As SGMS continues to lose money quarter after quarter, the book value of shareholders' equity on the balance sheet continues to fall. At the end of SGMS's fiscal 2009, the company had a book value of shareholders' equity of $620 M. In yesterday's SGMS press release, the balance sheet showed a book value of shareholders' equity of $316 M, meaning that $304 M in book equity had been wiped off the books because of quarterly losses in the past 13 quarters alone. Nearly 50% of SGMS's book equity has been blown away by the current management team that remains in place and will apparently now lead a combined SGMS/WMS entity that will have approximately $3 B in total LTD on the books when the deal is consummated. Wow!
Neither Lorne nor the CFO have ever mentioned this distressing fact in any quarterly cc. No wonder.
Yesterday's Q1 earnings release and conference call show perfectly why SGMS and its management are borrowing $1.5 B (at high cost) to acquire WMS. For the first time in many a quarter, SGMS did not have massive multi-million dollar asset write-offs or huge "one-time/non-recurring" expense charges. But despite this nice surprise, SGMS still lost a lot of money in Q1.
Why? Well the reason why is that the existing SGMS businesses do not (and will not) generate enough EBIT (Earnings Before Interest & Taxes) to cover the massive quarterly interest expense burden that the company's huge $1.6 B in LTD automatically bakes into the P&L every quarter. In Q1 SGMS had a positive EBIT of $11 M. However, after deducting $25 M in Interest expense (the "I") from the EBIT, the resulting EBT was a loss of $14 M. Even if Q1 Revenue had been $10 M higher (with a 40% margin), the EBT still would have been a loss of $10 M; not even close to break-even EBT. As a matter of fact, even if you take out the additional Q1 SG&A expense associated with the WMS acquisition and increase Q1 Revenue by $20 M (at 40% margin), the Company still would have had a net loss (EBT) for the quarter.
Lorne knows this ("Q1 financial performance was in line with our expectations") and he knows it is a trend he cannot reverse in the SGMS business. Luckily for him, interest rates today are low (relatively speaking), WMS has an un-levered balance sheet and WMS management & shareholders are apparently willing to take a cash buyout from SGMS, so Lorne gets to borrow another $1.5 B (primarily against the WMS cash-flow and debt-free balance sheet) and buy something that could "transform SGMS" (Lorne's words, not mine), even if the new debt burden will add another $100 M in annual interest expense to the combined P&L, wiping out 100% of the existing WMS EBIT in the process. Bigger? Yes. More profitable? Not anytime soon IMO.
A few highlights from yesterday's 37 minute SGMS Q4 earnings conference call:
1. Lorne droning on in his intro about the Company's "strong quarter", totally ignoring the huge surprise net loss SGMS posted in Q4. Not even a mention of the big earnings miss. Stock is already down 6% this morning. He should know the giant earnings miss would be a big problem.
2. CFO droning on his discussion of the results, treating the $30 Million in Q4 write-offs as if they were immaterial small numbers. Again, not any explanation of the 2 huge write-offs, nor any indication that the SGMS trend of massive quarterly surprise write-offs will end anytime soon. Totally disconnected from the realities of the capital markets.
3. Chambrello explaining how yet another poor quarter in China will be remedied by yet another new and improved marketing plan that now features "Sci Games Certified" game designs. The numbers don't lie! SGMs needs major change in China. SGMS may be the only company in the world with declining sales in China quarter after quarter.
4. CFO signaling that SGMS's financial performance in Q1 of 2013, which ends in less than 3 weeks, will also be poor, due to weak sales in China (during Jan and Feb) and higher SG&A expenses related to the WMS acquisition (an additional $5 Million or more in Q1).
5. Lorne and CFO did a particularly poor job answering the few analyst questions. Little enthusiasm by analysts for any of the #$%$ Lorne and CFO were serving up.
6. Lorne's wrap-up after the Q&A period was so weak it was embarrassing.
7. A few suggestions to SGMS Board of Directors:
- Don't let Lorne talk so much without a script during these calls
- Don't let CFO talk about sales, business development or operations
- When the Company has a bad quarter (like this one), acknowledge it; don't call it "strong"
- Get a real #$%$ board and let him talk
- Make a big change in China now!
Four large horrible numbers tell the story of another hideous quarter for SGMS:
1. Another giant writeoff of $24 Milllion for terminals and software in the Gaming group. This is a very big number given the relatively tiny size of this business unit. This writeoff continues the well-known SGMS tradition of regularly recurring non-recurring "extraordinary" charges against quarterly earnings.
2. Another big writeoff of $5.8 Million for asset impairment in the Lottery group. The regularly recurring non-recurring charges tradition rocks on. Extraordinary!
3. A 15% decline in China Sports Lottery (CSL) retail sales Q4 2012 versus Q4 2011 (in local currency terms). This sales decline is even worse in US$ when Chinese inflation is factored out of the RMB sales figures.
4. A 12% decline in tickets sold by CSL in Q4 2012 versus Q4 2011. Without the much-heralded Chambrello marketing plan for growing CSL ticket sales, I guess it could have been worse.
By the way, SGMS's net losses in 2012 dropped their net book equity down by $80 Million to $365 Million. This versus LTD of almost $1.5 Billion (4:1). And that's before the $1.6 Billion in new LTD to buy WMS.