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CryptoLogic Limited (NASDAQ:CRYP)

Q3 2009 Earnings Call Transcript

November 13, 2009 8:30 am ET

Executives

Brian Hadfield – President and CEO

Steve Taylor – CFO

Analysts

James Hollins – Daniel Stewart

Brian Kinstlinger – Sidoti & Company

Alex Silverman – Special Situations

Gary Dvorchak – Channel Island Partners

Roger Hardman – Hardman & Co.

Todd Eilers – Roth Capital Partners

Chuck Ryan [ph]

Michael Demaray – Elevated Capital

Operator

Good morning, ladies and gentlemen, welcome to the 2009 third quarter results conference call. Your host for today will be Mr. Brian Hadfield. Please go ahead Mr. Hadfield.

Brian Hadfield

Thank you, Teresa. Ladies and gentlemen, welcome to CryptoLogic's 2009 third quarter conference call. I am Brian Hadfield, President and CEO of CryptoLogic. With me here in Dublin is Steve Taylor, our Chief Financial Officer.

CryptoLogic had a disappointing and frustrating quarter due to a number of factors. Whilst we continued to make steady underlying progress in executing our new business strategy and plan, the benefits of those sanctions are coming through at a slower pace then we had anticipated.

To recap the key elements of this strategy are to license CryptoLogic’s acclaimed branded games to the world's major Internet gaming operators, to focus on our core business of building and hosting Internet casinos, while outsourcing poker through a shared network, and to reduce our cost base dramatically.

Steve will speak to the numbers in detail, but first I would like to take a few minutes to discuss where we are today in executing this strategy with a focus on the challenges and highlights of the last quarter. Let me begin with the challenges. As is typical in our industry, CryptoLogic’s core casino business normally experiences a summer slowdown in wagering activity. This year it was exacerbated by a difficult economic environment, which seriously reduced the normal bounce back in wagering volumes historically seen in September.

In branded games, CryptoLogic’s "build-once-license-often" model delivered strong revenue growth for the third consecutive quarter. Even so, the ramp up in revenue was not as fast as we’ve anticipated. There were three reasons for the slower than anticipated roll out, changes in licensee priorities, our decision to work with one of our partners to adjust the look and feel of some of the games in the interest of the player experience, and licensees requiring more technical assistance and marketing guidance than previously anticipated.

To mitigate these issues and improve the speed of the roll out, we created three teams with unique mandates, a technical SWAT [ph] team to help with the configuration, installation and launch of the games; a marketing team to assist in the positioning, promoting and management of the games; and a joint quality assurance team with our partners to ensure the highest quality customer experience.

I would also note that notwithstanding the challenges and disappointments, CryptoLogic made significant progress on several fronts, which illustrate the underlying strength of our strategy. Our operating expenses are down 7% from the previous quarter and 44% lower than the year ago as we continue to drive down overhead costs.

CryptoLogic’s branded game revenue increased 46% sequentially, marking our third consecutive quarter of growth from this critical new business line. We now have 50 branded games on the market and generating revenue, up from 33 at the end of the third quarter, 13 in the second, and just three in the first. We released new casino games featuring globally popular brands such as Batman, Wonder Woman, Street Fighter IV and others.

We earned a new casino licensee in Betsafe, which signed a three-year deal for our full casino suite in the third quarter. We expanded CryptoLogic’s customer base to 29, the most in our history after adding more big names such as Virgin Games, Unibet, and Rank Interactive. We extended an expanded our relationship with 888.com, and we continued to have a robust pipeline of new business opportunities.

With those highlights, I will turn the call over to Steve Taylor for some analysis of our financial results.

Steve Taylor

Thank you, Brian. I will remind listeners that CryptoLogic continues to report in US dollars. CryptoLogic revenue decreased to $9.6 million in the third quarter, down from $10.1 million in the second quarter of 2009. As Brian mentioned, this was mainly due to the slow seasonal wagering activity and a weaker than normal finish to the quarter, delays in the roll out of games by new licensees plus the negative impact of two large jackpot wins.

Poker revenue, while no longer central to our business strategy, was flat at $500,000. This reflects both the slower summer period and the rebuilding of revenue following the transfer of our poker revenue network to GTECH. Operating expenses were $9.2 million for the quarter, down from 9.9 million in the second quarter of 2009. This compares with $16.5 million in the third quarter of 2008, and reflects our ongoing focus on taking costs out of the business.

G&A costs were $2.4 million, up from $2.2 million in Q2 due largely to foreign-exchange movements but still down 22.4% from the $3.1 million in Q3 2008. Due to the factors I’ve cited, and in line with the estimate in our October 15 update, the company recorded a loss of $3.4 million or $.25 per share before minority interest. CryptoLogic ended the quarter with $28.4 million in net cash o4 $2.06 per diluted share, down from $33.8 million or $2.45 per diluted share in the second quarter.

The decrease in net cash was due largely to the operating loss in jackpot wins of $2.6 million paid out during the quarter. The company continues to be debt free. Finally, the board declared a dividend of $0.01 per share, down from $0.03 per share last quarter.

Let me close with our outlook for the fourth quarter. Forecasting has proven to be very difficult this year, since the implementation of CryptoLogic’s branded games is essentially in the hands of our licensees. We always try to give you the most accurate information based on our customer's latest roll out plans. While we have made some good progress with our branded games, the continued impact of the economic environment and the delays in rolling out these games will result in a loss in the fourth quarter.

In light of the company's performance in the current trading and economic environment, we are also undertaking a review of the carrying value of our assets. This is likely to result in a significant impairment charge in the fourth quarter. On the upside, CryptoLogic continues to expect a steady raise in branded game revenue in the fourth quarter. As Brian noted, we have 50 games on the market today and based on the latest information, we now expect more than 80 games to be on the market by the end of the year.

I will now turn the call back to Brian.

Brian Hadfield

Thank you, Steve. Today, we’ve tried to give our shareholders a clear picture both of the challenges of today, and the opportunities we see in the future. We are not satisfied with where we are, and that is why our team is working very hard with all of our customers to execute effectively in a difficult environment. But our strategy remains sound to return the company to long-term growth and profitability.

I remain confident in our business plan and the quality and strength of our casino and games and the support of our customers. Above all we greatly appreciate our shareholders’ patience as we navigate through this challenging transitional period. We would now be pleased to take any questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) The first question is from James Hollins of Daniel Stewart. Please go ahead.

James Hollins – Daniel Stewart

Hi, good – good afternoon rather. I have got a few questions. So I will go through them and then hope you will provide the answers. The first one is, I didn't see anywhere on the statement any comment on pipeline of new licensees. I was wondering if you can provide even if it was just a qualitative update on that. The second one is dividend policy in the future. Clearly, we have seen it come down now.

Can we expect a similar QonQ level of dividend, will it change over time. The third one was just on the balance sheet, maybe something I should know, but I saw there has been a removal of restricted cash of $5 million on Q3, and I think $7.2 million during the year. I was wondering what was going on there; and finally again the $28.2 million cash on the balance sheet. I believe that is all your own. Isn't it, because any client money is held elsewhere? So perhaps you could go over them if you like, otherwise please say the answers. Thanks.

Brian Hadfield

Okay, well. I think we will probably share the answers on this. Just starting from pipeline, from a pipeline perspective, actually in this quarter, we have signed a couple of new licensee deals, which we have not announced yet, and we have an active pipeline both for more branded games, and we're also are looking at some opportunities on the casino front. So to answer your question James, I think from a pipeline perspective, we still have a strong pipeline.

It is an active pipeline. It is a pipeline, where we have some closures already, and I anticipate that we will continue to develop and grow the business into next year. So I am positive about the pipeline and where we stand there.

James Hollins – Daniel Stewart

Thank you.

Brian Hadfield

From a dividend perspective, I think we have said before, the board takes a look on a quarterly basis at the situation with the dividend, and makes what we believe is the appropriate or we take the appropriate position at that point in time. So as this is done on a quarterly basis, I think, you know, you probably shouldn't look at it as is this the start of a trend? I think you should take a look at it as this is analysis at a period – point in time, and then we move on.

With regard to the balance sheet, I am sure Steve will have a couple of comments on the restricted cash and the release of that.

Steve Taylor

Sure, James in prior quarters, we had a requirement from the licensing and gaming authority, Malta, all of our licensees are licensed by and our e-cash operations are licensed by Malta to keep a restricted amount of $5 million set aside. We entered into some new arrangements with the LGA in Malta during the quarter, and that resulted in the release of that $5 million from the restricted cash flow balances.

In response to your question about the other cash on the balance sheet, the 28 million plus, that is in fact all of the company’s own cash.

James Hollins – Daniel Stewart

Great answers. Thanks very much.

Brian Hadfield

Okay.

Operator

Thank you. The next question is from Brian Kinstlinger of Sidoti & Company. Please go ahead.

Brian Kinstlinger – Sidoti & Company

Yes, thank you. I'm curious, what the size of your slot accrual for jackpots right now?

Brian Hadfield

Brian it is about $3 million.

Brian Kinstlinger – Sidoti & Company

So in a sense that is really an offset to cash right?

Brian Hadfield

Yes, and that amount goes up and down. It is amounts that are held to pay out future jackpot payments.

Brian Kinstlinger – Sidoti & Company

But it only goes down if the jackpots hit, and you have two payout cash, right?

Brian Hadfield

That is correct.

Brian Kinstlinger – Sidoti & Company

Okay, how many branded games – how many branded month games did you have in 3Q versus 2Q assuming every game has a potential three months in the quarter?

Brian Hadfield

How many branded month games, did you say Brian?

Brian Kinstlinger – Sidoti & Company

Right, you and I talked about how you could have three games in a month, right. So if it is launched day one in a month, would it be three. I'm just trying to figure out because some of the games were launched late. What the sort of revenue per game is because that is really the only way to look at it.

Brian Hadfield

Yes, if you could, as we are going through the call I will try and get that information for you. So at some point during the call I will give you a rough idea what that number is.

Brian Kinstlinger – Sidoti & Company

Fair enough.

Brian Hadfield

I don't have it right in front of me.

Brian Kinstlinger – Sidoti & Company

So now, of the 50 games you have right now, how many would you say are optimally placed, half, I mean, I don’t want you to give [ph] exact number, much less than half and are the newer games that you are launching recently, are they listening to you and putting them where you are suggesting or not so much?

Brian Hadfield

I think the answer to that Brian goes back to the statement that I made, which is we put a marketing team in place to help people get the best return, because you know, we have with some clients a fairly good track record of what the games can generate and where they are best placed.

As with anything, there are some clients that eagerly seek that information and we give it. There are other clients that for obvious reasons understand their websites and where they want to place it. So with those, all we can do is recommend. I would say in most cases, on balance I would say in most cases we are fairly comfortable with where they are placed, but there are some that we’ve worked with closely to move them because the rationale that they’ve used is probably not the rationale that we would use.

In the end, it is their website, but we are finding that most people are listening. We do give them advice. We give them some guidance. We give them placing positions. We give them promotional material. We give them some guidance as to how they can approach their players, but there will be a normal distribution in acceptance of that. That is just a statement of fact I think.

Brian Kinstlinger – Sidoti & Company

So it is more than half, or even more than two-thirds of your games are optimally placed. Is that a fair statement?

Brian Hadfield

Well, without looking at it statistically, I would say that we are probably, I would probably say, we are comfortable with 50% or just over 50%.

Brian Kinstlinger – Sidoti & Company

Okay, and then getting from 50 to 80 this quarter, where you are right now, how many of those are going to be towards the end of December, you know, and the launch because you have 30 to go almost at December, how much are going to be really right at the end?

Brian Hadfield

I would imagine that…

Brian Kinstlinger – Sidoti & Company

Maybe even a better question, how many game months do you think you will have in the quarter?

Brian Hadfield

Well, I'm anticipating that there will be 17 games launched in November, and roughly the same number in December.

Brian Kinstlinger – Sidoti & Company

It is helpful, okay, and to me it doesn't seem that your competitors felt the pressure in the third quarter that you did. Certainly, you hit the jackpots, but even excluding that it wasn't as pronounced and so I'm guessing. So it seems in the last couple of quarters you have been losing market share, maybe speak to why you think that is and what you are going to address the problems?

Brian Hadfield

I think there are a couple of things that we are doing. I mean I think people have seen changes in wagering levels. So I think that it is – a lot of it comes down to player acquisition. There are a couple of things that were – one we have done and one we're doing. We have completely reworked the lobby, and we did the first iteration of the lobby. We launched that the other day and that iteration of the lobby has got a totally different look and feel.

It is much more like what you would see on an iPhone. So it is the ability to flip things across. It is got a suggestion engine for people to look for games or play games. They can identify their favorites and things like that. So we’ve changed the whole look and feel of the lobby, and we did that using the latest technology and the initial feedback on that because it has only been out for a week. It has been very positive.

The other thing that we have done is we have helped one of our licensees with a total rebranding and that will be launched, not until the beginning of next year. But there has been a huge amount of work that has been done on the whole player acquisition side. So that coupled with the fact that we have changed the business model. So we have got the casino side, where we have continued to work. We do the things that I just talked about.

We help people with search engine optimization. We have developed a new lobby. We are looking at better branding. And then we have got the game side, which just requires some ramp up. But long-term I think both the casino side and the game side has got enormous promise. So I'm comfortable that the actions that are in place, albeit that we haven’t had the results in the timeframe that we thought. The actions that are in place are positive ones.

Brian Kinstlinger – Sidoti & Company

And so, you know casino is, everyone I think knows is the biggest part of your business. And so I'm wondering, will they need to offer incentives, such as dollars to be matched or however, you have to do it, will there significant incentives given to acquire new players, and if they do do that, does that impact you and your P&L?

Brian Hadfield

I think what you will see is, you will see a balanced approach. I don't think that, I think that anything that is just that is just sort of promotional based is not the only answer, because there is a cost associated with that. I do think it is about – and I think we had a chat about this before. The industry is getting much more sophisticated with regard to segmentation and subsegmentation.

Search engine optimization is key, and we have certainly helped people with the analysis of where do people fall out in the chain of looking at a website, logging on to a website, then sort of signing up and making not the first deposit, but the second deposit. So the analysis that we have been doing or helping people do is what happens between logging on to a website and making that second deposit, because we believe that the second deposit is key, not the first deposit.

So, yes, I think you will see – the competition in the marketplace means that there will be promotions. I don't think what you will see is a skyrocketing or spiraling out of control promotion thing. I think that will just be part of a multi-faceted approach, which will encompass the other things that I said.

Brian Kinstlinger – Sidoti & Company

Okay, and has there being any progressive jackpots that have been hit so far, suggests to you that hurts you, and if so what is the impact on the fourth quarter?

Brian Hadfield

Brian, there has been one Millionaires Club has won again in October. Basically, what we are doing is looking at changing the accounting estimates because right now the jackpot win is fully provided and it is paid out of a jackpot pool, but when the game resets what ends up happening is our revenue is impacted immediately, and our revenue goes down to replenish the reset amount.

And then we recover through contributions from player play over a period of time. The amount that we have put into the jackpot pool to cover the reset. So the answer, we are just working on the impact in the month of October of that particular jackpot win, and we will be reporting on that at the year-end call.

Brian Kinstlinger – Sidoti & Company

What is that, you have to replace what 300 or 600, what is it $300,000 or $600,000.

Brian Hadfield

On Millionaires Club, it is 175,000 pounds sterling.

Brian Kinstlinger – Sidoti & Company

Okay, and a couple of more quick ones.

Brian Hadfield

Brian just quickly, I did a quick calculation. I believe the answer is 56 game months in the last quarter.

Brian Kinstlinger – Sidoti & Company

56 games month in 3Q, do you know what it was in 2Q, as I'm making you do all this math?

Brian Hadfield

You are a very nice person. I answer I think to that is about 18.

Brian Kinstlinger – Sidoti & Company

18, cash, working capital has increased so many quarters in a row causing you to use more cash than net income every quarter. What is the problem and what is being done to sort of improve the cash flow?

Brian Hadfield

One of the things that has happened Brian over the course of the year is about $1.5 million more has been required in investment in working capital. Out of our cash usage this year, $1.5 million has been utilized for receivables and that comes from a number of different sources. Obviously branded games, we don't control the cash like we do in much of the hosted casino.

So we have receivable balances there, and we also because the poker room has moved over to GTECH, we have an amount as receivable from GTECH now every month that we didn't have before. All of those amounts that we have outstanding are current and up-to-date. So, I mean, clearly there will be some additional working capital requirement as we move forward, but all of the amounts are current and being collected.

I think the other area where our working capital has increased is in prepaid royalty payments for the branded games. Some of the new properties that we announced, we had a renewal with Marvel. We had a contract for the first time with DC Comics, and we also had one with Paramount. So far this year we have invested about $4 million in prepayable royalties on those properties.

Brian Kinstlinger – Sidoti & Company

That is in operating cash flow?

Brian Hadfield

Sorry.

Brian Kinstlinger – Sidoti & Company

That is in operating cash flow?

Brian Hadfield

Well, that is in your – that is a prepaid amount. So when you calculate operating cash flow, yes, it would be.

Brian Kinstlinger – Sidoti & Company

Okay.

Brian Hadfield

Okay, those prepaid amounts, we are very comfortable that they will be recovered quicker now with the branded games, because many of the products that the branded games licensees are taking are either Marvel or in all likelihood ultimately will be sort of DC Comics or Paramount properties. So that will improve the cash flow that we have to recover and pay off those prepaid amounts.

One thing, I would like to mention on the subject of Marvel, investors have asked us the question about Marvel, and one of our competitors putting up Marvel characters in some of their games. It is our view. We have a clear and exclusive use of Marvel's comic characters, and that we are reviewing with some concern the launch of the games that are very similar to our Marvel products.

We very much believe we will defend our rights to the exclusivity, and we are pursuing a solution in the spirit of our long-standing and mutually beneficial relationship with Marvel to get this sorted out.

Brian Kinstlinger – Sidoti & Company

Did you say exclusive, 100% exclusive for – because I thought it was no longer exclusive. I thought you guys had mentioned before?

Brian Hadfield

No, that is not true Brian. The use of the comic book characters, when we renewed the contract this summer with Marvel, we have exclusive use of Marvel's comic characters.

Brian Kinstlinger – Sidoti & Company

Okay, the last question that I have, first of all two part and they are different completely is, and been asked in every quarter, one, you guys buy stock to align your interest with shareholders, and the second is land-based slots, is there an opportunity given you do have those exclusive rights on Marvel, I'm not sure that is exclusive on DC or not, but is there any chance of taking your content and somehow getting it into Vegas casinos, you know from a traditional slot perspective?

Brian Hadfield

Well the – we’ll answer the second one first. Clearly, we have taken a look at the possibility of slots being used in a land-based environment, and we do have some discussions ongoing in that area. So whilst there are technical issues that have to be resolved because of the quality of graphics, et cetera, we believe that the games and the value of the games would be beneficial in that environment, and I anticipate that those talks will continue and will develop.

With regard to the shares, I think I’ve said before, the board is fully committed both to the strategy, and they have said that they will buy shares. I can only talk for myself and what I said is that I will – based on my family circumstances, I will continue to buy some shares over time. But the point is noted and as you know Brian, I unfortunately had to leave last week when we were having a discussion on this. But I will follow up the next time around.

Brian Kinstlinger – Sidoti & Company

Great. Thank you.

Operator

Thank you. The next question is from Alex Silverman of Special Situations. Please go ahead.

Alex Silverman – Special Situations

Good morning. Hello?

Brian Hadfield

Hi, Alex.

Alex Silverman – Special Situations

Can you give us – have your assumptions vis-à-vis the revenue per game changed on the branded side?

Brian Hadfield

Based on the modeling that we did earlier in the year, and the results to date, we haven’t changed. We have what we have done just to be clear on that is, there are some licensees where we think that games will generate X, there are other licensees maybe of a different size, where it won’t generate quite as much. We banded [ph] that and then we have modeled that and so far the results that we are getting matched the modeling.

So, we haven’t changed it yet. If there was something that caused us to change, we’d certainly talk about that, but the three bands that we have, the revenue fits into those bands quite nicely.

Alex Silverman – Special Situations

Because at $780,000 for admittedly a number of the games being implemented on a back-ended basis or back-loaded basis, it doesn't make a lot of sense given the model that you had before.

Brian Hadfield

You need to talk me through that a bit more Alex. I just want to make sure –

Alex Silverman – Special Situations

My understanding was to model roughly, and I understand that there are variances from customer to customer was $10,000 per game per month.

Steve Taylor

And I think Alex, Brian had said in response to the question from the last, from Brian Kinstlinger, who asked how many game months were outstanding during the quarter. The answer to that was 56. $780,000 divided by 56 game months gives you about $40,000 per game.

Alex Silverman – Special Situations

Okay, that's helpful.

Brian Hadfield

Okay.

Steve Taylor

It is, we do have a track record over time, but again as we talked on the last call if they come out to the end of the month, you know, they're clearly out there in the month but they don't have necessarily 50 days to accrue it. So it is something we've got to keep looking at over time, but we will continue to report the revenue that way.

Alex Silverman – Special Situations

Okay, thank you.

Steve Taylor

Okay.

Operator

Thank you. The next question is from Gary Dvorchak of Channel Island Partners. Please go ahead.

Gary Dvorchak – Channel Island Partners

Okay. Guys on the branded game, can you talk us through some of the lifecycle assumptions and may – and I think maybe the best way to do this, I mean I know, there's not a lot of history there. So it sounds it is still guesswork, but you know, maybe take like the first three games that you rolled out early on, and kind of give us a sense of how those ramped, at what speed did those ramp on a monthly basis.

Where do they peak out, and because I guess you know, the question I'm wondering about is you know, the fact that they are oriented towards characters and things like that, it doesn't seem to me like there is going to be something where it hits a steady state and it stays there you know, for years at a time. There is going to be some level of churn, and that the one thing if you model, you know, let's say 100 game sometime in Q1, and maybe you ramped to some higher number. You know, how much your placement is there going to be – is there going to need to be over time. So you know, give us a sense of how those ramps, at what speed, where do they plateau for a while, maybe

a guess, you know, have any of the first three games started to trail off in the revenue as an example, and just give us a sense of how we can think about what the total lifecycle is going to be on those, and also of the newer ones that you're rolling out, if they are following that with the same pattern that you saw in the early games.

Brian Hadfield

Gary, in answer to your question, I will give you the accountants answer and then that is it depends. It depends on a number of factors and particular, you cannot sort of generalize for all games because certain games as we have found with our hosted casino, if you take games like Cubis and Bejeweled that have been out there for some number of years now, they still are right at the top of our list of most popular games in our hosted casino. So –

Gary Dvorchak – Channel Island Partners

I'm just saying, just the branded.

Brian Hadfield

Well, I mean but those two games are significant games that are out there as part of the branded games strategy. So –

Gary Dvorchak – Channel Island Partners

I see what you mean, okay.

Brian Hadfield

Okay. Some of the other games, some of the Spiderman and the Hulk games and games of (inaudible), once again they have been out in our hosted casino for in some cases 2 plus years and they still continue to perform at the top end of the spectrum in terms of games that we have out in our hosted casino. So I think it's – if you look at the 310 plus games that we have in our hosted casino, we definitely do have some that go out.

They launched relatively successfully and then they function well for a while and then plateau and stay at that plateau for a long time. We have other ones that are out for a year or so or eight months or a year, and they start to fall off. They don't tend to be the branded games though. They tend to be some of the other ones that we have out there. In answer to your question in our modeling, we have built-in factors of introduction of new games out there in the marketplace to enhance and replace the ones that we have already placed with our customers, our licensees, and there are plans in place for 2010 to keep a pipeline of fresh product going out there such that we continue to keep the revenue fresh and keep it building.

Steve Taylor

Gary, I think the other thing is important is that we do have in the innovation center you know, we talked about it I think on one of the other calls, where we talked about we brought Jenga to the marketplace. We do have in development some other games that are not based purely on characters; they're based on either general games, casual games that we're putting a gaming spin on or in fact just new ideas in gaming.

So whilst we will continue to develop the relationship with the likes of Warner Bros, DC Comics, Paramount, et cetera that will be complimented and supplemented by additional games that'll be coming out through the innovation center, which will be based on the know, a variety of casual games that become gaming games, or just new games in the marketplace.

So whilst the branded games is an important element, the idea of the innovation center is to make sure that we develop other games, games that fit into social networking, games where you can play against the house, so you can play peer to peer, as those things will also be rolled out. So there is a broader spectrum than just branded games.

Gary Dvorchak – Channel Island Partners

Okay, yes. True enough. So on the branded games, on the licensed games; you said you're averaging $14,000 a month per game. So if you take the end of this year, using Q1 as an example, you have 88 games out. So internally in your modeling you then use 88 games at $14,000 a month. I mean is that like a plateau. You know, where would they typically peak out at?

You know, early – I know it's still early on. You know, how many are sort of missing what the average is, how many are outperformers, and then again focusing on the I guess the license rather than the (inaudible), you know, I don't mean to beat on it, but this is your know, it's critical obviously to the turnaround story, and you know, I guess we just want to get a better sense of really what the expectations are because I don't think you know, I'm sure everyone is disappointed that you know, you're not even doing a million a quarter in those games yet you know, relative to what the expectation was say a year ago.

Brian Hadfield

Yes, I think again I want to be clear as to how we do this. We take a look at – we take a look at the games and we take a look at the licensee and we know roughly based on the size of the licensee, the market share they have, what we anticipate from those. So we've got games that we pass out as high-volume games in a large market. You can also have a high-value game in a smaller market or with a smaller licensee.

So the way we model it, just to be clear, is we don't say if we're going to have 85 games or any number of games, you know, there are all going to be in one market. What we do is we take a look at it by licensee, by potentially game generation and then we model it that way.

Gary Dvorchak – Channel Island Partners

Okay.

Steve Taylor

On that digit [ph] come out to that number today. Will it continue that way over time. You know, we will continue to model it and take a look at it, but that's what the number is today. It has held fairly steady. So at the moment we're comfortable with it, but you know, as we sign more licensees, if we continue to get larger licensees, we would anticipate it would be further up the scale if they were smaller licensees, then some of it would drift down the scale slightly. I think that the reality of the marketplace.

Gary Dvorchak – Channel Island Partners

Hey, can you clarify on those royalty payments are those flat-rate, are they percentage of revenue, and then also on just to go back on that Marvel for a second and the fact those other games, what's their case that it's not exclusive or what if they said to you early on, I mean it seems like it be pretty kind of drive, either it's exclusive or it's not.

Brian Hadfield

Well, I mean, Gary the discussions are ongoing and as I said before we have had a long-standing relationship with Marvel, and we're looking to come to an acceptable conclusion on this without it, you know, spiraling completely out of control. So, I think we think we are going to come to an acceptable conclusion with Marvel, and I'd just like to reiterate that that we are strongly of the view that we have exclusivity on the comic book characters from Marvel, and we are willing to pursue that to ensure that that right is protected.

Steve Taylor

The answer on the royalty payments is percentage of revenue.

Gary Dvorchak – Channel Island Partners

Okay, and then the final question you know, what additional expense actions are you're going to take. You know, you obviously did a lot over the last year. To a certain extent, you know, some of that was low hanging fruit, because it was related to poker. So just taking poker expenses out but, you know, the reality of, you know, you guys had a $80 million cash balance you know, 18 months ago, a couple of years ago, and $15 million of that is gone and you're still, you know, you're burning pretty substantial amounts and you know, I think you need to be able to breakeven at a lower revenue expectation than we probably had you know, both you and the board and investors may be six months ago, you know, I just it's not really acceptable to continue to burn through cash at the rate it has been burned through, and I'm just wondering what additional actions you are going to take to get to breakeven more quickly under, you know, assuming an environment where maybe revenue isn't going to ramp as quickly as you would like.

Brian Hadfield

Well, we are in a budgeting process at the moment. We will continue to take a look at lowering our development costs. We've done, I think a good job of using remote development centers. We've got – we’re using tools that are actually lowering our development costs. So I think obviously from a headcount perspective, we are still taking a look at optimizing that. We are down in headcount from I think, last November roughly about 310 to 315 people down to about 225.

So we will continue to take a look at that. I believe there are some synergies that we have in the groups. We're taking a look at facilities. So we are continuing to take a look at, you know, every aspect of the business to streamline the business, and make sure that operating groups are working at the optimal level with the right tools and that is the process that we are going through in this year’s budget cycle.

So I think I would say, I'd characterize it as we are going through a diligent process, there were no sacred cows. We are taking a look at areas where we need to invest and develop, and we're taking a look at areas where we can clearly cut. So I'm confident that we will continue to lower our operating cost, and we will get our operating cost where it needs to be, and we will get the revenues where it needs to be, but we will look at both and we will look at them both diligently. So people –

Gary Dvorchak – Channel Island Partners

Do you have a sense of urgency to get there quickly? You know, I mean, a year ago the world was falling apart and everyone could be more tolerant of you know, the beginning of a turnaround cycle, but you know, we are little over a year into it, and we're not seeing any results. The main thing it's going in the wrong direction and you know, I like the strategy, I think you're doing the right things in terms of the product roll out and all that, but you know, you can’t see them burning through cash at the rate you have been burning through. I mean it's not tangible. So you know –

Brian Hadfield

I agree with your – I agree with your sentiment. There are two things that we will do. We will – we take the cost side extremely seriously, and we are not wasting time in addressing those issues. I can assure you of that. The second thing is that from a long-term perspective, we also have to make sure we do the right thing. So, we absolutely see the urgency, the need to act and I believe that if we take a look at the actions we've taken, they have been fairly substantial. We will continue to do that. Concurrent with that we will continue to develop the revenue side, because it has to be both sides of the equation, and I think we both are in violent agreement on that Gary. So I can assure you that we will – there is no sense of complacency in taking actions.

Gary Dvorchak – Channel Island Partners

Okay, thanks guys.

Brian Hadfield

Thank you.

Operator

Thank you. The next question is from Roger Hardman of Hardman & Co. Please go ahead.

Roger Hardman – Hardman & Co.

Thank you, Brian, right at the beginning you said one of the three reasons these results are disappointing, has there been a change in licensee priorities. Can you tell us what this change is, and whether it is general or whether it just applies to one or two of your bigger producers?

Brian Hadfield

Well I think it – we have [ph] to say that we've seen licensees slip dates during the year. So it'd be hard-pressed to say that it was, you know, limited to one or two. I think it really is, but this year has been a tough year for most people. There has certainly been a huge amount of pressure on the technology side of most of these businesses, and it really is a question of you know, what are the priorities, what are the – what are the resources they have available.

At no time have we talked about the potential release date that hasn't been agreed with the client, but unfortunately those priorities you know, either have slipped or changed. You know, we are attempting to do the best we can to stay as close to them as possible, which is why we've made some of the changes, but they have and I'm not blaming them that those delays have been at their end. You know, we've had the product, we've had the offering there. We just have to continue to work closely with them.

Roger Hardman – Hardman & Co.

Surely, it is quite an easy matter to slip another game into your website, if you're gaming host.

Brian Hadfield

Well, I think that you know, one of the things that I certainly would have said with the technology background is that I would have thought that whilst it's not quite as easy as you've suggested, it wouldn't necessarily be as complicated. But what we have discovered is that you know, when people go through the QA testing, when they do software implementations, when they do configurations, you know, we've had to give them more help than we originally anticipated. We are doing that, but it is a bit more complicated than we certainly anticipated. And all I can say is that my view was that we work in an online industry, the licensees work in an online industry. Clearly they do a good job. I thought it would have been easier, but it didn't prove that way. So we've made the appropriate adjustments.

Roger Hardman – Hardman & Co.

All right, okay. Thank you.

Brian Hadfield

The other thing we do have to recognize is that you know, I know what we do with our IT resources on a daily basis because we manage that. You know, I don't necessarily know what every licensee is doing with their IT resources on a daily basis. You know, so I'm just trying to be as realistic as I can. I think that what we've done with regard to the technical team and the marketing team will be of significant benefit. Going back I don't think we realized that we necessarily needed those things in place or to the degree that we have them in place today. I think that's a statement of fact.

Roger Hardman – Hardman & Co.

Thanks.

Brian Hadfield

Yes.

Operator

Thank you. The next question is from Todd Eilers of Roth Capital Partners. Please go ahead.

Todd Eilers – Roth Capital Partners

Hi guys. How are you?

Brian Hadfield

Fine, Todd. How are you?

Todd Eilers – Roth Capital Partners

Doing well, just a few questions. Brian, you mentioned that you guys had set up kind of three teams to kind of help address some of the rollout of these games.

Brian Hadfield

We've done it.

Todd Eilers – Roth Capital Partners

Right. I guess my question is, what's the incremental cost from setting up these teams? Did you just do it from your internal resources or you have to add some people or just trying to get a sense you know,

Brian Hadfield

I've not added to the cost. What I've done is I have reassigned people and put them, you know, in that position. So when we took our clients and marketing support team, I took an individual on that and gave them basically 90 plus percent of the time to work on this. I took one of the technical resources and he put a small team together.

And the other thing about this is the virtual team. So we have them in different locations, but they're committed absolutely to the licensees in the role I process. We got them involved early in the process so that, you know, hopefully we don't get to the situation where we learn quite late that there is going to be a delay.

Steve Taylor

Well, there's no incremental cost Todd.

Todd Eilers – Roth Capital Partners

Okay. And then just, I guess looking into next year, I mean can you safely say that you expect to be profitable in calendar 2010 given where you are at right now and maybe more importantly, you know, would you expect to be cash flow positive?

Brian Hadfield

The answer to both of those questions is yes.

Todd Eilers – Roth Capital Partners

Okay. And would you maybe just to give a little bit more detail, would you expect that to happen in the first half of the year?

Brian Hadfield

I think my best answer to that, Todd, is we're right in the middle of the budget cycle as we speak, and I think on the next call we could give you something much clear than I could today. So I'm not trying to duck it again. I'm just trying to be practical, and I hope that's what you'd want us to be.

Todd Eilers – Roth Capital Partners

Sure, now that's fair. And then last question, I know we all ask it every quarter, but just William Hill license, I know that it comes up or expires here at the end of next month. Should we expect to see a announcement or press release from you guys indicating, you know, what your relationship with them will be going forward and just any sort of update there to the extent you can provide it. I know you're under – in negotiations.

Brian Hadfield

Well, we're – you know they are licensee. We told to them on a regular basis. We continue to talk and I'm optimistic that we will be able to continue a longer-term relationship, but going back to your statement, yes, we will make a statement at an appropriate time, but the relationship is good. I talk to Henry on a regular basis.

Todd Eilers – Roth Capital Partners

Okay, thanks guys.

Brian Hadfield

Thank you.

Operator

Thank you. The next question is from Chuck Ryan [ph], a private investor. Please go ahead.

Chuck Ryan

Hi, good morning. As a shareholder, I just wanted to express some of my comments and ask a very simple question. As this is kind of a follow-up to what Gary had a few minutes back, and that is I was looking at their balance sheets as of December 31, 2006, you had cash investment and short-term investment worth $128 million and today it's down to $28 million. That's a rapid cash burn of almost $100 million in less than three years, and I'm just concerned and it's just very heartbreaking to see as a shareholder, to see all this cash being burnt and no increase in revenue, no profit.

In fact, we are looking at a very pessimistic quarter towards the end of the year, and I'm just very concerned and very unhappy with how the whole thing has unfolded, and at this rate if we continue, I'm afraid that in the next year or two, we won't have any cash left and we will be raking [ph] on debt, and my question to you is very simple. I mean does CryptoLogic know, does the management of CryptoLogic know what it's doing?

Brian Hadfield

I believe the answer to the question is yes, we do know what we're doing. We've articulated a strategy. We've had discussions with lots of people on that strategy. We have taken a new concept into the marketplace. We have had the parties 888, Victor Chandler, Virgin, Sky et cetera. All accepted our offering in the marketplace is a value and they have subscribed to it.

And I think arguably, we have one of the best casinos, from a pure gaming perspective in the marketplace. We are going through a transitional phase and I am sympathetic to the things you say, but from a strategy perspective, I am confident that we have a strategy that is differentiated in the marketplace that is accepted in the marketplace and will actually return shareholder value.

Chuck Ryan

Yes, I mean, and this is something that I've been hearing it on the prior conference calls, and I've been listening to your conference calls for quite some time and there was a time when you used to under-promise and over deliver and the last few quarters or so in the couple of years, I've seen the trend kind of reverse that you over-promise and under deliver. In the last conference call you said about expecting a diluted EPS of $0.65, between $0.65 and $0.71, cash generation of $11 million to $13 million and just three months or six months down the line the whole picture has changed. So that's the reason I'm just trying to explain like why, I'm sorry if this question sounds harsh, but that's the reason I'm expressing my concern about the way the whole thing has been happening over the past three years.

Brian Hadfield

I understand your concern, and all I can say is that I appreciate the fact that you've stayed with us. We will continue to execute the strategy, and hopefully you won't have – you won't need to have those concerns or have to voice them going forward, but I take your point.

Chuck Ryan

Thank you.

Brian Hadfield

Thank you.

Operator

Thank you. The next question is from Gary Dvorchak of Channel Island Partners. Please go ahead.

Gary Dvorchak – Channel Island Partners

Hey, I just had one follow up on the expense side. It is something that confused a lot on, since the preannouncement, you said in the last call, you said you had returned to profitability in the June month, and then through December and August and September you seemed to be on plan, and you know, you kind of implied that there really wasn’t a pick up in September as you expected, yet the loss this quarter was about $1 to $1 with the revenue mix [ph]. And I am just wondering why your expenses would suddenly ramp in September or where – are there some large expenses associated with the revenue that you were deferring or I mean I just I didn’t quite get the pattern as to how things could have going okay during the summer, and everything kind of came at the end. So maybe you can just clarify that?

Brian Hadfield

Well Gary, July was a month that came in largely as expected with the exception of the fact that some of the branded games moved out further, the scheduled slipped. August, quite frankly was an extremely disappointing month. Now, when we spoke to investors, that was the first week of August and being in the casino business, you can be doing well one week and be doing terribly the next.

August was a much greater drop-off in revenues than we had anyway shape or form anticipated. We have been trending in the right direction in hosted casino revenues during the rest of the year, and then August it just went very badly for us. We have always been used to seeing a strong bounce back in revenues in September, because in Europe when people return from vacation they get back to playing online casino.

The up-tick in September was not anywhere close to what it has been in historical experience. And really that is the reason why the miss that we have this quarter is largely one in revenues. It is not a miss in expenses.

Gary Dvorchak – Channel Island Partners

Okay, and August, September you are attributing all of that on the hosting side to the economy. You didn’t see any new competitors enter the market or anything else that maybe you think there was anything other than the economy?

Brian Hadfield

I mean, in large measure it is the economy. But we are not backing away or shying away from the fact that, it is a very competitive marketplace in Europe at the moment, and it continues to be and it will be going forward. So we just have to plan the business activities and level of expenditure around that.

Gary Dvorchak – Channel Island Partners

Okay, thanks.

Brian Hadfield

Okay.

Operator

Thank you. The next question is from Alex Silverman of Special Situations. Please go ahead.

Alex Silverman – Special Situations

My question has been asked. Thank you.

Operator

Thank you. The next question is from Michael Demaray of Elevated Capital. Please go ahead.

Michael Demaray – Elevated Capital

Hi guys. Obviously the branded games are ramping well. Have you guys put a number out there in terms of what you believe the ultimate market opportunity if for that business segment, and if so what is that number and how long do you think it takes you to get there?

Brian Hadfield

We have not, Michael put out a number in terms of what we think the ultimate market activity for that is. I think the reason, a big reason for that is the Internet casino market has always been very fragmented. There are some songs strong players in the industry and we are glad to say that many of the licensees that we have signed fall into that category as being the big players in Internet casino.

There is also quite a number of small players and so to be able to determine even if we were to cover many of the names in the industry, be able to determine how much revenue per site we might be able to make per game is very challenging, and we're just, we don't have enough data at this point in time to be able to prognosticate on how big the opportunity might be.

Michael Demaray – Elevated Capital

Okay, great. On the cash flow side, you know obviously you have dropped the dividend this time around. I would just say as a shareholder, I personally (inaudible) manage would prefer to just see it disappear. So, just wanted to throw that out there in terms of preserving cash and be cash flow positive operations under way. So thank you.

Operator

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Hadfield.

Brian Hadfield

Well, thank you for joining us today. I look forward to updating you on our progress as we implement our plan to return the company to profitability and long-term growth. Thank you for your attendance. Good afternoon or good morning.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.

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Source: CryptoLogic Limited Q3 2009 Earnings Call Transcript
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