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World Wrestling Entertainment, Inc. (WWE)

Q2 2010 Earnings Call

August 05, 2010 11:00 am ET

Executives

Michael Weitz - SVP, IR

Vince McMahon - Chairman and CEO

George Barrios - CFO

Donna Goldsmith - COO

Analysts

Richard Ingrassia - Roth Capital

Michael Kupinski - Noble Financial

Luke Shagets - Sterne, Agee

Operator

Good morning. My name is Casey, and I will be your conference operator today. At this time, I would like to welcome everyone to the WWE Second Quarter 2010 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 your host Mr. Michael Weitz, SVP of Investor Relations. Sir, you may begin.

Michael Weitz

Thank you and good morning, everybody. We really appreciate you joining us this morning. Joining me for today's discussion are Vince McMahon, our Chairman and CEO; Donna Goldsmith, our Chief Operating Officer; and George Barrios, our Chief Financial Officer.

We issued our earnings releases earlier this morning and will be referencing a presentation as part of our discussion. To clarify our performance and shed light on trends in the business, these and other materials such as quarterly financial and metric schedules are available on our corporate website at corporate.wwe.com.

We will be making several forward-looking statements today as part of our discussion. These statements are based on management's estimates. Actual results may differ due to numerous factors. These factors are described in our presentation and in our filings with the SEC.

Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release or on our website. Today, we'll review our financial results for the second quarter and we'll follow this review with a Q&A session.

At this time, it is my privilege to turn the call over to Vince.

Vince McMahon

Basically, we had a lousy quarter, and I think that it was sort of like a perfect storm, if you would, we had quite a number of negatives as it relates to the Icelandic volcano situation, which our troops were stranded over there for quite some time.

Notwithstanding that, another perfect storm as it relates to talent and intellectual property and the use of them at the end of WrestleMania, the remaining of those really our top talents, some of them retired, which one of them we knew was going to another we did not.

In addition to that there were considerable injuries that booked a number of our performers on the sideline as well, Undertaker, CM Punk, Shawn Michaels retired, Batista, unexpectedly, took a hiatus, Triple H injured. These are some of the stalwarts that we rely on.

These are some of the star, which that we are relying on to for pay-per-view numbers, rely on for live events, and that's really my major barometer in terms of where the business is going. All live events is for those pay-per-view numbers, because the pay-per-view is no different than really a live event that's simply televised.

So, those two are numbers that were indicative of the lousy quarter in terms of pay-per-view and the lack of attendance, but all of that of course relates to WWE not giving the public the performance in terms of attraction that they want to see.

And again, that's because of the perfect storm-type situation that we've never had in the business in terms of all of these talents leaving and injured all at the same time.

We did have a couple of strengths in terms of home video somewhat up. Our tour launch with Mattel, and Mattel as a partner is tremendous and we will continue to have very positive impacts.

International revenue was up as well. And generally speaking, notwithstanding the lousy quarter, we are extremely confident that the financial objectives we have stated before, our growth between 15% and 20% over the 2009-2012 period is very sound, so that's basically what I have. George?

George Barrios

Thanks, Vince. I would like to start by providing some additional perspective on our second quarter results. For the quarter, we reported significant declines in revenues and operating income as compared to the prior year quarter.

Our performance reflected the impact in timing of WrestleMania, which contributed approximately $32.2 million of revenue and $15 million of profit contribution to the second quarter last year. As a reminder, WrestleMania occurred in the first quarter of 2010.

To clarify trends in our business, I I'll discuss our performance on an adjusted basis, excluding the impact of WrestleMania. On such an adjusted basis, net income declined approximately $4 million with a 9% decline in profit contribution and revenues that were essentially flat to the second quarter last year.

Our performance fell below management expectations and prior year as trends weakened in the later part of the quarter. Although, ongoing economic difficulties likely played a part in our result, we believe that recent changes in our account base also impacted key operating metrics, particularly domestic pay-per-view buys and live event attendance. In fact, lower revenue from our pay-per-view business accounted for approximately two-thirds of the decline in adjusted earnings.

Increased profits in other businesses such as home video were offset by lower results in other areas. As such, the remainder of the decline can be attributed to $1 million in logistical costs associated with the Icelandic volcano, and a $3 million swing in other income, primarily due to the realization of foreign exchange losses in the current period as compared to realized gains in the prior year period. These factors more than offset improved efficiencies and reduced SG&A expenses in the quarter.

We view some of these factors as temporary in nature and remain confident in our ability to address the more fundamental challenges to the business, including pay-per-view. While these challenges post significant risk to 2010, we believe we can still meet our longer term financial target.

As previously communicated, our business outlook calls for average annual earnings growth of 15% to 20% over the 2009 through 2012 period. For more detailed review of our performance in the quarter, let's turn to page 5 of our presentation, which list the revenue and profit contribution by business unit as compared to the prior year quarter.

Starting with our live events, including merchandise sales at these events revenue increased 8% from the prior quarter on an adjusted basis. The growth was led by our events in North America, which benefited from increases in both, the number and pricing of events.

The numbers of events held in North America increased from 50 to 62 events and average ticket prices in the region increased 15% to $39.50, reflecting a price increase in select markets implemented in April.

Partially offsetting our performance in North America was a 19% decrease in average attendance to 5,800. We held two tours in Europe and Latin America. The former was impacted by ongoing weakness in the European economy and by scheduling changes caused by the Icelandic volcano.

As a reminder, the resulting ash cloud over Europe shutdown or impaired air travel for much of our European tour. In contrast, our tour in Latin America demonstrated our developing presence in Mexico and generated over 12,000 fans per event over an eight event tour. Overall, our average international attendance increased slightly to 8,200.

Turning to our pay-per-view business, revenue declined 29% on an adjusted basis, reflecting one fewer event and a 16% decline in buys for the comparable events produced in both, the current and prior year period. For these comparable events, domestic pay-per-view buys declined 19%.

On that part of our adjusted result, it should be noted that WrestleMania XXV generated $21 million in pay-per-view revenue based on approximately 960,000 buys in the second quarter 2009.

Revenue from the distribution of our television programming increased by 9%, or $2.5 million due to higher rights fees from our global television contract and the addition of the WWE Superstars television show. As a reminder, this program debuted on WGN America on April 16th of last year.

Notably, profit from our television business increased 25%, gross profit margins improved to 42% from 36% due to the expansion of revenue and significant efficiencies in our production processes.

In our Consumer Products segment, our licensing revenues declined slightly to $8.7 million. The prior year benefited from the release of a new video game, Legends of WrestleMania, which is updated on a 24-month cycle. As such, the timing of our video game releases resulted in lower game sales in the current period.

In addition, our SmackDown vs. RAW video game, which was released in October, generated sales of 370,000 units, representing a 20% decline from the prior year. Overall, lower game sales in the current period offset very strong growth from our new toy launch.

Revenue from the distribution of our toys increased by 175% in the period and outpaced the prior year by 66% on a year-to-date basis, demonstrates the strength of our Mattel partnership.

Our Home Video revenue increased 34%, or $2.9 million due to higher sales of new release and catalog titles. The growth marked the first quarterly increase since the third quarter of 2009. DVD and Blu-ray shipments increased 29% to nearly 1.1 million units during the quarter, reflecting video content with stronger appeal.

Quarter also benefited from a significant reduction in estimated return, and from the release of two additional titles.

Estimated return to a 24% of growth domestic retail sales, compared to 35% in the prior year quarter. These increases to net Home Video revenue was often marked by 12% decline in average pricing to $12.71, reflecting ongoing promotional activities.

In our magazine publishing business, revenue decreased 17% to $2.5 million, primarily due to lower circulation. Sell-through rates for WWE Magazine fell to 25% versus 32% in the prior year quarter.

In our Digital Media segment, revenue declined 32% to $5.4 million from the prior year, due to a 25% reduction in online ad sale, a loss of a key wireless contract and lower on online sales of merchandise.

Revenue from our online e-commerce site, WWEShop decreased 29% driven by 24% decline in the number of orders to approximately $47,000, and a moderate decrease in average revenue per order of $50.73.

During the quarter, WWE Studios recognized revenue of $0.7 million associated with three of our film projects. Behind Enemy Lines Columbia, See No Evil and The Condemned.

For our film releases to-date, we participate in the theatrical DVD and other revenues after distribution cost incurred by our partners have been recouped. Accordingly, we have not yet recorded revenues for 12 Rounds or The Marine 2. We continue to believe our portfolio for these films will ultimately surpass breakeven profit.

We have endeavored to improve the returns of our feature film projects, and as previously announced, we'll begin self distributing our film releases. Under this new model, we will begin to record both, film revenue and associated expenses once the film has been released for distribution.

The first film to be distributed under this new model Legendary is scheduled for release on September 10th.

Turning to our overall results, our profit contribution decline 9% to $43.8 million and margins fell to 41% from 45% in the prior year quarter. These results were primarily due to a reduction in revenue from our higher margin businesses such as pay-per-view and by the logistical costs related to the Icelandic volcano.

For the quarter, reported SG&A expenses decreased 4%, or $1.2 million to $31 million led by the timing of our advertising spend, a reduction in bad debt expense and lower staffing cost. These changes reflect management's sustained focus on operating efficiency and our continued success in managing expenses.

Page 14 of our presentation compares the quarter-over-quarter results and provides a summary of changes by business. As shown, adjusted operating income declined 21% driven by the reduction in profit contribution, partially offset by SG&A cost savings.

Adjusted net income declined approximately $4 million to $6.3 million. As mentioned earlier, the changes in pay-per-view business accounted for approximately two-thirds of the decline. The remainder of the decline can be contributed to a $2.5 million swing in foreign exchange gains and losses, which was reported in our other expenses as well as our volcano-related costs.

Page 15 of the presentation contains our balance sheet, which remain strong. On June 30th, we have more than $210 million in cash and investments with virtually no debt.

Page 18 shows our free cash flow. For the quarter, we utilized approximately $16 million of free cash flows, compared to generating $26 million of positive free cash flow on the prior year quarter. The decrease was driven by the timing of WrestleMania, higher investment in feature films and changes in working capital, including changes in the company's tax position.

In assessing our business performance, we believe that some of the factors that reduced our second quarter performance are temporary in nature. Although 2010 will be impacted by the short-term challenges, we remain committed to and confident in our ability to achieve the financial target that we communicated previously.

We believe we can address the more laughing challenges by focusing on the production of compelling unique content. Creating original content and cultivating a passionate global audience, these are the pillars of our business model and proven areas of strength for WWE.

That concludes this portion of our call, and I will turn it back to Michael.

Michael Weitz

Thank you, George. Casey, we are ready now, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first comes from the line of Richard Ingrassia with Roth Capital.

Richard Ingrassia - Roth Capital

Vince, obviously not much you can do about injuries, so I am more interesting in hearing your take on fair response to new talent of late and pipeline of talent to come?

Vince McMahon

Our fair response in terms of new talent, I have been, actually we have a huge one on RAW are called Nexus. It immolates from one of our television shows NXT in which we integrate new talent into WWE which of course is extremely important to us. There is been a very favorable reaction to a lot of our new talent, but obviously you can't wave the magic wand and have that happen overnight in terms of a benefits.

Nonetheless, I am very confident that the new talent infusion as well as some of the older talents coming back Undertaker and Triple H and things of people of that nature will have to the mix in and really make it a compelling talent line up.

Richard Ingrassia - Roth Capital

At a high level, a related question, is there really much you can do on the content side to improve sales near-term other than wait for that talent to return and wait for broad improvements in employment, broad economic factors?

Vince McMahon

As obviously with the agriculture economy and things about nature, you make more efforts too, but I would suggest that there is no quick turnaround in terms of a, again, we have the perfect storm unfortunately in terms of a talent retiring, injured, and we should never had that many talents injured at one time, top talent that is. They are coming back into the fold now and again an infusion of new talent, it is going to take a while.

Richard Ingrassia - Roth Capital

Any new thoughts on use of cash? And just to confirm with George, you don't hedge against currency fluctuations. Correct?

George Barrios

That's right. At this time, we don't hedge, Rich. We have a natural hedge on a live event side, given that's our revenues and expenses are done in the same currency. Our TV contract which is a significant part of our international revenues are denominated in US dollars, so we are going to have exposure there. So it's really primarily on the licensing side and at this point we just decided the cost of hedging isn't worth it.

Richard Ingrassia - Roth Capital

And on the cash spend?

George Barrios

Our cash spend, especially you've got two big items year-over-year. One is the film spend side. If you look at the first six months of the year, we had film spend this year about $21 million. Last year, the film spend was actually a net cash inflow because the tax credits that came in from previous film, offset the money we had spent. So we actually had $5 million of net cash inflow on the film spend side, that's a $26 million swing.

The other item was tax payments/federal tax maintenance. Last year, we were overpaid and got a refund and this year not, and that's about an $18 million swing. So those are the two big cash items.

Richard Ingrassia - Roth Capital

Then one more, last question, the cash on the balance sheet, any new thoughts, use of those funds?

George Barrios

Now we continue to view the cash on the balance sheet the same way. Given the inherent risk in the business, we think it makes sense from a long-term standpoint to have limited debt. From a liquidity standpoint given the nature of the business, we think it make sense to have about 30% or 40% of revenues, they are about per liquidity. Then we want cash available to invest in opportunities and in supporting the existing businesses.

Operator

Your next question comes from the line of Michael Kupinski with Noble Financial.

Michael Kupinski - Noble Financial

Just a couple of quick questions. I know this is a difficult question, but how quickly do you think it will take for you to kind of like get the storylines and the talent back on course.

Obviously you, internally you probably have some benchmarks when you think you kind of hope to regain the loss in maybe TV ratings and live events audience and so forth and start seeing some traction, what would it be one quarter, two quarters, three quarters, what do you think is the timeframe there?

Vince McMahon

Television ratings have been increasing actually since we've had this new intellectual talent and you don't benefit from that until probably seven, eight weeks on the other end, which is about where we are now. We are looking for SummerSlam to reverse the trend of the downward spiral pay-per-view because of this new infusion of talent.

So we look for SummerSlam to be the kick-off if you would for all the new talent integrating with others and more creative storylines and all of that, which have already been created but the answer is, I would think SummerSlam would be the kick-off for all of this new stuff.

Michael Kupinski - Noble Financial

In terms of pay-per-view weakness, is there any way to kind of guess or monitor how much of the weakness was related to talent issues that you might have had in the quarter versus maybe the impact of the price increases that you might have had?

Vince McMahon

There's really no way to tell exactly, except our general research indicates that if you have a strong attraction, people will buy it. We've been giving them good attractions, and by the way, we've been here many times before in our company in which for one reason or another because of the injury or what have you that we don't give the audience what they want.

We have been there many times before and we know exactly what we are doing it. One thing, if something is broken and you don't know how to fix it, it's another thing if it is broken but you do know how to fix it and are in the process. So, we do know what we are doing and we know how to fix this problem.

Michael Kupinski - Noble Financial

Over the course of the last few quarters you have been pretty successful in managing costs, and certainly you have the little extraordinary items in the costs related to the volcano, but the costs to sales were higher than I expected, were there any other extraordinary items in there that might have accounted for the this little stronger than expected expenses?

George Barrios

The primary one, Mike, if you look at the revenue was flat. You'd expect with flat revenue to get a little bit of degradation on the product contribution just from inflation. So we have a little bit of that but essentially with the $1 million or little bit more than that related to the volcano that drove the profit margins in the quarter.

Michael Kupinski - Noble Financial

It just seem like the expenses were $2 million higher than I was looking for, but I just thought there might have been something else in there?

George Barrios

No, half of that was the volcano, so there is some timing issues on our marketing spend that we think reverses, but the real unique item was the volcano in the quarter.

Michael Kupinski - Noble Financial

Then finally, do you have any updates from the plans for cable network, and how those discussions are going, and maybe what the timetable might be just any update on that?

Vince McMahon

First to the year, we are going to a cable systems and present what we think is a very, very sound proposal for everyone, them as well as us, pretty much based on the Major League Baseball model. We're all set to go. Indications are there is interest and in some cases a lot. So we are going to be pursuing that as the formal presentations beginning first to the year.

Michael Kupinski - Noble Financial

In terms of any capital that you might be put behind, have you given any thoughts about that?

George Barrios

Yes, we've given that a lot of thought. Not prepared to share anything at this point. But obviously, as part of the analysis that we're doing, we giving a lot of thought as to what the investments would be as well as to what the returns and value creation would be.

Operator

Your last question comes from the line of Luke Shagets with Sterne, Agee.

Luke Shagets - Sterne, Agee

Can you talk about what your long-term goals assume in terms of overall macro economic trends and consumers spending trends in particular going forward?

George Barrios

Yes. When we gave our three year plan last year, and talked about 15% to 20%, Luke, we said we probably could do with moderate revenue growth. So weren't expecting a bounce back or V-shape recovery. We thought it would be sluggish for sometime. We continue to believe that simply because that's the general consensus.

A lot of the revenues as we talked about at that time, we felt pretty good about because they were either contractual in nature and we've announced in subsequent to what we talked about last year specifically a new deal with RAW on USA, and new deal SmackDown on Sci-Fi. We had those in our sights, feel good about those, as well as our international TV agreement. So, TV in general, driving a lot of the growth and a lot of that being contractual.

The second part was on the Mattel deal. We knew going in that the Mattel deal would be impactful on three fronts. Number one, the commercial terms of the deal which was forged in a fairly competitive RP environment. Number two, the level of distribution our increased distribution on a global basis that Mattel's providing, we're seeing that in the numbers right now. And number three, we felt really excited about the product developments that working with the Mattel team we're going to be able to get new SKUs in the market.

So, while you can't say any of that is locked in, those things primarily in the 9 to 12 period we thought would support us. What we have seen in 2010 is maybe a little bit more sluggishness in the economy than we have thought, but not a lot more because we weren't planning for a big bounce back but it really is what Vince talked about at great length is really the perfect storm on the talent side.

Luke Shagets - Sterne, Agee

Then just a quick housekeeping question. On the international events, how many of those were buyouts?

George Barrios

We had a couple in the quarter which is why you see a little bit of disconnect. It's one of the reasons there is a disconnect on the revenue increase year-over-year in live events versus the profit decline. The disconnect as you gross up the revenue on the buyout deal for that increases and then also you had the volcano cost.

What I will remind you is that from an accounting standpoint, depending on the nature of control that we have, even if they are buyout deals, we do include the gross revenue and gross expenses. We just gross up the revenue further if we need to get the buyout as part of the deal. So you end up gross up the revenue for that amount. So, it's a little bit of different accounting that we did, probably a year and half ago, when we had a couple.

Operator

(Operator Instructions)

Michael Weitz

Cayce, is that it?

Operator

There are no questions in queue at this time.

Michael Weitz

Thank you, everyone. We appreciate you listening to the call today. If you have any questions, please do not hesitate to contact us, I am Michael Weitz at 203-352-8647. Thank you.

Operator

That concludes today's conference. Thank you for your participation. You may now disconnect.

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