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Pokertek Inc (NASDAQ:PTEK)

Q4 2012 Earnings Call

March 07, 2013 11:00 am ET

Executives

Mark Roberson - Chief Executive Officer, Chief Financial Officer & Treasurer

Analysts

Tom Pierce - Feltl & Company

Operator

Good day, ladies and gentlemen and welcome to the Q4 2012 PokerTek, Inc Earnings Conference Call. My name is Sue, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Mr. Mark Roberson, CEO. Please proceed, sir.

Mark Roberson

Thank you and good morning. Before we get started, I would like to remind you that we will make forward-looking statements on today’s call and that actual results may differ from expectations expressed. We undertake no obligation to update those statements, expectations or forecasts. Discussion will include non-GAAP financial measures including EBITDA. A reconciliation to net income is included in the earnings release this morning. Also, please refer to our periodic filings with the SEC. For additional information regarding forward-looking statements, non-GAAP measures, as well as the risks and uncertainties inherent in our business.

Now, with that we'll proceed. As reported this morning, business momentum and recurring revenue trends strengthened significantly in the second half of the year. Recurring revenue grew 41% on a sequential basis as compared to the middle of the year, driven primarily by increased installations in North America in Q3 and Q4.

Financial results for the fourth quarter demonstrated substantial improvement with net loss from continuing operations improving 57%, quarterly EPS edging closer to breakeven at negative $0.02 per share, and we posted our second consecutive year of EBITDA positive results.

When you compare the results to prior year, there are several key takeaways. Revenue comparisons to prior year were negatively impacted by the removal of games in Mexico last year and the timing of our reentry late this year. A trend of declining economic conditions in Eastern Europe and a shift in our revenue mix towards higher recurring revenue in 2012.

At the beginning of the year, we reacted to the regulatory change in Mexico and the trends in Eastern Europe by implementing new plans to lower our costs, increasing our focus on growing in the North American markets while investing in new markets and product development to position PokerTek for growth. As a result, revenue growth rebounded in the second half, margins remained strong and operating results improved.

With 2012 closing on strong footing, let's take a moment to review the status and expectations in our key markets. In Canada, we now have games installed at six properties in Ontario. This is a great example of our approach to identify markets and focusing where we believe electronic tables can provide a compelling value proposition for both, the player and the operator. We identified Ontario is an ideal markets for electronic table games and began working towards company and in product approvals over three years ago.

We entered field trial in Ontario with PokerPro in 2011, completed that trial in the spring of '12, and began rolling out additional installations shortly thereafter. The process was largest and long, but the investment has resulted in a solid base of high-performing tables and great properties with the potential for additional growth ahead.

In the U.S., the first electronic charity poker room opened near Cleveland, Ohio during the third quarter. The charity model represents a distinctly different model from traditional casinos and slot parlors and is one we believe presents tremendous potential.

We're pleased with the initial response from players and from charity and we're seeing steady growth in play every month since opening. We are evaluating other prospective locations in Ohio and expect additional rooms to follow. As we gain more experience with the charity model in Ohio, we believe there could also the opportunities to leverage this model in other states down the road.

As you know, we reentered the Mexico in December. As you may recall, Mexico represented 17% of our business prior to the regulatory change that required us to temporarily removed games in September of 2011. In December, the government began issuing permits on an operator-by-operator basis, allowing electronic card and roulette games back on the floor. We completed the initial installations in December with one operator, too late in the year to have a meaningful impact on the 2012 financial results. We expect additional installations to continue throughout 2013, and pleased to have Mexico coming back online.

In South America, we established our distribution network in the fourth quarter and began working with our partners to identify sites and prepare for initial installations. The first installations occurred a few weeks ago, we believe the South American markets represent an ideal opportunity for electronic table games as the landscape in those markets is dominated primarily by slot and bingo properties that serve the suburban area surrounding the larger cities. Those slot and bingo properties represent situations where we can provide a unique value proposition for operators and players where live table games are not readily available. With hundreds of electronic properties in Columbia, Peru and Argentina, the potential is certainly there.

In Asia, we're initially focused on Macau, where regulations that limit the number of table games are beginning to impact operators' ability to meet the demand for poker, baccarat and other games. Electronic table game offer a solution for operators to officially meet player demand and we believe that PokerPro is uniquely suited for the poker market in Macau. Based on our discussions with potential operators and the status of those plans, we are increasingly confident that we will enter the Macau market soon.

For ProCore, our installations to-date have been mostly limited to unregulated cruise and charity markets. The recent approval of Blackjack in Ontario will allow us to expand in that market going forward. We are also now preparing to deliver the ProCore platform with Blackjack and EZ Bac, the Gaming Labs International to begin testing and approvals. We expect the approval process to take several months after which will be able to begin offering those games to a much broader range of customers in regulated environment, including the U.S., Macau and other markets where GLI approvals are a requirement.

Now as we look forward to next year, or this year 2013, having recently reestablished our compliance with NASDAQ PokerTek is at an important inflection point. We're nearing EPS positive and we have significant opportunities to grow market share and expand in the new market. This week, we renewed our SCB line of credit which remains untapped, and we secured an additional $480,000 of equity. Those transactions serve to add liquidity to our balance sheet and position the company with working capital to meet our growth plans. Those plans include entering new markets in Asia and South America, expanding penetration in the U.S., Canada and Mexico, and obtaining the regulatory approvals for Blackjack and Baccarat. We expect to drive revenue growth while maintaining gross margins in the high 60% to low 70% range and control our expenses to generate improved financial results in 2013.

Before I wrap up and take questions, I would like to take a moment to recognize and thank a number of folks without whom we could not be successful. First, I'd like to thank the investors who had remained loyal followers of PokerTek over the years and also welcome our new investors who recently participated in the private placement and those who purchased stock in the open market recently. Your confidence and support are very much appreciated.

In addition, I would like to recognize the team at PokerTek for the hard work and dedication to deliver unparallel product and customer service. Their collective attitude of putting the customer first and do whatever it takes is our greatest strength and all of our results are directly attributable to those efforts. Finally, I'd like to thank our board. They have expressed their confidence by increasing their ownership, purchasing stock and private placements in the open market over the past year.

With that, we'll open the line for any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of [Nathan Jones], private investor.

Unidentified Analyst

Yes. I was just curious if you had long-term goal of trying to expand into the online if you could speak to that at all as it opens up and that is back in U.S.? Is that a plan going forward?

Mark Roberson

Thanks, Nathan. Thanks for the question. Obviously, we're monitoring the progress of legalization and the activities in Nevada and New Jersey and other states as well as at the federal level and you know it certainly comes up in our internal discussions quite often.

As we said in the past, the way that we look at it right now, there are a lot of folks out there large and small worldwide operating online sites, we'll be spending a lots of capital in a land grab for the U.S. markets. As we look at it, things could change, but at this point you we're pretty focused on executing our plans with electronic table game in the markets that we’ve identified where we can generate near-term revenue growth and near-term profitability. As a licensed company, obviously a server-based, Internet-based poker product, we do think that our company is uniquely positioned to coexist and complement some of those gaming operators online. At this moment, however, we're staying pretty focused on our current plans in the land based arena.

Operator

Thank you. Your next question is from Tom Pierce. Please go ahead.

Tom Pierce - Feltl & Company

A couple of questions for you, recently you announced that you had reinstalled 14 tables in Mexico; I wondered what the current situation is there.

Mark Roberson

The situation in Mexico, the way that the approvals work in Mexico is the government didn’t come out and give a blanket approval that says everybody can have electronic table games. It's more of a operator-by-operator, one-by-one approach. So, in December, we were able to start installing with one single operator in the market. In the early part of this year, we've been able to begin installing with the second operator in the market, and I expect that to continue throughout the year as opposed to going in, in one month and installing your 40 or 50 tables. I expect to install 40 or 50 tables spread over the year as those operators achieve their proper paperwork from the government. I do expect that to continue certainly through the first half as that happens. We are seeing certainly signs that the operators are getting the paperwork in order and jumping through the hoops with the government to be able to games back and we're obviously seeing a lot of interest from those operators who are anxious to bring that that table games revenue back online.

Tom Pierce - Feltl & Company

Other question, going into Macau, you're going there with a partner or anything?

Mark Roberson

We do have a distribution partner in Macau.

Tom Pierce - Feltl & Company

I think you probably are doing in South America too?

Mark Roberson

Yes. We announced, I believe it was in December, that we had completed our distribution network for the South American markets and Columbia, Argentina and Peru specifically, and obviously we took some time evaluating partners in making sure that in those local market it's important to have a local presence and they had local people on the ground and we are not looking to build a lot of fixed cost and open subsidiaries in those markets, so our approach is to partner with established, small but established distributors in those markets and partner with the right ones and work with them closely to identify the properties and put the marketing plans together to increase penetration in those markets.

Operator

Thank you. Your next question comes from Gary (Inaudible), private investor.

Unidentified Analyst

I have been doing (Inaudible), so I hope I don't make you go back on too much here, but I got just a couple questions. On your revenues, you are about flat for the three month in December and you are down from last year for the full 12 months, but then you mentioned you are up 41% or something like that from the second quarter to the fourth quarter and that's kind of an unusual comparison, I think. Was there something that happened in the second quarter that you that, I have been expect you compare to either last quarter for the same quarter or the prior quarter if [sequential].

Mark Roberson

That's really a great question. I think when you look at our year-over-year comps, one of the major things that skew that comp, is obviously the timing of the revenues in Mexico. When you look at 2011, we had 9 full months of revenue coming from the Mexico market. This year, we reentered Mexico, but we did it in December month, so that revenue that was in '11 is totally absent from '12.

A couple of other things that we saw, our business if you look at the revenue mix for 2011 versus 2012, it was heavier on the sale of hardware in 2011. We had far less selling of hardware, so especially if you look at Q4, 95% of the revenue in Q4 is recurring and probably about 5% was miscellaneous sale of parts and hardware, so there is a change in mix there.

The reason for the comparison to mid-year, when you look at the middle our quarters sequentially through 2012, Q2 was kind of our low point after losing the revenue in Mexico and having to hunker, having to cut cost and go through that process because of the revenue there temporarily, we reacted to that and we cut cost and we started investing in refocused on the U.S. market Ohio, we talked about South America, et cetera, in Ontario obviously a big component.

We didn't really see much fruit from that in first half, so what you can see when you compared to Q2 is that rebounding revenue sequentially coming out of a low point in the middle of year which really gives you a picture of you what's going to carry over into 2013.

Unidentified Analyst

Just one other question, I know that you've got a good Board of Directors there and with some good ties into the Native American gaming is there any chance that there's applications here for Native American casinos?

Mark Roberson

Yes. We do have products in Native American casinos, and that a market for us, and really no different than, it's different, but from a marketing and a targeting standpoint, not a lot different than targeting the commercial casinos in the U.S. We don't target certain properties because they are Native American, because they are commercial. It really depends on their specific circumstances as to whether they are a target or a good prospect for electronic table games or not.

Unidentified Analyst

Thank you very much.

Mark Roberson

Thank you appreciate the questions.

Operator

Thank you. (Operator Instructions). Your next question comes from the line of [John Henderson]. Please go ahead.

Unidentified Analyst

Hi. I just had a couple questions. In previous two conference calls, you referenced how you will be able to grow revenues sequentially each quarter this year. As you kind of look forward, can we expect this to still be the case?

Mark Roberson

Obviously if you look at what we've done Q3 and Q4, it's been about 20%, sequentially, each of those quarters and 41% cumulative from Q2. Looking ahead, we're not getting specific guidance of revenue growth numbers in 2013 at this time. I'd make a general statement that we obviously feel good about the growth prospects for 2013 given where we are exiting from 2012 and with the opportunities in these markets ahead.

Q1 is normally a seasonally a fairly good quarter. The cruise lines are reasonably significant part of our business and their businesses are a little bit seasonal and it's usually stronger in Q1, so you might see some uplift form that as well. Q2 is usually a little seasonally light, so I wouldn't necessarily predict Q1 to Q2 being a 20% uplift because of the seasonality, but I think what you will see when you get out into Q2 and Q3 is you are going to see really good cost to prior year.

Unidentified Analyst

I mean, operating expenses staying relatively level, or this choppiness kind of affect the operating expenses as well?

Mark Roberson

I would expect our operating expenses to grow some as we expand, but we're not planning to add lots of fixed costs. We're not planning to add many if any heads certainly in the next several months, or in the next two quarters. We would probably see a little uplift on the operating expenses from a variable standpoint as we are spending more on shipping and logistics and getting products out the door, but I wouldn't expect to see very much increase in operating expenses. It will be controlled. We would expect it to be in relation to revenue grow at a much smaller rate.

Unidentified Analyst

Okay. That's great. Okay. And finally, I guess, if you could give me an idea of operating margins. I mean, as you guys hit $2 million quarterly run rate, can you give me an idea where operating margins might be able to go?

Mark Roberson

I am not sure I can give you a specific number in terms of guidance on net margins at this time. Certainly I think you as you look at growing our recurring revenue business at, I expect the gross margins to continue to be in the high 60s, the other low 70% range which is where they’ve been pretty consistently for the past four to eight quarters. I'd expect that to continue, and obviously we expect to leverage our operating expenses and I'll expect to add significant operating expenses are need to grow the infrastructure as we go forward in a significant fashion. So, I mean, I think you are going to see leverage of our operating structure going forward that will filter down through the operating margin line on the net income and EBITDA basis.

Unidentified Analyst

Okay. That's all for now, maybe I'll get back in line.

Mark Roberson

Okay. Thanks.

Operator

Thank you. There are no further questions waiting at the moment. You have another audio question and that's from Tom Pierce.

Tom Pierce - Feltl & Company

This Ohio deal is intriguing to me. I think you've got right now one charity hall there and I think you have 17 tables in it and I was just curious about you said you’re looking at other ones. Do you expect 123, and if so how many tables would you hope to put in?

Mark Roberson

I think, you’re right, Tom. I think in the first, we have 17 tables in that room. To be perfectly honest, I think that maybe a little heavy for charity room in terms of number of tables. I would expect the model in the other charity rooms to be more in the range of 10 tables per room probably. And I would prefer to start with a smaller footprint and then grow that footprint rather than start with a larger footprint and built into it.

What we're seeing in the first room is, when you open any business sometimes you have a huge opening and then your business sort of trickles down, retains off and sometimes your business builds over time, I'd rather have it so strong and build that it did start relatively strong and continue to build, we're seeing the number of players, the rate of play, the room economics increase every month since it opened in September though. So, we're seeing it build and continue to build, which is a very good sign and we're seeing a lot of interest from and people look at that from other potential operators in Ohio.

And our strategy with the rooms in Ohio is going to be, obviously there are commercial casinos opening in Ohio in Cleveland and in other cities there, our strategy really is to stay away from those casinos. We're opening in the suburbs, in the outskirt and in the cities where those casinos aren't going and we think there's an opportunity to do that in multiple cities. Some cities may be able to handle more than one room. We don’t know that yet and we'll know a lot more about that in six or nine months after it got more than one room open.

Tom Pierce - Feltl & Company

One other question, EZ Baccarat, I think you have a crew ship sailing out of China?

Mark Roberson

Yes.

Tom Pierce - Feltl & Company

How has the reception been on those tables?

Mark Roberson

Without giving numbers I would say it's exceeded the expectation that I’ve had for the rate of play and acceptance by the Asian passengers. That ship has moved around little bit and it has different demographics cruise to cruise. When the cruise itinerary has more players who originate from China and are more of Asian descent obviously baccarat is primarily an Asian game, the play is of the charts. When it has Europeans on it, it's left out, so it's a little bit volatile cruise to cruise, but you can attribute that directly to the demographics of the audience on the cruise than the rate of play that it's getting.

You know, just overall I would say we've been very pleased with the with the way it's been accepting, the feedback from the customer and from the players has been really good and we are excited about it.

Tom Pierce - Feltl & Company

Okay. Cool. Well, thank you.

Operator

Thank you. And your next question comes from Gary (Inaudible).

Unidentified Analyst

Yes. I guess one more question and I am retiring, but what is the biggest barrier to your company getting into a location.

Mark Roberson

That's a good question. It really depends on the specific market region. In most instances, there are significant regulatory burdens that have to be overcome whether it'd be a company licensing process, a product approval process. In some cases, we're dealing with lotteries and government run entities as our customers, so linked in the contract process. We sort of gave the example during the call of Ontario, we started working on Ontario over three years ago and we went through a company licensing process then a product approval process and now this year we are getting product on the floor. That's a kind of extreme example. Most of the markets we are targeting are not, I wouldn't expect to take that longer to be that arduous, so that's an extreme example. Most of the markets that we're targeting right now they are regulated, but less regulated and that makes that process a little bit easier and less time consuming.

Tom Pierce - Feltl & Company

Okay. Well, good luck, guys.

Operator

Thank you. There are no further questions waiting.

Mark Roberson

Okay. Well, thanks everyone for joining in the call. I appreciate your investment and your interest in the PokerTek. And obviously if there questions following the call, feel free to reach out to us. We will also be making a trip to New York in the coming weeks or so and look forward to meeting with any investors at that time. Thanks again.

Operator

Thank you for joining today's conference. This concludes the presentation. You many now disconnect. Good day.

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