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Scientific Games Corp. (SGMS - Analyst Report) posted loss of 15 cents in contrast to the Zacks Consensus Estimate of a profit of 2 cents per share in first quarter of 2013. Scientific Games had reported earnings of 4 cents in the year-ago quarter.

Revenues

Revenues decreased 5.0% year over year and 11.9% sequentially to $219.6 million, which missed the Zacks Consensus Estimate of $228.0 million. The top-line decline was primarily attributed to lower sales of lottery systems and terminals and lower-than-expected instant ticket revenues.

Instant ticket revenues remained flat on a year-over-year basis but declined 2.7% sequentially to $122.8 million. Sales of lottery systems and terminals plunged 28.4% from the year-ago quarter and 53.4% from the previous quarter to $15.0 million. Service revenues decreased 5.9% year over year and 9.9% quarter over quarter to $81.8 million.

Scientific Games' U.S. instant ticket retail sales decreased 2.0% year over year in the quarter. U.S. lottery systems customer retail sales plunged 14.9% year over year in the first quarter.

Instant ticket retail sales in Italy (in terms of €) decreased 2.8% from the year-ago quarter, while China instant ticket retail sales (in terms of RMB) declined 12.5% during the same period.

Segment-wise, Printed Products Group revenues inched up 0.6% year over year but declined 2.6% from the previous quarter to $126.3 million. The results were negatively impacted by lower US and international revenues from price-per-thousand customers and a decrease in sales to US customers who purchase tickets on a percentage of sales basis.

Lottery Systems Group revenues decreased 9.8% year over year and 27.9% quarter over quarter to $58.2 million, reflecting lower sales to international customers. Service revenues decreased $3.0 million year over year in the reported quarter.

Gaming revenues declined 14.9% year over year and 9.8% from the previous quarter to $35.1 million. The year-over-year decline was primarily due to lower service revenues and lower sales from Barcrest’s gaming terminals.

Margins

Attributable earnings before interest, taxes, depreciation and amortization (EBITDA) margin jumped 220 basis points (“bps”) from the year-ago quarter to 35.8%. Sequentially, EBITDA margin declined 50 bps in the previous quarter.

Depreciation & amortization (D&A) expense increased 15.1% year over year but declined 49.2% sequentially to $32.8 million in the quarter. Selling, general & administrative expense (SG&A) increased 11.8% year over year to $50.6 million. SG&A decreased 1.0% on a sequential basis.

Higher expenses dragged down profit in the quarter. Operating margin was 5.1% compared with 10.8% in the year-ago quarter.

Scientific Games reported loss of 12.3 million compared with net income of $3.9 million in the year-ago quarter.

Balance Sheet & Cash Flow

Scientific Games exited the quarter with $90.0 million in cash and cash equivalents compared with $109.0 million in the prior quarter. Total debt remained flat at $1.47 billion at the end of the first quarter.

Recommendation

We believe that the company’s diversified product offerings, international development activities, recurring revenue business model, strong growth of 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 the WMS acquisition will hurt margins in the near term.

Currently, Scientific Games has a Zacks Rank #4 (Sell).

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