WMS TOP TEN

There was enough in FQ4 and guidance to round out a complete Top Ten. Unfortunately, most of them were negative.

We’re not exactly going against consensus (there were at least 3 downgrades to underperform today) by pointing out the negatives in this release/conference call but we do think we have some original thoughts.  So here we go:

1. Guidance was terrible…and perplexing
• The guidance for a YoY revenue decline in 1Q13 implies a $45MM sequential revenue decline.  They must have pulled forward a lot of demand into the 4Q.
• The decline in guidance comes despite:
• A supposed sequential increase in install base 
• Projected increase of new openings and expansion to the tune of 75% in September 2012 vs 2011
• WMS should be shipping replacing units to Alberta in September
• Our projections for new openings and expansions during for the period of July 1, 2012-June 30, 2013 are about flat with WMS’s fiscal 2012 period but we have replacement units increasing, largely due to Canada
• Management response:
• They believe that new openings and expansions will be down YoY, primarily because they are not including shipments to Penn’s Hollywood Columbus which should open with about 3,000 slot machines on October 8^th. 
• We think it’s a safe assumption that units will ship in the September opening
• WMS already shipped units to Cape Girardeau in the June Q
• WMS’s 500 Alberta units will be spread over the September and December quarters
• Given the timing of G2E, they expect that operators will want to kick the tires before placing orders.  Therefore, they expect a big drop off in replacement units.  Last year's G2E was during the same time period and the market for replacements in September was about flat with June.  WMS did see their shipments plummet from 3,700 to 1,600 last year (from 28% share to just 12%).
• We call that kind of sequential drop off “pulling forward” of demand.
• BYI also saw a drop-off in replacement units shipped between their June and September Q’s but the magnitude was much less (2,700 to 2,200)
• International continues to struggle – well, it was down 40% YoY – how much worse can it get?
• As far as full year guidance, WMS is not including shipments to any of the Ohio VLT’s.  WMS also assumes that the Western Canadian Lottery units don’t ship until 2H2013.
• We have Thistledown in our numbers
• We have the Lottery units shipping a bit earlier.
2. Is this IGT or WMS?  Wasn’t WMS taking a measured approach to investing in interactive.
• What’s the hurry in pouring good money after bad into interactive?  Last we checked, nothing is moving on the I-gaming front and social gaming companies like Zynga are getting crushed.
• WMS claims that the investment will ramp over the course of the year.   
3. WMS spent $83MM on refreshing their install base and the payoff was that participation revenues declined $43MM or 15%.  F4Q12 marked the 7^th consecutive quarter of revenue declines in participation revenue.  WMS should be gaining share, not losing share. 
4. Despite refreshing 2/3 of their install base with BB2 boxes and their “exciting” new content releases, win per day has been decreasing at an accelerating pace for the last 4 quarters.  The guidance for FY13 implies that the bleeding on win per day isn’t going to stop anytime soon.  WMS has had 8 straight quarters of win per day declines.
5. FY12 marked the 5^th consecutive year that notes receivable grew and increased as a % of product sales revenue.  We know that WMS is not alone in the practice of lending to their customers but at some point, you’ve got to wonder if they are just buying the business. 
6. The excitement about growth in other gaming operations revenue last quarter looks short lived as other revenues declined $2.3MM QoQ
   • Several of licensing agreements rolled off this quarter and there were a few unusual licensing fees last quarter.
   • Would have been nice if the company pointed this out last quarter since they clearly have visibility on expiring contracts. 
7. Reposting the question that one of our clients asked us:  While the large number of conversion kits and used units are all well and good, how much does this cannibalize demand for replacement units?
• While great for margins, conversion kits are clearly an alternative to replacing a box
• Used units typically get shipped into lower priced markets or simply to more price sensitive buyers
8. Replacement market is looking better than we expected.  WMS did not ship any replacement units of size to Canada this quarter.  Unless BYI really disappoints, replacement shipments look like they will be up double digits YoY.
• Yes, we’re excluding ~1000 used units that IGT included in their replacement number   
9. International is just terrible…oh wait, that’s obvious
• Down 40% YoY and 32% in FY12
10. While WMS did not guide on EPS for FY13, their guidance and commentary on the call implies flat operating income.  That said, as one of our clients pointed out and as we were already modeling, with the expiration of the R&D tax credits, the tax rate in FY13 is going to be 36-37% vs. 31.5% in FY12.