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Replacement demand is what it is but WMS margins and gaming ops revenue were both lower than expected.

WMS has probably “over-earned” on market share the last two quarters and replacement demand has been sluggish.  Outside of replacement demand accelerating, we’re not exactly sure what the next positive catalyst will be, but we would like to address a couple of concerns that emerged from the FQ1:  Gaming Ops revenues and Gaming Equipment margins.

Gaming operations were clearly a little disappointing in the quarter and the change in the presentation makes things even more confusing to draw insight

  • They missed our revenue number here by $3MM and gross margin by $2MM
  • The difference vs our number was driven by both a lower install base and average win per day
  • There were no new WAP games launched in the Q and Lord of the Rings generates a fee close to the participation average so that explains the slightly lower yields
  • Gaming Ops margins were good and should continue to benefit from Lord of the Rings, paying like a WAP game without the associated jackpot expense – assuming base grows
  • Under the old method, sequentially, we think that standalone units would have increased by ~100 units, LAPs would have been flat, and WAPs would have decreased by 175 units
  • In the next few quarters, they have several WAP games coming,  a new LAP (Godfather), and several standalones.  The December and March quarters will be very active from a release standpoint and should generate increases across the board in the install base

The margin issue… disappointing but we believe it is temporary

  • Lower xD margins and a higher mix of used/parts revenues meant margins were 3.6% lower than we estimated so gross margin was only $1.2MM better than our number
  • We shouldn’t really ding them for lower xD margins because that’s a temporary issue that will resolve itself by the YE
  •  xD was a much higher % of the mix than they estimated - this was partly magnified by the fact that there were many units shipped in the quarter and that xD just launched.  For the rest of the year, the mix will be less than 35%, aside from perhaps the very end of the year.  
  • While Bluebird (BB) margins were the same, there were less total units, so fixed costs were spread over a smaller base, further impacting margins
  • Used games and parts have much lower margins than conversion kits (which are around 90+%) so the mix of non-gaming dampened margins.  It seems like used games and parts should continue to be strong this year as they are getting lots of trade-ins of BB1’s for BB2’s – which isn’t a bad thing – but this is a lower margin income stream and it almost doubled YoY.