The European market is soft but its poor sales in North America that really surprised Square Enix this past year, resulting in an expected extraordinary loss out of its next financial report.

Square Enix has released an English transcript of the meeting in which it advised investors of an extraordinary loss last quarter, prompted CEO Yoichi Wada’s resignation, and admitted that its last three big western titles hadn’t met projections.

The publisher noted that its current financial year results are not hugely varied from previous years, and that net sales are close to forecast. The one area of major discrepancy is in the Digital Entertainment segment, where Square Enix forecast net sales of ¥94.5 billion and is expected to come in at ¥87 billion, a variance of ¥7.5 billion ($75.5 million). Of this ¥87 billion, sales are divided as follows: ¥53 billion in HD Games, ¥23 billion in Social Gaming and Others, and ¥11 billion in MMO.

Western HD Games fail to perform

“Of the negative variance of ¥12.8 billion against the operating income forecast, a large portion (more than ¥8 billion) originates from HD Games,” Wada explained.

The executive said Eidos’s portfolio was a huge part of the publisher’s console profits in the year following its acquisition, so Square Enix has pushed to release one or two western-developed and focused titles every year. Encouraged, Square Enix gambled a bit on FY2103, releasing western-developed titles only, and no Japanese-made blockbuster.

“We put considerable amount of effort in polishing and perfecting the game content for these titles, receiving extremely high Metacritic scores. However, we were very disappointed to see that the high scores did not translate to actual sales performance, which is where we see the substantial variance in operation profit/ loss against the forecast,” Wada said.

Square Enix did not disclose exact sales figures or projections, but said it expected to sell 2-2.5 million units of Sleeping Dogs in Europe and North America; 4.5-5 million units of Hitman: Absolution worldwide; and 5-6 million units of Tomb Raider worldwide.

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Square Enix’s financial forecast was actually based on a figure between 80-90% of its actual estimate, to allow for discrepancies, but sales fell well below the mark anyway.

“The European market was generally soft, however what affected us the most was the huge slump in North American sales. Not only were sales sluggish, but we were also hit by additional costs in dealing with distribution channels, such as price protection and rebates, which placed huge pressure on our profit and loss,” Wada explained.

“A large portion of the variance against forecast comes from the three titles I just mentioned.”

A practical example of the market variation is found in the March PSN charts; in Europe, Tomb Raider was the top PS3 game, while in the US it came in at fifth.

Wada acknowledged “certain degrees of success” from its western development teams, but said Square Enix’s revenue model is “outdated” and its selling capacity is “far weaker than [iy] ever imagined”.

“In the end, we simply failed to sell the required number of units,” he said.

Wada also said that development costs for the Wii U version of Dragon Quest 10 are having a negative effect on Square Enix’s margins; it released too close to the end of the year to have any significant impact sales-wise – although it should be noted that it’s not performing well. Later in the meeting, Wada said the MMO division is not living up to expectations, either.

Social, browser and mobile going strong

Square Enix expects its Social Gaming and Others division to return good sales figures, noting “continuous growth in net sales” and improving profit margins.

Wada said Square Enix is happy with its “competent” IPs, and that the social gaming division has improved since relocating and reorganising so teams can share expertise across projects.

“Although we have yet to come up with a powerful title that can turn around the entire gaming industry, we are pleased to see extremely strong and steady growth in this area,” he added.

Sengoku IXA and Million Arthur were cited as examples of successful titles produced in this division.

Cutting costs

Square Enix is now making an “extraordinary loss in an effort to sort out items not achieving expected revenue levels, through scrapping those items and terminating production”, Wada said – making a loss on disposing of unprofitable projects, in other words.

Of a ¥4 billion loss, more than ¥2 billion is related to studios in Japan, where production has been halted on some work-in-progress games.

More than ¥1 billion is related to the closure of a US division to develop casual games for smartphones, which “did not go well,”.

It looks like some projects have been closed in European studios, too, to the tune of “a few hundred million yen”.

In addition, Square Enix expects a ¥2 billion loss related to restructuring.

Executive shuffle

Wada took personal responsibility for Square Enix’s downfall in FY2013, voluntarily withdrawing from the board of director’s voting process and naming his successor.

“I recognize that the revisions to consolidated results forecasts for the current FY ending March 2013 are shocking, and I sincerely apologize to our shareholders and investors for the poor performance and not meeting your expectations,” Wada said.

“We have done everything we can do to adapt and respond to the drastically changing environment; however we have not been able to accomplish satisfactory results since FY2011. I intended to do what had to be done but these results came despite my best efforts. The seeds that we have planted have by chance, or by necessity, all worked in synch negatively resulting in a huge loss for FY2013. Consequently, we are currently planning some fundamental management reforms.”

Newly incumbent Square Enix president Yosuke Matsuda has promised a thorough review of the company’s business, and lay-offs have already begun, striking the Los Angeles office.