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EGT > SEC Filings for EGT > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for ENTERTAINMENT GAMING ASIA INC.

Form 10-Q for ENTERTAINMENT GAMING ASIA INC.


14-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and the related notes thereto contained elsewhere in this report. The information contained in this quarterly report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our annual report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 30, 2012 and subsequent reports on Form 8-K, which discuss our business in greater detail.

In this report we make, and from time to time we otherwise make, written and oral statements regarding our business and prospects, such as projections of future performance, statements of management's plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimates," "projects," "believes," "expects," "anticipates," "intends," "target," "goal," "plans," "objective," "should" or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by officers or other representatives made by us to analysts, stockholders, investors, news organizations and others, and discussions with management and other of our representatives. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement.

In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement. Some of these important factors, but not necessarily all important factors, are included in the section "Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 30, 2012.

We own or have rights to certain trademarks that we used in connection with our business or products, including, but not limited to, Dolphin™. Other than this trademark, this report also makes reference to trademarks and trade names of other companies.

On June 12, 2012, we effected a 1-for-4 reverse stock split of our common stock and corresponding decrease in the number of authorized shares of common stock. All historical share amounts and share information presented in the financial statements and notes have been proportionally adjusted to reflect the impact of this reverse stock split, including but not limited to basic and diluted weighted-average shares issued and outstanding. Certain reclassifications have been made to the prior periods' financial statements to conform to the current period's presentation.

Overview

Our primary focus is our gaming operations, which entail our slot operations (previously referred to as participation operations) in Cambodia and the Philippines and the development and operation of regional style casinos and gaming venues under our Dreamworld brand in certain markets within Indo-China.

Given the early stages of our casino development operations, revenue from our gaming operations is presently principally comprised of our slot operations, which involve the leasing of electronic gaming machines ("EGMs") on a revenue sharing basis to gaming establishments. We identify and secure venues for the placement of EGMs and casino management systems where warranted, which track game performance and provide statistics on each installed EGM owned and leased by us. We contract with the venue owners or operators for the placement of the EGMs on a revenue sharing basis. In addition, we acquire the EGMs and other gaming systems and peripherals and then install same at the relevant gaming venues.

As of September 30, 2012, our slot operations were located in two countries, Cambodia and the Philippines, and totaled 1,420 EGM seats in operation in five venues. In Cambodia, we had a total of 839 EGM seats in operation in two venues. In the Philippines, we had a total of 581 EGM seats in operation in three venues. Due to our ongoing efforts to improve the returns for our slot operations, we have refined our operating machine base to focus on those venues with the greatest potential. As a result, in July 2012, we terminated two contracts, one in Cambodia and one in the Philippines, with a combined total of 100 EGMs seats as these venues were not performing up to our expectations. There were minimal costs associated with the termination of these above-mentioned contracts and it is expected that the loss of these operations will not have any material impact on our future revenue. Approximately 22 EGM seats from the above-mentioned terminated contracts have been redeployed to other higher potential venues.

In Cambodia, our slot operations largely focus on operating a substantial portion of the gaming machine area in prime casino floor locations at NagaWorld, a wholly-owned subsidiary of Hong Kong listed NagaCorp Ltd. (HKSE: 3918). NagaWorld is a premier luxury destination gaming resort and the only licensed full service casino in a designated area around the capital city of Phnom Penh. Our slot operations at NagaWorld, which entail 670 EGM seats under contract, are a primary contributor to our slot revenue and cash flow. Revenue from our slot operations in NagaWorld declined during the three-month period ended September 2012 primarily due to a decrease in average net win per machine for these operations to $216 for the third quarter of 2012 compared to $233 in the prior year period. Based on our current information and our performance for October 2012, we believe that the decline in the third quarter of 2012 net wins was due to normal fluctuation. With prominent ground floor locations, quality product and customer service, and proactive marketing, we believe we are well positioned to maintain strong overall performance from these operations.

We recently expanded our slot operations in Cambodia at Thansur Bokor Highland Resort, a new casino resort developed by leading Cambodian hotelier, Sokha Hotels and Resorts. Thansur Bokor Highland Resort is located in a tourist area of the Kampot Province. The official opening of the resort was in May 2012. However, portions of the initial phase including the VIP gaming areas and entertainment complex are not yet complete. Under the terms of the agreement, we have the ability to place up to 250 EGM seats and jointly manage these slot operations in the resort. This strategic project expands our gaming operations in the Indo-China region with a prominent new partner and is anticipated to be a meaningful contributor to earnings once the facility is fully operational and the owner has implemented its broader marketing programs.

In the Philippines, our slot operations continued to post solid revenue despite a reduction in the machine base and adverse weather conditions during the quarter. We attribute this to our strategic efforts to enhance our operating performance and improve net wins per machine in this market. These efforts include: implementing, with the support of our venue owner partners, targeted marketing programs; the redeployment, when possible, of our gaming equipment assets from lower to higher performing venues in the market; and greater overall revenue sharing in this market due to our acquisition of a higher revenue sharing interest in one of our most promising venues in October 2011.

With regard to our other products segment, over the last several years we have made a strategic shift in focus of this division towards the higher-margin potential gaming chips and plaques, which feature a wide range of product offerings with state-of-the-art security features. With a focus on marketing and investment in product development, we have significantly improved the top-line performance of this business and better positioned these operations to capitalize on the future growth opportunities for gaming chips and plaques in our target markets.

We posted strong improvement in sales of our gaming chips and plaques for the three-month period ended September 30, 2012 compared to the prior year period due to higher customer reorders, which included $1.6 million in revenue for the partial delivery of a large order to an existing customer in Australia. The pipeline for the three-month period ending December 31, 2012 is attractive as well with announced orders for approximately $1.9 million in revenue, which include approximately $600,000 for the completion of the above-mentioned large order and approximately $1.3 million to supply a new casino in the Philippines.

We are focused on enhancing the profitability of our gaming chip and plaque operations in the future. Higher labor costs associated with the relatively short lead time and production inefficiencies related to the first time utilization of new in-house production processes for the above-mentioned large order negatively impacted gross margins for these operations during the three-month period ended September 30, 2012. However, through continued efforts to improve our manufacturing capacity and efficiency, acquired experience in new in-house production processes and planned cost reduction initiatives, we expect to increase operating efficiencies and automation that will drive long-term earnings improvement for these operations. These efforts are not anticipated to minimize the normal fluctuation in quarterly sales flow of this business segment.

Our consolidated revenue for the three-month period ended September 30, 2012 was approximately $7.9 million, of which revenue from our gaming and other products operations comprised 57% and 43%, respectively, of consolidated revenue. This compares to consolidated revenue of approximately $6.5 million for the three-month period ended September 30, 2011, of which revenue from our gaming and other products operations comprised 68% and 32%, respectively, of consolidated revenue.

Revenue from our gaming operations for the three-month period ended September 30, 2012 was approximately $4.5 million compared to approximately $4.4 million in the prior year period. Revenues from gaming operations during the three-month period ended September 30, 2012 included approximately $340,000 of casino revenue from Dreamworld Casino (Pailin), our first casino development project which opened on May 9, 2012. Gaming revenue declined approximately $718,000 for the third quarter of 2012 compared to three-month period ended June 30, 2012, primarily due to lower average net wins per machine for our slot operations at NagaWorld for the reasons discussed above. Gross margin for our gaming operations declined to 34% in the three-month period ended September 30, 2012 compared to 52% in the prior year period. The decline was the result of higher costs associated with general operating expenses for our new casino operations as related revenues are still ramping up.

Cash flow provided by operations was approximately $1.5 million for the three-month period ended September 30, 2012 compared to approximately $2.6 million in the prior year period. Adjusted EBITDA (as defined below) was approximately $2.3 million for the three-month period ended September 30, 2012 compared to approximately $2.8 million in the prior year period. The declines were principally due to lower revenue from our slot operations as a result of lower average daily net wins per machine at our operations in NagaWorld and higher general operating costs associated with our new casino operations.

Our recurring cash flow from operations along with our established market presence provides us a solid foundation from which to expand our gaming operations to include the development and operation of casinos and slot clubs under our "Dreamworld" brand in certain emerging gaming markets in Indo-China. We believe this expanded business model will allow us the potential for higher long-term incremental returns on our operations given the ability to collect a greater percentage of the gaming revenue compared to our existing slot contracts. In addition, it provides us greater long-term control over our operations.

We opened our first casino project, Dreamworld Casino (Pailin), located in the Pailin Province of Northwestern Cambodia near the Thailand border in May 2012. We have two other development projects in the pipeline, Dreamworld Club (Poipet), a slot club project located in the Banteay Meanchey Province of Northwestern Cambodia near the Thailand border, and Dreamworld Casino (Kampot), a casino project located in the Kampot Province of Southwestern Cambodia near the Vietnam border.

Dreamworld Casino (Pailin)

On July 12, 2011, we formed a new company, of which we are the sole owner, to develop and operate Dreamworld Casino (Pailin). Dreamworld Casino (Pailin) is constructed on land leased from a local land owner (the "Pailin Land Owner") and in consideration the Pailin Land Owner is entitled to receive a fair monthly rental fee and 20% of the profit before depreciation (the total gross revenue of the casino less any payouts paid to customers, operating expenses, and gaming and non-gaming taxes on the casino's revenue). The initial lease term is 20 years, which commenced in September 2011 and is subject to renewal by the parties in writing.

The initial phase of Dreamworld Casino (Pailin) measures approximately 16,000 square feet (1,448 square meters) and includes 30 table games and 50 EGMs. Of the 30 table games, four are housed within designated VIP facilities, which have not yet opened. The Pailin Land Owner also owns property adjacent to Dreamworld Casino (Pailin) measuring nearly 250,000 square feet (23,160 square meters). We have an option to lease this adjacent property at a future date and use it to develop additional phases of the Dreamworld Casino (Pailin). Such additional phases are intended to include expanded casino operations and complementary facilities such as hotel rooms, a spa and other entertainment amenities.

Total capital expenditures for the initial phase of Dreamworld Casino (Pailin) were approximately $2.5 million, which was paid solely by us from our internal cash resources.

We opened the mass market floor of Dreamworld Casino (Pailin) on May 9, 2012. We expedited the opening date in the second quarter of 2012 to fast-track the operation of the casino's mass market floor and establish our presence in the local market. We have recently improved and expanded our senior operations team at Dreamworld Casino (Pailin) and implemented a number of new marketing initiatives to ramp up operations of the mass market floor. In addition, we continue to actively pursue opportunities to partner with local gaming promoters for its VIP rooms and expect to open these facilities in the next several months. By utilizing gaming promoters, we expect to improve high net worth player traffic in the VIP rooms while minimizing the downside risk and volatility as the promoters typically share in wins and losses and assume the credit risk.

Given the early stage of these operations and the fact that the casino is not yet fully operational, we believe that results are not normalized. However, with the recent implementation of broader marketing programs and upcoming plans to open the casino's VIP facilities, we expect to establish normalized operating results within the next two or three quarters.

Dreamworld Club (Poipet)

On April 2, 2012, we entered into a machines operation and participation agreement (the "Poipet Agreement") with a Cambodian company, which owns and operates an existing casino in Poipet, Cambodia near the Thailand border, and a Cambodian individual, who controls the casino operating company and owns land on which the casino is located (collectively the "Poipet Local Partner"), to develop a slot venue. The slot venue will be developed as an extension of the existing casino and utilize its gaming license and will be operated under the Dreamworld name ("Dreamworld Club (Poipet)").

Under the terms of the Poipet Agreement, the Poipet Local Partner will allocate part of its land with an area of approximately 16,000 square feet (1,500 square meters) to us to develop and construct, at our own design, budget and cost, of a slot venue capable of placing and operating approximately 300 EGMs. Upon completion of Dreamworld Club (Poipet) we will have the exclusive rights to operate and manage the venue and EGMs therein. We and the Poipet Local Partner will split the win per unit per day from all the EGMs placed by us at Dreamworld Club (Poipet) and certain operating costs related to marketing and floor staff on a respective basis of 40%/60%. The initial project term is five years beginning from the commercial launch of the slot hall with an option to renew for an additional five years subject to the achievement of certain financial milestones during the initial five-year period.

Total capital expenditures for Dreamworld Club (Poipet), which principally include the development and construction of the facility and gaming equipment, are projected to be approximately $7.5 million, including an estimated $5.0 million to source top-of-the-line EGMs. We expect to provide the required EGMs through the purchase of new and used machines as well as those from our inventory. We are responsible for all capital expenditures for Dreamworld Club (Poipet), which we intend to fund through our internal cash resources.

We commenced construction for Dreamworld Club (Poipet) in August 2012 and remain on track to open in the first quarter of 2013 ahead of the Thai New Year.

Dreamworld Casino (Kampot)

On March 4, 2011, we formed a new company (the "Kampot New Company") with a local partner (the "Kampot Local Partner") to develop, own and operate a casino in the Southern Cambodia province of Kampot near the Vietnam border ("Dreamworld Casino (Kampot)").

The Kampot Local Partner owns a parcel of land in Kampot measuring approximately 91,000 square feet (8,500 square meters) where we will construct Dreamworld Casino (Kampot). The initial phase of Dreamworld Casino (Kampot) is expected to include up to 14 table games, such as baccarat, roulette and dice games, and 25 EGMs. Depending on demand and the availability of capital, we may add at a future date additional casino floor space and equipment as well as complementary facilities such as hotel rooms, a spa and other entertainment amenities.

The Kampot Local Partner will lease to the Kampot New Company the land for a period of 25 years for an annual fee of $1. We will provide funding for all development, construction and pre-opening costs for the Dreamworld Casino (Kampot), all necessary EGMs and gaming tables and paid the Kampot Local Partner a lump sum of $260,000 as the balance consideration for his contributions. We and the Kampot Local Partner will split the Kampot New Company's net revenue (the total gross revenue of the casino less any payouts paid to customers, operating expenses, and gaming and non-gaming taxes on the Kampot New Company's revenue) on a respective basis of 60%/40%. The initial lease term is 25 years, which commenced in March 2011 and is subject to renewal by the parties in writing.

Total capital expenditures for the initial phase of Dreamworld Casino (Kampot) are projected to be approximately $1.2 million as the EGMs will be sourced from our existing inventory.

We presently intend to resume development of Dreamworld Casino (Kampot) in the second half of 2013.

In addition to the above-mentioned projects, we continue to selectively pursue additional casino and gaming development projects with a focus on the Indo-China region. However, there is no guarantee we will be successful in signing new projects. We also own a parcel of land with total area of approximately seven acres (30,000 square meters) in the Takeo Province of Cambodia near the Vietnam border and were granted in-principle approval to build and open a casino-hotel in the Takeo Province by the Cambodian government. At the present time, we do not expect to commit significant capital to a hotel-casino project on this land in order to divert our available capital to the development of Dreamworld Club (Poipet) and other ongoing projects, which we believe will offer greater short- and medium-term return potential. Our future development plans for this land will be dependent on our available capital and local market conditions at that time.

Results of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2012 and 2011

The following is a schedule summarizing operating results on a consolidated basis and separately by each of our two operating segments, namely, gaming operations and other products, for the three-month and nine-month periods ended September 30, 2012 and 2011.

                                                    Three-Month Periods Ended September 30,             Nine-Month Periods Ended September 30,
(amounts in thousands, except per share data)          2012                        2011                    2012                        2011
Total:
Revenues                                        $             7,851         $             6,492     $            22,538         $            19,445
Gross profit                                    $             1,791         $             2,461     $             7,101         $             7,570
Gross margin percentage                                          23 %                        38 %                    32 %                        39 %
Adjusted EBITDA(1)                              $             2,308         $             2,834     $             8,342         $             9,185
Operating (loss)/income                         $               (27 )       $               638     $             1,190         $             1,933
Net income                                      $                43         $               647     $             1,499         $             1,646

Earnings per share:
Basic                                           $                 -         $              0.02     $              0.05         $              0.06
Diluted                                         $                 -         $              0.02     $              0.05         $              0.06

Weighted average shares outstanding
Basic                                                        29,926                      29,688                  29,915                      29,350
Diluted                                                      31,129                      29,982                  30,793                      29,631

Gaming:
Revenues                                        $             4,480         $             4,379     $            14,634         $            13,097
Gross profit                                    $             1,521         $             2,270     $             6,556         $             6,806
Gross margin percentage                                          34 %                        52 %                    45 %                        52 %

Other products:
Revenues                                        $             3,371         $             2,113     $             7,904         $             6,348
Gross profit                                    $               270         $               191     $               545         $               764
Gross margin percentage                                           8 %                         9 %                     7 %                        12 %


(1) "Adjusted EBITDA" is earnings before interest, taxes, depreciation, amortization, stock-based compensation, and other non-cash operating income and expenses. Adjusted EBITDA is presented exclusively as a supplemental disclosure because our management believes that it is widely used to measure the performance, and as a basis for valuation, of gaming companies. Our management uses Adjusted EBITDA as a measure of the operating performance of its segments and to compare the operating performance of its operations with those of its competitors. We also present Adjusted EBITDA because it is used by some investors as a way to measure a company's ability to incur and service debt, make capital expenditures and meet working capital requirements. Gaming companies have historically reported EBITDA as a supplement to financial measures in accordance with generally accepted accounting principles in the United States ("GAAP"). Adjusted EBITDA should not be considered as an alternative to operating income as an indicator of our performance, as an alternative to cash flows from operating activities as a measure of liquidity, or as an alternative to any other measure determined in accordance with GAAP. Unlike net income/(loss), Adjusted EBITDA does not include depreciation or interest expense and, therefore, does not reflect current or future capital expenditures or the cost of capital. We compensate for these limitations by using Adjusted EBITDA as only one of several comparative tools, together with GAAP measurements, to assist in the evaluation of operating performance. Such GAAP measurements include operating income, net income, cash flows from operations and cash flow data. We have significant uses of cash flows, including capital expenditures, interest payments, debt principal repayments, taxes and other non-recurring charges, which are not reflected in Adjusted EBITDA. Our calculation of Adjusted EBITDA may be different from the calculation methods used by other companies and, therefore, comparability may be limited.

A reconciliation of EBITDA, as adjusted, to the net income is provided below.

                                                Three-Month Periods Ended September 30,           Nine-Month Periods Ended September 30,
(amounts in thousands)                              2012                       2011                   2012                       2011
Net income - GAAP                            $               43         $              647     $            1,499         $            1,646
Interest expense and finance fees                            20                        105                    109                        305
Interest income                                              (4 )                      (20 )                  (32 )                      (61 )
Income tax expenses/(benefit)                                34                        (71 )                  124                        169
Depreciation and amortization                             2,052                      1,958                  5,884                      5,737
. . .
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