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Scientific Games Corporation (NASDAQ:SGMS)

2013 Gaming Investment Forum - Hosted by Deutsche Bank and UBS Conference Call

September 23, 2013 16:45 ET

Executives

Jeff Lipkin - Senior Vice President and Chief Financial Officer

Scott Schweinfurth - Executive Vice President, Chief Financial Officer and Treasurer, WMS Industries Inc.

Analysts

Unidentified Analyst

Okay, great. We are going to go ahead and get started with the next session. Next up, we have Scientific Games and WMS Industries. From Scientific Games, we have Jeff Lipkin, Senior Vice President and Chief Financial Officer. And from WMS Industries, we have Scott Schweinfurth, the Executive Vice President, CFO and Treasurer. I will let you guys – well, probably, they are going to do a little presentation and then we will open up to questions afterwards.

Jeff Lipkin

Great, thank you. And I have to read the obligatory Safe Harbor language. So if you guys can all follow along with me that will be helpful. In this presentation, Scientific Games makes forward-looking statements which are based upon management’s current expectations and estimates that are not guarantees of future results. Information regarding risks and uncertainties and other factors that could cause actual results to differ materially from those contemplated in the forward-looking statements is included in Scientific Games’ and WMS’ SEC filings, including Scientific Games’ most recent 10-Q and WMS’ most recent 10-K.

This presentation also includes certain non-GAAP financial measures, including additional information regarding these non-GAAP measures, including definitions of these measures in reconciliation to the most directly comparable GAAP financial measures can be found in the appendix to the presentation. The presentation is also posted on our website under the Investors tab.

So with that, we move on to the presentation. So again, I am Jeff Lipkin, I am the CFO of Scientific Games. I appreciate you guys coming this afternoon, wanted to give you a little bit of an update and talk to you a little bit about the combination. So just sort of the levels that because I know that there is different degrees of familiarity with the Scientific Games business. Scientific Games is a global lottery provider and gaming operator. We are headquartered in New York City. We have substantial operating presences in Atlanta, London, Leeds, Montreal, Beijing, Vienna and Santiago. We have virtually all U.S. lottery customers, some 43 jurisdictions in the U.S. And we operate in about 50 countries, very international business with about half of our revenue coming from outside the U.S. From an employee perspective, our employee base today is about 3,600 employees and our LTM revenue is $931 million and LTM attributable EBITDA is $338 million. Our attributable EBITDA is one of our financial metrics that includes our share of EBITDA from our joint ventures.

We operate in three segments. Our largest and most significant is our Printed Products segment. We are a leader in the $75 billion worldwide instant tickets market. We also provide a series of value-added services to our customers including things like warehousing, distribution and telesale. We have a growing iLottery business as well as a loyalty and rewards program. And we have very similar to what WMS does in their gaming operations business. We have a pretty robust collection of intellectual property for brands for our instant ticket business.

Systems business, we are a leader in that business as well. That’s the business of providing equipment and software to lotteries to run draw games primarily. We also operate VLT systems around the world and provide sports betting software, hardware and hosting capabilities. That’s about a third of our business and then about 15% of our business is our gaming business. In that business, we operate primarily in the UK, FOBT market, we operate a distributed network of machines that are server-based. There is in the UK some 20,000 machines that are spread out about five machines per location across the country. And we provide downloadable content and an interactive business that we are growing in that market as well.

So with that background on Sci Games, to touch on the integration, or the acquisition, the Sci Games-WMS merger is really a transformational combination. It combines a world-class lottery operator to world-class casino supplier. It’s a combination that combines from a product perspective allows us to provide to customers gaming machines, lottery tickets, scratch-off tickets, systems, sports betting, interactive. I think, at the core of the merger, one of the most important elements to it is that it allows us to leverage content across both gaming, lottery and interactive, and I think that you will see in our presentation. And that’s a very significant feature of this merger.

We are a leading gaming supplier as a combined company with extensive portfolio of products and systems capabilities. We have a comprehensive suite of interactive gaming solutions and services for iLottery and gaming and installed participation base. The Scientific Games business is largely participation oriented. And so we have on a combined basis about 40,000 gaming machines, of which 30,000 are Scientific Games machines and about 10,000 are WMS machines and about 36,000 lottery terminals that are deployed on a participatory basis, primarily in the U.S.

The merger has very attractive financial characteristics. There is anticipated to be about $120 million of run rate cash flow synergies, $100 million of anticipated cost synergies, and about $20 million of that is coming from CapEx savings, which we will be happy to touch on. There is also a very unique opportunity in this acquisition to take advantage of a very significant U.S. NOL that we had built up over the last few years. The challenge for us is about half of our revenues and cash flow comes from outside the U.S. and all of our indebtedness and a substantial amount of our capital intensive businesses are located in the U.S. So it creates the imbalance. And with the acquisition of WMS, we will be able to monetize that asset of ours.

The merger allows us to also leverage significant core competencies between the two companies. When you look at this business at a combination, it really is a mergerable scale and scope, which in the M&A world is pretty unique. And it’s a merger of scale, because we are entering into a new vertical market. And it’s a merger of scope, because we are leveraging a lot of the core competencies that exist at each of our companies. On the Scientific Games side of ledger, we have a very sophisticated systems business. We have hardware sourcing, engineering and manufacturing expertise. We have proficiency in the B2B, B2G procurement process with all of our customers largely being governments or government sponsored entities. We have a wide range of field operations infrastructure, which will be leveraged in this merger. We are a leading player in royalty programs and we have strong relationships with our government customers and regulators.

Contract that with the WMS side of the equation, they bring to their industry leading innovation, I think one of the things that we have thought from the outset of this merger and we continue to think that’s critical to a proper integration of these two businesses, is that nothing that we do in any way impacts the innovative culture that is quite unique at WMS and very valuable and something that we are going to in the integration process, Scott and I and others have gone to great lengths to make sure that we are not in any way impairing.

WMS has an unbelievably significant library of game content, high-performing game content and creates product development capabilities. They have the full suite of interactive products across real money and social play-for-fun platforms. They have an expertise in offshoring software engineering, which is something that at Sci Games we had not done to a large extent. We will leverage that in a combination and we will start to think about moving some of our software engineering resources, which are primarily located in Austria and Atlanta and Germany to locations like WMS’ facility in Pune, India. And WMS has an expansive portfolio of intellectual property and their side of the equation has strong relationships with casino operators and regulators.

In terms of the rationale for a merger, this merger creates a leading global gaming technology supplier creates – takes the advantage of very we think very favorable industry dynamics. There is in the gaming supplier space, a significant amount of consolidation that’s going on right now. We see the opportunity to take advantage of that from where we sit. We also see that there is expansion of gaming around the world that this opportunity allows us to take advantage of. And there is cyclical elements of this business and we then combine WMS at this stage of the cycle as very favorable from our perspective.

From our revenue base, the business is spread approximately half gaming and half lottery. It’s very diverse. There is no one customer that’s more than 5% of revenue. There is about two-thirds of the revenue coming from North America and about two-thirds of the revenue base on a combined basis is recurring in nature. There we enjoyed very specialized industry characteristics. I think what’s interesting is that there is a very strong customer base across the two companies, what’s interesting is there is very little overlap in that customer base. There is a couple of lotteries where WMS participates in VLT, but for the most part we view that the customer bases being opportunities on either side of the equation to help cross sell and there is substantial free cash flow generation as a result of the merger as we mentioned the NOLs but also the synergies.

Just a short I will try to explain the strategy and as simple way as possible I think if you look back to Scientific Games’ history, in 2001 when they acquired or at the time Autotote acquired Scientific Games. Scientific Games was a company based in Atlanta, Georgia that primarily printed in some tickets and primarily had customers in the U.S. and over the ensuing dozen years after that the team at Scientific Games worked hard to grow on two dimensions well both the number of products that we supply as well as the geographies that we participate. And I think a lot of our strategy with respect to WMS falls in the same category. We are seeing similar opportunity what we saw with Scientific Games in 2001 and so by leveraging these both shared unique competencies, we think that we can drive both geographic and product segment growth. So with that I will turn it over to my soon to be colleague Scott Schweinfurth for his presentation.

Scott Schweinfurth

Okay. Thank you, Jeff. So I am going to provide a little background here, here we go. So I am going to provide a little background on the WMS Company. We are headquartered in Waukegan, Illinois. We operate out of 14 countries globally and we have about 1800 employees. We earn revenues through two different ways. We either sell product out right which we call product sale business which you can see was about 56% of our overall revenues in our 12 months ended June of ’13. And then we have our gaming operations business which for the most part is leasing products or there are certain games that we create, but the only way you can get them on your casino floor is by leasing up from us and the lease payment is either a percentage of the coin into the game or a percentage of the net win of the game or in some jurisdictions where we can’t share in that because of loss we actually end up taking a fixed daily lease rate.

So on the product sales side within the last 6 months we have introduced new cabinet, complete cabinet and I will talk more about that later. But it’s really had a remarkable initial start performance of the product has been great and I will provide some statistics on that. We also have a My Poker product Bluebird 2e and Bluebird xD, so those are the four platforms good for selling in the product sales side of the business. And we believe we are the second largest ship share supplier in the U.S.

On the gaming operations side we have three types of participation games we have wider progressive games, local area progressive games and standalone games. And we have just under 10,000 of these out in the installed base and they are earning us a daily lease rate revenue of about upper 60s and that business tends to be a bit more recurring revenue whereas the product sales side is a dog-eat-dog fight everyday with our account executives out trying to get our customers to allocate their capital to WMS versus any of our competitors. In addition within our gaming operations business we also have our interactive business and I will show you some slides later on that will show you the tremendous growth that we have seen in the last 12 months in that interactive business and we do both social gaming, we do real money gaming and play for fun.

So on the products sales side we reported our June quarter results by about a month ago and we saw some really good momentum as a result of having that Blade cabinet to sell. Up until the launch of Blade in March 2013 we pretty much have the oldest products that of our competitors now with the Blade cabinet with the new CPU 3 platform and the capabilities of that platform we are able to generate greater demand from our customer base and indeed for the June quarter we believe all-in we had a 21% ship share in the U.S. and Canada and that what presented 40% sequential improvement over what we had seen in the March quarter.

In addition we were able to restart sales of the video gaming terminals to the taverns in Illinois right at the end of that June quarter. So between what we were able to sell in the months of March when we launched Blade and what we are able to sell during the June quarter we got 3,400 Blade cabinets out. And the performance on those cabinets is being quite strong I am going to show a slide demonstrating that, but in general it’s been averaging 1.5 times to 1.6 times house average over the 4 months period that we have the product out. This is G2E you can imagine we are going to be introducing a number of new video titles 40 new video titles for the Blade cabinet that you will see when you get to the floor tomorrow. And we have got a bunch of new series of products Supercharge Reels, Monster Progressive, Reel Intensity and the new generation of our Colossal Reel games which have been strong performers for WMS.

In addition we are also going to bring out a 3-reel mechanical Blade cabinet and the importance for that for WMS is that in the past the 3-reel mechanical has been somewhat around 30% of our overall units sold but over the last 18 months, 24 months it’s only been about 5% of the products that we’ve sold, so having an updated cabinet with great content on it we are hopeful will also help us continue to grow our ship share.

So this is some performance data relative to Blade and there is sort of two columns of information here. The columns on the left are showing for all of the units that are out for the six titles that we launched to it the average index which you can see is 1.55 house average. And then – this is the left hand column side and the right hand columns we have the units that have been in the field for 4 or greater months. And here you can see that the performance is 1.50 times house average. This is very significant that we have been able to see continued strong performance at this level over an extended period of time and that’s certainly what is driving the demand that we are seeing for that product.

Here is a view of the Blade mechanical products and I know many of you followed WMS over the years have been nagging me for I don’t know how long when are we ever going to have a mechanical reel on top of the WMS gaming product branded with Monopoly? Well, you are going to see it at the show tomorrow. But we are also bringing out as I said the mechanical reel from the for products sales side coming out with eight new games we are expecting to launch this product in the March 2014 quarter and really get back into that mechanical reel business.

On the participation side we also launched a new cabinet style called Gamefield xD and we launched that also in the March ‘13 quarter and out of 6 months period we have been able to get out 1,500 of the Gamefield cabinets, so it’s been very well received. We have launched with two Wizard of Oz games followed then up with the Monopoly game and just recently launched an Iron Man game you can see in several of the casino properties here in the strip. At G2E we are going to be introducing two new brands for that cabinet style Clue and Beetlejuice and you can see the Beetlejuice game is here I strongly recommend you come through the booth and have one of our producers are product people demonstrate these products to you because they are a boatload of fun. And we are pretty sure that’s going to continue the strong performance of that product in going forward.

In addition we are also going to be introducing some new titles for some of the premium participation brands that we have placed in the past more Monopoly games more Wizard of Ox games sort of the ring games etcetera. And what we are trying to do is expand the footprint of those games that are in casino floors. At our zenith, we were just under 10,500 with and about 500 striking distance at this point in time and we are hopeful with the quality of product that we are bringing out and the performance of that product that people will see on their casino floors that we will be able to exceed the overall installed base high that we had achieved.

Interactive products has really been a tremendous growth element for us from a revenue standpoint. You can see this was shown by quarter the revenues from that business over the last six quarters we did two acquisitions in this business. In the June ’12 quarter we bought Phantom EFX which really got us into the social gaming product line that business has been the primary driver for the growth that we have seen over the last year. We also bought a company called Jadestone which does games server integration which means they have made their servers interoperable with all of the major European online casino operators. And they have content on their servers that can be played and obviously our play here was to put the WMS content on these servers, because we thought that would improve the performance of the Jadestone company and we are just now we have announced a number of deals we have signed for that and we are now into the point of launching our product on that platform at this point.

On the Jackpot Party social casino, this is one of those crazy things where people are willing to pay money for something they otherwise would get for free, but they are willing to do it and we have seen very high monetization rates of our products there. And we believe that our monetization rates are on par with what the best of the industry has to offer. We also offer in addition to offering that Jackpot Party social casino on Facebook, you will also download the app on both Apple and Android systems at this point in time. And we are among the top four casino providers on both of those devices at this point.

We believe that we are well-positioned today. You are going to see lots of innovation and product differentiation and creativity on the floor – trade floor tomorrow. The performance of both Blade and Gamefield xD has sort of gotten our swagger back so to speak. And we are very excited about all the new content that we will be showing for each of those platforms on the trade floor. We are bringing out new video poker game for our My Poker platform. And we are also introducing a multi-game platform called Game Chest for the international market. This is something that our international team has been seeking for quite a while and we finally got to the point where we can offer this product to them. So we are very excited about that. And again, the tremendous growth that we have seen with WMS, I am sorry with Williams that are active should continue as we move forward. And we also believe we are well positioned to capitalize on the future. So we are trying to diversify our channels of revenues. So we are making a stronger play at global video lottery terminal business and at class 2 gaming of business which is something that we have had a little bit in the past, but you will see again on the trade floor that we have an abundance of products that we are bringing out for that.

We are going to continue to remain true to the innovation model. That’s something that’s worked for WMS in the past. And I think that’s one of the things that Scientific Games people have learned as part of the diligence and integration process that does make WMS special. And we are going to continue with that innovative focus as we move forward. We are going to be focusing on enhancing profitability and Jeff is going to talk in a few minutes about some of the class synergies that we think are possible with the acquisition. That’s certainly going to help with profitability along with growth that we are expecting and should share in placements of our participation product. And on the interactive side we want to deliver solutions that enables seamless and engaging play across all mediums for players worldwide.

With that, Jeff, thank you.

Jeff Lipkin

We just had a couple more slides before we wrap up. Just to give you a picture of the combined company post close, business will continue to be headquartered in New York. We will have major operational facilities in both Georgia and Illinois. On a combined basis, there will be approximately 5000 employees and revenue will be upwards of 1.6 billion in EBITDA inclusive of $100 million of cost savings that we have discussed approaching $700 million in EBITDA.

The business will be organized as we announced about a week and a half ago into two groups. We will be a gaming group and a lottery group. The gaming group will include everything that’s WMS today including some of the Scientific Games’ gaming assets and our VLT systems business, our UK global draw gaming business as well as some of the North American gaming activities that we have. On the lottery side, also we are pulling together what was previously operated as separate businesses into one group that will be called the lottery group and it will include everything that we currently offer in that business. When you sort of look at the combined company and its position within the sector, we are very excited about the positioning of the entity it puts us up in the upper echelon of gaming suppliers, the top competitors in both the lottery and gaming space. And I think what’s most important and most interesting is that we expect to have best-of-breed margins as well.

And then just briefly on the acquisition in terms of status update, I think many of you know the deal was announced back in January. Scott and I have been living together now for 8 months. It’s one of these things where we have been doing it for so long that it’s hard to imagine that we actually haven’t been working together at this point, but we are looking forward to moving beyond integration planning and into actually executing. I think we are well prepared. We have had a team of 30 plus people for the last 8 months working on extremely intense integration planning process. And I think we know exactly what we just need to get to closing.

From a U.S. antitrust perspective, we received an early termination in March. And from a shareholder, WMS shareholder perspective, we received approval in May. And then following up on that approval, we immediately launched the debt financing for the transaction, which is a $2.3 billion term loan and a $300 million unfunded revolver that has been totally syndicated and allocated, just the only condition to closing that facility is getting the remaining regulatory approvals and on the topic of regulatory approvals, we continue to make progress towards the timing that we announced at the outfit of this deal, a fall closing. There has really been fortunately nothing that’s come up as we have been through this process that has been a surprise or negative. It is unfortunately a very significant process and encompasses a large number of jurisdictions that we feel pretty good about how we are progressing.

So with that, Scott and I would be delighted to take any questions.

Question-and-Answer Session

Unidentified Analyst

If you have any questions, there is a microphone right here in the center, and I will try and kick it off and then if anyone has any questions, just get hold of the mic. You guys have been working together you just spent some 8 months, so you guys have been very, very close for that time, have there been any surprises in the integration process that as you guys have gone through?

Jeff Lipkin

I will start and then you can add Scott. So we have spent quite a bit of time in the due diligence process and developed a pretty extensive plan. What’s most interesting to me is sort of the old 80/20 rule that really isn’t much different from what we anticipated. Every time, we roll up these synergies we are within spitting distance of where we are back in January before we announced the deal and what we presented to the Board. So we feel very comfortable about what we have communicated in terms of synergies, the timing of them, the quantity of them, and there fortunately has been nothing that’s been very surprising that the recent performance in WMS’ business is something that we had anticipated and certainly something that I think their performance exceeds our expectation. So we are very pleased with that as well.

Scott Schweinfurth

Yes. I guess, I would say from the WMS perspective, we are the acquiree. So you never know quite what to expect in this process. We weren’t sure whether it was going to be the Scientific Games people in a room huddled together figuring out how they wanted to sort of do things to the WMS business, but I guess I would say we were very surprised that it’s been an incredibly collaborative effort, these teams which Jeff was talking about are teams that have both WMS and Scientific Games representatives on it. I think the conversations that we have had have been incredibly open, transparent and honest. We have gone down different paths in different areas. There is still more that needs to be done to sort of finish some of this off, but I think we have a clear understanding of what things are going to be and how things are going to move forward and how we have got the management team at WMS that has been announced and for the most part of the same management team that’s been there. And I think that’s given the employee base a little bit of a morale boost that the company is going to continue pretty much similar to what it’s been doing in the past.

Unidentified Analyst

Okay. Jeff, you touched on the WMS performance that you kind of anticipated the rebalance here so to speak of off of where you guys WMS type come from? What have you seen out of the results so far in the year and then kind of where do you think the trajectory is from here as you guys go forward?

Jeff Lipkin

Yes. So I think the most compelling evidence of their progress has been really the improvement in ship share and the new product that they had moved in a relatively short period of time. The fact that Scott demonstrated with the statistics that on, at least just relative to house average, the machines are performing extraordinary well and they are holding up over the entire period of measurement. And then on the participation business, we love that business. It’s something we want to grow with the WMS folks. So it’s really no different than what we anticipated, it don’t need a lot of consultants helping us, we’ve great experience in the gaming industry within our company and we huddled up in a conference room for several weeks and most of the people in the back row were not talking to me for about a month, but the point of it is that at the end of it we really had a very good sense of the products what sort of caused WMS to have a misstep in the past and what we felt was the right direction going forward. And to be honest, a lot of what they are doing was their own self-correcting. We feel opportunistic in the fact that we are able to buy them at this point in the cycle and much of the things that we are suggesting to do are really being facilitated by this transaction, not necessarily things that we are suggesting that Sci Games suggest – these are things that WMS had wanted to do are frankly things that we wanted to do that this deal is just the catalyst to make it happen. So we feel very good about the early indication.

Unidentified Analyst

You mentioned – you touched on the synergies earlier, as you have gone through the integration process, has there been anything that you have gained more confidence in that you can achieve, is there anything that you have seen that if you go okay, we might have to try a little bit harder in this area. So it generates the synergies you mentioned the $100 million before the CapEx synergies, but just in general as you kind of look at the buckets now where are you most comfortable and where you really need to go work hard and get?

Jeff Lipkin

I mean, when you look at the $100 million it really kind of neatly breaks down into like three major areas. So the first area is really G&A, which that’s probably 65% of the first year savings. As you merged the two companies immediately, there is the obvious overlap in G&A. I think when you get into the second year of integration, you start to take – get the benefits of things like offshoring and outsourcing, which are longer lead time initiatives. I think all the experience and exposure that we’ve both had with each other in the last 8 months in the planning that we have been able to do prior to closing, we feel very confident that those activities will be achievable. And again in both cases, we wanted to offshore our software development in WMS’ case was looking to look at alternative sourcing methodologies to reduce the cost of their equipment, but these are not necessarily ideas that we told each other we should do. It’s just that a merger of this size is a catalyst for them to happen. So it is absolutely amazing to me every time. And we have had three summits along the way that every time we roll up the synergies that we are literally basically in the same place. And there is about 30 teams doing it. So I think we don’t actually Scott or I could see the number until like 20 minutes before we go in the room and sort of one of those things where it’s just interesting. And here and there, there are some things that we thought there might be an opportunity. And reality is there is another opportunity that was bigger than we anticipated, but I would say more or less it’s very consistent.

Scott Schweinfurth

I think when you started you were at $90 million that was the announced number at the start. And then as time went on and people got more comfortable at the time of the financing, you have raised it up to $100 million. I think that’s a sign that the progress was being made and as Jeff said by the time we have done the full roll up of the numbers, we have been able to support out the $100 million number.

Jeff Lipkin

I mean, it’s important to understand that the $100 million is actually coming from both Sci Games and WMS. So when you look at that number relative to the combined expense base, it’s less than 10%. So it’s not a heroic effort in terms of the size of what we are proposing so.

Unidentified Analyst

You guys kind of kicked off the M&A within the space here. There has been another deal announced since then kind of how are you guys look at the space over the next couple of years and just from the Sci Games side, looking at the combined companies, do you foresee something where you need to do another kind of acquisition to kind of complete like fill out a space, which you don’t have or anything like that over the next couple of years?

Jeff Lipkin

Yes, I mean I will start Scott and you can finish, but from my perspective, the gaming supplier space is one that probably needed some level of consolidation. There is just a lot of competitors when we look at it relative to the lottery space which is much more consolidated. We see an opportunity to have scale benefits by going through consolidation. And in terms of additional products or services, I am sure there will continue to be opportunities. Since we have announced it and I am sure whenever we close it, we will continue to have a good backlog of opportunities to look at that are either technologies, intellectual property, tack-on businesses that are in certain geographies that are all attractive to us and quite frankly would accelerate some of the revenue synergies that we anticipate in the merger. So it’s always a build versus buy opportunity there. And in a consolidating space sometimes that opportunities presents themselves at the right time, so.

Scott Schweinfurth

I can’t tell you how many investor meetings I have sat through where people have said gee, shouldn’t there be some consolidation in the gaming supplier side of things. And finally, we have gotten to a point where there is some and you are right, Scientific Games sort of kicked it off if any of you know David Berman from Macquarie, you are going to want to get on his holiday gift list because he has had a very good year this year with all the deals that he has been involved in. So it’s I think there are some opportunities we have looked at a variety of them together over the last couple of months and we will continue to do that as we move forward.

Jeff Lipkin

I mean the financing market is being one that has been for much of 2013 have facilitated this to a large extent so…

Unidentified Analyst

Okay. Well, that wraps up discussion there. Thank you so much guys. I appreciate your time.

Jeff Lipkin

Thank you.

Scott Schweinfurth

Thank you.

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