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Bally Technologies, Inc. (NYSE:BYI)

F2Q2014 Earnings Conference Call

February 6, 2014 4:30 pm ET

Executives

Ramesh Srinivasan - President and Chief Executive Officer

Neil Davidson - Senior Vice President, Chief Financial Officer and Treasurer

Analysts

Steven Kent - Goldman Sachs

Steven Wieczynski - Stifel Nicolaus

Joseph Greff - JPMorgan

Joel Simkins - Credit Suisse

Todd Eilers - Eilers Research

Carlo Santarelli - Deutsche Bank

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter Fiscal Year 2014 Bally Technologies Conference Call. My name is Denise, and I'll be your coordinator for today's call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session at the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

At this time, I would like to turn the call over to the Chief Financial Officer, Neil Davidson. Please proceed, sir.

Neil Davidson

Great. Thank you, Denise, and welcome everyone to the Bally Technologies second quarter fiscal year 2014 earnings call. For today's call, I will cover our overall financial results, and then I will hand the call over to our President and CEO, Ramesh Srinivasan, who will add some further commentary on the business, before we open it up for questions.

First, let me review our Safe Harbor language. Today's call and simultaneous webcast contain forward-looking statements that involve certain risks, uncertainties and assumptions regarding Bally and our future business. These forward-looking statements are based on currently available information. Actual results could differ materially from those anticipated in the forward-looking statements, and reported results should not be considered an indication of future performance. We do not intend and undertake no obligation to update our forward-looking statements, including those related to forecasts of future performance, the potential for growth of existing markets or the opening of new markets for our products, future prospects and proposed new products.

More information on many of the various risks and uncertainties that may affect our business and financial results or may cause us not to achieve our forecasts are included in our annual report on Form 10-K for the year ended June 30, 2013, and other public filings we make with the Securities and Exchange Commission. The forward-looking statements made on this call and webcast, the archived version of the webcast and any transcripts of this call speak only to this date, February 6, 2014.

Today's call and webcast may include certain non-GAAP financial measures within the meaning of Regulation G. A reconciliation of all such non-GAAP financial measures to the most directly comparable financial measures, calculated and presented in accordance with GAAP, can be found in today's earnings release.

In fact, with the closing of the SHFL acquisition, we will be referring to adjusted earnings per share, adjusted operating income and adjusted operating margin percentage on our calls going forward, all of which are non-GAAP financial measures. Now, onto the quarter.

Today, we reported financial results for the second quarter ended December 31, 2013, marking our 10th consecutive quarter of year-over-year earnings per share growth on an adjusted basis. Revenue is at an all-time quarterly record of $285.2 million, up 20% over last year, driven primarily by all-time quarterly record Systems revenue of $85.5 million, up 51% over last year, and the inclusion of $29.4 million of revenues from SHFL for the 37 days post close. Revenues from recurring sources were also an all-time high and represented 51% of total revenues.

Adjusted earnings per share was $1.06, up 33% over last year. GAAP diluted earnings per share was $0.54. Both adjusted earnings per share and GAAP diluted earnings per share included a $0.02 loss related to negative foreign currency movements during the quarter and we incurred a total of $0.03 per share in foreign currency losses during the six months ended December 31, 2013. With the continued devaluation of several foreign currencies since the beginning of calendar 2014, particularly Argentina, we expect to incur additional foreign currency losses during the remainder of fiscal 2014.

Now on to the business. Electronic Gaming Machines or EGM, revenues from EGMs were $88.1 million for the quarter, up 7% from $82.6 million in the prior year, primarily driven by the sale of 1,025 Illinois VGTs versus 399 in the second quarter last year, the inclusion of 587 Equinox cabinets and 90 Electronic Table System seats through SHFL, but offset by the absence of Canadian VLT sales which amounted to 568 units in the second quarter of last year. We sold 5,152 new units during the quarter, including 3,652 units in North America, of which 2,000 were replacement units.

International unit sales improved largely as a result of the inclusion of Equinox sales in Australia and Asia as well as higher sales in Mexico and Central America, but were offset by lower sales to South America, particularly in Argentina. We believe weakness in sales in Argentina will continue for the foreseeable future, given the recent currency devaluation and continued import restrictions.

Average selling price or ASP for the quarter was $15,936, down slightly from last quarter. Our ASP continues to be impacted by mix including shipments of lower ASP Illinois VGT units and certain international sales during the quarter to lower ASP jurisdictions like Mexico. With the strong current backlog for the Pro Wave cabinet, we expect the ASPs in the back half of fiscal 2014 to increase over the first half.

EGM margins were 48%. However, after excluding $3 million of one-time inventory charges related to the acquisition, margins were 51% compared to 53% last year. Gross margin in the second quarter of fiscal 2013 benefited from the exercise of a lease buyout which added about 200 basis points.

Gaming Operations; revenues from Gaming Operations were $97.3 million, down slightly from $99 million in the comparable period last year. Gaming Operations were impacted by product mix and lower yields on certain variable fee games. However, results benefited from strong second quarter results from the New York lottery market as well as the inclusion of 2,985 leased ETS and Equinox EGMs.

Our Cash Connection WAP link ended the quarter with 1,804 units, up 35 units from last quarter. Centrally determined system unit count declined again by 2,948 units, primarily driven by the removal of certain license fees in Mexico. However, as a reminder, these are single dollar per day units. The margin on Gaming Operations was 70%, consistent with the comparable period last year and within our expectations at 68% to 73%.

Systems revenues set a fourth consecutive all-time quarterly record of $85.5 million, up 51% from $56.7 million in the comparable period last year, and was slightly ahead of our expectations. Maintenance revenues for the quarter were $24.7 million, up 6% from $23.2 million in the comparable period last year and down slightly from last quarter due to the temporary drop in unit count in certain customer credits. The margin on Systems revenue was 72% for the quarter, down from 76% last year, driven primarily by a higher mix of hardware revenues generated during the quarter.

With respect to Table Products, revenues from Table Products, which includes the sale and lease of shufflers, chippers and proprietary table products, was $14.3 million, which included $8.8 million of utility revenue and $5.5 million of proprietary table game revenue. Table Products margin was 71% after excluding $1 million of inventory charges related to the acquisition.

The effective income tax rate was 36% for the quarter. We expect our effective income tax rate for the remainder of fiscal 2014 to be between 35% and 36%. With respect to interest expense and amortization expense, interest expense for the quarter was $11.8 million, of which approximately $6.9 million was incremental and associated with the new term loan B, higher borrowings on our revolving credit facility and the amortization of new debt fees incurred. We expect interest expense will approximate $21 million per quarter for the remainder of fiscal 2014, of which approximately $17 million or $0.28 per share is incremental expense related to the acquisition of SHFL.

We have preliminarily allocated the purchase consideration for the SHFL acquisition with approximately $507 million being ascribed to identifiable and tangible assets which we anticipate amortizing over a weighted average life of approximately 9.5 years. For the quarter, amortization expense associated with the purchased intangibles was $5.5 million or $0.09 per share. Going forward, we expect amortization expense associated with the acquisition will approximate $13.5 million per quarter or $0.22 per share.

Before I turn it over to Ramesh, I'd like to provide a brief financial update on the acquisition of SHFL, which as I mentioned is included for 37 days of our second quarter results. We funded the acquisition with a new $1.1 billion term loan B and a $330 million draw on our existing $700 million revolving credit facility. As of December 31, 2013, we had $1.94 billion of debt outstanding, which was comprised of the $1.1 billion in term loan B, $353 million in term loan A, and $500 million drawn under our revolving credit facility. Our pro forma leverage was approximately 4 times.

Aside from reinvesting in our business and the potential for tuck-in acquisitions, we anticipate that we will continue to allocate our excess cash flow towards the repayment of debt with the goal of reducing our leverage ratio to approximately 3x within the next two years. The acquisition financing was provided on a fully committed basis and we paid approximately $5 million in ticking fees. By clothing on November 25 instead of the outside closing date of June 30, 2014, as set forth in the merger agreement, we avoided paying about $100,000 per day or nearly $22 million of additional ticking fees. At present, we expect the transaction to be accretive on an adjusted earnings per share, adjusted EBITDA and free cash flow basis in fiscal 2014 and we continue to expect it will reach GAAP accretive levels during fiscal 2015.

With the closing behind us, we initiated full year fiscal 2014 guidance for adjusted EPS with a range of $4.30 to $4.50. This guidance includes $2.05 per share of results for the six months ended December 31, 2013 which is comprised of adjusted earnings per share of $2.02 plus an add-back of $0.03 per share loss from unfavorable foreign currency movements incurred during the first six months of fiscal 2014.

In looking at consensus estimates, we now – some of our analysts have provided adjusted earnings while some have contributed an unadjusted earnings per share estimate. We believe adjusted earnings per share is a more appropriate metric for comparability purposes and we believe we have provided transparent disclosures in today's release with a reconciliation of adjusted measures to GAAP and an estimate of interest and amortization expense for the remainder of the fiscal year.

Finally, we now expect annualized synergies to be at least $40 million, up from the previously expected $30 million, a run rate which we anticipate accomplishing by the end of calendar 2014. With that, I'll turn it over to Ramesh.

Ramesh Srinivasan

Thank you, Neil. While also being a record quarter in many respects, Q2 fiscal year '14 has been a transitional quarter for Bally. We continue to make very good progress in our objective to be the provider of choice to the gaming industry with respect to both content and technology across the entire spectrum of gaming needs.

We do understand comparisons of our Q2 results with earnings estimates and other general expectations are going to be difficult. Inclusion of only 37 days of SHFL results make comparisons a bit odd. But integration process is moving forward well, while we are also making excellent progress in all our core business areas as our results continue to show. And as Neil just discussed, we have initiated new guidance and look forward to a promising future.

First, an update on the integration process. Practically, all aspects of the integration have gone better than expected since we closed on the 25th of November. The senior executive team was put in place day one and they hit the ground running. The product development, sales and services teams have come together quickly since then. Our combined services teams are well-known for their extraordinary customer-centricity. We've made good progress towards planning, achieving and exceeding our high levels of customer service only more efficiently now.

Most of our product development roadmap have been decided and released to customers. The entire integration planning and management groups are doing a great job of keeping us focused on both the integration efforts and core business execution. We now believe merger-related cost synergies will exceed $40 million on an annual run rate basis by the end of calendar 2014, with approximately half of that realized between now and the end of fiscal 2014.

With respect to the Q2 results and looking forward, let's start with Table and Utility Products. Table and Utility Products were only part of this quarter for a little more than a month but they made a strong impression nonetheless. In shufflers, the MD3 became the fastest model to reach 5,000 units placed, doing so in just 4.5 years. In roulette chippers, we secured the first customer commitments in both New Zealand and the U.S. for the ChipStar.

In proprietary table games, established products like 6 Card Bonus and Ultimate Texas Hold'em continue to expand, as they've been doing for some time now, while our new commission-free versions of Baccarat and Pai Gow Poker are off to a very good start.

With respect to EGM sales, we had a good quarter, aided in part by Equinox enjoying an excellent quarter in Asia, selling almost 250 games. We also had our best quarter yet in Illinois, selling over a 1,000 VGT units. Since we entered the Illinois market, we have sold over 3,400 units so far. We expect to continue to make inroads into the Illinois market well into FY '15.

With respect to the other markets, we have a number of titles which are proving to be top performers in multiple locations. Titles like Golden Tower, 88 Fortunes, Shadow Diamond, Siren of the Sea, Cash'M If You Can and the Quick Hit series of games are performing well. Customer response to the new Wave cabinet has been strong, reinforcing how important hardware innovation also is in this industry. With all that momentum behind us, we expect year-over-year increases in domestic replacement units starting in our third quarter, which will partially offset the absence of Canada VLTs this year.

The Duo Fu Duo Cai link is just starting to rollout in the U.S., where it will be on a fixed daily fee in most markets. This link has been one of the top performing in Asia for some time now, and with the rest of the SHFL content, we believe we are poised to improve on international EGM sales in the future. We believe the SHFL content which provides us with an additional style of game will further strengthen our content portfolio in North America, in both EGM sales and Gaming Operations.

We continue to invest in our third-party game development agreements, including a recent contract extension with Hi5. We anticipate being ready to launch within the next few months a number of international market-specific game product features which have been developed during the last couple of years. Some of them have been on display at the ICE Show in London this week.

With respect to Gaming Operations, despite being a few months away from our next series of significant premium game launches, the December quarter performance was reasonably good. The normal seasonal decline in certain of our variable fee games was further weakened by the December gross gaming revenue softness in many markets. Our variable fee yields generally improved in January over December but remained below peak levels. Our Gaming Operations revenue is about 45% variable, of which a meaningful portion is generated from the New York lottery market. The New York lottery had a strong quarter to cap off a very good calendar 2013.

As we mentioned in our last call, and in line with our expectations, our WAP installed base was relatively flat this quarter, growing by only 16 units. We expect our WAP installed base to see higher growth trends starting in the June quarter, helped by our upcoming releases of James Cameron's TITANIC, The Magic of David Copperfield, Pink Ladies - a follow-up to Grease, and other premium games.

We continue to expect that our increased investments in Gaming Operations related R&D efforts during the recent past will help us increase the number of WAP and premium games released every quarter. This increased output should help minimize time gaps between game releases on all our Games Operations cabinets.

We see enough market share gain opportunities before us, even if the broad gaming revenue headwinds make market economic conditions temporarily challenging. We believe that our investments in Gaming Operations will continue to increase.

The Systems division had another strong quarter, setting a quarterly revenue record for the fourth consecutive quarter. Gross margin percentage being at the lower end of our expected range is essentially a reflection of this quarter being our best in many years in terms of revenue from system hardware like iVIEW and DM. Our services teams were busier than ever as we had more installations than we expected during the quarter, resulting in a record quarterly revenue level.

We did a record number of Elite Bonusing Suite installations during the quarter. Recently developed software modules, like the Bally Enterprise Progressive System, BEPS, continue to gain traction with new installations completed in multiple casinos. The breadth and extent of our Systems customer base provides us an ever-expanding opportunity to innovate, create, enhance and sell additional software modules.

Given the increased momentum in the marketplace for hardware products like iVIEW and DM, we expect gross margin percentage to be around 72% for the remainder of FY '14. We now expect Systems revenues in this fiscal year will be at least 20% ahead of FY '13. Please note that we forecast the Systems business on an annual basis and this year may not follow the quarterly patterns of the past few years. The revenue level achieved during this past quarter was probably the high watermark for FY '14.

We realized a few years ago that to do well with Systems, we needed to build scale. Our increased R&D investments in Systems during the past few years were aimed at achieving that scale. Now with revenue levels arguably more than all our competitors combined and with an approximately $100 million annual run rate maintenance revenue stream, we believe that we have now given ourselves the kind of scale and R&D strength required to deliver ever-increasing innovation, service and value to our customers.

Efforts in our R&D labs are currently underway to mobile enable our various Systems products, enable better integration of all aspects of gaming across the entire casino floor and beyond, and to create increasingly more sophisticated and configurable marketing tools. We all know that the casino operated environment is more competitive today than ever before. That also means that the need for operator competitive advantage enabling modules is currently higher than ever before. I think the general discourse in this industry will soon be at least as much about overall technology spend as it is about replacement rates.

Regarding our Interactive division, we continue to make good progress with our Interactive business, both as a technology provider and as a content provider. Our significant presence in systems gives us a meaningful competitive advantage as an iGaming technology provider. Our iGaming Platform is now live in New Jersey for real money wagering. We are currently in the process of introducing additional mobile, poker and proprietary cable content related features to the site. As the calendar year progresses, we expect our New Jersey customer to start taking advantage of integration with our back-end core systems and launch one view of the patented-based marketing promotions.

As a content provider in the interactive space, our library of proprietary cable content and the exclusive relationship we have with Ongame Poker in the U.S. adds further strength to our already strong gaming content. Our broad-based content is currently being utilized both for real money wagering and for free play locations across the U.S., Europe and South America.

On the cost side of our business, when we discussed the integration related synergies, the majority of them are within SG&A. As we complete the initial phases of cost synergies, we will continue to manage this area actively. There will always be more work to do. Over time, we expect SG&A to decrease as a percentage of our revenues.

We continue to invest in and grow our cost-effective R&D efforts across all our product lines. Our R&D being about 11% of revenue understates the extent of our R&D efforts. Our 1,250 plus talented and dedicated employees in our India development centers continue to do excellent work for us, complementing our other phenomenal R&D teams all across the world including in the U.S., Australia and France. We believe that we derive much more R&D value than the 11% to 12% of revenues suggests.

Now having said all that, let me quickly summarize our current environment before we hand the call back over for questions. One, the SHFL acquisition successfully closed ahead of our anticipated schedule and we've been able to identify approximately $10 million more of additional cost synergies since closing. The fast closing eliminated significant financing fees and has allowed us to begin the integration efforts earlier than expected. We now look forward to the next phase of the integration which will focus on longer-term strategic initiatives designed to cross pollinate content and technology across our product lines with the goal of generating new and additional sources of revenue.

We also believe our greatly improved diversification of both products and geographies resulting from the acquisition will prove to be a winning combination. Such diversification will help reduce the effects of short-term market challenges in any one area and also provide multiple future growth platforms. We expect to gain EGM ship share in North America with the addition of the Equinox cabinet and a different style of proven leading content. From an international standpoint, Equinox has just begun to penetrate faster growing markets like Asia with strong success. Overall, we will remain very disciplined, working to maximize the value created by the SHFL acquisition.

Two, our underlying business continues to progress positively as evidenced by the strong second quarter results we were able to achieve and the future outlook we have provided. We continue to innovate and compete in all segments while managing costs prudently. Our Systems competitive strength continues to increase with every passing quarter. We are confident that four consecutive quarters of record revenues is only the beginning. Our large majority of our current customer base do not possess many of our recent innovative products like iVIEW DM, the various Elite Bonusing Suite software modules, Service Tracking Manager, and the Bally Enterprise Progressive System.

On the game side of the business, the new Pro Wave cabinet, which we released in late December, is off to a solid start and we believe it reinforces our position as the innovation leader and provides us with yet another promising catalyst for EGM sales. We also remain confident that our Gaming Operations business is well-positioned to see growth resume by the end of fiscal year 2014 and into fiscal year 2015 and beyond. We remain dedicated to further expanding our WAP and premium footprints and will showcase even more new and exciting brands and games at G2E 2014 to complement the seven WAP titles shown at G2E 2013. We continue to manage cost effectively without sacrificing growth and innovation. Excluding acquisition related and other one-time costs, our adjusted operating margin during the quarter was a record 27%.

Three, this industry is well on its way towards being as much about technology advancements as it has been about product investments. The underlying DNA of Bally is also moving in that direction and is well-positioned to lead and participate in that transformation. That game now is about being the best technology and content provider in the industry, being the best innovator in the business and executing well on all the carefully laid out strategies aimed at increasing shareholder value at every turn. We are ready for it.

With that, on behalf of all our Bally and SHFL teams, I thank all of you and our customers and partners for your continued support and guidance. Now, Denise, let's open up the line for the question-and-answer session please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Steven Kent of Goldman Sachs. Please go ahead.

Steven Kent - Goldman Sachs

A couple of things. Just wanted to talk to you a little bit about how you're seeing the weakness across the regional markets. You mentioned it a little bit in your discussion but IGT on their conference call mentioned that they were having – that their ability to lock in sales was difficult, and I just wanted to hear your view on timing of sales, whether the weakness in the regional markets is preventing you from being able to lock in sales two months, three months or six months out, or whatever your normal cycle is? And then, you mentioned the $40 million in cost savings would be in SG&A, but can you be a little bit more specific on where those might be?

Ramesh Srinivasan

With respect to the GGR weakness, let's talk about Gaming Operations, only about 44% of our Gaming Operations revenue is variable. So, in terms of our business spread across the various business areas that we have, it doesn't affect us that badly as it probably affects other companies. And in terms of revenue and business visibility, we have not seen any major change in the situation. The GGR weakness has affected Gaming Operations revenue to a certain extent but not as much as it has probably affected the other vendors in the business. But leaving aside Gaming Operations, as far as EGM sales, systems visibility, the rate at which customers are planning systems implementations and purchases, we have not seen a major change in all of that as far as our business is concerned, Steve.

Neil Davidson

Yes, and I would tell you, remember that from a sales standpoint we were launching the Wave. So, if anything, customer anticipation of the Wave has built a pretty good backlog there. With respect to the synergies, we think a majority of the synergies are going to come from SG&A. It is a mix between payroll, it's a mix between legal, marketing, all sorts of stuff. I'd say it's probably maybe half and half.

Steven Kent - Goldman Sachs

Okay, thank you.

Neil Davidson

Yes, and a lot of that was quite frankly some of the overlap in both Bally and SHFL senior executive team that Ramesh mentioned on the call with kind of day one.

Operator

Our next question will come from Steve Wieczynski of Stifel. Please go ahead.

Steven Wieczynski - Stifel Nicolaus

So the Equinox sales in the quarter were much better I think than we were looking for. Wondering if you could help us think about how you plan to position that product going forward. I assume the better sales probably came out of Australia but I know Shuffle Master always had the dream of bringing that product into the U.S. and some other international markets as well, so maybe just help us think about how you plan to position that going forward?

Ramesh Srinivasan

In terms of positioning the Equinox cabinet in Asia and Australia, there is no change in strategy. We continue to position that cabinet in those geographical areas just the way SHFL used to. Only thing, now we have additional Bally cabinets like the V32 cabinet for instance, that we can now position two different cabinets in those areas to increase our ship share there, so that one plus one becomes greater than two.

Now in terms of bringing it to the U.S., that is more of a reality than a dream, Steve, now and the Equinox cabinet is being placed in multiple casinos, mostly on a Gaming Ops basis. It is more on a fixed-fee kind of basis than it is on a sale basis at the moment. So currently, the Equinox placements are going to help Game Ops revenue than they help EGM sales for the foreseeable future.

Neil Davidson

Yes, and with our regulatory team, SHFL didn't have it approved in a whole bunch of jurisdictions by the time we took over in November and we're working hard to get approvals in all the jurisdictions in the U.S.

Ramesh Srinivasan

More than the cabinet, Steve, that kind of math, that kind of gambler style math is something that we've always been looking for, that not just from a cabinet perspective but even from a content perspective it's a very complementary addition to the content that we could place in the U.S., and with all the U.S. sales infrastructure that we have, that becomes an additional tool to increase our ship share in the U.S.

Steven Wieczynski - Stifel Nicolaus

Okay great. And then Neil, with respect to the guidance, I mean still with I guess five months left in your fiscal year and having that $0.20 delta still there, what are the one or two things that are going to swing that guidance one way or the other to the top or the bottom?

Neil Davidson

I think from, first Systems, Ramesh kind of pointed out where we thought Systems would be, we got really good visibility into that. With respect to Gaming Operations, we expect economy to kind of stay where it's at. Having said that, we have a number of different releases that Ramesh mentioned that are coming up, so kind of the timing of those releases and how the pipeline forms can give you a little bit of a range. We have a new cabinet, Wave, we feel good about it, we feel better than good about it. We've got a great backlog depending upon how that goes. We have a new business with Equinox cabinets coming into the U.S., some of that is timing dependent as I mentioned from a regulatory standpoint. And then Australia seems to be a pretty steady-eddy so to speak with respect to the Equinox cabinets itself, but can be penetrated a little bit better now with a stronger sales force with our V32 content. And Asia…

Ramesh Srinivasan

And we also have good reasons to believe we'll get good contribution from the Table Products as well, products like MD3, DeckMate 2 and all that are pretty well set to penetrate certain markets better, particularly in the international areas.

Neil Davidson

And then finally just a range of synergies.

Steven Wieczynski - Stifel Nicolaus

Great. Thanks guys.

Operator

Our next question will come from Joe Greff of JPMorgan. Please go ahead.

Joseph Greff - JPMorgan

Neil or Ramesh, you may have answered this, the incremental $10 million of cost synergies, where is it actually coming from? You talked about marketing, payroll, legal is an area but where is that incremental coming from?

Ramesh Srinivasan

It's coming mostly from the SG&A areas, Joe. Most of the synergies are coming, most of our cost synergies are coming from the SG&A area and as the last couple of months we have worked hard to understand the joint business better and as we understand it better, we realized that we initially underestimated what the extent of cost synergies could be. It's not any new area, it's coming from the same areas but we are finding more cost synergies.

Neil Davidson

It's interesting when you pontificate about synergies during the planning process and then you take one and one, and you look at the combined financials together, a lot more things catch your eye.

Joseph Greff - JPMorgan

And then, when you look at your back half of EPS guidance, how much of these synergies is baked in there?

Ramesh Srinivasan

Joe, I would say, if you want to do the math, I would say about half the cost synergies of the $40 million plus that we are expecting have kind of just about been achieved as of now. So I would say five months of that you could bake in into FY '14 and then it will continue to ramp up towards the end of calendar 2014.

Joseph Greff - JPMorgan

I mean the way I look at it is, if you guys are doing on average the next two quarters $1.175 of EPS and you find another $10 million or $20 million of SG&A, that's another $0.60 to $0.70 per quarter, but we can talk off-line.

Neil Davidson

We're not going to find all that in the quarter, right, to Ramesh's point.

Joseph Greff - JPMorgan

Not in the back half of the year but I'm looking at it more from a next year's perspective. Within the embedded Systems guidance, have you incorporated much credit from the two Systems deals recently announced?

Ramesh Srinivasan

As a general rule, Joe, I'd like to do my best not to discuss actual customer deals when we talk about Systems revenue. Every quarter there are always big installs and a bunch of small installs involved in our Systems revenue. You could probably expect one of those deals in our FY '14 numbers but ALH is going to be more towards the latter half of FY '15.

Joseph Greff - JPMorgan

Great. And then my final question, you gave us a lot of information going through the quarterly results in your comments about the maintenance revenue performance. You said there was a drop sequentially and you gave a reason. Can you just repeat that and maybe elaborate on that a little bit for us?

Neil Davidson

Sure. So there are some maintenance billings that are based on a number of connections. Some of those had a temporary drop in the number or the total count. So we had a little bit of a drop in maintenance and then we had a couple of customer credits. I would expect this is kind of a blip and that by next quarter we continue back up with a growth. So I wouldn't get too confused in trying to model it, I'd just pick back that growth.

Joseph Greff - JPMorgan

Great, thanks guys.

Operator

Our next question will come from Joel Simkins of Credit Suisse. Please go ahead.

Joel Simkins - Credit Suisse

Obviously we've been focusing a lot so far on the cost synergy side of the equation for SHFL. How are you thinking about revenue synergies and I guess you sort of integrated the entire portfolio and show up for sales pitches, how are you working to sort of bundle the entire platform and did they drive up sort of higher pricing?

Ramesh Srinivasan

See cost synergies are a little bit easier to measure and talk about while revenue synergies are a little bit more difficult, Joel, to actually measure. As the revenue growth continues and as we continue to become a better company, it is very difficult to ascribe a particular reason to a particular sale.

But having said that, I will tell you that the sales team have done a very good job of coming together during the last month or so, there definitely exists a lot of good cross-selling opportunities, both Bally and SHFL have had very strong customer relationships and those customer relationships are going to help us place products in front of customers which we have never done before because we didn't have that kind of relationship, so that is going to help. And then our new markets, for example SHFL slot content has never been launched in South Africa, so that's an area that we will start working on because we have strong relationships in South Africa. The kind of great content that has been so successful in Asia from SHFL has not been placed in the U.S. so far, that our U.S. sales team is going to help do that.

There are also a lot of product integration possibilities and value-added enhancements when you put cables and slots together. I think the ETS business of SHFL, our infrastructure, our ability to do cost-effective Systems R&D is going to help grow that business better, and I could go on and on. So there are a lot of such areas where we are going to make each other better and one plus one is going to be more than two. But it's difficult to quantify those, it's difficult to put a time basis on those.

Joel Simkins - Credit Suisse

Sure. And Neil, you talked pretty positively about the Wave. Can you just give us a sense of kind of what percentage of unit sales that looks like and what kind of ASP premium might that have versus the traditional kind of run-of-the-mill cabinet?

Neil Davidson

It has roughly a 10% ASP premium and I'm not at liberty to give you the exact numbers. I don't want to give the competitors anything.

Ramesh Srinivasan

And it is the technology behind it, Joel, apart from all the numbers. If you had walked the floors in the recent Consumer Electronics Show, everything was about curved screens, that's what it was about. So it is both a great innovation and it is also perfectly timed innovation, right. That is the current state-of-the-art, curved screens is what it's all about, so therefore it has particularly timely appeal.

Joel Simkins - Credit Suisse

And one final question if I may, Ramesh, you obviously talked about the significant installed base you guys have created at this point within the Systems business. I know you've been certainly driving over a number of years to drive that maintenance revenue piece. Is that something we should be thinking about growing us through the high single-digits, low double-digits going forward or are you going to be more cautious with pushing up maintenance fees?

Ramesh Srinivasan

By the way, I mean our maintenance fees increases, Joel, have not been because we've been increasing prices or anything like that, it has just been because there are a lot more customer product combinations today than few years ago, that's what it's reflective of. So there's no pricing pressure or anything like that in the marketplace. As we continue to increase our customer base and when one customer has five products today and had only two products three years ago, that increases our maintenance revenue. So it is just a natural part of the growth of the business. There is no particular price increases we need to do to grow that.

Joel Simkins - Credit Suisse

Thank you.

Operator

Our next question will come from Todd Eilers of Eilers Research. Please go ahead.

Todd Eilers - Eilers Research

Want to ask on Gaming Ops, I think you indicated you expect growth in the second half, can you maybe give us a sense for what gives you confidence in that, is it just the content that you have ready to release or do you have a certain level of backlog for some of the new titles, just kind of what gives you that confidence in light of the current environment for growth in the back half, and then I have one other question?

Ramesh Srinivasan

Todd, that Gaming Ops growth we expect towards the end of this fiscal year comes based on the number of releases that are about to come out in the next few months. There's a whole lot of premium brand names and non-brand names related WAP and premium games that are going to be released during the next few months and it is based on the initial feedback we have received about those releases is what gives us the confidence.

And in general, going forward from there, the effect of all the R&D studio increases we have done over the last couple of years, and now when you add the SHFL acquisition, we have very strong game studios in Australia and in China as well. So given the number of studios have increased, we now will be able to focus even more R&D studios on Game Ops. So, the general number of premium WAP releases every quarter is going to increase in about a few months from now.

So there's going to be a lot more consistency of game releases and quantity and quality-wise, that is what gives us the confidence about continued growth in Game Ops. And you add to that the fact that our market share is not great today in the Game Ops segment. We have a lot of market share gain opportunities in front of us as well.

Todd Eilers - Eilers Research

Okay, great. And then just one question on the equipment sales or EGM sales, I don't know if you guys gave it but when did the Pro Wave launch or when do you expect it to officially launch, and can you share maybe what the kind of backlog looks for that platform relative to other platform launches? And then the second part of the question was related to the Illinois VGT market, obviously very strong quarter for you guys in this quarter, how should we kind of look at that going forward on a quarterly basis? Should we expect similar type of level or might that drop off a little bit?

Neil Davidson

So, with respect to the Pro Wave, I would say, again I'm not going to give you exact backlog numbers, I'll say it's strong, it may even be stronger than we originally released the Pro Curve. So we are feeling really good about Wave overall. With respect to Illinois, look, it was a pretty busy quarter and we had been averaging about 600 or 700 units a quarter. I suspect 1,000 units is probably pretty high quarter to beat and it probably goes down a touch next quarter.

Ramesh Srinivasan

But the good news there, Todd, is that games continue to perform very well there, and don't forget it's a systems market for us as well. So in terms of customer relationships and all that, we deal both with games and with systems in the Illinois market and that could help us going into the future as well.

Todd Eilers - Eilers Research

Okay. Thanks guys.

Operator

Our next question will come from Carlo Santarelli of Deutsche Bank. Please go ahead.

Carlo Santarelli - Deutsche Bank

Just on the Gaming Ops footprint, I know you spoke of some new releases and you guys had mentioned how were a little bit less immune to peers given the amount of fixed units in your base, but when you look at the year-over-year mix change and you look at the year-over-year revenue performance in the segment, could you guys kind of explain what you think is causing some of the revenue pressure there given the WAP rollouts that you had last year that necessarily were a little bit – they are a little bit bigger portion of the mix this time around?

Neil Davidson

I think a couple of things going on and as Ramesh mentioned, we weren't necessarily immune to December GGR. Some of our variable fee products were impacted. However, because certain percentage of our variable fee comes from the New York lottery, that market has performed well. What we mean by product mix is, some of our WAP releases and in fact some of our premium releases are getting a little bit long in the tooth, meaning for example there are still some NASCARs out there that are performing okay. That game has been out there a while and is in need of a refresh. So we've got refreshes coming in the next coming months but we didn't really release the remaining new products going into this quarter, and as a result we – A., we're able to keep our WAP footprint at the same level by performance of those specific game themes that have been out some time had come in.

Ramesh Srinivasan

But the bottom line really, Carlo, is we have the ability to grow our Games Ops revenue and margins even if the environment remains a little bit tough. I mean no question about it. I know if the tailwind starts, nothing like it, that will be great, but we do have the ability to grow the Gaming Ops business even if the environment remains a little bit tough for a little bit longer.

Carlo Santarelli - Deutsche Bank

Understood, and then just in terms of the unit sales on the gaming equipment side, I may have missed it in the release, and if I did I apologize, but would you guys be able to breakout your replacement units and your domestic as well as international – domestic units as well as international?

Neil Davidson

Yes, so domestic was 3,652, so that it gets you to about 1,500 units international if my math is right. And then our replacement units were roughly 2,000 units, and then of that, international number, don't forget that's up and we hope will be up in the future because of Australia and Asia sales that we're getting now as a result of having the Equinox cabinet.

Carlo Santarelli - Deutsche Bank

That's great. Thanks Neil, that's helpful.

Operator

Ladies and gentlemen, that will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Ramesh Srinivasan for his closing remarks.

Ramesh Srinivasan

Thank you, Denise, and a great job. Thank you for handling a wonderful call. Thank you all on behalf of all our employees, SHFL and Bally. We are very grateful for you taking the time and for all your interest and thank you for all your guidance. Talk to you soon. Thank you.

Operator

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.

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