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Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F1Q11 (Qtr End 06/30/10) Earnings Call Transcript

August 5, 2010 5:00 pm ET

Executives

Norberto Aja – IR, Jaffoni & Collins, Inc.

Darren Richardson – President, CEO and COO

Stewart Halpern – CFO

Analysts

Ronald Rotter – R.L.R. Partners

Jeremy Levine – Mindscape Trading

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the fiscal 2011 first quarter 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, August 5, 2010.

I would now like to turn the conference over to Norberto Aja, investor relations for Mad Catz. Please go ahead sir.

Norberto Aja

Thank you, operator, and good day and welcome to the fiscal 2011 first quarter Mad Catz conference call. With me on the call today are Darren Richardson, Mad Catz’s President and Chief Executive Officer, along with Stewart Halpern, Mad Catz’s Chief Financial Officer.

Darren will provide an overview of the results and also comment on the drivers behind them. Afterwards, Stewart will review the financial results in greater detail, and discuss some of our operating goals going forward. Darren will then close the call with some thoughts on the outlook for our sector in the balance of fiscal 2011.

However, before we begin, let me just – 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 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, as well as 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 web cast include 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 call me at 212-835-8500.

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

Darren Richardson

Thank you, Norberto. Good afternoon, everyone, and thank you for listening today. Earlier today, we announced fiscal 2011 first quarter results. The fiscal first quarter is seasonally our weakest sales quarter of the year, and this year we had a comparison due in part to the success of our Street Fighter product line in the same quarter last year. However, we continue to believe we can meet or exceed our previously stated goal of high single-digit revenue growth in fiscal 2011 relative to the record $119 million of net sales in the fiscal year ended March 31, 2010.

As I mentioned on the last call, there are a number of very positive factors that will affect the years [ph] in our first quarter, including the acquisition of TRITTON Technologies, our new gaming audio line, the launch of Rock Band peripherals and bundles under our agreement with Harmonix, our Call of Duty Black Ops license agreement with Activision, together with the ongoing launch of the strongest portfolio of new products in Mad Catz’s history. We believe, we will start to see the benefits beginning in our fiscal second quarter.

With that, let me turn the call over to Mad Catz’s CFO, Stewart Halpern to review our financial results for the quarter. Stewart?

Stewart Halpern

Thank you, Darren. Net sales for fiscal 2011 first quarter decreased 11% to $19.9 million from $22.4 million in the fiscal 2010 first quarter. As Darren mentioned, decrease in overall sales was primarily due to the difficult comparison versus last year, which included very strong follow on sales of Street Fighter 4 based accessories. Also contributing to the decline were lower sales on the PC and hand-held platforms.

The decline in PC platform sales was due in large part to end of life product issues as reviewed last quarter. We continue to believe our recent new product releases will reverse this, but the timing and volumes of the new R.A.T. and Eclipse products shipped in Q1 weren’t yet sufficient to offset the trend. Sales of products for handheld products were down primarily due to not having a catalyst this year to match the boost in the category last year from the launch of Nintendo DSi.

These declines together were partly offset by the inclusion of one month of sales from our acquisition of TRITTON, and we are optimistic about the go forward contribution we believe we should see from the addition of those products to our line-up. I also like to point out for context that our trailing four quarters revenue of $116.5 million versus $111.8 million of Q1 last year is the highest total in the company’s history.

Looking into our sales for the quarter in greater detail. North American net sales decreased 25.3% to 10.8 million in fiscal 2011 first quarter, representing 54% of quarterly net sales, compared to 61% in the prior year period with this territory being hardest hit by the factors previously mentioned.

European net sales rose 15% to 8.3 million in the fiscal 2011 first quarter, and represented 42% of quarterly net sales compared to 32% in the prior period. The increase in European net sales was driven by successive sales of third-party products on a distribution basis.

Net sales to other countries increased 18% to $0.8 million in fiscal 2011 first-quarter, representing 4% of quarterly net sales compared to 3% in the prior period. The increase in sales was mainly driven by increased sales penetration in Asia. Looking at sales by platform, products for the Xbox 360 accounted for 31% of sales, or 6.2 million in the first quarter, up 13.8% decline versus 7.2 million in the respective prior year period, mainly related to the negative comparison on Street Fighter products mentioned above.

PlayStation 3 products accounted for 24% of sales or 4.8 million, an increase of 12.4% versus $4.2 million in the respective prior year period. Wii products represented 10% of sales, or $2 million in the first quarter this year, 11.2% increase versus the $1.8 million in the prior year period. For the reasons previously mentioned, PC product sales declined 31.2% to 3.4 million, or 17% of sales compared to the prior year period. While handheld platform products also for reasons previously mentioned, declined 61.9% to 0.6 million or 3% of sales in the fiscal 2011 first quarter.

All other platforms, including older generation consoles accounted for 15% or $3 million of fiscal 2011 first-quarter sales versus 12%, or $2.7 million in the comparable period last year. Gross profit margin improved to 29.9% as compared to 28.4% in the first quarter last year, largely due to product mix. Foreign currency translation had a negative impact on gross margin this quarter of approximately 160 basis points versus last year. Gross profit dollars fell 6.5% to $5.9 million from $6.4 million in the same quarter of the prior year.

Total operating expenses for the first quarter of fiscal 2011 rose 5.7% to 6.8 million, resulting in an operating loss of 0.8 million compared to an operating loss of 0.1 million in the comparable prior year period. This was in line with our expectation as we continue to make select ROI focused investments in marketing, as well as expansion of our R&D capabilities, primarily in Asia, to support our enhanced new product development efforts.

Operating expense for the quarter also takes into account higher accrual for bonuses, and one month of operating expense for TRITTON. Foreign-exchange loss for the first quarter of fiscal 2011 totaled $0.2 million compared to a foreign-exchange loss of $0.3 million for the comparable prior year quarter. Reflecting income tax expense of $0.2 million versus the prior year benefit of $0.2 million, we reported a net loss of $1.3 million in the quarter ended June 30, 2010, resulting in a loss per diluted share of $0.02, matching last year’s loss also of $0.02 per diluted share.

EBITDA decreased to a loss of $0.3 million in the fiscal 2011 first-quarter compared with EBITDA 0.7 million in the comparable prior year period. A few highlights from our balance sheet. Bank debt net of cash increased to $10.6 million from $9.4 million the prior year. Note that the bank balance on June 30 this year is net of approximately $1.1 million of cash deployed for the TRITTON acquisition.

Inventories were 23.9 million at June 30 this year, up $3 million from last year, primarily due to inclusion of the TRITTON inventory. Inventory turns on a trailing four quarters basis was 3.6 times, down modestly from 3.8 times at this time last year. Accounts receivables of $14.4 million were up versus $13.2 million last year due to timing differences, but our gross DSOs continued to decline and were 54 days versus 59 days in the year ago period.

For those interested in cash flow, net cash used in operating activities in the period were $7.2 million driven by investment in inventory. And following up on our comments from our prior earnings call in which we offered some perspective on the full fiscal year, as Darren noted, we continue to believe we will meet or exceed the previously stated target of organic sales growth in the high single digits for fiscal year 2011, with gross margins in the very high 20% to low 30% range, operating expense growth below that of sales growth, and a fiscal year tax rate in the range of 30% subject to fluctuation based on the distribution of earnings among the various territories in which we do business.

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

Darren Richardson

Thanks Stewart. Although economic and sector challenges remain, the video game industry outlook appears positive for the back half. For Mad Catz, we believe, value is going to start in our fiscal second-quarter, and we remain optimistic about the full-year outlook. Our focus remains on building our key brands by bringing high-value products to market that enhance the consumer experience.

Mad Catz, our casual videogame brand; Cyborg, our hard core PC and console gaming grand; TRITTON, our gaming audio brand; Saitek, our simulation brand; and Eclipse, our PC input device brand. By way of example, our recently released Cyborg gaming mouse is featured on the front cover of Maximum PC magazine. It scored a 10 out of 10 rating, declaring it as the best gaming mouse ever. Maximum PC also selected it as the gaming mouse for their esteemed dream machine gaming PC build, which they run once a year. It was also on the front cover of Popular Science magazine’s best inventions of 2010 edition, and that is to name a few.

We are delivering the best products in Mad Catz’s history. Consumers, critics, and reviewers are responding enthusiastically, and we believe this will continue to position Mad Catz for sustainable profitable growth.

That concludes my prepared remarks for the day. I will now turn the call back to the operator for questions. Operator.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We have a question from the line of Ronald Rotter with R.L.R. Partners. Please proceed.

Ronald Rotter – R.L.R. Partners

Hi, guys. A couple of questions, one, you mentioned sales from the one month of TRITTON Technology. Could you give us any further edification – was that a meaningful number, or could you give us any idea what that number might have been?

Stewart Halpern

Yes, we have not specifically disclosed TRITTON. It was a very helpful contribution. It was a noticeable contribution. It was not an incidental contribution, and as we said on the call, we are optimistic about contribution going forward. I think we talked about in the last call, at the time of acquisition that the gaming audio sector is the fastest growing sector in our industry. So we continue to look for…

Ronald Rotter – R.L.R. Partners

Okay, without telling us what the number was, I mean, the crust of this was only, like, $1 million, $1.4 million plus an earn out, or a sell-out, or whatever you want to call it, but was there – but you only had one month of sales in the quarter. Was there anything kind of oddball about that one-month sales figure, that it was a meaningful contribution, or was whatever number you saw in the month of June – is that something that we should see that type of number going forward on a regular basis? I mean, did you have a one-time order that–

Darren Richardson

I think the way to think about it is the sales for TRITTON for the year prior was about – prior to acquisition was $8 million loosely. And so for that month, we are pretty much on the standard run rate that we are having at that $8 million, although the category is growing. However, as we move forward, we are starting to increase distribution and in July and August we are rolling out some additional retail accounts here in North America.

Ronald Rotter – R.L.R. Partners

So – okay…

Darren Richardson

So, we got contribution, but it is really going to be Q2, Q3 and on into Q4 that we really start to see some meaningful sales.

Ronald Rotter – R.L.R. Partners

Okay. So the sales in June of this year weren't anything unique, any more than they were June of last year?

Darren Richardson

Correct.

Stewart Halpern

No, one time load in type of things.

Darren Richardson

It is absolutely in line with where the sales trend was running.

Ronald Rotter – R.L.R. Partners

Okay, and for the first time that I can remember, and correct me if I'm wrong, though, in the callout of the earnings report, you talked about the impact of foreign exchange rates on gross margin, and that was a pretty meaningful number. Is – was there anything unusual in this quarter in terms of currency that had you call it out this quarter, as opposed to other quarters or am I mistaken, have you called it out in other quarters?

Stewart Halpern

With all due respect, we have already talked about that a bunch, particularly over the past year and a half, when there was some pretty dramatic currency fluctuation, and so because we have called it out in the past, we also wanted to reference it this time. Also, if you recall on last quarter’s call, in talking about the year going forward, we made reference to – I can’t recall it was in response to a question or not, but given where the decline – the strengthening of the dollar relative to the prior year, we of course saw that there would be some currency impact.

Now the dollar has weakened again, so we think going forward we should get some of that back. But those are all the reasons that we called it out. There was nothing unusual.

Ronald Rotter – R.L.R. Partners

Okay, and the inventory increase, how do you feel about inventories? Are they at an acceptable level, or are they higher than what – since inventories did increase at a higher rate than sales, and I know you have a bunch of new products, so is that pretty much – inventories pretty much on plan, or maybe a tad heavier?

Darren Richardson

No, inventory is pretty much on plan. We have got an inventory build on TRITTON, and so we had a fairly large in transit on the inventory as well. So we had products coming in on the water to ship out in July.

Ronald Rotter – R.L.R. Partners

Okay, and then the other question, are you guys getting beat up on these international container rates that everybody else seems to – or have…

Darren Richardson

Yes, no question, inbound shipping remains something that is going up quite substantially. Hopefully, we don’t see this as a material impact on the margin, but certainly it will be a little ding in the margin.

Ronald Rotter – R.L.R. Partners

Okay, great. And, I guess, finally, the launch of these products, a bunch of new products, are the timing – is that going to hit the second quarter, or is that mainly third-quarter impacts with all of these new launches with the new products?

Darren Richardson

We are definitely going to see second quarter impact, because they are really starting to ramp up some of the TRITTON sales here in North America on the second quarter. And then we will also have some of the first Rock Band shipments heading out in the month of September. So, how much – the Rock Band launch is October 26, so it is really going to come down to what shipments leave that last week or two of September, and how much of that flips over into the first week or two of October. But, we will be moving a fairly substantial amount of product there. So that is definitely going to impact Q2.

Ronald Rotter – R.L.R. Partners

Okay, great. Thank you.

Darren Richardson

Thanks Ron.

Operator

(Operator instructions) We have a question from the line of Jeremy Levine with Mindscape Trading. Please proceed.

Jeremy Levine – Mindscape Trading

Hi. I just want to know, have you – has the Cyborg mouse started shipping, and can you tell me how – that seems to be a very well-reviewed product, how have you seen the sales trends in that, and when do you expect that to be a meaningful contribution?

Darren Richardson

The Cyborg mouse is shipping. You will see it listed in a lot of online sites. We don’t have significant bricks and mortar placements, mainly due to the timing of the launch, and the way bricks and mortar retailers do actual resets of products. It is a fairly regimented period. The reviews have been fantastic, sales have been very solid, and right now you will notice that on Amazon, or bestbuy.com, I think gamestop.com, and even madcatz.com we are actually sold out of pretty much of everything we have made.

We are doing a fairly gradual build on that product to make sure that everything is absolutely rock solid with it and to date, we have had absolutely no issues or negative feedback on any aspect of the product. So, sales have been good, but it is not major, but we are really ramping that up at this stage. So, it will definitely make an impact to our Q2 sales.

Jeremy Levine – Mindscape Trading

And what do you expect the run-rate for that product to be once you get (inaudible)?

Darren Richardson

Yes, we never breakout like individual products for competitive reasons, but I think if you look the way that is rated, I mean almost every single PC gaming publication has put it on the sort of 10 out of 10, 5 out of 5 best gaming mouse ever. And so from that, I would expect it to take a significant market share in the whole PC gaming space, and that is a significant market segment.

Stewart Halpern

With hopes that it crosses over into a broader market, because it is just simply a really cool product with a lot of great functionality.

Darren Richardson

I think there is going to be the consumer out there that really enjoys beautiful engineered products that will pick that up because it is very iconic.

Jeremy Levine – Mindscape Trading

I guess I have one more question. In reading the industry kind of – or the reviews of your products, which have been very good lately, people seem to say, very frequently, "Despite this being a Mad Catz product, it's of very good quality." How fair is it to say that you had some quality issues in the past? And have you addressed them, and how are you addressing them?

Darren Richardson

I should think it refers more to the – I mean, people talk about quality, and you have to sort of define what quality is, if you go back five years ago, and certainly before that, Mad Catz business was delivering value priced products into the console gaming space. The console gaming space, you know, 5 to 10 years ago was in that sort of $20 to $30 price point. The Sony controller for example, was $25, and then Mad Catz was a value alternative at $15.

Over the last five years, we have really been working on a transformation of the entire product line to evolve out of that value priced product range, where you have got average wholesale selling prices in and around that $10, and moving right up to now, where we have these beautiful products that are selling at $100, $130, the Street Fighter products, which have been very successful for us at around the $150 price point, an increasingly you see products when they do come into short supply turn up on Ebay with a substantial premium.

And so I don’t personally believe that it is so much referring to quality that Mad Catz made bad products in the past that were bad quality, it is just that we were servicing a very different market segment, and a market segment that was about delivering value to a value conscious consumer. And so the company has gone through quite a transformation, and all of those comments, while you can take it as a negative that Mad Catz used to produce products that weren’t great quality, what they are really trying to say is Mad Catz was better known for value priced products, and today we’re doing products that are grabbing people’s attention.

I don’t think there’s any question about that. People are going, wow, that is super cool. And frankly, they are not products that Mad Catz 3, 5, 10 years ago. We were very much a value alternative to a lot of the other first party products in the market. So I don’t personally see it as a reflection on quality, and whether things last or don’t last, we delivered a lot of value to a lot of consumers, and I think if you look at where our sales have been, I mean, I got involved in Mad Catz 10 years ago, when it was down around a $50 million company. Today we are at $120 million, and we didn’t get there by producing products that don’t function.

We got there by delivering products to consumers, increasing all over the world now, because in almost every market we deal in where we are regarded as one of the top deliverers of product in this category, have voted to say there is demand for the product. So, personally, I think we have definitely stepped up the kind of products we are doing. But I don’t think that negatively reflects on the products that have been done in the past. I think everybody here has always put a lot of heart and soul into the products, and personally I am proud of the products we did five years ago though it targeted a different consumer segment than what the products we are doing today.

Jeremy Levine – Mindscape Trading

Just one quick follow-up on that. What would you say your mix revenue was now, is between, call them, like proprietary type products versus, like, the value-added products, like the ones you sell – the private-label ones for GameStop, and the like?

Stewart Halpern

This doesn’t directly answer the question, but directionally it does, and that is in the past 2 to 3 years, we have about doubled the ASP on our products. So, I think that speaks to the point that Darren was making about that we have really – in our product portfolio, we have been selling much more higher end kind of product. So that doesn’t give you the exact breakdown you are talking about, but directionally I think it tells you how far the company has come.

Jeremy Levine – Mindscape Trading

And that still continues in an upward fashion?

Darren Richardson

Correct, yes. And it is not that we have totally abandoned the value product. I think the value product is still a nice piece of business. It is an important piece of business. We have a lot of placement in that business, and we are definitely not walking away from it. However, without having wireless control pads to Xbox 360 and some of the limitations that come about as a result of the next generation of consoles; it has forced us to innovate as a company.

It has forced us to grow, and frankly I think it has been healthy. And I think the company is a stronger, more resilient company, producing products that I think have much, much longer life spans today than the business that we were in about five or six years ago. So, I think what we’re looking at is a transformation of the company. People can see the difference, and that is a really positive thing.

Jeremy Levine – Mindscape Trading

Great. That's very helpful. Thank you very much.

Darren Richardson

Thank you.

Stewart Halpern

Thanks.

Operator

And we have no further questions from the phones at this time. I like to turn the call back to Darren Richardson.

Darren Richardson

Thank you all for joining us on the call today, and I look forward to updating you on our Q2 results when they come up later this year. Thanks a lot.

Operator

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

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