our pipeline, the number of new products, the number of new programs, the number of new licensed properties, we are hopeful that licensing revenue will pick up in the fourth quarter and in ’09 as well.

In the SG&A area I want to comment on that briefly. Third quarter SG&A was about $24 million, up from about $19 million in the third quarter of ’07. The increase in SG&A costs results from the staffing and build-up of our trading card company TC Digital and our website company TC Websites. We continue to invest in our new trading card website businesses which long-term we believe will contribute profits to the company and build shareholder value as well.

Given the uncertain world economic conditions, 4Kids is taking another hard look at expense cutting. We plan to reduce our overhead so 4Kids can be profitable in ’09 even if economic conditions in the US and around the world remain challenging.

We also need to do some more investment spending on Chaotic and on the distribution of the Chaotic trading card game in Europe. We feel that the launch of the Chaotic trading card game brand in Europe will give 4Kids the opportunity to [inaudible] a substantial number of additional Chaotic trading cards. For example, Pokémon and Yu-Gi-Oh! trading card sales in Europe were in the hundreds of millions of dollars. If Chaotic only does a small percentage of the European sales of Pokémon and Yu-Gi-Oh!, there’ll be a tremendous contribution to revenues of 4Kids.

4Kids other digital platforms in the last two years, I said in my conference calls that 4Kids is taking important steps to prepare itself to compete in the digital age. We have invested substantial sums in our website 4Kids.tv. We’ve upgraded the video player of 4Kids.tv and we expect to offer some additional content on this new video player. We expect to be able to continue to increase the video streaming on our site and to make 4Kids.tv a portal of choice for kids.

We are beginning to reap some of the benefits from the increased popularity of the 4Kids.tv website and website streaming in the form of increased advertising dollars. As advertisers continue to adjust their strategies to include the web we are on track to receive $2 million to $3 million from ad sales from the 4Kids.tv website, up from approximately $1 million that we earned last year.

I also want to caution though that certainly going forward if there is a tremendous advertising downturn certainly that would impact online advertising as well as television network advertising, because I believe that if the advertisers are going to squeeze down their budgets, they’re going to squeeze them down on both sides. But I think they’ll take a bigger bite out of the online piece than they will out of television as I certainly believe that for toys and things of elk, television has been the major driver for garnering kids to drive into the stores to purchase.

The full launch of our networks, on September 13 we launched the 4Kids programs on both Fox and the CW networks. [Inaudible] Fox will continue to be branded the 4Kids TV while our lineup on the CW will be branded the CW 4Kids. The CW lineup consists of Will and DeWitt, Spiderman, our new Teenage Mutant Ninja Turtles series called Back to the Sewer, our new Yu-Gi-Oh! series entitled Yu-Gi-Oh! 5Ds, our new animated series from Russia entitled GoGoRiki as well as a new season of Dinosaur King.

We are also broadcasting the first season of Chaotic episodes on the CW network that were originally broadcast on Fox. With the termination of the Fox agreement on December 31, ’08 we are moving our best shows from Fox to CW. We expect that our lineup on the CW beginning the weekend of January 3, ’09 will enable us to sustain the ratings we need.

We are carefully monitoring as I mentioned 4Kids TV ad spending in view of the economic conditions but are comfortable that the resulting combination will be stronger than the two networks would have been separately, and also of course the financial risks and rewards will be diminimus relevant to the amount of time that we have to sell on CW as opposed to the combination. The timing of the settlement not only is critical but also it reflects what we believe is a worsening climate for advertising in the first two quarters.

Other licensing business to discuss. In late September the 4Kids adaption of the popular Russian animated series originally entitled Smeshariki, which we renamed Gogoriki, debuted on CW. In Russia this Smeshariki series has generated a full line of 3,000 products in major licensing categories. We’ll also be adding several new series’ to our television lineup in the first quarter of ’09 such as Rollbots where Mattel is the master toy licensee.

We will also be adding Cayman Riders where [Bandai] is the master toy license, of which we don’t represent the property specifically but we do get a percentage of royalties from the property for running it on CW. Cayman Riders is actually very, very interesting in that it’s a live action series based on the most popular live action series in Japan which aptly is called Cayman Riders. Just like Power Rangers, the show has been re-filmed to star a more [inaudible] children, [inaudible] teenagers so that it looks like an American series as opposed to a Japanese series.

Rollbots, which is a 3D animated show, is all about little balls that are on tracks that open up to become all kinds of wonderful things. We think this concept will be very [pregnant] and [Tony Talot] with Mattel is currently developing a number of products that are based on the television show.

The results of these shows, especially Rollbots, Smeshariki or Gogoriki, have been extraordinarily received in Europe where we believe we’re going to get very significant for these shows on a worldwide basis.

In summary, I believe that the turnaround to become more apparent in what I expect to be a profitable fourth quarter of ’08 and a profitable ’08 presuming that economic conditions going forward do not deteriorate to a point where it’s obviously problematic in terms of our results.

But we have continued to have done considerable investment spending necessary for the company to remain on the cutting edge of kids’ digital entertainment as I talked about with our 4Kids.tv websites and our Chaotic game sites. Although this investment spending has depressed our financial results in 2007 and 2008, I believe that it has positioned us for future growth. This investment spending has also enabled us to create exciting new rapidly expanding digital platforms as I mentioned and they should increase shareholder value as they certainly add to profits and revenues.

I want to close on a positive note that the results of everything we have done are starting to bear fruit. The only thing that I caution about is how much the resulting economic climate will impact us. By reducing our exposure on television in terms of the amount of advertising we have to sell, by having many more properties in the pipeline that can generate revenues, by showing the Chaotic card game to be a very successful concept, I think we have a lot of arrows in our quiver that can sustain us even during these more trying economic times.

With that I want to again thank all of you for your support and I hope that you will now start to glean some of the things that we have been working on these last two years.

With that I’ll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from [Walter Rensley - Walrus Partners].

[Walter Rensley - Walrus Partners]

The payment going to Fox, is that on the balance sheet under accounts payable? Is that basically where that’s going to come out of and reduce the cash by the same amount in the fourth quarter or what’s the accounting going to be for that?

Bruce R. Foster

We’ve accrued for the amount that’s going to be owed. We’re only going to pay $6 million in the fourth quarter and then we have two $3 million payments which will be in the first quarter of 2009. And those two latter payments will be out of the fourth quarter collectibles but because it is collection period from advertising is that January to March timeframe. So we deliberately scheduled those payments to reflect when our cash receivables coming in will be substantial.

[Walter Rensley - Walrus Partners]

In general, you’re saving $15 million by not renewing the deal with Fox next year. How much do you think that’s actually going to save you? I mean, how much do you think you would have lost if you hadn’t done that?

Alfred R. Kahn

I think we could have lost anywhere between $6 million and $10 million in cash as well as actual EPS because we are seeing such a negative market in terms of ad sales. The first two quarters of the year for us because we’re in the toy and game area are certainly the least exciting in terms of ad sales in general. The best quarter is obviously the fourth quarter and under this Fox, it wasn’t a new option; it was part of our existing contract, we would have to have run the Fox block through September and therefore pay $15 million of the $21 million traditionally paid and not have any benefit of the fourth quarter which is traditionally 50% of the revenues.

So you can see that we could have lost $6 million to $10 million next year just on the Fox situation, and that doesn’t necessarily count the affect that the advertising business became much more difficult.

Bruce R. Foster

Just to give you a little bit of a benchmark. Last year fourth quarter of ’07 we had advertising sales of about $6 million with amortization of about $7.7 million so we lost $1.7 million in the fourth quarter on the Fox relationship. The first three quarters of ’08 we had about $8.7 million in sales and we had amortization of $11.5 million so we lost about $2.8 million. Collectively fourth quarter and the two three quarters we lost about $4.5 million.

Alfred R. Khan

I want to make sure we concentrate on that; that was in the timeframe when the market conditions were certainly different than they are currently and that our ad sales looked like they were going to be pretty powerful in that period because the business market, especially in the toy and gaming area, was reasonably strong.

I think we have really done ourselves something proud by getting out, by enabling us to concentrate on CW where the fee is certainly a lot less, and we feel we can maximize that fee and may even make money in that block, and that we will not get a very onerous and very significant liability off the balance sheet and off of our long- and short-term opportunities.

Bruce R. Foster

Just one more additional point on that. Fourth quarter of ’08 now our amortization expense will be $3.8 million through a delay in last year’s sales during that period of time was $6 million. That would generate a profit of $2.2 million versus a loss that we had in ’07 of $1.7 million. So if $3.9 million swing at the advertising would hold; again we’re not sure that that’s the case; but clearly a big thing.

Alfred R. Kahn

Clearly we’re going to make money in the fourth quarter on Fox as opposed to losing money on fourth quarter Fox last year.

[Walter Rensley - Walrus Partners]

The CW operation itself in 2009. You indicated that it could make money, probably will break-even, or what’s the outlook there?

Alfred R. Kahn

I think it’s very positive. I think because two things happen. We knock out our competitor. At one level we were competing with ourselves. You could see it in the ratings. When we did some promotion on one of the other networks, we end up taking away from our other network. So getting rid of one of them, we’re no longer competing with ourselves. Number two, we’ve diminished the number of advertising units in total, not just in the market one more network is out. Therefore whatever the advertising dollars are that are available can now be used by one less network.

I think also it gives us an opportunity to really hone in on our programming and get the best programs in total and put them in one block, which will be the CW block. Also as you know CW is a day date block. Unlike Fox CW runs the same time regardless of where you are in the country and with the same call letters CW.

As I mentioned on Fox, we’re on a lot of duopoly stations on Fox where the call letters weren’t Fox call letters. They might have been My something or some other situations so we then were never able to promote very well on Fox as an entity because we had so many different derivative call stations. With CW every station in the block is a CW station and as I mentioned they’re all day date.

So we think the promotion and the opportunity to promote those blocks is much easier. Add to it the best shows that we have will be only on one block, I think that we’re prone for a much better result providing that the whole market doesn’t go to hell in a hand basket.

[Walter Rensley - Walrus Partners]

The Chaotic business is two card games that are bigger I guess. How big are they and what’s the potential market for Chaotic if you can kind of get to their size?

Alfred R. Khan

We are extraordinarily happy with Chaotic and again remember, there’s probably any number of card games that are introduced every year; could be as many as 10 to 12 card games that are introduced. The retailers like to walk before they can run. So for instance, the Wal-Marts and the Targets, you present them with a new card game, they’re not going to give you 20 pegs. They’ll give you two pegs if you’re lucky. If you perform, they start increasing the amount of space they give you.

To our credit Chaotic has been building and therefore the amount of space that Chaotic has been getting has been obviously building over that timeframe as well. As we mentioned also in the cases of Target and Wal-Mart and other mass merchants, we might be in the toy department as well as in the front of the store in terms of their trading card section. So what we end up with is larger degrees of space. Those larger degrees of space will carry forward into ’09 so therefore the amount of goods that they’ll take on a regular reorder basis again, without anything else will be greater than they were in ’08.

So we’ll get increased revenues assuming that the card game continues the traction along the lines that it has.

We’ve also been told by a lot of the major retailers that they’re going to be limiting the number of card games in general they’re going to carry and that Chaotic has made the cut in all these stores. They’re going to cut back on new card games and they’re going to cut back on what they’ll be carrying so we are very happy that we are continuing in that basis which should lead again to more shelf space which leads to more shipments and then to more facings should lead to more sales.

Last year we had six releases of Chaotic products. This year we’re projecting 12 releases in the United States which obviously every time there’s a new release you’d assume that the buy-in would be there in terms of the retailers.

We’d also assume that of course add to it Europe and the European model that Chaotic sales should go up and profits should go up because the same websites, the same printing will be used again in Europe because they’ll be starting from year one in Europe using the cards and the websites that will be ready to go for the United States in year one. So Europe will be one year behind us and therefore the development costs relative to Europe should be relatively marginal compared to what it cost us to go out in the US initially.

[Walter Rensley - Walrus Partners]

The auction rate securities, any word on that how they’re coming along?

Alfred R. Kahn

I think that we have nothing new to tell you although again this is totally unscientific but it appears that there is certainly going to have to be some resolution because it has to be resolved in I think one of two ways. Either a) the government’s going to have to support the underlying insurance entities like AMBAC, MBIA, and try to strengthen their balance sheets to where they’ve expended their monies on the banks, and if AMBAC and MBIA and the other insurers are strengthened, that obviously elicits stronger opportunities for the auction rate securities to become more liquid because they’ll have a stronger backing.

There’s also been a number of conversations certainly rumors that the government may just give some kind of buy-back in general of some of these securities where they’ve done other buy-backs. When I talk about other buy-backs, I’m talking about other securities. Right now these auction rate securities are paying full interest payments to us.

We are husbanding our cash. We have done cash flow analyses that suggest that we’ll have no problem getting through our ’09 and beyond given the extent of what we’re trying to do and how we plan to do it, and that obviously this Fox agreement saves us a real $15 million going forward which is substantial relative to where our cash is.

We don’t see anything that I can tell you that will change the auction rate picture at the moment but I can tell you that we have been very judicious about use of cash and that judiciousness will continue probably in a much more tightened down way because of expense cuts and things we’re doing to make sure that we don’t waste any of the cash that we currently have.

[Walter Rensley - Walrus Partners]

You indicated in general that 2009 could be a profitable year. Do you have a ballpark idea of how profitable?

Alfred R. Kahn

I usually don’t give any long-term view and obviously I have a number certainly in the back of my head. I certainly have a number that’s been provocated to our Board and provocated to our people internally. That number certainly has some give relative to what happens in the market place. That’s the big unknown.

We don’t know how much this economy continues to ratchet down although I think we all would have to believe that the first two quarters at least of this next year, maybe possibly the next three quarters, are going to be difficult because right now some of the drivers, obviously the consumer spending is certainly Christmas.

You know that the economy is made up of 50% of consumer spending, the GMP, so the consumer now is spending for Christmas and certainly there’ll be a Christmas. Some believe that Christmas will be maybe a little bit down from last year but certainly it’s going to be more concentrated in retailers such as Wal-Mart and Cosco and Sam’s Club and places where consumers think they’re getting better value.

But when you get into the first two quarters, then it’s a whole unknown because what’s going to be the driver for consumers to go into these retailers except for essentials. That’s really the critical angle. But we think that the card game business should be okay because it’s low priced and that kids can pick it up with their pocket money they get after Christmas. We expect that after-Christmas sales of Chaotic could be very powerful because a lot of times kids get money for Christmas, and then what they generally do is go out and buy the things that they enjoy.

But there’s still that big overhang of what happens in the advertising market in terms of Chaotic, what happens in terms of retailers stocking, because probably the worst thing that happens to us and that’s happening to everybody as I mentioned is that the retailers are taking less of a position in terms of the amount of weeks of inventory they’re willing to hold. That certainly directly reflects how much you’re going to be able to ship.

The good news for us, and there’s a lot of good news, is our cards are manufactured in the United States so therefore we can respond very quickly to reorders so that we don’t have to build inventories and hold them in our warehouses waiting for retailers to reorder. We can actually go back to the printer and print product as it becomes needed.

The toy and game business in general is very problematic because if you look at China, China has a tremendous problem because of the amount of testing that has to be done now relative to making sure these products are safe is impacting the ability to deliver these products. It’s also increasing tremendous cost increases. We’re also hearing about a tremendous number of Chinese factories that are closing down because they’re profitability is very suspect because of the testing and the price of raw materials.

Now, the decrease in oil pricing certainly will have a positive impact in terms of plastics and in terms of other petroleum-based products. But I’m very pleased that our products are manufactured domestically, our products we can control the inventories domestically, and frankly when we ship to Europe we’re going to ship from the US. We find that that’s going to be a less expensive way of doing it than trying to build printers in Europe, although at some point in time when the retailers in Europe start to order substantial card shipments, we will look at putting up a printer in Europe to supply that.

But in the interim we’ll be shipping out of the US and therefore another way of really getting a real strong position around our inventories.

Operator

At this time there are no questions. I would like to turn the call back to management for closing remarks.

Alfred R. Kahn

Again I hope you can take from the [tenant] of this call that we are feeling certainly a lot better about our business opportunities and certainly a lot concerned about the economic state of this country and the rest of the world, something that we obviously can’t control.

However I think you’ll see as we move out, there will be other announcements of not only new deals but other initiatives that are being designed to respond to the current economic conditions but also to the opportunities that these economic conditions could result in. We are not cutting back on advertising in the fourth quarter. We believe that companies that cut back in tough conditions will lose market share. We believe that companies that continue to promote during tough conditions can garner market share from companies who are cutting back on promotion and advertising.

With all that I am cautiously optimistic, I feel better than I’ve felt about our prospects in a long time as I’ve been talking to you over the last two years, and we hope that the next conference call will be a time of some celebratory conversation and some more positive outlooks for the company going forward.

With that, thank you very much.

Operator

That concludes today’s teleconference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!