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Multimedia Games Holding Company, Inc. (NASDAQ:MGAM)

F3Q2013 Earnings Call

July 30, 2013 9:00 am ET

Executives

Todd McTavish - General Counsel

Patrick Ramsey - President & CEO

Adam Chibib - CFO

Mick Roemer - Senior VP, Sales

Analysts

Jeremy Jones - Wells Fargo Securities

Todd Eilers - Eilers Research

Steve Altebrando - Sidoti & Company

Justin Sebastiano - Brean Capital

Operator

Good day ladies and gentlemen, and welcome to the Multimedia Games Holding Company Third Quarter 2013 Conference Call and Webcast. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions)

I would now like to turn the conference over to your host today, Todd McTavish, General Counsel. Please begin.

Todd McTavish

Good morning. Today's call contains statements about future events and expectations, which are characterized as forward-looking statements within the meaning of federal securities laws, including without limitation the Private Securities Litigation Reform Act of 1995. These statements are based on management's current beliefs, assumptions, and expectations of our future economic performance taking into consideration information currently available to us.

Forward-looking statements involve risk and uncertainty that may cause our actual results, performance, or financial condition, to be materially different from expectations. Please refer to these Risk Factors section in our current and recent SEC filings for description of these risks and uncertainties. Multimedia Games assumes no obligation to update or alter its forward-looking statements.

Today's call may include non-GAAP financial measures within the meaning of Regulation G. The reconciliation of these non-GAAP financial measures can be found along with today's earnings release on our website www.multimediagames.com in the Investors Relations section. Financial and operating metrics provided during today's call maybe approximated. Please refer to the company’s financial statements as provided in today's SEC filings and earnings release for definitive numbers.

Now, I will turn the call over to our President and CEO, Patrick Ramsey.

Patrick Ramsey

Thank you, Todd, and good morning everyone. Thank you for joining us on this call. With me this morning are Todd McTavish, our General Counsel; Adam Chibib, our Chief Financial Officer; and Mick Roemer, our Senior Vice President of Sales.

We are joining you today from our offices in Las Vegas, which we opened about a year ago as we prepare to enter the Nevada market. I am happy to report we are making good progress in the state and I will get into those details in a bit. First I will touch on the financial highlights.

This morning, we reported first quarter revenues of $48.1 million, up 19% year-over-year and diluted earnings per share of $0.28, another strong quarter for us on both the top and bottom line. With only two months remaining on our fiscal year, Adam will be discussing our revised guidance for the final quarter in a bit. Now, I would like to touch on our strategic objectivities.

On the product front, our high-rise product has been deployed for close to 15 months and its momentum continues. In that time period we have placed over 700 high-rise games outside of Oklahoma and we have placed many within Oklahoma as well, which is helping our yields within that state.

In addition to our success in getting product trails, we have had very few removed or even converted, which is clearly a great indication of the games state-of-the-art and are appealing to customers and is a real accomplishment, as it truly was our first attempt to penetrate this premium game segment, a segment that is often characterized by significant amount of money invested in risky third-party kind of licenses.

And with Q3 right around the coroner, I'm excited to announce that we will be showing our new premium cabinet as the industry's largest acquisition in September. Our MPX cabinet has a very sleek design, our first dynamic button panel, and an interactive chair making the player experience even have much better.

We believe it will be a great complement to our high-rise series in that premium segment. Additionally on the product front we recognized it's important to add resources in R&D to develop more products as we grow. In just a few years we have increased our capacity considerably. This year, we will hit our goal developing over 50 new titles and in fiscal 2014 we hope to increase that number by over 20%.

Second, our domestic distribution network continues to grow and has increased considerably recently with the addition of the key few states. In the third quarter, we received approval for two more backend systems in the State of Nevada and certainly that was approved as well late in the quarter. These approvals help place Nevada number three in the list in terms of units sold for the quarter. I'm very happy with our progress in the State. I'm anxious to continue to grow our approved library for the nation's largest market.

And although New Jersey is a market that has had its struggle, we are excited to be lot ahead of schedule there and initial indications are very positive. In short, I feel like our timing has worked very well, in that we're in the process of building a powerful, well-rounded product portfolio, at the same time that we are obtaining new licenses to access much of the United States. And we are therefore better positioned to capitalize on opportunities and possibly some pent-up demand because of recent trends in the machine replacement cycle than ever in our history.

From an operating and financial standpoint the company's margins and profitability expanded again and we continue to walk what I believe is the right line between balancing and increased spending in R&D for our future and our current profitability. Our cash balance is growing and like we've consistently said our primary focus remains internal investment, we've been seeing strong returns here.

Our real rates for external investors therefore remains quite high, but we're continuing to look for ways to utilize our strong financial position to continue to grow and add value. For more detail on the financial results, I will now turn the call over to Adam to discuss the third quarter, Adam.

Adam Chibib

Thank you, Pat. Our third quarter was another strong quarter for the company. We were able to execute well on our strategy with record unit sales and continued expansion into new and existing jurisdictions, looking into first sale of products into New Jersey.

Revenues for our fiscal third quarter totaled $48.1 billion, an increase of $7.6 million or 19% year-over-year. Our fiscal third quarter revenues include the sale of 647 gaming units with revenues totaling $12.4 million versus 543 units sold and $10.4 million in revenues in the prior year period. We sold units in 15 states with Washington, Louisiana, Nevada, and Mississippi accounted for the majority of the total. The TournEvent system was sold with 50% of our games, up slightly from 47% in the first half of the year.

Gaming operation revenues for our fiscal third quarter totaled $34.3 million, an increase of $5.9 million or approximately 21% year-over-year. The increase in gaming operation revenues is attributable to an increase in our domestic installed base to 12,163 units, up 2014 units or 20% from the prior year period, and 451 units or 4% on a quarter sequential basis.

The increase in our domestic footprint since June of 2012 was driven by increases in Oklahoma, Washington, California, Texas, and Florida. Included in the quarter-end participation base were total of 713 premium games deployed outside of Oklahoma, 656 high-rise games, and 47 Smokin' Hot Jackpots, which represents an increase of 208 units, or 41% on a quarterly sequential basis.

Gross margins for the fiscal third quarter were approximately 81%, compared to 80% in the prior year period, and 81% in the fiscal second quarter. Gross margins continue to benefit from a high concentration of games sold with our TournEvent systems and from a strong mix of gaming operations revenues relative to total revenues.

SG&A expenses for our fiscal third quarter were $12 million, an increase of $704,000, or approximately 6% over the prior year period, and now represent 25% of total revenues versus 27.9% of total revenues in the prior year period.

Depreciation and amortization expense for our fiscal third quarter was $8.9 million, a decrease of $610,000, or approximately 6% from the prior year period. The $1.1 million decrease in depreciation expense is attributable to the depreciation change previously discussed, offset by an increase of $446,000 in amortization expense. Depreciation and amortization expense increased $757,000 on a quarterly sequential basis, and we expect to experience similar quarterly increases for the remainder of fiscal '13 and fiscal '14 as we continue to invest in expanding our installed base.

Operating margins improved to 29.1%, compared to the 19.1% in the prior year. The year-over-year improvement in operating margins is attributable to revenues increasing on a faster rate than expenses.

Net income for our fiscal third quarter was $8.4 million or $0.28 per diluted share, compared to net income of $7.2 million for $0.25 per share in the prior year period.

Pro-forma diluted earnings per share for the prior year fiscal third quarter was $0.19 per share. Please see the pro-forma reconciliation in this morning's earnings release.

EBITDA for our fiscal third quarter was $25 million, an increase of $5.8 million, or approximately 30% from the prior year period.

Our balance sheet remains extremely strong at the end of the fiscal third quarter with $100 million of working capital, $92.5 million of cash, and net cash of $62 million. We see these results even as we invested $11.1 million back into the company through the expansion of 451 proprietary units in our installed base and refreshes of our existing footprint. Additionally, the company purchased $1.2 million worth of shares or 56,000 shares of our common stock.

As a result of our continued success, we have increased our full year revenue and fully diluted earnings per share targets. The company now expects revenues for fiscal 2013 to range from $187.7 million to $190.3 million, with unit sales ranging from 2570 to 2670 units.

Additionally, we have increased our fully diluted earnings per share to a range of $1.07 per share to $1.10 per share. We are pleased with the progress we have made with respect to revenue growth, cash flows, and operating income for the quarter.

I will now turn the call back to Pat for some additional commentary before we get to Q&A. Pat?

Patrick Ramsey

Thanks, Adams. Clearly we remain excited about our business and we look forward to another great G3. We will be highlighting some great new high denomination test games, and in cabinet some incredible new videogames with multiplied progresses, and of course a grant finale of innovations through several national tournament of champions.

We thank you all for your continued interest and support of MGAM and now we will open up to questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jeremy Jones with Wells Fargo Securities. Please go ahead with your question.

Jeremy Jones - Wells Fargo Securities

Just a couple of granular questions and then one more high level. First, so the 102 units in Nevada, were those all sales or any placements?

Adam Chibib

There were -- the majority of them were sales but there were some rep share units that's placed in Nevada. 78 would fold in the Westward rep share.

Jeremy Jones - Wells Fargo Securities

And how many tournaments -- were there any tournaments or was that too late in the quarter to be precise?

Adam Chibib

A tournament was on trial but yes a good portion of the 78 were tournament, yes.

Jeremy Jones - Wells Fargo Securities

And looking at Nevada over the next few quarters how do you see that that ramping up going forward?

Patrick Ramsey

Well we still expect to penetrate the market further. So we, expect increasing penetration into that market. But when you look for the foreseeable future, I don't -- I can't give you exact numbers, but it should get bigger each quarter for the next several quarters.

Jeremy Jones - Wells Fargo Securities

And then, looking at margins on the gaming equipment side, they were much stronger than what we were thinking, I guess as you said on TournEvent mix. Do you think that that range or that level of gross margin is sustainable going forward?

Patrick Ramsey

No, well what we said, the mix does impact obviously our margins. But we do expect that mix to decrease overtime. So I do expected them to come down, over the next five quarters or so, if you want to look at this year and next year. I don't think we'll stay in that high of a range.

Jeremy Jones - Wells Fargo Securities

Then just more high level, we're starting to see a lot of consolidation in the gaming equipment space. Just from your perspective how do this space evolving over the next five years and how do you think about MGAM is placed in that changing environment?

Patrick Ramsey

I think it is a fact, Jeremy. I think we continue to feel the same way we did several years ago. We're in a good path. You know what, we continue to stay focused, but not great products, we're in a good path, continued to take market share and grow our company. And so there is consolidation around us. And I feel good about where we're, and we're confident looking at opportunities as well.

Operator

Our next question comes from Todd Eilers with Eilers Research. Please go ahead with your question.

Todd Eilers - Eilers Research

One or two I'll ask on the premium-leased segment. Obviously another strong quarter for you guys in terms of net placements there, it sounds like you've got or at least in your comments it sounds like there is a new platform you're launching at G3 this year. I'm wondering if you talk a little bit more about that. How is that new platform different than I guess the high-rise that you've got right now, and how do you see this opportunity going forward?

Patrick Ramsey

Well, we see it complementary and to high-rise. I mean, let's say we've approached that segment I think very smart. We're excited to release another product in that segment. How does it compare to high-rise? It's basically completely different look on top of it having a different button panel, on top of different lighting, on top of it, the screen is different, the feed is interactive, and more entertaining. And therefore the content that we're able to offer on it is different as well. So we'll show a couple, our panel will show a couple of themes at G3 this year, so I'm sure you'll get a good sense of it.

But to give a space for us, we've had success with our first attempt and so we're trying excited to follow-up with something that's -- it's even another step-up.

Mick Roemer

Well, Todd, so to be clear it's completely different redesigned cabinet. So it looks very different than high-rise and it's we can feel fit and nice with where the industry is going.

Todd Eilers - Eilers Research

And should we expect, would you add any third-party license content or will this all be proprietary in-house development games?

Patrick Ramsey

Well, certainly initially all developed in-house. We will wait for opportunities but for the most part, we're going to stay focused on treatment -- treating our own titles. And again, I should say that I mean we're showing that apparently we showed at G3 but it will be a while for commercial release and we're able to recognize revenue from it. So just like all the other manufacturers we will be showing on this new product and there will be some time to finish it and get it approved.

Todd Eilers - Eilers Research

And then, I want to ask a question regarding the -- there was some news recently a couple of months back regarding the NIGC, I guess they had issued a letter indicating that they were recommending a proposed change of definition of Class II games from two touch to one touch. So I'm wondering if you guys could may be comment on that and from the standpoint does that have any impact on your business would seem like it would be a positive, but I'm not sure how much of a positive for you guys, but any sort of color on your thoughts on that that would be helpful as well?

Patrick Ramsey

Yeah, you're right. I think it is overall for us a positive just because we're seen as a leader in the Class II space. But in terms of direct effect I don't think moving from two touch to one touch. We've looked at all of our properties and all of our placements, I don't think there's huge opportunity for yield list based on that change, it just has any, it's not my current footprint.

I think on a high level I'd say if you did look at the trend, I think it fits other tries to look at the Class II products where it may be would not have in the past and we don't have segment analysis that it would bring for us.

Todd Eilers - Eilers Research

Okay. So to the extent that there are certain properties that may be would look, just say tax as I guess on switching from Class III to Class II that that might result in increased I guess, unit opportunities and then Class II state then going forward?

Patrick Ramsey

That's right.

Todd Eilers - Eilers Research

Okay. And then last question was regarding the national tournament of champions, I was wondering trying to give us an update on just how's that grown for you, any feedback from your participant operating casinos, what sort of impact is that having on the business, any update there would be helpful? And then also can you give us a sense of what sort of impact does that have on your business, is that something that is just a cost for you guys, you generate any revenue, how does that impact your P&L?

Patrick Ramsey

Yeah, Todd, I'll give you the update. It's going very well. I mean overwhelmingly positive from the casinos that have participated. Usually when you host a final preliminary event it drives significant business for the property which is really why we've created it. And it's drawing a lot of attention to our product obviously. It's tough to exactly quantify what effect it has on our sales, a tournament has been well strong for us several years now.

But I would like to think it just like advertising or marketing its cushioned additional unit sales as well. So we're pretty happy with it. We're very happy with it and we're excited to host the finals I think having the 80 or so contestants compete in Las Vegas, in September, will again draw attention to this and we're looking forward to something even we'll update better in 2014.

Adam can direct me but I'll quickly address what is the cost or not and we've actually structured it to be close to a breakeven. So we're getting some good exposure, driving some good business for our customers and for us financially, no direct impact, so it seems like a win-win-win, win for customers, the players, win for the casinos and win for us.

Operator

(Operator Instructions) Our next question comes from Steve Altebrando with Sidoti & Company. Please go ahead with your question.

Steve Altebrando - Sidoti & Company

In terms of approvals in the in Nevada, are you now approved on all systems?

Patrick Ramsey

We're approved on the four major ones. Our first four and I think we're in process for a few more approvals or Mick tell me we're in process for the last one, which is Konami.

Steve Altebrando - Sidoti & Company

And then, in terms of -- if you can give any color on the initial interest of TournEvent in Nevada, I mean obviously 70 is a big number in a short period of time, but probably only six or seven casinos. Any color on the initial interest and also, if you're seeing it more as a strip product or more of a local product?

Patrick Ramsey

We continue to see more interest. And you're right it's about six or seven properties, at the end of the quarter we continue to grow. And everywhere from northern Nevada to the strip to the locals market, I mean it's a mix, which is good because like I mentioned in my initial comments, we had a nice portfolio where we can -- we don't have a one type of product that only applies to the strip, we've a pretty board base portfolio.

So we're seeing initial success I agree. 70 something is a pretty big number but it's just a fraction of the market and fairly. So we'll see some -- I think, we'll see some great success, we'll see some properties where our yields need to come up and it will be like any other market, but the size of it is what really is exciting for us.

Steve Altebrando - Sidoti & Company

Right. Well, would you say you're seeing a substantial backlog growing for TournEvent in Nevada?

Patrick Ramsey

Well, we've obviously ongoing trail but I wouldn't use the word substantial yet because we're still new to. Let's say, but certainly, backlog does exist then I wouldn't use the word substantial though. And I don't know I would use the word backlog, people want to try and we get it out in a trial. So, and we're seeing pretty good interest just like we expected in TournEvent.

Steve Altebrando - Sidoti & Company

And then, just lastly, how do you stand in terms of capacity obviously, sales were ramping a lot both on the manufacturing side and on the service side as well?

Patrick Ramsey

I'll answer the second part first. Service is probably the area that we're adding the most in raw headcount that in engineering. So I think we got that pretty well under control. From a capacity perspective, the good thing about this industry is that it's really final assembly that you do. So, we have a contract manufacture that bends the metal, makes the cabinet, builds the wire and harness and our responsibility is to do final assembly, which makes the manufacturing process much more efficient.

So, we can scale horizontally by adding more people and then we can scale vertically by adding more shifts. So, capacity should not be an issue at all our expert foreseeable future. And we're also opening up another assembly facility in Nevada, which should come online by the end of the calendar year, which will also increase our capacity and serve the western region of the United States to save on freight and shipping costs. So, capacity is certainly I think under control as well.

Operator

Our next question comes from Justin Sebastiano with Brean Capital. Please go ahead with your question.

Justin Sebastiano - Brean Capital

R&D was down a little bit sequentially in year-over-year from an absolute dollar standpoint and you guys are increasing your installed base is, are you obviously in your opening comments you mentioned that you're obviously very focused on increasing titles and R&D. So, where should we think about that number going forward?

Patrick Ramsey

It should continue to increase in absolute dollars. No question about that. I think the reason it was down on the P&L was that we the nature of the work probably required us to capitalize more that labor. So, you might see capitalized labor and our cash flow statement increase. So, when you look at those two together my guess is it probably went up. So, that stand enough the dollar will continue to increase. And again we've been very focused on letting it increase less as a percentage of revenue, had a revenue growth faster than in R&D expense. So, we go up in absolute dollars but let's say consistent like a percent of revenue is my guess.

Justin Sebastiano - Brean Capital

And then ASP is as I calculate was over 19K in the quarter now. The comments about selling a lot of TournEvent into the Nevada shipments I guess may be explains that, but is that true a number to do you think that is sustainable or should we kind of take it down as you may be get some multi-property owners getting some volume discount as you increase shipments there?

Patrick Ramsey

We've been pretty consistent in saying that they're going to come down. Obviously we expect volumes to go up and operating margins to improve, the operating margin level, the ASP should come down, margin should come down. But we should have more dollars to cover fixed cost therefore maintaining or expanding our operating margin is obviously the goal. So, it was one of our highest quarters, may be our highest quarter ever as far as ASP goes and largely because of the 6% of our units sold, our TournEvent enabled I think that will decrease overtime no question about it.

Justin Sebastiano - Brean Capital

And then, you mentioned Adam that D&A is going to increase at kind of the levels that we saw this quarter, does that mean you're going to look for about 750K increase quarter-on-quarter or do we kind of stay at this sort of $8.99 million level for the next several quarter?

Adam Chibib

No, it's going to increase between probably $500,000 to $700,000 sequentially. And if you think about it, when you add $12 million a quarter you divide that by four years and divide it by four quarters, it's a big step-up function in expense. Obviously, a step dropping off in the four year ago, but our levels of CapEx four years ago were smaller than they are today, so it's definitely going to be -- it's going to increase in that dollar range sequentially.

Justin Sebastiano - Brean Capital

Okay. And then, may be just talk a little about New Jersey and forgive me if you gave the number, about how many units were sold?

Adam Chibib

In New Jersey only 18 units were sold.

Justin Sebastiano - Brean Capital

Okay. And TournEvent is approved or in trail, how is that right now?

Adam Chibib

It is approved in New Jersey but no sales of TournEvent in New Jersey yet.

Justin Sebastiano - Brean Capital

Okay. Well, how is the interest there, is it similar to what we saw with Nevada?

Adam Chibib

Yeah, I'd say yeah there is no distinction by market. I think TournEvent is appealing to all markets we're seeing. And in addition, we have also -- it is very early in New Jersey Justin, but we're (inaudible) being tested in Holland, so we've a good well rounded portfolio being tested in early stages in New Jersey.

Justin Sebastiano - Brean Capital

Okay. And then just lastly, may be could you give us an update on Pennsylvania sort of a approval process there, are you trying units, any timeline update would be helpful?

Adam Chibib

Still we had recently announced we're not trying any units there quite yet, we will look in the early fiscal '14 for trials and placements.

Operator

I'm not showing any other questions in the queue at this time. I would like to turn it back over to Mr. Ramsey for closing comments.

Patrick Ramsey

All right. Thank you operator and thanks to those who joined us on the call. This concludes our third quarter operating's update. And we will see many of you in late September G3. Thanks again.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.

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