International Game Technology PLC (IGT) 2017 Q2 法說會逐字稿

Good day, and welcome to the IGT 2017 Second Quarter Results Conference Call. Today's conference is being recorded.

And at this time, I'd like to turn the conference over to Mr. Jim Hurley. Please go ahead, sir.

Thank you for joining us on IGT's Second Quarter 2017 Conference Call hosted by Marco Sala, our Chief Executive Officer; and Alberto Fornaro, our Chief Financial Officer. After some prepared remarks, we'll open the call for your questions.

During today's call, we will be making some forward-looking statements within the meaning of federal securities laws. Forward-looking statements are not guarantees, and our actual results may differ materially from those expressed or implied in the forward-looking statements. The principal risks and uncertainties that could cause our results to differ materially from our current expectations are detailed in our SEC filings.

Now I'll turn the call over to Marco Sala, CEO of IGT.

Thank you, Jim, and welcome, everyone. We are reporting a good second quarter result today. The $424 million in adjusted EBITDA achieved in the period was supported by strong underlining performance in our global lottery operations and encouraging KPIs for our global gaming business.

Lottery same-store revenues outside the Italy rose nearly 3% in the quarter, with solid growth in both our International and North America segment. The performance of instant and draw-based games was even better, up 5% in the period. Jackpot activity was lower as growth in International was more than offset by high North America jackpot comparisons in the quarter last year. In Italy, excluding Late Numbers, lotto wagers were up 1% on the continued growth of 10eLotto and Numero ORO.

The second quarter lottery performance is a clear demonstration of the steady growth we have achieved and continue to expect for the lottery business. For the second year in a row, we earned a substantial performance-based incentive from the New Jersey lottery. This was achieved through the effective management of business, especially strategic game launches.

Long-standing relationships are also a cornerstone of our lottery business. Recently, we signed a 3-year extension with the New York lottery, a longtime and important partner and the largest lottery in the United States. We are excited to deploy some of our latest-generation online terminals and instant ticket vending machines as well as PlaySpot mobile technology during the extension period.

We also won a new 7-year facilities management contract with the West Virginia lottery, a valued customer since 2009. In a separate agreement, we were selected as the exclusive printer of West Virginia's instant ticket for the next several years.

Turning to gaming. Global revenues were in line with the prior year when adjusted for the impact of DoubleDown. Revenue from sales of gaming machines rose 25% on higher replacement and the new and expansion unit. We shipped nearly 8,900 gaming machines worldwide during the second quarter, a 9% increase from the prior year. The AXXIS 23/23 and the Crystal Series cabinet were important drivers of demand internationally and in North America, and collectively represented over half of the total units sold in the quarter. Average selling price were also up on growing demand for the new cabinet.

Customer confidence in IGT's core offering is improving and has resulted in strong gaming machine unit shipments in the quarter. In North America, we maintained our leading position video poker and mechanical real games. Through our test bank discipline, we are making good progress in video real games. This is where most of the market demand exists and where we believe we are currently underrepresented. Our new proven performer titles are doing well, and there is a lot of interest in games on highly anticipated CrystalCurve cabinet, which we began selling in the second quarter. It is a compelling new addition to the already successful S3000, AXXIS 23/23 and CrystalSlant cabinet.

The global installed base of gaming machine continued to grow in the second quarter, both year-over-year and sequentially. This was led by international expansion for casino customers in the EMEA region and Greece VLT program. The total installed base in North America rose sequentially on higher VLTs and relatively stable casino result, which were helped by the launch of the CrystalCurve cabinet during the quarter.

They installed base of 3D games continues to grow, and advanced interest in the upcoming roster of new products is running strong. This include the large-format Wheel of Fortune MEGATOWER, S3000 XL, CrystalCurve ULTRA cabinet that will be launched in the third quarter. Several high-profile titles like Fort Knox, SPHINX 4D and The Voice will come to market in the fourth quarter. I should note the original timing of certain introductions has been pushed back a few months. We've done this to perfect the game and cabinet mechanics, thanks to some valuable feedback we received from both players and customers during the focused groups, which are now a key step of our game development progress. We expect these to help maximize the impact of games once they are brought to market. Importantly, this shift does not have a material impact on our outlook for the year.

As I reflect on the first half actuals and our expectation for the back half, I'm confident we can achieve our financial objectives for the year. We delivered on our commitment of improving profitability in the International division. And the KPIs for gaming and lottery are trending in the right direction. This supports our expectation for a greater proportion of sales and profit in the second half. We expect that improvement to be led by stronger result from our gaming business, particularly in product sales for our International and North American divisions. The pipeline of new products is there. Now we must execute. And we have every expectation that we will.

Now I'll turn the call over to Alberto.

Thank you, Marco, and hello to everyone on the call today. A summary of our second quarter financial results is presented on Slide 8.

At constant currency, revenue decreased 5% from the second quarter of 2016. Nearly half of the decline is attributable to the sale of DoubleDown on June 1, while the other half is the result of the new lotto concession dynamics. Apart from that, we saw strength in gaming machine product sales as well as our core lottery business despite tough jackpot and Late Number comparisons. We also had the contribution from the New Jersey lottery incentive. Adjusted EBITDA was down in line with revenues. Adjusted EPS include higher distribution to minority partners and then accrual for tax litigation in Mexico.

Let's now look at our operating segments beginning with the North American gaming and interactive on Slide 9. Revenue was $310 million compared to $350 million in the prior year. The majority of the decline, $29 million, reflects the sales of DoubleDown. Excluding DoubleDown, gaming service revenue was down on a lower installed base. Sequentially, we saw relative stability with the launch of the new CrystalCurve cabinet during the quarter. While overall yields were down, we saw year-over-year improvement in WAP yields for the second quarter in a row.

Gaming product revenue benefited from higher volumes and margins on terminal sales in the second quarter despite the comparison with the large system sales to station casinos in the prior year. We shipped 5,293 units in the second quarter compared to 5,163 units a year ago. Terminal revenue grew 16% on improved ASP and demand for our S3000 and Crystal Series cabinet and include 862 units at ilani. Sales of the new CrystalCurve cabinet also contributed in the quarter.

Operating income for North American Gaming & Interactive was lower largely due to DoubleDown. Excluding that, profitability was relatively stable as improvement in operating expenses mostly offset the lower installed base.

Our North America Lottery results are on Slide 10. We achieved 2% same-store revenue growth in the quarter on top of challenging jackpot comparisons. Instant ticket and draw-based games grew nearly 6%, the strong performance -- the strongest performance in last year. The decline in service revenue you see here was due to the exit of certain low-margins contracts. As Marco mentioned, we had a performance-based incentive benefit from the New Jersey lottery for the second year in a row. Despite the lack of a larger jackpot like last year, we were able to achieve the incentive through disciplined management and effective sales and marketing initiatives. We originally expected to recognize the incentive in the third quarter, but most of it was recorded in the second quarter with a small portion left to be recognized in Q3. Product revenue reflects the natural lumpiness of this business, which had large sales in California in the second quarter of 2016. Operating income for North America Lottery improved significantly, reflecting the incentive contribution and higher same-store revenue growth, partly offset by lower product sales.

International segment had a good quarter with positive trend across the board. On Slide 11, you can see that revenue improved 3% at constant currency. Product sales improved substantially in the second quarter, driven by 39% increase in terminal revenues. We shipped 3,591 gaming machine units in the period compared to 2,989 in the prior period, led by casino replacement sales in Latin America. We also recognize the revenue for some terminals that were shipped to Bahamas in the first quarter.

Lottery same-store revenue grew nearly 4% on strength in Latin America, including double-digit growth in jackpot games. Gaming service revenue reflect some softness in the interactive segment while the gaming installed base continue to grow. With contribution from Greece, South Africa, Argentina and Peru, revenue is relatively in line with prior year due to mix. As expected, international profitability recovered in the second quarter, confirming that the first quarter result reflect the combination of short-lived impact. Improvement in the second quarter operating income came from higher gaming product sales and mix, reduced SG&A expenses, lower bad debt and impairment. International operating income for the first half is only modestly below the prior year constant currency, and we continue to believe international sales and profit for the full year will be higher than 2016 levels.

Our Italy results are on Slide 12. Revenue declined 8% at constant currency, entirely from the expected impact of the new lotto concession and lower Late Numbers wagers. As a reminder, the lotto fee amortization is recognized against revenue at a rate of approximately $24 million per quarter. The $7 million rate impact you see on this slide refers to the change in the fee, which is now fixed at 6% of wagers compared to the tiered fee structure of the previous contract. Excluding Late Number activity, which was significantly elevated last year, lotto wager increased 1%, fueled by the performance of 10eLotto, which grew roughly 7% over the prior year period on high frequency of play. Scratch & Win wager was stable on good performance of the multiplier tickets despite fewer new ticket launches in 2017.

Machine Gaming revenue was essentially flat during the quarter as increased vertical integration was offset by higher gaming machine taxes that went into effect at the end of April. Sports betting revenue was up on higher wagers, especially on live bets and the lower payout. Italy operating income declined as expected, entirely attributable to the 2 dynamics that affected the revenues: the new lotto concession and lower Late Numbers activity.

On Slide 13, you can see the net debt of $7 billion at the end of the second quarter, nearly $600 million lower than at the end of 2016. This is despite the final lotto concession payment and nearly $300 million of negative FX impact and reflects disciplined asset and financial management. We recently completed a series of refinancing activities as part of the broader strategic capital structure initiative.

On Slide 14, you can see that since May, we have deployed DoubleDown proceeds to tender for our highest coupon notes and pay down the revolver facility. We also refinanced our term loan, upsizing it to EUR 1.5 billion and amended the revolving credit facility, reducing the aggregate commitments by about 30% to $2 billion. By proactively taking advantage of favorable market condition, we have lowered our interest cost, reduced our own liquidity needs, extended our maturities and introduced more flexible financial covenants. This action along with the anticipated retirement of the February 2018 notes maturity are expected to reduce our cash interest cost by an estimated $60 million on an annualized basis. We continue to monitor market conditions for additional value-accretive opportunities.

Our first half cash flow dynamics are on Slide 15. We generated nearly $550 million in cash from operation in the first half of 2017, and this is after roughly $246 million in cash interest expenses as well as DoubleDown transaction costs. We also made the final lotto upfront concession payment in the second quarter. I already mentioned the significant reduction in debt in the period, and we have ended the quarter with about $500 million in cash on the balance sheet.

Our outlook for the year is summarized on Slide 16. We have reduced the CapEx expected for maintenance and growth by $50 million to the new range of $575 million to $625 million, entirely due to timing. The outlook for EBITDA and net debt are unchanged. I do want to point out [the Dual] has been net neutral on our year-to-date results. If the euro-dollar exchange rate remains at current levels, we had a beneficial impact on our reported second half results.

Given the shift in timing of the New Jersey incentive payment from the third quarter to the second quarter, the mix of profits from the first and second half of the year is now more balanced than we originally described. We made a lot of good progress on many levels so far this year. We are bringing important new products to the market, and we are enhancing cash generation through disciplined asset and financial management. We look forward to building on this progress in the second half of the year.

At this point, we would like to open the call for your questions. Operator, could you please proceed?

(Operator Instructions) We'll take our first question from the line of Barry Jonas from Bank of America.

So just a couple of questions. First, on the guidance. More than halfway through the year, maybe just talk about some of the main factors between the low and high end of hitting EBITDA guidance?

Barry, we have not been, in the first half, very lucky with the jackpot and Late Number this year. So we need to see what happens in the second half. And certainly, if it's different for the first half will help improve our results. The other important factor, as we mentioned from the beginning of the year, that the product sales are normally for a seasonal reason skewed towards the fourth quarter rather than the third. And we have all these new product introduction in the third quarter. Obviously, simply timing of those sales could impact positively or negative what are our results. And as I mentioned, on a pure reported basis, we have changed that year-over-year has impacting negatively the first 6 months, and it's more or less at an average of 1/10 for the first half. Right now, it seems like could help the results on a reported basis.

Great. And then just at a high level, relative to gaming, maybe talk about the tone of your customers right now as you speak to them in North America and International. And maybe how do you see the cadence of market-wide growth going forward, that would be helpful.

Yes, Barry. I can answer this question. Let's start from the product sales. We are overall happy with the customer reaction to our new games and cabinets. That is the reason why we expect to sell overall a high number of terminal in the second half compared to the first in our business. The reason for that is because we are improving on the CrystalDual and CrystalSlant Cabinets and recent success of new titles. What are the customers are recognizing is that we are improving in bringing to the market new cabinets, but even more importantly, in bringing to the market contents that are performing better than the past. I want just to mention also the recently launched CrystalCurve during the second quarter where we -- that we launched both for product sales as well as for the recording part of the business that is doing well. we launched in the product base -- in the product sales 2 original titles for this cabinet. And we have a great lineup of additional games coming to the market in the balance of the year. So all in all, I think we are in a good momentum. It's clear that, very much, we rely on the performance of the new things that we will bring to the market, both in product sales as well as in the recurring part of the business. Don't forget that in the third quarter, we will launch 3 new cabinets: a large-format Wheel of Fortune with a very proven title, a large format of S3000 and even the CrystalCurve ULTRA with a new Ellen game. And then in the fourth quarter, we will launch other stuff. That will be very critical to assess our performance. But for the time being, I see the recognition of the effort we have done so far.

Great. And then just last one. We're right around the corner from G2E again this year. And maybe just, can you give us any initial thoughts around expectations for G2E this year and the product rollout, just given so much good product that you showed at G2E last year is only coming out now?

Yes, you are right, but we have the pipeline of the products that will coming out next week -- next year. So I mean, that is what we'll focus for G2E. It's clear that we'll be at G2E more based on the content than the cabinets since we have launched 7 new cabinets or we are going to launch 7 new cabinets by year-end. But we will have a good lineup of compelling content to push our presence in the various segments of the market.

Your next question comes from the line of Chad Beynon from Macquarie.

First off, wanted to start with capital allocation. So given the stronger-than-expected 2Q result, the lower annual CapEx that you guided to and the massive savings on the debt refinance, your deleveraging plans, I'm guessing, are slightly ahead of expectations just based on what we're seeing here. So could you update us just in terms of some near-term goals with capital allocation, some leverage targets and then what to do beyond that?

Chad, I don't think there's going to be a short-term change. We are continue to managing obviously the capital structure and the balance sheet very actively. And again, the goal is to continue the leverage until the end of 2018. Certainly, what we have done, it helps us -- and the favorable market condition is helping us in achieving that goal, but there is a lot going on in terms of the business in the next months. And obviously, the business in particular the gaming is an important contribution to our cash generation. So for the moment, I say no change. We will continue according what we have said, which is the cash generation from the business will be dedicated to the maintenance CapEx, some selected growth CapEx initiatives and then reducing the debt and pay the dividend.

Great. And then we've noticed during the last 6 months, you've had some announcements on different partnerships in both of your segments. Can you just give us an update in terms of if you think this is the best way going forward to get a good return on your business? Or if there are -- if there would maybe be some opportunities for tuck-in acquisitions if that's a good use of your capital and drive returns higher?

Chad, you are referring to some initiatives specifically?

Yes, the announcement with Konami was kind of the recent one on the cross-licensing agreement on the gaming side, obviously, Paradise last year and then I believe there were 1 or 2 on the lottery side as well.

But I would say there is not a big change. Wherein certain jurisdiction we believe that working together with a partner, for example, recently, we've announced the partnership in China with Telling make a lot of sense, we will always pursue because the goal obviously is to do in every jurisdiction to [do this] to bring lot of local knowledge and institutional knowledge is critical for us to succeed.

But China is a minor joint venture so far but with great potential. We decided to join with a strong local partner to pursue opportunities in China as regulatory environment evolves. The goal was really proactively position ourselves to be able to pursue those opportunities, especially for VLTs and interactive games. After many years, we realized that the partnership in this region is the best way to take advantage from further development. The other thing we recently did is a small acquisition of a multi-leading bingo -- video bingo company that fills a hole in our product offering. This is a very minor acquisition that we recently communicated and that is just to fulfill all we have in our offering for some selected jurisdictions.

We'll take our next question from the line of David Katz from the Telsey Group.

Alberto, could you talk about, within the quarter, have you quantified for us how much specifically benefit to EBITDA the New Jersey incentive provided? And I think you also may have made -- I'm sure you made the comment that the balance of earnings through the year is going to be a bit more balanced than the back-end loaded commentary you've made previously, which I think was in the neighborhood of around 55:45 second half versus first half. If you could be a bit more specific on both of those items, that would help, please.

I'll be very specific on New Jersey. It's $22 million that we were planning for Q3 and now we have anticipated in Q2. There is a remaining part that we will recognize once all the activity will be regarding the reconciliation of the data with the lottery will be finalized and will happen in Q3. Regarding -- I mentioned in the past some specific split between EBITDA in the first half and second half. If we are still looking at the second half to be above 50%, but with particularly for the New Jersey, now the percentage is more balanced than what I mentioned in the first quarter earning release.

Still north of 50%, but not as high as previously for the back half?

Correct.

Okay. And my second question is around the installed base improvements that we're seeing primarily in North America but elsewhere -- well, certainly, within North American VLTs and North American casinos, the unit placements are showing some improvement. The yield is still coming in a bit below what we are modeling. Can you give us some commentary around when you expect that to start to go up and flip? Is that something that we might expect to see in the back half of the year? Or is that something that's longer term? And what levers are you working on pulling beyond just placing some of your new premium product out?

Yes. I mean talking about yields, there are 2 different stories between the North American part of the business and the International part of the business. The trend in yield in North America was consistent with what we have seen in the several last quarters. I can elaborate by saying that WAP yield goes up but was more than offset by the balance of the portfolio wherein some occasion due to the performance and partially due to targeted pricing action we have taken earlier is creating this moderate decline. Clear that we rely very much on the new product that we'll bring to the market to stabilize not only the installed base but also the yield. For the International part of the business, it's more a matter of mix because in the last quarters, we have done stronger placement in South Africa and in Greece that are lower-yielding machines, and so that comparison is unfavorable. And so going forward, as long as the mix will be more, let me say favorable, from the perspective, we should enjoy a more attractive yield.

(Operator Instructions) We'll take our final question in the queue from Domenico Ghilotti from Equita.

Well, I have a question on the level of profitability that is flowing really from the EBITDA to the bottom line. So the amount of profit that you're retaining in bottom line is quite low and particularly so that minorities and tax rate was very high in the quarter. If you can elaborate on this. You were also mentioning some litigation in Mexico. So I'm trying to check if this was contributing to the high level of taxation?

Domenico, this is Alberto. Below operating income, you find, first of all, the negative impact coming from currency because as you know, half of our debt is basically euro. And the strengthening of the euro has generated...

Sorry to interrupt. I was focusing on the adjusted numbers so just in order to focus for the -- your answer on the adjusting numbers.

Okay, I'm getting there. So the tax has been impacted by 3 major factors. There is an accrual for a litigation that I've just mentioned. There is a normal impact coming from the fact that we have a purchase price adjustment from a tax point of view is nondeductible. And there is also the fact that, obviously, we have the gain on the sales of DoubleDown. It is impacting negative. So the tax is very negative for this quarter. Regarding the minority, there is -- there are 2 components. One, we talk about the component related to the new lotto concession that as we have a partner now we didn't have last year. But also, it's materializing in the second quarter, also the component of the minority related to New Jersey that last year was in the third quarter. So there is a combination of items impacting tax and minority interest on the quarter that are unfavorable.

Okay. And just a clarification. When you are referring to the gain on DoubleDown, so it is affecting in some way the adjusted numbers, both in terms of...

No, I was talking about the impact on the taxes that are quite higher.

Okay. And the second question is on the savings that you were mentioning in terms of financial charges due to the refinancing. First of all, I would like to check if there is a recent transaction in some way are also, say, affecting some one-off cost? So what is the cost that's incurred to have this refinancing? And second, if we should expect to see these savings, say, 1 year savings or yearly savings already flowing starting from the second half of this year, or how much, let's say?

Okay, I'll answer the second question first. Regarding the savings for this year, other things being equal, we are talking about 1/3 of the total amount to happen in 2017. Regarding the overall cost, we are -- in terms of fees for the entire refinancing is probably north of $20 million. And the $60 million that I was mentioning are basically coming from the utilization of the DoubleDown proceeds that we have repaid with those the revolving credit facility -- the utilization of the revolving credit facility for around $450 million. And the remaining, we have utilized to tender the 7.5% dollar bond that we did a few weeks ago. The other 2 important components are the fact that we have less fees on a go-forward basis on the revolving credit facility because we reduced by 30% the amount. And finally, the replacement of the bond that will be repaid in February 2018 for EUR 500 million with the term loan venture as a little bit more than 4% savings at current market rates. We also have negotiated with the banks a delayed draw down by the year-end. So it means we have significantly reduced recurring costs related to it because there will be between the drawing of the money and the repayment of the bond only little bit more than a month.

That will conclude today's question-and-answer session. I'd now like to turn the call back to Mr. Marco Sala for any additional or closing remarks.

I will have very brief remarks. Thank you for your interest in IGT, and I look forward to seeing you over the next several weeks. Thank you very much, and have a very good day.

Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect.