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Scientific Games Corp (NASDAQ:SGMS)

Deutsche Bank Leveraged Finance Conference

October 2, 2013 01:10 PM ET

Executives

Jeff Lipkin - CFO

Analysts

Unidentified Analyst

Good morning, everyone. Our next presenter company is Scientific Games. Scientific Games has been around for a long time. In fact I used to cover the Company very closely back in the early 1990s, mid-early 1990s after they I think acquired Autotote, if I recall correctly acquired a company called Autotote.

Anyhow, the company has recently made another big acquisition acquiring one of the top three manufacturers in the gaming business WMS. And here to present for the Company is Jeff Lipkin, the Chief Financial Officer. Sir maybe you could close the doors back there, thank you. Jeff?

Jeff Lipkin

Thank you, and good morning, everybody. Before we start just going to read our Safe-Harbor language. In this presentation of 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 these forward-looking statements is included in Scientific Games’ and WMS’s SEC filings including Scientific Games’ most recent Form 10-Q and WMS’s most recent Form 10-K.

This presentation also includes certain non-GAAP financial measures additional information regarding these non-GAAP measures including the definitions of these measures and reconciliation to the most directly compared GAAP financial measures can be found in the Appendix to this presentation. Presentation is posted on our website under the Investors tab. So with that lets.

Just level set for those of you who don’t know Scientific Games. We are a global company. We operate in little over 50 countries. We have substantial operating presence in Atlanta, the U.K., Montreal, China, Austria and Chile. We are headquartered in New York City. We have about 3,600 employees and we operate in three distinct areas. About half of our revenue today comes from our Printed Products segment. Printed Products is our business where we operate in a roughly $75 billion worldwide market producing scratch off tickets.

We print annually somewhere in the 40 billion ticket range. It’s a very significant part of our business. We also do what we call value chain management services, which is really forms of outsourcing for states and governments we do things like warehousing, distribution, Tel-Sell, marketing as well as in increasingly with the advents of privatization outsourcing activities for certain states or governments.

We also operate a very significant loyalty and high lottery business through this segment. And this is a segment of our business that has a very substantial license property component.

About a third of our business 20%, 30% of our business comes from lottery system. This is our business where we provide the technical infrastructure, the systems, the hardware, the point of sale equipment, to operate for lotteries in the United States on a management basis, participation basis, the draw based games. So, Powerball, Mega Millions that you would see in any of the 45 U.S. jurisdictions.

It’s about $200 billion worldwide market outside of the U.S. we generally sale the equipment to suppliers and then increasingly through an acquisition we consummated about a year ago we have now the technology to do both LAN based and interactive sports betting we’re legal around the world.

And then our gaming business which is about 16% of our revenue today is largely a participation based revenue stream. We operate somewhere around 30,000 terminals. Our biggest concentration is in the U.K. LBO market. These machines are at the Ladbrokes and Corals, the world and we operate server based gaming installation where we download content real-time to these machines.

Really the gaming component of our business throughout of the lottery business is that we basically has similar component tree and similar wide area network technology for our system.

We also, given our geographic breadths, are often structuring growth through joint venture. It’s sort of an opportunity for us to grow our business and at the same time mitigate the capital investment. And so the first handful of these the first five of these joint ventures are really how we have expanded our lottery business outside the U.S.

The first is in Italy, the next two are in China the fourth is Greece and the fifth is our privatization entity in the United States. And then we have two legacy joint ventures from our racing days, Robert is the communications network where we used to simulcast content through and then Sportech actually acquired our racing business when we sold it in 2012.

The joint ventures are an important part of our business as you can see recently we have just added New Jersey and Greece. The expectation is that there is some great new opportunities that will be coming through both the consolidated operations as we print tickets and also through the joint venture as we operate these businesses.

Switching over to WMS; WMS is headquartered in Illinois, they have a presence in 14 countries around the world, they do about 700 million of revenue and about $225 million of attributable EBITDA, have about 1,800 employees and focus on two markets. They really focus on one sector which is the slot machine business and the content and distribution of that content in a variety of different end markets.

They primarily produce machines for the casino and VLT operators. It launched a new platform called the Blade at the end of the first quarter, which has had very good commercial success in its first four months in the market place. They launched a new poker platform at the end of calendar 2012 and they still support some Bluebird cabinets that are pretty substantial deployment of those in the market today.

They are the second largest supplier measured by ship share in this category. And then they operate a gaming operations business which has two activities, one is that's where they have, their participation based schemes, they have about 10,000 games where they earn either percentage of net win or a percentage of coin in on those machines. And they have launched a new cabinet called the Gamefield xD recently as well for that marketplace.

This is their segment of their business that they put license brands on, we have a great degree of overlap between our two companies, our largest licensor is Hasbro. WMS’ largest licensor is Hasbro, so we think there is an opportunity between both of us having a very significant license brand component to our business to leverage that in the combination.

And then they have a very rapidly growing and successful interactive business where they do basically two things, they port LAN based games to an interactive environment and they operate social casinos.

Just to put a couple of seconds on the WMS business because they really have in the last few months seen a very significant improvement as part of our diligence in buying the business we felt that the business was at a inflection point and at least to date we have continued to feel good about that assumption.

Their June quarter, their June fiscal, so they just ended their year but their quarter reflected very good momentum; this was the first full quarter of having both the Blade and the Gamefield terminals out there. They saw on the sales side record new replacement unit ship, their ship share all in including all the other end markets Class II and VLT was about 21%, was substantially higher on just the U.S. Class III market, which ended up being about 40% improvement in their ship share over March quarter this year.

And for a period of time we’re unable to sell the VLT market in Illinois but recently have been able to change legislation and sell again one of the growth markets in U.S. this year.

The Blade terminal that they have has been extraordinarily been successful as I mentioned, they have shipped about 3,400 machines since it was introduced at the end of March. I think what's most telling about the performance of this cabined and this game is that it's performing at 1.5 to 1.6 times average, and that's both for the current terminals that have been distributed, but it's also the average over the life that that terminal has been in the field.

So if you average over the four months that they have been selling these machines, not only had they performed very well relative to its competition, it's actually held, which in this market is very important for our casino customers.

G2E just last week introduced about 40 new games for the Blade platform; these are variety of new game play mechanics and themes, so there is a very good portfolio of content to support these platforms and most impressive from my perspective at G2E was the diversity of products that they demonstrated, if you think about this the company has been either a merger or in integration since last G2E and they had just an outstanding mix of products, products that were not only geared towards the Class II markets but also Class III markets, but also towards the Class II markets, the VLT market, international they had, you can tell the product targeting Asia, and they came out with their first stepper product which is a 3-reel mechanical game. The 3-reel mechanical game has been a significant component of their sales in the past in the sell market, it’s been upwards 30% in the last several years that had 5% of sales in that market, primarily because it did not have product to sell into the market. So, having the new Blade 3-Reel mechanical is something we all are very excited about.

Just quickly on the participation side, as I mentioned they’ve seen substantial growth in their participation base. They went through period of time where they had in their state of terminals pretty old mix of machines and over the last sort of 18, 24 months they’ve upgraded that so that at this point about 80% of their state is been newer generation machines which is important because it allows them to continue to put out leading content for those machines because of the component the newer generation. So they have been through that cycle but have about 1,500 of these game fields machines that the game show that Iron Man and Beetlejuice.

So, very interesting important factor looks like very different than any other slot machine. It looks almost like pin ball machine which is very interesting given the history and legacy that WMS’s had and it’s continued to do very, very well in the field and has produced really industry leading yields on the machine. So we’re really excited about the Gamefield xD. If you look it relative to other technological innovation that they put out and the ramping of those sales from those new technologies compared to the recent century emerging or the transmitting technology that they’ve done it’s far and excess succeeding the ramp rate of those technology. And again here there is a very strong pipeline of product to support these platforms which is extraordinary important for the participation business.

Just where we are in the acquisition we announced the transaction at the end of January is for $26 in share roughly 1.5 billion in consideration, we received antitrust approval in March, we received stockholder approval in May and then shortly like two days after getting stockholder approval we launched is indicated and allocated the financing for this transaction. So, its $2.6 billion seen in credit facility which 300 million is a revolver and 2.3 is the term loan. So, now the only condition is just closing to drive down the funds and from a regulatory approval process, we Scientific Games has several lottery licenses but we’ll require to get license in the large number of jurisdiction to operate in the casino market and so we’ve been working through that over the last nine months to make really good progress, just last week we were granted a license in data which for some of you, I’m sure you’re aware is one of the key markets and had very good success getting through that process.

When we look at the company on a combined basis, what we’re doing is, we’re really not messing much with the WMS business. We are moving some of our gaming assets into what we’re calling the gaming group so our current UK participation business and business in North America of operating VLTs and VLT networks where we’re reporting up through the gaming group and then our lottery business will be largely intact.

The combined company is going to be headquartered in New York still with major operations in Georgia and Illinois combined basis will do about 1.6 billion and about 663 million of EBITDA, EBITDA inclusive $100 million of anticipated run rate cost synergies and we’ll have an employee that’s around 5,000 employees.

The combination is very transformative for us. You’ll see in a moment but we end up creating one of the largest most diversified B2B and B2G global gaming suppliers. Now, as you look at M&A deals this is unique deal in some respects because it is both a scale and scope transaction. So, from our perspective we are entering a new vertical and gaining substantial scope but at the same time we are able to get a lot of leverage out of the core corporate functions within the two companies and that’s the scale elements of it.

We end up coming together as a leading company and gaming machines lottery and ticket systems, sports betting and interactive and I think at the core of this transaction is really the leveraging of content across all of these hysteric end markets. And WMS is got a very long and rich history in producing some of the best content for the gaming market and is an extraordinarily innovative culture which we’re looking forward to leveraging in all of our end markets.

We’re going to be a leading gaming supplier with again a pretty extensive portfolio of products and systems capabilities and we’re going to have a comprehensive suite of both iLottery and iGaming products, so this merger will bring together the WMS iGaming business and the Scientific Games iLottery business and be able to delivered the customers a integrated suite of products and then we’ll have a fairly large installed participation base machine unit.

And then importantly from a financial perspective, we have communicated for several months now that we anticipate a $100 million of anticipated cost synergies from the transaction and about $20 million of CapEx savings and I think importantly one of things that this transaction does for us is it allows us to unlock a very significant asset in NOLs that we have in the U.S. that currently given that the makeup of our business is being half outside of the U.S. in all of our interest expense in U.S. and fair amount of our CapEx from the U.S. that we’re unable to utilize and so at the end of last year that was about a $255 million asset that this transaction will allow us to monetize.

When you sort of rank us against the peers and both sort of the combined gaming technology supplier base what you see is that we together become a much stronger, more diversified company when you look at the combined revenue and EBITDA but I think what’s most important is when you look at combined EBITDA margin, we anticipate having some of the best margins in the industry.

When you look at the capital structure, again as I mentioned we have already syndicated the $2.6 billion senior credit facility which will be about two-thirds floating and one-third fixed will continue to have the three tranches of high yield that mature in 18, 19 and 20th scientific games and effectively have a $2.3 billion term loan, were a BA3/BB- rated corporate credit and we end up being somewhere around 4.5ish time leverage of closing this is as of June and relative to where we are in a standalone basis, it’s not really very difference.

From a liquidity prospective and importantly from a debt maturity profile, we are going to be able to enjoy several years of no maturities and we are going to have substantial liquidity both in the form of cash and [undrawn] revolver at closing and from my prospective I am excited to be able to have a largely, pre-payable debt structure going forward which I think given the cash flow characteristics of this merger will be able to take advantage of.

Just on the cost synergies, what we have communicated was 50 million in year one, 100 million by the end of year two is coming from three primary areas which oversimplified about 50% of it comes from SG&A. The SG&A savings is from overlapping corporate functions, it’s coming from having duplicative G&A functions.

It’s coming from leveraging procurement across the larger enterprise; it’s coming from public company cost that will go away and thinks like [indiscernible] public accounting firms we feel that we have great line of sight into that $60 million bucket of that integration. We are not touching in anywhere near the creative elements of what makes WMS so special today, namely the R&D effort and the sales effort that they have.

And then really there is two other buckets, the R&D bucket is a little bit of a misnomer. We are not actually cutting the WMS R&D in a larger centers; duplicative platform that we are eliminating, duplicative technology that we are leveraging and most importantly what’s driving that saving is that we Scientific Games have a substantial amount of our software development in, what I would say are higher cost jurisdictions namely Georgia, Germany and Austria.

And WMS has a owned and operated facility in Pune, India that we are going to take advantage of, something that frankly was an independent company we have been doing, we are trying to do and we had plans to do it but this will, this transaction the transformational nature that will allow us to substantially accelerate moving resources to a lower cost jurisdiction and frankly if you look across the gaming suppliers state, I think we are probably one of the only guys that actually not in this jurisdiction at this point.

And then cost savings is coming largely from a competency that we have that we are going to be deploying at WMS and that is that we in the lottery space spend the great deal of time in engineering and procuring our capital for the contracts that we participated and as [cheaply] as possibly. And we sort of wake up every day and it’s in our DNA’s how to reduce the cost of our point of sale equipment and we think that there is an opportunity at the WMS, something that they were doing under their own anyway.

But this transaction will accelerate the opportunity to take cost out of the production of their both for force sale and participation products. And what this 22 million represents is if you assume a thousand dollars of cost that we can take out across a base of, I think [indiscernible] basis 22,000 machines, literally $22 million. So it’s also an area that we feel very confident and one of the challenges of this transaction is that we announced at the end of January.

But one of the clear benefits that we have had now eight months of intense integration planning with M&A consultants living with us. And so at this point, we are ready to go and we feel very confident in our ability to achieve these synergies and at this point I think collectively the teams are happy and willing to close and move on to the next stage of integration.

Just touching on a couple of revenue synergies, there are few that we are focusing on. I think one of the biggest areas is that we at Scientific Games have a robust systems capability. WMS unlike some of its competitors doesn’t actually have a system, somewhere that hurts them and is certainly in international markets, there is a requirement be able to sale machines, to be able to have a system that goes with it.

And so we actually in some of the international markets that they have an interest in getting into or already have a system in that market. But we will continue to work with our colleague at WMS to develop to sort of next generation system that allows them to continue to take advantage of these opportunities to grow their platform.

And then as I said secondly the international expansion opportunity, at Scientific Games we given our customer base as having like one or two max customers in any jurisdiction we have a great opportunity with infrastructure in 50 countries to be able to leverage that and help them grow outside the U.S. and I think you simplify the strategy for WMS down to like the most possible, simple it’s really to grow in as many jurisdictions and as many products as we can.

And that’s exactly how Autotote acquired Scientific Games, how we develop the Scientific Games business which was largely in its ticket business and largely in the land of Georgia and today is in, have of dozen different businesses in 50 countries. So we feel very confident our ability to do that. I think the other idea is that we’ve already seen some success on the interactive business. There is a very compelling case we made by marrying the iLottery and iGaming business. We recently together won one of the state procurements in Delaware to take that interactive business forward raising some benefits of the combination.

Then there is a good opportunity for us to leverage. You know it’s interesting. We actually don’t compete, really at all. And we have very little customers that overlap but obviously we believe that our lottery relationships could be very helpful to WMS. We would look to try to help them on a VLT basis getting into lottery jurisdictions where our customers also do gaming machines and then there is obviously an opportunity for us to try to sell our systems to casinos. So there is good cross selling that we are going to take advantage of.

In terms of cash flow if you sort of just add the two LTM EBITDA together and add this 100 million of synergies and sort of adjust for our joint ventures taking out what hit the P&L and adding in the cash distribution that we got on an LTM basis. And then pro forma in for the LTM CapEx and interest and taxes and making the assumption about working capital needs. And our view is that it’s probably somewhere between $150 million to $200 million of real free cash flow this business will generate for the foreseeable future. So we’re excited about that opportunity.

So in summary, I think this transaction is really transformative, and the one we are very excited about. It definitely changes the complexion of each of our businesses, and creates a global gaming technology supplier. We see some very favorable industry dynamics right now in terms of the consolidation that’s happening in the slot machine business and the opportunity to become a bigger player there, and the diversity and recurring revenue nature of our business, leveraging the marquee relationships that we both have in the portfolio brands, and then obviously we just commented on the cash flow generation that comes with this merger.

So with that, that’s our prepared presentation. I think we have a few minutes for questions.

Question-And-Answer Session

Unidentified Analyst

[indiscernible]

Unidentified Company Representative

So what’s the question now? The opportunity of internet gaming.

Jeff Lipkin

Yes, so as I mentioned I think we believe that the combination of iLottery and iGaming is going to be a compelling set of competencies to bring to market and we already do what they do. WMS has a pretty growing and driving business in that area. So they have, so do we, actually in our gaming. We have a business where we port our most successful LAN based games to the interactive environment, both on mobile and on computers.

And then we also have a business what we do for fun which is largely social today and Jackpot Party is their vehicle with which they do that. Really it is extraordinarily successful depending upon what’s that you look at. It’s one of the top four sites that they have, that participate in this area. And our view from our diligence was that what’s really driving that is the desire for players to get the casino content that they have.

There’s a lot of people that are competing in this market. But we feel that the content is what drives both stickiness with players and attracts them to your side. And so we are excited about being able to be an end-to-end provider; like in Delaware, what we were doing there. But also be able to leverage their content that WMS has in the interactive environment which is really what we’ve seen in terms of driving monetization of players. You know it is hard to know but the people that have real traditional slot content seem to have been very successful in monetizing customers.

Unidentified Analyst

[indiscernible]

Jeff Lipkin

To get what? No. We are getting license to be a casino supplier and part of the regulatory process that I mentioned, to own physical.

Unidentified Analyst

[indiscernible]

Jeff Lipkin

I think our combined view on interactive is there is sort of the Razor and then there is the Blade, and our view is that the platform is really the razor and the content is really the Blade and that there is a well established group of people who provide platforms today. Frankly it’s been legal for a long time in Europe and so it’s a very competitive field where people will spent a lot of money developing technology for that end market. And from where we see the opportunity for us more to monetize our content. And ultimately that’s where we see the value and as I said.

Unidentified Company Representative

Sir we got a gentleman behind you, thank you.

Unidentified Analyst

[indiscernible]

Jeff Lipkin

I am not sure I understand your question. I mean were we doing a $1.5 billion acquisition the day after we close? Probably not. But might we consider in a consolidating market an opportunity to grab assets that we think that are once in the lifetime assets? Perhaps.

I think what we would probably be more interested in from an investment perspective is probably if there is intellectual property or there are technologies that we could exploit across the combined platform or if there is a geographical or end market opportunity for us if we could buy something that immediately gave us a big footprint in a certain geography or in certain end market that might be of interest.

Unidentified Analyst

Integration is always difficult, taking two different companies of almost comparable size in putting the other, what do you think the challenges will be in the next year, you know, that you guys have focused on to make sure that this gets down right?

Jeff Lipkin

It’s a great question. So we’ve spent an extraordinary amount of -- and usually doing acquisition you’re sort of married 45 days later. We have been hanging out together for 9 months. And so this is not sort of just climate together and hope for the best. We have extraordinarily detailed integration plan that we worked on collectively and I will tell you that the WMS people have led half of those team and the Scientific Games people have led half of those teams. And when you look at the synergies, I will further tell you that a good portion of this is coming out of Scientific Games.

I actually have the opportunity to add it up. I will tell you that it’s maybe half and half something like that type of math and so I think I feel very good about the mechanical nature of bringing these two companies together because to a large extent we’re not touching their gaming business.

They will be getting additional assets in our gaming assets coming over to the gaming group. We definitely have Scientific Games’ people who are embedded in the old structure of WMS and we did that deliberately to make sure that two end markets communicate appropriately and exploit opportunities across both end markets appropriately.

I think the one area that one worries about in doing this that you can’t prepare for is that they’re very different cultures. The WMS [indiscernible] is extraordinarily innovative and it’s hard to appreciate that from the outside looking it and something having spent 9 months living with them that I fully appreciate now and it’s something that from the outside we were very mindful and we are very mindful of in the integration to protect because the innovative nature and the creative nature what comes that WMS is really one of core assets to this business, the people that generate these products.

Unidentified Analyst

So what are you doing until, I mean, they’re very innovative, they’re very creative, they’re very kind of independent and now you’re going to be taking them over, what do you do to make sure that you don’t squish that they just want to leave and go somewhere else?

Jeff Lipkin

So it’s a great question beyond the structural stuff like stable on that you’d anticipate a merger. You know what we’re not touching other areas that generate creativity within the business. You’re not seeing us take over their content generation division or their R&D function.

What you’re seeing is that there is two finance people or there two legal people, and so the area that we’re seeing the cost synergies coming from are not in any way directly affecting the functions that are the creative functions and so by keeping them manage by the same individuals and independent and in Chicago where they’re today.

Unidentified Analyst

So the entire gaming business will be operated out of Waukegan?

Jeff Lipkin

Waukegan in Chicago, two facilities, and Illinois and we’re not touching that. The entire gaming business is going to be in Illinois and the entire lottery business is going to be in Atlanta. We have cross-pollinated with senior executives. We have great visibility in where we’re going in terms of revenue synergies, but to a large extent we’re very supportive of their business plan. That was part of the premise for us doing this deal. And we had conviction in these new products the Gamefield and Blade coming to market.

Unidentified Analyst

And my question is that, there is no doubt that WMS had a rocky road in the last 12 to 18 months. What can you guys bring to just sort of provide them with the infrastructure and stability they like utilize this great product that they have to grow with less of the issues that they sort of dealt with?

Jeff Lipkin

It’s a great question, so obviously we spent an extraordinary amount of time in our due diligence trying to understand both how they got to where they got to and how they anticipate to get out of where they got to.

And if you boil it down and oversimplify, they effectively had some very advanced technology that they thought would be the spur the next replace cycle in the U.S. market and it was serve base gaming which really never played out for the whole host reasons why which you all know.

And down themselves flatfooted by not having new products for the end market that they were going into and it was just, they have put a lot of eggs in this baskets and strategically obviously we will makes sure that we continue and WMS recognizes themselves a normal cadence of bringing new products to market and new content to market.

And then I think in addition obviously I think by diversifying the business both geographically and product wise, we reduced the dependency on the U.S. replacement market which is part of the overall focus on that market and over focus on some technologies that impend out that largely caused them to get where they got.

Unidentified Analyst

I think we’ve come to the end. Jeff will be around the whole day. So if you guys have any other questions, please feel free to ask them and thank you very much for coming and thanks Jeff for taking our conference.

Jeff Lipkin

Thank you.

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