Scientific Games reports 3Q results

Gavin Isaacs, Scientific Games' President and Chief Executive Officer, said, "With an expanding portfolio of innovative new products, systems and services ahead of us, and the heavy lifting of integration mostly behind us, our team successfully accomplished in just eight months what we had originally expected to achieve in a year. The combined power of our talented people, innovation-focused culture and multiple brands was clearly demonstrated at the recent Global Gaming Expo and National Association of State and Provincial Lotteries trade shows. At both events, customer feedback to our latest innovative solutions was highly favorable. We have clearly established a solid foundation built on the most extensive portfolio of leading brands and products - including a diverse revenue base that is more than 60% recurring in nature - targeted at generating consistent long-term profitable growth."

"The benefit from having accelerated our integration activities yielded savings that contributed to the 850 basis point increase in AEBITDA margin over the prior-year period, and enabled us to pay down $73 million of debt in the third quarter, bringing total debt payments for the first nine months of 2015 to $109 million. With the integration largely complete, a deep portfolio of innovative solutions across our businesses and the scale to provide high levels of customer service, our strategic priorities remain focused on leveraging our capabilities to support customers' growth while improving our operating metrics," Mr. Isaacs concluded.

Impact of Certain Significant Charges and Other Items

In the 2015 third quarter, the Company recorded certain charges and other items, including items related to the integration and valuation of the Bally and WMS acquisitions that impact the comparability of reported results.

Reflecting the Company's current analysis of the gaming industry, including the impact of the prolonged reduction in overall customer spending on gaming machines and the decline in gaming operations installed base, Scientific Games initiated a review of the carrying value of goodwill and certain intangible assets associated with game machine sales and gaming operations during the 2015 third quarter (and which it expects to complete in the 2015 fourth quarter). This analysis determined that the current indicated fair value of the goodwill associated with these lines of business was below its carrying value.  The preliminary estimate of the indicated fair value resulted in a $535.0 million non-cash goodwill impairment charge with no tax benefit. 

Following completion of the analysis in the 2015 fourth quarter, if appropriate, an adjustment (which could be material) will be made in the Company's consolidated financial statements for the year ended December 31, 2015 to amend the preliminary estimate.  The Company also recorded a $103.6 million non-cash impairment charge in the 2015 third quarter for the write down of certain intangible assets in its gaming business, which is included in depreciation and amortization. There is no impact to ongoing operations, revenues, cash flows or financial covenant compliance due to these impairment charges.

The cash impact of the aggregate $648.3 million of charges noted in the table above totaled $9.7 million. 
In the 2014 third quarter, the Company recorded employee termination and restructuring costs of $2.7 million and acquisition, integration and other charges of $6.0 million primarily associated with the WMS acquisition, along with a $19.7 million impairment charge related to the Company's equity investment in its Northstar Illinois joint venture.

Merger Integration Update

"With the consolidation of gaming machine production at our Las Vegas manufacturing facility, we are now implementing efficiencies in our manufacturing processes that are expected to further reduce our cost of product sales and cost of services, while leading to improvements in working capital through accelerated inventory turns," said Scott Schweinfurth, Scientific Games' Executive Vice President and Chief Financial Officer.  "As of September 30, 2015, we implemented $194 million of the $200 million of annual cost savings related to the Bally acquisition which were expected to be implemented this year, and we implemented more than 85% of the expected second-year WMS-related synergies of $30 million.  We anticipate implementing approximately $10 million of incremental costs savings in the current quarter. Our integration initiative-related savings are reflected in the 850 basis point increase in AEBITDA margin compared to the year-ago period as well as the $53 million year-over-year decrease in aggregate quarterly selling, general and administrative expense and research and development costs on a pro forma basis.  We continue to focus on optimization of our business practices and capital base to deliver free cash flow growth, which will be prioritized for debt reduction."

The Company incurred approximately $10 million in aggregate restructuring and integration costs in the 2015 third quarter, with such operating costs incurred since the completion of the Bally merger totaling approximately $48 million. 

Gaming Segment Financial Highlights

Revenue increased $264.7 million, reflecting the inclusion of $286.7 million from Bally that was partially offset by $22.0 million in lower legacy Gaming revenue (i.e. that which existed prior to the Bally acquisition), due primarily to lower gaming machine unit sales. The revenue increase was also inclusive of a $4.1 million unfavorable foreign currency impact for the legacy Gaming business and a $6.7 million unfavorable foreign currency impact in the Bally business on a pro forma basis.

Gaming operations revenue increased $100.9 million year over year, reflecting the inclusion of $99.9 million from Bally (inclusive of a $1.1 million unfavorable foreign currency impact on a pro forma basis) and a $1.0 million improvement in the legacy Gaming business, inclusive of $3.7 million of unfavorable foreign currency impact. Gaming operations revenue increased 2 percent on a quarterly sequential basis.

The inclusion of 15,143 Bally WAP, premium and daily-fee units to the ending installed base was partially offset by a 1,123 unit decrease in the legacy Gaming installed base. The inclusion of Bally's installed base of WAP, premium and daily-fee units led to a $29.22 per unit decrease in average daily revenue. Average daily revenue for the legacy Gaming installed base increased 14 percent, or $10.64, year over year to $85.62 per unit, reflecting the high-earnings performance of WMS WAP and premium participation games and removal of lower-performing units.

On a quarterly sequential basis, the average installed base of WAP, premium and daily-fee units declined 1 percent, or 267 units, and the average daily revenue declined $0.37 per unit.

The year-over-year increase in the quarter-end installed base of other leased and participation units primarily reflected the inclusion of 18,068 Bally units, partially offset by an 81-unit decline in the legacy Gaming installed base. The addition of Bally's other leased and participation units led to a $4.07 increase in daily average revenue per unit, inclusive of a decline in the legacy Gaming business average daily revenue per unit in U.K. customers' betting shops, driven by the 5 percent year-over-year expected increase in the U.K. duty on gaming machines, along with unfavorable foreign currency translation.

Gaming machine sales revenue increased $63.3 million, reflecting $86.9 million from Bally (inclusive of a $5.6 million unfavorable foreign currency impact on a pro forma basis), partially offset by a $23.6 million decline in legacy Gaming product sales, inclusive of $0.4 million unfavorable foreign currency translation. The Company shipped 6,255 new gaming machines, including 3,670 new units to U.S. and Canadian customers and 2,585 new units to international customers. International shipments included 385 of the new Dualos Australian gaming machines. Other product sales revenue increased $9.5 million, inclusive of $9.4 million from Bally and a slight net increase in legacy Gaming revenue. The increase in legacy Gaming revenue was driven primarily by the deployment of approximately 2,300 self-service sports betting terminals to a customer in the U.K. (and we expect to deploy the remainder of the 3,000 contracted units in the 2015 fourth quarter), mostly offset by a decline in conversion kit sales. The 11 percent increase in average sales price per new unit reflected the benefit from Bally units, particularly sales of premium Pro Wave gaming machines.

Total new unit shipments in the 2015 third quarter were lower than the combined new unit shipments of the legacy Gaming business and Bally during the prior-year quarter. Shipments to U.S. and Canadian customers in the 2015 third quarter reflected 310 Illinois VLT units, 145 Oregon VLT units, 150 units for new casino openings and 3,065 replacement units. Combined shipments by WMS and Bally to U.S. and Canadian customers in the prior-year period included 913 Illinois VLTs units, 218 units for new casino openings and 3,448 replacement units.

Gaming systems revenue increased $56.2 million to $59.7 million and table products revenue increased to $44.3 million, primarily due to the inclusion of Bally.

Operating loss of $585.3 million compares to an operating loss in the prior year period of $10.9 million, primarily due to the $535.0 million goodwill impairment charge and the increase in depreciation and amortization reflecting the $103.6 million impairment charge to write down certain intangible assets, partially offset by the inclusion of Bally and benefits from cost savings associated with the Company's integration initiatives.

Gaming Segment Recent Business Development Highlights

Signed an enterprise-wide agreement with Alberta Gaming and Liquor Commission to deploy a suite of Bally gaming system solutions connecting the more than 14,000 gaming machines in the 28 casino properties across the province.

Introduced at G2E and in pre-G2E meetings the new TwinStar dual-screen gaming cabinet with the next-generation ArgOS operating system, which has been favorably received by casino operators. Initial production capacity for this quarter is fully committed and shipments are expected to begin in December following anticipated receipt of regulatory approvals.

Lottery Segment Financial Highlights

Lottery revenue declined $21.4 million, inclusive of an aggregate $10.6 million unfavorable foreign currency impact, reflecting $3.2 million in lower services revenue and $25.0 million in lower lottery systems product sales, partially offset by a $6.8 million increase in instant games revenue.

Services revenue decreased $3.2 million, inclusive of an unfavorable $1.8 million impact for foreign currency translation, largely reflecting the cessation of sales related to the previously announced loss of the Colorado lottery systems contract effective October 2014 and lower international service revenue reflecting the cessation of a contract in China as of June 30, 2015, partially offset by higher revenue from increased retail sales of Powerball® and Mega Millions® tickets.

Product sales revenue declined $25.0 million, inclusive of an unfavorable $4.9 million impact for foreign currency translation, primarily due to lower hardware sales to international customers reflecting a lower level of demand and international lottery bid activity compared to the record level of sales in the prior year.

Instant games revenue increased $6.8 million, inclusive of an unfavorable $3.9 million impact for foreign currency translation, primarily driven by a $6.1 million increase in licensing and player loyalty revenue and a $1.8 million revenue increase from customers to which the Company supplies tickets on a price-per-unit basis, partially offset by a $1.1 million decrease in revenue primarily from international customers that purchase tickets under participation-based contracts. Revenue from U.S. customers increased 9 percent year over year and 5 percent on a quarterly sequential basis.

Operating income rose $0.2 million, despite 10 percent lower revenue, reflecting a more profitable mix of business and lower operating costs. Lower operating expense included a $2.0 million decrease in selling, general and administrative expense and a $3.3 million decline in depreciation and amortization.

Lottery Segment Recent Business Development Highlights

Signed a new five-year agreement with extension opportunities for up to five additional years to provide lottery draw game services, including turn-key operation of the lottery gaming systems infrastructure, software and hardware/terminals to the Arizona Lottery, displacing the incumbent provider.

Signed a six-year contract with an additional three-year extension option to provide an instant games Cooperative Services Program to Land Brandenburg Lotto GmbH, the Brandenburg, Germany lottery.

Signed a new two-year agreement with extension opportunities for up to eight additional years for instant games and services with the Ohio Lottery, and a new five-year agreement with an additional two-year option for instant games and services with the Montana Lottery, both existing customers.

Signed one-year extensions of both the lottery systems and player loyalty contracts with the Maryland Lottery to June 2017 and a one-year extension of the lottery systems contract with the Iowa Lottery through June 2019.

Season two of the MONOPOLY MILLIONAIRES' CLUB TV game show began, with the first episodes premiering in September 2015. Planning is underway for season three, which is expected to premiere in September 2016.

Interactive Segment Financial Highlights

Interactive revenue increased $12.7 million, reflecting the inclusion of $8.6 million of revenue from Bally and a $4.1 million increase in the legacy interactive business, primarily due to an increase in real money gaming ("RMG") revenue.

The Company's original Jackpot Party® Social Casino underwent a significant software update and upgrade during the quarter, during which marketing efforts were reduced. As a result, while DAU was essentially flat, MAU declined on a sequential basis.

The new 2.0 version was successfully launched in October and, with the restoration of marketing, early results are encouraging.
A $4.3 million increase in RMG was due to the addition of new customers and growth of existing customers, reflecting the launch of additional new games.

Operating income increased $3.2 million, reflecting the benefit from the higher revenue and improved scale of the legacy Interactive business, partially offset by the impact from acquiring and integrating Bally.
Interactive Segment Recent Business Development Highlights
Entered into 10 new agreements with casino operators, including Four Winds Casino, Turning Stone Casino and Mohegan Tribal Gaming, for the deployment of the SG Universe interactive gaming suite of products, and launched 10 new customers on the Play4Fun Network Social Casino product.

The Company's latest Quick Hit® Slots social casino app was extended to mobile platforms during the third quarter, and player marketing to increase awareness of the app began to ramp up in October.

Continued to expand the Company's RMG business by launching RMG products with nine additional online casino operators, including additional bwin/Party and 888 sites, while reaching agreements and launching new customers such as Loto Quebec and Mr. Green. For the first nine months of 2015, twenty-one new sites have gone live compared to a total of eighteen for both calendar 2014 and 2013 combined. Of the thirty-nine live sites, thirty-three are now on mobile platforms.

Launched new premium slot games, including EMPIRETM, which was the first launch of a licensed brand for Interactive customers before its introduction in land-based casinos, with the launch timing coinciding with the beginning of the TV show's second season, and more recently a new OUIJATM themed game that was the second launch of a licensed brand in social gaming ahead of its launch to land-based casinos.  

Corporate

Corporate selling, general and administrative expense was $30.4 million compared to $33.8 million in the prior-year period, reflecting the benefit of integration cost savings as well as $4.9 million of lower integration and acquisition-related costs, partially offset by the inclusion of Bally.

Depreciation and amortization expense increased $8.7 million, primarily for corporate third-party brand licensing costs and the inclusion of Bally.

Earnings and EBITDA from Equity Investments

Earnings from equity investments increased $17.0 million, reflecting the non-recurrence in 2015 of a $19.7 million non-cash impairment charge recorded in the prior-year period to write down the equity investment of the Company's Northstar Illinois joint venture, partially offset by lower performance of LNS related to a decline in retail sales of instant games in Italy and lower earnings from CSG driven by a decline in retail sales of instant games in China coupled with an unfavorable foreign currency translations impact.

AEBITDA from equity investments was $4.9 million lower year over year reflecting lower performance at LNS and CSG.

Liquidity and Capital Resources

At September 30, 2015, cash and cash equivalents were $102.1 million compared to $171.8 million at December 31, 2014.
Liquidity at September 30, 2015, was $534.1 million, reflecting $102.1 million of cash and cash equivalents and $432.0 million of availability under the Company's revolving credit facility.

Since December 31, 2014, the Company has paid down $108.8 million in total debt. In the third quarter of 2015, the Company voluntarily repaid $60.0 million, net under the Company's revolving credit facility, made $10.8 million of mandatory debt repayments, and made $1.8 million of payments on capital leases. The Company remains firmly committed to prioritizing available cash flow for debt payments.

As of September 30, 2015, with total net debt of $8.3 billion, the Company was in compliance with the financial covenants under its debt agreements.

Capital expenditures increased $29.2 million year over year to $90.8 million for the three months ended September 30, 2015, including the impact of the acquisition and integration of Bally and the initiation of several new third-party brand license agreements.

For 2015, based on existing contractual obligations and planned investments, the Company expects capital expenditures to be within a range of $310 million to $320 million.

Net cash provided by operating activities for the three months ended September 30, 2015, was $141.1 million, inclusive of $9.7 million of cash-based costs associated with integration-related and restructuring charges. Net cash provided by operating activities increased $14.8 million over the prior-year quarter, inclusive of an $8.2 million unfavorable change in working capital.

The Company received total cash distributions of earnings and capital from equity investments of $2.8 million in the September 2015 quarter, which included $1.0 million in dividends and a $1.6 million return of capital payment from LNS, and a $0.2 million return of capital payment from ITL. In the prior-year period, the Company received a dividend of $1.3 million from RCN, a $6.9 million return of capital payment from ITL and a $5.6 million return of capital payment from LNS.

Free cash flow was $50.3 million compared to $64.7 million in the prior-year period.