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Cryptologic Limited
2000 2nd Quarter Results Conference Call
July 27, 2000 - 11:30 a.m. EST
Operator: Good morning, ladies and gentlemen. Welcome to the Cryptologic Limited second quarter 2000 results conference call. I would now like to turn the meeting over to Mr. Andrew Rivkin, President and Chief Executive Officer of CryptoLogic. Please go ahead, Mr. Rivkin.
Andrew Rivkin: Thank you. Welcome everybody to our second quarter 2000 conference call. My name is Andrew Rivkin. I'm the President and CEO of CryptoLogic. Today I'm joined by Mark Rivkin, COO and Executive Vice President, Harvey Solursh, Chief Financial Officer, Jenny Solursh, Senior Vice President and Nelson Lee, Director of Finance. CryptoLogic continues on a profitable path. Today we wish to review our performance for the second quarter 2000. Afterwards we would be happy to answer any questions.
For the three months ended June 30th, 2000, total revenue increased to $9.1 million, which is up 15% from the same second quarter of 1999. Please note that all figures are in U.S. dollars. Our net income for the quarter was $4.7 million, which compared to $4.9 million in 1999. On a fully diluted basis earnings per share were $0.31 for the second quarter of 2000 compared with $0.32 in 1999.
For the six months ended June 30th, 2000, our revenue rose 11.7% to $18.1 million, which compares with $16.2 million in the prior year. Net income was $8.8 million for the first half of 2000 versus $10.3 million in 1999. As a result, earnings per share for the first half of 2000 were $0.74 compared with $1.21 in 1999. On a fully diluted basis earnings per share were $0.58 versus $0.57 in 1999.
As expected, we recorded revenue growth in the second quarter of 2000 and continued our trend of profitable performance. During the quarter, CryptoLogic continued to invest in development and infrastructure initiatives that are key to our long-term growth and market leadership. As a result, net margins were 51%. This is in line with expectations for 2000 given our focus on enhancing our resources and technologies and supporting our growing licensee base.
The latter half of 2000 is expected to realize strong growth performance, particularly as we benefit from the contribution of major land-based licensees. And our growth prospects for the balance of the year continue to be promising on the international front.
CryptoLogic continued to strengthen its cash position, now at $40 million at the end of the second quarter. Also during the second quarter, we renewed our share buyback program. We have purchased approximately 182,000 shares in the second quarter, reinforcing our view that our common shares offer excellent investment opportunities. We continue to see benefits from our growing international licensee base. We expect to continue our international penetration given the new launch of Thunderbird's Internet casino in July, the addition of new licensees in South America and Australia subsequent to the quarter, as well as other opportunities that we are currently pursuing in foreign markets.
CryptoLogic's hallmark has been a profitable business model and success in signing brand name licensees from around the world. With this proven strategy, we will continue to thrive as the premier software provider to the world's leading gaming organizations and the fast-growing Internet gaming industry. We'd now be pleased to take any questions.
Operator: Thank you. We will now poll for questions. If you have a question, please press 1 on your touch-tone telephone. If you are using a speakerphone, please lift the handset first and then press 1. And should you wish to cancel your question, please press the number sign. Please press 1 at this time if you do have a question. There may be a brief pause while the participants register for their questions. Thank you for your patience.
Operator: And our first question will come from Peter Swan from Pacific Growth Equities. Please go ahead.
Peter Swan: Hi folks. I hope you all are doing well today. Numbers look decent. Could you give us some color on your international mix this quarter? I'd like to get a feel for how the overall business is breaking down and how important North American customers are.
Andrew Rivkin: In terms of the international mix, William Hill continues to help in that area. We've decreased to about 62% from about 65% at the beginning of the quarter.
Peter Swan: Okay. And then one additional follow-up question. Can you give us an update on 4.0?
Andrew Rivkin: Sure. Just one other comment. I think that International Thunderbird marketing in South America as well as our new Australian licensee will also help the international mix. In terms of 4.0, the software was released to our largest licensee in June. We have also given it to a second licensee and we're about to deliver to a third licensee. The first licensee who got it has started marketing Version 4.0. We expect the second and third to commence marketing the application in the third quarter. We will be delivering it to the rest of the licensees throughout the third and fourth quarters. We're extremely encouraged by the results that we've seen so far from the one licensee who's using the technology already.
Peter Swan: Great. Thanks.
Operator: Thank you, Mr. Swan. Our next question will come from Nicholas Walters from S Squared Technology. Please go ahead.
Nicholas Walters: Hi, good morning. My question is which company do you think poses the biggest threat or the most competition to your area of the business?
Andrew Rivkin: Our business model that we've developed over 1999 and 2000 is really to go after the large land-based gaming groups and I think that our company is significantly better positioned than our competitors, some of which have been successful in the Internet gaming arena but don't have the kind of financial resources, technical resources and human resources that CryptoLogic does to support the major land-based gaming group. In terms of executing on our strategic plan, which is really to grab the major groups and support them and help them build big brands, I think that there's nobody who's really significant in that marketplace today.
Nicholas Walters: Okay. Thank you.
Operator: Thank you, Mr. Walters. Our next question is from John Britton from Select Equity. Please go ahead.
John Britton: Good morning. I had a couple of questions following up on the disclosure and the release that the net margin expectation was to be down slightly. Can you give any better clarity on that? Is there a dollar figure you can discuss in terms of your development budget or are there other factors that you could amplify on that would bring that margin down?
Andrew Rivkin: We've increased expenditures in a number of areas to, as I mentioned in the last question, to help us execute our strategic plan which is to build relationships with major groups. Unless we spend these kinds of dollars now we will not be getting the types of relationships that we did manage to achieve in 2000, relationships with William Hill, relationships with Jupiters and some of our other newer licensees as well. So that spending will continue throughout the year 2000 and probably even into 2001 as well. We believe that increased spending now will generate very, very good earnings in future years related to the increased expenditures today. In addition to that we have incurred significant expenses related to development of Version 4.0 and that version will be in the marketplace for a year. We're already starting to see some of the benefits from it. We will continue to see those benefits over 2000 and 2001 and that accounts for a fair bit of the increased expenditures as well.
John Britton: Okay. So in the first quarter you had $3.6 million of development expenses. It went to $3.1 million in the second quarter and the overall margin... I think by the way you guys calculate it, you add in your interest income with your license revenue and that's presumably the number on which you're giving the guidance 45 to 50% net margin. Am I right on that?
Andrew Rivkin: I'm going to let Harvey answer that.
Harvey Solursh: You're right on that. We refer to total revenue including interest income.
John Britton: Okay. So 51% is what you calculate the net margin as being this quarter?
Harvey Solursh: Right.
John Britton: And that's going down to a range of 45 to 50 for the next two quarters?
Harvey Solursh: We believe that that range will be in the area of 50% for the next two quarters also.
John Britton: Okay. Then getting back to this development number, if it was $3.6 million in the first quarter, it fell to $3.1 million in the second, do you have dollar amount targets for the next two quarters for the development expense?
Harvey Solursh: No, we don't actually divulge our forecasts publicly.
John Britton: Okay. But in that number, the next two quarters, the expectation is that number in absolute dollar amount will rise pretty significantly and that will be partially from Version 4.0 but more from a marketing standpoint to develop these Thunderbird and other relationships.
Andrew Rivkin: No, I mean what we're suggesting our margins, which were traditionally around 63% have come down to about 50% and probably will stay at that level for the short term future. So we're not talking about further pressure on the margins, we're just talking about a decrease in margins which has already happened which will continue on for a few more quarters out while we continue to build these relationships and deliver on this technology.
John Britton: I see. So it's not that you're expecting a material step-down in margin from here?
Andrew Rivkin: No.
John Britton: I mean going from 51% in the most recent quarter I think the guidance was 45 to 50 in the release. Am I right about that?
Harvey Solursh: That's in the press release. It was 45 to 50, but we're at the upper end of 50%.
John Britton: Okay. So it's not as though you're expecting an even more accelerated spending pace that would depress that margin?
Andrew Rivkin: No, I think we mentioned it for the past few quarters.
John Britton: Okay, fair enough. And then also just in terms of the license revenue excluding the interest income, do you feel comfortable with kind of a $40-million number with that for the year, which would imply a pretty big step up in the second half. Is $40 million doable or will it be less than 39... and how do you gauge that? I guess I'm still curious as to what your level of confidence is anyway in that license revenue number only.
Harvey Solursh: The license revenue number at $40 million is definitely achievable. Our experience has been that once the new version gets out on a full basis we should see a dramatic spike-up in revenue.
John Britton: Right, okay. And then finally, just to follow up on that first question, the mix has come down, international mix is 62 from 65 in the first quarter. What do you expect it to be at year-end?
Andrew Rivkin: That's really hard to predict. We're focusing our attention on developing the international markets. We hope it will continue to decrease. We've got a couple of new licensees who have not even started yet who operate in the international arena. We've got a couple of new ones in the pipes who operate in the international arena. We've got new languages; I believe Chinese is about to be released. So, we're taking all the right steps to reduce that dependence on the one country but where it's going to wind up at the end of the year is impossible to say. What I can say is I think it's definitely going in the right direction.
John Britton: Okay. I guess another way of saying it is do you expect a majority of the increment of growth... again, there's rapid growth expected for the back half of the year in terms of license revenue. Do you expect a majority of that to be coming from outside the United States?
Andrew Rivkin: Yes, I think that that... we've already seen that happen in the second quarter and to some extent the first quarter as well and I believe that that trend will continue.
John Britton: Okay. Thank you very much.
Operator: Thank you, Mr. Britton. Our next question is from Jamey Cappello from Sidoti & Company. Please go ahead.
Jamey Cappello: Good morning, guys. How are you doing?
Harvey Solursh: Fine.
Andrew Rivkin: Good.
Jamey Cappello: Just a question regarding Jupiters. You signed them in February 2000 and they went live in the end of June. It's a pretty quick turnaround. Do you see the same quick turnaround regarding the new Argentinean gambling operator?
Andrew Rivkin: Actually, Jupiters did not go live in...
Jamey Cappello: Oh, I'm sorry. Excuse me. Thunderbird.
Andrew Rivkin: Thunderbird did go live in July.
Jamey Cappello: And you signed them in March. I'm sorry, my mistake.
Andrew Rivkin: That turnaround is possible. In terms of the Argentineans what are we looking at?
Harvey Solursh: We're looking at the end of August.
Andrew Rivkin: At the end of August. So also for a turnaround for that licensee.
Jamey Cappello: Okay, when the Argentinean one does go live at the end of August, is that going to have 4.0?
Andrew Rivkin: Yes, we're only delivering 4.0 now.
Jamey Cappello: Okay, great. Thanks.
Andrew Rivkin: You're welcome.
Operator: Thank you, Mr. Cappello. Our next question is from Fred Herzog, a private investor. Please go ahead.
Fred Herzog: Yes, good morning, gentlemen. I have a threefold question. One, can you differentiate your earning stream, revenue sharing versus the Internet casino you own versus actual software sales? Is there any way to break that down?
Andrew Rivkin: We actually don't own any of the Internet casinos. All our revenue is derived from licensing and support fees.
Fred Herzog: Okay. From licensing and support fees. There's no revenue sharing or licensing sharing of any of these fees with the licensees that you have?
Andrew Rivkin: The licensing and support fees are derived as a percentage of revenue of the licensees. That's how we charge them.
Fred Herzog: Okay. Now, are there any protocols in place that prevent U.S. citizens from gambling with the licensees that you derive these sharing agreements with?
Andrew Rivkin: Yes. We've got about six out of 17 licensees who restrict betting from U.S. citizens, and again that's up to the licensees and we implement on whatever their instructions are regarding where they're accepting wagers from and where they're not.
Fred Herzog: Okay. So there's the potential of 11 licensees taking bets from American citizens then?
Andrew Rivkin: That's correct.
Fred Herzog: Okay. Now, does management believe that it would be able to pass the probity requirements of gaming jurisdictions in the United States based on the fact that there are 11 licensees that potentially taking bets from American citizens?
Andrew Rivkin: As you might be aware, we're undergoing probity along with our licensee, Jupiters in Australia. It doesn't seem to me that over the year 2000 there will be any opportunity to be granted a license in the United States. I think that when there is an opportunity, we will be in an excellent position to become a license provider in that jurisdiction.
Fred Herzog: Okay, thanks.
Operator: Thank you. And our next question is from Jack Pitts from Steadfast Financial. Please go ahead.
Jack Pitts: I have a couple of questions. One, I noticed your cash from operations was slightly negative for both the three- and six-month period and it looks like a large amount of that is either going to restricted cash or cash... I guess somehow... I don't know where it's going but I just wonder if you could comment on that.
Andrew Rivkin: A good part of that has gone into restricted cash. It's related to opening new supplier relationships, in other words new relationships with financial institutions to process increased volumes that we're expecting over 2000 and 2001. So restricted cash has gone from about $5.3 million in 1999 to about $14 million in 2000 and that's going to be the fuel that's going to provide us the ability to do the kinds of numbers we're expecting for 2000 and 2001.
Jack Pitts: I mean is there a step increase in the number of banking suppliers and is there an average amount that each one needs to have or... I guess since revenues are basically about the same as last quarter and the quarter before, I'm just wondering why you would need to step that up by $9 million or over 130%.
Andrew Rivkin: Each relationship is different. There's not a specific amount that each bank requires but, as I said, we're anticipating growth and we're acquiring those kinds of deposits on hand to secure those relationships and that is really a very important part of our business. We're satisfied that we've got the kind of volume or capacity now that we need to support the kind of numbers we think we're going to be doing in the future. In addition to the restricted cash, we've also bought back, as we said, about 180,000 shares. That has had an impact on the cash flow in the last quarter as well.
Jack Pitts: Would we expect that number, the $14 million restricted in cash, to be flat now that you've accounted for the future growth in the next couple of quarters?
Andrew Rivkin: That'll vary depending on... we're always in the market to increase our relationships, especially international relationships. We will continue to utilize our significant financial resources to build those kinds of relationships if necessary. So, we're comfortable that we're where we need to be right now but this is a business that's shown strong growth over the past four years. If there's an opportunity to get another financial institution, we're not going to turn it down, that's for sure.
Jack Pitts: What exact advantage does another financial institution offer? I just wonder if you could go into detail and explain what it actually means in terms of, does it give you more ability to do what?
Andrew Rivkin: It gives you an opportunity to get better rates from the financial institutions. It sometimes gives you an opportunity to process in different jurisdictions. Again, that is the supply side of our business. It's a very important component having that kind of deposit in restricted cash considering our past performance on the fraud side is not a cause for concern in any way at all. I mean we've maintained, in almost four years of operation, a seven tenth of one percent of fraud on deposit. I don't think that there's too much risk in terms of fraud on that restricted cash. We have $40 million in free cash and we're not utilizing it right now. It just makes sense to further develop those supply relationships while we have opportunity to do so.
Jack Pitts: Thanks. Separately, the number of users in the user base, I don't think we got that number this quarter, and if you could also break it out into what percent of that increase was due to William Hill.
Andrew Rivkin: In terms of the user base, we've now got about 530,000 registered users which increased from about 480,000 at the end of 1999 and we don't break that out between licensees.
Jack Pitts: It was 530,000 as of the March quarter. What is it of in the June quarter?
Andrew Rivkin: Sorry, you're right because this is comparing the 530,000 from March to 480,000 at the end of 1999. I'm going to have somebody get that number for this quarter and we will get that back to you as the conference call goes on. Thanks very much for your questions.
Jack Pitts: Thanks.
Operator: Thank you, Mr. Pitts. Our next question will come from Pierre Cousineau who is a private investor. Please go ahead.
Pierre Cousineau: Good morning, gentlemen. My question has to do with electronic check processing. Are you planning to go beyond the gaming and what are your plans to expand on that?
Andrew Rivkin: We added ACH, electronic check processing in the first quarter of 2000. It's a good mechanism for people to deposit and also to withdraw from their e-cash applications or their e-cash accounts. Any plans that we have to go beyond gaming in terms of electronic commerce are going to be realized by our e-commerce subsidiary. Just allow me to sort of step back for a second. The number for registered users related to the last call was about 585,000 at the end of the second quarter.
Pierre Cousineau: Okay. Thank you very much.
Andrew Rivkin: Thank you.
Operator: Thank you. And our next question is from Pierre Beliveau who is also a private investor. Please go ahead.
Pierre Beliveau: Yes, good morning. How's everybody doing there?
Andrew Rivkin: Good, thanks.
Pierre Beliveau: My question -- actually, a lot of things have been covered here -- is to do with the e-cash. Now, I know that there's been some rounds as to separating that, put it in a separate entity, possibly doing an IPO or doing something else with it and I just wanted to know what shareholder value there would be in that. I know that there's some work going on in that area.
Andrew Rivkin: It's impossible to give you a number right now. The technology belongs to a separate wholly owned subsidiary of CryptoLogic. We've hired senior professional management there. We've hired a few more developers. So we're very actively working on bringing that technology to market. We're involved in a strategic round right now where we're going out trying to finance the business with some strategic partners. So that's where we are right now. What value there is to our shareholders today, again it's sort of a wholly owned private entity and it's really difficult to put your finger on at this stage.
Pierre Beliveau: Thank you. You did a U.S. tour for investor and institutional awareness and I'm wondering what kind of response you received in the U.S. as well as whether there was any more of that to be taking place in the future.
Andrew Rivkin: We had a terrific response. We had some analysts pick up coverage. We had a number of very good meetings and we will be doing further U.S. roadshows in the very near future.
Pierre Beliveau: Well, that's excellent. So keep up the good work and I appreciate you answering my questions.
Andrew Rivkin: Thanks very much.
Operator: Thank you. Once again, if anyone else does have a question, please press 1 on your touch-tone telephone. And our next question will come from Peter McCalum who is also a private investor. Please go ahead.
Peter McCalum: Hello. I just want to ask a question regarding your cash position that you have on hand. In the past it's been reported to be $50 million and in excess of that growing I believe at approximately $2 million per month. I see now you're reporting there's $40 million. It seems to be that you have removed the restricted cash from that. Does that represent a change in accounting practices? I'm just thinking back to your July 3rd interview in the Wall Street Transcript where you mentioned cash at approximately $50 million U.S.
Andrew Rivkin: Harvey, why don't you field that?
Harvey Solursh: Yes. Because we are reporting in U.S. dollars and because we're on Nasdaq, restricted cash comes out of the cash and cash equivalents. In our minds think of it still as all cash, like close to $54 million right now but for reporting purposes it is not included in the cash flow statements as part of the cash.
Peter McCalum: So just to clarify, this change represents the impact of moving to the Nasdaq?
Harvey Solursh: Yes.
Peter McCalum: Thank you.
Operator: Thank you, Mr. McCalum. Our next question is from Mike Wilson who is also a private investor. Please go ahead.
Mike Wilson: Hello, Andrew. About a year ago you were talking about diversifying into lotteries and horse racing and some other areas. Has there been any development in that area?
Andrew Rivkin: The technology that we built for Version 4.0 supports those applications. We're now looking at a number of lottery applications and just trying to find one that would be suitable. What we've done inside the application is build it so that it would facilitate those kinds of gaming activities. It's a matter of time before we're able to release those inside the Version 4.0 environment.
Mike Wilson: Okay. Thank you.
Andrew Rivkin: Thanks.
Operator: Thank you, Mr. Wilson. And at this time, Mr. Rivkin, we have no further questions from the phone lines, Sir.
Andrew Rivkin: Great. I'd like to thank everybody for joining us. We'll look forward to hearing from everybody again at the third quarter conference call. Thanks very much.
End of the Conference Call
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