Multimedia Games Q4 2007 Earnings Call Transcript

Multimedia Games (MGAM)

Q4 2007 Earnings Call

December 11, 2007 9:00 am ET

Executives

Clifton E. Lind - President and Chief Executive Officer

Randy S. Cieslewicz - CFO; Vice President Tax, Budget, Corporate Compliance

Shannon Brooks - Vice President and Controller

Howard Chalmers - Senior Vice President- Planning and Corporate Communications

Analysts

Ryan Worst - Brean Murray

Barry Kaplan - Maple Tree Capital

Presentation

Operator

Good day, everyone and welcome to the Multimedia Games fourth quarter 2007 conference call and webcast. This call is being recorded.

At this time for opening remarks and introductions I would like to turn the call over to Multimedia’s Chief Executive Officer, Mr. Clifton Lind. Please go ahead, sir.

Clifton Lind

Thank you, operator. I want to thank everyone for joining us on the call. With me today are Randy Cieslewicz, Shannon Brooks and Howard Chalmers. The Fiscal 2007 Fourth Quarter Operating results are reviewed in today’s news announcement and Randy will provide additional financial detail later on the call.

Q4 FY ’07 revenues were 31.2 million. EBITDA was 16.7 million up from 15.6 million last year. And we reported net income of approximately 1.4 million representing diluted earnings per share of $0.05. This compares to net income of approximately .1 million of break even for the Q4 FY ’06 period.

These Q4 FY ’07 Operating Results reflect modest quarterly sequential improvements in revenue and net income. This included several non-recurring items that in the aggregate impacted income by .8 million or $0.03 per diluted share.

During this morning’s call we will briefly review progress regarding our FY ’07 priorities as well as improvements in a number of our markets which we believe positions Multimedia for upcoming growth. As always we conclude by taking questions from the analysts and the investors.

Before we continue I’m going to ask Howard Chalmers, Senior Vice President for Corporate Communications to review the Safe Harbor language for us. Howard.

Howard Chalmers

Thanks, Cliff. And I’d like to remind everyone that today’s call and simultaneous webcast may include forward-looking statements within the meaning of the Applicable Securities Law. These statements represent our judgment concerning the future and are subject to the risks and uncertainties that could cause our actual operating results and financial condition to differ materially.

Please refer to the risk factors section of our recent SEC filing. 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.comin the Investor Relations Section.

I now return the call back to Clifton.

Clifton Lind

Thank you, Howard.

Our operating goals for Fiscal 2007 included the following: converting the significant portion of our installed base in our largest market to one cent stand-alone games; supporting the growth of customer operations in Mexico; developing new products and services for the Washington state market that would position us to capitalize on new unit and replacement market opportunities; developing a new palette of products, services and games to address additional Class III market opportunities; completing the design and engineering phases for our new line of proprietary gaming cabinets; and designing the new line of mechanical real products that we will offer in all of our markets.

With our successful execution of these initiatives we are confident that Multimedia is positioned to achieve growth in FY ’08 from both serving our current markets and entering new markets with new products.

In Oklahoma, we’ve been continuing to convert our installed base from multi-test Class II and server-based compact games to stand-alone units. As of September 30, 2007these stand-alone units accounted for more than 57% of our total installed base in Oklahoma. And as of November 30, 2007 these games accounted for roughly 66% of the installed base.

The higher level of player accesses for these stand-alone units has contributed to offsetting the impact of reductions in our revenue share percentage which has accompanied this shift from Class II to Class III games. This also is helping to increase the revenue from this market on a quarterly sequential basis.

Currently the majority of our One-touch units in Oklahoma are third-party vendor’s games. However, recently we began placing our first proprietary Class III games on our new proprietary M-game cabinets in Oklahoma. And we now have approximately 70 of our proprietary stand-alone games deployed in that market. The near-term ramp-up in game themes, approval and deployment in Oklahoma will provide a foundation for our move into several other traditional Class III markets.

While we are still early in the roll-out of our stand-alone products we are encouraged by the initial performance of our proprietary offerings as the represent a positive compliment to the mix of stand-alone units that we have deployed in Oklahoma today. They are expected to help us grow our share of the gaming floor in this important market. We can manufacture and offer these proprietary cabinets and game themes more economically and at a significant savings over purchasing third-party units.

In FY ’07 we expanded our agreement with our largest customer in Oklahoma by committing to provide approximately $6 million of the funding for the expansion of their Southern Oklahoma facility. When this expanded property begins operation in mid-calendar 2008, Multimedia will be in a position to begin placing approximately 14,000 new units at this property. All of these units are expected to be operational around the end of our fiscal FY ’08 with more than 60% of them expected to come online in Q3 of FY ’08.

Combined with the positive initial response to our stand-alone units in Oklahoma, this agreement positions us to grow our installed base in revenues in this market. Also with the completion of our share of the funding of the commitment of this expansion we forecast significant free cash-flow generation beginning in Q3.

Our current installed base inMexico is now about 3,000 units at 12 properties. This includes 2,854 units at 11 properties operated by our initial customer inMexico and 200 units at on property being operated by a new second customer inMexico with whom we entered into an agreement early in Q1 FY ’08. For FY ’08 we will continue to support the rollout of new planned facilities by both of our customers. We will also support their efforts to drive Hope for Day through marketing and promotion programs.

Last month in Washington State we entered into two contracts for the sale or refurbishment of player terminals. The first agreement was for the sale of 300 units from existing Multimedia inventory and the upgrade of 220 existing units at the customer’s property. The second was for the sale of 50 units also from existing inventory. These transactions represent our initial success in addressing the new replacement and new unit market opportunities in that state. We believe the Washington State market represents a meaningful channel for growth that will accelerate as we move through FY ’08.

In New York there are currently slightly more than 13,000 BLTs installed at race tracks throughout the state, all of which are operating on our central system. Revenue continues to grow on a monthly sequential basis and we are now operating at break-even in this market. The big leverage for our operations in New York will be when Aqueduct comes online. And while I do not have any new information with regard to the timing of this opportunity there does seem to be heightened interest from all stake holders in the state to resolve the issues that have delayed the introduction of VLTs at Aqueduct.

Later this fiscal year we anticipate the deployment of Class III Casino Commander Game Management System that will provide operators in the Class III markets the features and functionality that we have previously demonstrated and deployed for server-based and downloadable gaming and charity Class III and the Mexico markets. Our Casino Commander system has new features and is deployed in seven domestic and international casinos.

In summary for FY’08 we expect revenue and unit growth in the Oklahoma, Mexico and Washington State markets while also growing our presence in new domestic Class III, charity bingo and in international markets.

Randy Cieslewicz our CFO will now provide additional insights on the Q3 FY ’07 Operating results after which I’ll briefly review some of our new products that we have demonstrated at G2E and then we’ll open up the call for your questions. Randy.

Randy S. Cieslewicz

Thanks, Clifton.

As noted in our press release this morning total revenue for the September 2007 quarter declined on a year-over-year basis to 31.2 million. Yet on a quarterly sequential basis revenues increased 1%. The year-over-year revenue decline is primarily attributable to the removal early in the fiscal 2007 third quarter of 565 Class II units from a high earning facility in Southern Oklahoma, in order to facilitate the expansion of that property. When that expansion is completed Multimedia will have approximately 2,400 of the 6,000 units placed there.

Notwithstanding the removal of the Class II units revenues generated from Oklahoma were 15.2 million for the September2007 quarter versus 17.8 million in the June 2007 quarter and 18.4 million in the September 2006 quarter. Revenues from Mexico were 1.9 million for the September 2007 quarter versus 1.2 million in the June 2007 quarter.

Prior to the contract right accretion adjustment of 739,000 in Q4 net revenue per day for Oklahoma compact units decreased slightly on a quarterly sequential basis from $33.56 per day to $32.83 per day, or 2%. Class II revenues continue to be impacted by the production and the average installed player terminals as the majority of our terminals in the market have been converted to one-touch stand-alone compact games. However Class II hold per day increased 7% on a quarterly sequential basis reflecting the conversion of lowering performing units.

The quarter Oklahoma compact and Class II revenues for the September 2007 quarter reflect accretion of contract rights by each product line’s revenue. Our prior quarterly numbers reflect this accretion adjustment against Class II revenues only. Please refer to the table in the press release regarding this reclassification and if there are any questions in this I can address them in the upcoming Q&A session.

In future periods we will allocate the accretion of contract rights for development agreements by each product line’s revenue.

SG&A expenses of 15.6 million for the September 2007 quarter reflect a modest quarterly sequential increase. In a year-over-year basis SG&A expenses decreased approximately 2.1 million primarily due to reduced employee cost and shared compensation expense. We expect SG&A to increase to the 16 to 16.5 million range in Q1 due to the G2E Trade Show related expenses incurred in Q1.

Depreciation and amortization expense of 14 million decreased 800,000 on a quarterly sequential basis. The decrease in depreciation and amortization was primarily due to a reduction in network value of contract rights that were associated with the 560 Class II removals earlier inthe fiscal year. We expect depreciation and amortization expense to decrease by 1.2 million in Q1 compared to Q4 levels. The projected decrease in depreciation and amortization will primarily reflect approximately 1,400 California units rolling off the depreciation schedule.

Our expected Q1 FY ’08 capital expenditures of 10 to 12 million include purchases of approximately 250 third-party stand-alone units, component pats for in-game cabinets and maintenance CapEx, including CapEx associated with the refurbishment of player terminals that are being deployed in Mexico.

Our CapEx numbers inthe next several quarters will be dependant on the timing of purchases related to the development agreement expansion inSouthern Oklahoma. Following the completion if this expansion and the completion of our converging thePlatt Street units inOklahoma we expect our CapEx numbers to decline significantly.

We had a total of 400 third party stand-alone units that have been purchased but not yet deployed as of September 30, 137 of which were purchased on the last day of the quarter and as I just mentioned, we will purchase an additional 250 units by the end of December.

Our CapEx for Q4 was higher than expected due to the purchase of seven stand-alone third-party units very late inthe quarter plus higher than expected purchases of component parts for in-game cabinets.

Net income in Q4 includes interest income primarily related to imputed interest from capital advances associated with our development agreements of approximately 700,000. This compares to imputed interest income of 1.2 million in the year ago period and 550,000 in the June 2007 quarter. We expect to record imputed interest income of approximately 800,000 in Q1.

We are calculating imputed interest on interest-free loans to calculate the contract right or discount on our development agreement receivables. We calculate the discount on each interest-free note receivable based on our cost per capital. The discount is then booked to contract rights and is amortized against revenue for the life of the agreement.

Income taxes benefited from non-recurring items of approximately 800,000. We also expect to benefit in fiscal 2008 income taxes related to our R&B credit claims of prior years. In addition we’ve entered into an agreement with the IRS to settle our ongoing audit for a cost of approximately 67,000 plus interest.

Loads from operations in the September 2007 quarter were 7.1 million compared to 4.7 million in Q3 and approximately 11 million in Q2. I remind you that the lower than normal level of cash flow from operations in Q3 were primarily due to the timing of accounts payable payments for Class III purchases.

Cash used by investing activities of 18 million includes 16.3 million of CapEx and 16 million in advances on new development agreement which was offset primarily by development agreement repayments of 14.9 million. Of the 14.9 million received approximately 12.2 was related to the collection of notes receivable and 2.7 was related to modifications on our small development arrangements with our largest customer.

As previously disclosed we committed 66 million to facility expansion at Southern Oklahoma. We funded 24.8 million of this amount as of September 30^, 2007 and will continue to plan approximately 1.2 million per week, until our commitment is fulfilled in May, 2008. Our fundings in Q1 will approximate 20 million which will leave us with approximately 21.2 million of fundings which we will make between January and May 2008. With respect to development agreement receipts I expect we will receive approximately 5 million in repayments from development agreements in the first quarter.

During Q4 FY ’07 we have net borrowings under our new credit facility of approximately 38.9 million primarily reflecting completion early in the quarter of the 25 million modified Dutch auction tender offer and we had total outstanding borrowings under our new credit facility of approximately 82 million at the end of the fiscal year. In early October we admitted our credit facility into two components, a $75 million term loan and a $75 million revolver. As of today we have approximately 88 million outstanding.

Reflecting a high level of outstanding borrowings in higher grid pricing we expect Q1 interest expense to increase by approximately 300,000 over Q4.

I will now turn the call back over to Clifton.

Clifton Lind

Thank you, Randy.

As we’ve already mentioned in this morning’s call we have made progress in FY ’07 regarding the number of initiatives that address both our current and potential future markets. We believe that in FY ’08 we will begin to see tangible economic evidence of our success in the form of improving operator results.

This year’s G2E Trade Show represented a major milestone for Multimedia Games. In 2002 we began a transition to become a full-service gaming company. G2e ’07 signaled the completion of a five year journey to change our company from that of a niche Class II server based bingo provider for Native America tribes to a full-service gaming company. At G2E we demonstrated to our customers that we are ready to compete for the first time with a full palette of products to offer to the gaming community.

Our work in FY ’07 created the foundation that should allow FY ’08 to be a great year for us. Our new products are targeted at serving the stand-alone gaming market while we continue to deliver technically advanced offerings for the server-based market. Over the next few weeks we will turn all stand-alone units in Rhode Island. And in Q3 FY ’08 we expect to deploy additional stand-alone units in Class III markets we have not previously served.

In addition to introducing more than 40 new game themes we are particularly proud of our new entry into the community games category. Our new titles Bonus Revolutions, Sport of Teams and Emperor’s Fortunes each link multiple players in bonus round activities via side bets. Bonus Revolution represents a unique breakthrough among community bonus games because first, its shared bonusing feature can be adding to both new and existing titles, second each machine displays a portion of the synchronized animation creating a visually impressive player experience. And finally it’s scalable to suit the needs of different size casino floors, from a single bank of machines to hundreds of units.

We’ve also made great strides in hardware development over the last two years and we will soon be offering a complete new line of our own proprietary in-game cabinets in six configurations. This provides us with a complete selection of cabinets to meet the needs of all types of operators and in a variety of facilities.

In the gaming systems arena in addition to our Casino Commander system mentioned earlier in-game casino management system is a full featured system that will be further upgraded this year and marketed more broadly to charity and gaming operators, international and bingo markets in both Class II and Class III Casinos.

We also introduced a new currency system at G2E and have an additional currency system that is about to come out of the lab so we will be able to interface with any casino’s currency system supporting both server-based units and stand-alone offerings.

We believe our new products will lead us into new markets in addition to enabling us to provide additional products and services to existing markets. We will continue to focus on improving the yield of our installed based of 14,000 recurring revenue units. And we believe we have the products and tools we need to significantly move the needle in the average on the average hold per day in each market.

In addition we are going to increase our marketing business development and sales activities in all markets and we’ll be gearing up our sales staff to do just that. We hope it’s evident to you that we’re serious about Multimedia’s future role in the gaming industry, and we believe we have the basis for our growing optimism and confidence.

Operator, let’s open up the floor for questions.

Question-and-Answer Session

Operator

Thank you. [Operator instructions] We’ll take our first question from Ryan Worst from Brean Murray.

Ryan Worst - Brean Murray

Thanks, good morning, guys. Just, Clifton, can you talk about the outlook for converting the rest of the game base or as much as you’re planning on converting in Oklahoma? It seems like there’s about 2,000 Class II and over-compacted games still in the market.

Clifton Lind

Certainly, Ryan, that is correct and we intend throughout FY ’08 to move ahead smartly and systematically changing out the majority of those remaining units. We still have some location where our Class II games are earning as much as any of the Class III games that we offer. So our urgency top switch those out in the short-term is somewhat relieved. In other casinos we’re going to move ahead smartly and use a large number of our own new proprietary themes as well as third-party themes to complete the transition.

This week we’re scheduled to be a very large week for conversions for us, but as you know Oklahoma is in the midst of a significant ice storm right now. All of those have been delayed. The closer we get to the Christmas holidays the harder it is to schedule time to do conversions. We may have put off a number of scheduled conversions until the first week in January because of this weather.

In any event, we’re going to move ahead smartly and think about the end of FY ’08. All of the units in Oklahoma that we intend to convert from Class II will be converted.

Ryan Worst - Brean Murray

Okay, and then could you talk about the plans of your partner in Mexico as far as openings?

Clifton Lind

I think that they’ve gotten into a rhythm. We’re about 10 sites a year from our largest customer is what they’re publicly discussing that they can easily achieve. What we have learned is that even though there may be more than that on the schedule that that is what they can accomplish. We intend to support whatever they do. I think that’s a reasonable number to assume that they will proceed at for the immediate future.

Ryan Worst - Brean Murray

There hasn’t been a change in their aggressiveness since the tax rate increase?

Clifton Lind

No, no change whatsoever. As you know we talk to them on a daily basis and they remain committed and the only changes have to do with the construction schedule. As you know we have a long list of planned openings that go beyond our FY ’08 period.

Ryan Worst - Brean Murray

Okay, then just one last question. You talked about some Class II placements in Fiscal Q3 ’08. Could you expand on that or are they going to be for sale units or revenue share or are the community gaming products?

Clifton Lind

I think you’re referring to my comments about new markets. I think they will certainly bea combination of revenue share and some for sale. That of course will bein addition to allthe new Class III units that we plan to place, and the units that we plan to sell inthe market.

Ryan Worst - Brean Murray

Okay, those Class III markets are they travel casinos or are they more commercial?

Clifton Lind

Now that we’ve gotten the layouts with our Rhode Island machines, we’re now in the layouts for our GLI 11 units and we’ll soon be in the layouts for the GLI Twin units which are aimed at the broader Class III market. We’ll certainly start with Native America tribes that we have done business with for many years for our first Class III placements, that’s done in Washington State, Oklahoma and Rhode Island.

Ryan Worst - Brean Murray

Okay, great, thanks, Clifton.

Clifton Lind

Thank you.

Operator

Thank you. [Operator instructions] We’ll move next to Barry Kaplan of Maple Tree Capital.

Barry Kaplan – Maple Tree Capital

Good morning. My question is about the balance sheet. You’ve got roughly 49 million in notes receivable on the balance sheet. Can you talk about as you go forward, in terms of the money you’re going to put out for the development agreements in Oklahoma, minus what you’re going to be getting back, kind of where that number peaks at? I guess philosophically is there any reason why we then shouldn’t think about that as basically an offset of the company on the balance sheet. It’s not really included as an output when they’re calculating the enterprise value of the company.

And then similarly, your debt which was about 74 million, where do you think that’s going to peak out? Will it probably be the middle of fiscal’08?

Randy S. Cieslewicz

The balance of $49 million is all related to basically the development agreements. We will have the federal fund about $20 million in Q1 and about $21.2 million in Q2 and Q3. That will put it about 90 less the receivable portion of that. Assuming we receive as I said 5 million this quarter, the timing is always a little bit iffy in terms of payment, because it’s based on the operational results of the facilities. But let’s assume that we get conservatively get 10 million in receivables to 15 million, when we’re done with the Southern Oklahoma facility it would be somewhere between 70 an 80, where we peak out.

Of course the line of credit is pretty equivalent to that number receivables with the exception of the tender offer that we did. That increased it by about 25 million. I would assume right now that’s it’s going to peak out about 25 million dollars higher than that peak that’s in our receivable. If we said 80, it would be about 105 to 110, theoretically.

Clifton Lind

This is Clifton, as far as the comment about enterprise value, I think a fair view is to take the view that we have virtually no debt because certainly all of that receivable in reality will come in in a reasonably short period of time and be available to pay down that debt. I think you are correct I think looking at the enterprise value; we’re not giving the credit for that that we should be.

Randy S. Cieslewicz

The other thing I would add is we will purchase a number of units for the expansion so that may also impact the payable in the short-term so that may increase somewhat over that 110 level but not much beyond that.

Barry Kaplan – Maple Tree Capital

Thank you.

Operator

And it appears we have no further questions at this time. I’d like to turn the conference back over for any additional or closing remarks.

Clifton Lind

Thank you, Operator. And I’d like to thank everyone for joining us on this call. Finally I’d like to thank our talented and loyal staff who has worked so hard to build the future of this company. I look forward to speaking with you again when we report our Q1 FY ’08 results early next year. Have a good day.

Operator

Thank you and once again, Ladies and Gentlemen that will conclude today’s conference. We thank you for your participation. And you may disconnect at this time.

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