Midway Games Inc. Q3 2008 Earnings Call Transcript

| About: Midway Games (MWY)

Midway Games Inc. (MWY) Q3 2008 Earnings Call November 10, 2008 4:30 PM ET


Matt Booty - President and Chief Executive Officer

Ryan O'Desky - Chief Financial Officer and Treasurer

Miguel Iribarren - Senior Vice President, Publishing

Geoffrey Mogilner - Director of Corporate Communications


Ed Woo - Wedbush Morgan Securities Inc

Daniel Ernst - Hudson Square Research, Inc.


Thank you for your patience. Your conference will begin in approximately two minutes. Again, thank you for your patience and please standby. (Operator’s instructions)

Good day, ladies and gentlemen and welcome to the third quarter 2008 Midway Games earnings conference call. My name is Geri and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator's instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today’s call, Mr. Geoffrey Mogilner, Director of Corporate Communications.

Geoffrey Mogilner

Thank you. Welcome to our third quarter 2008 earnings call. With us on the call today are Midway's President and Chief Executive Officer, Matthew Booty; our Chief Financial Officer, Ryan O'Desky; and our Senior Vice President of Publishing, Miguel Iribarren.

I will begin today's call with the customary legal disclosures, after which Ryan will discuss our financial performance for the third quarter. Matt will then provide his comments and thoughts regarding our strategy and direction going forward including our financial guidance. After Matt's remarks, we will open the line for questions.

Throughout this call, we will present both GAAP and non-GAAP financial measures as they relate to our third quarter results and our outlook for our 2008 fourth quarter and four year earnings. These non-GAAP financial measures exclude items related to stock option expense, non-cash convertible debt interest expense and deferred tax expense related to goodwill.

Midway does not intend for the presentation of non-GAAP financial measures to be isolated from or substitute for or superior to the information that has been presented in accordance with GAAP and we encourage investors to consider all measures before making an investment decision. A reconciliation of the differences between the GAAP and non-GAAP measures is available in our press release posted under the tab, Current Headlines on our website at www.investor.midway.com.

During the course of this call, we may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning future business conditions and the outlook for Midway Games Inc. based on currently available information that involves risks and uncertainties.

Midway's actual results could differ materially from those anticipated in the forward-looking statements as a result of these risks and uncertainties, including without limitation, the performance of the interactive entertainment industry, dependence on new product introductions and the ability to maintain the scheduling of such introductions, the current console platform transition and other technological changes, dependence on major platform manufacturers and other risks more fully described under Item 1A, Business Risk Factors in the Company's annual report on Form 10-K for the year ended December 31, 2007 and in any more recent filings made by the Company with the Securities and Exchange Commission.

Each forward-looking statement including without limitation, the financial guidance speaks only as of the date on which it was made and Midway undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances except as required by law. Ryan.

Ryan O'Desky

Thanks Geoff and good afternoon. During the third quarter, Midway released TNA iMPACT! for the PS3, Xbox 360, PS2 and Wii worldwide, Unreal Tournament III for Xbox 360 in North America and Mortal Kombat: Kollection for the PS2 in North America.

Net revenues for the quarter totaled $51.4 million compared to third quarter 2007 net revenues of $36.7 million and compared to our updated guidance of $52 million. Next-generation console products contributed 71.4% of third quarter net revenues while previous generations console products contributed 15.5%, handheld products contributed 5.5%, royalty revenues contributed 5% and PC contributed 2.6%.

Our international business made up approximately 29.6% of net revenues compared to approximately 48.8% for the same period in 2007. For the nine months ended September 30, 2008, our international business made approximately 44% of net revenues compared to approximately 38.7% for the same period in 2007. The difference in our international business percentages for the quarter is primarily due to the release of Unreal Tournament III for the Xbox 360 in North America in the third quarter while the international portion of the game was released in the second quarter. For the quarter, the net loss was $0.83 per basic and diluted share or a loss of $75.9 million compared with the 2007 third quarter net loss of $33.5 million and compared with our updated net loss guidance of $0.70 per basic and diluted share.

The shortfall in EPS guidance is primarily due to price protection reserve for games that were released towards the end of the quarter as well as write down to the accelerated amortization of certain capitalized product development cost. Included in the quarter’s results were charges of $9.1 million, $0.3 million and $0.2 million related to non-cash convertible debt interest expense, deferred tax expense related to goodwill and stock option expense respectively. On a non-GAAP basis excluding the impact of these charges, the loss was $0.72 per basic and diluted share or $66.3 million compared with the 2007 third quarter net loss of $28 million and compared with our updated net loss guidance of $0.60 per basic and diluted share.

In addition, as we announced in previous filings, the additional charges we recognized for the game cancellation in Austin, the move of the Moore Park studio, exiting the licenses and other charges amounted to approximately $22.3 million or $0.24 per share.

At September 30, our cash balance stood at $11.5 million of which $1.1 million is restricted cash and another $21.6 million in net receivables. The third quarter cash used in operations was $46.9 million. During the quarter, cash invested in next-generation technologies and product development projects, totaled approximately $16.6 million.

At the end of the quarter the balance of capitalized product development costs was approximately $48.7 million, a decrease of $24.5 million from the previous quarter ended June 30. Of the total capitalized balance, 3.6% relates to products already in the marketplace as of the end of the quarter and the remaining balance relates to products that we expect to introduce in the future.

Gross receivables at September 30 were $46.2 million, reserves for price concessions, returns and uncollectible accounts were $24.6 million or approximately 53.2% of the gross receivables. The basic and diluted shares totaled 91.6 million shares for the third quarter. For the fourth quarter of 2008 we have assumed a basic and diluted share account of 91.7 million shares.

This concludes the financial update. Matt.

Matt Booty

Thank you, Ryan and good afternoon everyone.

Since I assumed the interim CEO role in March, the Midway management team, along with our Board of Directors has made several tough but necessary decisions for the long-term future of the Company, details of which we have disclosed in press releases and other filings over the past few months. We cancelled the large project at our Austin facility for which we recognized a non cash charge in the third quarter and we believe that the change has resulted in a studio focused on the right projects with a much better opportunity to succeed.

We have also moved the development team responsible for our TNA Wrestling franchise from a location north of Los Angeles down to our existing facility in San Diego. We are fortunate that a high percentage of the better in development team relocated, a testament to the studio leadership and belief in the franchise and we expect to benefit from reduced overhead and a better recruiting and hiring environment now that the team is in San Diego and hard at work on the next generation of the TNA Wrestling game.

The long-term impact of both of these studio-related decisions is that we are using our resources more effectively and realizing a number of synergies that we believe will allow us to produce higher quality games at a lower cost.

Over the last few months, we also extricated ourselves from two underperforming license agreements that were in place with partners with whom we have had a long history and hope to work with again. We chose to exit those deals on positive terms because they were set up during the last console cycles and we are not economically viable at this time. This is not market change in strategy and we will continue to opportunistically pursue a new licenses but, rather than invest resources and projects that we felt would not yield market success, we prefer to exit those particular licenses and we are fortunate to have understanding partners and to be able to do so on mutually beneficial terms.

The studio reorganizations, the factoring agreement and the license exits were important structural and operating changes designed to minimize cost, ensure successful launches of our core game franchises and refocus our resources on the strongest licenses and internal IP. While these decisions obviously impacted our result short term, I believe that they were all vital to building a foundation for Midway going forward.

My focus since assuming the role of interim CEO in March has been to improve execution in the three primary phases of making games, creating a green light in new concepts with the highest potential and actually developing the games themselves and then finalizing and launching the titles within established quality, profitability and scheduling parameters. While we have made significant strides in honing our processes with respect to green lighting and developing the games, one visible improvement is the way in which we have launched our games this season.

In the past, our sales and credibility have both suffered from missed launch dates and shipments split between skews. This year, we have improved this. With all versions and skews of TNA iMPACT! and Blitz: The League II shipping on the announced dates in the US and Europe and the upcoming Mortal Kombat versus DC Universe is expected to do so as well.

Although we continue to navigate through a difficult period, we are doing so with significant assets in place; a solid product development organization, valuable properties and licenses, a studio system unified and a common set of tools and technologies and a core engine making the most out of Epic's Unreal Engine such as the 60 frames per second fighting games, action and driving games and streaming open world games. We are seeing the benefit of these assets now and we expect the real advantages to become more apparent as some of the games currently in development hit the market.

We released several new titles during the third quarter and have continued full steam into the fourth quarter with what we believe is a strong fall lineup. In October, we launched Blitz: The League II with significant media support from the game's cover-athlete football legend Lawrence Taylor who just finished the whirlwind media tour for us. Also on October, we have launched more entries in the casual games category with sequels to our highly successful Game Party for the Wii and TouchMaster for the DS as well as releasing the highly rated Mechanic Master for DS.

In less than a week, we plan to launch Mortal Kombat versus DC Universe with a street date in North America of November 16 and in Europe of November 21. The excitement from fans and the gamer community has been very encouraging. Awareness is an all time high for this franchise and already reviews course are beginning to come in that indicate that this could be one of the highest rated Mortal Kombat games ever. The relationship with Warner Bros. interactive entertainment and DC comics has been very productive and with the broad market potential afforded by the T-rating, the engaging story mode, the high quality of the graphics and fighting mechanics and enthusiastic support from Mortal Kombat fans and DC comic fans alike, we have high expectations for this title.

In terms of guidance for the fourth quarter ending December 31, 2008, we expect net revenues of approximately $105 million with a net loss of approximately $0.20 per basic and diluted share. On a non-GAAP basis, we expect a fourth quarter loss of approximately $0.07 per basic and diluted share which excludes approximately $0.13 of stock option expense, deferred income tax expense related to goodwill and convertible debt non cash interest expense.

For the full year ending December 31, 2008, we expect net revenues of approximately $210 million with a net loss of approximately $1.78 per basic and diluted share. On a non-GAAP basis, we expect a full year loss of approximately $1.37 per basic and diluted share which excludes approximately $0.41 of stock option expense, non cash convertible debt interest expense and deferred income tax expense related to goodwill. Note that our guidance is tampered by the effect of foreign currency translations since the US dollar has gained strength recently.

As we look to next year, we have several key titles in the pipeline including Wheelman; this is Vegas and the next installment of our TNA iMPACT! franchise. Wheelman is an exciting cinematic action driving game starring Vin Diesel, an iconic figure in the gaming world who has been involved in the development of the game since its inception. We are gearing up for a big launch of Wheelman in the first quarter of 2009 which will set there on the open world setting in the unique and engaging vehicle combat system.

A final note on changes at Midway. Last week we announced that Peter Brown became the new chairman of Midway replacing Shari Redstone. Shari assumed the leadership of the Board last year and has provided tremendous guidance and support through the years. Peter has been a director of Midway since 2005 and we look forward to his increased involvement and guidance. Also, as we look forward to 2009, our Board and management both have been and continue to be actively engaged in addressing our liquidity and capital issues. Current economic conditions have made this task especially challenging.

Nonetheless in spite of internal issues that Midway faced in the beginning of this year and the challenges that the rest of the industry faces in the retail environment, we have made a number of changes so far that we believe will make us a more lean and agile organization. I am proud at the talent and passion of Midway's employees and coupled with solid content and the kind of execution we have shown in the second half of this year, they are the keys to reclaiming Midway's place as the top tier in the game publishing.

Thank you for joining us on this call. We look forward to reporting on our progress in future calls. That concludes my prepared remarks. Operator, please open the line for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Ed Woo - Wedbush Morgan Securities Inc.

Ed Woo - Wedbush Morgan Securities Inc

Great. I have a question regarding the retail environment. Have you seen any noticeable changes since the end of September?

Matt Booty

Yes, we have. The retail climate has gotten a little more difficult in the last couple of months especially with regard to initial shipping volume. I think what you are just seeing is a little more caution on the part of retailers whether or not that caution was warranted remains to be seen as we enter the holidays but certainly the retailers are a little bit more reluctant to step out and put in orders for very large day one sales number. So we are seeing slightly more conservative day one launch numbers for titles but again, I think that is understandable given the economic climate.

Ed Woo - Wedbush Morgan Securities Inc

Have you noticed any change in sell through to consumers in either specifically or in general?

Matt Booty

We have seen a little bit of softness in the last month. I think you are going to see a little more differentiation between the very top-tier titles and titles that are possibly not quite ambitious or more niche oriented. For instance, our TNA and our Blitz: The League games, we try to be very proactive in maintaining the rapid sell through of these titles by being a little more aggressive on pricing and we recently drop the price point on those two titles and we have seen some nice pick up. So consumers are responding to elasticity of pricing out there and I think that is another trend you are going to see going forward.


Your next question comes from the line of Daniel Ernst with Hudson Square Research, Inc.

Daniel Ernst - Hudson Square Research, Inc.

My first question is on your comments on liquidity. I wonder if you could drill down into the near-term outlook there specifically you got a $79 million convertible note due in April which really is not that far off and what your opportunity is for paying that off or refinancing that note. I hope that you can give us some there on specific current share price given those shares would be I assume overly diluted but I wonder if you have other options there and then on the retail environment, it is just a little bit about pricing. You had a number of games come out in the last year that were geared towards being tier one triple A titles but you had not reached that on a sales basis. Maybe I was wondering if there is an opportunity there to repurpose those since they are already developed as value add titles and then last question, what percent of sales was the catalogue in the quarter? Thanks.

Matt Booty

Yes, this is Matt. I will let Miguel talk to the retail and catalogue issue. Regarding liquidity, what I will say is that our Board and the management team here as I said has been and will continue to be actively engaged in addressing these issues. We are pleased with some of the operational achievements that we have hit over the last year but as I said, our outlook for the future is tampered by the capital and liquidity issues that you point out. The economic conditions do add challenge to this but our Board and management are very actively engage in addressing these issues right now. And I will let Miguel talk to the retail and catalogue question.

Miguel Iribarren

Yes, as far as, you have mentioned well, taking some of our frontline titles that we have released earlier in the year, perhaps last year and repurposing them. That is kind of part of the normal process of creating catalogue product. We have done that this year actually with a prior generation product, the Mortal Kombat. We have taken three Play Station II Mortal Kombat titles and bundled them together to make a Mortal Kombat Kollection, a product that we placed very well at retail and that is an example of that. We continue to strengthen our back catalogue obviously as we release more frontline product and we found a pretty good market up for catalogue so far this year, again, kind of indicating that there is some elasticity of price out there. As far as your last question about percentage of catalogue sales for the quarter, it looks like catalogue was about 22% of the quarter sales.

Daniel Ernst - Hudson Square Research, Inc.

Got it and then Matt, just one more question on the balance sheet, if you could be more specific on the refinancing of the April notes or a more near-term concern, do you have or have you been able to quantify yet the needs today, receivable risk at Circuit City?

Ryan O'Desky

This is Ryan. We have been monitoring the Circuit City situation closely for a while and our exposure is currently very… in the recent history, Circuit City has been about 1% to 2% of our net sales though.


(Operator's instruction) At this time, we have no additional questions. I would like to turn the call back over to Matthew Booty for closing remarks. Please proceed, sir.

Matt Booty

Thank you very much. That is all we have got. Thank you.


Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.

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