Shuffle Master Management Discusses Q3 2012 Results - Earnings Call Transcript

| About: SHFL entertainment, (SHFL)

Shuffle Master (NASDAQ:SHFL)

Q3 2012 Earnings Call

September 10, 2012 5:00 pm ET


Julia Boguslawski - Director of Investor Relations & Corporate Communications

Michael Gavin Isaacs - Chief Executive Officer and Director

Linster W. Fox - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Secretary


Todd Eilers - Roth Capital Partners, LLC, Research Division

James Omstrom - JP Morgan Chase & Co, Research Division


Greetings, and welcome to the Shuffle Master, Inc. Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Julia Boguslawski, Vice President of Investor Relations and Corporate Communications. Thank you, Ms. Boguslawski, you may begin.

Julia Boguslawski

Thank you. Good afternoon, and thank you all for joining us today for our third quarter 2012 earnings call. I'm Julia Boguslawski, VP of Investor Relations and Corporate Communications for Shuffle Master. With me today are Gavin Isaacs, CEO; and Lin Fox, CFO. Today's call is being simultaneously webcast through our website, and will also be archived for the next 30 days. If you haven't done so already, please download the quarterly presentation accompanying the webcast as we'll be referring to specific slides throughout the call.

Before we get started, I would like to remind you that various remarks we make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under Federal Securities laws. Actual results may differ materially from these anticipated results. Please see today's press release and our other SEC filings for a complete discussion of risks that may affect our results. The company assumes no obligation to update any forward-looking statements as a result of any new information or future events.

We will also be discussing certain financial measures such as adjusted EBITDA, which is a non-GAAP measure. A definition and reconciliation of this and other financial measures we use and discuss can be found in today's earnings release, as well as our most recent Form 10-Q.

Now, I will turn the call over to Gavin Isaacs.

Michael Gavin Isaacs

Thank you, Julia, and good afternoon. Moving to the agenda for this afternoon's call, I will give some commentary about the highlights from the third quarter, Lin will then go through the key metrics, and then I will give a brief G2E sneak peek before we take any questions.

The third quarter results demonstrated that continued execution against our strategic initiatives is a successful formula for driving long-term shareholder value. Growing recurring revenue, international expansion and new product innovation, proving its value in the marketplace were the central themes of the quarter, helping drive $63.4 million in revenue, a record for Q3.

The foundation of our financial model remains recurring revenue streams, and this quarter once again demonstrated how fully committed we are to growing this key metric. Recurring revenue was approximately $30 million, up 12% year-over-year and represents the 15th consecutive quarter of growth. The MD3 is a big driver of that growth, exceeding our expectations as a superior replacement product.

Our Proprietary Table Games segment has steadily continued to create new recurring revenue opportunities, and the breadth and depth of our brands has never been better. The upgrades we are making to our games have just -- have been home runs, and in many ways, we are just getting started.

This was a notable quarter for our slot machine business in that it marked a significant installation into Asia, consistent with our strategy to grow the business internationally. The early success of our Asian-themed titles recently launched to G2E Asia confirms that the targeted investments in our business are working.

We are very pleased by the momentum we have generated over the first 9 months of this fiscal year. Q3 year-to-date revenue of approximately $186 million is up 14% year-over-year, and diluted earnings per share growth is 28%, excluding expenses incurred in connection with the terminated Ongame acquisition. What is even more encouraging to me is how we have achieved this growth and the many sources that have contributed to it within the year.

There were many significant operational highlights for the quarter which are summarized on Slides 4 and 5. Beginning with the Utility segment, we posted 8% year-over-year growth in the quarter with total revenue of $24.4 million. This performance was driven by increased sales activity, strong lease placements throughout the year and MD3 momentum. The sales came from a number of sources namely replacement of previously sold shufflers in Macau and approximately $2 million from several new openings in the U.S.

At the end of the third quarter, our total MD3 installed base was an impressive 1,381 units, up 431 units from last quarter with approximately 53% of the total base on lease. This quarter marked our largest quarterly install of MD3s on lease with 187 placements. Our MD3 rollout strategy has been a key driver of Utility growth since its launch a little over a year ago. And as of Q3, its contribution is approaching $1 million in recurring revenue a quarter. On a Q3 year-to-date basis, our average lease prices are up 4% driven by new shuffler leases and ideals ramping up to full pricing.

Recurring revenues in PT -- in Proprietary Table Games hit another all-time high of $12.4 million in the quarter, fueled by contributions from every category: Premium games, side bets and progressive upgrades. We grew our lease installed base of premium games, side bets, progressives and add-ons by 1,372 units year-over-year. These new additions will add approximately $2 million to our annual recurring revenue stream. 60 net placements of Fire Bet in the quarter underscores the success of our brand accumulation strategy and proves that our acquisitions are translating into growth. There are now 1,139 progressive upgrades and 341 add-ons contributing approximately $7.7 million in annual lease revenue on a trailing 12-month basis. These upgrades are a great example of innovating within the Table Games segment and creating more opportunities for recurring revenue from existing units in the field.

As we've previously communicated, our e-Table category is not performing at the level we know it's capable of. However, the next 12 months will be an important turning point for the business as we launch several new concepts and enhancements, some of which will be at G2E. Part of my confidence comes from positive reaction to our Rapid Fusion and widescreen cabinet, both recently displayed at G2E Asia and the Australian Gaming Expo. Notwithstanding, we did increase recurring revenue in e-Table's year-over-year by 2%, driven by solid performance of our Table Master units in Maryland and our Vegas Stars in New York.

In July, the Nevada Gaming Commission granted Shuffle Master one of the first unrestricted interactive licenses in the United States. We also recently received a license in Gibraltar and have established a small office there. These licenses reinforce our commitment to the online space and to being a B2B partner with our land-based customers. Development of our own state-of-the-art online content platform continues, whereby we'll offer our renowned brands, both for real money gambling and free-to-play.

Last but not least, our Equinox slot product continued its ongoing trend of strong performance in the third quarter. Results were driven by a number of factors including continued success in Australia, international expansion into Asia and demand for new product offerings such as our Super Topbox. We placed 150 units into the Philippines, marking our first significant installation of Equinox into a major Asian gaming market. We also have a handful of units with serious growth potential currently incubating in Macau. Although only in its first inning, our new multi-level link product jackpot product, DUO FU DUO CAI, made its debut in the marketplace after a very successful G2E Asia and initial performance has far exceeded our expectations. We installed 1,050 machines worldwide in the third quarter with the majority of units sold in Australia, including $3.5 million in sales from Victoria.

Additionally, the new Super Topbox drove approximately $1.8 million in sales in the quarter. This demonstrates that we have a winning strategy in place. Even in one of the most competitive slot environments, we have continued to prove that we are successful at making great games that players want to play. And at the Australian Gaming Expo held in Sydney 3 weeks ago, this was even more evident as we unveiled several new titles including one of the most exciting brands in our company's history. The launch of the iconic Flintstones theme was a major milestone for Shuffle Master, and it took center stage at the show, generating significant buzz from customers throughout the entire region.

What pleases me most about the performance of the slot machine business this quarter is what actually pleases me about Q3 in general, that success came from a multitude of fronts and underscored the strength of our diverse business model. The focus and commitment of our team has never been stronger. Contributions came from so many different categories such as recurring revenue, replacements, new product innovation, new openings, geographical expansion and product upgrades. The diversity and fundamental strength of our business model allows us to deliver impressive results to our shareholders, even when one of our product segments is not performing optimally, and that is a powerful mix that sets us completely apart as a supplier in this industry.

With that, I'll turn the call to Lin to go through the financial results.

Linster W. Fox

Thanks, Gavin, and good afternoon to everyone. On Slide 6, you'll see that total Q3 revenue was $63.4 million, and Slide 7 shows it was up 9% year-over-year. On an apples-to-apples basis without the effect of foreign exchange, revenue was up 12%. Diluted earnings per share were $0.18 as compared to $0.17 in the comparable quarter last year.

Turning to Slide 8, recurring revenue increased 12% year-over-year to approximately $30 million, another record for the company. Slide 10 is a map of our revenue distribution by geography. 55% of third quarter revenue came from outside the United States. Asia represented 13%, up from 7% in the year ago quarter. Gross profit in the third quarter was up $3.8 million year-over-year, or $4.8 million without the effect of foreign exchange.

On Slide 12, you'll see that continued strength from our slot machine segment drove approximately $20 million in revenue in the third quarter, up 11% year-over-year, or 18% without foreign exchange. Total installations of 1,050 units grew 20% year-over-year, largely driven by sales into Australia and new placements in Asia, Mexico and Latin America.

Slide 13 shows our Utility segment performance and highlights recurring revenue of $13.7 million, up 10% year-over-year. As of Q3 year-to-date, approximately 60% of the shuffler business was driven by recurring revenue, and our shuffler lease installed base is now 8,245 units, up 563 units year-over-year.

Moving to Slide 14. Q3 recurring revenue from Proprietary Table Games grew an impressive 17% year-over-year, and total revenue increased 18%. The increase was led by strong contributions from all categories: Premium games, side bets and progressives.

Slide 15 shows our Electronic Table segment, which as Gavin mentioned, is in the midst of a retooling. Recurring revenue grew 2% year-over-year to $3.6 million, but total revenue declined by 11% due to a decrease in sales revenue and lower average sales prices. Although sales unit volume was up year-over-year, product mix and geography negatively impacted ASPs.

Turning to Slide 16. Third quarter gross margin grew 100 basis points year-over-year to approximately 63%, reflecting improved margin in the Utility and PTG segments. Utility margin increased 580 basis points to approximately 63% due largely to the increase in shuffler lease revenue. The margin was also favorably impacted by sales of MD3s into Macau in the third quarter.

PTG gross margin grew by 290 basis points to 82% as a result of the $2 million increase in total revenue. At 34%, ETS gross margins were negatively impacted by reduced sales in the quarter and lower ASPs.

EGM gross margin declined 360 basis points to 60% due to lower ASPs driven primarily by our expansion into Asia and Latin America as these markets traditionally have lower ASPs. Some of the decline was also due to foreign exchange as a result of a strengthening U.S. dollar. To a lesser extent, import duties and freight expenses for leased units in Mexico and Latin America also contributed to margin decline. ASPs in our core Australia market were actually up about 3%, reflecting placements of our new Equinox cabinet with Super Topbox.

As to operating expenses, Slide 17 shows our R&D investment in third quarter grew $1 million year-over-year but remained relatively flat as a percentage of total revenue at 12%. The biggest driver of the increased R&D investment relate to the development of online platforms and versions of our table games for online, social gaming and mobile applications. New product development in Utility and PTG also contributed to the increase.

Third quarter SG&A increased $2.2 million year-over-year, largely driven by over $1 million in greater payroll and related expenses. These expenses were due to interactive gaming initiatives such as hiring a Chief Strategy Officer at the end of fiscal 2011 in addition to entering Gibraltar. Increased sales and profit-driven compensation also drove higher expenses.

Additionally, the final Ongame fees and due diligence expenses were $500,000. Excluding the Ongame expense, SG&A remained relatively flat year-over-year as a percentage of total revenue at 29%. Year-to-date, SG&A was also 29% as was the trailing 12 months.

In Q3, the foreign exchange impact on earnings was minimal. Foreign exchange created $970,000 less gross margin and $830,000 less operating expense year-over-year.

Excluding Ongame expenses, operating margin for the third quarter was 22% of our total revenue, flat from a year-ago quarter. For Q3 year-to-date, operating margin was 21%, up 150 basis points year-over-year. In addition to recurring revenue growth and strong cash flow generation, operating margin improvement remains one of our main areas of focus. Net income grew 14% year-over-year to $10.4 million and was a third quarter record.

Slides 18 and 19 show our adjusted EBITDA and free cash flow performance. Third quarter adjusted EBITDA of $21.2 million was up 9% year-over-year. Free cash flow or adjusted EBITDA less CapEx, less cash taxes was $11.9 million in the third quarter, down 15% year-over-year. This was due to an increase of $2.6 million in cash taxes paid in the quarter as a result of higher U.S. and Australian income taxes payable, and to a lesser extent, increased CapEx from interactive initiatives.

The effective income tax rate was 21.8% in the third quarter as compared to 28.1% in the year-ago quarter. The lower effective tax rate for the current quarter is attributable to deductible expenses per transaction costs related to Ongame. In the second quarter, these expenses were not deductible since the proposed stock transaction disallowed a tax benefit for the related transaction cost. However, since we did not proceed with the acquisition, the entire $2 million of Q2 and Q3 Ongame expenses are now fully deductible. The rate was also favorably impacted by the expiration of several FIN 48 tax liabilities. We now anticipate our annual effective tax rate to be in the range of 29% to 31%.

As to working capital, Q3 inventory turns of 3.2 is a 39% improvement from Q3 2011 turns of 2.3.

Slide 20 shows that inventory levels continue to be well managed, dropping by $6.7 million from a year ago.

At 76 days, our global DSO for the third quarter increased 6 days from Q3 2011, reflecting the popularity of our extended payment sales model in Australia. U.S. DSO went down by a day to 52.

Operating cash flow for the third quarter was $15.3 million as compared to $20.2 million year-over-year. The decrease was mainly due to paying more cash taxes as previously discussed.

Moving to Slide 21. At $6.4 million, third quarter capital expenditures were $1.2 million higher year-over-year largely due to increased PP&E. Most of the increase came from internally developed software for Ongame -- sorry, online initiatives, and roughly $250,000 was attributable to our new consolidated facility.

For the 9 months ended July 31, 2012, our CapEx was relatively flat year-over-year at $21 million. We continued to generate cash and for the first time in 8 years, we had 0 net debt. We had availability of approximately $186 million under our revolver, and our leverage ratio was negligible, remaining well below our bank threshold of 3.75.

As our balance sheet clearly demonstrates, we have the financial flexibility that enables us to invest in the business and continue to evaluate compelling gross -- growth initiatives including acquisitions. Our focus is to invest wisely in strategic ideas that will drive profitable growth.

And with that, I'll turn the call back to Gavin.

Michael Gavin Isaacs

Thanks, Lin. Before we take questions, I'll give a quick preview of our G2E lineup. For each product segment, we will display a full arsenal of new and exciting innovation. Our booth will serve as a powerful visualization of what Shuffle Master does best, and that is deliver value to our customers on so many different levels and with so many different solutions.

One of our key characteristics as a gaming supply is our deep IP-rich portfolio designed to drive greater entertainment, security and productivity on the floor.

One of our initiatives within the organization is to improve our product planning process and strive for more structured product rollouts. I'm proud to announce that we will be showing a next-generation shuffler at the show, despite the fact we unveiled the MD3 at G2E last year. The team worked tirelessly to be able to showcase the new DeckMate 2 poker shuffler this year. Based on the success of the MD3, we feel confident that the DeckMate 2 will be met with enthusiastic response from our customers. Like the MD3, the Deck Mate 2 will now incorporate our proven Optical Card Recognition and its shuffle time is twice as fast as its predecessor.

Every year, we introduce new and exciting specialty table games that generate lots of attention at the show. This year will be no exception. In addition to new poker derivative titles and current twists to our existing game portfolio, we are debuting several intriguing blackjack side bets. Based on initial customer reaction, one game in particular, House Money, has the potential to become a staple in the blackjack pit.

We will also be showcasing new technology in our progressive category, a clear demonstration that we haven't stopped challenging the status quo and we continue to explore ways to make our specialty table game offerings more compelling. With over 25 new and proven titles on display this year, our slot machine lineup will showcase our growing success in competitive locals markets. Our single cabinet video strategy and deep portfolio of content positions us to continue gaining floor share in a growing number of markets around the globe. Our interactive corner is sure to generate heavy traffic with multiple new games available in various play-for-free and play-for-fun formats.

And last, our e-Table lineup will reflect the talent and the commitment of our R&D team. We will unveil what we consider the most significant iteration of the Rapid product line with upgraded hardware and software completely modernizing the experience, from both an aesthetic and functional point of view, we are confident that the new Rapid Fusion is a highly competitive and superior e-Table innovation.

With less than a month to go, we are ready for a great show, and I think it's clear that we have some serious innovation in our pipeline and powerful momentum in the marketplace. The company is functionally (sic) efficiently and effectively, never taking our eye off the ball when it comes to creating long-term, sustainable growth for our shareholders. My job as CEO and that of my entire management team, is to optimize every resource to hone our competitive advantages and deploy them against the most significant opportunities, and there are many. We will continue to provide you with an update on these opportunities during our next call.

I'll close by thanking our shareholders and the Board of Directors for their support and the great team at Shuffle Master, whose strong work ethic and positive attitude make coming to work every day a true pleasure.

With that, we will now take questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Todd Eilers from Roth Capital Partners.

Todd Eilers - Roth Capital Partners, LLC, Research Division

I wanted to ask on the EGM segment, the 150-unit sale in the Philippines, was that a new opening or an existing casino? And then can you maybe also give the total number of games placed outside of your core kind of Australia, New Zealand markets for that business?

Michael Gavin Isaacs

Yes, sure. The 150 were to an existing customer. In fact, it was PAGCOR, who distributes in most of the venues over there. In relation to the numbers -- Julia, did we not give that in the call there?

Julia Boguslawski

So really that was the big international placements, sort of the ones in the Philippines, and really most of the units still came from Australia. There was a small number of new units on lease in Latin America, I think about 30 or so. And then a handful in Macau that went on lease, but really the majority of rest of the units were from Australia.

Todd Eilers - Roth Capital Partners, LLC, Research Division

Okay, great. And then also wanted to ask about the Victorian market. Looks like if I kind of make the right assumption for an ASP for those units or that business in the quarter, looks like you guys placed or sold about 175, 180 units versus, I think, you had a little bit more last quarter in the neighborhood of maybe 280 or close to 300. I don't know if those numbers are exactly right, but it looks like it was a little bit less than what I would have thought as you kind of penetrate that market. Was there any reason why that might have been a little bit lighter this quarter? And I guess what are the expectations going forward for that market in Australia?

Michael Gavin Isaacs

Well, likely our customers don't think in quarters, it's only the financial markets do. Clearly, in Victoria, they were all waiting for the AGE. Every customer in Australia really waits for the AGE to see what's new and that was last month. So yes, they'll be part of it resulting in that. There's also the ending of the Tabcorp and the Tab's [ph] purchase agreements, which now are finalizing. So a lot of customers are waiting until there's no outstanding obligations to those companies. But we've sort of anticipated this quarter to be a bit lower in Victoria, and we expect it to jump back up this quarter.

Todd Eilers - Roth Capital Partners, LLC, Research Division

Okay, great. And then can you -- you mentioned launching the new DeckMate 2. Can you give us a sense for what the opportunity there is in terms of what's the installed base of, I guess, the first generation of product there? And how much of that was previously sold and how much of that is on lease?

Julia Boguslawski

Yes, Todd. There -- the DeckMate shuffler, we've got about 7,100 that we have installed to date with about 27% of those on lease. So that's not to say we would get 100% of all of those units that have been installed, but it's a really great opportunity, again, for existing sold shufflers in the field and opportunity for us to turn them into new recurring revenue units.


[Operator Instructions] Our next question comes from the line of James Omstrom from JPMorgan.

James Omstrom - JP Morgan Chase & Co, Research Division

Gavin, I guess just starting with the Shuffler segment, taking a look there. I notice, if I look at the -- just the lease installed base, you had a nice jump year-over-year. But looking sequentially, I think what surprises me a little bit is a slight decline. Could you just explain what happened there, and I guess what you're seeing?

Michael Gavin Isaacs

Sorry, I don't believe there was a decline. I think that -- sorry...

Julia Boguslawski

Yes, shufflers.

Michael Gavin Isaacs

Sorry, when we go to shufflers. I think what you're looking at -- if you're looking at the end of Q2, I think we might have misstated previously the unit number. Obviously, no difference in revenue. But the actual number was 8,101 at the end of Q2, and we've jumped to 8,245. I think there may have been a accounting error at the end of last quarter, if that's what you're referring to. But there's definitely not been a decline, it's been an increase.

James Omstrom - JP Morgan Chase & Co, Research Division

Okay. That explains it, yes, The number in the Q was 8,261.

Michael Gavin Isaacs

Yes. Yes, I think that's right. We think we picked that up, but it was not -- it had no change on revenues.

James Omstrom - JP Morgan Chase & Co, Research Division

Okay. And then I guess important -- just a bigger picture question, free cash flow, at least according to our estimates, continues to grow. Debt continues to be paid down and you're net cash positive at this point. I guess what are your cash priorities or uses of cash at this point? How do you view that?

Michael Gavin Isaacs

Okay, that's a great question. So the first priority would be to invest in our business. We believe we have some great organic opportunities. And accordingly, we're investing where appropriate. And I think, as you can see, when we decide to invest in R&D, in say, for example, our EGM business, we get results. We're hoping to show some results in the next 12 months coming from our e-Table business. And we actually increased a bit of R&D expenditure both in Proprietary Table Games on the progressive side and also on the Utility side. So I guess -- and that's not a major use of our sources, but it is an important one. We will continue to invest in our business to take advantage of the organic opportunities. But I did leave out there the new business, which is the interactive, which with the opening of places like the Gibraltar office and adding additional R&D resources internally, it's something that we have to factor for. I guess the second use of our sources is that we continually look for acquisitions which can assist us in growth. That seems to be a priority, it's favored by our shareholders and certainly our board and myself. And then finally, if we still have a surplus of funds or if we can't find the appropriate acquisition, we'll then look at the appropriate method of returning that excess capital to our shareholders.


There are no further questions in the Q&A at this time. I'd like to hand the call back over to management for closing comments.

Michael Gavin Isaacs

Well, thank you all again for your support, and we look forward to speaking to you all again soon and hopefully seeing you all at G2E. Thank you.


Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.

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