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WMS F2Q 2011 CONF CALL NOTES

WMS seems to be a victim of their own aggressive guidance this quarter with both results and guidance plagued by delays of product and jurisdiction launches.

  

  

WMS seems to be a victim of their own aggressive guidance this quarter, with both results and guidance plagued with delays of product and jurisdiction launches.  While we like the long term story here, we’ve felt that lately the company has become aggressive in what it promises the Street and this game usually doesn’t end well.  Gaming is a highly regulated business and delays are to be expected – this quarter demonstrated that. Coupled with the earlier known delays in IL, we also found out that WMS’s launch in Italy was delayed as was the timing of the commercialization of their portal application, coupled with slight delays in launching gaming ops titles.

 

Regarding the quarter, the real miss in our mind was on the game operation side.  Based on the Godfather launch and the launch of Great and Powerful Oz, New Monopoly refresh we thought that units would be moderately up. While they also missed our product sale revenues, this the miss was small and entirely due to the higher mix of used game sales at lower prices (~$5.3k vs. $8.5k last quarter). 

 

 

HIGHLIGHTS FROM THE RELEASE

  • "Reiterated its fiscal 2011 annual revenue guidance of $830-to-$850 million and revised its annual operating margin guidance to 20.5%-to-21.0% to reflect first-half fiscal 2011 results, lower contribution from gaming operations and the continuing impact from higher-than-anticipated, low-margin used gaming machine sales."
  • "Fiscal 2011 third quarter revenue guidance of $209-to-$215 million... with an expected operating margin of 20.5%-to-21.0%."
  • "Global new unit shipments of 6,310 units, an 8% increase in the average selling price to $16,620"
    • "New unit shipments in the U.S. and Canada...totaled 3,921 units"
    • "Replacement market shipments were essentially flat at 3,200 gaming machines" 
    • "International product shipments of 2,389 units represented 38% of total global shipments ...Growth in Mexico and Australia, coupled with modest growth in Asia and Latin America, more than offset lower shipments to Europe, which remains impacted by the challenging economic environment."
    • "Primarily reflecting a product sales mix that benefited from 23% of shipments being premium-featured, higher-priced Bluebird xD units. Bluebird2 and Bluebird xD units represented 96% of total global new unit sales"
    • "Mechanical reel products were 25% of global new unit shipments"
  • "Approximately 3,100 used gaming machines were sold in the December 2010 quarter at lower prices, reflecting both a greater year-over-year impact from trade-ins of lower-value competitor units and an increase in used Bluebird gaming machine sales"
  • "Sales of approximately 2,000 hardware and game conversion kits"

CONF CALL

  •  xD will reach parity margins with BB2 by June 2011.
  • Expect growth in the install base in 2H011 given the launch of numerous participation titles, believe that the average install base will be a few hundred above 2010 but slightly below their guidance range
  • Continue to believe that customer budgets will be similar to slightly better than 2010
  • They are experiencing some delays with Italy and IL getting pushed to FY2012 which impacted their guidance
  • Expect to be a couple hundred dollars above their original guidance for ASP and in-line with their guidance on global unit shipments
  • Demand for xD has exceeded their expectations
  • Over 50% of their used gaming machines were WMS machines
  • Most of the decline in their install base is due to old machines rolling off ahead of the launch of their new game titles in the back half of the year
  • Expect to achieve higher average revenue per day on their install base and achieve their original guidance parameters
  • Lower overall margins reflects the higher mix of product sales as a % of total sales and the higher % mix of used games
  • They also had slightly higher licensing expenses and higher WAP jackpot expenses in the quarter
  • Expect to see further increases in the D&A expense in the back half of the year
  • Expect to realize quarterly margin improvements in the March and June quarters
  • Reinstatement of the R&D tax credit resulted in a 2 cent EPS benefit. The 100% bonus depreciation benefit reduces their deferred tax liability adding $10MM of FCF. In the March and June quarter the tax rate should be in the 35-36% given the increase in the IL state income tax rate.
  • TTM return on invested capital was 14%
  • Growth in receivables is due to Mexico -where contracts have longer payment terms
  • Write-offs have historically been 0.5%
  • 2H growth drivers:
    • ASP growth
    • Install base growth
    • Growth in new markets like Mexico and New South Wales
    • Launch of new businesses like portal applications and i-gaming portal
  • ICE trade show feedback has been very favorable on their portfolio. Expect to realize greater penetration internationally with their BB cabinet.  Feel like the environment in Europe is stabilizing and should improve in the latter half of their fiscal year.
  • Concession with Cogetech - will place units in early September
  • Expect to hear who was awarded the systems contract in IL shortly
  • Great and Powerful Oz is exhibiting strong performance (was launched late in the quarter)
  • Recently started to ramp their marketing efforts in UK for their online casino site
  • Players Life - unique logins stand at 250,000. Have an additional 44 games in the pipeline with Players Life capabilities -2 of which launched this quarter
  • Portal applications being tested in 8 casinos - (Jackpot explosion) average coin-in increase has been about 35%. Regulatory approval has taken longer than expected - to late March- and expect to double their beta sites. Will launch a beta site in Vegas. Revenues will be minor in 2011 but should build in F2012.

 

Q&A

  • Believe that their ship share is in the 30% range globally
  • 27.5% of their product came from xD in the F1H2011
  • Average revenue per participation unit decreased YoY, why?
    • Difficult Wizard of Oz
    • Economy
    • Delayed launches of new games into the back half of 2011
  • Average order size was 26 this quarter, ticked up a little bit
  • Wagenet pricing: will be a combination of fixed fee and recurring fee and will depend on the size of the installation
  • NA shipments:
    • Portion of the Perryville units; small # of Cosmo units; Gun Lake



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THE CONSUMER’S MIXED SIGNALS

According to ICSC, chain store sales continued their weak start to 2011. In the latest week, sales fell 1.2% although year-over-year growth improved to 2.8%.  This was the third straight decline and the second largest one and since wintry weather has hit us (again), the inclement conditions were to blame for the weakness.  While growth of 2.8% was the second weakest in seven weeks, it was well above the prior week's 1.4%.

 

As a result of the weakness, the ICSC lowered its forecast for growth in January to about 2%. It was previously forecasting growth of about 2.5%, below December's 3.1% and the slowest growth since October.  Consistent with our view of consumer spending in 1H11, comparisons remain difficult.  While the Social Security tax cut provides upside risk to this outlook, the timing depends on how quickly the changes can be implemented.

 

On the positive side consumer confidence rose in January to the highest level in eight months! The Conference Board’s index of sentiment increased to 60.6 from a revised 53.3.  While this is a net positive today, a continued improvement in optimism and an improving labor market are needed to keep the momentum going. 

 

Is it sustainable?

 

Working against the potential for continuous improvement in confidence and consumer spending are declining home prices.  As our Financials analyst, Josh Steiner, noted in a note this morning, home prices are falling and he expects this to persist at an accelerating year-over-year rate through July 2011, and will continue to fall in absolute terms thereafter.

 

While the sales numbers may have been slowed by snowy weather in large parts of the country, overall sales trends remained constrained by weak-but-improving consumer fundamentals.  Specifically, the moderation in private sector job growth in the last two months highlighted that the labor market remains a drag on spending despite the drop in unemployment in December.

 

Meanwhile, wage income is generally improving, but only gradually and from a low base and most consumers are, voluntarily or involuntarily, not accessing credit to finance consumption.  As a result, expedited improvement in the labor market is needed to generate the necessary wage income to support spending.

 

Inflation is also a risk.  Gasoline prices continue to rise and are a drag on spending.  The average price gasoline has risen for eight straight weeks and was $3.16 per gallon last week.  Higher energy prices particularly hurt lower-income households who spend more disposable income on energy needs.

 

One of the key tenets of our Consumer Cannonball theme was the phasing out of government supported income payment.  While the government contribution to income growth dropped to essentially zero at the end of 2010, this has changed in early 2011 when Social Security withholding declined as a result of the tax bill. 

 

It is now consensus that sales growth in 2011 will accelerate thanks to the renewed government support.  Despite the uptick in confidence, weak fundamentals will remain a constraint and the government support will have a fading impact as we go through 2011, keeping consumers cautious and putting a governor on growth.  Furthermore, the decline in home prices is likely to dampen sentiment, particularly in the event that rates increase.

 

Despite today’s uptick in confidence, consumers will not lead the recovery in the near or intermediate term.

 

THE CONSUMER’S MIXED SIGNALS - housing vs consumer

 

Howard Penney

Managing Director


THE CONSUMER’S MIXED SIGNALS

According to ICSC, chain store sales continued their weak start to 2011. In the latest week, sales fell 1.2% although year-over-year growth improved to 2.8%.  This was the third straight decline and the second largest one and since wintry weather has hit us (again), the inclement conditions were to blame for the weakness.  While growth of 2.8% was the second weakest in seven weeks, it was well above the prior week's 1.4%.

 

As a result of the weakness, the ICSC lowered its forecast for growth in January to about 2%. It was previously forecasting growth of about 2.5%, below December's 3.1% and the slowest growth since October.  Consistent with our view of consumer spending in 1H11, comparisons remain difficult.  While the Social Security tax cut provides upside risk to this outlook, the timing depends on how quickly the changes can be implemented.

 

On the positive side consumer confidence rose in January to the highest level in eight months! The Conference Board’s index of sentiment increased to 60.6 from a revised 53.3.  While this is a net positive today, a continued improvement in optimism and an improving labor market are needed to keep the momentum going. 

 

Is it sustainable?

 

Working against the potential for continuous improvement in confidence and consumer spending are declining home prices.  As our Financials analyst, Josh Steiner, noted in a note this morning, home prices are falling and he expects this to persist at an accelerating year-over-year rate through July 2011, and will continue to fall in absolute terms thereafter.

 

While the sales numbers may have been slowed by snowy weather in large parts of the country, overall sales trends remained constrained by weak-but-improving consumer fundamentals.  Specifically, the moderation in private sector job growth in the last two months highlighted that the labor market remains a drag on spending despite the drop in unemployment in December.

 

Meanwhile, wage income is generally improving, but only gradually and from a low base and most consumers are, voluntarily or involuntarily, not accessing credit to finance consumption.  As a result, expedited improvement in the labor market is needed to generate the necessary wage income to support spending.

 

Inflation is also a risk.  Gasoline prices continue to rise and are a drag on spending.  The average price gasoline has risen for eight straight weeks and was $3.16 per gallon last week.  Higher energy prices particularly hurt lower-income households who spend more disposable income on energy needs.

 

One of the key tenets of our Consumer Cannonball theme was the phasing out of government supported income payment.  While the government contribution to income growth dropped to essentially zero at the end of 2010, this has changed in early 2011 when Social Security withholding declined as a result of the tax bill. 

 

It is now consensus that sales growth in 2011 will accelerate thanks to the renewed government support.  Despite the uptick in confidence, weak fundamentals will remain a constraint and the government support will have a fading impact as we go through 2011, keeping consumers cautious and putting a governor on growth.  Furthermore, the decline in home prices is likely to dampen sentiment, particularly in the event that rates increase.

 

Despite today’s uptick in confidence, consumers will not lead the recovery in the near or intermediate term.

 

Howard Penney

Managing Director

 

THE CONSUMER’S MIXED SIGNALS - housing vs consumer


EAT: STRONG QUARTER WITH MORE TO COME

Brinker put up a strong number that didn’t blow the doors out from a comp perspective but certainly impressed on the margin line.

 

Brinker’s 2QFY11 results were strong, as I wrote this morning, and the earnings conference call suggested that the upside I am forecasting in comps is within reach.  Some interesting takeaways from the conference call:

  • Chili's guest feedback scores continue to improve with attentive service being a key component of the increase.  Management’s internal metrics are validated by what we see in external research when we compare ourselves to the competition.
  • The strong comp performance was largely due to the year-over-year compare not having very much 3 for $20 during the month.  Management stated that this was a sort of a preview of the effect they anticipate from the lapping of 3 for $20 after 10 week during this current quarter.
  • The kitchen retrofits have been yielding positive results and management stressed that the kitchen process has been simplified. Furthermore, the restaurant level margin improvement seen in 2QFY11 does not include the food prep benefit to labor costs because the changes were not fully rolled out until this month. 
  • Another labor initiative, team service, is working well for Chili’s.  Margins have been enhanced by this initiative and it has coincided with higher earnings for staff along with higher guest satisfaction stores. 
  • The outlook for continued comp acceleration is strong; the new lunch menu has tested strongly in three test markets with no advertising aside from some use of the company’s database.  While it is tricky to extrapolate the results of test markets to the broader system, I am confident that a broader rollout, complemented by a more robust advertising allocation, will perform strongly and bolster a traditionally-soft day part for Chili’s.
  • During a period of slowing top line trends for the casual dining category, EAT saw sequential improvement.  The Gap-to-Knapp, adjusting for the 53rd week, improved by 120 basis points from 1QFY11 through 2QFY11.

 

My conviction in this stock remains high and I believe further sequential improvement is to come on the top line as well as further margin enhancement.  Below is a chart showing Chili’s comparable restaurant sales and projections for the next two quarters.

 

EAT: STRONG QUARTER WITH MORE TO COME - eat sss

 

Howard Penney

Managing Director


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