Fourth Quarter 2005
Investor/Analyst Conference Call
Multimedia Games, Inc.
HOST: Mr. Clifton Lind
DATE: December 1, 2005
Good day, everyone, and welcome to the Multimedia Games fourth-quarter fiscal year 2005 conference call and webcast. This call is being recorded.
(OPERATOR INSTRUCTIONS). At this time, for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr. Clifton Lind. Please go ahead.
Clifton Lind, Multimedia Games — President & CEO
Thank you, operator. I want to thank everyone for joining us on the call. With me today is Craig Nouis, our CFO; Neil Davidson, our VP of Finance, and Randy Cieslewicz, our VP of Tax and Budgeting.
The fourth-quarter operating results are reviewed in today’s news announcement, and shortly, we will provide some additional financial detail. In addition, on today’s call, I will review our plans and expectations for further revenue diversification and our prospects for fiscal 2006. But first, Julia Spencer will get us started with the Safe Harbor language.
Julia Spencer, Multimedia Games – Director of Corporate Publications
Thank you, Clifton. I need to remind everyone that today’s call and simultaneous webcast may include forward-looking statements within the meaning of applicable securities laws. These statements represent our judgment concerning the future and are subject to risks and uncertainties that could cause our actual operating results and financial conditions to differ materially. Please refer to the “Risk Factors” section of our recent SEC filings.
Today’s call and webcast may include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of all non-GAAP financial measures to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found on our website, www.MultimediaGames.com, in the Investor Relations section. I will now turn the call back over to Clifton.
Clifton Lind, Multimedia Games — President & CEO
Thank you, Julia. Q4 FY ‘05 revenues were $36.9 million, EBITDA was $20.7 million, and for reasons that I will detail shortly, diluted EPS was $0.10, coming in at the low end of the guidance range we provided at the time we reported Q3. Despite the transitional nature of fiscal 2005, Multimedia reported full-year revenues of $153.2 million and EBITDA of $89.5 million, both of which are largely in line with our fiscal 2004 results.
During Q4 FY ‘05, there were four factors that warrant a quick review. First, while we projected higher average hold per day for the network, the actual hold per day was slightly below our third-quarter levels. This was due primarily to the deterioration in the hold per day of our Alabama charity placements, a trend which we expect to reverse with the deployment of our new platform and our new content. Our Alabama charity offerings have not been refreshed since installation, and we have recently taken steps to correct this situation.
Second, while our Class II standard-sequence bingo games operating in Oklahoma continue to hold their own against similar games offered by other public companies, they are not as attractive to players as the predrawn games and the keno games offered by many of our nonpublic competitors. And therefore, we continue to lose some floor space in Oklahoma.
We have remained on an uneven footing in Oklahoma, as operators have not yet converted in mass to games played under the tribal-state compact. Due to this delay, in about two weeks, we will begin re-releasing all of our Class II games on the new Class III platform developed to support the games played under the compact. We believe this will allow us to better compete with the other games in the marketplace.
On a positive note, we recorded an increase in average hold per day for both nationwide Class II Reel Time Bingo placements and for the games played under the Oklahoma compact in the smaller halls where we placed them in early fiscal 2005. These games continue to build loyalty with our players.
Third, even though we reduced fourth-quarter SG&A costs by 9% compared with last year, during Q4 FY ‘05, we incurred higher-than-projected SG&A costs, including unanticipated legal expenses, repairs and maintenance of player terminals that we prepared to place in new markets in the immediate future, but which we had not pulled the trigger on at the time of our last conference call, and then, higher-than-projected Sarbanes-Oxley compliance costs. These items in aggregate obviously reduced our diluted earnings per share.
And finally, even though we had a slight increase in the number of non-Legacy player stations during the quarter, we lost [floor] space to nonpublic competitors in the Class II markets, including Oklahoma and at one facility in California.
As was the case throughout the year, we have had a large number of player terminals on hand, many of which are being depreciated despite not being “in revenue.” We hope to correct this situation in the next few months, as we will outline later in the conference call. In a few minutes, I will review our placement plans for these units in FY ‘06.
During the past three months, we have refocused our development resources on our most tangible near-term placements and opportunities, including: upgrading the Oklahoma and Alabama offerings; new terminal placements in Iowa and an international market, providing a new sweepstakes system for an existing market; and, completing architectural changes that will allow us to pursue new opportunities previously unavailable to us because we could not interface to back-office systems using older architectures. We have also made preparations to address new charity opportunities in two additional states.
Also in FY ’06, we will make additional progress on our goal of revenue diversification driven by new markets, new jurisdictions and new product opportunities that we are working on today. Craig will now provide some additional insights on the financials, and I will come back to provide an overview of our expectation for this upcoming year.
Craig Nouis, Multimedia Games — CFO
Thanks, Clifton. We provided details on our operating results in this morning’s press release, so let me take a few moments to review a few additional items.
As noted in our press release this morning, while we had previously forecasted a quarterly sequential increase in SG&A expenses, actual costs in the fourth quarter were higher then projected. Our September 2005 quarterly SG&A of $16.1 million included unanticipated legal expenses, and repair and maintenance of player terminals that we expect to place in new markets, as well as professional fees related to Sarbanes-Oxley compliance. On a year-over-year quarterly basis, SG&A expenses declined by 9%, or $1.5 million, as we continue to follow through on cost control efforts.
Depreciation expense increased as a result of the year-over-year increase in the total number of player terminals in our rental pool, both deployed in the field and in storage awaiting redeployment. For the full year, depreciation expense rose $17.5 million, or 50%; however, on a sequential quarterly basis, it was down approximately $500,000, or 4%. The sequential quarterly decline resulted from fewer deployments of new player terminals into the rental pool.
For the full year, amortization expense rose $2.3 million, reflecting our continued investment in intellectual properties, game content and systems. On a sequential quarterly basis, amortization expense rose $427,000, from $1.2 million in the June 2005 quarter, to $1.6 million in the September 2005 quarter. Combined depreciation and amortization for the 2005 fourth quarter rose $3.4 million, or 31%, compared to the prior year period. Based on our projected capital expenditures to the upcoming quarters, we expect the recent quarterly trend for relatively flat depreciation and amortization expense to continue.
Our cash position at September 30, 2005 decreased $5.8 million from June 30, 2005, reflecting cash advances of $17.6 million related to development agreements during the quarter, and $1.3 million for share repurchases.
Looking forward to FY 2006, we expect to advance an additional $39 million under our development agreement commitments. Net borrowings under our credit facility increased by approximately $4.6 million from June 30, to $39.8 million as of September 30, of which approximately $27.8 million was drawn under our revolving line of credit. As with the decrease in our cash position, the increase in borrowings under our credit facility was primarily driven by the development agreement advances made during the quarter. Our cash flow from operations was approximately $20.9 million for the September 2005 quarter.
Accounts receivable increased $8.1 million, to $18.8 million as of September 30, 2005, from $10.7 million as of June 30, 2005, due primarily to billings for the Israel lottery system sale. Subsequent to year end, we collected $4 million of the outstanding balance for Israel, and have also collected several past due balances from customers, which reduced our receivables to be in line with historical levels.
Of the $17.6 million advance for development agreements, $9.7 million was recorded as a note receivable, and $7.9 million was recorded as an intangible asset. Primarily as a result of these advances, intangible assets have increased from $45.3 million as of June 30, 2005 to $53.7 million as of September 30, 2005. As a reminder, we amortize the intangible assets related to the development agreements over the life of the contract, which is typically 6.75 years. The amortization, or accretion of these contract rights, is offset against revenue and can be found as a reconciling item on our cash flow statement.
Under the purchase terms of a vendor contract during the fourth quarter, we purchased 1,125 player terminal cabinets and will purchase an additional 1,625 player terminals during FY 2006. With these cabinets and the player terminals we currently have in our rental pool awaiting deployment, we believe we have sufficient player terminals to meet our FY 2006 requirements. For modeling of capital expenditures, in addition to the player terminal purchases and development agreements advances previously mentioned, we expect our maintenance CapEx to remain flat at levels of $4 million to $7 million per quarter.
Primarily as a result of share repurchases of 1.2 million shares during fiscal 2005, our weighted average common shares outstanding for the September 2005 quarter has been reduced to 27.1 million from 28 million as of September 30, 2004.
Finally, effective October 1, 2005, we adopted FAS 123R in accounting for our stock options, and have elected to use the Black-Scholes model. We are currently in the process of evaluating the model inputs, and have provided guidance excluding stock option expense. I will now turn the call back to Clifton. Clifton?
Clifton Lind, Multimedia Games — President & CEO
Thank you, Craig. In fiscal 2005, we increased R&D spending by nearly 40% over the fiscal 2004 levels, reflecting our commitment to continuing technological innovation. This commitment to R&D, coupled with the aggressive efforts of our sales and marketing staff, the unsurpassed quality of our development and test staffs, and the extraordinary service provided by our field service staff and our customer service staffs remain the primary factors that are driving our ability to locate and pursue new growth opportunities, such as the electronic instant lottery arena, and placements of our MGAMe™ casino management tools for the video lottery, charity and Native American markets.
I would like to review our fiscal 2006 strategies for new market placements, systems enhancements, and for new player terminal offerings. Multimedia’s anticipated placements and improvements in the earnings capability as measured by the hold per day are the strongest potential drivers of increased net income and increased fully diluted earnings per share.
As we are already recording depreciation for a majority of the terminals we have on hand, any terminal that is placed “in revenue” will be additive to earnings. So it should be clear once I review our terminal placement opportunities why we are so upbeat about our ability to deliver quarterly sequential EPS improvement throughout fiscal 2006.
Let’s start with Oklahoma. The Oklahoma transition to games played under the compact continues to move at a slower pace than we expected, and for that matter, than we are willing to accept. While we continue to expect conversions to games played under the compact, which, as I noted earlier, have the potential to generate higher hold per day, we believe that our tribal customers might continue to maintain a large number of Class II games at their facilities.
Accordingly, we are introducing a new platform for both video and mechanical variations of Reel Time Bingo this quarter, and we believe that these will be well received by our players. In addition, we intend to release a massive amount of new content for both the Class II system and the Class III system. Our strategy is to offer our customers the most advanced systems and content regardless of whether they continue to operate Class II games, convert to the games played under the compact, or choose to do both. This is why we have decided to re-release our Class II offerings on the new platform, allowing our games to compete better with the other games that are not played under the compact that are now offered in the market by approximately 35 competitors.
Before the end of the month, we will also begin to introduce the new games and platform in Alabama, thereby refreshing and updating our games with the new video and mechanical reel product with features and content similar to [those] we are about to release in Oklahoma.
Also during the next quarter, at our largest facility in Alabama, we expect a facility-wide conversion to Multimedia’s proprietary cashless card system, which will become the designated currency standard for all vendors’ player terminals. This will create a common currency so that cash players, who might not previously have taken the time to sign up for the facilities designated MGAM player tracking system, will now be entered into our player tracking system and cashless card system. There are a number of additional charity jurisdictions we believe will open over the next several quarters, and we will report on the progress in those jurisdictions on our upcoming call.
What our shareholders should be most excited about is the progress we have made in developing new products for the domestic and international markets. An example is the planned launch of our new promotional sweepstakes system, which will be coming up in the very near future. As the exclusive system provider for a designated facility, our sweepstakes system will support a digital communications and computer center in which the owners have invested several million dollars to create a facility that will benefit the citizens and the community. In addition to providing our system, we are delivering a large number of video sweepstakes readers which can be used by the players to view the results of their sweepstakes entries in an entertaining fashion. I’m particularly pleased with our rapid time to market in fulfilling our customer’s request for this new, unique and proprietary sweepstakes system.
In addition, our architects, designers and engineers have demonstrated their ability to develop a system requiring massive data communication and data storage capacity. This system could play a huge role in a large number of additional markets. Over relatively short time [periods], our system is expected to process billions of transactions, and this attribute should further solidify Multimedia’s role as one of the top providers of gaming systems in the world.
Giving the timing of the opening of this facility, we are projecting just a small contribution from this operation in our December quarter. However, we are very excited about the potential size of the new sweepstakes revenue opportunity as a contributor to profits in the upcoming quarters. We see a large number of applications for sweepstakes, promotional, and “amusement with prize” systems in other markets, and we are aggressively pursuing those opportunities.
Those of you who attended the G2E [Global Gaming Expo] Show in September know we expect to enter the Iowa lottery market with what we believe will be the state’s most advanced offering. Initial placements in Iowa are expected early in Q2 FY [’06]. Also in Q2 [FY ’06], we plan to make initial placements of bingo games in an international market, and we are now in the process of finalizing our business arrangements at this time. As the originator of electronic linked bingo-based games, Multimedia is well positioned to bring to that market an innovative offering, which will be a variation of the games that we currently play in our other Class II bingo systems in Alabama and Oklahoma. In addition, we see many opportunities worldwide to take this system into new markets, and we are aggressively pursuing those at this time.
With the upcoming release of the new products in Oklahoma and Alabama, the launch and initial placements of our sweepstakes line, the revenue generated from our highly successful launch in Israel of our electronic instant lottery ticket product, and the benefit of the placements in Iowa and possibly [of] a small number of internationally based machines, we will enter the second half of fiscal 2006 with a higher level of diversification than ever before. In addition to the progress we will make in the next 120 days, we believe that there will be additional diversification opportunities in the back half of FY ’06, with additional installs in some of the new markets we just discussed.
And the New York lottery’s video lottery market seems to be on a full speed ahead basis. The installed base of the player stations in the New York system will increase very dramatically in this next fiscal year, and not only will we be at a run rate which will surpass break-even, but we can also anticipate contributions to earnings per share [when we achieve] the run rate we will be at after all of the new facilities scheduled for this year are opened. [This will be] followed by the planned opening of an additional facility in fiscal 2007. Our New York lottery system is stable, proven and ready to accommodate an expected significant expansion by both existing operators and by those tracks still to come online.
Multimedia’s central system in New York is proving to be a model for lottery directors and other jurisdictions. Next week, we will be showcasing that product and our Israel instant lottery ticket product at LaFleur’s Ninth Annual Conclave in New York. We have also aggressively launched a domestic and international marketing program, which will be highlighted to the lottery directors at that time.
Craig has spoken to our expectations for expenses, maintenance and project CapEx, and the completion of our development funding programs. Reflecting these expectations and putting a good majority of the player terminals we have on hand “in revenue” during FY ‘06, Multimedia will begin generating growing levels of cash. We expect to allocate this cash flow to reducing borrowings under our revolving line of credit, [to] share repurchases and investments in new markets, and [in] technology to further extend our long-term diversification and growth potential.
We continue to evolve and innovate our technology to provide solutions for product introductions around the world, product introductions which will primarily be placed in emerging markets, and we have our expense control programs in place at this time. Together, these factors should drive earnings higher in fiscal 2006, and we are excited about the quarter-to-quarter opportunities that we see.
Operator, let’s open the floor to questions at this time.
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