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Scientific Games Corp. (SGMS - Analyst Report) posted loss of 28 cents in contrast to the Zacks Consensus Estimate of a profit of 6 cents per share. Moreover, the reported loss was much wider than the loss of 9 cents in the year-ago quarter.

Revenues

Revenues increased 4.3% year over year and 9.6% sequentially to $249.2 million, much better than the Zacks Consensus Estimate of $236.0 million. The top-line growth was primarily driven by higher sales of lottery systems and terminals and better-than-expected instant ticket revenues.

Instant ticket revenues increased 3.2% year over year and 1.5% sequentially to $126.3 million, while sales of lottery systems and terminals spiked 44.1% from the year-ago quarter and 57.7% from the previous quarter to $32.2 million. Service revenues decreased 3.9% year over year but increased 9.9% quarter over quarter to $90.8 million.

Scientific Games' U.S. instant ticket retail sales increased 5.1% year over year in the quarter. U.S. lottery systems customer retail sales jumped 10.9% year over year in the fourth quarter. Instant ticket retail sales in Italy increased 3.9% during the reported quarter. This strong growth fully offset a 14.9% decrease in China instant ticket retail sales.

Segment-wise, Printed Products Group revenues increased 3.6% year over year and 1.8% from the previous quarter to $129.6 million. The growth was primarily due to higher international revenues, strong revenue contribution from provoloto and increasing revenue contribution from US customers (including co-operative customers).

Lottery Systems Group revenues increased 16.1% year over year and 30.5% quarter over quarter to $80.7 million, reflecting higher equipment and service system sales revenues. Service revenues were essentially flat year over year.

Gaming revenues declined 12.3% year over year but climbed a modest 1.7% from the previous quarter to $38.9 million. The year-over-year decline was primarily due to the loss of the William Hill contract and closing of the over-the-counter business in 2011 and lower pub revenues in UK as well as outside the U.K. This fully offset the revenue increase in U.K. gaming business during the quarter.

Margins

Attributable earnings before interest, taxes, depreciation and amortization (EBITDA) margin jumped 230 basis points (“bps”) from the year-ago quarter to 36.3%. Sequentially, EBITDA margin remained flat in the last quarter.

Depreciation & Amortization (D&A) expense soared 110.2% year over year and 64.4% sequentially to $64.5 million in the quarter. However, this was partially offset by lower selling, general & administrative expense (SG&A), which decreased 2.5% year over year to $51.1 million. SG&A increased 15.1% on a sequential basis.

Higher expenses dragged down profit in the quarter. Operating loss was $6.3 million compared with a profit of $19.2 million in the year-ago quarter and $13.2 million in the previous quarter.

Balance Sheet & Cash Flow

Scientific Games exited the quarter with $109.0 million in cash and cash equivalents compared with $136.0 million in the prior quarter. Total debt remained flat at $1.47 billion at the end of the fourth quarter. Free cash flow improved to $17.5 million from an outflow of $5.1 million reported in the previous quarter.

Recommendation

We believe that the company’s diversified product offerings, international development activities, recurring revenue business model, strong growth from the Internet-based business and the pending WMS Industries acquisition 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 contributing to overall results. Further, stiff competition from the likes of International Game Technology (IGT - Analyst Report) and Bally Technologies Inc. (BYI - Snapshot Report) is expected to hurt profitability going forward.

Moreover, increasing investments for product development is expected to hurt profitability in the near term. Additionally a significant increase in regulatory, professional fees and other expenses related to WMS acquisition ($46.0 million in the first quarter) will hurt margins in the near term.

Currently, Scientific Games has a Zacks Rank #3 (Hold).

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