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CryptoLogic Limited (NASDAQ:CRYP)

Q3 2009 Earnings Call

November 13, 2009 8:30 am ET

Executives

Brian Hadfield – President and Chief Executive Officer

Stephen Taylor – Chief Financial Officer

Analysts

James [Holland – Daniel Stewart]

Brian Kinstlinger – Sidoti

Alex Silverman – Special Situations

Gary Dvorchak – Channel Island Partners

Roger Hardman – Hardman & Co.

Todd Eilers – Roth Capital

Chuck Ryan – Private Investor

Michael Demaray – Elevated Capital

Operator

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 operator. 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 actions are coming through at a slower pace than 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 to 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-one-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 had anticipated.

There were three reasons for the slower than anticipated rollout. 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 guidance than previously anticipated. To mitigate these issues and improve the speed of the rollout we created three teams with unique mandates. A technical swap team to help with the configuration, installation and launch of the games. A marketing team to assess the positioning, promotion 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 illustrates the underlying strength of our strategy. Our operating expenses are down 7% from the previous quarter and 44% lower than a 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 generating revenue, up from 33 at the end of the third quarter, 13 in the second and just 3 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 3-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 writing more big [names] such as Virgin Games, Unibet and Rank Interactive. We extended and expanded our relationship with 888.com and we continue 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.

Stephen Taylor

Thank you Brian. I remind you that CryptoLogic continues to report in U.S. 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 for the quarter, delays in the rollout 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 Network to G-Tech.

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 have cited and in line with the estimate in our October 15th update, the company recorded a loss of $3.4 million or $0.25 per share before minority interest.

CryptoLogic ended the quarter with $28.4 million in net cash or $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 and 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 rollout 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 and 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 rise 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 have tried to give our shareholder 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. 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 shareholder’s patience as we navigate through this challenging transitional period.

We would now be pleased to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James [Holland – Daniel Stewart].

James [Holland – Daniel Stewart]

I didn’t see any statement on pipeline of new licensees. I was wondering if you could provide a quantitative update on that. The second one is dividend policy in the future. We have seen that come down now. Can we expect a similar level of dividend or will it change over time? The third one was on the balance sheet. Maybe this is something I should know but it looks like there has been a removal of restricted cash of $5 million in Q3. I think $7.2 million during the year. I was wondering what was going on there. 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?

Brian Hadfield

I think we will probably share the answers on this. Just starting from the pipeline perspective, actually in this quarter we had signed a couple of new licensee deals which we have not announced yet. We have an active pipeline both for more branded games and we also are looking at some more opportunities on the casino front. To answer your question 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 we will continue to develop and grow the business into next year. So I am positive about the pipeline and where we stand there.

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 what we believe is the appropriate, we take the appropriate position at that point in time so as this is done on a quarterly basis I think you probably shouldn’t look at it as is this the start of a trend. I think you should look at it as this is analysis at a point of period in time and 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.

Stephen Taylor

In prior quarters we have a requirement from the licensing and gaming authority of Malta where 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 and Malta during the quarter and that resulted in the release of that $5 million from a restricted cash balance. 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.

Operator

The next question comes from the line of Brian Kinstlinger – Sidoti.

Brian Kinstlinger – Sidoti

I am curious what the size of your slot accrual is for jackpots right now.

Brian Hadfield

It is about $3 million.

Brian Kinstlinger – Sidoti

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

Stephen Taylor

Yes in that amount goes up and down. It is amounts that are held to payout future jackpot payments.

Brian Kinstlinger – Sidoti

But it only goes down if a jackpot is hit and you have to payout cash right?

Stephen Taylor

That is correct.

Brian Kinstlinger – Sidoti

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

Brian Hadfield

How many branded months games?

Brian Kinstlinger – Sidoti

You had talked about how you could have three games in a month, right, so if it launched day one in a month it would be three. I am trying to figure out because some of the games were launched late what the sort of revenue per game is. That is really the only way to look at it.

Brian Hadfield

As we go into the call I will get that information for you. At some point in the call I will give you a rough idea. I don’t have it right in front of me.

Brian Kinstlinger – Sidoti

On the 50 games you have right now how many would you saw are optimally placed? I don’t need an exact number. Much less than half? Are the newer games 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 goes back to the saying I made which is we put the marketing team in place to help people get the best return. We have with some clients a pretty good track record of what the games can generate and where they are best played. As with anything there are some clients that eagerly seize 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 all we can do is recommend. On balance I would say in most cases we are fairly comfortable with where they are placed but there are some where we have worked closely to move them because the rational they have used is probably not the rational 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. There will be a normal distribution and acceptance of that. That is just [inaudible] I think.

Brian Kinstlinger – Sidoti

So it is 1.5 or even more than 2/3 of your games are optimally placed, is that a fair statement?

Brian Hadfield

Without looking at it sophistically I would say we are probably comfortable with 50% or just over 50%.

Brian Kinstlinger – Sidoti

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 in the launch? You have 30 to go and we are almost to December. How many are going to be really right at the end?

Brian Hadfield

I would imagine that…

Brian Kinstlinger – Sidoti

Maybe a better question is how many games launched do you think you will have in the quarter?

Brian Hadfield

I am anticipating there will be 17 games launched in November and roughly the same number in December.

Brian Kinstlinger – Sidoti

To me it doesn’t seem your competitors felt the pressure in the third quarter that you did. Certainly the jackpots but even excluding that it wasn’t as pronounced 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 doing to address the problems.

Brian Hadfield

I think there are several things we are doing. I think people are seeing changes in wagering levels so I think a lot of it comes down to player acquisition. There are a couple of other things; one we have done and one we are doing. We are completely re-worked the lobby and we did the first iteration of the lobby. We launched that the other day and that iteration of the lobby has a totally different look and feel. It is much more like what you would see on an iPhone with the ability to flip things across. It has a suggestion engine for people to look for games and play games they can identify their favorites and things like that. So we have changed the whole look and feel of the lobby. We did that using the latest technology and the initial feedback on that, as it has only been out for a week, has been very positive.

The other thing 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. 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 the casino side where we continue to work. We do the things I just talked about. We help people with search engine optimization. We have developed a new lobby. We are looking at better branding. Then we have the game side which requires some ramp up. Long-term I think both the casino side and the game side has enormous promise. I am comfortable that the actions in place albeit we haven’t had the results in the timeframe that we had thought, the actions that are in place are positive ones.

Brian Kinstlinger – Sidoti

So in casino, as I think everyone knows is the biggest part of your business, 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 be significant new incentives to acquire new players and if they do that does it 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 anything that is just sort of promotional based is not the only answer because of the 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 sub-segmentation. 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 onto a website and sort of signing up and making not the first deposit but the second deposit. So the analysis we have been doing or helping people do is what happens between logging onto a website and making that second deposit because we believe the second deposit is key, not the first deposit.

Yes, I think you will see the competition in the marketplace means there will be promotions. I don’t think what you will see is a skyrocket or spiraling out of control promotion thing. I think that will just be part of a multifaceted approach which will encompass the other things that I said.

Brian Kinstlinger – Sidoti

Has there been any progressive jackpots that have been hit so far such as the two that hurt you? If so what is the impact in the fourth quarter?

Stephen Taylor

There has been on Millionaire’s Club that 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. 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.

The answer, we are just working on the impact in the month of October of that particular jackpot win. We will be reporting on that at the year-end call.

Brian Kinstlinger – Sidoti

You have to replace what your particular…what is it, $300,000 or $600,000?

Stephen Taylor

On Millionaire’s Club it is 175,000 Pounds Sterling.

Brian Kinstlinger – Sidoti

A couple of more quick ones.

Brian Hadfield

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

Brian Kinstlinger – Sidoti

56 month games in 3Q. Do you know what it was in 2Q as I am making you do all this math?

Brian Hadfield

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

Brian Kinstlinger – Sidoti

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?

Stephen Taylor

One of the things that has happened 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 receivables balances there. And we also because the poker room has moved over to G-Tech we have an amount that is receivable from G-Tech now every month that we didn’t have before. All of those amounts that we have outstanding are current and up to date. 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 branded games. Some of the new properties that we announced, we have a renewal with Marvel. We had a contract for the first time with DC Comics. We also had one with Paramount. So far this year we have invested about $4 million on prepaid royalties on those properties.

Brian Kinstlinger – Sidoti

That is in operating cash flow?

Stephen Taylor

That is a prepaid amount so when you calculate operating cash flow yet it would be. So, those prepaid amounts we are very comfortable that they will be recovered clear now with the branded games because many of the products that the brand games licensees are taking are either Marvel or in all likelihood will be 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 comic characters. 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 longstanding and mutually beneficial relationship with Marvel to get this sorted out.

Brian Kinstlinger – Sidoti

You say exclusive is that 100% exclusive or I thought it was no longer exclusive I thought you had mentioned before.

Stephen Taylor

No that is not true. 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

The last questions that I have, first of all two part and completely different is I have been asking every quarter; when are you going to buy stock to align your interests with shareholders? The second is land based slots. Is there an opportunity given you do have those exclusive rights on Marvel. I’m not sure if it is exclusive on DC or not but is there any chance of taking your content and somehow getting it into the Vegas casinos from a traditional slot perspective?

Brian Hadfield

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

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

Operator

The next question comes from the line of Alex Silverman – Special Situations.

Alex Silverman – Special Situations

Have your assumptions vis a vie 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 what we have done just to be clear on that is there are some licensees where we think games will generate X. There are other licensees maybe of a different size where it won’t generate quite as much. We banded that and then we have modeled that and so far the results we are getting match the modeling. So we haven’t changed it yet. If there was something that caused it to change we would certainly talk about that. 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 a 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. I want to make sure that…

Alex Silverman – Special Situations

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

Stephen Taylor

I think Brian had said in response to the question from Brian Kinstlinger when 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 $14,000 per game.

Brian Hadfield

We do have a track recover over time. Again, as we talked on the last call if they come out at the end of the month they are clearly out there in the month but they don’t have necessarily 30 days to accrue it. It is something we have to keep looking at over time but we will continue to report the revenue that way.

Operator

The next question comes from the line of Gary Dvorchak – Channel Island Partners.

Gary Dvorchak – Channel Island Partners

On the branded game can you talk us through some of the life cycle assumptions? I know there is not a lot of history there so some of it is still guesswork. Maybe take the first three games you rolled out early on and give us a sense of how those ramp and what speed do those ramp on a monthly basis. Where do they peak out? The question I’m wondering about is the fact they are oriented towards characters and things like that, it doesn’t seem to be that they are going to be something which it hits a steady state and stays there for years at a time. There is going to be some level of churn. That is one thing you model. Let’s say 100 games some time in Q1 and then maybe ramp to some higher number. How much replacement is there going to need to be over time? Give us a sense of how those ramp and what speed. Where do they plateau for awhile? Maybe a guess. Have any of the first games started to trail off in revenue, as an example? Just give us a sense in how we should think about what the total life cycle is going to be on those and also if the newer ones you are rolling out if they are following that with the same pattern you saw in the early games.

Stephen Taylor

In answer to your question I will give you the accountant’s answer. That is, it depends. It depends on a number of factors. 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 has been out there for some years now they still are right at the top of our list of most popular games in our hosted casino.

Gary Dvorchak – Channel Island Partners

I’m just saying just the branded.

Stephen Taylor

Those two games are significant games that are out there that are part of the branded games strategy. Some of the other games, the Spiderman and the Hulk games and games of that ilk, once again they have been out in our hosted casino for in some cases two plus years and they still continue to perform at the top end of the spectrum in terms of games we have out in our hosted casino.

I think if you look at the 310 plus games we have in our hosted casino we definitely do have some that go out. They launch relatively successfully and then they function well for awhile and then plateau and stay at that plateau for a long time. We have other ones that are out for a year or so, eight months or a year, and then start to fall off. They don’t tend to be the branded games though. They tend to be some of the other ones 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 we have already placed with our licensees and there are plans in 2010 to keep a pipeline of fresh product going out there such that we continue to keep the revenue fresh and keep it building.

Brian Hadfield

I think the other thing that is important we do have in the innovation center, 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 are based on either general games, casual games that we were 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, etc. that will be complemented and supplemented by additional games coming out to the innovation center which will be based on a variety of casual games that become gaming games or just new games in the marketplace.

Whilst the branded games is an important element the idea of the innovation center is to make sure we develop other games. Games that fit into social networking. Games that you can play against the house or you can play peer-to-peer. Those things will also be rolled out. There is a broader spectrum than just branded games.

Gary Dvorchak – Channel Island Partners

So on the branded games, on the licensed games, you just said you were averaging $14,000 a month per game, so if you take the end of this year using Q1 as an example with 88 games out. Internally in your model you use then 88 games at $14,000 a month? Is that like a plateau? Where would they typically peak out at? I know it is still early on but how many are sort of missing what the average is and how many are outperformers? Again, focusing against the license rather than the host. I don’t mean to beat on it but this is critical obviously to the turnaround story and I guess we just want to get a better sense really of what the expectations are because I’m sure everyone is disappointed that you are not even at $1 million a quarter on those games yet relative to what the expectation was say a year ago.

Brian Hadfield

Again, I want to be clear as to how we do this. 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 have got games that we parse out as high value games in a large market. You can also have a high value game in a small market or with a smaller licensee. So the way we model it just to be clear is we don’t say we will gave 85 games or any number of games they are all going to be in one market. We take a look at it by licensee and by potential game generation and then we model it that way.

On average it has come out to that number today. Will it continue that way over time? We will continue to model it and take a look at it. That is what the number is today and it has held fairly steady. At the moment we are comfortable with it. 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 is the reality of the marketplace.

Gary Dvorchak – Channel Island Partners

Can you clarify on those royalty payments are those flat rate or percentage of revenue? Then also just to go back to Marvel for a second and the fact there is other games, what is their case that it is not exclusive? What have they said to you early on? It seems like it would be pretty cut and dry. Either it is exclusive or it’s not.

Stephen Taylor

The discussions are ongoing and as I have said before we have a longstanding relationship with Marvel and we are looking to come to an acceptable conclusion on this without it spiraling completely out of control. I think we think we are going to come to an acceptable conclusion with Marvel. I would just like to reiterate we are strongly of the view that we have exclusivity on the comic book characters from Marvel. We will pursue that to ensure that right is protected.

Brian Hadfield

The answer on the royalty payment is percentage of revenue.

Gary Dvorchak – Channel Island Partners

What additional expense actions are you going to take? Obviously you did a lot over the last year. To a certain extent some of it was low hanging fruit because it was related to poker so it was just taking poker expenses out but the reality is you had an $80 million cash balance 18 months ago or a couple of years ago. $15 million of that is gone and you are burning through substantial amounts and I think you need to be able to break even at a lower revenue expectation than you probably have, both you and the board and investors, maybe six months ago. It is really not acceptable to continue to burn through cash at the rate it has been burned through and I am just wondering what additional actions you are going to take to breakeven more quickly under assuming an environment where maybe revenue isn’t going to ramp as quickly as you would have liked.

Brian Hadfield

We are in a budgeting process at the moment. We will continue to look at lowering our development costs. I think we have done a good job of using remote development centers. We were using tools that were actually lowering our development costs. 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 are taking a look at facilities. We are continuing to take a look at every aspect of the business to streamline the business and make sure operating groups are working at the optimal level with the right tools and that is a process we are going through in this year’s budget cycle. I think I would say I would characterize it as we are going through a diligent process. There are no sacred cows. We are taking a look at areas we need to invest and develop and we are a look at areas where we can certainly cut. I am confident we will continue to lower our operating costs and we will get our operating cost where it needs to be and we will get the revenue where it needs to be. 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? A year ago the world was falling apart and everyone could be more tolerant of the beginning of a turnaround cycle but we are over a year into it and we are not seeing any results. If anything it is going in the wrong direction. I like the strategy. I think you are doing the right things in terms of the product rollout and all that. You can’t sit here and burn through cash at the rate you have been burning through it. It is not tenable.

Brian Hadfield

I agree with your sentiment. There are two things we will do. 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 from a long-term perspective we also have to make sure we do the right thing. We absolutely see the urgency and the need to act. I believe if you take a look at the actions we have 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. I think we are in violent agreement in that fact. I can assure you there is no sense of complacency in taking actions.

Operator

The next question comes from the line of Roger Hardman – Hardman & Co.

Roger Hardman – Hardman & Co.

Right at the beginning you said one of the three reasons these results were disappointing was there had 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 users?

Brian Hadfield

I think we have to say we have seen licensees slip dates during the year. I would be hard pressed to say it was limited to one or two. I think it really is that this year has been a tough year for most people. There certainly has been a lot of pressure on the technology side in most of these businesses. It really is a question of what are the priorities, what are the resources they have available. At no time have we talked about a potential release date that hasn’t been agreed with a client but unfortunately those priorities either have slipped or changed. We are attempting to do the best we can to keep as close to them as possible which is why we have made some of the changes but they have. I’m not blaming them. Those delays have been at their end. We have the product. We have 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 are a gaming host?

Brian Hadfield

One of the things I certainly would have said with a technology background is that I would have thought that whilst it is not quite as easy as you have suggested it wouldn’t necessarily be as complicated. What we have discovered is that when people go through the QA testing and when they do software implementations and when they do configurations we have 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. All I can say is maybe 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 have made the appropriate adjustments.

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

Operator

The next question comes from the line of Todd Eilers – Roth Capital.

Todd Eilers – Roth Capital

You mentioned that you had set up three teams to kind of help address some of the rollout of these games.

Brian Hadfield

We have done it.

Todd Eilers – Roth Capital

My question is, what is the incremental cost from setting up these teams? Did you just do it through your internal resources or have you had to add some people? I’m just trying to get a sense.

Brian Hadfield

I have not added to the costs. What I have done is reassigned people and put them in that position. So when we took our client and marketing support team I took an individual on that and gave them basically 90% plus of the time to work on this. I took one of the technical resources and he put a small team together. The other thing about this is they are virtual teams so we have them in different locations but they are committed absolutely to the licensees and the rollout process. We have gotten them involved early in the process so hopefully we don’t get to the situation where we learn quite late that there is going to be a delay. There is no incremental cost.

Todd Eilers – Roth Capital

I guess looking into next year can you safely say you expect to be profitable in calendar 2010 given where you are at right now? More importantly would you expect to be cash flow positive?

Brian Hadfield

The answer to both of those questions is yes.

Todd Eilers – Roth Capital

Maybe to just get 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 is we are right in the middle of the budget cycle as we speak. I think on the next call we can give you something much clearer than I could today. I am not trying to duck it. Again, I am just trying to be practical and I hope that is what you would want us to be.

Todd Eilers – Roth Capital

I know we all ask it every quarter but William Hill license. I know it comes up or expires here at the end of next month. Should we expect to see an announcement or press release from you indicating what your relationship with them will be going forward? Any sort of update there or specifics you can provide? I know you are in negotiations.

Brian Hadfield

Well, they are a licensee. We talk to them on a regular basis. We continue to talk and I am optimistic we will be able to continue a long-term relationship. Going back to your statement yes we will make a statement at an appropriate time. The relationship is good. I talk to Henry on a regular basis.

Operator

The next question comes from the line of Chuck Ryan – Private Investor.

Chuck Ryan – Private Investor

As a shareholder I just wanted to express some of my comments and ask a very simple question. This is sort of a follow-up to what Gary had a few minutes back. I was looking at your balance sheet. As of December 31, 2006 you had cash investment and short-term investment worth $128 million and today it is down to $28 million. That is a lot of cash flow of almost $100 million in less than three years. I am just concerned and it is hard as a shareholder to see all this cash being burned and no increase in revenue. No profit. In fact we are looking at a very pessimistic quarter towards the end of the year. I am just really concerned and really unhappy with how the whole thing has unfolded. At this rate if it continues I am afraid in the next year or two we won’t have any cash left and we will be operating on [credit]. My question is really simple, does CryptoLogic know…does the management of CryptoLogic know what it is doing?

Brian Hadfield

I believe the answer to the question is yes we do know what we are doing. We have articulated a strategy. We have had discussions with lots of people on that strategy. We have taken a new concept into the marketplace. We have had the parties 888, Virgin, Sky, etc. all accept that our offering in the marketplace is of value and they have subscribed to it. I think arguably we have one of the better casinos from a 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 we have a strategy that is differentiated in the marketplace, is accepted in the marketplace and we will actually return shareholder value.

Chuck Ryan – Private Investor

This is something that I have been hearing on the conference calls and I have been listening to your conference calls for some time. There was a time when you promised to deliver. The last few quarters or so in a couple of years I assume the trends have not reversed. You have over promised and under-delivered. In the last conference call you said about expecting the value of EPS of $0.65, [inaudible] and just three months or six months down the line the whole picture has changed. So that is the reason I am just trying to explain why I am sorry if this question sounds harsh but that is the reason I am expressing my concern about the way the whole thing has been happening over the past few years.

Brian Hadfield

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

Operator

The next question comes from the line of Gary Dvorchak – Channel Island Partners.

Gary Dvorchak – Channel Island Partners

I just had one follow-up on the expense side. It is something that confused me a little and it was really since the pre-announcement in the last call you said you had gotten return to profitability in the June month and then through summer, August and September, you seemed to be on plan and you kind of implied that there really wasn’t the pickup in September that you had expected. Yet the loss this quarter was about $1 for $1 with the revenue miss and I am just wondering why your expenses would have suddenly ramped in September or are there some large expenses associated with the revenue that you were deferring? I didn’t quite get the pattern as to how you think things are going okay during the summer and everything kind of changed at the end. Maybe you can just clarify that.

Stephen Taylor

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 schedule 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 in any way shape or form anticipated. We had been trending in the right direction in hosted casino revenues during the rest of the year and then August 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 in online casino. The uptick in September was not anywhere close to what it has been in historical experience. 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

In August and September you are attributing all of that on the hosted side to the economy? You didn’t see any new competitors in the market or anything else that made you think there was anything other than the economy?

Stephen Taylor

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

Operator

The next question comes from the line of Michael Demaray – Elevated Capital.

Michael Demaray – Elevated Capital

Obviously the branded games are ramping well. Have you put a number out there for what you believe the ultimate market opportunity is for that business segment? If so what is that number and how long do you think it will take for you to get there?

Stephen Taylor

We have not put out a number in terms of what we think the ultimate market activity for that is. I think the big reason for that is the internet casino market has always been very fragmented. There are some strong players in the industry and we are glad to say that many of the licensees we have signed fall into that category as being the big players in internet casino. There is also quite a number of small players. To be able to determine even if we were to cover many of the names in the industry to be able to determine how much revenue per site we might be able to make per game is very challenging and we don’t have enough data at this point in time to prognosticate on how big the opportunity might be.

Michael Demaray – Elevated Capital

On the cash flow side obviously you dropped the dividend this time around. I would say as a shareholder I personally and the money I manage would prefer to see it disappear. So I just wanted to throw that out there in terms of preserving cash and build a cash flow positive operation. Thank you.

Operator

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

Brian Hadfield

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. 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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