Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Scientific Games Corporation (NASDAQ:SGMS)

Q2 2014 Earnings Conference Call

August 5, 2014 16:30 ET

Executives

Bill Pfund - Vice President, Investor Relations

Gavin Isaacs - President and Chief Executive Officer

Scott Schweinfurth - Executive Vice President and Chief Financial Office

Analysts

Steve Wieczynski - Stifel

Mike Malouf - Craig Hallum Capital Group

Todd Eilers - Eilers Research

Cameron McKnight - Wells Fargo

Brian Mullan - JPMorgan

Operator

Good afternoon, ladies and gentlemen and thank you for standing by and welcome to the conference call for Scientific Games Corporation’s 2014 Second Quarter Results. At this time, all participants are in listen-only mode. Following the prepared remarks, you will be invited to participate in the question-and-answer session. As a reminder, today’s conference call, August 5, 2014 is being recorded.

And now, I will turn the call over to Mr. Bill Pfund, Vice President of Investor Relations. Please go ahead.

Bill Pfund - Vice President, Investor Relations

Thank you, Ryan. Good afternoon to everyone and thank you for joining us to discuss Scientific Games’ 2014 second quarter results. With me are Gavin Isaacs, President and Chief Executive Officer; and Scott Schweinfurth, Executive Vice President and Chief Financial Officer.

Before we start, let me review our Safe Harbor language. Our call today contains comments that constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements, including statements regarding our outlook and future business conditions, are based on currently available information and involve certain risks and uncertainties. Our actual results may differ materially from those anticipated in the forward-looking statements. For information regarding risks and uncertainties, please refer to our earnings press release, information posted on our website and our filings with the SEC, including the company’s most recent Annual Report on Form 10-K and in our more recent reports filed with the SEC. The forward-looking statements made on this call and webcast, the archived version of the webcast and in any transcripts of this call are only made as of this date, August 5, 2014. During this conference call, we will also discuss certain non-GAAP financial measures. A description of each non-GAAP financial measure and a reconciliation of such item to the most comparable GAAP financial measure can be found in our earnings press release.

Now, let me turn the call over to Gavin.

Gavin Isaacs - President and Chief Executive Officer

Thank you, Bill. Good afternoon, everyone. First, I want everyone to know that I feel extremely proud and privileged to have the opportunity to lead this great company. This is a very exciting time for us. And I believe we have even more exciting times and opportunities ahead. For you baseball fans I believe Yogi Berra said it very well. This is a once in a lifetime opportunity and I have already had a couple of them.

Let me briefly highlight some of the key takeaways from our 2014 second quarter results. Revenue was $417 million, up $182 million over prior year quarter and included $170 million contribution from WMS and the 7% increase in lottery group revenue. The net loss was $72 million compared to $12 million in the prior year quarter. The increase included a $26 million pretax loss on the early extinguishment of debt associated with the refinancing of our 9.25% notes along with higher interest expenses in the quarter of $24 million and an $8 million charge recorded in earnings from equity investments related to our share of an estimated net shortfall accrual recorded by our Northstar Illinois joint venture.

Our attributable EBITDA was $132 million compared to $85 million in the prior year quarter, which reflected the year-over-year contribution from WMS and continued growth in the lottery group, partially offset by a decline in earnings from equity investments primarily due to the $8 million charge relating to our earnings from our Northstar Illinois equity investment. I think it’s worth noting that in addition to the quarterly sequential increase in revenue, partly reflecting seasonal influences, our attributable EBITDA also increased on a quarterly sequential basis. This increase reflects the benefit from our ongoing integration efforts and the progress made in improving our operating performance such as reducing the cost of product sales in the gaming segment and in reducing the cost of instant games in our instant products segment.

Scott will provide more details on our financial performance, but before turning the call over to him I would like to share some of my observations on our business as today marks my eighth week at Scientific Games. As you review Scientific Games at our core I believe we are relatively simple company. We have two businesses, our gaming business and our lottery business. These are organized into three operating groups; lottery, gaming and interactive. We break our lottery business into instant products and lottery systems and provide complete financial segment data on both. Over time we expect our lottery business in aggregate to provide steady growth and cash flows due to the nature of their portfolios of long dated contracts.

Within our gaming business we have three lines of business revenues our interactive products and services, our participation based games and services and our product sales line of business primarily the sale of new gaming machines. I see the lottery business being quite consistent over the longer term generating steady growth through long-dated contracts with upside growth opportunities from both winning new contracts and providing value added products and services such as premium promotional games, loyalty programs and marketing services. This year our lottery business is benefiting from the commencement of sales to our Northstar New Jersey joint venture and to our consortium that operates the Greek National Lottery. Recently we received favorable news that a consortium in Turkey with whom we have had an exclusive supply contract to provide both a lottery system and instant games won a ten year contract to operate at Turkey National Lottery.

We are excited that a new national lottery draw game the Monopoly Millionaires Club developed by Scientific Games and approved by the Multi-State Lottery Association will commence sales in the fourth quarter to be followed in early 2015 with the nationally syndicated TV show – TV games show. And as I have travelled, met with team members and customers and have gained better insights, I have developed great respect to the management team and employees in our lottery business. This group is well managed with a deep bench of experienced, dedicated people and is positioned to achieve its goals.

Our interactive business comprises two units social and real money gaming. Today most of our revenue comes from our two social game casinos Jackpot Party Social Casino and the new growing Gold Fish Social Slots Casino. But with 14 real money online casino license remote games server agreements operational as of today, we expect participation revenue from real money casino operators to provide steady and improving growth in coming quarters the base of players growth.

Our participation-based gaming business, particularly due to strong performance of our wide area progressive games is performing well both in absolute and relative terms growing our wallet share in spite of the gaming industry’s present challenges. Our daily average revenue of our WAP games is up 4% year-over-year and our footprint of WAP units is up 6% year-over-year. However, our footprint of non-WAP premium participation games declined year-over-year and on a quarterly sequential basis.

In the UK, the average daily revenue of our participation games also showed a modest improvement largely reflecting the positive player reactions and the introduction of new game content developed by both WMS and our Scientific Games gaming teams. While our shipments of new gaming machines were disappointing on a year-over-year basis compared to the record shipments of replacement units a year ago, on a relative basis, we believe that we experienced improved traction. We believe our ship share while below a year ago did improve over the level of the previous two quarters. This reflects the continued strong performance of our core videogames on our Blade cabinet and the introduction of our new Blade Stepper cabinet.

I have spent time seeing the lineup of new products and gaming content being developed for this year’s G2E. I am keenly aware that the core competency for developing innovative new products is alive and well in our gaming business. I can’t wait for our customers to see how exciting new lineup of games. With solid performance on our latest games including the new Blade Stepper, I believe we are well-positioned to recapture the ground we lost to our competitors. And with our integration efforts progressing ahead of plan and a renewed focus on identifying ways to improve processes and margins, together with an increased discipline on capital spending, I am confident that we will continue to strengthen our free cash flow generation.

As noted in our call on Friday discussing the pending acquisition of Bally, cash flow is the key focus. And our goal is to primarily use our increased free cash flow to pay down debt and bring our leverage ratios back to more optimal levels.

Now, please let me turn the call over to Scott to review our financial performance and outlook for the second quarter.

Scott Schweinfurth - Executive Vice President and Chief Financial Office

Thanks, Gavin and good afternoon, everyone. For the June 2014 quarter, our total consolidated revenue was $417 million, an increase of $182 million from the second quarter of 2013. The revenue increase included $170 million from the acquisition of WMS and a $13 million or 7% revenue increase in our lottery business. Our consolidated attributable EBITDA increased $48 million to $132 million primarily related to the WMS acquisition coupled with a slight decline in our lottery businesses, which included an $8 million charge recorded in earnings from equity investments related to our share of an estimated shortfall accrual by our Northstar Illinois joint venture.

Our consolidated cost of revenue, which does not include any depreciation or amortization expense decreased from 57% of revenue to 46% of revenue primarily reflecting the impact of the acquisition of WMS and the changing mix of revenue streams and was in fact slightly lower as a percentage of revenue than our 2014 first quarter.

Operating income inclusive of $5 million of employee termination and restructuring expenses primarily related to our ongoing integration efforts was $4 million, down from $12 million in the prior year period. Our net loss of $72 million compares to a net loss of $12 million in the prior year quarter and this increase reflects a $26 million pre-tax loss on early extinguishment of debt associated with refinancing our 9.25% notes due 2019, $24 million pre-tax of higher interest expense primarily attributable to the funding of the WMS acquisition and the $8 million pre-tax charge related to our share of the estimated net shortfall accrual relating to our Northstar Illinois equity investment.

Now, I would like to turn to a review of our three business segments performance beginning with our gaming segment. As a reminder, our gaming segment includes all of the WMS business, including interactive gaming, our legacy SG gaming business and the central monitoring control systems business. Segment revenue was $209 million, an increase of $169 million over to the prior year all of which related to the acquisition of WMS. Service revenues from our WAP and premium participation gaming machines was $58 million, essentially flat with the 2014 first quarter. The revenues reflect a 5% year-over-year increase in the average revenue per day for our WAP and premium participation units to $70.73 as we benefited from the player appeal and performance of our newest games, offset by a decline in the non-WAP premium installed base of participation units that we believe reflects the continued pressure on casino operators across the industry to control expenses and manage their cash flows.

At June 30, 2014, our footprint of 3,707 WAP units represented a 6% increase over the prior year’s installed base and comprised approximately 42% of WMS’ installed base of WAP and premium participation units compared to 36% at June 30, 2013. Our average installed base of other leased and participation units rose to 27,228 reflecting the addition of 2,462 leased WMS units, partially offset by a decline in the total installed footprint at UK gaming primarily reflecting the previously reported loss of the Bedford contract. The average daily revenue for these units increased slightly reflecting a slight improvement in the UK and the addition of higher yielding WMS units.

Services revenue from interactive products and services increased by $32 million year-over-year reflecting the inclusion of the WMS interactive revenues. As previously noted social casino revenue is now reported on a gross revenue basis before platform fees as a result of a change in the Facebook payment settlement process rather than on a net revenue basis as historically reported by WMS. The reported change represented approximately $8 million of the interactive services revenue and an equal amount to the cost of services for the current year period.

Daily active users increased to 1.4 million from just 600,000 a year ago and rose by 100,000 daily active users on a quarterly sequential basis. The sequential increase in our daily user base primarily reflected growth resulting from the launch of our second social casino app Gold Fish Social Slots near the end of first quarter and its increased availability as we extended the app across multiple mobile platforms in the second quarter and stepped up our targeted marketing of the Gold Fish site. While the average daily revenue per daily active user declined to $0.22 from $0.36 in the prior year quarter, largely reflecting the broader user base from the expansion across mobile platforms which tend to monetize at a lower average rate. The daily rate was essentially flat on a quarterly sequential basis.

Product sale revenue was $81 million, which included $77 million in revenue from sales of WMS products. However the WMS revenues represented a decline from the product sale revenue reported by WMS in the year ago period primarily related to a 2,187 units decrease in U.S. and Canadian shipments of WMS units. This reflects the decline from the record number of casino replacement units a year ago and the impact of 234 Canadian VLTs in the prior year. Similar to the challenges in the first quarter, we believe the decline in replacement unit shipments for the second quarter reflected a combination of casino operators limiting capital spending as a result of declines in their gross gaming revenues and an estimated decline in our ship share compared with the prior year quarter. However, we believe that our ship share improved from the 2014 first quarter.

International shipments of WMS gaming machines declined from 2,055 units to 1,222 units, largely reflecting lower shipments to Latin America including lower shipments to Argentina due to import restrictions and a decline in units shipped to Mexican customers reflecting the challenges in that market. Shipments of UK gaming bingo and arcade machines declined from 519 units to 328 units. During the second quarter the average selling price for WMS’ gaming machines at $15,405 was about flat with the prior year quarter.

As noted in the release, we fully launched the mechanical reel blade stepper cabinet in the second quarter shipping the total of 617 stepper units. Additionally, our other product sales increased reflecting higher subscription revenues related to the growing installed base of Blade video units, higher conversion kit sales and higher used unit sales. At the beginning of July, we received regulatory approval for Blade gaming machines in both Macau and Singapore. And in our services business, we began placing the first Blade participation units, a three-reel mechanical MONOPOLY Luxury Diamonds game that includes WMS’ first use of the mechanical wheel bonus feature at the top box. The first units have been an Atlantic City for just a few weeks and the early performance is very encouraging.

We incurred $2.2 million of employee termination and restructuring costs mostly related to headcount reduction and the remaining cost of exiting our online gaming business in the UK and a related managed services contract in Belgium. Attributable EBITDA in the quarter for the gaming segment of $73 million primarily represented the benefit of WMS and represented a $10 million quarterly sequential improvement largely due to improved earnings after adjustments for non-cash items and seasonal trends.

For our Instant Products segment, total revenue was $139 million, an increase of $9 million or 7% over the prior year period. Our U.S. revenue increased 12%, which compares to our U.S. lottery customers retail sales of instant games that increased 5% year-over-year. Our growth also includes the year-over-year benefit from sales to our Northstar New Jersey joint venture and a 33% increase in revenue from licensed premium promotional games and player loyalty programs.

International revenue declined slightly about 1% as a 2.5% decline in retail sales in Italy, lower China validation revenue and a decline in Canada related to lower sales to Loto-Quebec under proposing arrangements and the exiting of our unprofitable Provoloto operations in Mexico earlier this year were partially offset by the startup of sales of instant games to our Hellenic Lotteries joint venture in Greece and growth in certain other European and Latin American lotteries.

While operating income in the Instant Products segment increased 12% year-over-year attributable EBITDA for the segment was up only about $1 million or 1% from the prior year period primarily due to the impact of the $8 million charge related to our share of the estimated net shortfall accrual, higher Northstar Illinois equity investment. Along with higher SG&A, we also incurred $800,000 of restructuring costs in the quarter as we exited a small paper roll conversion facility in the U.S., which was non-core to our operations.

Turning to our Lottery Systems segment, revenue of $69 million was up 8% year-over-year or approximately $5 million largely reflecting a $4 million increase in product sales primarily due to sales of systems, hardware and software to international customers principally Norsk Tipping, the Norwegian national lottery. Service revenue increased $1 million or 3% primarily driven by higher sports betting revenue from international customers. In the U.S., the comparison with the 2013 quarter was unfavorably impacted by a record Mega Millions jackpot that benefited retail lottery sales in the year ago quarter. And looking ahead, the 2013 third quarter services revenue benefited from two large above $300 million Powerball jackpots.

Operating income increased $4 million largely reflecting an unfavorable mix of lower margin product sales. Attributable EBITDA was $22 million for the segment, a decline of $2 million or 8% from the prior year quarter as the higher revenue was offset by a less profitable revenue mix. On a quarterly sequential basis, Lottery Systems segment revenue operating profit and attributable EBITDA, were up as a $5 million sequential increase in revenue contributed to a $3 million sequential improvement in attributable EBITDA.

I would now like to review the significant progress we are achieving with our integration initiatives. I am very pleased that the efforts of our team has realized – that our team has realized to-date in integrating the businesses has resulted in cost savings ahead of our initial 2014 target of $15 million. Reflecting this great progress, we have raised our 2014 target to now obtain at least $70 million in annualized cost savings in 2014 and we continue to expect to achieve our target of $100 million in annualized cost savings by the end of 2015. As expected, certain of these integration initiatives require costs to be incurred to achieve the savings.

And during the second quarter, our employee termination and restructuring costs totaled $4.9 million primarily from employee separations. We anticipate we will incur additional integration related costs in the second half of 2014 as we continue to execute on our integration and other cost savings plans, although we believe the costs for our integration actions were more weighted – were weighted more heavily to the first half of the year primarily due to the timing of employee separations.

For 2014, we continued to expect such integration costs to total between $15 million and $20 million. In addition we expect an additional $15 million to $20 million of integration related capital expenditures of which the largest project is to implement the Oracle HR and finance software modules throughout the legacy SG business and there will be additional operating and capital costs incurred in 2015 to complete our plans.

For the second quarter our free cash flow defined as net cash provided by operating activities less capital expenditures was an unfavorable $31 million use of cash, which was a decrease of $34 million from the prior year largely reflecting a $23 million decrease in cash from net operating activities largely due to unfavorable changes in the current assets and current liabilities coupled with $11 million increase in capital expenditures. Our inventory value at June 30, 2014 was $33 million higher than at December 31, 2013 and our accounts payable had declined $57 million over the six months largely reflecting the timing of payments.

Capital expenditures for additions to property, plant and equipment lottery and gaming services expenditures and intangible assets and software expenditures was $55 million compared to $44 million a year ago with the increase due to the addition of $29 million of capital expenditures from WMS partially offset by a decrease in other capital expenditures. Due to lower than anticipated capital expenditures for the six months ended June 30, 2014, we are lowering our 2014 estimate from $280 million to a range of $260 million to $270 million.

During the second quarter as part of refinancing of our 9.25 notes we incurred $26 million of out of pockets refinancing costs. Net cash provided by operating activities was $24 million, a decline of $23 million from the prior year quarter as a $27 million increase in net earnings after adjustments for non-cash items and loss on early extinguishment of debt was offset by an unfavorable $27 million change in working capital and a $23 million decrease in distributed earnings from our equity method investees. Additionally, the distributed earnings and distributions of capital from our equity investees aggregate $54 million for the six months of 2014, up $9 million from the first six months of 2013.

We have invested $41 million in our joint ventures during the first six months of 2014 which principally reflects the capital contribution to ITL for funding participation gaming terminals in the UK for our customer contracts which we completed the full installation in the June 2014 quarter. And we have recorded related capital lease asset and liability on leasing such equipment from ITL to our UK gaming business.

In the second quarter, we also received a return of capital payment of $11 million from ITL. During the second quarter we refinanced our 9.25 notes due in 2019 paying related fees and other refinancing costs from our cash on hand. As a result we have $350 million of new notes due 2021 at a new rate of 6.625% which should yield an annual benefit of approximately $9 million in cash flow. In summary we believe that the combined company continues to benefit from the diversity of our revenue streams and when coupled with our intense focus on integration synergies and free cash flow generation we believe the foundation is clearly in place for improved operating results in future quarters. Ryan, would you now please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes through from Steve Wieczynski with Stifel.

Steve Wieczynski - Stifel

Hi, good afternoon guys. So Scott I guess first question is for you is actually kind of a technical question but with the social gaming revenues, I am just having a hard time kind of coming up with I know you talked about its gross versus net, so how should we think about that going forward I guess the question is if you guys reported $32 million there should that really have been about $24 million, $25 million is that the way to think about it?

Gavin Isaacs

Right. We reported under the method that WMS that use the number would have been $24 million and we have one quarter remaining the September ‘14 quarter where there will be a difference between what the way that WMS reported the number for the quarter and the way that Scientific Games reported the number. And the net the $24 million number with compared to $17 million number that WMS reported in the June ‘13 quarter.

Steve Wieczynski - Stifel

Okay. So is it fair to say then from the daily user if you – you guys just reported 1.4 number, if you expand that out a little bit that would look more like kind of last quarter like 1.34, 1.35 ish type range?

Gavin Isaacs

Right. It was up 100 – about 100,000 quarter-over-quarter on a sequential basis correct.

Steve Wieczynski - Stifel

Okay. Got it. Then we look at the product sales side of things it’s still pretty obviously a pretty tough operating environment and I know Gavin you guys don’t give guidance but maybe help us think about how you are thinking about the back half of the year from a products and even a gaming operation segment as well?

Gavin Isaacs

From the product sales, obviously Steve we have Q3 coming up in less than two months. I think that traditionally everyone that’s the major operators coming through the product side of that. And I know that will start probably in the next couple of weeks. We are hoping that will help drive some sales in the second half of year. And then asked G2E I think you are going to see some large products there and I think it’s hopefully bodes well again further improvements in the fourth quarter. From the gaming operation perspective I think that our WAP is probably one of the highlights of performance now wide areas of WAP is certainly one of that highlights of our performance with an increase in the wins and the actual placement. Clearly, environment at the moment has been one of reducing premium non-WAP games. We think that some of the great new games that we will be producing in Q3 and games like the new set that Scott referred to the reel on top. I think you’ll start to see some increasing placements there so on, certainly hopeful that will be the case.

Steve Wieczynski - Stifel

Okay. And then last question, Gavin going back to you with the question we have gotten a lot over the past couple of days since the deal was announced, the timing of that deal was extremely fast, can you give us a little bit more color in terms of why it came together so quickly and then the thinking behind that and why you – why did you think it was a good idea to get it done that quickly?

Gavin Isaacs

I think if you have a great idea in the synergies and meeting of the minds and then strategies all online why is there any reason to procrastinate. I think that was – this is an instance where we really did see both sides saw a great advantage in bringing these two companies together. And I think the longer you would delay these things, the longer the more people you get involved I think the likelihood of late and other potentially damaging messages can come out. And I thought this was very effective way to do it.

Steve Wieczynski - Stifel

Okay, great. Thank you for the color guys.

Gavin Isaacs

Thank you, Steve.

Operator

Next question comes through from Mike Malouf with Craig Hallum Capital Group.

Gavin Isaacs

Mike are you there?

Mike Malouf - Craig Hallum Capital Group

Yes. I am here right now, sorry. Thanks for taking my questions. I am wondering if you can give us any feedback with regards to the Casino operators on the consolidation it’s going on, on the gaming side. And I’m sure that they one of the things that questions like you’re getting are if your ship shares through one casino is 30% just to pick a number, if you combine WMS and Valley maybe that triggers something where perhaps they move that down to 25% just because they think that’s enough to give one company and I am just wondering if you could comment on some of the feedback you are getting? Thanks.

Gavin Isaacs

The feedback has been fairly positive and in fact feedback has been consistent from one perspective and that is it doesn’t matter whether you are big or small and it doesn’t matter whether we love you or we hate you, we are only going to buy games that perform. So I think they are so many companies out there now making content ultimately it becomes the opportunity to sell that the ship share moving around so much that if the games are good and that got legs casinos will buy them. And I think if it turns out that Valley games are good and the WMS games are good and that’s great for a combined. But you are not going to penalize one company by virtue of a merger their games are good. On the same token you can be a very small one man shop almost or a five men shop using right content and the biggest casinos will still buy from you. So I think it’s all being over played and I think the feedback we are getting across the board from customers as they get it. They understand why we do these things. But at the end of the day it looks we make right content, it doesn’t matter. They will buy the best games.

Mike Malouf - Craig Hallum Capital Group

Great and just one other question maybe for Scott is there some sort of maybe guidance that you can give us on the rate of debt that you are expecting for the acquisition?

Scott Schweinfurth

You mean the interest rate?

Mike Malouf - Craig Hallum Capital Group

Yes.

Scott Schweinfurth

I really will not know that until we go out and raise the actual financing over the coming months, what’s going to be a mixture of secured – unsecured debt notes and we will have to see what the market bears relative to the financing. But we are moving forward and on that because there is a lot to accomplish.

Mike Malouf - Craig Hallum Capital Group

Got it. Okay. Thanks a lot.

Operator

Next question comes through from Todd Eilers with Eilers Research.

Todd Eilers - Eilers Research

Hi guys. Thanks for taking my questions. It looks like obviously instant tickets are strong for you guys in the quarters, you highlighted that Greece I believe and New Jersey is kind of boosting that I was wondering if you can be talk a little bit more about the launch of instant tickets in Greece maybe what sort of impact that specifically had on you guys in the quarter and then I guess New Jersey as well and then also the launch of I guess the new Turkey contract maybe what the timing is on that? Thank you.

Gavin Isaacs

Thanks Todd. Certainly Greece it came in a bad expectation, but interestingly the number of stalls that we anticipated being opened and up and running was lower than what we planned. The revenue per stall is actually higher. So that bodes well for Greece for us. New Jersey sort of on plan as well I mean it wasn’t way above and it wasn’t way below but it was pretty much as expected and it’s growing, it’s great clearly the products being well received there and that’s very nice to see. And then finally in relation to Turkey we don’t anticipate that coming online until 2016. So obviously that’s a great one for us because it’s a supply contract and there is no equity investment upfront required.

Scott Schweinfurth

The other color I will add relative to New Jersey is when we took over that contract there was quite a supply of tickets from the previous provider that were in the warehouse that we needed to sort of (indiscernible) use up and that’s now been completed and so we are getting more of 100% allocation of purchases.

Todd Eilers - Eilers Research

Got it. And that’s helpful. And then also want to ask if you could talk a little bit more about the – you mentioned that the new kind of monopoly branded multistate lotto game I was wondering if you can talk a little bit more about that and maybe how that impacts Scientific Games as a company, how do you I guess generate revenue from that game, it sounds like it is expected to launch here in the fourth quarter, can you maybe talk about how many states have approved that game and maybe how many states I guess need to approve it for that to be meaningful for you guys going forward?

Scott Schweinfurth

Sure, it is a.

Gavin Isaacs

I would very quickly flick that one over to Scott given my experience and partly because you have that half the answer to that question.

Scott Schweinfurth

I am not sure I got all the questions out here, but we are going to be launching this new national draw game, it has a different focus than Powerball and Mega Millions in that instead of having one giant winner of a large jackpot, there will be lots of million dollar winners. And so if the main jackpot is not one, there will be even more million dollar winners in the subsequent drawing, it’s a $5 ticket and we are expecting to launch in October. I believe the expectation is we will launch with lotteries and I don’t know the number, but it’s about $150 million population of what the launch partners are and we expect that to grow over time as additional lotteries sign on and gear up to be able to provide it in their states. And we are going to earn a percentage of the sales, the lottery sales as our revenue. And from that, we will have to fund the cost of the TV game show that is also going to be MONOPOLY oriented that we will launch in the spring of 2015.

Todd Eilers - Eilers Research

Okay, very helpful. Thanks, Scott. Just one last question on the gaming business, is the – can you tell us how many I guess conversions you had in the quarter from the Bluebird 2 cabinet to the CPU 3 operating system, that you had talked about last quarter, it looks like it had a fairly decent impact, but just kind of curious how much of that activity happened in the quarter? And then how should we kind of think about that going forward was a more of kind of a one-time deal in this quarter or should we expect more of that for the remainder of the year?

Scott Schweinfurth

Todd, I would tell you that the number – that number really wasn’t a meaningful number for the quarter. We launched it sort of a mid-quarter. So, we are hopefully that this coming quarter with a full quarter’s worth of sell-through that it can be more meaningful. The item that drove the other revenue was more based on the subscription revenue from the PPP plan for the Blade platform, because as we have continued to sell Blade video product for the most part, they all come with that subscription plan. And so that tends to drive revenue. And I believe we also had some outright conversion sales to a couple of international customers that aided the revenue line for the quarter.

Todd Eilers - Eilers Research

Okay, thanks guys. I appreciate it.

Operator

Our next question comes through from Cameron McKnight with Wells Fargo.

Cameron McKnight - Wells Fargo

Great, thanks very much. Good afternoon.

Gavin Isaacs

Hi, Cameron.

Cameron McKnight - Wells Fargo

A question first for Gavin just on operating trends, I mean it seems that operating trends across gaming equipment are clearly under some pressure, your biggest competitor reported replacement units down 50% year-on-year. Your replacement units were down meaningfully year-on-year as well. How should we think about operating trends going forward? Should we think of gaming equipment as having to say a 12-month lag to regional gaming or do you think it’s – or do you think the relationship is closer? What should we be looking towards over the next 12 months for signs – in terms of signs if things are stabilizing?

Gavin Isaacs

Well, tough question, but I think the relationship is much closer than that. I think if you look at what’s happened in the last 10 months say, no one was even talking about regional softness until December to winter really. And then since winter, it’s been all of a sudden oh dear oh my, everything is down and clearly there is pressure and clearly there is economic issues around that are affecting our customers to extent that affects us. But ultimately the products are getting older in the field. And what we are seeing like today we saw one operator produced increased sales in almost all their markets, which is fantastic. And I think you see that, that sometimes is a result of investment in flows. And I think we see that with casinos and like obviously we see we have the benefit of seeing Native American casinos as well, but casinos invest in their product, they are not suffering as badly as some of you don’t and I think that there is an opportunity for that. I don’t know how to answer it other than saying that I think relationships are lot closer and I am really hoping that our people that the trends will improve.

Cameron McKnight - Wells Fargo

Right. Got it. And then just as a follow-up Gavin on the same vein what are you hearing from – I mean one question we get a lot from investor is what’s happening on the participation side of the business, what are operators saying on participation. Are operators pushing back on participation as a category or is that just that the bar has risen and the category is more competitive than it was say two or three years ago?

Gavin Isaacs

That’s, exactly right. The bar has reason a lot and it’s always being an area where operators are not necessarily enjoyed spending their money, but ultimately that’s where we spend a lot of our R&D and we create great products for customers so – for their customers. But clearly there is a lot of competition out there and the bar is being raised. And when your products are performing well and they become (tables) they need to be there. Where they are not they get removed. I think part of the softness we saw in our non-premium WAP when our premium non-WAP games expect we didn’t have a lot of great new titles which we are starting to come through now. So that’s a very competitive area and we look forward to competing in that going forward.

Cameron McKnight - Wells Fargo

Right. Got it. And then just a question for Scott, Scott in the first page of the release you noted $133 million EBITDA, but negative $30 million of free cash flow, going forward how should we think of the conversion rate of EBITDA to cash or the time?

Scott Schweinfurth

Well, I would hope that free cash flow number will be positive that’s clearly our focus. And you remember we defined the free cash flow as cash flow from operations on our cash flow statement less what we are spending on CapEx that’s a little bit different than attributable EBITDA as a starting point there. And this quarter – a couple of things relative to working capital went let’s say the wrong way and caused a use of working capital whereas in the first quarter was a generator of cash flow from operations during that cycle.

Cameron McKnight - Wells Fargo

Right, got it. Thanks very much guys.

Gavin Isaacs

Thanks Cameron.

Operator

And our next questions is from Brian Mullan with JPMorgan.

Brian Mullan - JPMorgan

Hi, guys, thanks for taking my question. I just wanted to ask question on the lottery systems business, recognized that it only accounts to roughly 10% of the gross profit of the current company less than that when you – mix obviously, but from the CapEx perspective Scott I was wondering if you could share how much of the $350 million of estimated in annual CapEx from last week’s presentation might be coming from that segment and along those same lines, is depending Valley deal change your desire to pursue new contracts for the segment for the foreseeable future, I know you noted in the past the competitor has several coming up over the next 12 months to 18 months?

Scott Schweinfurth

Yes. And we’ve actually submitted bids on three that were already do here.

Gavin Isaacs

Let me answer to that last part very, very firmly. We absolutely will not pull back from bidding on the contracts we want to go after. It’s very important to us and then part of our strategy going forward that we are focused on all our customers in all our segments and lottery is a key customer and lottery customers will be key and where it’s appropriate where it makes sense we will bid for lottery systems contract.

Scott Schweinfurth

And Brian I don’t have in front of me the breakout of the capital between the different segments, so let me get that and I will send that on to you.

Brian Mullan - JPMorgan

Understood. Okay. Thanks guys.

Operator

And we have no further question. So I’ll pass it back to Mr. Isaacs for any closing comments.

Gavin Isaacs - President and Chief Executive Officer

Well thank you. And let me reiterate that we are focused on generating higher cash flow from operating activities by increasing our margins, delivering cost savings from our integration efforts and controlling our working capital needs. We are also going to be building on our core competency aimed at increasing our share and expanding our business presence in under penetrated geographies to grow our revenues. We want to improve that free cash flow by remaining disciplined in our allocation of capital for those growth investments that provide sufficient economic return on a risk-adjusted basis, finally by primarily directing the use of that free cash flow towards paying down our debt.

We look forward to updating you on the progress towards these objectives along with our progress on the Minneapolis Millionaires Club, the Turkey lottery privatization efforts and the exciting new products which you will see at G2E. Of course we will provide you further information on the pending transformation – transformative acquisition of Valley which will combine two great innovative and wholly creative customer focused companies to create a leading supplier of gaming content systems technologies to enable one-stop shopping to our gaming and lottery customers. Thank you all for joining us. And I look forward to speaking to you all soon.

Operator

Thanks everyone for your time and your participation. And you may disconnect and have a great rest of the day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Scientific Games' (SGMS) CEO Gavin Isaacs on Q2 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts