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Edited Transcript of SGMS.OQ earnings conference call or presentation 7-May-19 8:30pm GMT

Q1 2019 Scientific Games Corp Earnings Call

May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Scientific Games Corp earnings conference call or presentation Tuesday, May 7, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barry L. Cottle

Scientific Games Corporation - CEO, President & Director

* Michael A. Quartieri

Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary

* Robert Jason Shore

Scientific Games Corporation - Senior Director of IR & Corporate Finance

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Conference Call Participants

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* Barry Jonathan Jonas

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Brad J. Boyer

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* David Brian Katz

Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure

* John G. DeCree

Union Gaming Securities, LLC, Research Division - Director and Head of North America Equity & High Yield Research

* Joseph Robert Stauff

Susquehanna Financial Group, LLLP, Research Division - Credit Analyst

* Michael Fawzy Malouf

Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Scientific Games First Quarter Earnings Investor Conference Call.

(Operator Instructions) Please note that this event is being recorded. I would now like to turn conference over to Robert Shore. Please go ahead.

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Robert Jason Shore, Scientific Games Corporation - Senior Director of IR & Corporate Finance [2]

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Thank you, Nancy. During today's call, we will discuss our first quarter 2019 results and operating performance, followed by a question-and-answer period. With me today are Barry Cottle and Michael Quartieri.

Our call today will contain statements that includes forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks and uncertainties that could cause actual results to differ materially from those discussed during the call. For information regarding these risks and uncertainties, please refer to our earnings release issued earlier this afternoon, the materials relating to the call posted on our website and our filings posted with the SEC.

We will also discuss certain non-GAAP financial measures. A description of each non-GAAP financial measure and a reconciliation of each non-GAAP measure to the most directly comparable GAAP measure can be found in our earnings press release as well as the Investor Relations section on our website.

I'd also like to remind everybody in the call that we're still in SEC quiet period relating to the SciPlay IPO and are restricted in what we can say about its business at this time, so we welcome you to take a look at our final prospectus that has been filed with the SEC.

As a reminder, this conference call is being recorded. A replay of this webcast and the company materials will be archived in the Investors section of our website at scientificgames.com.

Now let me turn the call over to Barry.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [3]

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Thanks, Bobby. Good afternoon, and thanks for joining us. We have a lot of exciting news to report since our last conference call.

Last week, we were in New York at the NASDAQ where SciPlay, our social gaming business, began trading under the ticker symbol SCPL. I want to thank all of our team members for making this possible.

Scientific Games received $301 million in proceeds from the offer, which enables us to make substantial payments to reduce debt. But this isn't the only thing we've been working on. We refinanced $1 billion of our 10% unsecured debt at a lower interest rate. We launched Jin Ji Bao Xi in game ops and in digital, the WAVE XL cabinet for sale. We won new, long-term contracts in sports betting and iGaming with Wynn, and we're part of the winning bid to operate the Turkey national sports betting concession. We believe all of this provides for continued growth for 2019 and beyond.

We're pleased to report that our first quarter results marked our 14th consecutive quarter of year-over-year increases in both revenue and consolidated AEBITDA. We generated $96 million in free cash flow and paid down $145 million in debt during the quarter.

In Gaming Ops, we've been successfully rolling out Jin Ji Bao Xi throughout the U.S. and currently have over 250 placements across 16 states performing well in excess of house average. We expect placements to increase throughout the year based on the timing of state approvals. James Bond's performance remains strong and gives us that one-two punch on WAP and premium.

We have a great upcoming road map of new games, including our first new WIZARD OF OZ title in 4 years; our next title in our James Bond series, Tomorrow Never Dies, which is interoperable across cabinets; and a wealth of other great games. As you can see from this rollout approach, we are focused on being more efficient with our game ops capital spend by building in content interoperability as we develop key games such as Jin Ji Bao Xi that will work across multiple cabinets, including the WAVE XL and the J43, and therefore, allows for more customers to deploy our games that reduce CapEx.

In Gaming sales, our new WAVE XL cabinet is now available for sale with 3 of our top internal brands, and we expect to have 12 games available on this cabinet by year-end. We're also making our highly successful J43 cabinet game library available on the WAVE XL. This is a successor to the Pro Wave cabinet, which revolutionized the look and feel of casino floors. We already have a strong book of business to drive sales in the back half of the year.

In Lottery, instant products showed solid results, including our MONOPOLY-branded family of games, which helped drive over $100 million in weekly retail sales in California and Florida. We recently held our final WILLY WONKA GOLDEN TICKET event, which successfully concluded this innovative multistate game. Over the 24-month life of this game, which was played across 17 U.S. states, we sold approximately $850 million in tickets, which provided meaningful revenue to the states to fund various education and social programs. Based on this experience, we're now launching our next blockbuster multistate lottery game, which is based on the hit TV game show, Deal or No Deal. We recently were awarded Walmart Services Division 2019 Supplier of the Year for product -- for the product for PlayCentral, a self-service vending machine. The recognition from one of the world's most well-respected retailers was both exciting and humbling.

Additional great product is on the horizon as we rolled out SCiQ across major retailers in multiple states. Our 10-store SCiQ pilot with Walmart in Florida is driving over a 40% year-over-year increase in instant ticket sales. We are progressing with the rollout of SCiQ in Ohio, where we've installed well over 2/3 of the 150 units earmarked for Kroger, which are driving a 10% year-over-year increase in instant ticket sales. We believe SCiQ provides more benefits than just increased ticket sales as evidenced by our pilot retailers reporting that shrinkage has virtually been eliminated.

In digital, we're winning new business in both sports and iGaming, including Wynn Resorts, the Turkish National Lottery, the Denmark national lottery and other wins and new market launches. Our OpenBet platform recently processed nearly 240 million account transactions, glitch-free, over the 3-day Grand National festival in the U.K. And just for a perspective here, our platform processed more transactions on the Saturday of this event than were processed by Amazon on Black Friday or Cyber Monday. Today, our iLottery product offering in Pennsylvania has generated nearly $300 million in handle, making it the most successful iLottery launch in the U.S.

We're in the early stages of the digitization of gaming and believe the maturation will come over the next few years when the true winners being defined as the ones that have the best capabilities and product offering to support the operators. We firmly believe we have the most robust and reliable and comprehensive sports betting and iGaming platforms for our customers.

Our Social gaming business outperformed the market by over 2x according to Eilers & Krejcik, elevating us to the #3 position in the social casino market segment. This above market growth has come across our entire games of portfolio, not just the new games. So both our ARP and DAU were up, and our other metrics have shown similar patterns, where we've historically aimed for 6-month returns on our marketing spend and have actively managed this aspect of the business to invest where and when it makes sense. In the first quarter, we started seeing even better than expected returns on some marketing channels, so we increased our spend on these channels to attract new players. We expect this to convert these players to sticky users who enjoy our games, which will drive revenue and AEBITDA.

We're taking the actions necessary to strengthen our balance sheet by providing innovative products across our businesses to grow future revenues, improving cash flow from our debt refinancing and the SciPlay IPO to pay down debt.

Our top priority is making the best use of our capital by launching products across platforms and channels to drive the greatest returns and set us up nicely for the remainder of 2019 and beyond.

And now let me turn the call over to Mike to provide his review of the first quarter results.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [4]

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Thanks, Barry. Good afternoon, everyone.

Consolidated revenue and AEBITDA both increased 3% from the prior year period. In our Gaming business, while revenue declined 5%, our AEBITDA was only down slightly, off by 1% while our AEBITDA margin improved 170 basis points to 51%.

We expect results to improve throughout the year driven by the launch of the WAVE XL cabinet and more great games on the J43 to drive product sales, new content in game ops, additional system installations in Canada and our continuing commitment to the continuous improvement process.

Game ops revenue was up modestly on a quarter sequential basis to $152 million while down 6% year-over-year. On a quarter sequential basis, our U.S. and Canada installed base was down 627 units driven by reductions of our legacy product, some of which is the result of temporary removals to make way for certain casino expansion projects. Our yields grew $0.25 from the prior quarter driven by new games, including our James Bond franchise, where play levels remained strong.

Revenue from our international units increased $2 million on a quarter sequential basis. Revenue from gaming machine sales decreased $9 million or 6% in the first quarter. We shipped 6,884 machines globally, including 3,864 replacement units in the U.S. and Canada and 937 open and expansion units. Internationally, shipments totaled 2,083 compared to 2,201 units a year ago.

Year-over-year, our average selling price for the quarter was down 3%, relating mainly to the mix of games in the international markets. We received a large allocation of more than 30% floor share at Encore Boston Harbor, with most of the units shipped this quarter and some additional units shipping in the second quarter. Gaming systems revenue was roughly flat from the prior year as strong software and maintenance was offset by a lack of major site installs in Canada this quarter. Q1 2018 benefited from the system go lives in Canada, and we expect to benefit from additional go lives throughout the rest of 2019.

Turning to lottery. Our first quarter revenue increased $25 million to $227 million, and AEBITDA was up $10 million compared to the year ago quarter. Within our lottery business, our systems revenue increased $35 million or 65% year-over-year. This was driven largely by $33 million of hardware sales and the new contracts in Kansas and Maryland that were not in place in the prior year period.

Our instant ticket revenue of $141 million was down 6% from the prior year. The timing and mix of shipments of our different contract types negatively impacted revenues this quarter, and we had a tough comparison with the WILLY WONKA promotion last year. As a reminder, under the new revenue recognition rules adopted last year, we will experience some lumpiness in the instant ticket business as revenue is recognized upon shipment for both POS- and PPU-related contracts.

Turning to our Social segment. We generated strong growth with revenue up 21% year-over-year to $118 million, and AEBITDA was up 10% to $25 million. These results were driven by increased monetization of paying players, with ARPDAU up 14% from the prior year or an increase from $0.42 to $0.48. We increased ARPDAU while also increasing our average DAU, which grew from $2.6 million to $2.7 million year-over-year.

In digital, we generated $70 million in revenue and $13 million in AEBITDA. We successfully launched iGaming in Sweden, renewed our Denmark sports contract and recently partnered with Wynn Resorts, as Barry mentioned earlier.

We launched Jin Ji Bao Xi, which is already a top 10 game on our platform, which is just one example of our continuous innovation with the digitalization of gaming and the power of our omnichannel offerings. We generated $96 million in free cash flow in the quarter, which is the result of improved operating cash flows, lower CapEx and favorable working capital.

CapEx was $67 million compared to $88 million in the prior year. As we commented before, 2018 was an unusual year, where there are higher-than-normal number of new and renewals of long-term, highly-accretive projects that required upfront CapEx. In the first quarter of last year, we had $14 million of CapEx related to these types of projects.

The favorable working capital benefited from the timing of accrued interest payments versus last year. We expect 2019 to be a much cleaner year from a cash flow perspective, but we will continue to have fluctuations from the quarter-to-quarter based on our refinancing activities, which impact the timing of interest payments.

Before concluding, I'd like to take you through a few housekeeping items in our press release. You'll see some changes in our KPIs, including game ops, which we now break down into 2 categories: U.S. and Canadian, and international. These changes to align how the management team views the business and will provide investors a better view of what drives our business and our results.

We are now including Illinois VGTs in our replacement units given the maturity of the market and how the industry tends to view these units now. We have revised our calculation of AEBITDA for our Social business to be consistent with that reflected by SciPlay in its publicly released results, which you will find in their S1 that's on file with the SEC.

We've supplementally provided this information on a historical basis in our release to provide investors with full visibility into these revised metrics.

In summary, we're continuing to grow and innovate across all of our businesses. While we remain firmly focused on the efficient deployment of our capital to generate the returns needed to enhance our free cash flow, to continue our deleveraging path.

And with that, operator, you could open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Barry Jonas from SunTrust.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [2]

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Maybe we can start with gaming. I'm just curious if you could talk about the underlying trends you're seeing in game ops and game sales, and I'm curious if the declines you saw this quarter is just from a tougher competitive environment or maybe just more onetime in nature.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [3]

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Thanks, Barry. This is Barry. I'll take that. Let me start by saying that we're -- as we've mentioned in previous earnings calls, we're laser-focused on growing gaming in 2019. And so I think it's important to keep some things in perspective on where we are in the cycle as you -- as we answer this question.

So let's take game ops first. So actually, for game ops, we're seeing game ops stabilize quarter-over-quarter. And we're excited with having basically a one-two punch with Jin Ji Bao Xi and Bond outperforming and also turning the tide with the other exciting titles that are in the pipeline. Because if you look at it, these things are in the early stage of their cycle. We just started to roll out the Jin Ji Bao Xi game, and it only has about 120 placements at the end of Q1. We're currently up to approximately 250 across multiple cabinets, the WAVE XL and J43. This game is performing above 2x house consistent to Bond or a WAP game, and it's a premium game.

Also, the Bond games continue to be our top-performing WAP, 2x since launch, and with Casino Royale leading the way as the #1 title. And we have a new -- a pipeline of new Bond themes coming, Tomorrow Never Dies and Live and Let Die, add on other great titles like WIZARD OF OZ MUNCHKINLAND. This is the first WIZARD OF OZ product launched in 4 years. We really feel strongly that we've got a lot of great momentum that began toward the end of Q1 that is going to continue throughout the year.

For game sales, we also are launching our 2 big major platforms into the market with the WAVE XL domestically and Dualos X internationally at the end of Q1. Both of these came out at the end of Q1. We believe these 2 products are going to be key to driving replacement share gains.

We also continue to see strong demand for the J43 cabinet, by the way. For perspective, the J43 is nearly 2.5 years old, and we sold over 14,000 units to date, including 2,000 units per quarter over the last 2 quarters. If you compare that basically to the original WAVE cabinet, we had sold at this point in time in the lifecycle about 12,000 units, and it represented about 50% of the total units that it's sold so -- that is sold live to date. So you can see that there's plenty of runway for J43 still to come.

Layer on that, these new cabinets, with great content like Fu Dao Le Riches, Heidi and Hanna's Bier Haus, 88 Fortunes Diamond, et cetera. The combination of this gives all of us confidence that the decline of replacement units is temporary, and we have great path forward with the game sales front.

And one other thing I just want to mention as you asked that question is we talked about before this notion of building great games in a cost-effective manner. And a core to that strategy was something we talked about as a content-first versus a cabinet-first, the interoperability of games, and you see that basically coming to life in Q1. Interoperability is the foundation of this strategy. We're taking our top games, and we're offering them to customers with multiple choice of cabinets. So just take Jin Ji Bao Xi as an example. Historically, we would've launched Jin Ji Bao Xi, and it would have been limited to basically probably the WAVE XL. Our interoperability allows us basically, efficiently deploy it across the original WAVE, J43 and WAVE XL. And we're already seeing, with the launch of Jin Ji Bao Xi, a huge mix of what it launches on, which gives us the -- helps us capture that footprint yet does it at less -- basically a more efficient CapEx.

And right now, already as of today, we've got about 70% of our comps coming out running on multiple cabinets. So we're executing on that strategy, and we're seeing the impact of that and excited about what that's going to look like for the rest of the year.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [4]

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Great. That's really helpful. And then maybe just a question on SCiQ. I think some of the metrics you gave in the opening remarks were very good. And I'm just curious, what's the right way to think about the sales cycle? Or what point we could see your sales inflection going forward, given some of those strong metrics you've quoted?

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [5]

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Well, there's -- it's Q here. There's a number of items that we have in the pipeline between retailers and the state lotteries right now. What we're seeing right now is very similar to Ohio, where the lotteries are interested in the product. But they're going to want to take a manageable chunk, maybe somewhere in that 300- to 500-type unit and get those rolled out on a, say, a very methodical approach.

So I think you will start seeing some of those sales coming through probably in the back half of this year. Because when you're dealing with a state lottery, it just -- the sales cycle just takes a little bit longer for them to go through their approval process, especially since this is a product that they're going to be purchasing. But the results are there.

I mean when you look at just the overall 200-plus units that we have out there on the test basis through the likes of 7-Eleven, Circle K, The Walmart, Kroger, those -- they're all seeing anywhere on average 12% to 15%. The 10% that we have in Walmart, it's well above 40%, is what they're seeing on the increase in sales. The big sizable example we have right now is Kroger with 2/3 of that 150. I think we're basically up to maybe 120 units at this point. They're seeing well in excess of 10% increased sales quarter-over-quarter -- or sorry, year-over-year. And what they're all reporting back, which I think is just the key of it all, their shrinkage is completely eliminated by this product.

So I think it's just going to be a matter of time just to get this stuff through the lottery procurement process, but I think as it goes, it's a first to market. We'll get there, and as soon as one lottery buys it, a lot of other property -- lotteries are going to be piling in on top of that. So we're pretty excited about what the opportunity that lies ahead of us on this.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [6]

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Great. And then just last for me. I wanted to touch on digital or sports betting in the U.S. You had a nice win with Wynn over the quarter. But yet, it does seem like the platform field is somewhat crowded out there. So maybe just can you comment on sort of how you guys are differentiating yourselves from the pack?

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [7]

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Yes. So look, I mean, I think you and I think most people know that while markets seem, quite frankly, to be growing at a really nice pace in terms of the regulations passing -- we've seen bills passed in both Iowa and Indiana, waiting for a governor's signature. You've got a whole host of probably, quite frankly, another 8 to 10 that are all in active legislation discussions, well ahead beyond the 7 live states that are out there now, which is really exciting.

But the reality is the U.S. sports betting and iGaming continues to be dependent on that, and then there's obviously a time frame of ramp-up that happens post that. So we're keeping the perspective that we're still in the early stages and -- but we believe it'll continue to play out over time. The team has done a really great job of signing up major players, Caesars, Wynn, Oenida in New York and continuing to do so as well as supplement that with some great deals over in Europe.

The thing that we have been talking about since the beginning is that if you look what happened in the U.K. market and you see who became the eventual winners, the people who become the eventual winners are the ones that built the best -- basically the most robust product that has -- that could be customized and differentiated from the competitors, that is able to handle the volume that is necessary so that it doesn't -- systems don't go down. It's reliable. It's fast. Players can get to the bets that they want in and out, et cetera, et cetera. We believe that we have, on a worldwide basis, proven that we have that best product. And once you get past this kind of initial rushing of going out and spending a ton of marketing, et cetera, to try to capture early share, what you'll see that plays out in the marketplace is the best product will win. So we continue to feel very confident we have the right product, and we're cutting great deals to get out there and be a leader in the space.

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Operator [8]

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The next question comes from Brad Boyer from Stifel.

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Brad J. Boyer, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [9]

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So first one for you, Barry. In the release, I noticed that you called out an opportunity to reduce costs. Just want to see if you could provide some more color around that, any specifics? I mean is this just kind of efficiency measures? Is this further headcount reductions? How are you thinking about the ability to further drive costs out of the business from here?

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [10]

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The way we're looking at it is that I think I've mentioned that the big strategy is how do we build the best games or best product experience but do it in the most cost-efficient manner as possible, and that's being smart about your road map. So you're not overbuilding market for markets that don't warrant that -- so take the gaming market, and you divide it up into WAP, premium, VLT, class 2, et cetera, making sure you have the right shots on goal with a product development process that is superefficient about developing toward that. It's about ensuring that your cabinet cost match the market and supply -- working both value engineering, supply chain management and then again portfolio management to put -- to get that in place.

So it's really -- and then you can -- and then leverage that cost obviously -- the cost reduction to obviously generate the cash you need to pay down debt and also invest in the areas of growth where we need.

But we're really looking at how do we do things as efficiently as we possibly can and then make sure our investment really hits on the things that are going to differentiate us and drive the business going forward, and it's been a lot of effort going on in the organization to do that.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [11]

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Yes. I'll just add on to that real quickly. And it's not that I'm saying, "Hey, there is a major program that's going on." This is something that's embedded in our everyday lives, and I got to give kudos to people like Jon Jensen, Mike Doty and the operations teams. They are grinding out every day trying to find that 1 or 2 things that they could do differently to make things more efficient, whether it's on the supply chain side, the manufacturing floor, the sales order process, you name it, freight and [bulks]. They are after everything every day, and it's just a little bit of piece every day that's helping us improve. And that's what you saw on those margins in gaming this year, or I should say, in the quarter with 170-basis-point improvement.

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Brad J. Boyer, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [12]

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Okay. And as I think through the opportunity there on the margin side, that's a good segue into my next question, I mean should we expect there to be the most upside within the Gaming segment, just given kind of how those things break out, irrespective of revenue mix? Or how should we think about the margin potential by segment from here as a result of kind of just getting more efficient with costs?

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [13]

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I'll kind of -- I think it's efficiencies across the board. Gaming is the one that's most prevalent because, let's face it, it's in the 4 walls where I sit every day. So I see it every day. But Pat McHugh and the team are doing the same things in the lottery division as well as some of the things that we can do on at a corporate perspective to help bring down the overall corporate cost, whether that's in your normal cost of finance, IP, the things to that effect. Barry, do you want to add anything on digital and social?

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [14]

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Yes. I was going to say that the digital side is a great example where obviously the (inaudible) repealed and getting out to market quickly. There is always an opportunity, and the team there is doing a great job of ensuring that we're getting to the market as fast as we can with the right product but continuing to think about how this thing streamlines and scales and gets better margin over time. So I think even in those areas, we constantly make -- driving those same efforts as well.

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Brad J. Boyer, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [15]

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Okay. That's helpful. And then if I'm hearing you guys correctly, I mean it sounds like you guys have some pretty nice momentum exiting the quarter here with respect to new product that's out there, both on the game ops and on the for sale side. Just curious, I mean the replacement units were down a bit year-on-year in the first quarter, and some of that was expected. But given the momentum you have on product, as we sort of transition through the year, is it your expectation that we're going to see that replacement number start moving back up closer to kind of that 4,000 level where it was a couple of quarters last year?

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [16]

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Yes. I would think -- I mean look, I'll give it in the perspective of what Q1 is like versus what the rest of the outlook will be for the rest of the year. We're definitely below where we wanted to be in Q1. But when we look forward, Dualos X is a brand new cabinet going out. This will be our first new cabinet internationally. WAVE XL is going to continue, as we've talked about. J43, going. So I mean I think if the market is there, I think we're going to have the products there to be able to substantiate and support it.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [17]

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Yes. I'd say -- I'd reiterate that as well. I mean the replacement cycle seems similar to last year with operator spending kind of flattish to up slightly. And with the way we positioned our product and where it's coming out, that gives us confidence.

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Operator [18]

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The next question comes from John DeCree from Union Gaming.

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John G. DeCree, Union Gaming Securities, LLC, Research Division - Director and Head of North America Equity & High Yield Research [19]

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So I wanted to maybe get a little higher level here. You've mentioned in your prepared remarks, Barry, a lot of the accomplishments you've made throughout the quarter, big refinancing post quarter last week, the SciPlay IPO. And as we look at the balance sheet, I think adjusting for some of the proceeds that you're expecting from SciPlay, leverage now looks like it's getting below 6.5x and starting to approach 6x, which I think was kind of a long-run target before setting any further expectations.

So wanted to get your thought now that you've kind of gotten some wiggle room with the capital structure and what plans are for debt reduction from here and if you've got any updated targets for leverage and time lines and things like that.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [20]

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Yes. Thanks, John. And yes, as you mentioned, you guys know where we're at now. We do have internal goals and as I look forward to the end of next year. I'd like to see us reduce leverage ratio by, at least, a full turn. And I think as you mentioned, we're -- when we have said this numerous times on these calls, as you mentioned, I mean we're pushing hard on everything. And you see it in the activity, right, the $96 million free cash flow this quarter, just the recent refi we did at a 10%, the opportunity we have for another refinancing and increased free cash flow this quarter, the proceeds from the IPO. We -- as we had discussed, 2019 CapEx will be a cleaner and freer year than 2018. And remember that we're still working off the net operating loss as well. So I -- kind of a combination of all that, we are 100% focused on shooting toward these internal targets.

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John G. DeCree, Union Gaming Securities, LLC, Research Division - Director and Head of North America Equity & High Yield Research [21]

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Barry, that's a helpful update. And then if I could maybe switch back to operations a little bit and on the gaming front, ask about, I guess, customer behavior, just more broadly so whether it's large companies, corporates involved in M&A, integration, looking at cost cuts across their organization. And it's only a representative of a portion of your customers, private companies and Native American making up the other. But from that segment, it seems to be quite busy with their own operations.

Have you seen a change in customer behavior, smaller order sizes or something to that effect over the last quarter or 2? Or perhaps, not much changed at all? How would you kind of characterize customer behavior as it relates to the Gaming segment?

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [22]

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I think I heard, I guess, a couple of questions in there. One is the -- what's the sense of the budgets that we're seeing, are we seeing a slowdown, and I'd actually say we're probably, generally speaking, seeing a slight uptick in capital spend from the strip operators and some regional operators. Obviously, there's some relative softness in select markets. The tribal casino operators seem pretty consistent in spending at the same levels.

In terms of operator consolidation, we expect that obviously to continue in 2019. But the reality is, is -- and this rule holds really across any and all comments, which is basically the operators are willing to pay for the best content given the ROI on slots. So as long as you're producing the best games, you will get placement. And look, there's been probably in the world of consolidation some. There has been some probably impact on game ops but less impact on game sales.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [23]

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Yes. I mean if you think about it, it's kind of the best of both worlds because you've got operators who are more constrained on capital, they're less likely to go do a large-scale CapEx project as first -- the first one that will come off their list, which then actually will free up additional capital in the back end to spend on, say, CapEx or other improvements that are going to yield a much faster return that are at a much smaller level, which kind of plays into the back fact you would expect the possibility of an increase in the replacement cycle basis.

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John G. DeCree, Union Gaming Securities, LLC, Research Division - Director and Head of North America Equity & High Yield Research [24]

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That's helpful. I appreciate that color guys. Last one, really quick for me. You've mentioned the Turkey national sports concession in your prepared remarks and a lot of focus on U.S. sports betting since it's so topical in the media pretty much every day. Can you talk a little bit about how large the international opportunity is for your digital business, I guess, sports and iGaming, something that maybe we don't talk about as much? And that's it for me.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [25]

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No, I appreciate you mentioning it. I think that there is a whole lot of focus on the U.S., but there's quite a bit of activity going on, obviously, in the U.K., the Europe as well. And there's numerous deals that have been out there such as Turkey, Denmark, Sweden. And we just obviously launched the New Zealand Racing Board. All of these have been really strong deals for us. And obviously, we don't disclose the dollar figure for each one of them, but we're seeing very active market deals coming to life, and the good news is we're extremely well positioned for those.

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Operator [26]

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(Operator Instructions) The next question comes from Joseph Stauff from Susquehanna.

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Joseph Robert Stauff, Susquehanna Financial Group, LLLP, Research Division - Credit Analyst [27]

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I don't know, is it possible to share with us just -- knowing that you had changed some of the reporting segments in game ops, any way you can share with us what WAP, premium segment would have looked like for the reported quarter? Just given the comp and sort of expectations and trying to figure basically, is that installed base as well as the average daily revenue per unit had grown sequentially?

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [28]

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Yes. I mean it would have grown sequentially, but I think the important thing is to why the switch. If you think about -- you could have a premium product on a premium cabinet move between premium and what we would call other just based on the physical location of when it moves. And so really it becomes very a daunting task to track every individual's serial number. And so when we actually start looking at it, we're really looking at it as a portfolio in its totality, which is why we felt it was more important to get to this more of a high level, very clear, easy-to-understand metric to go off of.

But when you look at basically the WAP segment, it's been increasing. We've seen that historically over the last probably 3 to 4 quarters as we continue to roll out new product with the James Bond franchise.

Premium has usually been this relatively flat segment for us just based on the fact that as new products come, you get a little bit of a bump, but at the same time -- and I'll say just in the instance of the 627-unit decline, the vast majority of those cabinets were in excess of 7 years old. And because they were classified as premium before, that's premium footprint that was lost. But when you look at the impact of the revenue, it's pretty minor in the whole grand scheme of things. So...

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Joseph Robert Stauff, Susquehanna Financial Group, LLLP, Research Division - Credit Analyst [29]

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No, understood. I mean it's definitely reasonable in terms of your reclass and why you're doing that. But I was just asking for expectations. And just to be clear, had you not done it, basically that premium and WAP segment again would have grown sequentially. Is that fair to say? Just to confirm that? Meaning like in the fourth quarter -- okay. Not a problem. You follow up with that.

I wanted to ask maybe one other specific question, and I don't know if you can comment or not, but on the social -- and I don't want to stay away from just the operating side as you commented you're on the quiet period. But from a Scientific Games perspective, given the fact that you owe or that you own something in the low 80s, is it -- is there any expectation that you would have to distribute those shares to shareholders after 180 days, after kind of the IRS requirement? And had you requested a PLR for that from the IRS?

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [30]

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Yes. Unfortunately, because of the blackout period that we're still in with social, we're restricted in what we could say at this point in time, but we might be able to answer that in a few weeks after the blackout period is over. Sorry about that.

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Operator [31]

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The next question comes from David Katz from Jefferies.

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [32]

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I wanted to ask sort of a bigger picture strategic question. Doesn't really involve anything in a quiet period, but historically, the approach has been to include things like systems and social and some of the other technology aspects of your offering and sell them -- I'm -- there's probably -- I'm searching for a better word than bundle, but to embrace your customer with several aspects of what you have in the technology side. Can you comment on how any of the recent developments may benefit or impact that approach?

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [33]

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Yes. So I mean essentially, if you're asking on -- so the -- what happened on -- relative to the action that we took with SciPlay. First of all, in terms of the social group, as you know, it's been an independent division within the organization. It's operated independently. It's been a B2C and purely free to play social business. And so that's not been one of the assets that we have typically bundled when we've gone and met with our customers. We've -- the -- we look to obviously provide a full customer experience both retail and digital, from enabling platform to content for so we could render a kind of a 360 experience with our customers to enable that -- the real-money gaming experience. This has been a different business in that sense.

But the other thing to remember that is as a go-forward business, as a go-forward path. There's -- first of all, I think it's -- this has been a huge win, I think, for both SciPlay and Scientific Games. We -- for Sci Games, we've raised $300 million to pay down -- to help pay down debt, and we maintained an 82.6% stake in a strategic and growing asset in SciPlay.

For SciPlay, it provides greater flexibility to pursue additional growth initiatives. There's nothing to prevent the 2 groups continuing to work together where it's strategic, quite frankly, if opportunities still exist. So I don't think that anything of what we did precludes that opportunity.

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [34]

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Got it. And my follow-up is in another direction around just thinking through the cash flow opportunities, and I appreciate your commentary about a cleaner year. But if you could talk about potential items or potential events or opportunities out there that may flex the cash flow up or down over the next 4 to 6 quarters that are out there that we should be contemplating as we model going forward.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [35]

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Yes. And so I'll speak to the outflows first because I always like to get that piece out of the way. So when you're looking at the CapEx spend, and this really kind of gets into the lottery systems contracts, the Pennsylvania RFP is out right now, and we're in the process of submitting our proposal for that. So that will be a sizable amount of CapEx, as we've discussed in the past.

Beyond that, there are opportunities, the next big one coming up, which is not our contract, it's an IGT contract. It's the New York State Lottery. That is coming out probably in a year or so from now. So that would be another potential outcome out there. But again, that is a nonrenewable on us. That would be new business assuming that it does go to the RFP process.

When I look on the interior side of what's coming in, I look at cash flow opportunities really around SCiQ and getting that really moving in the direction that it needs to, which I think it will starting the latter half of this year and then well into 2020 and beyond. I look at the interoperability of our game ops footprint.

To Barry's point earlier, if we would've launched Jin Ji Bao Xi 2 years ago or a year ago, there would've been a philosophy to put that on a new cabinet and only offer it on that new cabinet, which would have required us to have all new CapEx across the board. Today, with the interoperability, we're able to manage how many of those units we want out that's going to drive increased footprint versus protecting existing footprint by putting that game on there on an existing cabinet to continue that growth and the return on CapEx at that point.

The rest of the conversion, there's -- I think it's really just normal operating results that we just continue to grind on every day to improve the overall EBITDA and free cash flow. We're constantly monitoring the working capital to drive down days on hand for receivables as well as make the supply chain as efficient as possible.

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Operator [36]

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The next question comes from Mike Malouf from Craig-Hallum Capital.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team [37]

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I was wondering if you could just comment a bit on the dynamic that you're seeing in the U.K. with our recent GBP 2 betting limit and just how that's impacting your business over there.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [38]

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Yes. Right now, it's only been in place for roughly a month. So I mean it is in line with what our expectations were. We haven't seen anything really different, but it is very early to tell at this point. We were thinking the impact would probably be about $10 million on an annual basis. And again, the U.K. business itself is a relatively small percentage of our business, so I don't see it as a material impact to the overall SG entity in its entirety.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team [39]

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Okay. That makes sense. And then just as a follow-up kind of piggyback now to what you're saying at the previous question. Was wondering if you could just update us with how you're thinking about SCiQ and some of the timing with the rollout you see, your overall market assessment of that at this point.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [40]

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I hate to say like I sound like a broken record because I think I said the same thing on the last call. The opportunities are there. It's just we've got to get through the procurement process within the lottery, and that just usually takes a lot longer than what you typically see when you're dealing with a casino operator.

But more and more lotteries are knocking on our doors, and they want to see the product. They're hearing other property or I should say other lottery operators are getting the tool. They like it, and I would expect to start seeing increased sales, as I said, the back half of the year and then really starting to ramp up in 2020 and well into 2021.

But let's talk about just the addressable market. There's roughly 200,000 retailers in the U.S. alone that sell lottery tickets, and this isn't a tool that would go everywhere. But we look at that addressable market at roughly, call it, 60,000 units. And right now, to date, we've got less than 500 that have been sold and in place. So I think there's a substantial runway to come in the future.

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Operator [41]

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This concludes our question-and-answer session. I would like to turn the conference back over to Barry Cottle for any closing remarks.

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Barry L. Cottle, Scientific Games Corporation - CEO, President & Director [42]

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Thanks for joining us today. We really appreciate your support. The entire organization is excited for the opportunities ahead of us. I look forward to updating you on upcoming accomplishments and on our second results during our next call. Thanks so much.

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Michael A. Quartieri, Scientific Games Corporation - Executive VP, CFO, Treasurer & Corporate Secretary [43]

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Thanks, everyone.

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Operator [44]

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The conference has now concluded. Thank you for attending today's presentation, you may now disconnect. Have a good day.