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Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F2Q2011 (Qtr End 09/30/10) Earnings Conference Call

November 4, 2010 5:00 PM ET

Executives

Norberto Aja – IR

Darren Richardson – President and CEO

Allyson Vanderford – Interim CFO

Analysts

Ronald Ryder – RLR Partners

Jordan Ku – Yellowstone Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Mad Catz Fiscal 2011 Second Quarter Results Conference Call. (Operator Instructions)

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

Norberto Aja

Thank you, operator, and good morning, good afternoon, everyone and welcome to Mad Catz Fiscal 2011 Second Quarter Conference Call. With me on the call today are Darren Richardson, Mad Catz’s President and Chief Executive Officer, along with Allyson Vanderford, Mad Catz’s Interim Chief Financial Officer.

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

However, 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 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; second 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 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.

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 joining the call. Before we start, I’d like to introduce and welcome Allyson Vanderford, our Interim CFO, who will be joining me on the call today.

Earlier today, we announced fiscal 2011 second quarter and year-to-date results that clearly reflect the top and bottom line benefits of Mad Catz strategy to bring higher value, higher margin products to market. On today’s call, I’ll provide a brief overview of our financial and operation achievements for the quarter and describe the drivers behind the record second quarter net sales, gross profit, net income, EPS and EBITDA.

Allyson will then review our financial performance in greater detail, after which I’ll provide an update on both our product development pipeline as well as some thoughts on the industry and the company’s outlook for the balance of fiscal 2011.

There’s several very positive factors driving the record quarterly and year-to-date net sales, 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, our highly acclaimed Cyborg gaming mice and overall, the ongoing launch of the strongest portfolio of new products in Mad Catz’s history.

While second quarter net sales benefited from initial shipments of TRITTON and Rock Band products, it’s important to note that thanks to our strong portfolio of products across all our brands, we still generated growth on a quarterly basis even if both these product lines were excluded from our sales. Just as important as growing the top line, we’re able to leverage that growth all the way down to through the income statement.

While gross margins were below our 30% target due in part to lower margins on our Rock Band product line, Mad Catz still generated a record second quarter $10.5 million gross profit. Even though a large part of our selling expenses are variable, operating expenses as a percentage of net sales fell by over 9 percentage points to 22.9% contributing to record second quarter operating income, net income, earnings per share and EBITDA.

On a year-to-date basis, we recorded net sales and gross profit and we’re tracking well ahead of the prior year’s net income and EPS, leaving it very well-positioned to improve on fiscal 2010 record results.

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

Allyson Vanderford

Thank you, Darren. Let me begin with a brief review of the income statement. Net sales for fiscal 2011 second quarter were $37.4 million, up 73% from $21.6 million in the fiscal 2010 second quarter. The increase in net sales was primarily driven by sales of audio products, which include TRITTON, the Mad Catz’s PlayStation 3 Bluetooth Headset and distribution of Turtle Beach products in Europe. Additional increases came from the initial shipments of Rock Band 3 products, Cyborg gaming mice and an OEM project for our product that was bundled in with a video game at launch.

I’d also like to point out that with $37.4 million in revenue this quarter; we set a new record for trailing 12 months revenue of $132.4 million.

Looking at our sales in greater detail, North America net sales more than doubled, growing 103% to $24.4 million in the fiscal 2011 second quarter and representing 65% of quarterly net sales. This compares with 56% of sales in the prior year period.

European net sales rose 44% to $12.2 million in the fiscal 2011 second quarter, and represented 33% of quarterly net sales compared to 39% of quarterly net sales in the prior period. Europe had lower growth to North America due to primarily to lower selling of TRITTON and Rock Band products.

Net sales to other countries decreased 28% or a relatively modest amount on a dollar basis to $0.8 million or 2% of quarterly net sales in the fiscal 2011 second quarter, compared to 5% in the prior period. The sales result is due to a difficult comp against strong Street Fighter sales in Japan in the prior year.

Gross profit margin fell to 28.1% from 31.3% in the second quarter of fiscal 2010, largely due to a shift in our sales mix toward Rock Band 3 related products, which carry a lower margin. Also contributing to the decrease in margins is fluctuation in foreign exchange rates compared to the prior period.

Gross profit dollars grew 55% to $10.5 million from $6.8 million in the same quarter of the prior year.

Giving Q2 results and our performance in the first half of the fiscal year during which our growth margin was 28.7%, we remain comfortable with our full year target for gross margins in the high 20% to the low 30% range.

Total operating expenses for the second quarter of fiscal 2011 rose 24% to $8.6 million, representing 23% of net sales and driving an operating profit of $1.9 million in the quarter. This compares favorably to $6.9 million of operating expenses or 32% of net sales, which led to an operating loss of $0.2 million in the comparable prior year period.

Acquisition related items are a combination of an adjustment to the value of the TRITTON contingent consideration, which we required to revalue on a quarterly basis for the passage of time and updated probability assessment and transaction-related professional fees.

Operating profit performance was in line with our expectations as we continue to make strategic investments in marketing and R&D to aid our product development efforts. Foreign exchange gain for the second quarter of fiscal 2011 totaled $0.9 million, compared to a foreign exchange loss of $0.1 million for the comparable prior year quarter. This was due largely to an approximately 9% appreciation of the euro and an approximate 5% appreciation of the Great British pound versus the Hong Kong dollar during the quarter.

Reflecting the pre-tax increase, income tax expense was $1.1 million versus $0.2 million in the prior year period, leading to net income for the fiscal second quarter in the September 30th, 2010, of $1.1 million and earnings per diluted share of $0.02, compared to a loss of $0.02 per diluted share of $0.02 in the second quarter last year.

EBITDA increased to $3.6 million in the fiscal 2011 second quarter from $0.8 million in the comparable prior year period. This brings our trailing 12-month EBITDA to a record $13.7 million.

Finally, I’d like to note a few highlights from our balance sheet. As we announced a few weeks ago, we amended our asset back revolving credit facility with Wells Fargo Capital Finance to expand available liquidity in preparation for the holidays. Our capacity have increased to $50 million through December 30th, decreases to $35 million for December 31st through January 31st and reverse back to $30 million after January 31st, 2011.

As of September 30th, we reported borrowings under the revolving credit facility of $28.3 million and a net position of bank loan less cash of $24.6 million, compared to borrowings of $19.3 million as of September 30th, 2009 and a net position of bank going less cash of $13 million. The increase in borrowings is to support the increase in inventories and accounts receivable.

Inventory of $51.6 million is up $17.8 million from last year. Given the strengths we expect from our product sales and fiscal Q3 and Q4, we feel these are appropriate inventory levels. Inventory turns on a trailing four quarters basis were 2.1 times, down modestly from 2.6 times in the prior year period.

Accounts receivables is $28.5 million were up $16 million last year due largely to sales of Rock Band 3 products. Our gross DSOs were 69 days compared to 62 days in the year ago period.

In summary, we believe we will exceed our previously stated target of sales growth in the high single digits for fiscal 2011 with gross margins in the 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%. The estimated tax rate is subject to fluctuation based on the distribution of earnings among the various territories in which we do business.

I’d now like to turn the call back to Darren for some closing remarks. Darren?

Darren Richardson

Thanks, Allyson. Although economic and sector challenges continue, we remain very positive about our full-year outlook. We’re delivering the best products in Mad Catz’s history, consumers and reviewers have been responding enthusiastically, retailer demand continues to grow and based on sales to date, we’re optimistic that retail sell in will drive net sales for the year to a new record.

We are however mindful that consumers sell through in the holiday quarter will be key to delivering bottom line results for the year and it will not be until we collect the cash and the fiscal fourth quarter that we’ll see those results flow through the balance sheet. As we head into the holiday’s, we’re optimistic about our ability to pose strong results and I would like to share a couple of data points that make us feel confident.

First, sales made in the five months since we acquired TRITTON have exceeded the sales made in the 12 months prior to the acquisition. These sales have been almost exclusively in North America, so we know we have a lot more upsiders [ph] who leverage our global distribution platform and the holiday selling period is still ahead.

Second, in spite of the negativity that surrounds the music genre, Rock Band 3 has emerged as one of the best reviewed games of 2010 with a Metacritic of 94. Understandably, we took a conservative approach. But pre-sales for Rock Band products and especially the bundles exceeded expectations. We had key retailers increasing POs as we approached the launch.

The first week sales of bundles and standalone keyboards exceeded our expectations. We’re already receiving replenishment orders and the much anticipated Mustang Pro Guitar has yet to ship. It’s a good game and I think its longevity is going to surprise a lot of people.

Third, last year, we executed a very successful retail program with a range of Call of Duty Modern Warfare 2 products with end caps in most major retailers for the game launch, and the products remained at some retailers as ongoing skews and continued to post strong numbers today. On the back of that success, we’ve seen opening purchase orders from retailers for our upcoming Call of Duty Black Ops product range exceeds the life to date sales of the successful Modern Warfare 2 product line.

Last, but certainly not least, we continue to rollout our critically acclaimed line of Cyborg Pro Gaming Mice with a highly anticipated R.A.T. 9 Wireless version now shipping. Maximum PC called the Cyborg R.A.T. 7 the best gaming mouse ever. The consumer response has been just as enthusiastic. We’re seeing sales of the Cyborg range gathering momentum and Cyborg’s retail distribution footprint continues to expand.

In short, we’re seeing great results on multiple fronts and we’re excited about the year. We remained focus on continuing to manage the company to deliver quality, value-added products and our evolving brand lineup is a key component to our long-term growth strategy. The core of this brand strategy remains the Mad Catz’s casual gaming brand, complimented by the Saitek brand, which we’re focusing on simulation products; the Cyborg Pro Gaming brand; the Eclipse brand, which is focused on home and office consumer electronics products; and our newest brand, TRITTON, which is focused on gaining audio headsets.

We’re excited about our pipeline of products from across these brands that will be available for this holiday season and believe this product momentum positions us well to achieve our financial goals for the year.

That concludes my prepared remarks for the day. I’ll now turn the call back to the operator, so we can answer your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Ronald Ryder with RLR Partners. Please proceed.

Ronald Ryder – RLR Partners

Hi, guys. Congratulations on a great, great business quarter for you. The one question I have, which seems somewhat surprising is the gross margin shortfall. And you mentioned Rock Band that the shortfall was from Rock Band. Yet, I just cannot believe that with sales as strong as they were for the quarter with TRITTON sales in there, which I would imagine have very, very attractive and higher than average gross margins, that Rock Band sales would be enough to pull down gross margins.

So, I have to believe, and correct me if I’m wrong, that there were other issues in terms of gross margins. And you mentioned volatility of foreign currencies. But maybe – maybe, if you could, quantify the Rock Band impact and which category does Rock Band fall into sales, if you break down sales by category, so maybe that would be a little bit helpful.

Darren Richardson

Okay. Let me tackle that last part first. Rock Band falls into a couple of categories with obviously the bundle that includes the game coming through as part of the games, but not the totality of what it gets categorized as games. And then a lot of the other products come through in the specialty controller line.

Certain Rock Band products and I can’t go into the specifics are a lower margin product and particularly, when you look at the bundle with the game included, we don’t pick up an awful lot of margin on that game component, which is fairly typical. So, we definitely have some lower margin business. But at the same time, it’s very good top line, it’s still positive contribution and it leverages the entire platform.

Ronald Ryder – RLR Partners

Right.

Darren Richardson

The TRITTON product, the TRITTON margins, I would say categorized as being okay. I wouldn’t say they’re extraordinarily good. And I think that the …

Ronald Ryder – RLR Partners

Would it be fair to say that they are above average gross margins for the rest, if you exclude the margins on Rock Band, wouldn’t you – my guess would be audio typically has a much higher margin than other products, other categories that you’re in.

Darren Richardson

I know that they’re not higher than the average product. They’re kind of like in line; one or two products are a little bit lower than what would be average.

Ronald Ryder – RLR Partners

Okay.

Darren Richardson

And then the other thing is when you compare the year-on-year comp, even though the dollar has softened this year, which helps the European sales. Last year, the actual currency was much softer than it is this year. So, the expectation that’s it’s a lot better is really a little bit different than that was. And then lastly, we had an OEM product in there as well that also because of the nature of the product is a lower margin opportunity, but again it drives some top line and its also done in one or two shipments with pretty much no risk attached to it.

Ronald Ryder – RLR Partners

And let me ask while I have you, Darren, last quarter’s call at this point in time you were – generally had a strong feeling of optimism about the quarter that just ended. Could you share your thoughts about the December quarter or specifically you had mentioned also at the time that October sales were up nicely. I don’t know if you want to comment, I mean …

Darren Richardson

Yes. In fact, we’re very positive on the third quarter. I don’t think we have any question in our mind about getting it done on the top line. The sell in has been very, very strong and I think if you look at the sales through Q2, you start to get that last couple of weeks of September as where you get the ramp up on the bulk of this shipments heading into holiday.

So, we’re seeing a very, very strong ramp up. We’re seeing very positive pick up of product from retailers. We’ve got solid sell through on a lot of different fronts providing the consumer turns up and I think given that a lot of their products that were on are the kind of AAA titles within the space and we’re still seeing strong demand for AAA titles. I think we’re in a good space.

Ronald Ryder – RLR Partners

Call of Duty, that really ramps. When does that launches, what in November?

Darren Richardson

Yes. Well, that’s the launch like – the launch party, I think, its tonight.

Ronald Ryder – RLR Partners

Really, okay. Great.

Darren Richardson

So, Call of Duty is upon us right now.

Ronald Ryder – RLR Partners

The margins on that product above, below average?

Darren Richardson

Yes. The Call of Duty product lines are good margin. It’s in line with what we would say as the rest of the business.

Ronald Ryder – RLR Partners

Okay, great …

Darren Richardson

Yes. So, we’ve got a few little soft spots on margin there, a couple of them not entirely unexpected just because of the nature of the beast. But, overall, I think very solid and I think the key is gross profit. We still manage to put a couple of million dollars of extra gross profit down there and the bulk of that flowed right through the bottom line, so positive quarter.

Ronald Ryder – RLR Partners

Great. Would you expect the gross margin percentage to have a three in front of it in the quarter?

Darren Richardson

Put it this way, I would certainly hope so. You normally do get a couple of point left in the third quarter.

Ronald Ryder – RLR Partners

Right.

Darren Richardson

Just because you get a lot of leverage over some of the six cluster in your cost of goods.

Ronald Ryder – RLR Partners

Right, terrific. Great going. Great quarter.

Darren Richardson

Okay. Thanks, Ron.

Operator

Thank you. (Operator Instructions) And our next question comes from the line of Jordan Ku with Yellowstone Capital. Please proceed with your question.

Jordan Ku – Yellowstone Capital

You will have a very good revenue growth during the first half of the year. But do you still predict, project to the whole year revenue growth is only one, a single digit. Does that mean the second half of revenue, we are still down?

Darren Richardson

No. At the start of the year, we said we expected to meet or exceed high single digit revenue growth. So, we basically put that high single digit revenue growth as a baseline. And so given that we’re coming of a record year, effect of what we’re saying is we’re looking at a record year again for this year.

And if you look at the press release and then again in our call today, we’re actually have drop the meat, we’re talking about we’re going to exceed that. we feel very confident that we’re going to get it done on the top line and now, it’s going to come down to having the consumer turn up during the holiday period, have good sell through at retail and – so that we don’t have any big price protection exposure and if that happens, Q3, we should be able to get it done on the bottom line. And then Q4, we will have the bulk of the cash collections and we’ll see the benefits of those results flow through to the balance sheet, which at the end of the day is the thing we’re focused on is getting that balance sheet at the end of March looking as positive as it can be.

Jordan Ku – Yellowstone Capital

Thank you.

Darren Richardson

You’re welcome.

Operator

Thank you. And there no further questions from the phone lines at this time. Mr. Richardson, I’ll now turn the conference back over to you.

Darren Richardson

Okay. Thank you and thank you to everybody for joining the call today. I’d also like to thank our hardworking and talented team for all of the efforts that they’ve put to get the company to this point, so that – to where we’re actually delivering some really, really solid results and we want to carry that through not only on the top line, but to the bottom line over the next couple of quarters. Look forward to seeing everyone on the next call.

But in the meantime I’m going to be meeting with investors in New York, next Thursday, November 11th. So, if anyone would like to schedule a meeting or any other contact, please contact Joe Jaffoni at 212-835-8500. Thanks a lot and look forward to talking to you soon.

Operator

Thank you, and ladies and gentlemen that concludes the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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