Iao Kun Group Holding Company's (IKGH) CEO Ken Leong on Q2 2014 Results - Earnings Call Transcript

Aug.28.14 | About: Iao Kun (IKGH)

Iao Kun Group Holding Company Limited (NASDAQ:IKGH)

Q2 2014 Earnings Conference Call

August 28, 2014 9:00 a.m. ET

Executives

Garrett Edson - ICR

Pou Lam - Chairman

Ben Vong - COO

Ken Leong - CEO

Raymond Li - CFO

Edward Chen - Assistant to the Chairman

Jim Preissler – Director

Analysts

Brett Reiss - Janney Montgomery Scott

David Bain - Sterne Agee

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Iao Kun Group Holding Company Limited Second Quarter 2014 Earnings Conference Call. Today's call is being recorded. (Operator Instructions) I would now like to turn the conference over to Panalty Kristel [ph] of ICR. Please go ahead.

Unidentified Participant

Thank you. And welcome everyone to Iao Kun Group Holding Company Limited second quarter 2014 earnings call. Participating on the call today will be our Chairman, Mr. Pou Lam; our COO, Mr. Ben Vong; Mr. Ken Leong, Chief Executive Officer; Mr. Raymond Li, Chief Financial Officer; and Mr. Edward Chen, Assistant to the Chairman; and Mr. James Preissler, Director of Iao Kun Group. Earlier today, the company issued a press release reporting financial results for the three and six months periods ended June 30, 2014, which can be accessed at most financial websites as well as on our own at www.ikghcl.com. For the purposes of this call, all figures presented will be discussed in US dollars.

This conference call may contain, in addition to historical information, forward-looking statements about IKGH within the meaning of the Federal Securities Laws. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements other than those that are historical in nature. These forward-looking statements are based on current management expectations and are subject to risks and uncertainties that may result in expectations not being realized and may cause actual outcomes to differ materially from the expectations reflected in these forward-looking statements. For more information on these matters, we encourage you to review IKGH’s SEC filings.

I would now like to turn the call over to Garrett Edson of ICR.

Garrett Edson

Thank you, [Penalty]. I would like to briefly go through the second quarter 2014 financial results and then I will turn the call over to Mr. Jim Preissler for some further commentary and then open the call for Q&A.

Revenue for the second quarter of 2014 was $49.7 million, a 22% decrease from $63.5 million in the prior-year period. Net revenue as a percentage of Rolling Chip Turnover was 1.06%, down from 1.42% in the prior-year period. Win rate for the second quarter of 2014 was 2.18%, well below the statistical average win rate and compared to 3.06% in the prior year period.

IKGH's primary expenses commissions to agents which was $49.4 million in the second quarter of 2014, up 4% from $47.7 million in the second quarter of 2013. Commissions to agents as a percentage of Rolling Chip Turnover was 1.06% in the second quarter of 2014, down from 1.07% in the second quarter of 2013.

Selling, general and administrative expense as a percentage of Rolling Chip Turnover was 0.16% in the second quarter of 2014, up from 0.14% in the prior year quarter. Non-GAAP operating loss before amortization and change in fair value for contingent consideration for the second quarter 2014 was $7.5 million or $0.12 per share compared to non-GAAP operating income of $9.1 million or $0.20 per diluted share in the same period of 2013 due primarily to lower revenue increased commissions.

Non-GAAP loss before amortization, change in fair value for contingent consideration margin as a percentage of total revenue in the second quarter 2014 was negative 50.1%, down from non-GAAP income margin of 14.4% in the second quarter of 2013.

Net loss for the second quarter 2014, including all items, was $56.7 million compared to net loss of $3 million in the second quarter 2013, primarily due to lower revenue and a $45.1 million increase to the contingent consideration liability for Bao Li Gaming and Oriental VIP Room due primarily to an increase in the forecasted Rolling Chip Turnover performance based on past performance.

GAAP basic and fully diluted loss per share for the second quarter 2014 was $0.94 based on both a basic and fully diluted weighted average share count approximately 60.3 million. The basic and fully diluted weighted average share counts were calculated in accordance with generally accepted accounting principles.

Turning to balance sheet and cash flow statement. Cash on hand as of June 30, 2014, was $9 million. Cash provided by operations for the six months ended June 30, 2014 was $31.1 million. As of June 30, 2014, total available cage capital was approximately $223.4 million. The total available cage capital is comprised of markers receivable of $214.4 million and cash, cash chips and non-negotiable chips of $9 million.

I would now like to turn the call over to Jim Preissler, Director of Iao Kun Group for his closing thoughts.

Jim Preissler

Thank you, Garrett. For the first seven months of 2014, IKGH's Rolling Chip Turnover averaged 1.58 billion per month, giving us a Rolling Chip Turnover in Macau of 11.03 billion at July 31, an increase of 10% year-over-year. We are maintaining our 2014 Rolling Chip Turnover guidance for our five existing VIP rooms in Macau of 17 billion to 19 billion.

Last month, the Hong Kong Exchange completed its review of our application for listing and the application was accepted for detailed vetting.

Earlier today, we announced a change with regard to our six month dividend. Beginning with the six month dividend payable for this year, the Board of Directors has changed the six month dividend from $0.08 per share to 15% of IKGH's non-GAAP net income for the most recently completed six months ended June 30, divided by the number of ordinary shares outstanding on the record date for such dividend. For the six month dividend payable for 2014, this is expected to equate to a dividend of approximately $0.026 per share, a reduction from the prior year. Importantly we continue to maintain our overall annual dividend payment policy. To reiterate, 15% of IKGH’s non-GAAP net income for the most recently completed fiscal year, less the amount paid pursuant for the six month dividend, divided by the number of ordinary shares outstanding on the record date of such dividend.

Our performance in the second quarter of 2014 was clearly affected by the low win rate. However we remain committed to expanding our business presence in the Macau VIP gaming market and increasing our market share while prudently managing our capital to create long-term value for our shareholders.

This completes our prepared remarks. I’d like to turn it over to the operator to begin the Q&A section.

Question-and-Answer Session

Operator

(Operator Instructions) And we will go to our first question from David Bain with Sterne Agee.

And we will go to our next question from Brett Reiss with Janney Montgomery Scott.

Brett Reiss - Janney Montgomery Scott

What’s the ballpark timeline on the approval of the listing on the Hong Kong Exchange?

Jim Preissler

I think we are roughly in the range where we were before, which is at October – November timeframe. So I think we are still at pace for that. So I can turn over to Edward for a more detailed answer but nothing has really changed on the expected timeframe there.

Edward Chen

The status right now is we are answering questions but as the Hong Kong Stock Exchange put forward to us and I think from what the funds of orders [ph] and to ramp up questions, so we anticipate, I would say like if everything goes smoothly listing shall happen some time in the last quarter of this year.

Brett Reiss - Janney Montgomery Scott

Right, right. Now you mentioned that you want to try to expand your business but when you read descriptions of the business in Macau, it seems the casino owners, there is higher margins for them to have more business migrate to the non-VIP business model. So with that kind of backdrop, can you give me a sense of how in that environment you expand your business?

Jim Preissler

Right, I mean of course the – you would desire all your customers to be multi-million dollar customers but that’s not exactly the players’ desire. So the casino’s desire of course is for us to migrate their most highest margin segment but that’s not necessarily their ability to affect the market in that way. More it’s at odds. So our ability is to identify good agents who have good customers, that ideally we can add a high tier that we can extend credit tier and so on. So it’s ultimately the customers are driving that, it’s not us, it’s not casinos, it’s not anybody’s desires, it’s ultimately where the customers want to play. So because of that, what we are seeing is still very healthy cash VIP business and in our case, standard VIP business is coming back as well, and so I don’t really think there is much of an impact on us there. So our ability to grow is really the improvement over the start of this year. So since we kind of stopped to pull back on the credit front, and we stabilized our business and avoided the big bad debt risk, we have been able to grow our business at a faster pace since the start of the year and it’s clearly demonstrated when you are seeing in the Macau numbers. So I think we can continue that pace going forward.

I think also what’s going to happen is that there is a strong desire for lot of these players to achieve kind of the highest tier of play, that they are able to – enable them kind of the highest level of comps, get credit lines and all that type of stuff. So the desire inherently for the player is to move up the food chain as far as they can knock down the food chain.

Brett Reiss - Janney Montgomery Scott

Right, right. Could you just give us the numbers on what the share count is, did you buy back stock in the second quarter and what the current share buyback authorization is?

Jim Preissler

Sure. Raymond, do you want to quickly give us those numbers?

Edward Chen

The buyback trend for the 2013 is still effective but we didn’t buy back any shares in the second quarter. We think it will be beneficial to keep our working capital – we didn’t buyback in the second quarter because it seems our business are improving and are above the market of the VIPs. So I mean we will measure depends on the returns, that will be beneficial to all the shareholders. So for shares count, we have roughly 59 million shares count, after we issued the shares to the – one of the sellers for the VIP Room for last year. So roughly the share count now is 59 million.

Operator

And we will go to a question from David Bain with Sterne Agee.

David Bain - Sterne Agee

Guys, sorry I dropped off there, so I got the ending of I think Edward’s response on the Hong Kong Exchange but just to follow up on that. I think Edward, you mentioned that there has been a regular communication or comments to date on the application. Is that something that, that you deem as normal, nothing really spec out in terms of questions due to industry or company specific dynamics at this point?

Edward Chen

I guess it’s the application to SEC and the Hong Kong Stock Exchange, I mean like they do answer – they do ask the questions but they are not too familiar with. So we are preparing what the answers, responses of preparing, I was like, all the details to keep them, I was like, happy with what they asked, and like I said, once I talk to the sponsor, and they expect maybe two rounds of questions. So we are hoping, if everything goes on smoothly we can have the listing approval maybe in the last quarter of this year.

David Bain - Sterne Agee

I know you guys have had a kind of string of bad luck at the tables. But the rolling volume – Jim, as you mentioned that, kind of consistently outperforming the Macau market, especially the VIP market in a big way. Can you give us a bit of color as to the dynamics of players outside of -- maybe the acquisition of cash agents, what are the other drivers helping to outperform at this stage? I know you are adding a little bit more credit, and maybe some of the issues that some of the other operators may be going through or what’s helping if you could share at this point?

Jim Preissler

Yeah, it looks like over the course of the last year plus where we pulled out – pulled back on credit little bit earlier to preserve capital and for checks against bad debt. Potentially the rest of the market did not do sell. So it looks like the DSOs in the market line on the VIP side may have come up quite a bit. So competitively it gives us a better situation which to operate in, in that. We could still maintain our level of business. We can still gladly recruit agents, we could support big agents. So it’s allowing us to go after all the same market, the cash and the credit. So I think that’s kind of the biggest driver of why we could perform – outperform the market right now and we are looking to continue to do that. We are going after the both the cash and credit agents. And the other thing that’s happening is obviously for the smaller VIP rooms, they may not be able to have the wherewithal to support their bigger agents, because they have smaller capital bases, the ability to raise capital is lower. So if you go after try not to recruit some of the better agents of the small rooms at the same time.

David Bain - Sterne Agee

Two more if I could. Just looking at the current state of the VIP business, [indiscernible] some of which it sounds like impacted you less so than others, and maybe are helping you to actually gain shares, you mentioned like receivables versus peers. But in terms of the macro and political environment, in terms of your corruption what have you, corruption crackdowns or whatever, how do you handicap the current state of your operating environment, I mean is it stable, are you optimistic, are you pessimistic versus kind of previous stages?

Jim Preissler

But as far as inflection point to the market, it still seems like the market as a whole is kind of dragging along at the bottom here. So we don’t really see any major inflection points both positive or negative right now for the overall market for us. Obviously that gives us an environment where we can use our improved balance sheet and management to continue to grow at a faster cliff in the market. But obviously you can never quantify the political risks but it appears right now there is nothing major that is going to move the market one direction or another.

David Bain - Sterne Agee

Just one clean-up question for me, Raymond, can you help provide commissions as a percentage of roll, if you normalize the theoretical whole for the quarter and taking out those new pricing incentive?

Raymond Li

Yes, as a whole for the company, pricing for now – I mean it seems only that’s better is the volume of direct business and also for the – I mean sharing of the super agents, so coming downward, I mean for the clearance percentage should be an indication of the coming quarter or maybe the second half of the year. So it will depends on the amount of cash business and also the sharing of the super agents.

Operator

(Operator Instructions) Go to our next question from Peter Cyrus with Oneway [ph].

Unidentified Analyst

Peter Cyrus. Hi everybody. I understand that the win rate varies based on luck. Is there any way to calculate what it would have looked like on a normal win rate?

Jim Preissler

Yeah, so if we use kind of a normal 3% or so win rate, we probably would have generated about $9 million or $10 million for the quarter. If I had to guess roughly, was that sound right, Raymond?

Raymond Li

Yeah, yeah, exactly, it’s based on the normal win rate, we should generate of roughly around $8 million non-GAAP income for the quarter, yes.

Unidentified Analyst

Okay, that’s very helpful. So I mean because odds you are going to have, you are going to get lucky, or sometimes you are going to get unlucky, this quarter was unlucky. Also can you explain to me the contingent consideration of $45.1 million related to King's Gaming, Bao Li and Oriental VIP Room acquisitions, that was a big number. I just want to make sure I fully understand that.

Raymond Li

Yeah, yeah, so for the contingent consideration, I mean at the time of our acquisition, we need to make a forecast on the rolling chip performance of the VIP Room, Bao Li and also the Oriental. Because based on our past experience with King’s and also we take into consider with other investors [ph] so we, at the very beginning, we prudently projected – in the first years the performance of the Bao Li and Oriental, margin below the 2.5 billion threshold that means the seller entitled to earn our payment. But after the acquisition their performance are above our expectations. So for this year after we gather the information for the first year, so we revised projections, so we project that they will get the earn-out in the final year. So that’s why for the sales amount are because of the revision in the projections. So they are entitled to the earn out for the final year. So that amount will hit the here now on the income statements according to the accounting standard. So that clearly non-cash items, and that might adjust in the future, it depends on the performance – the actual performance of the two seller.

Unidentified Analyst

Is that – just so I understand, is this based on the earnings from these businesses or from the rolling chip turnover in the businesses?

Raymond Li

Yeah, I mean for the two VIP rooms are based on the rolling chip performance. So it depends on how rolling –

Unidentified Analyst

Yeah, good rolling chip performance but a low win rate it works against you, if you had good rolling and high win rate, it works for you.

Jim Preissler

Correct.

Unidentified Analyst

One way of question – which is if you look at the business now, and you have a normal rolling chip, let’s say you had – because it used to be easy to understand, it was on a rep share basis, now it’s on a win loss basis. So based on the way the business is currently structured, if you had a year like – if you had normal rolling – normal win rate for a calendar year, what kind of earnings would we see out of the company? I am not asking for projection and obviously you don’t – you’re never going to have normal win rate but I am curious what – I am trying to understand the earnings – the average earnings power of the company assuming a normal win rate?

Jim Preissler

Yeah, I mean that’s how we base our guidance for the year, it’s based on a normal win rate. So I can’t give you the calculation right now off the top of my head. I just can’t do it, but if you want a look to see how it would – went through the expectations, our guidance is based off a normal win rate, because again it’s out of everybody’s control, it’s out of our control, the casino’s control, the players’ control. All we can do is try to manage the volumes and risk on the credit side. So as far as the ultimate win rate the best we can do is use an expectation in that normalized range. And that’s how we base our guidance – if you look at the start of the year in our guidance.

Unidentified Analyst

So yeah, I did follow that, Jim but what I am asking you is – given the change in commission and everything, I see the rolling chip guidance for the year, but I see rolling chip guidance, what do I see in earnings guidance?

Raymond Li

Okay. Based on our present commission payout, I think if we have a normalized win rate of 50%, our earnings should be in the $13 million level or more.

Unidentified Analyst

And that’s for this year?

Raymond Li

For this year, yes.

Unidentified Analyst

Okay, what I am asking is – let’s go back to January 1, and assume that the win rate had been the same, so then I go back and add those other numbers, that you gave me before, right?

Raymond Li

Yes, I think it’s about $13 million. In the first quarter we made about $16 million, $17 million because of a high win rate. In the second quarter, if we have a normalized win rate of 3%, we could have made around $8 million, $9 million. So like we add up together that’s over $20 million. So that – again like I said the first quarter have a higher win rate.

Operator

And we will go to our next question from Matthew Campbell with Loretta Capital [ph].

Unidentified Analyst

Just if we step back and we look at the overall health of the VIP market, do you say that things are getting worse, better or staying the same?

Jim Preissler

The VIP market seems to be stable in a range of around maybe down 5% or 7% to up low single digits. So I think that kind of the range it’s in right now. So it doesn’t seem to be anything affecting it significantly both positively or negatively and the reason being is that there was a lot of growth on the cash side of the VIP the last couple of years. And at the same time there was also – we have seen for a lot of the market a large extension of their DSOs. So market wise DSOs have come up significantly over the last 12 to 18 months. So it makes a little more challenging to grow in that type of environment because not only did we have to continue to fund the growth going forward, they kind of have to figure out a way to take themselves out of the hole that’s been made over the last 12 plus months. So I think what we see here is – we don’t see any major risk of significant downturn, it looks like the market has absorbed – we saw one very very big bad debt that got us – supposedly has gone into over $1 billion. So we have seen kind of the market’s ability to absorb the bad debt – bad debt risk. So unless something significant higher happens, I don’t think we will see a major change in the overall VIP market on those ranges of activity.

Unidentified Analyst

So from a competitive standpoint, you have been able to grow your own, so you’re clearly taking share from some of those guys who were blacks with their credit, is it fair to assume?

Jim Preissler

Yeah, and I think that is the environment we have been trying to set ourselves up into because it’s very easy to dig yourself a hole that you can’t get out of. So I don’t know if that may happen to some of the other players in the market, but what we try to do is prevent that bad outcome for us. So in the market did appear to stabilize, we continue as well, and take advantage of it.

Operator

And we will go to our next question from Douglas Hoyt, a private investor.

Unidentified Analyst

Good morning. Clearly you guys have done a very good job with the cash agent initiative, and it’s very encouraging to hear that you feel comfortable with positioning a little bit more credit. But I am wondering if you can articulate a strategy going forward, given the substantial expansion in the number of VIP rooms coming over the next couple years. I am wondering if you have a real plan to maintain or expand your market share.

Jim Preissler

So I mean our market share is not based necessarily on just the number of rooms and the number of tables, it’s based on the overall volumes. So in a market where there is a potential expansion opportunity it creates dislocation and it will give us lots of opportunities to look at – okay, do we want to be in one of the new rooms that are opening up, do we want to go over to potentially upgrade one of our existing rooms to a room that’s been vacated at another casino. And to give you historical example of that, I think many of you remember that when the new Galaxy opened, we made a decision for a number of reasons both the location, the quality of the room, as well as the opportunity offered by the casino, the move from the MGM to the new Galaxy, which worked out tremendously well for us. So I think that’s what we are looking at when these new things happen, our market is that – where are the opportunities lie, that we open up a new room down town, is it open up a new room that we have been interested in getting into, can we expect migrate an existing room to a better location. So I think those are all the things we are going to really evaluate, it’s not just the single choice here. I think there are lot of opportunities for us to overall improve the business.

Unidentified Analyst

That’s obviously good to hear that you feel there are definitely some opportunities coming up and that sort of leads me into my next question – which is there is an awful lot of discussions recently over regional expansions, new countries opening casinos and legalizing gaming. I am wondering given the relatively small scale that you guys currently have, if you feel like there may be some sort of future opportunity to open a new room outside of Macau?

Jim Preissler

I think we are critically evaluating these opportunities outside of Macau. And this necessarily has to be – we are opening a full time room, it could be that, we are bringing our clients to those – an existing casino room there. So that - necessarily has a name on the door, but it’s more of a one-off trip type of room. So I think it’s definitely one of those opportunities because there are some very nice large casinos we are opening up region in there.

Unidentified Analyst

And the last one from me, last year at the shareholder meeting you guys authorized a higher counts for share issuance. And I noticed that on the Hong Kong listing application, I think one of the slides that you had made was an exemption for the restrictions at least immediately for share issuance. So I am wondering if you are looking at the possibility of issuing here in Hong Kong to fund expansion down the road?

Jim Preissler

Well of course, I mean one of the obvious reasons why we are moving to listing in Hong Kong, is to get more liquidity and hopefully have it translated to more buyers in the higher stock price. So you really get one shot at doing all these documents and you spend a significant amount of money doing it, so you have to kind of throw in every possible future outcome you can think of at the time you are doing it. So yeah, I mean if all of a sudden the stock tripled, it goes up 5x or something, we’d be stupid not to want to take advantage of such an opportunity. So I think when we are writing those documents, we have to look at all the potential future outcomes of how we are going to use the document. And I think that’s the kind of the reality of what goes into drafting these things. And you don’t want to have to spend several million dollars down the road to revise documents that – because you missed something earlier on when you first did the draft. So I think that’s what goes into writing the documents but as far as the opportunity, I think the best outcome for everybody here involved would be that the stock would go up significantly, we could potentially raise some more money down the road at significant higher prices, and use that to continue to expand and grow business. I think that would be in everybody’s best interest.

Operator

And we will go to our next question from David Bain with Sterne Agee.

David Bain - Sterne Agee

Hey guys, just two quick follow ups, one on August, any kind of trends to date, I think the market is looking at sort of mid single digit losses and VIP I am sure is in the double digits, and trying to get a sense as to maybe how you specifically are trending. And then – you put it up here, really quickly, listing cost for the Hong Kong Exchange process, and then maybe your outlook for 3Q and 4Q before we go into more normalized SG&A for next year?

Jim Preissler

Yeah, Edward, do you want to update us on the through for August for us versus the market –

Edward Chen

I guess we should be staying at like what our guidance is, maybe around $1.5 billion, $1.6 billion, on that level. So for us I think it would be a year-over-year gain for August.

David Bain - Sterne Agee

And then just the Hong Kong expenses for 2Q and what you may anticipate for 3Q, 4Q, I am just trying to get an idea of normalized SG&A as we look out for next year?

Edward Chen

What do you mean by Hong Kong expenses?

David Bain - Sterne Agee

I am sorry, for the listing process.

Raymond Li

I think for the listing expenses, we pay around 50% -- should be, roughly --

Edward Chen

$2 million.

Raymond Li

A little bit less than that. Between $1.5 million to $2 million should be a good guess yeah.

David Bain - Sterne Agee

I am sorry – on a quarterly basis?

Raymond Li

I mean for the whole amount, the final design of the whole process, I mean that roughly around $1.5 million to $2 million –

Operator

And we will go next to our next question from Brett Reiss with Janney Montgomery Scott.

Brett Reiss - Janney Montgomery Scott

One quick one, what corporate tax rate should I use for 2014 and ’15?

Raymond Li

We need not to pay any corporate tax in Macau and Hong Kong.

Brett Reiss - Janney Montgomery Scott

So the earnings that you mentioned in response to first quarter 16 million to 17 million and an 8 million to 9 million because the win rate was low and then 13 million for the balance of the year. You don’t have to pay any taxes on that?

Raymond Li

Yes, the tax is exempted [ph].

Jim Preissler

Our business is post Macau gaming tax, so the tax has already been taken off the top before we report any of our numbers. So the tax has already been paid.

Operator

And we go to a question from Douglas Hoyt, a private investor.

Unidentified Analyst

Yeah, I have noticed there has been some speculation that there may be a slight shift in the VIP market, premium mass player shifting to VIP, I am wondering if you are seeing that happening?

Jim Preissler

Yeah, thanks Doug, I mean one of the things I alluded to earlier is that one of the things that nobody controls whether it’s us or the casino is the players’ desire, and it appears that the players’ desire is to try to achieve the highest level as they can to take advantage of the most perks and services. So what’s happening is there is a lot of premium mass players who their desire is to be in the VIP rooms, right, their desire is to have a credit line, their desire to play large, their desire is to get all the perks and have an agent who is taking of their trip. So as the players grow and they can achieve higher levels, I think that’s what we are seeing in the market is that the ones that can qualify for VIP have a desire to do so.

Unidentified Analyst

Okay, great. Thank you.

Jim Preissler

Thanks guys. I think that concludes the last question in the queue. I think that concludes our conference call for today. Thank you for your ongoing interest in IKGH. We are out of time. So if we didn’t answer your questions, feel free to call us.

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Iao Kun (NASDAQ:IKGH): Q2 EPS of -$0.12 misses by $0.13. Revenue of $49.7M (-21.8% Y/Y) misses by $10.9M.