Solid quarter but “disappointing” guidance.
“Management is sandbagging”. “Guidance is conservative”. We’ve all heard it many times from the sell side – always when a buy rated stock provides disappointing guidance. We, however, really mean it! Look, we don’t have an axe to grind either way with IGT. We’re not trying to justify a Buy rating. Our call the last few months has been on BYI, not IGT. However, we’ll call a spade a spade and say that IGT is sandbagging. Guidance should’ve been 10 cents higher in our opinion. We lay it out below.
The quarter can be summed up as having very strong top line results for both product sales and gaming operations (solidly ahead of consensus) somewhat offset by disappointing gaming operations margins and higher operating expenses. We think management may be managing earnings a bit here. We’ve seen it from them before. With that level of revenues, EPS should’ve been a lot better.
Product revenues came in 19% ahead of our estimate due to better unit sales while gross margins were in-line with our estimate.
- We estimate that IGT’s share rose to 40% in September – their best market share quarter since June 2008 (IGT would like to send out a special thanks to WMS)
- Domestic units shipped exceeded our estimate by almost 3,000 units
- Replacements were 1,200 units better than we estimated due to higher share (we estimate 39% share vs. high 20's share average over the last 6 quarters)
- New units were 1,750 better than we estimated due primarily to the earlier than expected recognition of shipments to the 2 Kansas casinos opening in 1Q12 which we estimated accounted for 1,500 shipments
- Replacement units for the quarter look like they were in-line with our original estimate of 13k for the entire market – marking an 11% YoY improvement. We estimate that the YTD improvement in replacements is 13% with replacements tracking at 41.6k through September 30th vs. 37.7k shipped in the first 9 months of 2010.
- International product revenues were $8MM above our estimate but gross profit was $1MM below our estimate. We suspect that this is due to the lower margins from the Entraction acquisition – which contributed to revenue but delivered no profits in the quarter.
Gaming operations revenue was $8MM above our estimate while gross profit was $6MM below our estimate, after adjusting for the $4.8MM IP settlement charge.
- Better revenues were driven by improvements in WAP yields per day due to better game performance on fresh product. However, WAPs do have lower margins since the games are largely licensed titles with royalty payments and jackpot funding expenses.
- The quarter also got a boost from better than expected shipments to international markets –including shipments to CAGE
- Adjusted for the negative impact from rates and the IP charge, ‘normalized gross profit’ margin would have been 59% - below the 62% rate where IGT had been tracking for the first 9 months of the year. We suspect that next year’s guidance has a similarly conservative margin.
- SG&A was $13MM above our estimate – largely due to higher commissions from better product sales
ADDRESSING IGT GUIDANCE
IGT’s guidance for 2012 is pretty conservative in our opinion:
- Excludes their signed contract to ship 7,200 units into Canada. If half those units ship in F2012 than that will add 5 cents to IGT's results
- Flattish to slight uptick in the replacement environment. Unless current trends massively reverse, this is unlikely. For the TTM ended 9/30/2011 we estimate that 54k replacement units shipped in NA, a 12% YoY increase. Assuming just a 10% increase would add over 5,000 units to the market in IGT's fiscal 2012 and assuming that IGT can garner a 35% share that's another 2 cents a share.
- Flatish new and expansion opportunities in IGT's fiscal 2012 vs. 2011. We're not sure how that's possible, there were less then 12k new and expansion units shipped into NA for the TTM ended 9/30/11 and we estimate over 18k excluding any new units to Canada, Ohio VLTs, IL and counting 2 of 4 Ohio casino shipments. Assuming IGT get's 35-40% share of these openings we get another 3 cents
- These 3 items account for roughly 10 cents of EPS.
IGT’s install base and yields should show improvement YoY, however, we did take down our gross margins to 59%. We also assumed a 30% variable component to SG&A. All in, we get to $1.10/share for 2012.