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Cryptologic Inc. (NASDAQ:CRYP)

Q4 2009 Earnings Call

March 2, 2009 8:30 am ET

Executives

Brian Hadfield – President, Chief Executive Officer

Stephan Taylor – Chief Financial Officer

Analysts

[James Hollis – Daniel Stewart]

Brian Kinstlinger – Sidoti & Company

John Nevins – Wells Fargo Advisors

Operator

Welcome to the 2009 fourth quarter and year end results conference call. Your host for today will be Mr. Brian Hadfield.

Brian Hadfield

Ladies and gentlemen, welcome to Cryptologic’s conference call to discuss our financial results for the fourth quarter and full year 2009. I’m Brian Hadfield, President and CEO of Cryptologic. With me here in Dublin is Steve Taylor our Chief Financial Officer.

2009 was a difficult year as Cryptologic implemented its new strategy to improve its long term performance against the backdrop of the severe global economic downturn. Volumes across the industry, the delayed rollout of our branded games by licensees which we highlighted in the last call combined with an anticipated reduction in revenues from a key customer, blunted the underlying progress made in the year.

Clearly the financial results are disappointing as the benefits of the radical changes executed throughout last year have yet to make their full impact. At the same time, we also took further asset write downs and restructuring initiatives to align our costs with the challenging business environment.

Steve will go through the numbers in detail but first I would like to take a few minutes to discuss what we did well and where we have to continue to improve. Our key operational objectives at the beginning of the year were to strengthen our core business of building and hosting internet casinos while outsourcing poker to a shared network, to license Cryptologic’s branded games to the world’s major internet gaming operators, and to reduce our cost base dramatically.

Turning to the challenges first, Casino hosting together with the outsourced poker business was affected by the economic downturn with significantly depressed wagering volumes resulting in lower revenues.

This was exacerbated by lower contributions from some casino licensees including a key customer VAC as planned, migrated much but not all of its business to another network. However, expect to announce some positive news on this front very soon. Meantime, we added to our roster of full internet casino customers by signing betsafe.com on the gaming network in 2009.

Secondly, the ramp up of our branded games by new licensees was slower than anticipated mainly due to rescheduling by licensees. In other cases, some licensees needed much more technical and marketing guidance with their launch programs than we envisaged. We’ve since addressed these issues aggressively in the last quarter.

Recognizing the revenues decline, we have already taken actions to reverse that trend. We’ve also reduced our annual sales cost base by more than $20 million, significantly ahead of our initial targets. These measures included the merger of our poker business with GTECH and the downsizing of the operational and IT infrastructure across the company.

The result is our head count is down 24% from a year ago and by 32% from 2007. Costs are continuing to be managed closely and today we announced the integration of our Cypress office with our existing operations in Malta. This will further streamline our operational efficiency.

That said, the cost cutting program did not inhibit our new business performance and productivity during the year. Our total licensee base expanded to more than 30 leading internet gaming operators, the most in our history, including more significant names this year such as Bet Fair, Sporting BetClic, Tote Sport, Rank Interactive, Unibet and Virgin Games.

These positive and evolving relationships should form the basis of potential future business which should bode well for the company.

Despite the slower than expected roll out by new licensees, our branded games licensing business continued to gain excellent momentum with four consecutive quarters of revenue growth. The number of branded games in production increased to 66 games from just 33 in the previous year with approximately another 125 games still in the backlog.

These games are sought after by many of the world’s leading operators because they set the industry benchmark for quality, content and entertainment, all of which drive demand and generate value for our customers.

Cryptologic’s center for intervention launched last year enabled customers, partners, universities and other to participate in defining and guiding of future e-gaming. The center was fundamental to the launch of the new version of Gender, one of the world’s most popular board games in record time.

Other highly popular games launched including CoreDuty4, Street Fighter, as well as a host of in-house developed games including Monkeys to Mars, Triple Action Hold ‘Em and Cleo, Queen of Egypt. In all we launched 47 games in the year, a high output for a company of our size.

Through the center, we are also working on new games for the rapidly expanding mobile internet, social networking and 3-D domains. The first series of 3-D games is scheduled to be launched in the second quarter.

In early 2009, Cryptologic also signed an exclusive deal with DC Comics, a Warner Brothers subsidiary to develop betting games featuring popular comic heroes including Batman, Superman and Wonder Woman.

We also signed a deal with Paramount Digital Entertainment to develop games based on 20 movies including Braveheart, Forest Gump and Ghost. As the first games from these sources are now released, we are very excited about the games in the company’s pipeline.

During the year, significant investment was made in the major re-launch and branding of a new virtual casino lobby for hosted licensees. This new lobby, which has been well received by the media and licensees is available at casino and brings a new level of functionality to players.

In it, they can search and sort games more easily, customize their favorites and navigate easily through the lobby thanks to its user friendly, intuitive interface.

The new lobby is also backed by a new brand positioning exercise by Inter Casino with new websites, a soon to be released registration system and an aggressive print and TV ad campaign all designed to revitalize and reposition the brand.

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

Stephan Taylor

I remind listeners that Cryptologic continues to report in U.S. dollars. Cryptologic revenue increased to $9.9 million in the fourth quarter, up from $9.6 million in Q3. Revenue for the year was $39.8 million, reflecting lower wagering activity across the industry, adverse currency factors, delays in the roll out of games by new licensees and a reduced contribution from a key licensee.

Total annual recurring costs for 2009 which comprises operating, general and administrative finance and amortization expenses were reduced by $20.6 million to $55 million. In the fourth quarter, there were additional non recurring costs of $3.2 million related to the examination of balance sheet underlying values and amount spent to support the Inter Casino brand re-launch.

Based on our fourth quarter run rate our costs will be lower for 2010.

Operating expenses were reduced by 28.4% or $15.8 million to $39.9 million in 2009 from $55.6 million in 2008, significantly ahead of management’s plan. The decrease was attributable to the merger of the poker business with GTECH Corporation’s Boss Media subsidiary which eliminated the cost of a stand alone network, head count reductions, together with the rationalization of IT infrastructure and operational centers.

The company incurred a $24.8 million charge against the carrying value of its assets together with costs relating to restructuring initiatives in Q4 2009. This led to a net loss of $35.5 million for the year and a $24.8 million loss for the quarter. Approximately $3 million of cash will be used to complete the restructuring.

Cryptologic ended the year with $23.7 million in net cash or $1.71 per diluted share, down from $28.4 million or $2.06 per diluted share in the third quarter. The decrease in net cash was due largely to additional payments for royalties for branded games and amounts paid to assist a licensee for re-branding and re-launch of their site.

We currently have 74 branded games on the market today generating revenue for the business. Cryptologic continues to expect good momentum from branded games with an annual revenue run rate currently at $5 million per year as more games come on stream.

The average revenue per game was $7,900 per game month down from $13,800 at the end of the previous quarter. This change reflects a change in mix between large, medium and small licensees. During the quarter, we had 150 game months of branded games revenues.

I’ll now turn the call back to Brian.

Brian Hadfield

Although the company’s progress was overshadowed by a number of adverse factors last year, we’ve executed a major program to turn around the business. We remain committed to executing our strategy and moving in the right direction. As a result, the company is better positioned today than it has recently been to benefit from the improvement in market conditions.

We greatly appreciate our shareholders continued patience as we navigate through this challenging period.

We would now be pleased to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [James Hollis – Daniel Stewart]

[James Hollis – Daniel Stewart]

Where exactly are you going to move these further costs out and clearly you mentioned an annual run rate of $55 million. Do you mean that during 2010 that annual run rate will come down or is that what we should look for in 2010? The second question was can you give some numbers or even just a wider statement on current trading particularly relevant to albeit small fee poker. I know that I’ve seen that the BOSS network with GTECH’s network seems to be improving. I was wondering if you could give me any idea whether that is going well. And the third one, can you give us some target revenue growth even if the target revenue growth range for both hosting casino and branded games because I think you mentioned in the statement that you expect growth in both. Maybe give a range of what you’re targeting.

Stephan Taylor

First on your question of costs, costs will come out in all areas across the P&L in both the operating expense and G&A. We will continue to work the costs down over each quarter of 2010. We have taken some costs out. There were people reductions at the end of December, so some of those will come into play in the first quarter and there will be an ongoing plan throughout the year to realign our staff compliment to fit the business plan we have for 2010. So costs will come down each quarter.

[James Hollis – Daniel Stewart]

So you should exit 2010 with a run rate below $55 million clearly.

Stephan Taylor

No, I think what I’m saying is that with our current cost structure, what we’re experiencing in the first quarter of this year and with plans for the balance of the year, we will be below $55 million for 2010.

So your second question was on projection on growth rates. I think given the volatile and uncertain economic climate at the moment, we’re very hesitant about giving projections of growth rates and so I think we’d just like to point to the fact that there has been significant investment made in Inter Casino which is a long and valued licensee and a good partner of Cryptologic and the re-launch and re-branding. We expect that would generate positive results for us.

We also would like to point to the additional hosted casino licensees that are coming on board. We have Bet Safe that is coming on board. We’re currently talking to one other party. There will be an announcement about that relatively shortly.

Our business will benefit this year from the selling and marketing effort that we’ve had underway for most of the last couple of years and that’s where we think the upside is for the company.

[James Hollis – Daniel Stewart]

On the investment into Inter Casino, are you putting quite a bit of, or the licensee, are you putting quite a bit of marketing spend behind that and maybe give us a bit more detail on what seems to be a pretty interesting market around this Win a Trip to Space.

Brian Hadfield

As you probably know, that started last night, the first series of ads and it’s designed to reposition and re-invigorate the Inter brand so we’ve been working closely with them to do something on the system side. They’ve got a whole series of websites, new websites that you probably have seen and in conjunction with that, they have an aggressive print and TV advertising campaign.

The advertising campaign based on the astronauts, it is actually based on the Win a Trip to Inter Space and that’s done by a company in the U.S. So ostensibly it’s inviting people to register and then they go with that. I know the company is called Space Adventures. So far the initial feedback, there have been a few things on message boards and a couple of magazines have picked it up. So the initial feedback has been positive.

We know from last night that the number of sign ups increased quite dramatically, so we anticipate that, plus, the new website, plus the lobby, plus some other things that they’ve been talking about to be very beneficial to their business.

[James Hollis – Daniel Stewart]

Are you seeing in poker, seeing some benefits from the BOSS Media Network doing quite well at the moment?

Brian Hadfield

We saw poker increase by about 10% in the fourth quarter and it’s been fairly steady so far a month, two months now into this quarter, but we did see a 10% increase in Q4.

Operator

Your next question comes from Brian Kinstlinger – Sidoti & Company.

Brian Kinstlinger – Sidoti & Company

When I take the $8.7 million of casino revenue, the $1.2 million in games and $.5 million in poker revenue, that gets you to more than your revenue so I know you have the other compartment too so you could just break the four compartments of revenue down that would add up to the revenue base?

Stephan Taylor

Let me look at that for a second. Carry on with the next question please.

Brian Kinstlinger – Sidoti & Company

I think the most disappointing thing here is the revenue per game months so I’m wondering a, are you adding more smaller operators taking game throughout the year? Are they larger games and thus far in the quarter you’ve had two months. Is that trend of roughly $7,000 or $8,000, is that where the new target is or is it just an aberration do you think?

Brian Hadfield

I think we answered that question earlier, but similar games were added towards the end of the year to some smaller licensees. There are some bigger licensees that have games coming out so I don’t think that number is actually settled yet.

The first quarter, actually the first month was consistent with the end of Q4, but the hold rate was lower so the hold rate tends to flatten out as you know over time so we would anticipate an uptick on that.

So I think the answer to your question is there were a fewer smaller licensees that came out in Q4 which lowered it with some larger ones that are coming out in Q1 which we don’t have statistics on yet, which I think, well I hope it would have a positive effect.

January is pretty much on track, but with a slightly lower hold rate, which again we just anticipate bouncing back. As you know, because you’ve been following the business for a time, hold rate can fluctuate on a monthly basis, but over time, it evens out.

Brian Kinstlinger – Sidoti & Company

I’m wondering on your five or six or seven big ones that you have, revenue per game going down? It’s been there for a couple of months and is it getting stale?

Brian Hadfield

They seem relatively stable. They are stable.

Brian Kinstlinger – Sidoti & Company

So your progress is slowing. You’ve only added a couple in two months here so far and you’re still well under the 80 plus that you expected to be at the end of the year just three months ago or fourth months ago, so what’s happening?

Brian Hadfield

I believe the number is that January we anticipated would be slow because it’s immediately after year end. I think we’ve added 10 so far in January and to the end of February and it’s clearly been the months predicting exactly how many are going to rolled out, but I anticipate that number will at least double in March.

I know what the projected number is, but the projected number has never proved to be the real number.

Brian Kinstlinger – Sidoti & Company

What will double in March?

Brian Hadfield

I said we’ve got 10 out so far. I would anticipate that number will double in March, but what I did also say was that the scheduled number is more than that, but it’s been difficult to predict because we don’t directly control it. I would anticipate that we would double the number between now and the end of March and maybe there’s some upside.

Brian Kinstlinger – Sidoti & Company

The $5 million run rate that you’re talking about, is that where you’re just basically in the fourth quarter multiplying by four or are you looking at where you are today with the 70 some odd that really hasn’t added that much revenue?

Brian Hadfield

I would just take a simple look at what it was at the end of Q4.

Brian Kinstlinger – Sidoti & Company

So you’re actually a little bit higher right now or the same?

Brian Hadfield

Correct. I’m going to stop you. I think Steve might have your answer.

Stephan Taylor

The answer to your question is on every revenue line we have in the cleaning up of accounts in the financial statement, we have a reduction of $.75 million on the other revenue line.

Brian Kinstlinger – Sidoti & Company

How did that happen?

Stephan Taylor

We just, things that flow through revenue in the first place have to flow through revenue when they come back out again if you’re writing some of them off, so we have a number of items in the operating expenses line that are clean up and the mission at the end of this year was to make sure that we went into 2010 with a balance sheet that was in good shape.

Brian Kinstlinger – Sidoti & Company

Without any write offs where would other revenue be?

Stephan Taylor

Currently other revenue would be relatively minor.

Brian Kinstlinger – Sidoti & Company

We’ve been at over $1 million recorded this year, so that’s why I’m wondering.

Stephan Taylor

I think that number will be no more than I would suggest nor more than $.5 million on a go forward basis. Let’s go back to one thing, the backlog games, there’s still 120 plus games in backlog is another key element for the branded games.

Brian Kinstlinger – Sidoti & Company

Were the development costs for Inter Casino re-occur and are they footing the bill? Why are you footing the bill? Normally it’s reimbursed I would think by customers and then talk about is there more restructuring impairment in the first half of the year.

Stephan Taylor

In answer to your second question about restructuring and impairment, the answer to that is no. Once again, as I’ve said the balance sheet, the mission coming out of 2009 was to make sure that the balance sheet was as clean as it could possibly be so all of our assets have been subjected to a detailed valuation to ensure the carrying value going forward is correct.

In terms of this initiation that’s going on at Inter Casino at the moment is the first major initiative that’s happened to re-brand and re-position that brand in certainly as long as I’ve been with Cryptologic and I would suspect back into the early 2000’s, since the last time there were any major changes.

So this is a big initiative. Yes they are putting forward significant media spend. They are doing their part in accordance with our agreements to re-launch and re-position this brand, but it is an important customer for Cryptologic and that’s why we have contributed to the effort as well.

Brian Kinstlinger – Sidoti & Company

Will that all go away in the first quarter or is there more development spend for you I guess is the key.

Stephan Taylor

Not in terms of development spend. The major thing that’s got to come along yet that should be finished very shortly is this revision in our e-cash product to the registration system which is we feel based on research that’s been done, and certainly the Inter Casino people feel that it’s very important to increase the number of players who come to the Inter Casino website actually getting them to go through and make a first and second deposit and start playing.

That’s an essential component. We have been working on that for several months and as I say it should be done imminently.

Brian Kinstlinger – Sidoti & Company

So it’s still going to be the same in the first quarter as the fourth quarter? The spending that you did on Inter Casino, it will be the same in the first quarter as the fourth quarter?

Stephan Taylor

No.

Brian Kinstlinger – Sidoti & Company

It will be significantly less, a little bit less?

Stephan Taylor

Significantly less.

Brian Kinstlinger – Sidoti & Company

[inaudible] working without a contract right now and we’ve been expecting an announcement for a long time.

Brian Hadfield

The anyway hold player that wished to continue to play on Cryptologic Casino can play on the Cryptologic Casino and we have an agreement in place to do that.

Brian Kinstlinger – Sidoti & Company

How long?

Brian Hadfield

It’s an open ended contract. There is not end period to it.

Brian Kinstlinger – Sidoti & Company

So they could pull it tomorrow?

Brian Hadfield

They couldn’t under the terms of the contract, but it is not time dependant. But no, they couldn’t.

Brian Kinstlinger – Sidoti & Company

Can you tell what the progress of signing full suite licensees? It sounded like you were close last we spoke to having a couple of announcements. We haven’t seen that. Maybe talk about the progress you’re making right now.

Brian Hadfield

Again, without getting into the details of it, we have agreed terms and we have agreed both the term sheet and the terms of the contract for one and that should be announced imminently. It would have been nice if we could have announced it today and with that, there is another one that should follow close behind.

So again, our intent is to continue to develop the hosted casino business as an important part of what we do.

Operator

Your next question comes from John Nevins – Wells Fargo Advisors.

John Nevins – Wells Fargo Advisors

I need some help on the branded game launch. On November 13 we had 50 games launched. The estimate then was to hit 80 by the end of December. It came in at 66 and now we’re at 74. You must be talking to your customers, your licensees, your people. Is there a common theme as to why customers are taking so long to get games on the market? It just seems like things have even slowed down from a very slow 2009 and while I love the fact that the backlog has even grown this year, at this pace it will take two years to get the backlog up and running. So is there any color or anything that you could add to why it is taking so long to get these games on the market?

Brian Hadfield

I don’t think much has changed. We didn’t anticipate, once December/January comes round, we anticipate the potential slowdown. There were games that we anticipated in December. That’s absolutely true.

We talk to the customers on a weekly basis. I think it really is a priority issue of the customer and if the customer priority changes, something doesn’t necessarily slip from number to number two and may slip from number one to number four. That’s been the most frustrating thing for me.

I think partly it’s because whilst they like the games and they know the games generate a lot of revenue, those putting four or five or ten games out there and they put that in their mix of priorities.

So I don’t think it’s necessarily, one could argue that we only had three at the beginning of last year and getting to 66, were actually done fairly quickly. I anticipate that there will be a steady rollout from February onwards.

I can understand why you would say that 120 would take forever. Actually I think that’s more likely to speed up. Once someone has a couple of games in, they tend to move the others fairly quickly.

We’re also encouraging some people to get to the point where they can launch five or six games at a time as opposed to just one because what tends to happen, if they launch one or two, the lag time between the one and two to the three and four tends to be later.

I share your frustration. I wish I had a simple formula that said if we change X then it would move up quicker, but we do have a team of people in support of this that help from an implementation perspective. They talk to all the clients on at least, the major ones on a weekly basis and other ones on a bi-weekly basis. There is not simple answer, just priorities.

Operator

There are no further questions at this time.

Brian Hadfield

Thank you again for joining us today. We look forward to updating you in the near future. Thank you very much. Goodbye.

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