Scientific Games' (SGMS) CEO Barry Cottle on Q3 2018 Results - Earnings Call Transcript

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About: Scientific Games Corp (SGMS)
by: SA Transcripts

Scientific Games Corp. (NASDAQ:SGMS) Q3 2018 Earnings Conference Call November 8, 2018 8:00 AM ET

Executives

Robert Shore – Senior Director of Corporate Finance and Investor Relations

Barry Cottle – Chief Executive Officer

Michael Quartieri – Chief Financial Officer

Analysts

Barry Jonas – SunTrust

David Katz – Jefferies

Brad Boyer – Stifel

Carlo Santarelli – Deutsche Bank

John Decree – Union Gaming

Cameron McKnight – Credit Suisse

Mike Malouf – Craig-Hallum

Mike Pace – JPMorgan

Operator

Good day, and welcome to the Scientific Games Third Quarter 2018 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]

Please note, this event is being recorded. I would now like to turn the conference call over to Mr. Robert Shore, Senior Director of Corporate Finance and Investor Relations. Mr. Shore the floor is yours sir.

Robert Shore

Thank you, Mike. Good morning, everyone. During today's call, we will discuss our third quarter 2018 results and operating performance, followed by a question-and-answer period. With me this morning are Barry Cottle and Michael Quartieri.

Our call today will contain statements that includes forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks and uncertainties that cause actual results to differ materially from those discussed during the call. For information regarding these risks and uncertainties, please refer to our earnings release issued this morning.

The materials relating to this call are posted on our website and our filings with the SEC, including our most recent annual report filed on Form 10-K filed on March 1, 2018, as well as subsequent reports filed with the SEC, including our third quarter 2018 Form 10-Q filed this morning.

We will also discuss certain non-GAAP measures. A description of each non-GAAP measure and a reconciliation of each non-GAAP measure to the most directly comparable GAAP measure can be found in our earnings press release as well as in the Investors section on our website. As a reminder, this conference call is being recorded. A replay of this webcast and the accompanying materials will be archived in the Investors section of our website at scientificgames.com.

Now let me turn the call over to Barry.

Barry Cottle

Thanks, Bobby. Good morning, and welcome, everyone. On behalf of the entire Scientific Games team, we're pleased to report that our third quarter results marked our 12th consecutive quarter of year-over-year increases in revenue and consolidated AEBITDA.

We remain focused on our central priority of AEBITDA growth in each of our businesses in order to deliver the balance sheet. To that end, our four businesses collectively delivered 7% revenue growth, 9% consolidated AEBITDA growth, $123 million of free cash flow in Q3, which we used to make a $110 million in voluntary debt repayments.

The customer feedback we received at G2E, was extremely positive and we're humbled to receive several awards including being named land-based and digital supplier of the year. As we showcased the G2E, game ops is a major focus of ours and we will drive revenue improvements by making the best games for our customers in the most cost effective manner.

We've been successfully rolling out that James Bond franchise across the country and look to continue to success by releasing, two additional titles Tomorrow Never Dies and Live and Let Die in the first half of 2019. We are rolling out the Wave XL in late Q4 in North America featuring Jin Xi Bao Xi, which has been a huge overseas success, and we have a strong library of new content including Cash Wizard World and Dragon Spin Age of Fire.

In addition to the revenue opportunities, we're continuing to enhance the efficiency of our supply chain and building games more cost effectively. We expect these initiatives to collectively drive revenues, lower production costs, and drive higher cash flows going forward.

We're also looking to aggressively go after markets where we see tremendous upside. As an example, we entered into a long-term strategic partnership arrangement with gaming capital group to distribute slot related products in the state of Oklahoma. We will be leveraging their extensive distribution and service network in Oklahoma for both sales and leased gaming operations.

The benefits of this partnership is we’ve secured a minimum purchase and share in their footprint immediate, meaningful operational efficiencies and a significant potential upside with a partner that continues to grow in a very large market. We're excited about the opportunity to grow, market share and improve service and compete more effectively in this market.

Gaming Capital Group has consistently been one of our largest customers in this new arrangement, strengthens our value proposition for Oklahoma. We believe the combination of our efforts will provide a more meaningful return over the long-run when compared to status quo.

Our Lottery business remains strong and new innovations including high-definition and specialty printing, the higher denomination tickets are driving retail sales. Our track record of innovation for lottery retailers is continuing with the roll out of SCiQ. We executed our first significant contract, a 300 unit placement in Ohio with the state lottery determining optimal locations.

We're currently piling SCiQ in 53 locations across nine states, and the value proposition is proving out by driving increased retail sales, providing added security and operational efficiencies for the retailer. There are over 220,000 retailers that sell instant lottery tickets within the U.S. and we believe that up to 60,000 of them could benefit from this product.

We are also excited by the success for iLottery offering in Pennsylvania. Since its launch in May, handle has surpassed the $100 million making it the most successful launch in the U.S. In digital [Audio Dip] successfully launched OpenBet in Caesar's before the start of the NFL regular season and we're now live in New Jersey and Mississippi.

We recently closed on the acquisition of Don Best, which is the leading provider of realtime sports betting data and pricing of North American sporting events. With the inclusion of Don Best and Superbet. We add new capabilities on top of our turnkey solution to operate a state-of-the-art sports book, which will allow us to capture a larger percentage of the value chain in the BTB business model.

US sports business, the U.S. Sports Betting is in its infancy stage with just seven states live, which represents only 6% of the adult population. As we've commented previously, sports betting is a long-term game where the best product will always win out, and we're confident we have it with OpenBet and our other capabilities.

As sports betting rolls out across the U.S., we also anticipate iGaming will be a fast follow, in New Jersey the only state where iGaming is active, over 50% of GGR is run through our online gaming platform. As the market share leader, we're confident we will maintain this position as additional jurisdictions open based on our unrivaled content and platform.

And finally in our social business. The Facebook connectivity issue experienced in Q2 has been resolved with growing – resuming in late July, leading to record daily revenues in daily active users in August and September. During the third quarter, we grew revenue quarter-on-quarter by 5%, which is 14 times the market according to estimates from Eilers & Krejcik.

As disclosed in our earnings release, we are considering a possible initial public offering of a minority interest in our Social Gaming Business in 2019. The Social Gaming Business continues to experience rapid growth and has achieved significant scale. We believe an IPO would provide greater flexibility to pursue additional growth initiatives, specifically designed for our social business as well as unlocking additional value for Scientific Games’ stakeholders. We anticipate that the proceeds from the IPO would primarily be used to repay debt.

Overall, we are pleased with the quarter and our continued growth as we head into the fourth quarter and look into next year. We will remain focused on achieving our number one strategic objective of de-levering our business through the growth in revenue and AEBITDA. We will do this by continuing to make the best games for our customers in the most cost effective manner to improve game ops, along with innovation in our lottery and iLottery offerings, continued expansion of our social business and capitalizing on the rollout of U.S. Sports Betting and iGaming.

Now, let me turn the call over to Mike to provide his review of the third quarter results.

Michael Quartieri

Thanks Barry. Good morning everyone. As Barry noted, our results continue to be strong, consolidated revenue rose 7% and AEBITDA increased 9%. As a result of our improvements, growth and our focus on deleveraging, we decreased our net leverage ratio to 6.7 times at September quarter-end down from seven times at the prior quarter-end.

While we are pleased with our net leverage ratio going down we will build on this momentum into 2019 and continue to remain laser focused on strengthening our balance sheet.

Now let me turn to our operating units. First our Gaming Business, third quarter AEBITDA increased by 5% or $11 million over the prior year. Despite revenue declining, 1%, our AEBITDA margin improved 320 basis points to 51.9%. Revenue from gaming machine sales increased $4 million and 3% in the third quarter.

As Barry noted during the quarter, we entered into a strategic long-term relationship with Gaming Capital Group. In connection with this strategic relationship, a portion of our existing gaming machine footprint in Oklahoma was sold to our partner. We've shipped 7,663 machines globally, including 4,266 replacement units in the U.S. and Canada with 929 units associated with our Gaming Capital Group strategic relationship. 223 for expansion units and 549 VLTs to Illinois.

Internationally, shipments totaled 2,625 compared to 2,940 units shipped a year ago. Year-over-year, our average selling price for the quarter was up 3%. I remind everyone that last year's third quarter replacements were up 30% year-over-year, which is made for a tough comparison.

On the heels of our strong showing at G2E, we continue to expect strong replacement demand in the fourth quarter with it being the seasonally strongest of the year. In Gaming operations, revenue was consistent on a quarter sequential basis at approximately $160 million.

On a year-over-year basis, revenue was down 10% or $17 million, of which $4.5 million was the result of new revenue recognition accounting for WAP jackpot expense. For comparison purposes, the WAP jackpot expense was $5.5 million and treated as cost of services in the prior year. This change in classification has no impact on operating income, AEBITDA or cash flow.

On a quarter sequential basis, our installed base of WAP, premium and daily fee participation units was down 1,554 units, which includes the impact of our new strategic relationship with Gaming Capital Group and to a lesser extent, the removal of lower yielding Oregon VLT units right at the end of the period which are currently being redeployed in other jurisdictions.

Our WAP portion of our footprint is up nearly 200 units from the prior quarter, driven by the successful rollout of our James Bond Franchise. The Bond rollout in terms of placements has been lower than we expected due to the tight pace of state approvals. But the initial performance has been strong with Casino Royale and Thunderball on our Gamefield 2.0 cabinet comparable to Willy Wonka on Gamescape, our best performing WAP game to date at the same point in their life cycle.

Revenue from our other participation units was down $3 million on a quarter sequential basis. The installed base was up 152 units quarter-over-quarter. We placed an additional 430 units in Greece, bringing our total footprint there to over 3,400 units. This increase was offset by a decline in units in the UK. This mix shift of the installed base had a negative impact on our yields.

Gaming systems revenue increased $8 million year-over-year or 12%. The growth is primarily related to our ongoing installations in casinos in Canada, coupled with increased hardware sales for shipments of our innovative iVIEW4 player-interface display units. iVIEW4 sales continue to be very strong and we are still in the early innings of the replacement cycle of the existing 300,000 placements of prior versions of the iVIEW.

Through September 30, we have placed nearly 88,000 iVIEWs in service since its launch. Table products decreased $2 million year-over-year or 3%, strength in recurring utility products was offset by a tough comp in product sales with a prior year, including a large international expansion projects.

Turning to lottery, our third quarter revenue increased $4 million and AEBITDA was up $3 million compared to the year ago. Within our lottery business, our systems revenue increased $5 million or 8% year-over-year. The growth was driven largely by our new lottery system installations in Maryland and Kansas and our new investment in Keno in Pennsylvania.

Turning to our Social segment, revenue continued to grow strongly. Revenue increased 11% year-over-year to $105 million and AEBITDA increased 34% to $27 million. On a quarter sequential basis, our third quarter revenues were up 5% compared to the second quarter.

The Facebook connect issues that impacted the second quarter and into July are behind us and as Barry stated, August and September were both record months for daily revenue and daily active users. In digital, we generated $61 million in revenue and $12 million in AEBITDA.

We have been focusing resources on the development of our U.S. sports book and the New Zealand Racing Board implementation. This is being driven by redirecting employees that are generating time and materials revenues in the UK to help in the rollout in these markets. Although, this redirection will be accretive in the coming quarters, it is negatively impacting our short-term results.

In early November, we disclosed our – we closed on our acquisition of Don Best Sports Corporation, which is the leading provider of real-time sports betting data and pricing in North America sporting events. This acquisition instantly gives us a full turn key offering to our customers. We also successfully launched gaming content across 12 new client sites and signed eight new customers on our OGS platform during Q3.

During the quarter, we recorded $339 million in restructuring and other charges, which includes a $310 million charge related to the verdict in the Shuffle Tech legal matter. We have not made any payments on this matter and the verdict is still subject to post-trial motions and the appeal process.

Turning to cash flow, we reported $223.5 million in net cash flows provided by operating activities, which is $114 million improvement over prior year, principally related to improvements in our operating results, permanent enhancements to our working capital and the timing of interest payments due to the refinancing completed earlier in the year. We used this cash from operations to make $122 million of debt repayments, including $110 million of voluntary net repayments under our revolver.

Just to remind everyone, the fourth quarter will include higher scheduled interest payments and our final payment of €90 million for the lottery instant ticket concession in Italy. In addition, we recently sold a real estate asset for $40 million in proceeds, which closed in October. We continue to monitor capital markets for the best opportunity to optimize our capital structure, including potential refinancing in order to generate future cash interest savings.

This includes cash usage related to renewal of our lottery instant ticket concession in Italy, refinancing expenses and higher CapEx spend on several long-term and highly accretive projects including ongoing platform development in digital from the expansion in the U.S. and around the world. Lottery systems implementations in Maryland, in Kansas and the acceleration of our installed base of leased gaming machines.

These projects are generally very long in duration, in initial terms ranging from seven to 10 years before renewal options. These investments established a clear path for free strong cash flow in 2019 and beyond. In summary, I would remind everyone that our commitment remains firmly focused on deleveraging and debt reduction, which will be accomplished by continued growth in revenue and effectively operating the business.

Operator, you can open up the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] The first question we have will come from Barry Jonas of SunTrust. Please go ahead.

Barry Jonas

Hey guys. Good morning. So first question is the stock has been off meaningfully since Q2. What do you attribute that weakness to and does this change how you approach the business at all? Thanks.

Barry Cottle

Thanks Barry. So look, first of all, day to day changes in the stock, don't change how we run the business. We obviously certainly believe there's a disconnect between the share price and the underlying value. Both of us here bought stock at $33 and believe it was undervalued at those levels. But we remain focused on delevering the business by growing predictably and consistently growing the top line revenue and AEBITDA to generate free cash flow.

And so we're laser-focused on our growth initiatives to grow the company in the right way, growing game ops with improved content and cost effective cabinets, expanding on leading ship and wallet share in North America slots, while we see opportunities in international expansion there, continued lottery growth, with innovative offerings like iLottery and SCiQ, our systems business with strong year-over-year growth, market leading position and demonstrated by winning 45 out of 48 successful recent bids.

A solid worldwide digital business with upside in the U.S. for sports and iGaming, our social business is growing strongly with the record month in August and September. And then focusing our CapEx spend on highly accretive long-term projects to drive continued growth.

Barry Jonas

Great, great. So I guess next one, maybe just diving into the social gaming potential IPO, a little bit more. Maybe just some thoughts on what led to this decision, thoughts on the process for reaching a decision whether you'll do it or not? It would be helpful.

Barry Cottle

Okay. First – and I need to say at the start, I'm sure everybody is aware that there is very specific SEC rules that limit our ability to discuss the potential IPO further at this time. But I think at a high level, I'd say that, look, given the rapid growth of the business and its current scale, taking the business public could help position the company to accelerate that growth, realize value and also delever the business.

Barry Jonas

Got It. And then last one for me, just coming close to December. How are you guys thinking about potentially calling refinancing the 10% notes? Thanks.

Michael Quartieri

Hey, Barry, we're monitoring the markets on a daily basis and evaluating all the options. But it really comes down to just being a net present value question of where we think we can lock-in rates versus the call premium. The calls premiums effective December 1 at 105, you get to 2019 a year from now with that 102.5. That's a meaningful step down in the upfront premium. But we are mindful and when we look at this, we want to make sure that we're doing a transaction that's going to drive a meaningful reduction in our cash interest.

Barry Jonas

Got it. All right, thanks so much, guys.

Barry Cottle

Thank you.

Operator

Next we have David Katz of Jefferies.

David Katz

Hi, good morning everyone.

Barry Cottle

Good morning.

Michael Quartieri

Good morning.

David Katz

Several questions, if I may. And I'll keep it short. So with respect to the refinancing, where, let's say the last time, you really commented on it was maybe around G2E. The more specific question maybe, has the opportunity or has that NPV backup are improved since say the past 30 days.

Michael Quartieri

I think the market moves every day, especially when you're getting towards the midterm election. So I think now that that's past us, we'll see what interest rates look like over the coming weeks and make a decision accordingly.

David Katz

Got it. Okay and with respect to the indication about the social business, Barry. Clearly, there's a technology element that are integrated across the whole company. And that might apply to the interactive pieces, it might imply to the gaming systems pieces. How did you arrive at it, we can put aside the gating factors of whether you will or won't and what have you. But how did you arrive at just the social business rather than the other technology pieces of the business where there might be similar arguments for unlocked value?

Barry Cottle

Yes. I think I'll take that one. When you look at our – at the various business lines that we have, the social business is the only one that is a B2C business. Everything else that we have is really integrated into our B2B offerings to the casinos and to the lottery. So, looking at this, as we said, when we put the – when we unrestricted it back nearly two years ago, that this was an opportunity that was out there for us. But we do see a great value chain in what we're able to provide from an integrated basis to the casinos with the products that we have.

Michael Quartieri

Yes. And to add onto that, just specifically if you look at the iGaming and one of the core value propositions that we have when we – we work with partners like we have with Caesars is the integration of iGaming and sports betting did provide a seamless consumer experience both in and outside of the casino in areas where it's legalized.

And so those, the iGaming business and the sports betting in the digital side of real money gaming is closely interlinked with the retail experience, quite frankly. So one of the kind of core values that we bring that a large part of our competitors can't duplicate. So, we see those as super important to remain combined with the larger Scientific Game group.

David Katz

That's fair. One last one, if I may, around 007. I know you touched on it a bit in the release and in your commentary. But just thinking about the trajectory and how we are shaping the premium installed base as we get toward the end of the year. What can you tell us about how 007 has performed so far and in general, that premium installed base. What more specifics can you tell us about how those games are, executing and the recovery that we are expecting in the fourth quarter.

Barry Cottle

Yes, I mean, Q hit on this a little bit but if you mentioned the rollout is then obviously a little bit slower than expected given the pace of the state approvals. But we have maybe about 381 installed now across 19 states, 67 casinos. The performance has been extremely strong, the Casino Royale and Thunderball has been, I think as Q had mentioned, is comparable to our World of Wonka, which is the best black game we've had to-date.

So the performance of Bond has been really strong and it also has helped us actually add the number of WAP units on a forefront basis as well. I think to the tune of about $200. The other games also are performing extremely well – as well beyond those two games, you've got Diamonds Are Forever and Goldfinger all are performing above, well, well, well above the floor average.

And so from a performance perspective, we've been very happy with the Bond games. And then as I mentioned, I think in my – we've got two more coming out in early next year and first quarter. So we’ve got, I think we have really got strong line-up of Bond that we expect to continue to help grow the game ops space.

And to be honest with you, along with that we've got a significant other group of products that we showed at G2E, alongside of Bond, aimed at game ops. We think we're going to have a really strong impact. And if you look at the game ops space over the last three quarters has been from a revenue perspective have been pretty stable around the $160 million mark.

And now with the Wave XL and the content that we have coming out in the space, we're expecting to really make, we're expecting to see some real performance enhancement. Again, anchored by Bond but complemented by a lot of great content and new cabinets that we have come into market and game ops.

David Katz

Very good. Thank you very much.

Barry Cottle

Thank you.

Operator

Next we have Brad Boyer of Stifel.

Brad Boyer

Hey guys, thanks for taking my questions. First one here is just around the gaming segment margins, certainly a lot better than what we were looking for and what I think most folks are looking for. I know Barry, you had mentioned when we last spoke that, you saw an opportunity to take some more costs out of the business. Just curious if you could expand upon what drove the strong margin performance in the quarter and if you see that as being sustainable as we move forward?

Michael Quartieri

This is Q, I'll take that one. So the things that we've commented before as, one of our opportunities and looking at gaming is really around the supply chain. And we've been taken a very hard look at that and continuing to make progress on that. We also benefited in the quarter with a slightly higher ASP, which was up 3%. So that had a positive impact on the margin.

So what I expect our margins to be right at that 51% overall. No, I think you've got a nice little blip there on the ASP side. But we are very cost conscious and very mindful of the environment that we're in. I guess that the untapped area that we looked at is really around the supply chain. So if you go back to roughly two years ago, the low hanging fruit of looking at headcount, and the program that we put in place there was successful. We continue to kind of maintain that mantra going forward, not only in gaming but in all of our business segments. And where we're at to now, as I said, it's around the supply chain and making sure that we've got the most efficient manufacturing and supply process that we can.

Barry Cottle

Yes. And as Q said, we're still – we’ve got as we're still pounding through that, obviously that'll start to appear. And obviously going forward, as we work through inventory and work through things of that nature. So it's not something that appears over night. That's a goal of just to continue to keep value engineering, not just the existing cabinets, poor cabinets like the J43 but obviously the way that XL is – as that was coming out. And so as Q said, and we talked about earlier, it's a core initiative within our group is to continue to keep pounding the table on this.

But this is like visibility of the best games possible at the most cost effective manner that we can. And as Q said, supply chain is really where I think there's some opportunity obviously, but it'll be a gradual thing as we worked through inventory, et cetera, et cetera on that.

Michael Quartieri

And then just one other point to add on that, just as we were talking about before on the game development side, now that we're four years removed from the merger and we've got all of our new development all on the common platform. We do have the transferability of games that are being developed today. For example, something like Jin Xi Bao Xi when it comes out. It's going to be able to be plugged and played on anyone of our curve screen cabinets, whether that's the V75, the J43, the Wave XL or the even the existing Wave that's out there. So those types of opportunities are still there, still to be worked on and to come through our operating results accordingly.

Brad Boyer

Thanks. Appreciate the color there. And then second, I just want to see if you could expand a little bit upon this, relationship that you guys are building with Gaming Capital Group. And just curious, I know there were some Oregon installs that got converted or taken out. But if you could just speak a little bit about the delta between the one-time purchases by Gaming Capital and the decline in the participation installed base. And then should we expect any other noise in the installed base over the next several quarters as a result of this agreement? Or is this a one quarter phenomenon?

Barry Cottle

Yes, before jumping specific of that. I'm glad you mentioned because I do want to emphasize that. The deal we did with GCG is really about winning Oklahoma over the long- term. They are an incredibly talented and well-rooted distributor local in Oklahoma. And as you know, the gaming footprint there is about 75,000 today. And so the goal here was really about growing the share of that both in game ops and game sales.

And with the partner each – each of the parties in the partnership kind of bringing to table are assets and expertise. And again leveraging their extensive distribution and local service network there and we believe that we have it's a very valuable partnership for both of us where it's really meant to attack a market that we believe there's significant upside for us relative to our performance today. And as you said, there's some kind of – it's a complex deal and so there's some movements in – or impact to the current footprint, which reflects that. But the overall core purpose of the deal was really looking forward long-term and winning long-term.

Michael Quartieri

Yes, I think just in your comment regarding the Oregon units. These were units that were placed out there during the year and they decided that they were going to basically not use those from a sale perspective for Oregon. And so therefore they returned the units right at the end of the quarter. So from a – call it a revenue perspective, pretty much all those units are in the revenue number. It just happened to be that they contacted us to go ahead and remove the units which they were allowed to do. And those units right now are being redeployed in other jurisdictions and we kind of knew that this would happen.

That was part of our plan but unfortunately just one of those instances where if they would have placed the phone call to remove the units three days later that unit, which is roughly about 250 in total, would still be in the installed base. But when we get to basically almost at this point right now, all of those units are redeployed elsewhere and you'll see back in the footprint.

Brad Boyer

Okay, that's helpful. And then finally, just on the systems business, I wanted to see if you could just talk a little bit about where we are in the rollout cycle in Canada. And how we should kind of be thinking about the systems side of that business growing into 2019? Obviously, appreciate that the iVIEW replacement cycle is another segment or area of systems growth as we move forward. But just curious if there's anything in 2019 that we should be mindful of above and beyond just kind of the continued growth on the system side as we think through modeling it for 2019? Thanks.

Barry Cottle

Yes, I think when you're looking at 2019, the rollout of the candidate installations is going to continue, all the way through 2019 and some of these will actually come through in probably Q1 of 2020 as well. So we're not expecting any real significant declines, granted it is going to be lumpy throughout those periods, just based on the go-lives. So for example, you saw record Q4, Q1, Q2 a year ago, you see a slight decline this year, I think versus what everybody was modeling. And then we'll have a good Q4 again with some of the major sites going live with Gateway and Ontario and with Alberta in the quarter.

Brad Boyer

Okay. Appreciate all the color.

Michael Quartieri

I'll just say we'll still have probably close to 20 additional sites, still to go next year. So there's still significant runway going forward in 2019 on the revenue side.

Brad Boyer

Perfect. Appreciate all the color guys. Thanks.

Michael Quartieri

You're welcome.

Operator

And next we have Carlo Santarelli of Deutsche Bank.

Carlo Santarelli

Hey guys. Good morning and thanks for taking my question. As you think about the business, just bigger picture right now. Clearly a ton of moving parts with sports betting, with the lottery initiatives, obviously with the core content on the game side. And there has been quite a bit of M&A that you guys have kind of been at the forefront of whether it’d be sports betting or some other verticals, social gaming, et cetera. Could you talk a little bit maybe about kind of what you feel the organic growth rates look like in each of the verticals where there's a little bit less kind of noise from kind of ancillary bolt-on acquisitions?

Barry Cottle

Yes. I mean, well, first of all, it’s kind of step back, you described the M&A, it all fits into a larger picture of what we're trying to own and win in the space. And basically we are going to win wagering across three major verticals, gaming, lottery and sports. And we're strong believer that is going to be pervasive, player activity across the retail and digital. So we want to make sure we own the core parts of the value chain both on the M&A platform, enabling wagering piece of it as well as on the top content per se that people use, what they play in gaming or engaging with but lottery or in sports betting.

And so from an M&A perspective, we feel like we've accomplished that. We're at – we've now got, we really owned the core pieces of the value chain on the platform side and on the primary content side within that space. And all of those three verticals continued to grow with varying degrees of organic growth, whether it's retail or digital, but aggregately wherever somebody wants to leisure, that's what we're going to play and move forward on.

In each of these businesses, collectively as we've described before, it's continued to grow quarter-on-quarter, both top and bottom line. So again, we're very bullish on a go forward basis that there is significant growth on a – if you want to break down each of the different groups respectively.

Michael Quartieri

Yeah, I would say from a breakdown of individual business units, I think when you look at gaming, the tuck in acquisitions that have been done, whether that was Tech Art or DEQ are not real substantial to the operating results overall. And so there's really no special call out there. Looking at lottery there hasn't been really anything going forward from an acquisition perspective.

Lapis was the last tuck in acquisition we did, which was nearly two years ago. On a social perspective, it is the social Bingo app, but then again, that was purchased nearly 18 months ago and a lot of the growth that we've seen there is really a result of our management of that process and by applying our data analytics to their business, which is really growing that, and that's reflected in what you've seen in the contingent consideration payments, or accruals that we've made that are called out in restructuring and other charges.

And so really it kind of boils down to it's the NYX acquisition, that's really the item that needs to be called out, from call it non-organic growth, as that's the acquisition that just took place this year. And that's pretty much verbatim what the increase is in the digital segment, which is why we carved that all out separately and have it as a separate segment.

Carlo Santarelli

Okay. Thanks guys. That's very helpful. I appreciate it.

Operator

The next question we have will come from John Decree of Union Gaming. Please go ahead.

John Decree

Good morning guys. Thank you for taking my question. We touched on all the high-level stuff, so maybe just a couple of small housekeeping questions. In the prepared remarks did I hear you had your first kind of 300 unit a sale or placement of SciQ in Ohio and if I heard that correctly, I was wondering if you could provide a little bit more detail on that if it was purchased by the lottery, purchased by a large retailer, et cetera.

Barry Cottle

Yeah, sure. John. The order was placed by the lottery and the lottery is in the process of determining which locations they want to put those units into. So, it's very early in the rollout stage at this point.

John Decree

And the economic model there, is it, is it a one time sale fee plus a recurring revenue stream for you guys or is that also kind of being worked out right now with the lottery?

Michael Quartieri

No, that's consistent with what our economic model is. So there'll be a onetime purchase of the equipment, and then there's an ongoing maintenance fee that goes along with that on a recurring basis, which is kind of similar to what you would have in your systems business, as there's going to be a system component, that will require upgrades and additional functionality that will continue to goal out that's tied into those units.

John Decree

Got it. That's helpful. And then on the asset sale, a $40 million real estate sale was that the Illinois office? And then, does that come with some kind of annual run rate cost savings from carrying costs or property taxes and is there any other kind of non-core assets like that, that you're still working through that that might be on the block, next year?

Barry Cottle

Yeah. So the, the two assets that we've called out as held for sale in the 10-Q in prior quarters was the El Camino location, which I guess was the original shuffle, building a before Shuffle never moved in, and it became the Bally's building, which eventually became the corporate office for Sci Games. So, that's the building that actually sold for the $40 million in proceeds, cost save associated with that since the building went, got, or I should say, was classified as held for sale. The carrying costs of those assets were put into the restructuring charge, as they were non-core at that point going forward

So it should be $1 million to $2 million in savings just from a carrying cost perspective that you'll see year-over-year savings in. The other asset is the Chicago asset and that still remains on the market.

John Decree

All right. Thanks you. I appreciate the additional color.

Barry Cottle

You got it.

Operator

Next we have Cameron McKnight of Credit Suisse.

Cameron McKnight

Hi, good morning. Thanks very much.

Barry Cottle

Morning.

Cameron McKnight

So Barry, first a question on sports betting. Many, many deals have been announced in the past six to nine months. How sticky or long-term do you think a lot of those deals are, and when do you think sports betting might become – a U.S. Sports Betting might become material as far as NYX is concerned?

Barry Cottle

Yeah. Look, I think we think, we believe and I think most people believe that if you're still in an extremely early stages of the sports betting market, both from a deal making perspective is, as well as a rollout perspective. I think is, as we mentioned earlier, it's really just about 6% of the population in terms of states that are currently legalized today.

Most of the deals that we've seen in the marketplace without specific, speaking specifically to those deals are really deals that was done basically to get done, to a one state deal. I'm not long-term in nature at all and to basically get something up and running in New Jersey and as an, for people to get experienced essentially in, providing sports betting in the marketplace.

So we're, we think it's still early. As I mentioned before, we think, we've seen, we've lived and breathed, we've seen this movie before in the UK over the last decade and the best product wins out in the marketplace. And so we feel like we're really well positioned and we were in, continue to be in a lot of conversations as it relates to deals on a broader and a longer term basis.

And so I think it still has, it has ways to play out. I think, if you look at kind of the pipeline of states that are to be legalized, I think it'll, I think you're going to continue to see a lot of state activity over the next two to three years.

And obviously accordingly, commercial deals being set up as well over that time period and then you build into that, the launches, the marketing and the end, the execution, it's still a I think a long-term game that is probably, at least two to three years out and maybe to be material.

But I also believe that, I believe there's a real market there. I think as we all know that, that sports betting is happening today, there's a market out there and so I don't think, I think I, I believe that it's material and it, and it will be and it'll be attractive obviously, is that like most markets and we've seen an iGaming in everything. It is just going to take a few years to materialize.

But it is still early, but exciting nonetheless.

Cameron McKnight

Perfect. Thanks. And then in terms of the terms of the social business, EBITDA was up 7% quarter-on-quarter. The prior quarter was impacted by some changes that were made at Facebook. Can you talk about how that was mitigated during the quarter, and what should we think of as an appropriate sequential growth rate for AEBITDA in Social going forward is three to five the right way to think about it.

Michael Quartieri

So I can talk about the Facebook. On the Facebook side, essentially, as they encountered the privacy issues that occurred in the late spring, early summer time, there was changes made which basically prevented us from being able to authenticate the Facebook token in order to recognize players coming into the game. They had released several releases to that and that caused some disruption in our game and the ability for us to authenticate, Facebook players and in particular some of the payers that were coming into our games.

We consequently made it a fix to our games that enabled us that if we could, if there is an issue on the Facebook side, we're still able to authenticate the player and get them into the game to play. And we were able to get that in July and a proof point basically that it actually worked, is that occurred again, as everybody knows, a changes were made in August and yet we experienced, no issues when the issue occurred again.

So, we've been able to now, that's completely resolved and the game is back to growing up, as it would have done have we not encountered that issue. In terms of going forward, obviously, as I mentioned before, with the SEC rules that limit our ability to discuss, we can't – we’re not giving guidance beyond today's and previous earnings result related to the business.

Cameron McKnight

Sure thing. Thanks very much. And then one final one for Mike. In terms of the refi of the 10% notes, at what rate would it not make sense? Is 8% around about the breakeven point when the call premium is still at 105?

Michael Quartieri

That is probably about a fair kind of decision point that we would look at, but, it's really going to be dependent on what we see market conditions looking at, on a go forward basis. So, at 8%, we probably started looking at it, but, again, it's really going to be depending on what we see the rates doing in the future.

Cameron McKnight

Okay, perfect. Thank you very much.

Barry Cottle

Thank you.

Operator

Next we have Mike Malouf of Craig-Hallum.

Mike Malouf

Great. Thanks for taking my questions. Most of them have been asked, but I just want to do a little follow up on the SciQ. It sounds like that's a huge opportunity as you look at 60,000 opportunities, that retailers would benefit. Can you talk a little bit about the model that would drive a retailer to implement this? Why is it so beneficial? And then just a little bit more detail on the economic model with regards to how much these cost and how much, on a percentage of cost that maintenance is? Thank.

Michael Quartieri

Yes, sure. Let me kind of give you the perspectives from the Lottery retailers. So I mean, if you walk into any one of these convenience stores and you look at behind the counter, you see this large real, usually it's a plastic display unit and there's just rolls of live tickets behind you. From a retailer perspective, that's no different than cash that's sitting out there. And so every time that you do the end of the day where you're counting down, you're register and reconciling that to your POS system, the retailer is spending that time counting those tickets to make sure that they balance out to the POS system

With SciQ that security enhancement, one, it eliminate theft. So, shrinkage is an issue within the retailers themselves across the board. Number two, from that – I call it accounting or the revenue side of that business, rather than spending 30 minutes every day counting down those ticket, it's simply pressing a button and getting a report that instantly ties into the POS system. So that labor savings is significant at the retailer and then also back in their home offices where they have countless numbers of individuals that are responsible for the accounting and reconciling of those daily revenues on an ongoing basis.

And also the display units of the units we've seen has caused an increase in the revenues, in the pilots that we've done so far, in the 53 different locations we're seeing on average, it's roughly about a 10% to 15% increase in retail sales.

So there's three different benefits there to the retailer itself. From an economic model perspective and we haven't gotten into a lot of the details, which we won't, but from an overall perspective it is a, purchase on behalf either of the retailer or the lottery itself. And then there's an ongoing maintenance monthly fee that will be charged in order to maintain the unit and continue to do the upgrades of the software associated with it.

Mike Malouf

Okay, great. Thanks a lot for the help. Appreciate it.

Operator

And next we have Mike Pace of JPMorgan.

Mike Pace

Hi, thanks for taking my questions. I'd like to pursue maybe the Social IPO consideration a little bit. And I know you're a little handicapped on what you can say. But I guess -- do you think the business is right sized for a public equity event? Do you need any additional tuck-in acquisitions there before you make that decision? And then, I think somebody also mentioned the potential of selling a minority stake. And I'm just wondering, if that is any different than a typical 20% sale or not? And I have a few follow-ups there too.

Barry Cottle

Yes. Mike, unfortunately, given the rules, we're very limited on what we can really say about what the size of any type of IPO would be, whether it's minority or whatever. So we just got to stay clear of all of that. In regards to the business going forward, we kind of just based on where we see the growth in the business and its current scale. We view this as an opportunity to help accelerate that growth, realize value and help us with the deleveraging up at the corporate office.

Mike Pace

And then maybe to follow-up on that, this is something that you probably can't answer is, use of proceeds. You do talk about paying down debt. Just to be clear, that's not a requirement for you to pay down debt with proceeds there. That would be your decision. And then as structuring goes, if I understand it right, the social business is an unrestricted entity, but it's owned by a restricted entity. And I just wanted to make sure there would be no change to that ownership or structure, post any potential event there?

Barry Cottle

No, we don't foresee any change in that organization structure that would impact the ultimate ownership of our percentage within Scientific Games. And the whole concept around it as we stated two years ago, when we put it out as an unrestricted sub, the purpose of this is to primarily pay down the debt within the corporate entity. And when I say primarily, that's just the primary use of all of those proceeds.

Mike Pace

And just as – not as a requirement just as a choice, just to be clear there.

Barry Cottle

I think either way it would be the same.

Mike Pace

Got you.

Barry Cottle

At the deleveraging event.

Mike Pace

Okay. Thank you. And then just on the business, just looking for an update and apologize if this was mentioned earlier, I jumped on a little late. The Pennsylvania lotto contract update, just curious on expectations, thoughts on if upfront CapEx would be required upon a win. And I don't know if you have disclosed the size of this business historically?

Barry Cottle

From a process perspective, the expectation is -- new RFP should come out. We are thinking it would be sometime after the election. So obviously we've gotten past the election based meetings to-date, as very recently as within the last couple of days, expectation is we should be receiving the RFP some time early in Q1.

As we said, this will be a renewal and it's such instances where there is a renewal, even though you are the incumbent, there would be a upfront CapEx spend because the states require that all bidders be on a consistent and level basis. And therefore we would have to put in new CapEx, the CapEx that would be required for a state of this size is somewhere around that $80 million to $85 million mark.

We wouldn't expect this to be any different and from an economics perspective, we've never really commented specifically on economics around any individual contract. However, this is our largest domestic contract we have within the Lottery system business.

Mike Pace

Great. Thanks guys.

Operator

Well, at this time we will conclude our question-and-answer session. I will now like to turn the conference call back over to management for any closing remarks. Gentlemen?

Barry Cottle

Great. Thanks everyone for joining us today. We appreciate the support and following. On the heels of G2E, the entire team and I are highly enthusiastic about all the potential ahead. We look forward to updating you on upcoming accomplishments and our fourth quarter results during our next call. Thank you very much

Operator

And we thank you sir and to the rest of the management team for your time also today. The conference call has now concluded. At this time you may disconnect your lines. Thank you again everyone. Take care and have a wonderful day.