MAD CATZ INTERACTIVE INC 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended September 30, 2011
For the Transition Period from to
Commission File No. 001-14944
MAD CATZ INTERACTIVE, INC.
(Exact name of Registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There were 63,448,231 shares of the registrants common stock issued and outstanding as of November 4, 2011.
MAD CATZ INTERACTIVE, INC.
FOR THE PERIOD ENDED SEPTEMBER 30, 2011
TABLE OF CONTENTS
Item 1. Financial Statements
MAD CATZ INTERACTIVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands of U.S. dollars, except share data)
See accompanying notes to unaudited condensed consolidated financial statements.
MAD CATZ INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of U.S. dollars, except share and per share data)
See accompanying notes to unaudited condensed consolidated financial statements.
MAD CATZ INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of U.S. dollars)
See accompanying notes to unaudited condensed consolidated financial statements.
MAD CATZ INTERACTIVE, INC.
(1) Basis of Presentation
The condensed consolidated balance sheets and related condensed consolidated statements of operations and cash flows contained in this Quarterly Report on Form 10-Q, which are unaudited, include the accounts of Mad Catz Interactive, Inc. (the Company) and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all entries necessary for a fair presentation of such condensed consolidated financial statements have been included. These entries consisted only of normal recurring items. The results of operations for the interim period are not necessarily indicative of the results to be expected for any other interim period or for the entire fiscal year. The Company generates a substantial percentage of net sales in the last three months of every calendar year, its fiscal third quarter.
The condensed consolidated financial statements do not include all information and notes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with United States generally accepted accounting principles. Please refer to the Companys audited consolidated financial statements and related notes for the fiscal year ended March 31, 2011 contained in the Companys Annual Report on Form 10-K as filed with the United States Securities and Exchange Commission (the SEC).
The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to asset impairments, reserves for accounts receivable and inventories, contingencies and litigation, valuation and recognition of share-based payments, contingent consideration, warrant liability and income taxes. Illiquid credit markets, volatile equity markets, foreign currency fluctuations, and declines in customer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. Actual results could differ from those estimates.
(2) Recently Issued Accounting Standards
The Company recently adopted the following new accounting standards:
Improving Disclosures about Fair Value Measurements: In January 2010, the Financial Accounting Standards Board (FASB) issued an update which provides guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurement on a gross basis rather than on a net basis as previously required. This update also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. This update did not have a material impact on the Companys financial statements.
Effect of Denominating the Exercise Price of a Share-Base Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades: In March 2010, the FASB issued an update to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify an award with such a feature as a liability if it otherwise qualifies as equity. Affected entities are required to record a cumulative catch-up adjustment for all awards outstanding as of the beginning of the annual period in which the guidance is adopted. This update did not have a material impact on the Companys financial statements.
The following new accounting standards have been issued, but not adopted by the Company as of September 30, 2011:
Amendment to Fair Value Measurement: In May 2011, the FASB revised the fair value measurement and disclosure requirements to align the requirements under accounting principles generally accepted in the United States of America (GAAP) and International Financial Reporting Standards (IFRS). The guidance clarifies the FASBs intent regarding the application of existing fair value measurements and requires enhanced disclosures, most significantly related to unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The guidance is effective prospectively during interim and annual periods beginning after December 15, 2011. The Company does not expect the adoption of this guidance to have a material impact on the Companys financial statements.
Presentation of Comprehensive Income: In June 2011, the FASB issued ASU No. 2011-05, requiring entities to report components of other comprehensive income in either a single continuous statement or in two separate but consecutive statements of net income. The guidance is effective during interim and annual periods beginning after December 15, 2011. The Company does not expect the adoption of this guidance to have a material impact on the Companys financial statements.
Testing Goodwill for Impairment: In September 2011, the FASB issued ASU No. 2011-08, that allows companies to assess qualitative factors to determine whether they need to perform the two-step quantitative goodwill impairment test. Under the option, an entity no longer would be required to calculate the fair value of a reporting unit unless it determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The guidance is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011 although early adoption is permitted. As of September 30, 2011, the Company has not elected to adopt the new guidance early, and when adopted, this guidance is not expected to have a significant impact on the Companys financial statements.
(3) Fair Value Measurement
The following tables provide a summary of the recognized assets and liabilities carried at fair value on a recurring basis as of September 30, 2011 and March 31, 2011 (in thousands):
The following tables provide a roll forward of the Companys level three fair value measurements during the six months ended September 30, 2011, which consist of the Companys contingent consideration liability and warrant liability (in thousands):
(4) Contingent Consideration
On May 28, 2010, the Company acquired all of the outstanding stock of Tritton Technologies Inc. (Tritton). Tritton designs, develops, manufactures (through third parties in Asia), markets and sells videogame and PC accessories, most notably gaming audio headsets. The Company acquired all of Trittons net tangible and intangible assets, including trade names, customer relationships and product lines. Cash paid for the acquisition was approximately $1.4 million, subject to a working capital adjustment currently estimated to be $10,000. As a result of the acquisition, Tritton became a wholly-owned subsidiary of the Company and accordingly, the results of operations of Tritton are included in the Companys consolidated financial statements from the acquisition date. The Company financed the acquisition through borrowings under the Companys working capital facility. The acquisition expanded the Companys product offerings in the high growth gaming audio market and further leveraged the Companys assets, infrastructure and capabilities.
The contingent consideration arrangement requires the Company to pay the former shareholders of Tritton additional consideration based on a percentage of future sales of Tritton products over a five year period, subject to maximum annual amounts up to an aggregate of $8.7 million. The fair value of the contingent consideration
arrangement has been determined primarily by using the income approach and using a discount rate of approximately 17 percent. The amount paid for contingent consideration is expected to be reduced by the amount of any working capital adjustment. In May 2011, the Company paid $1,546,000 under this arrangement. As of September 30, 2011, the liability for contingent consideration is shown net of the estimated working capital adjustment and holdback of $10,000.
Inventories consist of the following (in thousands):
(6) Securities Purchase Agreement
On May 3, 2011 the Company filed a Registration Statement registering up to 8,893,211 common shares of the Company comprised of: (i) 6,352,293 common shares and (ii) 2,540,918 common shares issuable upon exercise of 2,540,918 warrants. In April 2011 the Company entered into a Securities Purchase Agreement (the Securities Purchase Agreement) with certain accredited investors, pursuant to which the Company sold (a) an aggregate of 6,352,293 shares of its common stock (the Shares) and (b) warrants to purchase an aggregate of 2,540,918 shares of common stock of the Company (Warrants and, together with the Shares, the Securities). The Securities were issued at a price equal to $1.92 for aggregate gross proceeds of approximately $12,196,000. The Warrants became exercisable on October 21, 2011 at a per share exercise price equal to $2.56. The Warrants contain provisions that adjust the exercise price in the event the Company pays stock dividends, effects stock splits or issues additional shares of common stock at a price per share less than the exercise price of the Warrants. The Warrants will remain exercisable October 21, 2016.
The Company accounts for the Warrants with exercise price reset features in accordance with the applicable FASB guidance. Under this guidance, warrants with these reset features are accounted for as liabilities and carried at fair value, with changes in fair value included in net earnings (loss) until such time as the Warrants are exercised or expire.
The fair value of the Warrants decreased from $3,250,000 as of the initial valuation date to $716,000 as of September 30, 2011, which resulted in a $2,534,000 gain from the change in fair value of warrants for the six months ended September 30, 2011.
These Warrants are not traded in an active securities market, and as such, the Company estimates the fair value of the Warrants using the Black-Scholes option pricing model using the following assumptions:
Expected volatility is based primarily on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the expected term of the Warrants. The Company believes this method produces an estimate that is representative of the Companys expectations of future volatility over the expected term of these Warrants. The Company currently has no reason to believe future volatility over the expected remaining life of these Warrants is likely to differ materially from historical volatility. The expected life is based on the remaining contractual term of the Warrants. The risk-free interest rate is the interest rate for treasury constant maturity instruments published by the Federal Reserve Board that is closest to the expected term of the Warrants.
(7) Comprehensive Income (Loss)
Comprehensive income (loss) for the three and six months ended September 30, 2011 and 2010 consists of the following components (in thousands):
The foreign currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries.
(8) Basic and Diluted Net Earnings per Share
Basic earnings per share is calculated by dividing the net earnings by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per share includes the impact of potentially dilutive common stock-based equity instruments.
Outstanding options to purchase an aggregate of 7,238,110 and 6,816,657 shares of the Companys common stock for the three and six months ended September 30, 2011, respectively, and 7,730,227 and 7,667,004 shares of the Companys common stock for the three and six months ended September 30, 2010, respectively, were excluded from diluted net loss per share calculations because inclusion of such options would have an anti-dilutive effect during these periods. Outstanding warrants to purchase an aggregate of 2,540,918 and 2,082,720 of the Companys common stock for the three and six months ended September 30, 2011, respectively, were excluded from the diluted net loss per share calculations because of their anti-dilutive effect during the period. Weighted average shares of 949,189 for the six month period ended September 30, 2011 and 10,217,744 for the three and six month periods ended September 30, 2010 related to $14,500,000 of convertible notes payable were excluded from the calculation because of their anti-dilutive effect during the period.
(9) Geographic Data and Concentrations
The Companys sales are attributed to the following geographic regions (in thousands):
Revenue is attributed to geographic regions based on the location of the customer. During the three and six months ended September 30, 2011, one customer individually accounted for approximately 24% and 22% of the Companys gross sales, respectively, and one other customer individually accounted for approximately 12% and 11% of the Companys gross sales, respectively. During the three and six months ended September 30, 2010, one customer individually accounted for approximately 34% and 30% of the Companys gross sales, respectively and one other customer individually accounted for approximately 12% and 11%, respectively. At September 30, 2011, one customer represented 32% of accounts receivable and another customer represented 13% of accounts receivable. At September 30, 2010, one customer represented 39% of accounts receivable and another customer represented 12% of accounts receivable. At September 30, 2011 and 2010, there were no other customers which accounted for greater than 10% of accounts receivable or gross sales.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise requires, all references in this section to the Company, we, us or our refer, collectively, to Mad Catz Interactive, Inc. and all of its subsidiaries, and all references in this section to Mad Catz refer to Mad Catz Interactive, Inc.
This section contains forward-looking statements and forward looking information (collectively forward-looking statements) as
defined in applicable securities legislation involving risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors including those set out under Forward-looking Statements herein and in Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011 and in Part II Other Information Item 1A. Risk Factors in this Quarterly Report on Form 10-Q. The following discussion should be read in conjunction with our condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.
We design, manufacture (primarily through third parties in Asia), market and distribute products for all major videogame platforms, the PC and, to a far lesser extent, the iPod and other audio devices. Our accessories are marketed primarily under the Mad Catz, Tritton, Saitek, Joytech, Cyborg, Eclipse, GameShark and AirDrives brands; we also produce for selected customers a limited range of products which are marketed on a private label basis. Our products include videogame, PC and audio accessories, such as control pads, steering wheels, joysticks, memory cards, video cables, flight sticks, flight simulators, dance pads, microphones, car adapters, carry cases, mice, keyboards and headsets. We also publish and distribute videogames.
Securities Purchase Agreement
In April 2011, the Company entered into a Securities Purchase Agreement with certain accredited investors, pursuant to which the Company sold (a) an aggregate of 6,352,293 shares of its common stock (the Shares) and (b) warrants to purchase an aggregate of 2,540,918 shares of common stock of the Company (Warrants and, together with the Shares, the Securities). The Securities were issued at a price equal to $1.92 for aggregate gross proceeds of approximately $12.2 million. The Warrants became exercisable on October 21, 2011 at a per share price equal to $2.56, subject to certain adjustments as specified in the Warrants, and will remain exercisable until October 21, 2016.
Convertible Notes Payable
On May 5, 2011, the Company repaid all remaining principal and interest related to the $14.5 million Saitek Notes. The repayment was partially funded with the net proceeds of the Securities Purchase Agreement, which occurred in April 2011.
Seasonality and Fluctuation of Sales
We generate a substantial percentage of our net sales in the last three months of every calendar year, our fiscal third quarter. Our quarterly results of operations can be expected to fluctuate significantly in the future, as a result of many factors, including: seasonal influences on our sales; unpredictable consumer preferences and spending trends; the introduction of new videogame platforms; the need to increase inventories in advance of our primary selling season; and timing of introductions of new products.
Potential Fluctuations in Foreign Currency
During the three and six month periods ended September 30, 2011, approximately 57% and 52% of total net sales were transacted outside of the United States, respectively. The majority of our international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause currency transaction gains and losses, which we have experienced in the past and continue to experience. Due to the volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations upon future operating results. There can be no assurances that we will not experience currency losses in the future. To date we have not hedged against foreign currency exposure.
Critical Accounting Policies
Our critical accounting principles and estimates remain consistent with those reported in our Annual Report on Form 10-K for the year ended March 31, 2011, as filed with the SEC.
RESULTS OF OPERATIONS
From a geographical perspective, our net sales for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands):
For the three months ended September 30, 2011, consolidated net sales decreased 31% as compared to the three month period ended September 30, 2010. In the United States, the decrease in net sales is primarily attributable to sales of our Rock Band 3 products in the second fiscal quarter of 2011, which was released in September 2010. In Europe the increase is largely attributable to foreign exchange fluctuations. In Canada the increase in net sales primarily relates to increased sales of Tritton and Cyborg lines of products.
For the six months ended September 30, 2011, consolidated net sales decreased 26% as compared to the six months ended September 30, 2010. In the United States, the preponderance of the decrease in net sales occurred during the latter part of the six month period for the reasons described above. In Canada the increase in net sales primarily relates to increased sales of Tritton and Cyborg lines of products.
Our sales by product group as a percentage of gross sales for the three and six months ended September 30, 2011 and 2010 were as follows:
Sales of products designed for use with the PlayStation 3 platform, and especially Mad Catz branded audio products were negatively impacted by a Play Station Network outage during the first quarter of fiscal 2012. Sales of products designed for use with the Wii platform continued to decline in anticipation of the release of a successor platform next year. Sales of PC products increased primarily due to sales of the Cyborg line of products. The increase in All others is primarily related to universal audio products.
Our sales by product category as a percentage of gross sales for the three and six months ended September 30, 2011 and 2010 were as follows:
The increase in audio products primarily related to increased distribution of Tritton products. The decrease in games as a percentage of total gross sales primarily related to lower sales of bundled products of the Rock Band 3 game. The decrease in controllers was primarily related to products compatible with the Wii and PlayStation 3. Sales of PC input device products increased primarily due to higher sales of the Cyborg line of products
Our sales by brand as a percentage of gross sales for the three and six months ended September 30, 2011 and 2010 were as follows:
The decrease in Mad Catz-branded products primarily related to lower sales of Rock Band 3 products. The increase in Tritton-branded products as a percentage of total gross sales primarily related to increased distribution. The increase in Cyborg-branded products primarily related to increased product offerings. The decrease in all other branded products primarily related to the termination of a distribution agreement under which the company sold third party products.
Gross profit is defined as net sales less cost of sales. Cost of sales consists of product costs, cost of licenses and royalties, cost of freight-in and freight-out and distribution center costs, including depreciation and other overhead.
The following table presents net sales, cost of sales and gross profit for the three and six months ended September 30, 2011 and 2010 (in thousands):
Gross profit for the three months ended September 30, 2011 decreased 29%, while gross profit as a percentage of net sales, or gross profit margin, increased from 28% to 29%. Gross profit for the six months ended September 30, 2011 decreased 31%, while gross profit as a percentage of net sales, decreased from 29% to 27%. We expect the gross profit margins to remain in the current range, although the gross profit margins may fluctuate due to factors such as changes in product mix and exchange rate fluctuations.
Operating expenses for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands):
Sales and Marketing. Sales and marketing expenses consist primarily of payroll, commissions, participation at trade shows and travel costs for our worldwide sales and marketing staff, advertising expense and costs of operating our websites. The increase in sales and marketing expense was primarily due to increased headcount, marketing spending and exchange rate fluctuations. We expect sales and marketing expenses in fiscal 2012 to increase, on an absolute dollar basis, over fiscal year 2011 levels.
General and Administrative. General and administrative expenses include salaries and benefits for our executive and administrative personnel, facilities costs and professional services, such as legal and accounting. The slight increase in general and administrative expenses for the six month period was primarily related to increased legal fees related to defending the Company in legal actions arising in the ordinary course of its business. We expect general and administrative expenses in fiscal 2012 to approximate fiscal year 2011 levels on an absolute dollar basis.
Research and Development. Research and development expenses include the costs of developing and enhancing new and existing products. The increase in research and development expenses relates to expanded research and development activities related to our audio products and software development. We expect research and development expenses in fiscal 2012 to increase, on an absolute dollar basis, over fiscal year 2011 levels.
Amortization. Amortization expenses consist of the amortization of the acquired intangible assets from Saitek, Joytech and Tritton. These acquisitions occurred in the third and second quarters of fiscal 2008 and first quarter of fiscal 2011, respectively. The slight increase in amortization expense was due to the amortization related to intangibles acquired in the Tritton acquisition. This increase was partially offset by a decrease related to intangibles acquired in the Joytech and Saitek acquisitions that became fully amortized.
Interest Expense, net, Foreign Exchange Gain, Change in Fair Value of Warrant Liability and Other Income
Interest expense, net, foreign exchange gain, change in fair value of warrant liability and other income for the three and six months ended September 30, 2011 and 2010 were as follows (in thousands):
The decrease in interest expense during the three and six month periods ended September 30, 2011 is related to lower debt balances as a result of the repayment of the convertible note.
The foreign exchange gains in all periods are due primarily to the rise in value of the U.S. dollar and Hong Kong dollar versus the Great British Pound and the Euro during those periods.
The change in fair value of warrant liability recorded in the three and six month period ended September 30, 2011 represents the change in fair value of the Warrants issued in connection with the Securities Purchase Agreement. Specifically, the decrease in the Companys stock price at September 30, 2011 reduced the value of the warrant liability and resulted in income during the three and six month periods.
Other income during the three and six month periods ended September 30, 2011 primarily relates to advertising income from our GameShark.com website. Other income in the three and six months ended September 30, 2010 included an insurance recovery that did not recur in the fiscal 2012 period.
Income Tax Expense (Benefit)
Income tax expense (benefit) for the three and six months ended September 30, 2011 and 2010 was as follows (in thousands):
The Companys effective tax rate is a blended rate for different jurisdictions in which the Company operates. The effective tax rate fluctuates depending on the taxable income in each jurisdiction and the statutory income tax rates in those jurisdictions in which we do business, including our U.S. operating company, and our Canadian parent company for which we continue to provide a full valuation allowances against its losses. The Company will continue to evaluate the realizability of its net deferred tax asset on an ongoing basis to identify whether any significant changes in circumstances or assumptions have occurred that could materially affect the realizability of deferred tax assets and expects to release the valuation allowance when it has sufficient positive evidence, including but not limited to cumulative earnings in successive recent periods, to overcome such negative evidence. Accordingly, it is reasonably possible that all or a portion of the U.S. valuation allowance could be released in the next twelve months and the effect could be material to the companys financial statements. The change in the effective tax rate in the second quarter of fiscal 2012 versus the second quarter of fiscal 2011 was primarily due to the book income in certain jurisdictions in the second quarter of fiscal 2011 as compared to losses in those jurisdictions in the second quarter of fiscal 2012.
For fiscal 2012, we project a 30% effective tax rate. Our current projected tax rate for fiscal 2012 could change significantly if actual results differ from our current outlook-based projections.
Liquidity and Capital Resources
Sources of Liquidity
At September 30, 2011, available cash was approximately $2.7 million compared to cash of approximately $3.7 million at March 31, 2011 and $3.7 million at September 30, 2010. Our primary sources of liquidity include a revolving line of credit (as discussed below under Cash Flows from Financing Activities), cash on hand at the beginning of the year and cash flows generated from operations during the year.
Cash Flows from Operating Activities
Our cash flows from operating activities have typically included the collection of customer receivables generated by the sale of our products, offset by payments to vendors for materials and manufacture of our products. For the six months ended September 30, 2011, cash used in operating activities was $6.3 million compared to cash used of $20.5 million for the six months ended September 30, 2010. Cash used in operations for the six months ended September 30, 2011 and 2010 primarily resulted from an increase of inventories due to the build-up in preparation for the peak annual sales season, partially offset by the correlating increase in accounts payable. The decrease in cash usage during the fiscal year 2012 compared to the 2011 period is mainly due to a later scheduled peak season forecast which required less inventory build-up during the second fiscal quarter. We are focused on effectively managing our overall liquidity position by continuously monitoring expenses, inventory levels and managing our accounts receivable collection efforts.
Due to the seasonality of our business, we typically experience a large build-up in inventories beginning during our second fiscal quarter ending September 30, with corresponding increases in accounts payable and our bank loan balance. These increases are in
anticipation of the holiday selling season, which occurs during our third fiscal quarter ending December 31. During the third quarter our inventories decrease and accounts receivable increase as a result of the annual holiday selling. A large percentage of our annual revenue is generated during our third quarter. During our fourth quarter ending March 31, the sales cycle completes with decreases in accounts receivable, inventory, accounts payable and bank loan and net increase in cash. We forecast the expected demand for the holiday selling season months in advance to ensure adequate quantities of inventory. Our sales personnel forecast holiday sales based on information received from our major customers as to expected product purchases for the holiday season, and we also utilize mathematical modeling techniques to forecast demand based on recent point-of-sale activity. If demand does not meet expectations, the result will be excess inventories, reduced sales and the overall effect could result in a reduction to cash flows from operating activities following payment of accounts payable.
Cash Flows from Investing Activities
Cash used in investing activities was $1.7 million during the six months ended September 30, 2011 and $2.2 million during the six months ended September 30, 2010. In the six months ended September 30, 2011, net cash used in investing activities consisted of capital expenditures to support our operations and were made up primarily of production molds, and to a lesser extent, computers and machinery and equipment. In the six months ended September 30, 2010, $1.2 million of the cash used in investing activities related to the purchase of Tritton and the remainder consisted of capital expenditures to support our operations and were made up primarily of purchases of production molds, and to a lesser extent, computers and machinery and equipment.
Cash Flows from Financing Activities
Cash provided by financing activities during the six months ended September 30, 2011 of $7.0 million was a result of net borrowings under our line of credit and net proceeds received for the issuance of common stock, partially offset by repayment of the convertible notes. For the six months ended September 30, 2010, cash provided by financing activities of $24.1 was a result of net borrowings under our line of credit.
We maintain a Credit Facility with Wells Fargo Capital Finance, LLC to borrow up to $30 million under a revolving line of credit subject to the availability of eligible collateral (accounts receivable and inventories), which changes throughout the year. The line of credit accrues interest on the daily outstanding balance at the U.S. prime rate plus 2.0% per annum. This facility expires on October 31, 2012. The Company is currently in negotiations to amend and extend the line of credit. At September 30, 2011, the interest rate was 5.25%. We are also required to pay a monthly service fee of $2,000 and an unused line fee equal to 0.50% of the unused portion of the loan. Borrowings under the Credit Facility are secured by a first priority interest in the inventories, equipment, accounts receivable and investment properties of Mad Catz, Inc. and by a pledge of all of the capital stock of the Companys subsidiaries and is guaranteed by the Company. We are required to meet a quarterly covenant based on the Companys free cash flow. We were in compliance with this covenant as of September 30, 2011.
At March 31, 2011 we had $14.5 million of convertible notes outstanding payable to the seller of Saitek (Saitek Notes) that were scheduled to mature on March 31, 2019. The Saitek Notes bore interest at 7.5% through March 31, 2014 and 9.0% thereafter. The Saitek Notes and all accrued interest were repaid in full in May 2011.
In connection with the Companys acquisition of Tritton, the Company is obligated to make certain payments to former Tritton shareholders of up to $8.7 million based on the achievement of certain specific performance measures. In May 2011, the Company made the first payment for $1.5 million. The aggregate fair value of the remaining payments was $3.9 million as of September 30, 2011, and is reflected in the Companys consolidated balance sheet.
We believe that our available cash balances, anticipated cash flows from operations and available line of credit will be sufficient to satisfy our operating needs for at least the next twelve months. However, we operate in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that we may not be required to raise additional funds through the sale of equity or debt securities or from additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, if at all. Furthermore, additional debt financing may contain more restrictive covenants than our existing debt.
Contractual Obligations and Commitments
On May 5, 2011, the Company repaid all principal and interest related to the $14.5 million Saitek Notes.
There have been no other material changes to our contractual obligations from the information provided in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.
As of September 30, 2011 and March 31, 2011, we did not have any relationships with unconsolidated entities or financial parties, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.
EBITDA, a non-GAAP financial measure, represents net income before interest, taxes, depreciation and amortization. To address the Warrants issued in the first quarter of fiscal 2012 and the resulting gain/loss on the change in the related warrant liability, we have excluded this non-operating, non-cash charge and defined the result as Adjusted EBITDA. We believe this to be a more meaningful measurement of performance than the previously calculated EBITDA. Adjusted EBITDA is not intended to represent cash flows for the period, nor is it being presented as an alternative to operating or net income as an indicator of operating performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with generally accepted accounting principles. As defined, Adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. We believe, however, that in addition to the performance measures found in our financial statements, Adjusted EBITDA is a useful financial performance measurement for assessing our Companys operating performance. Our management uses Adjusted EBITDA as a measurement of operating performance in comparing our performance on a consistent basis over prior periods, as it removes from operating results the impact of our capital structure, including the interest expense resulting from our outstanding debt, and our asset base, including depreciation and amortization of our capital and intangible assets. In addition, Adjusted EBITDA is an important measure for our lender. We calculate Adjusted EBITDA as follows (in thousands):
Certain statements in this Quarterly Report on Form 10-Q are not historical fact and constitute forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended and constitute forward-looking information as defined in applicable Canadian securities legislation (collectively forward-looking statements). These forward-looking statements may address, among other things, our strategy for growth, business development, market and competitive position, financial results, expected revenue, expense levels in the future and the sufficiency of our existing assets to fund future operations and capital spending needs. These statements relate to our expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future, and may be identified by the use of words or phrases such as believe, expect, anticipate, should, plan, estimate, and potential, among others. Specifically this document contains forward-looking statements regarding, among other things, the continuance of seasonal fluctuations in the Companys sales, inventories, receivables, payables and cash; the effect of currency exchange rate fluctuations; the sufficiency of funds available to meet operational needs; and our expectations for fiscal 2012 in respect of our gross profit margin, operating expenses and effective tax rate.
The forward-looking statements contained herein reflect managements current beliefs and expectations and are based on information currently available to management, as well as its analysis made in light of its experience, perception of trends, current conditions, expected developments and other factors and assumptions believed to be reasonable and relevant in the circumstances. These assumptions include, but are not limited to: continuing demand by consumers for videogames and accessories, continued financial viability of our largest customers, continued access to capital to finance our working capital requirements and the continuance of open trade with China, where the preponderance of our products are manufactured.
Forward-looking statements are not guarantees of performance and are subject to important factors and events that could cause our actual business, prospects and results of operations to differ materially from the historical information contained in this Form 10-Q, and from those that may be expressed or implied by the forward-looking statements. Readers are cautioned that actual results could differ materially from the anticipated results or other expectations expressed in these forward-looking statements for the reasons detailed in Part I Item 1A. Risk Factors of our most recent Annual Report on Form 10-K, and in Part II Other Information Item 1A. We believe that many of the risks detailed in our other SEC filings are part of doing business in the industry in which we operate, and will likely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen their significance. The forward-looking statements contained in this report are made as of the date of this report and we assume no obligation to update them or to update the reasons why actual results could differ from those projected in such forward-looking statements, except as may be required by applicable law.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
For the second quarter of fiscal 2012, our management with the participation of our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of September 30, 2011. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Accordingly, our disclosure controls and procedures have been designed to provide reasonable assurance of achieving their objectives. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of such date, our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the SEC.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The Companys process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during the process.
Item 1. Legal Proceedings
Circuit City Stores, Inc., et al., Debtors, Alfred H. Siegel, as Trustee for Circuit City, Inc., Liquidating Trust v. Mad Catz, Inc. and Saitek Industries Limited, Mad Catz, Inc., dba Saitek Industries Limited. Ch. 11 Case No. 08-35653 (KRH) (Bankr. E.D. Va. 2008 proceeding numbers 10-03763 and 10-03255). On or about December 23, 2010, Mad Catz, Inc. (MCI), along with approximately 500 other defendants who had rendered goods and services to Circuit City Stores, Inc. (Circuit City) prior to its bankruptcy, was served with a complaint alleging that payments to MCI from Circuit City made within the 90 day period prior to Circuit Citys bankruptcy filing (in the amount of $745,953.55) were voidable preferences, and therefore should be returned to the Trustee of the Bankruptcy Trust. The Bankruptcy Trust also alleged that it was entitled to certain offsets against MCIs bankruptcy claims against Circuit City. The Bankruptcy Trust also filed a similar suit against Saitek Industries Limited to void alleged preferential payments in the amount of $82,951.87. MCI has entered into a settlement agreement with Circuit City, under which all claims by both parties would be dismissed in exchange for payment by Circuit City to MCI in the amount of $135,000.
Ogma LLC. v. Activision Blizzard, Inc., et al., Civ. 2:11-cv-75-TJW (E.D. Texas 2011). On March 3, 2011, Ogma LLC (Ogma) filed an amended complaint against MCI and approximately 18 other defendants alleging infringement of United States patent number 6,150,947 by MCIs remote for the Nintendo Wii video game console. On May 13, 2011, the United States International Trade Commission (ITC) issued a Notice of Investigation regarding the matter. On July 11, 2011, the parties agreed to settle the matter and the District Court dismissed the matter with prejudice on the same day. As a result of the settlement, on July 25, 2011, the ITC issued document entitled Initial Determination Granting MCIs and Ogmas Joint Motion to Terminate the ITCs Investigation of Mad Catz. There has been no further action in this matter and therefore all claims against MCI have been resolved.
We may at times be involved in litigation in the ordinary course of business. We will also, from time to time, when appropriate in managements estimation, record reserves in our financial statements for pending litigation. Litigation is expensive and is subject to inherent uncertainties, and an adverse result in any such matters could adversely impact our operating results or financial condition. Additionally, any litigation to which we may become subject could also require significant involvement of our senior management and may divert managements attention from our business and operations. Although claims, suits, investigations and proceedings are inherently uncertain and their results cannot be predicted with certainty, we believe that the resolution of any current pending matters will not have a material adverse effect on our business, financial condition, results of operations or liquidity taken as a whole.
Item 1A. Risk Factors
There have been no material changes to the risk factors as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.
Item 6. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.