Good day, and welcome to the AGS Q3 2020 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would like now to turn the conference over to Brad Boyer, VP of Investor Relations, Corporate Development and Strategy. Please go ahead..

Thank you, operator, and good afternoon, everyone. Welcome to AGS’ third quarter 2020 earnings conference call. With me today are David Lopez, CEO; and Kimo Akiona, CFO. A slide presentation reviewing our key operational and financial highlights for the third quarter 2020 and can be found on our Investor Relations website, investors.playags.com.

On today’s call, we will provide an overview of our Q3 2020 financial performance and offer perspective on our current financial outlook. This conference call includes forward-looking statements.

Any statement that refers to expectations, projections or other characterizations of future events, including financial projections or future market conditions, is a forward-looking statement based on assumptions today.

Actual results may differ materially from those expressed in these forward-looking statements, and we make no obligation to update our disclosures.

For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the earnings release that we issued today as well as risks described in our Annual Report on Form 10-K, particularly in the section of these documents titled Risk Factors.

Our commentary today will also include non-GAAP financial measures. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends.

These measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in our earnings release issued today. Please refer to our filings with the SEC for more information.

With that, I’d like to turn the call over to our CEO, David Lopez..

Thanks, Brad, and good afternoon, everyone. As most of you on the call can relate, it’s hard to believe that it’s been nearly eight months since the World Health Organization declared the outbreak of COVID-19 a global pandemic.

While a lot has changed in the past eight months, our focus at AGS remains the same, create an environment for our employees that fosters a strong corporate culture; consistently and prudently allocate capital and other resources to support creativity and the delivery of high-performing game content; and finally, carefully manage our debt obligations and liquidity to ensure we are positioned to endure in the face of macroeconomic uncertainty.

With all of that said, I’m proud of the way our team rallied together delivered better-than-expected third quarter 2020 financial results. On our last call, I noted that I believe we had the best pipeline of product and new game themes in the company’s history.

These new offerings, combined with our resilient base of recurring revenue coming back stronger than expected and ahead of the rebuild in our operating costs allowed us to deliver $27 million of adjusted EBITDA in the quarter.

I’m particularly encouraged by our performance considering the unique set of challenges and uncertainties that continue to face the North American gaming industry and consumer more broadly.

Given the only certainty related to COVID is uncertainty, we are keenly focused on addressing matters and opportunities within our control to ensure we emerge from the pandemic a stronger and more nimble company. Along those lines, we are encouraged by the green shoots emerging across all three of our product segments.

First, with our Electronic Gaming Machine or EGM segment, our long-standing commitment to investing in R&D, coupled with ongoing refinement of our personnel, has our for-sale and recurring businesses on an encouraging trajectory. We shipped a total of 387 units in the third quarter, including sales into 11 U.S. states and two Canadian provinces.

Our recently launched Imperial 88 and Ultimate Choice Jackpot Families of games continue to perform nicely above house average, strengthening our new unit sales efforts. Additionally, giving the strong mix of our Orion family of cabinets in our sales base, our ASP, or average sales price eclipsed $18,000.

Looking ahead, though COVID has the potential to compromise operators propensity to spend capital on new game purchases, we believe our introduction of several newly highly anticipated form factors, including the Orion Curve and multiple new high-performing game franchises position us to command our fair share of future unit sales opportunities.

We are even more enthused about the prospects for our recurring revenue business, supported by our recent launched premium offerings, Orion Starwall and Orion Rise. Through the end of the third quarter, we installed 57 seats of Starwall, including 45 seats in the third quarter alone, with installs in both tribal and commercial jurisdictions.

Starwall’s initial performance has exceeded our expectations with the games performing well above house average. Looking ahead, though encouraged by Starwall’s performance to date, it’s important to note we will remain selective and only deploy new units for opportunities that deliver superior returns on our invested capital.

Looking beyond Starwall, the introduction of Orion Rise should further strengthen our ability to take advantage of additional opportunities to grow our premium recurring revenue footprint.

According to the Eilers market data report, premium recurring revenue units generated $1.3 billion of revenue in 2019, and AGS commanded less than 1% share of the revenue generated within the segment.

To be fair, we have not had the product to compete in the premium recurs space as our legacy big red Cabinet is the only AGS offering captured by Eilers in the segment. Looking ahead, we expect to leverage our world-class hardware offerings and deep pipeline of new game themes to strategically grow our presence in the premium recur segment.

Turning to Oklahoma. We are pleased with the way our Oklahoma installed base has performed since casinos began reopening in May.

Pent-up consumer demand, a resilient core gambler and fewer offerings competing for a share of consumers’ entertainment while continue to support GGR growth throughout the Oklahoma market in the third quarter, and our installed base benefited from this encouraging trend.

Looking ahead, we plan to leverage our new high-performing game content and recently launched premium offerings to further propel our Oklahoma business forward. Additionally, we intend to take advantage of opportunities that present themselves to further enhance the efficiency of our Oklahoma capital footprint.

All told, we are encouraged by our early signs of stabilization in our Oklahoma base and believe the business has the right leadership team and strategic plan in place to continue to improve moving forward. Shifting to our Table Game segment.

We continue to look for opportunities to leverage our growing product portfolio and take advantage of operators heightened cost focus to expand our site license portfolio. Through the end of the third quarter, we have gone live with three site license agreements, which we expect to collectively generate over $1 million of annualized revenue.

Operators’ interest in the site license concept continues to grow, presenting a unique growth opportunity for our Table Game business as site licenses run our presence in operators’ table pits, while simultaneously allowing us to establish a longer-term commitment from those customers.

In addition to site licenses, we continue to achieve measured success with our high-performing suite of Table Game progressive products. We ended the third quarter with over 1,400 progressive units installed and operator interest has held steady despite the challenges created by COVID.

Lastly, we remain committed to growing and diversifying our shuffler business and believe our customers post COVID search for additional operating efficiencies makes now an opportune time to broaden our presence in the shuffler space.

To that end, we expect to submit Pax S, proprietary table game shuffler to GOI for regulatory approval by end of the year. Looking ahead, we continue to see a unique opportunity in the market for efficient and affordable shuffler products, an opportunity we intend to capitalize on in the years ahead.

Lastly, our interactive segment continues to benefit from the rollout of real-money online gaming and additional jurisdictions throughout the United States with third quarter RMG revenues establishing a new quarterly record.

Looking forward, we are strategically positioning our real-money gaming business to be able to swiftly enter new markets as they come online, while we also look to broaden our operator partner relationships and regulated jurisdictions.

In social, we remain focused on launching our content with new and existing B2B partners as well as our B2C social apps, with newly signed deals helping to further stabilize our performance within the segment.

In the end, I believe we have the right people, processes and products in place to not only endure the unique set of challenges born of the COVID pandemic but to emerge a stronger and more nimble company as the world gradually returns to normal.

To that end, I would like to thank all of our employees across the globe for their tireless dedication and support over the past eight months. I truly believe our recent experiences will only help to strengthen our resolve moving forward. With that, I will turn the call over to Kimo to walk you through the quarter in greater detail..

Thank you, David, and good afternoon, everyone. I will begin by providing an overview of the company’s third quarter 2020 financial results, followed by an update on our balance sheet and liquidity position and close with some thoughts on our current outlook for the business.

On the whole, I’m encouraged by our third quarter financial performance as the results reflect the resiliency of a recurring revenue focused business model and the margin enhancements achieved through the implementation of strategic cost efficiency measures aimed at mitigating the impact of the COVID-19 pandemic on our business.

Total revenue for the quarter was $49.3 million, down 38% year-over-year, but considerably higher than the $16.8 million reported in the second quarter of 2020. We attribute the year-over-year decline to the lingering impact of COVID-19-related closures and post-reopening capacity limitations on our business.

To date, we estimate over 90% of the casinos in the United States and Canada have reopened in some capacity, with over 85% of our domestic installed base believed to be in service at the end of the third quarter.

Adjusted EBITDA totaled $27 million below the prior year’s $36.8 million, but well ahead of the $1.2 million EBITDA loss generated in the second quarter.

Adjusted EBITDA margin was 54.8% ahead of the prior year’s 46.3% as our resilient recurring revenue base came back online stronger than expected and ahead of post-shutdown ramp in our operating expenses.

Additionally, we sold 476 previously leased, lower-yielding units in the quarter, which I will describe in greater detail later in my prepared remarks. I will now provide an update on each of our business segments, beginning with our Electronic Gaming Machine, or EGM business.

Total EGM revenue in the quarter was $45.1 million, of which 71% came from recurring sources compared to $75.3 million and 65%, respectively, in the prior year’s quarter. We sold a total of 387 units in the quarter, and the domestic average selling price, or ASP, was $18,190.

The Orion Portrait cabinet accounted for 63% of total unit shipped, while a total of 76 Orion Curve cabinets were sold in the quarter, bringing total Curve sales to date to over 100 units. Pennsylvania, British Columbia and California emerged as our top three sales markets.

The quarter also benefited from the sale of 476 previously leased lower-yielding units to a distributor in Oklahoma, in line with one of our strategic initiatives discussed on prior calls. These units are not included in the reported sold-unit number for Q3 nor in our ASP metric, consistent with our presentation in prior quarters.

Our domestic installed base at quarter end comprised 16,825 units and domestic RPD was $20.81. We estimate our RPD for units that were active was $29.

We believe our active gains are modestly over-indexing relative to their pre-COVID levels of performance, an outcome we attribute to resilient regional gross gaming revenue trends and growing slot floor prominence in our casino operator partners post reopening revenue hierarchy.

Excluding the aforementioned sale of 476 previously leased units, our domestic installed base declined modestly on a sequential basis, predominantly a function of several tribal operators reconfiguring their slot floors in response to COVID.

Looking ahead, although we do not anticipate any additional sizable COVID-related removals from our domestic installed base, we do intend to pursue additional opportunities to strategically prune our installed base in future quarters. Shifting to Oklahoma.

We continue to be encouraged by the post-reopening revenue strength demonstrated throughout the Oklahoma gaming market.

And speaking with our operator partners, we believe pent-up consumer demand, a resilient core gambler and fewer offerings competing for a share of the consumers’ entertainment wallet continue to stimulate GGR growth throughout the market.

In the third quarter, our installed base of games continued to ride the broader Oklahoma markets tailwind, delivering improved performance versus the prior year.

Although early in the recovery process, we are encouraged by signs of stabilization in our Oklahoma performance metrics, and we believe we have the right team in place to lead our Oklahoma business forward.

To that end, we will continue to look for opportunities to strategically improve the overall capital efficiency of our Oklahoma installed base and deploy new high-performing game themes and hardware into the Oklahoma market to strengthen our performance. Our international installed base at quarter end included 8,030 units.

To date, a little over half of our casino operator partners in Mexico have reopened their businesses.

However, a lack of meaningful fiscal stimulus and stringent COVID-related operational protocols, including age-based visitation restrictions have compressed RPD metrics in the market despite most casinos operating at 30% to 50% of pre-COVID machine capacity.

It is important to note, however, that even after taking all of the current operating headwinds into account, our international business remains cash flow positive on a stand-alone basis.

Looking ahead, we expect more of our Mexico units to gradually come online over the balance of the year and believe RPD could gradually improve as operational protocols are eased. Our Table Products segment generated $2.3 million of revenue in the quarter, nearly all of which is recurring.

Table game adjusted EBITDA was $1.3 million compared to $1.4 million in the prior year’s quarter. The total Table Products installed base at quarter end comprised 4,012 units, representing an increase of 11% year-over-year and 50 units sequentially. We estimate over 80% of our table game lease installed base was active at quarter end.

As David mentioned, we have successfully executed three site license agreements for our table products, with each featuring a two year term.

Looking forward, we are encouraged by indications of increased operator entrants in our site license offering and believe our casino operator partners post-COVID search for improved operating efficiency could further stimulate site license demand in the quarters ahead.

Finally, our Interactive segment delivered quarterly revenues of $1.9 million, representing an increase of nearly 60% year-over-year. Our real-money gaming business continues to benefit from the addition of new casino operator partners with the segment achieving record quarterly revenue performance.

Within social, our business achieved another quarter of considerable top line improvement versus the prior year. Although Interactive contributed positive EBITDA for the third consecutive quarter, we believe the consumer’s preference for at-home consumption likely benefited our third quarter Interactive performance to some degree.

A factor investors should keep in mind when contemplating the segment’s forward growth trajectory. Turning our focus to cash flow and the balance sheet. CapEx for the quarter totaled $7.1 million, with growth CapEx accounting for approximately half of the total capital expended. Year-to-date CapEx through September 30, 2020, totaled $21.6 million.

We generated $4.8 million of free cash flow in the quarter compared to a negative $14.8 million in the second quarter. Looking ahead to the fourth quarter, we expect free cash flow to be modestly positive as we do not anticipate realizing any cash benefit from further strategic pruning of our installed base in the quarter.

Additionally, we expect to take advantage of strong operator demand for our new premium recurring revenue products to strategically invest in growing our installed base. As of September 30, 2020, our available liquidity was $113.2 million compared to $113.1 million at June 30, 2020.

As an indication of our confidence in the current trajectory of the business and our comfort with our current liquidity position, we fully repaid the $30 million outstanding on our revolving credit facility subsequent to quarter end.

Total net debt, which is the principal amount of total debt less cash and cash equivalents was approximately $541.1 million compared to $520.6 million at December 31, 2019. As a reminder, our first lien term loan and our $95 million incremental term loan both mature on February 15, 2024, and our revolving credit facility will mature on June 6, 2022.

Our total net debt leverage ratio, which is total net debt divided by adjusted EBITDA, for the trailing 12-month period increased from 3.6 times at December 31, 2,019 to 6.2 times at September 30, 2020. As a reminder, in May, we obtained covenant relief from the first lien leverage ratio test for 2020.

Although it is hard to predict exactly how the pandemic will continue to impact the macro-operating environment, we believe the measures we’ve taken to date position the company to endure through the most challenging time our industry has ever seen.

Furthermore, we continue to believe we are positioned to emerge from the pandemic as a stronger and more nimble organization.

Looking out over the balance of the year, we are encouraged by the resilience demonstrated within our recurring revenue businesses and are cautiously optimistic about the prospects for our new high-performing game themes and hardware.

Although visibility in the North American slot replacement market remains limited, we believe our improved game performance and refined sales practices should allow us to capture our fair share of operators’ new unit purchases.

On the lease side of the business, we continue to look for opportunities to strategically prune our installed base, while simultaneously and prudently deploying new premium content and hardware offerings to take advantage of new placement and revitalization opportunities that present the highest ROI potential.

Lastly, as it pertains to our EBITDA margins, I want to remind everyone that a combination of revenues coming back online faster than operating costs, a greater mix of higher-margin recurring revenues and the sale of 476 previously leased units with minimal associated costs produced a third quarter margin that was ahead of our historical run rate level.

As a large majority of our team returns to support current business levels and the mix of revenue normalizes, we would expect to gradually see some level of normalization in our reported margins, all else being equal. And with that, I will now move to the Q&A portion of the call..

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Barry Jonas with Truist Securities..

This is Avi on for Barry. Great quarter.

First question is with rising COVID cases, have you seen any related softness in your business?.

Sorry you’re breaking up a little bit, but I think you said with rising COVID cases, have we seen the softness in the business. And there’s nothing really that you can directly correlate. Obviously, we watch the numbers very closely. And it’s very interesting to date, yet we haven’t really seen much going on there. We’ll keep a very close eye on it.

Obviously, it’s hard for us to predict what will happen going forward, but nothing just yet..

Okay.

How are you prepared in the event we see another round of COVID-related casino shutdowns? Any lessons from the first time?.

Yes. Obviously, a lot of lessons from the first time. I think the first go around and maybe Kimo might have something to add here. But the first go around, put us in a very nice position here to know what steps to take as we move forward should something like that happen.

We don’t necessarily anticipate sort of that global type shutdown of casinos or we’ll say, in North America, the shutdown of casinos in North America like we did before, but should there be, we’ll call it, like rolling blackouts or a casino here or there, those are easier to manage.

Should it be anything larger than that, the experiences from the past put us in good position to know how to move more swiftly through the process..

Okay. Great.

And last question, as you think about your current business mix, are there any new areas that could interest you, whether it’s expanding Interactive offerings to sports betting or other areas or perhaps more well-known branded participation games?.

So yes, we get asked quite a bit. Good question. We get asked quite a bit on branded participation. It’s not a place that we’re at yet. We always evaluate it, look at it very closely. Should we find a licensed brand that we really think would offer some pop in that space for us. Obviously, we would get after that.

Same thing with diversification or sports or anything of the like, it have to be the right opportunity for us. But at the moment, what we find is that it was in the prepared remarks a little bit, but to expand on it, is that our portfolio is in the best position.

Our games on the EGM side, Interactive and of course, Tables and shufflers are in better position than we’ve ever seen it before. So we feel great about that. And right now, maybe the best way to look at it is that investing in ourselves and organic growth is probably the best route to go.

Now if something should come up, clearly would take a good look at it..

Thank you..

Thanks..

Our next question comes from Chad Beynon with Macquarie. Please go ahead..

Hey, this is Aaron Lee on for Chad. So you noted that your pipeline has been strong.

Can you talk about the number of titles that you’re rolling out on some of the newer cabinets like Starwall?.

Yes. So we don’t have – I don’t have the number of titles that we’re rolling out, but we have a full sort of schedule and pipeline. And specifically for Starwall, we have a couple of games in one family right now. We have them queued up for the next family to be released probably in early 2021. We don’t publish like the specifics on that.

The biggest thing there is to really get a feel for how Starwall is doing with the existing game family and then roll from there and have new titles and new offerings ready. No need to pre-release them or early release them other than some testing if we’re seeing as good results as we’ve got so far on the initial batch of Starwall games.

And that’s really our strategy for all of our new released cabinets. We’ll do the same when it comes to Curve, Curve Premium and Rise. But so far, Starwall is sort of knocking it out of the park for us. So we’re going to stick to our guns that are working, and we’ll do some testing on the new titles.

But we won’t see a full rollout of that until we feel like we need to go that route..

Okay. And just turning to Interactive for a moment. It’s really great to see you guys having the momentum in this business.

Just looking at the variability in the margins between 2Q and 3Q, how should we think about the margins going forward?.

I think as far as margins – and then we’ll just speak about the business specifically in Interactive. I think that COVID obviously aided the development going forward for our interactive division, it was very helpful. As far as margins and revenue go, we expect things to remain consistent. We see some new openings.

I think there will be – and when I say new openings, new openings of jurisdictions will come sometime in early Q1 of next year, that will be helpful. So we think things will remain relatively consistent until then. And then when we see those new openings or new jurisdictions, we can see a little bit more from there.

But I’d say that things will be relatively in line..

Okay, great. Thanks very much..

As there are no more questions, this concludes our question-and-answer session, which also concludes today’s conference call. Thank you for attending today’s presentation. You may now disconnect..