Light & Wonder Inc (LNW) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2014 Scientific Games Corporation earnings conference call. My name is Sheila and I will be your operator for today. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Mr. Bill Pfund, Vice President of Investor Relations. Please proceed, sir.

Thank you, Sheila. Welcome to everyone on the call, and thank you for joining us today. During this call, we will discuss our third-quarter results and operating progress followed by a question-and-answer period.

With me this afternoon are Gavin Isaacs, President and Chief Executive Officer; and Scott Schweinfurth, Executive Vice President and Chief Financial Officer.

As a reminder, this call is also being webcast, which may be accessed on the investor information section of our website at www.scientificgames.com. A replay of the call will also 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, issued today; 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 Gavin.

Thank you, Bill, and good afternoon, everyone. Today, Scientific Games reported financial results that demonstrate the progress we are beginning to realize in generating free cash flow in our operating businesses and the substantial success we've had to date with all of our integration activities. Whilst we still have further work to do in order to build the high-performing Company we believe is possible, I am proud of the efforts underway and the progress made in the quarter.

Most importantly, I am pleased by the progress the integration planning teams working on the pending merger of Bally and Scientific Games are making, and in the collaboration and teamwork that I see being demonstrated. People from across both organizations are coming together to plan our future -- a future that is very exciting.

This afternoon, I want to share with you some of the details of our operating results and integration planning, as they go hand-in-hand toward our focus on driving free cash flow growth. Notable operating achievements include: at quarter-end, on a quarterly sequential basis, the footprint of our WAP and premium participation gaming machines increased 322 units. And the average daily revenue increased 2% to nearly $72, which is also up 8% year-over-year, and which we believe will once again be the highest daily average among the major gaming suppliers.

Shipments of replacement units for casino operators in the US and Canada increased nearly 18% on a year-over-year basis, although total global shipments declined, principally as a result of fewer new casino openings domestically and the decline in international shipments. As measured by the number of sales leads we track -- up more than 40% over last year's show -- we believe we had a better G2E than in recent years.

Customer feedback was very positive on our latest new games, including our participation games that we expect to launch during the next nine months. Game performance on our Blade products continues to improve. I would also add that we continue to garner favorable feedback from casino operators on the pending combination of Bally with Scientific Games.

Let me reiterate our goal. We intend to lead the industry in innovation, and to be the partner of choice of our customers to help them engage their players to help them grow their revenues, as we believe this is our best path to success.

And as with our customers at G2E, we had a very favorable interaction and support from our North American lottery customers at NASPL. I'm looking forward to meeting with our international lottery customers this weekend at the World Lottery Association meeting.

We again generated strong revenue growth from our interactive gaming products and services. Revenues were up 19% on a quarterly sequential basis, largely due to the continued player appeal of our Jackpot Party Social Casino; the growth of our recently launched Gold Fish Social Slots app; and greater revenue from real money gaming, as we continue to increase the number of online casinos we serve.

After quarter-end, we launched the new $5 multi-state MONOPOLY MILLIONAIRES' CLUB lottery draw game. Ticket sales began on October 19 in 23 states, having a combined population of about 175 million people. With more states committed to launch the game during the coming months, we believe this may prove to be one of the most exciting new opportunities in the lottery industry to help grow our customers' revenues. And it is certainly one of the most exciting developments at Scientific Games to help grow our revenues in the near future.

Let me congratulate and thank all the team members who devoted endless hours and hard work to get this major new product successfully off the ground.

Equally exciting is the production work already under way to launch a companion MONOPOLY MILLIONAIRES' CLUB new TV game show early in 2015. Please stay tuned.

Turning now to our integration efforts. Based in our success to date, we are increasing the total expected annual cost synergies from the WMS acquisition by $15 million to $115 million by the end of 2015.

Due to additional actions taken in October following the close of this quarter, we now expect to achieve $85 million of annual cost savings in calendar 2014. Furthermore, based on the incredible collaboration, the common culture, and the goodwill amongst our teams, we are tracking ahead of our initial timetable and expectations for the integration planning of Bally and Scientific Games.

As a result, we now expect to achieve an additional $15 million in total annual cost synergies above our original expectations. That brings the total synergies to $235 million, of which we expect to achieve about 80% in 2015.

The recent experience gain through WMS and SHFL integrations have provided us with invaluable knowledge. And that experience is contributing greatly to our confidence in being able to swiftly and efficiently integrate Bally and Scientific Games after the closing of the acquisition. Recently, there has been a lot of speculation among investors and the press regarding our financing structure and ability to complete the Bally transaction. I want to clarify our position and end this confusion.

Our deal remains on track. We expect to close the Bally acquisition in this quarter, and immediately implement our integration plans. We have firm financing commitments in place to fully fund the transaction. We remain very comfortable with our planning, our ability to achieve the anticipated synergies, and our ability to repay the debt. Our goal remains to achieve a leverage ratio in the 4s within four years.

Now that both we and Bally have reported results, we currently expect to market the remainder of our debt financing within the next two weeks. Finally, we have nearly obtained all of the required gaming regulatory approvals. And as I said, we remain highly confident in closing the transaction this quarter.

We've also identified potential revenue synergy opportunities across our businesses. We have not yet fully quantify these opportunities. But we expect that in areas such as systems, branding, marketing, and product development, we will be able to substantially improve our products and services to enable future further growth.

We have already selected our leadership team. I'm truly fortunate to be able to draw from all of the talented people within Scientific Games, WMS, Bally and SHFL. I believe we will have the best team in our industry. After all, great companies are made up of great people.

Now let me turn the call over to Scott.

Thanks, Gavin, and good afternoon, everyone. For the third quarter, total revenues increased to $416 million compared to $234 million a year ago, with the increase reflecting about $163 million from the WMS acquisition, and a healthy 9% growth in our lottery business. Attributable EBITDA increased $38 million to $128 million. And on the higher attributable EBITDA, we generated $65 million in free cash flow. As a result of the higher free cash flow, our net debt decreased $58 million from June 30, 2014.

The net loss for the third quarter was $70 million, inclusive of a $20 million non-cash impairment charge to write down the value of our minority equity investment in the North Star Illinois joint venture; $6 million for transaction-related costs, primarily associated with the pending acquisition of Bally; and $2 million of employee termination and restructuring expense. We also incurred $21 million of higher interest expense primarily attributable to the funding for the WMS acquisition.

Turning to a review of our three business segments' performance, I will now begin with our gaming segment, which generated revenue of $203 million, an increase of $164 million over the prior year, all of which related to the acquisition of WMS. Service revenues from our WAP and premium participation gaming machines was $58 million, essentially flat with the 2014 second quarter, and with the prior-year result reported by WMS. The results reflect an 8% year-over-year increase in the average revenue per day of our WAP and premium participation units to $71.95.

We continue to benefit from the player appeal and performance of our newest games, such as the 3-reel Mechanical Monopoly Luxury Diamonds game introduced in July, offset by a decline in the average installed base of WAP and premium participation units.

I would note that despite the removal of 92 units, including 66 WAP units related to the closure of four casino properties in Atlantic City during the quarter, we reversed the trend that we have experienced during the last three quarters of a declining footprint.

At September 30, 2014, our installed base was 9,054 units, an increase of 322 gaming machines over the 8,732 installed base at June 30, 2014. At September 30, 2014, our footprint of 3,625 WAP units was essentially flat on both a year-over-year and quarterly sequential basis, and represented approximately 40% of WMS's installed base of WAP and premium participation games.

Our average installed base of other leased and participation units was essentially flat year-over-year, while the ending footprint declined 118 units, reflecting the previously reported loss of the Betfred contract in the UK that was largely offset by the addition of 2,135 WMS leased units. The average daily revenue for these units increased 15% year-over-year based on the addition of the higher-yielding WMS leased units and a slight improvement in the UK.

Services revenue from interactive products and services increased $39 million year-over-year, reflecting the inclusion of WMS. The WMS interactive revenue primarily reflected continued growth in social gaming due to a 78% year-over-year increase in daily active users, partially offset by a 26% decline in average revenue per daily active user.

On a quarterly sequential basis, interactive revenues increased 19%. Daily active users increased 200,000 or 14%, primarily driven by continued strength in our Jackpot Party Social Casino and progress of our second successful social casino app, Gold Fish Social Slots.

The average revenue per daily active user decreased to $0.23 from $0.31 in the prior-year quarter, largely reflecting the broader user base from the expansion across mobile platforms, which tend to monetize at a lower average rate, while increasing slightly from the $0.22 daily rate in the June 2014 quarter.

Product sales revenues was $68 million, of which $64 million was from the sales of WMS products. Global shipments of WMS units declined 26% year-over-year, which, while down, represented an improvement over the last two quarters' results.

While replacement gaming machines to US and Canadian casino operators increased by 262 units or 18% on a year-over-year basis, the improvement was more than offset by 557 fewer units shipped to new casino openings; 325 fewer Illinois VGT units, as the Illinois market matures; and a decline of 445 WMS international units, largely reflecting lower shipments to Latin America including the lower shipments to Argentina due to import restrictions, and a decline in units shipped to Mexican customers reflecting challenges in that market.

Other product sales revenue increased, reflecting higher subscription revenues related to the installed base of Blade video units, higher conversion kit sales, and higher used unit sales.

During the third quarter, the average selling price for WMS's gaming machines was $15,211, down 1% compared with $15,405 in the 2014 second quarter. We incurred $1.5 million of employee termination and restructuring costs in the gaming business, mostly related to headcount reductions. Attributable EBITDA for the gaming segment in the quarter was $67 million.

For our instant products segment, total revenue was $134 million, about flat with the prior year. The 13% growth in revenue from customers with participation contracts, and 5% growth from customers with price per unit contracts, were mostly offset by the decline in licensing and player loyalty revenues. This primarily reflects the timing of certain licensed end promotional games, and a challenging comparison with the prior-year period that included the benefit from the launch of several new promotional and loyalty programs.

The growth in revenues from customers with participation contracts includes the benefit from a 7% increase in US lottery customers' retail sales, and our growth in sales of instant games to our Northstar New Jersey and Hellenic Lotteries joint ventures.

Operating income in the instant products segment increased approximately $1 million over the prior year, primarily reflecting the benefit of higher revenue. Attributable EBITDA for this segment increased about the $2 million or 3% from the prior-year period. The decrease in earnings from equity investments to a $15 million loss primarily reflects the $20 million non-cash impairment charge we recorded to write down our Northstar Illinois equity investment.

Turning to our lottery systems segment, revenue of $79 million was up 27% or approximately $17 million year-over-year, largely reflecting an increase in product sales primarily due to higher sales of low-margin lottery hardware and software to international customers. Service revenue was essentially flat on a year-over-year basis, and down slightly on a quarterly sequential basis, largely reflecting the benefit of two large, above-$300 million Powerball jackpots in the prior-year period.

Operating income decreased $7 million, largely reflecting the unfavorable mix of lower-margin international product sales compared with higher-margin software sales in the prior-year period, along with higher depreciation and amortization related to higher capitalized software costs. Attributable EBITDA decreased $4 million, primarily reflecting the less profitable revenue mix.

Turning to cash flow for the third quarter, net cash provided by operating activities increased $101 million to $126 million, largely benefiting from $82 million favorable change in working capital. For the nine months year-to-date, net cash provided by operating activities was $233 million, up from $96 million in the year-ago period, largely reflecting a $51 million increase in net earnings after adjustments for non-cash items, and an $81 million favorable change in working capital.

Additionally, the distributed earnings and distributions of capital from our equity investees was $68 million in aggregate for the first nine months of 2014, up $20 million from 2013. We invested $43 million in cash in our joint ventures during the nine months of 2014 which principally reflects the previously disclosed capital contribution to ITL during the first six months of 2014 for funding participation gaming machines in the UK.

This does reflect a decline of about $22 million from the prior-year nine-month period, which had included approximately $43 million of our initial investment in the Hellenic Lotteries joint venture. Capital expenditures were $62 million compared to $32 million a year ago, with the increase due to the addition of $37 million of capital expenditures from WMS, partially offset by a decrease in other capital expenditures.

Reflecting the lower-than-anticipated capital expenditures year-to-date, we are lowering our 2014 estimates for CapEx to a range of $245 million to $255 million from the previously estimated range of $260 million to $270 million.

In summary, we believe that the combined company is, and will continue to benefit from the diversity of our revenue streams. And when coupled with the intense focus on integration synergies, free cash flow generation, and ultimately leverage reduction, we believe the foundation is in place for improving operating results in future quarters, particularly as we layer in the benefits from our pending acquisition of Bally.

And with that, let me turn the call back to Gavin.

Thank you, Scott. Before opening the call to your questions, I want to reiterate our key strategies: to develop great creative content that can be leveraged across our multiple distribution channels to help our gaming and lottery customers engage their players and increase the revenues. We will seek to constantly refine our business processes, with the goal of improving our operations to better utilize working capital, increase operating margins, and generate more cash flow.

We plan to leverage our increased scale and size, following the pending Bally merger, to deliver positive revenue synergies and grow our business. We will maintain tight management on expenses and focus on delivering the targeted cost synergies and asserting strict discipline in the deployment of capital. And as stated previously, will drive free cash flow to pay down our debt. This, as we've previously noted, is a key priority of the senior management team and our Board of Directors.

Finally, and nearer-term, let me remind you that with the launch of MONOPOLY MILLIONAIRES' CLUB and our anticipated closing of the Bally merger, the fourth quarter will be an exciting quarter.

Sheila, we will now take the first question.

(Operator Instructions). Cameron McKnight, Wells Fargo.

A question for Gavin or Scott. You generated $65 million of free cash flow this quarter. This was a pretty meaningful improvement on free cash flow from last quarter. Should we think of this as a baseline going forward, or are things still bouncing around quarter to quarter?

I think things are still bouncing around a little bit on a quarterly basis. We do have additional synergies that we are expecting both in the December quarter and next year, even without the impact of the Bally transaction, that would presumably help grow the amount of free cash flow.

Right. Okay, thanks. And then just on replacement unit sales -- replacement units were up 18% year-on-year this quarter. So a pretty big increase in the comp versus last quarter. Have there been any one-offs or big orders that flow through either quarter? And can you just comment generally on what drove the year-on-year increase in replacement sales this quarter?

I think there's two things, Cameron. First of all, there were no extraordinary orders. And I think I told you, when I started last quarter, that I was very delighted to see that innovation was alive and well at WMS, and that I felt we hadn't been doing a good job of selling the product. I think that the new team sort of started to shift into gear towards the midway part of the third quarter, and I think that everyone is enthused by it. That's number one.

And number two, I think our product is getting better. Last Friday, I spent the day in Southern California. And the feedback from the customers was that our Blade video is continuing to improve performance. And, furthermore, the 3-reel mechanical was in this quarter, and it wasn't in last quarter. And that's obviously having a big impact. So it's product and people.

Right, okay. Thanks very much. And then just one final question, if I may. It would be helpful for equity investors if you were able to map out the remaining steps in financing the Bally acquisition.

Sorry, explain that? I missed the first part of that question.

It would just would be helpful for equity investors if you were able to lay out the final steps that you guys need to take in the financing of the Bally acquisition.

I think as Gavin said in his speech, we're expecting to launch the notes offering within the next two weeks, which is the final piece of the financing that we need to put in place. We have sort of accelerated the filing time for both our 10-Qs. Bally also did the same. And now that all that information is out, we're better positioned to go to the marketplace.

Okay, perfect. Thanks very much.

Steven Wieczynski, Stifel.

Gavin, I guess first of all, with your synergies now, and bumping that up on the Bally transaction -- can you maybe just help us understand where that $15 million, or the additional of $15 million came from? Is it one bucket, or is it kind of across the board?

Well, I'll get Scott to get more specific. But you're talking about $15 million in the Bally or the (multiple speakers)?

The Bally.

Okay. So the way we did the integration was when we were planning it, we've done some previous work on a prior acquisition. And we looked at all the different areas in which we operated in which there were potential synergies and potential overlaps. And effectively, that breaks up into 19 different groups. And we allocated, based on the numbers we had, amounts to those 19 groups, and we came up with our 220.

As we've gone through that exercise, we found that in some areas we were right, and in some areas we were wrong. But overall where we were right there were some further areas to improve; and, hence, we found that we could stretch ourselves and get that extra 15. So 235 is the number we're going public with and that we feel comfortable with.

The only thing I would add is, I think we've also determined that some of the initiatives we can accomplish on a more accelerated basis. And by doing some of that, it creates the synergies over a longer timeframe.

Okay, got you. And then when we look at your products, WMS -- their ASP was down year-over-year. And if we look actually at the Bally results, Bally actually had a pretty nice upswing in their ASP.

So I guess when you look out for the next 12 months or so, are you pretty comfortable that on the WMS side of things, their ASP will stabilize, and you'd actually be able to start to get a little bit of price back there on that product?

I feel very comfortable. The more integration planning we do, the more the teams start working together. There is very positive feeling amongst the groups as we are working and planning this thing. And I think we feel that the message we are giving our customers, which is that we're going to support all product lines, and that we're going to continue to invest in R&D and provide the best content across all the platforms, is resonating very well.

So I do believe that as long as we continue to develop great games -- and as I pointed out, our leads at G2E were up 40% year-on-year. If we could get a similar clearance rate to last year, that would be awesome. Bally also tell us that they had a very good show. So I feel pretty good about the gaming business in the environment we are in.

I'll maybe just a second that point; I'll speak for Neil here. They have the Wave product --

Oh, the Wave product (multiple speakers).

-- which has just done very well in the marketplace. And it just demonstrates that if you have a high-performing product, you can command a higher price for it.

And the SHFL content. So all the different arms of the business have got strength, so it is very positive.

Okay, great. Thanks, guys.

Mike Malouf, Craig-Hallum Capital Group.

I have a question with regards to the synergies. Can you talk a little bit about where some of these additional synergies are specifically coming from? What's the -- what have you guys uncovered?

Well, I guess I would say that the preponderance of the synergies are in the SG&A area. And we've identified additional, both headcount and non-headcount related synergies, as we've been going through the integration processes. As Gavin said, there is 19 different teams that are working on the different functional areas. And as we've -- as time has gone on here, and we've looked into the detailed cost structures of both the companies, we've been able to identify more there.

In addition, I think on the manufacturing side of things, we've also been able to achieve a bit more than what was anticipated at the time we initially put together the synergy estimates.

When you look out longer-term, how much standardization do you think you'll be able to effect on the machine sort of behind the door? Are those estimates in the numbers? I would imagine it might take longer than one year to do that.

They will. And that's part of the strategy, clearly, is to have one OS running all of these things. That's where you do get a lot of the benefits, and where our customers see huge benefits. To have one OS and to have multiple different hardware opportunities, and all the different flavors of software, gives the customers great flexibility. And that's what's resonating with them. But that is clearly not in year one.

Okay. And then with regards to revenue growth, I know you don't talk about synergies on the revenue side. But as you've been looking at the -- putting these companies together for at least a few months now, are you more open to that opportunity with regards to revenue synergies? Or do think that is still kind of off the table?

No, I think that we definitely expect to achieve some. I mentioned that my talk. But I'm not prepared to quantify them at this stage.

Okay. All right, thanks.

Todd Eilers, Eilers Research.

I wanted to ask, on the gaming ops side, it looks like you had a nice pickup in non-WAP premium units. And I know that the trend over the last year or so has been a mix shift towards more WAP, but this quarter kind of reversed that trend.

How should we think about that going forward? Are we kind of at -- do you expect the mix that we're at this quarter to remain the same? Or should we expect more WAP or more non-WAP going forward?

Todd, I think if you'd look back over probably the last 2 to 3 years of quarters, you'd see that the WAP number has been somewhere in the sort of 35% to 40% range. It sort of fluctuates, depending on the performance of the products that are there.

Obviously, we just showed our customer base all the new things they are going to be able to put on their floor over the next 9 to 12 months before the next G2E. And there was a good concentration of WAP and non-WAP products. I don't think you're going to see a significant movement one way or the other with the WAPs, as an overall percentage of the product. But it's always been about game performance in the business, and obviously we're anxious to get the new products out and approved, and get them on the floor.

Yes, I thought the highlight of our show, from my perspective, was the offerings in that area. We've been a little bit constipated, perhaps, in getting product out to the floor. But, certainly, whatever pills they took, it seemed to have worked. And unlike other companies, we seem to get a lot of credo and credit for products that won't be out for a year or more. We have products coming out every quarter now. And I think we have a very healthy product line, so I feel pretty comfortable with that. International was also a good grower for us.

And then just also if I could just follow up on the installed base question. So it looks in total for the premium games was up -- in the period -- was up 322 sequentially. But it looks like the average was down roughly 300, implying a lot of the installs were late in the quarter.

Should we expect that kind of end-of-period number to carry through into the next quarter? Are there any other kind of moving parts? I know it's tough, but I just wanted to kind of get your sense at this point.

Again, based upon the products set and what we have getting approved in the December quarter, we are hopeful that while we get those two products out there that it will result in some improvement in the overall installed base. And relative to the average base for the quarter, we're certainly starting a higher point than we did at the end of the September quarter; so that certainly helps.

And a lot is in the hands of the customers, obviously.

Okay, perfect. Thanks, guys.

Howard Bryerman, PENN Capital.

I just wanted to follow up on the financing question, just to clarify my own mind the mechanics behind the bridge loan. It's my understanding that based on what you're saying, that the transaction is fully financed. Yet, in two weeks you'll be going out to market, the senior note piece.

The way I understand it -- and I just hope this is correct -- is if we were to stop right now, the banks would turn around, and they would fund the completion of this transaction. However, in two weeks, after the successful completion of a senior note deal, you would no longer need the banks, right? So it's either/or. It's not as if the senior note deal -- that the transaction would be contingent on the senior note deal; it would be either/or.

Perfectly correct.

Okay. Just wanted to make sure I understood that. Thank you.

Thank you for pointing that out.

I would now like to turn the call over to Mr. Isaacs for closing remarks.

Well, thank you all. I have some closing remarks, but I think we'll just end it there, and say thank you for your support. I think the next quarter is going to be incredibly exciting. We, as a group, cannot wait to get this deal closed and get on with running what's going to be -- we hope to be one of the great companies of the future. And we look forward to your support. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.