Scientific Games Corp. (SGMS - Analyst Report) reported dismal second quarter results. The company posted loss in the reported quarter in contrast to the Zacks Consensus earnings estimate of 12 cents per share. Revenue also fell well short of the Zacks Consensus Estimate of $245.0 million.

Quarter Details

Total revenue increased 4.1% year over year to $229.3 million, primarily driven by higher sales of lottery systems and terminals and better-than-expected service revenues. Instant ticket revenue declined 8.3% year over year to $119.6 million, while sales of lottery systems and terminals soared 172.1% year over year to $21.0 million. Service revenue increased 8.0% year over year to $88.6 million.

Scientific Games' U.S. instant ticket retail sales increased 10.0% year over year in the quarter. U.S. lottery systems customers' retail sales climbed 3.8% year over year in the second quarter. This strong growth fully offset a sluggish 7.5% decrease in China instant ticket retail sales and an 8.0% decline in instant ticket retail sales in Italy during the reported quarter.

Segment-wise, Printed Products Group revenues were down 7.4% year over year to $122.7 million, primarily due to lower revenue contribution from licensed properties business (down $8.7 million), lower U.S. and International revenue (down $12.2 million) and unfavorable foreign exchange (down $1.0 million) in the reported quarter.

Lottery Systems Group revenues increased 13.7% year over year to $64.6 million, primarily on the back of higher sales of software and hardware to international customers and higher U.S. service revenue.

Gaming revenues surged 35.8% year over year to $42.0 million, driven by a 6.3% year-over-year increase in Global Draw’s gross win per machine per day. Incremental revenue from the Barcrest acquisition ($9.9 million) also drove growth during the quarter.

Attributable earnings before interest, taxes, depreciation and amortization (EBITDA) declined to $83.5 million from $90.5 million in the year-ago quarter. Joint venture EBITDA was $21.2 million in the reported quarter compared with $24.5 million in the prior-year period.

Depreciation & Amortization (D&A) expense soared 34.8% year over to $39.1 million in the quarter. Selling, general & administrative expense (SG&A) increased 8.6% year over year to $47.2 million in the reported quarter.

Higher expenses dragged down profit in the quarter. Operating income (including stock-based compensation but excluding employee termination and restructuring costs) plunged 47.6% year over year to $15.1 million compared with $28.9 million in the year-earlier quarter.

Scientific Games reported a net loss of $12.6 million or 14 cents per share compared to net income of $7.0 million or 8 cents per share in the year-ago quarter. Including one-time items and charges, net loss was $9.3 million or 10 cents per share in the reported quarter.

Scientific Games exited the quarter with $112.4 million in cash and cash equivalents compared with $100.4 million in the prior quarter. Total debt was $1.37 billion compared with $1.39 billion at the end of previous quarter.

During the quarter, Scientific Games acquired three companies including Parspro, Provoloto and ADS/Technology and Gaming. The acquisitions are expected to boost its topline going forward.

Recommendation

We believe that the company’s diversified product offerings, international development activities, recurring revenue business model and strong growth from the Internet-based business will drive the stock over the long term.

Further, the domestic lottery industry is undergoing a transition, which involves increasing involvement of private vendors in state lottery management, higher prize payouts and introduction of tiered pricing for national jackpot games, to add impetus to the sagging U.S. lottery industry. We believe that Scientific Games is well positioned to benefit from these transitions going forward.

However, we believe that these measures will take some time before it starts to boost the overall results. Moreover, increasing investments for product development is expected to hurt profitability in the near term.

Thus, we prefer to remain on the sidelines. We maintain our Neutral recommendation on Scientific Games over the long term (6-12 months). Currently, Scientific Games has a Zacks #3 Rank, which implies a short-term Hold rating.