Canadian online gaming provider and Motley Fool Hidden Gems pick CryptoLogic (NASDAQ:CRYP) reports Q1 2006 earnings this Wednesday. If you're worried that recent discussions in the U.S. Congress about banning Internet gambling will have an impact, read on.

What analysts say:

  • Buy, sell, or waffle? Of seven analysts polled, buyers outnumber the rest. Four are raising, two call, and one encourages investors to fold.
  • Revenues. Four estimates average out to 23.2% growth over last year, predicting just less than $25 million.
  • Earnings. Consensus estimates call for $0.49 per share, 44% higher than last year's earnings.

What management says:
In its earnings release for 2005, the company wrote, "By executing a disciplined strategy that targets key customers, product segments, and markets, CryptoLogic has achieved record revenue and earnings, and consistent cash generation -- even in the fast-evolving and increasingly competitive Internet gaming industry." For 2006, the company predicted $25.1 million to $25.5 million in first-quarter revenues, with earnings of $6.7 million to $6.9 million, or $0.49-$0.50 per diluted share.

"CryptoLogic's growth plan remains principally focused on driving significant organic growth from its existing customers," management wrote, "while targeting selected new customers that meet the clear criteria of brand strength, established player bases, and marketing resources and commitment. Although no new customers were added in 2005, the company renewed and strengthened existing customer relationships."

What management does:
Net margins have been slowly growing, primarily because of robust improvements in interest income, strong revenue growth, and steady increases in poker and other forms of Internet gambling. Poker is the fastest-growing portion of CryptoLogic's business.

Margins %*

9/04

12/04

3/05

6/05

9/05

12/05

Gross

37.6

37.3

36.4

36.4

37.7

39

Operating

25.1

24.5

23.9

23.2

24.1

21.8

Net

21.8

21.5

21.4

22

23.4

23.8

Sales Growth %**

42.7

32.6

33.2

33.5

34.8

39.6
* Trailing-12-month (TTM) data for quarter ending in month indicated.
** Year-over-year comparison for quarter ending in month indicated. All data from relevant company quarterly and annual Canadian filings via www.sedar.com.

One Fool says:
Last year's loss of a major customer, BetFair, and a failure to sign new customers has weighed heavily on Cryptologic's stock. Though another minor customer subsequently resigned, a major customer recently renewed its agreement with Cryptologic, driving shares sharply higher late last week. Nonetheless, no new customers have been signed up, which is a bit disturbing. Cryptologic can obtain only so much organic growth from current customers, especially once online gambling's popularity begins to level off.

In addition, management seems determined to award stock options to itself and to employees, despite shareholders' votes against such measures over the past few years. This year's proxy statement includes a proposed amendment to the existing options plan, allowing new options across three categories -- one for management and employees, one for new hires, and one for those acting in other beneficial capacities. In the proxy statement, Cryptologic writes, "The growth of the Company's business requires the ability to attract and retain high-quality and motivated personnel by using incentive stock options as part of employee compensation." I'm sorry, but I tend to think there are better ways.

Competitors:

  • Progressive Gaming (NASDAQ:PGIC)
  • Interactive Systems (NASDAQ:ISWI)
  • PartyGaming (LSE:PRTY.L)

Fool contributor Jim Mueller owns shares in Cryptologic. Fool rules are here.