Scientific Games Corporation

During this call we will discuss our first quarter results followed by a question and answer period. Please refer to our earnings press release for further detail.

As a reminder, this call is being simultaneously webcast and is accompanied by a slide presentation which are both available along with our press release in the investor information section of our website at www.ScientificGames.com. We’ve also posted reconciliation information for return on invested capital and wholly owned EBITDA on our website.

A replay of the call and the accompanying slide presentation will be archived in the investor information section of our website.

Before we begin I’d first like to remind you that this conference call will contain statements that can constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Act of 1995. This information involves risks and uncertainties that could cause actual results to differ materially from these forward-looking statements.

For certain information regarding these risks and uncertainties, please refer to our earnings press release that was released today, the materials related to this call posted on our website, and our filings with the SEC including our annual report on Form 10K for the year ended December 31, 2011 and our subsequent reports filed with the SEC.

During this conference call we will discuss certain non-GAAP financial measures as defined by the provisions of Regulation G. A description of each non-GAAP financial measure and a reconciliation of each non-GAAP financial measure to the most comparable financial measure or measures calculated and presented in accordance with GAAP can be found in our earnings press release and in the accompanying presentation on our website.

Now, I’ll turn the call over to Lorne.

Thank you for joining our first quarter 2012 earnings call. With me here as usual are Jeff Lipkin, our CFO and Mike Chambrello, President of our Asia Pacific Operations.

I’ll try to make my prepared comments relatively brief so we can have as much time as possible for Q&A. Revenue growth in the quarter of 19% reflected strength in many areas of our company importantly the two legs of our lottery business Printed Products and Lottery Systems, exhibited quite strong growth in the quarter as did our Gaming business.

One factor driving these results were the overall health of the US lottery industry. In the United States our customers’ retail sales of instant tickets rose 12.2% in the quarter while sales of draw games grew 15.8%.

These growth levels were significantly higher than in the first quarter of 2011. Instant ticket sales were driven by strong performance in larger states while draw sales reflected a record Mega Million jackpot and the third largest Powerball jackpot in the game’s history which benefited from the ticket’s price increase from $1 to $2 in January.

There were several other drivers behind the growth in our US lottery business. Instant ticket sales to the Illinois lottery where sales were up about 27% fiscal year-to-date through March was an important factor.

We are the exclusive supplier of instant tickets and associated cooperative services in Illinois in addition to our private manager duties through our Northstar joint venture.

Our success with Illinois demonstrates the value to lotteries focusing on revenue growth. Lotteries are often constrained in terms of what they can do to drive growth and instead are forced to improve contributions to the state through cost control.

Private management has certainly been the catalyst for Illinois’ improved performance but underlying this performance has been the fundamental change in focus from cost containment to revenue growth and notably the vast majority of Illinois’ growth has come from the increased sales of instant tickets.

Accordingly, elected officials and lottery directors are increasingly recognizing that one of the easiest ways to increase state revenue and reduce state budget deficits is to outsource more responsibility for the lottery value chain to experienced operators such as Scientific Games. The success in Illinois clearly supports this strategy.

In Scientific Games we are heavily compensated on a revenue participation basis and the strength in the US lottery industry was clearly reflected in our performance this quarter. Printed Products revenue overall improved by 8.5% over last year with Printed Product sales in the US or instant ticket sales in the US growing significantly faster and at the same time there was substantial operating leverage as operating income grew nearly three times as fast as revenues.

Lottery Systems which grew at 14% was a beneficiary of not only the strong jackpot performance but also US instant ticket validation growth since most of our lottery systems contracts compensate us on both lotto sales and instant ticket sales. Interestingly strong overall growth across our lottery business has occurred despite softness in Italy and China which have historically been above average growth markets for the company.

In Italy retail sales of instant tickets declined by approximately 4% due to a variety of factors including terrible weather and transit strikes that disrupted deliveries to retailers. We also had very challenging year-over-year comparisons in large part due to the mix of products launched in the first quarter of 2011 including the formal introduction of the 20 Euro ticket which was very well received last year.

In China, instant ticket retail growth decelerated to just under 1% in the quarter as a consequence of new product introductions and distribution expansion running well behind projections. We are cautiously optimistic that sales in China will accelerate through the balance of this year as both product and distribution development catch up to plan.

Mike will comment on these matters in more detail in a moment. I think it’s very important to point out that despite the softer numbers in Italy and China in Q1, we reported extremely strong results for the quarter owing to the geographic diversity of our business and our participation based revenue model.

Revenue in our Gaming business increased 81% in the first quarter with Global Draw’s UK total gross win and gross win per machine per day increasingly approximately 61.5% and 5.8% respectively. Following our successful rollout of terminals to Ladbrokes’ entire state last year.

Ladbrokes’ first quarter 2012 cash box improved nearly 17% year-over-year demonstrating our ability to help our gaming customers drive growth.

Gaming revenue performance also benefited from the acquisition of Barcrest. The increased profitability of our gaming service revenue in the first quarter reflects the inherent operating leverage in this business.

Indeed, the leverage in this business was actually understated as losses related to Barcrest’s analog business and inventory write downs reduced operating income by $1.3 million in the quarter. As we indicated would be the case at our last conference call, we had completely exited the analog business during the first quarter.

We remain focused on developing and delivering new and innovative content across our lottery and gaming businesses including new interactive content as well as new games for our proven lottery retailer network and server-based gaming materials. We also continue to see increasing interest from our customers in our Internet-based loyalty programs.

We recently signed an agreement with North Carolina to provide properties plus service and the Iowa lottery extended its existing properties plus program with us.

The Tennessee lottery added our Points for Prizes store to its player loyalty program in February and achieved record instant ticket sales that month. We see additional opportunities in the pipeline and believe that as states ultimately begin to provide internet-based offerings our long track record as a proven and trusted vendor will provide a significant competitive advantage.

Finally, I should mention that while we continue to invest aggressively in content, technology, and business development in both our lottery and gaming markets, the traction that we’re gaining in terms of revenue growth is translating as well into operating leverage and expanding ROIC, our return on invested capital. Return on invested capital improved to 18.2% on a trailing 12 month basis through the first quarter 2012 versus 16% in the prior year period and I believe this metric validates our strategy of prudently committing both capital and operating resources to our primary growth initiatives.

With that, I’ll now turn it over to Mike to talk a little bit more about China.

As Lorne mentioned, the China sports lottery retail sales in the first quarter increased only 7/10ths of a percent year-over-year to approximately RMB 4.5 billion. Now, we’re clearly disappointed with our soft Q1 retail sales.

However, sales did improve each month from January to March so at a minimum directionally we’re moving in the right direction.

We’re also encouraged that the instant ticket market in China as a whole grew about 7% and the entire lottery market increased by 30% in the quarter really suggesting that there isn’t a decline in consumer demand or any overriding macroeconomic or structural issues in the market. Clearly, the lottery market overall is very strong.

Our ability to drive continued sales growth depends almost entirely on a steady stream of quality, new game introductions, expansion of our retail distribution network, and higher price points. The slowdown in CSL and ticket retail sales during the quarter was primarily due to the lack of new and frankly, compelling products in the market and limited expansion of the CSL retailer network.

Several of the games that we had planned for release simply didn’t launch in the quarter including a new RMB 30 ticket and the new NBA games, one of which was a RMB 20. I don’t want to take everyone’s time to go through the number of reasons behind that but really suffice it to say that we don’t expect that to happen again.

We also faced extremely tough comps from Q1 2011 when retail sales increased 38% following the launch of our first fluorescent ink game and the first two NBA games, which were both high performing games.

While we’ve got our work cut out for us to achieve our previously expected growth targets for the full year, we remain bullish on the second half of 2012. We now expect the new RMB 20 NBA game which I mentioned, to launch in early June.

We also expect other core games planned for launch through late summer and believe they will also drive strong consumer demand. Importantly, these games which will materially increase the average sales price are in the marketing plan and have already been approved so the risk of what happened in Q1 is minimal if anything.

We’re also working very aggressively to grow the CSL retailer network and increase the penetration of instant ticket validation devices. To give you a sense for the current situation, in mature markets we currently look at a retailer density statistics of about 1,000 people per retailer.

In China, that statistic is currently over 10,000 people per retailer. We’re very confident that expanded retailer distribution will significantly grow our revenues.

As we mentioned on our last call, the CSL has embarked on a one validation device for one retailer project where each retailer would have our traditional IBT or barcode reader. The date we deployed approximately 2,600 to 2,700 barcode devices.

We expect that number to grow to 30,000 or more during the second half of this year. In addition, we believe retail sales will benefit from our first operating efficiency program OEP management contract in Hubei Province with the Hubei Sports Lottery which is very, very similar to our US and European CSP contracts.

We’ll be providing the Province with a number of value changes, management services designed to optimize instant ticket sales where we’ll be compensated based on a percentage of retail sales. It’s worth noting that Hubei is the ninth largest Province in China with 57 million people and better than average GDP per capita but is ranked only 25th in overall ticket sales among the 31 Provinces as of Q1 2012.

Given this dynamic we believe we’ll have a great opportunity to increase sales in Hubei and improve the effectiveness of the program. The announcement of this new management model has caught the attention of several other provinces and we anticipate adding OEP services to more provinces in the future.

As I’ve said before and often, and as we’ve seen in the past, there really is no linear path for retail sales growth in China as we face ongoing challenges and opportunities that are really quite unique to this market.

Our ability to drive continued sales growth depends on again, steady stream of new game introductions, expansion of our retailer distribution network, and higher price points. We are executing on these key drivers and on that basis we’re confident in our mid and long term sales outlook.

With that, I will turn things over to Jeff to discuss the financials.

Our results for the first quarter reflected year-over-year revenue growth in each of our segments with 19% consolidated revenue growth. Attributable EBITDA grew 16% and our return on invested capital also increased approximately 200 basis points as compared to the prior year period.

We believe these results reflect both the solid fundamentals in our lottery and gaming businesses and the strength of our globally diverse business model.

Let’s jump into the highlight of our results. Q1 revenue was $235 million compared to $197 million last year.

Operating income rose 55% primarily driven by higher revenue and a more profitable mix of business. SG&A increased approximately $7 million year-over-year of which $3 million related to higher compensation expense as a result of investments made in our growth initiatives and $1.2 million of higher stock based compensation expense.

We also had $1.5 million of incremental SG&A in Q1 12 associated with the inclusion of Barcrest in our results.

EBITDA generated from our equity investments was $23 million up nearly $2 million compared to last year while earnings from equity investments were relatively flat on a year-over-year basis. Our interest expense decreased by nearly $2 million year-over-year primarily due to a decrease in borrowing costs on our variable interest rate debt and the expiration of an interest rate swap in October.

Our 73% effective tax rate in Q1 12 primarily reflects the fact that since we established a valuation allowance in Q4 2010 against our US deferred tax assets, our effective tax rate does not include the tax benefit of our US losses. We reported net income of $1.8 million or $0.02 per share in Q1 12 compared to a net loss of $7 million or $0.08 last year.

Turning briefly to our segments, Printed Products revenue grew 9% in the quarter. This was driven by robust retail sales in both the US and certain international jurisdictions, in particular from our customers that compensate us based on a percentage of retail sales.

The biggest contributors were Illinois, Florida, the Ukraine, and the United Kingdom.

Notably we realized significant leverage in the Printed Products business this quarter as operating income rose 22% driven by both higher revenue levels and a more profitable revenue mix. SG&A increased by $600,000 year-over-year primarily due to higher compensation expense of $2.7 million which was largely offset by a $2.2 million insurance recovery received during the quarter related to a customer claim.

Lottery System’s revenue increased 14% year-over-year led by higher jackpots and instant tickets validation revenue. Our 60% increase in sales revenue was largely due to the timing of product sales to international customers.

Lottery Systems operating income was $8 million down from $10 million last year principally due to higher SG&A related to the increase in compensation expense and the resolution of a legal matter that favorably impacted Q1 2011.

Gaming revenue increased 81% year-over-year reflecting several factors including the acquisition of Barcrest which added $13 million in revenue. We also realized a 17% increase in Global Draw’s terminal base and a 6% increase in Global Draw’s gross win per machine per day.

Gaming operating income was $1 million compared to an operating loss of approximately $2 million last year primarily due to higher revenue and a more profitable mix of service revenue along with lower G&A.

However, margins on product sales were negatively impacted by an $800,000 write off of Barcrest inventory due to a fire during the quarter at a third party warehouse. We also recorded a $500,000 income statement loss from the liquidation of terminals related from Barcrest analog business which we exited during the quarter.

Gaming incurred $3 million of employee termination and restructuring expenses related to the integration of Barcrest and the reorganization of Game’s media along with higher SG&A of $1.5 million from the addition of Barcrest overhead. We expect additional restructuring charges of approximately $2 to $3 million in the balance of 2012 in connection with the continued integration.

We also want to note that following a strategic review of our global printed products business we recently decided to close our Australian printing plant by year end. Going forward we’ll service these customers from our other production facilities.

This decision was based on a number of economic factors including the respective cost basis among our various facilities. We currently believe the reorganization will result in non-operating expenses of approximately $8.5 to $10.5 million including $5 to $7 million related to employee termination and restructuring costs and approximately $3.5 million of accelerated appreciation.

We expect the majority of these charges to be incurred during 2012.

Moving on to the balance sheet, our debt less cash at year end was approximately $1.3 billion and liquidity stood at $289 million including $189 million of availability under our revolver and cash of a little over $100 million. We’re pleased to report that as a result of our continued growth and attributable EBITDA our debt less cash to trailing 12 month attributable EBITDA is below 20 times.

Our free cash flow is breakeven for the first quarter compared to free cash flow of $27 million last year. The year-over-year variance was due in large part to an improvement in payment terms of our new Italian instant ticket contract effective with the new concession in October 2010 which resulted in a onetime benefit in the first quarter 2011.

Total CapEx in Q1 was $22 million or basically flat to last year. In summary, we’re very pleased with our first quarter results.

It’s important to note that both our strong performance reflects the geographic diversity of our business. While certain of our lottery customers realized lower growth rates for this quarter, most notably Italy and China, our US lottery and gaming businesses performed extremely well which led to very strong Q1 results.

At the same time we’ve continued to make significant progress on our growth initiatives while also increasing return on invested capital.

With that Lorne, I’ll turn it back for you to wrap up.

There are not any prepared comments to wrap up so operator you can open the program up to Q&A.

Just a couple of questions, I wanted to start off with the online systems segment, obviously a very strong quarter there with the record jackpots. My question I guess is on the gross margins, I would have thought we might of seen a little bit more flow through in that segment this quarter.

Was there anything going on that maybe caused that not to be a little bit higher? I just want to kind of understand that a little bit better.

One of the factors that influenced the gross margins during the quarter was compensation expense. Some of it was our investment in growth as well as the reduction in the China rate impacted us a little bit in terms of profitability and mix of our margin for the quarter.

I don’t know if it’s possible but can you maybe give us a sense for how much of the growth in that segment this quarter I guess maybe came from elevated or record jackpots from the multi-state lotteries versus I guess just more of the core products?

I think when you break the growth out for the quarter -- as sort of an illustration -- about a third of it came from the instant tickets, about a third of it came from each of the jackpots, the Powerball and Mega Millions jackpot roughly. I think it was sort of evenly split amongst the three of them as the drivers of that growth.

With respect to Italy, obviously the retail sales were down in the quarter, but if I look at kind of the earnings from joint ventures it didn’t seem to be as low as I might have thought it would be given the decline in retail sales. Can you maybe talk a little bit about how you’re able to kind of preserve that earnings level?

Were there some cost reductions, maybe in terms of marketing spend or anything like that in Italy, or just anything that might have helped you there?

That’s exactly what it was, it was sort of marketing spend that was -- we sort of invested a lot in Q4. You’ll recall sort of some of the expenditures that hit us in Q4 and we sort of didn’t need to invest as much in Q1 so part of the improvement in profitability relative to the retail sales growth was due to efficiencies and marketing is probably the largest.

Overall for the year, we think marketing is probably in line with where we’ve traditionally spent and where we spent last year but it gets paid differently every year depending upon what promotions are going on.

Then just last question on expenses, for SG&A I think if I read correctly -- I’m just trying to get a sense for maybe what were the non-recurring items in your SG&A line item? The reported number was $46.2 million and I think I saw a $2.2 million gain if I’m correct, was that the only kind of non-recurring item gain or expense there?

And if so, that would take you to $48 million is that kind of a good run rate going forward?

Well, you’re including stock based comp?

Yes, including stock based comp.

I mean, I sort of look at it without stock based comp but that seems -- I mean, we don’t give guidance but it’s sort of where it’s been the last couple of quarters so I don’t expect to see it at this point widely different. The big changes for the quarter were obviously the additional of Barcrest.

You’re right that there was a onetime item related to an insurance recovery but there was also a onetime item in Q1 2011 so they really don’t impact it so much, year-over-year it’s about the same, the onetime item. So the real drivers were some increased comps to support our growth, the Barcrest addition and so therefore it’s sort of in line with the last couple of quarters.

I had a quick question and I actually had some follow ups but I just wanted to talk a little bit about your Printed Products business and if you’re seeing any sort of I want to say halo affect from maybe the higher jackpots driven by the higher price points and if you’re seeing any of that kind of spill over into your instant tickets?

Well, as I said in my prepared remarks and Jeff did, instant ticket sales in the first quarter and actually so far year-to-date have been very strong. The irony in your question is I’ve far more often been asked whether the size of the lottery business was more or less finite and with all this huge jackpot money going on was that cannibalizing the instant ticket?

You’re actually the first person who has even raised the possibility that the huge jackpot could actually be synergistic with the instant ticket business. We don’t have any data to illuminate that one way or the other but I certainly hope you’re right but certainly we haven’t seen even remotely any evidence that one cannibalizes the other.

I know one of your partners/competitors spoke today about Pennsylvania and the RFP for that market. If I’m not mistaken you guys have both the online and instant contracts through 2014/2015 so could you maybe explain the dynamic there and if they do go towards privatization how you see that process playing out?

Well, I can’t imagine who the competitor -- but anyway, they’ve really started a procurement process in Pennsylvania with the issuance of the RFQ that was responded to within the last few days. So I think you know, it’s normally our policy and should be everyone’s policy not to comment at all on any procurement process that’s underway.

So we do obviously have some thoughts on it, but I don’t think I’m comfortable saying anything more than that today.

Then Jeff, if you could just help bridge the gap to your cash from operations if we were to look at obviously your net income, adding back your FAS and depreciation, could you kind of bridge the gap of the delta between the sum of those three and how we get to the 21.9 of your cash from ops?

The biggest impact on the quarter was a significant change in working capital and when you look at a year-over-year basis the biggest impact of that was really to one time impact from the new contract terms in Italy. So when you get past sort of net income, D&A, and the non-cash add backs it’s really all coming from working capital.

I’m not sure that answers your question.

Could you maybe quantify what the Italy impact was or is that something we’d be able to do from looking at last year’s Q?

Yes, I mean we actually disclosed it in our release today, the impact of the year-over-year change was roughly $25 million or so to $35 million I’d say by far, the single largest item. What happened is we had payment terms under the old contract which are 210 days and under the new contracts we had payment terms that were 90 days and it just sort of so happens that with the timing of when both of those hit we got cash collections in Q1 2011 so what happened is you sort of had a onetime reduction in receivables related to both the old CLN and the new LNS receivables being collected in the quarter.

Just a quick question on the Illinois lottery, it sounds like things are certainly off to a great start as they went and outsourced. Are you getting any kind of daily, or at least an update of how their online sales are doing and whether they’re getting any kind of cannibalization with regards to the other parts of the lottery?

I was at a lottery conference just a couple of days ago in Amsterdam, it was an international lottery conference and I happened to be on a panel with Jaymin Patel, the CEO of GTECH, and as you know, and the individual who is probably closest to what’s happening with the launch of the online sales in Illinois. So I think the easiest way for me to answer that question is to give you the exact answer that Jaymin gave when he was asked that exact question the other day and what Jaymin said was that thus far they have signed up 120,000 users which is actually a phenomenal achievement in a relatively brief period of time and I can’t recall what he said the retail sales were but he did definitely make the comment that he was certain that it was incremental to the retail sales and not cannibalizing so that’s the best information I can give you from the horses’ mouth and probably the last time I will ever quote Jaymin Patel in one of our conference calls.

As you look out into sort of the opportunity online do you think we might see some scratch tickets online at Illinois or are they going to stay with just the numbers? Then as you look out into other states that are sort of pursuing this and certainly looking at Illinois how do you see this playing out over the next 12 months or so?

Some color on that would be great.

I would hope within the next 12 months in total we would see maybe half a dozen different lotteries in the states selling lottery products over the Internet. I can’t say with any certainty or any knowledge when Illinois would intend to expand the product line from draw games to instant tickets, but I can certainly tell you that a significant number of other lotteries that I talk to on a regular basis are very interested in the idea of instant tickets on the Internet and really see that as the greatest growth prospect for lotteries on the Internet.

And I might add, that that interest is not limited to lotteries in the United States but I am also seeing very significant interest on the Internet in other jurisdictions around the world where we have a customer base similar to the one that we have in the states. So I see it beginning to gather some momentum over the next 12 months and I certainly would expect it to really begin to accelerate after that.

I’d be very, very surprised if it doesn’t.

The only thing that I would add is that the enabling legislation in Illinois only provided for in state games and Mega Millions and they’re working to try and get Powerball added. So technically it currently only sells the in state games and Mega Millions, I believe.

Thanks everybody again for joining us this evening. I think as Jeff summarized very well, I think we had a pretty nice quarter in the first quarter.

I think there was really no exceptional or non-recurring events to attribute it to, I think it reflects gathering momentum in our business. I would actually want just to take one second and embellish upon a comment that Mike made about China when he talked about the sales accelerating through the first quarter.

I think that’s a much more important point to appreciate than what the comparisons of the individual months in the first quarter happen to have been compared to last year because the fact is that the sales in February were about 40% higher than they were in January and sales in March were about 40% again higher than they were in February and April sales were pretty strong at that level too. So if we’re looking at comparisons to last year it gives us one picture but if we’re looking to the acceleration of revenues through the first four months I think that gives a very different picture and I think as a number of the things that Mike talked about including finally getting these new products into the market and the distribution expanded I think we’re feeling pretty good that we will be seeing this acceleration continue.

So apart from that I really have nothing more to say to wrap up other than again thank you and we look forward to speaking to you in three months.