Majesco Entertainment (NASDAQ:COOL)
Q4 2012 Earnings Call
January 14, 2013 4:30 pm ET
Jesse Sutton - Chief Executive Officer and Director
Michael Vesey - Chief Financial Officer and Principal Accounting Officer
Sean P. McGowan - Needham & Company, LLC, Research Division
Edward M. Woo - Ascendiant Capital Markets LLC, Research Division
Good afternoon, and welcome to the Majesco Entertainment Fourth Quarter and Full Year Fiscal 2012 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Stephanie Prince of LHA. Please go ahead, Ms. Prince.
Thank you, Denise, and good afternoon, everyone. Welcome to Majesco Entertainment's fourth quarter and full year fiscal 2012 earnings conference call for the quarter and year ended October 31, 2012.
With me on today's call are Jesse Sutton, Chief Executive Officer; and Mike Vesey, Chief Financial Officer. Before we get started, I would like to remind you that this call is being recorded, and an audio broadcast and replay of the teleconference will be available in the Investor Relations section of the company's website.
As a reminder, this call may contain forward-looking statements, including statements regarding management's intention, hope, expectations, representations, plans or predictions about the future. Such statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risk and uncertainties that could cause actual results or actual future results to differ materially from the expectations set forth in the forward-looking statements. Factors that could cause actual results to differ materially are specified in the company's annual report on Form 10-K for the year ended October 31, 2012 and other filings with the SEC.
The company does not undertake and specifically disclaims any obligation to release publicly the results of any revision that may be made to forward -- to any forward-looking statements to reflect the occurrences of anticipated or unanticipated events or circumstances after the date of such statements.
To facilitate a comparison between the reported periods, the company has presented both GAAP and non-GAAP financial measures. GAAP financial measures include expenses related to non-cash compensation, changes in the fair value of warrants, severance costs and the benefit from the sale of certain state income tax benefits derived from net operating losses. Operating income, net income and diluted income per share have been adjusted to report non-GAAP financial measures that exclude these items. These non-GAAP measures are provided to enhance investor's overall understanding of the company's current financial performance and the company's prospects for the future. These measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered as substitute or superior to GAAP results.
Reconciliation between GAAP and non-GAAP financial measures is included in the earnings press release issued earlier this afternoon.
I would now like to turn the call over to Jesse. Jesse?
Thanks, Stephanie. Today, I'll start my remarks with some highlights of fiscal 2012 and our outlook for fiscal 2013. Mike will then review our financial results. I'll then conclude with some comments on our upcoming products and the outline of our slate for the year. We'll then open the call up for questions.
Fiscal 2012 revenue of $132 million met our expectations, albeit at the lower end of our guidance range, and up 6% year-over-year. This result was against a backdrop of decreases in retail sales for the entire interactive gaming industry. We ended the year in a strong financial position with $31 million in combined cash and availability from our factor and no long-term debt.
Our Zumba Fitness products continued to account for much of our revenue, driven by the introduction of 3 sequel titles throughout the year, including Zumba Fitness 2 in the first quarter, Zumba Fitness Rush in the second quarter, and Zumba Fitness Core in the fourth quarter. The introduction of Zumba Fitness Core marked a first for the interactive fitness category. It's the only game offering a targeted workout to tone and define a player's core.
As the newest iteration of the company's best-selling franchise, the game received a major marketing push, and both the Wii and Kinect's SKUs ranked among the top 10 performing titles in November's NPD results.
However, the rapidly declining Wii market, coupled with the soft Kinect platform and software sales, had a material impact on Zumba Core's performance, not to mention the total sales to request all the Zumba catalog SKUs. We are proud that the Zumba Fitness franchise remains the second largest fitness franchise in the entire video game industry and has now sold over 8 million units.
During the year, we also made a substantial investment in NBA Baller Beats across our flagship license, talent, soundtrack, marketing and retail programs. The game earned the Best Kinect's Game of the Year Award from GameZone and a Silver Award for family-friendly gaming as Best Sports Game of the Year. Baller Beats also garnered a significant amount of top-tier press focused on its technical innovation and higher production values. These accolades attest to the high quality of Baller Beats, but the industry praise didn't translate into the revenue we expected through the holiday selling season, at least in part because of weak sales of the Kinect platform.
In regards to our slate of social and mobile games released over the past quarter, the results were mixed. The revenue they have generated has not met our internal expectations. Our Mini Putt Park game was targeted at a flourishing audience when we started development but that same audience was mature and ultra-competitive upon release.
In retrospect, our entry into the Facebook market was simply too late. We regard mobile gaming as an opportunity to apply our learning from the freemium model business in a way that takes what we have learned about the freemium model to a growing market and apply it in a way that is more complementary to our existing brands and business expertise.
In planning for fiscal 2013, it became clear that the dynamics in the interactive video game industry posed a number of challenges for us. Wii and other established gaming platforms are reaching the end of their product life cycle, and software sales are consistently in double-digit declines year-over-year. We consider 2013 a transition year, as the first-party manufacturers introduced new platforms, and consumer adoption and preferences become apparent.
While the industry undergoes this transition in 2013, it's prudent for us to scale our investment in our console slate back so we can preserve our cash balance and determine what combination of platforms and products will provide the most profitable opportunities moving forward. Accordingly, we are making the necessary adjustments to our business model and cost structure so we are well positioned as the next generation of consoles develop.
First, we have closed our Facebook-focused social gaming studio in Foxboro, Massachusetts, and we'll now focus on mobile gaming through a variable cost model, utilizing outside developers overseen by our mobile production team based in L.A. Stephen Saiz, who some of you may know, joined us from Disney's mobile games division last year and will be heading up this effort.
Second, we have reduced the size of our internal game testing group in New Jersey. By moving to a variable cost model for quality assurance, we can adapt more efficiently to the peaks and valleys in workload, while maintaining the knowledge and expertise we have developed in our production staff over 20 years.
Finally, as part of the strategic realignment, we have also pursued cost reductions to better align our resources with our smaller slate that focused on our strongest brands. We have been careful to keep our infrastructure intact and not compromise our core competency of creating and marketing games for the casual mass market.
I would now like to pass the call to Mike Vesey, our Chief Financial Officer, to provide a financial review of our fourth quarter and full year results detail strategic alignment. Mike?
Thank you, Jesse. I'll begin by recapping our results for the fourth quarter and full year and close with some comments about our outlook for fiscal 2013. As is our custom, I will use non-GAAP results when discussing our financial results.
Revenue for the 3 months ended October 31 was $26.6 million, a 6% increase from the $25.1 million reported in the fourth quarter last year. The increase was primarily due to the timing of our pre- holiday release schedule. The fourth quarter of fiscal 2012 reflects initial sales from the release of Zumba Fitness Core released on October 16, 2012, while comparably Zumba Fitness 2 for the 2011 holiday season was released on November 15 and was recorded in our first fiscal quarter. The release or street date to these products is determined by factors such as optimization of available retail shelf and promotional space.
This revenue increase was largely offset by declines in demand for our catalog products on the Nintendo Wii and DS. As a result, we had a shift in our product mix between the 2 periods. Total revenue from Zumba Fitness products accounted for approximately 70% of sales compared to 58% in the same quarter 1 year ago.
Our gross margin was 18% in the fourth quarter compared to 17% 1 year ago. Gross margins in each period reflect accelerated amortization on our new-released products, which did not sell to our original expectation, particularly our products developed for the Kinect platform. The 2011 quarter included losses related to Hulk Hogan's Main Event and Twister for the Kinect, while 2012 reflects losses for NBA Baller Beats.
2012 also includes a charge of approximately $1.3 million to write off excess basketball accessory inventory related to the NBA Baller Beats product.
On a non-GAAP basis, operating expenses increased approximately 9.3% or $600,000 to $7.4 million, primarily due to higher selling and marketing expenses of $3.8 million compared to $2.7 million in the year-ago fourth quarter. Partially offsetting the higher selling and marketing expenses was a decrease in G&A expenses of approximately $600,000 or 26%, reflecting lower employee bonus expenses.
Please note we continue to invest in development of freemium games business, recurring expenses of approximately $1.3 million during the quarter. As a result, we reported non-GAAP -- a non-GAAP net loss of $2.7 million, flat with a non-GAAP net loss from the prior year. Non-GAAP diluted net loss per share for the fourth quarter was $0.07 in both periods.
Turning now to our full year results. Revenue for the 12 months ended October 31, 2012 was $132.3 million, a 6% increase compared to $125.3 million reported for the 12 months of fiscal 2011. The increase was primarily due to increased sales for our Zumba Fitness products, partially offset by decreased sales of our catalog games for the Nintendo DS and Wii. The 2012 results improved revenue from the release of 2 Zumba Fitness sequel products for the Wii and Xbox 360, as well as catalog sales of our original Zumba Fitness product. 2011 only include sales of our original Zumba Fitness product.
International net revenue increased to $29 million from $15 million in the same period 1 year ago, accounting for 22% and 12% of our revenue in 2012 and 2011, respectively. The increase reflects the benefits of selling finished goods through redistribution agreement in certain markets in 2012 compared to 2011 where relations manufacturing rates to another publisher in all markets.
Overall, sales with Zumba products accounted for approximately 76% of our sales during the 12-month period compared with 70% 1 year ago. Our gross margin for the full year was 33%, down from 36% in the same period 1 year ago. The decrease was primarily due to the impact of higher license costs and promotional allowances to retailers on our Zumba products, as well as the reverse margins on other products on legacy platforms.
Operating expenses were $38.1 million in 2012, an increase of $5.5 million or 17% from the prior year. The bulk of the increase was due to a $5.5 million or 37% increase in selling and marketing expenses, reflecting increased media advertising, primarily related to Zumba Fitness and other new Kinect products, as well as higher sales commissions and other variable costs associated with increased sales volumes.
Research and development costs were approximately $800,000 or 11% higher due to cost related to our online and mobile games business and increased production headcount. Development costs associated with online and mobile games were $4.2 million in 2012 versus $3.2 million in 2011, reflecting a full year of costs for our Foxboro studio, which was acquired in June 2011, partially offset by lower spending for third-party development.
For the year, we also recorded a $1.2 million charge for the loss on impairment of software and license fees for canceled games in development compared to a $1.5 million charge in 2011. As a result, non-GAAP net income for the full year decreased to $4.4 million compared to $11.1 million in the prior year. Non-GAAP diluted earnings per share for the 12 months decreased to $0.10 compared to $0.28 in 2011. These earnings came in below our guidance primarily due to accelerated amortization and inventory write-offs related to Baller Beats in the fourth quarter.
Now turning to our balance sheet. We ended the year with $18 million in cash and equivalents. An additional $13 million is available to us under our factoring agreement, giving us total cash and availability of roughly $31 million. Net cash provided by operating activities for the 12 months ended October 31, 2012 was $6.1 million compared to $9.4 million during the prior year. The decrease was primarily due to operating income, which is $8 million lower than 2011, offset by lower working capital needs and investment in capitalized software and licensing costs.
As of October 31, we had approximately $3.5 million invested in capitalized software development, reflecting a smaller slate for console products planned in 2013 due to the console transition. We ended the quarter with $7.8 million of inventory compared to $11.6 million at the end of 2011. We're comfortable with our cash and liquidity position in this transitional year in the industry, and I put a focus on carefully managing and preserving our liquidity resources during the upcoming year.
I'd now like to discuss our 2013 outlook. As Jesse discussed, we recently implemented a strategic realignment, reducing overhead in selected areas and turning some fixed costs into variable costs. These initiatives are intended to preserve our cash and liquidity position as the market user base for the next-generation consoles develops. Specifically, we reduced headcount by approximately 40 people, including approximately 14 employees in our game development studio in Foxboro, Massachusetts, who were primarily focused on developing games for Facebook; and approximately 14 employees in our internal game testing group in New Jersey. We will continue to develop freemium games through our mobile production teams in Southern California and the use of outside development studios. We will also maintain our infrastructure in New Jersey with lower fixed costs by transitioning to a variable labor model for game testing.
In addition, we eliminated approximately 10 marketing and administrative positions, reflecting the smaller game slate in 2013. We expect to record a charge of approximately $700,000 to $1 million in severance and other expenses in the first quarter of fiscal 2013. Preliminarily, we expect these initiatives to result in reduced operating expenses of approximately $1.5 million to $2 million annually.
Looking ahead, there are a number of uncertainties related to our top line for 2013. Console software sales on traditional game platforms are declining, but we do not yet know the rate of adoption for the next generation of consoles. As a result, it is impractical first for us to offer the quantitative revenue and earnings guidance for 2013 that we normally would. Instead, this year, we're sharing our best year of fiscal 2013 on a qualitative basis.
Early analysis of holiday sell-through indicates weaker demand for our products on the matured Wii console, including our Zumba titles, resulting in an expected decline in holiday sales of at least 50% this year compared to last. As a result, given our dependence on holiday sales of these products, we expect net sales for the first quarter and full year 2013 to be impacted and be significantly lower than 2012.
We expect to report between a modest loss to breakeven results for the first quarter and a loss for the year on a non-GAAP basis prior to any severance or one-time charges due to the realignment.
We plan to invest $3 million to $3.5 million in the development of freemium mobile games. As we have discussed in the past, these development expenses are expenses incurred due to the uncertain nature of the revenue stream under the freemium model.
So in summary, we have substantially strengthened our balance sheet and cash position over the past few profitable years, and we are comfortable with our cash and liquidity position during this transitional year coming up in our industry. By focusing on carefully managing and preserving our liquidity resources, we have the balance sheet to take advantage of opportunities for growth that industry transitions normally present.
Jesse will now give you an overview of our upcoming releases. Jesse?
Thanks, Mike. I will now provide some comments in our slate for 2013. As we've announced, we are putting together a smaller slate of console and mobile games for this year, focusing on high-profile, more risk-averse games, preserving cash and watching how the market develops during this hardware transition so we can best position ourselves for fiscal 2014. Strategically, we remain focused on building new experiences around big brands and continuing to diversify our portfolio. Our mobile strategy is now focused on high-profile, free-to-play games.
So far, we've announced a few titles that will be released during the first quarter, which includes the just past holiday season. These include Maestro Piccolo's Flea Symphony for the iPhone, iPad and iPod Touch. This game recently received the Editor's Choice Award from Apple. Flea Symphony turns players into mini maestros, who conduct a tiny orchestra of fleas to create beautiful melodies with a range of instruments, including tuba cannons, guitar string launchers and even turntables. Players must solve 100 levels of progressively complex musical puzzles through 5 imaginative music box worlds.
We also launched Monster High: Skulltimate Roller Maze on Nintendo DS and Wii. This game was released as part of a distribution agreement that we had with Little Orbit. Also included in the agreement is an additional Nintendo 3DS SKU that we plan to launch in March. Players can pick their favorite Monster High character and form a team of friends as they scape through the crypts of Monster High. Along the way, players collect power-ups, avoid monstrous obstacles, scream past the competition and use each character's special ability and ghoul power to win the race.
We have also announced a few titles that we expect to release during the balance of the year. This include Young Justice: Legacy for Xbox 360 and PlayStation 3, which we'll launch in April as part of our distribution agreement with Little Orbit. Based on the Warner Bros hit animated series that airs on the Cartoon Network, this game lets players assemble their Young Justice team from 12 heroes including NightWing, Kid Flash, Robin and more. Players track down notorious villains and are mentored by powerful superheroes as they explore, customize and battle in this action-packed, RPG-style game.
Last week, we announced Phineas and Ferb, our working title, for retail consoles and gaming handhelds, including smartphones and tablets. This game is based on the animated hit Disney television series. We expect to announce additional details before the end of the first quarter of fiscal 2013. During the year, we will also be releasing the next innovation of our best-selling Zumba Fitness franchise, along with the additional titles for our 2013 lineup, both freemium and our next-generation consoles.
In closing, we remain positive on the growth potential and our target market for casual games over the long-term. We have been in the business for over 20 years and have successfully navigated through several industry transitions in periods of uncertainty. Supported by our strong cash position and balance sheet, we are confident that we will resume growth as industry dynamics clarify.
Now I will ask the operator to open the call up for questions. Operator?
[Operator Instructions] Our first question will come from Sean McGowan of Needham & Company.
Sean P. McGowan - Needham & Company, LLC, Research Division
A couple of questions. I was wondering if Jesse could give us a little bit more color on just what you see as your position for the online and mobile markets going forward. And second, kind of related to that, what do you expect to be your position for the new platform? When -- are you going to be there for -- at launch on some of these new hardware platforms? What are you doing for Wii U now? Just help us out with some of these more emerging platforms.
Okay. So let's start with the mobile platforms. And really, what you'll see as a focus for us for the next year, we'll be focusing more on what we've been very good at historically, which is bringing out branded, high-profile brands onto those mobile -- onto these mobile platforms and tablets. I think we talked earlier about having the smartphone and tablet rights, along with the console rights, to Phineas and Ferb. I think it's looking along those lines of bringing well-known, high-profile brands; fun, monetize-able experiences free-to-play to that market with a built-in level of awareness. As far as next-gen consoles are concerned, not much has been talked about from our -- from the first-party next-gen console creators. So there's not much I can comment on now other than to say that we anticipate and intend on being an important part of the next console cycle, specific to our area of expertise, however, the casual game market, the fitness market, et cetera. And as far as the Wii U and the launch of the Wii U, for us, we made a determination to wait and see when the installed base would grow so that next year, when we're able to launch the next -- our next list of holiday titles, including Zumba, we could -- we could install it -- we could push it into a bigger installed base than currently exists.
Sean P. McGowan - Needham & Company, LLC, Research Division
Now, when you said next year, you meant fiscal '13?
I mean fiscal '13. Yes, correct.
Our next question will come from Ed Woo of Ascendiant Capital.
Edward M. Woo - Ascendiant Capital Markets LLC, Research Division
I noticed that we are going through a very difficult transition right now. Would you say that this possible console transition might be different? Or how might it be similar to previous console transitions?
It's a good question, Ed. Before I get into that question, I want to just clarify, I jumped and said fiscal 2013 earlier with regard to the next year's titles. I'm talking about calendar '13 as far as the next-gen cycle is concerned. Turning back to your question, Ed, I think this is a decidedly different transition. Historically, the transitions were pretty clear. They were about console to console or handheld system to handheld system, from 1 generation to the next. And it was just about upgrading graphics, gameplay with the occasional change in gameplay dynamic like the Wii brought us. But really, what we're dealing with now is a very different kind of consumer dynamic with the free-to-play world, with the online mean and hard-core world, which has grown tremendously over the last 12 to 18 months, as well as -- right now, there's a real challenge in getting the consumers to spend the kind of dollars for a game that we used to -- that we used to take for granted. So there's alternative ways of generating revenue post-launch of a title with downloadable content and things along those lines, that we have to convince the consumer much more intensely to spend the kind of retail dollars that, historically, was easier to do.
Edward M. Woo - Ascendiant Capital Markets LLC, Research Division
Okay. And the other question is, there hasn't been any comments on the Cooking Mama game in a while, is there any update to -- when we may see another version of the game?
As of now, there's not much to discuss. We do continue to support the catalog of the Mama brand. And as we get more clarity on when the best time to launch new Mama titles arises, we will make the market aware of that. Look to us to potentially talk more about Mama in our first quarter earnings call.
[Operator Instructions] And now our next question will come from John Taylor of Arcadia Investment Corp.
I got a couple of questions too. So with your cost structure adjustments, I'm wondering if you might go through kind of what your fixed cost -- what your fixed cost looked like this year versus next year, say, on a 12-month run-rate basis, just the actual numbers. You did this for us a couple of years ago, I remember. It was really useful. So that's the first question. And then the other one is, so you took a haircut on the NBA Ballers product, I wonder how much inventory you still have there and what's the retail channel situation look like as it relates to that, and price protection, or how much is out there sort of thing?
Okay, John. It's Mike, John. So going back a couple of years, we used to describe the business as having $3.5 million of fixed cost per quarter. And we were, back then, building the business so that if we did $60 million to $70 million of revenue and we did margins in, say, around the 30% range, we think we would be at breakeven, and there was good leverage beyond that. So in this current restructuring, we're really moving back to very similar numbers. If you look at the growth in our expenses over the past couple of years, a lot of it was advertising, which we consider variable in that model. And we also have brought on some increases to our management team for some marketing personnel and things like that. It helps with building a larger slate around Zumba. So we're pretty much working back to that $3.5 million fixed cost amount and trying to reposition the company, so that we could be breakeven as a $60 million to $70 million company going forward.
Okay. Great. Very helpful. Okay. And then, so -- and so, the $3.5 million includes the fixed cost to the marketing department or probably not?
Yes, when we talk about the numbers, yes, it does, includes the people but it doesn't include, for example, if we're going to do an advertising campaign...
Okay. Perfect. I understand. Okay. Great. And then, what's the channel situation look like in the balance sheet risk, is what I'm really looking at here, I guess, for the basketball product?
Yes. Well, first, I'll start with the balance sheet. We think we took our balance sheet numbers down to a good level as of October 31, so we reserved for the accessories. We had basketballs we don't think we'll be able to move, and whatever inventory we had, in-house. And then, in terms of inventory in the field, they still have some, but it's not a -- it's not an unvariable situation where we would expect any material charges, mainly because the retailers this year were -- it wasn't a product where they're going to take a lot of risk on their own and bring it in-house upfront, particularly with the size of the product. So we think we're adequately reserved with our year-end reserves on all those items and don't expect any significant charges going forward.
Okay. Great. Let me ask, kind of, a follow-up question to what Ed was going after in terms of platforms. I wonder -- so with Android and iOS and the console and portable formats that come from the traditional video game business and online, whatever, is there any way you could make a stab at a percentage or rough percentage breakdown by operating system of how much you expect to come from sort of the traditional console as opposed to the traditional handheld as opposed to the new? Any way to kind of bracket that, roughly, the way you're thinking about it?
You're talking about -- when you say "new," are you talking about new platforms?
I'm talking about Android, iOS, Open, Facebook, whatever, yes, the sort of nontraditional versus the traditional. And I guess you'd have a 4 -- a 2 x 2 matrix there, right? Traditional mobile, non-traditional, yes, that way kind of thing?
I -- yes, I would tell you that you could -- in terms of how we view the expectations going forward, I think we're viewing the next year's number in line, really, with this year's percentages, with it being primarily the traditional consoles for next year as far as generating the vast, vast majority of our revenues. Obviously, that means if we have a hit on any of our other areas, that would be somewhat unexpected.
Okay. So to rank them -- so the traditional console is #1 by far, and then everything else takes a number and gets in line?
And, Ladies and gentlemen, that will conclude our question-and-answer session. I would like to turn the call back over to Mr. Sutton for any closing remarks.
I want to thank everybody. To recap, we remain optimistic about the long-term growth opportunities in the interactive entertainment industry. And we believe that we have made the right decisions for the company to get us through the upcoming year. We look forward to speaking with you again on our first quarter call in March. Thank you, operator.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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