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Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F2Q09 Earnings Call

November 18, 2008 5:00 pm ET

Executives

[Noberto Iaia - Investor Relations]

Darren Richardson - President, Chief Executive Officer, Director, Mad Catz Interactive, Inc. & Mad Catz, Inc.

Stewart Halpern - Chief Financial Officer, Mad Catz Interactive, Inc. & Mad Catz, Inc.

Analysts

Ronald Rotter – RLR Capital Management

Operator

Welcome to the Mad Catz fiscal 2009 second quarter earnings conference call. During the presentation all participants will be in a listen only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded Tuesday, November 18, 2008. I would now like to turn the conference over to [Noberto Iaia], Investor Relations.

[Noberto Iaia]

Welcome to the Mad Catz fiscal 2009 second quarter earnings conference call. Thank you for joining us today. On behalf of the company we would like to apologize for the delay in holding today’s call and regret any inconvenience this delay may have caused.

Before we get to the discussion of the quarter’s results let me read some brief Safe Harbor language. Today’s discussion will contain forward-looking statements about the company’s financial results, estimates and business prospects that involve substantial risks and uncertainties. The company assumes no obligation to update the forward-looking statements contained in this conference call as a result of new information or future events or developments.

You can identify these statements by the fact that they use words such as anticipate, estimate, expect, project, intend, plan, believe and other words and terms of similar meaning in connection with any discussion of future operating or financial performance.

Among the factors that could cause actual results to differ materially are the following, the ability to maintain or renew the company’s licenses, competitive developments affecting the company’s current products, first party price reductions, price protection taken in response to price cuts, the ability to successfully market both new and existing products domestically and internationally, difficulties or delays in manufacturing, delays in the company’s ability to obtain products from its manufacturers in China as well as market and general economic conditions.

A further list and description of these risks, uncertainties and other matters can be found in the company’s reports filed with the appropriate regulatory authorities. Today’s call and webcast may include non-GAAP financial measures within the meaning of SEC Regulation G. When required a reconciliation of all non-GAAP financial measures to the most directly comparable financial measure are calculated and presented in accordance with GAAP can be found in today’s press release

As part of Mad Catz’s ongoing efforts to raise its visibility within the financial community the company regularly meets with or conducts calls with members of the financial community. If you’re interested in meeting with Mad Catz management, please call myself at 212-835-8500. I would now like to introduce Mad Catz President and Chief Executive Officer, Darren Richardson, who will be joined on today’s call by CFO, Stewart Halpern.

Darren Richardson

First I’ll give you a quick overview of what we’re seeing in the marketplace which I think will provide some context for our fiscal 2009 second quarter results. I’ll touch on a couple of the highlights for the quarter and then turn the call over to Stewart who will provide additional financial perspective. Afterwards I’ll discuss our outlook for this Holiday season as well as throughout fiscal 2009.

Historically in Q2 sales in July are okay, August is one of the softest months of the year and as sales build through September with the last two weeks really determining the quarter. This year sales were on track for a very strong second quarter but it really fell away in the critical last two weeks as retailers pulled back on purchasing not so much in response to a fall off in consumer demand because consumer demand remained relatively consistent, but more in an effort to trim inventory levels in expectation of a fall off in consumer demand.

We began shipping the Rock Band licensed Fender Precision Bass for the Xbox 360 in September but not in quantities large enough to materially impact the quarter. Also we continued to make a progress on our strategy to further broaden geographic diversity as well as product line diversity which continues to benefit our gross profit margin which was another record quarter and the 10th consecutive quarter of year-on-year gross margin improvement.

Having said all of that our SG&A although sequentially lower remained high relative to sales and is an area where we clearly have more work to do and where we’ll continue to in focus moving forward. When I look at the second quarter results I think there are definitely some positives but at the same time it’s disappointing because I know we left a lot on the table.

Now I’d like to turn the call over to Mad Catz CFO, Stewart Halpern for some additional detail after which I’ll share some thoughts on our upcoming Holiday season.

Stewart Halpern

Net sales for the quarter ended September 30th, 2008 were $25.8 million up 53% from $16.9 million in the prior year period. The increased level of net sales was driven by contributions from our PC product as well as growth in sales of products for the current generation of video game consoles as well as increased European penetration.

Sales of PC and related products accounted for approximately $8.6 million of the increase and console video game products increased modestly over last year’s sales. Total sales for current generation console video game products rose approximately 53% year-over-year and comprised approximately 60% of console video game product sales.

This growth was fueled by Wii product lines which represented 18% of total sales for the quarter versus just 4% a year ago and was largely attributable to the strength of our Wii Fit peripherals. As Darren mentioned we also shipped our first product under our MTV Harmonics Rock Band license, the Fender Precision Bass for Xbox 360. Although this is one of our top selling products for the quarter it was late in shipping and we expect greater impact from this line in Q3.

Sales outside of North America in the second quarter represented approximately 43% of total sales versus 30% in the prior year period. This increase reflects our new strength in the European PC games accessory market, increased European market penetration with our traditional product line as well as increased rest of world sales which comprised approximately 4.4% of sales in the period from less than 1% a year ago.

In particular with our diversified product line up we see improved potential in the Asia Pacific markets. During the second quarter we recognized net foreign exchange loss of approximately $100,000 as compared to a net foreign exchange gain of approximately $300,000 in the prior year period.

While unfavorable foreign exchange rates modestly impacted the fiscal second quarter results we believe the long term benefits of the international growth and ongoing diversification of our sources of revenue far outweigh any potential currency fluctuation risk. Gross profit or the second quarter rose 56% to a record $7.7 million up from $5 million in Q2 of fiscal ’08 while gross profit margin increased 60 basis points to 30%.

These improvements were largely a result of our efforts to focus on our higher margin product lines. Partly offsetting those improvements were higher freight costs incurred due to air shipments of some of Rock Band products as well as the prior period errors disclosed in our 10-Q and press release which negatively impacted margins by approximately 140 basis points in the quarter.

Despite the strong net sales and gross margin trends net loss for the quarter was $1.2 million or $0.02 per diluted share compared to net income of $0.9 million or net EPS of $0.02 per diluted share for the second quarter of fiscal 2008. In our press release we also show a non-GAAP adjusted EPS measure which excludes the impact of amortization of intangibles related to acquisitions as well as stock-based compensation expense.

Non-GAAP EPS for the quarter was a loss of $0.01 versus a gain of $0.02 per share in the prior year period. Total operating expenses increased year-over-year by approximately 130% in the quarter. This increase partially reflects the higher level of sales and related co-op expense. The increased scope of our operations and the addition of over $600,000 in amortization of acquired intangible assets from the Saitek and Joytech acquisitions.

Sales and marketing is up $1.9 million versus last year of which $1.1 million relates to Saitek selling expense and staff. The other big moving parts were increased co-op expenses based on higher sales, increased staff levels, travel and trade shows. G&A was up approximately $2.2 million half of which directly relates to Saitek with the remaining drivers as reallocation of costs associated with our Asian operations, accounting staff and related fees.

The increases in R&D are largely derived from the enhanced capability and activities relating to our PC game products R&D team. And of course the increase in amortization of intangibles is from the two acquisitions we did last year. During this quarter we have merged two more of the Saitek legal entities into Mad Catz entities which we believe will help further improve operating efficiencies.

On an annualized basis we have already reduced over $2 million in Saitek’s annual operating expenses and we will continue to look for additional efficiencies throughout our global business. EBITDA for the second quarter was $225,000 as compared to $2 million in the second quarter of 2008. Regarding the balance sheet the net position of our bank loan less cash at September 30, 2008 was $11.9 compared to $3.9 million as of September 30th, 2007.

Taking into account the net drawn down for acquisitions over the past 12 months the business generated over $5 million in free cash flow. Also relating to the balance sheet as many of you know Circuit City recently filed for Chapter 11 Bankruptcy. Circuit City represents less than 5% of our business and at the time of the filing our total exposure to Circuit City was approximately $400,000 of which a bit less than $200,000 related to receivables on the books as of September 30th.

We took a 50% reserve on that balance so our September 30th financials reflect unpaid Circuit City exposure of only approximately $100,000. I’d now like to turn the call back to Darren who will close with a product update and thoughts about the Holiday season.

Darren Richardson

We recently began shipping products for the smash hit Rock Band game. As I mentioned earlier on the call we had launched the Rock Band licensed Fender Precision Bass for Xbox 360 in September. That was followed in October by our Rock Band licensed Portable Drums and Premium M.I.C. both for the Xbox 360 console and more recently by the Rock Band Cymbals Expansion Pack for all platforms.

We also recently signed an agreement with Nintendo to bring our suite of Rock Band products to their popular Wii system and we look forward to beginning to address this console in the first quarter of 2009. In addition to shipping these product within North America ahead of the Holiday season we plan to offer the entire Mad Catz line of Rock Band products to select European territories to coincide with the launch of Rock Band 2 in Europe.

Given the large installed base of Rock Band and continued popularity for Rock Band 2 and Expansion Packs we expect these premium instruments to be a significant driver of sales this Holiday season and we look forward to expanding the range throughout 2009 and beyond. We also continue to build our portfolio of brand licenses with the addition of Raymond Raving Rabbits, Street Fighter 4, Bionic Commando and Resident Evil 5.

Mad Catz is also introducing a new range of game pads and flight sticks that are cross compatible between the PC and either the Xbox 360 or Playstation 3 video game consoles. Just a couple of words in terms of outlook, despite the consumer challenges both domestically the video game industry has remained relatively consistent.

I mentioned earlier on the call that we saw sales trail off in the latter part of September as retailers pulled back in anticipation of softening demand. So far we haven’t really seen any dramatic change in consumer demand. As a result we are seeing quite strong sales in the last three to four weeks as retailers replenish low inventories and prepare for the critical US Thanksgiving Holiday weekend and it’s only after we see those sales results that we’ll have a clearer sense of what the balance of the year holds.

Regardless we’re planning for the worst while hoping for the best and we’re focused on three things this quarter, number one driving sales of products that attach to successful game franchises, for example Rock Band as well as our core accessory lines that deliver value to the consumer. Number two is we’re going to remain focused on our SG&A reduction initiatives and number three is focusing on inventory management.

We look forward to reporting our success in this regard to you in future quarters and I’d now like to open the call to questions.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Ronald Rotter – RLR Capital Management.

Ronald Rotter – RLR Capital Management

I see that in the quarter you had a little over $2 million in sales of batteries which I don’t recall you’ve had in the past. Could you tell us what that was all about and is that a recurring item or is that an ongoing sale that we should be looking forward to?

Darren Richardson

I just need to see that, Ron. To be honest, I haven’t noticed that that’s there. Batteries probably used to be broken out into the accessories category so it’s probably a new item that is being brought [inaudible].

Ronald Rotter – RLR Capital Management

It shows that you had 9% in the quarter and none last year. So I don’t know.

Darren Richardson

Yes and what we do from time to time is just reallocate some of those categories. If you’ve got a category that’s on a growth trend, we’ll drop that in there so that you have it and [inaudible].

Ronald Rotter – RLR Capital Management

Is that a category that is in fact growing and that’s the reason it was broken out or just one of those numerical odd things that nothing really that different?

Darren Richardson

To be honest with you, I didn’t even notice that it was broken out separately this quarter from before.

Ronald Rotter – RLR Capital Management

On the SG&A, you had it down sequentially from the first quarter but that’s when you have all of your accounting costs in there. What do you see as a typical run rate going forward? Do you expect that $3.6 to be the run rate is that still higher than what you would expect it running going forward?

Stewart Halpern

It’s higher than we’d like and we think there are additional efficiencies that we’re going to strive for there. I’d say we’re hopeful that that should come down but in terms of a neighborhood on a short term basis there’s no magic solution to get it materially down on a short term basis but we expect to try to bring that down at least modestly over time.

Ronald Rotter – RLR Capital Management

But it should be within the ballpark of that number going forward?

Stewart Halpern

Yes, reasonably in that range because again if you think about the fairly significant way in which we’ve expanded the scope of our operations we need to support the expanded scope of operations. Having said that, we do think that there are additional opportunities for efficiencies and our hope would be to take that down at least modestly over the next couple of quarters.

Ronald Rotter – RLR Capital Management

Finally, and I guess it’s difficult with everything going on, your credit line’s expiring next year. I guess the timing right now probably isn’t all that great to be renegotiating or looking forward to extending that. Is there anything that you can share with us in that regard?

Stewart Halpern

I think we’d agree that this is not the best environment in terms of negotiation bank transactions, but we feel that we do have time. We have a good relationship with Wachovia. They’re in the process of merging with Wells Fargo which from what we could see probably is a good thing for that organization. For the moment, we feel fine about it and we feel like we’ve got plenty of time.

But fundamentally we think the opportunity for the business to demonstrate that it continues to be a business worthy of financing certainly on an asset backed base business and perspective and hopefully on a cash flow perspective as well.

Darren Richardson

Just to date you know how dated a relationship with Wachovia has been entirely unchanged. We’ve not seen any impact from that.

Ronald Rotter – RLR Capital Management

Finally, I’m not to sure that I misunderstood what you said earlier, Darren, about since inventories were running low at the retail level because they weren’t buying. Were you saying you were hopeful that they would now as their inventories run that they would be buying or have you in fact seen the last couple weeks a pick up?

Darren Richardson

No, no we’re seeing the last couple of weeks a pick up. The last three or four weeks have been very strong sales so we’ve made up what was a lot of the shortfall in Q2. The real telltale in this business is what happens from Thanksgiving beyond. Thanksgiving is the first time that you really get to see what the consumer is going to do.

You can pick a couple of skews that are not as strong as they were, you can pick a couple of skews that are performing much better than this time last year. But on the balance you would pretty much say the point of sale trend on a whole is looking okay, not wow, it’s a great year, but it’s definitely not looking the year that you read about in the financial press at the moment.

We’re fingers crossed that that continues on and I think historically the video game sector has done pretty well. To the extent that we’ve got products that attach AAA software titles, which we do, and to the extent that we’ve got a part of our portfolio that ties to adding value products that really deliver value to consumers, then both of those things hopefully will combine to do reasonably well. Again, it’s really going to be back half of the year.

At the same time we’re looking at what we can do to make sure we totally, totally trim inventory so that we come out of the balance of the year without too much inventory.

Stewart Halpern

I just wanted to follow up on the battery question. That was really driven by, we had a couple of power accessories for the Wii. I think in the past we had broken out power or battery but hadn’t been as meaningful but we got a big jump because we did have a couple of Wii power related accessories.

Ronald Rotter – RLR Capital Management

Is that an ongoing type of sale we should be seeing going forward or was it a special product account?

Stewart Halpern

We’ll certainly continue to sell the product. Whether it will be as material or meaningful is a little bit hard to say, but it’s not a one time thing of its nature. It goes along with our interest in trying to expand our presence in the Wii platform.

Ronald Rotter – RLR Capital Management

For Rock Band, in terms of the sales in the second quarter, was that a production limitation situation? There hasn’t been much in the way of advertising for and marketing for it. When I go into the stores, I don’t even see it even on display. Is that because there just wasn’t that much production or is the demand less? I guess the real bottom line question is what are you seeing in terms of consumer demand? There seem to be a lot of guitar products out there.

Darren Richardson

First of all, there’s a lot of different approvals that you need to go through for a product like that because you end up with the Harmonic MTV guys, the Microsoft guys, the Fender guys. So it takes a while to just get through that process. So we’re late getting into manufacturing, the manufacturing has been moving along fine. We did air freight some product in to get to market for the launch of the games.

It’s the bass guitar not the guitar guitar but at the same time, it’s actually trending just a little bit under what you’re seeing there for the first party Rock Band the first party Guitar Hero guitars which frankly is quite positive. We’re happy about where it’s going and hopefully we’ll be able to continue through the balance of the year.

Operator

There appear to be no further questions at this time.

Darren Richardson

Thank you for joining us on the call today. We look forward to updating you on our progress when we host our third quarter ’09 call. All the best for the Holiday season until we talk again then.

Stewart Halpern

Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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Source: Mad Catz Interactive, Inc. F2Q09 (Qtr End 09/30/2008) Earnings Call Transcript
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