Scientific Games’ (SGMS) CEO David Kennedy on Q1 2014 Results – Earnings …

Scientific Games Corporation (SGMS) Q1 2014 Results Earnings Conference Call May 8, 2014 4:30 PM ET

Operator

Good evening, ladies and gentlemen, and welcome to Scientific Games First Quarter 2014 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 call is being recorded.

It is now my pleasure to introduce Bill Pfund, Vice President of Investor Relations for Scientific Games. Mr. Pfund, you may begin.

Bill Pfund

Thank you, Erica. Welcome everyone, and thank you all for joining us this afternoon. 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.

With me this evening are David Kennedy, President and Chief Executive Officer; and Scott Schweinfurth, Executive Vice President and Chief Financial Officer.

As a reminder, this call is being simultaneously webcast, which may be accessed on the investor information section of our website at scientificgames.com. A replay of the call 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 from those discussed. For certain information regarding these risks and uncertainties, please refer to our earnings press release, the materials relating to this call 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 financial 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 David Kennedy, President and Chief Executive Officer.

David Kennedy

Thank you, Bill. And good afternoon everyone. Thank you for joining us today as we discuss our 2014 first quarter results in our ongoing integration efforts. Our consolidated revenue was $388 million, up $169 million compared to the first quarter of 2013, our attributable EBITDA increased $45 million to $123 million and our free cash flow increased $37 million to $24 million.

Let me share my perspective on the overall performance of our business before turning it over to Scott to provide you with more detail of our results. Total revenue of our lottery business including both Instant Products and Lottery Systems increased 7% or approximately $13 million over the prior year quarter. By continuing to create high performing games, providing innovative game delivery platforms and offering value added services, we remain focused on helping our lottery customers around the world grow their revenues which in turn helps us increase our revenues.

The important contributors to the growth of our lottery revenues included our success with instant games in jurisdictions where we earned revenue on the participation basis, higher international lottery system product sales, our premium promotional and licensing efforts and the benefit from new lottery contacts including revenue earned from supplying our Northstar New Jersey joint venture and our new customers in Panama and the Dominican Republic.

Additionally, in April 2014, we entered into a new three year contract to continue serving as a primary supplier to the operator of the French National Lottery, which is the second largest instant game lottery in the world. And we also were awarded a new six year contract to continue serving as a primary supplier of instant games and related services for the Washington Lottery with additional extensions at the lottery’s option.

Our instant game contract with Loto-Quebec expired in January 2014. However, we have continued to provide instant games to this customer under the previous contract terms while the new contract is being negotiated. Our new contract with Loto-Quebec is anticipated to become effective in the second quarter and will represent a significantly smaller portion of such customer’s instant game business than the recently expired contract.

Most recently, we had a soft launch of sales of instant games in Greece and tomorrow, we expect the full launch. As a reminder, we have a 16.5% equity investment in the consortium that was awarded the 12 year confession that is bringing first instant games to Greece in more than a decade. Scientific Games has exclusive responsibility for and earns revenue firm instant game design and the production and supply of the instant games.

Now let’s turn to our gaming business. In our gaming business WMS operations contributed $157 million of the total $169 million year-over-year consolidated revenue increase. WMS’s new unit sales were appreciably down compared to the prior year quarter, which decrease we believe primarily reflects the conditions prevalent in many areas of the global gaming industry including the lower gross gaming revenue in many domestic gaming jurisdictions throughout the quarter.

We believe that many of our customers have responded reducing the capital spending. In addition, we believe our ship share decline modestly from that achieved in the December 2013 quarter. Against this backdrop of challenging industry conditions, our Blade games continue to perform well on a relative basis compared to the casinos house average. And we continue to develop comprehensive pipeline of new game [theme].

At the end of March, we launched our new Blade stepper 3-Reel mechanical unit with four commercial launches in the current quarter. This new product line generated significant interest in at G2E and we look forward to a broader rollout in the current quarter. While still very early, customer feedback and performance on casino floor is encouraging and in line with our strategy of broadening our product lines, this reopens an important segment of the casino floor to WMS product line.

The consisted four new games with innovated content is clearly helping our WAP participation gaming business. In addition to the original Willy Wonka video slot game, which continues to perform well, we also now have the Willy Wonka 3-Reel mechanical game.

Our portfolio of Game Themes and the Gamefield xD cabinet expanded in the first quarter with the new clue game. These new WAP games provide player feel and drove modest revenue growth in the WAP and premium participation category.

Importantly the performance of these new games is yielding higher revenue per day as we’ve clipped $7 per unit per day for the quarter. This is a notable achievement in light of the headwind of the gross gaming revenue declines in many U.S. regional jurisdictions during the quarter.

In our UK gaming operation after securing a five year contract renewal with Ladbrokes, we’re currently on target to complete the rollout of approximately 9,000 of our new [clear kit] gaming terminals across the entire state this quarter. Additionally we have just begun to rollout WMS gaming content across our UK installed base of terminals and the initial results are encouraging.

These positive events are tempered by the UK government’s announcement of its intent to increase the gaming machine duty on certain gaming machines from 20% to 25% of net win in March 2015. In addition the UK government has proposed additional regulations that would take effect in October 2014 related to the opening of new bidding shops, new requirements for players weighing more than 50 pounds and allowing players to set limits before commencing play on the amount of time or money they want to spend. These proposed changes will likely negatively impact our UK customers’ business and therefore our future revenues.

The interactive gaining revenue reflects ongoing success in both the real money gaming and social gaming applications. We continue to pursue new supplier agreements with additional real money online casino operators to integrate with their remote game server which features our library of interactive games such as releases agreement announced with bwin party.

During the March quarter, we expanded our interactive portfolio with the launch of the second social casino The Gold Fish Social Slots Casino on Facebook. During the soft launch period, our social gaming team closely monitored the analytics as they drove a series of live test with the player audience. Following the success of the testing period in the current quarter we are beginning to expand the availability of this new gaming site across mobile platforms and grow the player base through highly selective marketing.

Additionally we recently expanded our Jackpot Party Social Casino to the Yahoo platform. We are one of the first three casino games to be available on Yahoo. The result of all these efforts was new daily revenue records in April.

As we move forward, I am encouraged about the progress we continue to make across our various integration initiatives and by the execution of our specific business strategies targeting the growth opportunities that we see in the marketplace.

Even as we remain highly focused on implementing our integration plans and delivering our cost savings we also are proceeding with our initiatives and investments to grow the business. Within the Gaming segment we have strategies to further broaden the gaming revenue stream in North America as well as target expansion through new international opportunities.

We are investing in international initiatives to develop specific new products, supported by direct sales and distributions such as our initiatives focused on Australia and with our product development teams having no shortage of new game ideas we look to broaden our portfolio by targeting specific underpenetrated opportunities in North America as well as in international markets such as we are doing with the Blade 3 Reel mechanical product. By investing in the development of these products and initiatives in 2014 we expect to position our business to capitalize on future opportunities.

Now let me turn the call over to Scott who will provide more detail on our financial results and ongoing integration efforts.

Scott Schweinfurth

Thanks David and good afternoon everyone. For the March 2014 quarter our total consolidated revenue was $388 million an increase of $169 million from the first quarter of 2013 which includes $157 million from the acquisition of WMS, $13 million or 7% in our lottery businesses and a small decline in our UK gaming business. our consolidated attributable EBITDA increased $45 million to $123 million primarily related to the WMS acquisition and the $2 million increase in our lottery businesses.

Our consolidated costs of revenue excluding depreciation and amortization decreased from 57% of revenue to 47% of revenue primarily reflecting the impact of the acquisition of WMS and the change in mix of revenue streams.

The increases in other operating expenses including SGA, RD in play termination and restructuring and DA were all primarily related to the acquisition of WMS. Without the WMS impact, our costs increased by $8 million mostly due to higher DA. As a result of higher expenses primarily related to WMS, we had an operating loss of $12 million compared to $11 million of operating income in the prior year period. Our net loss of $45 million includes $23 million of higher interest expenses primarily attributable to the funding of the acquisition under the new term loan and $4 million of higher income tax expense.

Now I would like to briefly overview our three business segments’ performance beginning with our gaming segment, which as a reminder, includes all of the WMS business, including interactive and the legacy SG gaming and video businesses.

Revenue was $194 million or an increase of $156 million over the prior year of which $157 million was from WMS. Services revenue from WAP and premium participation gaming machines was $58 million. The average installed base of WAP and premium participation gaming machines in the March 2014 quarter was 9,142 units, down 57 units from what WMS reported in the prior year period, primarily representing a decline in the footprint of nine WAP units that was partially offset by growth in our WAP footprint.

The daily average revenue increased 1% relative to WMS’ prior year period to $70.13, a level not seen at WMS since 2011, despite the current downward trend in casinos growth gaming revenues. The increase largely reflects the favorable game performance of our WAP games along with the shift to a higher proportion of WAP units in installed footprint.

At March 31, 2014 WAP units were 42% of WMS’s installed base of WAP and premium participation unit compared to 35% at March 31, 2013.

Our average installed base of other lease and participation units rose 28,989 reflecting the addition of 2,609 lease WMS units and growth in the total installed footprint at SG gaming customers, despite the previously reported loss of the Bedford contract near the end of the quarter.

Services revenue from interactive products and services increased $31 million year-over-year, representing the inclusion of the WMS interactive revenues.

During the 2014 first quarter daily active users rose to 1.3 million from just 600,000 a year ago. The increase in the user base primarily reflects the growth in broadening of our player base particularly with the increased availability across multiple mobile platforms. Coupled with the initial benefit from the launch of second social gaming site Gold Fish Social Slot during the quarter.

The broader user base is also evidenced in the slight decrease in the average revenue per average daily user to $0.23 from $0.26 in the December quarter. As previously mentioned social casino revenue is now reported on a gross revenue basis before platform fees, as result of a change in the Facebook payment settlement process rather than on a net revenue basis, as historically reported by WMS.

The reporting change represented approximately $6 million of the interactive services revenue and an equal amount to cost of services for the current year period. Product sales revenue of $68 million included $63 million in revenue from sales of WMS products. This represents a decline of $35 million or 36% from the product sale revenue reported by WMS in the year ago period.

The year-over-year decline in U.S. and Canadian shipments of 2,030 WMS units, primarily reflects the decline in casino replacement units as well as the absence of VLT shipments to Canadian customers compared to 628 VLTs shipped to customers in Canada in the prior year period.

We believe the decline in replacement unit shipments for the first quarter is the combination of casino operators limiting capital spending as a result of declines in gross gaming revenue and a modest decline in our ship share.

We’ve experienced a decline in sales of our lower price Bluebird 2 gaming machine which we believe largely reflects the aging and limitation of the CPU-NXT 2 operating system. In order to provide a new option for our customers, we are now offering our newer CPU-NXT 3 operating system and its growing library of high performing games in the less expensive hardware of the Bluebird 2 cabinet.

This will enable our customers, who want the latest WMS games to potentially purchase more units with the capital that is budgeted. We incurred $5.2 million of employee termination and restructuring costs in the quarter, mostly related to selling our online real money UK gaming operation and exiting our managed services online gaming business in Belgium.

Attributable EBITDA in the first quarter for the gaming segment was $63 million, primarily representing the year-over-year impact from WMS and is an increase over the $55 million recorded in the December largely due to improved earnings after adjustments from non-cash items and a full quarter of WMS. JV EBITDA was essentially flat year-over-year.

Now turning to our Instant Products segment, total revenue was $129 million, up 2% or $3 million over the prior year period. Our U.S. revenue including sales to our Northstar New Jersey JV increased 8% as our U.S. lottery customers’ retail sales of instant games increased 4% led by higher revenue growth in jurisdictions in which we supply games on a participation basis.

International revenue declined 5% including Middle East where retail sales of instant games declined 3% year-over-year. Revenue from customers to which we supply instant games on a price per unit basis declined $2.4 million which can reflect quarterly changes and the timing of marketing programs and/or the launch of new games. The $2 million increase in licensing and player loyalty revenue was primarily driven by promotional and linked games. We incurred $4,000 of restructuring costs in the quarter as we completed exiting certain of our lottery operations in Mexico. We now have a 3 year contract to supply instant games to a distributor in Mexico.

Attributable EBITDA in the Instant Products segment was $62 million up $1 million from the prior year period, reflecting higher revenue partially offset by higher SGA expenses.

Turning to our Lottery Systems segment, revenue of $65 million was up 18% year-over-year or approximately $10 million. Product sales revenue rose $8 million primarily due to sales of system hardware and software international markets. Service revenue increased 2 million or 5%, primarily driven by higher sports betting revenue from international customers.

Attributable EBITDA was $19 million for the segment, up $2 million from the prior year quarter as the higher revenue was partially offset by a less profitable revenue mix.

In summary, on the legacy Scientific Games side revenue increased 6% to $232 million compared to the prior year quarter, primarily driven by growth in the Lottery Systems product sales and instant games partially offset by $1 million decline in the [upstream] gaming business.

Legacy WMS revenue for the quarter decreased by 12% or $157 million compared to a $178 million reported by WMS in the prior year quarter, reflecting the decline in new units sold.

I would now like to review the progress of our integration initiatives as we continue to execute our detailed plans during the 2014 first quarter.

As a result of our sustained efforts to reduce costs, we continue to realize cost savings that are ahead of our initial 2014 target of 15 — am sorry, $50 million by the end of calendar year 2014. We continue to expect to achieve at least $60 million of cost savings on an annualize run rate basis by the end of 2014. We also continue to expect to achieve our target of $100 million of cost savings on an annualized run rate basis by the end of 2015.

As expected the majority of the first year’s savings are coming from the following categories: Elimination of duplicative public company costs; lower compensation cost as we have already reduced headcount by approximately 4%, primarily in the corporate functions and other areas that are part of the SGA expense; lower stock compensation costs to the impact of substantially all of the WMS equity plan awards that were busted or canceled a closing combined with subsequent employee departures. Manufacturing cost savings from sourcing initiatives and utilizing SG expertise in this area, indirect procurement savings resulting from the increased buying power of the combined organization and exiting our interactive gaming operations in the UK and Belgium and exiting certain Mexican lottery operations which will improve our bottom line.

As originally expected, the planned initiatives reduced cost of product sales and lower RD costs have longer lead times because they are often dependent upon certain prerequisite actions and these areas among others are expected to lead to additional cost savings in 2015.

Certain of these integration initiative require cost to be incurred to achieve the savings. And during the first quarter our employee termination and restructuring costs totaled $5.6 million along with $3.7 million of other costs associated with the WMS acquisition including previously announced retention bonuses.

Our costs to achieve the integration savings are weighted more heavily to the first half of the year based on the timing of employee terminations such as those related to the businesses we’ve already exited plus the timing of retention payment.

We anticipate we will incur additional integration related costs in the coming quarters as we continue to move forward on our initiatives. For 2014, we continue to expect such costs to total between $15 million and $20 million. In addition, we expect an additional $15 million to $20 million of integration capital expenditure of which the largest project is to implement the Oracle HR and Finance software modules throughout the legacy SG businesses.

And there will be additional operating and capital costs incurred in 2015 to complete our plans. Another area of focus for us is cash flow. As a result of the combination of our cost reduction actions, the impact of the WMS acquisition and distributed earnings from our equity investees, our free cash flow defined as net cash provided by operating activities less capital expenditures increased by $37 million to $24 million in the 2014 first quarter. Net cash provided by operating activities increased by $60 million to $83 million reflecting an increase in net earnings after adjustments for non-cash items of $17 million largely attributable to the acquisition of WMS, a favorable contribution from reduced working capital $27 million mostly due to a reduction of receivables, partially offset by an increase in inventories, again mostly related to WMS and a $16 million increase in distributed earnings from equity investments.

Our capital expenditures for property, plant and equipment including lottery and gaming services expenditures and intangible asset and software expenditures was $60 million compared to $36 million a year ago with the increase mostly due to the addition of $36 million of capital expenditures from WMS partially offset by a decrease in other capital expenditures. As a [side by] I think it’s worth noting that our GA expense for the quarter of $94 million, of which most of the $61 million increase is from WMS exceeded our total capital expenditures of $60 million.

Additionally we made a capital contribution of $18 million to ITL to fund capital equipment for our customer contract and we recorded a related capital lease asset and liability of $14 million on leasing such equipment from ITL in our UK gaming business. In the quarter, we received a return of capital distribution of $22 million from LNS, as well as total proceeds on the sale of our equity investment in Sportech of $45 million, which included a $15 million gain on sale.

Additional cash items in 2014 first quarter was a previously announced 2 million shares repurchased for $30 million along with the redemption of common stock under our stock-based compensation plan to fund employee withholding taxes on rested shares for $19 million and required principle payments of $6 million, mostly under our term loan.

In summary, we believe that the combined company benefits from the diversity of revenue streams and when coupled with our intense focus on integration synergies and free cash flow generation, the foundation is in place for improved operating results in future quarters.

Erica, would you please open the line for questions.

Article source: http://seekingalpha.com/article/2204793-scientific-games-sgms-ceo-david-kennedy-on-q1-2014-results-earnings-call-transcript?source=google_news

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