Scientific Games Stock Takes Hits

Shares of Scientific Games Corporation (SGMS - Analyst Report) fell 21.8% and closed at $13.85 after the company released its third quarter results.

Management Changes

The company announced the retirement of Mr. Joseph R. Wright from the post of CEO at year-end, although he will continue on the board. Mr. Michael R. Chambrello was named the new CEO. This news affected the company’s stock price negatively.

Results Analysis

Earnings, excluding the impact of one-time items, were 24 cents per share, down 25% from 32 cents per share reported in the year-ago quarter. However, earnings beat the Zacks Consensus estimate of 18 cents per share. Earnings benefited from a lower tax expense and lower non-cash deferred financing fees, offset by higher interest expense.

Net operating revenues declined 18.1% year-over-year to $239.1 million, driven by declines in all of its three segments: Printed Products (-21.9%), Diversified Gaming Group (-11.8%) and Lottery Systems Group (-15.4%). Foreign currency translations negatively impacted revenues by approximately 4%. Moreover, a major contributor to the revenue decline was the shift in China instant tickets sales to the company's joint venture and revised lottery contract terms, which negatively impacted revenue by 5% each.

However, the continued expansion of Global Draw and Games Media and constant service revenue in the Printed Products and Lottery Systems Groups contributed favorably to the top-line.

Gross margin expanded 200 basis points year over year to 42% in the quarter, as a result of the company’s focus on reducing expenses. A major contributor to the margin improvement was the launch of instant ticket production in China and cost benefits of previous years. Moreover, $6.9 million of cost improvements from the previously announced Profitability Improvement Program benefited margins. The company has generated cost savings of $18.2 million year-to-date from the Profitability Improvement Program initiated in the fall of 2008.

The company remains well on track to meet its stated goal of $15 to $20 million cost savings for the full year 2009 and expects additional cost savings of $10 to $20 million beginning in 2010. Operating expenses fell 21% to $138.3 million.

Adjusted EBITDA declined to $81.7 million from $96.8 million in the year-ago quarter. However, SG&A savings offset some of the decline. However, EBITDA margin improved to 34% in the quarter from 33% a year ago.

Operating Performance

Third quarter free cash flow improved to $21.6 million from negative $15.6 million in the year-ago period. The $37.2 million improvement in free cash flow was driven primarily by improved working capital management and lower capital expenditure. Capital expenditures during the quarter were $23.9 million, a decline of $24.9 million from the year-ago period. We remain confident on the company’s growing cash flow.

The company exited the quarter with $213.1 million in cash and cash equivalents. The company had $1,115.1 million in net debt. During the quarter, the company repurchased approximately $43 million of convertible debentures, bringing the year-to-date total debt repurchased to $175 million. Currently the outstanding obligation on the convertible debentures stands at approximately $99 million.