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Midway Games Inc. (MWY)

Q4 2007 Earnings Call

March 6, 2008 4:30 pm ET

Executives

Geoffrey Mogilner – Director IR

Ryan O’Desky – Interim VP of Finance

David Zucker – CEO

Analysts

Heath Terry – Credit Suisse

John Taylor - Arcadia

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Midway Games earnings conference call. My name is Melanie and I’ll be your coordinator today. (Operator instructions). I would now like to turn the call over to Mr. Geoffrey Mogilner, Director of Investor Relations, please proceed.

Geoffry Mogilner

Thank you, welcome to our fourth quarter and full year 2007 earnings call. With us on the call today are Midway President and CEO David F Zucker, our Interim Chief Financial Officer, Ryan O’Desky O’Desky, our Senior Vice President of Worldwide studios, Matt Booty and our Vice President of Publishing Migues Iribarren. I will begin today’s call with a customary legal disclosures, after which Ryan O’Desky will discuss our financial performance for the fourth quarter and full year. David will then provide his comments and thoughts regarding our strategy and direction going forward, including our financial guidance. After David’s remarks we will open the lines for questions.

Throughout this call we will present both GAAP and non GAAP financial measures as they relate to our 2007 results and our outlook for our 2008 first quarter 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 the non-GAAP financial measures to be isolated from, a 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 GAAP and non-GAAP measures is available in our press release posted under the tab current headlines on 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. Midway’s actual results could differ materially from those described in the forward looking statements as a result of a number of risks and uncertainties including without limitations, the performance of the interactive entertainment industry, dependence on new product introductions, and the ability to maintain the scheduling of such introductions, the new console platform cycle and other technological changes, dependence on major platform manufacturers and other risks more fully described under item one, risk factors in the company’s annual report on for 10K for the year ended December 31st, 2006 and in other filings made by the company for the securities and exchange commission.

Each forward looking statement including without limitation financial guidance speaks only as of the date on which it’s made and the company undertakes no obligation to update any forward looking statements to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated events or circumstances except those required by law, Ryan O’Desky.

Ryan O’Desky

Thanks Geoff, and good afternoon. During the fourth quarter, Midway release Unreal Tournament 3 for PS3 North America and PC worldwide and has shipped over 1 million units to date. We also release Stranglehold for the PS3, Blacksite: Area 51 for Xbox 360 and PC worldwide and PS3 North America. Ultimate Mortal Combat for DS Worldwide and a North America only Aqua Teen Hunger Force Zombie Ninja Pro for the PS2, Foster’s Home for Imaginary Friends for the DS and Game Party and Cruis’n for the Wii.

Net revenues for the quarter totaled $77.7 million compared to fourth quarter 2006 net revenues $96.9 million, and compared to our updated guidance of $80 million. Next generation consol products contributed 57% of the fourth quarter net revenues, while current gen consol products contributed 5%. Handheld products contributed 12 % and PC another 22%.

Our international business made up of approximately 38% of total revenues. Revenues for the full year totaled $157.2 million down 5.1% from 2006. Next generation consol products contributed 56% of the full year revenue. Our international business contributed approximately 39% of total revenues which is up from 25% in 2006. For the year, the net loss was $1.07 per share or $97.4 million. For the quarter the net loss was $0.33 per basic and diluted share or $29.7 million compared with the 2006 fourth quarter net loss of $2 million and compared with our updated net loss guidance of $0.21 per basic and diluted share.

Included in the quarter’s results were charges of $6.3 million, $0.3 million and $0.1 million related to non cash convertible cash 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 of $0.25 per basic and diluted share or $23 million compared with a 2006 fourth quarter net loss of $0.3 million and compared with our updated net loss guidance of $0.13 per basic and diluted share.

The shortfall on EPS guidance in the fourth quarter was primarily attributable to accelerated amortization of certain capitalized development costs and royalty costs. At December 31st our cash balance stood at $27.5 million, with another $44.5 million in net receivables. The fourth quarter cash used in operations was $2.1 million. During the quarter, cash invested in next generation technologies and product development projects totaled approximately $28.3 million. At the end of the quarter, the balance of capitalized product development costs was approximately $55.4 million a decrease of $18.8 million from the previous quarter ended September 30th.

Of the total capitalized balance, approximately 13% 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 receivable at December 31st were $77 million. Reserves for price concessions, returns and uncollectible accounts were $32.5 million or approximately 42% of the gross receivables. For the quarter, average days sales outstanding were 53 days.

The basic and diluted shares totaled 91.4 million shares for the fourth quarter and 91.2 million for the 12 months that ended. For the first quarter of 2008 please assume a basic and diluted share count of 91.4 million shares. This concludes the financial update, David.

David Zucker

Thank you Ryan O’Desky. 2007 was a challenging year for Midway as we made the transition to the next generation of consoles. Our first true next gen. multiplatform title stranglehold sold over a million units and provided an affirmation that our standardized technology tool set for a next generation titles is on the right track with core underlying game play technology and animation systems. We experienced a delay in shipping the PS3 version of two of our titles in 2007 including stranglehold and that adversely impacted our results. We believe we have overcome the technical hurdles associated with finalizing and shipping PS3 games as a result of that process. And now that we have our systems working, we expect the PS3 versions of our future titles to ship day in day with other versions.

We believe that our initiative to unify our internal product development around a common course set of technology and tools and to seek to build great games and high potential mass market genres, is heading in the right direction. We believe we have made significant progress toward these goals and they will see a return on our investment in terms of our future individual title development costs, reusability of resources, our assets and code and quality of various upcoming internal projects.

We’ve attracted and retained some of the best talent in the interactive entertainment industry and with our core engine predominately in place now, we believe our product development teams will be able to leverage the work done on early next gen. titles like Stranglehold, Blacksite and Real Man for products already in development as far out as 2009 and 2010.

Over the last year we’ve had three titles become million plus unit sellers. Stranglehold as we mentioned earlier, Rampage which originally launched in 2006 but has been a perennial catalog seller and hit 1 million units last year and Unreal Tournament 3. Unreal Tournament 3 for the PC and the PS3, have now shipped over a million units total. While it may seem the PC market is slowing as indicated by MPD sales for this title. That is not the case internationally, where PC sales continues strong in a number of markets.

As we expected our European PC sales of Unreal Tournament 3 are outpacing North America and overall the title is turning out to a success. Later this year, we are scheduled to launch the Xbox 360 version of Unreal Tournament 3 and expect it to perform equally well. We set a number of goal, I’m sorry we set a goal a number of years back to grow our European sales to be on par with the rest of the publishers in the industry and we have exceeded that in a faster timeframe than we expected.

Our strategy of going direct in the three largest regions in the pal territories, the UK, Germany and France along with strong operational performance on the sales and marketing front has allowed us to grow the percentage of our revenue derived from Europe and pal territories from 18% in 2004 to over 35% in 2007. We’re now seeing some of our big titles garnering as much as 40% or 50% of their revenue from European pal sales, more in line with our competitors.

We’ve also shown some success when we go back to our roots. One of the many ways core competencies is in making fast paced addictive short play cycle games. This is reflected not only in our front line sports titles, but also in our casual titles. Touchmaster for the DS which launched in June collection of more than 20 games that take unique advantage of DS touch-screen interface performed well in both North America and overseas.

Game Party for the Wii has sold consistently well in North America and is doing well in Europe since shipping a few weeks ago where it debuted at number 3 on the Wii sales charts in the UK according to chart track. New way a strong history in the casual game space and we’ll have more initiatives in this area including new consoles titles and the launch of our casual games online web based portal in the near future. At the end of December, upon the resignation of former Chairman Ken Cron, the board elected Shari Redstone to chair our board of directors. Recently Midway entered into a $90 million credit facility with National Amusements Inc., the company that has a president Shari Redstone and as Chairman and CEO, Sumner Redstone was also a beneficial holder of a majority of Midway stock.

The National Amusement credit facility replaces Midway’s previous $30 million facility with Wells Fargo, Foothill and will be used for working capital, capital expenditures and other general corporate needs. As Ryan O’Desky mentioned, we ended 2007 with $27.5 million in cash and $44.5 million in net receivables on the balance sheet. And along with additional availability under the credit facility, we expect to be able to fund our presently anticipated need through 2008.

Turn to guidance, for the first quarter ending March 31st, 2008 the majority of our titles have already been released such as Timeline, Stranglehold expansion pack for Xbox 360 and PS3 worldwide, and in Europe and in Europe only we’ve released Hour of Victory for the PC, Unreal Tournament 3 for the Playstation 3, Game Party and Cruis’n for the Wii and Foster’s home for Imaginary Friends for the Nintendo DS. We expect net revenues approximately $28 million, the net loss of approximately $0.30 per basic and diluted share.

On a non GAAP basis, we expect a first quarter loss of approximately $0.21 per basic and diluted share, which excludes approximately $0.01 of stock option expense and deferred income tax expense related to goodwill and $0.08 of convertible debt non cash interest expense. Our goal continues to be to get the profitability as quickly as possible in this new console cycle. In 2008 we plan to grow our revenues significantly, as we expect to release more front line console titles in our 2007 line up including some reinvigorated franchises with well established fan bases as well as new IP with broad market appeal into a market hungry for quality content.

For the first time in recent years we believe we have a number of titles with the potential to break out and overachieve. Of our established franchises, we plan to start with a new next gen. installment in our over the top fantasy lifestyle basketball franchises. NBA Ballers: Chosen One. We recently announced our cover athletes, Dwight Howard and Al Horford. Al Horford is a top competitor for Rookie of the Year and Dwight Howard is the NBA Eastern Conference player of the month for both November and December has established himself as one of the leagues elite big men and was recently named the 2008 All Star Dunk Contest champion. In fact, how he clinched the championship with a dunk inspired by shut them down super move directly from NBA Ballers: Chosen One.

We kicked off our campaign for the game with a recent All Star event in New Orleans where our booth had among the highest traffic of any of the other NBA partners in attendance. The response from consumers and press was great. And basketball fans had the first opportunity to get their hands on a playable build of the game. The Midway brand has long been associated with over the top sports games and this summer we’re planning to launch the first ever game based on the television wrestling franchise is rapidly drawing in popularity, TNA Impact.

TNA, or Total Non-stop Action has been diverting fans and talent away from the WWE since its debut in 2002. Most recently we hosted a fantastic European tour including Kurt Angle, former Olympic champion and a highly popular former WWE star. Buzz is very strong for this game and we’re already building up an impressive number of presales even though the game is not scheduled to launch until summer.

We’re very excited about the prospects for Wheel Man and innovative high action cinematic driving game, scheduled for the second half of the year. Wheel Man stars Vin Diesel an iconic figure amongst gamers who’s been involved in the developing of the game. And then later in the year, we expect to launch the next generation debut of our perennial top selling franchise Mortal Kombat. The Mortal Kombat franchise has sold over 7 million units during the PS2 console cycle and we will be unveiling details on the next iteration at our Gamers Day event in mid April.

Later this year we also expect to release a new version of our 1.5 unit selling hard hitting unlicensed football franchise, With the League and finally we recently announced This is Vegas, an ambitious new intellectual property from our Seattle studio that we believe will deliver on the promise of open world gaming evolved. Players will be able to live their Vegas fantasy in a vast open world, lifestyle action experience. Game players will be able to experience those classic Vegas moments as they fight, drive, party and gamble in the first true Vegas open world.

This is Vegas is one of the highest testing game concepts we have ever tested and we’re particularly excited about the sales potential of the game. We’ll have more exciting news coming up in the future including announcements regarding casual games, Blitz, Mortal Kombat, and This Is Vegas among others. We believe that 2008 will be an important year for our consumers and investors alike. With many of the technological hurdles associated with the transition to next generation under our belt, support form our board and a line up of front line titles that include some of the most bankable franchises in our highest testing new intellectual property, Midway is poised to make some great strides this year.

We look forward to reporting to you our progress in future calls. That concludes our prepared remarks, Operator please open the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions). And our first question comes from the line of Heath Terry with Credit Suisse, go ahead.

Heath Terry - Credit Suisse

Great thank you, I was wonder if you could give us an idea as we look out past this year what kind of development slate that you’re looking at obviously not looking for titles or anything but from a numbers standpoint, are we, should we expect that the line up for 2008 is essentially kind of the development run rate that Midway’s at or is the plan to continue to grow the number of titles that’s being presented or produced every year. And I’m speaking primarily from an internal development standpoint. And is there a goal or kind of a run rate that Midway’s internal operations can generate from a title development set of 3, 4, 10 titles a year that given the size you’re at right now we should expect to see.

David Zucker

Yeah, we’re really focused on fewer, bigger, better. And so games like This is Vegas that we think have the potential to really move the dial on units. We have internal project development studios in Chicago we have five teams here. We have a studio down in Austin Texas, Seattle, Moorpark outside of Los Angeles, of course San Diego location, then Newcastle so we, those are our internal studios, and all those studios are working on a next gen. titles so I think you can expect a similar kind of run rate going forward in terms of gains. But our focus really is on creating those break out game that really can move the dial on the revenue side.

Heath Terry - Credit Suisse

Are there numbers that you can put around that in terms of when we’re thinking about modeling out this business how many titles from both the development standpoint you know from, on the cross side of the equation but also obviously from the revenue side of the equation that is your, that’s your goal for the business?

David Zucker

Yes again we’ve given direction in terms of our specific release for 2007. You can see we have our internal development teams and studios are all working on games so I think you know the current run rate is pretty good handle for that as I said. And our focus really is not so much on the number of games as it is on creating games that are going to breakthrough and doing a better job of that historically. Games like This Is Vegas and of course you got Mortal Kombat game this year and others that we think have potential to give us higher unit numbers.

Heath Terry - Credit Suisse

Okay. Great, thank you.

Operator

Our next question comes from the line of John Taylor with Arcadia, go ahead.

John Taylor - Arcadia

Hi, I’ve got a couple of questions, let me follow up on Heath’s question a different way. If I had your amortized product development royalty cost and your R&D and your additional capitalized on the balance come up with about a $130 million so is that a reasonable guess or a $120 $130 kind of a ranges, is that a reasonable guess as to what the dollar investment in product development is going look like over the 2008 fiscal year?

David Zucker

Yeah said, and we’ve said this in the past we, our run rate on a quarterly for cash, product development expenditure is between $25 and $30 million a quarter and that is certainly as we look out over 2008 that is what you should use as a guide.

John Taylor - Arcadia

Great, and then the team doing the Las Vegas product could you talk a little bit about what they’ve been involved with in the past maybe talk about the engine a little bit just give us a little more background on those guys and what they’re using?

David Zucker

Yeah that is our surreal studio in Seattle. That’s the group that formally made the suffering series for us and before that, before we acquired them worked on the Dragon series of games with Sony. The engine that they’re using is our common technology throughout the company. It’s a large open world engine, a massive technology effort over the last two to three year, involving a lot of shared components with our other studios.

John Taylor - Arcadia

Is on real based in some degree?

David Zucker

Yes it is. Midway’s core technology engine is based on real three of course we have over time over the last year and a half added substantial new modules to that and extended and modified quite a bit of it. Unreal three is primarily geared for first person shooters and as you can imagine, the technology added for a fully realized open world game is required a lot of technology extended on top of base unreal.

John Taylor - Arcadia

Right, okay good. And then last question, so I got you revenue breakdown here by product, could you maybe talk about the three or four biggest product categories and maybe give us a sense of how that mix looks US versus domestic you know sense what were the drivers of the, how important were the key drivers on the international side?

David Zucker

For 2007 or?

John Taylor - Arcadia

Yeah, 2007.

David Zucker

The quarter or for the year?

John Taylor - Arcadia

For the year, maybe quarter being more useful, but for the year would be fine.

David Zucker

Let’s see 2007 our big drivers were Stranglehold which was multiplatform.

John Taylor - Arcadia

Now let me ask in a different way. So I’m looking at the PC business of $31 million roughly in ’07 how much of that was in the US versus elsewhere or say PS3 looking for kind of relative strength in the North American by platform versus other market.

David Zucker

You know and obviously we did say I think 37% or 38% of our revenues for the year came out of Europe which is a big as a mentioned in my remarks, was a big jump from where it’s been. It’s more in line with what we should be doing going forward. The PC in general as you know performs over-performs relative to US and Europe, and we saw PC titles like Hour of Victory and certainly Unreal Tournament for the PC has performed better percentage wise in Europe than in the US.

John Taylor – Arcadia

Okay.

Ryan O’Desky

I would just add that I think going forward you are, you should see for most frontline PC product you should see international sales outperform domestic sales. That’s just kind of the way the market has gone.

David Zucker

We’re definitely seeing softness in the PC market in North America and we think that will continue but it’s still a very healthy strong market over in the pal territories.

John Taylor - Arcadia

Okay, great. Thank you.

Operator

(Operator instructions). I am showing no further questions, I’ll turn the call back over to David Zucker, for closing remarks, please proceed sir.

David Zucker

Thanks for your time and questions, we look forward to talking to you again soon, thank you.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. That does conclude the presentation, you may disconnect. Have a wonderful day.

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