Light & Wonder Inc (LNW) 2014 Q1 法說會逐字稿

Good evening, ladies and gentlemen, and welcome to the Scientific Games first-quarter 2014 conference call.

At this time, all participants are in a listen-only mode.

(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.

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 afternoon 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 www.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 will turn the call over to David Kennedy, President and Chief Executive Officer.

Thank you, Bill.

Good afternoon, everyone.

Thank you for joining us today as we discuss our 2014 first-quarter results and 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.

Important contributors to the growth of our lottery revenues included our success with instant games in jurisdictions where we earn revenue on a participation basis, higher international lottery system product sales, our premium promotional and licensing efforts, and the benefit from new lottery contracts 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 the primary supplier to the operator of the French national lottery which is the second largest instant game lottery in the world.

We also were awarded a new six-year contract to continue serving as the 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-Québec expired in January, 2014.

However, we have continued to provide instant games to this customer under the previous contract terms while a new contract is being negotiated.

Our new contract with Loto-Québec 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 a 12-year concession that is bringing the first instant games to Greece in more than a decade.

Scientific Games has the exclusive responsibility for and earns revenue from instant game design in the production and supply of 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' 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 revenues in many domestic gaming jurisdictions throughout the quarter.

We believe that many of our customers have responded by reducing their capital spending.

In addition, we believe our ship share declined modestly from that achieved in the December 2013 quarter.

Against this backdrop of challenging industry conditions, our Blade Games continued to perform well on a relative basis compared to the casino's house average, and we continue to develop comprehensive pipeline of new game themes.

At the end of March, we launched our new Blade Stepper three-reel mechanical unit with full commercial launch in the current quarter.

This new product line generated significant interest at G2E, and we look forward to a broader rollout in the current quarter.

While still very early, customer feedback and performance on casino floors 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 consistent flow of new games with innovative 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 a Willy Wonka three-reel mechanical game.

Our portfolio game themes in the game field xD cabinet expanded in the first quarter with a new clue game.

These new WAP games provide player appeal 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 eclipsed $70 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 US regional jurisdictions during the quarter.

In our UK gaming operation, after securing a five-year contract renewal with Ladbrokes, we are currently on target to complete the rollout of approximately 9,000 of our new clarity gaming terminals across their entire state this quarter.

Additionally, we have just begun to roll out WMS gaming content across our UK install 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 betting shops, new requirements for players wagering more than 50 pounds, and allowing players to set limits before commencing play on the amount of time and money they want to spend.

These proposed changes will likely negatively impact our UK customers' business, and therefore, our future revenues.

The interactive gaming revenue reflects ongoing success in both real money gaming and social gaming applications.

We continue to pursue new supplier agreements with additional real money, online casino operators to integrate with our remote game server, which features our library of interactive games such as the recent agreement with -- announced with BWin Party.

During the March quarter, we expanded our interactive portfolio with the launch of a second social casino, the Goldfish 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 tests 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 were 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 by 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 targeted 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're doing with the Blade three-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.

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% growth 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 a $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 changing mix of revenue streams.

The increases in other operating expenses including SG&A, R&D, employee termination and restructuring, and D&A were all primarily related to the acquisition of WMS.

Without the WMS impact, our costs increased by $8 million, mostly due to higher D&A.

As a result of the 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 expense primarily attributable to the funding of the acquisition under the new term loan and $4 million of higher income tax expense.

Now, I'd 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 non-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 trends in casinos' gross gaming revenues.

The increase largely reflects the favorable gain performance of our WAP games along with the shift to a higher proportion of WAP units in our installed footprint.

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

Our average installed base of other leased and participation units rose to 28,989 reflecting the addition of 2,609 leased WMS units and growth in the total installed footprint at SG Gaming's customers despite the previously reported loss of the Betfred 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 and broadening of our player base, particularly with the increased availability across multiple mobile platforms, coupled with the initial benefit from the launch of our second social gaming site, goldfish social slots during the quarter.

The broader user base is also evident 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 a 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 US and Canadian shipments of 2,030 WMS units primarily reflects a 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 a combination of casino operators limiting capital spending as a result of declines in gross gaming revenues and a modest decline in our ship share.

We've experienced a decline in sales of our lower-priced Bluebird 2 gaming machines, which we believe largely reflects the aging and limitations of its CPU-NXT2 operating system.

In order to provide a new option for our customers, we are now offering our newer CPU-NXT3 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 quarter, 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 product segment, total revenue was $129 million, up 2%, or $3 million over the prior-year period.

Our US revenue, including sales to our Northstar New Jersey JV, increased 8% as our US 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 Italy, 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 $400,000 of restructuring costs in the quarter as we completed exiting certain of our lottery operations in Mexico.

We now have a three-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 SG&A expenses.

Turning to our lottery segment -- 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 systems hardware and software in 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 a $1 million decline in the SG Gaming business.

Legacy WMS revenue for the quarter decreased by 12% to $157 million compared to $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 continued 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 $50 million by the end of calendar-year 2014.

We continue to expect to achieve at least $60 million of cost savings on an annualized 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 savings are coming from the following categories -- elimination of duplicative public Company costs, lower compensation costs as we've already reduced headcount by approximately 4% primarily in the corporate functions and other areas that are part of the SG&A expense.

Lower stock compensation costs through the impact of substantially all of the WMS equity plan awards were vested or cancelled at 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 to reduce cost of product sales and lower R&D 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 initiatives require costs 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 have already exited plus the timing of retention payments.

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 expenditures 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 of $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 investees.

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 sidebar, I think it's worth noting that our D&A 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 a 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 the 2014 first quarter were the previously announced 2 million shares repurchased for $30 million, along with the redemption of common stock under our stock-based compensation plans to fund employee withholding taxes on vested shares for $19 million, and required principal 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.

(Operator Instructions)

Brian Mullan, JPMorgan.

Scott, congratulations on the new role.

You touched on free cash flow at the end of your remarks.

Could you just talk broadly about your views on the priority of free cash flow use going forward between the different options the Company has?

Is there a target leverage ratio you'd like to see Sci Games get to in the near- to intermediate term?

Thank you.

I think naturally our primary use of cash flow is to fund additional initiatives within the business to grow the business.

David, made reference to some revenue opportunities that we are pursuing, particularly in the gaming side of the business.

I think some of that will require some capital as we move forward.

In the past, the Company has looked at a variety of other uses of cash flow including paying down debt.

Our current credit agreement does have provision for some obligatory paydowns if cash flow is in excess of certain amounts.

We would certainly look at that.

In terms of the leverage ratio, at this point, I would say I don't have a target that we would like to get to.

I think I need more time to determine exactly what that means relative to the full operations and where we are taking the operations.

But, I am comfortable with the current leverage ratio we have and the current credit agreements that we have in place.

Thank you.

Carlo Santarelli, Deutsche Bank.

David, in the prepared remarks, and Scott, I know you touched on it as well.

You mentioned the $24 million in free cash flow in the quarter.

I was just trying to understand a little bit better what that included, and is that inclusive of the sales as well as, obviously, the buyback capital that you used?

No, it is not.

In fact, it is the net cash provided from operating activities, less additions to property and equipment, lottery and gaming operation expenditures for software, and that sort of thing, and intangible assets.

And, that should total to the free cash flow of approximately $24 million.

It does not include the return of capital payments from LNS.

It does not include the sale, or the proceeds from the sale of Sportech.

And, it does not reflect the use of cash to buy back shares.

Okay, understood.

Thank you.

That's helpful.

And then, just if I could touch on the acquisition comment.

Could you put a little bit of framework around some of the, I would guess, pieces of the puzzle that you would be looking to acquire in what piece of the business?

Would that be more of a domestic acquisition?

Something in the slot industry?

Or, are you thinking something more international and maybe a little bit outside of the gaming business, more towards the core lottery business?

I am not sure exactly what you heard.

Perhaps we had a miscommunication.

We didn't talk about any acquisitions.

Perhaps, you heard Scott refer to a priority being to invest in the existing business.

Which is just the investment of retained earnings in that business.

We didn't mention -- .

Sorry, I thought Scott mentioned one of the uses of capital was potential acquisition activity.

That is what I thought I heard.

Maybe I am mistaken.

No, I don't think so.

Understood.

That is all for me.

It's good to clear that up.

Thank you.

(Operator Instructions)

Todd Eilers, Eilers Research.

I apologize, if you touched on some of these before I got on the call a bit late.

I wanted to see on the lottery side, can you give us a sense for how much the New Jersey market contributed this quarter?

Was it material or not for your instant ticket business?

And then also, an update on Greece?

At this point in time, what is your best guess for when that market launch is?

Todd, first on New Jersey, I would say it has an important contribution to our revenues but not a material one.

That is the way I would characterize the New Jersey contribution.

Secondly, on Greece, I did say in my remarks, and unfortunately as you said, you got on the call later; that we've had a soft launch and we expect to launch tomorrow, as a matter of fact, a full launch in Greece tomorrow.

Perfect.

I apologize for that.

And then, I had a couple of other questions on the WMS side of the business.

Obviously, the premium units declined sequentially there.

And, I guess that is for the second quarter in a row there.

How should we look at that install base going forward?

Should we expect stabilization here through the remainder of the year?

Or, might we see some further unit removals at this point in time?

What are your thoughts going forward there?

I will give you a first thought, and then I would ask Scott, because he has got a history in the business to comment.

But, I would say that one, while it did decline, and I wouldn't want to project exactly where we would go with that business just because of the conditions in the marketplace.

On the other hand, it remains a focus and a target in our business.

We like that business a lot.

We would like to expand it if market conditions are conducive to that.

I guess I would add, that there is a bit more competition in that marketplace, particularly in the non-WAP units at this point in time, and so that has an impact on ability to grow the business.

It is also dependent upon game performance.

We have seen that in the past, with good games, you will be able to garner more share on the casino floor.

One of the key areas of focus over the last 12 months has been growing the WAP footprint, and we have been fairly successful with that.

That produces higher gross profit dollar contribution on a daily basis, and we have variety of new products for both the WAP area and the non-WAP area that we will be coming out with over the near term.

Great.

Thanks.

Kevin [Coyne], Goldman Sachs.

I just wanted to follow up on the leverage question.

I know you don't have a precise target in mind, but with your peers rated investment grade, do you feel a need to be there at some point?

Are you more or less more comfortable being a high-yield credit profile?

We certainly feel extremely comfortable with where we are and having a high-yield profile.

We don't have a target to becoming investment grade.

Okay.

That is helpful.

Then, I was just wondering if I could ask a broader theoretical question.

As we think about, let's say, us on the analyst aside, sometimes follow the replacement cycle, and we have certainly seen it widen and stay wide for a while relative to where it was maybe five years ago.

When we think about the mix of machines on almost any gaming floor, we know that certain machines last almost forever.

There could be reels and video poker machines out there for over 20 years that still run fine.

But, if we think about the machines that have been installed in the last five years, is there a theoretical or estimated useful life on those machines?

Whether it be monitors, or something like that?

That makes you think or the market think that there is a limited amount of time they are going to need to be out there?

I know that you can swap out software and do that to always upgrade the case and the box and whatnot.

Is there any theoretical time frame that we can think of with this current generation of machines to where they will need to be replaced?

I will make a couple of comments, and then I will turn it over to Scott, because he has got the history in the gaming business.

But, I know that in the server-based gaming business in the UK, what drove the replacement cycles there, were the upgrades to the machines as much as anything.

And then their ability, because of those upgrades, in order to deliver games that enhance the player experience.

I suspect it is the same thing in the casino.

What I would call, broadly speaking, the innovations in both the cabinets, the machines, the platforms, the software, and the games themselves, is what really drives it.

Is not so much, from what I hear from your question, the physical aspects of the [games] (multiple speakers).

Mine is more of a wear-and-tear question.

No, I don't think that's an issue at all.

I think it is all about the innovations to improve, enhance, the player experience.

Scott?

You are spot on with that.

The machines are built to last.

There is a robust secondary market, that once the class III casinos decide that they're going to replace what they have on the floor, we will often take trade-ins; or they will sell them directly to third-party distributors who place them mostly in international markets that can't afford the high price of the new gaming devices.

The useful life of the machine is lengthy.

Fair enough.

I appreciate it.

We have no further questions.

I will now turn the call over to Mr. Kennedy for any closing remarks.

Thank you very much.

Thanks to all of you for joining us.

In closing, I want to reiterate a few points.

That we are clearly focused on delivering the cost savings and increased cash flow from our integration efforts in the near-term, to investing in our core competencies to grow our businesses by executing our strategies aimed at increasing our global share of the casino floor, and expanding our business presence in underpenetrated markets, and driving operational efficiencies and improvements.

Thanks again.

We look forward to updating you on our progress on our second-quarter earnings call.

Thank you.

Thank you for your participation on today's conference.

This concludes the presentation.

Everyone may now disconnect and have a great day.