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Cryptologic Inc. (NASDAQ:CRYP)

Q1 2010 Earnings Call

May 7, 2010 8:30 am ET

Executives

Brian Hadfield – President, Chief Executive Officer

Stephan Taylor – Chief Financial Officer

Analysts

Brian Kinstlinger – Sidoti & Company

[Gary Devorchuck – Channel Island Partners]

[Marc LeDuc – Private Investor]

Operator

Welcome to the 2010 first quarter financial results conference call. I would now like to turn the meeting over to Mr. Brian Hadfield.

Brian Hadfield

Welcome to Cryptologic’s conference call for the first quarter of 2010. I’m Brian Hadfield, President and CEO of Cryptologic. With me here in Dublin is Steve Taylor, our Chief Financial Officer.

Q1 was a difficult quarter for Cryptologic as the benefits of our operational progress have taken longer than we had hoped to bear fruit and ultimately translate into revenues. Despite a strong January, first quarter revenues were impacted by sluggish wagering activity across our licensee base and an unanticipated decline from a key customer transition last year.

In addition, a six-week delay in software implementation of Inter Casino hampered the full launch of a new branding and streamlined registration process, thereby pushing back the start of a major new marketing and advertising campaign. That said, Q2 has started well with revenues to date, and to the same period in the previous quarter.

The hosted casino business continues to be the focus of aggressive management action and we expect its performance to improve. The operational team in this segment has also been strengthened. We’ve delivered all new virtual casino lobby which together with the re-branding and re-launch by Inter Casino and back to a major advertising and marketing campaign, represents the first such major investments in many years aimed at driving long term growth.

In addition, Cryptologic’s full internet casino hosting suite for Betsafe.com is expected to live this month. Our customer base continues to expand with the signing of multi-year licensing deals for branded casino games with William Hill, Bet 24, and Betson.

With regard to William Hill, as you’re aware, much of their casino franchise has been transitioned to another environment so their players have the option to remain with the Cryptologic casino from here on.

Additionally, we expect to rebuild licensing revenues with William Hill through our branded games, nine of which will launch by the end of the first quarter, so revenues will begin to ramp up from Q2 onwards.

We’ve also made solid progress in other important respects. Our cost base continues to shrink due to ongoing initiatives to streamline the business. Operating expenses were reduced by 36% and general and administrative expense by 12% in Q1 compared with the previous quarter.

On a constant currency basis, our overall costs, which includes operating, G&A, finance and amortization, has been cut by approximately 21% compared with the first quarter of 2009. The employee numbers decreased from 211 to 198 during the quarter and is down from 246 in Q1 2009.

Our branded games licensing segment continues to gain traction, increasing revenues for a fifth consecutive quarter with 26 new branded games launched in the period. 18 of these games were not launched by licensees until well into the last month of the quarter so their revenue contribution will start to flow through from Q2.

There are now a total of 108 branded games launched by licensees to date, which a notable achievement is given that there were just three introductions at the end of the first quarter last year. With a further backlog of approximately 92 games expected to go live in 2010, the prospects of steady growth in branded games remains excellent.

Our games portfolio remains strong and we are developing some of the most innovative games in the industry. During the quarter, we released six 3D games as part of a targeted launch. These were created to capitalize on the rapidly growing popularity of the 3D movie genre and will help to cement our reputation for creativity and cutting edge content.

We believe 3D games will provide a new level of gaming experience and become an important new factor for the industry long term. In time for the world cup, we will shortly also be launching into football themed games.

I will now turn the call over to Steve Taylor for some analysis of our financial results.

Stephan Taylor

Thank you, Brian. I remind you that Cryptologic continues to report in U.S. dollars. Cryptologic revenue decreased to $7.6 million in the first quarter, down from $9.9 million in Q4, 2009. As Brian commented, this reflected subdued wagering activity and reduced contribution from a key customer transition last year as announced previously.

After normalizing for an $800,000 benefit recorded in Q4, 2009 from the revision of our jackpot policy, revenue decreased by 15.9%. The average revenue per branded game was $5,600 per game month compared with $7,870 in the last quarter of 2009.

Operating expenses were $8.1 million for the quarter, down 36% from $12.6 million in Q4, reflecting our ongoing focus on taking cost out of the business. Included in Q4 2009 operating expenses were one time items of $1.t5 million related to the re-launch of a major licensee brand and $1.9 million in impaired assets removed from the year end balance sheet. After excluding the impact of these items, operating expenses were reduced by $1.1 million or 11% in Q1 2010.

General and administrative expense decreased 12% to $2.2 million in Q1 from $2.5 million in Q4. Cryptologic ended the quarter with $19.7 million in net cash or $1.42 per diluted share, down from $23.7 million or $1.91 per diluted share in the fourth quarter. The decrease was due to the timing of a tax payment of $1.4 million, which is ultimately recoverable, and the cash impact of the operating losses of $2.4 million.

At the end of Q1, all net assets of the company were in U.S. dollars with a net liability position in Euro’s and Pound Sterling of $7.6 million. Revenues in the quarter were made up of 39% U.S. dollars, 28% in Euro’s and 33% in Pound Sterling.

Expenses in the period were 31% in Euro’s, 32% in Pound Sterling and 37% in Canadian dollars. These figures are all included in the notes to our quarterly financial statements.

Turning to the 2010 outlook, management expects overall revenues to improve gradually over the year driven by an uptick in wagering volumes and impact of new licensees. Revenues in April were significantly better than in the previous two months and revenues to date are ahead of the equivalent period in the previous quarter.

These encouraging trends have continued into early May though the start of the World Soccer Cup in June provides some near term uncertainty. That said, branded games revenues are expected to gain momentum as new games come on stream.

The number of branded games launched by licensees to date and generating revenues is currently at 108 with approximately 92 games in the backlog. Finally, we also expect our full-hosted casino suite to go live at Betsafe.com this month.

With that, I’ll turn the call back to Brian.

Brian Hadfield

Thank you, Steve. We’ve been through a difficult period, but believe that the worst is over and the add book is improving gradually. We greatly appreciate our shareholders continued patience. As you would expect, the company continues to assess its revenue streams, costs and strategic direction to accelerate its move towards profitability.

We’d now be pleased to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Kinstlinger – Sidoti & Company.

Brian Kinstlinger – Sidoti & Company

When you talk about strategic direction, are you talking about, your comments just now towards profitability, are you talking about strategic alternatives or the direction of the company without strategic alternatives? Are you talking about what the company strategy is and maybe changing that or are you talking to a consultant about the direction of the company, which included potentially take-outs?

Brian Hadfield

What it means is that we will continue to take a look at the strategy for the company. We’ll take a look at the alternatives and we’ll take a look at the best thing to do to return shareholder value.

Brian Kinstlinger – Sidoti & Company

I’m wondering, you’ve added a ton of licensees. Branded games haven’t really done exactly what you expected from a revenue standpoint and you struggled to return to profitability since 2006 and I’m wondering why strategic alternatives is the main thing you’re expressing right now, because I’m sure your property would be worth more to someone else to maybe make it profitable.

Brian Hadfield

I think I’ve answered the question and that is, we continue to execute a strategy we have and we look at whatever makes sense for the shareholders and for the company in general. So we will continue to do that.

With regard to the branded games having gone from three to 108 with 18 of the 26 in the quarter only coming out later in the quarter, there’s been a fair amount of traction on that. So I wouldn’t say that’s not necessary worked. It’s certainly been slower than we would like because as you know, we’ve had discussions on that in the past.

Brian Kinstlinger – Sidoti & Company

What was the game months in the quarter?

Brian Hadfield

The game months in the quarter, 224.

Brian Kinstlinger – Sidoti & Company

So you had 50% more game months and $100,000 more revenue. I would say the quarter was disappointing.

Brian Hadfield

18 of those games came out.

Brian Kinstlinger – Sidoti & Company

Game months for just when they were released.

Brian Hatfield

Game months, we do it on a percentage of how long it’s been out.

Brian Kinstlinger – Sidoti & Company

All I know is, there’s been 224 game months versus 150 and $100,000 more of revenue.

Brian Hatfield

All I’m saying is that 18 games came out in the last few weeks of March, that’s all.

Brian Kinstlinger – Sidoti & Company

Right, so even if you’re 18 games off that number completely, you’re still 40% off and only 5% off on revenue.

Brian Hatfield

As we said in the beginning, wagering overall was subdued. So I take your point. I would not categorize it as not working however.

Brian Kinstlinger – Sidoti & Company

When you say revenues are better than last year, where are revenues right now? I know you have a system almost daily where they are. Maybe give us, since things have been so poor, what revenue was for the first month and what they are so far maybe compared to last year.

Stephan Taylor

Hosted casino revenue so far this quarter for the properties that are still with us, and understand that William Hill has had a reduction in hosted casino revenue since last year, but the other properties that we have are at a rate of 101% to 102% of what they would have been at the same quarter last year, and I think we had significant bounce back in the second quarter of 2009.

Brian Kinstlinger – Sidoti & Company

You’re not saying the June total, you’re June excluding, last year, excluding William Hill.

Stephan Taylor

That’s correct.

Operator

You're next question comes from [Gary Devorchuck – Channel Island Partners]

[Gary Devorchuck – Channel Island Partners]

Maybe to clarify on the branded games, can you give us an analysis maybe equivalent [inaudible]. So there’s an issue with a lot of games coming late in the quarter, but if you look back to games that had been fully operational in Q4 and they’re still running in Q1, are those continuing to ramp or have they fallen off? Maybe some more color in that regard if you have that.

Brian Hadfield

I don’t think it’s a problem that the revenues have started to fall off on the games. I think what we saw consistent with our hosted casino revenue patterns, we saw a drop off in wagering across the board amongst our branded games licensees in the games that we provide for them in the months of February and March.

So we’re not seeing sort of a trail off the games that are out there. It’s more a general malaise situation amongst all the licensees that we have.

[Gary Devorchuck – Channel Island Partners]

In terms of where you are quarter to date, how has it been trending more recently? Obviously, Greece, and there’s issues with the Euro’s and everything else in the news right now. I’m curious if there’s been a more recent impact or has the trend April into May all been better direction.

Brian Hadfield

I think the trends for April into May, the licensee that we assisted in terms of the re-launch, we put new technology in place. They’ve spend significant dollars in terms of television advertising and that has sort of resulted in stronger results for them.

I can’t say that at this point in time we’ve seen any real impact of the currency troubles that are plaguing Europe at the moment.

[Gary Devorchuck – Channel Island Partners]

Betsafe, are they live now or did they go live in April? What would be the timing on that one and on the hosted?

Brian Hadfield

That site is due to go live on the 18th of May.

Operator

You're next question comes from [Marc LeDuc – Private Investor]

[Marc LeDuc – Private Investor]

What’s the status with the conflict that you have with Marvel? How much will it cost and what’s the time frame that you figure it will be resolved?

Brian Hadfield

The situation is that we have a process, which is a contractual process. If we have any issue with Marvel, that is the arbitration process that we’ve entered into. We continue to have talks with them. Our goal is to satisfy it as quickly and as soon as we can, preferably without going deep into an arbitration process.

But based on the confidentiality of the contract, I can’t really expand more than that. Suffice to say, we’ve had a long-standing relationship with them and we would like to resolve this as amicably and as quickly as possible.

[Marc LeDuc – Private Investor]

Basically, how much the games that is copying? Is it only a conflict with one game or two games or is it more of a lot of games that they’re using from Marvel?

Brian Hadfield

I prefer not to get into that. We have a contract with Marvel and we just are looking to resolve it with them.

Operator

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

Brian Hadfield

Thank you again for joining us today. We look forward to updating you in the near future and we appreciate your questions and support. Thank you very much.

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