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Majesco Entertainment Company (NASDAQ:COOL)

F3Q2010 Earnings Call Transcript

September 14, 2010 4:30 pm ET

Executives

Todd Greenwald [ph] – Director of IR and Strategic Planning

Jesse Sutton – CEO

Mike Vesey – CFO

Analysts

Sean McGowan – Needham

David Bench [ph] – Trinidad Capital [ph]

John Taylor – Arcadia

Operator

Good afternoon and welcome to the Majesco Entertainment Company fiscal third quarter 2010 earnings conference call. All participants will be in a listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Todd Greenwald [ph], Director of Investor Relations and Strategic Planning. Please go ahead, Mr. Greenwald.

Thank you, operator and good afternoon. I'd like to welcome you to Majesco Entertainment's conference call.

Todd Greenwald

Thank you and good afternoon. I would like to welcome you to Majesco Entertainment’s conference call. Before we get started I would like to remind you that the call is being recorded, and an audio broadcast and replay of the teleconference will be available in the Investor Relations section on 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 31st, 2009, 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 non-cash compensation, settlement of litigation, changes in the fair value of warrants, the closure of the California development studio, severance, 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 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 a substitute, or superior to GAAP results. Reconciliation between GAAP and non-GAAP financial measures is included in the press release issued earlier today.

With me on the call are Jesse Sutton, Chief Executive Officer and Mike Vesey, interim Chief Financial Officer. I'd now like to turn the call over to Jesse.

Jesse Sutton

Thanks, Todd. I will open the call with some highlight and an overview of our performance in the third quarter. Mike will follow with the financial review and I will conclude with an update on our product slate for the rest of the year, and then we would be happy to take your questions.

While our revenues were down for the quarter versus last year, they were consistent with our internal expectations. The revenue decline was almost entirely due to a lighter release slate than the same quarter a year ago. This year, our only significant new release in the quarter was Tetris Party Deluxe, compared to last year’s releases of the Night at the Museum, continued strength of Gardening Mama, as well as 11 other releases on the Wii and DS in the quarter.

Going forward, our fourth quarter is off to a strong start and will be driven by Greg Hastings Paintball 2, Crafting Mama, and My Baby 3 and Friends. We are especially excited by this year’s holiday line-up, which includes Babysitting Mama, a significant new addition to the Mama franchise, as well as Zumba Fitness, which is an innovative dance fitness party that will be released on the new Kinect for Xbox 360, PlayStation Move, and the Wii. Initial demand from retailers is shaping up well for both Babysitting Mama and Zumba Fitness.

We continue to make progress with new properties, including Martha Stewart, Zumba Fitness, and My Baby 3. We also have much more in store for next year with many new titles and brands that we have not yet announced. Our efforts to leverage the strength and popularity of our Cooking Mama franchise continue and for the first time, we will be launching two new Mama brand extensions this holiday: Crafting Mama for the DS, and Babysitting Mama for the Wii.

We also continue to control our costs to drive profitability. Our operating expenses are down 42% in total largely due to the closure of our studio and reduction in staff earlier this year. We are committed to achieve, improve, and sustain profitability.

Finally, I would like to point out that we have a strong team in place and have fortified it in the recent months with a new Senior Vice President of Production, a new CFO, and a new Head of IR and Strategic Planning.

We recently added Chris Gray as Senior VP of Production. We are thrilled to have someone with Chris's talents and wealth of experience join the Majesco team. Chris's successful record, designing and developing great games is perfectly aligned with our goals for the future of our product line. His critical expertise will help ensure we are publishing a world-class portfolio of mass market games.

I would also like to welcome Mike Vesey who has been with the Company for over four years and is now our Interim Chief Financial Officer.

Finally, we recently hired Todd Greenwald to manage Investor Relations and Strategic Planning. So, I wanted to introduce him as well. Todd expands our executive team and should help us achieve our strategic goals. I would now like to pass the call to Mike Vesey, Majesco’s Interim Chief Financial Officer to provide the financial review of our fiscal third quarter results. Mike?

Mike Vesey

Thank you, Jesse. First, I will recap our results for the quarter then close with some comments about our guidance for the year. To start, I would like to point out that our revenues and operating results vary significantly from quarter to quarter based on the timing of our new release titles and the holiday selling season. We operate with a fiscal year ending October 31st. So generally our highest revenue quarters are first and fourth quarters, which reflect the holiday selling season while the second and third quarters are generally slower. You will see our results for the third fiscal quarter of 2010 reflect lower revenues, lower expenses and a reduced non-GAAP net loss from the prior year.

Revenues for the three months ended July 31st, 2010, were $12.2 million, compared to $17.2 million in comparable quarter last year. The prior year’s quarter results include revenues from two initiatives that we decided to move away from as related operating expenses resulted in unacceptable levels of profitability, namely, the introduction of our line of Go Play branded titles for the Nintendo Wii, which required substantial advertising support, and the building of a direct distribution business in Europe. We have now transitioned to a licensing model in Europe, which we expect will result in comparatively lower revenues, but also lower operating expenses and better profitability.

As far as significant releases in each quarter, the third quarter of fiscal 2010 included Tetris Party Deluxe for the Nintendo Wii and DS. The prior year’s quarter was impacted by two releases: Night at the Museum and Battle of the Smithsonian, which was released on three platforms, and also Gardening Mama for the Nintendo DS. Gardening Mama was actually released late in the second quarter of 2009, however, contributed significantly reorder sales during the quarter ended July 31st, 2009.

In both years, our titles based on the Mama brand were a big part of the business accounting for about a third of our revenues in the current year’s quarter and close to half in the prior year.

Our gross margin in the quarter was 22.9%. This is up from 20.5% in the same period a year ago. This increased margin was primarily due to under performance of several of our value releases in the prior year.

I will point out that in our cost of sales category on our income statement you notice a shift within cost categories for the current quarter. Our product cost as a percentage of sales increased by 17 percentage points while amortization of development and license fees decreased by a similar amount. This reclassification results from the structure of our partnership regarding the Tetris titles and has no net impact on our margins.

Operating expenses. Our operating expenses declined 41.7% from the same quarter last year to $4.5 million. These reductions were the result of several initiatives implemented at the beginning of the fiscal year to reduce our cost structure, namely, the downsizing of our European office and the implementation of a lower cost licensing model, the closure of our in-house development studio and reduced media advertising dollars spent in the prior year to support the launch of the Go Play brand.

Our net loss decreased 68% from $5.2 million in the third quarter of 2009 to $1.6 million in the same period in 2010 while our non-GAAP net loss decreased to $1.4 million from $3.5 million during the same period.

You will note that our weighted average number of shares outstanding increased over the prior year from 29.3 million to 36.9 million shares. This is mostly due to a $9 million equity financing we completed in September of 2009.

The net result is our basic and diluted net loss per share for the quarter was $0.04 compared to $0.18 in the same period last year. Our non-GAAP basic and diluted net loss per share was $0.04 compared to a net loss per share of $0.12 in the same period last year.

So, in summary, the quarter was seasonally slow on the top line. However, the changes we implemented to our cost structure resulted in a significantly decreased non-GAAP net loss of 59% or $2 million from the same quarter in the prior year.

Now results for the nine month period ended July 31st, 2010. For the nine months ended July 31st, 2010, the Company’s net revenues decreased 25.9% to $52.3 million. This decrease was due to decline in sales of games for the Wii system. During fiscal 2009, we benefitted from two extremely successful games released during the period of rapid growth for this platform: Jillian Michaels’ Fitness Ultimatum, and Cooking Mama world kitchen.

Capacity, for fiscal 2010, while we did release a sequel to the Jillian Michaels’ game, it was not as successful as the first. Also, our first game Wii game based on Mama since World Kitchen, Babysitting Mama, is not due to launch until first quarter of 2011. The Mama titles account for about 45% of our revenues for the nine months ended July 31st, 2010, and 50% for the same period in the prior year.

Gross margins decreased to 27.9% for the nine months ended July 31st, 2010, compared to 31.3% in the prior year. The decrease is primarily due to impairment charges taken in the first and second quarters of fiscal 2010 to write down the investments in some of our non-core Wii titles, for which marketing condition had deteriorated prior to the release.

Operating expenses. Similar to our current quarter results, you will see significant reductions in our operating expenses for the nine month period. Operating expenses declined from $23.2 million to $15.4 million due to the impact of the closing of our studio, European distribution office, and reduced television advertising.

On a year-to-date basis, net income was $600,000, a significant improvement compared to a net loss of $2.7 million in the same period last year. Non-GAAP net income was $0.2 million compared to $1.1 million in the prior year period. The Company’s diluted earnings per share for the nine months ended July 31st, 2010, was $0.01 compared to a $0.10 loss during the comparable period in the prior year.

The comparability of these amounts was significantly impacted by the change in value of warrants issued as part of our 2007 equity financing and the benefits (inaudible) sales, including [ph] tax benefits. Therefore, we provide non-GAAP earnings per share on our press release. The company’s non-GAAP diluted earnings per share for the nine months ended July 31st, 2010, was $0.01 compared to $0.04 in the comparable period in 2009.

Now, turning to our balance sheet, as we prepare for the holiday season, we have $10.5 million in cash at July 31st, 2010, and additional $1.4 million available to us under our factoring arrangement. During the fourth quarter, we are set to utilize a significant of our cash and available liquidity to purchase inventory related to our holiday releases and accordingly have taken advances under our factoring agreement of $5.8 million at quarter end.

You will note that at July 31st, our inventories, accounts receivable and payables are all down from our seasonally high balances at the end of the last fiscal year. Again, we would expect these balances to increase next quarter due to seasonality of our business.

We have approximately $5.5 million invested in capitalized software development and prepaid royalties as of July 31st, 2010, with another $3.3 million committed to complete these games. The majority of this investment is related to our key holiday releases, including, Greg Hastings Paintball 2, My Baby 3, and Crafting Mama in Q4, 2010, and Babysitting Mama and Zumba Fitness in the first quarter of our fiscal 2011 fiscal year.

I will also note that while we expect to begin shipping our Babysitting Mama game during the last week of our 2010 fiscal year, we will have a November, 2010 Street day. Our policy is to defer any revenue recognition until the Street day in these situations. So, we expect to be carrying accounts receivable and deferred revenue balances on October 31st, 2010 fiscal yearend balance sheet related to this launch and we’ll recognize the related revenues in fiscal 2011.

Now, for our 2010 outlook. Our final holiday release schedule has resulted in the shift of some of our new releases into fiscal 2011 where in the case of Crafting Mama the final week of fiscal 2010. Specifically, all three SKUs of our Zumba Fitness release will launch in mid-November to better aligned with the Microsoft Kinect launch window.

The PlayStation version of Greg Hastings Paintball 2, originally planned for the PS3 in September will instead launch in early 2011 as a downloadable title for the PlayStation network. As a result, the revenue mix for the fourth quarter of 2010 will be weighted less to new release titles and shift some revenue and earnings from fiscal 2010 into fiscal 2011.

We now expect to achieve approximately $77 million to $80 million in sales in the – for the fiscal year, down from $80 million previously. Accordingly, we continue to expect to be profitable in fiscal 2010, but are currently expecting non-GAAP EPS in the range of $0.01 to $0.03. While this is down from prior expectations of $0.05, it still compares very favorably to last year’s non-GAAP loss of $0.15.

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

Jesse Sutton

Thanks, Mike. With the 2010 holiday on the imminent horizon, I would like to also take a moment to talk about our excitement about this year’s holiday selling season. There are many new control devices launching in the coming months. In a few weeks, Sony will release the PlayStation Move. And in less than two months, Microsoft will launch Kinect for the Xbox 360. We are very excited about these initiatives, and we feel they reflect the common sense within the industry consistent with our strategic focus that the great opportunity ahead continues to be offering quality entertainment experiences to the growing demographics in gaming. Whether it is new control schemes, new digital platforms, or new hardware platforms, we believe the common theme is that mom, kids and families are all playing more games more than ever.

We believe this is an affirmation of the general strategy we have pursued and that despite the fluctuations of the economy itself in all sectors, great software will gain great traction. We believe our 2010 line-up is perfectly suited to take advantage of these trends, and we are encouraged by early indications of demand for our holiday releases.

We are featuring a solid line-up of titles. From promising brand extensions to quality licenses and fresh IP. Key titles include Zumba Fitness, Greg Hastings Paintball 2, Crafting Mama, Babysitting Mama, My Baby 3 and Friends, and Flip's Twisted World. Majesco is excited to be supporting both PlayStation Move and Kinect with our exhilarating Zumba Fitness product. In addition, Babysitting Mama and its innovative play mechanic with a plush doll should stand out very prominently on store shelves this holiday season and be a great extension of the Cooking Mama franchise.

Looking out to holiday, let me spend a few moments on the titles that we are most excited about here at Majesco: Zumba Fitness. It’s an innovative dance fitness party, a true, one-of-the-kind exercise program that will release this November for Kinect for Xbox and PlayStation Move, and the Wii. With all consoles now rushing towards motion controls, dance and fitness theme games have proven to be a big success on the Wii, and Zumba is an excellent blend of both, combining a unique fitness program with nine different dance titles and 30 different music tracks and routines.

We believe this product offers a genuine point of differentiation over other fitness games on the market since it combines fitness and dance in one fun, innovative offering. Zumba Fitness is taught in more than 60,000 class locations worldwide with over seven million Zumba enthusiasts engaging with the brand.

We are equally excited about Babysitting Mama, which releases in November. We expect Babysitting Mama to be a significant new addition to the Mama franchise given its new and innovative play mechanic that lets girls play with a plush doll as they play the game. This doll allows kids and parents to use a baby as the controller, combining the doll and game in one amazing cradle package. The Wii remote is tucked into the back of the plush baby as players enjoy more than 40 activities, including rocking the baby to sleep, feeding, bathing, changing, and playing plus much, much more.

Just as importantly, the doll is included with the game for a healthy $49.99 price point. Coupled with a strong marketing campaign and retail merchandizing programs, we believe Babysitting Mama is positioned for success this holiday season. While it is still early, we know that initial demand from our retail partners is shaping up well for both Babysitting Mama and Zumba Fitness.

In addition to the upcoming introductions of Kinect from Microsoft, and the PlayStation Move from Sony, we are extremely excited about the new 3DS from Nintendo, which is expected to launch in North America early next year. We believe this will be another huge hit for Nintendo, building on the success of the original DS, which has now sold over 120 million units of hardware worldwide.

And, as we announced at EBITDA, we expect to be there on day one to support it with some of our best brands. While DS sales have been somewhat sluggish as of late, we believe the 3DS will usher in a robust upgrade cycle and be a meaningful catalyst for the handheld market, which should be beneficial to Majesco as well. In 2011, we will be supporting the 3DS with our biggest and best brands as well as some new IPs, which will take full advantage of the 3D screening camera.

Finally, we point out that we have many new digital initiatives underway. We are aggressively targeting all of the new emerging digital platforms, from Xbox LIVE and PlayStation Network to Facebook and iPhone. We expect to build this digital business substantially in 2011 and 2012 alongside our traditional publishing model. We have already released several titles on Xbox LIVE, Wii Virtual Console, DSi ware [ph], and iPhone in 2010.

In Q4, we will release Serious Sam: The Second Encounter on Xbox LIVE Arcade and have other digital titles for Facebook and iPhone do out before the end of the year. Expect to hear much more about these initiatives in the coming months.

In summary, the July quarter was soft on the top line due largely to the seasonality and smaller, more focused release slate. However, our operating loss was reduced significantly because of effective cost cuts in the past nine months. Looking forward, while we are disappointed to be slightly lowering our earnings forecast for the fiscal year 2010, this is driven by the timing of a few releases, which has shifted from Q4 into Q1 and not due to under performance of any of our products. We remain very excited about this upcoming holiday season and our lineup for 2011.

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

Question-and-Answer Session

Operator

Yes, sir. (Operator instructions) Our first question comes from Sean McGowan from Needham. Please go ahead.

Sean McGowan – Needham

Hi, guys. Actually I have two questions, first, on the Zumba, do you expect, Jesse, that that would primarily be a Wii title in terms of the ultimate sell through even though it may actually play better on Kinect and Move just because we have installed base, so tip towards Wii?

Jesse Sutton

I think that’s a good question. You make a good point in that the installed base is still large on Wii right now that this – that the Move and the Kinect are essentially playing catch-up, but there is going to be a lot of focus on the platforms, on the new platforms, specifically for Zumba, and not only by us, but even by the first party. So, there is going to be a lot of focus on and I believe that the game play mechanics, which play really well on Kinect and same on PlayStation 2 alongside the Wii. But really the Kinect with its fully body movement is going to be really well received and should do justice as well across the board.

Sean McGowan – Needham

Okay. And the secondarily, I wanted to ask you about has to do with the two baby products. So, can you comment on kind of the demographics of who would buy My Baby versus who would buy Babysitting Mama, and can you clear up any questions that might be about the rights surrounding My Baby?

Jesse Sutton

Okay. I will work backwards. There is really nothing to – for us to talk about with regard to the rights. We’ll be shipping the product as we announced at the end of – or at the middle of October. That doesn’t change and there is nothing to talk about there. However, as far as the demographics are concerned between the two, they both are geared towards six to 12 year-olds, primarily girls, and – which is really right now for the DS the main demographic for the platform.

Sean McGowan – Needham

Okay. Thank you.

Operator

Our next question comes from David Bench [ph] from Trinidad Capital [ph]. Please go ahead.

David Bench – Trinidad Capital

Hi, guys. While I understand the OpEx cost-cutting that you guys have done, can you give a little bit more color on the gross margin and why the percentage was a little bit lower, I know that it was higher than previous years, but it actually was lower than last few quarters. And also if you can go into a little bit more on the 3DS, I know that – I think there was a talk about Bloodrain and some other titles coming back, if you can just talk about that.

Mike Vesey

Sure, David, this is Mike. As far as the gross margin goes for the quarter, this is a slow quarter and our sales were pretty much dominated by catalog sales of our products, which had a lower margin. And also the new release was the Tetris title. So, the Tetris title is a well-known brand with very predictable sales and long legs in terms of its sales cycle. But the – in exchange for that predictability of performance, the royalty rate is somewhat higher than some of our titles where we have a large upfront cost and have higher margin going forward.

Jesse Sutton

As far as utilizing old brands like Bloodrain or for that matter discussing a lot of the potential products down the line, I would just say that you can expect to hear a lot about those new products like that over the course of the next two to three months as things become more complete.

David Bench – Trinidad Capital

Great. And if you guys tell us just – give a sense of what you believe the cash position will look like as of the end of October, that might be helpful for us as well as other investors.

Jesse Sutton

We don’t usually comment on cash position going forward, but I guess Mike can touch on the fact that – if you want to add to this – ?

Mike Vesey

Yes, I think what we can say and what we did say was the – we are purchasing a lot of inventory for the holiday season and we would expect to deploy a substantial amount of our cash balance. So, I think when you – we are not going to be sitting on a large cash balance at the end of the year. We think it will be deployed in inventory purchases.

David Bench – Trinidad Capital

Okay. But, will you be going into your line or you don’t think there are a going to be a need to that at this point?

Mike Vesey

Yes, when you say our line, our factoring agreement, yes, we will be factoring obviously with those as we do now and drawing down on that line as of October, yes, should expect to –

Jesse Sutton

And we do that all year round.

David Bench – Trinidad Capital

Yes. Okay, thank you.

Operator

Our next question comes from John Taylor from Arcadia. Please go ahead.

John Taylor – Arcadia

Hi, I have got a couple of questions too from me. So, with the introduction of Kinect, it gives you guys an opportunity to get back on 360 where you haven’t been for a little while. I am wondering how you are thinking about that in terms of potential revenue contribution, if not in Q4, but I think – yes, not Q4, but say next fiscal year, kind of may be we are thinking single digit percent or double digit percent. How significant might that be?

Jesse Sutton

What I would say is that I guess the best way to respond to that, John, is the way that we are currently viewing this new cycle of platforms, essentially new platform launches with the Kinect and the Move and even the 3DS next year, you will probably see a pretty even portfolio across all of the newer platforms combined with the catalog that we will be bringing into next year. So, I think you are going to see a pretty spread out – a broader base of our sales through all three – all four platforms, readily [ph].

John Taylor – Arcadia

Yes, so because you’ve been pretty much nailed to Nintendo lately and of course Nintendo has been having kind of a rough year. So, this would seem to represent some big new and potential installed bases that open up some blue sky?

Jesse Sutton

Oh, absolutely. We are keenly excited about the potential. I mean we have always been excited and we continue to be excited about the Nintendo platforms for this holiday specifically and especially for 3DS next year. But, this just broadens our demographic. I have always said we are demographic focused and not – demographic focused and platform agnostic. So, we are focused on the moms, the tweens, boys and girls in the family, and wherever those demographics go, we are going to follow.

John Taylor – Arcadia

So, what is – can you give us a sense of what it costs to port a game that you’ve done of Wii already say to the Kinect or to take advantage of the other formats?

Jesse Sutton

I can say categorically you can't really port anything. Everything has to be created from scratch to build a new and unique experience for those individual platforms, and that’s what we intend on bringing to the consumer.

John Taylor – Arcadia

Okay. So, that’s a good lean in for a followup and that is, so, how much are you guys spending on product development in terms of cash, forget whether it gets expensed or capitalized, but what’s your cash development budget, say, for the current fiscal year and how do you think it’s going to differ next year?

Jesse Sutton

What I would say is this. We usually, the way we have talked about it in the past is that our games on Wii had been around $0.5 million to $1.5 million and the games – to develop – and the games on DS have been anywhere from 250 to 700 on the really high end, and – the rare high end. And it really is going to be no different from these new platforms.

John Taylor – Arcadia

Okay. All right, great. And then, could you characterize for me the sales and marketing budget in the fourth quarter compared to the Q4 of last year and do you think that’s going to change much as you go into the next fiscal?

Jesse Sutton

Q4, you want to put in a word –

Mike Vesey

Yes –

Jesse Sutton

As far as the costing.

Mike Vesey

Yes, the sales and marketing budget in terms of how much we are going to spend in the – on holiday marketing –

John Taylor – Arcadia

Yes, because you’ve nailed down operating cost pretty tightly and I am just wondering, are you going to loosen that up a little bit or how are you thinking about that?

Mike Vesey

Yes, we are going to spend some advertising for the holiday season. The majority of it we think would be in the next fiscal quarter although there will be some advertising to spend against our initial launches. So, it will be – we think somewhat in line or slightly lower than last year’s fourth quarter.

John Taylor – Arcadia

Okay. And then last question, the roughly $80 million you are thinking about, whatever the range is, what percent is likely to come from non-US markets and how do you think that percent is going to change next year?

Jesse Sutton

At this point, it’s very, very nominal what we would be expecting from the international markets. Today, we are just licensing out most of our products internationally and not doing distribution, so you are really are talking about less than 5%.

John Taylor – Arcadia

Okay. Okay, great, thank you.

Operator

(Operator instructions) And, ladies and gentlemen, this concludes our question-and-answer session for today’s call. I would like to turn the conference back over to management for closing remarks.

Jesse Sutton

I want to thank everyone for cutting in on the call today. And we look forward to discussing our fourth quarter 2010 highlights in January.

Operator

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

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