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Multimedia Games, Inc. (NASDAQ:MGAM)

F1Q08 Earnings Call

February 6, 2008 9:00 am ET

Executives

Clifton E. Lind – President, Chief Executive Officer & Director

Randy S. Cieslewicz – Chief Financial Officer & Vice President of Tax

Shannon C. Brooks – Vice President & Controller

P. Howard Chalmers – Senior Vice President Planning & Corporate Communications

Analysts

Michael Friedman – Noble Financial

Ryan Worst – Brean, Murray, Carret & Co.

Operator

Good day everyone and welcome to Multimedia Games’ first fiscal quarter 2008 results conference call and webcast. This call is being recorded. At this time I would like to turn the call over to Multimedia Chief Executive Officer Mr. Clifton Lind. Please go ahead sir.

Clifton E. Lind

I want to thank everyone for joining us on the call. Randy Cieslewicz, Shannon Brooks, Howard Chalmers are with me today. The fiscal 2008 first quarter operating results are reviewed in today’s news announcements and Randy will provide additional financial details later on today’s call. Q1FY08 revenues were $30.2 million, EBITDA was $14.7 million up from $11.4 million last year and we reported net income of approximately $400,000 or $0.01 per diluted share. This compares to a net loss of approximately $2.8 million or $0.10 a share for Q1FY07.

During this morning’s call we will briefly review progress regarding our FY08 priorities and provide an update on developments in several of our markets. As always we will conclude by taking your questions. Before we continue I will ask Howard Chalmers, Senior Vice President for Corporate Communications to review the Safe Harbor language.

P. Howard Chalmers

I’d like to remind everyone that today’s call and simultaneous webcast include forward-looking statements. These statements are based solely on present information and are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the risk factors section of our recent SEC filing for a description of certain of these risks and uncertainties. The company does not undertake and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise except as required by applicable law. Today’s call and webcast will include non-GAAP financial measures within the meeting of the 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’ll now turn the call back over to Clifton.

Clifton E. Lind

I’d like to start off by sharing my optimism for the future of Multimedia Games. In my opinion, we have more talent and depth than ever before in the technical staff, sales staff and other critical areas. We have a better and more complete palette of products and systems than ever before and I am confident about our opportunity to compete aggressively in the mainstream of the gaming industry. Let me review some of the reasons for my confidence. In addition to Multimedia’s core operating priorities, the company has five tactical goals for 2008 each of which is targeted at increasing our installed base of player terminals expanding our operations into new jurisdictions and positioning the company for resumed earnings growth and significant improvement in cash flow generation in the latter part of the fiscal year and beyond.

These goals include growing the install base and current market sectors Oklahoma, Alabama, Washington and Mexico, supporting our customers in these markets to help drive hold per day as such growth provides a significant lever towards improving our operating results, capitalizing on the sales opportunity for both new and replacement units in Washington state, continuing to develop and place new products in both current and new markets. This initiative includes the completion of the engineering and laboratory and regulatory phases for our proprietary gaming cabinets as well as the design of new mechanical reel products to address Class II charity, international and domestic and additional Class III market opportunities. Completing the funding for and supporting the expansion of a key customer’s facility. The expected June opening of the first phase of this facility will lead to the significant expansion of our installed unit base and also be the tipping point at which we expect to begin generating meaningful increases in free cash flow.

We believe that we are on track to complete each of these initiatives and we are confident that these efforts are positioning Multimedia to achieve growth in FY08 and beyond. In Oklahoma we continue to convert our install base from multi touch Class II player against player bingo games and server based compact games to standalone games. As of December 31, 2007 these standalone games accounted for more than 68% of our total install base in Oklahoma compared to approximately 63% of the Oklahoma installed based on September 30, 2007.

The increased win per day at these standalone units has contributed to offsetting the impact of the reductions in our revenue share percentage which has accompanied our shift from Class II to Class III gaming. While the majority of our one touch units in Oklahoma consist of third party games we now also have a modest number of our proprietary video titles installed in the market. The performance of these units is meeting our internal expectations and we believe that the revenue contributions from the placement of our own units will grow as we install units in larger facilities and introduce mechanical reel models of our proprietary standalone games.

Another ongoing focus for Multimedia is to continue to increase our library of approved standalone games for titles in Oklahoma. To date we have received approval of five games and we anticipate having at least 40 games approved by fiscal year end. Most of the expected new game approvals will take place beginning around mid Q3FY08 and thereafter. We continue to believe that we can use these game themes to hasten our entry into several traditional Class III markets. It is important to note that the roll out of our proprietary Class III games in Oklahoma not only provides a nice compliment to the mix of third party license games that we offer but also creates economic efficiency because it costs us less to produce these games on our proprietary cabinet than to purchase third party units. We believe that offering customers both our proprietary games and popular third party games will help us grow our market share in this key jurisdiction. As I stated earlier, another meaningful contributor to increasing our install base in Oklahoma is a pending completion of a key customer’s expanded facility in southern Oklahoma. The initial phase of this expansion is on track to open in June of this year at which time we will add more than 800 units to our install base at that property. Later this fiscal year we expect to add an additional 560 units as the second phase of the expansion is complete.

Since May 2007 we have been funding our portion of the financing for this site expansion at an average rate of approximately $1 million a week and upon completion of our portion of the funding will total about $66 million. The scheduled completion of our funding commitment is in the last month of Q3FY08, will coincide with the opening of the initial expansion phase and we expect these events will benefit cash flow during the last quarter of FY08. Our install base in Mexico as of December 31, 2007 was 3,515 units in 14 properties and include 459 units that were added in December of 2007. Year-over-year growth in the Mexico installed base was more than 280%. Based on the development plans that our two customers have shared with us we are optimistic that growth will continue throughout calendar 2008. We will continue to support our customer’s expansion initiatives and as the installed base grows we will work with our customers to promote improvement in hold per day.

In Washington State we are positioned to build on our success late in calendar 2007 when we entered into two contracts for the sale or refurbishment of player terminals. We believe opportunities provide new and replacement units as well as new systems and services in that market will continue for the foreseeable future including the potential for some very near term placements. In Washington State represents a meaningful channel for unit growth in FY08 and FY09 and revenue growth over the next several years that did not exist in FY07. Randy will review the accounting treatment for our Washington state sales in a few minutes.

In New York there continues to be more than 13,100 BLT’s installed at race track throughout the state all of which are operating on our central system. While the install base will remain relatively stable pending the opening of other new facilities, revenue continues to grow. We have had two recent successes in the deployment of new products and markets we have not previously served. In December we deployed our initial 50 Class III units in Rhode Island and early indications are that the units are performing well. We remain hopeful progress can be made in FY08 in our efforts to diversify into the more traditional gaming markets.

Also in December we secured a 5 year contract with the Ontario lottery gaming corporation for the development of gaming software and systems to be used at four of its electronic bingo sites. The majority of the revenue from this original agreement approximately $3.5 million is expected to be recorded upon completion and delivery of the new products around the end of calendar 2008. Going forward we will receive a license fee for each additional site at which the product is installed. This Ontario contract is an important entry into the large additional charitable bingo gaming industry. And we believe our system development expertise will help us to enter both new domestic and new international markets addressing the traditional bingo and charitable bingo industry. Randy Cieslewicz our CFO will now provide additional insights on Q1FY08 operating results after which we’ll open up the call for your questions.

Randy S. Cieslewicz

As noted in our press release this morning total revenue for the December, 2007 quarter improved approximately 4% on a year-over-year basis to $30.2 million yet on a quarterly sequential basis the revenue declined by approximately $1 million or by 3%. The quarterly sequential revenue decline primarily reflects the fact that Q1 is historically our lowest performing quarter of the year and we experienced a decrease in charity revenue due to competitive factors. The year-over-year revenue improvement came despite the fact that last year’s first quarter period included 560 Class II units that were installed at a high earning facility for the entire December, 2006 quarter but which were removed in mid fiscal 2007 to facilitate an expansion at this property. As we’ve noted before we’ll add approximately 1,400 units at this facility in two stages later this year.

Reflecting the normal historical seasonality of our business, revenues generated from Oklahoma were $17.2 million for the December, 2007 quarter versus $18.2 million in the September 2007 quarter and $16.9 million for the December, 2006 quarter. Revenues from Mexico were $2.1 million for the December, 2007 quarter versus $1.9 million in the September, 2007 quarter reflecting the quarterly sequential growth in the installed base of nearly 1,000 units in this market.

Hold per day of Oklahoma compact units decreased on a quarterly sequential basis by 3% yet improved on a year-over-year basis by 16%. Again the quarterly sequential decline primarily reflects the historical seasonality of our business. SG&A expenses of $16.1 million for the December, 2007 quarter reflect a quarterly sequential increase of approximately half a million due to the exclusion of [inaudible] trade show expenses in Q1. SG&A expense in the December, 2007 quarter decreased by $2.5 million from $18.6 million for the December 31st, 2006 quarter due primarily to a lower headcount, a decrease in consulting and contract labor related to the design of our MGAME gaming cabinet, decrease in legal fees associated with litigation and a write off of third party gaming content reflecting Multimedia’s initiatives to transition Oklahoma’s install base from multi touch Class II units to standalone Class III units. We expect SG&A to decline to a range of approximately $15.5 to $16 million in Q2. Depreciation and amortization expense of $12.5 million decreased $1.5 million on a quarterly sequential basis primarily reflecting approximately 1400 California [inaudible] units that rolled off the depreciation schedule. We expect depreciation and amortization in Q2 to decrease approximately $400,000 and then increase with the expansion of the facility in southern Oklahoma. Our expected Q2FY08 capital expenditures of $5 to $7 million include component parts for MGAME cabinets, [inaudible] licenses and maintenance cap ex including cap ex associated with the refurbishment of player terminals that are being deployed in Mexico.

Our cap ex over the next several quarters will remain dependant on the timing of gaming units purchased related to the development expansion of southern Oklahoma. As of today we expect to purchase an additional 600 to 800 third party compact units in Q3. Following the completion of this expansion and the completion of our conversion to Class III units in Oklahoma, we expect our cap ex spending to decline significantly. We have a total of 430 third party standalone units purchased but now yet deployed as of December 31st. In addition to the third party standalone units available to be deployed over the last several quarters we have accumulated component parts necessary to build approximately 2,000 MGAME Class III units.

Net income in Q1 includes interest income primarily related to imputed interest for capital advances associated with our development agreements of $804,000. This compares to imputed interest income of $652,000 in the year ago period and $714,000 in the September, 2007 quarter. We expect to report imputed interest income of approximately $1 million in Q2. We are calculating imputed interest on interest free loans in accordance to FAS 13. We calculate the discount on each note receivable based on our cost of capital the discount is then booked to contract rights and is amortized against revenue for the life of the agreement.

Cash flows from operations in the December, 2007 quarter were $11 million compared to $7.1 million in the September, 2007 quarter and approximately $11.4 million in the December, 2006 quarter. Cash used by investing activities of $28.1 million includes $12.3 million of cap ex and $20.2 million in advances on the new development agreement which was offset in parts by the development agreement notes receivable repayment of $5.7 million. As we have noted our total commitment for our customer’s facility expansion in southern Oklahoma of $65.6 million and we have advanced $44.1 million for this project to date with approximately $19.4 million advanced in the December, 2007 quarter. We will continue to fund $1.2 million per week until our commitment is filed in May, 2008. As such, our funding in Q2 will be approximately $15.6 million and will fund the final $5.9 million in April and May.

During Q1FY08 we had net borrowings under our new credit facility of approximately $11 million and we had total outstanding borrowings under our new credit facility of approximately $93 million at December 31, 2007. As of today, we have approximately $100 million outstanding on our credit facility. Reflecting the higher levels of outstanding borrowings offset by lower rates we expect Q2 interest expense to be slightly higher than Q1 levels.

As previously disclosed in November we entered into two contracts for the sale of player terminals in Washington State. One for 520 units and ancillary products and one for 50 units. We have installed the units for both contracts however the accounting for the sale of the units will be treated differently for each of the contracts. We recognize revenue of $714,000 on the sale of 50 units in Q1 and we deferred $3.9 million in revenue related to the 520 units which will be recognized over the five year term of the contract. The deferral of revenue of the 520 unit contract is related to revenue recognition and the fair value for the new products allowed under the expanded compacts. In the future, revenue from this market will be deferred over the term of the agreement for contracts in which these new products exist.

Finally, income taxes benefitted from R&D credits from prior years. In future quarters we continue to expect the effective tax rate to be volatile due to the adoption of 123R and as a result of foreign income taxes withheld from Mexico receipts. In Q1 we adopted FIN 48 which is related to uncertain tax positions and recorded a reserve of $295,000 related to prior periods. This reserve was recorded directly to retained earnings as prescribed in the literature.

I will now turn the call back over to Clifton.

Clifton E. Lind

Let’s up on the call up for questions, operator.

Question-and-Answer Session

Operator

The question and answer session will be conducted electronically. (Operator Instructions) Your first question will come from Michael Friedman with Noble Financial.

Michael Friedman – Noble Financial

When looking at the Mexico electronic gaming market and you compare it with the Oklahoma Class II market as it stood prior to the compacts, which do you think is a stronger market? Can you kind of compare the two markets against one another?

Clifton E. Lind

We’ve been providing Class II games in Oklahoma since 1997 and we created that market and therefore it was a very strong market because there was a long period when the demand for Class II games was far above the supply. In the Mexico market we have a very different situation where a new product is being introduced to that market in a format that has not been traditionally available to the players. As such, we think that is a market that is going to have to be developed over time and in particular with the business model and the type of entertainment facility that our primary customer is offering, that is a market where customer’s are going to have to be encouraged to come visit the facility and see the entertainment value of the variety of products that are offered there.

As such, hold per day in that market is only a fraction of what hold per day was in the Oklahoma market when we opened it up. We think hold per day in that market will develop over time and we think that has a potential to be an even larger market for us in the short term than ever the Oklahoma market was if you measure that market based upon the unit counts that we will have down there. However, it appears to us today that hold per day is going to develop much more slowly and is going to require a good bit of cooperation between our company and the customers we serve down there in putting a good bit of effort into developing the player patronage of the established months which are being put in upscale facility and are not the upscale facility that are not the traditional electronic bingo environment that the players in Mexico have been familiar with today. So we think it will end up being a much, much larger market unit wise however, we think hold per day will take a large number of quarters to develop as the facilities get promoted and customers are brought into the facility and then repeat customers come back.

Michael Friedman – Noble Financial

Okay and then related to that can you refresh my memory on the how the Televisa contract works? How long does it run? And does the time frame begin the moment the machines are placed or is there a flat period of time that you sign the contract and it runs to that certain period.

Randy S. Cieslewicz

It was four years from the date the first machines were installed which is May 2006 so through May 2010.

Michael Friedman – Noble Financial

And is there a way to renew that going forward? Is there something place for NSI to renew or is that something that can be negotiated in the future?

Clifton E. Lind

Well yes and no. Both, there is something in place and in addition to that we intend to work with our customer as their business model changes and renegotiate the contract in a mutually beneficial manner.

Operator

(Operator Instructions) We’ll hear from Brean Murray’s Ryan Worst.

Ryan Worst – Brean, Murray, Carret & Co.

Back to the Mexico, where do you think your customer is in terms of marketing those facilities and kind of doing a better job in terms of their data base marketing and things like that?

Clifton E. Lind

Well Ryan we’re having ongoing meetings with the customer and the customer is now approaching the number of units that they said they wanted to have opening before they began their marketing effort in earnest. We have part of our team down there both the Austin team and the team that’s from the base of Mexico in meetings this week on this very topic. So I will have better information in the near term than the past. But suffices it to say we expect them to start marketing. We are working more closely with them than ever on how we can jointly promote the products that are down there and the facilities that are down there and it’s our hope and our expectation that in the very near future they’ll start putting some effort into marketing these wonderful facilities that they have there.

Ryan Worst – Brean, Murray, Carret & Co.

Okay and then with your second smaller customer, about how many units did you have down there during the quarter?

Randy S. Cieslewicz

200.

Ryan Worst – Brean, Murray, Carret & Co.

200? Was that in the beginning of the quarter or about an average for the quarter?

Randy S. Cieslewicz

Yes they just have one site open as of today so the same 200 that they opened up in late calendar 2007.

Ryan Worst – Brean, Murray, Carret & Co.

Okay. And then can you talk a little bit about the charity market? It looks like one per day declined there. And then what you expect the profit margin to be on the revenue from Ontario?

Clifton

Okay on the first question Ryan our revenue for the charity market did go down because our primary customer converted to a player tracking system as of September 1st that we are not on. We certainly have plans to work with our customer and get on that player tracking system in the reasonably near future so that the patrons who are playing our game can accumulate player tracking points but right now players who are playing our games in those facilities don’t accumulate player tracking points so we are at a competitive disadvantage in that regard. In addition, to that our launch we do not have any five reel mechanical products in that market and there is a series of launches that will begin late in this quarter and continue throughout the end of our fiscal year of new products for all of the Alabama markets and we think that those new product launches will get our whole for day back up to where it was historically or better. So we remaining committed to the Alabama market and other charity markets and have specific strategies in place over the remaining quarters of the year to improve our hold per day. Randy if you’ll take the second question.

Randy S. Cieslewicz

The expected margin is about 30%.

Ryan Worst – Brean, Murray, Carret & Co.

And is that going to be recognized all at one time?

Randy S. Cieslewicz

When it’s completed and done.

Ryan Worst – Brean, Murray, Carret & Co.

Okay. Clifton how long before you get on to that player tracking system in Alabama?

Clifton E. Lind

Well that’s not certain at this point in time. We’re exploring a number of different options in that regard and certainly by the end of the fiscal year they’ll be some resolution to that.

Ryan Worst – Brean, Murray, Carret & Co.

Okay. And then can you quantify the Class III performance thus far in either Rhode Island or Oklahoma or both?

Clifton

Just saying that it is up to our expectations and we have every reason to believe that our games are going to be very competitive with any other games that are offered in either of those markets.

Ryan Worst – Brean, Murray, Carret & Co.

Okay. In Rhode Island, is there a certain threshold or performance requirement before you can increase the number of games there?

Clifton E. Lind

Yes they evaluate every quarter the performance of all the vendors. They use what they call the efficiency ratio which rates the earnings off of the vendor’s machines compared to the floor space that they have and the goal of course is to have an efficiency ratio greater than one. During the first evaluation we were in fact one of the two vendors that had an efficiency ratio of greater than one. So we’re going to be working real hard to build our presence not only at the one smaller facility we’re in but in other facilities in that state as well.

Operator

(Operator Instructions) We’ll pause for just a moment to all you to signal.

Clifton

Operator, while we’re doing that I would like to again return to a point that Randy touched on briefly and that is in late May we complete our funding obligation for the major facility in southern Oklahoma that we’re participating in the expansion financing for. When that happens we will we forecast that we will reach the maximum amount of our borrowings under our current bank facility; we currently expect that to be approximately $115 million and we believe that between that point in time and the end of the fiscal year it will be paid down measurably into the $90 million to $100 million range at the end of the fiscal year depending on other financing activities or other cap ex expenditures that are not on the horizon right now. So we do expect to make good progress in reducing our bank debt by the end of the fiscal year. Back to you, operator.

Operator

And there are no further questions at this time. Mr. Lind I’ll turn the call back over to you for additional closing remarks.

Clifton

I want to thank everyone for joining us on the call this morning. We believe that our efforts in FY07 and Q1FY08 created the foundation for 2008 to be a great year for us. Our new products are targeted at serving the stand alone gaming market while we continue to deliver technologically advanced offerings for server based gaming markets. We have a long history of opening up new markets and being the product innovator for those markets. We believe our new products will lead us into new markets in addition to enabling us to provide additional products and services for the existing markets. We will continue to focus on improving the yield of our installed base of over 14,000 recurring revenue units and we believe that we have the products and the tools that we need to significantly move the needle on the average hold per day in each of our markets. Accordingly, we believe that our historically slow first quarter now behind us and with continuing progress on our key initiatives we’ll begin to see tangible economic evidence of our success in the form of improving operating results during FY08.

Finally, I’d like to thank our talented staff for all of their efforts to secure a bright future for our company. Their tireless work in support of our operating initiatives is creating a solid foundation for our future success as we begin to demonstrate our ability to compete in the mainstreams of the gaming markets. I look forward to speaking with you again when we report our Q2FY08 results in May. Thank you operator that concludes our comments.

Operator

Thank you all very much for joining us today. That does conclude the presentation. Have a great afternoon.

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