As we pursue our growth strategies in all three vertical markets, we are not only considering potential acquisitions, but also forming strategic alliances with partners whose strengths complement ours. In May, we entered into one such strategic relationship with Harrah’s, the world’s premier provider of branded casino entertainment. The agreement calls for GTECH to supply Harrah's properties with gaming machines, and for our two companies to work together to develop new game content.
And just this week, we announced a joint venture with Veikkaus Oy, the operator of the Finnish national lottery, to develop and market innovative new games and solutions for the lottery and gaming industries. Primarily focused on developing government-sponsored games and solutions over expanding interactive channels including the internet, mobile phones, and interactive television, this partnership is another important way for us to enhance our solutions and game content portfolio, and deploy it over the widest array of distribution channels in the industry. Veikkaus, a leader in the area of new game development in the lottery industry, will be able to teach us a great deal about their approach to game development, the interactive channel experience and the European marketplace. The alliance also offers us a great way to pilot test new products.
Finally, an update on the situation in Brazil. Earlier this year, a judge overturned the 30-percent holdback of GTECH revenues that had been in effect in Brazil since last summer. Federal attorneys have had three opportunities to appeal that decision since it was made, and the filing deadlines for two of those appeals have since passed without action. This suggests to us that we are finally reaching the end of this difficult situation. We are also pleased that we have been able to sign a new contract with Caixa. While it is not a long-term contract, it may end up extending beyond next May.
I would also like to take this opportunity to highlight two recent appointments to our management team. The first is our new Senior Vice President and Chief Technology Officer, Doctor Joseph Nadan. Dr. Nadan has a great background in technology strategy, financial systems, and consumer electronics – all of which will be a tremendous asset to GTECH.
We also named Bruce Rowe to the position of Vice President of Business Strategy, Gaming Solutions, and General Manager of Nevada operations. Bruce comes to us from Harrah’s, bringing with him a deep understanding of the commercial gaming marketplace, as well as information technology. We’re delighted to have both of them on board.
And now, I would like to turn the call over to our CFO, Jaymin Patel.
Jaymin Patel: Thank you Bruce. Good morning, everyone.
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Slide #8
I would like to start by reviewing GTECH’s first-quarter performance.
To reiterate Bruce’s comments, the first quarter of this fiscal year was successful on all fronts...strategic ... operational ... and financial.
Service revenues in the first quarter increased approximately thirty-eight million dollars ($38M) or more than fifteen percent (15%), driven by a number of factors.
Starting with lottery service revenues, we once again enjoyed solid same store sales growth in the United States, with an increase of approximately six percent (6%). This increase in same store sales was driven by new games such as Pharaoh’s Gold and Dominoes in Minnesota, promotions such as the Jersey Cash 5 Raffle in New Jersey and Double Draw on Pick 3 in Illinois, the continued success of keno in Michigan and enhanced marketing efforts by our customers.
The strength in same store sales, combined with net contract wins, including the launch of the Florida contract, the continued ramp-up of Tennessee, the benefit of the new instant ticket vending machine (ITVM) contract in Illinois, and strong jackpot activity, drove GTECH’s domestic service revenues up fifteen million dollars ($15M) or approximately twelve percent (12%), to one hundred and forty-three million dollars ($143M).
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International same store lottery sales grew by approximately three percent (3%) on a constant currency basis. Whilst many jurisdictions enjoyed strong increases in same store sales, it was partially offset by some weakness in Taiwan and Poland. Factoring in the partial release of fiscal year 2005 Brazil revenues held in escrow, contractual rate changes, the favorable impact of foreign exchange rates, and the loss of the Puerto Rico contract, our international lottery service revenues increased by approximately ten percent (10%), to one hundred and eight million dollars ($108M).
Total service revenues included approximately eight million dollars ($8M) of service revenue from gaming solutions, up approximately two million dollars ($2M) over the same period last year. This was driven by the addition of new VLTs in Rhode Island and the acquisition of Spielo.
We also recorded approximately thirty-two million dollars ($32M) of service revenue from commercial transaction processing, up approximately eleven million dollars ($11M) over the same period last year. This was driven by an eight percent (8%) increase in same store sales coupled with the benefit of the release of Brazil revenues held in escrow, the acquisition of BillBird and favorable foreign exchange rates.
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Excluding the benefit of the release of a portion of the prior year’s Brazil revenues held in escrow, service revenues increased approximately twenty-seven million dollars ($27M) or eleven percent (11%) quarter over quarter. This level of performance would suggest that the service side of our business continues to be quite strong.
Product sales in the first quarter were thirty-five million dollars ($35M). This includes the sale of video lottery terminals to Atlantic Lottery Corporation in Canada, Sweden and West Virginia, handheld lottery terminals to ONCE in Spain and instant ticket vending machines for the Pennsylvania Lottery.
Slide #9
In the quarter, we recorded one hundred and forty-nine million dollars ($149M) in revenue from our US lottery group --- one hundred and twenty-eight million dollars ($128M) from the international lottery group --- seventeen million ($17M) from gaming solutions --- and thirty-two million dollars ($32M) from commercial services.
Slide #10
Gross profit increased approximately nineteen million dollars ($19M) or sixteen percent (16%) quarter-over-quarter.
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Service gross profit increased approximately sixteen million dollars ($16M) or fifteen percent (15%). This was primarily the result of the release of Brazil revenues held in escrow, combined with the increase in same store sales. This was partially offset by the impact of higher depreciation and amortization.
Product sale margins were in-line with guidance at thirty eight percent (38%).
Operating expenses for the quarter were forty-five million dollars ($45M), or thirteen point eight percent (13.8%) of total revenue.
The four point four million dollar ($4.4M) increase in SG&A was driven primarily by the increased activities in new business development.
The strength in revenues drove operating income growth of approximately fifteen million dollars ($15M) or nineteen percent (19%).
Below operating income, other income and expense declined approximately fourteen million dollars ($14M), reflecting the one-time gain associated with the sale of our interest in Harrington Raceway in Delaware in the first quarter of last year and higher interest expense driven by higher average debt balances quarter-over-quarter.
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Diluted earnings per share increased three cents ($0.03) or approximately seven percent (7%), to forty-three cents ($0.43) per share compared to the forty cents ($0.40) we reported in the first quarter of last year.
Excluding the impact of the one-time gain recorded in the first quarter of last year, earnings per share increased eight cents ($0.08) or twenty-three percent (23%) quarter over quarter.
Slide #11
During the quarter, we generated approximately one hundred and twenty-two million dollars ($122M) in cash from operations. This financed forty-three million dollars ($43M) of capital expenditures and generated seventy nine million dollars of free cash flow ($79M).
We also repurchased more than one point three million shares (1.3M) of our stock at a cost of approximately thirty-two million dollars ($32M) and paid dividends of approximately ten million dollars ($10M).
At the end of the quarter, we had cash and short term investment balances of approximately three hundred and thirty-five million dollars ($335M) and we had approximately forty-seven million dollars ($47M) remaining under our current share repurchase authorization.
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Slide #12
Average capital employed grew by approximately two hundred and seventy-eight million dollars ($278M), or twenty-four percent (24%), year-over-year and we generated returns on capital employed of approximately sixteen point five percent (16.5%).
In view of the pace of capital investment, we are pleased to maintain returns on the overall portfolio that are significantly higher than our weighted average cost of capital.
It is important to note that in the period ending May 2005, we had cash balances resulting from debt offerings. If we were to exclude this cash from the calculation, our return on capital employed would have been approximately four hundred basis points (400 bps) higher.
Again, our calculation of Return on Capital Employed is provided in the Investors section of our website.
Those are the key financial highlights of our first quarter. Now I would like to turn our attention to the outlook for fiscal year 2006.
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Slide #13
Based upon our current outlook, we expect service revenue growth in the range of eleven to thirteen percent (11% - 13%), based on the following assumptions and factors:
1) | Same store sales growth of five to six percent (5% - 6%), |
2) | The net effect of contract wins and contractual rate changes, |
3) | Fluctuations of foreign currencies against the US Dollar, |
4) | The full year impact of the acquisitions completed in fiscal year 2005, and |
5) | The net effect of receiving one hundred percent of our Brazilian revenues under the new contract terms and conditions; |
Based on the revised outlook for Brazil, we now expect US Dollar revenues from Brazil to be approximately one hundred and ten million to one hundred and twenty million dollars ($110M - $120M) this fiscal year, including the return of a portion of last year’s revenues previously held in escrow.
We continue to expect product sales in the range of one hundred and eighty to two hundred and ten million dollars ($180M - $210M).
We expect service margins in the range of forty to forty-two percent (40% - 42%) and product margins in the range of thirty-eight to forty percent (38% to 40%).
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We continue to believe that the effective tax rate for this fiscal year will be thirty five percent (35%), although we expect tax rates to fluctuate quarterly. For planning purposes, I would suggest you use the same quarterly patterns as those reported in fiscal 2005.
Based upon this outlook, we now believe that diluted earnings per share will be in the range of one dollar and sixty-four cents to one dollar and seventy cents ($1.64 to $1.70) for fiscal year 2006. This excludes the impact of the adoption of SFAS 123R, share-based payments, as we do not expect to adopt this mandate until fiscal year 2007.
Slide #14
In fiscal year 2006, we plan to invest between two hundred and thirty and two hundred and forty million dollars ($230M - $240M). Approximately fifty percent (50%) will be for maintenance capital requirements within the core business and the balance will be invested in growth opportunities.
Given this investment outlook, combined with our current operating forecast, we now expect to generate free cash flows in the range of one hundred and eighty to two hundred million dollars ($180M to $200M), prior to financing any dividends, stock repurchases or acquisitions. This is more than ten percent higher than our previous free cash flow guidance.
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Slide #15
Now let’s look at the outlook for our second quarter, which ends August 27th.
This is a quarter of difficult comparisons for us, given the significant level of jackpot activity in the second quarter of last year and the resulting benefit to service margins, as well as the timing of product sale revenue recognition, which as you know, can be lumpy.
Today, we expect service revenues to increase ten to twelve percent (10% - 12%) quarter over quarter and we expect product sales in the range of thirty to thirty-five million dollars ($30M - $35M). This compares to product sales of seventy-five million dollars ($75M) in the second quarter of last fiscal year.
We expect service margins to be in the range of thirty-eight to forty percent (38% to 40%), reflecting lower jackpot activity and higher depreciation year over year.
We also expect product sale margins in the range of thirty-eight to forty percent (38% to 40%).
Finally, we expect earnings per share to be in the range of thirty-seven to forty cents ($0.37 to $0.40) per share, assuming a fully diluted share count of one hundred thirty million shares (130.0M). This compares to the forty cents ($0.40) per share we reported in the second quarter of fiscal year 2005.
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To summarize, we are pleased with the underlying strength of the business. Our continued financial, operational and strategic successes provide further confidence in our ability to drive profitable growth for our shareholders in both the near term and over the next several years.
Thank you for your attention. Now Bruce and I would be happy to answer any questions that you may have.
Slide #16
[Q&A]
Slide #17
Bruce Turner: If there are no further questions, please allow me to sum up. GTECH’s first-quarter results show that we continue to enjoy solid business growth while also making excellent strategic progress.
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Our long-term strategy remains the same. We will work to drive new growth through acquisition and partnerships ... and we will continue to focus on M&A transactions that enhance our offerings in the online and instant channels, monitor games, gaming machines, and the full range of interactive channels. All of these activities will bring us closer to achieving our ultimate goal: to become a fully-diversified, world-class gaming company. This will ensure that we have a wealth of opportunities to fuel our continued growth.
We’ll be back for our regular quarterly call in September. In the meantime, thanks again for joining us, and have a great summer.
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