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Midway Games Inc. (MWY)

Q1 2008 Earnings Call Transcript

May 5, 2008 4:30 pm ET

Executives

Geoffrey Mogilner – Director IR

Ryan O'Desky – Interim CFO and Treasurer

Matt Booty – Interim CEO and President

Miguel Iribarren – SVP, Publishing

Analysts

Daniel Ernst – Hudson Square Research

Heath Terry – Credit Suisse

Operator

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

I would now like to turn the call over to Mr. Geoffrey Mogilner, Director of Investor relations. Please proceed sir.

Geoffrey Mogilner

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

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

Throughout this call, we will present both GAAP and non-GAAP financial measures as they relate to our first quarter results and our outlook for our 2008 second 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 non-GAAP financial measures to be isolated from or substitute for or superior to the information that has been presented in accordance with GAAP, and we encourage investors to consider all measures before making an investment decision. A reconciliation of the differences between the GAAP and non-GAAP measures is available in our press release posted under the tab, Current Headlines, on our Web site at www.investor.midway.com.

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

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

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

Ryan O'Desky

Thanks, Geoff, and good afternoon. During the first quarter, Midway released an online Stranglehold expansion pack for Xbox 360 and PS3 in North America. In Europe, we released Unreal Tournament 3 and BlackSite: Area 51 Game Party and Cruis’n for the Wii, Foster’s Home for Imaginary Friends for the DS, and Hour of Victory for the PC.

Net revenues for the quarter totaled $30 million compared to first quarter 2007 net revenues of $11.1 million and compared to our updated guidance of $28 million. Next generation console products contributed 76.1% of first quarter net revenues, while previous generation console products contributed 4.9%. Handheld products contributed 11.4%, PC another 2.8%, and royalty revenues contributed 4.8%.

Our international business made up approximately 72% of total revenues compared to approximately 37% for the same period in 2007. For the quarter, the net loss was $0.37 per basic and diluted share or a loss of $34 million compared with 2007 first quarter net loss of $19.8 million and compared with our net loss guidance of $0.30 per basic and diluted share.

Included in the quarter's results were charges of $7.1 million, $0.3 million and $0.2 million related to noncash convertible debt interest expense, deferred tax expense related to goodwill and stock option expense respectively. On a non-GAAP basis, excluding the impact of these charges, the loss was $0.29 per basic and diluted share or $26.4 million compared with the 2007 first quarter net loss of $18.2 million and compared with our updated net loss guidance of $0.21 for basic and diluted share. The shortfall in EPS guidance in the first quarter was primarily attributable to accelerated amortization of certain capitalized development costs, price protection, product costs and administrative expenses.

At March 31, our cash balance stood at $17.7 million with another $6 million in net receivables. The first quarter cash used in operations was $8.3 million. During the quarter, cash invested in next generation technologies and product development projects totaled approximately $24.1 million. At the end of the quarter, the balance of capitalized product development costs was approximately $61.6 million, an increase of $7.4 million from the previous quarter ended December 31. Of the total capitalized balance, less than 1% relates to products already in the marketplace as of the end of the quarter and the remaining balance relates to products that we expect to introduce in the future.

Gross receivables at March 31 were $33.7 million. Reserves for price concessions, returns, and uncollectible accounts were $27.7 million or approximately 82% of the gross receivables. The basic and diluted shares totaled 91.4 million shares for the first quarter. For the second quarter of 2008, please assume a basic and diluted share count of 91.6 million.

This concludes the financial update. Matt?

Matt Booty

Thanks Ryan. Hello everyone. Before we get into the discussion of our results and our upcoming games, I would like to take a moment to introduce myself as this is the first time that I've spoken to the investor community in this capacity. As you may have read, I was recently named Interim President and CEO of Midway and I'm very excited to have this opportunity to lead Midway's talented teams and employees as we roll out our 2008 titles and shape our strategy for the next few years.

I have been here at Midway my entire career, which started 17 years ago in 1991. I was here during our heyday in the coin-op era and I've also been here through several console transitions having served along the way as a programmer, a team lead and a studio head. Most recently, I served as Senior Vice President of Worldwide Studios heading up product development.

My major goals are simple. First, get our 2008 games set up for success. Secondly, put Midway back on the path to profitability. In terms of these two goals, I firmly believe that our core strategy is sound. And after spending three years and over $100 million to develop a centralized engine, tool set and outsourcing infrastructure, I believe that we have a foundation that will allow Midway to lower the development cost and time to market for future titles, while also allowing us to focus on quality.

Building on this foundation, we have some high potential new IP as well as we established franchises in our portfolio. My intention is to improve execution on a number of fronts, to deliver on the commitments we have made to quality and to pursue new revenue opportunities.

The first quarter had no new retail releases in North America. However, we did ship a number of our holiday titles in the European territories, which is reflected in our strong performance of over 72% of revenue internationally for the quarter.

During this second quarter, a couple of weeks ago, we shipped the latest game in our over the top NBA basketball franchise, NBA Ballers: Chosen One with Dwight Howard and Al Horford as cover athletes for the Xbox 360 and PS3. And later this summer in the third quarter, we expect to ship the Xbox 360 version of Unreal Tournament 3. UT3 has already shipped more than 1 million units worldwide for the PS3 and PC, and the Xbox 360 version will feature exclusive new characters, new expansive maps and split-screen capability.

In terms of guidance for the second quarter ending June 30, 2008, we expect net revenues of approximately $18 million with a net loss of approximately $0.38 per basic and diluted share. On a non-GAAP basis, we expect a second quarter loss of approximately $0.28 per basic and diluted share, which excludes approximately $0.01 of stock option expense and deferred income tax expense related to goodwill, and $0.09 of convertible debt non-cash interest expense.

On April 17, we held our annual Gamers' Day press event in Las Vegas, and the response was very positive from press and analysts. The event was our biggest ever with almost 400 attendees from 139 media outlets across 15 countries and it produced more than 13 million consumer impressions of Midway's 2008 games. In addition to providing a deeper look at our product lineup, including hands-on demonstrations for most of our games, we also revealed the first next generation installment of our $1 billion Mortal Kombat franchise, Mortal Kombat vs. DC Universe.

Our Mortal Kombat creative team has been working in close collaboration with Warner Bros. Interactive Entertainment and DC comics including two of the top comic book authors, Jimmy Palmiotti and Justin Gray, to create an integrated and compelling storyline. At this point, we have only revealed four of the characters, Scorpion and Sub Zero from MK, and Superman and Batman from DC Comics.

The announcement received a strong reaction from press and consumers alike on the day that it was announced and Mortal Kombat vs. DC Universe garnered enough attention to knock Grand Theft Auto IV off the number one position on popular game site gamespot.com and the trailer took the top spot on gametrailers.com. Look for more information to be revealed over the next few months including new characters from both universes building up to an expected Q4 launch.

Also, in keeping with the spirit of our Las Vegas venue, we gave the press hands-on time with our ambitious new intellectual property from our Seattle studio called This is Vegas, a game which we believe will deliver on the promise of open world gaming evolved. Players will be able to live out their Vegas fantasy in a vast open world lifestyle action game and they will be able to experience classic Vegas moments as they fight, drive, party and gamble in the first true Vegas open world. The press is really beginning to understand how this game will be differentiated from other open world titles. For example, 1UP.com said the designers certainly have the insane spirit of Sin City nailed down and the look and vibe are dead on.

Another big title that got a lot of attention at the event was TNA Wrestling slated for a September release on Xbox 360, PlayStation 3, PlayStation 2 and the Wii. At Gamers' Day, we had top wrestlers from TNA helping us promote the game, including AJ Styles and current World Heavyweight Champion, Samoa Joe. The event also included a hands-on demo of the game that went over very well. GameTab said that TNA is shaping up to be one of the smoothest, slickest playing brawlers to hit the ring in years. And videogamer.com in the UK said it is a WWE killer that will have enough to force THQ to raise their game. The buzz is very strong for this game and we are already building up an impressive number of presales as we head up to a late summer launch.

First looks at our Gamers' Day demo have also established Wheelman as an exciting cinematic action driving game. Wheelman stars Vin Diesel, an iconic figure in the gaming world, who has been involved in the development of the game since its inception. Gamespot.com said, with over the top stunts and a cosmopolitan setting, Wheelman looks to bring some new flair to the action adventure driving genre. And whatsplaying.com said Wheelman has basically the best controls of any open world title. Wheelman is tight, responsive, and accurate. At heart, Wheelman handles like a solid racino driving title, more arcade than simulation, and that's exactly the right feel for the game's tone and story.

Finally, we also announced Blitz: The League II for PS3 and 360, the follow up to the successful Blitz: The League, which sold over 1 million units. Overall, this year's Gamers' Day was a success for Midway in establishing our upcoming games in the minds of the press and analysts. And the buzz is continuing to build as we approach the summer and fall launch dates.

In addition to the frontline console titles, we are also working hard to leverage our core competency in fast paced addictive games with a number of casual offerings. Most notable are our new version of TouchMaster for the DS and Game Party for the Wii. Game Party has been a major success for us and has shipped over 800,000 units to date and continues to sell well both domestically and overseas. Midway has a strong history in the casual games space and we expect to have more initiatives in this area including new console titles and the launch of our casual games Web site in the near future. We expect to make more announcements soon with further details about our 2008 lineup.

In closing, I'd like to reiterate our immediate goals. Our core technology is in place and we plan to continue producing games in multiple genres, leveraging the shared skills, resources, and talent across our studios. We plan to improve execution by promoting tighter coordination between sales, marketing and product development, and by making the right decisions for our products in order to allow us to build long-term franchises especially in terms of launch strategy.

And finally, we are pursuing new opportunities to increase our revenue base, including greater focus on casual games, growth in overseas territories and licensing opportunities. We look forward to reporting on our progress in future calls. That concludes my prepared remarks.

Operator, if you could please open the line for questions.

Question-and-Answer Session

Operator

Yes, sir. (Operator instructions) Our first question comes from the line of Daniel Ernst with Hudson Square. Go ahead.

Daniel Ernst – Hudson Square Research

Good evening. Thanks for taking the call. Two questions, if I might. The first, cash down almost $10 million quarter on quarter, $17 million left, what options do you have available to you to increase liquidity here? Is there anything in your current notes or covenants that suggest you might be approaching a default or does that restrict at all your ability to raise additional capital here? Give us a little color on what options you have available to you, and then I have a follow-up question on the titles launch.

Matt Booty

Yes, I think our cash and cash equivalents at least of the quarter right now and under the NAI, National Amusements facility, combined with actively managing our working capital, looking at some cost-cutting measures and possible utilization of some other liquidity sources, all of that will be adequate to fund the levels of inventories, receivables and other requirements that we have for this year and beyond. So, basically, we believe that we are well funded through the end of 2008. Ryan, do you have anything to add to that?

Ryan O'Desky

No.

Daniel Ernst – Hudson Square Research

Okay. Maybe we can jump down afterwards because I think you will be on a fairly tight (inaudible) to make that. The second question I had was just on kind of looking back over the last year, you had a lot of big next gen titles, like BlackSite and Stranglehold that may be fair (inaudible) expectations. Is there anything different you're trying to do this year that can bring that frontline titles slate up to a more profitable level? And then sort of a related question, can you bring any of those titles that were largely geared for 360 and PS3 to the Wii platform which now has a larger global installed base than the other two?

Matt Booty

Yes, I think that the management team we have in place now has put a lot of energy into looking at what went right and what did not go right last fall and we really believe that we've got our 2008 lineup set up for success. It's very competitive industry right now and I think that the successful launch of a game depends not only on a good core game but also on how and when you launch it and making sure that all of the sales, marketing and retail efforts are coordinated. I think that in a lot of cases, there were a number of factors that contributed to the games that we had come out and specifically the ones you mentioned, Stranglehold and BlackSite, not performing up to their potential. So, we believe we have looked at that and feel very positive about our 2008 lineup.

In terms of bringing some of those PS3 and 360 games out for the Wii, I think that the games that are successful on the Wii are titles that are made specifically for the Wii both in terms of its audience and its technology and where appropriate, for example, we brought some of our Mortal Kombat titles over to the Wii. We will take a look at that and I think that also like a lot of other people in the industry will continue to look at titles specifically made for the Wii as those seem to be the most successful.

Daniel Ernst – Hudson Square Research

Okay, thanks.

Operator

(Operator instructions) And we have a question from the line of Heath Terry with Credit Suisse. Go ahead.

Heath Terry – Credit Suisse

Great, thank you. You mentioned the National Amusements revolving or credit facility. Can you give us an idea to what extent you started to use that and whether or not any of that is reflected in the cash balance that you recorded for this quarter? And then going forward, is that something that you'll report as debt on the balance sheet or how exactly will that show up?

Ryan O'Desky

As of the quarter ended March 31, 2008, you will be able to see in the balance sheet, there was $19 million of debt taken from that facility and we will be using the availability of that facility as needed in the future.

Heath Terry – Credit Suisse

Okay, great. And then in terms of how you get the cash burn down, is there a plan around that or is the plan to grow the business to the point of being profitable so that you feel like ultimately you're at the right size?

Matt Booty

I think that the answer is exactly both of those things. As I mentioned earlier, we are aggressively looking at possible cost-cutting measures and taking a look at the whole business. At the same time, we also plan to continue moving forward with our product lineup. So, I think it's a combination of both. We need to use the money we have smartly and we need to launch good games that are successful for us.

Heath Terry – Credit Suisse

Great. And then, from a distribution perspective, obviously for most of your competitors that are – and for you, this is increasingly a global business. Generally, Europe and international as a whole has been a lower percentage of revenue for Midway versus the other U.S. based game companies. Is there a solution to that without having to obviously go out and open your own sales offices and put people on the ground? Is there some kind of longer-term partnership that you may be in a position to develop with one of the other U.S. or even your distributors to improve that?

Miguel Iribarren

Yes, Heath, this is Miguel. Right now, we are directing about 70% to 75% of the pal market which is obviously all of Europe and a few other international places. That gives us obviously most of that territory in terms of direct footprint. We are looking at ways to further leverage into the remaining 25% to 30%. But we do use distribution partners to gain access to those markets. We feel like we are pretty much represented everywhere through the world right now. And the distribution partners we have in those remaining territories, we do spend a lot of time working with them, picking the right people. But that isn't to say that we wouldn't try to increase our footprint going forward. But, if you look at our performance internationally, we have improved it I think pretty dramatically over the last three years. We expect that performance overseas to continue to improve not just as our foot footprint grows but also just as our execution grows in those existing territories. Obviously, we are always open to looking at ways to better get reach into more territories, but right now I don't think that's an area that we think we are performing well in.

Heath Terry – Credit Suisse

Great, thanks, Miguel.

Operator

Ladies and gentlemen, I'm showing no further questions at this time. I'd like to turn the call back over to management for any closing remarks. Please proceed gentlemen.

Matt Booty

Thanks everyone for being on the call. Thank you.

Operator

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

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