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Scientific Games Corp. (SGMS - Analyst Report) reported dismal third quarter results. The company posted loss of 8 cents in the reported quarter in contrast to the Zacks Consensus Estimate of a profit of 7 cents per share and earnings of 6 cents in the year-ago quarter.

Quarter Details

Total revenue increased 2.1% year over year to $227.5 million, primarily driven by higher sales of lottery systems and terminals and better-than-expected service revenues. Instant ticket revenue declined 1.8% year over year to $124.4 million, while sales of lottery systems and terminals soared 39.7% year over year to $20.4 million. Service revenue increased 1.5% year over year to $82.6 million.

Scientific Games' U.S. instant ticket retail sales increased 8.9% year over year in the quarter. U.S. lottery systems customer retail sales climbed 8.5% year over year in the third quarter. This strong growth fully offset a 17.6% decrease in China instant ticket retail sales and a 6.3% decline in instant ticket retail sales in Italy during the reported quarter.

Segment-wise, Printed Products Group revenues were down 1.8% year over year to $127.4 million, primarily due to lower revenue contribution from licensed properties business (down $6.2 million), lower International revenue from customers that purchase tickets on a price per thousand unit basis (down $3.2 million) and unfavorable foreign exchange (down $1.4 million) in the reported quarter.

Lottery Systems Group revenues increased 3.8% year over year to $61.9 million, primarily on the back of higher sales of software and hardware to international as well as U.S. customers.

Gaming revenues surged 14.2% year over year to $38.3 million, driven by incremental revenue from the Barcrest acquisition ($6.7 million) in the quarter.

Attributable earnings before interest, taxes, depreciation and amortization (EBITDA) increased to $82.5 million from $81.7 million in the year-ago quarter. Joint venture EBITDA was $19.2 million in the reported quarter compared with $22.8 million in the prior-year period.

Depreciation & Amortization (D&A) expense soared 40.2% year over to $39.2 million in the quarter. However, this was partially offset by lower selling, general & administrative expense (SG&A), which decreased 6.9% year over year to $44.4 million in the reported quarter.

Higher expenses dragged down profit in the quarter. Operating income plunged 38.2% year over year to $13.2 million compared with $21.4 million in the year-earlier quarter.

Scientific Games reported a net loss of $7.2 million or 8 cents per share compared to net income of $5.5 million or 6 cents per share in the year-ago quarter. Including one-time items and charges, net loss was $27.1 million or 30 cents per share in the reported quarter.

Scientific Games exited the quarter with $136.0 million in cash and cash equivalents compared with $112.4 million in the prior quarter. Total debt was $1.47 billion compared with $1.37 billion at the end of the previous quarter.

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 they start to boost the overall results. Further, stiff competition from the likes of International Game Technology (IGT - Analyst Report) and increasing investments for product development is expected to hurt profitability in the near term.

Thus, we remain cautious on the stock and maintain our Underperform 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.

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