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Majesco Entertainment (NASDAQ:COOL)

Q1 2013 Earnings Call

March 12, 2013 4:30 pm ET

Executives

Stephanie Prince

Jesse Sutton - Chief Executive Officer and Director

Michael Vesey - Chief Financial Officer and Principal Accounting Officer

Analysts

Sean P. McGowan - Needham & Company, LLC, Research Division

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

Edward M. Woo - Wedbush Securities Inc., Research Division

Operator

Good afternoon, and welcome to the Majesco Entertainment First Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Stephanie Prince of LHA. Please go ahead, Ms. Prince.

Stephanie Prince

Thank you, Amy, and good afternoon, everyone. This is Stephanie Prince. Welcome to Majesco Entertainment's first quarter fiscal 2013 earnings conference call for the quarter ended January 31, 2013.

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 risks 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 fiscal 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 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 noncash compensation, changes in the -- actually, non-GAAP financial measures, include expenses related to noncash compensation, changes in the fair value of warrants, severance costs and the benefit from the sale of certain income tax benefits derived from net operating losses.

Operating income, net income and diluted income per share have been adjusted to exclude these items. These non-GAAP measures are provided to enhance investors' 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 this afternoon.

I would now like to turn the call over to Jesse Sutton. Jesse?

Jesse Sutton

Thanks, Stephanie. Today, I'll start my remarks with some highlights of the first quarter. Mike will then review our financial results. As is our custom, I'll conclude with some comments on our upcoming product releases before opening the call up for questions.

As we have signaled on our fourth quarter call, our first quarter results came in directionally as expected, with revenue well below last year, reflecting declining demand over the holiday season for our titles as the current generation of console platforms reaches the end of their product life.

For example, as you know, we derived a significant portion of our product sales from Wii products in the last year. As a point of reference, software sales for all video games for the Nintendo Wii platform declined 44% in 2012 according to the research firm, the NPD Group.

To best manage the business during the transition to next-generation consoles, we've made adjustments to our cost structure, business model and product slate. For 2013, we are planning to introduce a smaller slate of products focused on lower-risk, high-profile, branded console and mobile games in partnership with consumer-oriented companies like Disney and Zumba.

We believe this is the right strategy to guide us through the industry shift, one that will enable us to preserve our cash as we determine what combination of platforms and products will provide the most profitable opportunities moving forward.

We remain confident in the strength of brands, such as Zumba and Disney, and our ability to deliver compelling experiences based on them regardless of platform.

Over the course of our 20-year operating history, we've witnessed new hardware generations before and adapted and thrived. From our perspective, this waiting period while next-generation consoles are introduced and consumer preferences become apparent, is no different.

Most importantly, we have a strong balance sheet with $27 million in cash and no long-term debt, which gives us the necessary financial flexibility to prepare the company for its next growth phase.

I would now like to pass the call to Mike Vesey, our Chief Financial Officer, to provide a financial review of our first quarter and discuss the outlook for the balance of the year. Mike?

Michael Vesey

Thank you, Jesse. I'll begin by recapping our results for the first quarter and close with some comments about our outlook for the year. As is our custom, I'll use non-GAAP results when discussing our financial operations.

Revenue for the 3 months ended January 31, was $23.5 million, a 65% decline from the $66.2 million reported in the first quarter of last year. The decrease was primarily due to lower sales of our Zumba Fitness products on the Wii platform and lower revenues from new releases on the Microsoft Kinect and Nintendo 3DS. The decline in Zumba sales was due in part to timing differences of our newer-released titles versus last year. We released Zumba Core late in the fourth fiscal quarter of 2012. As a result, approximately $11 million of sales reflected in our prior year results.

Net revenues in European markets decreased approximately $10.6 million from $16.7 million during the same period a year ago. Total revenue from Zumba Fitness products accounted for approximately 67% of sales compared to 77% in the first quarter a year ago.

Our gross margin was 30% in the first quarter compared to 35% a year ago. The decrease in gross profit primarily reflects lower average prices for our Wii products due to promotional pricing.

On a non-GAAP basis, operating expenses decreased approximately 46% or $7 million to $8.1 million. This was primarily due to lower selling and marketing expenses of $3.7 million compared to $9 million in the year-ago first quarter, reflecting decreased media advertising on new releases and lower commissions and other costs associated with the lower sales volumes.

Also included in the first quarter operating expenses is $776,000 or $0.02 a share of severance charges related to the strategic realignment that we completed in January. We did not include these severance expenses in our non-GAAP operating results.

We also continue to invest in the development of the mobile freemium games, expensing approximately $1.3 million of development costs during the first quarter. We plan to invest approximately $3.5 million in development of freemium mobile games in total during 2013.

We reported a non-GAAP net loss of $1.1 million compared to non-GAAP net income of $7.3 million in the prior year. Non-GAAP diluted net loss per share for the quarter was $0.02 compared to an $0.18 profit in last year's first quarter.

Now turning to our balance sheet. We ended the year with $27 million in cash and equivalents. An additional $7 million is available to us under our factoring agreement, giving us total cash and availability of roughly $34 million. Net cash provided by operating activities for the 3 months ended January 31, 2013, was $8.8 million compared to $9.4 million in the 2012 first quarter. The decrease reflects the effects of our net loss in the first quarter compared to net income of $7.7 million in the prior year period, which was somewhat offset by the timing of cash receipts from sales and disbursements for licenses and development costs.

As of January 31, we had approximately $4.3 million invested in capitalized software development and prepaid license fees, reflecting the smaller slate of console products planned for 2013. We ended the first quarter with $3.3 million of inventory compared to $7.8 million at the end of the first quarter of last year. We continue to focus on carefully managing and preserving our liquidity resources.

I'd now like to discuss our 2013 outlook. As we've previously disclosed, our strategic realignment reduced overhead in some areas and converted all product testing and mobile development to a variable expense model. This was done to preserve our cash and liquidity position as the market and user base for the next-generation consoles develops. These initiatives are expected to result in reduced operating expenses of approximately $1.5 million annually beginning in the second quarter.

Given the decline in first quarter revenue, which includes the important holiday selling period, as well as the light release slate for the next 2 quarters, we continue to expect revenue for 2013 to be significantly below 2012, resulting in a net loss for the full year. We're currently working on our 2013 holiday release slate and will have further information on our future updates.

In summary, we have strengthened our balance sheet significantly over the past several years and are confident that our cash and liquidity position will support us through this transitional year in our industry. We remain focused on carefully managing and preserving all of our liquidity resources as we prepare for the renewed industry growth.

Jesse will now give you an overview of our upcoming product releases.

Jesse Sutton

Thanks, Mike. I'll now provide some comments on our slate for the second quarter and the balance of 2013. As we've previously said, we have planned a smaller slate of console and mobile games for 2013. This line-up includes higher profile, more risk-averse games than previous years, all built around new experiences from big brands as we continue to diversify our portfolio. Our mobile strategy is now focused on high-profile, free-to-play games.

In the first quarter, we released Maestro Piccolo's Flea Symphony for the iPhone, iPad and iPod Touch. We're proud to be able to say that this game received the Editor's Choice Award from Apple. Players must solve 100 levels of progressively complex musical puzzles through 5 imaginative music box worlds. During the second quarter, we're launching Monster High: Skulltimate Roller Maze on Nintendo 3DS. This release is part of a distribution agreement with Little Orbit that includes the Nintendo DS and Wii SKUs released during the first quarter. Players can pick their favorite Monster High character and form a team of friends as they skate through the crypts of Monster High, collect power-ups, avoid monstrous obstacles, scream past the competition and use each character's special ability and ghoul power to win the race.

Other titles that we will release during the balance of the year include Young Justice: Legacy on Xbox 360, PlayStation 3 and Wii U, will be launched this holiday, also as part of our distribution agreement with Little Orbit. Based on WB's hit animated series that airs on Cartoon Network. This game lets players assemble their own Young Justice team from 12 heroes, including NightWing, Kid Flash, Robin and more. Players can track down notorious villains and be mentored by powerful superheroes as they explore, customize and battle in this action-packed RPG-styled game. We also recently announced Phineas and Ferb, our working title for retail consoles and gaming handhelds, including smartphones and tablets. This game is based on the animated Disney hit television series. We expect to announce additional details soon.

We also expect to announce the specifics of the next innovation of the best-selling Zumba Fitness franchise plus additional titles for our 2013 line-up as we get closer to the important E3 industry event in early June.

In closing, our strategy for this year is designed to preserve cash as we watch how the market develops during the current hardware transition so we can best position ourselves for fiscal 2014. We have been in business for over 20 years and have successfully navigated through several industry transitions and periods of uncertainty before, and we're confident that we will resume growth as the next-generation market develops. Now, we will open the call up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Sean McGowan at Needham.

Sean P. McGowan - Needham & Company, LLC, Research Division

Two questions if I can. Jesse, first, could you comment on what features of the -- that have been released about the PlayStation 4 kind of get you most jazzed, now that you can talk a little bit more openly about it? And for Mike, could you be more specific about specifically what you've done to kind of migrate to a variable cost model and how sustainable that is?

Jesse Sutton

Sure. Sure, Sean. As far as the PlayStation 4 is concerned, I think as the next-generation platforms come out, there are a few dynamics that really play to our advantage based on industry history. One is how -- usually when the next-generation platforms come out, what they really focus on, especially PlayStation and Microsoft, are the hard-core gaming group. And they'll include with that some select product, but what that does is it primarily allows the previous generation platforms, as we've seen with the PlayStation 2 to the PlayStation 3, to overlap and create a market dynamic that really builds the mass market interest in those platforms as pricing comes down for those platforms and they become more attractive. So we're looking forward to taking advantage of those dynamics, as well as keeping a close eye on where we can play in the new platforms.

Sean P. McGowan - Needham & Company, LLC, Research Division

Thank you. And Mike?

Michael Vesey

Yes. So when we had our workforce reduction, we've let about 40 people go. About 9 of those were in overhead [ph] positions, and the rest were either in our mobile studio up in Foxboro, Massachusetts, or in our game-testing facility down here in New Jersey. In the case of the mobile group, what we decided to do there was, instead of maintaining a full team of developers in-house, we'll outsource the development of the games and we'll have producers and Q&A and operations personnel internally kind of surrounding them, so that we can -- depending on the slate of the games in development, our costs will go up and down as opposed manning a full facility, as we had in Foxboro. And we think that's sustainable, as long as we want it to be. In terms of the QA testing personnel, we used to maintain full teams here year round because we had a pretty predictable flow of games coming off, mainly the Wii and DS platforms. Now that the flow is a little more choppy and we're reducing the slate in 2013, we decided to go to a model where we could outsource some of the labor, either with part-time employees or outside testing facilities and just have our lead testers and producers oversee the process here. So again, it replaces some fixed labor that we had in-house all year-round with some variable expenses that we'll just bring on seasonally as the work flow and the game flow requires.

Sean P. McGowan - Needham & Company, LLC, Research Division

And you're saying you'd be prepared to modify that when conditions kind of get a lot more favorable?

Jesse Sutton

We could, we could. If we fall into a scenario where we see a number of years where we would be producing a steady flow of games, we could maintain full teams, but it may not be necessary. We still have the -- we're able to maintain our skill base here with the lead testers and producers still being employed here. And it's really just the variable labor that we are outsourcing. So it's really at our discretion going forward.

Operator

[Operator Instructions] Our next question comes from Ed Woo at Ascendiant Capital.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

I had a question in terms of -- we've already seen the Wii U launch and it seems like there's some disappointment with that. And now we're expecting the PS 4 and possibly the next Xbox to launch later this year. Does it mean that you are pretty much going to limit your investment in the Wii U and possibly wrap up your investments in either the PlayStation 4 or the next Xbox?

Jesse Sutton

Hi, Ed. This is Jesse. So as far as next-generation is concerned, we haven't really announced much. So there's not too much I can discuss here at this point. We'll learn more about the -- our lineup as we get closer to E3. But that being said, I will say that with, look, the Wii U, it's been a slower start than most people would have liked to see. And I think that we've all -- none of us are -- want to count out Nintendo. It really is -- it is always the game that drives the hardware sales. And as they position their full line-up of 2013, we think it is -- there's a good probability that they can generate some traction and build off of their fantastic brand base that they've always had. We're going to -- we're in an interesting position now, and it's what we really talked about earlier in my statements; which is the industry is going through this transition, and Majesco is going to try to be opportunistic, sit back a little and watch what the new platforms do, take what we'll call risk-averse bets on the kinds of brands and products that we bring to those platforms, if and when we do, and look at other opportunities in other areas that can create value as well.

Edward M. Woo - Wedbush Securities Inc., Research Division

Great. And then I had a question on your outlook for mobile development in fiscal '13. What was it in fiscal '12? And do you see that opportunity being much brighter than the console opportunities?

Jesse Sutton

That's a good question, Ed. The mobile business right now is something that we're still trying to develop as much as we can here. As the -- as we have seen over the last 18 months, the transition from premium paid games to free-to-play games on mobile, that have really generated success, and it’s only been a handful of people that have been able to do that. We continue to learn in that space and we'll continue to invest in that space. But right now, we're going to try to invest on high-profile brands, like Phineas and Ferb, to generate as much of an installed user base, so we can leverage that for all of our future products as well.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Jesse Sutton for any closing remarks.

Jesse Sutton

Thank you, operator. And thank you, everyone, for joining us today. We remain confident about our position and the long-term opportunities in the interactive entertainment industry. We look forward to speaking with you again on our second quarter call in June.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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