Tracy Egan – VP, Marketing
Mark Roberson – CEO, CFO and Treasurer
James Crawford – President
Jeffrey Link [ph]
PokerTek, Inc. (PTEK) Q3 2011 Earnings Call November 8, 2011 11:00 AM ET
Good day, ladies and gentlemen and welcome to the third quarter 2011 PokerTek earnings conference call. My name is Tanny, and I will be your conference moderator for today. At this time, all participants are in a listen-only mode. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.
I would now like to hand the presentation over to your host for today, Tracy Egan, VP of Marketing. Please proceed.
Thank you and good morning. Welcome to PokerTek's investor conference call for the third quarter ended September 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 web cast 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. 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 GAAP financial statements can be found in today’s press release, and we also ask that you refer to our public filings with the SEC for additional information.
Now, I’ll turn the call over to Mark.
Thanks, Tracy. Thank you all for joining us today. On today’s call, we will review the quarterly operating results, and also provide you with an update on the state of the business, and our growth plans. I know many of you will be interested in hearing about the situation in Mexico; we will discuss the current status and our future expectations for that market, and also update you on market opportunities in other markets that will drive placements and operating results going forward.
Overall, Q3 marked another quarter of solid financial performance. On an annualized basis we stand at approximately 6.5 million in recurring revenue, producing strong margins and stable operating expenses. Q3 also marked our fourth consecutive quarter of EBITDAS profitability.
As we look ahead, there are several key drivers that will impact our trajectory over the next several quarters. First, as previously announced, we have moved the tables in Mexico following a determination that all electronic roulette incurred gains are not permitted. Based on the information we are receiving from our customers and advisers in the market, we believe this to be a temporary situation.
The government is currently focused on inspecting casino operators and tightening up enforcement, which has resulted in the closure of numerous properties operating without proper permits, import documents and other paperwork. Once that phase is complete, the expectation in the market is that those remaining properties will be allowed to reinstall electronic roulette and card games in early 2012.
Prior to removal, the tables in Mexico generated approximately 70,000 of monthly revenue at approximately 45% gross margins. The table performance and margins were significantly below what we see in other markets, where our margins traditionally run at approximately 70%. We are proactively bringing a small number of tables back to the US to meet anticipated demand in other markets, but our plan is to leave the majority of the Mexico tables in country, while the regulatory process runs its course.
We believe that if electronic tables are allowed back on the floor next year, the market will be more concentrated as a result of the removal of illegal operations, especially where manual games are being dealt. As a result, if the government allows e-tables back on the floor, we expect the market to have fewer operators and those installations should generate revenue and margins more in line with our other markets.
Outside of Mexico, we have several significant opportunities in the pipeline. Throughout our markets we have a dominant position in automated poker, and we estimate the addressable market to be approximately 8000 to 10,000 gaming positions. We have limited competition in this niche market, and we believe we have room to increase our installed base by a factor of three or more in our target markets over time.
Near time there are several meaningful placement opportunities teed up and James will elaborate on those specific markets in a few moments. The ProCore platform for house bank Blackjack and specialty games also creates significant placement opportunities for growth and product diversification. We are approaching the house bank e-tables market in a two-phased approach. First we will continue to deploy the account-based version with Blackjack to cruise ships, and also to select markets in Europe where TITO and GOI [ph] approvals are not required.
We have identified specific near-term installation targets estimated at 600 to 900 player positions for the account-based version. Second we plan to submit the SAS/TITO version of the ProCore table to GOI for regulatory approval in the coming weeks. Once approved the SAS/TITO version of the ProCore table opens larger gaming markets for Blackjack and additional specialty games in regulated markets.
Overall the third quarter was solid, and the numbers reflect continued execution in our target markets. Mexico will obviously have an impact on our numbers short-term; however, we have significant opportunities to increase our installed base in other markets.
James will now provide additional detail on those markets.
Thanks Mark. Mexico was unexpected, but the good news is that we have numerous opportunities to replace that business with higher performing installations in the short-term. We also expect that when Mexico returns, we will be positioned for stronger product performance and with better regulation and less competition from unlicensed operators.
For Q2 in Africa, we continued placements in Tanzania with our new partner, TCS John Huxley, adding two new sites, and bringing our installed base up to 60 positions. We signed a new multi-year contract with our customer in Romania to expand our footprint. As a result, we installed two additional sites for a total of 50 positions in early Q4, which brings our total installed base in Romania to 130 positions.
We added 10 positions in Canada with Atlantic Lottery for a total of 50 positions in Coasters properties. We continue to install on cruise ships, bringing total player positions to 704. we also installed 20 players positions in the Caribbean, which we expect to get live in November.
Looking forward, Ontario’s AGCO approved poker probe for field trial in the third quarter, and we installed our first two tables in October. OLG [ph] operates 22 sites, in which we have identified nine as being excellent opportunities with limited or no competition from manual table games. We expect a successful field trial lasting 60 days with additional installations to follow.
The Ohio market is moving ahead on a fast track. The Ohio lottery expects VLTs to be in operation at the tracks in early 2012. we are actively working on the application process and expect Ohio to be a significant opportunity in 2012. South America, we are presenting both ProCore and Blackjack Pro at the SAGSE Show in Buenos Aires this week. The South American market is dominated by slot only properties, where manual table games are not allowed. As a result, we believe there is a large underserved market for electronic table games.
We expect to have initial placements in Colombia, Panama and Argentina in the next six months. With ProCore we continue to focus on account based Blackjack, while preparing the SAS/TITO for the GLI regulatory approvals process. Our tables on cruise ships continue to perform well, and we continue to receive excellent feedback from both the operators and players like.
As of September 30, we have 84 player positions installed on cruise ships, and we expect to continue to expand cruise ship installations over the next several quarters. We expect Blackjack Pro approval in France before the end of the year, and we continue to target other markets like Romania and Germany.
As soon as the SAS/TITO platform is approved, we have a much larger available market to expand the products. I am very excited about the short term and long term growth opportunities for PokerPro and ProCore. We will be expanding all our installed base in North America, Europe, South America and in the cruise market in Q4.
Back to you Mark.
Thanks James. We released our quarterly financial results this morning. I will provide a brief summary of those results, and then we will take any questions you may have.
Total revenue for the quarter increased 13% to $1.6 million and 14% to $4.3 million on a year-to-date basis. revenue increases were primarily driven by business in Europe, Africa, and North America, and the cruise ship markets, and were partially offset by lower revenues from Mexico.
Revenues from Mexico accounted for 13% of total quarterly revenue, 17% on a year-to-date basis. As discussed earlier on the call we are optimistic that Mexico will return as a more stable and profitable business. However, we are not counting on additional revenue from that market for the balance of the year.
Gaming positions decreased 16% to 1,958 from 2334 last year. Excluding Mexico, gaming positions grew 14% due to PokerPro and ProCore placements on cruise ships and international markets, primarily in Europe and Africa.
Gross profit increased 8% to $1.1 million for the third quarter and 25% to $3.5 million on a year-to-date basis. The increase in gross profit was primarily attributable to increased revenues, improved asset utilizations and reduced product costs, partially offset by lower margins in Mexico.
Operating expenses remained stable declining to $1.6 million for the quarter from $1.7 million last year. On a year-to-date basis, operating expenses declined to $4.7 million from $5.0 million during the prior year period.
Net loss from continuing operations improved 24% to $0.07 per share from $0.11 per share for the comparable period of 2010. On a year-to-date basis, the net loss from continuing operations improved 42% to $0.21 per share from $0.41 per share last year.
Including discontinued operations, year-to-date results improved 61% from $0.61 per share to $0.21 per share this year. EBITDAS improved to a profit of $156,000 for the third quarter, compared to a loss of $83,000 in the prior-year period. On a year-to-date basis, EBITDAS improved from a loss of $203 thousand to a profit of $409,000, representing our fourth consecutive quarter of profitable EBITDA performance. Overall, Q3 was another in a series of solid quarters, Mexico will obviously impact the results in the short term, but I’m confident that we will replace that revenue with higher margin business in the US, Canada and Europe, and I am also optimistic that Mexico will return as a much more stable and profitable market next year.
In the meantime, we are focused on growing our penetration and our recurring revenue from PokerPro and ProCore in Europe, the US, the Canada, and with the cruise ships.
That concludes our prepared remarks, and we will now take any questions.
(Operator instructions) we have a question on the line from Jeffrey Link. Please proceed with your question.
Good morning Jeffrey.
I wanted to I guess get a little bit more color on the Mexico piece, when in the quarter did the revenue stop?
Yes, the revenue stock right at the end of the quarter. we have seen declines in the Mexico business throughout the quarter, and a little bit in the second quarter as well as a result of increased competition from manual table games operating illegally in the market for the past several months. So we have seen some decreases throughout the months of the current quarter. However, the information bulletin which came out, which caused the removal of the tables from the market occurred at the very end of the quarter.
So then it would be in the fourth quarter that you would see the real loss of the 70,000 a month?
That is correct.
And in terms of just making sure that the expenses are I guess in line with this reduced revenue, what are you doing to make sure that the cash flow still remains strong as it can be?
Obviously we’re taking a look at all the variable costs in the business, and reducing expenses where we can from a variable standpoint. So that we will obviously look at expense reductions throughout the business and we have taken some steps there at the margin. We do expect this business to come back next year. So we’re not taking extreme measures. But we obviously are watching the pennies wherever we can. Primarily we are also looking at the opportunities which James mentioned such that we can replace the Mexico business from a top line standpoint over the next couple of quarters.
If you look at what the tables in Mexico were generating, we had 76 tables in the market generating about 70,000 a month, which on a per table basis is a little less than half of what our average tablets generate in other markets of the world, and obviously at lower margins. So one of the ways that I would look at the Mexico business is that in the other markets that we’re looking at, we really need to install between 30 and 40 tables at normal margins, and normal revenues per table to offset the Mexico business. It is not quite as big as it looks when you think about 76 tables coming out because of the performance of those tables.
So actually one would potentially see any improvement in gross margin in the fourth quarter?
What do you expect, just so that there is an expectation for revenue, what do you think revenue will be coming in at year-over-year in the fourth quarter given that Mexico assuming that it does not come back on in the fourth quarter?
I mean, we traditionally don’t put out specific revenue or financial guidance quarter-to-quarter. If I were modeling this sitting in your shoes, I would expect to see $70,000 of revenue per month, come off the top line at the 45% margin levels, some reduction in expenses, and some of that will be offset with new installations in the quarter, but given that we are a recurring revenue business, it takes a little bit of time for that recurring revenue stream to catch up. So I can’t specifically answer your question, because we just don’t give specific numerical guidance on the numbers but if I were modeling it in your shoes that is the assumptions that I would use.
And since I am still kind of newer to the story, are you providing any kind of 2012 growth target on the top line?
No, we don’t -- we have not provided any specific numerical guidance for revenues, or top line growth. However, qualitatively I would tell you that we are very optimistic about the opportunities that we see in the very short term to be able to replace the Mexico business based on the opportunities both in North America on cruise ships and in Europe, some of which are teed up, we believe for a very short-term growth. And then we also are optimistic about the fact that we do believe that the Mexico business will come back online during next year such that by the time we get to putting tables back into Mexico, we think we will be doing on a much stronger base of business in Mexico with improved product performance in that market, as well as continued growth in the non-Mexico markets, again primarily Europe in the cruise ships, as well as some select opportunities in the US and in Canada.
In terms of your abilities to be able to build the tables to meet demand, where do you stand both in terms of is demand outstripping supply right now, are you guys in a good enough financial position to be able to produce all that you need to produce, can you give us a little color on that?
Yes, as I have mentioned, we are bringing some inventory back from Mexico. Our strategy is we are leaving the majority of the tables in storage in Mexico, depending resolution of the regulatory process in the country. However, we do have a handful of tables in the 15 to 20 range that we are bringing back to the US to meet demand in other markets. So we have adequate inventory right now to meet the demand without spending lots of money on new products.
But how about on the Blackjack side?
Yes, on the Blackjack side for the near term account-based opportunities we are looking at, we have about 20 tables in inventory that we can place before we start ordering more products. As those get deployed, we will build a little bit of a backlog to manage cash as replacing that product.
I was looking at the balance sheet, and was looking at the deferred revenue line, what does that comprise of?
Yes, the deferred revenue line, let me back up and just give you a little background on our revenue models, and our alternative customer pricing options. Predominantly we lease or license our product on a monthly recurring revenue basis, such that customers are paying a percentage of their revenue to us on a monthly basis for use of the hardware and software.
We also in some cases, sell the hardware to customers for either upfront cash or a hardware purchase price financed over time. Whenever we sell the hardware, we also include a recurring revenue component for software licensing fees and maintenance. So what you are seeing in the deferred revenue line are what goes into that account, when the sell the hardware, the revenue from the hardware sale goes to deferred revenue. And then that revenue is recognized over the life of the software maintenance contract. So what you are seeing there is we are continuing to recognize revenue from prior hardware sales, principally in Europe from Q1.
I guess what I am trying to understand is I see the deferred revenue line has been declining over the last several quarters, so how do one interpret that?
You would interpret we had more hardware sale installations in the fourth quarter of last year, and in the first quarter of last year than we have had in the most recent quarters. So as we look forward into some of the markets that James was referring to, some of those placements will be on a straight lease basis, and others will be on a hardware sell basis, to the extent that they are on a hardware sell basis, you will see new increases in the deferred revenue line.
Okay, well that makes sense. I’m going to ask one other question, then I will get back in queue, just if anybody else wants to ask questions as well. You know, I was looking at the share count which has been sequentially growing at least just looking at March, June and September, how much of that is being done through, I guess, employee share compensation, how much of that is the result of needing to raise additional capital?
We certainly try to balance dilution with raising capital and growing the business. What you see in Q2 to Q3, there was very little sale activity of shares in the open market or capital raising in Q3, they are really none. We did however did utilize restricted stock and stock options as compensation for employees, and our compensation philosophy with the companies, the stages [ph] of companies we under compensate on a cash basis, and we use equity compensation to make up for that and to align the interest of employees, officers, directors with the shareholders. So we have seen an increase in the share account based on issuances of restricted stock that vest over time in the third quarter.
Okay, I will get back in queue, if somebody else has to question, and I have got one that I want to follow up on after.
Okay. Thanks Jeffrey.
(Operator instructions) You have a follow up from the line of Jeffrey Link. Please proceed.
Well, it looks like I’m the one dominating the calls today.
Everyone else is a little shy this morning Jeffrey, so go right ahead.
Let me ask if you will, the elephant in the room question about you know stock performance, stock price performance, and hope we can obviously get the most value here on the stock price, one way would be through the growth in the fundamentals of what you guys are doing, and it looks like you are doing a really good job, stock prices are reflecting that right now. now that you have got Mr. Lahti you know more involved, has anybody given thought to what if somebody were to look to acquire the company, what type of kind of metrics you would have to hit, i.e. you know a certain revenue target that potentially would make you an interesting acquisition or the fact that you have got interesting technology, will that be sufficient. You know, can you provide us with at least some thoughts, and obviously I know you can’t go into anything specific here, but you can just give us here at least a view as to if one were to look to acquire you, why would one do it and at what levels would one look to do that?
Yes, let me give that a shot Jeffrey, I think it is always difficult to attempt to decipher what might be in some other potential acquirer’s minds somewhere down the road in terms of what drives their decision process. Our approach right now is focused as you said on running the business, executing the operating plan, making the company stay as profitable as we can, while we continue to invest in the technology and grow the PokerPro dominance in that segment of the market, and launch the ProCore platform which is the new technology, which we think is very unique in the market.
So with regards to what a potential acquirer might look for down the road, you know, I don’t think that it would necessarily correlate to size of the company. I think potential acquirers look at can they pick up good technology that supplements their business, and can they pick up revenue producing products or business that is accretive to their EPS. So when I look at PokerTek and I will just look at the valuation, probably the easiest way to look at it is to look at valuations of other companies in the industry, which are traditionally trading, companies which have recurring revenue businesses similar to PokerTek, although they may be a little larger, consistently trade currently at 2.5 times revenue, and about 8 to 8.5 times EBITDAS.
So if you are looking at what is going on at PokerTek, whether it is standalone or at some point an acquisition candidate, how do you look at valuing a company like this, those are the sort of metrics that I would use if I were building a model or looking at valuing a company like PokerTek that is creating good results, improving operating results, the strong revenue business, the strong margins, and has a lot of opportunity to grow in its niche addressable markets.
Have there been any recent examples that you can point to of some smaller
companies that may have been acquired?
You know, there is one example that comes to mind although I would caution that I don’t think it is directly comparable. Amaya Gaming in Canada recently acquired Chartwell. There really has not been other small gaming acquisitions in recent months that I can point to, and none that are really comparable to PokerTek in terms of our technology or our business model.
And what valuation was that acquired, do you recall?
I believe it was similar to the multiples I just described, I don’t recall for sure Jeffrey.
Okay, listen, thanks very much and you guys are doing a great job.
Hi, I appreciate it Jeffrey. Thanks for your support, but I appreciate the questions.
I’m showing no additional questions at this time.
Okay. thanks everyone and have a good afternoon.
Thank you for attending today’s conference. This concludes the presentation. You may now disconnect and have a great day.