Bally Technologies, Inc. F3Q08 (Qtr End 03/31/08) Earnings Call Transcript

Bally Technologies, Inc. (BYI)

F3Q08 Earnings Call

May 12, 2008 4:30 pm ET

Executives

Richard Haddrill – President, Chief Executive Officer

Robert Caller – Executive Vice President, Chief Financial Officer, Treasurer

Gavin Isaacs – Executive Vice President, Chief Operating Officer

Ramesh Srinivasan – Executive Vice President, Bally Systems Division

Analysts

David Katz – Oppenheimer & Co.

Steven Kent – Goldman Sachs

Amir Markowitz - JP Morgan

William Lerner – Deutsche Bank Securities

Steven Wieczynski – Stifel Nicolaus & Co.

Presentation

Operator

Welcome to the Q3 2008 Bally Technologies, Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Richard Haddrill, Chief Executive Officer.

Richard Haddrill

Welcome to Bally Technologies’ third quarter fiscal 2008 earnings call. We are again pleased to report record revenues and earnings. With me today are Gavin Isaacs, our Chief Operating Officer; Ramesh Srinivasan, Executive Vice President of Systems; Robert Caller, Chief Financial Officer and Treasurer; and Neil Davidson, Vice President of Corporate Accounting.

First Robert will review the Safe Harbor language and cover our financial results. Then Gavin and Ramesh will discuss the highlights of each of the games and systems business units and then I’ll have some overall comments and financial guidance. We will then open it up for some questions.

Robert Caller

First I would like to review our Safe Harbor language. Today’s call and simultaneous web cast will contain forward-looking statements about Bally and our future business. These forward-looking statements are based on currently available information. Actual results could differ materially from those anticipated in the forward-looking statements and reported results should not be considered an indication of future performance.

More information on factors, risks and uncertainties that may affect our business and financial results, or may cause us not to achieve our forecast are included in our annual report on form 10K for the period ended June 30, 2007 and other public filings we have made with the Securities and Exchange Commission.

The forward-looking statements made on this call and web cast, the archived version of the web cast and any transcript of this call speak only as of this date, May 12, 2008. Today’s call and web cast may include non-GAAP financial measures within the meaning of Regulation G. A reconciliation of all such non-GAAP financial measures to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found in today’s press release.

Now for the financial results. Today we reported record financial results for the third quarter of fiscal 2008. Total revenues increased to $233 million, a 33% increase from the prior year period. We recorded strong revenue in all three of our gaming lines of business. Revenues from systems were exceptionally strong again this quarter, increasing 85% to $57 million as compared to the prior year period and consistent with the December quarter.

We also reported significant increases in revenues in both gaming equipment sales, which increased to $103.7 million, a 20% increase over the prior year period and gaming operations which increased to $59 million, a 32% increase over the prior year period. Net income for the quarter was $30.2 million or $0.52 per share on a fully diluted basis as compared to net income of $0.12 per share on a fully diluted basis in the comparable prior year period.

Adjusted EPS which adds back the effect of share based compensation was $0.56 per share in the current quarter. Adjusted EBITDA was $74.2 million, a 104% increase as compared to the same period last year. Operating income increased to $54 million in the current period or 24% of total revenue as compared to $18.4 million or 10% of total revenue in the comparable period of the prior year.

The 20% increase in gaming revenues was driven by an increase in game sales. During the quarter we recognized revenue on 6,742 games as compared to 6,032 in the comparable prior year period, a 12% increase. Our average selling price (ASP) increased slightly during the quarter as compared to the first two quarters of this fiscal year largely due to the impact of product mix, a price increase and smaller discounts.

As of March 31, 2008, all games we have shipped to date to Oregon have been deferred to future periods. We expect to begin recognizing this revenue margin in either Q4 of fiscal 2008 or the first quarter of fiscal 2009. Margins on new game sales for the quarter were 44% which were the same as the margin in the December quarter. The improvement in our game sale margins over the past twelve months has been significant from 35% in the prior year period to 44% in the current period.

During the quarter we recorded a $900,000 inventory charge associated with the consolidation of our European inventories. We continue to focus on improving our game sale margins and expect several points of improvement over the next 6 to 18 months.

The increase in our systems revenue and the backlog in our systems business continue to be strong. Revenues in the quarter increased 85% to $57 million reflecting an increase in the [inaudible] of a number of new system installations, sales of new products such as the iView player, communication units and related software products and the continued increase in our maintenance revenue to $10 million.

Margins in the system business this quarter remained in our target rage of 70% to 75% but decreased slightly from recent quarters to 71% due to the increased sales of hardware versus software. Hardware has a higher cost of goods sold than software.

Our gaming operations business also reported very strong results. Revenues in gaming operations increased 32% to $59 million from the prior year quarter and $5 million from the December quarter. Revenues in gaming operations were significantly higher than in the prior year and in the December quarter due primarily to increases in the install base of rental and daily fee games and the popularity of our premium games.

Gaming operations margins were 70% in the current quarter which is significantly higher than the 58% margin recorded in each of the comparable periods of the prior year and in the December quarter driven by the increases in our premium daily fee games and favorable jackpot expense. We expect future gaming operations margins to typically range between 65% to 70%.

SG&A expenses increased 18% to $60.4 million for the quarter as compared to $51.3 million in the prior year quarter but declined as a percent of revenue to 26% from 29% last year. SG&A was consistent with the December quarter.

In the current quarter the company won table litigation against IGT and Shuffle Master and settled certain liabilities related to Mind Play. The settlement resulted in a reduction of approximately $2.7 million in SG&A.

Research and development expenses increased 20% to $15.1 million for the quarter as compared to $12.5 million in the prior year period. We continue to derive significant benefit from our Indian development centers.

Now to the balance sheet. As of March 31, 2008 we had cash of $36 million. During the quarter we repurchased 280,000 shares of our common stock for $10.7 million at prices ranging from $33.15 to $41.25 per share. Year to date we have purchased approximately 429,000 shares for $16.7 million and paid down debt by $25 million. We have $64.3 million remaining under our authorized share repurchase plan and expect to utilize more of this authorization from time to time.

Inventories increased slightly to $91.2 million as of March 31 from $90.1 million at December 31, 2007. Revenues grew to $217.7 million from $190 million at December 31. However our aging percentages remain consistent.

Now I’ll turn the call over to Gavin for some more discussion of gaming equipment and gaming operations results.

Gavin Isaacs

As Robert discussed we are extremely proud of the revenues derived from the sale of our gaming devices and from our gaming operations during the quarter. Our revenues from the sale of gaming devices increased 20% to $104 million as compared to the comparable period in the prior year. During the quarter we shipped approximately 6,100 units to customers in North America which include units to Oregon for which revenue was deferred.

This reflects the continued strength of our alpha-based products in this difficult replacement cycle. We estimate that our North American ship share in the quarter was in the low 30’s up from the mid to high 20’s in recent quarters and up significantly from recent years. Year-to-date the split between our mechanical reel and video games in North America is about 50/50. This increase in video products reflects our continuing improvement in this important segment of the market and we are continuing to focus on improving these offerings.

We were also especially pleased with the increased results from our international operations. New unit sales to international locations increased to over 1,600 units or approximately 24% of our unit sales recognized in the quarter. This compared to approximately 900 units in the same period last year and approximately 1,000 units in the December quarter.

International sales continue to grow as a percentage of revenue. Our 44% margin on game sales remained flat during the quarter as compared to the December quarter. While our used day margin on game sales of 45% is significantly improved over the 34% recorded in the comparable period of the prior year it remains an opportunity for the company. Margins in the current quarter were impacted by approximately $900,000 in inventory charges associated with the consolidation of European inventories.

The company continues to focus on improving purchasing and manufacturing efficiencies related to a single game platform. Engineering efforts increased volumes and pricing effectiveness based on strong game performance and better management of software. Our goal is to increase our margins on game sales to the high 40’s over the next 6-18 months.

Our gaming operations results were also very strong with revenues increasing 32% to $59 million as compared to last year. Gaming operations revenue increased $4.8 million or 9% from the December quarter. Our margins on gaming operations were also very strong at 17%.

The increase in margin is attributable to increased rental and participation revenue in the current quarter with minimal incremental cost of goods sold and a favorable jackpot expense when compared to the December quarter. Rental and daily fee games increased 6,461 units to 12,377 units at March 31, 2008, a 109% increase from March 31, 2007 and an increase of 3,087 units from the December quarter.

Half of this increase was the result of the conversion of approximately 1,500 class II to class III games in markets like Florida, Oklahoma and California. The balance was related to the increase in placements in our premium games including Hot Shot progressives, Real Winners and Millionaire 7’s.

We are obviously keeping our eye on developments in the economy and the impact it is having on casino operators as we look forward to Q4 and fiscal 2009. We expect the replacement market will remain sluggish next year but are optimistic that the growing acceptance of our products in the market and our relatively small but growing in full base will benefit us as compared to others.

Now I will turn it over to Ramesh who with his systems team have again hit another 6.

Ramesh Srinivasan

Six in Cricket is equal to a home run. We recorded another excellent quarter with our systems revenues at $57 million which is an increase of 85% over the corresponding prior year period. In addition, the backlog in our systems business continues to be strong. These results are consistent to the revenues we recognized in the December quarter. This increase resulted from a number of key go-live during the quarter as well as continued increases in our maintenance and services revenues.

Over the past 18 months we have executed more than 100 major go-live which include major new installations and upgrades with our customers averaging well more than one per week. This is a good commentary on our market momentum and our continually increasing ability to execute well.

The cumulative number of iView player communication units purchased and commitments to be purchased as of March 31, 2008 now add up to approximately 111,000 and continue to validate our evolution of referral gaming network [inaudible] of the future strategy.

Systems revenue related gross margins declined slightly to 71% from 73% in the December quarter primarily as the result of increased hardware versus software proportion in the revenue for the quarter. We continue to expect future systems margins in the range between 70% to 75% depending on the product mix. The higher proportion of software versus hardware the higher the margins will be.

Maintenance revenue has increased to $10 million for the quarter and we are currently on a run rate for maintenance revenue to exceed $40 million for fiscal 2008. As we install more systems we expect our maintenance revenues will continue to increase. With a larger installed systems footprint our opportunity to sell up newer products as well as services will also grow. These newer products are mostly software based and are expected to be very profitable.

We are seeing strong customer interest in our integrated business intelligence solutions due to be released in the June/July time frame and our recently re-designed and released Table View product.

We will be releasing the 11.0 version of each of our products during the coming months. Many of these releases have involved major re-engineering exercises enhancing our previously well established products into state of the art technologies and provide new strength like vertical and horizontal scale ability and internationalization while maintaining the functionality, breadth and depth they have always been known for.

The 11.0 version of SDS due to be released in August will enable SDS, the industries leading Unix based slot system, to run on both Unix and Windows platforms based on a single code base thereby creating a new opportunity for us to penetrate the small to medium casino segment more effectively.

All our new releases will include the newly designed and created Bally integration gateway that will make interoperability between systems much easier than before and provide value with another competitive advantage in this area.

On behalf of the systems team I am very pleased, proud and excited with what we have accomplished in systems over the past three years and with these upcoming products releases we will become a truly world-class enterprise software technology company, something unique in the gaming industry.

Now let me turn the call back over to Dick.

Richard Haddrill

Since our last call there have been a number of exciting developments for Bally. First we are extremely proud to again report record revenue and profits and good momentum for the future.

Second, we have made significant progress in our industry leading position in systems and the network for the future. For example, a customer communication network like iView is now considered a must for any new casino and at our user conference in February we announced the enhanced iView DM (picture-in-picture) which is being met with great customer interest. Further, casino industry thought leaders like Pachanga switched their systems business to Bally and had a successful go-live this quarter. The Verona casino, which has piloted server, based gaming technology for three years, recently committed to Bally’s iView network and bonusing software.

Also during the last three months we announced significant systems partnerships with Foxwoods, the nation’s largest casino, and Sands Bethworks. These all serve as strong endorsements for our products, our ability to deliver and our overall direction.

Third, innovation is not just exemplified in our systems business. The continued positive growth in our gaming operations placements and revenues and gaming inter-chip share are solid evidence that our culture of innovation is thriving across Bally. Our overall R&D personnel at March 31 increased by 47% from a year ago to over 1,100 employees and this represents almost half of our non-casino employees. With these additional resources we are efficiently and effectively driving continued improvements in product quality and innovation.

We continue to focus on practical and executable technologies that provide our customers with benefits today and a clear path to the network floor of the future.

Fourth, regarding intellectual property we are very pleased but not surprised by the recent District Court of Nevada’s summary judgments in Bally’s favor on long-standing table technology patent litigation with IGT and Shuffle Master. This ruling underlines Bally’s commitment to sound intellectual property and willingness to vigorously defend ourselves against meritless claims.

As a major technology innovator and provider, Bally has a healthy respect for the importance of our own IP and the legitimate IP of others. However, we believe last year’s Supreme Court KSR decision is adding increased rationality to the application of IP and patent proliferation which is particularly rampant in gaming. I should also add that we remain very confident in our position in the Wheel litigation.

So Bally is well positioned for the future. We have several dynamics that we believe will allow our revenues to grow faster than the market. We expect to benefit from a growing install base of gaming operations units, a historically low base of Bally products in North America, expansion into new international markets and a growing base of systems customers who will buy our newer products and services and generate increased maintenance fees.

We also expect further improvement in both game sale margins and our operating leverage in fiscal 2009. So currently we expect revenues for the fiscal year ending June 30, 2008 to exceed $885 million and fully diluted earnings per share to be in the range of $1.78 to $1.90. We also currently expect fully diluted earnings per share for our fiscal year 2009 to be in the range of $2.10 to $2.50.

However, we caution investors that our guidance for fiscal 2009 is based on our overall view of business today and on economic conditions which remain uncertain. In addition, our guidance is based on certain assumptions about our new product introductions, competitor product offerings and customer buying patterns and we do expect some normal seasonality in the operating results of fiscal 2009 with the first half of the year having somewhat less earnings leverage than the second half of the year.

In closing, I would like to thank the management team and employees of Bally for their tremendous efforts that continue to propel us as leaders in the industry. We thank our investors for your confidence and support.

With that, I’d like to open it up for any questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from David Katz - Oppenheimer & Co.

David Katz – Oppenheimer & Co.

With respect to Washington State, you made some commentary in one of the footnotes, I believe on Page 4 of the release, Footnote 2, where you talk about daily fee revenue from approximately 9,100 units including centrally determined systems. Should we be thinking about that as Washington State and is there an expectation as to when that revenue is recognized?

Richard Haddrill

We will recognize the revenue for Washington state in Q4. There are other units that are not related to Washington state related to another major gaming jurisdiction that we would expect to begin recognizing in Q1 of 2009.

David Katz – Oppenheimer & Co.

What was the EBITDA for the quarter in Vicksburg?

Richard Haddrill

We don’t disclose that number David. Although it runs for an annual basis on about the $20 million range.

David Katz – Oppenheimer & Co.

If you could just reiterate your commentary on SG&A and should we look at the March quarter as a run rate going forward? Again, if you already commented on that in your next year’s guidance, if you could flush that out a little bit I’d appreciate it.

Richard Haddrill

David the March quarter did have the favorable impact of litigation settlement so we would expect the run rate to be a little bit higher than that as we head into Q4 and fiscal 2009.

David Katz – Oppenheimer & Co.

The amount higher was about $3.5 million? Is that right?

Richard Haddrill

The litigation settlement and resolution of issues with Mind Play was about $2.7 million.

David Katz – Oppenheimer & Co.

Lastly, gross margins on unit sales, where do you have a long term target in mind as to where you can get on those? It is obviously a question that comes up every quarter but what are the updated thoughts as to what you think you can really get that to and what time frame?

Richard Haddrill

We believe we can get those game sale margins into the high 40’s in the next six to18 months. Longer term we hope we can do even better than that. But we can see a path to get into the high 40’s in a manageable time frame.

David Katz – Oppenheimer & Co.

The deferred revenue balance that you have that is growing regularly, how should we look at that in terms of the time over which you expect to recognize it? Is that one quarter out; is it two quarters, three quarters?

Richard Haddrill

It is split between current and long-term on the balance sheet. The current deferred revenue we would expect to recognize in the next twelve months. The long-term between 12 months and four to five years out. We look at it as just an increasing, even though it is classified as a liability, really as an asset to the company in that it gives us greater visibility of future revenues and it allows us to have bookings and a very conservative approach to our accounting over the last year or two.

It is hard to project whether the balance of deferred revenue will go up or down over the next year but we are guessing it won’t go up at quite as fast a rate in the future year or two as it has this past year.

Operator

The next question comes from Steven Kent - Goldman Sachs.

Steven Kent – Goldman Sachs

Dick, maybe you could just talk about the strategy of the wide area progressive games. That seems to be moving around a little bit more. Especially as you see yourself going against W [inaudible] who is surging on wide area progressive and as always IGT. What is your general strategy there on that part of the business?

Gavin Isaacs

In the wide area progressive category apart from some products we still have in New Jersey we are primarily focused on our Millionaire 7’s and our Quarter-Million Links. Millionaire 7’s traditionally a dollar game under the F6000 platform has been moved into the penny with the same max bet characteristics. It is growing quite well. The win per day has increased a lot as we have invested in that product and our placements are improved.

Our Quarter-Million strategy will start to roll out late this quarter/early next quarter as we begin to improve in that. So we see this as an important part of our business and it is an area we are investing in. The Millionaire 7’s will be our premier product at the moment.

Richard Haddrill

I think it is safe to say we put a lot more investment in the last three years in daily fee games than wide area progressives which has been just a recent investment in R&D that we are very optimistic about as we go forward into 2009.

Operator

The next question comes from Amir Markowitz - JP Morgan.

Amir Markowitz - JP Morgan

In the game ops business the 70% margin this quarter but said you expect 65-70 going forward. Was there something one-time? Was it related to the jackpot expense? Why was that at the end of the high end of the range?

Richard Haddrill

There is a bit of a seasonality factor. The December quarter has been historically a lower season for us. March has been historically stronger. That was coupled with in the December quarter some unfavorable jackpot expense. So as we go forward we are being prudent to forecast 65-70% with the view that we will have some jackpot hit and seasonality may not always be as strong as March. On the other hand our growing base of games does allow us to have operating leverage so we are reasonably optimistic we can be in that 65-70% margin.

Amir Markowitz - JP Morgan

In your game ops business have you seen any impact from the slowing consumer? It is hard to tell because you have been growing your base pretty significantly. If you look at a same-store number if that is possible have you seen any impact from a slower economy?

Richard Haddrill

Amir we have about half of our gaming ops premium revenue related to games that are on daily fee as opposed to rev share. So in that regard we are somewhat less susceptible to actual game play than some of our competitors. Nevada we might be seeing a little of that impact you are referring to but much less so in the rest of the country.

Operator

The next question comes from William Lerner - Deutsche Bank Securities.

William Lerner – Deutsche Bank Securities

Could you give us a sense for approval time lines for iView BM and then in the next two quarters, the June and September quarters, the way we track this we have something like 14-15,000 new domestic units coming on line in each of those periods. Clearly that is embedded somewhere in your guidance here but what has been the experience? Are people ordering closer in? There was talk a while back about some products being delayed or cancelled although we haven’t seen much on that lately. I’d like to get some color around that.

Richard Haddrill

First, on the iView DM our view there is that we will have that out in a commercial test in the July/August time frame and commercially available in certain Native American and possibly GLI jurisdictions by September/October. Some of the larger jurisdictions could be several months after that. So that is the time frame for iView DM.

Gavin Isaacs

Bill, we see the casino openings for 2009 being slightly less than 2008. Obviously at this stage we can pretty much track when each of those openings is coming up. Most of the casinos that are opening are already working with their vendors and doing the collections so I’m not quite sure on your numbers but certainly we factored them in for next year.

Richard Haddrill

It is clear that as we look at 2009 we are remaining cautious about the economy. If we had been doing our 2009 forecast six months ago it would have been more robust.

William Lerner – Deutsche Bank Securities

On the new units stuff, what is implicit in your guidance? Is it maintaining this new level of market share or is there some other contemplation?

Richard Haddrill

Our view is that we have had pretty good success here in this particular quarter. As we did our 2009 guidance we were looking at what we had done over the last 9 to 12 months more than what we did just in one quarter. So, we were looking at something in the mid to high 20’s as opposed to something in the 30’s.

Operator

You have a follow-up question from David Katz - Oppenheimer & Co.

David Katz – Oppenheimer & Co.

In some of the channel checks we have talked to slot managers about your product and we get a bit less enthusiasm about the video relative to the mechanicals. Gavin if you could maybe update us on where you are and what you expect for the next few quarters in getting that video product along?

Gavin Isaacs

There are three parts of that. First of all this year we are almost 50/50 with video and [inaudible]. Now we are in many areas regarded as the leaders in the mechanical reels [inaudible] and accordingly therefore our video gets compared to that. So there is a little bit of that.

The other thing is we recognize our video hasn’t been as strong as it needs to be and we see that as a huge opportunity for us and it is something we are working on. You’ll start to see around the mid-year period new ranges of video, new games. Still volatility closer to what the market seems to be expecting coming out and we are beginning to utilize our Indian development centers to help us get more product to the market in those categories quicker. So we see it as a big opportunity.

Richard Haddrill

Gavin if I could just add the 50/50 is our North American split. Internationally it is a greater video content so we are doing well in video but I think compared to our stepper in our own standards we can do even better and as Gavin said we are excited about that.

Operator

The next question comes from Steven Wieczynski - Stifel Nicolaus & Co.

Steven Wieczynski – Stifel Nicolaus & Co.

Just when you are looking through your Q right now and listening to the call when you talk about your international growth, I think it is at 24% of the units sold during the quarter, can we just get a little more color in terms of which markets you are seeing some pretty good growth in?

Richard Haddrill

It’s not just units in the systems business we are doing well internationally. South America probably represents our strongest growth here in recent quarters but we’ve entered Eastern Europe, South Africa and we opened our office in Macao a year and a half ago. So we have a lot of places to grow internationally. Our forecast for 2009, for example, includes international growing faster than North America and yet still doesn’t have us entering Australia which is a huge market.

So South/Central America, Eastern Europe, we are doing well in Western Europe and South Africa and Asia are all kinds of engines of growth. Gavin?

Gavin Isaacs

We said in the last several months that we were investing in international. Across the board we have put better managers and better infrastructure to support the business and we’re just beginning to see the benefit of that now.

Steven Wieczynski – Stifel Nicolaus & Co.

Bob, what was in the other income line?

Robert Caller

Other income is our interest income and expense, our foreign currency translation gains and losses.

Operator

There are no further questions at this time.

Richard Haddrill

Again thanks to our investors for your interest and patience. Again a big thanks to our customers and employees for the continued great momentum at Bally and we are excited about our future. Thank you.

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