International Game Technology PLC
Q4 2016 Earnings Call Transcript

Published: 9 Mar 2017

[Operator:]

Good day and welcome to the IGT 2016 Full Year Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to James Hurley, Senior Vice President of Investor Relations. Please go ahead, sir.

[James Hurley:]

Thank you for joining us on IGT’s fourth quarter and full year 2016 conference call. Marco Sala, our CEO, will provide an overview of the year and comment on broader strategic initiatives; then Alberto Fornaro, our Chief Financial Officer, will provide operational and financial perspective on those results. After our prepared remarks, we will open the call for your questions. During today’s call, we will be making some forward-looking statements within the meaning of the 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. And now, I’ll turn the call over to Marco Sala, CEO of IGT.

[Marco Sala:]

Thank you, Jim, and welcome, everyone. 2016 was an important year for IGT. We have enforced our number one position in lottery globally and made good progress on our Gaming turnaround. We also delivered on our financial commitments. Today, we are reporting fourth quarter and full year 2016 results that are in line with our expectations. For the full year, 2% constant currency revenue growth translated into a 3% increase in adjusted EBITDA. Disciplined operational and capital management led to a reduction in net debt, despite the substantial upfront Lotto concession payment we had in the year. When I spoke with you about our objectives for 2016, I focus on five key areas

[Alberto Fornaro:]

Thank you, Marco, and hello to all of you. Our fourth quarter financial results are summarized here on Slide 9. Revenue dropped 2% in constant currency as a strong global lottery service revenue growth was more than offset by lower gaming service revenue mostly at DoubleDown. Adjusted EBITDA was 6% lower, mostly due to the large Italy VAT credit we had in the prior year, as well as higher SG&A costs. Adjusted EPS grew to $0.88 from $0.63 as we had some favorable tax settlement in the fourth quarter of 2016. Let’s now look at our operating divisions beginning with North America Gaming & Interactive on Slide 10. Gaming service revenue was primarily impacted by lower installed base compared to the fourth quarter of 2015, a decline in daily active user was the primary driver at DoubleDown. Product sales increased 20% in the quarter driven by larger system sales at MGM National Harbor and Palms. The contribution of a recent IP settlement, a portion of which is recurring and revenue associated with Gaming machines shipped to MGM National Harbor in the third quarter. We shipped 5,419 Gaming machines compared to 6,597 units in the same period last year, which included an additional 1,100 Canadian VLTs. Casino replacement units rose 5% year-over-year reflecting strong demand for our S3000 and CrystalDual cabinets. Operating income largely reflects lower Gaming service and DoubleDown revenue, partially offset by improved product sales in the quarter. Turning to North America Lottery on Slide 11. Total revenue rose 6%, same-store revenue growth was driven by strong performance in instant ticket for the third consecutive year. Indiana was among the best performing states due to strong holiday sales and the introduction of the popular $10 oversized scratch ticket. Multistate Jackpot performance was modestly below the prior year’s level after many quarters of above average results. The growth in product sales came from increased instant ticket printing revenue particularly in Texas. Operating income was up substantially from the prior year revenue growth, and lower depreciation and amortization associated with several recent lottery contract extensions. Moving to International on Slide 12, revenue declined 15% at constant currency. Broad-based lottery performance drove 2.6% same-store revenue growth, which stands in EMEA and Latin America, once again partially offset by weakness in the UK. On a constant currency basis, gaming service revenue increased 6%. The installed base grew to 10,453 from 9,400 units in the fourth quarter of 2015 on growth in Eastern Europe, South Africa and Mexico. The installed base was up despite approximately 600 units compared to sales in Europe. The decline in product sales is mostly due to lottery product sales, reflecting the natural variability of that business. In Gaming, terminal sales were down or lower unit volume, although Gaming system sales were up double-digit in the quarter. Operating income declined on lower revenues. Our Italy results are on Slide 13. In the fourth quarter we had one-off amortization of the new Lotto concession fee for $8 million, similar to our Scratch & Win contract Lotto fee amortization will be booked against the revenues at a rate of approximately $24 million per quarter. In order to better understand the accounting mechanism of the new Lotto concession we are prepared a dedicated slide that can be found in the appendix of this presentation. The Investor Relations team is happy to walk you through those mechanisms after this call. Lotto wagers rose a remarkable 15% in the fourth quarter, which included significant late number activity. 10eLotto and Numero ORO performance was also strong, growing 8% on top of the 14% growth in the prior year. Excluding the effect on late numbers, Lotto wagers rose 2%. As anticipated the late number activity has moderated since at the January draw of late number 53 of the National Wheel after an extraordinary 257 draws. Scratch & Win wagers were down in the period, something we attribute to increase the player interest in late numbers. Sports Betting wagers grew 6% in the fourth quarter with particular strength in live wagers. Italy fourth quarter operating income was relatively stable in constant currency as a strong Lotto growth compensated for the large VAT credit $14 million in the prior year. On Slide 14, you have a consolidated view of reported revenues and adjusted operating income for the quarter, as I have just described global lottery growth and higher North America Gaming product sales were more than offset by lower gaming service revenue. Adjusted operating income reflected the same adjusted EBITDA dynamics I reviewed earlier. On Slide 15, we have summarized the results for the full year, revenue were up 2% in constant currency, reflecting strong growth in lottery service revenue, that was partly offset by DoubleDown and lower lottery product sales. Adjusted EBITDA of $1.755 billion was in line with our guidance of $1.74 billion to $1.79 billion. CapEx was $557 million for the year, slightly over our most recent guidance due to increased investment in gaming but well below our regional guidance for the year. Approximately 80% of our CapEx we use for lottery maintenance and investment in the Gaming installed base. The remaining 20% was used for growth initiatives. Let’s turn to our debt and leverage profile, which you can see in Slide 16. Net debt at the end of the fourth quarter was $7.6 billion and compares favorably to our outlook $7.7 billion to $7.9 billion. Even if we exclude the FX benefit, a 4.31 times our leverage ratio is at its lower level of the year despite the net $409 million of Italy upfront concession payment we made during the year. As a remainder, a third and final upfront concession payment of €170 million is scheduled for the second quarter of 2017 of which we are responsible for approximately €105 million. Our cash flow is shown here on Slide 17. During the year, we generated close to $1 billion in cash from operations. This is after significant interest and cash tax payment. Working capital was also use of cash during the year, mostly due to higher gaming inventory to support our new games and cabinets. The free cash flow you see here is before the capital contribution from minority partners to the Lotto concession. Adjusted for that, our free cash flow was modestly positive in a year, where we had high CapEx. On Slide 18, we have our outlook for 2017. We currently expect adjusted EBITDA of $1.680 billion to $1.760 billion for the full-year period. We are using an average euro/dollar exchange rate of $1.10 for all the guidance we are providing today. As a reminder, every $0.01 change in the euro dollar rate has a $9 million impact on adjusted EBITDA and $35 million impact on net debt. Implicit in our full year outlook is an expectation of solid underlying profit expansion particularly in the North American Gaming & Interactive and International segment. This growth essentially compensate for approximately $65 million in lottery benefits we had with Powerball and late numbers in 2016. It also offsets approximately $35 million of headwinds in 2017, primarily from impact associated with the new Lotto concession. We expect 2017 to evolve as a tale of two halves with difficult year-to-year profit comparison in the first half transitioning to grow the back half. There are some discrete reasons for this

[Operator:]

Certainly. [Operator Instructions] We will now take the first question from Barry Jonas from BoA. Please go ahead.

[Barry Jonas:]

Hi, guys. Just a couple of quick questions. So for gaming in North America, I completely understand the new products coming out in the second half and maybe some higher expectations for that. But, I guess, just generally speaking, as you talk to your customer base, what are your thoughts about the replacement cycle this year in general?

[Marco Sala:]

Hi, Barry. It’s Marco. We as always, we see that the performance for our customers are doing better. We do not know how much they will translate into additional investment in our slot machines, in the slot machines not in our - in the market. Therefore, as we did last year we are planning a relative stable replacement rate, while we should expect lower contribution coming from the new openings.

[Barry Jonas:]

Great. And then, just a question on Italy. Can you give us maybe a regulatory update in terms of your expectations for any new taxes this year as well as the timing for the new sportsbook licenses?

[Marco Sala:]

Look, regarding taxation, it’s totally unpredictable. There is now the Italian government that is looking at the maneuver for raising additional money for being compliant with the European Union request, but apparently, they are not touching gaming. But you never know till the very end, this is reality. And we will see the discussion that will be done in fall, when they will approach the budget law. For the time being, unfortunately, I do not have any hints to share with you.

[Barry Jonas:]

Okay. Great. And then, just lastly on Scratch & Win, I mean, clearly you guys are investing in the instant tickets business. Do you think that when the Italian Scratch & Win contract comes up for renewal, would you expect to have a much bigger contribution in terms of the JV economics or else in terms of providing tickets to the joint venture in terms of your overall penetration?

[Marco Sala:]

And I understand the question, but it’s too early to reply to this question, this discussion that will be raised later on.

[Barry Jonas:]

Got it, okay. Thank you very much.

[Marco Sala:]

Thank you, Barry.

[Operator:]

Thank you. We will now take the next question from Chad Beynon from Macquarie. Please go ahead.

[John Cardoso:]

Hi, guys. This is actually John for Chad. You mentioned earlier in the call you’ve had some nice system wins in the last few years. Can you help us think about the backlog for this business? And generally, what customers like for your product these days?

[James Hurley:]

Sorry, John, you dropped out, which business are you referring to?

[John Cardoso:]

Sorry, the systems business.

[Alberto Fornaro:]

This is Alberto here, Chad. But the performance of the system business, particularly in this quarter has been particularly positive for us, because we had National Harbor obviously and we had another delivery at Palms in North America. Also, we had good activity in the international regions with Genting in Malaysia and another installation in South America. So overall, it has been - and Marco was in his remarks also remembering what has happened during the year. So the business is going with Station for example. So the system business has been quite positive in 2016 and for the future. Marco?

[Marco Sala:]

No, but I think - as we said since the very beginning, the system would have been an area of focus of our company. And we are seeing the PlaySpot application. We are seeing the Cardless Connect, that are getting traction in our customers and we are extensively discussion - sorry, extensively discussing with many of them in order to implement these add-on on their system. So we are positive about our ability to develop that segment over the next years.

[John Cardoso:]

Great. That’s good color. And then, switching gears a bit, some of the other social gaming companies have the strategy of having multiple brands, so that there’s less of a ceiling. Do you guys consider this approach? Can you help us think about that outlook?

[Alberto Fornaro:]

That’s - it’s exactly what we are seeing in the market and we are working as one of the main pillar we have in our set of actions to revert the trend in DoubleDown. And as anticipated that we are going to launch at the end of the second quarter, a new app totally dedicated to our stepper contents and we rely on it as part to allow our strategy to revert the trend in DoubleDown.

[John Cardoso:]

Great. That’s very helpful. That’s it for me guys. Thanks for taking my questions.

[Operator:]

Thank you. [Operator Instructions] We will now take the next question from David Farber from Credit Suisse. Please go ahead.

[David Farber:]

Good morning, guys. How are you?

[Marco Sala:]

Hi, David. We are good. What about you?

[David Farber:]

We are great. I had two quick questions. The first was just there were some local articles, the Circuit Court in Florida perhaps better lottery contract that was made invalid, we had a number of guys that asked us, and I would be curious to hear your thoughts you may teams timely. What do you think is going to happen with respect to Florida? What you think cash flows will be, if there’s timing, just how do you guys think about some of the local news coming out of Florida with respect to the contract there and a follow-up. Thanks.

[Marco Sala:]

I think the answer would be shorter than the question, because it’s very intense political situation in Florida, and until the method is resolved, our previous contract in Florida, we remain in place, while the new one gets sorted out. It is important to keep in mind that we competed than one, the new lottery contract in an open and well organized process. Further proceeds from lottery - from Florida lottery which amounted to $1 billion fund the education system in Florida the critical need, so in essence. We are monitoring the situation as it develops, but we feel we are in good shape, because we have the current contract and we won a regular contract.

[Alberto Fornaro:]

And David, let me add one thing that was in your question regarding the CapEx, as I mentioned, it is included in this year obviously if there is a delay. This is going to be the third year in a row that we include in the guidance and then it’s moved forward.

[David Farber:]

Okay. Thank you. And then maybe just a little bit more color on DoubleDown, maybe if you can just talk a little bit more about what’s driving some of the weakness there, and then somewhat related does it recent performance make you consider M&A perhaps like some of the other operators that are in the interactive space? That’s it for me. Thanks.

[Marco Sala:]

Look, one of the reason why DoubleDown is suffering is an increased competition - and increased competition it has been very often driven by new applications. And so the first answer regard to our willingness to launch our own application relying on one of the strongest segments of our gaming portfolio. In addition to that, we are investing to upgrade our platform and improving our offering on Android devices. We were lagging behind accordingly to our technologies, and we have invested in order to reduce the gap. We are supporting our loyalty program, which has been gaining traction after being launched and we will continue to promote it, and in addition to that we intend to improve and expand our content as always. Recent Gamings introduction we recently introduced a new LN [ph] title, Lucky Larry’s Lobstermania 2 have been successful and improving the player engagement and retention. So we are working on these areas, and we are getting more and more confident that these actions will result in a return to growth. Talking about the M&A activities, as you can imagine, there is a lot of activity the interest in the social casino space. As you would expect all major players are engaged. DoubleDown is a valuable asset, and we regularly receive the interest from potential buyers. This market because the social casino market is attractive and a natural complement to our activities. So what I can say is that we believe we have the right strategies to grow DoubleDown organically as part of IGT.

[David Farber:]

Helpful. Thanks. That’s it for me.

[Operator:]

Thank you. We will now take the next question from David Katz from Telsey Group. Please go ahead.

[David Katz:]

Hi, good morning.

[Marco Sala:]

Hi, David.

[David Katz:]

So with respect to DoubleDown, and I apologize because we’re all piling on DoubleDown. However, when we look at that business and we see what - and I know other questions have asked about additional brands and apps, et cetera. But weaving that into the systems business that you have, and using it in a different way rather than in a B2C way, but rather in a B2B way, and using it the way one of your competitors is integrating it along with its enterprise system business. Is that or other similar strategy is something that you are or would like to consider?

[Alberto Fornaro:]

David, I would say that our focus for DoubleDown right now is on the B2C side, because it’s a valuable business. There has been some and then these business changes happen quickly. So for example, on the multi-app, so we have devised a strategy that is still B2C focused in order to recover what we have lost in the second half of this year. Marco has told you about the games and told you about the multi-apps, but we have recently launched, for example, a customer loyalty program there and most importantly, at the end of the second quarter of the sector. So this is what we are focused on and this is the B2C side.

[David Katz:]

Got it. And one more question if I may. If you could update us, Alberto, just looking through the balance sheet, and if there may be any opportunities forthcoming to refinance or lower your interest costs in any areas as we have seen some others with much higher cost of capital take advantage of? Are there any of those opportunities for you in the near term?

[Alberto Fornaro:]

We have, first of all, a maturity of the bonds in 2018 in February, that is a legacy GTECH bond for €500 million that is very close. At the moment, we have the credit facility that has ample liquidity which it’s obviously for us a sort of insurance in case the capital market have problems. But right now, the liquidity is good and so on. So we will evaluate during the year what is the best way to go to refinance our debt. Taking also into consideration, what is going to happen during the year in terms of growth opportunity. Marco has mentioned some extension. So I think that in the remaining part of the year definitely we will decide what is the right way to deal with this maturity that we have in 2018.

[David Katz:]

And one last one if I may, in terms of new slot product, either in there for sale or recurring revenue business, are you getting any results that you can share from the testing phase of any of your new products or any updates on products that we should expect to start rolling out that you mentioned later in the year?

[Alberto Fornaro:]

I think I can provide you on some titles for sales. We developed some titles that went out quite well from the tests and are already performing also on the floor. I’m talking about Golden Egypt, Ocean Magic, Big 5 Safari and that’s just to give you some examples. And we are positive on it, because we are realizing that the customers are relying on the performance of those games much more than they did with the launches in the past, with new launches in the past, because they see the performance of the games in the field. And so we are rather positive on it. And then you appreciated that in the second half of the year when it comes to the installed base, we were relying very much on Wheel of Fortune 3D. And as a matter of fact, it performed quite well and was one of the drivers of the performance we had on our installed base in the fourth quarter. So we expect that also the new cabinets and the new cabinets and the new contents that will come in during the year will contribute to our performance in installed base as well.

[David Katz:]

Got it. Thank you very much. Thanks for taking my questions.

[Operator:]

Thank you. [Operator Instructions] We will now take the next question from Domenico Ghilotti from Equita. Please go ahead.

[Domenico Ghilotti:]

Good afternoon. A few questions, the first is a follow-up on DoubleDown. In the previous calls you mentioned that one of the potential drivers could have been also the expansion to new market. Is it something that you are still considering or do you want to focus, first of all, on the - so the turnaround in the domestic market? Then on your guidance for 2017, you have been providing some color on the main drivers. Can you maybe elaborate a little bit more for example in terms of underlying trends in the North America, International, Italian lotteries, what do you see the evolution net of the tough comps, so net of the one-off late number and Powerball and Mega Jackpot?

[Marco Sala:]

Okay. For the first question, Domenico, regarding the first question, we delayed in International expansion. We are much more focused on the actions I have just described in order to turnaround business mainly - in the geographies where we are currently present and we are very much focused on North America. Regarding the guidance, reality is that our guidance for 2017 are assuming a solid EBITDA growth for our underlying business, because as you can recall, we benefit from the record Powerball in 2016, Jackpot in the first quarter and we also as you were remembering at a strong late number in Italy beginning in quarter two. And these in total are benefits that we estimated, as Alberto said, in about $65 million that we have and you have to take into consideration when you look at the starting point for our 2017 forecast. You also need to appreciate that we are anticipating approximately $35 million of headwinds in 2017 that are related today new Lotto performance - sorry, concession. So I think you can appreciate the growth of the underlying business implied in our guidance. Now, where this growth is coming? Lottery is expected to continue to grow between 3% and 5% as we are always planning net of all the comparison with the previous year - the benefits, let me put it this way, we enjoyed in the previous years. But the most part of the growth will come from the Gaming business. That is where we are expecting to grow, because we can build on the stability we achieved in 2016 and build the programs, so we were discussing it about, are the main growth driver we expect to achieve the guidance and we have just described.

[Domenico Ghilotti:]

Okay. So should we expect that can - in terms of installed base, we will start to see really an increase in the installed base in your North American Gaming business?

[Marco Sala:]

We can say that we expect overall considering the North America and International part of the business a growth in the overall installed base, yes.

[Domenico Ghilotti:]

Okay. And last question, so just the additional clarification on the trends. How do you see the Italian market, still as a stable market net of the, say, the late numbers or more struggling or maybe slightly more positive? How do you see the consumption trend?

[Marco Sala:]

Now, look, I’m talking with everybody, I’m always saying that Italian market is almost a stable market then. I’m always - sometimes I’m surprised by our performance, because last year we grew in all categories of the Italian market, but if I look Italy overall and I look at Italian market I see it as a stable market where you can have some innovation that works very well, as it happened with the Lotto in the last couple of years. But the market overall, if I look at the per capita consumption, if I look at the weight of this sector on the Italian GDP, I think it’s one of the most developed market in the Europe.

[Domenico Ghilotti:]

Okay. Thank you.

[Operator:]

Thank you. We will now take the next question from John DeCree from Union Gaming. Please go ahead.

[John DeCree:]

Hey, everyone. Thank you.

[Marco Sala:]

Hi, John.

[John DeCree:]

Marco, I think you just covered most of my questions about the EBITDA guidance for the year. But did want to ask, thinking about - you guys did a good job of kind of telling us some of the headwinds in the year. When we think about something like Greece coming online in OPAP, wanted to get your thoughts on that timing, and then if there is anything else kind of new businesses that you expect to kind of come online whether on the lottery side or the gaming side as the year progresses, as we kind of think about the cadence of guidance throughout the year.

[Marco Sala:]

I think that talking about Greece, we started the deployment of our machines, you know that we deployed first of all the simpler [ph] system for the entire operation and we started deploying the machines. So we do not expect, I would say, any surprise, but I mean I do not expect anything that should slowdown the deployment of the machines in Greece. And I’m not sure that I got the rest of the question to be honest with you. What you were referring to?

[John DeCree:]

Are there other potential contracts or major shipments in any jurisdiction that might be coming online later this year?

[Marco Sala:]

There is Colombia that is something we are looking carefully. They are discussing on a VLT program in that country and that would be a good opportunity to have, because it will be a program that accordingly to what we understand could be similar to the Italian program. And therefore, that would represent an opportunity as long as it will materialize.

[John DeCree:]

And one follow-up if I could, maybe, Alberto, for you, when we think about CapEx, some of the timing is a little bit hard to pan especially with Florida and so on, but is there any color you can give us on kind of the cadence of CapEx spend if it’s heavily weighted to the back-half or the front-half, even any color you could give us there?

[Alberto Fornaro:]

No, it should be - the CapEx is basically the results of the several wins that we had very recently. Now, as it happens for Florida there could be delays. So usually, what we do is we stick to the contract when we give you the guidance. And then, normally, there are some delays and therefore we have changed the CapEx guidance often during the year. We changed the CapEx guidance often during the year, I was saying because we quantify the delays and therefore we’ll give you an update. And therefore, respect to the - depending on the development of Florida we will give you an update regarding that. Let me however remind you that there is an important - in terms of CapEx, outside the normal maintenance there is an important maturity that is the Lotto in the second quarter as I mentioned in my speech, where we will have a large planned investment for the remaining upfront fee and during the entire year for the deployment of the new technology.

[John DeCree:]

Okay. Thanks for all the color, everyone.

[Alberto Fornaro:]

Thank you.

[Operator:]

Thank you. As there are no further questions in the queue, I would now like to turn the call back to Mr. Marco Sala, CEO for any additional or closing remarks.

[Marco Sala:]

Thank you all for your questions and for your interest in IGT. We achieved a lot in 2016. I’m very grateful to everyone throughout the organization for their hard work and contribution to our accomplishments. There is much more for us to do. But I’m confident that we are pursuing the right strategy, that we are developing the right products and solutions, and that we have the right teams around the world to meet our objective. With that, I wish you all a good day.

[Operator:]

That will conclude today’s conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.