Scientific Games Corp. Q2 2008 Earnings Call

| About: Scientific Games (SGMS)

Scientific Games Corp. (NASDAQ:SGMS)

Q2 FY08 Earnings Call

August 1, 2008, 08:30 AM ET

Executives

A. Lorne Weil - Chairman and CEO

Michael R. Chambrello - President and COO

Joseph R. Wright - Vice Chairman

Analysts

Celeste Mellet Brown - Morgan Stanley

Lawrence A. Klatzkin - Jefferies & Company, Inc

Steven M. Wieczynski - Stifel Nicolaus

Robert J. Evans - Craig Hallum Capital Group

Carlo Santarelli - JP Morgan

Ralph Schackart - William Blair & Company

Operator

Hello everyone. Thank you for joining us this morning. With us today are Mr. Lorne Weil, Chairman and CEO; Michael Chambrello, President and COO; DeWayne Laird, CFO.

During this call, they will discuss Scientific Games' second quarter 2008 financial results, followed by a question-and-answer period. A replay of the call will be available at the company's website, www.scientificgames.com, for 30 days. As a reminder, this call is being broadcast live. Please refer to yesterday's press release for full details.

Before turning the call over to management, Scientific Games would like to remind you that this conference call will contain statements that constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigations Reform Act of 1995. This information involves risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. For certain information regarding these risks and uncertainties, reference is made to Scientific Games' annual report on Form 10-K for the fiscal year ended December the 31st, 2007.

Now let's begin. Mr. Weil?

A. Lorne Weil - Chairman and Chief Executive Officer

Thank you very much, operator. Good morning everyone, and welcome to our second quarter 2008 conference call. We are here this morning, as usual, with Mike Chambrello and DeWayne Laird, and we are joined today by Joe Wright, who as I think most of you know, will be taking over as CEO on January the 1st next year when I will relinquish that title to become Chairman. At that time, Joe will have the privilege of inherited responsibility for the quarterly conference calls, thereby mercifully ending my uninterrupted streak of quarterly conference calls that something I think is just shy of 70.

We were reasonably pleased with the results of the second quarter, which came in pretty much in line with expectations we outlined on our last conference call. Revenue was 14% ahead of last year and exceeded $300 million in a quarter for the first time. Adjusted EBITDA, as we defined it in the press release, was $104 million, 17% of last year, is also a record.

EPS on a reported basis was $0.31, nearly 50% higher than reported EPS in the first quarter of 2008. EPS was $0.35 after adjustments and $0.41excluding non-cash stock option expense.

In terms of the adjustments themselves, there were four items: the Global Draw earn-out, which we've discussed previously; the extinguishment of debt pursuant to the $850 million financing completed in the second quarter, which is something I will talk a little bit more about later on; the resolution of the California Horse Racing Board matter, which I don't expect to be talking about later on; and about $1 million to enhance the retirement package of Bill Huntley who has been one of the most important contributors to the success of this company for many, many years, dating back to our early pioneer days together in the company formally known as Autotote.

And indeed I would like to take this opportunity to thank Bill publicly for all the great work he has done for us in that time. The combination of Autotote and Scientific Games that took place in the fall of 2000 seems actually impossible to believe that it's been pretty much eight years by now could not possibly have been as successful as it has been without Bill's leadership.

Fortunately, Bill whose expertise in technology and operations is, in my humble opinion, second to none, not only in our company, but even our industry, will continue to be closely involved with Scientific Games as a consultant well into the future.

As we reported in the press release, instant tickets continued to perform extremely well in what is considered to be an otherwise difficult economic environment. Instant tickets same-store sales increased about 6% in the quarter. Mike will talk about that in more detail later. The latter rate of growth was somewhat below the trend growth rates that we have become used to in the last six or seven years, but in actuality, consistent with our internal expectations and excellent in deed considering the general economic climate.

Over the course of the last several weeks, there have been any number of items in the press commenting on the strength of the lottery business in general, and the instant tickets segment in particular, and strongly contrasting it with what has been taking place in the gaming industry overall.

In past conference calls, going back not just quarters but indeed years, we've commented in great detail on why we think this is generally the case, and why in this kind of environment we would see pretty much what we're seeing. So I don't think I need to belabor it here yet again.

The positive margin gain coming from the integration of OGT, this is something we've talked about for a few quarters. It was felt in the second quarter, but unfortunately, this was masked by the impact of sales to China. As mentioned in the press release, the combination of air freight and duty to China reduced Printed Product margins by about 2 percentage points in the second quarter. And as was not mentioned in the press release, plant loading and efficiencies in Alpharetta associated with the scheduling of the China business, though a little difficult to measure exactly, probably impacted margins negatively by at least another two points.

Taking together these items represented about $0.04 per share earnings in the second quarter, and we would not expect these to correct themselves until we are up and running in China, which will be in the latter part of the fourth quarter. And again, Mike will talk about that in some more detail in a moment.

At the same time, our Lottery Systems business demonstrated strong same-store sales growth of about 7% with most of the growth coming from outside the United States where lottery fundamentals continue to be very strong. The exceptional start-up growth that we've seen in China importantly impacted overall growth in both instant tickets and systems, although this revenue, of course, is excluded from both instant tickets and systems for purposes of calculating same-store sales.

Overall, Lottery Systems revenue growth was 35% in the quarter with 16% growth coming in lottery services. In a few moments Mike will talk at some length about our overall activities and progress in China.

The diversified gaming side of the business had an eventful and positive quarter. The issue with the California Horse Racing Board now fully resolved, fortunately notwithstanding. Global Draw continued to perform superbly with financial performance enhanced by a full quarter's worth of revenue from William Hill and growing revenue in Mexico.

In June, I was privileged to attend the conference in the UK sponsored by Games Media, which included the Chief Gaming Officers from each of the seven UK pub companies with whom we currently have contracts. And I must say I was extraordinarily impressed by the enthusiasm that each of the participants expressed regarding our strategy in the rollout of our program.

As mentioned in the press release, second quarter gaming revenue absorbed a significant negative impact due to the shift in the Games Media paradigm from one-time sales boxes to participation-based essentially facilities management service revenue. But we are more than ever confident of the wisdom of this strategy, in particular following the conference that we had in UK in June.

Over the course of the last three months, we've had meetings with a significant number of current and prospective shareholders and lenders, and have noticed quite a bit of thematic consistency from one meeting to the next.

So, before handing things off to Mike, I thought I would do something a little different today, and take a couple of minutes here to catalog what seem to be a half dozen of the most, as they say, FAQs, and to review what have been our FGAs, that's Frequently Given Answers in case you hadn't been able to guess.

So, question 1, what kind of acquisition strategy can we expect? Answer: I think it's very unlikely that in the near future we will make an acquisition in a completely unrelated business. Any acquired company will most likely fall directly into an existing business area, offer significant cost and revenue synergy opportunities, and be meaningfully accretive to the earnings in the short term. We would also expect to have a recurring revenue business model, have a lot of operating leverage, and be inherently insensitive the economic and other environmental uncertainties. Believe it or not, such candidate actually exists if you know where to look for them.

Question two: what is the ideal leverage ratio for Scientific Games and do you have a target? Answer: Since we're interacting with both shareholders and lenders, we have to find a way to keep both groups happy. So the answer is a ratio of debt to EBITDA that lies somewhere between three and two. Given the stability and predictability of our cash flow and certainly it's never more apparent than it is now, I think we could clearly tolerate a leverage ratio higher than three, but our plan nevertheless is to adopt a ratio of three as the red line. And if drops to two, I would consider us to be on the verge of being underleveraged and likely to take appropriate action.

Question three: what proportion of your earnings comes from outside the United States and what is the trend? Answer: in the first half of this year, more than 60% of our operating profit was generated by revenue coming from outside the United States. This ratio has been increasing steadily over the last couple of years, and we would expect it to continue to increase given that our primary growth drivers at present are international instant tickets and international gaming machine system.

Furthermore, we would expect our business outside the United States to be positively impacted by activities such as sports, and internet wagering, which for obvious reasons have gained little traction, at these legally, in the United States.

Question four: apparently companies like Coke and Pepsi are seeing a significant slowdown in their sales through the convenience store channel. Given that a large percentage of lottery sales are through this channel, are you seeing the same pattern and if not why not? Answer: we are not seeing this pattern at all, as Mike will describe in a little more detail in a little moment. Generally speaking, I don't think that most state governments are terribly concerned about the sale of soda pop, since unlike lottery tickets, 35% or 40% of the proceeds of the sale of soda does not go directly to fund education or senior citizen prescription drug plans or other government programs. When the economy is weak and tax receipts are declining, lottery sales are more important than ever to state and national governments.

Question 5: how is your management succession going? Answer: it's going very well, indeed. Joe Wright has been on Board for three to four months now and he, Mike and I have been spending a significant amount of time together and are working together exceedingly well. I think we are very comfortable with the way that the assignment of the responsibilities is evolving and I think that by the time we made the official change at the end of the year the transaction will have been entirely seamless.

Question 6 and finally, tell me all about your business in China. Answer: I think I'll let Mike answer that one and on that note, I will hand the program over to him. I should mention I realize I haven't said anything about the third quarter, that I will do that after Mike makes his remarks.

Michael R. Chambrello - President and Chief Operating Officer

Okay, thanks Lorne. The second quarter and really the first half of the year has been one of non-stop activity across all lines of our business, but let me just take a few minutes to discuss a few of the key areas starting with Printed Products.

On previous calls, we've discussed the potential impact of economic uncertainty on instant ticket retail sales, as Lorne had mentioned. In the U.S. 17 lottery jurisdictions experienced instant ticket sales... record sales over the 12-month period ending June 30th of 2008. On average, overall year-over-year sales growth fell right into the 67% growth range that we discussed earlier in the year.

As Lorne motioned, many recent published reports have indicated the lottery... that lotteries have generally not been adversely impacted by the economic downturn to-date and that's our general observation as well. While we remain very sensitive to economic factors such as gas prices, increased cost of food, and other basic necessities, we continue to see sustained growth in our core instant ticket business.

While China remains a key driver of instant ticket production, we remain at capacity in our Alpharetta and other printing facilities due to the overall strength and demand throughout the U.S., North America, and Europe. We are on track to print and distribute 30 billion tickets from Georgia alone this year. That's roughly 10% to 12% more volume than we believed possible at the beginning of this year as we continue to find ways to produce more, more efficiently, more effectively and meet customer demand.

As Lorne noted, primarily due to the increased cost of air shipping importing tickets into China, we showed a margin decline of around 2% for Printed Product versus Q2 of 2007. Another factor to keep in mind is that while we run at or near capacity in Alpharetta and, in fact, our other operating and production facilities, we lose some flexibility and therefore efficiency in running certain game types and run sizes on presses that have availability as opposed to the specific press that can print the certain game or run size at the lowest possible cost, not just our [ph] games lowest cost, the lowest cost in the industry.

We do estimate that this capacity situation reduces our efficiency and therefore our margin and I agree with Lorne that that's generally in around the 2% margin decrease or so. Once we have our presses up and operating in China, as well as the likely addition of a new press, this situation will resolve itself. We are very comfortable that once China volume is satisfied by production in China, we will see a return to our traditional operating efficiencies with subsequent margin improvement.

And taking a little different course, another true measure of success is of course contract awards and extensions. As I am sure all of you are aware, we are awarded the primary contract to provide tickets and CSP services to the state of Florida. This contract is longer than normal, six years, and with a four years' worth of extensions, an award Scientific Games is primary provider of 90% of the Florida instant ticket production. Two other vendors will split up to the remaining 10%. Also in Q2, we are awarded a five-year contract in Montana with no secondary vendors provided for. We were also fortunate enough to receive one year extensions in Minnesota and Wisconsin, a two year extension in New Hampshire, a three year CSP extension in Delaware, and a five year extension in Kentucky, all at largely the existing commercial terms.

Moving across the ocean or pond, in Europe, sales in Italy and the UK remain very strong. With sales of 2.3 billion euros in Q2, Italy achieved its highest quarterly sales ever. In addition to the continued sales strength in the UK, Scientific Games executed a new contract with Camelot with payment based on a percentage of retail sales. That new agreement starts in January of 2009.

In Camelot's proposal for the new license in the UK, they featured increased growth in the sales scratch tickets as a primary driver for increased sales and return to the national lottery. As a percentage of sale customer, SG will more directly be involved in game design and retail marketing. We see the UK market and our expanded relationship with Camelot as a significant long-term growth opportunity.

So, as we find to ourselves in the peak summer months, historically the period of lowest sales for instant tickets, the fundamentals are strong and the trends that have been historic on a year-to-year basis we see remaining in this quarter as well, or in Q3, as Lorne will address.

Moving over to MDI, sales in MDI were up almost 18% in Q2 versus same period last year, largely driven by the introduction of the Indiana Jones scratch ticket launch that was launched in conjunction with the movie premier. A record 22 lotteries participated in the launch, once again demonstrating if you offer the right brand or licensed product, tremendous interest and sales are generated. While sales are significantly higher, cost associated with the production of Deal or No Deal and a significant mix change between license fee in merchandise games reduced margin by about 6% to 7%.

We previously discussed the success of the aggregated Deal or No Deal game, which culminated in a Scientific Games sponsored winners' event in LA in May. Howie Mandel, the host of the actual game show, participated and over $3 million in prizes were given away. I assure you, a good time was had by all.

Based on the overwhelming success of deal one, as we refer to it, we have entered into an agreement with NBC and Universal Studios to sponsor a lottery week in a special half power daily syndicated version of Deal or No Deal that premiers in September of 2008. The actually lottery week where all 27 contestants would have been selected by playing or participating in lotteries Deal in No Deal game will hear in the spring or summer of '09.

While these event-based games are more expensive to operate than our traditional licensed product offerings, they offer a significant form of interactive entertainment that has demonstrated great appeal traditional and nontraditional players alike. In the future, we will be announcing other aggregated and entertainment theme games that demonstrated long-term player and viewer appeal, very exciting times in MDI.

Now let's move to China. As many of you are aware, our original plans in China called for the rollout of 12 provinces prior to the start of the Olympics. I am pleased to say that we exceeded that target by a wide margin. We launched our 30th province during the second week of June, a tremendous accomplishment, never in the history of the lottery industry have so many jurisdictions been launched in such a short period of time.

As stated in our press release, recent weekly sales have exceeded US$60 million, this from the start of just a few million dollars doing the last week of March of this year. Size of the network is a frequently asked question. We currently have over 50,000 active retailers with around 16,000 out of the available 50,000 terminals deployed.

In China, we operate under a super retailer model, where one terminal-based retailer services other satellite retailers. Given China's population, we have a retailer penetration of about one retailer for very 20,000 people. In comparison, in the U.S. and other mature markets, the optimum retailer density is about one retailer per every 1,000 people. Some of the most successful lotteries such as Massachusetts have even greater penetration with a retailer density of one to 500 population.

Looking out a little bit into the future, we anticipate that by the end of year we'll be have installed all 50,000 terminals with an active retailer base well in excess of 100,000. In 2009, we plan to deploy 9,000 terminals serving approximately 100,000 retailers. Practically speaking, the current retailer density enables us to serve only about 150 million people growing to approximately, let's say, 350 million in 2009 out of a total population of 1.2 or more a billion people, clearly the opportunity for significant and just as importantly, sustained sales growth over the next few years in China is to use the word staggering.

I am also pleased to report that we are well into production of the post-Olympic games. Six new games have been approved by the government, including three 5 RMB games, two 3 RMB, and one 10 RMB, all currently being prepared for distribution. This price point mix is very similar to the price point mix of the Olympic games.

Interestingly, one of the three RMB games will provide direct support to the Earthquake Relief Fund and one of the five RMB games will be the first holiday game ever in China.

On an average, retailers have three or may be four weeks of inventory on hand. We anticipate that we will continue to shift product by year through the end of this year. We remain on schedule to begin production with one press in December and the second press in the first half of next year. Sales continue to exceed expectations in China, and we very much look forward to the launch of the post-Olympic games.

Let me spend just a couple of minutes on lottery systems. We had an active and successful Q2 with the launch of the new system in Connecticut in mid-May. This system, of course, featured the new wave terminal, but also included the launch of two new system-based products, lottery in motion, which allows the central system to provide point-of -sale advertising for our communications network, and Lottery Insight, which is state-of-the-art lottery management passcode [ph] and sales reporting tool. Both have been very, very well received by the lottery and by our retailer base there.

In the additional good news category, we received a five-year contract extension for both online lottery and video services in Delaware, a one-year contract extension in Iowa, and a four-year extension of our field marketing services contract in Puerto Rico, which has driven online... record online sales in that jurisdiction.

Mexico, however, remains a trouble spot. The actions we have taken in conjunction with Televisa are behind where we would like them to be. If we are not able to make substantive progress over the next quarter, we will make... take more definitive action to ensure that the weeding does not continue into 2009. We will have more detail on our progress and our plan course of action on our next call.

As I'm running out of time, I will turn the program back to Lorne.

A. Lorne Weil - Chairman and Chief Executive Officer

Thanks, Mike. With a report like that, actually you can take all the time you want. That's a lot of great stuff. Before I turn the program over to Q&A, let me say a few words about how we might be thinking about the third quarter and specifically, how it might be different from the second quarter that just ended.

The most important issue to consider at this point is the change in the interest charges that will occur from Q2 to Q3. Needless to say, we were very pleased to have enabled and complete the financings that we did during the quarter, considering the sorry state of the credit markets, but there is clearly an associated cost.

The interest on our bank debt in the new deal is LIBOR plus 250 basis points, something which we have reported clearly previously. And that's considered by many in the credit marketplace to have been a terrific deal for us to have pulled off, but unfortunately it compares unfavorably in terms of spread to the previous bank deal, now nearly five years old, which was at LIBOR plus 150. Of course, back at that time LIBOR was much higher. So the actual interest rate today compares quite favorably to what it did even as recently as last year. But clearly it will go up considerably from the second quarter to the third quarter as the charge goes up by one basis point.

In addition, we added a new subordinated debt component to give us incremental liquidity, a decision that in retrospect seems to have been very wise indeed. But until the funds are put to productive use, we're going to be incurring negative arbitrage, and this will impact the third quarter as well.

I should say that this whole financing is an excellent example of our willingness and commitment to do things, which have clearly negative short-term impact in order to position ourselves in the best possible way for the long run. We could easily have postponed doing this financing and not incurred these increased interest charges. Either because of the increase in the spread or because of the terrific amount of liquidity, we now have dry powder, as some people call it, from this deal. But our view without question is that we are so much stronger now, as a result of having done at that whatever short-term earnings pain we might have is far more than worth it.

Beyond that, we are anticipating that our earnings from the Italian joint venture in the third quarter will be very significantly ahead of the third quarter last year so that the year-to-year is terrific. But reflecting the fairly predictable summer slowdown, we expect that the third quarter joint venture earnings will be well below... not well below... below this year's second quarter, which was quite strong. And then looking further ahead, we expect that the Italian earnings will rebound very strongly in the fourth quarter.

There will of course be offsets to the interest and joint venture impacts. For example, retail sales in China ran at about $43 million a week in the second quarter and we would hope that that would remain at the $60 million or a little bit higher level throughout the third quarter, thereby positively impacting both the Chinese printing contract and the Chinese systems contact.

But as both Mike and myself mentioned earlier, incremental freight duty and our inefficiency factors will continue to moderate the associated profitability until we are up and running in the China plant. At that time, obviously, the profitability equation can be expected to change very significantly. And that's as close as I am comfortable getting with the topic of guidance.

And with that I will turn it over to Q&A.

Question And Answer

Operator

[Operator Instructions] Your first question comes from the line of Celeste Brown from Morgan Stanley. Please proceed.

Celeste Mellet Brown - Morgan Stanley

Hi, guys, good morning.

Michael R. Chambrello - President and Chief Operating Officer

Good morning.

A. Lorne Weil - Chairman and Chief Executive Officer

Good morning. You finally made it ahead of Larry.

Celeste Mellet Brown - Morgan Stanley

This is my goal in life.

A. Lorne Weil - Chairman and Chief Executive Officer

Yes.

Celeste Mellet Brown - Morgan Stanley

Mike, there is still a lot of concern, I think, about what's going to happen once the Olympic sales or once you stop selling the Olympic tickets in China. And there's a lot concern that you are going to see a slowdown in that $60 million a week numbers that Lorne talked about aren't sustainable. Can you just talk a little bit more about why you think those numbers are sustainable and what you are doing from a ticket perspective that you think makes it more interesting and attractive to keep the sales going in China?

Michael R. Chambrello - President and Chief Operating Officer

Sure. Well, I think, Celeste, the first really, really big and great step was the CSLs foresight in getting games planned and approved well in advance of sort of the Olympic phase. I wish that I had the ability to discuss the specific games that are going to hit the street, but obviously the CSL would like to launch those at the appropriate time. But suffice it to say that all of the markets research that was done on these games, the price points, which really work so very favorably with the Olympics, we decided not to change those and risk any disruption there. So, we think the games are going to play very-very well, very, very, very well. And keep in mind that as the volume has hit the $60 million mark, it was on a lower] level of retailer penetration and that will have throughout the course of the year.

So, we think with the game types, the price points, the price structure, the themes of the games and the increasing retailer base, and we will finally start to do a little in-store merchandising and marketing in the second half of the year. I think for all of those reasons, we're going to remain very, very strong

Celeste Mellet Brown - Morgan Stanley

Okay, thanks. And I guess questions for you also, Mike, the Mexico loss was bigger in the quarter. Is that because the restructuring of lottery? And also, if you can comment on your thought on when you get instance, is that still in the second half?

Michael R. Chambrello - President and Chief Operating Officer

Sure. No, there was no restructuring in Mexico. We are and have been along with Televisa expending a little more time resourcing and obviously money on trying to rate the ship down there. And we have had some impact on sales, but that's nearly the order of magnitude impact that we need and want in order to make that successful. At this point, we have four games that are in the government approval process. They are further into the government approval process and instant tickets have been at any point since we've been in Mexico. And the best guess and, Celeste, I'd just say it's the best guess because of the failed ability to meet targets in the past, is that there'll be a November launch with these four instant ticket games.

Celeste Mellet Brown - Morgan Stanley

Okay, thanks. And then, if I could, are we allowed to ask Joe Wright questions?

A. Lorne Weil - Chairman and Chief Executive Officer

Sure, absolutely.

Celeste Mellet Brown - Morgan Stanley

Hi, Joe. Just wanted to ask you your philosophy, if I can put you on the spot on guidance for you, continue with... are you in line with Lorne's philosophy or do you think that guidance is a good idea for companies?

Joseph R. Wright - Vice Chairman

Well, seeing how I am sitting just a couple of feet away from Lorne, I totally agree within his philosophy. No, I think it's a good balance between what is reasonable direction going forward without going fully into the guidance game. And so I think we are doing just fine and I look forward to meeting you.

Celeste Mellet Brown - Morgan Stanley

Okay, thank you. I look forward to meeting you as well.

Operator

Your next question comes from the line of Larry Klatzkin from Jefferies. You may proceed.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Hi. Always beauty before age, so, Celeste, I bow you going first. Joe, welcome, and a couple questions here. One, global Draw, you... first of all, Mexico Global Draw, you're beating the pants off of IGT. Do you see a chance of increasing that order from 1500?

A. Lorne Weil - Chairman and Chief Executive Officer

I am not... I don't know how to respond to that we were beating the pens off of IGT.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Your numbers seem to be better than IGT's. How about that?

A. Lorne Weil - Chairman and Chief Executive Officer

I think IGT is doing just fine and thank goodness, we are doing just fine. I think if we continue to rollout our first quarter in Mexico, and the machines continue to perform at the level they have been, then I think it's reasonable to anticipate that we will get follow-on orders.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Okay. You have 10,000 Global Draw units sitting in a warehouse that will port off to UK for the new machines. What's looking for placing those machines?

A. Lorne Weil - Chairman and Chief Executive Officer

Again, there are a number of important prospects, largely in Central Europe and in Latin America. I wish that we had some specific contracts that we could announce, but we are very, very close on a couple of quite significant commitments, but we are not quite there yet. For people who didn't... who didn't fully understand Larry's question and panicked to think that we had built 10,000 machines and have been sitting in a warehouse, this is absolutely not the case.

What happened was when we acquired Global Draw a few years ago, we acquired a fairly old legacy installed base of machines, which we deliberately consciously and as just turned out, very-very successfully replaced with a brand-new machine. And all of those machines, which were fully depreciated at the time, I might add, came out of the field, were refurbished in our Irish plant. And we now have available to us in... to be used in certain markets machines that have the capability of generating very significant income at either zero capital investment on our part or zero incremental deprecation. And that is the set of machines that Larry was referring to a moment ago.

Lawrence A. Klatzkin - Jefferies & Company, Inc

As far as Games Media, how many units are currently on the field on test and what's it doing on ramp-up on that?

A. Lorne Weil - Chairman and Chief Executive Officer

I think we have about 600 installed now. I think it's not entirely accurate to say that they are on test. Most of them are there pursuant to contracts, which contractually call for a ramping up of number of machines that we have installed as we meet certain benchmarks and milestones in terms of the performance of the machines. So, this is not a subject of test or evaluation that's taking place, but rather the beginning of a deliberate set of contracts to roll machines out.

In terms of how we are doing against those benchmarks, we are doing fine. The machines are performing extremely well. As I think you know right now, the pub in the street in the UK is going through a difficult period as a consequence of a variety of factors, not the least of which is the smoking ban that was implemented in the UK several months ago. As I think we have seen in New York, in establishments like pubs, there is initially, as we saw again the bars in New York, not that I would know personally, a sharp fall-off in business and then a slowly and gradual building back up, and I think eventually exceeding the previous levels. So I think we are quite enthusiastic that in the medium term, this will actually have been for the best in terms of the pub industry in our business, but at the moment, it's slowing us down a little bit because the pubs have other things on their mind. But as I mentioned before, I spent a lot of time with these gaming officers from the seven companies that we have contracts with now at a conference that we had in the UK in June, and the input that I got from these people was terrific. They clearly feel that our strategy is dead on the money and that gaming is a critical element of the, let's say, of the resurgence of the pub industry in the UK.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Could you... I mean, is it unreasonable to think that Games Media could have some significant contribution to earnings in 2009?

A. Lorne Weil - Chairman and Chief Executive Officer

Absolutely. I mean, I would expect that we certainly hope and expect that by the end of this year we should have... we would have an installed base of machines in Games Media that would be measured in the thousands. And we have a business model and again, we're conforming quite well to this business model so forth that would generate approximately ₤60 or $120 a week in participation revenue for each of these machines. So if you do the math, that's about $600,000 per year per machine and the revenues in 'O9 would be that figure of time however many machines we have installed. But at the same time, the cost structure is essentially fixed. All of the costs that we would need to be incurring to support a base in the field of x thousand machines is already in place. We work off of the Global Draw field maintenance organization, the communications network is in place, programmers, content developers, and so forth. So, whatever revenue we generate in '09 on the basis of the installed base that would exist at the end of the year, all of that would be incremental to our earnings in '09.

Joseph R. Wright - Vice Chairman

I don't know if you want to answer, but I come out with a... given a ramp-up like that, you could make more than $20 million in EBITDA from that, which is not much of contribution right now.

A. Lorne Weil - Chairman and Chief Executive Officer

You're right, I would not want to answer.

Lawrence A. Klatzkin - Jefferies & Company, Inc

As far as the validators are working well in China, any chance you might try to apply those elsewhere? I know you could use a lot more selling locations in Florida and other places. Any chance that a state might say try these out to increase the selling locations and hence the lottery revenues?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes, I think I'll let Mike answer that because this is something I know that he has been giving a lot of thought to.

Michael R. Chambrello - President and Chief Operating Officer

Yes,actually, Larry, I think it's... you are right on the mark given the success here, not just in places like Florida, but also outside of the U.S., in North America, it really provide another very, very economical low capital entry into certain markets that may be we wouldn't want penetrate if we had to have... invest a lot of capital and lot of associated risk. But having said that, if you look at some of... even more mature jurisdictions, not just in the United States, but in Europe as well, if we took the super retailer handheld approach, as by the way was the way of the world about 30 years ago here in the U.S. or 25 years ago, it's an area that we think is something that can be migrated outside of China, and we certainly are looking into that.

Lawrence A. Klatzkin - Jefferies & Company, Inc

I mean, you get that going in California, you could literally double the lottery; I mean, getting a lot more locations.

Michael R. Chambrello - President and Chief Operating Officer

Yes, again, as view it as a tool that will allow us greater penetration and we know we are under-penetrated in place like California, obviously in others. But it also again probably provides a different option for us in penetrating new markets where we would simply historically would not want the risk the much higher capital in a traditional environment.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Are you talking, Mike, like a Brazil or a Russia, something like that?

Michael R. Chambrello - President and Chief Operating Officer

Yes, any of the developing countries, yes, developing companies developing markets.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Thank you guys.

A. Lorne Weil - Chairman and Chief Executive Officer

Thanks Larry.

Operator

Your next question comes from the line of Steven Wieczynski from Stifel Nicolaus. You may proceed.

Steven M. Wieczynski - Stifel Nicolaus

Hi, good morning guys.

A. Lorne Weil - Chairman and Chief Executive Officer

Hi, Steve.

Steven M. Wieczynski - Stifel Nicolaus

Hi. Just two questions; first, going back to Global Draw, Lorne, maybe you can talk about the domestic opportunities for Global Draw in places like, you said, Maryland, for instance, if they pass laws?

A. Lorne Weil - Chairman and Chief Executive Officer

Domestic meaning the United States?

Steven M. Wieczynski - Stifel Nicolaus

Right.

A. Lorne Weil - Chairman and Chief Executive Officer

Sure. I think in the fullness of time, the opportunity for us in markets in the states that have the characteristics that drive our strategy is a great opportunity had you asked whether I think the prospects are for Global Draw in mega casinos in Las Vegas. I would have given you, I think, a different answer. But I think in applications, particularly where it's government sponsor gaming, as will be the case in Maryland, where the ability to design and manage a wide Aragon [ph] network across the state of Maryland incorporating a large number of machines, I think Maryland will probably be something on the order of 15,000, and I think where the business model is likely to be a participation-based model rather than a straightforward sale, again, which I at least cautiously expect could be the case of Maryland. Then I think all of the elements are in place there for an opportunity that's consistent with our... with the strategic posture we have in the gaming business. And therefore I would think Maryland would be a very good example of a market, as you have said, domestic market where we would be potentially very competitive.

Steven M. Wieczynski - Stifel Nicolaus

Okay, got you. And then going back to Mexico, Mike, I think you said you're looking for a November launch of those four games, but what if that doesn't pay enough? I mean, how long do you wait around for Mexico, I guess is the best way to say it?

Michael R. Chambrello - President and Chief Operating Officer

Steve, as I said my comments, we're plugging away and working really with Televisa to write a ship down there. However, if we are disappointed again either in instant tickets retailer expansion sort of commitments to the type of retailer marketing that is required, then we are simply not going to allow ourselves to continue to bleed at this rate in Mexico and we'll let those events unfold, see where we end up, but we will be working on other plans and options to ensure that we stem the loss as we enter into next year.

Steven M. Wieczynski - Stifel Nicolaus

So will that be like another year or less than that?

Michael R. Chambrello - President and Chief Operating Officer

You know Steve, it's premature because we are not waving a white flag and surrender here. So let's see how we do over the next quarter or so and then will be in much better position to address that question.

Steven M. Wieczynski - Stifel Nicolaus

Okay, got you. Thanks guys, good quarter.

A. Lorne Weil - Chairman and Chief Executive Officer

Good, thanks, Steve.

Michael R. Chambrello - President and Chief Operating Officer

Thank you.

Operator

Your next question comes from the line of Bob Evans from Craig-Hallum. You may proceed

Robert J. Evans - Craig Hallum Capital Group

Good morning, everyone, and great quarter.

A. Lorne Weil - Chairman and Chief Executive Officer

Hi, Bob.

Robert J. Evans - Craig Hallum Capital Group

Can you first comment on MDI? How did it perform this quarter, how would you expect performance next quarter?

A. Lorne Weil - Chairman and Chief Executive Officer

I will ask Mike to deal with it.

Michael R. Chambrello - President and Chief Operating Officer

Look, we are very-very pleased with MDI's performance this quarter. Sales were significantly higher than last year. As I said, we are going through a little bit of a mix in MDI from the straight license-less merchandising model, which has been so successful and at nice margin, very-very nice margins, to sort of trending to this aggregating game model, entertainment, interaction and things of that nature where the costs are higher, but we are really bringing in new and different players as well as existing player. So, like any of our business units, it's going through a little bit of an evolution right now. But I think the... we would have been very concerned if sales hadn't picked up from last quarter or last year. But they have been and we remain very optimistic that that's going to be a terrific business over the long term.

Robert J. Evans - Craig Hallum Capital Group

Okay. And can you comment further on China? I mean, could we get a ballpark sense of how much revenue was specific to China this quarter?

Michael R. Chambrello - President and Chief Operating Officer

You know Bob I don't think we're going to go into that level of detail.

A. Lorne Weil - Chairman and Chief Executive Officer

Bob, I think you can figure it out or at least get close to estimating because we talked earlier about having average retail sales in the second quarter of around $43 million a week. So --

Robert J. Evans - Craig Hallum Capital Group

Yeah, we come back into it from that, that's fine. And basically use of about $60 million a week as it relates to going forward. Do you think you can do things as it relates to your production capacity or process between now and end of year, where that number might be able to go higher on a per week basis or do you think that's kind of the level to look for?

Michael R. Chambrello - President and Chief Operating Officer

Well, it's actually... it's a little more complicated than that, Bob, because certainly there are tweaks and we continue the tweak and I will tell you that Jim Trast [ph] and our production teams around the world have just done a phenomenal job of getting us... again, we are 10% or 12% higher in volume than we would have ever anticipated we could have gotten to just six months ago. But we may have room for tweak, but the other thing that we're very, very cognizant of is that we've got a long and very loyal list of customers around the world that we need to ensure not adversely impacted by the great opportunity that we have in China. So, we literally every week do a balance, but I would just be much more comfortable sort of using that $16 millionish going forward. And if something good breaks, then that would be terrific, but we're kind of stretched at capacity and quality and balance with customers at this point.

Robert J. Evans - Craig Hallum Capital Group

Okay, fair enough. And, Lorne, I think you said over 60%... over 60% of your operating profit is coming outside of the U.S. right now.

A. Lorne Weil - Chairman and Chief Executive Officer

Yes.

Robert J. Evans - Craig Hallum Capital Group

Do you how much ballpark that is in revenue? And then my follow-up to that would be as you get to the end of '09, what might you think... I mean, where do you think we may be, say, end of '09 in that?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes. The revenue is... the revenue split between domestic and international is a little closer to 50:50, whereas the operating profit, as I said before, is a little over 60 and a little less than 40. And I think there is certainly on the portfolio of businesses that we have now. So again assuming we don't make a largest domestic acquisition, which at sitting here at this moment I would consider very unlikely. The momentum of the business is such that I would expect that by the end of '09 the revenue would be... percentage would be considerably more international and the operating profit also considerably more international.

Robert J. Evans - Craig Hallum Capital Group

Can you see it more as 75% by that time?

A. Lorne Weil - Chairman and Chief Executive Officer

If China does everything that we think it's capable of doing, and if Global does everything it's capable of doing, I think we begin to get close to that number. And if we actually were to see Mexico come to life and interestingly enough, how soon we forget that no one so far in this call has asked anything about Germany, so let me volunteer the fact that it's getting better, but it's not getting better at the rate that we would like it to. I think if some of these other things were to happen, then that would just further accelerate the swing to revenue and earnings coming from outside the states, no question about it.

Robert J. Evans - Craig Hallum Capital Group

Okay. And final question as it relates to Q3, can you comment kind of Q2 versus Q3 on the core US business, how should we view that? And if I kind of add up the put and takes Q2 versus Q3, I mean, I get somewhat comparable revenue and earnings. Am I thinking about it the right way?

A. Lorne Weil - Chairman and Chief Executive Officer

I think as we see it right now, the puts and takes on the core business would probably lead us to an EBITDA in the third quarter that was higher than the second quarter. But we have working against us the interest issue that I talked about earlier and the inevitable slowdown of the Italian joint venture earnings.

Robert J. Evans - Craig Hallum Capital Group

Okay, alright, thank you.

Operator

[Operator Instructions]

A. Lorne Weil - Chairman and Chief Executive Officer

Okay, well, if there aren't any further questions

Operator

We do --

A. Lorne Weil - Chairman and Chief Executive Officer

Hello.

Operator

Pardon me, interruption. We do have a questions from the line of Carlo Santarelli. You may proceed.

Carlo Santarelli - JP Morgan

Yes, hi, guys, thanks. I was just hoping maybe you guys give a little bit more color on Global Draw and where we stand in terms of total placements, where you guys stand at the end of the quarter and what maybe we could target at year-end for that?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes. Well, right now we've approximately 12,500 machines placed in Global Draw. I think over the balance of the year we can expect to see a modest increase. I think we'll see modest increases in machines in Latin America, modest increases in machines in a couple of locations in Central Europe and some modest increases in... even in the UK we've been picking up independent licensed betting shop operators at a fairly decent rate. But rate, as we see at right now, I wouldn't expect before the end of the year that we would have installed any major new customers in addition to the base we have right now. I could... it's well within the realm of possibility that we would be announcing one or more major new customers or one or more major new commitments for machines before the end of the year, but for a variety of reasons it's not likely that they would be installed before the end of the year.

Carlo Santarelli - JP Morgan

Understand. And I guess, along those lines, I know you guys have mentioned a run rate of, call it, $80 million in EBITDA in the 4Q. Should we be thinking that that's maybe pushed back just a little bit as you wait to get the installations in and sign up the contracts?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes, I think we can think that that's been... that will probably push back a bit, but not a lot.

Carlo Santarelli - JP Morgan

Okay, great. Thanks guys.

A. Lorne Weil - Chairman and Chief Executive Officer

Sure.

Operator

Your next question comes from the line as a follow-up from Larry Klatzkin from Jefferies. Please proceed.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Hi, two quick questions, one, how many machines are in Mexico right now and should we expect that to be at 1500 at year end?

A. Lorne Weil - Chairman and Chief Executive Officer

I am not... I think there is around 400 in Mexico right this minute, the number of machines is increasing steadily. Again, as the performance warrants, we're hopeful that we could reach 1500 by the end of the year, but it's difficult to predict that with certainty, Larry.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Okay. And then the first line that comes in in China that comes in place on December, beginning of December. Is that... how many ticket production is that for?

A. Lorne Weil - Chairman and Chief Executive Officer

That press is a 4 billion standard ticket press. The second press is an 8 billion standard ticket press. So, by... certainly by the second half of next year, our capacity will be at 12 billion and we maybe able to up it from there on some of the other activities that we are pursuing. So we are very, very comfortable that in the intermediate term, we are going to be well positioned to meet increasing volume in China by production in China.

Lawrence A. Klatzkin - Jefferies & Company, Inc

So when the first line comes on line, you'll probably still be shipping some tickets from the United States in addition?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes, we'll have to.

Lawrence A. Klatzkin - Jefferies & Company, Inc

But not by Airborne?

A. Lorne Weil - Chairman and Chief Executive Officer

Yes, let's hope that we stop to making the airline rich. They will... we will have to supplement the local conical [ph] press certainly.

Lawrence A. Klatzkin - Jefferies & Company, Inc

Alright. Yes, so I would expect it be over 4 billion. Okay, great, thank guys.

A. Lorne Weil - Chairman and Chief Executive Officer

Thanks, Larry.

Operator

And your final question comes from the line of Ralph Schackart from William Blaire. You may proceed.

Ralph Schackart - William Blair & Company

Good morning. Mike or Lorne, can you talk about any emerging interest in either newer developing markets given your tremendous success in China and what you guys are doing in Italy? And also too, can you speak to your capacity to handle any of this building interest? Thanks.

Michael R. Chambrello - President and Chief Operating Officer

Well, I think, let me answer the second question first. Again as we offload current China demand to China-based production, then that's going to free up certainly a reasonable amount of capacity. As I mentioned in my comments, we're in the planning stages for another press and would anticipate that this press would be in the 4 billion to 6 billion capacity and it may replace an existing press or it may be a new press in either the United States or the UK or somewhere along those lines. So, I think long term we are going to have adequate capacity to meet the expanding market.

As it relates to other developing markets, again, we have been so focused on China, well, I am not trying to... we are trying ensure we said is for existing customer that we haven't been very, very aggressive in developing markets. However, in our planning stages there are certainly other Asian markets. I will use Vietnam as an example, someone referenced earlier on the call, maybe Bob Evans, the Brazils and the Russias, countries that heretofore, we have not wanted to participate in because of the high risk, again the high risk to capital. And these are areas with a different model that we think may be much more appealing and there may be some hitch in this along the line, but the risk is much lower if we implement the China model.

So I think as we looked out over late this year, 2009, and certainly into 2010, our ability to successfully implement internationally, I think, has been reinforced by China and some other jurisdictions outside of Asia that will move forward a little more aggressively and a little more confidently into areas that generally have been on our radar screen in the past.

Ralph Schackart - William Blair & Company

Great, thank guys, and great to see everything coming together.

A. Lorne Weil - Chairman and Chief Executive Officer

Thank you.

Operator

This now concludes the Q&A for today's call. I would like to turn the call back over to Mr. Lorne Weil, please proceed.

A. Lorne Weil - Chairman and Chief Executive Officer

Thank you, operator, and thank you all for joining the call. We hope to see you again in 90 days, by which time Mr. Laird having been on a 90-day crash diet will return as Mr. Laird. And till then, we wish you all a great quarter and thanks for calling.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.

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