MAD CATZ INTERACTIVE INC 10-Q 2014
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended September 30, 2014
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)
7480 Mission Valley Road, Suite 101,
San Diego California 92108
(Former name, former address and former fiscal year, if changed since last report)
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 64,488,798 shares of the registrants common stock issued and outstanding as of October 31, 2014.
MAD CATZ INTERACTIVE, INC.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014
TABLE OF CONTENTS
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See accompanying notes to unaudited consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See accompanying notes to unaudited consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
See accompanying notes to unaudited consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to unaudited consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
Nature of Operations
Mad Catz Interactive, Inc. (Mad Catz) designs, manufactures (primarily through third parties in Asia), markets and distributes innovative interactive entertainment products marketed under its Mad Catz® (gaming), Tritton® (audio), and Saitek® (simulation) brands. Mad Catz products, which primarily include headsets, mice, keyboards, controllers, specialty controllers, and other accessories, cater to passionate gamers across multiple platforms including in-home gaming consoles, handheld gaming consoles, Windows® PC and Mac® computers, smart phones, tablets and other mobile devices. Mad Catz distributes its products through its online store as well as through many leading retailers around the globe. Operationally headquartered in San Diego, California, Mad Catz also maintains offices in Europe and Asia.
Basis of Accounting
The accompanying unaudited consolidated financial information has been prepared by management, without audit, in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. The consolidated balance sheet at March 31, 2014 was derived from the audited consolidated financial statements at that date; however, it does not include all disclosures required by accounting principles generally accepted in the United States (U.S. GAAP).
In the opinion of management, the unaudited consolidated financial statements for the interim period presented reflect all material adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations as of and for such periods indicated. These unaudited consolidated financial statements and notes hereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014. These consolidated financial statements refer to the Companys fiscal years ending March 31 as its fiscal years. The Company generates a substantial percentage of net sales in the last three months of every calendar year, its fiscal third quarter. Results for the interim periods presented herein are not necessarily indicative of results that may be reported for any other interim period or for the fiscal year ending March 31, 2015. All currency amounts are presented in U.S. dollars.
Principles of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of Mad Catz and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. References to the Company, we, us, our and other similar words refer to Mad Catz Interactive, Inc. and its consolidated subsidiaries, unless the context suggests otherwise.
Use of Estimates
The unaudited consolidated financial statements have been prepared in conformity with U.S. GAAP. Applying these principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the reported amounts of sales and expenses during the reporting periods. 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, warrant liability and income taxes. As future events and their effects cannot be determined with precision, actual results could differ from these estimates.
Recently Issued Accounting Standards
The following new accounting standards have been issued, but not adopted by the Company as of September 30, 2014:
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The effective date of ASU 2014-09 is for annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact of adopting ASU 2014-09.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entitys Ability to Continue as a Going Concern. ASU 2014-15 requires management to perform interim and annual assessments of an entitys ability to continue as a going
concern for a one year period subsequent to the date of the financial statements. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entitys ability to continue as a going concern. The guidance is effective for all entities for the first annual period ending December 15, 2016 and interim periods thereafter, with early adoption permitted. Adoption of this guidance is not expected to have any impact on the Companys financial statements.
(2) Fair Value Measurements
The carrying values of the Companys financial instruments, including cash, accounts receivable, other receivables, accounts payable, accrued liabilities and income taxes receivable/payable approximate their fair values due to the short maturity of these instruments. The carrying value of the bank loan approximates its fair value as the interest rate and other terms are that which is currently available to the Company. The carrying value of the note payable approximates fair value as it represents the present value of the fixed payment schedule using an effective interest rate of 5.25%, which approximates the interest rate on the Companys bank loan.
For a description of the fair value hierarchy, see Note 2 to the Companys 2014 consolidated financial statements contained in the Companys Annual Report on Form 10-K for its fiscal year ended March 31, 2014.
The following tables provide a summary of the recognized assets and liabilities carried at fair value on a recurring basis as of September 30, 2014 and March 31, 2014 (in thousands):
The following tables provide a roll forward of the Companys level three fair value measurements during the six months ended September 30, 2014, which consist of the Companys warrant liability (in thousands):
Inventories consist of the following (in thousands):
(4) Securities Purchase Agreement
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). 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. 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 until October 21, 2016.
The Company accounts for the Warrants with exercise price reset features as liabilities and carried at fair value, with changes in fair value included in net income (loss) until such time as the Warrants are exercised or expire.
The fair value of the Warrants decreased from $75,000 as of March 31, 2014 to $20,000 as of September 30, 2014, which resulted in a $55,000 gain from the change in fair value of warrants for the six months ended September 30, 2014.
These Warrants are not traded in an active securities market, and as such, the Company estimated 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 is 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.
Fluctuations in the fair value of the Warrants are impacted by unobservable inputs, most significantly the assumption with regards to future equity issuances and their impact to the down-round protection feature. Significant increases (decreases) in this input in isolation would result in a significantly higher (lower) fair value measurement.
(5) Basic and Diluted Net Loss per Share
Basic net loss per share is calculated by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share includes the impact of potentially dilutive securities unless inclusion of such securities would be anti-dilutive.
Outstanding options to purchase an aggregate of 7,091,167 and 7,012,031 shares of the Companys common stock for the three and six months ended September 30, 2014, respectively, and 7,750,878 and 7,978,227 shares of the Companys common stock for the three and six months ended September 30, 2013, respectively, were excluded from the diluted net loss per share calculations because of their anti-dilutive effect during these periods. Outstanding warrants to purchase an aggregate of 2,540,918 shares of the Companys common stock for each of the three and six months ended September 30, 2014 and 2013, were excluded from the diluted net loss per share calculations because of their anti-dilutive effect during these periods.
(6) Geographic and Product Line Data and Concentrations
The Companys net sales are attributed to the following geographic regions (in thousands):
Revenue is attributed to geographic regions based on the location of the customer. EMEA includes Europe, the Middle East and Africa. During the three and six months ended September 30, 2014, one customer accounted for approximately 12% of the Companys gross sales in each period and one other customer accounted for approximately 11% and 10% of the Companys gross sales, respectively. During the three and six months ended September 30, 2013 one customer accounted for approximately 13% and 11% of the Companys gross sales, respectively, and one other customer accounted for approximately 12% of the Companys gross sales in each period. At September 30, 2014, one customer represented 16% of accounts receivable and another customer represented 10% of accounts receivable. At March 31, 2014, one customer represented 15% of accounts receivable. During the three and six months ended September 30, 2014 and 2013, no other customers accounted for greater than 10% of gross sales. At September 30, 2014 and March 31, 2014, no other customers accounted for greater than 10% of accounts receivable.
The Companys sales by platform as a percentage of gross sales were as follows:
The Companys sales by product category as a percentage of gross sales were as follows:
The Companys sales by brand as a percentage of gross sales were as follows:
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, 2014 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 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, 2014.
We design, manufacture (primarily through third parties in Asia), market and distribute innovative interactive entertainment products marketed under our Mad Catz® (gaming), Tritton® (audio), and Saitek® (simulation) brands. Our products, which primarily include headsets, mice, keyboards, controllers, specialty controllers, and other accessories, cater to passionate gamers across multiple platforms including in-home gaming consoles, handheld gaming consoles, Windows® PC and Mac® computers, smart phones, tablets and other mobile devices. We distribute our products through our online store as well as through many leading retailers around the globe. Operationally headquartered in San Diego, California, we also maintain offices in Europe and Asia.
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 or titles; the need to increase inventories in advance of our primary selling season; and timing of introductions of new products.
During each of the three and six month periods ended September 30, 2014, approximately 72% of total net sales were transacted outside of the United States. 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 foreign currency exchange gains and losses, which we have experienced in the past and continue to experience. Due to the volatility of foreign currency exchange rates, among other factors, we cannot predict the effect of foreign currency exchange rate fluctuations upon future operating results. There can be no assurances that we will not experience foreign currency exchange losses in the future. To date, we have not hedged against foreign currency exposure and we cannot predict the effect foreign currency fluctuations will have on us in the future.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies and estimates remain consistent with those reported in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014.
RESULTS OF OPERATIONS
For the three and six months ended September 30, 2014, net sales increased 26% and 7%, respectively, as compared to the three and six months ended September 30, 2013. The increase in net sales was driven primarily by sales of products related to the new consoles, which launched in November 2013, growing at a faster rate than the decline in sales of products related to legacy consoles. This is a result of the installed base of new consoles continuing to increase, our Xbox One headsets shipping this quarter, and strong sales of our Xbox One racing wheel and fight sticks. Sales of products related to new consoles, primarily audio, represented 21% and 17%, respectively, of our sales during the three and six months ended September 30, 2014.
Outside of console gaming products, our sales of products designed for the PC and Mac, which represented 43% and 45% of our sales during the three and six months ended September 30, 2014, respectively, have been driven by growth in sales of our Saitek flight
simulation products due to new product introductions and increased marketing activities, offset partially by declines in sales of our gaming mice and keyboards. The decline in sales of gaming mice and keyboards was driven primarily by a planned reduction in product placement at some U.S. accounts and an increase in aggressive pricing competition within this space.
We also experienced an increase in sales of products developed for smart devices, which represented 11% and 10% of our net sales during the three and six months ended September 30, 2014, respectively, driven primarily by controllers sold to a customer in APAC under a private label program.
From a geographical perspective, our net sales for the three and six months ended September 30, 2014 and 2013 were as follows (in thousands):
Our sales by platform as a percentage of gross sales were as follows:
Our sales by product category as a percentage of gross sales were as follows:
Our sales by brand as a percentage of gross sales were as follows:
Gross profit is defined as net sales less cost of sales. Cost of sales consists of product costs, cost of licenses and royalties, write-downs of inventory, cost of freight-in and freight-out and distribution center costs, including depreciation and other overhead costs.
The following table presents net sales, cost of sales and gross profit for the three and six months ended September 30, 2014 and 2013 (in thousands):
Gross profit for the three and six months ended September 30, 2014 increased 41% and 16%, respectively, due to the increase in net sales, while gross profit margin increased to 30% in both periods compared to the three and six months ended September 30, 2013. The increase in gross margin in both the three and six month periods was due primarily to decreases in sales returns and discounts, distribution overhead and royalties and licenses as a percentage of net sales. These improvements to gross margin were offset partially by a decrease in gross margin due to product mix and an increase in freight expense as a percentage of net sales. We expect gross profit and gross margin for the full year fiscal 2015 to increase compared to fiscal 2014.
Operating expenses for the three and six months ended September 30, 2014 and 2013 were as follows (in thousands):
Sales and Marketing Expenses. 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 decrease in sales and marketing expense in both the three and six months ended September 30, 2014, compared to the same prior year periods, was primarily due to a concerted effort to reduce overall operating expenses as well as timing of certain marketing activities compared to the prior year. We expect sales and marketing expenses for the full year fiscal 2015, on an absolute dollar basis, to decrease slightly from fiscal 2014 levels.
General and Administrative Expenses. 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 decrease in general and administrative expenses in both the three and six months ended September 30, 2014, compared to the same prior year periods, was primarily related to lower professional fees and other administrative expenses due to a concerted effort to reduce overall operating expenses, partially offset by an increase in incentive compensation expense. We expect general and administrative expenses for the full year fiscal 2015, on an absolute dollar basis, to increase slightly from fiscal 2014 levels.
Research and Development Expenses. Research and development expenses include the costs of developing and enhancing new and existing products. The decrease in research and development expenses in both the three and six months ended September 30, 2014, compared to the same prior year periods, was primarily related to a reduction in software development expenses compared to the prior year. Additionally, during the six months ended September 30, 2014, we received a reimbursement of engineering work performed on behalf of a third party. We expect research and development expenses for the full year fiscal 2015, on an absolute dollar basis, to decrease slightly compared to fiscal 2014.
Acquisition Related Items. Acquisition related items represent adjustments to the contingent consideration valuation related to the Tritton acquisition. As the contingent consideration was converted to a note payable in fiscal 2014, amounts related to the Tritton acquisition will be zero in fiscal 2015.
Amortization of Intangibles. Amortization expenses consist of the amortization of the acquired intangible assets from prior acquisitions. We expect amortization of intangibles for the full year fiscal 2015, on an absolute dollar basis, to decrease compared to fiscal 2014.
Other expense consists primarily of interest expense on our outstanding debt, foreign currency exchange gains or losses, change in fair value of the Warrants issued in connection with the Securities Purchase Agreement entered into by the Company in 2011 and other items that may be specific to a reporting period. The foreign currency exchange gains or losses are associated with fluctuations in the value of the functional currencies of our foreign subsidiaries, which include the Pound Sterling, the Euro, the Canadian dollar, the Hong Kong dollar, the Japanese yen, and the Chinese Yuan Renminbi (CNY), against the U.S. Dollar. Other expense was $477,000 and $608,000 for the three and six months ended September 30, 2014, respectively, compared to other expense of $818,000 and $906,000 for the three and six months ended September 30, 2013, respectively. The change is primarily due to gains on the fair value of the warrant liability of $74,000 and $55,000 for the three and six months ended September 30, 2014, respectively, compared to losses of $317,000 of expense and $334,000 for the three and six months ended September 30, 2013, respectively. Additionally, foreign currency exchange losses resulted in $382,000 and $417,000 of expense for the three and six months ended September 30, 2014, respectively, compared to $392,000 and $416,000 of expense during the three and six months ended September 30, 2013. Interest expense, net, increased to $167,000 and $325,000 for the three and six months ended September 30, 2014, respectively, from $135,000 and $253,000, respectively, in the same periods last year due primarily to interest expense associated with the note payable which did not exist in the prior year, offset partially by a decrease in the average balance under our bank loan.
Income Tax (Expense) Benefit
Income tax expense of $21,000 and $110,000 reflect effective tax rates of (2.3)% and (2.5)% for the three months ended September 30, 2014 and 2013, respectively. Income tax expense of $4,000 and income tax benefit of $31,000 reflect effective tax rates of less than 1% for each of the six months ended September 30, 2014 and 2013. Our effective tax rate is a blended rate for the
different jurisdictions in which we operate. Our 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 allowance against its net operating losses. We will continue to evaluate our ability to realize our U.S. 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 ability to realize our deferred tax assets and expect to release the valuation allowance when we have sufficient positive evidence, including but not limited to cumulative earnings in successive recent periods, to overcome such negative evidence.
Mad Catz does not record deferred income taxes on the approximate $41.1 million of undistributed earnings of its non-Canadian subsidiaries based upon the Companys intention to permanently reinvest undistributed earnings. Mad Catz may be subject to income and withholding taxes if earnings of the non-Canadian subsidiaries were distributed. Considering the Mad Catz tax loss carry forward and related valuation allowance, the deferred tax liability on the Companys undistributed earnings would be no more than $2.8 million at September 30, 2014.
LIQUIDITY AND CAPITAL RESOURCES
The table below provides a summary of cash (used in) provided by operating, investing and financing activities during the six months ended September 30, 2014 and 2013 (in thousands):
Our cash balance was $1.7 million and $1.5 million at September 30, 2014 and March 31, 2014, respectively. Our primary sources of liquidity include a revolving line of credit (as discussed below under Financing Activities), cash on hand and cash flows generated from operations.
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. Net cash used in operating activities for the six months ended September 30, 2014 primarily reflects the net loss for the period before non-cash items (i.e. depreciation, amortization, stock-based compensation, and provision for deferred income taxes), a $4.2 million increase in accounts receivable resulting from the increase in net sales and an increase in inventory of $3.1 million as we build inventory due to forecasted demand during the holiday selling season. The decreases in operating cash flow were offset partially by a $4.3 million increase in accounts payable related to inventory purchases and timing of payments. Net cash used in operating activities for the six months ended September 30, 2013 primarily reflects the net loss for the period before non-cash items (i.e. depreciation, amortization, provision for deferred income taxes, stock-based compensation, contingent consideration, and change in the fair value of warrant liability) and an increase in inventory of $3.7 million as we built inventory in anticipation of increased demand during the holiday selling season. These decreases in operating cash flow were offset partially by a $4.1 million decrease in accounts receivable resulting primarily from the decrease in net sales as well as improved collections. We are focused on effectively managing our overall liquidity position by continuously monitoring inventory levels and expenses, 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. A large percentage of our annual revenue is generated during our third fiscal quarter and, typically, our inventories decrease and accounts receivable increase as a result of the annual holiday selling. During our fourth fiscal 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, and/or reduced sales and the overall effect could result in a reduction to cash flows from operating activities following payment of accounts payable.
Net cash used in investing activities, which 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, was $0.7 million during each of the six months ended September 30, 2014 and September 30, 2013.
Net cash provided by financing activities during the six months ended September 30, 2014 and September 30, 2013 of $4.6 million and $3.8 million, respectively, was primarily the result of net borrowings under our line of credit described below.
We maintain a Credit Facility with Wells Fargo Capital Finance, LLC (Wells Fargo) to borrow up to $25 million under a revolving line of credit subject to the availability of eligible collateral (accounts receivable and inventories), which changes throughout the year. The Credit Facility expires on October 31, 2015. Under the line of credit, interest accrues on the daily outstanding balance at an interest rate that ranges from U.S. prime rate plus 0.50% to 2.00% or, at the Companys option, LIBOR plus 2.50% to 3.50% with a LIBOR floor of 1.50%. At March 31, 2014, the interest rate was 5.25%. We are also required to pay a monthly service fee of $1,500 and an unused line fee equal to 0.25% of the unused portion of the loan. Borrowings under the Credit Facility are secured by a first priority security interest in the inventories, equipment, and accounts receivable of certain subsidiaries and by a pledge of all of the capital stock of our subsidiaries and is guaranteed by the Company. From October 2013 through May 2014, we were required to maintain a monthly financial covenant based on a trailing three months Adjusted EBITDA, as defined. Effective June 2014 through June 2015, we are required to meet a monthly financial covenant based on a trailing twelve months Adjusted EBITDA, as defined. As of September 30, 2014, we are in compliance with the covenants. For periods subsequent to September 30, 2014, we believe we will be able to meet the covenants. However, there can be no assurance that we will be able to meet the covenants subsequent to September 30, 2014 or that we would be able to obtain waivers from Wells Fargo to the extent we are not in compliance with the covenants.
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, and in the longer term, including any payments due on the note payable. 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. We depend upon the availability of capital under our Credit Facility to finance our operations. To meet the requirements of the monthly financial covenant, our plan depends on our ability to increase net sales and improve gross margin. If we are unable to comply with the monthly financial covenant contained in the Credit Facility, Wells Fargo may declare the outstanding borrowings under the facility immediately due and payable. If we need to obtain additional funds as a result of the termination of the Credit Facility or the acceleration of amounts due thereunder, there can be no assurance that alternative financing can be obtained on substantially similar or acceptable terms, or at all. Our failure to promptly obtain alternate financing could limit our ability to implement our business plan and have an immediate, severe and adverse impact on our business, results of operations, financial condition and liquidity. In the event that no alternative financing is available, we would be forced to drastically curtail operations, or dispose of assets, or cease operations altogether.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
In July 2014, we entered into a new office lease agreement to relocate our headquarters whereby beginning in October 2014, we reduced the annual rent expense by approximately $0.3 million per year. The new office lease expires in November 2020. There have not been any 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, 2014.
As of September 30, 2014 and March 31, 2014, 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.
ADJUSTED EBITDA (Loss)
Adjusted EBITDA (loss), a non-GAAP (Generally Accepted Accounting Principles) financial measure, represents net loss before interest, taxes, depreciation and amortization, stock-based compensation, gain/loss on the change in the fair value of the related warrant liability, goodwill impairment, if any, and acquisition related items. Adjusted EBITDA is not intended to represent cash flows for the period, nor is it being presented as an alternative to operating or net loss 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 GAAP. 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. Our management believes, 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 (the Exchange Act) 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 significant seasonal fluctuations in our quarterly results of operations, inventories, receivables, payables and cash; the sufficiency of funds available to meet operational needs, including payments under our note payable; the ability to meet the financial covenants under our existing credit facility; the effect of foreign currency exchange rate fluctuations; the possible use of financial hedging techniques; our expectations regarding sales, gross margins and operating expenses; and the potential release of the valuation allowance against our deferred tax assets.
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.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes 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 necessarily is required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures. As required by Securities and Exchange Commission Rules 13a-15(b) we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer (who is also the Chief Accounting Officer), of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
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, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Our 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.
PART II OTHER INFORMATION
On October 3, 2013, the Company filed a complaint for patent infringement styled Mad Catz Interactive, Inc. v. Razer USA, Ltd., Case No. 13-cv-02371-GPC-JLB, in the United States District Court for the Southern District of California against Razer USA, Ltd. (Razer). The complaint alleges that the Company holds an exclusive license, within the United States, to make, use, sell, offer for sale, import, gift or otherwise dispose of the any product falling within the scope of one or more claims of U.S. Patent No. 6,157,370 (the 370 Patent), including all right, power and interest to enforce the 370 Patent against any and all third parties, as well as exclusive standing to bring suit against any third party infringing the 370 Patent. The complaint further alleges that Razer has infringed and continues to infringe the 370 Patent by making, using, offering for sale, selling, and/or importing in the United States certain products covered by one of more claims of the 370 Patent, including Razers Ouroboros computer mouse. On January 10, 2014, Razer filed a counterclaim against the Company for alleged infringement of U.S. Patent No. 8,605,063 (the 063 Patent). Razer further contends that the 370 Patent is invalid and unenforceable, and denies infringement. Mad Catz also contends that the 063 Patent is invalid and unenforceable, and denies infringement. No trial date has been set in the matter. On August 22, 2014, the Court heard oral argument regarding the parties patent claims construction positions and took the matter of patent claims construction under submission at that time. The Court has not yet issued an order regarding claims construction. The parties are currently conducting discovery. The Company believes that Razers allegations lack merit and intends to vigorously defend all claims asserted. We have not recorded any accrual for a contingent liability associated with this legal proceeding based on our belief that a liability is not probable and any range of potential future charge cannot be reasonably estimated at this time.
In March 2014, the Better Mouse Company, LLC filed a complaint against the Company and its subsidiary, Mad Catz, Inc., for patent infringement in the United States District Court for the Eastern District of Texas. The action is styled Better Mouse Company, LLC v. Steelseries Aps et al, Lead Civil Action No. 2:14-CV-198. By its complaint, the plaintiff alleges that the Company and its subsidiary have infringed and continue to infringe U.S. Patent No. 7,532,200. The Company answered the complaint on July 17, 2014 and has denied all substantive allegations of infringement and damage. No trial date has been set and no discovery has commenced. We have not recorded any accrual for a contingent liability associated with this legal proceeding based on our belief that a liability is not probable and any range of potential future charge cannot be reasonably estimated at this time.
In addition to the foregoing matters, 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.
There have been no material changes to the risk factors as previously disclosed in Part I Item 1A. Risk Factors our Annual Report on Form 10-K for the fiscal year ended March 31, 2014.
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.