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| MCZ > SEC Filings for MCZ > Form 10-Q on 17-Feb-2009 | All Recent SEC Filings |
17-Feb-2009
Quarterly Report
Potential Fluctuations in Foreign Currency
During the first nine months of fiscal 2009, approximately 43% of total net
sales was 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 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.
Material Weakness in our Internal Control 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 December 31, 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 are in the process of implementing
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 collectability 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 collectability 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 December 31, 2008, one customer represented 35% of total
accounts receivable and another customer represented 9% of accounts receivable
for a total of 44% of accounts receivable. The customers comprising the ten
highest outstanding trade receivable balances accounted for approximately 72% of
total accounts receivable at December 31, 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, a customer representing less than 5% of
our sales, filed for Chapter 11 bankruptcy. We have assessed the impact of this
filing on our business and accordingly have recorded charges to bad debt expense
of $363,000 and $460,000 for the three and nine months ended December 31, 2008,
respectively in relation to this account.
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 used to establish
our inventory reserves as reported during the past three fiscal years. However,
in light of the recent economic environment, we are taking a refined approach in
our assumptions about future demand for our products. We will continue to assess
our assumptions about future demand for our products and update such
assumptions, if necessary. 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 our Company has one
reporting unit and we assess fair value based on a review of our market
capitalization as well as 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 necessarily the
best indicator of the fair value of our Company at any moment in time. However,
we do believe that market capitalization over a sustained period is an
appropriate measure, and given that the carrying amount of our reporting unit
has exceeded its market capitalization over a sustained period, including our
most recent third fiscal quarter which is our strongest quarter due to
seasonality of the business, we determined that a triggering event had occurred
in the quarter ended December 31, 2008. Based on the foregoing, we have
recognized a goodwill impairment charge of $28.5 million at December 31, 2008,
which represents management's preliminary estimate of the goodwill impairment
based on the fair value analysis completed to date. We have used the quoted
market price of our common stock (market capitalization) as a basis for
determining the fair value of the reporting unit. We expect to complete step two
of the impairment analysis during the fourth quarter of fiscal 2009 and, to the
extent that the completed analysis indicates goodwill impairment different from
management's preliminary estimate, we will recognize such change in its
estimated impairment in the fourth quarter.
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 nine months
ended December 31, 2008 and 2007 were as follows (in thousands):
Three months ended December 31, $ %
2008 % of total 2007 % of total Change Change
United States $ 23,956 59 % $ 19,440 57 % $ 4,516 23.2 %
Europe 14,548 35 % 13,342 39 % 1,206 9.0 %
Canada 787 2 % 1,007 3 % (220 ) (21.8 )%
Other countries 1,526 4 % 485 1 % 1,041 214.6 %
Consolidated net sales $ 40,817 100 % $ 34,274 100 % $ 6,543 19.1 %
Nine months ended December 31, $ %
2008 % of total 2007 % of total Change Change
United States $ 51,069 57 % $ 40,258 61 % $ 10,811 26.9 %
Europe 34,050 38 % 22,574 34 % 11,476 50.8 %
Canada 1,349 1 % 2,356 4 % (1,007 ) (42.7 )%
Other countries 3,404 4 % 516 1 % 2,888 559.7 %
Consolidated net sales $ 89,872 100 % $ 65,704 100 % $ 24,168 36.8 %
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For the three months ended December 31, 2008, consolidated net sales
increased 19% as compared to the three month period ended December 31, 2007. Net
sales in the third quarter of fiscal year 2009 increased primarily due to the
Saitek acquisition, and to a lesser extent, 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' and handheld
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 gaming products,
input devices and other PC accessories.
For the nine months ended December 31, 2008, consolidated net sales increased
37% as compared to the nine months ended December 31, 2007 primarily due to the
Saitek acquisition, and to a lesser extent, the other factors discussed above.
As most of the Saitek entities have been merged into Mad Catz entities, it is
impractical to quantify the impact of its acquisition on the three and nine
month periods.
Our sales by product group as a percentage of gross sales for the three and nine months ended December 31, 2008 and 2007 were as follows:
Three months ended
December 31,
2008 2007
PC 27 % 15 %
Xbox 360 21 % 16 %
Wii 17 % 6 %
Handheld Consoles(a) 9 % 21 %
PLAYSTSTION 3 5 % 11 %
PLAYSTATION 2 3 % 12 %
GameCube 2 % 6 %
Xbox 1 % 4 %
All others 15 % 9 %
Total 100 % 100 %
Nine months ended
December 31,
2008 2007
PC 29 % 8 %
Xbox 360 18 % 18 %
Wii 18 % 6 %
Handheld Consoles(a) 10 % 19 %
PLAYSTATION 3 7 % 15 %
PLAYSTATION 2 4 % 14 %
GameCube 2 % 7 %
Xbox 1 % 5 %
All others 11 % 8 %
Total 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 nine months ended December 31, 2008 and 2007 were as follows:
Three months ended
December 31,
2008 2007
Control pads 26 % 26 %
Accessories 24 % 12 %
Personal computer products 21 % 13 %
Batteries 9 % 4 %
Cables 7 % 12 %
Bundles 7 % 17 %
Games(b) 1 % 3 %
Steering wheels 2 % 4 %
All others 3 % 9 %
Total 100 % 100 %
Nine months ended
December 31,
2008 2007
. . .
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