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Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F2Q12 (Qtr End 09/30/2011) Earnings Call

November 9, 2011 5:00 pm ET

Executives

Norberto Aja - IR, Jaffoni & Collins, Inc.

Darren Richardson - President and CEO

Allyson Evans - CFO

Analysts

Ronald Rotter - RLR Capital Management

Stan Trilling - Credit Suisse

Operator

Welcome to the Mad Catz Interactive fiscal 2012 second quarter results conference call. (Operator Instructions) It is now my pleasure to turn the conference to Norberto Aja.

Norberto Aja

Good afternoon everyone and welcome to Mad Catz's fiscal 2012 second quarter earnings conference call. With me on the call today are Darren Richardson, Mad Catz's President and Chief Executive Officer; and Allyson Evans, Mad Catz's Chief Financial Officer.

Darren will provide an overview of the results and his perspectives on the industry environment and the company's upcoming product set. Afterwards, Allyson will review the financial results in greater detail, before turning the call back to Darren for some closing remarks.

But before we begin, let me just take a few minutes to read the Safe Harbor language. Today's discussions 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, believe and other words and terms of similar meaning in connection with any discussion of future operating or financial performance.

Among the factors that could cause the 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, the ability to successfully market both new and existing products domestically and internationally, difficulties or delays in manufacturing, or a downturn in the market or industry.

A further list and description of these risks, uncertainties and other matters can be found in the company's reports filed with the Securities and Exchange Commission and the Canadian Securities Administrators. A further list of these risks and uncertainties and other matters can also be found on the company's reports filed with the appropriate regulatory authorities.

Today's call, November 9, 2011 and webcast includes non-GAAP financial measures within the meaning of the SEC Regulation G. When required, a reconciliation of all the 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, and good afternoon everyone. Thank you for joining us today. Fiscal 2012 second quarter sales of $25.8 million are on par with the second highest level ever recorded in the second quarter in the company's history.

However, the same quarter last year was a blow out quarter by any measure. Thanks largely to the initial launch shipments of Rock Band 3 and strong sales contribution from a distribution agreement for third-party products, but it seems being terminated. So this year was always going to be a difficult comparison, but it's hard not to be a little disappointed with the results.

We have a promising new product development pipeline, as evidenced yesterday by the announcement that four Mad Catz products were named as CES Innovations 2012 Design and Engineering Award Honorees. And we are hopeful that strong new product launches combined with margin in excess of our targeted 30% could bridge a large part of the sale shortfall.

Unfortunately, product development and manufacturing delays resulted in a nominal sales contribution from new products during the quarter. And while gross margins improved from the prior quarter, they were below our target.

We remained focused on executing our plan to grow their business and as expected, expenses grew 5%, predominantly on the back of increased sales, marketing and research and development expenses. In other words, we continue to invest in the business, its strength and the company's future. In the process, we're growing the base of evergreen products, products that don't need to be reinvented each year. And we're expanding our distribution platform to new markets.

As we continue to invest in the transformation of the company from a provider of commodity video game products to a company that develops innovative products for passionate consumers. We expect to continue investing in sales, marketing and research and development expenses that could negatively impact the results in the short-term. But we believe we'll benefit the business in the long-term. We're committed to our business plan and we're confident in the ability of our talented team to execute on our growth strategies and deliver long-term success.

In conclusion, Mad Catz is committed to delivering products that appeal to passionate consumers, growing its distribution platform and creating a vehicle for delivering sustainable, profitable growth. We've made progress on these initiatives over the last several years. And while we clearly have more work to do, we fully understand the challenges and opportunities and are focused on the job at hand.

With that, I'd like to turn the call over to Allyson to provide some additional color on the results.

Allyson Evans

Thanks, Darren. Let me begin with a brief review of the income statement. Net sales for the fiscal second quarter were $25.8 million, down 31% from $37.4 million in the fiscal 2011 second quarter. This decline was primarily driven by the negative comparison to the launch of Rock Band 3 and strong sales contribution from the distribution of third party products in the prior year quarter. Partially offsetting these declines were strong sales of our Tritton-branded headsets, including products related to the recent launch of Gears of War 3 and our Cyborg R.A.T. Gaming Mice.

On a regional basis, fiscal 2012 second quarter North American net sales fell 51% to $12 million and represented 47% of quarterly net sales. The decline in North American sales was due principally to the challenging comparison related to Rock Band 3 sales in the prior year and essentially represented our total net sales decline. European net sales increased 4% to $12.7 million and represented 49% of quarterly net sales. Finally, net sales to other geographies rose 39% to $1.1 million or 4% of quarterly net sales.

Gross profit fell 29% to $7.4 million from $10.5 million in the same quarter of the prior year. The decline in gross profits was primary due to the lower sales in the quarter. Despite the lower gross profit dollars versus the prior year, our gross profit margin actually increased by 80 basis points to 28.9%. Total operating expenses for the second fiscal quarter of 2012 rose 5% to $9 million and represented 35% of net sales.

We continue to make investments in our business and during the quarter we increased headcounts, and as Darren noted, allocated additional resources to our research and development efforts, particularly to support the development of new products such as our audio and software product lines. As a result, the company recorded an operating loss of $1.6 million in the quarter. In the prior-year period, we recorded operating expenses of $8.6 million and an operating profit of $1.9 million.

Foreign exchange gain for the second quarter of fiscal 2012 was $0.2 million compared to a gain of approximately $0.9 million in the prior-year quarter. Mad Catz recorded a $1.5 million benefit related to the revaluation of a liability associated with warrants issued in the April 2011 private placement. This is a non-cash item and we expect to continue evaluating the liability on a quarterly basis, as it will likely fluctuate based on a number of factors including predominantly changes in the company's stock price.

After this benefit, an income tax expense of $0.3 million, net loss for the second quarter of fiscal 2012 was $0.5 million or $0.01 per diluted share. This compares to income tax expense of $1.1 million and net income of $1.1 million or $0.02 per diluted share in the second quarter last year. Adjusted EBITDA loss in the quarter was $0.6 million compared to positive adjusted EBITDA of $3.6 million in the second quarter of fiscal 2011.

Moving on to the balance sheet. As of September 30, inventory of $33.6 million is down 35% from $51.6 million last year. Primarily related to lower receipts in new products due to product development and manufacturing delays. Inventory turns on a trailing four quarter basis were 2.7 times compared to 2.1 times in the prior four quarter period.

Accounts receivable of $15.7 million was also down significantly from $28.5 million in the prior year quarter, primarily reflecting lower sales in the fiscal 2012 second quarter period. Our growth DSOs were 55 days compared to 70 days a year ago. Accounts payable of $20.4 million was down significantly from $38.4 million in the prior year quarter, primarily reflecting reduced inventory purchases discussed above. Net working capital in the quarter was $9.9 million, up from $9 million in the prior year.

We reported borrowings under the revolving credit facility of $17 million and an acquisition of bank loan less cash of $14.3 million. This compares to borrowings of $28.3 million and an acquisition of bank loan less cash of $24.6 million as of September 30, 2010.

In summary, while the first half of 2012 has been challenging, we believe we are well positioned from a financial perspective to support the company, take advantage of a number of new opportunities and drive sustainable long-term growth.

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

Darren Richardson

Thanks, Allyson. At the beginning of the year, we anticipated our revenue would be back-end loaded compared to fiscal 2011. While we expected a stronger contribution from new products in the second quarter, product development and manufacturing delays resulted in only a minimal contribution and pushed the expected contribution back further.

We're experiencing a slow start to the third quarter and we have a firm idea if the quarter will pick up, until we see the initial consumer response to the holiday buying season, which in North America starts with the Thanksgiving weekend. As a result, the back half of the year will depend largely on the economy and whether we can maximize production and placement of our new products.

As I've mentioned before, we are very pleased with the progress we are making on developing a portfolio of innovative products that appeal to passionate consumers on each of our five core brands. Mad Catz, our console and casual video gaming brand; Tritton, our gaming audio brand; Cyborg, our hardcore PC and console gaming brand; Saitek, our simulation brand; and Eclipse, our PC input device and multimedia brand. As a company we remain committed to these businesses and to our goal of creating long-term sustainable growth.

At this point, we'll open the call to your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from the line of Ronald Rotter.

Ronald Rotter - RLR Capital Management

A lot of hopes and anticipations for the company. Holiday period was predicated on the Tritton co-branded products with Microsoft, as yet we haven't seen any announcement or any shipment of that product. Although, it was one of the products that you received the award from CES, were nominated for award. Could you tell us, what's the status of the shipments scheduled for that is? Do we expect to get it out in the stores before the Thanksgiving critical period?

Darren Richardson

We actually announced the shipment of the first of the five products, the Detonator Headset at the end of September. But we had almost nothing meaningful in terms of revenue for the second quarter. So that product's adding retail and is just to the point now where we're getting it into reasonably full supply. We're still a little bit backordered, but we're just in the process of catching up.

We've just stared shipping the Trigger Headset, which is the second one. And we'll have an announcement on that any day now, probably tomorrow actually. But that one's also hitting the store shelves as we speak. And we're still in the ramp up phase there, so it's going to be backordered for a little while. So it will be out in the marketplace, but not in the quantities we would like to have had for the holiday.

And then we've got another three headsets. The next one hopefully to hit the market will be the Primer, which is the entry-level wireless product, which hopefully we'll have into manufacturing in the next couple of weeks. But again, it's definitely going to miss the critical Thanksgiving weekend. And then the other two are going to follow fairly shortly after that with the Warhead being the one that won the nomination yesterday with CES.

Ronald Rotter - RLR Capital Management

Those won't hit the market by Thanksgiving?

Darren Richardson

No, they're not going to make Thanksgiving. And that's going to be a significant miss for us, because frankly those first three products we had planned to be shipping by September. And we've just been late getting them into manufacture. And then the second impact of that is now you're trying to get new products kicked-off in manufacturing when existing products of those same factories. And we're working with factories who are making world-class household named audio products.

You now keep competing for production time with other brands that are being manufactured in there alongside U.S. So it becomes a compounding problem. So a couple of weeks delay certainly cost you a lot on the back-end. So we've had some executional issues with those that have set us back. There is no question about that.

Ronald Rotter - RLR Capital Management

And then, none of the co-branded Microsoft products will have hit the shelves by the holiday period, is that correct? Like the Detonator?

Darren Richardson

No, the Detonator is a co-branded Microsoft product. That hit the shelves at the end of September, was our first shipment. And you'll find that at retail today, in retailers like Amazon, GamesStop, Best Buy and a number of others.

Ronald Rotter - RLR Capital Management

And what's been the early reception of that product?

Darren Richardson

The early reception has been very positive. The reviews have been great. Frankly, it's been a little bit impacted by not having sufficient inventory. So it's been heavily backordered for the last little while and we're just in catch-up mode now. But hopefully in the next couple of weeks we'll be out of backorder and have store shelves fully set for Thanksgiving on that one. The Trigger, the second one is just hitting stores as we speak. But again, not in quantities to really kind of make an impact at the retail shop level.

Ronald Rotter - RLR Capital Management

And could you discuss what the issues are and are the issues pretty much behind you now, so it's just a matter of getting them. I mean have they been all approved in just the matter of getting them manufactured now or are there still issues that we have?

Darren Richardson

The ones that are shipping are all approved. The ones that aren't, we are still working through final little technical bibs and bobs and then final approval. But the real issue is we've had a lot of new products that we've worked on. And we've tried a couple of different approaches in terms of outsourcing, different parts of the development on those, to try and speed up, getting products to market, they're complicated products.

And in reality, in highest sight, we probably bit off a little bit more than we could chew and we're paying a price for it now. But one sort of primary things we want to do in the process, is we didn't want to comprise the product by cutting corners. And so we are very, very confident that the product that is shipping is an excellent product and it is going to be a great product in the marketplace for quite a few years to come.

Ronald Rodder - RLR Partners

And Trigger product headsets, when will that be reaching the stores?

Darren Richardson

You'll find it at certain stores as we speak. But again, it's quite heavily backordered. So we're just in the catch-up phase. So we've got it to market, but not in the quantities that we want.

Ronald Rodder - RLR Partners

And will that retail for and what is that retailing for?

Darren Richardson

That's a $50 product. That's the entry-level wired product. And then the Detonator that is shipped in September is the premium wired product. And then the Primer, which will be the next one to ship will be the entry-level wireless product.

Operator

And our last question today comes from the line Stan Trilling.

Stan Trilling - Credit Suisse

Darren, in your last conference call you stated that, you told that 40% to 50% of your revenues would come from your audio products over the 12 to 18 months. Obviously, it's more like 18 and 12. Have you changed those targets at all or how far out they are?

Darren Richardson

Stan, I actually think for the quarter we're at 43%. And as we annualize out, I think we are fairly confident that we're going to meet that, particularly given the bulk of the products that are going to make that big change haven't really impacted yet. So by the time we get through Q3, I feel very comfortable with that.

In fact, I think for year-to-date we're at about 38% on a year-to-date basis for audio products. So I think we're in line with that, especially given we haven't had the products that are going to need to actually start to make an impact yet.

Stan Trilling - Credit Suisse

Can you give us any further color on how late you think the premium wireless product will be?

Darren Richardson

At this stage, honestly we don't know. We're at that final stage, where we've got a number of outstanding issues we are trying to resolve. And if the things that we're working on to fix those issue or come together, then it's going to be not to far off. But they are complicated products and we want to have those products absolutely rock solid before they ship. So if we get them out in December timeframe that would be great. Otherwise we'll launch them when they are ready to launch, but we won't launch them until they are ready to go.

Stan Trilling - Credit Suisse

I am a little disappointed in the lack of transparency on these problems. If you knew about it would have been helpful to quell expectations, if we would have heard about the potential delays and some timelines. Thank you very much for your time.

Darren Richardson

Yes, and just on that one, Stan. We do announce products as they are shipping as a matter of course. So we did announce the Detonator shipping and I think the announcement was the September 30.

Stan Trilling - Credit Suisse

I understand that, but when you made that announcement, the fact that you didn't say anything else at all about the other products. To me it was a real disappointment. And that's why I'm talking about the lack of transparency.

Darren Richardson

Yes, understood.

Operator

And I would now like to turn the call back to Mr. Darren Richardson.

Darren Richardson

Well thanks everyone for joining the call today. As always we are very much value maintaining and active dialog with the shareholders and the investment community at large. So please contact Norberto Aja with our investment firm, Jaffoni & Collins at 212-835-8500, if you've got any further questions or if you would like to schedule a time to talk with us. Thank you again and look forward to updating you at the end of the next quarter.

Operator

And ladies and gentleman, that will conclude our conference call for today. We thank you for your participation. And you may now disconnect your lines.

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