Midway Games, Inc. Q2 2008 Earnings Call Transcript

Aug. 4.08 | About: Midway Games (MWY)

Midway Games Inc. (MWY) Q2 2008 Earnings Call August 4, 2008 4:30 PM ET

Executives

Ryan O'Desky - Interim Chief Financial Officer and Treasurer

Matt Booty - Interim President and Chief Executive Officer

Miguel Iribarren - Senior Vice President, Publishing

Geoffrey Mogilner - Director of Corporate Communications

Analyst

Ed Woo - Wedbush Morgan Securities Inc

Edward Williams - BMO Capital Markets

Todd Greenwald - Signal Hill Group

Presentation

Operator

Welcome to the Midway Games second quarter 2008 earnings conference call. (Operator instructions) I would now like to turn the presentation over to your host for today’s conference Geoffrey Mogilner, Director of Corporate Communications.

Geoffrey Mogilner

Welcome to our second 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 second 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 second quarter results and our outlook for our 2008 third 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 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 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 performance 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

During the second quarter Midway released NBA Ballers, Chosen One for Xbox 360 worldwide and for PS3 in North America and Unreal Tournament III for Xbox 360 in Europe.

Net revenues for the quarter totaled $23.4 million compared to second quarter 2007 net revenues of $31.8 million and compared to our updated guidance of $18 million. Next-generation console products contributed 81.4% of second quarter net revenues while previous generations console products contributed 4.5%, handheld products contributed 11.3%, royalty revenues contributed 6.2% and PC had a negative contribution of 3.4%.

Our international business made up approximately 39.5% of total revenues compared to approximately 28% for the same period in 2007. For the quarter the net loss was $0.38 per basic and diluted share or a loss of $34.8 million compared with the 2007 second quarter net loss of $14.3 million and compared with our net loss guidance of $0.38 per basic and diluted share.

Included in the quarter’s results were charges of $8 million, $0.3 million and $0.1 million related to non-cash 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 $26.3 million compared with the 2007 second quarter net loss of $11 million and compared with our updated net loss guidance of $0.28 per basic and diluted share.

At June 30, our cash balance stood at $15.7 million of which $1.1 million is restricted cash with another $0.1 million in net receivables. The second quarter cash used in operations was $32.9 million. During the quarter cash invested in next-generation technologies and product development projects, totaled approximately $26.2 million.

At the end of the quarter the balance of capitalized product development costs was approximately $73.2 million, an increase of $11.6 million from the previous quarter ended March 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 June 30, were $19.7 million, reserves for price concessions, returns and uncollectible accounts were $19.6 million or approximately 99% of the gross receivables. The basic and diluted shares totaled $91.6 million shares for the second quarter. For the third quarter of 2008 we’ve assumed a basic and diluted share account of $91.6 million shares.

This concludes the financial update. Matt.

Matt Booty

With three of our largest events for this summer Midway’s Gamer’s Day, E3 and Capcom are already completed. Midway has gained positive momentum that has not only increased the visibility of our 2008 lineup, but has also reestablished the Midway brand and started the process of restoring our standing as a publisher and developer of high-quality games.

Later this month, we will have a strong presence at the Leizig games convention, one of a largest consumer oriented interactive entertainment conventions in the world and we look forward to some positive press coming out of that as well.

Recently, we made some changes to our organization designed to realize cost efficiencies, while giving us a better ability to react swiftly to changes in the market, to reach our target markets and to perform more effectively as a global company. We are combining the operations of our more product California facility, the team that makes our TNA Wrestling franchise into our San Diego facility.

The decision was prompted by the fact, that our lease was coming due in our more product location, but more importantly this move will enable the team to leverage synergies with our other development studious and work more closely with a third-party production, licensing and quality assurance groups that are currently in San Diego.

The TNA franchise is important to Midway and we feel this move will help us make better games, allow us to recruit from the better talent pool in the San Diego area and to work more effectively with our TNA partners; this along with other structural changes are all part of an ongoing internal effort to streamline and strengthen our organization.

We are very excited about our slate for the back half of 2008. To-date, already this quarter, we have shipped Unreal Tournament 3 for Xbox 360, which finally puts the world renounced multi player action from Epic Game's, the creators of Gears of War, into the hands of 360 owners. The PC and PS3 versions have shift over one million units and the Xbox 360 version with exclusive maps and characters as well as split-screen game play is of to a great start. Also this quarter, we expect to release the TNA impact Wrestling game for Xbox 360, PS3, PS2 and Wii worldwide.

In terms of guidance for the third quarter ending September 30 2008, we expect net revenues of approximately $52 million with a net loss of approximately $0.37 per basic and diluted share. On a non-GAAP basis, we expect the third quarter loss of approximately $0.27 per basic and diluted share, which excludes approximately $0.10 of stock option expense, deferred income tax expense related to goodwill and convertible debt non-cash interest expense.

We enjoyed seeing many of you at E3 this year, where we got a chance to show of some of our upcoming games. E3 coupled with our very successful Gamer’s Day held back in April gave is the opportunity to demonstrate the quality and appeal of our line-up. For example, at E3, Blitz: The League II was nominated for a best game award by Planet Xbox 360. This is Vegas, was nominated by two publications as the top title and Mortal Kombat versus DC Universe was nominated for numerous best fighting game of the show award.

Early on some doubted that a Mortal Kombat title would do well paired with another $1 billion plus franchise like DC comics, but with the interviews we held and the hands-on time we provided to press an analysts at these events, I think opinion has turned the quarter. For example, U.S.A today said “it sounds like an unusual marriage at first, but once you begin brawling in Midway’s Mortal Kombat versus DC Universe you will learn it surprisingly works.”

Many have said “It harkens back to the days of Mortal Kombat II in terms of how it controls fuel” and once we reveal that this far from a water down version of Mortal Kombat to accommodate a license, many of the hardcore fans have become advocates.

We followed up a strong selling at E3, with the presence at Comic-Con in San Diego, where franchise co-creator Ed Boon sat on a panel with DC comics author Jimmy Palmiotti towards standing room only crowd and the days following Comi-Con buzz for the title really hit a high point topping out on ign.com as the number one entertainment property, which includes movies, TV shows and Video games.

Leading up to launch we will be revealing more characters, more game play and more story elements, all of which we expect will continue to build up the excitement for MK versus DC Universe.

P&A impact slated for a September release on Xbox 360, PlayStation 3, PlayStation 2 and the Wii also got a lot of attention at E3. We had few of the talented people from TNA join us there and the press has really started to see the potential of this title. We have some exciting announcements planned in conjunction with the TNA organization and like the television series itself we believe we are ready to take on the competition with a more advanced, more innovative product. The buzz is very strong for this game and we are already building up an impressive number for pre orders as we head up to launch.

Blitz: The League II for PS3 and 360, the follow-up to the successful Blitz: The League which sold over 1 million units has also begun to build up solid interest. Blitz’s is known for it’s over the top, no-holds-barred football action and Blitz: The League II continues that tradition. It is an all new story mode penned by former ESPN Playmakers writer, Peter Egan and football legend Lawrence Taylor returns to star in the game.

In addition we have signed on the voice talent of Frank Caliendo of Frank TV as the announcer and a well know actor from Jerry Maguire, Jay Mohr as the agent. I’m very pleased with the progress on Wheelman, which is now scheduled for a first quarter 2009 release. At both our Gamers Day and E3 the demo impressed everyone who got the opportunity to sit down at the controls.

Wheelman is an exciting cinematic action driving game starting Vin Diesel, an iconic figure in the gaming world who has been involved in the development of the game since its inception. At E3 some press recorded a saying thing, such as “It looks and plays like a summer block buster and Wheelman looks like it has a lot of potential. I love taking Vin Diesel behind the wheel and the studs and cut scenes were phenomenal.”

We’re continuing to reveal more of the open world action and our unique and ambitious new intellectual property from our Seattle studio called “This is Vegas,” slated for a 2009 release. This is Vegas, is the evolution of open world gaming introducing more depth, humor and lifestyle elements into the genre that has been seen before.

The back drop gives us the perfect context for the type of game we’re creating, allowing players to emerge themselves in their wildest Vegas fantasies and experience classic Vegas moments as they fight, drive, party and gamble.

In addition we’re continuing to grow our presence in the casual game space. With the recent launch of our own portal called Midwayarcade.com; Midwayarcade.com brings a number of our arcade and touch screen classic games to PC such as Defender, Joust, Spy Hunter and Mahki. These are now available for download starting for as little as three games for $5.

Midway has always had a core competency in fast paced addictive games and we have proven this out with the success of such tiled as Touchmaster for the DS and Game Party for the Wii. We expect to release sequels for both this holiday season. Touchmaster continues to be one of our top catalogue titles and Game Party has been a major success for us, shipping over 1.2 million units to-date and continuing to sell well both domestically and overseas. We’re expecting impressive results from Game Party II and Touchmaster II as well.

In closing we’re making great strides in setting up our 2008 titles for success and are lining our organization to deliver on our promise of improving execution and making the right decisions for our products in order to allow us to build long-term franchises. I believe that if we make games that our teams are proud to have worked on and give those games the best opportunity to succeed in the market we will meet our goal to put Midway back on the path to profitability.

Our shared core technology platform and our overall development strategy are both in place. It is now our task to improve execution on a number of fronts, to deliver on the commitments we’ve made to quality and to pursue new revenue opportunities. We look forward to reporting on our progress on future calls.

That concludes my prepared remarks. We will open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ed Woo of Wedbush Morgan and Securities.

Ed Woo – Wedbush Morgan Securities Inc

Its good to see you guys out at E3. I had a question is it too early to tell pre orders for some of your other holidays particularly Mortal Kombat?

Miguel Iribarren

This is Miguel, Generally we don’t give out preorder numbers, but we are very happy with where Mortal Kombat stands, we are also very happy with where TNA stand as well, but generally we don’t like to for competitive reasons give out actual numbers on any of those titles.

Ed Woo – Wedbush Morgan Securities Inc

Great and another question I had is, TNA have you guys mentioned whether it’s going to be annual release.

Matt Booty

Yes, our plan is to make that into an annual release and we are part of the motivation for moving the development team into our San Diego studio is to have access to a lot of the better recruiting in that area as we do plan to build that team and build that game into what is hopefully a year end franchisee for us.

Operator

Your next question comes from the line of Edward Williams of BMO Capital Markets.

Edward Williams - BMO Capital Markets

Good afternoon, just a couple of quick questions for you guys. First of all what is the headcount that your studios at this point and where is your thought at the current cost structure that you have in terms of whether or not you fill so, you have a sustainable revenue stream for that cost structure or if we should look for some reductions in headcount.

Matt Booty

Our current total headcount in the company is about 900 of which close to 700 of those are in PD and as I mentioned in my remarks we are very actively and in a detailed way looking at all of our cost structures and across the entire organization at where we could get efficiencies and that is really the active work of the leadership team in the company right now to be reviewing all of those.

Edward Williams - BMO Capital Markets

I was cut off, so I missed part of the call. As you look at that, do you have any sort of timing as to when you think you may be able to have some of the decision made

Matt Booty

Yes, not at this time.

Edward Williams - BMO Capital Markets

Okay. And what about your exposure on international, the percentage of revenues is really high obviously in the quarter, but as you look at your international exposure in general, do you field that your on ground presents is appropriate at this point or is there other markets you want to add; how are you scanning at this point?

Matt Booty

Yes, I think if you look at our numbers so far this year you will see that it looks like we’re all running a little bit ahead of where we usually are in that, just really due to timing releases early in the year. We had some carryover titles that hadn’t released in Europe at the end of last year in Q4 that’s released in Q1 of this year.

So there’s a little bit of -- just the total numbers of skews being mismatched, so a number so far through the first six months is a little bit higher than you’d expect. I think towards the end of the year, for the full year I think you’ll see that coming in more in the 35% to possibly a high 40% range; Europe as a percent of our total revenue that is.

In terms of people on the ground, we’re very happy with the offices we have in Europe right now and how they’re performing. We are always looking to expand that opportunistically as the businesses are skewing plan in the size our operations dictate, so it is would not be out of the realm of possibility to see us pick up some more direct distribution somewhere in the PAL territories going forward, but we don’t have any plans to announce anything right now that way, but right now we are directing about 70% of the PAL territories and we feel pretty good about that, but again we’re always looking to review that.

Edward Williams - BMO Capital Markets

Okay, then just looking out towards the balance of this year and into next year, how do you expect the casual product to perform or what’s sort of percentage of revenues and then if you can characterize the casual performance on a profitability in terms of how it differs relative to your frontline, but how material should we look for the casual games for you guys?

Matt Booty

We haven’t really given any guidance for the next year and really haven’t talked about all our products for next year either. So it will be hard for us to really comment on percent of business at this point, but going forward obviously the casual, the Wii business in particular, the casual product on that platform have certainly performed better than what we have expected in the past. So we do have some robust plans going forward for casual games.

In terms of your question about the business model for casual games, it’s a little bit different in that. I think Midway has a lot of publishers that are going to approach it more as a portfolio business, so where you will see some titles; like for us Game Party, is a very successful game in terms of profitability, particularly relative to the PD investment for that title. You need to think about that whole platform on a portfolio basis and factor in kind of all the development that goes in not just the products that ultimately get released, but all the R&D that goes into the gains that you don’t see.

I think overall that business model relative to our overall business model, I think actually its going to be from a profitability standpoint fairly similar to the extent that when we have big winners obviously you’ll see higher profits, so, there is no real good easy way to say whether that business is more or less profitable.

Edward Williams - BMO Capital Markets

And what should we look for Matt in your view at lease as getting a resolution to the whether or not you get the job permanently or when we’ll get a solution to the CEO and CFO positions.

Matt Booty

Yeah well as I’m sure you’d expect, that’s the primary responsibility of the Board of Directors to find the permanent CEO and the process continues and I’ve also got faith its being done as quick an expedient as way it can be done. So, I wouldn’t want to second guess what they’re doing, but that is being handled by the board right now.

Operator

(Operator Instructions) And your next question comes from the line of Todd Greenwald of Signal Hill; please proceed.

Todd Greenwald - Signal Hill Group

Hi, thanks. A couple of questions; one, just looks like your top line came in a little bit above where estimates were for the quarter. I was wondering what drove that upside, was it NBA dollars or was it more catalogue sales of Unreal or anything else and then also just explain how the PC category made up the negative 3% of sales in the quarter.

Miguel Iribarren

This is Miguel, I’ll take the first part of that question. Revenue upside we did have one kind of big positive that we hadn’t forecasted in your last years guidance and that was releasing Unreal Tournament 3, 360 in the PAL territories. Most of those shipments ended up in the second quarter just for market purposes, given the nature of that territories and holidays in there if you want to get that product out earlier rather than later. The North American version of that game launched a week later up here in North America, but in Q3, so you have a little bit of a skew product upsize there, that’s helped drive revenues for the quarter.

The negative percentage of the PC is mainly due to timing of returns in price protection in the quarter versus the amount of sales of PC units in the quarter.

Todd Greenwald - Signal Hill Group

Okay and then would any of you guys like to comment on your outlook for the full year now that you pushed out a few of your key holiday titles like Vegas and Wheelman?

Miguel Iribarren

No

Operator

And that does conclude the question-and-answer-session.

Matt Booty

Well that’s all, thank you very much.

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