Mad Catz Interactive, Inc. F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

Aug.19.08 | About: Mad Catz (MCZ)

Mad Catz Interactive, Inc. (NYSEMKT:MCZ)

F1Q09 Earnings Call

August 19, 2008 5:00 pm ET

Executives

David Jacoby – Investor Relations. Jaffoni & Collins Incorporated

Darren Richardson – President and Chief Executive Officer

Stewart Halpern – Chief Financial Officer

Analysts

Ronald Rotter – RLR Partners

David Brigham – Brigham Investments

Joseph [Miranda] – Private Investor

Operator

Welcome to the Mad Catz Interactive fiscal Q1 2009 results conference call. (Operator Instructions) I would now like to turn the conference over to Dave Jacoby, Investor Relations.

David Jacoby

Today’s discussion will contain forward-looking statements about the company’s financial results, estimates and business prospects that involve substantial risks and uncertainty. 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 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, market and general economic conditions.

A further list of descriptions 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 may include non-GAAP financial measures within the meaning of 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 efforts to raise its visibility within the financial community, the company regularly meets with or conducts calls with members of the financial community. If you’re interested in meeting with Mad Catz management, please call me at 212-835-8500.

I would now like to introduce Mad Catz President and Chief Executive Officer, Darren Richardson, who will be joined on today’s call by CFO, Stewart Halpern.

Darren Richardson

First, I’ll briefly review some of the fiscal 2009 first quarter highlights and then turn the call over to Stewart, who’ll provide some additional financial perspective. Afterwards, I’ll discuss our strategy for growth throughout the fiscal 2009 as we leverage what is the broadest suite of product lines and most robust portfolio of licenses in Mad Catz history.

There’s no doubt that it was an outstanding quarter on both the revenue and gross profit basis. With record first quarter net sales of $23.2 million, a 59% increase over the prior year, record first quarter gross margins of 34.9% which makes it the ninth consecutive quarter of year-on-year gross margin improvement and that resulted in record first quarter gross profit of $8.1 million which was a 72% increase over the prior year.

Operating expenses were up significantly, driven largely by the amortization of intangible assets resulting from the Saitek acquisition, the addition of Saitek’s overhead, the reallocation of some expense items from COGS to G&A and accounting and SOX compliances. As we mentioned on the last call, we’re implementing a restructuring plan that will bring the SG&A in line and Stewart will provide some additional color on that in a moment. The net result was a loss of $777,000 or $0.01 per share on a fully diluted basis. EBITDA remains a valuable metric to gauge the underlying performance of the business and it was a positive $283,000 for the quarter.

With that I would now like to turn the call over to the Mad Catz CFO, Stewart Halpern, for some additional detail.

Stewart Halpern

Net sales for the quarter ended June 30, 2008 were a fiscal Q1 record of $23.2 million, up 59.3% from $14.6 million in the prior year period. The increased level of net sales was driven by the growth in all segments of the business, with contribution from Saitek as well the year-over-year increase in console video game product sales of approximately 7%. We’re very pleased to show positive year-over-year comps for console video game sales and look forward to continuing this trend as we continue to increase the breadth of our products offerings on the current generation consoles.

Sales of products relating to the current generation consoles represent approximately 40% of gross sales for the quarter and this was the first period in this cycle in which the aggregate increase in current generation product sales more than offset the decline in prior generation product sales. This performance was driven largely by the success of our Wii Fit range of accessories which represented our first breakout products on this very popular console. In a few moments Darren will discuss what we believe to be a strong product pipeline that will further support our efforts to expand on Q1’s momentum relating to the current generation of video game consoles.

As Darren mentioned, we made significant progress in our effort to increase market penetration in Europe, aided significantly by Saitek’s strong distribution and retail presence there particularly in Germany, a market into which Mad Catz previously did not do direct sales. As a result, consolidated European sales more than doubled year-over-year, an increase of approximately 41% of net sales, up from 29% in the fiscal 2008 first quarter.

Gross profit for the quarter rose 73% to $8.1 million, up from $4.7 million in Q1 of fiscal 08 while gross margin points improved by approximately 280 basis points toward a quarterly record 34.9% compared to 32.1% in the prior year period, although this quarter’s gross margin benefited approximately two points from the release of a sales reserve which we would not expect to be a recurring phenomenon. Even without this benefit the gross margin would still have been a record for the quarter.

The gross margin improvement was aided by a number of factors including a higher mix of direct import sales to customers, renegotiated shipping rates and the continuation of our strategic focus on higher margin product sales. Despite the strong net sales and gross margin performances, net loss for the quarter was increased to $777,000 or a loss of $0.01 per diluted share compared to a loss of $181,000 or $0.00 per share in the year ago period. This increased loss was driven by higher operating expenses led by SG&A expense of $7.9 million or 34% of net sales compared with $4.5 million or 31% of net sales in the prior period.

As discussed in prior calls we continue to make efforts to bring the Saitek operating cost structure more in line with that of Mad Catz and we are confident that this SG&A percentage of sales will trend downward directionally as we progress through the year. During Q1 we merged Saitek’s U.S. operations into those of Mad Catz and we have recently completed the merger of the Saitek U.K. entity into our European entity. This quarter we were targeting the merger of Saitek’s Hong Kong entity into ours. Reducing the number of operating entities will increase operating and accounting efficiencies and are just one component of what we expect will be further efficiencies to be gained through the year.

As Darren mentioned, EBITDA for the first quarter was $283,000 compared to EBITDA of $400,000 in the same period in 2008. Regarding the balance sheet, the net position of bank loan less cash at June 30, 2008 was $10.9 million versus $6.2 million at March 31, 2008 with noteworthy contributors in the change being building inventories for the upcoming fall selling season as well as an increased receivable balance based on the higher sales. I’d also like to point out that the net debt position is inclusive of the drawdown last fall of approximately $15 million for the Saitek acquisition so the business has been nicely cash flow positive on an operating basis over the prior 12 months.

And now for some elaboration on our product positioning and thoughts about what we see for this fall, I’d like to turn the call back to Darren.

Darren Richardson

As Stewart mentioned earlier in the call, the first quarter saw strong demand for our range of products to support the Nintendo Wii Fit. Wii Fit sales helped solidify our presence on this highly popular console which Mad Catz had previously not addressed with as complete a line of product offerings as the other two current generation consoles. Wii Fit continues to sell very well in stores and we expect our peripherals to continue achieving healthy attach rates throughout the holiday season.

During the next two quarters we’re rolling out our full line of products to support the smash hit, Rock Band game. This includes a wired and wireless base modeled after the iconic Fender Precision Bass, portable drums sets, microphones with controller built in for ease of menu navigation and premium wooden guitars using real Fender Stratocaster guitar bodies with Mad Catz electronics to play the Rock Band game. In addition, we’ll begin shipping Coffin Case branded carrying cases that are compatible with both Rock Band and Guitar Hero.

Given the large installed base of Rock Band and the title’s continued popularity we expect these high quality instruments to be a significant driver of sales this holiday season. In addition to the Wii Fit and Rock Band products, Mad Catz will continue rolling out several established and newly acquired brand licensed products and peripherals. As we also announced yesterday, we are very excited about the agreement that we have signed with Capcom to produce branded controllers and accessories based on the Street Fighter, Bionic Commando and Resident Evil video game properties. This agreement aligns our products with three of the video game industry’s most popular and enduring franchises and enhances our pipeline of products tied to highly anticipated software releases.

Earlier we announced licenses for Ubisoft’s Petz and Rayman Raving Rabbids which will further compliment our handheld and Wii product lines and the addition of NASCAR as well as Manchester United, Liverpool and Arsenal European Football Clubs continues to strengthen our sports licensing portfolio.

Turning to Saitek, we recently introduced a new range of lifestyle themed PC accessories and we’re starting to gain traction in the U.S. market. The video game industry has remained very resilient in the face of the current economic downturn and is poised for continued growth this holiday season, both domestically and overseas. In addition to this industry’s strength we’re hopeful that Mad Catz will benefit from our further console hardware price reductions which would have a very positive impact on our business.

We’re very pleased with our position going into the upcoming holiday season. Our license portfolio, led by Rock Band, is deeper and stronger than it has ever been in the past. Our penetration into Europe has greatly expanded our reach and reduced our reliance on North American markets. The diversity of our product lines now includes a broad range of PC peripherals in addition to AirDrives audio technology that both increase our scale and reduce our reliance on console specific products.

I would now like open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ronald Rotter – RLR Partners.

Ronald Rotter – RLR Partners

Have you broken out the Saitek revenues and operating income for the quarter and will you be doing that in the 10Q? Then also I have an accounting question. It appears from looking at the balance sheet that there was declining goodwill of $697,000 in the quarter and also a decline in the intangible asset account of $759,000 which is roughly $1.45 million, yet on the amortization of intangibles it shows a $612,000 so I was just wondering if you could specify what the difference there is.

Also, Rock Band on the fourth quarter call, you had indicated would start shipping in July, I believe. Has that in fact started shipping and if not, what’s the story there? And the G&A was up from $3.6 million in the fourth quarter to $4.1 million in Q1. Is that $4.1 million the future run rate?

Stewart Halpern

Let me take a couple of the accounting oriented type ones and then I think Darren can maybe talk to their Rock Band one. On first with regards to the breakout of Saitek, as I mentioned we’re starting to merge entities together and so some clean separations, practically speaking, won’t be feasible. What we can do though is we can obviously break out the product sales and you’ll see I think in the supplementary information in the press release as well as what you’ll see in the 10Q where we give some information on a product basis. PC is essentially the Saitek product line. To give you a little bit more clarity, in the quarter the Saitek product sales were about a little bit over $7.5 million but in terms of going further down in the sense of Saitek income statement, we’re at a point where, practically speaking, can’t quite fully do that.

With regard to the point about the goodwill and intangibles, that gets really detailed. If you wouldn’t mind, I’d prefer to follow up with you offline on that one. The G&A, the $3.6 million to $4.1 million, there are two things that are driving that. In Darren’s opening comments he made reference to a reclass from –

Ronald Rotter – RLR Partners

Between the GM.

Stewart Halpern

So that’s actually close to $400,000 right there and then there’s also the Q1 is where all of our year end audit fees show up and there was a, and based on the additional work relating to Saitek and us being a bigger, more complicated entity. At that time frame, the audit fees were up a pretty noticeable amount. So those are the two real drivers on the G&A line amount.

Ronald Rotter – RLR Partners

So when you talk about the gross margin being up dramatically, in reality, I mean if you take the two points that you got from non-recurring release of sales reserves and now roughly about 1.5 points of reallocation, in reality, the gross margin was down from a true operating basis. Is that correct?

Stewart Halpern

Well, there’s some other moving parts. There are just some things that brought it down so I think it’s fair to say that on an aggregate basis it’s probably up close to a point but there was a mix of things. Some things bring it up; some things bring it down. The other thing –

Ronald Rotter – RLR Partners

But are they, but you’re saying on an ongoing basis, it really widened back up.

Stewart Halpern

On an ongoing basis, the reclass that we’re talking about is something that is not a one time event and will be carried forward every quarter.

Darren Richardson

And just on the reclass, part with the inclusion of Saitek’s China operations, we now have 80 people in Hong Kong and China and so the scope of work that is being done there is a lot broader than the way it was classified in the past as more of a sourcing operation. So it buffed it out, the different elements of that into research and development and accounting and finance and some of those things that now that it’s becoming a much more meaningful number as it actually makes sense to drop it into some of those other buckets.

And then in terms of the Rock Band, we’re actually just in the process of shipping Rock Band now. We started shipping out of Hong Kong at the end of July and we’re now in the process of shipping into retail.

Ronald Rotter – RLR Partners

So when should we expect to see it in the stores?

Darren Richardson

It’ll probably take two weeks before it works through their distribution centers so I would say by the end of August we should be in store.

Operator

Our next question comes from David Brigham – Brigham Investments.

David Brigham – Brigham Investments

Without getting into guidance about future quarters and so forth, I know you’ve got a good look at the second quarter. Can this company become a $500 million company in five years or three years? And what’s its earning power once you get these revenue sources diversified the way you want them and so on and so forth? Can you –

Darren Richardson

Yes, I think just in terms of general philosophy on that. If you look at where we’ve been over the last 10 years I think you could, I got involved in Mad Catz back in 1999 when it was a $45 million company. I think for a long period we did a pretty good job of growing the business and very aggressively growing the business and although we didn’t really lose a lot of any very much money along the way, we made money in almost every single year. We didn’t really make anything that you’d say was meaningfully profitable but it was a good growth story.

The last couple of years, we’ve really pulled back to try and get margins up to where we want, so we’ve got a higher margin business and a profitable business. And I think we’ve done a very good job of that but I think, as we all know, you need to have growth and profitability. The last, and particularly this quarter, we’re now starting to see some pretty impressive growth, not just from the Saitek acquisition, although that’s a very meaningful part of the growth story, but also in the core business, in the video game console accessory business. And when I look to the pipeline of products that we’re coming out and the Rock Band products, in particular, have a lot of potential to continue to drive that growth.

If we can drive growth and keep the margins in that low 30% mark, which frankly comes pretty well against other companies in and around our space and our style of business, then we’ve got a bright future. I think if you take a company like Logitech as a very good example of a company that’s done a great job of maintaining solid margins in that low 30s and continually building up the company and driving growth over a long period of time, that demonstrates that it can actually be done. And I think the Joytech acquisition in the middle of last year followed by the Saitek acquisition, provided we can continue to drive the growth, maintain the margins and then bring the op expense under control. And the op expense, when you look at it on an annualized basis is a little bit skewed because we got half of the operating expenses through the third quarter but the reality is the bulk of the sales came in the first half of that third quarter for Saitek. So we missed the bulk of the sales but we got 50% of the operating expenses. So, as we move through the third quarter this year you’ll start to see some of those op expense percentages just normalize just on a mathematical basis. Now, that said, I think we’ve still got some big opportunities to bring down some of the op expense categories and we’re working on that. Collapsing entities in to each number so we bring down the number of legal entities and by doing that reducing our audit costs because we’ll go from say 11 legal entities where we are today down to seven, will have some significant impacts as well.

So, we’ve got a lot of initiatives, it will just take a little while for it to work through but in terms of top line and margins, I feel very good about where the business is at. Op expense, I wish it was than that, however, I believe we can tackle that and I would rather deal with op expense problems than dealing with the sales and gross margin problems. I feel like we’re in a very, very good place.

Operator

Our next question comes from the line of Joseph [Miranda] – Private Investor.

Joseph [Miranda] – Private Investor

In the press release you have a line item that says, “Achieved further retail presence for air drives and air drives [inaudible] in the US and UK.” Can you explain that a little more or quantify it?

Darren Richardson

I think air drives is a really, really interesting product which once people actually try the product and understand what it does, people like it a lot. The challenge is it’s not obvious to people what it does and why it’s different and it’s a difficult marketing proposition because there’s a lot of things to explain. So, getting air drives out in to people’s hands is the first biggest challenge. We’ve actually got pretty good dot com placement on air drives on a lot of the major sites and that’s the first step in to being able to get air drives in store. We have a couple of things we’re working on now that will start to see a few more placements in some more meaningful retailers so it’s going to be a little bit of a slow burn until that one catches on. And, we’ve got a couple of things we’re looking out on the marketing front that may actually be able to drive air drives along a little bit further as well.

So, I would say I’m not thrilled where we’re at on air drives, I still believe in the product, I think the product is good it’s just a matter of how to actually get it out in to full distribution and help people understand that it does.

Joseph [Miranda] – Private Investor

Also, is there anything, again, I know you may not be able to name names but, is there anything gin the product pipeline on the software side that Mad Catz is working on for release in the next year?

Darren Richardson

We’re doing some exploration on the software side. To be totally honest, we pulled back fairly heavily from the software side over the last two years mainly because the area we were trying to mine was interactive software where the hardware provided the most interesting part of the game. We have certainly been such a huge thing in that space that it’s hard to kind of come up with things that are innovative and different that would go up against that. Then secondly, with the new generation of console, it’s just a little bit early in the cycle to have real mass market adoption of things that are kind of more interesting and a little bit more niche which is a kind of product we’ve done in the past. So, we’ve got a couple of things we’re working on and would like to explore.

One of the things that we definitely have in and around Sidekick is the leaders in Slide SIM and Slide SIM hardware so we’re exploring a couple of opportunities there that would actually make sense to be able to bundle in some software in around those Sidekicks. And again, would be a very nice little niche place.

Operator

We appear to have no further questions at this time.

Darren Richardson

Thank you for joining the call today. We look forward to updating you on our progress when we host our second quarter call in the not too distance future.

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