After taking a look at the latest quarterly results from uWink (NASDAQ: UWKI.OB), parsing the numbers, and talking to management, it struck me that it’s a good thing that uWink isn’t a restaurant company because it was not a pretty picture…and then I caught myself.

You see, right now, uWink is indeed a restaurant company until they start selling and licensing their proprietary gaming and point of sale (POS) software on a large scale, which is the whole basis of my original investing thesis for buying shares of uWink.

In the end, I don’t really care about the success of their restaurants, and neither should you, but rather the continued success of that software and licensing business.

But, and this is a big but, until that happens, uWink is on borrowed time, and is indeed solely a restaurant company, that HOPES to license its software to really increase revenue, and ultimately, stay in business.

uWink is not like other companies that I follow for many reasons.

For one thing, the company never hosts analyst conference calls when they release earnings, and never puts out a press release announcing earnings.

In fact, we are lucky to even get a 10-Q to look at.

I guess I should also explain that uWink is a penny stock trading on the pink sheets/bulletin board exchanges, and therefore, isn’t even followed by hardly anyone on Wall Street, so odds are, if uWink did host a conference call, it would probably fall on deaf ears.

So, as a result of this lack of information, I thought it was prudent to take a look at uWink’s latest quarterly results, and update you on the company and what’s going on.

The stock has taken quite a hit lately, but such are the vagaries of dealing with companies this small with such a thin trading volume.

However, that being said, there are very good reasons why uWink’s stock is lower, and some serious issues that I think you should know about and that I’ll be addressing in this post.

New to the uWink story?

uWink is an entertainment and hospitality software development company that develops casual, interactive, social games, in addition to licensing the rights to those games and their proprietary touch-screen ordering and gaming interface to restaurants, entertainment venues and the hospitality industry.

uWink also owns and operates three restaurants under the uWink brand name that utilize this technology.

uWink’s CEO is Nolan Bushnell, who also founded Atari Inc. (OTC: ATAR.PK) and Chuck E. Cheese’s, now known as CEC Entertainment (NYSE: CEC).

Want More?

• Start: with my initial buy recommendation and company overview here,
• OR: read how uWink is licensing their software platform to other businesses here.

Click here to read my complete uWink research report.

I’ll break down this report into 4 parts:

• Hit Me With The Numbers: Sales, Earnings, Same-Store Sales, Down Sharply
• Other Business Highlights: Cash on Hand, Restaurant Location Updates
• Where Is uWink Headed?: Focus Now on Software and Licensing
• Bottom Line: Change the Way You Think About uWink

Hit Me With Some Numbers

Sales, Profit Down Sharply

Here are some of uWink’s earnings highlights (growth from previous year’s Q2/there are no analysts that cover uWink):

• Quarterly sales of $.503 million (down 30%, from $.719 million in the prior year)
• Quarterly operating loss of -$1.61 million (a increase of 17.5%, from a -$1.37 million loss in the prior year)
• Quarterly net loss of -$1.58 million, or -$0.12 per diluted share (a increase of 17.0%, from -$1.35 million, or -$.21 per diluted share, (There was a lower share count last year.)
• Gross margin of 71.1% (down from 71.4% from prior year)
• Same-store sales down 38.2% (ONLY at the Woodland Hills location)

My Take: One word: UGLY.

Of course the majority of these sales figures, and the same-store sales figures, were from uWink’s location in Woodland Hills, California, and does not include much if any revenue from their recently opened Hollywood and Highland location, and the soon-to-be-opened Mountain View, California location.

Essentially, these sales figures are strictly from one location.

I will warn you that taking same-store sales results from one location and trying to paint a picture of a company’s health and what it might portend for the future, as well as trying to compare that to other restaurant chains, is an exercise in futility, and is definitely not an apples-to-apples comparison.

But at this stage of that game, I’m just passing along the numbers that are available as we try and get a handle on uWink’s business and future prospects and how to accurately value the company.

Management gave several reasons as to why sales declined at this location precipitously. They were as follows:

• General weakness in the Southern California/Woodland Hills economy
• The natural tendency for a new restaurant concept to experience a drop in revenue in its second year of operation
• Regular updating of the software in the Woodland Hills location, which functions as a test lab, which has prevented uWink from offering guests a consistent experience
• Experimentation, starting in early 2008, with a new method for pricing game play, under which uWink charged game “credits” to play the games and patrons earned game “credits” with food purchases

Bottom Line: These are all plausible explanations. I think it’s too early to tell whether or not the uWink concept itself has flaws and whether or not the business model is sustainable in terms of operational execution at the restaurant level.

While these numbers look gruesome, what isn’t in the filings but that I found out by talking to management, is that even with these heavy losses, which are a result of high employee and development costs for uWink’s software, the actual restaurants themselves, Woodland Hills and now Hollywood and Highland, are actually break even or better on a cash flow basis.

The problem is that with uWink’s other expenses and reporting structure, this simply doesn’t show up on the earnings statement, or the balance sheet.

I’ll discuss in more detail later in this post what this means for uWink, and how uWink actually does NOT want to be in the restaurant business, but is simply using their restaurant locations as testing grounds for their software in order to license that software to other businesses.

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Other Business Highlights

uWink Close to Opening 3rd Restaurant Location

• uWink now has two locations open and fully operational: Hollywood and Highland, California, and Woodland Hills, California.
• uWink’s 3rd and final location in Mountain View, California, will be opening sometime in early September (which has been delayed from early July).
• uWink now has about $3.2 million in cash on the balance sheet, with no debt.
• uWink expects this cash to last for at least 12 months.
• uWink has slightly changed their gaming structure to allow people to play games for free for up to 70 min. before having to pay for more game credits
• uWink is not expecting to open any more restaurant locations once the Mountain View location comes online.
• uWink also doesn’t expect to franchise their restaurant concept much if at all, in the coming months/years.
• uWink now is focusing on becoming a software and licensing company, NOT a restaurant company.

Bottom Line: By the end of September, uWink should have all three of their locations up and running.

In addition, as a result of uWink curtailing any additional store openings, they expect that their current cash on hand of about $3.2 million will last them for at least 12 months.

By then we should see more traction in their software licensing side of the business, and get a clearer picture on the operations of the three restaurant locations and get more clarity as to where uWink is headed.

I’ll discuss this more in the section below, but uWink is essentially using their three locations as a testing ground, as evidenced already by the slip in sales at their Woodland Hills location as a result of some tests gone wrong, and turning their attention to actually getting this technology into other businesses’ hands.

This is where an investment in uWink can pay off, and what I would like to focus on.

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Where Is uWink Headed?

It’s Time to Put Away the Restaurants

This is where things get interesting, and where as investors, we need to focus our attention.

uWink is NOT trying to be a restaurant company.

I’ll repeat that for those who are focused on the sales numbers above: uWink is NOT trying to be a restaurant company.

Frankly, this is a good thing as evidenced by what’s going on with their one location that has been open for over a year.

Rather, what uWink is trying to accomplish is fine tuning their software and point of sale (POS) systems that run their terminals in each restaurant to the point of perfection.

They then intend to turn around and license and sell that software to other businesses in the hospitality industry.

This opens up a huge potential market for uWink and one in which they are much better suited than as restaurateurs.

If you can think of a business, then you can also think of an application for uWink’s software, touch screen terminals, or both.

Some of the possibilities include: hotels, dorms/schools, kiosks at restaurants, gaming terminals at restaurants, ski resorts, bars, pool halls, clubs, and other as-yet-unknown applications.

As I wrote about previously, uWink in fact has already signed their first software and licensing deal with InSite Development, to provide unique touch-based technology for the senior housing market.

This was one application of uWink’s software that I didn’t see coming, but that shows the vast potential and scope of what uWink is trying to accomplish.

Under this agreement, uWink’s interactive digital content operating system and real-time, multi-player game platform will initially be deployed into Arbor Court, a groundbreaking retirement housing community in Lancaster, California.

There will be 231 units built at Arbor Court and each unit will contain a flat screen touch monitor, powered by uWink’s intuitive interface, that will allow the residents one-touch connectivity to a wide variety of information and services including food and pharmacy ordering, video conferencing, assistance and maintenance requests, and games and other digital content.

You can read more about this here.

If uWink’s software can be utilized to make seniors’ lives easier, then what can it do for the hotel or restaurant industries, let alone other applications for children, schools, or maybe even theme parks.

This is where you need to turn your attention when evaluating uWink as a company, and as a stock.

The future for uWink lies not with its current three restaurant locations, but rather with the company’s potential to proliferate the market with applications and services to make things easier for people, and to help businesses squeeze higher margins out of their current operations.

In essence, uWink will be a pick-and-shovel company selling the software and systems so that other companies can then in turn duke it out and compete with each other for consumer’s dollars, all the while, uWink sits back and enjoys their nice and juicy high margin recurring revenue.

Finally, in my talks with management, they have assured me that they are in fact rolling out several test campaigns with high profile restaurant companies (they wouldn’t tell me which ones), that will provide further validation, and traction as they transition into a software vendor.

These tests might lead to significant investments and purchases from these companies as they see the benefits of the uWink terminals and the cost savings it could lend to their operations, which in these lean economic times, is no small feat.

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Bottom Line

Change the Way You Think About uWink

You need to look at uWink not as a restaurant company, although for now, that’s all they are, but as a software development company, which they aspire to be.

Truth-be-told, uWink’s latest quarterly numbers were a disaster, and there’s no sugarcoating that.

Same-store sales were down, admittedly only using ONE restaurant location, so it should be taken with a grain of salt, and the company continues to burn through cash in their attempts to finish opening their 3rd and final location, as well as software and development initiatives.

I won’t sit here and tell you that uWink is a high quality company with a proven track record that is trading on the cheap.

The reality is that uWink has a lot to prove.

They have about 12 months of cash left to prove it before we will most likely be further diluted as shareholders and/or uWink would have to take on debt to continue to finance further deals in their software and licensing side of the business.

An investment in uWink is an investment in the belief in the management team and the long term prospects of the company, NOT in its current form.

There is a very real possibility that uWink will go out of business before they ever make enough money to justify more debt financing to continue their operations.

It basically boils down to these two scenarios:

• uWink is unsuccessful or marginally successful with their current restaurants, but cannot sign up enough software and licensing deals to make up for their burn rate and overhead, can’t get financing, and go out of business.
• uWink is unsuccessful or marginally successful with their current restaurants, and signs enough software and licensing deals to make up for their burn rate and overhead, are able to get additional financing at reasonable terms, and stay in business

In either scenario, the success of uWink’s restaurants is NOT material to their future success.

As such, you have to understand the business and what you are getting yourself into before purchasing shares in uWink.

I caution you to allocate funds for uWink that you can afford to lose completely, and reiterate that uWink is the absolute most risky investment that you’ll ever partake in, at least one that’s legal and isn’t found at the craps tables.

Every portfolio has room for one super speculative play, and I believe that this should be that play.

Finally, remember that I never would have recommended purchasing uWink’s shares if I did not myself believe in the company, and the potential that’s there, regardless of the risk.

Things are tenuous now, and are reflected in the current stock price, but I believe that within the next 12 months we’ll have sufficient insight and be able to evaluate what’s going on over at uWink and decide if our investment thesis still makes sense.

Namely, that uWink is a software development company that happens to own a few restaurants that it uses as proving grounds for its eventual romp atop the software and licensing business for the hospitality industry.

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New to the uWink story?

Click here to read my complete uWink research report.

• Start: with my initial buy recommendation and company overview here,
• OR: read how uWink is licensing their software platform to other businesses here.

• Warning: uWink trades with very high bid/ask spreads. Learn how to protect yourself from getting screwed by the market makers.

*Variables You Should Know About uWink, Inc. (Nasdaq: UWKI.OB)
Current Recommendation:	BUY
The Company:	uWink, Inc. is an entertainment and hospitality software development company that develops casual, interactive, social games, in addition to licensing the rights to those games and their proprietary touch-screen ordering and gaming interface to restaurants, entertainment venues and the hospitality industry. uWink also owns and operates three restaurants under the uWink brand name that utilize this technology.
Why Buy Now:	Top-Flight Management With Large Stakes in the Company (CEO Nolan Bushnell is the founder of Atari and Chuck E. Cheese) Great Scalable Concept Ground Floor Opportunity Multiple Revenue Streams High Margin Software Licensing Business High Margin Restaurant Business Continued Execution Over the Last 6 Months Fantastic Growth Potential in an Expanding and Rapidly Developing Market Fantastic Stock Entry Point Largely Underfollowed Stock (No Analyst Coverage) Well Capitalized for the Next 12 Months or More
Market Cap:	$9.00
Revenue (TTM):	$2.51
Cash/Debt:	$3.2/ $0
Current Price:	$.70
Risk Rating (?):	10 (Highest Possible Risk)
Position Size (?):	1/4 (11-23-07), 1/4 (12-6-07), 1/4 (1-15-08)
Buy Around Price (?):	$1.80 (11-23-07), $1.85 (12-6-07), $1.25 (1-15-08)

*As of 8-20-08. Except share price, all values in millions.