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| MCZ > SEC Filings for MCZ > Form 10-Q on 18-Nov-2008 | All Recent SEC Filings |
18-Nov-2008
Quarterly Report
Material Weakness in our Internal Controls over Financial Reporting
We have made a determination that the material weakness related to our
financial reporting process described in our Annual Report on Form 10-K for the
year ended March 31, 2008 was not remediated as of September 30, 2008.
Specifically, we determined that (i) application of our policies and procedures
do not include adequate management review of manually prepared schedules and
(ii) our consolidation process is manually intensive and includes a significant
amount of top-sided journal entries. We concluded that this material weakness
largely resulted from the excessively manual-intensive nature of our
consolidation process, exacerbated by insufficient resources relating to the
incremental reporting requirements resulting from the acquisition of Saitek in
November 2007, and the ensuing integration of the financial operations of the
five Saitek operating companies, including the need to develop controls and
procedures consistent with public company standards for U.S. GAAP reporting in
the Saitek operating entities, which previously were not subject to such
reporting requirements. We have developed and started to implement a plan to
remediate this material weakness, including the following steps:
• Developing and implementing new reporting instructions and checklists for
the newly-acquired foreign subsidiaries' accounting functions.
• Pursuing alternatives to upgrade our information technology tools to minimize the manual process currently required to record, process, summarize and report information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended.
• Retaining additional senior accounting personnel with specific responsibilities to improve the oversight and review of financial reporting.
• Implementing additional management reviews of manually prepared schedules.
In addition, we continue to evaluate our controls and procedures and may, in
the future, implement additional control enhancements.
Notwithstanding our continued remediation efforts, based on a number of
factors, including the performance of additional procedures performed by our
management designed to ensure the reliability of our financial reporting, our
Chief Executive Officer and Chief Financial Officer believe that there are no
associated uncertainties and trends related to the material weakness and the
consolidated condensed financial statements included with this Quarterly Report
on Form 10-Q fairly present, in all material respects, our financial position,
results of operations, and cash flows as of the dates, and for the periods,
presented, in conformity with U.S. GAAP.
Critical Accounting Policies
Our condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these condensed consolidated financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, contingent assets and liabilities, and revenue and
expenses during the reporting periods. The policies discussed below are
considered by management to be critical because they are not only important to
the portrayal of our financial condition and results of operations but also
because application and interpretation of these policies requires both judgment
and estimates of matters that are inherently uncertain and unknown. As a result,
actual results may differ materially from our estimates.
Revenue Recognition
We evaluate the recognition of revenue based on the applicable provisions of
Staff Accounting Bulletin No. 104, Revenue Recognition. Accordingly, we
recognize revenue when each of the following have occurred (1) there is
persuasive evidence that an arrangement with the customer exists, which is
generally a customer purchase order, (2) the products are delivered, which
generally occurs when the products are shipped and risk of loss has been
transferred to the customer, (3) the selling price is fixed or determinable and
(4) collection of the customer receivable is deemed reasonably assured. Our
payment arrangements with customers typically provide net 30 and 60-day terms.
Revenues from sales to authorized resellers are subject to terms allowing
price protection, certain rights of return and allowances for volume rebates and
cooperative advertising. Allowances for price protection are recorded when the
price protection program is offered. Allowances for estimated future returns and
cooperative advertising are provided for upon recognition of revenue. Such
amounts are estimated and periodically adjusted based on historical and
anticipated rates of returns, inventory levels and other factors and are
recorded as either operating expenses or as a reduction of sales in accordance
with Emerging Issues Task Force 01-9, Accounting for Consideration Given by a
Vendor to a Customer (Including a Reseller of the Vendor's Products) .
Customer Marketing Programs
We record allowances for customer marketing programs, including certain
rights of return, price protection and cooperative advertising. The estimated
cost of these programs is accrued as a reduction to revenue or as an operating
expense in the period we sell the product or commit to the program. Significant
management judgments and estimates must be used to determine the cost of these
programs in any accounting period.
We grant limited rights of return for certain products. Estimates of expected
future product returns are based on analyses of historical returns, information
regarding inventory levels and the demand and acceptance of our products by the
end consumer.
Consistent with industry standards and practices, on a product-by-product
basis by customer, we allow price protection credits to be issued to retailers
in the event of a subsequent price reduction. In general, price protection
refers to the circumstances when we elect to decrease the price of a product as
a result of reduction in competitive prices and issue credits to our customers
to protect the customers from lower profit margins on their then current
inventory of the product. The decision to effect price reductions is influenced
by retailer inventory levels, product lifecycle stage, market acceptance,
competitive environment and new product introductions. Credits are issued based
upon the number of units that customers have on hand at the date of the price
reduction. Upon approval of a price protection program, reserves for the
estimated amounts to be reimbursed to qualifying customers are established.
Reserves are estimated based on analyses of qualified inventories on hand with
retailers and distributors.
We enter into cooperative advertising arrangements with many of our customers
allowing customers to receive a credit for various advertising programs. The
amounts of the credits are based on specific dollar-value programs or a
percentage of sales, depending on the terms of the program negotiated with the
individual customer. The objective of these programs is to encourage advertising
and promotional events to increase sales of our products. Accruals for the
estimated costs of these advertising programs are recorded based on the specific
negotiations with individual customers in the period in which the revenue is
recognized. We regularly evaluate the adequacy of these cooperative advertising
program accruals.
Future market conditions and product transitions may require us to take
action to increase customer programs and incentive offerings that could result
in incremental reductions to revenue or increased operating expenses at the time
the incentive is offered.
Allowance for Doubtful Accounts
We sell our products in the United States and internationally primarily
through retailers. We generally do not require any collateral from our
customers. However, we seek to control our credit risk through ongoing credit
evaluations of our customers' financial condition and by purchasing credit
insurance on certain European accounts receivable balances.
We regularly evaluate the collectibility of our accounts receivable, and we
maintain an allowance for doubtful accounts which we believe is adequate. The
allowance is based on management's assessment of the collectibility of specific
customer accounts, including their credit worthiness and financial condition, as
well as historical experience with bad debts, receivables aging and current
economic trends.
Our customer base is highly concentrated and a deterioration of a significant
customer's financial condition, or a decline in the general economic conditions
could cause actual write-offs to be materially different from the estimated
allowance. As of September 30, 2008, one customer represented 32% of total
accounts receivable and another customer represented 10% of accounts receivable
for a total of 42% of accounts receivable. The customers comprising the ten
highest outstanding trade receivable balances accounted for approximately 69% of
total accounts receivable at September 30, 2008. If any of these customer's
receivable balances should be deemed uncollectible, we would have to make
adjustments to our allowance for doubtful accounts, which could have an adverse
effect on our financial condition and results of operations in the period the
adjustments are made.
On November 10, 2008, Circuit City Stores, Inc., a customer representing less
than 5% of our sales, filed for Chapter 11 bankruptcy. We do not believe this
filing will have a material adverse impact on us.
Inventory Reserves
We value inventories at the lower of cost or market value. If the estimated
market value is determined to be less than the recorded cost of the inventory, a
provision is made to reduce the carrying amount of the inventory item.
Determination of the market value may be complex, and therefore, requires
management to make assumptions and to apply a high degree of judgment. In order
for management to make the appropriate determination of market value, the
following items are commonly considered: inventory turnover statistics,
inventory quantities on hand in our facilities and customer inventories,
unfilled customer order quantities, forecasted customer demand, current retail
prices, competitive pricing, seasonality factors, consumer trends and
performance of similar products or accessories. Subsequent changes in facts or
circumstances do not result in the reversal of previously recorded reserves.
We have not made any significant changes in the methodology or assumptions
used to establish our inventory reserves as reported during the past three
fiscal years. We do not believe there is a reasonable likelihood that there will
be a significant change in the future methodology or assumptions we use to
calculate our inventory reserves. However, if our estimates regarding market
value are inaccurate, or changes in consumer demand affect specific products in
an unforeseen manner, we may be exposed to additional increases in our inventory
reserves that could be material.
Valuation of Goodwill
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS
No. 142"), we perform an annual impairment review at the reporting unit level
during the fourth quarter of each fiscal year or more frequently if we believe
indicators of impairment are present. SFAS No. 142 requires that goodwill and
certain intangible assets be assessed for impairment using fair value
measurement techniques. Specifically, goodwill impairment is determined using a
two-step process. The first step of the goodwill impairment test is used to
identify potential impairment by comparing the fair value of a reporting unit
with its carrying amount, including goodwill. If the fair value of a reporting
unit exceeds its carrying amount, goodwill of the reporting unit is considered
not impaired and the second step of the impairment test is unnecessary. If the
carrying amount of a reporting unit exceeds its fair value, the second step of
the goodwill impairment test is performed to measure the amount of impairment
loss, if any. The second step of the goodwill impairment test compares the
implied fair value of the reporting unit's goodwill with the carrying amount of
that goodwill. If the carrying amount of the reporting unit's goodwill exceeds
the implied fair value of that goodwill, an impairment loss is recognized in an
amount equal to that excess. We have determined that we have one reporting unit
and we determine fair value based on a discounted cash flow model, for which the
key assumptions include revenue growth, gross profit margins, operating expense
trends and our weighted average cost of capital. Given the volatility of our
stock price and market capitalization, which fluctuates significantly throughout
the year, we do not believe that our market capitalization is the best indicator
of the fair value of our Company.
We performed the most recent annual goodwill impairment test at the end of
fiscal year 2008 and determined that there was no impairment. Given the current
economic conditions and volatility of the stock markets, we evaluated whether a
triggering event had occurred in the quarter ended September 30, 2008. Based on
the facts and circumstances known to us, including our financial results for the
six months ended September 30, 2008 as compared to forecasted results, we
determined that a triggering event had not occurred. Furthermore, we generate a
substantial percentage of our net sales in the last three months of every
calendar year, our fiscal third quarter. During the third quarter of fiscal
2009, we will assess to determine if a triggering event has occurred, and if
required, will perform the first step of the goodwill impairment test in
accordance with SFAS No. 142. The assessment will consider our actual
performance during the upcoming retail holiday season, among other
considerations. If a triggering event is determined to have occurred, and the
results of the first step of the impairment test indicates an impairment exists,
we will proceed to the second step of the goodwill impairment test, which would
result in a goodwill impairment charge in our consolidated financial statements.
Share-Based Payments
We expense the estimated fair value of share-based awards over the requisite
employee service period. Accordingly, stock-based compensation cost is measured
at the grant date, based on the fair value of the award, and is recognized as
expense over the employee's requisite service period.
The fair value of each option award is estimated on the date of grant using
the Black-Scholes option valuation model. The expected life of the options is
based on a number of factors, including historical exercise experience, the
vesting term of the award, and the expected volatility of our stock and an
employee's average length of service. The expected volatility is estimated based
on the historical volatility (using daily pricing) of our stock. The risk-free
interest rate is determined on a constant U.S. Treasury security rate with a
contractual life that approximates the expected term of the stock options. We
reduce the calculated stock-based compensation expense for estimated forfeitures
by applying a forfeiture rate, based upon historical pre-vesting option
cancellations. Estimated forfeitures are reassessed at each balance sheet date
and may change based on new facts and circumstances.
RESULTS OF OPERATIONS
Net Sales
From a geographical perspective, our net sales for the three and six months
ended September 30, 2008 and 2007 were as follows (in thousands):
Three months ended September 30, $ %
2008 % of total 2007 % of total Change Change
United States $ 14,343 56 % $ 11,103 66 % $ 3,240 29 %
Europe 9,963 39 % 5,062 30 % 4,901 97 %
Canada 322 1 % 663 4 % (341 ) (51 )%
Other countries 1,122 4 % 25 0 % 1,097 4,388 %
Consolidated net sales $ 25,750 100 % $ 16,853 100 % $ 8,897 53 %
Six months ended September 30, $ %
2008 % of total 2007 % of total Change Change
United States $ 27,069 55 % $ 20,818 66 % $ 6,251 30 %
Europe 19,467 40 % 9,232 30 % 10,235 111 %
Canada 562 1 % 1,349 4 % (787 ) (58 )%
Other countries 1,878 4 % 32 0 % 1,846 5,769 %
Consolidated net sales $ 48,976 100 % $ 31,431 100 % $ 17,545 56 %
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For the three months ended September 30, 2008, consolidated net sales
increased 53% as compared to the three month period ended September 30, 2007.
Net sales in the second quarter of fiscal year 2009 increased primarily due to
the acquisition of Saitek in November 2007, which accounted for 96% of the
increase. Sales in the quarter also benefited from the increase in sales
relating to current generation platforms, particularly the Wii platform, which
more than offset the decline in sales relating to prior generations' platforms.
The increased share of European and other country sales is due primarily to the
Saitek acquisition. The acquisition of Saitek added sales in the new product
group PC, which includes personal computer products, cables and batteries.
For the six months ended September 30, 2008, consolidated net sales increased
56% as compared to the six months ended September 30, 2007 primarily due to the
acquisition of Saitek in November 2007, which accounted for 92% of the increase,
as well as the other factors discussed above.
Our sales by product group as a percentage of gross sales for the three and
six months ended September 30, 2008 and 2007 were as follows:
Three months ended Six months ended
September 30, September 30,
2008 2007 2008 2007
PlayStation 3 7 % 13 % 9 % 18 %
Handheld Consoles(a) 12 % 18 % 12 % 18 %
PlayStation 2 4 % 17 % 4 % 16 %
Xbox 360 17 % 25 % 14 % 20 %
GameCube 3 % 8 % 3 % 7 %
Xbox 1 % 7 % 1 % 6 %
Wii 18 % 4 % 18 % 5 %
PC 30 % - 32 % -
All others 8 % 8 % 6 % 10 %
Total 100 % 100 % 100 % 100 %
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(a) Handheld consoles include Sony PSP and Nintendo Game Boy Advance, Game Boy Advance SP, DS, DS Lite, and Micro.
Our sales by product category as a percentage of gross sales for the three and six months ended September 30, 2008 and 2007 were as follows:
Three months ended Six months ended
September 30, September 30,
2008 2007 2008 2007
Control pads 23 % 36 % 19 % 38 %
Accessories 20 % 24 % 20 % 21 %
Personal computer products 29 % - 31 % -
Cables 7 % - 9 % -
Bundles 7 % 14 % 7 % 13 %
Games(b) 2 % 6 % 2 % 8 %
Steering wheels 1 % 2 % 1 % 3 %
Batteries 9 % - 9 % -
All others 2 % 18 % 2 % 17 %
Total 100 % 100 % 100 % 100 %
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(b) Games include GameShark videogame enhancement products in addition to videogames with related accessories.
Gross Profit
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, 2008 and 2007 (in thousands):
Three months ended September 30,
% of Net % of Net $ %
2008 Sales 2007 Sales Change Change
Net sales $ 25,750 100.0 % $ 16,853 100.0 % $ 8,897 52.8 %
Cost of sales 18,027 70.0 % 11,900 70.6 % 6,127 51.5 %
Gross profit $ 7,723 30.0 % $ 4,953 29.4 % $ 2,770 55.9 %
Six months ended September 30,
% of Net % of Net $ %
2008 Sales 2007 Sales Change Change
Net sales $ 48,976 100.0 % $ 31,431 100.0 % $ 17,545 55.8 %
Cost of sales 33,156 67.7 % 21,799 69.4 % 11,357 52.1 %
Gross profit $ 15,820 32.3 % $ 9,632 30.6 % $ 6,188 64.2 %
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