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MGAM > SEC Filings for MGAM > Form 10-K on 15-Nov-2012All Recent SEC Filings

Show all filings for MULTIMEDIA GAMES HOLDING COMPANY, INC.

Form 10-K for MULTIMEDIA GAMES HOLDING COMPANY, INC.


15-Nov-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

FUTURE EXPECTATIONS AND FORWARD-LOOKING STATEMENTS

Multimedia Games has made forward-looking statements in this Annual Report on Form 10-K that are subject to risks and uncertainties. Such forward-looking statements include, but are not limited to, statements regarding future actions, operating results, liquidity, capital expenditures, cash management and financial discipline, product, system and platform development and enhancements, customer and strategic relationships with third parties, strategies, initiatives, legal and regulatory uncertainties, including outcomes of litigation, the effects of such outcomes upon our business, changes in existing laws and regulations or in the interpretation of such laws and regulations, entry into new markets or jurisdictions or the obtaining of new licenses. The forward-looking statements may be preceded by, followed by or include the words "may," "might,"
"plan," "estimate," "expect," "intend," "believe," "should," "would," "could," "anticipate," "continue," or the negative or other variations thereof or comparable terminology that convey the uncertainty of future events or outcomes. All forward-looking statements are based on current expectations and projections of future events. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all forward-looking statements.

Forward-looking statements are not guarantees of performance. You should understand that the factors discussed in Item 1A of Part I of this Annual Report, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in the forward-looking statements. Actual results could differ materially from those stated or implied by our forward-looking statements, due to risks and uncertainties associated with our business or under different assumptions or conditions. You should not place undue reliance on any of these forward- looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

OVERVIEW

The Company designs, manufactures and supplies gaming machines and systems to casino operators in North America, domestic and selected international lottery operators, and commercial bingo gaming facility operators. The Company's standalone gaming machines are primarily sold and placed in Class III settings while its central determinant and server-based centrally-linked products and systems are primarily sold and placed in Class II, video lottery terminal and electronic bingo settings. We use the term Class III to refer to traditional slot machines in commercial jurisdictions as well as compact games in various tribal gaming jurisdictions. The Class II market is associated with Native American gaming in the United States and is generally understood as the game of chance commonly known as bingo (whether or not electronic, computer, or other technological aids are used in connection therewith).

The Company was incorporated in Texas on August 30, 1991. In April 2011, the Company changed its name from Multimedia Games, Inc. to Multimedia Games Holding Company, Inc. Initially, the Company derived the majority of its revenues from the placement of bingo games, including satellite linked, high stakes bingo games and interactive high speed bingo games played on interconnected electronic player stations placed in participating bingo halls owned primarily by Native American tribes. The Company has since expanded its product line and markets served to include gaming facilities operated by Native American and commercial casinos and derives the majority of its gaming revenues from participation, or recurring revenue agreements. Under these agreements, the Company places player terminals and systems as well as its proprietary and other licensed game content at a customer's facility in return for either a share of the revenues that these terminals and systems generate or for a fixed daily lease fee. The Company also generates revenue from the sale of gaming units and systems that feature proprietary game content and licensed game content. Today, the Company continues to increase participation and for-sale revenues by expanding into additional gaming jurisdictions and into other segments of the gaming market. The Company also generates revenues by providing the central determinant system operated by the New York State Division of the Lottery for the video lottery terminals installed at racetracks in the State of New York.

BUSINESS STRATEGY

We are currently focused on executing a business strategy that will allow the Company to continue the development of high performing gaming products, invest in our existing gaming operations markets, expand our total addressable market to include new gaming jurisdictions and drive continued profitability and cash flow.


Product Development

One of our top priorities is investing in research and development activities to expand our product portfolio and build on the recent success of our newest high-earning games. The creation of a consistent number of high-earning games is critical to our ability to enter new markets, expand our existing footprint and keep our installed base of games fresh by allowing the Company to better serve a growing number of our customer needs, more effectively maintain the performance of our installed base, and better support a growing footprint of games, particularly within a single customer facility.

As a result of our continued investments, our growing product portfolio positions the Company to offer our tribal and commercial casino customers a full range of Class II and Class III products, as well as our award-winning slot tournament system and new premium participation games:

TournEvent: Transforms the traditional process through which casino operators create tournament venues on their slot floors by offering a proprietary in-revenue game that can be converted into a tournament game. TournEvent also enables operators to create unique team slot tournaments, offering a variety of customizable configurations based on the number of players, mechanics of team advancement, rankings and prizes. As of September 30, 2012, TournEvent is available in 117 casinos nationwide encompassing nearly 1,800 total units.

High Rise Games: The High Rise Games series allows us to address the premium participation segment of the slot floor. These games are presented in a unique gaming cabinet that features the industry's largest top box, a vertically oriented 37" LCD screen. As of September 30, 2012, we have deployed 198 High Rise Games units in 55 casinos in 11 states.

By expanding our portfolio with products such as TournEvent and the High Rise Games, we are able to work closely with our customers to more fully serve their needs, allowing us to forge deeper relationships with our customers and expanding the scope of our market opportunity.

Our growing library of Class II and Class III content also allows us more flexibility in managing our existing installed base. We can now more quickly replace titles within our installed base whose performance is in decline with fresh, high-performing content. Additionally, by offering our customers a greater choice when purchasing our gaming machines for use in their facilities, we can better support a larger footprint of games, effectively increasing our addressable market for game sales.

Class II: The development of high-performing Class II content enables us to continue to serve our largest customer and, given the renewed focus on Class II content by our tribal customers, provides us with the opportunity to better serve our existing customers and secure new relationships with new tribal customers. As of September 30, 2012, we have 144 proprietary Class II video and mechanical reel game titles, compared to 106 at the end of fiscal 2011 and 70 at the end of fiscal 2010.

Class III: Our investment in Class III game development is yielding new games and play features that provide enhanced entertainment experiences. Among our newest games are the High Rise Games series and Side Action series. As of September 30, 2012, we have 78 proprietary Class III video and mechanical reel game titles, compared to 44 at the end of fiscal 2011 and 41 at the end of fiscal 2010.

Gaming Operations Investment

We are also focused on investing in the maintenance and growth of our existing domestic installed base through the extension of placement or development agreements and continuous refreshes of existing games with new high performing games. We are also investing in new markets as they become available through the licensing process.

During fiscal 2012, we paid our largest customer total unit placement fees of $13.2 million as part of an agreement to extend approximately 85% of the units installed on a revenue sharing basis at three of the customer's facilities for a total of 3.5 years. This extension strengthened our long-term strategic alliance with our largest customer and solidified the recurring revenue stream from our games placed in the customer's facilities.

We are committed to leveraging our growing portfolio of high-earning proprietary games that are delivering an entertainment experience players find both exciting and entertaining. Through the continuous replacement of third party units within our participation footprint with our own proprietary games and content, we will be better positioned to generate a higher return on our investments in gaming technology and on our investments in securing floor space at our key customers' facilities. This proprietary product includes our Class II and Class III titles as well as our new High Rise Games, which have, to date, generated performance in excess of floor average.


Furthermore, we are focused on expanding our addressable markets to include new commercial and tribal jurisdictions. We are committed to offering new customers in newly licensed jurisdictions our products on a participation basis and believe our expanded product portfolio positions us to leverage our product development and licensing investments by further expanding our participation installed base.

Addressable Market Expansion

We continue a concerted effort to expand our total addressable market by targeting new gaming jurisdictions across the United States and ramping up our regulatory licensing activity. We have leveraged our expanding game portfolio gaming operations investments to target customers in newly licensed jurisdictions and to expand our national reach.

We secured licenses in fiscal 2012 to market and place or sell our products in Idaho, Michigan, Nebraska, New Mexico, North Dakota, Ohio and Pennsylvania, and secured a license to distribute and manufacture in Nevada in fiscal 2011. We are awaiting approval of our gaming platform in both Nevada and Pennsylvania, which are separate certifications than the distributor licenses in each state. As of September 30, 2012, we believe our 161 licenses in 27 states allows us to address approximately 35-45% of the total addressable market in the United States.

We are currently pursuing licensing in a number of new states and jurisdictions and the Company expects to receive licensing approval in British Columbia, Colorado, Delaware, West Virginia, Maryland and Oregon during fiscal 2013, with product placements and sales expected to begin in late fiscal 2013 and into fiscal 2014.

Profitability Growth

The final key piece of our long-term growth strategy is leveraging our focus on fiscal discipline to generate strong profitability and solid free cash flow, setting the stage for continued success. The Company's cash position rose by approximately $27.0 million in fiscal 2012 to $73.8 million as of September 30, 2012. The Company was in a net cash position (total cash in excess of total debt) at September 30, 2012 of $40.5 million compared to a net cash position of $9.7 million at September 30, 2011 and a net debt position of $22.8 million at September 30, 2010. Additionally, in fiscal 2012, the Company generated free cash flow of $29.3 million and total cash of $23.5 million compared to $31.2 million and $38.4 million, respectively, in fiscal 2011 and $31.7 million and $38.3 million, respectively, in fiscal 2010.

By generating strong financial returns in our business, we are further able to invest in the balance of our long-term growth strategy by developing additional new proprietary games, refreshing our existing installed base with high-performing games and expanding our installed base, and further expanding the number of markets where we are licensed. Please see the definitions of free cash flow and net cash position (net debt position) included in "Reconciliation of Non-GAAP Financial Measures" below.


RESULTS OF OPERATIONS

The following tables set forth our end-of-period installed base of player terminals as of September 30, 2012, 2011 and 2010.

At September 30 At September 30 End-of-period installed player

terminal base:                          2012     2011   % change      2011     2010   % change
Oklahoma                               7,922    7,500      5.6  %    7,500    7,047      6.4  %
Washington                               338      224     50.9  %      224      104    115.4  %
California                               588      306     92.2  %      306       98    212.2  %
Mexico                                   913    3,475    (73.7 )%    3,475    4,784    (27.4 )%
Alabama                                  199      121     64.5  %      121      114      6.1  %
Other                                  1,623    1,228     32.2  %    1,228      885     38.8  %
Total participation units             11,583   12,854     (9.9 )%   12,854   13,032     (1.4 )%

Below are our revenues and costs and expenses for the periods noted above. This information should be read in conjunction with our Consolidated Financial Statements and notes thereto.

                                              Year ended September 30,             Year ended September 30,
                                              2012         2011    % change        2011        2010    % change
                                              (in thousands)                       (in thousands)
Revenue
Gaming Operations
Participation revenue                    $   96,426     $ 86,107     12.0  %   $   86,107   $ 84,983      1.3  %
Lottery                                      15,584        9,369     66.3  %        9,369      7,839     19.5  %
Gaming Equipment and Systems Sales
Player terminal and equipment sales          33,626       23,243     44.7  %       23,243     18,148     28.1  %
Systems and Licensing                         9,167        7,666     19.6  %        7,666      5,217     46.9  %
Other Revenue                                 1,373        1,470     (6.6 )%        1,470      1,749    (16.0 )%
Total Revenue                               156,176      127,855     22.2  %      127,855    117,936      8.4  %
Costs and Expenses
Cost of gaming operations revenue             9,004        9,136     (1.4 )%        9,136      9,451     (3.3 )%
Cost of revenues equipment and systems
sales                                        18,548       14,623     26.8  %       14,623     11,065     32.2  %
Selling, general and administrative          49,648       42,042     18.1  %       42,042     39,293      7.0  %
Write-offs, reserves and impairment
charges                                       1,187        2,013    (41.0 )%        2,013      5,010    (59.8 )%
Research and development                     15,428       12,930     19.3  %       12,930     12,144      6.5  %
Amortization and depreciation                38,270       40,957     (6.6 )%       40,957     51,593    (20.6 )%
Other income (expense), net                   1,206          225    436.0  %          225     (1,144 )  119.7  %


The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto, included in "Part IV - Item 15. Exhibits and Financial Statement Schedules."

Fiscal 2012 Compared to Fiscal 2011

Total revenues in fiscal 2012 were $156.2 million, compared to $127.9 million in fiscal 2011, a $28.3 million, or 22.2% increase, primarily due to an increase in proprietary unit sales and entry into new markets.

Gaming Operations - Participation Revenue

Oklahoma gaming revenues were $62.7 million in fiscal 2012, compared to $60.8 million in fiscal 2011, an increase of $1.9 million, or 3.1%. Oklahoma's end of period unit count as of September 30, 2012 was 7,922 compared to 7,500 as of September 30, 2011, a 422 unit or 5.6% increase, with the majority of the increase taking place in the last quarter of fiscal 2012.

Washington gaming revenues were $10.7 million in fiscal 2012, compared to $6.9 million in fiscal 2011, an increase of $3.7 million, or 53.5%. Washington's end of period unit count as of September 30, 2012 was 338 compared to 224 as of September 30, 2011, a 114 unit or 50.9% increase. The increase in gaming operations revenue was primarily the result of an increase in back office fees received on player terminals sold in a market which utilizes our back office equipment.

Revenues from California were $6.1 million in fiscal 2012, compared to $2.3 million in fiscal 2011, an increase of $3.8 million, or 164.2%. California's end of period unit count as of September 30, 2012 was 588 compared to 306 as of September 30, 2011, a 282 unit or 92.2% increase. The increase in gaming operations revenue relates to the increase in participation units. The majority of units in fiscal 2011 were not installed until the latter part of the fiscal year.

Revenues from the Mexico market were $2.0 million in fiscal 2012 and $7.0 million in fiscal 2011, a decrease of $5.0 million or 71.3%. As of September 30, 2012, we had 913 player terminals installed in Mexico compared to 3,475 player terminals installed as of September 30, 2011. The reduction in the number of units and corresponding reduction in revenue relates to our planned strategy to optimize our deployed capital in Mexico by removing older games from our customer locations and replacing units at a conservative pace to maximize the return on investment.

Alabama gaming revenues increased $842,000, or 56.1%, to $2.3 million in fiscal 2012, compared to $1.5 million in fiscal 2011. The increase in revenue relates to the increase in player terminals. Revenue generated in fiscal 2012 and fiscal 2011 for Alabama relates exclusively to Native American customers within the state.

Other gaming operations revenue relates to participation revenue from other states, including Wisconsin, Texas, New York, Minnesota, Kansas, Idaho, Michigan, Mississippi, Louisiana, Florida, Connecticut, New Mexico, Arizona, Arkansas, Indiana, Iowa, Ohio, and Rhode Island. Gaming revenue from these states combined was $12.7 million in fiscal 2012 compared to $7.6 million in fiscal 2011, a $5.0 million or 66.2%, increase. The end of period participation unit count for these states increased 32.2% to 1,623 as of September 30, 2012 from 1,228 as of September 30, 2011. The increase in gaming operations revenue was primarily the result of an increase in our installed base of participation games.

Gaming Operations - Lottery

Revenues from the New York Lottery system increased $6.2 million, or 66.3%, to $15.6 million in fiscal 2012, from $9.4 million in fiscal 2011. The increase is attributable to the opening of the Resorts World Casino in New York, New York, which resulted in the addition of 2,500 video lottery terminals and electronic table games on October 28, 2011 and approximately 2,500 additional units on December 15, 2011. This increased the total number of units within the New York Lottery system from 12,500 as of September 30, 2011 to approximately 16,900 as of September 30, 2012. The unit count as of September 30, 2012 reflects a temporary removal of some units due to remodeling at two casinos. These terminals and games are not our units, thus are not included in our installed base; instead we provide the back office system and receive a percentage of the net win generated by these terminals and games from the New York Lottery.

Gaming Equipment and System Sales -Player Terminal and Equipment Sales

Player terminal and equipment sales were $33.6 million in fiscal 2012, and $23.2 million in fiscal 2011, an increase of $10.4 million or 44.6%. Player terminal sales in fiscal 2012 were $29.5 million on the sale of 1,961 proprietary units, compared to sales of $17.5 million on the sale of 1,150 proprietary units in fiscal 2011. The player terminal and equipment


sales increase is attributable to continued growth in new markets and continued penetration into existing markets. Gaming equipment sales were $2.1 million in fiscal 2012 compared to $2.7 million in the fiscal 2011 period. Generally, gaming equipment sales include ancillary equipment necessary for the full functionality of the player terminals in a casino. Player terminal and equipment sales also include $2.0 million and $3.1 million related to deferred revenue recognized during fiscal 2012 and fiscal 2011, respectively, due to final execution of deliverables or mutual agreement to changes in contract terms.

Gaming Equipment and System Sales - Systems and Licensing

Systems and licensing sales revenue was $9.2 million in fiscal 2012, compared to $7.7 million in 2011, a $1.5 million or 19.7% increase. Systems and licensing revenue for 2012 relates to (i) $6.8 million of licenses associated with the player terminal sales during the period; (ii) $1.7 million of license revenue from game conversions; and (iii) $665,000 of systems and game themes sold in prior periods being amortized to revenue from deferred revenue over the contract period. Systems and licensing revenue in fiscal 2011 relates to (i) $4.3 million of systems and game themes sold in prior periods being recognized from deferred revenue during the period; (ii) $3.0 million of licenses associated with the player terminal sales during the period; and (iii) $411,000 of license revenue from game conversions. The increase in the year for systems and licensing is primarily attributable to the increase in sale of licenses related to player terminal sales.

Other Revenue

Other revenue was $1.4 million in fiscal 2012 and $1.5 million in fiscal 2011 a $97,000, or 6.6%, decrease. This reduction relates to a decrease in maintenance and service contracts in fiscal 2012.

Cost of Gaming Operations Revenue

Total cost of gaming operations revenue, which includes field service and network operations personnel, as well as royalty and participation fees, decreased $132,000, or 1.4%, to $9.0 million in fiscal 2012, from $9.1 million in fiscal 2011. Costs of gaming operations revenue decreased primarily due to fewer participation fees paid to third-parties for their leased machines.

Cost of Equipment & System Sales

Cost of equipment and system sales, which includes the cost of goods sold for player terminals and other equipment and system sales, increased $3.9 million, or 26.8%, to $18.5 million in fiscal 2012, from $14.6 million in fiscal 2011, primarily due to the increase in player terminal equipment sales. Costs of revenues related to player terminal sales were $16.1 million and $8.7 million in fiscal 2012 and fiscal 2011, respectively. Cost of equipment and system sales in fiscal 2012 includes $1.3 million related to the sale of gaming equipment during the period and $1.2 million of costs of prior period shipments being amortized from deferred revenue over the contract period. Cost of equipment and system sales in fiscal 2011 includes $4.7 million of costs of prior period shipments being amortized from deferred revenue over the contract period and $1.2 million related to the sale of gaming equipment during the period.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, or SG&A, increased approximately $7.6 million, or 18.1%, to $49.6 million in fiscal 2012, from $42.0 million in fiscal 2011. This increase was primarily a result of an increase in (i) salaries and wages and employee benefits of $2.1 million to retain and attract employees; (ii) stock compensation expense of $1.9 million; (iii) long term incentives of $1.5 million; (iv) annual incentives of $784,000; (v) advertising and promotions of $600,000; and
(vi) other taxes and license fees of $583,000.

Write-off, reserve and impairment charges
Write-off, reserve and impairment charges in fiscal 2012 were $1.2 million, a decrease of $826,000, or 41.0%, compared to $2.0 million in fiscal 2011. The write-off, reserve and impairment recorded charges in fiscal 2012 consisted of a reserve for a Mexico income tax assessment during the current period due to a change in the status of the claim. The write-off, reserve and impairment charges in fiscal 2011 consisted of (i) an $821,000 write-off of older equipment deemed obsolete due to changes in the rate of adoption of our newer proprietary game content; (ii) a $484,000 payment for a central system service interruption; (iii) a $355,000 write-off of prepaid loan fees in conjunction with the refinancing of our credit facility; (iv) a $203,000 write-off of install costs at the Alabama locations associated with our voluntary withdrawal from the charitable bingo market; and (v) $150,000 related to a Mexico customs audit.


Research & Development
Research and development expenses increased approximately $2.5 million, or 19.3%, to $15.4 million in fiscal 2012, from $12.9 million in fiscal 2011. Our research and development costs increased primarily due to salaries and wages, due to increased headcount and continued efforts to attract and retain employees, independent testing lab fees, and contract labor.

Depreciation and Amortization

Depreciation expense decreased $3.6 million, or 9.6%, to $33.7 million in fiscal 2012 from $37.3 million in fiscal 2011, primarily as a result certain assets becoming fully depreciated. Amortization expense increased $911,000, or 24.8%, to $4.6 million in fiscal 2012, compared to $3.7 million in fiscal 2011, primarily because of an increase in capitalized software costs, which led to an increase in the associated amortization expense.

Other Income and Expense

Interest income decreased $1.0 million, or 39.4%, to $1.6 million in fiscal 2012, from $2.6 million in fiscal 2011 due to reduced outstanding note receivable balances. During fiscal 2012, the Company recorded imputed interest of $1.3 million relating to development agreements with an imputed interest rate range of 5.25% to 9.0%, compared to $2.3 million for the same period in fiscal 2011.

Interest expense decreased $1.7 million, or 54.5%, to $1.4 million in fiscal 2012, from $3.1 million in fiscal 2011 due to a significant reduction in interest rates charged under our Credit Agreement and a reduction in the outstanding debt balance.

Other income increased $322,000 to other income of $1.0 million in fiscal 2012, from $723,000 in fiscal 2011. The increase primarily relates to a . . .

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