SGMS

Scientific Games Corp (SGMS)

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Scientific Games Corp. (SGMS)

Q3 2008 Earnings Call

October 31, 2008 8:30 am ET

Executives

Lorne Weil - Chairman and CEO

Mike Chambrello - President and COO

DeWayne Laird – CFO

Joe Wright – Vice Chairman

Analysts

Larry Klatzkin - Jefferies

Celeste Brown - Morgan Stanley

Ralph Schackart - William Blair

Bob Evans - Craig Hallum

Carlo Santarelli - JP Morgan

Presentation

Operator

(Operator Instructions) Thank you for joining us this morning. With us today are Lorne Weil, Chairman and CEO, Mike Chambrello, President and COO, DeWayne Laird, CFO. During this call they will discuss Scientific Games Third 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 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 Scientifics annual report on Form 10-K for the fiscal year ended December 31, 2007.

Lorne Weil

Here with me in New York are Mike Chambrello and DeWayne Laird as usual. Joe Wright is dialing in from out of town due to a commitment made many months ago but he will of course be in attendance for the first quarter conference call at the end of February and I think Joe is on a line from which he can not only monitor this call but can answer questions if anybody would like to ask him any.

Overall we were pretty pleased with the quarter which by every financial measure was well ahead of the third quarter of last year. Revenue for the quarter was about $292 million up about 9% from the third quarter last year. Revenue from the racing related businesses continued to retard overall revenue growth excluding these business overall revenue for the quarter was up by more than 11% indicating strong momentum in our core lottery and gaming businesses.

A similar pattern can be seen in quarterly EBITDA. Adjusted EBITDA in the third quarter of 2008 increased by 21% to nearly $97 million excluding the racing related businesses adjusted EBITDA was up by 26%. On more than one occasion in the past we have discussed the idea that all things remaining equal our EBITDA ought to grow organically at about twice the rate of revenues due to the operating leverage that is inherent in the business. In the third quarter which was relatively free of either acquisition impacts or unusual items we saw these relationships borne out pretty clearly.

Earnings per share in the third quarter were $0.27 excluding the asset impairment charge that was taken in the third quarter of 2007 EPS last year was about $0.17. On an apple to apples comparison EPS in the third quarter 2008 was nearly 60% ahead of last year and would of course been even higher still excluding the impact of racing. Considering the deterioration that has taken place in the environment since the third quarter of last year I think we can be confident that our primary strategies are working well.

While every measure of performance was well ahead of last year reported earnings were down sequentially somewhat from the second quarter 2008 pretty much as we had talked about on the second quarter conference call. The major contributing factors identified at that time were a seasonal decline in our Italian joint venture income and increase in interest expense attendant to our debt refinancing completed in the second quarter. Given what has happened in the credit markets in the last several weeks thank God for that, and somewhat higher depreciation expense.

Having mentioned our bank refinancing let me just take a second and comment on the fact that liquidity wise we are in excellent shape. We have close to $150 million in cash, unused revolver capacity of close to $200 million and bank debt that is scheduled to mature several years out with a very solid bank group JP Morgan, B of A, UBS, Wells Fargo and so forth. At least right now compared to a couple of deals that have happened in gaming in the last couple of days extraordinarily attractive rates which happens to be Libor plus 250 basis points.

As Mike will address in a few minutes we’d expect that increased instant ticket sales in China together with associated system revenues would offset a portion of the sequential decline discussed above but because of product introduction, pricing, logistical and inventory issues that were pretty much beyond our control this did not occur as planned.

In essence, while instant ticket revenues in China increased modestly from the second to the third quarter we wound up selling considerably more tickets at lower average prices. This in turn negatively impacted both manufacturing margins and for obvious reasons, airfreight costs. On the other hand what did occur as planned was a significant increase in the level of overhead spending in China in advance of and to drive anticipated increases in revenues. We’ll talk quite a bit more about this over the course of this presentation. This further depressed margins.

As Mike will explain in more detail we’ve made excellent strategic progress in the last several weeks in the areas of new ticket introduction, price point enhancement, inventory logistics and retailer expansion. We’re confident that the impact of these factors will be strongly felt in the coming months and quarters.

As we mentioned in the press release we have substantial production capacity coming on stream in China during 2009 and our goals for new product introduction and retailer expansion we have planed to introduce at least 40 new tickets in 2009 through a network that has just been expanded to nearly 125,000 retailers double what it was roughly 90 days ago. Anticipate that this capacity will be fully utilized.

Elsewhere in our instant ticket business in the third quarter we continued to see relatively minimal revenue impact from either the general economic environment based on yesterday’s economic data we now know to have effectively been the start of a long anticipated recession or the record level of oil and associated gas prices now prevailed during much of the third quarter.

Read the rest of this transcript for free on seekingalpha.com