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PokerTek, Inc. (PTEK)

Q3 2010 Earnings Conference Call

November 02, 2010 11:00 am ET

Executives

Jody Burfening – IR, Lippert/Heilshorn & Associates

Mark Roberson – CEO, CFO & Treasurer

James Crawford – President & Board Member

Analysts

Shawn Bitzan - Feltl & Company

Caroline Hughes - D&B

Tom Pierce - Sargent & Lundy

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 PokerTek Inc earnings conference call. My name is Annie and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Ms Jody Burfening. Please proceed ma’am.

Jody Burfening

Thank you operator and good morning everyone. Welcome to PokerTek’s investor conference call for the third quarter ended September 30, 2010. This is Jody Burfening of Lippert/Heilshorn & Associates. The purpose of today’s call is to provide PokerTek’s investors and other interested parties with information about its operating results and to communicate other business developments.

Joining us from management are Mark Roberson, Chief Executive Officer and Chief Financial Officer; and James Crawford, President and Founder.

Before we begin the call, I’ll read the Safe Harbor statement under Private Securities Litigation Reform Act of 1995. The statements that are about to be made in this conference call that are not historical facts are forward-looking statements, and involve risks and uncertainties. These and other risks and uncertainties are described in more detail in the company’s most recent Annual Report on Form 10-K and other reports filed with the Securities and Exchange Commission.

The company expressly disclaims any obligation to update or revise publicly any forward-looking statements whether as a result of new information, future events, or otherwise. The company may also discuss EBITDA, a non-GAAP measure used internally to evaluate performance and allocate resources on today’s call. The manner in which the company uses EBITDA may differ from the manner in which other companies use the term EBITDA or EBITDAS.

With that introduction, I’ll now turn the call over to Mark. Go ahead please Mark.

Mark Roberson

Thank you Jody. Welcome everyone; we appreciate you joining us today. Over the past several quarters we’ve been focused on targeting the right market, repositioning our business and running lead. Those efforts continue to drive favorable trends in our operating results while at the same time we’ve been investing in opportunities for future growth.

For the quarter, our margins increased 87%, our bottom line improved 55% and our operating cash flow was positive for the first time. We are increasing market penetration in our target market especially in Mexico where we have firmly established a dominant share as well as in Eastern Europe. We are also pursuing growth opportunities in several new regions as we look to diversify our market base and expand our growth. France, where we announced regulatory approval last week, is one example of the initiatives to expand our global footprint.

We’re also progressing its plans with the ProCore platform. For those who may be unfamiliar, ProCore is a new hardware platform which lowers our manufacturing costs while also allowing us to diversify our electronic table game offerings. The first game being released on the new platform is BlackJack which will be showing at the upcoming Global Gaming Exposition in Las Vegas later this month. Our improving financial performance comes down to three basics, financial discipline, cost control and maintaining of target focus in sales and marketing.

We will continue to demonstrate that same financial discipline as our focus shifts from turnaround and cost reduction to increase in market penetration and revenue growth. James Crawford will discuss some of the marketing initiatives that we’re currently working on after which I’ll review the operating results in more detail and we’ll take your questions. James?

James Crawford

Thanks Mark. As we look at our market opportunities for PokerTek, there are three distinct areas of focus. We are being cautiously aggressive in traditional North American markets where gaming is highly saturated. We are being very active in Mexico and Eastern Europe where the environment for electronic table games is favorable. Looking ahead we expect to continue growing in these target markets while also entering new markets and adding new products.

In Mexico, we have established PokerPro as the dominant poker table where we now have over 60 tables installed. Our current penetration represents approximately 25% of the estimated addressable market for PokerPro and we believe that the sizeable market will continue to grow especially since large operators are beginning to market poker and that our share of the market will also continue to expand.

In Europe we have a solid pipeline of opportunities that and opened a, excuse me, opportunities and opened a new 8 table room in Bucharest during the third quarter. We also placed PokerPro at other sites in Eastern Europe and Africa. With approval in France now in hand we are actively working on opportunities in that market with over 200 casinos a large percentage of which are electronic. We believe that the France market will provide significant growth opportunities in 2011.

We are also actively pursuing the South American and Asian markets where we see solid growth potential for both PokerPro and ProCore. The Asian markets in particular are experiencing explosive growth and there are several specific target markets that are ideal for electronic table games.

We look forward to sharing more with you regarding our progress in each of those markets as they develop. Also as Mark mentioned, we’ll be showing ProCore to the industry for the first time at the Global Gaming Exposition in Las Vegas in two weeks. We have previewed the product for select customers and have received positive feedback and a high level of initial interest. With the efficient low cost player-friendly design, we are very excited about the potential for ProCore to be a growth engine for 2011. Mark.

Mark Roberson

Thanks James. I trust that everyone has had the opportunity to review the earnings release this morning containing the detailed financial results. As a reminder, we announced our plans to discontinue the amusement business last quarter. As a result, the amusement results have been reclassified as a discontinued operation in accordance with GAAP. Revenues, margins and operating expenses for all periods now represent the results of our continuing gaming business.

Quarterly revenue increased 9% to $1.5 million compared to $1.3 million in the prior year. For the first nine months, revenue was $4.3 million compared to $4 million. The increase in gaming revenue is primarily due to growth in our target markets, principally Mexico and Europe, partially offset by decreases in North America as we reposition tables to our target markets.

Our PokerPro table count as of September 30 was 235 as compared to 174 at September 2009 and 220 at the end of June this year. The change in table count as with our revenues was directly correlated to the strategic expansion in Mexico and Europe. On a sequential basis, compared to the second quarter of 2010, revenues increased 13%. Similar to the year-on-year comparison, the sequential top line growth was primarily due to increased Mexico and European business. Also as discussed last quarter, the second quarter is seasonally softer for our cruise business and we saw that business improve during the current quarter as expected.

Gross profit increased to over $1 million for the quarter, representing an increase of 87%. The increase in gross profit is a function of the increase in our top line revenue combined with growth in our margin rate to 72% for the quarter. The margin expansion is attributable to improved product performance combined with more effective asset utilization in our target markets and lower depreciation.

Operating expenses were $1.7 million for Q3, unchanged from the third quarter of 2009. For the nine months, operating expenses were $5 million, down 15% from $5.9 million last year. We implemented significant cost reduction initiatives leading up to the third quarter of last year and our operating expenses have remained relatively stable in the $1.6 to $1.7 million range for the past four quarters, even as we’ve invested in expanding our international business and improving our products.

On the combination of revenue growth, margin expansion and lean expense management, our bottom line operating results improved significantly. Net loss from continuing operations for the quarter was $0.7 million or $0.05 per share compared to $1.2 million or $.10 per share last year. For the nine months, the comparison was a $0.16 per share loss versus $0.39 last year, an improvement of 59%.

EBITDAS was negative 49,000 for the quarter compared to a loss of 210,000 a year ago, an improvement of 77%. On a year to date basis, EBITDAS improved 91% from a loss of $1.6 million to $147,000. For the quarter, operating cash flow was positive 175,000 compared to negative 516,000 one year ago.

For the first nine months of 2010, cash used in operations improved to $71,000 compared to a use of cash of $1.9 million in the first nine months of 2009. Cash flow improvements are a direct result of improved operating results and tight working capital management. We also received partial payment in Q3 from the conversion of a lease customer to a hardware sale that favorably impacted our cash from operations.

Excluding this one time payment, our cash flow results continue to improve significantly over the past year, mirroring the trends in our improving P&A results. Overall, the strategic initiatives we’ve put into place over the last 18 months are continuing to drive bottom line results. Our revenue mix is improving, our gross profit margins are expanding, operating expenses continued to be under control.

We have encouraging near term and longer term opportunities to expand our business and we’re confident about the trend heading into year end. That concludes our prepared remarks and we’ll now open the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions) and your first question comes from the line of Mark Smith. Please proceed sir.

Hi guys, this is Shawn Bitzan in for Mark Smith.

Mark Roberson

Hey Sean, how are you this morning?

Shawn Bitzan - Feltl & Company

Great. Can you quantify your expectations on how big the total opportunity is in France?

Mark Roberson

Yes, I mean I can tell you, France – there are over 200 casinos in France and based on the information we have, over half of those are electronic only venues. So at this point we can’t tell you a specific number that that is going to equate to in terms of precise placements of PokerPro. But obviously if you look at a market with 200 properties, a little over 100 of which are fully automated electronic facilities, we certainly believe it’s a very favorable market for PokerPro and for electronic table games in general and yeah, we’ll certainly have more to follow with specifics as we enter the market.

Shawn Bitzan - Feltl & Company

Okay. Next, can you provide some insight on your year-over-year performance dealing with cruise ships?

Mark Roberson

Yeah. The cruise ship business has been a very good stable line of business for us. It’s performed very well. If you look at our cruise ship business, we did experience some seasonality in the second quarter of this year which we’ve experienced in the second quarter of 2009 and basically every year. Coming into Q3, we saw revenues from our cruise business improve during the quarter as expected, again primarily that’s the result of Q2 having some seasonality in it just from repositioning of cruise ships and itineraries and sort of thing. So year-on-year our cruise ship business is very stable, very steady.

Shawn Bitzan - Feltl & Company

And do you think it’s better and stable and steady due to the macro environment or something more fundamental that you guys are doing?

Mark Roberson

I think over the past year all businesses have struggled with consumer spending and those sorts of things and I can’t speak for the cruise industry as a whole but I’m sure it’s been no different there. But I think we’ve done a good job and our partners in the cruise business have done a good job, managing the tables on the ships and running them to effectively promoting them well to keep the revenues where they are and it would have kind of been difficult to count them year overall so we’re pleased with that.

Shawn Bitzan - Feltl & Company

Alright, thank you guys.

Mark Roberson

Thanks Sean.

Operator

And your next question comes from the line of Caroline Hughes. Please proceed.

Caroline Hughes - D&B

Yes, good morning. Thanks for taking my question.

Mark Roberson

Good morning Caroline.

Caroline Hughes- D&B

Good morning. Gentlemen can you talk a little bit more about how you’re developing your opportunities in Asia and what you see happening there?

Mark Roberson

Yeah. As you may or may not know or recall, we took over distribution rights outside of North America earlier this quarter in the first quarter. Prior to Q1 of this year, Aristocrat had control of distribution in Europe and Asia. As we entered international markets this year, we focused initially on Europe as we – well we entered Mexico then we focused initially on Europe and we spent a lot of effort in Europe. We’re just now starting to turn our focus to the Asian markets, there’s not a lot specifically that I could tell you right now with regard to specifics in terms of what we’re doing, it’d be a little premature.

But I definitely look forward to coming back and being able to talk to you more specifically about specific opportunities and installations in Asia in the near term.

Caroline Hughes- D&B

Okay, we’ll listen for that and then just more, you seem to be right on the cusp of turning EBITDAS positive, what are your thoughts about that?

Mark Roberson

Well our first quarter of this year was EBITDA positive. We were negative in Q2 and just modestly negative in Q3 from EBITDA standpoint. So you’re right, I mean we’re basically right on that line where we’re a few thousand positive, a few thousand negative quarter to quarter. We do believe that it was the result of the initiatives we’ve been working on for the past close to two years. We’ve cut the costs; we’ve reduced the operating expenses pretty dramatically. We stabilized the revenue and are starting to grow again, our margins are expanding and we believe that we’ll be able to continue those trends going forward.

Caroline Hughes- D&B

Okay great, thanks very much.

Mark Roberson

Thank you.

Operator

(Operator instructions). Your next question comes from the line of Tom Pierce. Please proceed.

Tom Pierce - Sargent & Lundy

Good morning guys.

Mark Roberson

Morning Tom

Tom Pierce - Sargent & Lundy

Nice looking quarter. Question for you, let’s talk a little bit about BlackJack. That’s a new game for you, I would think that BlackJack is maybe more competitive because there’s been a number of electronic BlackJack tables out there, but tell me, how do you view it as getting into the marketplace? You’ve been – one of the first places with PokerTek’s was cruise lines, how does that look, how do the things in Mexico look trying to put this in? Can you expand upon that a little bit?

Mark Roberson

Yeah, I think that we initially look at that product not because there was a lot of competition but because there was a lot of opportunity and the initial feedback from the places where we have previewed the product has been very, very favorable. Talking about how innovative PokerPro was in the past, we’ve tried to take that and extrapolate it into the BlackJack product that we’re going to unveil at G2E.

Everyone that’s seen it gave us some positive response and we have some huge initial interest in seeing the product. Now proof is into putting obviously but I believe that the fact that BlackJack is just a huge part of the gaming industry’s revenue period gives us an opportunity to leverage the innovative news that PokerTek has come to represent into that industry and so we’ll be able to take a product that we can develop into multiple markets.

Mexico is going to be a huge opportunity for us as that market grows. Europe obviously there’s a huge [resident] to electronic gaming in a lot of different markets throughout Europe and the United States again becomes – I think there’s going to be places where PokerPro possibly doesn’t have any footprint in the United States but that electronic BlackJack will. So it will help us utilize the licenses that we have in markets that we don’t have a big presence in North America.

Again proof is in the putting but we’re really excited about BlackJack as an opportunity.

Tom Pierce - Sargent & Lundy

So I get this, pricing is going to be similar to your PokerTek table?

Mark Roberson

That’s not firmly established because there will be several variations of the table but it will be on the ProCore platform, the low cost initiative that we put forward to get ProCore to where it is now. We’re going to obviously move that to the BlackJack table as well. So our hope is that we’re going to have a very robust, efficient high quality product at a low cost.

Tom Pierce - Sargent & Lundy

Good. Thank you very much.

Mark Roberson

Thanks Tom

Operator

At this time there are no further questions. I’d like to turn the call over to Mark for closing remarks.

Mark Roberson

Thank you. I appreciate everyone joining the call today. Have a good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation; you may now disconnect and have a great day.

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