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Majesco Entertainment Co. (NASDAQ:COOL)

F3Q09 Earnings Call

September 14, 2009 4:30 pm ET

Executives

Jesse Sutton - Chief Executive Officer, Director

John S. Gross - Chief Financial Officer, Executive Vice President

Gui Karyo - Executive Vice President - Operation

Analysts

Sean MacGowan - Needham & Company

Ed Woo - Wedbush

Operator

Hello. This is the course call operator. Welcome to the Majesco Entertainment Company’s third quarter 2009 earnings conference call. (Operator Instructions) At this time, I would like to turn the conference over to Mr. Mike [Smarchiasi] of [inaudible] Communicators. Mr. Smarchiasi, you may begin.

Mike Smarchiasi

Thank you, B.J. and good afternoon. I would like to welcome you to Majesco Entertainment’s conference call today. Before we get started, I would like to remind you that this call is being recorded and the audio broadcast and replay of this 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 year ended October 31, 2008 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 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 results. The GAAP financial measures include expenses related to non-cash compensation, settlement of litigation and related charges net, changes in the fair value of warrants, the closure of the California studio, and a 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 expenses. Charges in income related to non-cash compensation, warrants, the closure of the California studio, and income tax benefits. These non-GAAP measures are provided to enhance investors’ overall understanding of the company’s current fiscal 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 a substitute for or superior to GAAP results. A reconciliation between GAAP and non-GAAP financial measures is included in the press release issued earlier today.

On the call today is Jesse Sutton, Chief Executive Officer; John Gross, Chief Financial Officer; and Gui Karyo, Executive Vice President of Operations.

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

Jesse Sutton

Thanks, Mike. Good afternoon, everyone. Thank you for joining us today. I will open the call with a review of the quarter and John will follow with the financial review and our outlook. Gui, John and I will then be happy to take your questions.

We delivered another quarter of solid top line performance, generating revenue of $17.2 million, an increase of 19% over last year, driven by the launch of Night at the Museum as well as the continued strength of our Cooking Mama franchise and Jillian Michaels Fitness Ultimatum.

During the third quarter, we shipped 11 new SKUs, including six DS, four Wii, and one Xbox 360. In the first nine months of the fiscal 2009, we produced revenue of $71 million, an increase of almost 54% from the year-ago period. While we had some pressure on our margin and profitability this quarter, it was due to a few specific items and we remain optimistic about our performance for the full year. Our profitability was impacted by lower gross margins and marketing spend for both Night at the Museum and the Go Play titles, which performed below expectations.

Let’s take a moment to discuss both projects. Night at the Museum was an opportunistic pick-up only a few months before its release and we expected a lower margin than our traditional product lineup, given the distribution nature of the deal. It is clearly a high profile title and if it performed well, would add to our gross profit. However, its performance was software than what we had targeted.

In regards to the launch of our own IP, Go Play line, as we noted in the last call, we supported its launch with marketing to try to establish the brand. The trade-off here is that if you don’t have a license with a natural consumer draw, some level of marketing investment is necessary. In retrospect, unlike 2008, this summer was weak industry-wide and be it that or the product, we were disappointed by the performance of both Go Play titles.

The key takeaway here is that we allocate our marketing investment on a product-by-product basis and in the third quarter, the titles we supported resulted in marketing investment above our normal levels, which did not deliver the expected results.

We allocate a certain amount of marketing support to select titles during the year. These are limited, selective, and managed investments and in the fourth quarter, we expect to return to more normalized marketing levels.

Clearly our entire management team remains focused on delivering profitable growth and capitalizing on the significant progress we have made on the top line. We are reiterating our guidance for non-GAAP earnings per share of between $0.10 and $0.14 for the full fiscal year. We are also increasing our revenue guidance to $85 million to $90 million on the strength of our fourth quarter release schedule, which I believe is our strongest ever, led by both Momma and Jillian titles. The guidance assumes the release of 37 SKUs announced in the fiscal year, of which 13 are scheduled for release in the fourth quarter.

As I stated earlier, we are expecting a strong fourth quarter performance and our outlook is based on a release schedule which will include SKUs in our two biggest franchise titles, the third iteration of the record-breaking Cooking Mama franchise, Cooking Mama 3 Shop and Chop for the DS; and the sequel to last year’s holiday hit, Jillian Michaels Fitness Ultimate 2010 for the Wii and DS. In addition, we have a solid lineup of Majesco owned IPs with a Boy and his Blob for the Wii, and Our House Party for Wii and DS.

For the fourth quarter, we have a product slate with expected gross margins that will result in full-year margins in line with our historical experience in the range of the low to mid 30s. We will have some very modest strategic marketing investment behind the Jillian and Cooking Mama launches but expect amounts spent on advertising to be well below third quarter levels.

In addition, our plans to close the studio, which we discussed on the last conference call, are on track and we expect to complete this process during the quarter.

All of this, coupled with a fixed cost structure that remains under control, should allow us to return to profitability in the fourth quarter.

Overall, our business continues to evolve positively. We are executing on our strategy of franchise development with our singles and doubles approach. Our pipeline continues to expand and we are seeing an increasing number of higher quality new business opportunities which meet our financial criteria and fit our core strategy.

This is highlighted by several recent announcements with established brands, including Alvin and the Chipmunks: The Squequel for Wii and DS, which will launch this December, in advance of the theatrical release of the movie with the same name that opens on Christmas Day; two new Tetris games for Wii and DS launching next spring; and we are bringing the Zoomba fitness program to videogames with a release scheduled for holiday 2010.

We remain excited about the prospects for the overall industry and specifically our position in the family friendly causal gaming market. Our market focus and the success of our business in the past several years are driving many of the new opportunities that are coming across our plate and we are well positioned to capitalize and leverage this momentum.

With a proven track record and scaleable fixed cost structure, we believe we are well-poised to continue to drive our top line performance and deliver improved profitability. Our strategy is anchored by a portfolio approach, limited development and marketing costs, and minimal sales thresholds to reach profitability and ensures we are maximizing our success rate while we seek to develop new franchises.

I would now like to pass the call to John Gross, Majesco's Chief Financial Officer, to provide the financial review of our fiscal 2009 third quarter. John.

John S. Gross

Thanks, Jesse. The details for the quarter are, as Jesse indicated, our revenues were up 19% to $17.2 million versus the year-ago period, driven by the performance of Night at the Museum and the continued success of our Cooking Mama franchise, especially Gardening Mama, which was released late in the second quarter.

DS revenues in the quarter were $9.6 million versus $8.1 million in the year-ago period, while Wii revenues were $6.2 million in the quarter versus $5.0 million a year ago.

Our gross margin in the third quarter was 20.5%, down from recent levels and from the 42.5% in the year-ago period. As we’ve noted on prior calls, our gross margin can see wide swings, which are largely a function of promotional activity and the mix of product in a particular quarter.

As Jesse has noted, this quarter was primarily impacted by the soft performance of the Go Play brand and Night at the Museum. Looking at our cost components, our amortization of development and licensing costs increased 18 percentage points as measured against revenue versus last year, primarily due to increased royalties associated with Night at the Museum and we recorded higher amortization costs as a percent of sales as a result of the lower-than-expected sales performance.

Looking at our operating expenses, while they were up on an absolute basis against the year-ago period, they remain under control, especially our fixed costs. As a percent of sales, total operating expenses, which include the incremental marketing and all our variable selling and marketing expenses, were driven up by four primary factors. First, selling and marketing expenses were impacted by our discretionary marketing campaigns for television and Internet advertising supporting titles such as Go Play and Night at the Museum. We continue to reevaluate our campaigns and we expect to see a more modest budget in the fourth quarter.

Second, as a result of our increase in sales volume, variable selling and marketing expenses accounted for a large portion of the dollar increase but were in line with previous quarters on a percentage of sales basis.

Third, with our decision to wind down the studio, we recorded a $400,000 charge in research and development, which represents all of the expenses associated with the studio in the quarter that would not be assignable to games in production.

And finally, we continue to make some modest investments for the development of games for new platforms such as iPhone, Facebook, and other digital applications, the cost of which are included in R&D.

G&A expenses as a percent of sales recorded another significant decrease, from 16.8% to 13.2%, a 360 basis point drop in the quarter, and from 14.1% to 10.1%, a 400 basis point reduction for the nine months. These declines further highlight the operating leverage we have built into the business. Total cash fixed costs for the quarter, which include G&A, product research, and the fixed portion of selling and marketing, related primarily to employee costs, remained in line with our expectations of $3 million to $3.5 million. This excludes costs expense for the studio, non-cash compensation, and any annual incentive bonuses.

G&A remains an ongoing focus. As an example our new lease, which starts in November, has a 20% reduction in rent, and we continue to renegotiate some of our key vendor contracts resulting in 10% to 20% reductions or more in some cases.

The GAAP operating loss for the quarter was $4.2 million, compared to operating income in 2008 of $300,000. Non-GAAP third quarter 2009 operating loss was $3.3 million, compared to a non-GAAP operating income of $0.7 million in 2008. The GAAP operating loss for 2009 included $500,000 in non-cash compensation expense and $400,000 for the entire expense of the studio in the quarter.

The GAAP operating income for 2008 included a non-cash compensation expense of $400,000 and $100,000 of studio related expenses.

Profitability was unfavorably impacted by our lower gross margins and higher marketing during the quarter.

For the third quarter, GAAP net loss was $5.2 million, or $0.18 per share, which included an $800,000 non-cash charge for the fair value of warrants issued, compared to a third quarter 2008 GAAP net income of $500,000, or $0.02 per share, which included a $400,000 non-cash gain in the fair value of warrants issued.

The non-GAAP was $3.5 million, or $0.12 a share, compared to a non-GAAP net income of $600,000, or $0.02 per share in 2008.

Turning to our balance sheet, as of July 31st, we had $6.3 million in cash or cash equivalents. Our [due to] factor was $736,000, which represents gross receivables sold to the factor of $9.6 million less allowances of $2.8 million and advances from the factor of $7.6 million. This compares to 2008 fiscal year-end of $5.5 million in cash or cash equivalents and a due to factor which was $983,000, representing gross receivables sold to the factor of $12 million, less allowances of $3.4 million and advances from the factor of $9.6 million.

Our capitalized development costs and license fees were up 22% versus year-end, reflecting the growth in the number of titles we are publishing and the higher cost and longer development cycle of the Wii titles. The vast majority of capitalized costs pertained to titles not yet released as of the end of the quarter.

For our 2009 outlook, based on our current release schedule, we are raising our revenue guidance from $80 million to $85 million to $85 million to $90 million. Our profit guidance remains unchanged for non-GAAP EPS of $0.10 to $0.14 a share.

Our expectation of a return to profitability in the fourth quarter and for the year is based upon five factors -- a strong schedule of new releases, including Cooking Mama 3 and Jillian Michaels 2010, as well as Boy and his Blob and Our House Party. The mix of product carries with it margins that should return our margins to more traditional levels; lower amounts spent on marketing in the fourth quarter versus the third quarter; a very strong holiday catalog, including Gardening Mama for its first season; and reduced expense for the studio as shut-down expenses were recorded in the third quarter and any remaining activity of the smaller staff is related directly to titles. And of course, our ongoing control over fixed costs.

The guidance assumes the release of approximately 37 SKUs in 2009, including approximately 18 DS and 12 Wii.

As a reminder, our results are also impacted by seasonality from the December holiday period and variability based on release schedules.

I will now turn the call back to Jesse. Jesse.

Jesse Sutton

Thanks, John. I would like to conclude with some comments on our remaining 2009 lineup, which includes a number of titles that we are excited about. Fiscal fourth quarter titles include Jillian Michaels Fitness Ultimatum 2010 for the Wii and DS, features a celebrity fitness trainer, life coach, and star of the popular television series, The Biggest Loser, as she leads players through high intensity one-on-one workouts while providing direct feedback and motivation to help players reach their personal fitness goals. Cooking Mama 3 Shop and Chop for the DS is the latest version of the best-selling franchise that has entertained 4.5 million people to date. Mama’s newest game features a brand new shopping feature, along with fresh recipes, ingredient combination, multi-player chef challenges, and Gardening Mama connectivity.

A Boy and his Blob for the Wii is IGN’s Best of E3 Runner-up in the Wii platform category. The game is a rebirth of the NES classic that expands upon the original platform adventure and features groundbreaking hand-drawn and painted animation technology. By feeding the blob jelly beans, players can activate his special abilities to transform him into tools that help the player solve puzzles, defeat monsters, and escape danger.

Our House Party for Wii turns the Wii remote into the ultimate home renovation tool that lets up to four players compete party style to build their own personalized trophy home that they can then share with friends via Wii Connect 24.

Looking at our fiscal first quarter 2010, which includes the holiday sales periods, Alvin and The Chipmunks The Squequel for the Wii and DS launches in advance of the theatrical release of the same name that opens on Christmas Day, featuring songs from the Grammy and American Music Award-winning Alvin and the Chipmunks library, this rhythm action game challenges players timing and musical skills as they perform in a variety of concert locations around the world.

[Foots] Twisted World for Wii, a Gamespot E3 09 Editors Choice Award Finalist, is a unique puzzle platformer that stars Flip, a magician’s apprentice who mistakenly gets sucked into a cube of the world where up and down are only a matter of perspective. Players will help Flip escape his cube prison by rotating the environment 90 degrees in any direction with a simple twist of the Wii remote.

That concludes our formal remarks. Operator, if you can review the Q&A instructions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Sean MacGowan from Needham.

Sean MacGowan - Needham & Company

Thanks, a couple of questions, if I can -- whether it’s Jesse or John, whoever would prefer to answer it, how much of the reduction in the marketing spend expected in the fourth quarter is a result of seeing maybe not getting a good return on that investment in the third quarter, or was it already planned to be lower?

Jesse Sutton

It was already planned to be lower. I’ll actually have Gui, if you want to address that.

Gui Karyo

Sure, yeah and -- it really -- there’s no change in our anticipated marketing spend for the fourth quarter per se. We did already have plans for Jillian and Mama in particular that remained about the same, as well as for the other SKUs that we are releasing. Obviously we’ve taken some lessons from what has happened over the summer with the Go Play line but to the point Jesse made in the script, you know, we have always viewed the larger marketing expenses on a case-by-case basis. This is just information that is fueled how we will look at [inaudible].

Sean MacGowan - Needham & Company

Okay, and maybe Gui, you can address this as well then -- given what happened with some of these titles in the summer, how clean would you say you left the trade, you know, in terms of allowances or just actual inventory out there?

Gui Karyo

You know, I don’t think we’ve ever spoken specifically about how clean we’ve left the trade on a product and that’s a precedent I don’t think we’re prepared to start. What I would say is that for the past three years, through a variety of products, both very successful and less successful, we have managed to maintain a very healthy relationship with our retail partners on the net balance of inventory and I would say that going forward, we expect to see the same.

Sean MacGowan - Needham & Company

Okay. Thank you.

John S. Gross

Sean, actually in the case of both Go Play and Night at the Museum, we did address them immediately to the extent it came up, so -- and which is what we always do, but for certain we did.

Sean MacGowan - Needham & Company

Okay, and the last question is you know, I think throughout this year, you have kind of nudged the revenue goal up a bit. Given what’s a pretty robust release schedule, you know, with some question -- I mean, there’s some products that we don’t really know how well they will do -- would you say there is upside potential in your revenue range for the fourth quarter?

Jesse Sutton

I think whenever you talk about a pipeline of product, there’s always the opportunity for a more favorable reception at the consumer level. We obviously hope for that and all I can say is we are confident and we are excited about the release of those titles.

Sean MacGowan - Needham & Company

Okay. Thank you.

Operator

Your next question is from Ed Woo from Wedbush. Please go ahead.

Ed Woo - Wedbush

I had a question about the current retail environment. We saw that Wii sales continue to be weak but DS sales continue to hold up. Has anything changed as of current?

Jesse Sutton

I would say that -- let me take that on a couple of levels. First I think macroeconomically at that level I think we are going to start seeing an improvement in the retail sector in general. I think this was a quiet summer for the retail sector. On that same note, I think industry wise, even more specifically for us Nintendo wise, there really wasn’t enough major software releases throughout the last four or five months to really drive consumers to the stores and now I think we are going to a very robust holiday period where you have some very high profile brands being released and that will have a significant impact driving consumers to the marketplace as well as an improved macroeconomic environment.

Ed Woo - Wedbush

And the other question I have is, is there any difference between the U.S. environment and international environment?

Jesse Sutton

I would say that the international environment, or more specifically the European environment, is facing challenges that we here don’t have to face, or we face a lot less of and that is most specifically with piracy related to the DS. There’s a piracy issue that Europe is dealing with. Obviously it’s a very small part of our revenue stream; nevertheless, it is something we keep our eye on.

I also want to just add to the point I was making previously, I neglected to add that we do anticipate some potential price reductions in the hardware for Nintendo that should have a good impact for bringing consumers to the store as well.

Ed Woo - Wedbush

Great. Would you be able to quantify -- would that be on the handheld and the Wii or --

Jesse Sutton

I think the most important one for us is the Wii and that’s the one that I’m hearing the most noise about.

Ed Woo - Wedbush

Okay. Well, I’ll definitely look forward to the next Cooking Mama and good luck.

Operator

Ladies and gentlemen, this concludes the question-and-answer session for today as we have no further questions. I will turn the floor back over to Mr. Sutton for any final closing remarks.

Jesse Sutton

I just wanted to thank everybody for joining us today. We look forward to speaking to everyone again at our year-end 2009 conference call in January. Have a good day.

Operator

Thank you all very much for participating in the Majesco Entertainment company’s conference call. This concludes today’s event. You may now disconnect your lines.

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Source: Majesco Entertainment F3Q09 (Qtr End 7/31/09) Earnings Call Transcript

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