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Marvel Entertainment, Inc. (MVL)

Q2 2007 Earnings Call

August 7, 2007 9:00 am ET

Executives

Peter Cuneo - Vice-Chairman of the Board

Ken West - Executive Vice President, Chief Financial Officer

David Maisel - Executive Vice President, Office of the Chief Executive

John Turitzin - Executive Vice President, Office of the Chief Executive

Analysts

Drew Crum - Stifel Nicolaus

Barton Crockett - JP Morgan

Eric Handler - Lehman Brothers

Gordon Hodge - Thomas Weisel Partners

David Bank - RBC Capital Markets

Joe Hovorka - Raymond James & Associates

Presentation

Operator

Welcome to the Marvel second quarter results conference call. (Operator Instructions) I would now like to turn the conference over to Peter Cuneo, Vice Chairman. Please go ahead, sir.

Peter Cuneo

Operator, thank you very much. My name is Peter Cuneo, I'm the Vice Chairman of Marvel Entertainment. Welcome, everyone to our second quarter conference call. Here with me in New York today we have David Maisel, the Chairman of Marvel Studios; John Turitzin, who is the Executive Vice President of the company and part of the Office of the CEO; and Ken West, our Executive Vice President and Chief Financial Officer.

As we usually proceed, we'll start with the reading of the safe harbor announcement, then Ken West will have some prepared comments and then we will open the floor to Q&A.

Operator

Some of the statements that the company will make on this conference call such as statements of the company's plans, expectations and financial guidance are forward-looking. While forward-looking statements reflect the company's good-faith beliefs, they are not guarantees of future performance and involve risks and uncertainties, and the company's actual results could differ materially from those discussed on this phone call.

Some of these risks and uncertainties are described in today's news announcement and the company's filings with the Securities and Exchange Commission, including the company's reports on Forms 8-K, 10-K, and 10-Q. Marvel assumes no obligation to publicly update or revise any forward-looking statements.

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Ken West

Thank you very much, Peter and good morning, everyone. Earlier this morning, we released our earnings announcement and financial statements so I'll briefly highlight a few key points for this call.

Our second quarter results reflect improved year-over-year operating income contributions from each of our businesses. We have previously mentioned our anticipation that more than half of this year's earnings would be generated during the first half of this year and our results are in line with that expectation.

Moving on to our segments. Much of the strength in our second quarter licensing results related to the continued recognition of revenue from our Spider-Man merchandising joint venture with Sony, triggered by the second quarter release of Spider-Man 3. While we believe the majority of the joint venture revenue related to Spider-Man 3 has been recorded in the first half of 2007, we do anticipate additional revenue from overages from this source in the second half of the year.

The increase in joint venture revenue more than offset a decline in Marvel Studios revenue versus last year’s second quarter when Marvel Studios benefited from licensing contributions from the first two Spider-Man films. Though as usual, we're not breaking out the domestic and international components of the Spider-Man joint venture, when those international revenues are combined with our other international consumer product revenues, Marvel achieved very strong gains in total international licensing revenues this quarter and the first half of 2007.

Publishing showed continued strength in both the direction and mass market channels in both trade paperback and comics, driven principally by increased sales of special series including Civil War and Steven King's Dark Tower. Operating margins in our publishing division rose to 45% this quarter compared to 41% last year, reflecting the benefit of higher unit sales and lower per unit costs from larger print runs. We anticipate continued strong results from publishing, which would balance out at an operating margin between 42% and 43% for the year, as compared to 41% recognized in 2006.

Marvel's toy segment net sales principally reflect fees received from Hasbro under our five-year master toy license agreement, where as our prior-year second quarter revenues reflect wholesale sales of toys manufactured and sold by Marvel. Reflecting the change in mix, toy segment operating margins in this quarter rose to 55% as a result of the concentration of royalty-related revenue recorded in this segment from our license agreement with Hasbro. While Hasbro has not been has not been disappointed with licensed Marvel toy sales to date, we have reduced our forecast for the second half of the 2007 to the lower end of their forecast to reflect a possibility of lower reorders, though we are hopeful that the planned DVD releases in Q4 will further stimulate sales. This reduced forecast has been offset by expected greater contribution from both international licensing and publishing in the second half.

Finally, our corporate overhead decline versus last year’s second quarter, principally due to a decline in employee payroll taxes related to option exercises. Full year corporate overhead is expected to range between $21 million and $22 million.

Now let's turn to cash flow. Since June 30, we have expended approximately $60 million to repurchase an additional 2.3 million shares of Marvel stock. Assuming no further stock repurchases, we anticipate ending the year with no borrowings other than film financings and a cash balance, including restricted cash, in the range of $65 million to $75 million. There remains approximately $100 million authorized under our stock repurchase program.

As we continue to self-produce films, generally accepted accounting principles require that cash flow from operating activities be reduced for film spending with the offsetting film borrowings presented in the cash flows from financing activities. As a result of this mismatch of slate spending and borrowings on the GAAP statement of cash flows, the positive cash flows generated by our operations will be offset by money spent on our slate of film productions, negatively impacting the line item cash flows from operating activities.

You'll also note when you review our 10-Q, that we have closed two separate financings, each totaling $32 million. These loans are non-recourse loans secured only by our distribution contracts relating to the foreign distribution rights to both Hulk and Iron Man in certain foreign territories. Collectively, we have drawn down only $8.5 million from these facilities through June 30, 2007 bringing our total film financing as of June 30, 2007, to $133 million. We expect that borrowings under our film debt facilities will continue to grow as production and post-production continues on our two films slated for release next year.

Now, given performance to-date that is largely within plan, we have reiterated our existing financial guidance for 2007. Given the weighted average benefit of share repurchases during the second quarter of 2007, we have generated a benefit to reported earnings per share but not at a level sufficient to warrant a change in our earnings per share guidance. We are now anticipating a full year 2007 diluted weighted average share count of approximately 84 million, which does not assume any further share repurchase activity for the balance of the year.

Let me now turn the call back over to Peter to commence the Q&A period.

Peter Cuneo

Thanks, Ken. Operator, we'd like to start Q&A, please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Drew Crum - Stifel Nicolaus.

Drew Crum - Stifel Nicolaus

Good morning, everyone. I wonder if you could address your comments concerning the reduced forecast for toys? Is there a specific property that is driving that decision? Just quantify for us what Hasbro’s expectations were for toys in the second half of the year?

Secondly, if you could address the deferred revenue line item, which I think sequentially is up about 47%. Is that all Hasbro-related and when might we expect minimum guarantees from Iron Man and Hulk to hit the balance sheet? Thanks.

Ken West

With respect to the revenues that are recorded in our toys segment, about 85% of those amounts reflect our royalty earnings from Hasbro. Just to give you a little bit more specifics, the amount of revenue that was recorded in the second quarter for reported earnings under that Hasbro license agreement was $16.4 million on the quarter which means that for the first half we have recognized approximately $37.5 million. Our agreement with Hasbro is that it allows us to disclose only the amount of royalty earnings under the license, which I just mentioned. So there’s really no other additional information that we are allowed to disclose at this time.

Drew Crum - Stifel Nicolaus

Fair enough.

Peter Cuneo

Now you had, also Drew, a question about deferred revenue?

Drew Crum - Stifel Nicolaus

Correct.

Ken West

The components of deferred revenue at June 30, 2007 have many components, the most significant of which relate to the Hasbro advantage which cumulatively we have collected $105 million over a year ago, $70 million which was collected during the current quarter, we have earned out the $37.5 million that we have disclosed so far. So that is the major component of deferred revenue, as well as multi-character license agreements that have characters licensed both for the Iron Man movie and the Hulk movie which are being deferred until the earliest in-store exploitation date next year for those movie releases.

Operator

Our next question comes from the line of Barton Crockett - JP Morgan.

Barton Crockett - JP Morgan

I suspect you may not be able to go here, but I just wanted to give it a shot. The Spider-Man gross toy sales in the last movie I think were like $175 million in ’04. Is there any sense just generally, I know you can’t say specifically with Hasbro, but generally should we be looking for gross toy sales north of that or south of that? That would be the first question.

John Turitzin

Barton, I think I can only reiterate what Ken just said. Our agreement with Hasbro is such that we really can’t make a comment on those specific numbers.

Barton Crockett - JP Morgan

That’s fair. I wanted to turn a little bit to the movies for next year: Iron Man, Hulk and just a question about the timing and the P&L impact. You have got these release dates in the second quarter and if the movies perform, if the box is in line with the mid-point of the range that you disclosed, would we expect in the second quarter the movies would be profitable or unprofitable just given the timing of recoupment of the marketing costs and maybe the subsequent leverage, greater release, and later release windows like the DVD release window? So would it be kind of unprofitable or maybe neutralish in the second quarter or maybe more profitable in the third and fourth quarter?

Ken West

Barton, that’s an excellent question. When we talk about the revenue recognition associated with the release of movies, such like all the other studios release, it’s very much associated with the timing of the cash collection through our distributor. Our distribution arrangements that we have both with Paramount and Universal are what they call net deals. So once they actually recover their print and advertising costs and the distribution fees, revenues then and cash come to Marvel. That might be a delayed process depending on the timing of the collection worldwide that they collect in excess of their print and advertising costs. So, when we give guidance for 2008, we’ll have more considerations and disclosures about that specifically and that is principally what we have.

Additionally, there will be certainly more amounts that will be collected after the DVD release which is yet another promotion window; but again, the timing is something we have really got to get our hands around for 2008 guidance.

Peter Cuneo

I would like to talk a little bit, Barton, about timing for a minute, because I think it’s very important again for us to comment that it’s very difficult on our business to really forecast the timing of much of our revenues and we are very chunky business and for this reason, we don’t give quarterly guidance. If this forecasting is tough for us, you know also that it’s difficult for people like yourself who are trying to follow us. Inevitably, The Street consensus is going to be different than our internal expectations. We have seen that of course in the first quarter this year and in the second quarter of this year where we were pleased with our results for the quarters. In the first quarter, we were well-above The Street consensus; in this quarter, we’re slightly below.

But this really relates again to the timing of revenues and how difficult it is for anyone to project our business. We have maintained our full year guidance with the same range because we are concerned, even though we’re halfway through the year, about the sell-through of toys in the back half of the year. We have had an unprecedented number during the summer of film releases for large budget films that were highly toyetic. So we have a unique situation here that we’re hopefully projecting properly.

Barton Crockett - JP Morgan

I’ll leave that there for now. Just one another question on the publishing, the growth there, exceptional year-to-year there in the quarter. My question, though is, surely that can’t continue. I mean we start to create an issue of tough comps for next year. I wonder about the back half of the year. I was just wondering what you think would be a reasonable baseline assumption? I mean my baseline would tell me that I want to assume that maybe things are down next year just given tough comps. I just wonder if there is any reason you might think that is to conservative?

Peter Cuneo

Well, again, Barton, we don’t comment, we don’t give guidance for the coming year until we finish and report our third quarter of the previous year. So in early November we’ll be giving that guidance. Again, one of the reasons we delay the guidance so long is to get maximum transparency on our business and there are a lot of things happening as we sit here today that could have an effect in 2008. So I think it’s way premature at this point for us to comment on that.

Barton Crockett - JP Morgan

Anyway, exceptional results there and thanks for the answers, I appreciate it.

Operator

Our next question comes from the line of Eric Handler - Lehman Brothers.

Eric Handler - Lehman Brothers

Thank you very much, another toy question here. It seems like Spider-Man 3 toys got off to a really good start with your promotions with Toys ‘R’ Us and Wal-Mart. Did you get a sense that once Transformers came out, that really took some of the wind out of the Spider-Man 3 toy sales?

Secondly with Sega signing license deals to develop games for Thor and Captain America, is that a signal that those are two properties looking for releases for film in 2009?

John Turitzin

First again on Spider-Man 3 toys we don’t have that kind of detail to really have a reaction. Again, this is very much in Hasbro’s camp and I don’t think we have a comment on that.

David Maisel

We’re still developing as I mentioned on previous calls about five properties that we’re going choose our future movies from. Thor and Captain America are two of those; there is also Ant-Man, Nick Fury and The Avengers. We haven’t decided yet which films will be our next movies. The Sega deal is for both classic and film aspects of Thor and Captain America. So, it really isn’t an indication of what the next films will be. The films will be drawn out of the five I have mentioned that we’re currently developing.

Operator

Your next question comes from Gordon Hodge - Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

Ken, I just wanted to make sure I was clear on your comments about the loans related to foreign distribution. I think if I’m not mistaken, you sold both the international rights or the rights that you intended to sell, distribution rights for both Iron Man and Hulk 2. I am just wondering are the loan amounts against those pre-sales and were those pre-sales in line with your expectations?

I am curious if you recognized any video game overages in the second quarter or was that something that you would expect in the second half as your guidance indicated?

Last question, Wolverine and Punisher 2, curious if there is a chance that either of those two movies comes out in 2008? Thanks.

Ken West

With respect to those foreign distribution loans, as you stated, they are representative of pre-sales, they are in line with that which we anticipated. We have done those small drawdowns as of June 30 and of course they are reflected as the debt.

As far as the video games and interactive overages, we did recognize in the second quarter some small amounts of overage income for the classic video games. So we have more expectations in the balance of the year and for 2008.

David Maisel

Regarding Wolverine and Punisher 2, there has been, as I am sure you are all aware, activity on both of those fronts with directors announced for both Wolverine and Punisher 2 recently, and a lead actor for Punisher 2 as well. So while release dates have not been announced yet by Fox or by Lions Gate, there is a chance that one or both of those can make ‘08. But at this point, we don’t know for sure.

Operator

Your next question comes from David Bank - RBC Capital Markets.

David Bank - RBC Capital Markets

On your previous conference call you guys had indicated that in terms of Spider-Man LP revenue, you had expected 2Q through 4Q revenue to be slightly less on a cumulative basis than 1Q07 LP revenue. I just wanted to know if that still stood.

The second question is, the studio revenue line coming out at something like $3.5 million for the quarter was a little bit of a surprise given the strength in the box office, I am sure it’s related to the upfront payments you got. I realize you are hesitant to give specific guidance, but can you give us a little more transparency on how you see the studio revenue playing out from Spider-Man 3 for the rest of the year?

A toy-related question. I believe that Hasbro has said that they expect Spider-Man 3 toys to exceed Spider-Man 2 sales, so if you’re familiar with that comment, I think you could probably comment on that.

The last thing is, what do you think the toy sales from Spider-Man 3, I have told you about how we should think about the slate toy sales and are you looking at an equally competitive environment in terms of toyetic movies next summer?

Peter Cuneo

David, let me take the second one that you asked which had to do with studio revenues and that some people were surprised it was only $3 million given that Spider-Man 3’s worldwide box I believe is now up to $885 million. Again, and this relates to my comments about quarterly guidance and the chunkiness of our business, we basically book our revenues based on getting cash or reports from our licensees and what the royalties look like. In the case of Spider-Man 3, we have already received $10 million in advances, non-refundable advances that were recorded in previous periods as revenue. Given the timing from Sony on the results of box office, et cetera, we would not expect to see anymore revenue from our gross participation and box office until at earliest the fourth quarter of this year. In fact, that might even extend back into the first quarter of 2008. We certainly won’t see any revenue or any cash from our share of DVD business until 2008.

Ken West

David, with respect to your first question, we did make a comment in the last quarter’s earnings conference call that we did anticipate that the excellent results we had from the joint venture and the licensing revenue recognized from that would exceed that recorded in the balance of the year, which remains to be true. That is our forecast.

David Bank - RBC Capital Markets

I’m sorry, but you did say cumulatively will be slightly less. Does that continue to be your forecast?

Ken West

Yes. That is correct. And then again, I hate to repeat myself but your question about Spider-Man 3 toy sales versus Spider-Man 2 whether they are going to exceed or not, again is not a question that we can address here for the reasons I previously discussed.

And you had a question about the slate films with regard to toys?

David Bank - RBC Capital Markets

At this point does it looks like you’re up against the same kind of toyetic film competition?

John Turitzin

Yes, and every summer now looks like it’s going to be similar to this summer where there is a lot of people putting out properties that are IP-based and have toyetic aspects to them. We do have a lot of long lead time with our partner Hasbro. We have had a lot of meetings about toys for Iron Man and Hulk and they’re developing programs for both of those toys, but we do realize that every summer we’re going to have a competitive environment for the films and a competitive environment on the toy shelf.

Operator

Your next question comes from Joe Hovorka - Raymond James & Associates.

Joe Hovorka - Raymond James & Associates

Back on the loan of $32 million, was that the right number for the foreign territories?

John Turitzin

Yes, and there are two separate loan facilities of the $32 million.

Joe Hovorka - Raymond James & Associates

Is that all of the foreign territories that your reserve, that you sell for those two films or just a portion of it?

John Turitzin

Those represent specifically for each of the movies, Iron Man and Hulk.

Ken West

$32 million for each film.

Joe Hovorka - Raymond James & Associates

$32 million?

Ken West

A total of $64 million.

Joe Hovorka - Raymond James & Associates

Okay, I misunderstood. Thank you. The second question is, can you just help us understand how a movie’s budget is spent? Once principal photography is completed, are you 50% done? Are you 40%, 60% as far as spending money on the budget?

John Turitzin

After the principal photography you enter post production, which is a combination of your visual effects work, your editing of the film, your music costs and also you’re going more intensively into the marketing area. So, when we look at our films, we are actually looking at all the costs tied together, there is the production of the movie and the marketing costs and we are managing all of those every day.

From a point of view on just a production budget, not the marketing money, you’re more than halfway through normally by the end of principal photography, sometimes as much as 60%, 70%, 75% through in terms of your spend. It varies depending upon the level of visual effects you have in the movie, and any particular projects different nuances in terms of its cost structure and cash flows.

So right now with Iron Man as, I am sure you’re all aware, we wrapped about a month ago, we’re in post production now on the editing, the visual effects and the music and I’ll take this opportunity to give a quick update on the movies.

We just recently had ComiCON last weekend, where we presented for the first time the Marvel Studios presentation on Saturday, half hour on Iron Man and half hour on Hulk, where we flew in a large number of members of our cast and we couldn’t be happier with the reaction that we received. In fact, Iron Man received the only standing ovation from any film presentation that occurred at ComiCON. With Hulk, we just started week 5 of filming up in Toronto and everything is progressing well, an early stage obviously, in that movie at this point in time. But everything is in order and progressing as planned.

Operator

Mr. Cuneo, there are no further questions at this time. I will turn the conference back to you for your closing remarks.

Peter Cuneo

Operator, thank you very much. I thank all of you for listening and thank you for participating on the call. Have a good day.

TRANSCRIPT SPONSOR

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Did the analysts get it right?

Wall Street hires some smart cookies. But it’s not always in their best interest to put the hard questions to management. Are YOU even their top priority?

Motley Fool co-founder David Gardner is still bullish on Marvel. It’s up 643% since he recommended it to his Motley Fool Stock Advisor subscribers back in July 2002. Now, discover the companies David and his brother Tom recommend in their free research report “The Motley Fool's 2 Top Picks - Plus Wall Street's Dirtiest Secret.”

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