4 Kids Entertainment Inc., Q1 2009 Earnings Call Transcript

4 Kids Entertainment Inc. (KDE)

Q1 2009 Earnings Call

May 11, 2009 9:00 am ET

Executives

Alfred R. Kahn - Chairman and Chief Executive Officer

Bruce R. Foster - Chief Financial Officer

Garth Russell - Investor Relations, KCSA Strategic Communications

Analysts

No Analysts

Presentation

Operator

Good morning. My name is Julianne and I’ll be your conference operator today. At this time I would like to welcome everyone to the 4 Kids Entertainment first quarter 2009 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). I would now like to turn the call over to Mr. Garth Russell with KCSA Strategic Communications.

Garth Russell

Good morning everyone. Welcome to the 4Kids Entertainment first 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 provide to be 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 the next few minutes reviewing with you the company’s first quarter of 2009 financial results. Revenues by reportable segment for the company as a whole were as follows.

In the licensing segment first quarter of 2009 revenue remained constant approximately $5.6 million. This consistency between periods is primarily attributable to increased domestic licensing revenues from Monster Jam property of approximately $1.4 million substantially offset by decreased domestic licensing revenues attributable to the Yu-Gi-Oh and Shaman King properties of approximately $0.9 million and $0.4 million respectively.

In the advertising media and broadcast segment, first quarter of 2009 revenue was approximately $0.8 million as compared to $3.6 million in ’08, a decrease of approximately $2.8 million. This decrease was the result of the CW’s $3 million minimum guaranteed share of revenue which was also against the company’s revenues from the sale of network advertising of the CW4Kids when compared to the same period in the prior year which Fox Broadcasting was amortized and classified as an expense, partially offset by increased revenue from the sale of internet advertising time on the company’s website.

In the television and film production and distribution segment, first quarter of 2009 revenue was approximately $3.3 million as compared to $2.5 million in ’08, a decrease of approximately $0.2 million. This decrease primarily resulted from decreased production of service revenue from the Viva Piñata and Teenage Mutant Ninja Turtles television series of approximately $0.7 million and $0.2 million respectively partially offset by increased international broadcast sales from the Dinosaur King television series of approximately $0.8 million.

In the trading card and game segment, first quarter of ’09 revenue was approximately $0.4 million as compared to $2.4 million in ’08, a decrease of approximately $2 million.

During the three-month ended March 31, 2009, retail sales were negatively impacted by the continued global economic downturn. As a result of the downturn, many retailers maintained reduced inventory levels, and the company’s trading card and game distribution segment was negatively impacted by the resulting cut-back by the company’s distributors on the orders placed with TC Digital. Additionally, subsequent to March 31, 2009, some of the company’s larger distributors who sold us most market new players are now migrating out of their prior model. In anticipation of new sales terms, the retailers and distributors have been significantly reducing inventory levels over the last several months.

Now turning to the expense side, selling, general and administrative expenses decreased $0.8 million to approximately $11.8 million for the three-month ended March 31, 2009, when compared with the same period ’08. The decrease was primarily attributable to decreased informational selling expenses of approximately $0.9 million, decreased advertising and marketing costs of approximately $0.3 million, decreased travel and containment cost of $0.2 million, decreased website cost of approximately $0.2 million, decreased recruiting cost of approximately $0.2 million as well as bad debt expense of approximately $0.1 million, again this was partially offset by increased foreign exchange losses with currency fluctuations of approximately $0.4 million.

Cost of sales of trading cards demonstrates inventory costs related to the Chaotic Trading Card game. Cost of sales decreased $0.5 million to $0.5 million for the three-month ended ’09 when compared with the same period in ’08. The decrease was primarily attributable to the overall decrease in trading card revenue. In an effort to increase future trading card sales, additional promotional moneys were given to retailers and distributors causing trading card revenues to fall between same quarter cost of sales.

Production service cost for the first quarter of ’09 was approximately $1.1 million as compared to $1.5 million in ’08, a decrease of approximately $0.4 million. This decrease was primarily attributable to decreased production costs for the Viva Piñata and Teenage Mutant Ninja Turtles series partially offset by increased production cost for the well-performing Chaotic television series.

Amortization of television and film costs for the first quarter of ’09 was approximately $1.2 million as compared to $1.7 million in ’08, a decrease of approximately $0.5 million. The decrease was primarily due to the decreased amortization of the Teenage Mutant Ninja Turtles and Viva Piñata television series.

Interest income decreased $0.3 million to $0.4 for the three-month ended March 31, 2009, as compared with same period of ’08 primarily as a result of lower cash balances and the company investing its surplus cash in US Treasury Securities particularly to lower interest rates on investments.

Income taxes, the company continues to record a full evaluation against these deferred taxed assets and accordingly did not record a benefit from income taxes for the first quarter of ’09 and ’08. As a result of the above-mentioned items, the company had a net loss for the first quarter of approximately $4.1 million as compared to a net loss of approximately $6.4 million in ’08.

Loss per share on a fully diluted basis was $0.39 per share for the first quarter of 2009 on approximately 13.2 million diluted shares as compared to a loss per share on a diluted basis of $0.48 per share for the same period in ’08 of approximately 13.2 million diluted shares.

On the guidance found on SFAS 160 effective January 1, 2009, the loss attributable to 4Kids Entertainment Inc. for the first quarter of ’09 was approximately $2 million or a loss per share on a fully diluted basis of $0.15 per share.

Now turning to the balance sheet, as of March 31, 2009, the company’s cash and cash equivalents as well as short and long-term investment balances was $28.9 million. Of that total amount, the company had approximately $46.9 million in auction rate securities which had been written down on the balance sheet to approximately $19.5 million. Based on the company’s projected cash flows, current cash and cash equivalents and its overall cash position, the company expects to have adequate liquidity to fund its day-to-day operations in 2009.

Working capital consisting of current assets less current liabilities was approximately $11.6 million as of March 31, 2009, and approximately $17.6 million as of December 31, 2008.

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

Alfred R. Kahn

Good morning everybody. Actually, I’m very very excited about this conference call even though I’m certainly not excited about the results. I think there were a lot of exciting things that happened and are continuing to happen as the company starts to turn around from the horrendous couple of years that we’ve had.

First, as Bruce mentioned, the company reported a loss of $0.15 per share for the first quarter of 2009 as our revenues declined from $15 million in 2008 to $10.2 in the first quarter of ’09. That revenue decline was attributable to two factors, first, Chaotic Trading Card sales for the first quarter of ’09 was $437,000 down from the $2.4 million for the first quarter of ’08. I will discuss the reasons for the decline in Chaotic Trading Card sales a little bit further on the call.

Second, our termination of the Fox agreement effective December 31, 2008, reduced both our revenues and our expenses for the first quarter of ’09. Our first quarter ’09 revenues included $3.3 million of Fox-related advertising revenues. While the $0.15 loss is by no means satisfactory, I think we can get through this loss in the appropriate context.

The first quarter was seasonally weak for the company as consumer spending on toys, games, and licensed merchandize users declined after the Christmas selling season. We’re also in the midst of the most serious worldwide recession in decades which has substantially reduced commercial activity around the world.

Before giving you the business update, I’d like to spend some time drawing down on some of the numbers that you can begin to see some of the positives from the company’s restructuring efforts and the movement into more trading card, more game related, more internet related activities.

Although 4 Kids results were negatively impacted by the weak economy, particularly in the trading card segment of the business, I’m pleased to report that our licensing segment for the first quarter of ’09 was basically flat at roughly $5.6 million when compared with first quarter of ’08. There was still a substantial amount of work to be done to rebuild our licensing business; however, this challenging economy is a positive development when the company reports revenues that are flat in the significant business segment.

In the first quarter of ’09, we had begun to see some of the benefits from the cost cutting steps we had taken in December ’08. Total cost and expenses in the first quarter of ’09 was approximately $14.6 million, down from approximately $22 million in the first quarter of ’08. The $5.2 million of the cost saving was attributed to the termination of the Fox agreement effective December 31, 2008; there has been an additional $2 million in cost reductions which shifted to P&L in the first quarter of ’09.

As discussed in our previous conference call on March 16^th, 4 Kids has done some additional cost cutting beginning in mid March. The results of this new round of cost cutting further reduced the company’s expenses beginning the second quarter of ’09. We estimate that the total cost and expenses for the second quarter of ’09 will be down by an additional $2 million.

Let me assure you that our cost cutting efforts are ongoing as we continue to look at additional steps to further reduce our expenses and bring them in line with what we believe is the base case for our revenues.

The first quarter number suggests that we’ve gotten some additional revenue such as even a modest increase in Chaotic Trading Card sales and continued to benefit from expense reductions when we will reach a breakeven point and stop burning cash. We will then have a solid base in which to add additional revenue streams from existing properties, company initiatives, and new properties.

In the last conference call I discussed the litany of challenges faced by Chaotic in the fourth quarter of ’08. While we expected the severe economic downturn to negatively impact our business, based on consumer behavior and past recessions, we believe that sales of our less expensive games such as trading cards will only be marginally impacted by economic weakness. It was the higher priced merchandize that had a tougher time selling. We sold over $7 million of the trading cards in the third quarter. We had shipped additional trading cards in October and we’re poised to sell fourth quarter orders through distributors and retailers for additional Chaotic products.

During the fourth quarter, the trading card category as a whole including Chaotic did not sell for as anticipated. Major retailers stopped ordering products in the fourth quarter causing distributors of Chaotic Trading Cards to cut if not cancel their orders. When the dust settled from the very disappointing fourth quarter, our distributors were left with substantial amounts of trading card inventory including Chaotic. Our trading card subsidiary TC Digital was also left with too much Chaotic Trading Card inventory.

TC Digital purchased the trading cards in response to orders that were subsequently reduced or cancelled. As a result, we took a $3 million inventory rate on Chaotic Trading Card in the fourth quarter.

As I stressed in the last conference call, I met with some of our larger trading card distributors a couple of months ago and have been in contact with them on almost on a weekly or a daily basis. They told me that retailers were now requesting that distributors maintain 10 to 15 weeks of trading card inventory rather than the 20 to 30 weeks of supplies that has been the norm. This change in the ordering pattern from our distributors is as a result of distributors focusing on reducing their own inventory to the newer levels of supply requested by the retailers. Simply stated, distributors are not ordering significant volumes of additional trading cards whether or of Chaotic or other trading card games until such time that the distributors have drawn down the inventories that they and the retailers currently have.

In this new ordering pattern which has negatively impacted our first quarter trading card sales, our distributors have ordered very little additional Chaotic Trading Cards while focusing their attention primarily on moving the Chaotic inventory which they have on hand.

We’ve been carefully monitoring the POS data that we get to receive from our distributors to gauge the true first quarter 2009 sell-through of Chaotic Trading Cards. Given the weakness in the economy, the lack of retail traffic, and the actions of new Chaotic Trading Card releases, the first quarter sales of older releases of the Chaotic Trading Cards were actually not bad at all considering everything considered, but how are we going to get Chaotic Trading Cards sales back on track?

First, we took a major step to get greater television exposure to the Chaotic series. We have made a deal for Cartoon Network to broadcast the second and upcoming third season of the Chaotic Television series Monday through Friday with an additional Saturday run beginning in early June. We believe that the Cartoon Network’s broadcast of Chaotic will give us an early expanded frequency and reach that we need to introduce the Chaotic Trading Card game to a much broader audience to not only drive sales of Chaotic Trading Cards in the United States.

The Monday through Friday telecast of Chaotic on Teletoon in Canada has demonstrated the power of frequent airings translating into very substantial Chaotic Card sales in the ’08. Chaotic’s popularity in Canada has enabled a Canadian Chaotic beverage licensee to receive substantial initial orders for the Chaotic beverage.

Second, the Chaotic website has been totally revamped and was relaunched in March. This new version of the website has more features, is more user friendly, and requires fewer computers resources than the original Chaotic website which required users to have a sophisticated graphics card in order to play the Chaotic Trading Card Game online. This redesigned Chaotic website has been well received by the Chaotic fan base.

Let me give you some statistics to reflect the growth of chaoticgame.com since its relaunch in March. This would also indicate obviously some traffic related to the success of the Chaotic Trading Card Game at retail as we get out of the first quarter. Registrations of new players have grown sequentially reaching 1.5 million users. The site has now played over 3 million games which is over 275,000 games played alone in April, an increase of over 37% from games played in December, which should have been the biggest month because of the nature of Christmas sales. In the month with chaoticgame.com, it took us three months to reach 1 million codes uploaded. In April 2009 alone there were 4 million codes uploaded driving the total codes uploaded to over 60 million.

Third, in March and April, we also just launched an organized played program for the US with new and experienced Chaotic players. Organized played demo base would introduce the Chaotic Trading Card to kids around the country. We have also been sponsoring Chaotic Tournaments for the more accomplished Chaotic players in both the US and Canada.

Fourth, we started to advertise the Chaotic Trading Card Game both in US and Canada when we were shipping a new trading card release. We did begin shipping a new trading card release on June 7^th to provide Chaotic fans with an initiative to upgrade their decks.

Fifth, we have license fees supporting Chaotic. Activision is on track to release a Chaotic videogame in the fourth quarter of ’09 on the Wii, DS, and PlayStation. Spin Master is also looking to release its Chaotic toys in the US and Canada and possibly Europe during the fourth quarter of ’09. Our Chaotic beverage license fee has also experienced initial success in Canada. These product releases will bolster the presence of Chaotic in the marketplace and we believe one has the popularity of the Chaotic brand. These license fees are also being encouraged to include Chaotic Trading Cards with their products.

We believe that all these Chaotic initiatives will help us continue building the brands in the US. We have exposure on Cartoon Network in the US and projected release by activation of the Chaotic videogame and first skews of the Chaotic toy lines and Spin Master in the fourth quarter, and perhaps the beginning of an economic recovery, we’re hopeful that sales of Chaotic Trading Cards in the US will pick up in the second half of ’09.

We also know that we talked about how long it takes kids to get interested in new trading cards games or in new online initiatives. We looked at the Webkinz’s success. Webkinz has been in the market for years before it broke through and became one of the number one selling products in the marketplace. We believe the same thing is apparent in terms of Chaotic as more kids get exposed to the Chaotic brand; they like it, they play it, they register online, and hopefully with a new television exposure and other licensing initiatives and promotions, this will ratch it up in more aggressive fashion as we move into the third and fourth quarters of this year.

Chaotic in Europe; the Chaotic Television Series is now being broadcast five days a week in the UK on Jetix and five days a week on Gulli TV in France. We expect RTL2 to start broadcasting the Chaotic Television Series five days a week in Germany beginning in late May or June. We expect that the five-day-a-week television exposure on networks which have top kids ratings in their markets will really help us launch Chaotic in Europe. We have translated both the Chaotic Trading Cards and the chaoticgame.com websites into French and German. We’ve begun actively selling Chaotic Trading Cards in the UK and we’ve begun to feed the market in France and Germany with Chaotic Trading Cards.

Initial UK Chaotic Trading Card sales are encouraging and we’re working with our UK distributor to expand the availability of the Chaotic Trading Card Game at retail in the UK. We have a solid advertising and marketing plan for these European markets which should enable us to make the most of the five-day-a-week telecast of Chaotic. We also anticipate that the European sales of Chaotic Trading Cards will begin to make a significant contribution to trading card revenue in the second half of the year.

The hope for a success for Chaotic in the UK, France, and Germany will enable us to establish Chaotic licensing programming in these countries and set the stage for the rollout of the Chaotic Trading Card in other European countries as well as other countries throughout the world.

We also started finishing up negotiations to create more value for the website that we built to establish Chaotic and that’s a new sports card license for our card management system which will enable us to use the card management system and the game engines to support other types of trading cards besides Chaotic. As I mentioned, we’re in process of signing a sports card license. We’ll make that announcement when that sports card license is complete. It will enable us to both sell cards at retail and also have the game available online similarly to how we handle Chaotic; each card will have a code, each code will be uploaded to the web, and the individual players can participate in the gaming both individually online or person, desirous of which way they want to play.

Let me touch briefly on some of the other properties which also have I think some exciting news attached to them. Besides moving Chaotic to the Cartoon Network, we’ve also reached an agreement with Cartoon Network to telecast the Yu-Gi-Oh! 5D series Monday through Friday in the US. We believe that Yu-Gi-Oh! property will benefit from the added exposure and we’re now working with our Japanese partners to relaunch Yu-Gi-Oh! toy line with new licensee playmates. As I discussed in our last conference call, Toonami has terminated its distribution agreement with Upper Deck and is now distributing the Yu-Gi-Oh! Trading Cards in the US and Europe. We’re also working with Toonami to ensure smooth transition so that sales of Yu-Gi-Oh! Trading Cards are not negatively impacted by the change in distributors.

The first quarter Yu-Gi-Oh! numbers were down, but substantially not down as much as we projected, and we’re now encouraged that Toonami will be able to sustain a level of Yu-Gi-Oh! support throughout this year, and with the added exposure on Cartoon Network, we believe that these things will actually result in positives for the company.

I also want to make it a point that both Chaotic and Yu-Gi-Oh! continue to be broadcast on CW on Saturdays. So, what you’ll end up with is now a five-day-a-week Monday through Friday run and a Saturday run on Cartoon, but also a CW run will continue. All that aggregated should be very helpful for the brands that we’re talking about as a whole.

Teenage Mutant Ninja Turtles; a few weeks ago the deal for the new Teenage Mutant Ninja Turtles feature film schedule for 2011 was announced. 4Kids will serve as the licensing agent for the Turtles’ movie rights. The new Turtles movie has ready deals rate treated from additional interest from license fees. We’re also in the midst of the 25^th year anniversary celebration of the Teenage Mutant Ninja Turtles. The celebration kicked off in New York City with the Turtles lighting the Empire State Building and the Tribeca Film Festival screening the original feature film to over 10,000 fans on a night that was very chilly.

I also want to talk about Dinosaur King. We’re really excited that right now Dinosaur King is the number one show in England and they’re also doing extremely well in France. This property will continue to grow and we believe additional revenues will be associated with Dinosaur King in Europe as we blow out the rest of this year.

The lifeblood of our company’s still new properties we are now in the process of setting up a number of new properties, many of which are not television based and therefore requires a less investment by 4Kids in television programming and website initiatives. These new properties will be announced when the deals have been completed. We also, as I mentioned, are continuing to look for additional ways of aggregating our websites. We’ll be selling ads on chaoticgame.com as well which should add additional revenues to the overall company’s bottom line.

Network operations and 4Kids TV website; we fortunately have been able to sell out our advertising time on CW and on our 4Kids TV website despite the weak advertising market. Our challenge has been to improve our ratings on CW which we hope to at the termination of our Fox agreement, and with Fox no longer in the kids business it will help our ratings on CW. Thus far, we haven’t been able to take advantage of the opportunity presented by Fox programming not competing with the CW programming predominantly because there are a number of new boys’ initiatives in the market; Disney rebranded Toon Disney to Disney XD which is a boys’ block, Nickelodeons putting more boys programming on Nicktoons. So, all that has created a more I think difficult market in terms of boys programming, but we have some brands in place that we believe will help us to resurrect some of the ratings and continue to make through that particular marketplace profitable for us as we move forward.

The New York Stock Exchange; as you are aware 4Kids received a letter from New York Stock Exchange advising us that our shareholders’ equity as of December 31, 2009, was $74.491 million which is a mere $9000 below the New York Stock Exchange listing requirement of $75 million in stockholders’ equity. In the next few weeks we’ll be submitting a plan to the New York Stock Exchange regarding how 4Kids intends to get back into the compliance with the $75 million in net asset listing standard. It is 4Kids’ intention to maintain its listing on the New York Stock Exchange.

In summary, we’re weathering the economic storm. As a result of making painful cuts and difficult choices we’re much closer to the point where our expenses are equal to or less than our base cost revenues. We can then hopefully grow our revenue, whether from existing properties such as Chaotic or from new properties, so as to get back to the profitability 4Kids enjoyed for many many years. We’ve become a more focused company as we are carefully monitoring our cash flows and our expenses. We’re exploring low-cost new business opportunities that we can maximize the substantial investment that we’ve made in our trading card platform and internet platforms.

It has been a most difficult process, but I believe that 4Kids has made the necessary investments to reinvent 4Kids Entertainment. It is not only a merchandise licensing company but also a trading card company with multiple internet platforms ready to compete in a digital age. As our results improve, I believe that the stock market will be able to properly assess the true value of our assets and for a more streamlined business and that we have some improvement in the stock price. I can’t imagine how difficult it has been for our shareholders as we see the stock migrate to levels that I never thought we were absolutely never going to see, but I want to thank all the shareholders for their patience throughout this rebuilding process and the most difficult of economic times. I believe that all of this will be warranted in terms of their patience as we move forward and see improvements in our underlying businesses as well as our expense structures.

I will now attend to any questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). There are no questions at this time.

Alfred R. Kahn

If anybody has any questions after this call, please don’t hesitate to call Bruce or myself if you have anything you want to discuss specifically. What I want to suggest is that we were victims of the perfect storm and that that perfect storm, whether it be auction rate security problems, the marketplace coming down because of the economy, a redo of all of our assets; this has all been very painful, but again, I am very comfortable where we are today and I am feeling very very bullish for the first time in a long time, that all these results will result in not only profits, but also significant increases in share price hopefully as these initiatives roll out. If there are no further questions, I want to thank you all for your participation this morning and look forward to talking to you more as we move out through the rest of the year. Thank you very much.

Operator

Thank you all for participating in today’s 4Kids Entertainment first quarter 2009 earnings conference call. You may now disconnect.

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