Mad Catz Interactive, Inc. F4Q09 (Qtr End 03/31/09) Earnings Call Transcript

Jun.24.09 | About: Mad Catz (MCZ)

Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F4Q09 Earnings Call

June 24, 2009 5:00 pm ET

Executives

Joseph Jaffoni – 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

Buck Vassar – Fulton Trust

Ronald Rotter – RLR Capital Management

James [Starkland] – Private Investor

Operator

Welcome to the Mad Catz Interactive fiscal Q4 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Joe Jaffoni. Please go ahead, Sir.

Joseph Jaffoni

Thank you operator and thanks everyone for standing by and waiting. As you saw this afternoon there was three news announcements that went out, the last of them being the earnings release which is out right now.

Let me just read the Safe Harbor language and we won’t delay any more and we will get to management’s comments.

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 company’s ability to maintain or renew 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 web cast includes non-GAAP financial measures within the meaning of SEC Regulation G. 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 news announcement.

I just want to remind everyone that as part of our ongoing Investor Relations effort the company will meet and conduct conference calls with members of the financial community and for those of you interested in that please call me on (212) 835-8500.

Again, I apologize for the delay in getting the call started today. Without any further delay I would like to introduce Mad Catz President and CEO, Darren Richardson, who will be joined on today’s call by our CFO, Stewart Halpern. Thank you.

Darren Richardson

Thank you Joe. Good afternoon and thank all of you for joining us on the call today and my apologies for the delay. Earlier today we announced our results for the fiscal fourth quarter and all of fiscal 2009 including record sales levels for both periods.

On today’s call I will provide an overview of our recent achievements after which Stewart will review our financial performance for the fourth quarter and fiscal year and discuss some of our goals for fiscal 2010. Afterwards I will provide an update on our new product development initiatives and give some thoughts on the outlook for our sector during the current economic environment and the balance of calendar 2009.

Overall, fiscal 2009 was an active and productive period for Mad Catz as we achieved solid sales growth, grew sales in all of the primary geographic regions we address, completed the global integration of the Saitek operations, secured additional high-profile, mass appeal licenses, launched several new successful products such as our Rock Band and Street Fighter ranges, improved our operating cost structure and recently made significant progress in improving our near-term liquidity and our access to working capital with the agreements that were announced this afternoon with Wachovia and for the Saitek acquisition note.

As you see, we have a number of non-cash charges flowing through the P&L this quarter so I would like to turn the call over to Stewart early and give him the necessary time to explain those items but before I do I think it is important to provide detail on the impact of the recent currency volatility on the business.

Since we now derive approximately 40% of our sales in foreign currency, a sharp rise in the value of the U.S. dollar against the British Pound or the Euro has the effect of reducing our sales in those territories when converted to U.S. dollars. However, the Chinese currency trades within a tight band with the U.S. dollar so we don’t get the corresponding benefit to our cost of goods sold. As a result, our margins get compressed.

During Q3 we saw an unprecedented strengthening of the U.S. dollar that continued through Q4 and has only recently started to subside. The continued sales growth against the backdrop of the current macro economic environment is a considerable achievement and speaks to the momentum we are building. When considered alongside our upcoming product pipeline, our expanded sales and distribution capabilities and the progress we have made on reducing operating costs, I believe we are now well positioned to demonstrate the true earnings power of the business once the macro economic environment normalizes.

With that, let me turn the call over to Stewart to review our financial results for the quarter and fiscal year-end.

Stewart Halpern

Thank you Darren. We are pleased to have had record sales in both the fiscal fourth quarter as well as for the fiscal year. Sales for the fiscal year were $112.6 million, a 28% increase from $87.7 million last year. Sales for the quarter were $22.8 million, a 3.9% increase from $21.9 million last year.

The fiscal year benefited from our first full year of our PC accessories business but we also grew our console video game business and had nice successes with new products such as our Rock Band accessories and our suite of products related to Street Fighter IV which we released in our fiscal fourth quarter.

As Darren alluded to, our business was negatively impacted by foreign exchange at several levels, most notably gross margin. Our gross margin for the year was 28.4% compared with 32.9% last year. For the quarter our gross margin was 24.3% compared to 29.6% last year. Because of the impact of the weak U.S. dollar Darren discussed, the negative impact on gross margin for the year from the weakened dollar was approximately 4.4% and for the quarter approximately 9.3% outweighing all other factors. As a result, gross profit dollars increased 10.8% to $32 million for the year and gross profit dollars for the quarter where most of the gross margin currency impact was felt declined 14.8% down to $5.4 million.

SG&A for the year totaled $28.2 million, up 32% from last year, which did not include a full-year of Saitek or Joytech overhead. SG&A for the quarter was $5 million, a decline of 33.4% versus $7.5 million last year. We continue to believe that in fiscal 2010 we will make significant improvements in SG&A over fiscal 2009.

Our earnings for the quarter and fiscal year were impacted by two non-cash, non-operating items that I would like to briefly discuss. First, if you remember from last quarter we took a charge for the estimated impairment of good will in our fiscal Q3. This quarter we finalized that estimate, resulting in a non-cash charge of $27.9 million for the year with a credit of $626,000 this quarter as part of the finalization of that Q3 estimate.

Secondly, in Q4 we had a valuation allowance of $4 million that shows up as a tax expense related to the deferred tax asset at our U.S. subsidiary. This is a book tax expense only and will not result in any impact to our cash taxes.

On a reported basis, including these two non-cash, non-operating charges our net income for the year is negative $32.6 million or negative $0.59 per share versus a gain of $3.2 million or $0.06 per share last year. For the quarter the loss is $3.7 million or $0.07 per share versus a loss of $832,000 or $0.02 last year. In the press release you will see that there is an adjusted net income reconciliation which shows our results excluding the impact of these items.

Our adjusted EBITDA which is not impacted by these two items was $4.5 million for the year, down from $10 million last year and was a negative $333,000 in Q4 down from a positive $690,000 last year.

On a more positive note we also announced today that we have extended the maturity and amended the $14.5 million note issued in conjunction with the acquisition of Saitek. Originally the note required us to pay off $4.5 million plus accrued interest this October with the balance due in October 2010. We have extended the maturity to March 31, 2019 which we believe is a significant improvement from a liquidity point of view.

The interest rate will stay the same at 7.5% for the next five years after which interest will increase to 9%. As part of the restructuring we will make payments of $500,000 this October and $1.5 million next March and we will also begin to make partial payments of interest at approximately $45,000 on a current basis quarterly beginning June 30.

We also announced today that we have extended for an additional three years our working capital facility with Wachovia. You will note from the press releases issued earlier that we chose to reduce the amount of the loan to $30 million down from $35 million because we believe $30 million provides us enough capital to finance our business while the lower amount of the loan saves us money on closing costs and unused line fees. Based on market conditions the rate on the loan is adjusted up to prime plus 2% from our current prime plus 75 basis points which will lead to an increase, but we don’t believe a significant increase, in our borrowing costs.

These two developments will provide us continuing financial flexibility to pursue our efforts at growing our business and increasing shareholder value. Now to give you some more insight into our outlook and how we are going to accomplish those things I would like to turn the call back to Darren.

Darren Richardson

Thank Joe. We remain focused on bringing value added products to the market and aligning our products with the most promising and successful gaming titles on the market. This strategy has yielded tangible successes and Mad Catz continues to make progress in this area. In particular, our line of Street Fighter IV and Rock Band products continue to generate significant sales and positive reviews and these product lines have given us great traction with a pair of the most successful gaming titles on the market today.

We also launched an extensive new range of controllers and accessories for the Nintendo Wii including a Mad Catz remote and z-chuck, our first Wii controllers for the Wii platform and a line of fun products featuring the characters from Ubisoft’s hit game Rayman Raving Rabbids.

The Wii remains a platform where we are under represented and we are committed to growing our market share in the Wii console this fiscal year. As most of you who have been following the Mad Catz story know, we have made significant progress in bringing to market products that are more sophisticated and provide a greater degree of differentiation to the playing experience. We recently launched our first Xbox 360 wireless product, the [standard] British Invasion Guitar replica for Rock Band and that is going to be followed later this year with a product close to my heart, a full-size Fender Wooden Stratocaster that is actually manufactured by Fender with electronics components supplied by Mad Catz.

The third product in the Xbox 360 wireless range is a Rock Band licensed replica Fender Telecaster guitar that introduces unique, super fast buttons targeted at the growing numbers of expert Rock Band and Guitar Hero players. These products all carry advanced feature sets and premium price points and have been very well received by reviewers, the media and trades when they were showcased at E3 last month.

Saitek has successfully established [front] positions in niche segments through outstanding product design and innovation and we continue to build on our market leading range of Saitek’s flight sim products. As we move through fiscal 2010 we will begin applying that same distinctive core competence to larger market segments. This is projects that we are all very excited about.

During our first quarter of fiscal 2010 we are seeing an industry wide slow down as we work through a tough prior year comp when Wii Fit and Grand Theft Auto were launched. Although retailers remain guardedly optimistic on the video game category outlook for the year, they continue to exercise extreme caution in regards to inventory exposure especially through the slower summer months.

For Mad Catz Q1 specifically, we are expecting a difficult comp for sales and margins with continued improvements on OpEx line from the cost reductions previously implemented. Looking at fiscal 2010 we are focused on a number of key objectives that we believe will position us to deliver EBITDA and earnings growth over the course of the year. We expect to continue leveraging our product development capabilities to increase the flow and timeliness of new products, increasing the market penetration of our PC products with a particular focus on North America, and further expanding our portfolio of licensed product.

We also remain disciplined on managing expenses which will bring more dollars to the bottom line. The company’s future is bright as we have the best product line up in our history, the most sales and product distribution reach ever, an improved operating expense structure and amended credit and note agreements. Our strategy remains simple; Stay close to our customers, drive innovation into our products and operate with financial discipline.

That concludes my prepared remarks. Now I would like to turn the call back to the operator and we will answer your questions.

Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Buck Vassar – Fulton Trust.

Buck Vassar – Fulton Trust

Two questions. One, it looks like your inventory turnover is starting to increase. Can you give us some type of feel for turnover on new products you are introducing?

Darren Richardson

The inventory turnover is not just related to new products. I made a couple of comments through the course of last year that our inventory was higher than we would have liked. We have made some good improvements into bringing that down. I am happy where it is today but I would still like to bring it down a little bit from where we are. Fundamentally, North America the inventory is looking good. In Europe it is a little bit higher mainly because they are seeing a much more significant market slow down than we are seeing in the U.S. So, the inventory front has made some good strides and I am very pleased with that.

Buck Vassar – Fulton Trust

Stewart, do you by any chance have the cash flow from operations number?

Stewart Halpern

One thing, if you are talking about the cash flow for the period on a year-over-year basis I think the simple way to look at it is if you look at the net debt, which is the debt balance less cash that net debt balance increased by about $4 million over the course of the 12 months. So in effect that is sort of a negative cash impact of about $4 million over the year.

Operator

The next question comes from Ronald Rotter – RLR Capital Management.

Ronald Rotter – RLR Capital Management

Congratulations on getting that credit line changed and the debt agreement with the Saitek, that clearly was a very dangerous liquidity issue coming up in October had that not been renegotiated. On the sales, marketing and G&A line they were dramatically lower in Q4 yet were up for the year. Is that strictly a matter of reallocation of those expenses throughout the year as opposed to lumping it all into the quarter or were there in fact some reductions? I’m sure there was probably some but maybe you could quantify how much came from reallocation versus from actual reductions?

Stewart Halpern

So if you are talking about SG&A for the full year on a year-over-year basis, the comparison there I think is skewed by the fact that last year we didn’t have a full year of Saitek in so I think we talked about this on prior calls, as we got into the year you started seeing our first couple of quarters were in fact the full amount of the Saitek and also some Joytech overhead as well. Then as we started to implement some of the efficiencies that we knew we would get when we did those acquisitions you started seeing I think even last quarter significant SG&A improvement and that much more so this quarter. So I think if you look at the full year, year-over-year it is a little bit skewed by the fact that it is not quite an apples-to-apples comparison.

Ronald Rotter – RLR Capital Management

I remember, and I forget exactly when, but I remember there was this issue where you did change the method of allocation of numerous expenses. Was that prior to this year so none of that really reallocation in how you allocated expenses? Whether you accrued it or took it as it occurred?

Stewart Halpern

Well there weren’t any accrued versus incurred issues. I think you are talking about the fact that at the beginning of the year we changed the allocation of some of our Asian costs of goods sold and we pulled out a piece that was about $400,000 to $500,000 a quarter out of COGS and into G&A.

Darren Richardson

I think the other thing Ron is referring to is we used to accrue audit fees throughout the course of the year and then last year we actually moved that to where it actually is incurred in the quarters where we worked with that. So that hits Q1 but last year we already had that in Q1.

Ronald Rotter – RLR Capital Management

So in other words, basically what we are looking at in Q4 is truly a reduction in expenses as opposed to any reallocation of expenses?

Stewart Halpern

There is no reallocation issue there and so it started and as Darren mentioned the change in the practice relating to the audit fees will be on an apples-to-apples basis.

Ronald Rotter – RLR Capital Management

Where did these cuts primarily come from? Were they mostly just consolidating now? You have had Saitek long enough that you can consolidate some of those costs?

Darren Richardson

In Q4 last year, after the Saitek acquisition, we had a separate Saitek sales organization with their own office and distribution center up in Torrance and I think we had about 23 people attached to that. We consolidated that down into our operation and I think we ended up with about 3-4 people who have been acquired as part of that but all of the rest went to savings. It took a little while getting out of the lease so there was a bit of a tail of expense that comes from there but that happened in about April of last year. So now you are starting to see those come through on an annualized basis and again Q4 is the first quarter we have had where we have got an apples-to-apples comp on the same business because in Q3 we only had Saitek for half a quarter so we missed the bulk of the sales for the quarter but we ended up with about half of the operating expenses. So you should start to see those things work through. All that work is being done. It is just a matter now of where you have some visibility to it.

Ronald Rotter – RLR Capital Management

The other obvious question, it is one thing to cut all of those sales force and all of this, but it appears like your sales line also was pretty weak and I don’t know if that came from Saitek or it came from Mad Catz. I guess the concern is you cut all of these people from Saitek, could you talk about what the sales of Saitek were in the quarter versus last year?

Darren Richardson

Well you can sort of see it in the PC numbers. The PC numbers were down a little bit but for the year it was actually a solid year. So year-over-year we actually grew the PC business. The big impact area, a lot of the PC business is European and particularly German and UK business. It is growing in the U.S. but we basically had the impact of foreign exchange which if you look at the massive swing in the Pound coming through sort of October/November you had about a 40% appreciation of the U.S. dollar which pretty much knocked 40% right off the top line. So that is going to impact the PC sales more than the console sales because the PC sales are more European focused.

We have a lot of moving parts. I think in all of the years I have been doing these quarter-end reports this is probably one of the more complicated ones because we have a number of those non-cash issues. We have some really significant foreign exchange issues which historically you have movement in foreign exchange but it moved relatively slowly and you could make adjustments to pricing and so forth. Now we are in a market where it moves at quite a dramatic rate, and a rate which we haven’t seen in the last 10 years, and it moved so fast you really couldn’t respond in terms of pricing particularly in an environment where retailers are under a lot of pressure. There is a lot of weakness in the market there. So it is going to take just a little bit of time to work out but those rates are now starting to swing back in our favor so hopefully by Q1 we will start to see some continuing improvement there which would take off some of the pressure on the sales line, but also help bring the margins back in line.

I think even in light of that once you actually look at what happened in native currencies the business doesn’t look too bad. The sales line actually was fantastic in native currencies but once you actually throw it over to U.S. dollars…

Ronald Rotter – RLR Capital Management

Where is it in the release? I don’t see anywhere in the release where it talks about PC sales versus last year. I know typically you break it down.

Stewart Halpern

That break out will be in the K which we will hopefully get filed no later than a day or two.

Ronald Rotter – RLR Capital Management

So could you just tell me while what PC sales were versus last year?

Stewart Halpern

Practically speaking on a percentage basis it is pretty similar. About 30% of sales is from the PC family.

Darren Richardson

I think it is also worth noting that since the acquisition we have brought a lot of the Saitek PC products, we have been able to cross them over to Xbox 360. So now we are growing that whole Saitek console business which they always had some but it is growing fast. I think as we move forward looking at how our performance is in that PC segment on the quarterly reports is an important one because we are focused on growing it.

Ronald Rotter – RLR Capital Management

So I guess what I’m really getting to, you have not seen a negative impact on sales from cutting out all of these expenses from Saitek?

Darren Richardson

No we haven’t. If you look at the [inaudible] impact, losing Circuit City half way through Q3 which was one of our cow PC accounts, that was a hit. Then we have a couple of other markets in Europe that are much, much softer than the other European markets and a couple of those are predominately PC. So we have got a few different structural things going on and then for the last quarter we have got really successful high-end gaming keyboards that you will see in Best Buy and a number of the key PC outlets, that whole part of the business if you look at where Best Buy is going it is kind of like a little bit of a barometer for the PC business. That segment is struggling. Hopefully it will bounce back later this year but there has been a little bit more impact from the economy on that than the traditional console business.

Operator

The next question comes from James [Starkland] – Private Investor.

James [Starkland] – Private Investor

Can I ask real quickly how come the press releases aren’t making the wire? Like the NFL accessories and the Wii accessories?

Stewart Halpern

I think you are speaking to the difference between kind of a trade press announcement about products versus an investor release. They do have different purposes. So the releases you are referring to which may not necessarily get exposure on business wire are the things we are putting out about products on trade press. You will tend to see those at a minimum on our own website and they kind of get picked up by different media outlets from there because we don’t put them out on the investor business wire routes. You might not see on Dow Jones, for example, and things of that nature.

James [Starkland] – Private Investor

My second question is will we get the actual amounts or number of the units of the Fight Stick that were sold or no?

Stewart Halpern

We typically wouldn’t break out sales by product and by units of that nature.

Darren Richardson

Generally though when we went into the Street Fighter range obviously the economy was in difficult shape. We had a product there and specifically the tournament edition stick which was $150 product that incorporates very high cost buttons from a Japanese manufacturer, Sanwa, who did the original cabinet for Street Fighter. So retailers were cautious. A lot of retailers committed to very, very small units. Hundreds of units opposed to thousands of units so we kept that one fairly modest. I think as I talked about on the last call we pretty much built all of our inventory for Street Fighter. We shipped it in and it was gone within a week and a half or two weeks. The challenge with Street Fighter has been being able to get the buttons, the Sanwa components which is kind of like a very, very critical feature of the product and we have been chasing [inaudible] on that. The product has been on Ebay at $150 a unit so you can understand the kind of shyness on that as well as the retailers’ shyness. I don’t think anybody envisaged the kind of quantities that were run. So in terms of units it is not massive units but it is still kind of like very meaningful business. It is ongoing. So it has definitely been a win for us.

Operator

There are no further questions at this time. I will turn the call back to you to continue your presentation or for closing remarks.

Darren Richardson

Thank you all for joining us on the call today. We look forward to updating you on our progress when we get to our Q1 2010 results. Thanks a lot.

Operator

Ladies and gentlemen that does conclude today’s conference call. You may now disconnect.

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