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Marvel: 2Q Conference Call Revelations

By: Craig Schneider (08/16/00)

By the time a company reports its second quarter results, many investors have already shifted their attention to the second half. However, sometimes it's best to listen a bit closer to the conference call.

Marvel Enterprises' (NYSE: MVL - news) shareholders certainly had their eyes on the horizon Tuesday when the superhero entertainment company posted a loss for the second quarter of $0.43 per share, wider than the $0.38 in the year-ago period.

There were no real expectations that the company would show signs of profitability or start recording revenue from X-Men toy sales. Total sales declined about 17%. Shares still gained $0.31 to $5.13 for the day but fell slightly in early Wednesday trading.

Management has pretty well voiced its aspirations already so that investors for the most part already knew what to expect going into the second half. However, investors who tuned into the conference call got wind of some issues plaguing the toy industry that are spooking Marvel execs.

Investors already knew what the X-Men movie blockbuster opening meant for the company's strategy. With $144 million box office sales to date, it gives Marvel much needed leverage when the company negotiates future deals in which it wants to share in the profits. Marvel already has 20 films and television projects in development, all with some kind of profit participation and/or ownership in the products.

Another major event in the quarter was Marvel's Toy Biz securing the exclusive licensing rights for creating the action figures of the ``Lord of the Rings'' movie trilogy. The first is set for release late next year and will coincide with Marvel's much-anticipated Spider-Man flick staring Toby McGuire and related toy line.

Investors also knew from our last update, which included discussions with management, not to expect much in the way of positive data in the second quarter.

But some things in the report are still worth noting: While total sales declined about 17% from year-ago levels to $51 million, total cash flow grew about 19% to $7.4 million during the same period. Licensing revenue was roughly flat at $7 million, but that did not include any revenue from the Spider-Man movie. Licensing cash flow declined slightly because of the company's increased investment in Marvel.com.

What's more, publishing revenues and cash flow increased from Marvel's comic book sales and a rise in advertising dollars. Toys sales declined about 9% to $32.6 million, but the decline was expected from the slowdown in World Championship Wrestling (WCW) sales. Corporate spending also declined, reflecting a $2.5 million one-time charge last year and successful cost control efforts.

Marvel also announced a partnership with Riot Entertainment, in which the companies will develop and provide content using Marvel's characters for wireless platforms such as Internet-connected cell phones and hand-held devices. Riot is backed by Nokia Corp. (NYSE: NOK - news), News Corp. (NYSE: NWS - news) and Softbank.

Management was also optimistic for X-Men toy sales, which are expected to start offsetting the WCW problem in the third quarter. Alan Fine, Toy Biz president and chief executive, said he's ``quite pleased'' with the sales and that the company is getting ``very good reorders every week'' from major retailers. He believes X-Men revenue will be on par with WCW for the back half of the year.

Management also expects to start recording Spiderman licensing revenue in the third and fourth quarters, as well as revenue from the Riot deal. A new X-Men television show on the Warner Brothers Kids Network will begin airing on November 4 and a whole new X-Men line will hit retailer's shelves in the fourth quarter to benefit from that exposure. Licensing has also been strong, but not overwhelming.

After the typical round of bullish comments on the conference call Tuesday, management expressed some concern for the toy industry going forward. Management was quite vocal when it came to expressing their concern for issues plaguing other major toy makers such as Hasbro Inc. (NYSE: HAS - news) and Mattel Inc. (NYSE: MAT - news). On July 20, Hasbro said second-quarter profit fell 80% on lower sales and warned it will face a difficult second half as well. ``Our biggest concern would be the environment in the toy industry, which is simply something we can't read,'' said Peter Cuneo, Marvel's chief executive officer.

What has them spooked? Inventory. ``Hasbro (NYSE: HAS - news) has a tremendous amount of business they need to cycle through with Star Wars, Pokemon and Furby,'' Fine explains. ``And they don't have anything that's hot or new to refocus that with. We hear they are sitting on quite a big inventory.'' The concern is that the backlog on the retail shelves and in the warehouses could mean that one or both of the companies will start dumping it in the back-end of this year.

Management also made mention of a computer chip shortage in the toy industry - something Hasbro touched on -- which could delay the release of some products.

What do we think about all this? Marvel shares are certainly not immune to these issues given its top line exposure. Investors are after all still waiting to see its toy sales start ramping from X-Men.

But nvestors should not be ditching Marvel in light of the industry's inventory concerns or chip shortages. If anything, the decline in popularity of Star Wars, Pokemon and Furby toys means there's even more room in kid's toy chests for the X-Men collection, which retailers say are selling very well. Just note, however, that if there are further shortfalls in other major manufacturers, Marvel could get hit regardless.

We're not worried. Management is making all the right moves. As the shares have corrected in anticipation of the second-quarter results, now is the time to add to your position. The third and fourth quarters will likely be stronger.

We continue to rate Marvel Enterprises a ``buy''.

Updated on August 16, 2000 with MVL at $4.93.
Recommended on December 11, 1999 at $6.69.

(The Magic 25 is a diversified portfolio of stocks that Individual Investor believes will outperform the market over the course of the year. In 1999, the Magic 25 portfolio was up 79.3%. On average the portfolio has risen 31.6% annually.)

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