Marvel Entertainment Q3 2007 Earnings Call Transcript

Nov. 5.07 | About: Marvel Entertainment (MVL)

Marvel Entertainment, Inc. (MVL) Q3 2007 Earnings Call November 5, 0000 3:00 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 ChiefExecutive

John Turitzin - Executive Vice President, Office of theChief Executive

Analysts

Michael Savner - Bancof AmericaSecurities

Eric Handler – Lehman Brothers

Drew Crum - Stifel Nicolaus

David Miller - Sanders Morris Harris

David Bank - RBC Capital Markets

Joe Hovorka - Raymond James

Barton Crockett – JP Morgan

Operator

Welcome to the Marvel Entertainment 2007 third quarterresults conference call. (Operator Instructions) I would now like to turn the conference callover to Peter Cuneo, Vice Chairman of Marvel Entertainment. Please go ahead,sir.

Peter Cuneo

Thank you, operatorand good morning, everyone. My name is Peter Cuneo. With us today in New YorkCity we also have David Maisel, the Chairman of Marvel Studios; John Turitzin,who is our Executive Vice President and General Counsel; and Ken West, who isExecutive Vice President and Chief Financial Officer for Marvel.

As is our usual course of events, we're going to first havea reading of the Safe Harbor Statement and then we will have some openingremarks from Ken West and then we will open the floor for Q&A.

John Turitzin

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

Some of these risks and uncertainties are described intoday's news announcement and the company's filings with the Securities andExchange Commission, including the company's reports on Form 8-K, 10-K, and10-Q.

Marvel assumes no obligation to publicly update or reviseany forward-looking statements.

Peter Cuneo

Thank you. Now KenWest has some prepared remarks.

Ken West

Thanks, Peter andgood morning, everyone. Marvel's third quarter results issued early thismorning reflect improved year-over-year operating income contributions fromeach of our businesses.

Now for some brief highlights for each of our segments:

Our third quarter licensing results reflect the continuousstrength of the Marvel brand and its characters, highlighted by Spider-Manjoint venture net sales of $24.2 million, principally composed of licenseoverages. We expect to have continued strong overages from the joint venture inthe current quarter as well.

In addition, Q3 licensing segment performance benefited fromsettlements of various licensee audit claims totaling $16.8 million related tothe use of Marvel's intellectual property. Given the confidentiality clausesthat are typical in our audit settlement agreements, we are not able to providemore detail on this benefit.

We also recorded modest year-over-year gains ininternational consumer products revenues, which gains were even stronger whenone includes the international component of the joint venture licensingresults, amounting to approximately $12 million.

Publishing continues to reflect continued strength in boththe direct and mass market channels for both trade paperbacks and comics,driven by increased sales of special series including World War Hulk and Stephen King's Dark Tower. Operating margins in ourpublishing division rose to 43% and are consistent with the recent margins wehave been achieving, reflective of the benefit of higher unit sales, whichgenerate lower per-unit cost from larger print runs.

Marvel's toy segment net sales principally reflect fees fromHasbro under our five-year master toy license agreement, whereas our prior yearthird quarter revenues reflect wholesale revenues of toys produced and sold byMarvel. Reflecting this change in mix, toy segment operating margins rose to61% in the recent quarter.

We have confirmed that two SKUs of Curious George productsthat we sold contained lead in excess of federal thresholds. We are workingwith the Consumer Product Safety Commission and following their proceduresrelating to this issue. We do expect to announce a recall of approximately175,000 units in the next few weeks and have taken a reserve of approximately$1.1 million in our Q3 to provide for the estimated cost of this recall.

As for cash flows, they continue to be very strong in Q3 andyear-to-date, enabling the company to continue to actively repurchase $126.1million in Marvel common stock on the open market as disclosed in today'srelease.

As we have previously indicated, as Marvel continues toself-produce films, GAAP require that cash flows from operating activities bereduced for film spending, with the offsetting film borrowings presented in thecash flows from financing activities. As a result of this mismatch of slatespending and borrowings on the GAAP statement of cash flows, year-to-date cashflows from operating activities were just $16.3 million, as this figure wasdiminished by a net of $186 million spent on our slate of film productions forthis period.

Our total film financing as of September 30, 2007 amounts to $241.6 million, including$40.1 million of capitalized fees and facility origination costs. We expectthat borrowings under our film debt facilities will continue to grow the nextfew quarters as production and post-production continues on our two filmsslated for release next year.

Absent further stock repurchases, we anticipate ending 2007with no borrowings other than film financings and a cash balance includingrestricted cash in the range of $40 million to $50 million.

At September 30, 2007, our fully diluted share count was 80.5 million shares. Assumingno additional share repurchases, we anticipate our weighted average dilutedshare count to approximate 78.3 million shares in Q4.

Now let's turn to our financial guidance, first for 2007. Asindicated in this morning's release, based on the strong performance in Q3, wehave raised our full-year 2007 net sales guidance to a range of $455 million to$475 million. Net income for 2007 is now anticipated to be in a range of $132million to $138 million and reflecting a modestly lower weighted average sharecount for the full year, and we anticipate diluted EPS in a range of $1.60 to$1.65.

Like other studios, we do not plan to provide guidance onthe box office or performance for our slate of Marvel-produced films.Accordingly, our 2008 financial guidance reflects only the operations from ourlicensing, publishing and toy segments, including consumer product licensingand toys for Iron Man and The Incredible Hulk. We collectivelyterm revenues and expenses related to our self-produced feature films as filmcontributions.

With that background, our guidance for our core business,excluding Marvel's film contributions, is for net sales of $360 million to $400million; net income of $100 million to $118 million; and diluted earnings pershare of between $1.30 to $1.50 on an expected weighted average share count ofapproximately 78.6 million shares.

Our primary assumptions and drivers for 2008 financialguidance can be found on page 4 of this morning's release.

Finally, let me provide you with some color on ourexpectations on the timing of revenues associated with the performance of ourself-produced feature films. Our distributors -- Paramountfor Iron Man and Universal for The Incredible Hulk -- will provide withus monthly revenue reporting and cash approximately 45 days following eachmonth's end. It is this reporting that trigger's Marvel's revenue recognitionprocess.

It is important to note that our distributors will firstoffset print and advertising, or P&A costs, they incur for the films inaddition to the distribution fee against their collections prior to therecording of new revenue to Marvel. Moving through the calendar, ourdistributors will also offset P&A costs and their distribution fees relatedto the release of each film's DVDs against revenues prior to their reportingany earned revenue to Marvel.

Accordingly, the box office success of each film, combinedwith the magnitude of P&A costs as well as the timing of each DVD releasewill directly impact the timing of when we're able to record initialcontributions from the release of our feature films.

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

Peter Cuneo

Thank you very much,Ken. Operator, we'd like to start the Q&A.

Question-and-AnswerSession

Operator

Your first question comes from Michael Savner - Banc ofAmerica.

Michael Savner - Banc of America Securities

Were there any other one-time payments aside from thesettlement of the audit claims? Any other one-time benefits either in the thirdquarter or that's implied in the fourth quarter guidance? Specifically what I'mthinking about is anything related to advances for future Spider-Man sequels or anything like that?

Peter Cuneo

No, Michael. The onlyone-time event was the net results of our audits.

Michael Savner - Banc of America Securities

I understand you're not wanting to give revenue guidance forthe movies coming out next spring, but can you just give us an update on thecost side of the equation? If there's been any material change to the guidanceyou've given before, should we still be thinking of negative costs for you tothe range of $140 million to $160 million and net P&A to you of $90 millionto $100 million? Has anything changed dramatically in those cost assumptions?

David Maisel

I think what we've talked about as illustrative examplesback in August of '06 was a production range of $100 million to $160 million andwe will be in that range for these films given our best estimate right now of wherewe're going to end up. So nothing materially has changed from the illustrativeexamples that we've given in the past.

Michael Savner - Banc of America Securities

Okay, and at thispoint can you tighten the range on the two movies for next year? Are you goingto be doing that going forward, or you're not going to do that? Because that'sobviously a very big range and a year-and-a-half ago that was understandable;but as we're just a few months out, it would be helpful to get a little bitbetter sense of the cost side.

David Maisel

Yes, at this point,we're not planning to tighten the range in terms of the production estimatesfor the films. If that changes, obviously, we will let you guys know rightaway.

The P&A, just to be clear, it's a little bit prematurefor me to comment where the P&A is going end to up, as you might imagine.We're just entering the process now with our studio partners of determining thebudget for the two films, but we will let you guys know if that falls outsideof the illustrative range that we've given in the past.

Michael Savner - Banc of America Securities

Sure, and did you saya couple minutes ago that the revenue that you're going to see from Paramount,even domestically, there would be about a 45-day delay in that, is that right?

Ken West

Yes, collections eachmonth will be reported and paid to us 45 days after the end of that month. Specificallyas an example, if monies are collected let's assume in July, we would expect tocollect our share September 15th.

Michael Savner - Banc of America Securities

lastly, the strike that was announced last night from thewriters, should we assume that that won't have any impact on Iron Man and Hulk, and too early to talk about whether that has an impact in '09yet?

David Maisel

That's right. It'svery unlikely to have any impact at all on our '08 activities and it's toopremature to see if that's going to impact our '09 development.

Operator

Your next question comes from Eric Handler – LehmanBrothers.

Eric Handler – LehmanBrothers

In terms of looking at your guidance for next year,specifically on licensing, I wonder if you could give a little bit moregranularity? The numbers actually seem pretty good for licensing. Can you givesome specifics? The international business, the guidance suggests about $60million, which would easily be a record number for you guys. Specifically, arethere any things in there that's been driving that from a product lineperspective, maybe?

Secondly, with regard to the film financing, producers fees,is that going to be done in arrears as well?

Lastly, what does your earnings guidance suggest in terms offree cash flow for next year?

Peter Cuneo

Let me start with theinternational licensing for 2008. You're absolutely right, our internationalbusiness continues to grow very, very nicely. I think this would be shared here,that generally speaking investors do not appreciate how strong the basebusiness for Marvel is. I would simply define the base business from Marvel asa business that's not influenced by films in a particular year. Some of thehints of that are in fact the progress we've made internationally, although we havecontinued progress domestically as well, it's more dramatic internationally.

Also, look at our publishing business over the past coupleof years. The publishing business is almost not affected at all by filmreleases. Also, that's a good reflection of Marvel's base. We're far lessdependent now than we were years ago on films in each year.

So the international continues to grow for '08, as it hasgrown for the past number of years and we continue to have great expectationsfor that area.

David Maisel

I think the second part of your question was related to thefilm finances. As you might imagine, there are four incremental revenue streamsthat can come in from our film production activities. One is the consumerproducts revenues tied to those films; second is the producer fees; the thirdis the funds from the pre-sale territories; and the fourth is the result of theeconomics from the actual release of the movies.

Ken, perhaps you could talk through those four? The lastthree are not included at all in our guidance.

Ken West

So the elementsincluded in page 4 of this morning's earnings release, hopefully provide youwith the best estimate associated with building your models associated with ourperformance for 2008 to fit into the guidance range that we've alreadyestablished and hopefully those are the indicators that will help you the best.

Eric Handler - Lehman Brothers

But the producer feesand the presales, are those recognized in arrears as well as the economics?

Ken West

Those items, whichare excluded from our guidance, as we talked about the fact that everything todo with the film's release in 2008 is excluded from the guidance, those will berecognized upon release, depending upon the performance of the films and the guaranteesof selling the foreign pre-sale territories. Those will be recognized in 2008when we actually deliver the actual film in the can to the distributors toexploit in their specific territory.

Of course, those and all revenues associated with the filmwill be recognized at the anticipated ultimate gross margin on the entirestream of income and expenses built into the model for ultimate.

Eric Handler - Lehman Brothers

Free cash flow outlook for next year?

Ken West

2008 free cash flowis anticipated in the range of approximately $60 million, which compares to2007 which was substantially more on the basis that there were threesubstantial differences that are non-recurring in '07 of course, that are notgoing to be built into '08's guidance.

The most significant of which was the fact that under theHasbro license agreement, we collected $70 million pursuant to that licenseagreement in '07, there are no such collections required under the Hasbrolicense agreement in '08. So we'll continue to earn out those advances in '08.

Additionally, there's approximately $42 million of taxrefunds that were received in '07 and those related to exercise options thatwere done in '06, for which we got a cash benefit refund this year; those arenot expected in '08.

The third, but certainly the lesser element was themagnitude of the audit settlements that we benefit from Q3 of the $16 millionplus.

Operator

Your next question comes from Drew Crum - Stifel Nicolaus.

Drew Crum - Stifel Nicolaus

First question pertains to comic book publishing, justlooking at the industry data it looked like sales slowed in the month ofSeptember. I'm just wondering if there any spill over effect or delayed releaseof specific titles that will benefit your fourth quarter?

Second question, I just want to get an update on your macroperspective on toys. You were obviously very cautionary coming off the secondquarter.

Third, if I could get the overages figure in the quarter andyear-to-date? Thanks.

Peter Cuneo

Drew, it's PeterCuneo, let me take at least the first question. With regard to comic bookpublishing, we feel very optimistic about the progress we've made. We don'tforesee any real bump from anything that happened in September. We feel prettygood about our business for the fourth quarter as well and going on out into2008.

With regard to the macro picture on toys, we continue to bevery pleased with our relationship with Hasbro and with how that is going. Ithink they've expressed something similar on their calls as well.

David Maisel

Going forward regarding toys for '08 and beyond, we're veryexcited about the cooperation and the working relationship with Hasbro as weplan out the toys for Iron Man andfor Hulk. It's very exciting to havea partner that is as excited about those properties as we are, developing areally great toy line, and also we'll be spending a significant amount of moneyadvertising and marketing those properties, which we expect will help the filmsas well.

Ken West

Drew, you had a question in regard to the overagesrecognized in the quarter?

Drew Crum - Stifel Nicolaus

Correct.

Ken West

In the quarter werecognized approximately $23.5 million of overages both from our classicmulti-character licenses and from the joint ventures, that's worldwideoverages.

Drew Crum - Stifel Nicolaus

Ken, is there a year-to-date figure you can offer?

Ken West

Year-to-date of approximately $56 million through September30.

Operator

Your next question comes from David Miller – Sanders MorrisHarris.

David Miller - Sanders Morris Harris

Can I just get a sense of how those economics flow using thetypical industry waterfall analogy with regard to Iron Man and Hulk. ShouldI assume that the first stair on the waterfall is the producer's fee and thenafter that you have the P&A and then the distribution fee assuming it's 8%,and then the credit facility. I'm actually wondering where the credit facilityfalls in the waterfall? If you can detail that, that would be great. Thanks.

David Maisel

In broad strokes, the first part of the waterfall are whatwould be called the gross fees and those would include our producer fee, butalso include the distribution fee for our distribution partners, Paramountand Universal. We've never given specific guidance in terms of what that exactfee is.

After that is the recoupment of the distributor's expensesfor the marketing distribution of the movie.

After that is the interest and fees and principal for theactual film itself, which is where the facility gets paid back; and then afterthat, of course, at the end of the waterfall, all of the remaining profits fromthe movie go to Marvel.

Operator

Your next question comes from David Bank - RBC CapitalMarkets.

David Bank - RBC Capital Markets

Just a little more color on the toys, if possible. Youactually gave us some helpful guidance in terms of what I'm assuming the 10%from Marvel Studios in the licensing side is from Iron Man and from Hulk andsome other characters, I just want to clarify and make sure that's correct.

Since you've given us that color on the licensing side, isthere any way you could get a little bit more specific on the toy side in termsof order of magnitude of contribution, maybe relative to some of the othermovies that you've had and some of the other characters, like as I said, it'snot a Spider-Man, but is it a Ghost Rider, is it a Silver Surfer type order magnitude? Someadditional color like that.

Ken West

Just to address yourpoint in reference to the 10% from Marvel Studios that we have on page 4 of ourguidance, that specifically relates to license revenue associated with both Spider-Man 3 and Fantastic Four 2 which we anticipate in 2008.

Peter Cuneo

There are no fundsfor the licensing of Iron Man and of Hulk in that line, David.

David Bank - RBC Capital Markets

Okay, and so none inthe toy side as well?

Peter Cuneo

The merchandising and toys are up in the domestic andinternational numbers. With regard to where we see those, obviously verycandidly, there's nothing in the world like Spider-Man.So when we look at Iron Man and Hulk, we have lower numbers built intoour plans for next year. Iron Man beinga first film which we think has lots of opportunity for merchandising and fortoy sales, without we would obviously be conservative, it being the first film.

Secondly, on Hulk,which has more of a history, we did pretty well with Hulk 1 toys and merchandising. Our forecast would be a little moreaggressive vis-à-vis Iron Man, butneither of them would be anything close to Spider-Man.

Operator

Your next question comes from Joe Hovorka - Raymond James.

Joe Hovorka - Raymond James

Thanks, guys. Acouple of question related to the films. When does Hulk wrap up its principal photography?

David Maisel

Hulk has two weeks left of principalphotography at this point.

Joe Hovorka - Raymond James

Can you give us a progress point on where Iron Man is? I know we wrapped upprincipal photography by the end of the second quarter. How much is complete atthis point of the film?

David Maisel

Right now, we're, asyou said, in post-production on Iron Man andwe continue working through post-production, the visual effects, the editing,the music mixing, et cetera. That work normally will go all the way through therelease delivery date of the film, when we hand it over to the distributors,which is normally five weeks prior to the release date of the movie itself.

Joe Hovorka - Raymond James

Can you give an indication of how much of the budget hasbeen spent on Iron Man at this point?Not giving the dollar figure, but are you 80% of the way through the budget, isit more or less?

David Maisel

We wouldn't givespecific numbers like that, but as you might imagine from the productionbudget, given that we're in post-production now, a greater than the majority ofthe budget has been spent at this point. Money being spent at this point is onediting and visual effects and music.

Joe Hovorka - Raymond James

I think on the last call you said as much as 70% of thebudget could be spent on principal photography. Is that still fairly accurate?

David Maisel

As a rough number,that's a good illustrative number.

Joe Hovorka - Raymond James

I know this has been asked a bunch of times, but I think I mayhave miss it, the 5% or whatever the producer fee is, that is not included inthe guidance, correct?

David Maisel

It's not included inthe guidance and that's the 5% producer fee to Marvel Entertainment.

Operator

Your next question comes from Barton Crockett – JP Morgan.

Barton Crockett - JP Morgan

One thing that's always been interesting with your companyis trying to really grapple with the lumpiness in the licensing revenue linefrom year to year and to just try and get at that, I wanted to ask you a coupleof questions. One, in your '07 guidance, can you give us a sense of what you'reanticipating in your revenue there from licensing in the licensing segment?

Peter Cuneo

Barton, as you know,we've never given guidance with regard to segments.

Barton Crockett - JP Morgan

Well, you're givingsome for '08.

Peter Cuneo

Well we really didn’tgive hard guidance, we gave some broad ranges but typically, we don't like todo that, and I think we're going to continue that policy at this point.

Barton Crockett - JP Morgan

Okay, that's fair. Assumingthat the licensing line this year in '07 is somewhere in probably the $200million-ish plus range, which is safe, I'm sure, just given I think you'realready there, licensing in '06 was $127 million and now you're saying for '08,it's going to be in a range of $190 million to $215 million excluding thestudio contribution. Clearly, there's a lot of kind of volatility there in thatnumber.

Can you break down one element of it that I think might helpus understand this a little bit better and that is the mix between upfrontminimums and overages? You guys were giving some of that disclosure in yearspast and you've kind of scaled that back, but to my mind, that certainly helpedexplain some of the variance in '06 and might help us get some comfort withwhether '08 is more like a trend line to build off or more unusual because ofsome great deals coming in the door?

Ken West

The accounting that'sapplied associated with all different licenses certainly come in all differentcolors and it really depends on the term specific in each individual contractas to the whether upfront the minimum guarantee can be accrued as compared torecognizing it as earned; depending upon, again, what elements are in thecontract or on a cash received basis. So it's hard to anticipate, we do ourbest to associate it with the mix of all those three different parameters, butit's all dependent upon the actual terms of each individual negotiatedcontract.

Peter Cuneo

Barton, the trendover the years has been to more cash basis accounting in our licenses. I thinkthat's an important point to make, which we of course, prefer, because then weand investors can actually see the cash that's coming in the door, but we stillhave a number of contracts where accrual-based accounting is applied, but it'sour intent over time to go even more to cash basis.

Barton Crockett - JP Morgan

Leaving aside the cash basis, I'm wondering about is, isthere anything unusual in terms of a large number of upfront minimums that areboosting '07 and/or boosting '08 that might not be there in '09, or is this arelatively normal run rate for upfront minimum payments?

Ken West

There's reallynothing unusual other than the large advances under the Hasbro master toylicense, but again, that did not affect the revenue recognition, that's justcash advances. So there's really nothing unusual in the comparison of '07 to '08 in the way we model.

Barton Crockett - JP Morgan

Switching gears here a little bit on the studio side, youtalked about the recognition of revenues, but I wanted to make sure Iunderstand the recognition of expenses on the studio. Can you outline whatexpenses would be recognized and how the timing of that would flow?

Ken West

Barton, when we actually develop the ultimate for bothrevenues and expenses for any film that's released, in essence it's going todrive to a gross margin on the film product itself. So to the extent if theultimate revenues for any project were $500 million and the costs were to be$400 million for simplicity, then we'd have a 20% margin associated with everydollar of revenue when it's recognized and as it's recognized. Does that help?

Barton Crockett - JP Morgan

That does help, sobasically you would recognize the film level expenses as you recognize therevenues?

Ken West

Correct. In the sameproportion.

Barton Crockett - JP Morgan

Is there some base line level of spending though for thestudio ex the film that would be flowing through the P&L next year? If so,is that in your guidance or excluded?

Ken West

There's nothingspecifically associated with the release of either of these two films. What isincluded is the interest costs associated with the initial borrowing of theclosing costs back in 2006 when we closed the financing, plus all thecapitalized interest and such amortization. That's all.

Barton Crockett - JP Morgan

But there's also likesome overhead in terms of base overhead that you guys had $1.2 million expensehere in the quarter for the studio and some base overhead for script reviewbefore you're able to get green light. Is any of that in the guidance for nextyear?

Ken West

Yes. Our traditional studio overhead, that which we incurredday in and day out, of course is built into our core model and our coreguidance.

Operator

Your next question comes from Joe Hovorka - Raymond James.

Joe Hovorka - Raymond James

Can you tell us how much you've shared with your licensestudios as far as the royalty share on the merchandise year-to-date?

Ken West

We've never really given that type of guidance and we'vedisclosed in the past that sharing with different studios ranges up to andincluding as much as 50% of our revenues, but that's just a number implicit inour numbers.

Joe Hovorka - Raymond James

When you gave your illustrative examples at your analystmeeting, all of your models were built on a seven-year ultimate revenue for thefilm. I know GAAP allows you to do over 10 and I think there would be adifference as far as amortization of the film costs if you did over 10 asopposed to 7. How will you be recognizing that in your financial statements?Would you do seven-year or ten-year amortizations?

Ken West

Joe, I think it's alittle premature to address that at this present time, but as we get closer tomid-08, we will certainly be able to address all specifics and detailsassociated with the revenue recognition for all film models.

Joe Hovorka - Raymond James

Lastly, the restricted cash on the balance sheet, can youremind me what that is? Is that related to the film facility?

Ken West

The restricted cashon the balance sheet at September 30 has two components, one of which relatesto collection for the Spider-Man jointventure, which is simply restricted until distributed to both to Marvel for itsshare and to Sony for its share. That's a joint held account and also a balancethat's been funded and awaits to have disbursements associated with theproduction cost spending for both the IronMan and The Hulk production.

Joe Hovorka - Raymond James

And that's related tothe reserve territories?

Ken West

No, that's relatedspecifically to the borrowings for the film's production.

Operator

Mr. Cuneo, there are no further questions at this time. I'llturn the call back to you. Please continue with your presentation or closingremarks.

Peter Cuneo

Thank you very much, operator and thank you all forparticipating today and we look forward to talking with you again next quarter.Thanks again.

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