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Majesco Entertainment Company (NASDAQ:COOL)

Q4 2009 Earnings Call

January 14, 2009 4:30 pm ET

Executives

[Mike Smarjiaski – Vendor Communicators]

Jesse Sutton – Chief Executive Officer

John Gross – Chief Financial Officer

Guy Karyo – Executive Vice President Operations

Analysts

John Taylor – Arcadia

Todd Greenwald – Signal Hill

Operator

Welcome to the Majesco Entertainment Company’s fourth quarter and fiscal year 2009 earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to [Mike Smarjiaski of Vendor Communicators]

Mike Smarjiaski

Good afternoon. I would like to welcome you to Majesco Entertainments 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 result 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 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 results and GAAP financial measures including 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 development studio and a benefit from the sale of certain state income tax benefits derived from net operation 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 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 in included in the press release issued earlier today.

On the call today we have Jesse Sutton, Chief Executive Officer, John Gross, Chief Financial Officer and Guy Karyo, Executive Vice President of Operations. I would now like to turn the call over to Jesse.

Jesse Sutton

I’d like to wish everyone a Happy New Year and thank you for joining us today. I’ll open the call with some highlights and an overview of our performance for fiscal 2009. John will follow with the financial review and our outlook. Guy, John and I will then be happy to take your questions.

In 2009 we continued to move forward with our strategic plan and deliver a strong top line performance. We exceeded our revenue guidance despite the challenging economic environment and continued softness across our industry which was driven by a consumer retail environment that was much weaker than expected.

However, we were disappointed with our bottom line results and I will discuss shortly a number of actions we have taken which we believe will return us to profitability for 2010 and beyond.

For the year, our revenue was $94.5 million, an increase of 48% from 2008. We also had a good fourth quarter in which we generated revenue of $23.9 million, an increase of 33% against a very strong comparison in the year ago period.

In 2009 we shipped 33 SKU’s including 17 DS, 12 Wii and one Xbox 360. Revenue for the year was driven by the continued success of our hit franchise Cooking Mama, Jillian and Michael’s fitness Ultimatum 2009 and 2010, and increased distribution sales.

During the year, Cooking Mama reinforced its position as an Evergreen brand with all SKU’s since the launch of the franchise delivering impressive results including our third DS SKU, a first line extension in Gardening Mama. The Cooking Mama franchise has now sold more than six million units and extended its reign as the most successful third party franchise on the DS.

While we had a good revenue performance, our gross margin and profitability for the quarter and full year were below our expectation primarily impacted by a few specific items which include the cancellation or timing of 2010 titles, Our House Party for the Wii and DS which significantly underperformed at retail, new IP titles which had weak sell through and higher allowances as a result of a difficult retail environment, and our international business where we were impacted by industry wide softness and had a few key releases slip into 2010. John will provide some additional detail on these items shortly.

Our bottom line performance is a key focus to our management team and we are taking a number of steps to fine tune our strategy for fiscal 2010 to better position us in the current operating environment. We believe this will result in improved profitability which is reflected in our guidance.

We are looking to focus our resources on our best opportunities, publishing stronger titles, and driving additional efficiencies across our operations by reducing our overall cost structure. Our portfolio approach of limited development and marketing costs and minimum sales thresholds with the goal of maximizing our success rate and developing new franchises remains intact.

As we enter 2010 we continue to make progress in our efforts to expand the Cooking Mama franchise. Our first step in this regard, Gardening Mama, was released in 2009 and was well received by consumers. The Mama brand continues to strengthen and we have plans to introduce two new line extensions in 2010. In addition, we continue to explore opportunities to leverage this important franchise across new media.

We continue to look at a number of higher quality new business opportunities including many established brands. This is highlighted by several announced titles for 2010 including Alvin and the Chipmunks, Catchers Party Deluxe, Hello Kitty and Zoomba Fitness. Titles such as these provide instant awareness with our distribution partners and consumers. This helps us with both our sell in and sell through efforts and limits the amount of required marketing.

In addition, we continue to look at opportunities to exploit hot new technologies such as 3D which was the most talked about technology at this year’s Consumer Electronics Show. We are set to launch our first 3D game, Attack of the Movies 3D this spring.

The game is the first ever 3D shooter designed exclusively for the Wii. The game transports players to six fantastic movie themed worlds and features classic enemies culled from the annals of film history. The game also comes packaged with four pairs of 3D glasses to support four player cooperative shoot outs and does not require a 3D enabled TV.

Overall, in regards to marketing, we returned to a more normalized run rate in the fourth quarter and would expect that to continue throughout 2010. This will in part, be driven by the established brands we are looking to work with. However, we will continue to allocate our marketing investments on a product by product basis and provide support to select titles during the year.

We have made adjustments to our title line up and green light process which reflects recent trends from both consumers and distribution partners. Based on the current environment, we conducted a detailed review of our title line up and made the decision to take an impairment on certain new IP in our 2010 portfolio and cancel the number of games in development. We believe this will allow us to better focus our resources on our most promising and highest margin potential titles.

On the cost side, while our overhead had remained under control as a percentage of revenue, we have launched cost initiatives in both our U.S. and international operations as well as other programs that we expect to result in annualized savings of approximately $2.5 million to $3 million in 2010.

These efforts are focused on transitioning our European business to primarily a lower cost licensing model which will substantially reduce our international overhead. In addition, we have implemented a reorganization of our domestic operations to further improve operating efficiencies.

This includes a reduction in work force across our organization of approximately 17%, and as a result we expect to record a charge of approximately $.5 million in the first quarter.

On the digital and mobile front we continue to take an R&D approach in our efforts. As many of you are aware, we have been building our knowledge base and experience in this developing market through a number of carefully selected efforts.

While this remains a small part of our business, we are looking at a number of opportunities to work with partners in this space that will increase our exposure while limiting our overall risk. Social and casual multi-player games are specific areas of interest along with digital downloadable content across all distribution channels.

We continue to focus on the fastest growing market segment in the industry, the family friendly mass market genre. We view all platforms as potential opportunities and while we believe Nintendo systems continue to present the best fit for our strategy in the near term, we are closely watching the development of the next generations of systems.

In fact, we believe that 2011 is the year all three major consoles broaden their appeal to the family friendly demographic. Microsoft is reported to launching the Napol for holiday 2010, Sony is expected to launch the Lawn controller for PlayStation 3 this spring and Nintendo will continue to bring innovative products to the Wii.

As a result, the family friendly video game market should experience its most exciting period yet. We also believe that Nintendo’s DSI will be a great source of game innovation and prove to be as successful as the DS.

As such, the steps we are taking today will be critical to assure that we’re well positioned to take advantage of the opportunities for these platforms in 2010 and 2011.

Although we continue to operate in a soft retail gaming environment, we are making prudent adjustments to our business including the refinement of our product selection process. We are improving operating efficiencies and reducing costs in both our domestic and international operations and focusing our resources on our best opportunities. All of these steps are being made with the goal of delivering profitability.

Our Cooking Mama franchise remains a bright light and is having a strong first quarter across both its current and catalog SKU’s. We continue to enjoy strong relationships with our distribution partners and we remain optimistic about the future for our company and the industry as a whole.

The company is well capitalized and in a position to execute. Our management team and Board are committed to improving our performance and we believe we have the right strategy in place to do so.

I would now like to pass the call to John Gross, Majesco’s Chief Financial Officer to provide the financial review for our fiscal fourth quarter and 2009 results.

John Gross

Looking at the results for the fourth quarter and full year, our revenue in the quarter was up 33% to $24 million which was driven by the performance of the Mama titles including the newly launched Cooking Mama DS title and the new Jillian and Michael title.

Revenue for the full year was up 48% exceeding our previous guidance of $85 million to $90 million. This compares to revenue of $64 million in the year ago period. Revenue gains for the year were driven by the performance of the Cooking Mama franchise, Jillian and Michael’s titles and strong distribution revenues.

Before I discuss the details, I’d like to review the four items Jesse mentioned before which had a dramatic impact on our results for the quarter and for the year. They are the impairment charges for the 2010 titles, the performance of Our House in the fourth quarter, the performance of some of our other new IP titles in the quarter and the international performance in the quarter.

First, as to the cancellation of the impairment of the 2010 games; as a result of the industry wide softness and performance of our titles, we decided to cancel certain titles for 2010 and took impairment charges against others. When we cancel a game, we write off the capitalized costs to product R&D.

Impairment means that when we do our routine evaluation of games in production and their expected performance, the projected future cash flows will not cover the value of the capitalized software development costs and/or license.

We do this routinely and when we did these evaluations after the holiday performance at retail for us and the industry, we determined that a number of our 2010 titles not yet released needed to be impaired. These charges are included in the amortization costs and amortization with the cost of sales.

The total of the cancelled and impaired games is $3.2 million or $0.10 per share for the quarter and $0.11 for the year.

Second, the disappointing performance our the Our House SKU’s; in addition to the weaker than expected sell in, the sell through was also very weak. The result was that additional allowances above what we anticipated were required for the retailers to move the product through the channel.

In addition, as a consequence of its poor performance, we accelerated amortization over the current quarter sales. In total these factors added up to $1.6 million or $0.05 per share.

Third, the performance of our other new IP titles; while they had respectable sell in, they had weak sell through at retail leading to higher allowances and some additional accelerated amortization which contributed to a $0.04 per share loss in the quarter and the year.

And fourth, our European business was impacted by the industry weakness in the packaged goods sector and the slippage of a couple of key titles into 2010 from 2009. This had a $0.03 impact on our earnings per share.

These items virtually all impact our gross profit and I will now turn back to that. When we look at the gross margin, our gross margin for the quarter was 3.4% down from the 27.8% in the year ago period. The impairment charges I mentioned had an 11 point affect on our gross margin.

The performance of Our House in the quarter had a six point affect on our margin. The performance of international had a three point affect on our margin and the allowances on the other products had a impact of five points on our gross margin.

When I turn now to our operating expenses, our operating expenses for the quarter were $6.3 million up in absolute dollars from last year but relatively flat as a percentage of sales. When you look at the 2009 quarter, it includes the impairment charges for the cancelled games of $635,000 without which our operating expenses would have been $5.6 million.

Looking at the 2008 expenses for the quarter, they get the benefit of a $1.2 million credit related to our settlement litigation last year. When you adjust both those items out, our absolute dollars are down in our operating expenses and as a percent of sales they’re down roughly nine points.

Also in the quarter, our marketing was down substantially from third quarter levels at 10% of sales relative to 24% of sales last quarter. Our D&A and our fixed costs also remained under control.

Looking at profitability, I’ll focus on the non-GAAP results and you can refer to the reconciliation between GAAP and non-GAAP contained in our press release. For the three months ended October 31, our non-GAAP operating loss was $4.9 million versus a non-GAAP operating loss last year of $400,000.

For the same period, our non-GAAP net loss was $5.4 million versus a non-GAAP net loss of $700,000 last year. And finally, our non-GAAP EPS for the three month period was a loss of $0.16 versus a loss of $0.03 last year.

For the twelve month period, our non-GAAP loss was $3 million compared to a non-GAAP profit of $3 million a year ago. Our non-GAAP net loss for the year was $4.3 million versus a profit of $2.5 million a year ago. And finally, our non-GAAP EPS for the year was a loss of $0.15 compared to a profit of $0.09 a year ago.

Turning to our balance sheet, as of October 31, we had $11.8 million in cash or cash equivalents. As a reminder, we raised just under $9 million in September. Our due to factor was $1.2 million which represents gross receivables sold through a factor of $19 million less allowances of $4 million and advances from the factor of almost $14 million.

This compares to 2008 fiscal year end of $5.5 million in cash or cash equivalents at the end of 2008, the due to factor was $983,000 which represents gross receivables of $12 million less allowances of $3.4 million and advances from the factor of $9.6 million.

As expected during the quarter we built our inventory to over $9 million for the holiday period. The majority of the increase was for Cooking Mama which was sold during the first quarter of 2010. Our inventory will return to normal levels at the end of the first quarter.

Our 2010 outlook is as follows: based on our current release schedule, we are providing full year revenue guidance of $80 million. Our profit guidance is for non-GAAP EPS of $0.05. Our expectation of a return to profitability for the year is based on the successful implementation of the following initiatives; the continued success of the Cooking Mama franchise, with one new line extension and our ability to further leverage the brand, a reduction in marketing spend from 2009, continued control over fixed costs, the successful implementation of additional cost reduction efforts, and finally and most importantly, the successful refinement of our product selection process to better meet the current retail environment.

The guidance assumes the release of approximately 37 SKU’s in 2010 including approximately 14 DS and 16 new Wii. As a reminder, our results are impacted by seasonality from the holiday period and variability based on release schedules.

I will now turn the call back to Jesse.

Jesse Sutton

I would like to conclude with some comments on our 2010 line up which includes a number of titles that we are excited about. Fiscal first quarter titles includes Alvin and the Chipmunks, the Squeakquell for Wii and Nintendo’s DS, launched in advance of the theatrical release of the movie of the same name that opened on December 24. Featuring songs from the Grammy and American Music Award winning Alvin and the Chipmunks library, this rhythm action game lets players star as the chipmunks where groups and the Chippetts or both as they rock out on the ultimate world wide tour.

The Hello Kitty Party for Nintendo DS lets players enjoy 25 themed games as they shop, cook, dress up and more and all in preparation for a super fun party.

Looking at the rest of fiscal 2010 some of our announced titles included Catcher’s Party Deluxe for the Wii and Nintendo DS, represents a strategic partnership with Tetris Online Inc. to support the North American launch and distribution of its two newest additions to the Tetris franchise.

Tetris is one of the leading and most distinctive video game brands and franchises in the world. In the game’s 25 year history, over 125 million units have been sold. Loved globally by people of all ages and all cultures, the Catcher’s game continues to be one of the most widely recognized video games of all time.

Ghost Liner, linked to the paranormal for the Nintendo DSI turns your hand held into a portable to the astral plane. Coupled with the DSI camera, this protection and communication tools lets you find, summon and capture and interact with ghosts living amongst us. Ultimately, you can help them find peace as you develop your own paranormal prowess within an augmented reality that promises to change your perspective forever;

And Zoomba Fitness, for a to be announced system for a one of a kind exercise program that pares Latin rhythms with red hot international dance steps so you have a blast as you party your way into shape. Through invigorating, high calorie burning fitness classes, Zoomba fitness has helped melt the pounds and inches off more than five million Zoomba enthusiasts in more than 75 countries.

As I mentioned before, Attack of the Movies 3D, the first ever 3D designed exclusively for the Wii.

That concludes our formal remarks. Operator if you can view the Q&A and instructions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Taylor – Arcadia.

John Taylor – Arcadia

Could you give us the percentage of revenue that came from the Mama franchise in the last fiscal year and looking forward, I wonder if you might talk about the pricing assumptions for Wii and DS titles. Given all the rebating and price discounts and stuff that were going on in holiday time frame, does that have any implications for launch prices going into 2010?

John Gross

In terms of the Cooking Mama franchise it’s roughly 40% to 50% of our revenue for the year.

Guy Karyo

I would say overall when you include the discounting, and as you are aware there was a rather aggressive amount of discounting across the top retailers this holiday. Including discounting there was definitely an appreciable price pressure on DS and Wii and in aggregate we expect that trend to continue through next year.

Our forecast and guidance are based on the expectation that the average wholesale price whether it’s the SRP price or promoted price will be lower in 2010 than we experienced in 2009.

John Taylor – Arcadia

So to translate that into practical terms is that sort of imply kind of a $5.00 off? Can you give us kind of a price point range or bracket?

Guy Karyo

It’s very product specific so if you’re talking about for example the products that we impaired, a lot of that had to do with our expectation not of volume but of pricing and in those cases we’re expecting a one or two price point drop; meaning where it might have been $29.00 it might have been $19.00 or it might have been $39.00 it would be $29.00.

For our core products we are more likely talking about something like a $5.00 difference as you would see a promotion that would take a $29.00 product to $24.99. There was a fairly significant amount of even more aggressive promotional pricing. Toys R Us did a number of ads which were buy one, get one 50% off, something along those lines which effectively has a price point drop of somewhere between 25% and 35% on average.

We don’t expect to see that as a predominant trait through the year although around holiday sales programs whether that be Easter or next Christmas, we are expecting to see more of that. It just won’t be the prevailing trend.

Operator

Your next question comes from Todd Greenwald – Signal Hill.

Todd Greenwald – Signal Hill

I wonder if you would share your thoughts on the Wii and DS market right now. How bad is it? On the one hand it seems like you have hardware sales that are pretty robust but on the other hand there’s a real oversupply of software, especially third party software and not much demand for those titles. Do you think that’s a fair assessment and how do you feel about it over the next six months or so?

Jesse Sutton

I think the DS platform is actually stronger than people give it credit for. I think where its got the most, where its dealing with the most difficulty with DS is in Europe more than here, and if you have products that have historically done well in the DS, they’re going to continue to do well.

We’ve actually seen some pretty good success with our recent releases on DS. That being said, as far as the Wii platform is concerned, the real question the Wii platform has had a lot of over crowdedness in the market and probably began its holiday sales a little later into the holiday than anyone was expecting.

What we’re hearing, what we’re seeing now and this goes to the famous John F. Kennedy quote, “In Chinese the word crisis is composed of two characters; one represents danger and the other represents opportunity.”

The Wii market now is where a lot of our larger competitors have determined to significantly reduce their portfolio and focus on more of their much more higher profile titles. That’s going to hopefully make the market a little less crowded and give us some opportunity to put out some well known brands on the platform as well as come out with products at reduced prices in 2010.

Guy Karyo

I might add that some of the trends that greatly affected Wii over this holiday weren’t exclusively Wii. They were across multiple platforms and video games in general. What you will have seen we think at the end of the day when all the numbers are in, is that there was much more price pressure than anyone expected on console, and that the products, and there was a greater differentiation than there had been in previous holidays between the products that were able to withstand the price pressure and the products that weren’t.

So there was a bigger gap between successes and failures and that was not just true for the Wii but it was true for console. It just happened to be particularly obvious with the Wii.

Todd Greenwald – Signal Hill

On your gross margin, obviously it was pretty low in Q4 even excluding the impairment. How do you see that trending in 2010?

John Gross

I would expect it to be below where it was last year, probably in the neighborhood of 30%, but nowhere near where it was in the fourth quarter because in addition to the impairment we had a few other unusual items. Our House, not the least of which was Our House which in and of itself was about six points of margin.

What we would like to believe was the unusual level of allowances against these games was another factor and most certainly the impact on gross margin of international, we would expect to be totally eliminated by virtue of the model we’re using next year. So I’m pretty confident that we’ll be able to restore it back up in the neighborhood of 30%.

Operator

At this time I’d like to hand the conference back to management for any closing remarks.

Jesse Sutton

Thanks again for joining us today. We look forward to speaking to you again in our first quarter conference call.

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Source: Majesco Entertainment Company Q4 2009 Earnings Call Transcript

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