Scientific Games Corporation
Q4 2007 Earnings Call Transcript

Published: 4 Mar 2008

[Operator:]

Good day ladies and gentlemen and welcome to the Fourth Quarter 2007 Scientific Games Corporation Earnings Conference Call. My name is Leticia, and I will be your coordinator for today. At this time, all participants are in a listening-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions]. I would now like to turn the call over to Mr. Lorne Weil, Chairman and CEO. Please proceed, sir.

[A. Lorne Weil:]

Thank you, operator. Good morning everybody, and thank you for joining our fourth quarter and year-end conference call. With me here today, as usual, are Mike Chambrello and DeWayne Laird. We have a lot of things to talk about this morning in large part, because we have more balls in the air at the moment by far than we have had at any time in the past. Relative to what was known publicly at the time of our last conference call. China would appear to be the most important development, although the recent contract awards in Global Draw and Games Media would certainly come as a close second. As I think many of you know, Mike Chambrello has been our quarterback in China since we started our activity there; and in a few minutes, Mike will develop a significant amount of time to walking us through the associated challenges and opportunities. As you will see, the challenges are significant. The construction and start-up of a state-of-the-art instant ticket plan, combined with the implementation of a 90,000 terminal network and the allotted timeframe would be a major undertaking in the United States. The retailer network alone is about six times larger than the largest network in the United States. Never mind China, where we are also building the fundamental infrastructure as well. But as Mike will outline in a few moments, the potential rewards are really amazing. Setting aside a range of one-time event and the fact that we were still dealing operationally with the final consolidation of OGT, we think the top numbers in the fourth quarter were pretty decent. Revenues were up 15% to $268 million; EBITDA was up 53% to $73.3 million; and what we have referred to as adjusted EBITDA was ahead 29% to $84.6 million. As importantly, the adjusted EBITDA margin on revenue was 31.6%, so we are beginning to get the operating margin back to where we think it needs to be. As will be clearer in the discussion later on, several factors are at work that should drive overall margins higher in the medium-term, although there may be some twist and turns in the road in the very near term. Printed Product revenues were up 17% in the quarter overall, despite the fact that phone card revenues declined by nearly a third. After some appropriate adjustments detailed in the press release, same store revenue was ahead about 8% over 2006. Italian sales were quite strong in the fourth quarter after what had been a bit of slow down in the third quarter; but even without Italy, same store sales growth was still close to 7%. So even with all the uncertainty and dislocation going on in the economic environment, instant ticket sales were holding up well through the fourth quarter. Also as mentioned in the press release, Printed Product margins appeared to have declined from 45% in the fourth quarter of 2006 to 39% in the fourth quarter of 2007. But interestingly, if we eliminate OGT and phone cards from the numbers, both revenue and gross margin, the resulting gross margin in the fourth quarter was in fact identical to 2006 at 45%. So in terms of the core instant ticket business then, there was really little or no margin erosion from year-to-year. Looking ahead, we can expect that the completion of the OGT San Antonio consolidation is Alpharetta; we'll have a positive impact on overall margins. As we will plan that we recently developed a significant to reduce the cost of our phone cards, and then finally there will be the benefit from the disposition of the losing operation in Peru and the closure of the manufacturing facility in Germany, which Mike will talk a little bit more about later. Having mentioned Germany though, let me talk for a moment about what's going on in that marketplace. As we have been discussing for sometime, the development of the German instant ticket market had been held back by the political uncertainty surrounding the whole German lottery situation. Finally, in December 2007, the situation was resolved and the German lottery block ratified a new agreement with German Government, extending the individual lottery licenses in the 16 states for another four years. While it's still a little too early to breakout the champagne, we are beginning to see encouraging signs. In March, we will begin a co-op services operation in the State of Rheinland-Pfalz, bringing the number of CSP customers to four, and we will book... and we believe that we will sign a fifth contract in the not too distant future. We recently sold our first licensed product game in Germany in the State of Essen, and we have seen some very positive response to the introduction of higher priced tickets. So Germany may, at last, be coming to a tipping point. As mentioned in the press release, we have not yet reached the tipping point unfortunately in Mexico, which continues to be a financial drain, but we are beginning to develop some degree of optimism. Since this is as much a lottery systems issue as it is an instant tickets, let me now turn it back to a brief review of where we were in the systems business in the fourth quarter, and then Mike will return to the subject of Mexico during his remarks. Ironically, given the fallout associated with the recent Pennsylvania announcement, the fourth quarter was a very strong quarter for the systems business with significant progress having been made on a year-to-year basis in all respects. Revenues were up 21% to $73 million, gross margins were up 31% to $34 million, and operating profit increased about 13 fold from just under $1 million in 2006 to about $13 million in 2007. Needless to say, we were disappointed with the outcome of the contract award in Pennsylvania to the best of our knowledge at least, because there was nothing released formally by the lottery. We were in fact the preferred vendor from the point of view of technical performance and marketing, but we were unfortunately way underbid on price. But we are convinced that our strategic posture in the systems business is the correct one and that in the fullness of time, the wisdom of our strategy will be borne out. Several years ago, we very clearly articulated our strategy in the Online Systems business, given that the basic technology and associated service had began to de-commoditize, we would build our strategy around our ability to help our customers, grow their online revenues, much as we had built our instant ticket business. And this would have three important benefits. One, in the business that was both capital and fixed cost intensive, revenue growth was the easiest way to accelerate the return on investments. Two, by demonstrating our ability to generate revenue growth, we would enhance our competitive standing in the marketplace. And three, by creating proprietary content, we would have product to sell lotteries that were not our online customers and we could do so outside the scope of the traditional RFP process. The success we have had with licensed properties in the instant ticket business, where retail sales have grown ten fold in the last five years underscores the logic of the strategy. In terms of our focus on revenue growth, I think we have largely achieved our goal. For example, over the last five years, revenues of Scientific Games 16 or 17 online customers have grown an aggregate of 24% or 2.5 times faster than the rest of the industry, whose aggregate revenue growth was about 9%. Within the 14 states making up in North East region, which includes Pennsylvania by the way, our customers' aggregate revenue growth was nearly three times the rest of the region. In the higher growth sub segment of Keno, the per capita sales of our Keno customers are presently four times the remainder of the industry, which is an astonishing difference. Our strategy going forward assume continue to invest in game development, proprietary and license intellectual property as exemplified by our recently announced online Wheel of Fortune game and continue to invest in state of the art technology with the clear focus on revenue growth. I think the award to us of the Sisal contract announced morning, one of the largest, if not the largest terminal procurements in the history of the online business, more than attests to our commitment to technology leadership. And finally, we must insist on earning an acceptable rate of return on investment. We view winning online contracts that has substandard returns as an effect building bridges to nowhere, and we can't see the sense in this for either us or in the long run, our customers or our shareholders. Let me elaborate a little on this last argument. A few weeks ago, there occurred an event, which went largely unnoticed, but to which I think we need to pay serious attention. A woman, who just happened to have been born on January, the 1, 1946, a year in which by the way were born such notables as Bill Clinton, George W. Bush, Sylvester Stallone, my Vice Chairman and dear friend, Peter Cohen and at least notably yours truly became the first baby boomer to catch the Social Security check. It's entirely possible that one or the other of the four presidential candidates still standing may indeed turn out to be the future we have been waiting for, but I can tell you that this woman is definitely the future we haven't been waiting for and indeed is the future we have been dreading. As if we didn't have enough to worry about what was the housing collapse, a credit crisis in $100 a barrel oil, now we have to think about exploring entitlements as far as the future as the mind's eye can see. If the lottery industry in North America intends to have even a scintilla of relevance in this coming world, then it will need to begin to worry a lot more about revenue, and we will be there to help it. Let me now turn to the diversified gaming side of our business. For sometime we have been pursuing a strategy of diversifying the assets of our racing related businesses, away from its original core. The reasoning behind this is by now quite obvious and needs no elaboration. As outlined in the press release, we have several important developmental activities come to fruition in the fourth quarter. We were awarded a race book contract by the Oneida in Wisconsin, and the Internet and interactive voice response contract in the State of New Jersey, a key new agreement in the Dominican Republic, and a contract for OTB in Brazil, this by the way pretty much our first foray in to the Brazilian market with potential to expand in sports as well as Global Draw type gaming systems. The potential for our racing related customers, key customers in other areas of our business, is beautifully illustrated by the Global Draw contract recently awarded to us by CIE in Mexico. CIE has been key strategic customers of our since they took over the operation of the Mexico City race track more than ten years ago, and as they themselves have diversified to become one of the most successful gaming companies in Latin America; our opportunities with them have multiplied. Prior to the word of the Global Draw contract, we had already embarked up on a program that implemented the Keno system throughout their network. In the coming months, we expect to see further important gaming related contracts arise within our traditional Latin American racing customer base. As mentioned in the press release, the operating performance of Global Draw has continued to improve month by month, since the launch of our new server base Nevada Gaming System and associated proprietary games, parallel to the launch of the new regulations in the U.K. in September. Virtually from scratch, we have built what we feel is one of the most effective and impressive game development teams in the industry, and the success of our new games in such a short period of time is testimony to this. Indeed, more than one major international gaming equipment player has expressed serious interest in buying content from us. The award to us of at least 500 shops or 2000 terminals by William Hill was a tremendous milestone in the fourth quarter; and as we speak, we are rolling out the entire network for the end of the year... excuse me, for the end of first quarter launch. Finally, as also mentioned in the press release, the Games Media pub-based strategy is proceeding precisely according to plan. And we expect that during the balance of 2008, we will be able to build the major install base of machines within the pub environment to take forward into 2009. I might mention here that just a few minutes ago before coming into this meeting, I happened to see a research note from Morgan Stanley in the UK on my e-mail, speaking very positively about the prospects for the digital gaming business in pubs in the UK; and anybody, who hasn't seen it, I would recommend it to you. At this point, I'll hand the program over to Mike, who will address some of the more important operating matters in more detail. Following Mike's remarks, I will say a few words about the general subject of guidance and offer some comments and how we are thinking about financial performance for this year and beyond.

[Michael R. Chambrello:]

Okay, thanks Lorne. I will spend the majority of my time discussing in some more detail. Our China contract and ongoing activities. You would want to follow-up on a couple of Printed Product matters and certainly Mexico identified during our last call. First in Printed Products, late in the fourth quarter, we received permission from the workers council in Germany to close the production component of our facility in Bielefeld, Germany. We'll continue to maintain our CSP facility, staff and operations going forward; however, by the end of February, today, we will have migrated all of our productions to other facilities although primarily Leeds. The result of this closing is a net reduction in force of approximately 75 people and our ongoing operations in Germany will remain in the exciting, and we think quickly growing CSP component of our business. Also in December of last year, we were successful in transferring a license of our Peruvian lottery operations to a third-party. As noted earlier, we recorded a depreciation and amortization charge associated with this transaction as well as about the $2.7 million in Q4. We will however continue to provide the new license holder with traditional lottery tickets, which we'll produce at our facility in Chile. That's been a time consuming venture and it's certainly one that that we are happy to have closer to and to Lorne's point in that, we'll working to help them grow revenue in certain product, which in the end is what we do best. Also, we completed the closure of the San Antonio facility and a fully absorbed San Antonio's production capacity between 4 million and 5 million tickets into Alpharetta. We are confident of achieving really exceeding our $20 million annual cost savings target associated with this shutdown in the final OGT integration. We'll begin to see the effects of this cash savings in Q1 of this year and full effect on a run rate basis beginning in Q2. We've also identified almost $15 million worth of additional margin improvement activities for our Printed Products Group. These margin improvements largely will be achieved through continued reduction in waste as an example in Leeds. And some of our other facilities that waste reduction will count for about 35%. A reduction in make-ready time by just over 30%, continued press and production facility optimization, reduced staffing and ongoing cost containment and reduction from our supplier network. We'll begin to see the effect of these reductions in Q2 with full impact throughout the second half of 2008. So clearly what we have defined and what we laid out on the last call is in affect and I am quite confident that we'll be able to successfully execute each of these margin improvement activities. Moving on to the Systems Group and really specifically Mexico, couple of comments. We continue to work very closely with Televisa to address really the three primary issues that continue to be a drag on sales. The first of these issues is online game make-up. We are working with Televisa today to generate credible market research for new online products and features as well as price points over the next 30 days or so. As a result of these activities, we will be rolling out online product game changes as early as Q2 and into Q3 of this year, not itself the silver bullet, but certainly one of the components that we need to execute in order to bring that online component to a level of acceptable sales. The second driver, for our long-term success is the optimization of the retailer network. We are working with Televisa management to provide extensive training to the lottery sales force and applying best practices in lottery merchandising. We are managing the agent network for removing low selling agents and redeploying them into higher selling locations, and we are recruiting new venues for retailers particularly in Mexico City. Third and most importantly, is the launch of instant tickets. If I acknowledge that any forecast for the start of instant ticket sales may stress the limits of credibility, mine in particular. We believe that instants will launch in the second half of 2008 hopefully early in the second half and it really comes down to the ability to get a maturity license by Televisa to support and sell these instant tickets. So we will keep you posted on that. We remain cautiously optimistic, but we do think we have positive movement in Mexico at this point. Next, let me focus on China. The China development has been a series of very complex business development activities. Really, it's complex as the enormity of the opportunity this market represents. As Lorne mentioned, please keep in mind that we are building the infrastructure to serve China on a national basis in a very short period of time; a daunting, but very, very exciting task. Today, I'll describe each of the contracts and business opportunities that we have successfully executed as a result of our China strategy, which has been developed over the last two years or so. Let me start with our most recent announcements. First is the CSLP or the China printing deal. Late last year, we executed a contract with China Sports Lottery Printing Company for the implementation and operation of instant ticket manufacturing plant in Beijing. We entered into this agreement in a joint venture with CITIC Media, one of the most one of the most adverse, successful, and certainly respected companies in China. The term of this contract is for 15 years plus 1 year for implementation and allows CSG, which is the name of our joint venture company, the use of the CSL trademarks in sales and operations support of CSL management team, which has been invaluable in these early stages. During the first year of the implementation period, Scientific Games has executed an independent instant ticket supply agreement, which will allows us to import tickets into China from our other operating facilities. A press very similar to the P6 recently installed in Georgia is on order and we look forward to its installation in Beijing later this year. Scientific Games will receive a percentage of the face value of all tickets manufactured for import into China, while CSG, our joint venture company with CITIC will receive a percentage of the face value of all tickets manufactured in China, we will work very closely with the CSLP throughout the 15-years term of this agreement. And in fact their compensation is based on a percentage of net profit generated by the joint venture, insuring our goals are perfectly aligned with theirs over the term of the contract. The CSL will soon be announcing specific dates for the start of sales in which four provinces will be part of the initial launch. However I will tell you that the first shipment of Olympic-themed instant tickets is en-route to China as I speak. Second is the instant ticket system; in early January, Scientific Games and the China Sports Lottery entered into an agreement for the implementation, operation, and ongoing support for a National Instant Ticket Central System. The systems contract is for an eight year term and is highly linked to the printing contract as the CSL would like all 31 provinces to be selling instant tickets, utilizing the Scientific Games system by the beginning of 2009. Scientific Games will receive a percentage of the value of the tickets over the eight-year term. In this venture, we have no partner, and we work very closely with the CSL on this project and we'll continue to do. I am happy to say that this system has already been installed in the secured facility in Beijing, and is currently in final testing. Under the terms of the contract, Scientific Games will install 90,000 instant ticket validation terminals, within the first two years of this agreement. These handheld terminals are being manufactured in China. And the first 10,000 or so will be deployed in the initial four provinces for start up, which will come very, very shortly. We anticipate that an additional 40,000 terminals will be in operation across the number of additional provinces, by the launch of the Beijing Olympics in August of this year. Scientific Games will maintain the system, including a national call center. However Scientific Games will train CSL staff that will operate the system on a day-to-day basis. We also have the opportunity to enter in to additional CSP contract similar to the previously announced Shandong contract with other provinces. These types of activities will incur... will occur following the initial launch of the four test provinces coming very, very soon. So, the logical question is how big can these China contracts in our GLB, Guard Libang operations be for us. It really isn't possible to accurately forecast with a great degree of accuracy; however, to sort of put a box around it given the propensity to play in China is likely that business currently under contract will equal that or exceed our U.S. co-op services profitability as soon as 2010. In order to achieve this level of profitability, CSL's instant ticket sales would only have to perform really at a fraction of their online sales today. In fact we believe well within the term of our contracts that the retail sales of instant tickets will surpass the sale of online tickets just as they have here in the U.S. and are positioned to do in Italy, France and so many other places in the world today. It really is hard to contain our enthusiasm and my personnel enthusiasm and excitement over this opportunity. It's going phenomenally well, and our relationship with CSL is as strong as any one we have in the world. We'll keep you posted and you will certainly be reading about the launch not in the distant future. Finally, on a China basis, we formed the strategic alliance with REXCAPITAL, which will allow us to combine Scientific Games lottery and gaming experience and expertise with REXCAPITAL's market presence, licensing capabilities, capital strength, and excess to expand the distribution channels. Jointly, we will peruse opportunities in China related to instant tickets sales and production, sports wagering, Bingo, high frequency games, and expanded retail distribution infrastructure. I know it's a lot to cover. And I am sure there will a number of follow-up questions, but with that I will turn the program back to, Lorne.

[A. Lorne Weil:]

Thanks Mike. For elaborating on what I think every body would agree some amazing developments, really genuinely amazing and of course thanks for the great job and bringing these opportunities home and a very complicated and very competitive environment. I have known a lot of very smart guys, very capable guys in my career, who nevertheless simply couldn't come home with the deal of the century and I think the fact that you've done this is really just amazing. As I mentioned earlier, I would address the matter of guidance to some degree, so let me now do that before turning the program back to Q&A. I have been having a lot of discussion of the subject of guidance with many professionals in the investment industry over the last several months. And on the basis of this, I would guess perhaps somewhat ironically that a majority of the people on this call are probably not in favor of guidance per se. There is of course a particular review expressed from time-to-time that we Scientific Games could be somewhat more communicative and helpful than we have been, and I would not disagree with this conceptually and I think it's something that we plan to address. As I indicated in our last conference call, our financial focus right now is in bringing our cash return on capital employee back to the peak levels that we operated at two or three years ago, because I think this is both the best way to position ourselves for the long run, and the meantime to maximize shareholder value. And as I outlined in the last call from an earnings point of view, we are generating an awful lot of EBITDA, but not enough of it is getting to the bottom line, because of the interest and depreciation impact that the few under performing assets. So our primary goal this year is to fix this starting with the integration of OGT, which on about $100 million investment are generated close to zero cash return last year, and will be forward on the certainly in the range of $30 million a year or more. And the turn around of Mexico as Mike talked about a moment ago, and then moving on from there. So, let me address how we are thinking about this year in cash terms and without actually getting to the subject of earnings guidance per se, maybe I am splitting hairs, but I don't think so. Specifically then, we are projecting operating free cash flow of 2008 after interest, taxes and capital expenditures will be in the range of $135 million to $155 million or about $1.40 to $1.60 in free cash flow per share compared to operating free cash flow in 2007 that was about $20 million negative and about $125 million or $130 million negative including the acquisition of OGT. These operating cash flow figures are based on a 2008 CapEx projection of between $140 million to $160 million, and again let me reinforce that this includes all of the necessary investments for the activities in China as Mike talked about a moment ago compared to 2007 CapEx of $216 million. A lot of course has been made of the impact at the Pennsylvania online contract will have on our financials going forward. So, let me say a word about this. As we see it right now, from an operating point of view, the Sisal terminal procurement announced this morning will essentially offset the loss of Pennsylvania in 2009 and 2010, and do so without any without any associated CapEx, so that from the cash flow and return on investment point of view obviously we are far ahead. Of course that leaves open the question of what happens in 2011 to which I would answer as follows. It turns out rather fortuitously that the CapEx that would have been allocated to Pennsylvania is considerably more than sufficient to cover all the CapEx requirements for the two major China Sports Lottery contract as I mentioned a moment ago. So unless we are really missing something, we expect that the profit and cash flow from China in 2011 will dwarf what would have been the contribution from Pennsylvania. So again, although obviously we can't hide our disappointment that the Pennsylvania situation worked out the way it did. The overall financial picture going forward is in fact falling into place very nicely and certainly somewhat more positively than some earlier research models might have indicated. And with that, I will turn the program over to Q&A. Operator? Question And Answer

[Operator:]

[Operator Instructions]. And your first question comes from the line of Larry Klatzkin with Jeffries. Please proceed.

[Lawrence A. Klatzkin:]

Hey guys, good presentation. Couple of questions; one, you are saying you are looking for a proper ROI. Can you enlighten us on what a target ROI would be for investors?

[A. Lorne Weil:]

Yes. I think we need overall to be... talking in very simple terms where the ratio of cash EBITDA to net capital employee is at least 30%. And we were at that level... we were at the few points actually even higher than that level a few years ago. We've come off of that and our goal is, we need to get back to that.

[Lawrence A. Klatzkin:]

Where do you say on the payer contract if you had won it at the level it was won, what kind of return was that have been?

[A. Lorne Weil:]

It wouldn't have been even close to that. It wouldn't have been within significant distance to that.

[Lawrence A. Klatzkin:]

Itwould have been more single digits?

[A. Lorne Weil:]

It would have been definitely single digits.

[Lawrence A. Klatzkin:]

Okay. Second thing is...

[A. Lorne Weil:]

And by the way, I am not seeing whether it had a plus sign or minus sign in the front of us, I am always saying that it would have been single digits.

[Lawrence A. Klatzkin:]

All right, cool. Second thing to you, Mike, you guys... your population for the four provinces was only like 280 million, but you are implying that by the Olympics, you'll have another 40,000 terminals out there for a number of provinces. What kind of population might we want to be looking at when you have the 50,000 terminals out? Obviously, it's going to be a lot more than the 280 million.

[Michael R. Chambrello:]

Yes, it is. But also keep in mind that the four targeted provinces are for the larger and more successful provinces on the online side today. It was just one of the reasons why the CSL has chosen them. So, if you were to look at roughly 2.5 times the current population, then we'd be somewhere in the ballpark.

[Lawrence A. Klatzkin:]

All right. So if we say, by second half of the... by the fourth quarter, your population on that side of 700 million. That would be... that would probably make sense?

[Michael R. Chambrello:]

Sure, we can certainly do that.

[Lawrence A. Klatzkin:]

Okay.

[Michael R. Chambrello:]

And again, depending on sales that maybe more aggressive than that. I think that the sort of the governor on the growth will be the ability of the individual provinces to come online and get there activities squared away in a way that allows us to expand. So, a lot of excitement over there and a lot of provinces lined up that particularly want to... want to take up the Olympic-themed games.

[Lawrence A. Klatzkin:]

All right. Lorne, the Brazil... I guess you're doing sports betting on there. I guess sports betting is going to be reported with the racing, and what kind of potential do we see the sports betting driver generating?

[A. Lorne Weil:]

It has huge potential. If you look at the places in the world, that started with racing. And then from a regulatory point of view, we are to able broaden into sports. It's a very big and a very profitable business. I know we have been talking about this for some time, and one of the things that has been holding the development of this business back ironically has nothing to do at all of the sports. It has friendly [ph] enough to do with racing and not to drift too far a field. But I think you, Larry, certainly some of the people on the call have been reading about it and following a development in the racing business called TrackNet, which is joint venture between Magna and Churchill Downs that is really far in a way the dominant factor now in the signals that racing people all over North and South America want to bet on. And while they have been getting their act together, they haven't been granting rights to these signals to anybody, ourselves or anybody else and we can't get these... haven't been able to get these what we call race and sports books open and running allover the Caribbean and Latin America, where we've had these opportunities, because without the key signals... the key racing signals, the economics of it just doesn't work. But, it seems as though finally TrackNet has begun to get its act together. I think the signals are... we have are now proceeding to make deals to have these signals, and I think we will start to see this race of sports business begin to accelerate very rapidly now. And I think Brazil, which is obviously a huge economy, which historically has had a very high propensity to gamble although at a certain point in time, much of the gambling in Brazil will then... basically cut back and stopped is now in a phase, where clearly it appears to be opening back up and re-accelerating again. And I think we are really in on the ground floor, and I think this is a tremendous opportunity.

[Lawrence A. Klatzkin:]

All right, fantastic. So, I mean, if we are trying to think long-term, what could sports betting mean to the company?

[A. Lorne Weil:]

Well, longer-term sports betting... as we are thinking about our three four year timeframe, in our minds, I ... sports betting should be able to contribute easily $40 million to $50 million a year of EBITDA if we can get over some of these institutional hurdles that we have been talking about, because the fundamental infrastructure that derives from the racing business, which we've had all over the world for so many years. Simply, overlaying sports on top of that, so we have really very little to do in terms of pioneering new market areas. The numbers all add up that way. So, it's really just a question of getting some of this mechanical stuff dealt with, Larry.

[Lawrence A. Klatzkin:]

Okay,cool. And the last question is Mike, you are doing these things in Printed Products in the margin right now is typically like 45%, when you take OTG, I'm assuming that with the new plant is fixed. What do you see in long-term Printed Products margins going to with all these cost saving measures?

[Michael R. Chambrello:]

Well, part of it is with the integration is to get back kind of fully integrated basis, consolidated basis to the 45%. So, that's our target now and I am confident and our senior management of Printed Products is confident that we'll get there, and I can assure you Lorne is very diligent in ensuring that we get there.

[Lawrence A. Klatzkin:]

But you don't see going better than that with some of the things you are doing?

[Michael R. Chambrello:]

Well, let's see how we go over the next six or eight months and obviously continuous improvement is our objective. And we'll get back to the consolidated 45% and go from there.

[Lawrence A. Klatzkin:]

All right; and Lorne thank you for some indication on free cash flow and some guidance, that's very appreciated.

[A. Lorne Weil:]

Sure, Larry.

[Operator:]

Your next question comes from the line of Celeste Brown with Morgan Stanley. Please proceed.

[Celeste Mellet Brown:]

Hi guys, good morning.

[Lawrence A. Klatzkin:]

Good morning.

[Michael R. Chambrello:]

Good morning.

[Celeste Mellet Brown:]

I have some annoying questions for you that you might not want to answer. I'm just trying to think about...

[A. Lorne Weil:]

It's hard for me to believe that you would ask a normal question to us.

[Celeste Mellet Brown:]

I know you don't like to give guidance, but just if we can think about like the first quarter, is there anything strange in the first quarter? Would you think about this year versus last year is just something that maybe... wouldn't on the radar screen on most investors?

[A. Lorne Weil:]

Mike, you want to take a shot at that?

[Michael R. Chambrello:]

Yes, actually Celeste, there are a few... at least a few worth mentioning. Sort of that goes into the good news category is again China. In the first quarter, we produced about 700 millions or will have produced by the end of the quarter about 700 million tickets from China, obviously great news. However, due to the timing of delivery, filling the initial pipeline, it's really unlikely that we'll recognize much if any of that revenue in Q1. So, if you think about it in terms of... we used a little less than a third of our month's production capacity in Q1 without the benefit of any real material revenue recognition. That will be... that will clearly be felt in Q2. So that's sort of an anomaly that is unusual for us, again all driving to very, very good news. Another thing to keep in mind, you maybe aware of this anyway and I consider it sort of the lumpy part of our business, which is on the systems side is product sales. In Q1 of last year, we had a very, very significant product sale in Quebec. We don't have anything similar in Q1 of 2008. So clearly, that's going to be a difference. But as Lorne mentioned in the press release dictates the product sale pipeline got pretty well filled up this morning with Sisal and that gives us a nice steady product sale 2010. And as Lorne said, that certainly dwarfs any product sale in recent memory or my years of experience in the business. Another one probably worth mentioning is related to Leeds, and this is a situation that's really pretty similar to that Germany restructuring that we went through last year. And given the regulations in Europe is really subject to consultation with our workers. But what we are going to do is restructure our current model for the production of prepaid phone cards, which really will allow us to substantially reduce the standards single wrap prepaid card and increase some product standardization, which simply means, we are going to drive this product to much more of a lottery based product, and which will allow us to optimize our press, packaging, all other things that will significantly improve profitability. The problem is this transaction period will happen in Q1. So, our Q1 phone card business will be significantly lower than Q1 of 07. However, by the end of the year, because of this retooling of our production and packaging infrastructure, our overall profitability for the year should be higher. But we will probably take a bit of a hit in Q1 as a result of this restructuring. One other thing Lorne didn't mention it on this call, but he has on previous calls is MDI. MDI is really our most difficult business to forecast, because unlike other parts of our business, each game is really sold as a one-off, so there is no long-term contract or pipeline. Q1 08, it will be a little softer as Q1 07, and that's primarily due to the timing of some Major League Baseball contracts and the changes and example Massachusetts. It's only doing half the game that it did in Q1 of 07. So there are some changes, but what I will tell you that Q2 really looks strong. And that's Q2 book business. Again, it's hard to see much more than a quarter out on MDI, but whatever softness we'll see in Q1 will be more than made up in Q2 in MDI. And I guess finally it's always worth just throwing in the luck of the draw. Last year in Q1 we had a jackpot, a little bit in excess to $250 million, which gave us a nice bump in the Systems Group in Q1. We are sitting here today at a $153 million. If we get hit Saturday or Wednesday or the following Saturday, then we'll fall short of that. That's sort of part of the business, but it could have an impact on Q1 08 versus Q1 07. Those are the things that immediately come to my mind. I don't know, Lorne, if anything else comes to yours.

[A. Lorne Weil:]

Well, not to totally pile onto the first quarter, but this is kind of good news, bad news. But we will begin in the first quarter to accrue for the Global Draw earn out that we will actually pay sometime in 2009. And, I think right now the accrual in the first quarter is a couple of million dollars. And then... sorry, on the subject of Global Draw and Games Media, and again this is a fundamentally good news, but very good news, but it still has a year-to-year impact on the first quarter. And that is, the first quarter of last year was the... really the grand finale to the Games Media analog one-time equipment sale business. And it's really been since then that our focus has been completely on shifting at over to a participation-based digital business. So, we won't have... we shouldn't... I kind of imagine that, we have anything like the one-time analog sales in the first quarter of 08 that we have in 07. But by the same token, as we move through the progress of the year, the recurring revenue participation business is going to be getting bigger and bigger and bigger. So, taking now all that together, Celeste, I hadn't actually realized before you asked the question that there were that many anomalies in the first quarter. And I don't... and they.... adding them all up, probably it sounds like it's a much bigger deal than it is. But in terms of modeling... certainly in terms of modeling, the first quarter of 08 against the first quarter of 07, those are some things I think have to be taken into account.

[Celeste Mellet Brown:]

Can you give us the MDI revenue for the first quarter of 07 and all of 2007? That might help us with our modeling.

[A. Lorne Weil:]

Sure. Mike you have...

[Michael R. Chambrello:]

Yes. For the first quarter of 07, we had revenue of almost $17 million. I actually don't have the full year. And what was the follow-up question, Celeste?

[Celeste Mellet Brown:]

Yes, the full year.

[Michael R. Chambrello:]

It's like $78 million, last year.

[Celeste Mellet Brown:]

Yes.

[A. Lorne Weil:]

We are just...

[Michael R. Chambrello:]

We are checking on that, Celeste.

[Celeste Mellet Brown:]

Okay.

[A. Lorne Weil:]

Let's keep going and then when we dig it out, I will just... even if you are not the person asking the question, we'll just interject it into the discussion.

[Celeste Mellet Brown:]

And just one final question. Lorne, are you at all concerned about the Mayor Bloomberg's threat to close the New York OTBs?

[A. Lorne Weil:]

Well, I am kind of reluctant to give you what... to tell you how I really feel, but I'll tell you anyway. New York City OTB is not a customer of ours, nor is the betting... the racetrack organization, which is the New York Racing Association that generates the overwhelming majority of the betting handle of New York City OTB. So, the closure of New York City OTB would in that sense that has no impact whatsoever negatively on us. But, as I think about it, if you look around the city, off-track betting in Nassau County, off-track betting in New Jersey, off-track betting in the Catskill region and then in Connecticut, where we actually own the OTB. Every OTB operation around the city is either a customer of ours or our own operation. And so, if New York city OTB were to shut and literally the billion dollars of OTB handle that is currently going through New York City OTB, looks for a home nearby, it would actually have an enormously positive impact on us. So, I am not hoping that it happens, because I think that's kind of gets in the area schadenfreude. I can tell you that if it were to happen, it would be ironically a very positive thing for us.

[Celeste Mellet Brown:]

Thank you.

[Operator:]

Your next question comes from the line of Bob Evans with Craig-Hallum Capital. Please proceed.

[A. Lorne Weil:]

Bob before you go ahead, let me just tell Celeste that the total revenue for MDI in 07 was $71 million.

[Robert J. Evans:]

Okay, good morning. Thank you.

[A. Lorne Weil:]

Hi Bob.

[Robert J. Evans:]

Hi,a few more questions just to try to get a sense of how you are thinking about things. Just one... just clarification, when you are talking about operating cash flow, I just want to make sure we are talking about the same. Could you just define it, as you see it?

[A. Lorne Weil:]

Yes. Either EBITDA... cash EBITDA, so it's EBITDA that excludes the non-cash stock-option expense.

[Robert J. Evans:]

Yes.

[A. Lorne Weil:]

Minus cash interest, minus cash taxes, minus CapEx.

[Robert J. Evans:]

Okay.

[A. Lorne Weil:]

Or it's net income traditionally adding back D&A and then going from there.

[Robert J. Evans:]

And do you have ballpark idea of what was to think about for D&A, because that's I think an area, we have not modeled properly in the past, for the year... if you want to give it for the year?

[A. Lorne Weil:]

Yes. For the year, I would put it in the range of $140 million.

[Robert J. Evans:]

Okay. I know last quarter, if I am not mistaken, is around 37. I don't know if there are some unusual items there, but I am just wondering...

[A. Lorne Weil:]

I think that was probably... I think that's probably close to an indicative run rate.

[Robert J. Evans:]

Okay, so take that as a run rate and maybe grow it a little bit.

[A. Lorne Weil:]

Yes.

[Robert J. Evans:]

Okay. And then on the interest side, anything unusual there, where again you are... I mean I kind of have you around $60 million?

[A. Lorne Weil:]

Well, the cash interest... we have... there's two components to our interest. There is the cash interest and then there is the P&L charge for expenses that were associated with putting loan facilities in place that we have to amortize over whatever the life of the various loan agreements are. I think the cash interest in 07 was about $50 million, Bob.

[Robert J. Evans:]

Right.

[A. Lorne Weil:]

So, say $10 million less than whatever you have there. And all of our debt is... not all of it, but certainly the preponderance of our debt as you know is LIBOR based. LIBOR is now considerably lower than it was during 07. And if we were to... let's say we generate $150 million in cash over the course of 08, equally quarter-to-quarter-to-quarter, that would also say that, and we'd simply use that to pay our revolver down, then we have a lower interest rate based on the lower LIBOR applied to at least somewhat lower debt. So I think, given that you should be able to calculate out the interest within a reasonable margin of error.

[Robert J. Evans:]

Okay, I agree. And, you lead into my next subject on the... you are going to generate a lot of cash this year. Any thought on using that cash for buyback, given where you are valuation is?

[A. Lorne Weil:]

Yes. There is a lot of thoughts given to using that for buybacks. I think we have said that we... our board re-upped our authorization to buy a couple of $100 million worth of stock. Given the... let's say the skittishness right now in the credit markets and who knows, where this all is going. We are not going to run out tomorrow and use all of our liquidity to buy back stock. I think that would probably be not the wisest thing you can do. But I think... I think I can say with a high degree of confidence that as we are generating cash through the year, there... and obviously we'll have to look at it quarter-to-quarter to see where the stock is. But certainly our intention right now to... and that the stock were to remain at these levels to use all of the... that free cash flow if it comes to buy back stock.

[Robert J. Evans:]

Okay, And service gross margins for the Printed Products business up a little bit sequentially, but still quite ways away from where you've been historically in the high 40s. Again just... how should we think about that for Q1 and when do you think you get back to your traditional high 40s type?

[A. Lorne Weil:]

Yes, well. I think getting back to the... I think the single biggest contributor to getting back to the traditional Printed Products service margins is the full integration of OGT, because there you've got $25 million of revenue a quarter that since the acquisition of OGT has been... at best a marginal contributor. And as Mike said a minute ago, you are going to have a very significant pick up. And we are... at least our aim is to get to a point, where we are generating in the range of $30 million or slightly more than that, relative to the $100 million acquisition price and around $100 million of revenue and that would be EBITDA. So the gross margins is going to be considerably higher than that and I think, we will begin to move back and get close to that 49%. I think the... I think we would have seen very substantial progress in the first quarter. Not in fact as Mike mentioned that $700 million worth of tickets, which... most of which have been produced and are on a Board... on their way to China and in different situation would be recognized as revenue and the associated gross margin in the first quarter. As this is not going to happen and because of the way the fixed cost, variable cost nature of this business works that the revenue that we would get on that 700 million ticket generates very significant incremental gross margins. So unfortunately that will impact the cosmetics profitability of the first quarter, but then it will completely flip the other way in the second quarter. So, I would say really... and then taking into account, I think Mike talked about. It would be the second quarter, when I would expect to see us, maybe not hitting on all 16 cylinders, but certainly hitting on 15 cylinders in the Printed Products services.

[Robert J. Evans:]

And Lorne, if you... or Mike, if you are willing to guesstimate the EBITDA impact of the China volume, kind of moving towards that, the impact of that moving from Q1 to Q2 on EBITDA, ballpark guess, what are we talking $5 million, $2 million?

[A. Lorne Weil:]

It's... I guess we are comfortable saying that it's more than $2 million, but I think for a variety of reasons, we just assume not discuss that at least now, Bob.

[Robert J. Evans:]

Okay, fair enough and final question. So, again getting back to Q1, if we... of all the things that Mike said, how should we view EBITDA year-over-year. Given what you said, I can't review what as may be, we might set down comparison for a lot of one-off reasons is that there?

[A. Lorne Weil:]

I wouldn't think that EBITDA will be down year-over-year, Bob, no.

[Robert J. Evans:]

Okay, but maybe modest growth versus what you would normally...

[A. Lorne Weil:]

What might have been possible, yes.

[Robert J. Evans:]

Okay, fair enough, thank you.

[Operator:]

Next question comes from the line of Carlo Santarelli with Bear Stearns. Please proceed.

[Carlo Santarelli:]

Hey guys, the one thing I was wondering if you could touch on a little bit once you roll out namely with your Global Draw machines right now, and how that's progress?

[A. Lorne Weil:]

Carlo, I am sorry; DeWayne and I were having a side conversation. And I just completely missed the question.

[Carlo Santarelli:]

No problem, I was just wondering if you guys can maybe talk a little bit more in detail about your roll out of your Global Draw terminals and what you've kind of seen I know you mentioned in the press release the trends you are seeing through January, but overall what's the feeling been over there given the new machines and the legislative changes just talking about and every thing else?

[A. Lorne Weil:]

It's been hugely positive. It's been overwhelmingly positive. The smoking ban had somewhat of a negative impact, very early on when the smoking ban was introduced. And it quickly faded, and I think if anything for a crazy ironic reasons that the smoking ban actually maybe helping us, because all of the gambling venues in the UK have a smoking ban. And If you ever been to the casinos or the what they call adult entertainment centers or large Bingo halls, there it's is much more difficult to skip out for a minute to have a cigarette than it is in the betting shop, where you can practically play the machines with one hand and have your arm out the window smoking with the your other hand. So that hasn't been an issue for us at all. And what has really been tremendously positive is the way that there is new network of ours is working. And the way the public has responded to the new proprietary games we've developed, which we've been developing over the course of the last 18 months and we are able to introduce in September when the regulations changed. I had... I was fortunate... I've had dinner a few weeks ago with the CEO of Gallup. A gentleman named Neil Golden. And he simply couldn't say enough about how thrilled they were with our new equipment and particularly our new games and how tremendous they were performing in the market, and what a positive impact it was having on their business. It's too bad that... from our perspective it's too bad that Gallup Coral is a private company, because they were releasing their numbers the way Ladbrokes and William Hill do. It would be a tremendous testament to how our toughest performance that I can simply tell you that the reaction in the marketplace has just been phenomenal.

[Operator:]

Your next question comes from the line of Ralph with William Blair please proceed

[Ralph Schackart:]

Hi good morning. Lorne, I was wondering if you could help us quantify the change in pricing terms of the instant ticket business in Pennsylvania. And secondly and more broadly, I think there is a perception in the market that changed pricing there it's going to have an eroding effect and future negotiations, would you mind spending couple of minutes on that please?

[A. Lorne Weil:]

An eroding effect on future negotiations of what?

[Ralph Schackart:]

Future pricing, contracts with other states.

[A. Lorne Weil:]

Yes, the only contract that really is... you have to put everything in the proper time perspective. The reduction in the price in Pennsylvania is not a leading indicator of... this is the miss-perception that just about everybody that follows the business half. The Pennsylvania's instant ticket contract is... was close to ten years old, but had been extend over and over and over. And when we first got that contract, instant tickets sales in Pennsylvania were about $200 million a year. And by the time the contract was completely redone, the instant ticket sales were about $2 billion a year. The pricing in Pennsylvania was really bringing the price of Pennsylvania down in line with where Georgia, Tennessee, everybody, everybody already was. So, with the exception of Florida, which is the last really old contract that is still in effect. Pennsylvania is not leading the way to the rest of the industry, but quite a contrary, Pennsylvania was simply coming back in line with where the... all of the rest of the industry already is. So the statement or the questions that this is going to set off a wave of whatever you want to call it in future negotiations, this is simply completely missing the point. So, we don't have the slightest concern about that, and with the caveat being that Florida is still the last of the real old contracts that remains to be dealt with. That's really the situation.

[Ralph Schackart:]

Right, Lorne, I think that's helpful to clear that up. And Mike, I am sorry if I missed it. Did you give any sort of timing on the consolidated Printed Product project margins to get back to 45%?

[Michael R. Chambrello:]

Well, we are going to... certainly, we will start to see the impact as Lorne mentioned in Q2. Q3, I would be fairly optimistic about and certainly our target is to trying to get back inline by the end of the year.

[Ralph Schackart:]

Okay, great. Thank you.

[Operator:]

Question comes from the line of Steven Wieczynski from Stifel, Nicolaus. Please proceed.

[Steven M. Wieczynski:]

Hi, good morning guys. Just one question for you on Mexico; Mike, I think you said you start, you expect that instant ticket sales there, kind of start going into second half of this year but, if that doesn't happen, are you guys pretty much committed to stay in there and seeing this through, is there... or would you guys think about leaving that without really seeing any sales kind to flow through?

[Michael R. Chambrello:]

I think right now, we are thinking in terms of that instant ticket sales are going to begin in the second half. And that if they do... if and when they do, it will straighten these numbers out. But obviously, if they don't, we can't go on forever being in the position where we have this kind of capital committed and this kind of organization on the ground committing, which is eating up our resources, and not generating return. And this is clearly not what we market for when we entered into this contract and agreed to make the capital commitment we did and agree to put the organizations on the ground that we did, it was with the clear understanding that instant tickets was part of the deal. And with the rate including instant tickets, that's 4% or 5% of sales. This at a level of sales common to the demographics and population in Mexico would have been... should have been one of the very most profitable contracts we have. But on the other hand if it doesn't happen then it clearly is not what we bargain for, and we would have to take some kind of action. I wouldn't want to say just at the moment what form that action might take, but we are certainly not going to sit here forever bleeding like this and having all of these assets on the balance sheet, not only not generating any positive return, but actually pathetically generating a negative return. So, we are prepared to give it until the second half of this year and then if it doesn't turn around, we will do something, but I just... at least over the year, I wouldn't want to talk about what that might be.

[Steven M. Wieczynski:]

Okay. Great thanks guys.

[Operator:]

And your last question comes from the line of Amir Markowitz [ph] with JPMorgan. Please proceed.

[Unidentified Analyst:]

Hey good morning.

[A. Lorne Weil:]

Good morning.

[Unidentified Analyst:]

You guys talked a lot about the opportunity on the sports side, which I had mentioned a little bit about what's going on with Guard Libang. But I wanted to kind of get a better sense of what's going on there. Have tickets already started?

[A. Lorne Weil:]

What's going on where?

[Unidentified Analyst:]

With Guard Libang JV and...

[A. Lorne Weil:]

Yes, actually, the Guard Libang relationship and our acquisition of 50% of Guard Libang, which we can get in the third quarter I guess, of last year, yes, we are very, very happy with... to... maybe to characterize something that Larry Klatzkin asked to very early on in the call. Guard Libang right now, by the end of the first quarter on the CWL side, will be servicing a population in excess of 1 billion people. And so, we achieved with Guard Libang, profitability in the fourth quarter of last year. We will be profitable in the first quarter of this year and throughout the course of this year, working with Guard Libang management, which is by the way, I would like to say is excellent, excellent, excellent. We will be adding some of the... working with them and some of the marketing merchandising game designed activities have been so successful everywhere else. So, we see continued growth with Guard Libang, and I am really very, very optimistic particularly for the second half of this year to the level of profitability we might achieve with the... Guard Libang. But I do want to say that, I think we only owned part for a very, very small part of Q4. After the closing, the company was profitable and will be profitable in Q1.

[Unidentified Analyst:]

Okay. And as a follow-up on China, do you guys have a sense of what... kind of the breakeven level sales needs to be on the sports lottery side? So what level do we expect you guys to start being profitable on the sports lottery side?

[A. Lorne Weil:]

It's Lorne. It's very, very, very low. Because the... there is two aspects to the cost structure; one is the cost of producing the tickets, and the other is the cost of the system. If we were building the plant in China first and then we have to begin filling the pipelines in China with tickets being produced in the Chinese plant. Then the issue of breakeven is a hugely relevant question and we would probably lose a ton of money between the time we started the plant and the time we had hit breakeven, because our plan is to build the biggest printing press at least rate now that exist in the industry with the capability of producing in the range of 8 billion tickets a year. And with a plan of that size with all attendant fixed cost probably until you get at least half full, you would be losing money. But, the way the deal is working is we are able to begin by shipping the tickets from Alpharetta, where obviously you were long past the point of breakeven, so that we can build up the local demand from the states knowing that the minute we opened the plant the volume in the market should already be big enough to allow us to be far more than breakeven, so it's a very good question. But the logistics of the way the whole thing has come together, I think anticipate that quite well. And the case of the system, as Mike said, our responsibility is to design a system build a system, install a system, which we have already done and procure and install several tens of thousands of terminals. The terminals themselves are at very low cost. These are... don't visualize a water terminal you think just visualize a handheld thing like when you take a rental car back. And don't imagine what we have in the states with satellite dishes on the roof and all the rest of the stuff, because these things are going to be working on a wireless network. So, the capital is very low. The communications costs are relatively low. And anyway, they are being paid by the China's sports lottery. So once we are done building and installing the system, and we continue to get very attractive percent of all of the instant ticket revenues we don't have a hell of a lot of ongoing operating costs. So I think... taking all of that together to be perfectly honest, I think we should be profitable that the way we sell the first ticket. I don't think there should be any worrying curve there at all or certainly not an appreciable one.

[Unidentified Analyst:]

Okay thank you.

[A. Lorne Weil:]

Okay, everybody. Well, thank you very much for taking all this time. And I think you can tell from the tenure of the this morning's meeting that we were or about as positive and optimistic about this year, and the years going forward as we can be notwithstanding the... I forget what day of the week the Pennsylvania thing black whatever it was Tuesday, but we are not letting that dim our enthusiasm for this business in the slightest. As I said to Bob Evans, we anticipate being very, very, very cash positive this year, which will have two very important impacts. It will importantly begin to move our return on capital employees back to where it needs to be. And it will allow us to keep our current liquidity powder dry, but have an awful lot of cash available to buyback our stock, which again at this level we couldn't possibly think about doing anything else other than. And with that, we'll actually see you speak to you sooner than we normally do, because we'll be reporting our first quarter I imagine towards the end of April. So, we will be speaking to you all in a couple of months. Thanks very much.

[Operator:]

Scientific Games management would like to remind you that this conference call contained statement that constituted forward-looking statement made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. This information involves risk and uncertainties that could cause actual results to differ materially from the forward-looking statements. For certain information regarding these risks and uncertainties, reference is made to the Scientific Games Annual Report on Form 10-K for the fiscal year ended December 31st, 2006. You may all now disconnect; good day.