Found In Translation: Analyzing THQ's Earnings CallExecutives at game companies sometimes speak in a special language that offers an overt meaning and a hidden meaning at the same time. This language is often used in earnings calls, where the executives are doing their level best to convince analysts that the company's prospects for the coming quarters are good, no matter what just happened in the last quarter. IndustryGamers is here to help with finding the underlying meaning, this time with THQ's statements during the earnings call.
President and CEO Brian Farrell started the earnings call with an admission of fact: “On our last call we told you we anticipated that our third quarter would be the largest in our company's history. Unfortunately, we were wrong.” Not an apology, as you might have expected, given the magnitude of THQ's fall for the third quarter, with a $125 million dollar miss on their sales projections. Given that start, what do you do next? Trot out the scapegoat for an actuarial evisceration. “The disappointing performance of uDraw this holiday, and continued weakness in the kid's license category overshadowed the very successful releases of Saints Row The Third and WWE 12. Udraw hardware and software sales were approximately $100 million below our plan, and our other casual titles were approximately $25 million below plan, substantially reducing our revenue and profits for the quarter.”
You see, it wasn't really our mistake, it was that evil uDraw. Bad uDraw! No biscuit! You have to like that “substantially reducing” phrase though; it's factual but has a rather innocuous sound to it, like calling a near-fatal collision caused by driving with your eyes closed an “unfortunate incident.”
Back to the rhetorical efforts to absolve executives of responsibility: “We were confident that uDraw would resonate again this holiday, given last year's robust sell-through and 2 independent studies indicating we were addressing a sizable market on the HD platforms. Our confidence was misplaced.” Notice the introduction of evidence to show that it really wasn't management's fault that the uDraw didn't sell. We had 2 studies that said it would sell! Actually, if you look carefully, Farrell didn't say that. What he said was that the uDraw studies showed they were “addressing a sizable market on the HD platforms.”
In other words, there are plenty of PS3s and Xbox 360s out there - which is not at all the same as saying your product will actually sell to those consumers. It would be interesting to see those studies and look at what they actually said, and how many people they surveyed or showed the product to. Was there actual focus testing? Or was this just a study to show how many households had an HD console? We will almost certainly never know.
Now we come to the turn, that part of the speech where the adroit performer attempts to shift the audience's perception. Here Farrell is going to try the difficult task of taking the huge negative impact of the Q3 sales debacle and turn it into a positive. “What we had viewed to be a product that would generate revenues and profits while we continued to build our portfolio of core gaming franchises has instead created a catalyst for us to evaluate our business from top to bottom.”
Did you notice how your attention was directed to a nice, hopeful strategy (“build our portfolio of core gaming franchises”) while turning the horrendous third quarter into a “catalyst for us to evaluate our business.” Now we're off to the races, discussing all the positive steps the company is taking to position it for a bright, profitable future.
Here's the plan: “Here's what we've done to address these issues. First, we have ceased production of uDraw hardware and have developed a plan to move remaining inventory through the channel. We have no other remaining commitments with respect to uDraw.”
In other words, we are liquidating uDraws at a few dollars apiece to every Big Lots and Dollar Store and any other retailer that likes cheap products, unless we can't find anyone who will take them, in which case we will landfill them.
Next, getting rid of the kids' games. “Second, last week we announced a refinement of our strategy to focus exclusively on high-quality core games and connected experiences for our key franchises and are in the process of exiting the traditional kid's video game business. As part of our exit, we have reached agreement with two of our licensors and are in ongoing discussions with two others.”
One of the nasty problems with licensing agreements is they often have payments scheduled whether you sell anything or not. We're trying to wriggle out of these agreements, and have managed it with two companies so far. We may end up in court with the others.
What else? “Additionally, we have substantially eliminated our development expenditures for this category. These two actions have significantly reduced our financial commitment as we exit this business.”
We've laid off all the developers working on kids' games.
“We have concluded an extensive review of our operations, and are implementing a plan to bring our costs in line with our anticipated level of revenues.”
We're laying off a lot more people all around. We're also cutting down CEO Farrell's salary to less than a thousand dollars a day (that's $359,000); of course we'll double that again as soon as we think no one's paying attention in a year, if all goes well. Let's not mention the layoffs at all, that would be kind of a downer as we're trying to get analysts to think we're looking good for the future.
What Farrell failed to say in so many words at the earnings call is that THQ is dancing on the edge of the abyss. Companies in trouble tend to get shuffled to the back of the line when customers are paying their bills. If you're a retail chain and owe money to Activision, EA, and THQ, who do you pay last? That's right, the company that may not be shipping product in six months or a year if they go out of business.
Software companies that sell packaged software also need big wads of cash in order to build inventory to ship out to retailers. Many of those retailers take a long time to pay for those shipments... months in some cases. And they may not pay for all of it, but they'll ship back unsold copies. And charge the shipping costs off against what they owe you, too. This means that a company like THQ needs to have cash, and good credit lines with vendors, and credit facilities with banks, in order to finance manufacturing. This can all dry up if companies begin to think you might not be around.
If THQ's plan suffers a major hiccup, like a delay of months in shipping a key title, the rest of their plan could unwind. Certainly another misstep on the scale of uDraw would probably be fatal.
Could THQ be sold? Possibly, but one of the dangers of depending on licensed product is that licenses are not normally transferable to a new owner. They have to be renegotiated. Also, if you declare any form of bankruptcy, license agreements usually terminate. That removes a big tool that THQ could use to help get through tough financial times. Using licensed products is like juggling with knives; it's flashy and attracts attention, but if you stumble you will probably bleed.
THQ has a very tough year ahead, and hopefully (for the sake of remaining employees, at least) they can get through it and return to profitability and some measure of stability. Hopefully the employees who have lost their jobs can find new work in the industry; many may be looking at mobile and social game companies, where much of the hiring seems to be occurring these days. If you want to keep track of how THQ is being perceived by the investors, keep your eye on the stock price (currently at 53 cents a share; it was over $30 a share a few years ago). If the stock doesn't rise above $1 in the next few months, THQ may be delisted altogether, making their financial position more strained than ever.
