Scientific Games Corp. (SGMS) reported first quarter 2011 loss per share of 5 cents, missing the Zacks Consensus Estimate of 4 cents. Earnings in the reported quarter were significantly below earnings of 10 cents per share in the year-ago quarter, due to weak revenue growth which missed Zacks Consensus estimate of $201.0 million.

Operating Performance

Operating income in the quarter was $14.4 million compared with $21.5 million in the year-earlier quarter.

The decline in operating results was primarily driven by higher Selling, General and Administrative expense (SG&A), which increased 11.1% year over year to $35.0 million in the quarter.

Adjusted EBITDA decreased slightly to $75.0 million from $76.6 million in the year-ago quarter. Joint venture EBITDA was $21.2 million in the reported quarter, compared with $18.7 million in the prior-year period, primarily due to higher EBITDA incurred by the company’s Italian and Chinese joint ventures.


Net operating revenues (excluding racing business, which was divested in October 2010) increased 2.6% year over year to $196.7 million. This growth was primarily driven by strong instant ticket sales and higher service revenues, which fully offset lower sales of lottery systems and terminals.

Instant ticket revenues rose 3.5% year over year to $113.9 million, while service revenue climbed 5.5% year over year to $73.7 million. However, sales of lottery systems and terminals declined a whopping 41.5% year over year.

Scientific Games’ U.S. instant ticket and lottery systems customers’ retail sales increased 4.3% and 6.4% year over year, respectively, in the quarter. China Sports Lottery instant ticket retail sales surged 37.7% year over year, while instant ticket retail sales in Italy jumped 9.7% in the reported quarter.

Segment wise, Printed Products Group revenues were up 3.2% year over year to $115.6 million primarily due to improved performance by the company’s licensed products business ($0.7 million), higher revenue from international customers ($4.4 million) and favourable foreign exchange ($0.8 million).

Lottery Systems Group revenues decreased 2.6% year over year to $56.4 million primarily due to lower sales of hardware and software ($3.2 million) and loss of contracts in New Hampshire and Vermont in July 2010 ($2.1 million).

Diversified Gaming Group revenues increased 11.8% year over year to $24.6 million, driven by the launch of approximately 4,300 Global Draw terminals in Ladbrokes’ betting shops in the U.K. and increased revenue from other U.K. customers ($2.6 million), including customers obtained through the Sceptre Leisure Solutions acquisition (completed in the second quarter of 2010). Higher revenue from customers in the Caribbean and Mexico ($0.5 million) also contributed to the upside.

Balance Sheet

Free cash flow in the reported quarter was $26.8 million versus cash usage of $2.9 million in the previous quarter.

Scientific Games exited the quarter with $118.6 million in cash and cash equivalents compared with $124.3 million in the prior quarter. Total debt was $1.39 billion at the end of the quarter compared with $1.40 billion in the prior quarter.


We maintain our Neutral rating over the long term (6-12 months). We believe the divestiture of the racing business and large contract re-pricings will help Scientific Games focus on its core business (lottery and gaming).

We also 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 first quarter results, intense lottery competition, a leveraged balance sheet, loss of contracts and a slowing trend in China will continue to temper near-term results.

Currently, Scientific Games has a Zacks #4 Rank, which implies a short-term Sell rating.

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