Scientific Games Corp. (SGMS) reported fourth quarter 2010 earnings of 2 cents, missing Zacks Consensus Estimate of 4 cents. This was better than a loss of 5 cents reported in the year-ago quarter.
The year-over-year growth was driven by higher revenues (excluding racing business for both the periods) in the quarter. Scientific Games completed the sale of Racing Business in October 2010.
Operating Performance
Scientific Games reported an operating loss of $5.6 million compared with $6.4 million in the year-earlier quarter. This excludes one-time charges and stock-based compensation.
The improvement in operating results were primarily driven by lower Selling, General and Administrative expense (SG&A), which decreased 6.4% year over year to $37.5 million in the quarter.
Adjusted EBITDA decreased slightly to $77.7 million from $79.1 million in the year-ago quarter. Joint venture EBITDA was $19.3 million in the fourth quarter of 2010, compared with $16.0 million in the prior-year period, primarily due to higher EBITDA of the company’s Italian and Chinese joint ventures, along with the inclusion of the company’s 20% equity interest in Sportech Plc.
Revenue
Net operating revenues decreased 8.9% year over year to $212.1 million, driven by the weak results in two of the three segments: Lottery Systems Group (down 5.5% year over year) and Diversified Gaming Group (down 50.0%), partially offset by an increase in Printed Products (up 6.9%).
A major contributor to the revenue in the quarter was higher instant ticket revenues, which increased 8.0% year over year. However, revenues were negatively impacted by lower Sales revenues, down 26.2% year over year. Service revenues fell 24.4%, negatively impacting the overall revenue. Scientific Games’ U.S. instant ticket and lottery systems customers’ retail sales upped 4.9% and 2.2% year over year, respectively, in the quarter.
Segment wise, Printed Products Group revenues were up primarily due to improved performance from the company’s MDI licensed properties and Internet services business ($4.8 million), higher revenue from international customers ($4.8 million) and higher revenue from the company’s U.S. and European CSP contracts ($0.9 million). Scientific Games’ U.S. instant ticket customers’ retail sales increased approximately 4.9% in the fourth quarter.
Lottery Systems Group revenues decreased primarily due to lower sales of hardware and software ($3.2 million) and a decline in service revenue ($0.5 million). Scientific Games’ U.S. lottery systems customers’ retail sales increased approximately 2.2%.
China Sports Lottery retail sales increased 22.8% year over year in the fourth quarter attributed to higher average selling prices, expansion of the retailer and validation network and enhanced merchandising and promotional activities.
Diversified Gaming Group revenues fell due to the divestiture of the Racing Business in October 2010.
Balance Sheet and Cash Flow
Free cash flow in the reported quarter was negative $2.9 million, down from $14.5 million in the year-ago quarter. The reduction in free cash flow was due to an increased interest expense and the loss on settlement of a foreign currency hedge related to the Italian instant ticket tender process.
Scientific Games exited the quarter with $124.3 million in cash and cash equivalents compared with $151.5 million in the prior quarter. Long-term debt was $1.39 billion at the end of the quarter compared with $1.47 billion in the prior quarter.
Our Take
We maintain our Neutral rating over the long term (6-12 months). We believe the company’s diversified product offerings, international development activities (China, Italy), recurring revenue business model and strong growth from the Internet-based business will drive the stock over the long term.
However, weak fourth quarter results, near-term revenue weakness and increasing competition from International Game Technology (IGT) compel us to remain on the sidelines.
Currently, Scientific Games has a Zacks #5 Rank, which implies a short-term Strong Sell rating.
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