WMS: GAMACHE SELLING JUNK IN A BOX?

It’s hard to even get excited about the long term with this kind of uncertainty.

WMS’s F4Q left little reason for investors to stay optimistic.  Considering the company’s track record, investors could have looked past one quarter of poor performance and given management the benefit of the doubt.  However, two quarters in a row of pitiful results and lots of excuses extinguish confidence in even the most bullish of analysts.  As we sat and listened to the call last night, we couldn’t help but shake our heads and ask - why is Gamache trying to sell us junk in a box?

There were so many things wrong with the quarter, that we don’t know quite where to begin.  One thing that became clear though is that WMS is now a ‘turnaround’ company and will remain in the penalty box for many a quarter to come.  While the March quarter was filled with operational issues, management’s forward outlook took a major step down.  Management claims that more uncertainty in the economy vs 3 months ago is driving the outlook and we at Hedgeye do not disagree with their macro assessment.  However, WMS probably had a “come to Jesus” moment that they have little to no visibility in their business – due to the economy, heightened competition and worse ship share - but also maybe to a disconnect to what their customers wanted.  Was WMS was pushing junk in the box to their customers as well?  

We’re going to be revising our estimates for the FY12, but below are some thoughts following a conversation with management.

• Color on the write downs and impairments in the Q and to come:
  • Product sales:
    • Orion was the unit that produced the Helios platform – which wasn’t selling. Customers prefer the higher priced xD machines than the cheaper Helios platform.
    • The original plan was to wind-down the BB1 cabinet over a few years but now they have decided to accelerate that wind-down
    • Impairments represent the layoff in work force of these two product lines and remaining inventory
• R&D:
  • Postponed many projects which led to a write down
• Gaming operations:
  • The write down was on licenses which largely had to do with postponed R&D and delays in release.
• Lease business:
• Units are basically being leased based on the present value of selling price plus some nice financing rate.
• They will look to do more of these deals if they can expand floor share vs. doing a straight sale and if the ‘economics’ make sense… yes, they are essentially just doing more financing for customers and deferring revenues.
• Italy:
  • Italy has been a big disappointment.  Novamatica is the competitor that they referred to as ‘mucking’ things up for everyone else.  Regulators aren’t happy with the integrity of the games and therefore, they are continuously tied up in the retesting phases which is holding up the approval of their games and likely those of BYI’s games.
• Used game sales and lower margins?
  • All of the used games are basically received as trade-ins which count as a reduction towards new purchases for customers.  A year ago, they were making 20-25% margins; now only 10-15% on trade-in re-sales.
  • WMS claims that they aren’t giving more discounts to their customers but rather that the resale value for used machines has declined since the market is ‘flooded’ with them.  Regardless of the excuse, WMS is eating the lower margin – so this is just another form of discounting… hence, their ability to keep high ASPs.
• They will likely sell less international units next year. 
• Their view of the NA market is clearly more bearish than ours.  We feel that some of that may be conservatism, but a lot of it is share losses and more deals that will come in the form of leases rather than sales
• Other game operations should be flat sequentially and then begin to grow. The growth will come from :
  • Annual royalty payments that just come in at year end
  • Online Casino
  • Network gaming – portal applications
  • Operating leases – Seminole was place at the end of the quarter but was a very small contributor given the timing of installation
• Reasons for delays in the gaming operations titles:
  • They put too much network functionality into too much of their product line and as a result, have had too many reworks and approval delays.  Expect 2 more quarters of declines in their install base.
• We estimate that flooding caused almost a $1/day decline in average daily yields this quarter