Scientific Games Corp (SGMS): Scientific Games’ CEO Discusses Q3 2013 …

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Barry Jonas with Wells Fargo. Please proceed sir.

Barry Jonas – Wells Fargo

Can you give us some color on customary actions to WMS and the combination that you saw at G2E?

Lorne Weil

I think all the customers that we saw at G2E, most of them we had seen in most cases more than once prior to G2E and many, if not all whom we’ve seen subsequent to G2E. We’re extremely enthusiastic about the combination of the two companies and felt that the cultures were highly compatible in terms of commitment to supporting the customers and working with the customers and making the customers revenue grow, which is the business we’re all in. And felt that from a people point of view and from a technology point of view, we have significant assets to contribute to WMS.

I think they all felt very confident that we had no intention whatsoever of implementing any cost reduction programs that would even remotely compromise the integrity of the WMS quality or content development activity which at the end of the day is really what this business is all about. We reassured them that in all likelihood and indeed at this point it’s coming to pass that we would increase our commitment to things like content development.

So, I say overall we were very pleased with the customer response, but of course customers have every right to reserve their final judgment until they see our actions become translated from what our words had been. So we have every intention of doing that and assuming we do what we say we’re going to do, I think we’re in a good shape.

Barry Jonas – Wells Fargo

Great. And I think the deal closed little less than a month ago, as we think about the guided synergies that were previously given of $50 million in year one, $100 million in year two, can you give us some color or some thought about how we should think of the ramp of those synergies?

Lorne Weil

Well, I’ll let Jeff.

Jeff Lipkin

Yes, I mean we’ve been added now I think it’s actually 19 days short of three weeks, but we on day one under Scott’s guidance have started immediately executing on the plans that we’ve all worked on. And I’ll let him add on to it, but I think we feel comfortable that there will be some amount of synergies that will even be evident in the fourth quarter, but it sort of depends. There is different buckets. There are things like moving certain technologies or off-shoring certain development activities. Obviously it will take a little bit longer, but some of the procurement things that we have been working on over the last five months or some of the head count adjustments we’ll have a more immediate effect.

So I think that you can expect that we have very comprehensive plan that we’re executive towards. We have weekly calls with Scott where he reviews where we are against our target and that’s why we feel as good as we do about both the number and the phasing that we’ve previously communicated.

Scott Schweinfurth

I guess I’d add that we spent pretty much 8.5 months and we’re planning stage for the process, and I think we had multiple readouts during that effort. And in each of those readouts, the dollar amount of the cost synergies was in the same ballpark, there weren’t any significant changes. So we have pretty well defined plans. We got to day one. We closed and the next day everything functioned as was meant to be. There were no big oops relative to that and now we’re in the implementation stage of the plans.

And as Jeff was saying, there are some things that are done sooner rather than later.

And so there will be some level of cost savings here in the December quarter, but there is also some costs to be incurred to achieve some of those savings. It will be something of an offset to that and I think the intention is to provide a little bit better clarity as we go forward once we get past this initial transition stage, but right now as Lorne said in his remarks, we’re highly confident that we’re going to be able to achieve the numbers that were initially described.

Barry Jonas – Wells Fargo

Great. Thanks so much guys.

Scott Schweinfurth

Thanks, Barry.

Operator

Our next question comes from the line of Todd Eilers with Eilers Research. Please proceed.

Todd Eilers – Eilers Research

Hi guys, thanks for taking my questions. It looks like you guys had a pretty strong quarter with respect to gross margins kind of across the board for all three business segments. Wondering if you could maybe speak to that a little bit. What kind of drove that, especially in the Diversified Gaming segment. It looks like a pretty big sequential and year-over-year increase there. Obviously on the Lottery Systems side, I am sure the strong multi-state jackpot is probably helped there, but to the extent you’ve kind of talk about what’s driving that and how much that’s sustainable going forward would be helpful. Thank you.

Lorne Weil

Yes, sure. So I would say starting with Printed Products. The biggest component there would have been the mix of business heavily weighted towards MDI this quarter which has a higher margin relative to the Printed Products part of the business. On the Lottery Systems side, I think it’s a little bit of equipment sales which often has slightly higher gross profit margin and in this case they did relative to the service revenue that we had also complemented as you suggested, Todd, by the Powerball jackpot which for us has a very high incremental margin. And then on the gaming side, I think it has a little bit to do with some one-time things that happened in the prior year quarter.

So some restructuring charges that we had taken in prior year that are not there now. So that sort of impacted the prior year quarter, but is not impacting this quarter.

Todd Eilers – Eilers Research

Okay. Great. And then also had a question regarding China and Italy markets. Obviously it looks like we’re finally seeing some stabilization there, I guess more so in China. I know you guys don’t provide quarterly guidance or anything like that, but I was wondering if you might be able to provide some directional comments or just maybe some thoughts on the October trends in both markets for retail sales.

Jeff Lipkin

Yes, I think Italy is – I’ll start with Italy. Italy was a little bit easier that’s the performance that we saw was sort of what we had been anticipating which was that the market had been stabilizing. The monthly results there in the third quarter reflected summer months which are generally not the stronger months for us in terms of the Italian market. And it’s really – it is true of all of our markets that it’s really product-driven. October has started out sort of non-inconsistent with where we saw better part of the third quarter I would say, September and August at least.

And in China, I think Lorne mentioned, that we saw some improvements coming out of September into October that was attributable to the NBA game. And so we’ve seen a little pickup in fact in positive territory in those two months which I think again is directly attributable to the product that we have in the market during that month. So China continues to be a challenge for us, but we do have – and we did anticipate having probably the strongest products of the year in the market during this timeframe.

So that’s why we were in the last call excited about where we saw trends heading because we knew that the NBA game and the product support and the marketing support around the NBA game was going to be significant.

Todd Eilers – Eilers Research

Okay, great. And then just one final question on the Diversified Gaming business. I guess more so in the U.K. obviously little bit weakness there this quarter. I was wondering if – a couple of items there. Number one, I guess just wondering if you could maybe give us a sense for how some of the new games are performing that you’ve just rolled out. And then two, you mentioned that you’re starting to I guess deploy some of the WMS content or IP on some of the lottery tickets. Have you been able to get some of the WMS content on to some of the server-based gaming machines you have, and if not, when should we kind of expect to start to see some of that content out in the field?

Jeff Lipkin

All right, just on the second question first. We are working through getting some content onto the global draw network. We’re in the process of supporting some games. I think you’ll start to see that in earnings probably towards the spring next year of ‘14.

In terms of the new games, I assume you’re referring to the Coral’s rollout. I think when you look at sort of Coral’s relatively to other publicly reporting peers, you’ll see that Coral substantially outperformed the market which one could attribute to a lot of things but would certainly not inconceivable that the machine and the content are a big portion of it, as it typically is the case in the U.K. market when a new game comes out like we just introduced.

So I think it’s fair to say that when we looked at our performance of our customers, our large customers relative to the competition, I think it’s also fair to say that across the board, we outperformed during this time period, the competition both with Coral this day but also in our other large customers, other large LBO customers.

Todd Eilers – Eilers Research :Okay, great. Thanks guys.

Operator

Our next question comes from the line of Steve Wieczynski with Stifel. Please proceed.

Steven Wieczynski – Stifel

Hi, good afternoon guys. So I don’t know if Scott can answer this, but maybe you can help us draw out a bigger picture question. Obviously IGT reported that they are continuing to see a little bit of pressures in terms of ASPs and it sounds like there are some smaller competitors out there that to continue to impact opportunity to sell at higher prices. Is that something that you’re seeing at this point, Scott?

Scott Schweinfurth

Well, that’s been a very competitive market for probably at least two years now. And I think that’s going to continue given the state of the economy and the state of our customers business, but the most important thing for any manufacturer is content performance. And we’re very pleased with what we’ve seen with the launch of the Blade platform and the performance of that product line, since we’ve taken it out there. And I think with the pricing plan that we have with that, it’s fairly high value proposition for our customers and we’ve been able to ship some. So I think that demonstrates people are willing to pay for the content.

The other thing that impacts ASP is sort of the mix of the business, because certainly the Illinois VLT unit sales have a lower price to them, I believe that I heard on the call today that poker units that IGT sold had a relatively low price to them.

So that has an impact on overall ASPs, but I go to back what I started within that is, is if you have high performing product, people are willing to pay for products.

Lorne Weil

Yes. It’s Lorne. Let me just add to what Scott said, I completely agree with that. I think our view again is that this is really all about content, it’s really – it’s pointless to sell a razor really cheaply if the blades that you put in it don’t work. So if you look at the performance of actually coincidental term, the Blade cabinet it’s performing consistently 150% of house average, I mean the same is true also of the participation games and the Gamefield, except there is not a 150% in cases.

In many cases, it’s 200%, 300%, 400%, 500% but in the case of the Blade, even in the for-sale market, that level of performance compared to competing products over even a reasonable life of that product translates to several hundred thousand dollars of incremental profit for the operator.

So this is clearly not a business where at least the smart operators are going to be base their long-term strategy on how cheap they can buy the equipment for, and any more than our lottery ticket customers base their decisions on who sells the cheapest ticket because at the end of the day lotteries and casino operators are in the business of generating money, not saving and closing dimes and buying stuff.

So we’re not seeing – at least I am not seeing and I am not as close to it as Scott is, but a lot of resistance to the pricing of the Blade cabinet. As long as the Blade cabinet and other WMS products continue to perform relative to competition at the levels that they do – we don’t think that’s going to change and we don’t have any intention of competing in a business where people won’t sell in boxes on the basis of price again, because of our business model is our customers are there to growth their revenues, not to buy cheap boxes to take up space on the floor.

And we have hundreds of brilliant content developers and half a dozen studious around the world, dedicated to developing the content that drivers that performance. So it all first together in our business model. Somebody else has a different business model, where it works for them to compete on price so they can find a customer whose model of how to maximize profits is to buy cabinets at the best possible price then good luck to them but that is clearly not our strategy.

And in the days that we’ve seen over the course of the nine months that we have been intimately involved with WMS, we don’t see anything in the data – in our data to indicate that.

Steven Wieczynski – Stifel

Okay, thanks. And then I guess for you, Lorne, you talked about global drawdown I know you called out weather during the quarter. I think you said most of that was impacting the July results?

Lorne Weil

That’s correct.

Steven Wieczynski – Stifel

So can you walk me through, did you start to see a reacceleration there, August, September and maybe also what you’re seeing – what you saw in October.

Jeff Lipkin

Yes, and I think we’ve recently defined as the beginning part of the fourth quarter have seen a little bit of a rebounding. I mean I think that when you look at sort of July, August and September, I believe each of the months was down, but July was down substantially relative to August and September, and certainly what we’re seeing October. And as much as one doesn’t like to blame things on the weather, when you read about the operators, the public operators. Certainly the weather is really the number one factor that really effected foot traffic into the betting shops during that time period.

It’s also the case for us which is somewhat specific that in the same month last year we had released a new roulette game that played extraordinarily well. So we had a difficult comp at the same time that we had the weather incident in the month of July, which caused again the – probably the single biggest decline that I’ve seen in memory for a long time in the global draw business. So it is heavily weighted towards July.

Steven Wieczynski – Stifel

Okay. And then one more quick one if I could. Any – your updated thoughts for point in terms of providing guidance once the WMS deal – once we get the numbers for WMS in the last quarter and going forward?

Jeff Lipkin

Yes, it’s a great question. We’re having discussions with our board. In fact at our next board meeting, we’re going to sort of go back through how we would propose to present the combined company. And this discussion of guidance comes out periodically and I don’t want to handicap of where we think it would come out but certainly we understand the comment and whether or not we give guidance. I think it’s view that we will give plenty of good information that to the extent somebody does the work on where – and we get the KPIs that we’re available publicly you look at the those KPIs, now it seems down for several quarters, you can get very, very close to where our performance actually comes out if you both look at those KPIs and you do that work.

So that’s something that I can guarantee you that we will do, whether we go a step further and sort of tell you the answer on top of giving you the background for it or something that we’ll have to defer until our next conversation with our board if unclear and there is different points of view around guidance obviously.

Steven Wieczynski – Stifel

Okay, great. Thanks guys. I appreciate it.

Operator

(Operator Instructions) Our next question comes from the line of Mike Malouf with Craig-Hallum Capital Group. Please proceed.

Ross Licero – Craig-Hallum Capital Group

Hi, thanks. This is Ross Licero on for Mike. I had a question about the new content and the global draw business. It seems like for the last few quarters, you guys have been doing better on the cash box from the competition. Have you seen this reflected, or is the sales pipeline of new customers growing as a result?

Jeff Lipkin

The number of units are up quarter-over-quarter, which is one way of answering your question. The little different in that business is concentrated in a few large operators, so you don’t typically see as much contract changes, as Lorne mentioned, we just re-won the Ladbrokes contract for five years with 9,000 machines. So it’s obviously our most significant customer. And in fact an expanded base of units from what we have today, 9,000 being higher than what we have today. And so – but I would say that when you look at the third quarter terminals, year-over-year they were up about 1,300 or something like that.

Ross Licero – Craig-Hallum Capital Group

Okay, great. And in that Ladbrokes contract, is there going to be another refresh between now and 2019 for the machines?

Lorne Weil

No.

Ross Licero – Craig-Hallum Capital Group

Okay, great. Thanks.

Lorne Weil

Yes.

Operator

(Operator Instructions).

Lorne Weil

Okay. I guess there are no more questions. So if not, I thank you again for joining the call. I hope you are as enthusiastic about the outlook for this company as we are. Certainly, I think it’s fair to say that you can characterize the feeling in this room here as one of unbridled enthusiasm. And hopefully as we move through the next few quarters, we will see results that justify that level of enthusiasm. And until then, thanks again. Good night.

Operator

Ladies and gentlemen, that ends our presentation. Thank you for calling. Have a good day.

Article source: http://seekingalpha.com/article/1820842-scientific-games-ceo-discusses-q3-2013-results-earnings-call-transcript

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