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Executives

Tracy Egan – Vice President, Marketing

Mark Roberson – Chief Executive Officer, Chief Financial Officer and Treasurer

James Crawford – President

PokerTek, Inc. (PTEK) Q2 2011 Earnings Call August 9, 2011 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the Second Quarter 2011 PokerTek Incorporated, Earnings Conference Call. My name is Ann, and I will be your coordinator today. As a reminder this conference is being for replay purposes. At this time, all participants are in listen-only mode. (Operator instructions) We will be facilitating a question-and-answer session following the presentation.

I would now like to turn the presentation over to Tracy Egan, Vice President of Marketing. Please proceed.

Tracy Egan

Thank you and good morning. Welcome to PokerTek's investor conference call for the second quarter ended June 30, 2011. The purpose of today's call is to provide our investors and other interested parties with information about the Company’s operating results and to communicate other business developments.

Joining us today are Mark Roberson, Chief Executive Officer and Chief Financial Officer, and James Crawford, President. Today’s conference call is being simultaneously webcast and will be also be archived for replay purposes.

Before we get started, I would like to remind you that certain comments about future expectations, plans and prospects for the Company constitute forward-looking statements for purposes of the Safe Harbor provision and the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from these expectations and we undertake no obligation to update those expectations.

We will also be discussing certain financial measures such as earnings before interest, taxes, depreciation, amortization and share-based compensation which represent a non-GAAP financial measure. A reconciliation to the most recently comparable GAAP measures can be found in today’s press release.

Now, I’ll turn the call over to Mark.

Mark Roberson

Thanks, Tracy. Welcome everyone to our second quarter conference call. I hope we’re going to set an opportunity to review the information that was released this morning. The company had a strong quarter and achieved several notable milestones. Financially, this is the third quarter in a row with EBITDA positive operating results. We were positive 133,000 this quarter. One year ago, we were at negative 222,000 and two years ago, we were at negative 900,000. For Q2 all financial measures strengthen with revenues up and margins exceeding 70%.

There is a clear pattern when you step back and view the results over two year period rebuilding you’re recurring revenue business with higher margins and lower operating expenses and those actions are continuing to drive tangible financial results.

From a product standpoint we saw our investments in the ProCore platform began to bear fruit. We installed our first Blackjack games on the new platform earlier this year and based on the performance and feedback from those initial installs, we rolled out the remaining inventory during June.

Those tables which are in play both on cruise ships and in land based casinos are performing well and generating a very positive player response. I emphasis this point because it validates our plan to expand our game offerings and become a more diversified player in the electronic table games business.

PokerPro has a dominant position in the industry and is generating solid financial performance. The ProCore platform allows us to build on our core Poker business expanding the attainable share of our customer’s floor and our ability to drive increased market penetration in growth.

From a balance sheet perspective, our cash position increased to $1.2 million at the end of the quarter and our officers and directors participated in a private placement transaction in May that strengthened the company’s balance sheet and provide additional capital just forth the ProCore rollout.

Overall, a good quarter and we’re continuing to execute on the strategic objectives communicated earlier this year. James will provide a brief update on the state of the Poker business and the performance of our Blackjack tables.

James Crawford

Thanks Mark. As Mark said, one of our primary areas of focus has been to carefully manage our current customer base and to maximize our revenues, while beginning to establish and expand our Blackjack business. With regards to PokerPro, we’ve been busy with our existing customers. Cruise ship installs increased bringing the total number of PokerPro tables installed on ships to 62, which is the highest number in our company history.

We extended and signed a new multi year contract with one of our best customers in Europe and we expect to have additional rooms opened with this customer before the end of the year. We also reentered the Bulgarian market with the new customer installing four tables at the end of the quarter.

In Tanzania, after the success of their initial two table install, our customer added two additional tables to accommodate their expanding Poker business. We’ve upgraded many of our customers with PokerPro’s newest new Tournaments Plus software version 3.0 one of these site with Harrah's Cherokee Casino here in North Carolina where we temporarily install ten additional PokerPro tables for a total of 20. And this allows Harrah's Cherokee to host the states first world series of Poker tournament in May. It was a great week of Poker action with over 1000 players competing in 14 tournaments and a variety of cash games over the span of 10 day.

Culminating with the final tournament where 269 players competed for a WSOP main event. With regards to our distributor relationship TCS’s John Huxley have start up strong with inflations in Africa being planned for the third quarter. Matsui our Asian distributor is also planning their first installations before the end of the year.

As far as new opportunities go, we are also working hard in south America and expect to see installation there before the end of the year.

We will be presenting both PokerPro and Blackjack Pro at the (inaudible) in November. Blackjack Pro is already a welcome addition to our diversification strategy. In the second quarter for the first time in our history, the growth in poker was exceeded by Blackjack Pro. We added 60 new Blackjack Pro player positions while PokePro had a net of 40 position base.

Expanding from two ships in Q1 to five in Q2, our Blackjack footprint on cruise ships, continue to perform and exceed expectations. Our Balckjack Pro table was introduced into Mexico and we continue to see strong interest and good results by operators there.

Blackjack Pro is currently being evaluated for approval by the French Police, interestingly the only automated table game approved in France currently is our account base PokerPro system.

As you can see, we’ve been executing our strategy of maintaining and increasing our current revenue base while continues to expand our poker business with new customers. Blackjack Pro further builds on our existing customer base while giving its opportunities and meeting new markets. Mark?

Mark Roberson

Okay. Thanks, James. Let’s dive into the numbers, which were favorable and practically every category compared to prior year. Total revenue for the second quarter increased 23% and came in at $1.6 million for the quarter. The revenue growth came primarily from the increase in our installed base as we continue to expand our market penetration in Europe, Africa and Mexico and as we continue to relocate tables to increase performance.

Gaming positions increased 24% to 2,710 from 2,184 last year. The net growth in gaming positions primarily came from new installations in Europe, Africa and Mexico and of course, from the introduction of Blackjack.

In Mexico, where we’ve established a dominant position over the past two years, we recently shifted our focus from growing market penetration, the increasing performance in revenue from the poker tables currently in the market while also beginning to establish our new Blackjack business.

The European markets as well as Africa were recently partnered with TCS John Huxley, continue to drive growth and we expect to increase our penetration in those markets with both poker and with Blackjack.

In the cruise segment we continue to selectively add poker and see larger growth opportunities at Blackjack. Gross profit increased 46% to $1.1 million, margin strengthened to 71% compared to 60% for the prior year period.

To provide some additional perspective, two years ago, our margins were under 40% and we’ve seen the marketable margin gains at the time as we focused on improving performance and reducing product costs.

Operating expenses decreased 8% to $1.5 million; everyone at PokerTek has embraced the culture of watching and controlling our expenses, following restructuring and cost reduction initiatives in 2009 and prior which significantly reduce our overhead. We maintained our operating expenses at a very stable and predictable level even as we’ve been increasing our penetration internationally and investing the development of poker and Blackjack.

As we grow, I’d certainly expect that cost cut is approached to continue. Net loss from continuing operations improved 55% to $0.06 from $0.15 per share last year. As you may recall, we incurred charges in the second quarter of 2010 related to the discontinuance of our amusement business. Including the results of those discontinued operations, our amusement business, including the results of those discontinued operations our quarterly net loss improved 80% to $0.06 per share from a loss of $0.35 last year.

EBITDA from continuing operations improved to a profit of $133,000 for the second quarter compared to a loss of $233,000 in the year ago period. For the first half, EBITDA improved from a loss of $121,000 to a profit of $254,000. Again, this is our third consecutive quarter where EBITDA has been in the black. The numbers represent another quarter of solid financial performance.

Stepping back from the numbers, there are several takeaways that I will focus on, early success of Blackjack on ProCore bodes well for our strategy of moving from poker only to drive an increased growth as an electronic table games company. A number of current customers specifically requested Blackjack, an additional product, and we believe we’ll increase our share of the casino floor with our – with our customers.

It’s also clear that house-banked etables open up new markets and opportunities with customers that we have not previously engaged with. Overall, our numbers continue to strengthen, our poker business is producing solid results and PreoCore will provide a new catalyst for growth as we diversify and expand our electronic table games business.

That concludes our prepared remarks for the quarter. And we’ll now take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Tom Pierce with (inaudible). Please proceed.

Unidentified Analyst

Hi guys, nice profit.

Unidentified Company Representative

Hi, Tom.

Unidentified Company Representative

Hi, Tom.

Unidentified Analyst

A question for you. Now it seems to me that come from your Brazil are changing some of their laws kind of like Mexico did and (Inaudible) am I recalling right.

Unidentified Company Representative

That is true there has been quite a bit of prep about Brazil and their legislature every time since had indicated that gaming is going to be on the agenda. We have not yet seen gaming come on the agenda in Brazil. So it’s certainly something we’re watching, we don’t see any indication that gaming is going to be legalized in Brazil during 2011 but it’s certainly something that we are watching very closely as we look out into 2012.

Unidentified Analyst

Very good. One other question. Canada any progress – there?

Unidentified Company Representative

We are in the regulatory throws of the process. We’ve been in it for a while and we believe that we are closer than we’ve ever been before and we hope that very shortly we will be able to announce that we’ve at least entered into to silt route there. Again we have been working on that project for over a year and half now and it has just been a very long process but the good news is that that is a great opportunity for us, we will come out of it, we will come out of the regulatory process here and again we can’t predict just like we can’t predict in any jurisdiction. But we think we are close as we have ever been and if we take.

Unidentified Company Representative

Certainly on the one yard line although we can’t predict how long is takes to get across the one yard line.

Unidentified Company Representative

If we took other companies estimates and our actual get them through, we are nearing the end of that cycle. So as soon as the FEs are completed and approved we will be installing.

Unidentified Analyst

Very good. Well thank you.

Unidentified Company Representative

(Inaudible)

Unidentified Analyst

Thank you.

Operator

And our next question comes from the line of (Inaudible). Please proceed.

Unidentified Analyst

Good morning.

Unidentified Company Representative

Good morning.

Unidentified Company Representative

Good morning Jeffrey.

Unidentified Analyst

Couple of questions and again I’m still kind of new to some of the seasonality of your business I noticed obviously you talked about the revenue being up year- over-year. I see the revenue was down sequentially and also the deferred revenue was down in this quarter. And I was just trying to understand what’s behind that?

Unidentified Company Representative

Yes we do have some seasonality in our business that we have talked about in the past the second quarter from a participation revenue standpoint was normally the weakest quarter of our year and when we look at Q2 of this year compared to Q1 of this year we did have a dip with Q1 being the strongest quarter particularly for our cruise business in the cruise industry and the casinos on the cruise ships are far busier in the third and I am sorry the fourth and first quarter of the years and the second quarter is usually the slowest. And there is couple of reasons for that one is ships are repositioning during the second quarter you have ships moving from Caribbean and repositioning for Alaska and other cruises those types of definition cruises generally drive lower casino play than Caribbean hot weather cruises and there are other demographic regions as well.

So we do every year see a drop off in that business from Q1 to Q2 and then we start seeing it come back when we get into August and September. But you know when you look at this year compared to last year we certainly saw much less of a seasonal drop off Q1 to Q2 than we have in the past.

Unidentified Analyst

Okay. And James I just want to make sure I was correct you had said you added 60 Blackjack tables this quarter and 40 net Poker.

James Crawford

Yeah I said 60 player positions, so a table has six positions…

Unidentified Analyst

I see so it was six tables and then how many….

James Crawford

It was actually it was 10 tables with six positions each.

Unidentified Analyst

I see okay. So 10 tables and then it was net 40 Poker tables.

James Crawford

Net 40 player positions and that was a combination of some tables that we are repositioning in Mexico and some other jurisdictions where we actually – we don’t if the tables are not in play or even if they are reinstalled in a customers hand and they moving from one casino to another if they are not lob we don’t count them in table count. So you will see some movement there and what so basically what I’ve said was that we actually had I came I don’t know – I don’t have the number right in front of me. We actually had….

Unidentified Company Representative

We installed Jeffrey about 15, 16 PokerPro tables during the quarter but we also had some underperforming tables particularly continuing 1G, 2G installations in places like Iowa where they just weren’t performing and they have been for few years and we pull those tables back. So when you look at net of four we actually had in the range of 12 or 13 tables that we pulled back in from underperforming installations that were redeployed see end up with the net of four when you look at the total line.

Unidentified Analyst

Okay. I guess I am just trying to understand as you look out into the back half of the year now given the demand for the Blackjack tables are you guys giving any kind of guidance as to the demand and how much you’re going to be able to supply to be able to meet that because as I understand I think at this point your demand for Blackjack is exceeding your ability to produce the tables is that correct?

Mark Roberson

Yeah, that’s correct. I mean we’re looking at ways to expedite our supply chain a little bit, but we are as of this particular moment in time, we are absolutely out of BlackJack tables, which is a problem that as a company we’ve never experienced before, and we’re actually very happy as pervasive as it may seem to be in that position to be out of inventory and to have situation a little – our operations are scrambling to meet demand. As we look at the back half of the year, operationally, we can deploy, we have 16 tables installed as of the end of the quarter. Without having to jump through too many hoops, we can certainly more than double that for the back half of the year. We may look at other opportunities to pull more tables than from a manufacturing standpoint as well to have them available for yet to the end of the year.

Unidentified Analyst

I wanted to, I guess just also make sure I understand the actual sale and the arrangement you get for giving a participation; how that compares to the poker sales and the participation in those?

Mark Roberson

Well, BlackJack versus poker?

Unidentified Analyst

Right.

Mark Roberson

On BlackJack, everything that we’re putting out at this point is, we are not selling the table, although we will end up having some transactions in the future where we do sell BlackJack tables. At this point, the customers that we’re targeting, we are doing revenue share of 60 participations with. So when you look at what we’ve done so far is all recurring revenue monthly lease business. And when you look at poker, the majority of our poker business is also recurring revenue monthly lease business as well, greater than 80%.

James Crawford

This is James. They are ultimately I think, if you look out a year I would say that, I mean our goal would be to have a bully a really strong blend of both tables that are sold with some recurring more of a service and support the that covers our overhead and then our recurring you know then our strictly recurring revenue share of business. So where it makes sense for us to do revenue shares where the numbers make sense that look good and to give return on our investments, then we’ll do this revenue shares. But I think, as time progresses, you’ll see like even the tables that we’re pulling back, and where we had this, even though we only had a net of four those of the table that we pull back will give us an opportunity do go in as we exhaust the inventory that we have to place those tables in a stronger demand opportunity with a higher recurring revenue opportunity to share in.

Unidentified Analyst

Where do you expect gross margins for the overall company to head in the back half of the year?

Mark Roberson

Jeff, what I’m giving precise guidance, I think we said before that we’re expecting margins to be sustainable in the high-60s to mid-70s range.

Unidentified Analyst

Okay. And I just have one final question and then I’ll turn it back to I guess next one in queue. The distributor relationships that you have in Asia and Africa, how are those sales are ranged in terms of hardware sale and the participation there?

Mark Roberson

Yeah. We have different models in different markets, it’s not a standard model that we would say applies, and you know probably I’d to step back to you know what is PokerTek’s approach to partnering with distributors. We’re not out partnering with distributors all over the place. We really pick specific geographic areas and try to pick partners in those geographic areas where we have a good match, and based on the opportunities and customers in the region, and the distributor you know we basically balance the revenue structure to the customer and to the distributor to match the opportunity in the market.

So in some cases, we will sell through a distributor and sell them the hardware with an upfront payment for the hardware and a recurring fee. In other cases, distributors act more like sales agents where they’ll get a cutoff to topper distribution fee at the top, but it’s more of a recurring revenue arrangement.

Unidentified Analyst

But in all cases, there is a recurring; you’re still getting recurring revenue from the sales to distributors.

Mark Roberson

That’s right.

James Crawford

And certainly out of all of the placements we have there, very few and I mean you could count probably on one hand where they were just outright sales where no recurring revenue existed. And in fact, one of those customers is not coming back to just sign into service and support agreements because they realize that they need to be able to touch the company to get update and have a product that is support 24/7.

Unidentified Analyst

All right. Well, thanks very much. Keep up the good work.

James Crawford

Thank you.

Mark Roberson

Okay. Thank you Jeffery.

Operator

(Operator Instructions) And there being no further questions at this time, this does conclude today’s question-and-answer session, I would now like to turn the call back to Mr. Mark Roberson for closing remarks.

Mark Roberson

Thanks everyone. I appreciate your attendance on the call and participation. Have a good afternoon.

Operator

Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes the presentation. And you may now disconnect. Have a good day.

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