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Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F1Q13 Earnings Call

August 8, 2012 5:00 p.m. ET

Executives

Norberto Aja - Investor Relations

Darren Richardson - President and Chief Executive Officer

Allyson Evans - Chief Financial Officer

Analysts

Ronald Rotter - RLR Partners

Stan Trilling – Credit Suisse

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Mad Catz Fiscal 2013 First Quarter Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference call is being recorded, Wednesday, August 8, 2012.

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

Norberto Aja

Thank you, operator. Good afternoon everyone and welcome to Mad Catz's fiscal 2013 first quarter 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 begin the call by providing an overview of the results and the principal drivers behind them. Afterwards, Allyson will review the financial results in greater detail, before turning the call back to Darren for some closing remarks.

Before we begin, however, 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 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, and 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, August 8, 2012, 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, and good afternoon everyone. Thank you for joining us on your fiscal 2013 first quarter conference call. Three years ago we made a strategic decision to shift our focus towards high value products designed for passionate hardcore consumers. This shift hasn’t happened overnight and is still ongoing. We are now reaching an inflection point where the growth in the targeted product categories is more than offsetting the decline in the sales of legacy products.

We are pleased to see strong net sales growth of 33% for our first quarter, historically our weakest quarter of the year. And specially pleased to see all territories return to growth. In the first quarter of fiscal 2013, sales of PC and Mac input device products, predominantly gaming mice and keyboards, grew 83% and accounted for 21% of sales. Sales of Saitek flight simulation products grew 22% and accounted for 10% of sales. The sale of audio products grew 107% and accounted for 44% of sales. On an annualized basis, sales of audio products accounted for 41% of sales, or $50 million in net sales, meeting our previously stated goal of having our line of audio products account for 40% to 50% of net sales.

We also believe these premium products have much a longer product life span and offer the best path forward as the video game industry reaches a transition with casual gamers migrating to mobile gaming, leaving hardcore gamers who demand the best. We realize and understand that more sales of these key products are needed and we are committed to increasing our sales and marketing efforts to expand awareness of these products, while keeping a sharp eye on operating expenses.

In addition to our focus on creating aspirational products, we have also expanded our geographic footprint as we continue to build a worldwide sales and marketing team. As games increasingly cross geographic borders and the internet allows worldwide online competition, the company is committed to positioning itself as a leading provider of products that optimize the passionate video gamers’ performance on a global basis.

Last year we announced the opening of our sales and marketing office in Japan. We are starting to realize the benefits of our investment and expanding our geographic footprint, especially in the Asia Pacific region. Our sales classified to other countries have grown from 2% of sales in fiscal 2011 to 5% of sales in fiscal 2012, and now represent 7% of sales in the first quarter of fiscal 2013. We are hopeful that the addition of our recently announced sales and marketing office in South Korea will further accelerate sales in that vibrant gaming market.

In summary, our focus and our goal is to bring to market a compelling consumer offering. We believe that Mad Catz can succeed if we build on our strength to go after the targeted segments within the video game industry and leverage our expanding distribution footprint to deliver to those consumers products with designs and features that are central to the gaming experience.

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

Allyson Evans

Thanks, Darren. Let me begin with a brief review of the income statement. Net sales for the first quarter of fiscal 2013 increased by 33% to $21.8 million, compared to $16.5 million in the first quarter of fiscal 2012. This was primarily driven by the strong performance of our Tritton, R.A.T. and Saitek products, including the success we are having with audio products related to Microsoft’s Xbox 360 platform. This growth was partially offset by the continued decline of Rock Band 3 related products in North America, and declining game pad and steering wheel sales.

Looking at our sales by geography, North American sales increased by approximately 8% to $10.4 million for the first quarter of fiscal 2013, and represented 48% of total net sales compared to 59% of sales in the prior year period. European net sales increased 54% to $9.8 million and represented 45% of total net sales compared to 38% of net sales in the first quarter of fiscal 2012. Net sales to other geographies more than tripled to $1.6 million representing over 7% of total first quarter fiscal 2013 net sales, compared to less than 3% a year ago.

Overall, sales outside of the U.S. now account for over 56% of our sales, the highest percentage to date. Gross profit increased by 59% to $6.3 million from $3.9 million in the prior year period, and gross profit margin increased to 29% in the first quarter of fiscal 2013 from 24% in the prior year period. This gross margin increase is largely due to fixed cost leverage related to higher sales and reduced price protections, co-op spending and sales discounts.

Going forward, we expect our gross margin performance to be within the guidance range we set forth in prior shareholders communications, which is to remain within plus or minus 2.5 points of 30%.

Total operating expenses for the year decreased 10% for the quarter to $8 million representing 37% of net sales and leading to an operating loss of $1.7 million in the first quarter of fiscal 2013. This compares to $8.9 million to $8.9 million of operating expenses in the prior fiscal quarter, or 54% of net sales and an operating loss of $4.9 million. The decrease in operating expenses was primarily driven by the completion of certain research and development activity which have resulted in our strong current and future product pipeline.

For the quarter, the company recorded a foreign exchange gain of $0.3 million compared to less than $0.1 million a year ago. The gain in each period was primarily due to the fluctuation of the British pound and euro against the U.S. dollar and Hong Kong dollar. After income tax expense of $0.3 million, compared to an income tax benefit of $0.6 million in the prior year period, net loss for the first quarter of fiscal 2013 was $1.7 million or $0.03 per diluted share compared to $3.5 million or $0.06 per diluted share in the prior year period.

Adjusted EBITDA, a widely used measure to monitor financial performance, was a loss of $0.6 million in the fiscal 2013 period compared to a loss of $4 million in the prior year period. Moving on to our balance sheet. As of June 30, 2012, we reported borrowings under the revolving credit facility of $13.7 million, and an acquisition of bank loan less cash of $11.9 million. This compares to borrowings of $14.8 million and a net position of bank loan less cash of $12.8 million as of June 30, 2012.

On August 1, 2012, we amended our secured working capital credit facility with Wells Fargo Capital Financial LLC. This amendment reduces the interest rate from U.S. prime rate plus 2% to U.S. prime rate plus 50 basis points, with the potential for further reductions subject to the company's performance. The credit limit of $30 million remains unchanged.

Inventory of $28.1 million is basically flat with $28.7 million last year and is in line with what we expected at this point in this cycle. Inventory turns on a trailing four quarter basis were 3.2 times, compared to 4.8 times in the prior four quarter period. Subsequent to year-end, we have made progress in reducing our inventory and we will continue to strive to make further reductions.

Accounts receivable of $11.9 million increased from $9.9 million a year ago, primarily reflecting increased sales volumes during the fiscal 2013 first quarter. Our gross DSOs were 70 days compared to 91 days a year ago. Cash provided by operations during the first quarter of fiscal 2013 was $3.3 million compared to cash used in operations of $5.8 million in the prior fiscal quarter. The primary source of cash in the fiscal 2013 quarter was decreased inventories of $4.1 million. Cash used in investing activities in the first quarter of fiscal 2013 was $0.3 million compared to $1.1 million in the prior year quarter. The decrease primarily reflects lower capital expenditures in the fiscal 2013 period.

Cash used in financing activities in the first quarter of fiscal 2013 was $3.5 million compared to cash provided of $4.7 million during the prior year fiscal quarter. This decrease primarily reflects capital raised from the PIPE transaction completed in April 2011 and increased borrowings under the company's line of credit, partially offset by the repayment of the long-term debt balance in the prior year quarter.

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

Darren Richardson

Thanks, Allyson. In the current quarter today we are seeing continuing top line sales growth but at lower rate than Q1. We are excited about our pipeline of new products for the holiday season, including the highly anticipated Warhead 7.1 wireless headset for the Xbox 360. We are pleased to be working Best Buy as our North American launch partner for the Warhead, with sales expected to kick off in the next two weeks.

Damage Inc., our World War II combat flight game and stick for the Xbox 360, PlayStation 3, and PC launches globally on August 28. And the Kunai headsets for PlayStation 3 and Vita are in mass production now. These new releases are expected to make a positive contribution to fiscal 2013 second quarter sales. We are also optimistic that the launch of these key new products and some upcoming product releases will contribute to our return to growth for fiscal year 2013.

We were pleased to see margins of 29% in the fiscal first quarter. If we can sustain margins in the 30% range and return to top line growth, than we should be well positioned for return to profitability in fiscal 2013. Looking ahead, we have a range of exciting initiatives that should benefit fiscal 2013 and beyond. Expanding our line of products for passionate consumers, leveraging our expanding global distribution footprint, launching a targeting increase in our marketing and awareness, continuing to carefully targeted software opportunities that pose manageable downside risk by complementing our hardware initiative, and maintaining our commitment to supporting the professional gaming community and developing products that live up to their exacting demands.

That’s concludes my prepared remarks for today. Before we move into the Q&A session, I want to take a moment to thank the entire team at Mad Catz for their continued dedication. I will now turn the call back to the operator so we can answer any questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Ronald Rotter with RLR Partners. Please go ahead.

Ronald Rotter - RLR Partners

Couple of questions, and correct me if I am wrong, but it looks from looking at the numbers that sales of Tritton products in the June quarter were flat sequentially with the March quarter. I know in the March quarter you had still some production issues. Was that -- but overall sales sequentially are always down in the June quarter from the March quarter for overall sales, I don’t know about Tritton. Just asking what’s your thought and opinion about sales from the Tritton products in the quarter.

Darren Richardson

Yeah, you typically see Q1 sales a significant step down sequentially from Q4 sales. The fact that Tritton sales were flat with Q4 is a positive. In term of the production issues, that really is around the Warhead at this stage. And the Warhead is going to start impacting sales in about two weeks time. So based on that I think we are actually in pretty good shape and as you can see from the numbers we have got significant growth in the [audio] category across the board.

Ronald Rotter - RLR Partners

Then, Allyson, and correct me if I am wrong. Allyson, I thought, said that guidance for gross margin going forward was 30% give or take 2.5%. I thought you had stated that your goals were to keep gross margins at the 30% plus level not 30% plus or minus 2.5%?

Allyson Evans

The guidance that we have given I think in our prior 10-K was 30%, plus or minus 2.5% is certainly like it even though that’s 30%. But there is a range.

Darren Richardson

Yeah. So the goal is definitely to stay above, to get back above 30%.

Ronald Rotter - RLR Partners

And is -- with the Warhead product, you had mentioned that the growth in the quarter to date is -- that there is growth but not at the rate of the June quarter. The June quarter seems like it’s almost like the year. Your ECS can, well, is not as easy your December quarter but is your second easiest comparison for the year, much easier than the first quarter comparison than the March comparison. I am sorry, I am saying -- getting this part confused.

Darren Richardson

Yeah, I think I know where you are coming from though. Yes, so Q1 was a good step up, so that’s positive. If you look at Q1, our cost history, it’s I think about the third best Q1 on sales that we have had. So it’s slightly below our record quarter for Q1. So in terms of what you can expect from Q1 it was actually pretty good outcome.

Ronald Rotter - RLR Partners

No, I am talking about the growth -- what you are talking about anticipated growth in this?

Darren Richardson

Off of Q2?

Ronald Rotter - RLR Partners

Right, right. Especially with the Warhead 2 being a major product hitting the sales.

Darren Richardson

And I am really looking at growth to date, that we’ve already......

Ronald Rotter - RLR Partners

Okay. Which would not obviously include the Warhead, so.

Darren Richardson

Yeah. And then we have got the Warhead and a couple of other products that are coming here in the next month.

Operator

Our next question comes from the line of Stan Trilling with Credit Suisse. Please go ahead.

Stan Trilling – Credit Suisse

One quick question having to do with the Warhead release and anticipation for reviews in the gamer magazines. Any feedback on that?

Darren Richardson

In fact there has been a spate or reviews just launching in the last 24 hours. And so we will get those up on our website here in the next day or so and provide with links to those. But the product is reviewing exceptionally well.

Stan Trilling – Credit Suisse

Terrific. Can you give us of sort of look at how the Game Store sales are going on Warhead?

Darren Richardson

Yeah, it’s not meaningful quantities. We only had some very small quantities there and the bulk of what we have is being directed to Best Buy, to get Best Buy’s set up so that they can rollout in all stores which hopefully will have taken place in the next two weeks so it will find its way into a store. And so once it’s available in-store, that when we will put in our now shipping release out, which is our normal factor to announce now shipping so that people know that they can actually go into a store and buy the product.

Stan Trilling – Credit Suisse

And will also make a public release that it is available, because it’s frustrating to see the availability on Game Store but not one else has the product available.

Darren Richardson

Yeah, our practice has been to do a now shipping release when the product is generally available at retail. And doing that before it’s available at retail would only send people into stores to find that they are not in store.

Operator

(Operator Instructions) Our next question comes from the line of [Keith Burns with Sector Analytics] Please go ahead.

Unidentified Analyst

Just wondering, can you give us some guidance on how we should model SG&A, specific in Q3, should be this quarter going forward. And an idea on tax rate, thanks.

Allyson Evans

For SG&A I would expect, Q1 we are about at the rate we are going to be going forward. There will be some variability in the sales number as the component of that is variable with sales. But we think we are at approximately at the right SG&A structure. The income tax rates fluctuates. More transfer pricing requires movement of income in between the entities and then each entity has its own tax rate. So it’s sort of hard to predict how that’s going to come out at the beginning of the year. You notice in Q1 we actually has tax expense on a pretax loss which just is a function of where the income ends up after the price -- after all the transfer pricing is performed. So it’s a little hard to predict what tax is going to be.

Unidentified Analyst

Okay. Thanks very much. What about commission rates in Q3? Typically, you saw SG&A and rise due to, as Darren said in the past, due to commission rates. And idea how we should model that going forward? Is it going to be typical? Have you made any structural changes to the sales force commission rates going forward?

Darren Richardson

No, it’s not really commission rates. There is a tiny little bit of commission rates in there. But typically as co-op advertising and market develop fund programs, they are a percentage of sales. And so as sales go up you will see that variable element come through the sales and marketing line. But it’s going to be pretty much inline where it had been in previous years.

Operator

Our next question comes from the line of Ronald Rotter with RLR Partners. Please go ahead.

Ronald Rotter - RLR Partners

Skullcandy announced that the Astro Gaming that they acquired, that their product will -- they will start putting it in the retail channels, in the past it had been only offered online. Not being a gamer, can you tell me is that a product that competes directly with the Warhead products and just what the nuances are between the two products?

Darren Richardson

It certainly competes directly with the Tritton range. It’s a well respected product line that has a hardcore following. In terms of the Warhead, the Warhead has -- we have the exclusive of the direct connection to the Microsoft console and so we have some exclusive features now that we believe are superior to anything else that’s in the marketplace today.

Operator

There are no further questions at this time. I will turn the call back to you for closing remarks.

Darren Richardson

Thanks everyone for joining us on the call today and we look forward to updating you on our progress when we host the fiscal second quarter 2013 call. Thank you.

Operator

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

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