Light & Wonder - Q3 2020

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to the Light & Wonder 2020 Third Quarter Investor Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing star, then zero on your telephone keypad. A brief question-and-answer session will follow the formal presentation. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. Now, let me turn the conference over to Robert Shore, Senior Director, Investor Relations and Corporate Finance for Light & Wonder. Mr. Shore, you may begin.

Robert Shore (Senior Director of Investor Relations and Corporate Finance)

Thank you, operator. During today's call, we'll discuss our Third Quarter 2020 Results and Operating Performance, followed by a question-and-answer period. With me today are Barry Cottle and Mike Eklund. Our call today will contain certain statements that include 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 related to the call posted on our website, and our filings with the SEC. We will discuss certain non-GAAP financial measures.

A description of each non-GAAP measure and the reconciliation of each non-GAAP measure to the most direct comparable GAAP measure can be found in our earnings press release, as well as in the investor section on our website. As a reminder, this conference call is being recorded. A replay of this webcast and accompanying materials will be archived in the investor section of our website at lnw.com. Also, some of the reference slides are available on our investor relations website. While management will not be speaking directly to these slides, these slides are meant to facilitate your view of the company's results and to use as a reference document following the call. Now, I'm going to turn the call over to Barry. Barry?

Barry Cottle (President and CEO)

Thanks, Bobby. Good afternoon, everyone, and thanks for joining us. We are very pleased with our financial and operational progress in the third quarter as we execute across numerous fronts that will continue driving success. I'm very proud of the team and how we're performing, with our strong operational execution delivering solid financial results, new business wins, and great product development. I'm excited to share some highlights with you today, which all really center on the strength we're seeing in the recovery of our business and the long-term value opportunity at Light & Wonder. All in, the entire organization has never been more excited for the future with a new board, industry-leading talent, and winning culture. We continue to improve our financial position through positive cash flow and continued focus on key balance sheet management.

For the quarter, we generated $140 million in operating cash flow and $62 million in free cash flow, representing an increase of $11 million year over year. We renegotiated covenant relief for additional financial flexibility as we navigate through the evolving market environment, and we continued to deliver on our delevering priorities by paying down $100 million in debt in early October. We achieved strong business unit performance, underscored by three of four business units delivering year-over-year revenue and AEBITDA growth, while gaming achieved outsized sequential revenue and AEBITDA growth. We have a number of innovative products that are giving us an edge in this current environment and beyond, including cashless, contactless gaming solutions, sports betting, iGaming, and SciPlay, while our lottery business remains resilient.

On top of these performance results, we are embarking on an exciting new chapter for Scientific Games with a refreshed board and new investor base. We now move forward with an enhanced board that shares our commitment and disciplined approach to delevering while investing in our people and products to win and create sustainable, long-term shareholder value. Further to this last point, as you all know, a number of institutional investors acquired 34.9% of shares outstanding from MacAndrews & Forbes. With that transition, we welcome Jamie Odell and Toni Korsanos to our board as the Executive Chair and Executive Vice Chair, along with Tim Throsby and Hamish McLennan as two additional independent directors with exceptional global business experience. We've been working with Jamie and Toni as advisors for the past year and a half.

They are accomplished industry veterans that share our passion for culture, talent, and products. They oversee a new board that comprises a majority of independent directors. The board and the management team will review all strategic options to improve and maximize shareholder value with an overarching strong determination to delever the balance sheet. This broader review of strategy will be supported by operational improvements, along with a renewed focus on working capital management. Finally, I want to thank Ronald Perelman and the rest of MacAndrews & Forbes for their support over the years. Now, I'll provide a bit of color on some of the opportunities we have in our business units. In gaming, we grew the business from the second quarter, and we introduced some really exciting products at this year's Virtual Global Gaming Expo.

I'm very excited about the cabinets and games that are on the roadmap, and the feedback from our customers was extremely positive. Additionally, we've made great strides recently in investing in our culture and talent, including hiring some of the best R&D people in the industry. We expect these improvements to lead to greater hit rate going forward that ultimately translate into revenue and free cash flow. Our new Kascada cabinet is targeted initially to go after the premium game ops market. This new cabinet is the next generation of our top-selling TwinStar J43, where we have sold over 25,000 units since launching. It's really a beautiful cabinet with an innovative K-Curve and an ultra-high-definition display. It has incredible light effects, and sitting down at this cabinet offers an immersive experience.

Kascada will launch with Coin Combo, a new premium game ops title, which was developed by our studio that produced many of our top game franchises, like 88 Fortunes, Dancing Drums, and Jin Ji Bao Xi. Our cashless and contactless solutions that we've been working on for years is now gaining momentum in the market. Unified Wallet, which powers the cashless gaming experience, was named one of the top 20 most innovative gaming technology products by Casino Journal. Our solution is currently in pilot with two corporate customers, with the deployments expected in the fourth quarter and into 2021. We are extremely well-positioned for cashless gaming, given our market-leading footprint of approximately 525,000 connected slots. Additionally, SG Vision Chip Tracking is set to release in the fourth quarter and will be placed at a pilot site in Q1 2021.

This hardware and software subscription service will capture the value of bets and send accurate ratings, so casino operators can properly invest in the table game player segment. Along these lines, the pipeline and interest for the electronic table games segment remains strong. Growth continues for the Vault Subscription program, using a table game subscription model that allows operators access to a robust library of proprietary game titles. A common theme here is we expect to increase the recurring revenue component of our business, led by our focus on increasing our domestic premium footprint in game ops. Despite the pandemic, we're continuing to attract the best talent in the industry. I'm especially excited to welcome Ted Hase, who will be joining the team in 2021.

Ted is a highly successful game designer and the creative force behind some of the industry's most notable games, including Buffalo Grand, Tarzan, and Walking Dead. We also recently completed the process of reorganizing our studios with the goal of developing a higher quantity of top-performing games. Ted will be leading our Las Vegas location. This reorganization will help amplify our unique strengths and focus the studios on developing content for the largest market opportunities. Overall, the team is doing a great job looking at the business with a fresh outlook, enhancing the culture, and improving our product roadmap, commercial approach, marketing, and analytics. As a result of these efforts, we expect to see an increased game ops footprint in 2021 and beyond, which is one of our key priorities.

In our lottery group, we see strong industry trends continuing in domestic instant ticket sales, where we are the market leader. This led to 10% growth in revenue from the prior year. We've also seen great results with our Scientific Games Enhanced Partnership, or SGEP, program. For new listeners on the call, this program is one in which Scientific Games provides instant game category managed services across the full supply chain, providing game design and portfolio management, advanced logistics and analytics systems and services, and retail optimization. States that have converted to our SGEP program outpaced industry sales growth by over 40%. During Q3, we continued with major deliveries, including converting the national lottery in Turkey with our JV partner, with over 5,000 SG's WAVE lottery terminals, plus retail and digital scratch games and systems.

We continue to win key contracts and extensions, including securing wins in Massachusetts for an instant ticket contract for five years, a 10-year Iowa Lottery systems contract, a 10-year contract in Oklahoma, which includes both systems and SGEP, along with a host of other wins and extensions, both domestically and abroad. On the product side, we are relaunching our highly successful multi-state Willy Wonka linked instant game and continue to have success with our retail solutions. I do want to touch briefly on Brazil. Collectively, with our JV partner, we have chosen to withdraw from the proposed structure due to a failure to finalize negotiations with a local lottery retailer and an unfavorable Supreme Court ruling. After carefully considering our options, we determined that proceeding further with the project would not be financially prudent. We didn't make a material capital investment in this market.

We will continue to explore opportunities in the country. In lottery, look for stability in domestic trends, coupled with the opportunity for additional SGEP conversions. Our digital business continues to capture market share and sees significant global opportunities across both sports betting and iGaming. During the quarter, the transformation of our product development and delivery capabilities were evidenced by several new deal announcements and deployments. We signed a new partnership with Hard Rock International for a full sports technology stack and iGaming ecosystem to power their U.S. growth plans. We've already launched retail sports in Iowa and New Jersey for them during the quarter, with mobile coming soon.

We also extended our contract with BetMGM for iGaming, signed up NetEnt as a partner in the U.S., and reached an agreement with Big Time Gaming, a provider of some of the most sought-after games in iGaming, to become the sole distributor of their content in the U.S. and Canada. We also signed a multiyear contract renewal with the Flutter Group for our sports product. Flutter's brand portfolio includes global market leaders in a wide array of regions, including FanDuel, Betfair, Paddy Power, Sky Bet, Sportsbet in Australia, and PokerStars. This year marks the twentieth anniversary of our partnership with the Flutter Group. Over the last three years, we've reengineered our sports ecosystem to be both fast to market and highly customizable.

This has led to increasing customer demand and the velocity of sportsbook deployments, moving from an average of one per year in 2017 to launching more than 20 year-to-date. Our iGaming platform is highly scaled, feature-rich, and year-to-date has delivered more than 13 billion game rounds to players across the world. We use a product strategy similar to Netflix. We create the industry's best iGaming content, including our own franchises such as Monopoly, Jin Ji Bao Xi, and Raging Rhino, and then supplement that with the world's leading content from third-party studios. In New Jersey alone, which is the most mature iGaming market in the U.S., we have a 40% market share, and our revenue during the quarter was up over 100% from the prior year.

Across both sports and iGaming, we are highly scaled, cash generative, with a loyal customer base in major regulated markets across the UK, EU, APAC, and Canada. With that experience and the transformations of our people, products, and technology, we are well-positioned to capture further market share globally. And finally, with SciPlay, we generated above-market growth in revenue and strong growth in AEBITDA again this quarter. Our baseline of revenue remains above pre-COVID-19 levels, driven by improvements made to our games in recent quarters. Our evergreen franchises of social casino games provide a highly reliable and sticky user base of players. In fact, over the past four years, this business has grown above a 20% CAGR and outperformed the market by approximately 40%, delivering predictable results in AEBITDA growth.

In addition to the organic growth in our social casino franchises, we are entering the $20 billion casual game genre with Solitaire. We will provide updates on this exciting initiative, with the first step being beta testing in Solitaire Pets Adventure in the first half of 2021. To wrap up, I'm really pleased with the cash flow we achieved in the business this quarter, driven by the breadth of our portfolio, which has enabled strong growth, the great talent we've assembled, and the governance changes we have implemented. There's a ton of enthusiasm right now throughout the organization, and I've never felt more confident in our position and the team we have than I do right now. Looking ahead, we continue to execute on our key initiatives that drive growth and profitability as we identify new opportunities to capitalize on Light & Wonder's leadership and unique market position.

Importantly, we have the flexibility we need to thoughtfully position the company for long-term success and are committed to unlocking the full potential of the company's best-in-class collection of products and technologies to deliver outsized returns to investors. With that, I'll turn it over to Mike Eklund to provide some financial highlights. Mike?

Michael Eklund (EVP and CFO)

Thanks, Barry, and good afternoon, everyone. I appreciate you all taking the time to join the call today. I want to start off today by simply emphasizing how excited I am about this new chapter for Light & Wonder under a revitalized board and a revitalized shareholder base. It's definitely an exciting time in the company's history, and I'm delighted to be a part of it. I continue to see a tremendous opportunity to deliver significant value to our shareholders, and it's great to know we have a strong and like-minded board, and one that will challenge and support this management team to make it happen. Obviously, the transition of the shareholder base and the board was a major focus area for us in Q3, and it was a major accomplishment for us in Q3.

In addition to supporting the transition, our global teams were also maniacally focused on growing out of a very challenging Q2 environment and positioning the company so that it can be nimble to perform strongly in whatever geopolitical and/or macroeconomic environment we find ourselves in through the end of this year and beyond. For Q3, three areas I'd like to highlight to start off the call today. First, as Barry mentioned, we generated $62 million in free cash flow, which was an $11 million year-over-year improvement. That was in the middle of a very challenging global economic backdrop and slowdown. This was driven by an across-the-board, and as I mentioned last quarter, a renewed focus by our global teams on working capital management. We will continue to put significant attention and effort towards ensuring we deliver strong free cash flows in future quarters and every quarter.

Second, we ended Q3 with $1.2 billion in available liquidity. Just over $1 billion of that was in cash and cash equivalents. This was coupled with the strong support we received from our banking group. Many of you are on the phone today. Thank you for your support, as we partnered with them to amend our credit agreement, which extended the covenant relief period under the revolving credit facility through the first quarter of 2022. The $100 million payment we made against the revolver in October also underscores our confidence in our financial position. Third, the breadth and resiliency of the Scientific Games portfolio continued to show its value and core strength.

Despite the COVID impact on the gaming industry, all three of our other businesses, lottery, digital, and SciPlay, combined to post a 16% year-over-year revenue growth and 24% year-over-year Adjusted EBITDA growth. This is a true testament not only to the hard work of the teams within these business units, but also the value of meaningfully participating in a diversity of land-based and digital markets across real money and free-to-play gaming. Now let's talk about our quarterly results in a bit more detail. Third quarter consolidated results showed a significant sequential improvement of 30% in revenue and 94% in Adjusted EBITDA. Versus prior year, however, revenue declined 18% to $698 million. These lower revenues drove a year-over-year Adjusted EBITDA decline of 32%, down to $235 million.

Importantly, that $235 million was up sequentially from $121 million in Q2. Given the reality of the global gaming market, which is seeming a lot more like a U-shaped recovery than a V-shaped recovery, and the continued uncertainty of the global pandemic, we will continue to be somewhere between disciplined and cautious in our approach, and we will continue to focus on cash flow and throttling spend and investment in line with the current market outlook. This will include diligence on expense controls until revenues fully normalize. As a result of all of these measures, when revenue does return, we expect to have a higher flow-through from revenue to cash flow. Turning to our balance sheet and cash flows, we delivered $140 million in cash flow from operations, which is in line with prior year.

The team continues to do an outstanding job managing the factors that are largely in our control, and year over year, delivered $44 million source of cash from working capital improvements in the quarter. This resulted in free cash flow of $62 million, and as mentioned earlier, this is an $11 million year-over-year improvement. As you will see in our press releases, we have also recast our free cash flow to exclude changes in restricted cash. Absent this change, free cash flow would have been higher this quarter. This revised presentation intends to more accurately align with what investors care about, which is the cash we generate that is available for debt reduction and strategic investment, excluding legally or contractually restricted cash. Our CapEx spend for the quarter was $50 million, compared to $75 million last year.

For 2020, we now expect capital expenditures to be between $210 million and $225 million, which is just about $100 million below the guidance we set back in February of 2020. Finally, we ended the quarter with a net debt leverage ratio of 9.6. I'll quickly now turn to our Q3 business unit performance, starting with gaming. In gaming, our results continued to be impacted by the pandemic, with revenue and Adjusted EBITDA down 49% and 66% year over year, respectively. We did see strong sequential improvement, however, with revenue up 154% and Adjusted EBITDA up 348% versus Q2. To add some color on the current environment, over 90% of U.S. casinos are now open.

We are continuing to see strong year-over-year coin-in growth in our gaming operations segment, with about three-fourths of our installed base currently being live. While we benefited from four new openings this quarter, we won't have the same level of new casino openings in the fourth quarter. Our lottery revenue and Adjusted EBITDA both increased about 10% from the prior year. Our strong results were the product of both continued rebound of domestic instant lottery sales and growth in the international product sales. From a margin point of view, the growth in SGEP was offset by higher revenues and a lower margin equipment sales, which was $9 million above last year, due primarily to increased sales into Turkey and Italy. Our digital revenue increased 15% to $75 million, and Adjusted EBITDA increased 47% to $25 million versus the prior year.

That $25 million number was helped by the completion of work delivered in the quarter. Just as a quick reminder, our current sports business is primarily internationally based, with this being, this business being more of a services and a time and a materials model. That model tends to cause some lumpiness in quarter over quarter revenues around when we deliver the end solutions and associated licensings into the marketplace. Our $25 million Adjusted EBITDA number this quarter was helped somewhat by that phenomenon in the business. That's opposed to our sports and iGaming business in the U.S., which is smaller, part of our current revenue stream and will grow, kind of it tends to grow more smoothly and in line with the market.

Finally, on SciPlay, our business continued to perform better than the market, with revenue up 30% and Adjusted EBITDA up 54% over the prior year. The business also showed strong productivity, with Adjusted EBITDA margin increasing 500 basis points to 33%. In closing, Q3 was a solid result in an otherwise pretty difficult market. We made progress in several key areas that are worth mentioning again here as we wrap up the call. We transitioned to a new and independent board and a renewed shareholder base. We continued to strengthen our liquidity position, which is now at $1.2 billion, while also paying down $100 million on our revolver. We've added additional flexibility by extending our covenant relief period through Q1 of 2022.

We have three of our four businesses delivering very solid top and bottom line growth and dropping nice productivity to the bottom line. And importantly, we saw positive momentum in our gaming business from Q2 to Q3, while improving its long-term cost structure simultaneously. In the middle of all of that, we stay focused on and continue to hire industry-leading talent across all BUs and corporate functions, and we continue to invest in a high-performing and winning culture. Going forward, we will continue to build upon this momentum, focusing on at least four key finance priorities. The first is predictability, which to us is developing a high say-do ratio in everything we do. The second is a set of balanced priorities, which is focusing on liquidity, growth, and profitability.

The third is operational excellence and ensuring that it's core to everything we do and delivering enhanced margins and an improved customer experience as we do it, and then fourth and finally, a renewed focus and determination on delevering the company. With that, we are happy to take your questions. Operator, could you please open the line?

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Barry Jonas of Truist Securities. Please go ahead.

Barry Jonas (Managing Director and Senior Gaming Equity Analyst)

Hey, guys, good afternoon. My first question is, can you talk a little bit about how you're weighing the different paths and time frames to deleverage? It seems like there are multiple options on the table on top of free cash flow generation, whether that's asset sales, equity raises, or anything else. Thanks.

Barry Cottle (President and CEO)

Thanks, Barry. This is Barry, and I'll take that. So, you know, I think as most of you probably noted in our September 14th investor press release, and actually confirmed last week in our first board meeting, there is renewed interest to evaluate initiatives that we believe will drive shareholder value. But obviously, it's early, and we can't really speculate at this time. As you guys know, it's something we have and will continue to consider with various structural avenues to delever. Meanwhile, operationally, and as demonstrated this quarter, we're also committed to delevering by achieving greater cash flows from top and bottom line growth, cash and cost management, and working capital management.

Barry Jonas (Managing Director and Senior Gaming Equity Analyst)

.Great. And then just one more for me. We've been hearing a lot about cashless gaming. Maybe can you talk about, Barry, how you see the market opportunity and what differentiates your product from other offerings out there?

Barry Cottle (President and CEO)

Absolutely. So, first of all, I think like everyone has, we're seeing an increased, you know, interest in momentum, obviously, due to, you know, the market conditions that have happened. We're actually excited about this because it's an area we've been working on for a while, and we've developed some really good IP around it. In terms of our positioning, how we see it, I mean, I think, you know, number one, we're extremely well positioned in the segment, given the leadership position we have in the systems category, you know, which, as you know, we have about 525,000 slot machines connected and about 5,000 tables.

So, you know, it really helps us, you know, we're already a part of that last mile, let's just call it, between the wallet and the slot. So we've got a solution that, as I mentioned before, we've been working on now for a while, combination of hardware, software. We're in pre-production currently. We have two large corporate customers that we expect deployments beginning later this year. I think, you know, for us, it's like I said, we're seeing both from a regulatory perspective as well as from an operator perspective, you know, increased interest in moving this stuff forward.

In terms of, you know, the revenue model, I think, you know, the good thing about this is it's one that's gonna be, won't dive into the detail, but it's a multiple stream revenue, which is a combination of some upfront hardware along with, you know, software licensing, maintenance, et cetera. So, I think, again, a good product, good mix, and we're in a really nice position there, given our current position in the marketplace, as well as the length of time and IP that we've developed in it.

Barry Jonas (Managing Director and Senior Gaming Equity Analyst)

That's great. If I could just sneak in one last one. We're certainly seeing some instances of second waves of COVID in certain states. One of your competitors talked about seeing in October some slight softness in some of their participation revenues. Just wondering if you're seeing anything like that in any of your segments.

Barry Cottle (President and CEO)

I mean, you know, right now, I'd say, you know, we remain cautiously optimistic. Obviously, you've seen the progress that we made from Q3, you know, over Q2. But we're aware, as others are, of the other, you know, the things that are popping up in, particularly over in Europe and some of the countries there. So, you know, right now, I would just say that, you know, we continue to see progress, but are monitoring the, you know, the situation closely as these things are starting, you know, hitting the market.

Michael Eklund (EVP and CFO)

Yeah, the only thing I'd add to that, Barry, this is Mike, is, I mean, obviously, first and foremost, the health and safety of our team members, our customers, our suppliers, continue to be at the forefront of everything we do. We, too, are watching the same thing you're seeing as well. We hate to see it. But obviously, if it goes that direction, we've got a playbook now coming out of Q2, that we didn't want to run, but we needed to run to get the cost structure where it needed to be to kind of play that thing out. You know, reluctantly, we'd just go back there again if we had to, but we're cautiously optimistic this thing will continue to move forward. We like the momentum we saw Q2 to Q3.

We think we'll see momentum Q3 to Q4, but like you and like everybody else, we're watching the same things you all are, and it's, it's anybody's guess right now how this thing's gonna turn out.

Barry Jonas (Managing Director and Senior Gaming Equity Analyst)

Great. Really appreciate all the color. Thanks, guys.

Operator (participant)

Next question comes from Chad Beynon of Macquarie. Please go ahead.

Chad Beynon (Managing Director and Head of U.S. Research)

Good afternoon. Thanks for taking my question. Nice results overall. Really, the only, I guess, confusing thing for us is on the game ops, so I just wanted to revisit that a little bit. I believe you said that 25% of your installed base were inactive during the quarter, and the active units were up double digits. So I'm just a little confused on how that led to a 38% year-over-year decline, if you could confirm that. And then more importantly, on these inactives, is that what it was blended during the quarter? And have you seen more of these units turned on, which could obviously help some momentum into the fourth quarter and beyond? Thanks.

Oh, Chad, this is Bobby. We report in our KPIs, we'll give you the total installed base. So that's really kind of a blended number, but the KPI is actually the total number of reported units in our KPIs. You know, we said about 70%-80% of our units are currently turned on. You know, continuous year-over-year upticks in terms of play levels. But yeah, I couldn't, like, kind of you couldn't really kind of back into you know win year-over-year, but that's that's sort of the reporting process there.

Okay, so have you seen more of these turned on as you progress through the quarter, or is that how we should think about, you know, absent any changes with, with the second wave, kind of how that, that could potentially sit, in the fourth quarter?

Yeah, it's been relatively consistent, kind of that 70%-80% range. You know, one thing I'd mention from a model perspective is New York is a really big market for us, and that opened kind of mid-September. So that was only in the quarter, about one month. But for the most part, it's kind of been in that 70%-80% range, Chad.

Okay, great. I guess moving on to the social business that really held up very well. I think there were some fears that could come down. Could you talk about how the Come2Play integration has gone so far? And if there's any plans to roll out other titles? Or if the thinking right now is monetization on the core games and then just further integration on Solitaire Pets and some of the Come2Play titles. Thanks.

Barry Cottle (President and CEO)

Yeah, absolutely. So I think, first of all, the Come2Play integration to SciPlay has actually gone well. We have built a really nice playbook with Showdown on the bingo front and just followed that same playbook, and it's really worked nicely plugging them into our, you know, the analytics, the UA, and the monetization schemes that we have there. As you mentioned, there's one game that we were super excited about when we went into this acquisition, which was a solitaire game that we expect out in beta in the first half of next year. I would say that's the first of- you think of this as a studio that specializes in this genre.

We'll focus initially on this solitaire game that has growth, and the way we tend to build games is called splinter-cell. We'll splinter off, spin a team off of that and go after a related card game. Think of it as a center of excellence in that genre that we will, you know, begin to build from.

Chad Beynon (Managing Director and Head of U.S. Research)

Thanks, Barry. Appreciate it.

Operator (participant)

The next question comes from John DeCree of Union Gaming. Please go ahead.

John DeCree (Global Head of Institutional Research)

Hi, everyone. Good afternoon. Barry, I wanted to ask a little bit about some of your comments in the prepared remarks and your focus on the installed base. You've hired some high caliber new talent to the R&D side of the business, and just wanted to see if you could help us understand what that means for R&D on the gaming segment going forward. Should we expect to see a little bit more capital going to R&D, or would it be a kind of reallocation of resources? And what would the output kind of look like? You've mentioned higher performing games and more of them, but what does that take? Is it gonna be more games in general or a focus on improving quality? I guess, how do we think about spend and, and output of the game studios with some of the changes that you're making there?

Barry Cottle (President and CEO)

It's a great question. I would. My top line would say, I think it's more of a focusing, you know, strategy as opposed to a quantity strategy. In fact, just the opposite. I think coming in the, you know, coming in the door, if you look at a year to two years ago, we were spread too thin, going after too many markets and geographies. The team that's leading the gaming team has really done an amazing job of coming in, putting the plan together to really refocus the development resources towards the largest profit pools, and within those profit pools, finding the gaps in the genres where we need to fill in.

The strategy is really about increasing the R&D after those large profit centers, and then offsetting that with not going after unprofitable efforts that are currently going on and finding efficiencies in other manners. The model is really, you know, the formula is very simple. We attract and get great R&D talent. We've restructured the studios in accountable creative centers, led, you know, by both the internal top talent that we have and some that we've brought in. We then, you know, target those after those profit centers, and then we've designed an incentive program for them to incent them toward it and drive, you know, forward on it. So we're super excited. We've already started to see, you know, that we showed at the Virtual G2E some of the outcomes of this strategy, and I'm really excited about the product roadmap and games that we've got coming, based on this.

Michael Eklund (EVP and CFO)

Maybe, John, I'll just-

John DeCree (Global Head of Institutional Research)

Thanks, Mike.

Michael Eklund (EVP and CFO)

I'll just add one thing real quick. As Barry said, it's fewer, but better games, right? And then putting our full weight and energy behind those games. And then as you talk to Matt and Siobhan and Connie and the team, it's definitely gonna be more money in R&D in going after and prosecuting the product lineup, but we're gonna self-fund it by taking cost out of other places, and that's the plan the team has in place.

Barry Cottle (President and CEO)

And higher top line-

Michael Eklund (EVP and CFO)

Yes

Barry Cottle (President and CEO)

Obviously, too.

John DeCree (Global Head of Institutional Research)

Got it. That, that's helpful. And Mike, perhaps, good segue into my second question, probably your area of expertise on working capital. Something you've talked about on prior calls, and now you've had a few months to roll up your sleeves. I was wondering if you could kind of help unpack that a little bit and kind of maybe give us some examples of areas of improvement, and then to the extent that you'd be willing to kind of quantify the opportunity in terms of impact on free cash flow. Is it, you know, kind of nickels and dimes here and there, or is the opportunity to increase cash flow through those initiatives, you know, a little bit larger than that?

Michael Eklund (EVP and CFO)

I'll probably stop short of giving guidance, and what you'll probably hear me say is a bit of a no-brainer, so I'll apologize, but it's just good old-fashioned cash flow from operations and working capital. It's DSI, DPO, and DSO. All right? When we look at those numbers vis-à-vis the benchmarks in this industry and other industries, it would suggest we've got a lot of juice in that squeeze, if you will. And we're just gonna get really maniacally focused on our procure-to-pay processes, our quote-to-collect processes, fine-tuning our supply demand planning processes, making sure that we have the inventory required to deliver, you know, valuable top-line growth. And all of those things just get rid of all the waste that's in them.

When we're done with that work, and it'll take some time to get through that in a meaningful way and to put the automation, the tools, the technology, the intelligence we need around it, but it's bigger than a breadbox, for sure, which is why we're gonna focus on it.

John DeCree (Global Head of Institutional Research)

Very good. Thanks, guys. I'll hop back in the queue.

Operator (participant)

The next question comes from Ryan Sigdahl of Craig-Hallum Capital Group. Please go ahead.

Ryan Sigdahl (Senior Research Analyst)

Great. Thanks, guys, for taking our questions. So a really nice margin expansion in digital this quarter. You noted some one-time stuff going on, but is Q3 a good run rate in the near term? And then what does the longer-term EBITDA margin look like in that business segment?

Michael Eklund (EVP and CFO)

I'll do the Q3 to Q4 run rate, then I'll let Bobby jump on the back of it. What I was trying to articulate there in the commentary is clearly we were helped by some one-time deliveries in Q3, so I don't think the Q3 run rate is indicative of Q4 run rate. And so we should just expect some of that one-time delivery not to repeat itself in Q4. That being said, we're still obviously very positive about the future of that business, the growth of that business, how we're winning in that business. A lot of really good things there, but we did have a nice little pop, one-time pop in Q3 that we wouldn't carry over into Q4.

Yeah, that's really it. We had, you know, we recognized some license revenue in the third quarter in digital. There's a bit more detail on that in the SEC filing. So, you know, some comparability issues, kind of Q3 to 4Q. But, you know, this is really gonna grow kind of into 2021 and 2022.

Ryan Sigdahl (Senior Research Analyst)

Then just any longer-term targets or expectations on margins in that segment?

No, we don't. I mean, there's operating leverage in the business, and as it scales, it's obviously going to improve, but no kind of near-term target there.

Moving on then, in the U.K., some of the B2 operators there got a pretty large legal settlement, up to GBP 1 billion from a back tax refund. Have you guys been able to claw back any of that, given participation-based machines there? Anything you can share there?

Yeah, nothing we can really share right now. You know, our tax team is definitely all over it. Something we're looking at, but, you know, probably pretty minimal that we can quantify at this time.

Great. That's it for me. Thanks, guys. Good luck.

Barry Cottle (President and CEO)

Thanks, Ryan.

Michael Eklund (EVP and CFO)

Thanks, Ryan.

Operator (participant)

The next question comes from David Katz of Jefferies. Please go ahead.

David Katz (Managing Director)

Afternoon, everyone, and thanks for taking my question. If you don't mind, I'm gonna take a run at some of the initiatives, comments, you know, that were made earlier. You know, I am sort of wondering if those initiatives are more, you know, strategic in nature. Are they, you know, intended to, you know, obviously, they should include an outcome where they reduce leverage or, you know, can they be isolated to just, you know, strategic, you know, strategic-oriented, allowing companies to grow differently and better and the like?

Barry Cottle (President and CEO)

Look, you know, as I mentioned before, we can't speculate on specific actions. You know, the goal here is, as we had mentioned before, is to both drive shareholder value and delever the company. You know, we're looking at a, you know, we're looking across the company at, at, you know, what, strategic initiatives make sense in order to, to, you know, achieve, you know, maximization of shareholder value, and that's really the only guidance that we can give at this time.

David Katz (Managing Director)

I see.

Michael Eklund (EVP and CFO)

Yeah, and David, the only thing I would add is I think it's all of the above. It's obviously we have an overarching objective to delever the company. We've tried to be pretty consistent about that. There's a new board, the leadership team's coming together. We're reviewing the strategy as we always do in terms of how to best maximize shareholder value. In the meantime, we're just driving like crazy to get top-line growth, primarily in our gaming business, back and put the products in place we need to win in the marketplace, and gain share. This focus on cash and operational excellence and cost is another big thing. We think all those things are going to go a long way towards delevering the company, and we're just going to stay focused on that.

David Katz (Managing Director)

I understand. Not, not an easy one to ask or answer. If I can just follow up with respect specifically to the slot offerings within the company. You know, historically, we've seen companies in that business, you know, go through repositionings or retoolings or a variety of other, you know, characterizations. And that can take some time because of the product development process inherent in it. How would you sort of characterize where yours is? Is it, you know, some fine-tuning of the process? Is it more of a retooling? How would you, you know, position that at this point?

Barry Cottle (President and CEO)

Look, I think we're actually, if you remember, we. About three years ago, we started some initiatives to get to a single platform, so we're completely platform-agnostic. We began to do a reassessment of the product, of the geographies and the target markets. Actually, Jamie and Toni joined us about a year and a half ago and started working that strategy. And, so I would say, you know, this is not, okay, we're a complete overhaul, and we're starting from scratch right now. I would say, you know, the. Actually the products that we. The first products we showed at G2E is, you know, it has a, you know, whatever you call a fingerprint on what is called an outcome of that.

So I think you're gonna start to see in the product roadmaps coming out, an outcome of the strategies that we've been putting in place. And I think it's only, you know, you know, given the timeline that you described, it's only gonna get better over time as we continue to bring in more talent and the like. And so, I would say, you know, our expectation is you're gonna start seeing improvement immediately, but that gets our expectations as they accelerate even more as the team that's in place, you know, can make even greater impact as they will.

Michael Eklund (EVP and CFO)

Yeah, and I think the initial reaction to that, to your point, Barry, on G2E, was fantastic. Matt and the team were able to do a little bit of a virtual petting zoo, and the feedback they got from the marketplace and the customers, I mean, we thought it was a great event. The customer feedback was awesome. I think they're 15 months into that retooling, as you mentioned, and we're pretty excited about what we're seeing so far, and I think the customers are reacting well to it.

Barry Cottle (President and CEO)

Yeah.

David Katz (Managing Director)

Thanks very much. Appreciate it.

Operator (participant)

The next question comes from Joseph Stauff of Susquehanna. Please go ahead.

Joseph Stauff (Senior Equity Research Analyst)

Thanks. Thank you very much. Good afternoon. I guess two questions. You know, look, I don't want to belabor the point because I know you're a little restricted in how you can answer it, but as we think about this strategic review process, right, the board was just reconstituted, as you referenced, just had the first board meeting. Is this something that is likely to take, say, six months, or, or could that be done sooner, relative to how you think about the portfolio and whatever strategic decisions would be made? Is there any kind of just baseline guidance or timing that you could give us from that front?

Michael Eklund (EVP and CFO)

We're not. We're trying not to put timelines around it right now. I mean, obviously, we're all coming together. We had a great first board meeting with all the new members last week. We're working through it thoughtfully at an appropriate pace, and when it's time to talk to the market about anything that might change, if something were to change, then we'll do that timely with all of you, of course.

Joseph Stauff (Senior Equity Research Analyst)

Okay. And then maybe something, hopefully, that's more explicit that you could answer is, you know, strategically, how do you think about the benefits of having both gaming and lottery under one roof? That is, do you think one or the other businesses that you derive significant synergies? Maybe there are some marginal synergies from having them together.

Barry Cottle (President and CEO)

Yeah, look, I mean, I guess how I would describe it is, you know, right now, you know, operationally, we're focused on being the global B2B provider of choice across, you know, the key forms of wagering. That's gaming, sports betting, and lottery, while supporting, obviously, our strategic stake at social. Strategically, that means providing best-in-class platforms and content. It means leading the digital transition and growth, and then leveraging the broadest portfolio and deep partnerships in order to create differentiation. So to that end, you know, the kind of key synergies that cut across our businesses today is we've got an amazing house of brands and franchises that we're able to leverage across all of our groups, right? So whether that's, you know, Willy Wonka, Monopoly, 88 Fortunes, all of our business units have access to that, which is nice.

The other is, you know, there are some shared customers across some of the business units as well. There's, as an example of Canadian lotteries, where we'll supply various forms of gaming, lottery, and digital as well. We're obviously in early stages of that, as we had mentioned before, but that, that's how you should think about our business. That's how we've been approaching it.

Joseph Stauff (Senior Equity Research Analyst)

Okay. Thanks very much.

Michael Eklund (EVP and CFO)

Thanks, Joe.

Operator (participant)

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

Barry Cottle (President and CEO)

Great. Thanks for joining us today, everyone. I know we've had a lot of new listeners on today's call, as well as our longtime supporters. We're truly excited about the talent and expertise we've added to our board, and the value-creating opportunities that lay ahead with such a strong team and portfolio of assets. I look forward to speaking to you next quarter and updating you on our progress to improve our balance sheet and deliver the best products to our partners in mobile and land-based gaming. Thank you all for your support.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.