IGT: FQ3 FINE BUT NEW ISSUES EMERGING

Several issues have us concerned despite our expectation for a decent quarter and guidance.

We expect IGT to report an in-line to slightly better quarter than the consensus of 29 cents.  In a sea of misses, a meet is not such a bad thing.  Guidance shouldn’t change much, also probably a positive on the margin.  We appreciate IGT’s cash flow generation and willingness to return cash to shareholders and the favorable long-term fundamental backdrop for the slot industry makes for a favorable long-term story – on the surface. 

On the other hand, IGT has also held in better than most of our names through the turbulence of the past 3 months.  Moreover, there are a few issues that concern us that could weigh on the stock.  Given the following issues – which probably haven’t been appropriately vetted by investors and analysts – we prefer to be on the sideline for now.

• Industry replacements will likely fall in CYQ2 versus last year.  During the next two years new and expansions units (including Canada) should grow at a healthy clip and drive large YoY increases in total shipments.  However, replacements still make up the lion’s share of total NA shipments and it is disconcerting that after several years of growth, they appear to be stalling out at about 55,000 units/year.
• We’re once again hearing that there is an ongoing brain drain at IGT.  When CEO Patti Hart joined the company in 2009, there was the expected changing of the guard.  We are now hearing – 3 years later - that there is more discontent and departures among key box and content developers.  The brain drain may have an impact on the next wave of developments down the road.  The wave of new openings and IGT’s share procurement in Canada may hide the impact for a while, but it raises an important red flag for long-term investors.
• According to AppData, Double Down’s MAU looks like they’ve taken a breather since April and DAU’s also look flat QoQ at 1.4MM.  While DoubleDown is not going to make or break the quarter, it is a sore topic for many investors.  Therefore, disappointment in interactive may elicit an exaggerated response from the investor community, especially given that Patty has marketed this segment as a large source of growth for IGT.

 

F3Q Detail

We estimate that IGT will report $576MM of total revenue (2% ahead of consensus) and in-line adjusted EPS of $0.29.

Product sales of $264MM at a 53.7% gross margin

• NA sales of $167MM and gross margin of $94MM
  • $105MM of NA box sales: 7,150 gaming machines at an ASP of $14.7k
    • 4,250 replacements and 2,900 new units, including shipments to:
      • 684 units to Scotia Down
      • 1,425 units to Cleveland and Toledo
      • Over 400 units to PNK’s Baton Rouge
  • ASP’s should be down sequentially due to mix and volume discounts on large orders which shipped this quarter
  • We expect margins to be down slightly on a QoQ basis to 56.4% from 57.1% in the March Q
• Non box sales of $62MM
• We expect a sequential uptick due to the Revel opening, for which IGT provided the system.
• International sales of $97MM and gross margin of $48MM
• $77MM of box sales: 4,500 units at an ASP of $17.1k
• Non box sales of $20MM
• 49% gross margins down from 50% in the March Q
• Gaming operations revenue and gross margin of $312MM and $187MM, respectively
• End of Period install base of 56,750
• Core gaming operations revenue of $272MM, implying an average win per day of $53/day
• Maryland Live Games came online but only for 23 days of the quarter
• $40MM of interactive revenue
• $29.6MM of DoubleDown revenue
• $10.5MM of other interactive revenue
• Other stuff:
  • SG&A: $101MM
  • R&D: $55MM
  • D&A: $19MM
  • Net interest expense: $20MM
  • 37% tax rate
  • Weighted average shares outstanding: 294MM