Mad Catz Interactive, Inc. (NYSEMKT:MCZ)
F4Q10 (Qtr End 03/31/10) Earnings Call
June 10, 2010 5:00 pm ET
Norberto Aja – IR, Jaffoni & Collins, Inc.
Darren Richardson – President, CEO & COO
Stewart Halpern – CFO
Sean McGowan – Needham
Ronald Rotter – RLR Partners
Ladies and gentlemen, welcome to the Mad Catz fiscal 2010 fourth quarter and full-year results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we’ll conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded, Thursday, June 10, 2010.
I would now like to turn the conference over to Norberto Aja. Please go ahead, sir.
Thank you, operator. Welcome to our fiscal 2010 fourth quarter and full year results conference call. With me on the call today are Darren Richardson, Mad Catz’s President and Chief Executive Officer; and Stewart Halpern, Mad Catz’s Chief Financial Officer.
Before we begin, however, let me just take a few minutes to read the Safe Harbor language. On today’s discussion it 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 the 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 the 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 the members of the investment community. If you are interested in meeting with Mad Catz’s management, please don’t hesitate to contact me at 212-835-8500.
I would now like to introduce Mr. Darren Richardson, President and Chief Executive Officer of Mad Catz. Darren?
Thank you, Norberto. Good afternoon, everyone, and thank you for joining us on the call. Earlier today, we announced our results for the fiscal fourth quarter and full year 2010, which reflect record sales for both periods.
On today’s call, I’ll provide an overview of our fourth quarter and fiscal 2010 results. Then Stewart will review our financial performance and discuss some of our operating goals going forward. Afterwards, I’ll provide an update on our new product development initiative and provide some thoughts on the outlook for our sector in fiscal 2011.
We’re pleased we delivered strong Q4 results to cap off what is arguably the best year in the Company’s history. The quarterly and annual results set or match records on a number of key criteria and 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 and the world economy.
Fiscal 2010 delivered another year of record sales and we continue to leverage that top-line performance all the way down through the income statement. We exceeded our fiscal year target of reducing operating cost by over 10%.
The sales growth, gross margins, and vigilance on cost delivered strong results on gross profit, operating income, net income, earnings per share and EBITDA for the quarter and the fiscal year.
But the most telling numbers to me are the bank loan finishing the year at $3.8 million and the cash at bank of $2.2 million resulting in a net loan balance position of $1.6 million, down markedly from $17.4 million as of December 31, 2009 and $10.4 million at the same time last year at March 31, 2009. Everything we do at the company is ultimately aimed at increasing earnings and free cash flow and our fiscal 2010 results demonstrate that’s what we are doing.
With that let me turn the call over to the Mad Catz CFO, Stewart Halpern to review our financial results for the quarter and the fiscal year-end. Stewart?
Thank you, Darren. As Darren mentioned, we are very pleased to be reporting record fourth quarter and fiscal year revenue for the second consecutive year. Sales for Q4 this year were $26.3 million, up 15.4% from $22.8 million in Q4 of last year.
During the Q4 period we increased sales in each of North America, Europe, and rest of world territories and benefited from the release of our suite of new FightingSticks and FightPads for the latest iteration in the Capcom Street Fighter franchise, Super Street Fighter II, as well as continuing strength across a range of core products. Sales for the full year of fiscal 2010 were $119 million, an increase of 5.7% over fiscal 2009.
For the year strong gains in European sales, which were up 18% year-over-year offset flat sales in North America and lower rest of world sales, which were down 500,000 or 12%. North American sales in the year were hurt by negative comps on the Wii platform wherein we had no releases of Wii products that matched the success of U.S. sales of Wii Fit accessories in fiscal '09 as well as negative comps on the PC platform where we were hurt by a lack of new product releases and aging of the current product line.
As Darren will elaborate on in a minute, for fiscal 2011, we have an exciting group of new products launching for the PC platform among other new products. So we are confident about our opportunities for the PC platform going forward.
Additional data on sales by region, platform and product category is included in the press release and the 10-K. But I just wanted to give you some of the highlights. Also relating to sales, I’d like to mention that during the fiscal year, we established a representative office in Spain as well as hired a Vice President of Sales for the Asian region. So we continue to build out what we believe to be a very powerful global sales capability.
Gross profit dollars in Q4 of this year rose 30% to $7.1 million from $5.4 million in the same quarter of the prior year. And for the full year increased 13.7% to a record $36.4 million from $32 million in the prior fiscal year. Gross profit margin for Q4 was 26.9% versus 23.9% in Q4 of fiscal 2009 with approximately two percentage points of the increase relating to foreign currency translation.
Gross margin for the year was 30.6% compared to 28.4% in fiscal 2009 with most of the improvement relating to a mix of operating leverage we get from the fixed cost components of our COGS, as well as lower freight costs, particularly, a lower level of air freight versus last year. Foreign currency translation had a negative impact on our gross margin in fiscal 2010 of less than 0.5.
Total operating expenses in fiscal 2010 were $28.2 million compared to $31.6 million, exclusive of the $27.9 million goodwill impairments in the prior fiscal year. This is a reduction of 10.7% and consistent with our previously stated goal of reducing our operating costs by no less than 10% for the year.
For the quarter, total operating expenses rose 31.6% to $6.3 million from $4.9 million last year, with the increase coming from higher sales costs consistent with the increase in sales, bonuses for achieving financial targets and some incremental investments in sales and R&D capabilities.
Operating income for Q4 of this year was $744,000 versus breakeven, exclusive of the impact of goodwill impairment adjustments last year. And operating income for the full fiscal year of 2010 was $8.2 million versus a negative $0.4 million exclusive of the impact of goodwill impairment in fiscal 2009.
For the quarter, we recorded a gain of $0.1 million compared to foreign exchange loss of $1.3 million in the fiscal 2009 fourth quarter. Foreign exchange loss for fiscal 2010 was $0.3 million versus a loss of $0.5 million in the prior year.
Interest expense for Q4 this year was approximately flat with last year at $0.6 million. And for the year, interest expense was $2.2 million this year versus $2.1 million last year. Other income in Q4 was approximately flat with last year at $0.1 million and down for the year at $0.3 million this year versus $0.4 million in fiscal 2009.
In Q4 this year, we had a tax benefit of $0.1 million versus tax expense of $2.5 million in Q4 of fiscal 2009, resulting in net income of approximately $1 million or $0.02 of EPS in Q4 of fiscal 2010 versus a net loss of $3.7 million or negative $0.07 EPS last year in Q4.
For the full year of fiscal 2010, we recorded tax expense of $1.5 million versus $2.9 million in fiscal 2009, resulting in net income for fiscal 2010 of $4.5 million or $0.08 per diluted share compared to a net loss of $32.6 million or $0.59 per diluted share in the prior fiscal year which results include the goodwill impairment.
Adjusted EBITDA increased over 150% to a record $11.9 million for the full year fiscal 2010 from $4.5 million in fiscal 2009. For the fourth quarter, EBITDA this year was $1.7 million compared to an EBITDA loss of $0.3 million in the prior year period. As you can see, we’re able to successfully grow sales, while operating the business more efficiently, and brought that growth to the bottom-line where it counts most.
Moving to the balance sheet, we find ourselves in a more solid position as we reduced our net position of our bank loan less cash at March 31st 2010 to just $1.6 million compared to $17.4 million as of December 31st 2009. In addition, we are able to do this while paying down our note payable related to the Saitek acquisition by $1.5 million during the quarter.
Couple of additional notes on the balance sheet. We continue to strive for a disciplined approach to our working capital management and are pleased that year-end inventories are down, albeit modestly from $17.8 million at March 31, 2009, to $17 million at March 31, 2010, a decrease of approximately 5%.
Inventory turns for the year were improved to 4.76 times for fiscal 2010 versus 4.26 times last year. In addition, we continue to improve on our AR DSOs with gross AR DSOs down to 63 days in fiscal 2010 from 66 days in fiscal 2009.
Now for those of you who have followed Mad Catz over the years, you know that we have not given formal financial guidance, but we do want to help members of the investment community understand the opportunities we foresee for the business. Accordingly, we’d like to offer the following perspectives based on our current outlook.
Our budget anticipates net sales growing on an organic basis at a high single digit rate of growth for fiscal 2011. As far as gross margins, if fiscal 2011 currency exchange rates were at fiscal 2010 levels, we would expect our gross margin to be in the same range as in fiscal 2010. In other words, the very high 20% range to the low 30% range. However, if freights remain at levels we see today, we could see several gross margin points of downside to fiscal 2010 levels.
On an organic basis, operating expenses should grow at a mid single digit rate as we selectively continue to make certain investments expected to show positive return on investment. On top of that we will take on a modest amount of operating cost. And I emphasize the word modest from the TRITTON acquisition.
We expect our normalized tax rate in fiscal 2011 to be in the low 30% range, subject to fluctuation based on the distribution of earnings among the various territories in which we do business.
Hopefully, that will provide some helpful perspective for those of you who are trying to quantify the direction of our business.
In closing, we are pleased with the strong results we’ve delivered and our strong product pipeline. Together with our continued focus on execution in cost management, we believe we are well-positioned for growing value for our shareholders.
As a final note, I encourage members of the investment community to come see us at E3 in Los Angeles next week. Meetings can be arranged by contacting Jaffoni & Collins or you can stop by our booth.
I’d now like to turn the call back to Darren for closing remarks. Darren?
Thanks, Stewart. Looking forward to fiscal 2011 I think there are many reasons to be apprehensive. The world economy appears to be improving yet remains uncertain and even the video game industry is being soft. As we’ve pointed out in the past, we are exposed to a multitude of exchange rates and the continued strength of the U.S. dollar has the potential to be a significant headwind for our European business for the foreseeable future.
We conduct a large part of our business in China, where we face similar exchange rate exposure as well as the potential for cost increases as a result of increasing labor cost. However, we’re coming off the back of the worst economic crisis we’ve seen in our life time and during that crisis we’ve been able to grow the business, improve profitability, and generate cash.
On the last call I mentioned that we announced the strongest portfolio of new products in Mad Catz’s history at the Consumer Electronics Show in January. The level of consumer and media interest in those products continues to be unprecedented and the reviews overwhelmingly positive. Those products are now shipping. And although they won’t have a meaningful impact in the first quarter of fiscal 2011, they are expected to make a positive contribution for the year.
We’re also excited about the potential impact of a number of announcements we have made subsequent to the end of fiscal 2010. I’d like to highlight three of them in particular.
First, we recently signed a multi-year licensing agreement with Harmonix Music Systems to become the principal peripherals partner for the Rock Band franchise. Harmonix has given Mad Catz the North American and European rights to produce and distribute Rock Band music video game controllers for future Rock Band releases, including a Rock Band 3 game, which we expect will launch ahead of this holiday season.
Second, we recently acquired TRITTON Technologies, a privately help provider of gaming audio headsets, high performance multimedia consumer electronics and computer peripherals. The gaming audio headset space is one of the fastest growing segments in the video game industry, largely due to the success of online games like Call of Duty-Modern Warfare 2.
The TRITTON brand and products are highly regarded by hardcore gamers and we believe we can successfully leverage Mad Catz’s distribution network and license properties to drive sales growth.
Third, we recently signed an extension of the license agreement with Activision to create accessories for the next iteration of the Call of Duty franchise. Call of Duty Black Ops scheduled to launch in November 2010.
In conclusion, our focus remains on building our key hardware brands by bringing high value products to market that enhance the gaming experience. Mad Catz, our console and casual video gaming brand; Saitek, our PC and console simulation brand; Cyborg, our hardcore PC and console gaming brand; Eclipse, our PC input device brand; and now TRITTON, our gaming audio brand.
We are delivering the best products in Mad Catz’s history. Our customers are responding enthusiastically. And our results are highlighting the value of the initiatives that continue to position Mad Catz for sustainable profitable growth.
That concludes my prepared remarks for today. I’ll now turn the call over to the operator so that we can answer any questions. Operator?
Thank you. (Operator instructions) And our first question comes from the line of Sean McGowan with Needham. Please proceed with your question.
Sean McGowan – Needham
Thank you. Actually, two parter; one is a housekeeping and the other is a bigger picture. So on the taxes in the fourth quarter, I may have missed it in your comments, Stewart, but what was it that drove the benefit in the fourth quarter and are there any unusual things that we should look forward in the upcoming year regarding that? And then bigger picture, he risk of sounding like I’m (inaudible) here, we’re going to hear a lot next week about controller-less environment. So what does the company that makes a lot of money selling controllers feel about the industry moving towards bodies being controllers? And what might be your place in that ecosystem? Thanks.
Hi, Sean. It’s Stewart. Thanks for the question. In Q4, as you know, you kind of do a true-up of your tax for the year and just pick a variety of moving parts, transfer pricing between our different entities being one of them, where we completed a transfer pricing studies. It really ended up being a true-up where to get a little bit more technical, some of the income we had booked in our Asian entity was shifted to the U.S. where we have some NOLs. And so that’s why we ended up getting the tax benefit and the true-up for Q4. As I mentioned, on a go-forward basis, we probably see a more normalized rate in the range of 30% to low 30s.
And then in regard to the second question on Natal, I think Natal is a really exciting thing for the whole video game space, because it adds an entirely different element to game play. And so it’s going to be interesting to see how that’s incorporated.
In terms of the impact on gaming generally, there is an awful lot of gaming that quite simply won’t be replaced by Natal. So I see Natal as additive to the overall gaming experience. An example of that would be the Rock Band products that we are doing for this year, air guitar is fun but an actual guitar is actually more fun again and some of those sorts of nuances. And for people who are more in the kind of hardcore part of the market or even more just a lot of the general game play, playing Call of Duty with a control pad is absolutely fine. And although it's possible to actually hold a gun up and point out at the TV in a Natal system and play a game, it's very difficult to physically do that for more than about five minutes or 10 minutes at a time depending on his fitness.
So to the extent that the video games are relaxing couch activity. They will probably remain a relaxing couch activity, and we see the Natal project as an extension to games, and also a way of actually spicing up some of the existing game content. For Mad Catz, we’ll actually have some Natal products and they are more of the sort of general accessory line, but there are things that you can do in and around Natal that also add to the experience.
Just one final point to elaborate. If you look at the trend over time, so “standard controller” over time has become a less of a percentage of our business. At this point if you look in our disclosure, you’ll see that for fiscal 2010, 28% of the business was what we call the kind of the controller segment and so there is a full 72% of the business that is non-controller.
Sean McGowan – Needham
Great. Thank you. Both answers are helpful.
Thank you. And our next question comes from the line of Ronald Rotter with RLR Partners. Please proceed with your question.
Ronald Rotter – RLR Partners
Hi, guys. A great year and a great fourth quarter. Little surprise on seeing the meaningful reduction in debt; no reduction in interest expense. I don't know; maybe you paid most of that debt down at the end of the fiscal year. Maybe you could give us some guidance on what we should look for in terms of interest expense in the coming year. And my guess is, hopefully, that will offset what, all things being equal, will be a reduction in gross margin dollars.
Thanks, Ron. This is Stewart. As you probably know pretty well, there’s some significant seasonality in our business. And so what happens is that we go through the beginning part of the year seasonally not strong in terms of cash flow generation. We get into the holiday season where we’ve got peak inventories. We do a big portion of our sales in our fiscal Q3 and we don’t get those receivables paid down until Q4. So the skewing of the seasonality is such that we actually do have a reasonable debt balance through the year as you saw through this year. But then, when you get that big sales boost in Q3 and collect the receivables in Q4, you get a lot of cash coming in.
So, just to give you some perspective on that, in terms of free cash flow, for the year we were a little bit over $9 million in free cash flow. If you look at the free cash flow in Q4, the free cash flow in Q4 was like $16 million plus. So it’s that seasonality that really impacts your interest costs.
Ronald Rotter – RLR Partners
Yes, but you had the same seasonality last year where you ended the year with significantly more debt.
Yes, but we have significantly improved sales and financial performance. But the debt balance across the year, Q4 aside, was not meaningfully different. Really it is the cash collections in Q4 that bring balance down. But to the extent that you have the balance through the year, you get that interest rate; the interest cost built up for the first three quarters of the year.
Ronald Rotter – RLR Partners
So should we look for debt to creep back up as the year goes on next year?
Again, on a seasonal basis, the debt will increase, given that we’re looking for higher sales, as I mentioned, according to our budget, and by the way, we aspire to resulting better than our budget, but our budget suggests higher sales. We’ll have higher working capital needs. So, our peak debt level on a seasonal basis could actually be higher than it was last year, but to the extent we’re successful in the holiday season, we get the collections, we would expect that there would be a similar Q4 cash collection result, the net of which is that even as we grow the business, we think that the interest cost line probably should stay relatively flat.
Ronald Rotter – RLR Partners
Okay. And then on the gross margin, I take it that with currencies where they are today. We should expect a meaningful gross margin hit in the first quarter, is that fair to say?
I think it’s fair to say that, as I mentioned in my remarks, just on a current basis, there’s probably about two points or so of negative growth impact from the foreign currency translation.
Ronald Rotter – RLR Partners
And then one final question, just European business in general. You had very, very strong European business in Q4. Was there any unusual items there in the fourth quarter and what should we expect going forward from just European business?
One of the things we saw was really retailers had a good Q3 and we had a good Q3 as a result. They really came out of Q3 with quite low inventory on hand. So we saw a lot of strong replenishment through that early January period.
Ronald Rotter – RLR Partners
So going forward, what should we look for in terms of European business? I mean everything we read in the headlines and everything would dictate a hit to your European business going forward. Should we expect that with Mad Catz?
At least in terms of what we've seen, I think it’s somewhat country-specific. And so Europe as a whole, we think, there continue to be opportunities to grow the business as we’ve described our overall growth outlook. Clearly, there are some countries in Europe that are struggling. And so I think it’s really more of a country-by-country situation than it is a pan European situation.
Ronald Rotter – RLR Partners
Thank you. (Operator instructions) And Mr. Richardson, there are no further questions at this time. So I’ll now turn the conference back over to you.
Great. Thanks a lot and thank you for everyone for joining the call today. We are looking forward to updating you on our first quarter results coming up in the not too distant future. Thanks a lot.
Thank you. And 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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