UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

For the transition period from                                    to

Commission File No. 0-24993

WPT ENTERPRISES, INC.

(Exact name of registrant as specified in its charter)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No x

As of August 7, 2007 there were 20,491,993 shares of Common Stock, $0.001 par value per share, outstanding.

WPT ENTERPRISES, INC.

INDEX

					Page of
					Form 10Q
PART I.		FINANCIAL INFORMATION
		ITEM 1.		FINANCIAL STATEMENTS
				Condensed Consolidated Balance Sheets as of July 1, 2007 (unaudited) and December 31, 2006	3
				Unaudited Condensed Consolidated Statements of Earnings (Loss) and Comprehensive Earnings (Loss) for the three and six months ended July 1, 2007 and July 2, 2006	4
				Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the six months ended July 1, 2007 and July 2, 2006	5
				Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2007 and July 2, 2006	6
				Notes to Unaudited Condensed Consolidated Financial Statements	7
		ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12
		ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21
		ITEM 4.		CONTROLS AND PROCEDURES	21
PART II.		OTHER INFORMATION
		ITEM 1.		LEGAL PROCEEDINGS	22
		ITEM 1A.		RISK FACTORS	22
		ITEM 4.		Submission of Matters To a Vote Of Security Holders	24
		ITEM 6.		EXHIBITS	24
SIGNATURES					25

 

2

Part I. Financial Information

 

ITEM 1. FINANCIAL STATEMENTS

 

WPT ENTERPRISES, INC.

Condensed Consolidated Balance Sheets

		July 1, 2007			December 31, 2006
		(unaudited)
		(In thousands)
Assets
Current assets:
Cash and cash equivalents		$	1,544		$	8,360
Investments in marketable securities		33,012			31,263
Accounts receivable, net of allowances of $18		3,141			2,353
Deferred television costs		953			1,722
Other		624			735
		39,274			44,433
Property and equipment, net		1,537			3,375
Restricted cash		347			453
Investments		2,923			2,923
Other		156			156
		44,237			$	51,340
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	1,060		$	674
Accrued payroll and related		940			1,205
Other accrued expenses		789			1,076
Deferred revenue		2,557			4,740
Income taxes payable		1			394
		5,347			8,089
Commitments and Contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value; authorized 20,000 shares; none issued and outstanding		—			—
Common stock, $0.001 par value; authorized 100,000 shares; 20,492 and 20,378 shares issued and outstanding, respectively		20			20
Additional paid-in capital		42,970			41,719
Retained earnings (deficit)		(4,058		)	1,561
Accumulated other comprehensive loss		(42		)	(49		)
		38,890			43,251
		$	44,237		$	51,340

 

See notes to condensed consolidated financial statements

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WPT ENTERPRISES, INC.

Condensed Consolidated Statements of Earnings (Loss) and Comprehensive Earnings (Loss)

(unaudited)

		Three months ended						Six months ended
		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
		(In thousands, except per share data)
Revenues:
License fees:
Domestic television		$	4,306		$	7,259		$	6,708		$	10,304
International television		765			661			1,220			1,568
Product licensing		979			804			1,859			1,517
		6,050			8,724			9,787			13,389
Online gaming		260			821			810			1,732
Event hosting and sponsorship fees		1,357			1,412			1,482			2,209
Other		53			72			133			152
		7,720			11,029			12,212			17,482
Cost of revenues		3,087			4,176			5,239			6,596
Gross profit		4,633			6,853			6,973			10,886
Selling, general and administrative expense		5,950			4,361			11,233			9,509
Loss on abandonment of online gaming assets		2,270			—			2,270			—
Earnings (loss) from operations		(3,587		)	2,492			(6,530		)	1,377
Other income:
Gain on sale of investment		—			—			—			5,675
Interest		248			419			911			744
Earnings (loss) before income taxes		(3,339		)	2,911			(5,619		)	7,796
Income taxes		—			344			—			1,639
Net earnings (loss)		(3,339		)	2,567			(5,619		)	6,157
Unrealized gains (loss) on securities		(16		)	(840		)	7			(411		)
Comprehensive earnings (loss)		$	(3,355	)	$	1,727		$	(5,612	)	$	5,746
Net earnings (loss) per common share - basic and diluted		$	(0.16	)	$	0.12		$	(0.27	)	$	0.30
Weighted-average common shares outstanding - basic		20,603			20,603			20,603			20,310
Dilutive effect of common stock equivalents		—			—			—			2
Weighted-average common shares outstanding - diluted		20,603			20,603			20,603			20,312

 

See notes to condensed consolidated financial statements

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WPT ENTERPRISES, INC.

Condensed Consolidated Statements of Stockholders’ Equity

Six Months ended July 1, 2007 and July 2, 2006

(unaudited)

				Common Stock					Additional Paid-in			Retained Earnings			Deferred			Accumlated Other Comprehensive
				Shares		Dollars			Capital			(Deficit)			Compensation			Earnings/(Loss)			Total
															(in thousands)
2007
BALANCES AT JANUARY 1, 2007				20,378		$	20		$	41,719		$	1,561		$	—		$	(49	)	$	43,251
Common stock issued				114					1												1
Share-based compensation									1,250												1,250
Other comprehensive earnings																		7			7
Net loss												(5,619		)							(5,619		)
BALANCES AT JULY 1, 2007				20,492		$	20		$	42,970		$	(4,058	)	$	—		$	(42	)	$	38,890
2006
BALANCES AT JANUARY 2, 2006				20,158		$	20		$	34,113		$	(6,208	)	$	(1	)	$	10,449		$	38,373
Reduction of deferred compensation															1						1
Common stock issued				220					1												1
Share-based compensation									2,409												2,409
Income tax benefit from stock option exercises									1,457												1,457
Realized gain on sale of investment																		(5,675		)	(5,675		)
Other comprehensive loss																		(411		)	(411		)
Net earnings												6,157									6,157
BALANCES AT JULY 2, 2006				20,378		$	20		$	37,980		$	(51	)	$	—		$	4,363		$	42,312

 

See notes to condensed consolidated financial statements

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WPT ENTERPRISES, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited)

		Six months ended
		July 1, 2007			July 2, 2006
		(In thousands)
OPERATING ACTIVITIES:
Net earnings (loss)		$	(5,619	)	$	6,157
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities:
Depreciation		361			255
Share-based compensation		1,259			2,293
Realized gain on sale of investment		—			(5,675		)
Income taxes		—			1,457
Loss on disposal of online gaming assets		2,270			—
Increase in operating (assets) liabilities:
Accounts receivable		(788		)	1,151
Income taxes payable		(393		)	—
Deferred television costs		760			904
Other		(129		)	159
Accounts payable		386			(710		)
Accrued expenses		(596		)	810
Deferred revenue		(2,183		)	(1,799		)
Net cash provided by (used in) operating activities		(4,672		)	5,002
INVESTING ACTIVITIES:
Purchase of property and equipment		(509		)	(1,836		)
Purchases of short-term investments in marketable securities		(34,297		)	(24,981		)
Sales/redemptions of short-term investments in marketable securities		32,555			21,172
Proceeds from sale of investment		—			5,686
Net cash provided by (used in) investing activities		(2,251		)	41
FINANCING ACTIVITIES:
Decrease (increase) in restricted cash		106			(196		)
Proceeds from stock option exercises		1			1
Net cash provided by (used in) financing activities		107			(195		)
Net increase (decrease) in cash and cash equivalents		$	(6,816	)	$	4,848
Cash and cash equivalents - beginning of period		8,360			1,737
Cash and cash equivalents - end of period		$	1,544		$	6,585

 

See notes to condensed consolidated financial statements

6

WPT ENTERPRISES, INC.
Notes to Unaudited Condensed Consolidated Financial Statements

1. BASIS OF PRESENTATION

These condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable to interim financial information. Accordingly, certain information normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America has been condensed or omitted.  For further information, please refer to the annual audited financial statements of the Company, and the related notes, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, previously filed with the SEC, from which the information as of that date is derived.

In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results for the current interim period are not necessarily indicative of the results to be expected for the full year.

Certain minor reclassifications to amounts previously reported have been made to conform to the current period presentation. These reclassifications had no effect on net earnings (loss) or stockholders’ equity as previously presented.

2. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per common share is calculated by dividing net earnings (loss) by the weighted-average number of common shares outstanding during the period. Shares for certain stock options granted to employees and consultants of the Company are included in the computation after the options have vested when the shares are issuable for relatively minimal cash consideration in relation to the fair value of the options (Note 3). Diluted earnings per common share is calculated by adjusting weighted-average outstanding shares, assuming conversion of all potentially dilutive stock options and awards (common stock equivalents). However, common stock equivalents are not considered in the calculation for loss periods because to do so would be anti-dilutive.

3. SHARE-BASED COMPENSATION

The Company uses the Black-Scholes option-pricing model to estimate the fair value and compensation cost associated with employee incentive stock options in accordance with SFAS 123(R).  The bases for the key assumptions included in the model are as follows:

·                  Expected volatility — As the Company has a relatively short operating history and no definitive peer or peer groups, expected volatility was based on historical volatility of the Company’s stock since it began trading in August 2004.

·                  Forfeiture rate — The Company uses historical data to estimate employee departure behavior in estimating future forfeitures.

·                  Expected term — Due to the Company’s limited operating history including stock option exercises and forfeitures, the Company calculated expected term using the “Simplified Method” in accordance with SAB 107.

·                  Risk free interest rate - For periods within the expected term of the share option, risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.

Following is a summary of the assumptions used to estimate the weighted-average fair value of the stock options granted during the periods presented using the Black-Scholes option-pricing model:

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		Three months ended July 1, 2007			Three months ended July 2, 2006			Six months ended July 1, 2007			Six months ended July 2, 2006
Risk free interest rate		4.84		%	5.06		%	4.65		%	4.68		%
Expected term		6 years			6.5 years			6 years			6.5 years
Expected dividend yield		0		%	0		%	0		%	0		%
Expected volatility		72.22		%	78.91		%	73.03		%	81.57		%
Forfeiture rate		12.99		%	4.13		%	12.99		%	4.13		%
Weighted-average fair value		$	3.06		$	3.80		$	3.17		$	4.24

 

The table below summarizes share-based compensation expense, net of tax, related to employee stock options under SFAS 123(R), which was allocated as follows (in thousands):

		Three months ended July 1, 2007			Three months ended July 2, 2006			Six months ended July 1, 2007			Six months ended July 2, 2006
Total cost of share-based payment plans		$	662		$	678		$	1,250		$	2,280
Amounts capitalized in deferred television costs		1			—			1			—
Amounts charged against income, before income tax benefit		$	661		$	678		$	1,249		$	2,280

 

No income tax benefit was recognized in the statement of earnings (loss) for share-based compensation arrangements for the six months ended July 1, 2007 and July 2, 2006.  Management assessed the likelihood that the deferred tax assets relating to future tax deductions from share-based compensation will be recovered from future taxable income and determined that a valuation allowance is necessary, to the extent that management currently believes it is more likely than not that tax benefits will not be realized. Management’s determination is based primarily on historical earnings volatility, and the Company’s relatively short operating history and expected taxable losses for fiscal 2007.

The following table summarizes stock option activity through the six months ended July 1, 2007 and July 2, 2006:

					Number of Common Shares
			Options outstanding		Exercisable		Available for grant		Weighted-avg. exercise price
2007
Balance at January 1, 2007			2,318,166		1,050,200		983,501		$	6.76
Granted			287,000				(287,000	)	$	4.80
Forfeited /cancelled/expired			(90,466	)			90,466		$	8.49
Balance at April 1, 2007			2,514,700		1,010,533		786,967		$	6.47
Granted			182,000				(182,000	)	$	4.53
Forfeited /cancelled/expired			(85,667	)			85,667		$	5.25
Exercised			(113,660	)					$	0.0049
Balance at July 1, 2007			2,497,373		912,139		690,634		$	6.67
2006
Balance at January 2, 2006			2,158,000		620,333		283,667		$	7.14
Granted			219,000				(219,000	)	$	6.20
Forfeited /cancelled/expired			(159,333	)			159,333		$	8.13
Exercised			(115,000	)					$	0.0049
Balance at April 2, 2006			2,102,667		785,500		224,000		$	7.36
Authorized							1,080,000
Granted			109,500				(109,500	)	$	5.18
Forfeited /cancelled/expired			(153,501	)			153,501		$	10.07
Exercised			(105,000	)					$	0.0049
Balance at July 2, 2006			1,953,666		619,333		1,348,001		$	7.42

 

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The following table summarizes significant ranges of outstanding and exercisable options as of July 1, 2007:

Options outstanding												Options exercisable
Range of exercise prices		Number outstanding		Weighted-avg. remaining contractual life		Weighted-avg. exercise price			Aggregate intrinsic value			Number exercisable		Weighted-avg. price			Aggregate intrinsic value
$             0.0049		111,340		4.66		$	0.0049		$	454,835		111,340		$	0.0049		$	454,835
$  3.93 —   4.80		824,000		9.58		4.46			4,800			—		—			—
$  5.18 —   9.92		1,325,366		7.48		7.57			—			739,133		7.88			—
$11.95 — 14.51		220,667		8.12		12.19			—			56,000		12.70			—
$15.05 — 19.50		16,000		8.10		15.33			—			5,666		15.57			—
		2,497,373		8.10		$	6.67		$	459,635		912,139		$	7.26		$	454,835

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $4.09 on June 29, 2007, which would have been received by the option holders had they exercised their options as of that date.  The total intrinsic value of options exercised during the three months ended July 1, 2007 and July 2, 2006 was $0.5 million and $0.8 million, respectively.  The total intrinsic value of options exercised during the six months ended July 1, 2007 and July 2, 2006 was $0.5 million and $1.4 million, respectively.

As of July 1, 2007, total compensation cost related to non-vested share-based options not yet recognized was $3.5 million, which is expected to be recognized over the next 29 months on a weighted-average basis.

4. INCOME TAXES

The income tax provision was $0 and $1.6 million for the first six months of 2007 and 2006, respectively, and the effective tax rate for the first six months of 2007 and 2006 was approximately 0% and 21%, respectively. Management expects the Company to generate a net operating loss for 2007, and a valuation allowance has been recorded for the net deferred tax asset related to the net loss generated in the first six months of 2007.

Effective for the first quarter of 2007, the Company adopted Financial Accounting Standards Board Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). Based on the Company’s assessment of its tax positions in accordance with FIN 48, there was no impact on the results of operations, financial condition or liquidity and accordingly, there was no cumulative effect adjustment recorded for the change in accounting principle in the first quarter of 2007. Furthermore,  the income tax provision during the period ended July 1, 2007 was not impacted by FIN 48.

5. ONLINE GAMING COMMITMENT AND RELATED LOSS ON ABANDONMENT OF ONLINE GAMING ASSETS

On April 23, 2007, the Company entered into a three year software supply and support agreement (the “Agreement”) with CryptoLogic Inc., and its wholly-owned subsidiary WagerLogic Limited, (collectively referred to as “CryptoLogic”). Pursuant to the Agreement, CryptoLogic will operate an online gaming site for the Company featuring a poker room and casino games utilizing its proprietary software, in exchange for a percentage of the revenue generated from the site.  The Company will be entitled to approximately 80% of net gaming revenues from the operation of the site.  Under the Agreement, the Company will also be a member in a centralized online gaming network (the “Network”) with several other licensees of CryptoLogic pursuant to which players will be able to play on the Company’s branded gaming site on the Network.

Prior to signing the Agreement with CryptoLogic, the Company was developing its own proprietary online gaming platform internally, which management decided to abandon and replace with the CryptoLogic arrangement.  As a result of signing the Agreement with CryptoLogic, during the second quarter of 2007, the Company wrote off approximately $2.3

9

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million of capitalized costs related to the online gaming platform previously being developed internally.  The assets written off consist primarily of software and computer equipment.

The online gaming site on the CrytoLogic platform became operational in June 2007, but operations during the quarter were not material.

6. CONTINGENCIES

On July 19, 2006, a legal action was commenced against the Company by seven poker players that alleges, among other things, an unfair business practice of the Company. On March 14, 2007, the plaintiffs filed a motion for summary judgment in the case and on April 12, 2007, the Company filed its opposition to the motion. On May 22, 2007, the Court denied the plaintiffs’ motion for summary judgment. A trial date has been set for April 1, 2008. Although management is currently unable to predict the ultimate outcome of this matter, it believes that the Company is not likely to sustain any material loss in connection therewith, and accordingly, no provision for loss has been recorded in connection therewith.

The Company is also involved in various inquiries, administrative proceedings and litigation relating to other matters arising in the normal course of the Company’s business.  While any proceeding or litigation has an element of uncertainty, management currently believes that the final outcome of these matters is not likely to have a material adverse effect upon the Company’s future financial position or results of operations and accordingly, no provision for loss has been recorded in connection therewith.

7. SEGMENT INFORMATION

The operating segments reported below are the segments of the Company for which separate financial information is available and for which operating results are evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

Three months ended July 1, 2007 (in thousands):

					WPT Online
		WPT Studios			Gaming			Content			WPT Global Marketing			Corporate			Total
Revenues		$	5,778		$	260		$	29		$	1,653		$	—		$	7,720
Cost of revenues		2,748			162			20			157			—			3,087
Gross profit		3,030			98			9			1,496			—			4,633
Total assets		3,743			381			84			960			39,069			44,237
Depreciation		82			15			—			—			83			180

 

Three months ended July 2, 2006 (in thousands):

					WPT Online
		WPT Studios			Gaming			Content			WPT Global Marketing			Corporate			Total
Revenues		$	8,524		$	821		$	83		$	1,601		$	—		$	11,029
Cost of revenues		3,657			381			33			105			—			4,176
Gross profit		4,867			440			50			1,496			—			6,853
Total assets		1,877			764			38			1,174			44,647			48,500
Depreciation		86			—			—			—			49			135

 

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Six months ended July 1, 2007 (in thousands):

					WPT Online
		WPT Studios			Gaming			Content			WPT Global Marketing			Corporate			Total
Revenues		$	8,646		$	810		$	77		$	2,679		$	—		$	12,212
Cost of revenues		4,418			462			46			313			—			5,239
Gross profit		4,228			348			31			2,366			—			6,973
Depreciation		167			27			—			—			167			361

 

Six months ended July 2, 2006 (in thousands):

					WPT Online
		WPT Studios			Gaming			Content			WPT Global Marketing			Corporate			Total
Revenues		$	12,979		$	1,732		$	162		$	2,609		$	—		$	17,482
Cost of revenues		5,489			789			70			248			—			6,596
Gross profit		7,490			943			92			2,361			—			10,886
Depreciation		158			1			—			—			96			255

 

8. SUBSEQUENT EVENTS

On August 6, 2007, the Company entered into an agreement with a Chinese government-sanctioned body with authority over certain leisure sports, including the popular national card game “Traktor Poker,” known as Tuo La Ji.   Pursuant to the five year term of the agreement, the Company will receive exclusive branding and certain marketing and sponsorship rights related to the China National Traktor Poker Tour.  In exchange for these rights, the Company will pay an annual fee, which starts at $505,000 in the first year and increases by 10% annually for the remaining four years of the agreement.

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WPT ENTERPRISES, INC.
Management’s Discussion and Analysis of Financial Condition
And Results of Operations

ITEM 2.              MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Financial Overview

We had a net loss in the first six months of 2007 of $5.6 million, or $0.27 per fully diluted share, compared to net income of $6.2 million, or $0.30 per fully diluted share, in the 2006 period. The primary reasons for the net loss in the 2007 period compared to the net earnings in 2006 were the following:

·                  Revenues decreased by $5.3 million, principally because of the delivery of fewer television episodes in 2007.

·                  Gross margins were lower in 2007, principally because of the delivery of ten episodes of our Professional Poker Tour® (the “PPT”) series in 2006 for which a majority of the production costs had been expensed in an earlier period. In addition, online gaming operations contributed to the overall lower margin in the first six months of 2007 as a result of an amendment of the agreement with the service provider that was effective in July 2006, which significantly increased the percentage of revenues paid to that party.

·                  Selling, general and administrative expenses increased year-over-year by $1.7 million. The increase was primarily due to the Company’s efforts to develop its own online gaming software and support infrastructure.

·                   During the second quarter of 2007, we wrote-off approximately $2.3 million in online gaming assets as a result of ceasing development of our stand-alone online gaming operation and joining the CryptoLogic network.

·                   The prior year period included a gain on sale of our investment in PokerTek, Inc. of $5.7 million.

Business Overview

We create internationally branded entertainment and consumer products driven by the development, production and marketing of televised programming based on gaming themes. Our World Poker Tour®, or WPT, television series, based on a series of high-stakes poker tournaments, currently airs on the Travel Channel in the United States and has been licensed to telecast in more than 150 markets globally.  We also operate a real-money online gaming website which prohibits wagers from players in the U.S. and other restricted jurisdictions.  We currently license our brand to companies in the business of poker equipment and instruction, apparel, publishing, electronic and wireless entertainment, DVD/home entertainment, casino games and giftware.  We are also engaged in the sale of corporate sponsorship.  We have three operating units:

WPT Studios, our multi-media entertainment division, generates revenue through the domestic and international licensing of broadcast and telecast rights and through casino host fees. Since our inception, the WPT Studios division has been responsible for approximately 73% of our total revenue. We licensed the WPT series Seasons One through Five to The Travel Channel, L.L.C. (“TRV” or “Travel Channel”) for telecast in the United States under an exclusive license agreement (“TRV Agreement”). On April 2, 2007, we entered into an agreement (the “GSN Agreement”) with Game Show Network, LLC (“GSN”), pursuant to which GSN agreed to license from us the sixth season of the Show for the payment of a $300,000 license fee per episode.  Under the TRV agreement, we received an average of $477,000 per episode for Season Five.  We also have license agreements for the distribution of our WPT and PPT episodes into international territories for which we receive license fees, net of our agent’s sales fee and agreed upon sales and marketing expenses.  We also collect annual host fees from the member casinos that host World Poker Tour events (our member casinos).

Since our inception, fees from the TRV Agreement and an agreement with TRV relating to the PPT series have been responsible for approximately 59% of our total revenue. For each season covered by the TRV Agreement and related options,

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TRV has exclusive rights to exhibit the episodes in that season an unlimited number of times on its television network in the U.S. for four years (three years for the episodes in Season One). We have produced five complete seasons of the World Poker Tour series under the TRV Agreement.

Under the TRV and GSN Agreements, TRV and GSN pay fixed license fees for each episode we produce, which are payable at various times during the pre-production, production and post-production process and revenues are recognized upon receipt and acceptance of the completed episode. Television production costs related to WPT episodes are generally capitalized and charged to the cost of revenues as revenues are recognized. Therefore, the timing and number of episodes involved in the various seasons of the series affect the timing of the revenues and expenses of the WPT Studios business. The following table describes the timing of Seasons One through Six of the World Poker Tour series, including the delivery and exhibition of the episodes each season:

World Poker Tour Season		Date of Agreement or Option for Season		Number of episodes (including specials)		Production Period and Delivery of Episodes		Initial Telecast of Episodes in Season
Season One		January 2003		15		February 2002 — June 2003		March 2003 — June 2003
Season Two		August 2003		25		July 2003— June 2004		December 2003 — September 2004
Season Three		May 2004		21		May 2004 — April 2005		October 2004 — August 2005
Season Four		March 2005		21		May 2005 — April 2006		October 2005 — June 2006
Season Five		March 2006		22		May 2006 — April 2007		August 2006 — August 2007
Season Six		April 2007		23		May 2007 — April 2008		January 2008 — August 2008 (projected)

 

The agreement with TRV relating to the PPT series, which continues to cover the broadcast rights to Season One was substantially similar in structure to the TRV Agreement.

Under the WPT and PPT Agreements, TRV has the right to receive a percentage of our adjusted gross revenues from international television licenses, product licensing and publishing, merchandising and certain other sources, after specified minimum amounts are met.  For the six months ended July 1, 2007, we recognized $0.4 million of Travel Channel participation expense that was recorded in cost of revenues.

WPT Global Marketing, includes branded consumer products, sponsorship, and event management divisions. Our branded consumer products division generates revenue principally through royalties from the licensing of our brand to companies seeking to use the World Poker Tour brand and logo in the retail sales of their consumer products. In addition, this business unit generates revenue from direct sales of company-produced branded merchandise. We have generated significant revenues from existing licensees, including Hands-On Mobile and Take Two. We also have licensees that are developing new licensed products including interactive television games from Pixel Play.

Our sponsorship and event management division generates revenue through corporate sponsorship and management of televised and live events. Our sponsorship program uses the professional sports model as a method to foster entitlement sponsorship opportunities and naming rights to major corporations.  Anheuser-Busch has been the largest source of revenues through its sponsorship of Seasons Two, Three, Four and Five of the World Poker Tour series on TRV. In addition, we had an agreement with Blue Diamond Almonds to sponsor the WPT Season Five Championship in April 2007 at the Bellagio.  We began recognizing revenues from these agreements as the Season Five programs were broadcast.

WPT Online.  In 2005 we began operating WPTonline.com through a license agreement with WagerWorks, Inc., under which we licensed our brand to WagerWorks and WagerWorks shared with us a percentage of all net revenue it collected from the operation of the online poker room and online casino. WPTonline.com generated approximately $0.8 million in revenues, which are presented gross of WagerWorks costs, for the six months ended July 1, 2007, compared to costs of revenues of approximately $0.5 million. In June 2007, WPTonline.com ceased operations and the relationship with WagerWorks, Inc. was terminated as we transitioned to a new online software platform as described below.

In 2006, we decided to develop our own software for our online poker room. We licensed a software platform from CyberArts Licensing, LLC, and hired thirty employees in Israel to develop the software and a support infrastructure. On April 23, 2007, we entered into a three year software supply and support agreement (the “Agreement”) with CryptoLogic Inc., and its wholly-owned subsidiary WagerLogic Limited, (collectively referred to as “CryptoLogic”). As a result of the decision to move away from the online gaming platform we were developing based on the CyberArts software and stopping the development of our own online gaming site, we have written off certain property and equipment and related capitalized costs of approximately $2.3 million during the second quarter of 2007. In addition to the write off, we curtailed our Israel operations and closed one of our two offices. In our Nahariya, Israel office, we currently have eighteen employees focused on marketing initiatives including affiliate marketing, search engine optimization and customer retention.

Pursuant to the Agreement, CryptoLogic operates an online gaming site for us featuring a poker room and casino games utilizing its

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proprietary software, in exchange for a percentage of the revenue generated from the site.  We are entitled to approximately 80% of net gaming revenues, as defined below, from the operation of the site. Under the Agreement, we are also a member in a centralized online gaming network (the “Network”) with several other licensees of CryptoLogic pursuant to which players are able to play on our branded gaming site on the Network. As a condition of joining the Network we have applied for a gaming license in Malta which we anticipate to be in effect by the third quarter of fiscal 2007, however, in the interim, we are currently licensed in Curacao, as are the other licensees in the Network.

On June 14, 2007 CryptoLogic delivered the poker software to us and the go-live date was June 28, 2007. On July 26, 2007, CryptoLogic delivered ten casino games (the “Initial Casino”), including multi-hand blackjack, European roulette and multiple interactive slots including their most popular – Millionaire’s Club ®, Bejeweled ®, and The Hulk TM.  We also have an option, exercisable at any time prior to July 1, 2008, to require CryptoLogic to provide our customers with access to a full suite of casino games within three months of such notice.

We are entitled to the following percentages of net gaming revenue: (a) Seventy-eight percent (78%) of the first $150,000 per month, (b) Seventy-nine percent (79%) of revenue in excess of $150,000 but less than $500,000 per month; and (c) Eighty percent (80%) of the revenue in excess of $500,000 per month.  CryptoLogic is entitled to earn the following annual minimum guaranteed revenues associated with our online casino: $500,000 for the Initial Casino and $2,500,000 for the full suite of casino games.  There is a one-time fee of $50,000 payable by us for the initial preparation and launch of the site, and we are required to pay a monthly fee of $7,500 for the management of tournaments, collusion detection, customer support and overall management of the poker room.  In addition, we are obligated to contribute 4% of poker room revenue for certain marketing initiatives.

If, at any time after the nine (9) month anniversary of the go-live date, monthly gaming revenues fall below $500,000 for three (3) consecutive months, CryptoLogic has the right to terminate the Agreement on ninety (90) days written notice.  However, we may prevent any such termination through payment of the shortfall of CryptoLogic’s percentage of such gaming revenue within thirty (30) days of receipt of CryptoLogic’s notice of termination.

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Results of Operations

During the period ended July 1, 2007, we experienced substantial operating losses as compared to earnings in the comparable periods of the prior year. This decline in our operating results as compared to the prior year quarter was due primarily to a one time gain on the sale of an investment in the prior year, combined with increased costs in the current year related to our online gaming operations. See additional details below.

Six Months Ended July 1, 2007 Compared to the Six Months Ended July 2, 2006

Revenues. Our total revenues decreased by $5.3 million (30%) during the six months ended July 1, 2007, compared to the six months ended July 2, 2006. Domestic television licensee fees decreased $3.6 million (35%) in the first six months of 2007 compared to the 2006 period. The decrease was primarily a result of the delivery of fourteen episodes of Season Five of the WPT television series in the first six months versus sixteen episodes of Season Four of the WPT and ten episodes of the PPT delivered in the 2006 period. Online gaming, sponsorship and international television license revenues also decreased a combined $2.0 million (36%) in the first six months of 2007 compared to the 2006 period. The decrease of $0.9 million from online gaming revenue during 2007 primarily was due to lower levels of player activity versus the prior year period.  Event hosting and sponsorship revenues decreased $0.7 million primarily due to the timing of airing ten Season Five episodes in the first six months of 2007 versus the airing of fourteen episodes of Season Four in the prior year period.  International television licensing revenues decreased by $0.3 million as a result of fewer distribution agreements in the international marketplace.  Product licensing revenues increased by approximately $0.3 million (23%) in the first six months of 2007 compared to the 2006 period. The increase was primarily due to higher interactive gaming revenues from Take Two.

Cost of revenues. Cost of revenues decreased by approximately $1.4 million (21%) in the first six months of 2007 compared to the 2006 period.  The decrease was a result of a decrease in production costs of $1.2 million as we delivered fewer episodes in the 2007 period versus the 2006 period, as noted above. Additionally, online gaming cost of revenues decreased $0.3 million in the 2007 versus the 2006 period due to lower revenues.

Gross margins.  Overall gross margins were 57% in the first six months of 2007 compared to 62% in the first six months of 2006.  Domestic television licensing margins were 40% in the first six months of 2007 compared to 49% in the same period in 2006.  This decrease was principally because of the delivery of ten episodes of our Professional Poker Tour series in 2006 for which the production costs had been expensed in an earlier period.  In addition, online gaming contributed to the overall lower margin in the first six months of 2007 as a result of an amendment of the agreement with WagerWorks that was effective in July 2006, which significantly increased the percentage of revenues paid to it.

Selling, general and administrative expense. Selling, general and administrative expense increased $1.7 million (18%) year-over-year to $11.2 million. The increase was primarily due to the Company’s efforts to develop its own online gaming software and support infrastructure prior to entering into an agreement with CryptoLogic relating to our online poker room and casino.

Loss on abandonment of online gaming assets. We wrote-off approximately $2.3 million in online gaming assets as a result of ceasing development of the stand-alone online gaming platform we were developing based on the CyberArts software.

Other income. Other income decreased primarily as a result of recognizing $5.7 million in gain on sale of investment in the first six months of 2006, relating to the sale of the stock in PokerTek, Inc. Interest income increased by $0.2 million (22%) for the first six months of 2007 compared to the 2006 period, primarily due to higher cash equivalents and short-term investment balances.

Income taxes.  The income tax provision was $0 and $1.6 million for the first six months of 2007 and 2006, respectively, and the effective tax rate for the first six months of 2007 and 2006 was approximately 0% and 21%, respectively. We experienced no effect of adopting Financial Accounting Standards Board (“FASB”) Interpretation 48, Accounting for Uncertainty in Income Taxes, in 2007. We expect to generate a net operating loss for 2007, and a valuation allowance has been recorded for the net deferred tax asset related to the net loss generated in the first six months.

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Three Months Ended July 1, 2007 Compared to the Three Months Ended July 2, 2006

Revenues. Our total revenues decreased by $3.3 million (30%) during the three months ended July 1, 2007, compared to the three months ended July 2, 2006. Domestic television licensee fees decreased $3.0 million (41%) in the second quarter of 2007 compared to the 2006 period. The decrease was primarily a result of the delivery of nine episodes of Season Five of the WPT television series in the second quarter versus ten episodes of Season Four of the WPT and nine episodes of the PPT delivered in the 2006 period. Online gaming, sponsorship and international television license revenues also decreased a combined $0.5 million (18%) in the second quarter of 2007 compared to the 2006 period. The decrease of $0.6 million from online gaming revenue during 2007 primarily was due to lower levels of player activity versus the prior year period, as well as us ceasing operations on the WagerWorks network in June while transitioning our online gaming operations to CryptoLogic.   Product licensing revenues increased by approximately $0.2 million (22%) in the second quarter of 2007 compared to the 2006 period. The increase was primarily due to higher interactive gaming revenues from Take Two.

Cost of revenues. Cost of revenues decreased by approximately $1.1 million (26%) in the second quarter of 2007 compared to the 2006 period.  The decrease was primarily a result of a decrease in production costs of $1.0 million as we delivered fewer episodes in the 2007 period versus the 2006 period, as noted above.

Gross margins.  Overall gross margins were 60% in the second quarter of 2007 compared to 62% in the second quarter of 2006.  Domestic television licensing margins were 40% in the second quarter of 2007 compared to 51% in the same period in 2006.  This decrease was principally because of the delivery of nine episodes of our PPT series in 2006 for which the production costs had been expensed in an earlier period.  The lower domestic television margins in the 2007 period were largely offset by increased margin contribution from product licensing, international television and sponsorship

Selling, general and administrative expense. Selling, general and administrative expense increased $1.6 million (36%) year-over-year to $6.0 million. The increase was primarily due to our efforts to develop our own online gaming software and support infrastructure prior to entering into an agreement with CryptoLogic relating to our online poker room and casino.

Loss on abandonment of online gaming assets. We wrote-off approximately $2.3 million in online gaming assets as a result of ceasing development of the stand-alone online gaming platform we were developing based on the CyberArts software.

Income taxes.  The income tax provision was $0 and $0.3 million for the second quarter of 2007 and 2006, respectively, and the effective tax rate for the second quarter of 2007 and 2006 was approximately 0% and 12%, respectively. We expect to generate a net operating loss for 2007, and a valuation allowance has been recorded for the net deferred tax asset related to the net loss generated in the second quarter.

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