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Scientific Games Corp. (SGMS) posted a loss of 14 cents per share in contrast to the Zacks Consensus Estimate of a profit of 2 cents in second quarter of 2013. The company had reported a loss of 12 cents in the year-ago quarter.

Revenues

Revenues increased 4.0% year over year and 7.0% sequentially to $235.0 million, which beat the Zacks Consensus Estimate of $231.0 million. The increase in revenues can be attributed to improvement in the core lottery business, which posted decent revenue growth based on accelerating instant ticket and lottery system retail sales.

Instant ticket revenues increased 5.8% year over year and 3.0% sequentially to $126.5 million. The instant ticket and draw game retail sales of the company's U.S. customers increased 4.9% and 10.8%, respectively, during the quarter. Instant ticket sales continued to be propelled by strong performance in larger states, while draw sales benefited from a record Powerball jackpot of $591 million in the quarter.

During the quarter, Scientific Games also secured a number of contracts from the likes of New Jersey Lottery, Hellenic Republic Asset Development Fund, Hungarian State Lottery, and largest electronic lottery provider in the Dominican Republic.

Lottery authorities of the state of Ohio, Oregon and West Virgina extended their contracts during the quarter. Moreover, Scientific Games won contracts in Israel, Australia, Switzerland and Norway.

Instant ticket retail sales in Italy (in terms of €) decreased 2.4% from the year-ago quarter, while instant ticket retail sales in China (in terms of RMB) declined 7.6% during the same period.

Segment-wise, Printed Products Group revenues increased 6.0% year over year and 3.0% from the previous quarter to $353.3 million. The results were primarily driven by higher ticket sales and incremental revenues from Provoloto acquisition.

Lottery Systems Group revenues increased 6.6% year over year and 18.4% quarter over quarter to $68.9 million, reflecting higher sales to international customers. Service revenues increased $1.1 million year over year as a result of higher U.S. retail sales from Powerball jackpot.

Gaming revenues declined 6.8% year over year but increased 2.7% from the previous quarter to $36.1 million. The year-over-year decline was primarily due to lower revenues from customers outside the U.K. coupled with negative impact of foreign exchange and a loss from the William Hill contract in 2012.

Margins

Attributable earnings before interest, taxes, depreciation and amortization (:EBITDA) margin declined 47 basis points (bps) from the year-ago quarter to 36.5%. Sequentially, EBITDA margin increased 68 bps compared to the previous quarter.

Depreciation & amortization (D&A) expense increased 17.0% year over year and 31.4% sequentially to $43.1 million in the quarter. Selling, general & administrative expense (SG&A) decreased 0.7% year over year and 8.9% sequentially to $46.2 million.

Operating margin was 5.3% compared with 5.0% in the year-ago quarter and 5.1% in the previous quarter, due to lower SG&A expense.

Scientific Games reported loss of $12.4 million or 14 cents per share, compared with net loss of $10.9 million or 12 cents per share in the year-ago quarter and net loss of $12.3 million or 15 cents per share in the previous quarter.

Balance Sheet & Cash Flow

Scientific Games exited the quarter with $78.1 million in cash and cash equivalents compared with $90.0 million in the prior quarter. Total debt declined to $1.46 billion from $1.47 billion at the end of the second quarter.

Recommendation

We believe that the company’s diversified product offerings, international development activities, recurring revenue business model, strong growth of the Internet-based business and the pending WMS Industries (WMS) acquisition will drive the stock over the long term.

Further, the domestic lottery industry is undergoing a transition, which involves increasing involvement of private vendors in state lottery management, higher prize payouts and introduction of tiered pricing for national jackpot games to add impetus to the sagging U.S. lottery industry. We believe that Scientific Games is well positioned to benefit from these transitions, going forward.

However, we believe that these measures will take some time before they start contributing to the overall results. Further, stiff competition from the likes of International Game Technology (IGT) and Bally Technologies Inc. (BYI) is expected to hurt profitability, going forward.

Moreover, increasing investments for product development is expected to hurt profitability in the near term. Additionally, a significant increase in regulatory, professional fees and other expenses related to the WMS Industries (WMS) acquisition may take a toll on the company’s margins in the near term.

Currently, Scientific Games has a Zacks Rank #3 (Hold).