Scientific Games’ CEO Discusses Q1 2013 Results – Earnings Call Transcript

Scientific Games Corp (SGMS) Q1 2013 Earnings Call May 7, 2013 5:00 PM ET


Good evening, ladies and gentlemen, and welcome to Scientific Games first quarter 2013 conference call. At this time all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded. It is now my pleasure to introduce Cindi Buckwalter, Vice President for Scientific Games. Ms. Buckwalter, you may begin.

Cindi Buckwalter

Thank you very much. Welcome and thank you all for joining us this evening. During this call, we will discuss our first quarter results followed by a question-and-answer period. Please refer to our earnings press release for further details.

As a reminder, this call is being simultaneously webcast and is accompanied by a slide presentation. They’re both available along with our press release in the investor information section of our website at A replay of the call and the accompanying slide presentation will be archived in the investor information section of our website.

This conference call will contain statements that constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that could cause actual results to differ materially. For certain information regarding these risks and uncertainties please refer to our earnings press release and materials relating to the costs posted on our website and our filings with the SEC, including our most recent annual report on Form 10-K and our subsequent reports filed with the SEC.

During this conference call, we will discuss certain non-GAAP financial measures. A description of each non-GAAP measure and a reconciliation of each non-GAAP financial measure to the most comparable GAAP financial measure can be found in our earnings press release.

Now I’ll turn the call over to Lorne Weil, Chairman and CEO.

Lorne Weil

Thanks Cindi. Good evening everyone. And thank you for joining our first quarter 2013 earnings call. Jeff Lipkin, our CFO with me this evening and I also have Mike Chambrello who most of you run our Asia-Pacific business to join on this evening’s call, as we are feeling considerably more optimistic about China than we felt in the last few quarter and I want Mike to have an opportunity to share our excitement with you.

The first quarter was an extremely busy and productive one for us. We had a lot going on from a business development standpoint which should benefit us as the year progresses. We are also very focused on executing on the key steps required to close the WMS transaction and our proceeding as expected.

It’s a risk spending a moment on our integration planning as we have been making great progress. We have selected executives from each company to serve on an integration planning committee and we have identified few corporate individuals to start the planning team.

In addition, we have engaged integration consultants with experience in the gaming. With respect to the required gaming approvals, we have filed applications in each of the jurisdictions and which we are seeking gaming regulatory approval prior to closing the merger. Another milestone in the process is the WMS stockholders meeting later this week to consider and vote on the proposed merger. As I previously mentioned, this acquisition obviously is far and away the most transformative development in our history and we’re excited about the opportunity to work with our new colleagues and look forward to growing our business together. In the meantime our excitement continues to build around the opportunities we see for the combined company. Just last week we announced that we and our partners had been selected as the primary vendor team to operate internet gaming systems and services for the Delaware state lottery. For this bid, we joined up with 888 and Williams Interactive, a subsidiary of WMS to provide a full turnkey solution for the gaming platform, content, and operational services.

For those of you that don’t know, Delaware is the first US state to implement interest at i-gaming, including poker, slots and bingo. This made for an extremely competitive process and therefore a huge win for us. This also goes to show that gaming expansion is accelerating through state lotteries and we believe this joint effort with WMS is a prime example of the type of opportunity that can be realized by our pending merger with WMS. We can’t talk about Delaware without mentioning their success with sports betting, where at this point we’re the only vendor supplying sports betting platform for a lottery in the United States. Betting through our system during the 2013 NFL season increased by 30% versus the prior year reinforcing our enthusiasm for the sports betting business.

Indeed with our many years of gaming expertise combined with our recent acquisition of Parrsboro and its world class state of the art, sports betting solution we see the potential in this area to be one of the next waves of lottery development. In particular we’re excited about the prospects for sports betting throughout Europe, given the increasingly hospitable regulatory environment.

We have worked with Parrsboro to integrate our venue based lottery system in Norway which supports nearly 4000 retail points of sale for (inaudible), with Parrsboro sports betting interactive system and we know firsthand how successful this combination of product offerings can be; we believe it will prove attractive to lotteries and licensed private sports with operators around the world, as they seek additional sources of revenue.

Further to this point, later this year we expect to launch a nationwide lottery based sports betting network in Germany that has been in development as many of you know for quite some time. To continue on this sports thread as many of you know, we have long and the only vendor able to offer lotteries, the opportunity to create instant games highlighting the teams, logos and mark associated with the NBA, NHL, major league baseball, Nascar and major league soccer.

These rate brands give lotteries the opportunity to offer fantastic experience and surprises and authentic branded merchandise. We have had success with these games in the United States and with the NBA in China. In a few minutes Mike is going to talk about the really great project we will launching in China in the fall that coincides with next year’s NBA sessions.

Our licensed property group has now taken the sport thing to another level, the fantasy level by creating extremely realistic instant ticket fantasy game based on pro-football. We’ve developed an innovating instant ticket offering tying into the both the strength pro-football and the popularity of fantasy football through a license with the pro-football hall fame. This is a very attractive license offering prices including BI trips to pro-football biggest game as well as trips to the annual hall of fame Enshrinement weekends. The license also provides access to some of the very best players in the history of pro-football; former Dallas Cowboy Emmitt Smith, he is available as a spokesperson and a wide variety of hall of famous are available on the fantasy play style of the ticket and for appearances for launch events for prizing option.

In addition to Emmitt Smith our license property group has secured Franco Harris, Gale Sayers, Roger Staubach and (inaudible) with more to be partly offering. To give the ticket as broad and appeal as possible we developed a unique extended play game style that is (inaudible) of the elements of the fantasy football league.

The demographics of fantasy game player 87% male with an average age of 33 and they create a strong segment participating lotteries. We are optimistic about the offering as football is the most popular sport on the fantasy game industry posting 35 million fantasy players growing (inaudible).

Turing to another topic, getting a lot of attention lately, a number of U.S. states and international jurisdictions are actively pursuing some form of privatization or outsourcing, and we expect to see further lottery development activity throughout the year.

In April, our joint venture in New Jersey and which we hold 18% equity interest was notified of intend to award contract to provide marketing and sales services for the New Jersey lottery. We expect to become the primary supplier of instant tickets to New Jersey, for the first time in our company’s history. We are excited about this opportunity as we have never been a primary supplier we never been a primary supplier to New Jersey, and therefore have not had the level of lottery related supply revenue that is expected from this opportunity.

New Jersey’s instant ticket retail sales were approximately $1.4 billion in the latest fiscal year. We are also happy to report that an alliance we formed with the company in Panama was awarded a 10 year contract with the Panama Lottery to supply instant tickets under a cooperative services program until the year 2023. We are the exclusive supplier of instant tickets and services for the term of the contract. Currently traditional draw based lottery games are the only offering in Panama. So we will be introducing the instant ticket product into the market place.

This is an important opportunity to demonstrate how the products technology and best practices we use around the world could be successfully deployed in Latin America to grow our customers’ lottery businesses. In addition, we recently executed a new contract with the Oklahoma lottery to provide lottery systems and instant ticket services. And we are awarded a two year extension by Montana for our instant ticket contract.

Jeff will cover the details on the quarter. However I did want to note that our Q1 results were in line with our budget. The first quarter has historically been a seasonally lower quarter. Our Q1 results last year were somewhat had an anomaly and reflected some unusual items that benefited the quarter. So to wrap up my commentary, I will say that I am very happy with the direction in which the company is heading. We are highly focused on executing on the number of significant business initiatives and we anticipate momentum will accelerate as the year progresses. Looking ahead we continue to lay the ground work for opportunities in 2013 and beyond including joining forces with WMS.

I will now turn things over to Mike to discuss China.

Mike Chambrello

Thanks Lorne. As Lorne just mentioned we really are very encouraged by the recent performance improvement we are seeing in China. While we are not yet in positive territory, year-over-year retail sales results have now improved with sequential quarter and we saw material improvement in March and April retail sales performance relative to February. Additionally the 15% growth of the overall lottery industry in the first quarter in China, reflect sustained consumer demand in this geography.

Simply quiet, we believe the key to our improved performance, since better gains, lower inventory retail, and increased retail and marketing in promotions. We now removed old inventory from retailer locations and warehouses in all provinces and replenishing this inventory with new games; games that really do reflect SGMS best practices; really reverting to the game design and price structure and product launch planning that enjoyed so much success in China prior to 2012. Back to basics, you would be getting to see the results. This approach includes launching the types of games that have been successful in other parts of the world and are differentiated from other products such as family of games that content common themes that are grouped together at retail to increase consumer awareness. But in fact we introduced our first family of games in April with a second schedule for mid-May.

The launching distributions of these games types have been well coordinated and the reception of both province and retailer levels so far has been very positive. We have additional family of games products planned for once in third and fourth quarters as wells as the re-launch of the very successful 30 RMB game later this quarter which had previously been so successful primarily due to its start price of 1.5 million RMB.

As Lorne mentioned later this year, our product launch plan includes extensive play games as well as a rebranded series of NBA games which for the first time will include individual players in addition to the team theme games. This will be 10 RMB and 20 RMB games.

The NBA games will have a very unique design and use innovative printing technology that will further differentiate this product all other tickets on the market. I have actually have samples in front of me and to say they’re fantastic, I think would be a great understatement.

Any way as part of our enhance marketing strategy, we are continuing toward very closely with the lottery partners to help highlight the game benefits to player and also raise awareness of winners to further engage existing players and draw a new series in group players.

Other initiatives include exploring new price structures that should make game more compelling and competitive in the marketplace. Our weekly results beginning to reflect all of these developments, sales in the last four weeks ending April 28 with highest of 2013, this is contributed to our over our year today non-picture improvement of 1.3% compared to the same period in 2012.

I wanted to note one other item. We’ve said before that we believe the rollout of the competitive draw-based lottery product over the year has directly impacted in tickets. We’ve also commented that is the rollout of this product which is maturity or saturation. We believe that the trajectory of instant ticket sales will turn more positive in fact we’re starting to see a slowdown in growth of this competitive product and believe that most of the growth is now coming from the provinces that are just beginning to introduce these games.

Looking ahead we see opportunities in high frequency system based games and electronic instant tickets. We believe we can offer unique content enhanced by the game inventory provided by WMS to supplement existing product including ironically new high frequency games to support their next cycle growth as well as introducing new product lines into each of these distribution channels.

While the timing of these product introductions is difficult to predict, we feel we are very well positioned in each of these areas and certain key provinces and believe that any one of these opportunities combine with our initiatives in instant ticket business could sustain and even accelerate the positive momentum we’ve seen in the last few months. All in all, very encouraged.

With that I’ll turn things over to Jeff to discuss our financials.

Jeff Lipkin

Thanks Mike. Hello everybody and thanks again for joining us this evening. As Lorne mentioned our first quarter results were in line with our expectations. It’s important to evaluate our first quarter results in the context of our financial performance historically. If you look at our numbers over the past few years, Q1 is been a slower quarter for us. If clean results of our racing business which we sold in Q4 2010, we reported revenue of 191.8 million and 196.7 million and a terrible EBITDA of 73.8 million and 75.0 million in Q1 2010 and Q1 2011 respectfully.

In Q1 2012, we benefited from few unusual items which caused our financial results in 2012 to be much higher relative our first quarter results historically. The most significant items that impact the comparability with the impact of the highest even Mega Millions jackpot in lottery systems, a significant products sell by Barcrest in our gaming business and achieve point $2 million insurance recovery that we received in Q1 last year.

With that background turning to our core business in Q1 ’13, retail sales performance in many of our core market started off slowly this quarter as we eluted too on our last earnings call. However, importantly as the quarter progressed we experienced improved sales performance in several key areas of our business. We are further encouraged at this improvements same stuff continued until April.

We are encouraged that we have recently signed a number of new contracts entered into several contract extensions and further several important business initiatives that should begin to bear fruit later this year.

Before I go into more details on our results, I should mention that during the quarter we sold the installed base of gaming terminals in our UK pub business. As a result beginning with this quarter we are treating results of this sale as a discontinued operation as required under applicable accounting rules.

All the numbers in our press release and discussed on our call today are from continuing operations ongoing or otherwise noted. Revenue for the quarter was 219.6 million as compared to 231.2 million in the prior year period. Printed products revenue was up 800,000 lottery systems was down 6 million and gaming was down 6 million.

Operating income for the quarter was 11.1 million principally due to lower and less profitable revenue mix and an increase in SGA and depreciation amortization expense partially offset by lower employee termination and restructuring expenses.

The SGA increase was largely driven by approximately 4 million of fees and expenses related to WMS acquisition. Looking at the individual segment, printed products revenues was relatively flat as the strength we realized in our license property business was offset by our US price per thousand and percentage of sales businesses.

In part due to challenging year-over-year comparisons from the very strong sales levels in Q1 2012. Internationally revenue rose from percentage of sale customers and from the acquisition of Provoloto but was offset by lower sales from price per thousand customers including Italy.

Printed products operating income was 33.9 million as compared to 35.1 million last year; driven impart by a 1.5 million increase in SGA principally due to the incremental over head from the acquisition of Provoloto in the absence of the insurance recovery, we received last year; partially offset by lower compensation expenses here.

We all set a $1 million increase in depreciation amortization expense primarily related to a license thing; third party brand. This was partially offset by a 1.5 million positive impact from a more profitable revenue mix this year.

Lottery systems sales revenue was lower year-over-year as hard ware and software sales fluctuate from quarter-to-quarter due to their non-recurrent nature. The decline in lottery service revenue was primarily due to challenging comparison; against Q1 last year, which included a record 656 million mega millions jackpot.

Lottery systems operating income decrease primarily due to a lower and less profitable revenue mix and a $2 million increase in depreciation, amortization expense related to deployment of new hardware in China and the amortization of new technology development costs.

Our gaming results reflected lower retail sales levels including the loss of the William Hill contract; lower revenue from our customers outside the UK along with lower sales of gaming terminals. Gaming operating loss was 1.5 million compared to an operating income of 3.7 million last year.

Primarily due to a lower and less profitable revenue mix and a $2.3 million increase in SGA offset by a $1 million insurance recovery in the current period. The less profitable revenue mix was principally due to a loss of 2 million in revenue from William Hill and the interruption of 1.9 million of revenue from customers in Puerto Rico and Italy, which we are hopeful could resume in the near future.

The increase in SGA reflected 2 million and legal fees and expenses related to our gaming business in Italy along with severance costs. The increases were partially offset by the absence of the 2.3 million of re-structuring cost in the prior year period.

Moving down to PL, our earnings from equity investments decreased by 2.7 million year-over-year, primarily due to results of RCN, China and Italy. We realized that at 1.5 million decrease year-over-year and other rank coming expense, primarily due to an increase in foreign exchange, transaction expenses during the quarter.

These factors resulted in a reported loss for the first quarter of 12.3 million or $0.15 per share. Turning to attributable EBITDA, EBITDA from equity investments declined year over year by 1.4 million to 21.7 million reflecting lower results in Italy, China and RCN, attributable EBITDA decreased 8.2 million year over year to 78.6 million as a result of the factors I’ve mentioned.

Moving on to the balance sheet, our debt less cash at quarter end was approximately 1.4 billion. Our liquidities stood at nearly 300 million, including approximately 206 million of available (inaudible) and cash of 90 million. Our free cash flow is negative thirteen’s of the quarter compared to positive 127,000 in Q1 last year, primarily due to increased cap ex in Q1 2013, related to the timing of the purchase of gaming terminals and printing press upgrades in the US, partially offset by increased cash flow from operating activities, 1.3 million principally due to distributions of earnings from one of our equity investments.

(Inaudible) focused on executing on our significant new business development including the launch of instant tickets in Greece and Panama, startup of Properties Plus in Maryland and the opportunity in New Jersey for a joint venture. We’re also working on several other business developments that may provide incremental revenue in 2013 and beyond. As Lorne mentioned we are very pleased with our progress towards completing the WMS acquisition. We look forward to the opportunity to begin to leverage the many opportunities we see from the combined company, with that I’ll turn it back to Lorne to wrap up.

Lorne Weil

Thanks Jeff, really not much more to say in terms of prepared comments. As Jeff summarized I think our first quarter in terms of financial performance was pretty much exactly where we expected. We are seeing several very positive trends as we move from the first into the second quarter along the lines of what Mike described taking place in China, we’re very optimistic about the trajectory of our performance through the balance of the year and of course we’re very, very positive about the step function increase in performance that will result from our impending merger with WMS, so really with that I think we can end our prepared remarks and operator, if you’d like to open up the program for Q and A please.

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