Scientific Games Corp.(SGMS) reported second quarter 2011 earnings per share of 12 cents, comprehensively beating the Zacks Consensus Estimate of 4 cents. However, earnings in the reported quarter were significantly below the year-ago earnings of 19 cents per share.
Operating Performance
Operating income (including stock-based compensation) in the quarter was $28.9 million compared with $5.0 million in the year-earlier quarter.
Selling, General and Administrative expense (SG&A), increased 9.2% year over year to $38.3 million in the quarter.
Adjusted EBITDA rose to $90.5 million from $85.7 million in the year-ago quarter. Joint venture EBITDA was $24.5 million in the reported quarter, compared with $17.8 million in the prior-year period, primarily due to higher EBITDA incurred by the company's Italian and Chinese joint ventures.
Revenue
Net operating revenues (excluding racing business, which was divested in October 2010) increased 7.4% year over year to $220.2 million, 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 10.1% year over year to $118.4 million, while service revenue climbed 9.4% year over year to $75.1 million. However, sales of lottery systems and terminals declined a whopping 33.3% year over year.
Scientific Games' U.S. instant ticket retail sales increased 6.5% year over year in the quarter. U.S. lottery systems customers' retail sales decreased approximately 8.2% year over year in the second quarter. China Sports Lottery instant ticket retail sales increased 13.9% year over year, while instant ticket retail sales in Italy jumped 12.6% in the reported quarter.
Segment wise, Printed Products Group revenues climbed 9.4% year over year to $132.5 million primarily due to higher revenue from U.S. customers ($6.0 million), higher sales to international customers ($3.9 million) and increased revenue from European cooperative service partnerships ("CSPs"), and favorable foreign exchange translation ($2.1 million).
Lottery Systems Group revenues plunged 8.6% year over year to $56.8 million primarily due to lower U.S. online lottery retail sales ($2.1 million) and loss of contracts in New Hampshire and Vermont in July 2010 ($2.2 million).
Diversified Gaming Group revenues (excluding racing business) surged 42.2% year over year to $30.9 million, aided by the launch of approximately 8,000 Global Draw terminals in Ladbrokes' betting shops in the U.K. and favorable foreign exchange translation ($1.7 million).
Balance Sheet
Free cash flow in the reported quarter was $26.6 million versus $26.8 million in the previous quarter.
Scientific Games exited the quarter with $127.3 million in cash and cash equivalents compared with $118.6 million in the prior quarter. Total debt remained flat year over year at $1.39 billion.
Recommendation
Scientific Games signed a five-year instant ticket contract extension with Georgia Lottery to remain the primary instant ticket vendor through September 10, 2018. Moreover, the company’s Sciplay joint venture signed an agreement with the California Online Poker Association (COPA) to offer intrastate Internet poker services.
We believe the agreement with COPA will augment the company’s revenue going forward. We believe that the Internet-based lottery business has strong growth potential and Scientific Games is well positioned to grab this opportunity over the long term.
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, intense competition from International Game Technology (IGT) and privately held Intralot S.A. and Lottomatica S.p.A, a leveraged balance sheet, lower lottery revenues, loss of contracts and a slowing trend in China will continue to temper near-term results.
We maintain our Neutral rating over the long term (6-12 months). Currently, Scientific Games has a Zacks #5 Rank, which implies a short-term Sell rating.
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