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Mad Catz Interactive, Inc. (MCZ)

F3Q10 (12/31/09) Earnings Call Transcript

February 9, 2010 5:00 pm ET

Executives

Norberto Aja – IR, Jaffoni & Collins

Darren Richardson – President, CEO & COO

Stewart Halpern – CFO

Analysts

Michael Pachter – Wedbush Securities

Ronald Rotter – RLR Partners

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Mad Catz Interactive fiscal 2010 third quarter results 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, February 09, 2010.

I would now like to turn the conference over to Norberto Aja, Investor Relations. Please go ahead, sir.

Norberto Aja

Thank you, operator. Welcome to our third quarter fiscal 2010 earnings call. Today on the call we have Darren Richardson, our President and Chief Executive Officer, along with Stewart Halpern, our Chief Financial Officer.

Before we begin, let me just take a few minutes to read the 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, belief, 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, 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 includes 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 calculated and presented in accordance with GAAP can be found in today’s press release.

As part of Mad Catz's ongoing investor relations effort, the company regularly meets or conducts calls with members of the investment community. If you are interested in meeting with Mad Catz's management, please call me at 212-835-8500.

With that, I would now like to introduce Mad Catz's President and Chief Executive Officer, Darren Richardson. Darren?

Darren Richardson

Thank you, Norberto. Good afternoon and thank you all for joining us on the call today. Earlier today, we announced fiscal 2010 third quarter results that clearly reflect the top and bottom line benefits of Mad Catz’s strategy to bring together higher value, higher margin products to market.

On today’s call, I will provide a brief overview of our financial and operational achievements for the quarter and discuss the drivers behind the quarterly record net income, EPS and EBITDA. Stewart will then provide our financial performance in greater detail, after which I will provide an update on both our product development pipeline as well as some thoughts on the company’s outlook for the balance of fiscal 2010.

Let me begin by saying that by virtually every financial measure, our Q3 results demonstrate the excellent progress we are making on the key initiatives we’ve discussed to build shareholder value and we did so while navigating a very challenging period for the video game industry.

Net sales increased 20% for the fiscal 2010 third quarter versus prior-year quarter, mainly reflecting the success of our Call of Duty

Modern Warfare 2 product line, new placements of remotes for Nintendo Wii and continued growth of our European distribution network.

Net sales for the fiscal 2002 [ph] third quarter were just shy of the company’s record quarterly net sales set a few years ago, but our gross margins this period are 33% compared to 25% in the fiscal 2005 period. It’s also important to note that our year-to-date sales are tracking ahead of fiscal 2009, which is the current record sales year.

Just as important as growing the top line, we’re able to leverage that growth all the way down through the income statement. Gross margins returned to our target of north of 30%, and even though a large part of the selling expenses are variable, we continue to reduce overall operating expenses and the strong sales growth, gross margins and vigilant on costs resulted in record quarterly gross profit, operating income, net income, earnings per share and EBITDA.

During the last two years, we’ve had our hands full integrating the acquisitions we made in 2007, a process that wasn’t made easy by the economic crisis. So it’s gratifying to see all the hard work done by everybody in the organization clearly visible in the financial results.

We also believe that the Q3 results validate that our business model is scalable and capable of generating significant operating leverage.

With that let me turn the call over to Stewart to review our financial results for the quarter. Stewart?

Stewart Halpern

Thank you, Darren. Q3 net sales of $48 million for the quarter were the second best of any quarter in the company’s history and increased over 19% versus the $40.8 million in the third quarter of fiscal 2009.

North America net sales of $24.6 million were approximately in line with last year’s $24.7 million with a small change mostly due to a negative comp on our Wii platform product sales in the territory and general softness in the market. Sales in Europe were up 58% to a record $23 million based on the broad success of new products as well as initiatives to continue to grow Mad Catz’s non-US sales platform. For the first time in the company’s history, non-US sales exceeded sales in the US. Net sales in the rest-of-world markets declined approximately $300,000 versus Q3 of last year.

For the nine-month period net sales were $92.7 million representing a record for any nine-month period in the company’s history, and is just over 3% higher than the same period last year.

Gross profits in Q3 were a quarterly record $15.9 million, which is up over 50% from Q3 last year. You may recall that Q3 last year, we were very aggressive in taking inventory reserves to get in front of any potential problems related to the unprecedented economic uncertainty that was prevalent, and this impacted gross margins both on a percentage of sales and dollar basis last year. This is year, with the return to more normal levels of inventory reserves as a percentage of sales along with better product mix and reduced freight costs, gross profit margin for the quarter was nearly 33%, up over 6 points from last year. On a year-to-date basis, gross profit dollars are a record $29 million, up over 10% from last year.

In recent quarters, we’ve noted the impact of foreign currency translation on gross margin, and I would like to point out that for Q3 this year, foreign exchange had a relatively modest impact of only negative 0.5 point with a negative 3.5% impact for the nine-month period.

Looking now at operating expenses, we continue to maintain our discipline on the cost structure of the business and are pleased with the efforts of the entire team towards becoming a more efficient enterprise. As such, we remain on track to significantly exceed our previously-stated goal of reducing SG&A by no less than 10% during this fiscal year.

In an effort to better compare our year-over-year operating expense performance, the following discussion excludes the $28.5 million one-time goodwill impairment charge taken in the prior year quarter. In the fiscal 2010 third quarter, SG&A fell 6.2% to $7.2 million, while for the first nine months of fiscal 2010, our SG&A expenses have declined by 20.9% to $18.3 million.

For the quarter, total operating expenses declined 1.9% to $8.3 million from $8.5 million in the third fiscal quarter of 2009; and in fiscal 2010 to date, again without the impairment charge, total operating expenses were down 16.2% representing savings of $4.3 million.

Reflecting the over 19% increase in net sales, 600 basis points plus gross margin improvement and continuing operating expense reductions, we recorded an operating income of $7.3 million compared to operating income of $2.1 million in the comparable prior-year quarter, which again excludes the impact of the one-time goodwill impairment charge in last year’s Q3.

After accounting for the impact of interest expense, foreign exchange loss and other income, we reported pre-tax income of $6.8 million in Q3 of fiscal 2010 compared to a pre-tax loss of $25.8 million in the prior-year period, while pre-tax gain of $2.7 million excluding the one-time goodwill impairment charge last year.

Reflecting taxes of $1.6 million this quarter, compared to $1.1 million last year, our net income in the quarter was a record $5.3 million or $0.09 per diluted share, also a quarterly record compared to a loss of $26.9 million or $0.49 a share in the prior-year period inclusive of the goodwill impairment or $0.04 per share of income excluding the impairment.

Note that for this quarter, there is a disparity between basic and diluted EPS of $0.01 per share, which is based on the accounting treatment of convertible securities relating to the Saitek acquisition, but there is no such impact on the nine-month number nor do we expect one on the EPS for the full-year ending 03/31/2010. Diluted EPS for the nine-month period is $0.07 versus a loss last year of $0.53, again that loss including the impact of the goodwill impairment, but if we exclude that impairment loss, the gain for the period was $0.02 per share of EPS.

Adjusted EBITDA improved significantly in the third quarter of fiscal 2010; thanks to the improvement in sales and the continued reduction in operation expenses. The adjusted EBITDA was $8.7 million or more than double the $4.2 million in the prior-year period. On a year-to-date basis, adjusted EBITDA is $10.3 million, also more than doubling last year’s $4.7 million.

Free cash flow for the quarter, which takes into account capital expenditures and cash taxes, was negative $4.5 million versus negative $6.9 million last year. Free cash flow for the first nine months of fiscal 2010 was negative $7.4 million versus a negative $12.8 million for the first nine months of fiscal 2009. These negative cash flow numbers reflect the typical seasonality of our business whereby the preponderance of our net free cash is generated in our fiscal Q4 as receivables are collected from holiday sales.

Some balance sheet highlights. The net position of our bank loan less cash at December 31, 2009 was $17.4 million down over $2 million compared to $19.5 million at the same time a year ago. Our inventory balance at December 31, 2009 was $24.7 million, seasonally down from last quarter’s $33.8 million and $3.2 million higher than $21.5 million in the prior-year period.

Frankly, period-end inventories were a bit higher than we would like, but we are comfortable with our total exposure as the higher period-end inventories were partially offset by lower open factory orders. I expect you will see this play out when we report our fiscal year end results, which should show continuing seasonal reduction in inventories.

In conclusion, based on these results, we believe that we are well positioned to deliver for fiscal 2010, the strong growth in earnings, EBIDTA and free cash flow that we previously indicated.

Now I would like to turn the call back to Darren for some closing remarks.

Darren Richardson

Thanks, Stewart. On the last call I mentioned that we were poised to announce the strongest portfolio of new products in Mad Catz’s history, and we did that at the Consumer Electronics Show in January. The level of consumer immediate interest was unprecedented and the reviews overwhelmingly positive with at least one flagship product from each of our core hardware brands garnering special attention.

For Mad Catz, our console and casual gaming brand, we debut the new Tatsunoko VS. Capcom Arcade FightStick, the first of our highly successful arcade sticks to launch on the Nintendo Wii platform. It retails for $79.99.

For Saitek, our PC and console simulation brand, we introduced the X65F FightStick with force-sensing technology. Simulation enthusiasts want products that best replicate reality and theX65F is the first time force-sensing has been used on a simulation product. So it is effectively a fight stick with no moving paths just like the real fight stick in an F-16 or F-22 fighter jets. The X65F retails for $400.

For Cyborg, our hardcore PC and console gaming brand, we unveiled a range of Cyborg gaming mice. Similar to a Herman Miller designed chair, every surface you touch is adjustable, our first for a mouse. The design is derived from Cyborg’s heritage of ergonomic and adjustable flight sticks, a niche market, and applies the same concepts to mice, a significantly larger market. The mice come in four configurations with prices ranging from $50 to $130.

Last but certainly not least, for Eclipse, our PC input device brand, we introduced a wireless backlit keyboard packed with first [ph], including a programmable touch-panel resembling that of an iPhone screen. The keyboard comes in two configurations and will retail for $80 and $130 respectively.

We believe our product line up is the best in the company’s history and our continued efforts to expand our sales and distribution reach along with our efforts to control costs, position Mad Catz for the future. In particular, we are very excited about the opportunities in the PC space, a $2 billion a year market. We are expanding our footprint in that market with innovative high-end products which affords us a compelling growth opportunity. Our history of only creating products that were quickly marginalized, discounted or copied is just that, history.

In conclusion, our focus remains on achieving near and long-term success, and to that end we will continue to evolve and strengthen our four key hardware brands with a focus on bringing high-value products to market and enhance the gaming experience. Mad Catz’s , our console and casual video gaming brands; Saitek, our PC and console simulation brands; Cyborg, our hardcore PC and console gaming brands; and Eclipse, our PC input device brand.

Finally, we recently announced the partnership with Teenage Cancer Trust, a charity that funds and develops specialist teenage cancer units at hospitals that enable young people to be treated in a positive age-appropriate environment. To support TCT, we are currently hosting an auction on eBay of two Mad Catz’s Rock Band Fender Strato Electric Guitars; guitars which have been signed by the charity’s patron, Roger Daltrey, founder and lead singer of the Who, which you undoubtedly saw this weekend during the super ball. We believe TCT is doing very worthwhile work and we are proud to support their efforts. We would encourage all of you to check out the auction and getting on some bidding for this great cause.

That concludes our prepared remarks. I would now like to turn the call back to the operator for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Michael Pachter with Wedbush Securities. Please proceed with your question.

Michael Pachter – Wedbush Securities

Hi guys, I guess I have a question for Darren. I just want to understand better your positioning of the Cyborg and Eclipse products. You talked high end and then you were talking about the $2 billion market. I assume that means $ 2 billion opportunity for the high-end products. Could you talk to us about who competes for that $2 billion of revenue, what the barriers to entry are, like what kind of shelf space constraints are there, where exactly do we feel we see these products? And then how are you going to drive awareness of your products and differentiate them from whoever the competition is, what kind of marketing spend is that going to require? Thanks very much and congratulations on good quarter.

Darren Richardson

Hi Michael, the $2 billion relates to the entire mouse and keyboard market generally, and it is broken up into a number of different categories. We already have a pretty strong presence in the PC gaming space, which is a sub-section of that market. And a lot of the things that we are doing on PC gaming products are really bleeding edge technology. So if you look at something like our new Cyborg mouse, it is using 5,600 dpi processor, which is absolutely as fast as you can go today.

Now what we are doing is then sort of stripping some of that sort of very, very, very leading-edge stuff back and restyling things into a very nice up-market line of mice and keyboards. The keyboard that we are talking about in particular for the Eclipse line which is more the executive home or office product is packed with a whole bunch of things that have never been done before, and this using technologies that we are really bringing out of things that we have been doing on slides [ph] in for some time and then implementing those into categories that are much more mass market.

So I think you will see distribution on those products going through most of the major PC mass market channels, for example Best Buy, Dixons in the UK, Fnac and so forth in France, as well as the online retailers who are gaining a bigger presence in that space like Amazon. So given the unique nature of the product and how most of those things are very innovative, we feel pretty confident that we are going to be able to get some placement there.

Michael Pachter – Wedbush Securities

What about competition?

Darren Richardson

Our competition would come mainly from Logitech; it would be the number one player in that sector and a number of other players. But one other thing we are doing is coming in with very unique, very high-end products and so forth. So this is not a matter of battling out at the entry level. And so I think for a lot of those the products themselves are such showcase products that we can start to build some brand and brand personality around the product themselves.

Michael Pachter – Wedbush Securities

Are you getting cooperation at retail, I mean, is Best Buy excited about it, Amazon excited about it?

Darren Richardson

Yes, Best Buy is excited about it, and we expect to see the top of the line backlit keyboard placed at Best Buy and some other retailers.

Michael Pachter – Wedbush Securities

Great. Thanks very much.

Darren Richardson

Yes, thank you.

Operator

(Operator instructions) Our next question comes from the line of Ronald Rotter with RLR Partners. Please proceed with your question.

Ronald Rotter – RLR Partners

Hi, guys, congratulations also on a great quarter. There is clearly a divergence between your results on a relative basis in the US and in Europe, and all the press lately has been of the problems in Europe. So do you have the same confidence level in European sales that you witnessed versus going forward with all of the negative publicity about what’s going on in Europe?

Darren Richardson

Yes, we are actually seeing a couple of different things happening in different markets. Even when you look at Wii performance, for example, in Europe our Wii performance was very strong; in North America, we fell off a fair bit on Wii. So we’ve also had a couple of things in the North American market with some customers, for example Circuit City, that where there last year that have gone away and so forth. So the US has been a little bit more patchy than what we are seeing in Europe. Now in Europe, we just have a lot of full head of steam going on a lot of different things. We have just opened an office in Barcelona and going direct in the Spanish market where previously we were through a distributer and so forth. So we are actually seeing the European market move well. The other thing is last thing on the top line just with exchange rate conversion we had sales deflated as a result of that. So we’ve got a little bit of an advantage in the comparison with just having the exchange rate change out on that one.

Ronald Rotter – RLR Partners

Call of Duty. Modern Warfare clearly was a big, big product for you in North America and I think in Europe also in the quarter. Could you give us just a rough idea did that represent Call of Duty related products, is that as much as 10% of revenues in the quarter?

Stewart Halpern

It’s certainly safe to say that was a significant factor but it certainly wasn't the growth driver. As you know we don’t typically disclose individual product sales, but it was very meaningful, but certainly was not the preponderance of our growth.

Ronald Rotter – RLR Partners

Okay. Can you give us any guidance for the fourth quarter, whether a possibility of it being in fact profitable in the fourth quarter?

Stewart Halpern

Well, you know that (inaudible), Q4 is always a challenge to break even, this is probably due to the seasonality of the business in general as well as the product release schedule. I don’t think that Q4 this year is going to be dramatically different than history that we are going to maintain the discipline on the cost side. So we are hopeful, but we don’t want to create any expectations that it can be meaningfully different than the trend.

Ronald Rotter – RLR Partners

Okay. Great, thank you.

Stewart Halpern

Thanks.

Operator

(Operator instructions) Mr. Richardson, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Darren Richardson

Okay, thanks a lot. I’d like to conclude the call by thanking all you for your participation on today. I’d also like to take this opportunity to express just how proud I am of the organization and the tireless dedication of everyone at Mad Catz. We look forward to continuing our dialog with you and reporting on our fiscal 2010 performance in the coming months. In the interim, if anyone would like to schedule a call with our investor relations firm, Jaffoni & Collins, they can be reached at 212-835-8500. And look forward to talking to you soon. Thank you.

Operator

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

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