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Majesco Entertainment, (NASDAQ:COOL)

Q3 2011 Earnings Call

September 13, 2011 4:30 pm ET

Executives

Jesse Sutton - Chief Executive Officer and Director

Michael Vesey - Chief Financial Officer

Todd Greenwald -

Analysts

Adam Krejcik - Roth Capital Partners, LLC, Research Division

Unknown Analyst -

Operator

Hello, this is the Chorus Call operator. Welcome to the Majesco Entertainment Company's Fiscal Third Quarter 2011 Earnings Conference Call. [Operator Instructions] This conference is being recorded. At this time, I'd like to turn the call over to Todd Greenwald, Director of Investor Relations and Strategic Planning. Mr. Greenwald, the floor is yours, sir.

Todd Greenwald

Thank you, and good afternoon. I'd like to welcome you to Majesco Entertainment's conference call. Before we get started, I'd like to remind you that the call is being recorded, and the 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 31, 2010, 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 fair value of warrants, severance costs 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 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, Chief Financial Officer. I'd now like to turn the call over to Jesse.

Jesse Sutton

Thanks, Todd. I'll open the call with some highlights and an overview of our performance in the third quarter. Mike will follow with a financial review, and I'll conclude with an update on our product slate for the upcoming holiday season. Then we'd be happy to take your questions.

In Q3, we experienced a solid quarter despite what's normally seasonally -- a normally seasonally weak time of year for us. Zumba Fitness remained strong, especially in Europe, and was largely responsible for the strong growth seen in the quarter. Sales grew over 60% to $19.5 million, and our gross margin expanded to 41%, up from 23% last year. This resulted in non-GAAP EPS of $0.03, up from a loss of $0.04 last year.

We continue to be delighted by the success of Zumba Fitness. Zumba Fitness has been an industry's #1 fitness title for all of 2011 and is now one of the best-selling fitness video games in history. Additionally, Zumba Fitness continues to be the #2 best-selling Wii title here in the U.S. each month since launch for the 10th consecutive month since November 2010.

Overseas, Zumba Fitness continues to top the charts where it just finished a run of 10 consecutive weeks as the #1 title across Chart-Track U.K. all formats chart, as an ongoing advertising has contributed to increased sales in France and Italy as well.

We are also pleased to see the result of a recent Nielsen survey, which found Zumba Fitness to be one of gamers' top 10 games to buy next. This speaks to the continued momentum and demand for the game coming nearly 12 months after its release in 2010.

Zumba Fitness has sold more than 3 million copies worldwide, and we are looking forward to new and exciting features in the upcoming sequel, Zumba Fitness 2, coming to the Wii this holiday, and another yet to be announced platform early next year.

We are also enthusiastic about our recent launch of BloodRayne: Betrayal and were thrilled when Sony chose this fan favorite title to be 1 of 4 games to be featured worldwide in Sony's PLAY promotion this past August. Critics seem to agree, as IGN rated this title a 9 out of 10 and Joystiq concurred with a 4.5 out of 5. Initial sales look promising, and we are excited to see continued support for that digital title.

Once again, we're very excited about our holiday release slate, which we think positions us well to have our biggest holiday yet. I will discuss our titles later on in the call.

Now I'd like to pass the call to Mike Vesey, our Chief Financial Officer, to provide the financial review of our fiscal third quarter results. Mike?

Michael Vesey

Thank you, Jesse. First, I'll recap our results for the quarter and close with some comments about our guidance for the year. As I discuss our financial performance compared to the prior year, I'll use non-GAAP results in both periods. Our non-GAAP results include adjustments for noncash or infrequently occurring items.

The most significant items in the quarter are an approximately $1.3 million noncash gain related to the revaluation of our warrant liability based on fluctuations in our stock price and approximately $400,000 in noncash compensation expense. Please refer to our press release issued earlier today for a reconciliation of our GAAP to non-GAAP results.

Now for the quarter. Revenues for the 3 months ended July 31, 2011, were $19.5 million, an increase of 61% over the $12.2 million reported in the comparable quarter last year. Revenues from royalties and product sales to our European distribution partner accounted for approximately $5.3 million of the increase, as Zumba Fitness was a leading performer there.

Domestically, we had 2 new product releases for the Nintendo DS during the quarter: Spy Kids: All the Time in the World and Cake Mania mainstream. However, the majority of the sales were from our Zumba Fitness and Mama product lines.

Our gross margin for the quarter was 41%. This is up from 23% in the same period a year ago. Our current quarter's margin reflect the impact of our Zumba Fitness products, which carry competitively higher price points when compared to our lineup from a year ago and continue to sell at their original retail prices for the Nintendo Wii and Microsoft Kinect SKUs.

Our operating expenses include 2 notable increases from the prior year related to product research and development and marketing. First, research and development expenses for the quarter increased $1.2 million from the same period in the prior year, primarily due to our investment in our Social Games business. We completed the acquisition of Quick Hit on June 3 to build our Social Games business. We're developing and operating freemium games for play on Facebook and mobile devices with this group. During the period, we incurred approximately $1 million of expenses related to our Social and Mobile Games business.

Second, sales and marketing expenses increased approximately $700,000 due to volume-related sales and marketing costs. As a result of the increased sales activity, non-GAAP net income for the quarter was approximately $1.1 million compared to a loss of $1.4 million in the same period last year. Non-GAAP diluted earnings per share for the quarter was $0.03 compared to a per share loss of $0.04 for the same period last year.

Now reviewing our year-to-date results. Revenues for the 9 months ended July 31, 2011, were $100.2 million, an increase of 92% over the $52.3 million reported in the same period last year. Again, sales of our Zumba Fitness titles were the main driver of the increase.

Our gross margin for the 9-month period was 41%. This is up from 28% in the same period a year ago. The gross margins reflect continued sell-through of our Zumba Fitness products on the Nintendo Wii and Microsoft Kinect at their original retail prices.

Operating expenses were $26.9 million, an increase of $11.5 million from the prior year. Approximately half of the increase is due to media and variable sales costs related to our higher revenues. $2 million was the result of the investment in our Social Games business. The remainder of the increase is due to higher profit-based bonuses and general and administrative expenses. As a result, non-GAAP net income for the 9-month period increased to $13.9 million compared to $200,000 in the prior year. Non-GAAP diluted earnings per share for the 9-month period increased to $0.35 compared to $0.01 for the same period last year.

Turning to our balance sheet. We closed our third fiscal quarter ended July 31, 2011, with $19.7 million in cash and equivalents and an additional $3.7 million in advances available to us under our accounts receivable factoring agreement, leaving us with total cash availability of roughly $23 million. As of July 31, we had approximately $9.4 million invested in capitalized software development and prepaid royalties with another $9.3 million committed to complete the games under development. This is roughly double the amount from the prior year.

We had $4.6 million of inventory compared with $3.5 million in the third quarter of 2010. We expect to utilize our cash balance in the next fiscal quarter to build up our seasonal inventory for the upcoming holiday selling season.

Now for an update on our 2011 outlook. Based on our third quarter results, we're increasing our guidance for sales and non-GAAP earnings per share for the fiscal year ended October 31, 2011. We now expect net sales for the year to be between $120 million and $130 million and non-GAAP earnings per share in a range of $0.35 to $0.38. This is an increase over our previous guidance of sales of $110 million to $120 million and non-GAAP EPS of $0.30 to $0.35.

Our guidance reflects increased advertising and marketing expenses of approximately $1.5 million to $2 million that we expect to incur in our fourth fiscal quarter of 2011 in support of our holiday product launches. The benefit of these expenditures are expected to be reflected in our results for the first quarter of fiscal 2012 as retailers reorder product during the holiday selling season.

It should be noted that due to our October 31 year end date, the majority of sales for our holiday lineup will be reflected in the first quarter of our next fiscal year. Additionally, our product mix in the fourth quarter is typically more heavily weighted to sales of our lower-priced catalog products as our distributors order for the holiday season.

Accordingly, our gross margins as a percent of net sales are generally lower in our fourth fiscal quarter. We expect our gross margins to return to historical levels in the first quarter of 2012, reflecting a higher percentage of our premium-priced products and new holiday release slate, which Jesse will now provide an update to you on.

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

Jesse Sutton

Thanks, Mike. I will now provide some comments on our lineup for the rest of 2011. Looking forward, we are very excited about the upcoming holiday season. This may be our biggest opportunity in the company's history. We have a larger slate of titles than in years past, and more importantly, a much higher caliber of titles backed by far more significant brands than we've ever had in the past. Big brands like Zumba Fitness and Cooking Mama and Twister, well-known celebrities like Hulk Hogan and Jillian Michaels and proven Hollywood licenses like Alvin and The Chipmunks and even JAWS should separate this holiday season from those of years past.

This holiday, we expect to launch many titles for the Kinect as well as the 3DS. Kinect for the Xbox 360 is off to an astonishing start, quickly ramping up to the 12 million unit installed base, which we believe could be well over 20 million in the next 6 to 12 months. As more and more casual gamers migrate to a new motion-based gaming platforms like the Kinect, the Move and the Wii, we believe this will create more opportunity for us given our demographic focus on family and casual gamers.

We are supporting the Kinect this year with several big titles. Hulk Hogan's Main Event, which is the first motion-based wrestling game on the Kinect and lets players train with icon Hulk Hogan as they build their own wrestling personalities and learn the art of showmanship to win over the crowd. I personally met with Hulk a couple of times over these past few months, and we are really excited about his significant support of this title along with his fan base and TNA.

Twister Mania is a contagiously fun, interactive party game, which challenges players to stretch and shrink their body into hundreds of different shapes, animals and symbols. It's laugh out loud fun. The game is designed exclusively for Kinect and leverages full body motion mechanics. One reporter mentioned Kinect and Twister Mania are like peanut butter and jelly; they go so well together. This game allows up to 8 players in team-based pairs, so it's a social party game that is fun with family and friends, kids and adults, everyone really.

Alvin and The Chipmunks: Chipwrecked is an endearing title we are launching on Kinect, Wii and DS. This will launch in front of the blockbuster movie being released in December by Fox. Who doesn't love to dance to munktastic songs? And the set list is amazing, including 30 favorites like Beat It, Play That Funky Music and We're the Chipmunks.

Motion Explosion! is a fun, family-friendly experience that puts your motor skills to the test with activities that keep your entire body moving as fast as your mind can trigger your next move.

And finally, we will also continue to market and support the original Zumba Fitness for Kinect, which should continue to sell well this holiday as that installed base grows.

While Nintendo 3DS got off to a somewhat slower start, we are very encouraged by Nintendo's quick action to reduce the hardware's price and believe in its long-term viability. We have announced 6 new titles for the 3DS this year, and are most excited about Cooking Mama 4: Kitchen Magic as well as JAWS: Ultimate Predator, Pet Zombies, The Hidden, Nano Assault and Face Racers: Photo Finish. Much like Cooking Mama's original 2006 debut early in the DS's life cycle, which continued to sell well even 5 years later, we believe that Cooking Mama 4 can establish itself now on the 3DS and experience a similarly long sale for many years to come.

But we aren't leaving our core Mama fans behind. Conversely, we plan to widen the current audience with Camping Mama: Outdoor Adventures for the Nintendo 3DS, which just came out today.

In addition to Mama, we're featuring Papa as well as a daughter and a son. Would-be campers can choose to play as either the son or daughter with Mama and Papa offering guidance on outdoor activities like rock climbing, caving, rowing and tree climbing as they navigate new environments that span forests, mountains and seas.

Finally, following the huge success of Zumba Fitness on Wii, we will continue to build this solid franchise with Zumba Fitness 2 coming this holiday for Wii. We built from the ground up with a brand new development team. The sequel features beautiful new 3D avatar renderings as well as contagious new music, including both the traditional rhythmic Zumba beats fans love to select, new licensed tracks from today's hottest artists including Pitbull and Nicole Scherzinger.

Of course, there is exciting new choreography, more than double the number of dance styles and dynamic new arenas. Part of the reason for the significant success is that this is a dance and a fitness title, so you will see new features like the calorie counter and custom workout feature for the fitness enthusiasts.

The Zumba brand remains in rapid growth mode, and we are very happy to have partnered with the preeminent leader in the dance fitness world. We are also demonstrating our commitment to digital and social games. This quarter, we released Parking Wars 2 for Facebook, and we are entering our first season with Quick Hit's NFL online game. We are very excited about where these projects are in their life cycle. Parking Wars 2 is in early beta, while Quick Hit is entering its second NFL season. We will have more to discuss in our 2011 year end call next quarter.

I'm very proud of our holiday lineup. I think we are putting our best foot forward, and the games really look great. In summary, we are very encouraged by our performance so far this year and look forward to executing on our holiday release slate while also investing in the growth of our social gaming initiatives.

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

Question-and-Answer Session

Operator

[Operator Instructions] And the first question we have comes from Adam Krejcik of Roth Capital Partners.

Adam Krejcik - Roth Capital Partners, LLC, Research Division

A couple questions for you. I guess first on BloodRayne. Can you kind of go over the economics of that model? I guess, the margin structure and how that might affect margins in Q4, Q1 here? And then I have a couple follow-ups.

Michael Vesey

Yes. Sure, Adam, this is Mike. So it's a downloadable title sellable for points on both the Sony Network and the Microsoft Network. The retail equivalent to the customer is about a $15 title. We get 2/3 of that so we get $10. The incremental cost to us is basically 0 beyond that. Upfront development costs for a game, we don't give specific game information but for a downloadable game like that is anywhere from $200,000 to $700,000 typically.

Adam Krejcik - Roth Capital Partners, LLC, Research Division

Okay, great. And then switching to the balance sheet, you mentioned capitalized costs have gone up to about $9.4 million. Are those -- is that kind of evenly spread among the titles you've announced? Or is that also some royalties and license fees for some titles that are in the pipeline? I guess any more clarity on that capitalized software development line.

Michael Vesey

Yes. The majority of it is for titles that will release this holiday. I'll extend the holiday for us a little bit through February for a second Zumba release that we anticipate doing later in the year. But 80% of that balance are for games that will be released by February of next year.

Adam Krejcik - Roth Capital Partners, LLC, Research Division

Okay, great. And then switching over to digital. I guess kind of any update in terms of the Quick Hit integration with Jeff Anderson, when we should expect some of the first titles from -- that they're working on the release. And then I think you mentioned last time you hadn't acquired the rights to that NFL game, but it sounds like now you are going to be operating that. And is that generating revenues, positive cash flow? Any details on that would be great.

Jesse Sutton

Adam, it's Jesse. So far, it's been a great transition with the other Quick Hit folks. Jeff Anderson, who has come on board to be our Senior VP of Social and Mobile, has been great at helping us learn how that free-to-play business model works, and he has been taking our current products as well as the products that are in development under his team's guidance and really tweaking them to make them maximally efficient monetization-wise as they come out and as we continue to tweak the current ones. So we are, as I said, continuing to learn. There's a lot more that we'll discuss at our year end conference call as it relates to this. The season -- the NFL season just started, and this is when the real business begins for the Quick Hit NFL game. We are extremely excited about it. And like I said, by the time we speak next, the season will be most of the way through and we'll have some good feedback on that.

Adam Krejcik - Roth Capital Partners, LLC, Research Division

Okay, so just to clarify, you are the publisher of that game now.

Jesse Sutton

Yes, yes.

Operator

[Operator Instructions] We do have a question from Sean McCoy [ph] of the Wall Street Resource.

Unknown Analyst -

I just want to touch base; Zumba seems to really have -- is really taking its stride, not only the game but the workout, and it's becoming extremely addicting. My sister is actually a Zumba instructor, and she said it's a workout where you just burn a ton of calories and you actually have fun doing it. I'm just really amazed with the growth here. Can you guys talk about the growth going on in Europe?

Jesse Sutton

Sure. I mean, we've been pretty amazed at how well it sold in Europe, and it hasn't even had -- the Wii version hasn't had a holiday yet. This is going to be its first holiday. So we're really excited about it. It's been the #1 title out there for a while, and the Zumba brand itself, Zumba Fitness is a global brand that speaks to over 10 million people weekly and is continuing to grow. We feel that we are, in our partnership, we've been a great partner for Zumba in that we've helped build their brand and they've helped in broadening the awareness of our products within their entire community in such a great way.

Unknown Analyst -

Yes. Yes, launching that in the third quarter really helped you guys out with the sales and actually turning a profit. So one other question regarding Quick Hit and Facebook. I understand you guys have about 90,000 fans. How are you guys planning on growing that fan base? And the infrastructure that you brought on board with the acquisition, how many employees did you guys bring on board? And how is that affecting your overall growth of the social gaming industry? And are they helping out in any other manners?

Jesse Sutton

Yes, so the Quick Hit team is responsible for all of our products, essentially, either the oversight or the development of, including the Quick Hit NFL. Like I said before, the NFL game is -- the season's just started, so now is when we anticipate to have significant revenues there that we can report back in January to let you know how we did. We are very pleased. It's a standalone -- it was primarily a standalone online game and the only reason it was brought over to Facebook, so that it can take advantage of the Facebook audience, and that's still a work in progress. We really haven't marketed it yet too intensely on Facebook to date.

Operator

Well, at this time, we're showing no further questions. I'll go ahead and hand the conference back over to management for any closing remarks.

Jesse Sutton

We want to thank everybody for coming on to our third quarter conference call, and we look forward to discussing our year end results and our holiday update in January. Thanks again.

Operator

And we thank you to management for your time. The conference has now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you.

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