Scientific Games Corporation
Q1 2016 Earnings Call Transcript

Published: 28 Apr 2017

[Operator:]

Good day everyone and welcome to the Scientific Games First Quarter 2017 Investor Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, that today's event is being recorded. At this time, I would like to turn the conference call over to Bill Pfund, Head of Investor Relations. Sir, please go ahead.

[Bill Pfund:]

Thank you, Jamie. Good afternoon, everyone. During today's call, we will discuss our 2017 first quarter results and operating performance, followed by a question and answer period. With me this afternoon are Kevin Sheehan, Chief Executive Officer; KJ Tjon, Chief Operating Officer and Mike Quartieri, Chief Financial Officer. Our call today will contain statements that include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks and uncertainties that could cause actual results to differ materially from those discussed during the call. For information regarding these risks and uncertainties, please refer to our earnings 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 filed on March 3, 2017, as well as subsequent reports filed with the SEC. We will also discuss certain non-GAAP financial measures this afternoon. A description of each non-GAAP financial measure and a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure can be found in our earnings press release, as well as on our website. As a reminder, this conference call is being recorded and a replay of this webcast and the accompanying materials will be archived in the Investors section at scientificgames.com. Now let me turn the call over to Kevin.

[Kevin Sheehan:]

Thanks, Bill. And good afternoon, everyone and thanks for joining us. Our first quarter results mark the sixth consecutive quarter of year-over-year increases in both revenue and attributable EBITDA. Revenue grew 6% to $725 million. On a constantan currency basis revenue would have been up nearly 8%. Our attributable EBITDA increased 11% to $287 million, reflecting the higher revenue and 160 basis points improvement in our margin. Our margin benefited from the actions we took in the fourth quarter to streamline our organizational structure. This is a great start to the year, all three of our operating business segment contributed to the revenue and earnings growth. Our success is rooted in the efforts of entire team pulling together and I'd like to give my complements to all of our Scientific Game employees around the globe. I believe we are starting to see some real momentum across our businesses. In our gaming business, sales of gaming machines provided a strong boost to our results. Global unit shipments were up 24% over the prior year, table products also turned in an exceptional performance. Revenue was up 16%, reflecting both solid organic growth in lease revenue from our shufflers, proprietary table games and other table products coupled with the addition of the DEQ acquisition. DEQ's products are a smart complementary tuck-in to our existing table games business. The acquisition was completed on January 18th with cash from our operating cash flow and was quickly integrated. Our lottery business generated revenue and attributable EBITDA growth despite having a tough comparison with last year due to the incremental sales associated with the $1.6 billion Powerball Jackpot. Our instant games business experienced a revenue gain of nearly 5% in the first quarter, driven by our ongoing efforts to help lotteries grow their market and an increase in license game products. And finally but certainly not in the least, our interactive division continues to shine, its results were driven by strong growth in our social gaming B2C business, our strategy of leveraging our existing library of game content and intellectual property continues to deliver rapid top-line growth. Revenue growth exceeded the industry average on a year-over-year basis and reflects both share gains and market expansion in a healthy growing industry. Complementing the strong organic growth of the Social Casino business on April 7 we completed the acquisition of Spicerack Media, the [indiscernible] of Spicerack develop what has become the number four social bingo app the popular Bingo Showdown mobile game. The addition of a social bingo app is highly complementary to our existing game portfolio. Bingo games have an attractive player profile and financial characteristics and the acquisition will be immediately accretive to our earnings. Joining us today for her first call is KJ our Chief Operating Officer. KJ will you please review the performance of the gaming and lottery segments.

[Karin-Joyce Tjon:]

Thanks, Kevin, good afternoon, everyone. Our gaming business generated an $18 million increase in revenue over the prior year despite a $5 million of unfavorable foreign exchange impact. Segment AEBITDA also increased by $18 million primarily due to the impact from higher revenue coupled with lower SG&A expense that resulted from the organizational streamlining in the fourth quarter. The A EBITDA margin of 47.7% was a 240 basis points improvement over the prior year. As Kevin mentioned, a key element of the revenue growth in gaming was a 24% increase in global unit shipments of gaming machines. During the first quarter, we shipped 8,359 new gaming machines globally compared with 6,748 units in the prior year. In the U.S. and Canada we shipped 5,862 units including 3,139 replacement units, 250 VLTs Oregon, 861 CGTs to Illinois and 1,862 units for new casino openings and expansions. The demand from new casino openings included shipments for the Ilani Tribo Casino in Washington where we received a 57% share of the shop floor including participation units. In addition, we shipped units to the New Kansas Crossing Casino and some other casino expansions. The higher shipments reflected strong sales of both the pro waves cabinet and the expanded TwinStar family of gaming machines. Reflecting a favorable mix our average sales price rose to $17,015 from $16,719 a year ago. In gaming operations, revenue was down 7% year-over-year and flat on a quarterly sequential basis. On a quarterly sequential basis, our footprint of WAP and premium units declined 322 units, but that impact was offset by a 3% increase in the average daily revenue of $1.73 per unit. The increase in the daily revenue was largely due to the continued installation of high performing Gamescape unit in our footprint coupled up with the seasonal improvement. The success of our Gamescape cabinet featuring the Willy Wonka, world of Wonka content continue to generate exceptional player engagement in its initial installation. We will follow the success of Willy Wonka with the highly anticipated launch of THE SIMPSONS game near the end of the second quarter. Additionally, the development of the new fully digitized game table remains on track and we expect to launch this innovative product in the second half of the year. The footprint of other participation and leased units was essentially flat on a quarterly sequential basis. An increase from the installation of VLTs in Greece was offset by the removal of some lower performing units in other markets. In Greece, based on the expected rollout plan communicated by OPAP we expect to have our full complement of 5,000 units installed by mid-year 2018, with a majority of the units installed by year end 2017. Gaming systems revenue of $62 million was up from $60 million in the prior year quarter, reflecting slightly higher hardware sales. We have begun to see increased traction on our new innovative iVIEW4 display, which provides a dramatic revolution in player engagement for our systems customers. As Kevin noted table products revenue rose 16% year-over-year primarily due to an increase in the leased revenue from shufflers, proprietary table games, and other table products. The total installed base of proprietary table games progresses and shufflers continue to expand year-over-year on a quarter sequential basis, reflecting both organic growth from the introduction of our new products such as the Shuffle Star continue shuffler along with the benefit of the DEQ acquisition. Turning to Lottery. Our revenue increased $1 million inclusive of an unfavorable $2 million foreign currency translation. First quarter lottery results had a tough comparison to the prior year, where in the first quarter of 2016 it included about $5 million of incremental benefit from the $1.6 billion Powerball jackpot. Lottery segment AEBITDA increased $4 million or 5% compared to the prior year quarter, largely due to the impact of the higher revenue, lower SG&A expense, resulting from lower payroll and associated cost and a slight increase in EBITDA from our joint ventures. Looking a bit closer to revenue. Instant games revenue increased $6 million or nearly 5% over the prior year, primarily reflecting an increase in revenue from sales of license games along with the higher revenue from price per unit contracts, reflecting the timing of new game launches. Year-over-year services revenue decreased primarily reflecting the tough comparison with last year's first quarter results, which had benefited from the large Powerball jackpot. The addition of the Arizona Systems contract essentially offset the impact from the expiration of the Indiana Terminal Services Transition Agreement. Now let me turn the call over to Mike.

[Mike Quartieri:]

Thanks, KJ. Good afternoon, everyone. Continuing on from gaming and lottery, our interactive segment had another great quarter, revenue was up 33% year-over-year to $96 million and our growth once again exceeded the industry norm on a year-over-year basis. As a result of the strong revenue growth operating income increased $6 million and AEBITDA rose nearly $8 million or 49% compared to the prior year period. The AEBITDA margin increased to 23.9%. While the margin improved it's important to recognize that our interactive business is at an early stage of development and growth. Our original social casino apps, Jackpot Party and Gold Fish continue to provide double-digit growth and we have expanded our offering with the addition of new casino apps. Leveraging our extensive library of gaming IP and game content, each of these new apps provides differentiation and therefore creates the opportunity to appeal to a broader market and grow our paying customer base. The marketing support to create awareness, the player acquisition cost to build the player base and the prelaunched development investment are the primary drivers behind the increase in SG&A expense in the period. Our interactive B2B business, which includes our game content for real money gaming and our SG Universe social solutions also increased in the quarter. Revenue grew 30% over the prior year period despite the unfavorable impact of about $1 million of foreign currency exchange. At the corporate level, operating expense increased as the benefit from lower payroll cost was offset by higher legal costs. Now turning to cash flow and the balance sheet. Operating cash flow increased $10 million to $111 million, which included $13 million of cash payments related to the business improvement initiatives we implemented in the fourth quarter. Changes in working capital contributed $7 million to cash flow compared to $19 million in the prior year period. Free cash flow was essentially flat year-over-year as the $10 million increase in operating cash flow was largely offset by $10 million in capital expenditures. Midway through the first quarter, we completed a very successful refinancing. Since we've previously discussed this, I won't rehash it in detail. In summary, as a result of the refinancing transactions, we lowered our cash interest, reduced our exposure to variable interest rates, extended our maturities and paid off the $45 million outstanding balance on the revolving credit facility. Given the refinancing occurred midway through the quarter, our interest expense for the period reflected about half of the benefit. We recorded a $29.7 million charge for the extinguishment and modification of debt related to the refinancing transactions. During the quarter, we also completed the $21.5 million acquisition of DEQ, which was funded from operating cash flow. And we incurred about $3 million of acquisition related expense included in restructuring and other which was an add back to AEBITDA. Cash and cash equivalents increased by $17 million during the first quarter. In early April we used available cash on hand to fund the acquisition of Spicerack Media into our interactive business, which is immediately accretive to our earnings and operating cash flow. Going forward, our primary goal remains to create operating improvements and opportunities that will enable us to further reduce leverage. And now I'd like to open up the call for questions, operator?

[Operator:]

Ladies and gentlemen at this time we'll open the floor to questions. [Operator Instructions]. And our first question today comes from Barry Jonas from Bank of America. Please go ahead with your question.

[Barry Jonas:]

Hi guys, just a couple from me. Kevin, is there still room to cut cost out of the business or is your focus not really more on driving the top-line?

[Kevin Sheehan:]

I think we have to be measured, but there is still a solid opportunity as we get through quarter-by-quarter. This is something that I think is going to be not big amounts in any particular point in time, but just operational excellence and scale benefits as we get moving. So it should be accretive benefits every quarter.

[Barry Jonas:]

Great. And then you guys have been exploring ways to monetize your interactive business since I think September. Just wondering where you are in that process, and maybe some general thoughts about the double down sale?

[Kevin Sheehan:]

Yes I'm not sure we're actually -- we're not looking to do anything aggressively at all. We have a great business that's growing phenomenally well. We've got the best in class management team, we've got very creative development people in that business. And we see a long runway of growth. However, just when you talk about the double down and another great competitor. And when you look at the multiple that that business was able to achieve. And you look at the trajectory of what we are accomplishing I think that bodes well for us and I'll leave it at that.

[Barry Jonas:]

Great, and if I could just ask one last one. I think game apps was maybe one part of the report where we saw a little bit of contraction. Just curious where we are in the cycle there and if you think stabilization is near?

[Kevin Sheehan:]

Yes, I think I am little disappoint to be honest with the performance in the first quarter and we have in our hands kind of approach on that right now. And we believe that the Gamescape success and making sure of our sales team understands the power of what it's been accomplishing, where it's been launched. Is a great story to tell to everyone that hasn't brought the games yet and we feel that we have got an improving trend as we go through the remaining quarters of the year.

[Barry Jonas:]

Great, thanks so much.

[Kevin Sheehan:]

You welcome.

[Operator:]

Our next question comes from Steven Wieczynski from Stifel. Please go ahead with your question.

[Steven Wieczynski:]

Hey, good afternoon guys. So I guess first on the slot side of things. Obviously you had a really strong quarter for the for sale products and you obviously benefited from some new properties, but as we look at the replacement, the replacements were essentially they are up slightly just pretty much flattish. And I guess the question is, what are you hearing from your customers in terms of replacement spending as given how we are seeing some upticks here in some of these regional markets. Are any of your customers are thinking about getting a little bit more aggressive on the replacement side of things?

[Kevin Sheehan:]

I think it's a little early to say that we are seeing that, but just start to sense a feeling that with the seizure situation starting to move into the past and the reinvestment cycle starting to be more obvious and the economic situation starting to modestly improve that we're cautiously optimistic that things will be a little bit better than the neutral that you are referring to, but let's wait and see.

[Steven Wieczynski:]

Okay, got you. And then going to the interactive side of things, I know a couple of your competitors out there said acquisition cost have started to pick up a little bit in a space. Is that something that you guys are seeing are you being pretty rationale in terms of what you willing to spend?

[Kevin Sheehan:]

I think if you look at the results, it speaks for itself and I would say that this is the thing why I said we have a management team that I believe is really, really top notch and we are paying for leads that are -- that have a return on them. So I think our guys are very disciplined. So I don't see any change in that trend.

[Steven Wieczynski:]

Okay, got you. And the one quick question, not sure if you will answer this or not. But obviously your stock is in a very positive more here in the last six months or so and I guess with your leverage still being pretty high at this point. Is there any thought in terms of potentially using equity to drive down leverage at some point?

[Kevin Sheehan:]

No I think we feel very confident, our management team here feel some power to drive the business forward and have no interest in doing that at this point. Not to say that things don't change but right now we feel very confident with our position and where we are going. And would rather see us ourselves delever, the old fashion way.

[Steven Wieczynski:]

Okay, great. Thanks Kevin, appreciate it.

[Operator:]

Our next question comes from David Katz from Telsey Advisor Group. Please go ahead with your question.

[David Katz:]

Hi, afternoon. And I wanted to follow-up on the social rather interactive aspect of the business. Can you talk a little bit clearly you have a long runway within I believe is what your comment was. Can you talk about the dual aspects of that on the one side being a B2B and the other being B2C and how you see those evolving when you indicate you had a long runway for them?

[Kevin Sheehan:]

Yeah I think each one is -- you're exactly right it's a little bit of a different story. On the B2C we have got -- one of the things when I came in was we don't know where we are going with the business let's always be thoughtful about the alternatives whether somebody comes along and wants to offer some fortune which we are not interested in right now or we go and say, hey, you got the track for the future for an IPO. So we always want to be looking at that growth rate and the way we see the business today we have a phenomenal opportunities going forward and at these outsized growth rates we want to keep running as fast as we can on that business. And on the B2B you saw the growth there as well and I think we have a compelling preposition and as the operators continue to watch what we are able to accomplish I think that growth continues as well.

[David Katz:]

Are there any sort of data points or anecdotal support from customers on that B2B side in terms of what they are looking for or what they aspire too that you as the sort of leader on the enterprise system side can engage with? If you could pull a little more meat on that skeleton?

[Kevin Sheehan:]

Yes, I think it's the fact that the Scientific Games and our powerful brands have very strong content and making sure we're thoughtful to provide a solution to our customers to enhance their repertoire for their customers is very important to us as well. So I think we're just going to continue to do what we've been doing without getting into the recipe.

[David Katz:]

Very good. And if I can just ask one more detail, is there any sort of update on your CapEx expectations for this year and any qualitative thoughts you can give me around '18 would be helpful as well? And that's it from me.

[Mike Quartieri:]

Sure, it's Mike Quartieri. No, in the press release we reaffirmed our original guidance between $280 million to $310 million. And I think that would a consistent expectation. I think every year going out unless there is a major system project on the lottery side that we would need to fund.

[David Katz:]

Got it, thank you very much.

[Mike Quartieri:]

You're welcome.

[Operator:]

Our next question comes from Mike Malouf from Craig-Hallum Capital. Please go ahead with your question.

[Mike Malouf:]

Hi, thanks for taking my questions. Hate to keep harping on interactive, but when you take a look at the EBITDA multiples I mean the EBITDA percentage that you have this quarter obviously up from last year. I'm just wondering if you can give us a sense of since in this growth phase currently, what is the potential for EBITDA margins in interactive, is it as profitable as the other parts of the business?

[Kevin Sheehan:]

I think we have -- we can't talk about forward-looking stuff, but I would say that Mike's commentary earlier on is really if you think about it as we become bigger and we have more games launched, the marketing associated with the new games becomes a lesser factor as you think about it in '18 and '19 et cetera. So, with that I think we are all confident that the margins will continue to grow. If we were to stop investing in the future, we have much higher margins, but that would be with the secret formula we have right now that wouldn't make any sense. So we're going to build that business very carefully and grow the margins, but also be thoughtful about making sure we've got the next big thing coming down the path.

[Mike Malouf:]

Okay, great. And any plans in the near future or even perhaps in the next 12 months for further refinances with regards to the debt?

[Mike Quartieri:]

No, I think we're just going to continue to watch the markets and take advantage of any opportunities that present themselves.

[Mike Malouf:]

Okay, great. Thanks.

[Kevin Sheehan:]

Of course we will. We're going to be smart about it of course.

[Operator:]

Our next question comes from Joe Staph [ph] from Susquehanna. Please go ahead with your question.

[Unidentified Analyst:]

Thanks very much. I was wondering if you can I guess expand your thoughts as you think about machine sales segment you had an extra ordinary growth in first quarter I know a lot of that kind of extra ordinary growth was from the Ilani. And I guess how do you think about this business going forward? And your story obviously has a number of moving pieces. So I wanted to see if you're comfortable to the extent you can help us bracket ship share I guess if you look at your stock and you look at your operational turnaround past year or so, you have been able to stabilized that declining ship share and I guess as of the end of the year it was kind of maybe 27%, 28%. The first quarter I guess in theory would go up given the outstanding performance and I was wondering where you think you can take that again just trying to think about the pathway and what you could actually do with the gaming unit segment?

[Kevin Sheehan:]

Yes, I think at the end of the day the market share gain is got to be very capital, because that's usually not a winning proposition. The success of this brand and the other brands we compete with very good companies is the success of the games that you produce and we've got a lot of effort as you guys know in R&D to make sure we're thoughtful about the games that are coming out so that we continue to attract the attention of all the casino operators because if you have a successful platform you're going to sell the product, and that's critically important to us. So that coupled with the signing of just as an example, I believe we have this unprecedented opportunity with the signing of James Bond and having the right stall of the movies and all the Bond characters and all the Bond ladies and all the characteristics and you think about Bond and what that has done for the gaming industry, there is always a couple of scenes there. So it's incumbent on us as an organization to make sure that we are being very thoughtful about this as we look to the next generation of gaming and trying to be on that cutting edge to say, hey, here is some new thoughts and new thinking. And I think we've got a lot of effort right now going on into making sure we're being thoughtful about that and creative to ensure that we're taking full advantage of that signing as an example.

[Unidentified Analyst:]

And I guess can you talk about maybe the Ilani as a case study about, what were some of the things that contributed obviously you're getting such a high share and whether or not you can replicate that elsewhere?

[Kevin Sheehan:]

Yes I mean I think it gets back to content. And I think we have a great reputation in that market and the success. So beyond that I don't think we want to get into.

[Unidentified Analyst:]

Thank you.

[Operator:]

And ladies and gentlemen our final question for the day comes from Chad Beynon from Macquarie. Please go ahead with your question.

[Chad Beynon:]

Great, thanks for taking my question. Mike you finished your response for the CapEx with unless there is another lottery big CapEx. And I wanted to kind of poker that for a second, we've read that in Italy there could be discussion of pulling forward the instant ticket contract which is a very profitable you had a very expensive one. Could you just help us think about I guess what's out there in the press anything legislatively and then more importantly, if this is pulled forward how you would value that versus some of your other opportunities? Thanks.

[Mike Quartieri:]

Obviously Italy is a key market for us from an instant product side. So we're going to do whatever we need to do to make that we maintain that position and maintain that revenue and EBITDA growth for our company. In regards to really other CapEx items, I think the next line of contracts that are really coming up we've already talked about the Maryland System contract moving forward at this point. There is legislative meetings taking place in May which we're hope that the contract gets signed at that point. Pennsylvania is out for until the end of '18. Italy will be out till 2019, so at this point those are the three main contracts that we have we would be looking for to make that type of large scale investment in.

[Chad Beynon:]

Okay. And you haven't heard anything from legislatively from the Italian representatives or your contacts there that this could potentially be pulled forward I guess that was the first part of my question on that.

[Mike Quartieri:]

No, not at this point.

[Chad Beynon:]

Okay thanks. And then just switching gears to the Spicerack acquisition, this complements a lot of your home grown games. Are there any other segments with also kind of within social gambling where you think you could add on to kind of bulk up your overall offerings to customers? And that's it from me.

[Kevin Sheehan:]

Sure and obviously we're not going to get specific on that. But I would tell you that we have our eyes out to make sure that we'd be thoughtful when something like that comes along. This acquisition I believe is going to turn out to be a fantastic one for us. And if you look at the business model of the number one and the number two player in that space, you'll see what they did once they expanded the reach of the Bingo with the introduction of some gaming within in that proposition. So those are the kinds of the things thinking out of the box to kind a create the incremental value is what would get us interested.

[Chad Beynon:]

Okay, thank you very much.

[Kevin Sheehan:]

Okay

[Operator:]

Ladies and gentlemen at this time, now we will conclude our question-and-answer session.

[Kevin Sheehan:]

Thanks so much, I appreciate that. Thanks for joining us this afternoon guys. And 2017 has started well, we are building momentum and we are excited about our prospects for growth and improvement during the year. Our team is focused on executing our strategies and our plans for '17 and beyond and continue to identify opportunities that can generated incremental value across our businesses. As we proceed through 2017 we will remain disciplined in our attention to costs and execution. We would smartly invest in innovation to lay the foundation for 2018 and 2019 and beyond. And we will focus on continuous improvement to shape our business for the long-term benefit of our stakeholders. We look forward to updating you guys on our progress during the second quarter conference call. Thanks and have a nice evening everybody.

[Operator:]

Ladies and gentlemen that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.