Business News

MEGA Brands reports fourth quarter and 2008 results

Tuesday 07. April 2009 - MEGA Brands Inc. (TSX: MB) announced today its financial results for the fourth quarter and full year ended December 31, 2008. (All figures are expressed in US dollars.)

For 2008, the Corporation reported sales of $447.7 million, down 14.6% compared to $524.5 million in 2007. Net loss was $458.7 million or $12.53 per diluted share, compared to a net loss of $97.1 million or $2.82 per share in the previous year.

The 2008 results were impacted by Impairment of Goodwill and Intangible Assets and Other Charges of $404.5 million which reduced earnings by $11.05 per diluted share.

For the fourth quarter of 2008, net sales declined 21.6% to $101.0 million compared to $128.8 million in the same period in 2007. Net loss was $323.3 million or $8.83 per diluted share, compared to a net loss of $66.2 million or $1.81 per share in the fourth quarter of the prior year.

The fourth quarter results were impacted by Impairment of Goodwill and Intangible Assets and Other Charges of $234.4 million which reduced earnings by $6.40 per diluted share.

“Consumer products companies were affected by the dramatic decline in the global economy during the fourth quarter of last year and MEGA Brands was no exception,” said Mac Bertrand, President and Chief Executive Officer. “We experienced lower than expected sales and took additional charges resulting from the extremely weak retail environment, including restructuring charges and write-offs of bad debt.”

Despite the lower results, solid progress was made in many areas that will help the Corporation in 2009 and position it for the economic recovery.

– The actions taken in 2008 under the Corporation’s ongoing Value
Enhancement Plan have reduced annual expenses by more than $30 million.

– Significant supply chain improvements have been realized, a key factor
in reducing the Corporation’s year-end inventories to $65 million, or
$26 million lower than at the end of 2007.

– The Corporation ended 2008 with cash and cash equivalents of
$49.4 million compared to $8.5 million at the end of 2007. As at
March 31, 2009, cash and cash equivalents were substantially at the
same level as at the end of 2008.



“For 2009, we are planning for an even more challenging retail environment than last year,” added Bertrand. “One of our first priorities this year is to preserve cash and increase liquidity. We are continuing to take additional measures under our Value Enhancement Plan to reduce costs and working capital requirements while benefiting from a decline in resin prices and a lower Canadian dollar.”

“On the product side, our focus is on basics, lower price points and working closely with our customers to deliver winning programs at retail. With great innovation and exciting new licenses, our product lines are in tune with the times, offering the best value for consumers and retailers in an uncertain economy.”

Recent Developments

On April 1, 2009, the Corporation executed a waiver and amendment agreement (the “Seventh Amendment”) to the Credit Agreement providing for certain changes to the terms of its Credit Facilities maturing in 2012. These include a waiver of the minimum cumulative EBITDA covenant for the quarters ended December 31, 2008 and March 31, 2009 and relaxing the minimum cumulative EBITDA covenant to $4.0 million for the quarter ended June 30, 2009; $24.0 million for the nine-month period ending September 30, 2009 and $37.0 million for the 12-month period ending December 31, 2009. For the periods ending March 31, 2010 and June 30, 2010, the Corporation must have a minimum rolling twelve-month EBITDA of $40.0 million. Effective July 1, 2010, the more restrictive financial covenants in the existing Credit Agreement will come back into force. The Seventh Amendment also provides for an event of default in relation to any adverse deviation in month-end cash and short-term investment balances in any month in excess of $9.0 million compared to the Corporation’s forecast and introduces certain other restrictions and compliance requirements on the Corporation, including a limitation on certain asset sales. The Amendment and Waiver also reduce the Corporation’s revolving facility from $100.0 million to the actual amount presently outstanding thereunder, being $96.9 million. Finally, the Amendment provides for increased fees and interest payable in respect of the Credit Facilities and for other fees payable in certain circumstances and imposes certain ongoing reporting obligations on the Corporation.

Results of Operations

The Corporation’s results for the years ended December 31, 2008 and 2007 were affected by numerous write-offs and charges which make it difficult to analyze the trends in its operating performance. Such write-offs and charges are quantified and described below under various headings, along with an indication of their classification in the statements of loss according to GAAP. Under securities regulations, the Corporation is required to caution readers that financial measures adjusted to a basis other than GAAP do not have standardized meaning and are unlikely to be comparable to similar measures used by other issuers. Management uses non-GAAP measures and believes that such measures provide meaningful information on the Corporation’s financial condition and operating performance.

Charges impacting 2008 results of operations

In 2008, the Corporation recorded Impairment of Goodwill and Intangible Assets and Other Charges of $404.5 million ($234.4 million in the fourth quarter), as follows:

Impairment of goodwill and intangible assets

During the third quarter of 2008, the deterioration in the global economic environment combined with the decline in the Corporation’s stock price triggered a requirement for an interim goodwill impairment test and assessment of the recoverability of the Corporation’s other assets. In anticipation of performing a comprehensive analysis of goodwill and an assessment of the recoverability of other assets, the Corporation recorded a preliminary provision of $150.0 million against the carrying value of these assets. This provision included, amongst other things, the impact of downsizing of the Chinese operations.

During the fourth quarter of 2008, the Corporation commenced a comprehensive step-two analysis of the goodwill and an assessment of the recoverability of other assets. Based on this preliminary assessment, the Corporation believes that the resulting fair value of goodwill may range from $30.0 million to $50.0 million for the Toy Segment only. As such, the Corporation has recorded an additional preliminary goodwill charge of $164.5 million in the fourth quarter and reduced the carrying value of the Rose Art Trademark by $49.0 million. For the year, the goodwill and intangibles impairment charges totaled $318.5 million ($213.5 million in the fourth quarter).

These non-cash impairment charges are recorded separately in the statement of loss.

Plant closure, integration and other restructuring charges

The Corporation recorded charges of $27.6 million ($3.1 million in the fourth quarter) for plant closure, integration and other restructuring costs. This amount includes $21.5 million ($1.5 million in the fourth quarter) recorded mainly in cost of sales for inventory, asset write-offs and severance related to the significant downsizing of the Corporation’s factory in China. It also includes $3.6 million ($0.7 million in the fourth quarter) of integration costs, recorded mainly in other selling, distribution and administrative expenses related to the consolidation of the Corporation’s distribution activities in Fife, Washington. The balance of $2.5 million ($0.9 million in the fourth quarter), recorded in other selling, distribution and administrative expenses, represents mainly lease termination fees as well as professional fees in connection with the sales process for the Stationery and Activities business.

Voluntary product recall and other charges

The Corporation recorded $39.6 million ($8.9 million in the fourth quarter) for voluntary product recall and other charges. Of this amount, $12.5 million, recorded against other selling, distribution and administrative expenses, is related mainly to bad debt as a result of financial difficulties faced by customers in Mexico and, the United Kingdom. Another $13.2 million (nil in the fourth quarter) is recorded against net sales and represents returned MAGNETIX product inventory from retailers and related penalties. The balance of $13.9 million ($6.8 million in the fourth quarter), recorded in cost of sales, is for MAGNETIX and other inventory write-offs.

Litigation expenses

The Corporation recorded litigation expenses of $11.9 million ($4.8 million in the fourth quarter), mainly for the ongoing litigation related to the MEGA Brands America acquisition. This amount is recorded separately in the statement of loss.

License termination and prototype charges

The Corporation recorded license termination and product development charges of $4.4 million ($1.6 million in the fourth quarter). Of this amount, $2.8 million (nil in the fourth quarter), recorded in cost of sales, represents license termination fees mainly resulting from the Corporation’s product line rationalization under its VEP. The balance of $1.6 million ($1.6 million in the fourth quarter) represents the amortization of 2007 prototype costs.

Write-off of deferred financing costs

The Corporation wrote-off $2.5 million ($2.5 million in the fourth quarter) of deferred financing costs related to previous amendments to its Credit Agreement.

Charges impacting 2007 Results of operations

In 2007, the Corporation recorded Impairment of Goodwill and Intangible Assets and Other Charges of $116.6 million ($35.8 million in the fourth quarter), as follows:

Impairment of goodwill and intangible assets

The Corporation recorded a write-off of intangible assets of $4.2 million related to MAGNETIX resulting from product recalls.

Inventory provisions and sales below cost

The Corporation recorded a charge of $20.0 million (nil in the fourth quarter), primarily as a result of the transition of MAGNETIX to MAGNEXT and other slow moving products. The total amount is recorded in cost of sales. The Corporation also reduced gross profit by $14.8 million (nil in the fourth quarter) and recorded related freight charges of $0.6 million (nil in the fourth quarter) in other selling, distribution and administrative expenses as a result of the sale of excess inventory below cost.

Plant closure, integration and other restructuring charges

The Corporation incurred plant closure, integration and other restructuring charges of $9.0 million ($4.9 million in the fourth quarter). This amount includes integration charges of $4.9 million ($4.9 million in the fourth quarter) related to the completion of the integration of MEGA Brands America and $1.5 million (nil in the fourth quarter) for inventory write-downs as part of the integration of two factories in China into a single facility. Both charges are recorded in cost of sales. The Corporation also recorded a charge of $2.6 million (nil in the fourth quarter) related mainly to the sub-lease of excess warehouse space at unfavorable terms, classified in other selling, distribution and administrative expenses.

Voluntary product recall and other charges

The Corporation recorded charges and incremental costs of $56.1 million ($20.9 million in the fourth quarter) primarily related to product recall and other charges. Of this amount, $26.7 million ($6.2 million in the fourth quarter) related to reversals of sales and credits associated with recalled products, $18.0 million ($0.8 million in the fourth quarter) to write-offs of finished goods, components and fixed assets, recorded in cost of sales, as well as $11.4 million ($6.7 million in the fourth quarter) for incremental advertising, logistics and administrative costs, recorded mainly in other selling, distribution and administrative costs.

Litigation and related expenses

The Corporation recorded litigation and related expenses of $8.9 million ($4.3 million in the fourth quarter), mainly for the ongoing litigation related to the MEGA Brands America acquisition. This amount is recorded separately in the statement of loss.

License termination charges

The Corporation recorded charges of $3.0 million ($1.5 million in the fourth quarter) in other selling, distribution and administrative expenses related to the termination of licensing agreements, as a result of product line rationalization under its VEP.

Year ended December 31, 2008 compared to year ended December 31, 2007

Net Sales



Net sales in 2008 were $447.7 million compared to $524.5 million in 2007. This decline is due in equal proportion to lower sales of the Toys and Stationery and Activities product lines.

Net sales of Toys declined 10% to $280.9 million in 2008 compared to $310.9 million in 2007, mainly as a result of significantly lower shipments of licensed products in Boys 5-plus construction and, to a lesser extent, lower shipments of magnetic construction products. Net sales of preschool construction toys and games and puzzles were stable. Other Charges reduced reported sales by $13.2 million in 2008 and $26.7 million in 2007.

Net sales of Stationery and Activities products decreased 22% to $166.8 million in 2008 compared to $213.6 million in 2007. Net sales declined in the activity and writing instruments categories, offsetting increased shipments in the boards and accessories category.

North American sales were $297.5 million in 2008 compared to $352.7 million in 2007. This decrease is due mainly to lower sales of Stationery and Activities products. International sales declined to $150.2 million compared to $171.8 million in 2007, primarily as a result of lower sales of Toys product lines. International sales accounted for 34% of consolidated sales in 2008 compared to 33% in 2007. Other Charges reduced the reported North American and International sales by $10.5 million and $2.7 million, respectively, in 2008 and $20.1 million and $6.6 million, respectively, in 2007.

Cost of Sales

Cost of sales decreased to $342.2 million in 2008 compared to $403.4 million in 2007. This decrease reflects cost improvements and efficiencies resulting from VEP implementation as well as reduced production which more than offset higher labor and input costs in China, as well as increased resin prices compared to 2007. Cost of sales in 2008 includes Other Charges totaling $38.4 million, primarily related to the significant downsizing of the Corporation’s plant in China and product recall charges. In 2007, cost of sales includes Other Charges of $57.3 million, mainly related to product recall, inventory revaluation and integration charges.

Gross Profit

Gross profit was $105.5 million in 2008 or 23.6% of sales, compared to $121.2 million or 23.1% of sales in 2007. Excluding Other Charges of $51.6 million in 2008 and $84.0 million in 2007, gross profit was 34.1% compared to 37.2%. This decline is due mainly to an unfavorable product mix in 2008 compared to the previous year, reflecting a lower proportion of sales of Boys 5-plus and magnetic construction toys. Both of these product lines have historically generated higher margins than the Corporation’s other product lines.

Operating Expenses

Marketing and advertising expenses were stable in 2008 at $26.6 million compared to $26.2 million in 2007.

Research and development expenses declined to $17.1 million in 2008 compared to $22.0 million in 2007. This decrease reflects mainly a reduction in third-party services, a significant decrease in the number of products listed by the Corporation following the rationalization of its product lines completed in the first quarter of 2008, net of a write-off of $1.6 million of development costs.

Other selling, distribution and administrative expenses increased to $130.1 million in 2008 compared to $127.8 million in 2007. The 2008 figure includes Other Charges totaling $20.8 million, reflecting mainly the write-off bad debt, a lease cancellation and integration charges. In 2007, Other Charges in other selling, distribution and administrative expenses totaled $19.5 million.

The Corporation incurred litigation expenses of $11.9 million in 2008 compared to $8.9 million in 2007. This reflects increased activity in connection with litigation related to the MEGA Brands America transaction.

The Corporation received $9.4 million from its insurers in 2008, representing the final recovery in connection with a $13.5 million settlement of lawsuits related to magnet ingestion paid by the Corporation in 2006. This compares to a recovery of $3.5 million ($2.8 million net of related expenses) recorded in 2007.

The Corporation also recorded charges of $49.0 million for impairment of intangible assets and $269.5 million for impairment of goodwill in 2008 compared to $4.2 million in 2007.

Loss from Operations

As a result of the above, the loss from operations was $393.8 million compared to a loss from operations of $66.7 million in 2007. Loss from operations includes Impairment of Goodwill and Intangible Assets and Other Charges of $404.5 million in 2008 and $116.6 million in 2007.

Non-Operating Expenses

Interest and other expenses amounted to $43.9 million in 2008 compared to $26.5 million in 2007. This increase is due mainly to higher average long-term debt and the amortization of deferred financing costs related to amendments to the Corporation’s credit facilities. In 2008, the Corporation also recorded a charge of $6.6 million to reflect the change in fair value of an interest rate swap agreement.

Income Taxes

Income tax expense was $20.9 million in 2008 compared to $4.0 million in 2007. The Corporation recorded valuation allowances of $136.1 million in 2008 and $27.8 million in 2007 on future income tax assets resulting from losses carried forward originating mainly from Impairment of Goodwill and Intangible Assets and Other Charges in both years. The tax rate used to establish the income tax expense is the applicable estimated effective rate of each entity of the Corporation. The effective tax rate reflects the Corporation’s structure for tax purposes as well as the financing structure put in place following the acquisition of MEGA Brands America.

Net Loss

Net loss in 2008 was $458.7 million or $12.53 per diluted share, compared to $97.1 million, or $2.82 per diluted share in 2007.

Impairment of Goodwill and Intangible Assets and Other Charges reduced earnings by $11.05 per diluted share in 2008 and $3.41 per diluted share in 2007.

MD&A Filing

MEGA Brands plans file the Management’s Discussion and Analysis as well as the audited consolidated financial statements and notes for the years ended December 31, 2008 and 2007 via SEDAR on April 6, 2009. The MD&A, financial statements and notes will be available on the Corporation’s Web site on April 7, 2009.