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Multimedia Games, Inc. (NASDAQ:MGAM)

F4Q12 Earnings Call

November 15, 2012 9:00 a.m. ET

Executives

Patrick Ramsey – President, CEO

Adam Chibib – CFO, SVP

Mick Roemer – SVP, Sales

Analysts

Justin Sebastiano - Brean Capital

Steve Altebrando – Sidoti & Company LLC

Todd Eilers – Roth Capital Partners

Operator

Good day ladies and gentlemen, and welcome to Multimedia Games Holding Company fourth quarter 2012 financial call and webcast. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session with instructions following at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I’ll now turn the conference over to Adam Chibib, chief financial officer. Please begin.

Adam Chibib

Thank you very much. Good morning everybody. Today’s call and webcast contains statements about future events and expectations which are characterized as forward-looking statements within the meaning of the applicable securities laws including without limitation the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current belief, assumptions and expectations of our future economic performance taking into account information currently available to us.

Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to be materially different from the expectations of such results, performance or financial condition. Please refer to the Risk Factors section in our current and recent SEC filings for description of certain of these risks and uncertainties. The company does not undertake and expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

Today’s call and webcast may include non-GAAP financial measures such as EBITDA within the meaning of Regulation G. A reconciliation of non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP can be found in the company’s current and recent SEC filings that can also be found along with today’s earnings release on our website www.multimediagames.com, in the investor relations section.

Financial and operating metrics provided during today’s call and webcast maybe approximated. Please refer to the company’s financial statements as provided in today’s SEC filings and earnings release for more definitive numbers.

Now I’ll turn the call over to our President and CEO, Patrick Ramsey. Pat?

Patrick Ramsey

Thank you, Adam and good morning everyone. Thank you for joining us on the call. With me here in Austin are Adam Chibib, our Chief Financial Officer and Mick Roemer, our Senior Vice President of Sales.

This morning we reported fourth quarter revenues of $41.4 million and diluted earnings per share of $0.28 inclusive of a $0.04 net benefit from non-recurring items, a very strong finish to what I believe was pivotal year in our company’s history. Year over year we saw significant improvements in our key metrics and this is particularly impressive because our last quarter of fiscal 2011 was incredibly strong. We are already very focused on 2013 and beyond. But Adam gets into the detailed financial results, it is worth spending a few minutes to summarize our year.

If you recall 12 months ago I laid out four factors that would be critical in determining our success. First, our mission was simply to expand the Multimedia Games footprint and we certainly did that successfully. We sold 71% more games this year than we did last year and equally as important, our domestic footprint of being nonrecurring revenue grew over 1200 units. Although we continue to diversify our business it’s still highly concentrated in seven states. So we did one level deeper, I believe our expansion story is even more compelling. For example, in Oklahoma which represents over 70% of our domestic recurring revenue footprint, our base grew 6% over last fiscal year and outside of Oklahoma, that recurring revenue base grew 46% over last fiscal year. Which underscores the fact that our games are working in many jurisdictions nationwide.

This expansion was driven by several factors, our expanding access through regulatory licensing, our creative and growing portfolio of games and our focus on service and relationships. We now hold licenses to sell games in 161 jurisdictions and we can sell into a slot market that equates to approximately 40% of total U.S. So we are looking forward to and expect access to several of the largest markets in the future, including Nevada, New Jersey, Illinois and Pennsylvanian subject to appropriate regulatory approvals.

As for our portfolio of games, TournEvent served a very important strategic and financial purpose for our company as it represented about a third of our unit sales or about 10% of our total revenues. But more importantly it gave some new customers a very compelling reason to begin a relationship with a new equipment supplier. In our High Rise Games, our first attempt to enter the premium participation segment has gotten off to a strong start.

Second, we plan to continue strengthening our relationship with our largest customer in Oklahoma. And I specifically mentioned that we needed to increase the number of successful proprietary Class II games in that footprint. At fiscal year end, we had over 2000 Class II games at their facility, which is really one of our best achievements over the past several years. In January of 2012 we extended several agreements that were set to expire in 2013 for an additional three and half years and we are proud to remain a long-term partner with them.

Third, I discussed our focus on profitability. After several years of turning the ship in the right direction we knew that 2012 was a critical one in order to show that our hard work and investments could pay off on the bottom line. I feel we have done a good job balancing our level of spending and investment with our growth. We recognize R&D has to be more laser focused than many of our larger competitors. And I believe our return to healthy profitability level was a reflection of this focus.

Finally, I mentioned that it was critical for us to build our games and technologies so that we can enter new jurisdictions. We entered several new markets in fiscal 2012, including Michigan, Ohio and North Dakota. And just after our fiscal year ended, we went live in two Las Vegas casinos with a tactical trial, that is another test in the regulatory process in Nevada to help us gain access to the nation’s largest market.

With the high level summary of 2012, I will turn it over to Adam for more detailed financial review. Adam?

Adam Chibib

Thank you, Pat. Our focus in 2011 was to leverage our balance sheet and our talented group of employees to get our new products into an expanding number of markets and customer facilities. Our focus in 2012 was to continue our expansion into new markets, grow our topline and begin to scale the business.

We’re happy to report that we achieved each of our goal for fiscal 2012 and we have a great foundation for furthering our success into 2013. Some of the highlights for the year include: fiscal 2012 revenues totaled a record $156.2 million versus $127.9 million in the prior year, an increase of $28.3 million or approximately 22% with over 70% of our revenues coming from recurring revenue arrangements.

We sold 1961 units in 19 different states which represents a year-over-year increase of approximately 71% or 811 units. Our year end domestic installed base rose approximately 14% or by 1291 units ending the year with 10,670 installed units, and we now generate recurring revenue in over 20 different states.

We entered the premium participation market in fiscal 2012 and grew units from zero in March up to 198 units outside of Oklahoma. Our total revenue shipments for fiscal 2012 which include units sold and net additions to our domestic installed base was over 3200units versus 2228 units in fiscal 2011. And finally, we ended the year with cash balances of $73.8 million and net cash of $40.5 million.

Revenues for our fiscal fourth quarter were $41.4 million, an increase of $5.7 million or approximately 16% year-over-year and up $900,000 or approximately 2% on a quarterly sequential basis. During the fiscal fourth quarter the company sold 538 proprietary games bringing our total for the year up to 1961 units.

Revenue generated from unit sales for the fiscal fourth quarter and for the year were $9.9 million and $36.3 million respectively. For the full year, unit sale revenues increased $15.8 million or approximately 77% with the majority of our unit sales coming from Washington, California, Mississippi and Louisiana. Gaming operations revenues for our fiscal fourth quarter were $29.6 million, an increase of $4.1 million or approximately 16% year-over-year and up $1.2 million or approximately 4% on a quarterly sequential basis.

Gaming operations revenues for the year ended totaled $112 million, up $16.5 million or approximately 17% year-over-year. The majority of the growth in gaming operations revenues came from New York Lottery, California and Washington. These gains were partially offset by lower revenues from Mexico which declined by approximately $5 million year-over-year.

Gross margins for the fiscal fourth quarter and for the year were 81% and 82% respectively, consistent with the prior year comparable period. Selling, general and administrative expenses for our fiscal fourth quarter totaled $12.9 million, an increase of approximately 20% or $2.2 million year-over-year. The year-over-year increase in SG&A is attributable to higher variable compensations and higher stock compensation costs and to a portion of our G2E expenses occurring in our fiscal fourth quarter this year versus our fiscal first quarter in the prior year due to the timing of G2E in 2012.

For the year, SG&A expenses totaled $49.6 million or 32% of total revenue versus $42 million or 33% of total revenues in the prior year. The year-over-year increase in total SG&A expenses is primarily related to higher salaries and wages and license fees as the company added sales and service resources in newly entered markets, higher sales commissions associated with higher unit sales and higher stock compensation costs and higher G2E expenses associated with the G2E timing in fiscal 2012.

Write-off, reserve and impairment and settlement charges for our fiscal fourth quarter totaled $1.2 million pretax which is consistent with prior year fiscal fourth quarter. The fourth quarter charges related to reserves for ongoing tax litigation activation in Mexico. For the year write-off, reserve, impairments and settlement charges totaled $1.2 million pretax versus $2 million in fiscal 2011.

Research and development expenses for our fiscal fourth quarter totaled $4 million or approximately 10% of revenues, an increase of $750,000 or approximately 24% over the prior year period. For the year research and development expenses totaled $15.4 million or approximately 10% of revenues, an increase of $2.5 million or 19% year-over-year. The year-over-year increase in research and development expenses reflects higher average headcount for fiscal 2012 versus 2011 and increased dollars to attract and retain engineering personnel.

Depreciation and amortization in the fiscal fourth quarter totaled $9.6 million, a decrease of $872,000 or approximately 8% year-over-year. For fiscal 2012 depreciation and amortization totaled $38.3 million, a year-over-year decrease of $2.7 million or approximately 7%. The decrease in depreciation and amortization is related to lower capital expenditures over the last several years.

EBITDA, a non-GAAP financial measure, for our fiscal fourth quarter totaled $17.4 million, an increase of $1.8 million or approximately 11% year-over-year. For the full fiscal year EBITDA was $71.1 million, an increase of $16.1 million or approximately 29% year-over-year.

Diluted earnings per share for the fiscal fourth quarter were $0.28 inclusive of a $0.04 per share net benefit versus $0.11 per share inclusive of a $0.04 per share net charge in the prior year period. For fiscal 2012 the company reported earnings per share of $0.96 per diluted share inclusive of a $0.09 per share net benefit versus $0.20 per diluted share inclusive of a $0.04 per share net charge in the prior year period. For the full year company’s effective tax rate was an 11.4% tax benefit. We expect our effective tax rate to increase substantially in fiscal ‘13 to an extent ranging from 36% to 40% of pretax income.

Turning to the balance sheet, we ended the year with $73.8 million in cash and $33.3 million in debt resulting in $40.5 million of net cash compared with $9.7 million in net cash at the end of fiscal 2011. Free cash flow which is defined as cash flow from operations less net capital expenditures was $29.3 million for fiscal 2012 versus $31.2 million in fiscal 2011. Fiscal 2011 free cash flow included a benefit of $18.1 million related to a tax refund from the U.S. treasury department.

We anticipate continued growth in our cash balances and are pleased to announce that our Board of Directors has authorized a new three-year $40 million share repurchase program. This new program replaces our $15 million share repurchase program which resulted in the use of $11.9 million for the purchase of 2.2 million shares at an average price of $5.36 per share.

Turning to our guidance for fiscal 2013, we’re forecasting revenues of $155.5 million to $170.2 million which represents a year-over-year total revenue growth of approximately 6% to 9%. The revenue growth reflects an expected 10% to 15% year-over-year increase in unit sales as well as a modest increase in domestic installed base partially offset by continued declines in Mexico.

As we have previously noted, unit sales and install base growth expectations with respect to measured level of initial success for the company in Nevada beginning in the second half of our fiscal year. In addition, Multimedia Games expects that total operating expenses, including SG&A, research and development costs, and depreciation and amortization, will increase modestly from fiscal 2012 levels as the company continues to add additional headcount in research and development and sales and services.

Operating margins are expected to improve from 15% in fiscal 2012 to a range of 16% to 17% in fiscal 2013 and operating income is expected to increase approximately 11% to 21% year-over-year to range from $26.7 million to $29.2 million. The company expects to generate EBITDA, a non-GAAP financial measure, of $70.6 million to $79.2 million in fiscal 2013, representing growth of 7% to 11% over total EBITDA of $71.1 million reported in fiscal 2012.

Finally, the company currently expects in fiscal 2013 cash will be in the range of 36% to 40% compared to fiscal 2012 full year effective tax rate benefit of 11.4%. As a result, Multimedia Games expects to report fiscal 2013 diluted EPS of $0.60 to $0.65 per share representing a year-over-year increase of approximate 12% to 21% over reported fiscal 2012 EPS and applying a 38% tax rate through the fiscal 2012 reported numbers. We’re pleased with how our fiscal year wrapped up and we remain excited about our future.

I will now turn the call back to Pat.

Patrick Ramsey

Thanks Adam. Looking ahead to 2013, we’re going to continue to prioritize our investment distribution in the profitable market and in continued product development and our strategic objectives reflect these priorities. First on the product side, we’re going to continue our prudent investment in R&D to develop new competitive high-performing games and technologies to support the core franchises to drive incremental growth.

Our efforts over recent years with TournEvent are indicative of our ability to commercialize innovative concepts and products and our recently announced National TournEvent of Champions shows that we are creatively thinking when it comes to expanding nationwide. With this success comes the opportunity to defend and advance our product capabilities and progress our competitive position. As we have done with TournEvent we will continue to advance the quality of our participation in for sale games as this effort still remains critically important for new and existing customers.

Second, distribution is critical. We plan to make progress in our effort to increase our addressable market through investments in and expansion of our distribution platform. Most important we will continue to process entry into Nevada in a very measured way. We remain alert of the technical and regulatory aspects of our efforts and we’ll also stay disciplined around our customers’ capital cycles as we progress.

We recognize that once trials are complete and, as we expect, our games are cleared to sell in Nevada, we will have distribution capabilities in close to two-thirds of our target addressable North American markets. And as I mentioned earlier we will continue with our regulatory approval effort and are in various stages in Illinois, Pennsylvania and New Jersey among others.

Third, profitability of course remains the priority. We plan to drive productivity and leverage our cost structure to support new initiatives with a focus on profitable growth that generates increased operating cash flows. Recognizing a shift in our tax pattern, we will continue our discipline of generating revenue and profit growth. We are also mindful that increased scale should provide us with profitable benefits.

Fourth, we remain focused on shareholder value. We will prudently allocate the company’s accelerating cash flow and use our strong financial profile as an asset for investment growth and shareholder return. As we have discussed, the primary focus of our cash allocation is internal investment in the growth of our business as this has generated the most compelling return opportunities. But we will continue to review opportunities to advance our product and geographic scope through M&A in a shareholder friendly manner. And finally, our buyback program that we announced today shows that we are focused on returning capital to shareholders efficiently over time.

And fifth, we want to continue making strides in building a company culture that is empowered, engaged, passionate and creative. Our goal is to become the major supplier in the states and it’s only possible by retaining and attracting the benefit.

Before I open it up for Q&A and because we are coming off to another successful G2E I wanted to close with a brief summary of what we heard about our showing there this year. I believe Brian McGill of Janney Montgomery said it best in his write-up when he wrote, while we were not surprised to hear positive commentaries surrounding the MGM games, we were positively surprised by the frequency. I am not surprised by either of these takeaways but this point is important. We aren’t just about every customer’s radar screen and our products rank up there with some of the best in the industry.

I like to thank our employees, our customers and our investors for great 2012. Having said that, I will now open it up to Q&A. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) First question is from Justin Sebastiano of Brean Capital.

Justin Sebastiano - Brean Capital

So does EPS guidance reflect any share repurchases?

Adam Chibib

Modest. Modest share repurchase, yes.

Justin Sebastiano - Brean Capital

And then the gross margin particularly in the game equipment sales was lower. And I know you guys meant for lower than I was looking for and you mentioned in the press release higher shipping costs reflecting the expansion into more states and expedited shipping fees. Do you expect this to continue? Is this the right level we should be looking for gross margins or is this purely a function of now you’re getting into new markets, it’s kind of the beginning of that effort in some of those states. And you’d expect to ramp up as you ship more into those states and it’s kind of smooth it out as you get better?

Patrick Ramsey

I think this was probably a little bit lower than it will be going forward for fiscal ’13. I think to your point, expedite shipping costs should resolve themselves, we had a shortage in one particular product line that we ended up having to pay a lot of expedited freighting to get it here and get it out to customers which we shouldn’t have that problem going forward. So yeah I think that will take up a little bit from this level. So I think it will be a little bit better than this next time – next year.

Justin Sebastiano - Brean Capital

And ASPs while year over year they are 18%, 19% growth, I mean it was considerably lower – not considerably, but lower than the June quarter. Was there – and you sold a lot of units, was there any sort of volume discount or could you maybe talk a little bit about why the drop-off sequentially in ASP?

Patrick Ramsey

Yeah, the June quarter was by far the highest point of the year, so my guess is this is a better level to be at versus where we were in the June quarter. And I will have to do a little bit of product mix well. I think we sold on a percentage basis TournEvent was a smaller percentage of total sales in Q4 than it was in Q3. And so that mix impacts us in a little bit and as we have been saying for years now as we get to commercial market and bigger customers, corporate discounts will become more part of our business versus that had been in the past. So those factors impacted ASPs in the fourth quarter.

Justin Sebastiano - Brean Capital

So just last question, from June 2011 through I guess June of 2012 your gross margins in the game equipment and systems was 56% to almost 59%. Can we expect you guys to get back to that level or is it – I know you said it’s going to get a little better from here but is that 50% gross margin kind of the right way to model you guys in ‘13 or should we kind of bring it down maybe 54%, 55%?

Patrick Ramsey

I think obviously 54%, 55% is probably among the best in the industry, I think we’re modeling anywhere about that, factoring conservatism I think 54%, 55% is probably the right range going forward.

Operator

Our next question is from Steve Altebrando of Sidoti & Company.

Steve Altebrando – Sidoti & Company LLC

Hi guys, in regard to Nevada, is there any recent change in the timing of the regulatory process and are you guys at the point yet where you’re actually speaking to customers on the ground?

Patrick Ramsey

The timing remains (inaudible) with revenue – we’re looking for revenues still in the second half. In regards to speaking to customers, making our team are actively talking to customers and have had those relationships and continue to grow, and we opened our office there in the summer. It has been buzzing with activity. So we are getting ready. The timing remains the same as what we originally announced.

Steve Altebrando – Sidoti & Company LLC

In regard to TournEvent obviously you have in California and Washington which have been great markets for you. Do you sense you’re kind of nearing the point of saturation there or is there still room to go in those markets?

Mick Roemer

In terms of TournEvent we are reaching a saturation just because we covered most of the properties in Washington and California, certainly we have room with other product offerings that we have in those states. TournEvent now is really expanding to the rest of the country driven by the TournEvent of Champions.

Steve Altebrando – Sidoti & Company LLC

And just last one, Adam, what’s the level of maintenance CapEx for the current installed base roughly?

Adam Chibib

Consistently over the last several years, we have replaced about 16% to 17% of our installed base. And so if you want to use simple math, now we have 10,000 machines, that’s about 1600, 1700 machines per year, and we might use $9000 per box that will include the cost of the box, rate of installation, that’s a pretty good guess of the maintenance CapEx.

Operator

Our next question is from Todd Eilers of Roth Capital Partners.

Todd Eilers – Roth Capital Partners

Obviously High Rise platform is doing very well with unit placements and obviously higher yields for you guys is helpful as well. From what I have heard, the One Red Cent game is doing very well. Can you maybe talk to how some of the other titles are doing on that platform and just in general kind of what your expectations are for the next couple of quarters. Seems like you have a lot of momentum of that product.

Patrick Ramsey

I agree, there is maximum momentum (ph), now we continue to see nice growth. And remember, One Red Cent is one of the first, if not the first we’ve put out on that platform. So you’re right, it is doing well, the one that stands out initially but we only have a handful of games out in total, three different – in fact, only three different games. And as we said at G2E we have our next pipeline coming up this year in that segment. So we will continue to grow and expand it. We are seeing good results with that platform and with that cabinet. And hope to follow One Red Cent and the others with several (inaudible).

Todd Eilers – Roth Capital Partners

And then on the game sales side, I don’t know if you have this number or not, but trying to get a sense for how much of the total units deployed in the quarter both sold in and incremental lease units, how much of that might have been from new casino openings and was it material in the quarter?

Patrick Ramsey

From new casino openings, I know it’s certainly not the majority, it’s just a small piece. It’s definitely not material. Adam is looking at his state by state list now. It’s going to be a small number though.

Adam Chibib

Yeah, we have 20 in Ohio, that’s probably – 20.

Todd Eilers – Roth Capital Partners

And then just last question on the National TournEvent of Champions, obviously you’ve had great success in California and Washington. Can you maybe spend a little bit more time on the strategy with this and what specific states are we going to be hosting this TournEvent, I am assuming obviously we expect this to drive sales but just any additional color you can provide kind of on the strategy and what we should be -- investors should be looking forward to for this new event?

Patrick Ramsey

Yeah, the strategy is fairly simple and it’s two-fold. One is a great marketing promotion to get every casino in the country we bring to the tournament on the floor. In addition, the second part of that is we want to create excitement and add value for our current customers and our operators and I think that really makes us stand out. That’s the strategy behind it. And in terms of a target market it’s literally everywhere, where we are and we have TournEvent and we have access to sell games.

So given just the initial results and excitement we go around California and Washington where we heard not only from operators but from the customers themselves. We jumped on this, and thought this is great opportunity to really add value to our customers. So ultimately it will probably be in 20 to 25 states across the next year culminating in with the finals in Las Vegas around (inaudible) future lease. So we do – we’re excited, we have probably 60 to 80 customers already signed up for it by now and hope to grow that number by the time the finals come around.

Operator

Thank you. This ends the Q&A portion of today’s conference. I’d like to turn the call over to management for any closing remarks.

Patrick Ramsey

All right. Thank you, operator. Thank you to those who joined the call. Again thanks for a great 2012. And this concludes our fourth quarter earnings update.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Have a wonderful day.

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