PolarityTE, Inc.
Q4 2007 Earnings Call Transcript

Published: 15 Jan 2008

[Operator:]

Welcometo the Majesco Entertainment Company’s fourth quarter and fiscal year-end 2007earnings conference call. As a reminder, all participants will be in alisten-only mode. There will be an opportunity for you to ask questions at theend of today’s presentation. (Operator Instructions) Foryour information, this conference is being recorded. At this time I would like to turn the conference over to Mike [inaudible].

[Investor Relations Representative:]

Goodafternoon. I would like to welcome you to Majesco Entertainment conference calltoday. Before we get started, I would like to remind you that this call is beingrecorded, and the audio broadcast replay of this call conferencewill be available in the Investor Relations section on the company’s website. Asa reminder, this call may contain forward-looking statements, includingstatements regarding management’s intentions, hopes, expectations,representations, plans or predictions about the future. Such statements areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Theseforward-looking statements are subject to risks and uncertainties that couldcause actual results or actual future results to differ materially from theexpectations set forth in the forward-looking statement. Factors that couldcause actual results to differ materially are specified in the company’s annualreport on our Form 10-K for the year ended October 31, 2006, as well as other filings with the SEC. Thecompany does not undertake and specifically disclaims any obligation to releasepublicly the results of any revision that may be made to any forward-lookingstatements following the occurrences of anticipated or unanticipated events orcircumstances after the date of such statements. Duringthe 12-months ended October 31, 2007, the company recorded a $2.8 million charge inconnection with the expected settlement of a class action litigation. Thecharge is comprised of $2.5 million representing the fair value on the date theagreement was executed of the common stock expected to be distributed when thesettlement becomes effective; and $0.3 million, representing the increase ofthe value of the shares since that date. Thecompany will adjust the fair value of the liability to the fair value of theshares expected to be distributed at each balance sheet date and record the resultingchange as a non-cash charge to earnings in each period until the shares aredistributed. The settlement provides that if the fair value of the stock fallsbelow $2.5 million, the Company will issue additional shares, subject tocertain limitations, with a fair market value equal to the amount of thedecrease. Therefore, the liability will not be adjusted below $2.5 million. Inaddition, during the 12 months ended October 31, 2006 and 2007, the company recorded gains related tovendor settlements of $4.8 million and $266,000, respectively. Also, during thefourth quarter of 2007, the company raised $5.9 million in capital. As part ofthat transaction, warrants to purchase shares of the company's common stockwere issued that contain a provision that under certain circumstances in whichthe company is sold, merged, or otherwise enters into a fundamentaltransaction, as defined in the warrant agreement, with a company that is notpublicly traded, the warrants may be settled by a cash payment. Therefore,the warrants were recorded as a liability, at their fair value of $2.1 million.The company will measure the fair value of the warrants at each balance sheetdate, and record the change in fair value as a non-cash charge or gain toearnings each period. The warrants were valued at $1.5 million at October 31, 2007. Due to fluctuationsin the company's stock price, this resulted in a non-cash gain of $0.6 millionduring the quarter ended October 31, 2007. Tofacilitate a comparison between these periods, the company has presented bothGAAP and non-GAAP financial results. GAAP financial measures, including gain onsettlement of liabilities and other gains; settlement of litigation and relatedcharges net; change in fair value of warrants; operating income; net income;and basic and diluted loss per share, have been adjusted to report non-GAAPfinancial measures that exclude these charges and income related to gains onthese settlements and warrants. Thesenon-GAAP measures are provided to enhance investors' overall understanding ofthe company's current financial performance and the company's prospects for thefuture. These measures should be considered in addition to results prepared inaccordance with GAAP, but should not be considered a substitute for or superiorto GAAP results. A reconciliation between GAAP and non-GAAP financial measuresis included in the press release issued earlier today. Onthe call today we have Jesse Sutton, Chief Executive Officer; John Gross, ChiefFinancial Officer; and Gui Karyo, Executive Vice President of Operations. Iwould now like to turn the call over to Jesse Sutton.

[Jesse Sutton:]

ThanksMike. Good afternoon everyone. Thank you for joining us today. I will open thecall with some highlights and a strategic overview of our performance 2007.Then, John will provide the financial review for our fiscal fourth quarter andfull year ended October 31, 2007, and our outlook for the upcoming year. I willthen comment on our 2008 release schedule and provide some summary remarks,after which we will be happy to take your questions. 2007was our first full year of operations under our new mass market casual gamesstrategy. The core of this strategy isour focus on producing intuitive and fun to play games that capitalize on thebroad appeal and reach of casual game platforms, such as the Nintendo DS andWii consoles. Thisnew strategy is aligned with our core strength, which includes theidentification, development and marketing of product for the casual gamer. For the full-year, we reported net revenue of$51 million, in line with our updated guidance and made significant progresstowards our goal of achieving profitability. Weimproved our gross margin 420 basis points to 33.9%. Our financing costsdeclined by $819 thousand or 35%. We made substantial improvements and on anon-GAAP we reduced our operating loss by 84% to $1.3 million and our net lossby 72% to $2.8 million. Thisrepresents a $6.5 million improvement at the operating line and $7.3 millionimprovement on the net income line – and this on net sales which were almost$16 million below last year. This is a clear indication that we have got ourcost structure under control and are executing on our strategy and moving thecompany towards profitability. Weare extremely pleased with the progress we have made over the last year, as wehave completed the transition to our new strategy, and in the processestablished a performance baseline for our company moving forward. Wehave streamlined our overall operations and implemented a focused anddisciplined business model, which has reduced our development and marketingexpenses and driven our improved financial results, specifically our margin andprofitability performance. Webrought $6 million of additional capital into the company to enable us toincrease the number of titles we bring to market each year. We have movedforward in resolving outstanding litigation and we have laid the groundwork toachieve continued improvement in our financial and operating results in theyears ahead. Wereleased 19 titles in 2007, with 13 titles for the DS handheld; our first 2titles for the Nintendo Wii console and 4 titles for other platforms. During2007, revenue from new releases comprised 58% of our total net revenue, with 20%coming from the sale of games on the Wii platform; 56% from DS and 24% fromother platforms. This compares to 2006 with revenue from new releases comprised57% of our total net revenue, with 16% coming from Jaws Unleashed. In 2006, 24%of total net revenue came from the DS. CookingMama had an incredible year, with solid performances on both the Wii and DSplatforms and was among the best-selling new third-party DS titles. We hadanother solid performance in the fourth quarter and in the year as our mostsuccessful title. Thus far, the CookingMama franchise has sold more than 1.4 million units for both the DS and Wii. Withthe release of Cooking Mama 2

[John Gross:]

ThanksJesse. Net revenue for the fourth quarter of 2007 was $11.9 million compared to$21.5 million reported for the same period last year. The decline was primarilyattributable to the strong performance of Jaws Unleashed and the launch ofCooking Mama 1 for DS, introduced in Q3 and Q4 of last year respectively, and avery strong fourth quarter value pricing program last year. Inthe fourth quarter of 2007, 68% of our net revenue was from new releases and32% from our catalog. 21% of net revenuewas from sales of console systems which included 8% contributed from the Wii. Inthe fourth quarter, 79% of our net sales was from games from handheld systemswhich included 72% from games from the DS. In the fourth quarter of 2006, 65%of our revenue was from sales of games for new releases, with 30% from catalogproduct. Consolesystems, principally for Jaws Unleashed, provided 30% of that revenue. Thiscompares to 70% in the fourth quarter of 2006 for handheld systems, whichincluded only 36% from games developed for the DS. Thesplit between domestic and international revenues in the fourth quarter was 81%and 19% respectively. This compares to 86% domestically and 14% internationallyin the same quarter last year. Costof sales was $8.2 million in the quarter which compares to $17.3 million in thefourth quarter of 2006, reflecting a combination of lower revenues and improvedmargins. Aswe executed our business model we continued to reduce our development andlicensing costs as a percentage of sales, to 17.3% in the fourth quarter,compared to 25.8% in the fourth quarter of 2006. Grossmargin was 31.2% for the quarter compared to 19.8% for the same quarter lastyear. The increase was primarily attributable to lower margins in some of ourvalue programs last year, compared to the higher margins of our Wii titles andthe success of Cooking Mama in the fourth quarter of 2007. Ourexpenses remain under control. Looking at our operating expenses, productresearch and development costs for the quarter fell slightly to $624 thousandcompared to $654 thousand in the fourth quarter of 2006. This is comprised ofthe fixed costs of the quality assurance department that principally evaluates,tests and oversees the development of our product. Sellingand marketing expenses were $1.7 million compared to $2.4 million in the fourth quarter of 2006. The decrease was volume-driven and primarily the result of the lower variable selling and marketing expenses on2007’s lower revenue. Rememberthe total selling and marketing expenses include both fixed costs, primarilyfor employees, as well as variable selling and marketing costs associated withtitles launched during the quarter. G&Adecreased to $2.3 million in the fourth quarter of 2007, compared to $3.2million in the same period last year. The decrease reflects our ongoing costcontrol efforts, as well as lower professional and legal expenses. Our G&Aincludes $492 thousand of stock-based compensation expense during the quarter,compared to $1.2 million in the fourth quarter of 2006. Totalcash fixed costs for the quarter, which includes G&A, product research andthe fixed portion of selling and marketing, which relates to employee costs,was within our expectation of $3 million to $3.5 million. OurGAAP operating loss was $1.5 million compared to $1.9 million in the fourthquarter of 2006. Non-GAA P operating loss for the fourth quarter was $1.2million compared to a non-GAAP operating loss of $2.1 million in the fourthquarter of 2006. The improved performance reflects improved gross margins and ongoingefforts to manage and reduce expenses. Financingcosts decreased 92% to $75 thousand from almost $1 million in the fourthquarter of 2006, as we benefited from the $6 million in added capital, makingus less reliant on financing our product purchases and from negotiating betterterms with our financing sources. TheGAAP net loss was $961 thousand or $0.04 per share, compared to a loss of $2.9million or $0.13 per share in the fourth quarter of last year. Our fourthquarter 2007 non-GAAP net loss was $1.2 million, or $0.05 per share, comparedto the fourth quarter of 2006 non-GAAP net loss of $3.1 million or $0.14 pershare. Inaddition, as previously announced during the quarter, the company entered into agreementsto settle certain litigations pending in the United States District Court,District of New Jersey; a securities class action brought on behalf of apurported class of purchasers of the company's securities, a private securitiesaction filed by Trinad Capital Master Fund Ltd., and a second action filed byTrinad purportedly on behalf of the company. Underthe terms of the settlement agreement in the securities class action, which issubject to notice to the shareholder class and court approval, the company'sinsurance carrier will make a cash payment and the company will contributeshares of its common stock with a market value of $2.475 million. The sharesbeing contributed to the settlement will be distributed to the settlement classif and when the court grants final approval to the settlement and thesettlement becomes effective. Atthis time, the company cannot estimate the exact number of shares that will becontributed to the settlement; however, it will not be less than 1.8 millionshares. Further, if the average closing bid price of the company's common stockfor the 20 days prior to the settlement becoming effective is less than $1.37,the company would have to issue additional shares to fulfill its obligationunder the settlement, or could, under certain circumstances determine not toconclude the settlement and revert back to disputing the class claims. Alsoduring the quarter, the company raised approximately $6 million in grossproceeds from a group of institutional and accredited investors in exchange forshares of common stock and warrants to purchase additional shares of commonstock at $2.04 per share. The warrantscontain a provision that under certain circumstances under which the company issold, merged, or otherwise enters into a fundamental transaction, as defined inthe warrant agreement, the warrants may be settled by a cash payment. Therefore,the warrants were recorded as a liability at their fair value of $2 million inaccordance with FASB statement No. 50, Accounting with Certain FinancialInstruments with Characteristics of both Liabilities and Equity, and FASB Staffposition No. 150-1, Issuers Accounting for Freestanding Financial InstrumentsComposed of More Than One Option or Forward Contract Embodying Obligationsunder FASB Statement 150. Thecompany will measure the fair value of the warrants at each balance sheet date,and record the change in fair value as a non-cash charge or gain to earningseach period. The warrants were valued at $1.3 million at October 31, 2007. Due to fluctuationsin the company's stock price, this resulted in a non-cash gain of $600 thousandduring the quarter ended October 31, 2007. Turningto our results for the full-year ended October 31, 2007, net revenue was $51 million, consistent with ourmost recent guidance and compared to $66.7 million last year. The decrease inrevenue was primarily attributable to the company’s shift away from publishinghigher-priced premium gains in 2007. In2007, 58% of our net revenue was from new releases and 36% from ourcatalog. 30% of net revenue was fromsales of games for console systems which included 20% contributed from Wii. Forthe year, 64% of our net sales was from games for handheld systems whichincluded 56% from games for the DS. In2006, 57% of our net revenue was from new releases and 33% from our catalog. 34%of net revenue is from sales for console systems which included PS2 and Xbox.56% of our net sales was from games for handheld systems which included 24%from games for the DS. In2007, we made substantial progress across virtually all of our reportingmetrics, driven by our ability to implement and execute on our newstrategy. Cost of sales was $33.7million for the year, compared to $46.9 million in 2006. Development and licensing costs as apercentage of sales were 15.2% in 2007 versus 21.9% in the year-ago period. Wedrove our gross margins from 29.7% in 2006 to 33.9% this year, which reflectsour focus to improve profitability. Product research and development costs for2007 were $2.3 million compared to $2.6 million in 2006. Selling and marketingexpenses were $7.6 million compared to $10.9 million in 2006, a reduction of31%. The2006 costs were driven by higher variable selling and marketing costsassociated with 2006 higher sales and 2006 media and marketing campaigns forthe last of the premium-priced big budget games published in the first quarterof last year. G&Adecreased 25.7% to $8.4 million in 2007, compared to $11.3 million in 2006. Thedecrease was primarily driven by lower legal expenses. Our G&A includes$1.5 million of stock-based compensation in 2007, compared to $2.2 million in2006. OurGAAP operating loss was $3.8 million compared to a loss of $3 million in 2006.We generated a non-GAAP operating loss of $1.3 million in 2007, compared to anon-GAAP operating loss of $7.7 million in 2006, an improvement of $6.4 millionwhich puts us on pace to reach breakeven slightly above $50 million in sales atsimilar cost levels. Interestexpense and financing costs decreased 35% in 2007 to $1.6 million from $2.4million in 2006, as we benefited from the capital infusion in the fourthquarter, which enabled us to be less reliant on our financing of productpurchases, and from negotiating better terms from our financing sources. TheGAAP net loss in 2007 was $4.8 million or $0.20 per share compared to a netloss of $5.4 million or $0.24 per share in 2006. Our 2007 non-GAAP net loss was$2.8 million or $0.12 per share compared to a 2006 non-GAAP net loss of $10.1million or $0.45 per share, an improvement of 72% or over $7 million. Throughoutthe year we executed on a number of initiatives to strengthen our balance sheetincluding improving our cash balance and reducing inventory. As of October 31, 2007, we had cash andcash equivalents of $7.3 million; this included the benefit of $6 million incapital we raised in September. Thepayable for the factor was $1.5 million, which represents gross receivablessold to the factor of $7 million, less allowances of $3.1 million, net ofadvances from the factor of $5.4 million. Ourreceivables are in good shape, and the increase in our inventory is virtuallyall related to purchases of Cooking Mama titles made in October subsequentlysold in the first quarter 2008. Theincrease in our capitalized software licensing costs is largely the result ofcosts related to development and licensing costs for Cooking Mama and otherproducts launched or to be launched after October 31, 2007. Accountspayable and accrued expenses were $10.3 million at year-end, including a $2.8million accrual related to the expected settlement of our class actionlitigation. Turningto our outlook for 2008, we expect full-year net revenue in the range of $53 to$58 million. In addition, as we have previously discussed, due to our product leadtimes, we do not expect to see the full financial benefit from expanded productlines until 2009, which will be driven by the gross capital we raise in 2007and our new Studio. We expect to see a continued improvement in our grossmargin, as we remain disciplined in our approach to the business. Interms of cash fixed costs which include our general and administrative, productresearch and the fixed portion of sales and marketing costs, we expect thatnumber to once again fall towards the higher end of the range of $3 and $3.5million per quarter in 2008, excluding the costs of our recently announcedStudio. The majority of the Studio costs will be reflected in development, witha remainder included in product research or G&A. Wecurrently anticipate 41% of revenue will be generated from console systems and59% from handheld systems. From a profitability perspective, for the full-yearwe would expect to be breakeven or better on an operating basis. Our guidance assumes the release ofapproximately 25 titles in 2008 with approximately 9 Wii and 15 DS titles. Overallwe are very pleased with the financial progress we made in 2007. Today we are a significantly more profitablecompany than a year ago, and we expect to continue to expand our margins in2008. Weare executing our new strategy, growing the business, improving our financialposition, and are on a clear path to reach sustainable growth andprofitability. Iwill now turn the call back to Jesse.

[Jesse Sutton:]

Thanks,John. In the new year, we look to build on the operating and financial progress for 2007. Wehave implemented astrategy that plays to our strengths and are executing with a disciplined financial approach that is drivingour performance. Overthe past several years, the fastest growing segment of the industry has been the casual game market. The Nintendo Wii and DS platforms, with their massmarket appeal, had anoutstanding holiday season as they continued to broaden their installed baseboth in the U.S. and globally. Consumerdemand for the Nintendo platforms remains strong and is expectedto continue into 2008. According to NPD, as of November 2007 in the U.S., the DS had a base of more than 15 million and the Wii with more than 6 million units. Globally, the DS has an installed base of more than 61 million units and the Wii approximately 17 million units. Givenour specific focus on this segment, we expect to continue to benefit from thistrend. Our core focus remains the identification, development and publishing of massmarket games that are innovative, intuitive and fun to play. We will continue toaggressively pursue new casual gaming products, and opportunistically target core game titles that meet our financial criteria. Weare prudently expanding our total number of annualtitle releases, and expect to increase our new titles by 30% for 2008. Weexpect to increase the number of titles in subsequent years, driven by the growth capital we raised in 2007 and the launch of Majesco Studios, which will providedevelopment capacity and allow us the opportunity to build a company-owned library of valuable, proprietaryintellectual property. Lookingat the first quarter of 2008, we were pleased with ourholiday performance, which was led by our Cooking Mama title. In the quarter, we had a solid line-up of new releases, consisting of oneWii game and two DS. Our first quarterreleases include, Cooking Mama 2

[Operator:]

(OperatorInstructions) Your first question comes from Edward Wu – Wedbush Morgan.

[John Gross:]

Give or take, it isprobably up about 4 million shares or sofrom where we are.

[John Taylor:]

Great. Theforeign, international revenue piece. Can you talk about how you booked that?Did you get aguarantee on that? Was there any upfront money paid that you got booked intorevenue, or is that purely anearn as you go kind of thing?

[John Gross:]

There aremultiple questions there. From anaccounting point of view, itis booked like any other sale and interms of the mechanicsof the agreement,there is an upfrontminimum guarantee, but we don’t book that until we actually ship it.