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IGT F1Q13 REPORT CARD

Takeaway: IGT thesis remains intact: better capital deployment, strong EPS growth, and cheap valuation.

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance

 

 

OVERALL

  • SLIGHTLY BETTER: While the topline was clearly ahead of the Street and our estimate we think that the the core results were weaker than the headline.  Product sales were strong but benefitted from the recognition of deferred units.  Core gaming operations continue to disappoint but gross margins and better cash flow were encouraging.  Overall, the EPS beat vs. our numbers was really a combination of the lower SG&A, R&D, D&A and rentention accruals in the quarter. 

2013 GAMING OPERATIONS REVENUE AND GROSS PROFIT

  • SLIGHTLY WORSE:  F1Q 2013 gaming ops revs fell 4% but margins showed improvement. Installed base was up 2%.  IGT is still targeting flat gaming ops yield in 2013 as well as better gross margins
  • PREVIOUSLY:  “In 2013, we expect Gaming Operations revenue and installed base to be about flat with 2012, while gross margin and profit per unit are expected to show modest improvements.”

 

GAMING EQUIPMENT SALES AND MARGINS

  • BETTER:  Product sales revenues soared 30% YoY and margins rose 4% YoY, both better than expected. Uptick in margins was due to higher non-box sales and discount sales were down significantly. $5MM in royalty settlement fees also helped.
  • PREVIOUSLY: “On the strength of our VLT business in Canada, Ohio, and Illinois, where we expect to enjoy leading ship shares, we anticipate our product sales revenue and gross profit to deliver double-digit increases, while gross margin may be slightly softer due to mix.”

IGTi REVENUE AND MARGINS

  • SAME:  IGTi revenues and margins were $1MM and 1% lower YoY, respectively.  Online casino customers, including Italy, rose 20%.
  • PREVIOUSLY:  
    • “Moving forward, we expect some additional costs and, in the short term, lower revenues and gross margin in our IGTi business as this restructuring plan is executed. On the positive side, these actions are anticipated to reduce annual operating expenses in our IGTi business.”
    • “At our IGTi group, we expect to see continued growth in our mobile real-money wagering business consistent with our past trends.”

ADJUSTED OPERATING MARGINS

  • BETTER:  Adjusted operating expenses were 32% of revenues for the first quarter compared to 34% of revenues in the prior year quarter.  IGT sees more room for improvement.
  • PREVIOUSLY: “For the year, adjusted operating expenses were about flat as a percentage of revenue, and we expect this trend to remain consistent into 2013.”

MEGAJACKPOTS  

  • WORSE:  Megajackpots drove gaming ops revenues and average revenue per unit per day lower.  Margins, however, did improve more than 200bps YoY as IGT managed their capital investment.
  • PREVIOUSLY: “We expect to stabilize our MegaJackpot revenues."

SG&A GROWTH

  • SAME:  F1Q SG&A grew about $10 million or 12% YoY, with almost the entire increase attributable to investments in Interactive. The YoY increase should moderate in 2H and particularly in 4Q as IGT laps the consolidation of Double Down.
  • PREVIOUSLY:
    • “The vast majority of the growth in SG&A this year has been related to our Interactive businesses. That's the IGTi business and then, obviously, the acquisition of Double Down. In fact, the base SG&A has grown less than double-digit dollars. So we would expect to continue to invest in the Interactive business, but at a rate that's less than the revenue growth expectations going forward. And then in the base business, we'd expect again low, low single-digit SG&A growth.”
      • Q: So if I think about that just empirically, maybe $30 million in incremental SG&A?
      • A: I think that's about right on the growth next year, recognizing that we have one more quarter of Double Down next year than we had in the prior first quarter

GAMING OPERATIONS CAPEX

  • BETTER:  Gaming ops capex was about $30MM in F1Q 2013.  IGT expects total capex to be at or below year-ago levels for FY 2013, however this quarter certainly ran materially below last year.
  • PREVIOUSLY: “I would think about capital in the Gaming Operations business as flat to down slightly.”

GAME OPS YIELD

  • SLIGHTLY WORSE:  Average revenue per unit per day in the first quarter was $46.80, down 7% over the prior year quarter and down 8% sequentially.
  • PREVIOUSLY: “I would expect that there will be continued pressure on yield, so we're taking active steps in the quarter and have been for the last quarter”

IGT F1Q13 CONF CALL NOTES

Takeaway: Continue to like prospects over the near and intermediate term due to strong EPS growth, better capital allocation, and cheap valuation

IGT F1Q13 CONF CALL NOTES

 

 

"Our robust first quarter results.... provide a great start toward what we expect will be our fourth consecutive year of double digit growth in adjusted earnings per share from continuing operations"

 

- Patti Hart, CEO of IGT 

 

CONF CALL NOTES

  • Gaming operations:  remains challenged for a variety of reasons.  However, focus on profitability is bearing fruit. 
    • Continue to focus on managing this business for cash flow and profitability
    • That said they are encouraged by the performance of some of their recent releases
    • Developed a new rapid progressive that they will launch next month
    • They are launching more direct marketing programs for MegaJackpots
  • Product sales:  confident that they will continue to gain share
    • Takes the Cake and Dolly Parton very popular
  • Interactive:  impacted by the closure of their international poker network
    • Are now able to launch IGT titles to the online casino in a very efficient fashion. Still expect the DD acquistion to be GAAP accretive by 2014
  • Customer sentiment is improving towards IGT's products

Q&A

  • What was the CA number shipped in the Q? 1,600 units.  Expectation for CA remain consistent with what they have previously disclosed.
  • Domestic replacement market is continuing to bump along as they expected.  They remain cautiously optimistic on overall replacements and their ability to take more share.
  • High-Five's recent success in the social gaming space?  Not concerned about them in the social gaming space, despite their ability to make good games.
  • Gaming operations yield performance?  Still possible to get to flat YoY yields by YE but are monitoring that.  Their approach to gaming operations is a fulcrum approach: Doing a lot to market direct to consumers on their social gaming platform. They will not chase yield through inefficient capital allocations. Will not use capital to drive yield. 
  • Size of the ASP decline in NA: really primarily VLT driven, but they also had lower MLDs as a % of total shipments in the quarter which were particularly high last year. Expect margins to be comparable to prior year in non-box sales.  Less discounting in the quarter on boxes also helped margins.
  • Game operations margins were improved due to lower jackpot expense and lower D&A
    • There is more room for D&A to continue to go lower and help margins.  However, they are also working hard on licensing fees to contribute to margins.
  • Ship share in December?  Pretty confident that it remained in the high 30's.
  • Success metrics of their game operations: time of games in the field, churn in their install base, yields, measure effectiveness of direct to customer marketing.  MegaJackpots have been traditionally a hit driven business. 
  • Is the $30MM of capex for game operations sustainable? They will put more capital to work if they find appropriate opportunities. They still expect to be at or below last year's capex number.
  • Reason that the acquisition related costs were down was because they re-marked their expenses at year end. They don't do as comprehensive of a review each quarter. Retention and amortization is static throughout the year but retention payment will likely go up throughout the course of the year. 
  • Discounts in NA for game sales were down materially in the quarter. The environment remains very competitive as it has been over the last year.
  • They aren't updating guidance because it's just too early in the year and there is no extraordinary reason to raise or lower guidance right now. There is a lot of timing in play in some of the sizable orders. International markets are still struggling. Also, underlying trends in gross gaming revenues for the market as a whole are also fluctuating.
  • Operating expense increase YoY is almost all attributable to the investments they are making in the Interactive business
  • Outlook for international? Continue to invest in that business. The market is difficult to predict. They are still looking for slight growth in the year. 

 

HIGHLIGHTS FROM THE RELEASE

  • EPS outlook of $1.20 to $1.30 unchanged
  • Gaming operations: 
    • YoY revenues fell due to lower MegaJackpots and was partially offset by higher lease operations
      • Install base: 56,800 (+2% YoY)
      • Yield: $46.80 (-7% YoY)
    • Gross margins improved 200bps "primarily due to an increase mix of lower-yielding higher-margin lease operations games and lower jackpot expenses"
  • Product Sales:
    • Revenues "increased 30% to $235 million in the first quarter, due to increased North America machine sales related to Canadian and Illinois VLT customers, as well as increased non-machine intellectual property licensing fees"
      • 7,200 units recognized and 6,800 shipped (5,100 replacement) 
    • "North America gross margin increased... largely due to increased non-machine revenues, which included $5 million of royalty settlement fees."
    • The YoY drop in ASPs in NA was "mainly due to an unfavorable pricing mix related to increased VLT sales."
  • Interactive: DoubleDown sales were better than expected while IGTi was weaker
    • DoubleDown: Revenues of $41.3MM and gross margin of 60%
      • DAU: 1,462MM; Booking per DAU: $0.31
    • IGTi: $11.6MM of revenues at a 51% gross margin

TRADE OF THE DAY: DRI

Today we shorted Darden Restaurants (DRI) at $45.98 a share at 12:43 PM EDT in our Real-Time Alerts. We are re-shorting one of Hedgeye Restaurants Sector Head Howard Penney's Best Ideas (on the short side). Nice short selling opportunity at the immediate-term TRADE overbought signal; we shorted on green, we'll cover on red.

 

TRADE OF THE DAY: DRI - DRI


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TAP - MillerCoors STRs Shake out some weak shorts

One of our preferred shorts (TAP) is up over 1% today – SABMiller reported STRs (shipment to retailers) of (1.1%) for the 4th quarter and STWs (shipments to wholesalers) of (-1.4%) for the MillerCoors JV in which both TAP and SAB participate - both results likely ahead of admittedly modest expectations.

 

The result represents sequential improvement from Q3 where STRs declined 2.4%.



Before investors break out the champagne (or beer), some context is needed – Q4 is the easiest STR comp of the year for MillerCoors, lapping a down 3.3% in Q4 2011.  Further, the spread between STR’s and STW’s (30 bps) indicates that only a small bit of the build-up in distributor stocks was worked through this quarter – STRs declined more than STWs by 70 bps in Q1 and 170 bps in Q2, corrected by 20 bps in Q3 and 30 bps in Q4.



Bottom line, the incremental information today isn’t enough to shake us off our short thesis, but was apparently enough to shake out some weak shorts.



Being early on shorts is painful, we get it – and while we recognize TAP is inexpensive, and shorting inexpensive names isn’t our go to move, we are sticking with our “cheap, for some very good reasons” meme that we have been running with on TAP.

 

Call with questions.

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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QUADRILL-YEN: NOT YET, AT LEAST

Takeaway: While the BOJ disappointed short-term market expectations, we still think the outlook for Japanese monetary POLICY is decidedly dovish.

SUMMARY BULLETS:

 

  • From our purview, Governor Masaaki Shirakawa and his fellow board members met Prime Minister Shinzo Abe & Finance Minister Taro Aso halfway at best on this one amid his constant struggle to protect BOJ independence.
  • On the explicitly dovish front (i.e. incrementally bearish for the yen) is their well-telegraphed +2% CPI target (as forecasted by 21 of 23 economists), their less-telegraphed accelerated time frame (i.e. “at the earliest possible time”) and the fact that the recently revived Council on Economic and Fiscal Policy will now monitor the BOJ’s progress at achieving this end until the target is reached.
  • What we found quite hawkish (i.e. bullish for the yen), relative to expectations, is their commitment to seeing their current ¥76 trillion Asset Purchase Program through to its culmination at the end of calendar 2013, prior to actually implementing the open-ended Asset Purchase Program – which initially targets ¥13 trillion ($146.5B) per month of mostly low-impact securities (¥10 trillion will be Japanese Treasury bills, which are more-or-less cash substitutes in Japan).
  • Forex market participants (speculators are still net short) didn’t like this latest iteration of Delaying the Drugs, which is why into and through this latest BOJ board meeting we have anchored on what is likely to become of Japanese monetary POLICY after Shirakawa and his two deputy governors are replaced in late-MAR/early-APR.
  • All told, our TREND and TAIL bearish thesis on the Japanese yen continues to play out in spades. And while we expect the pace of depreciation to slow over the next couple of months, we do think early 2Q and early 3Q catalysts will  continue to perpetuate a weaker yen over the intermediate term. As we suggested back on DEC 17th, ¥100 on the USD/JPY cross continues to be a reasonable target to hit prior to any major reassessment of Japanese monetary and fiscal POLICY.

 

With the conclusion of the Bank of Japan’s two-day monetary POLICY meeting overnight, the BOJ and Japan’s Cabinet Office issued a joint statement confirming already-reset market expectations for “price stability” in Japan. The primary deltas on the POLICY front include:

 

  • Adopting a joint +2% INFLATION target to be achieved at “the earliest possible time”: “The Bank recognizes that the inflation rate consistent with price stability on a sustainable basis will rise as efforts by a wide range of entities toward strengthening competitiveness and growth potential of Japan’s economy make progress. Based on this recognition, the Bank sets the price stability target at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI).” (source: BOJ; six of nine voted in favor of this change)
  • Adopting open-ended asset purchases to commence in JAN ’14: “With respect to the Asset Purchase Program, after completing the current purchasing method, from January 2014, the Bank will introduce a method of purchasing a certain amount of financial assets every month without setting any termination date. Particularly, for some time, following the introduction of this method, the amount of monthly purchases is specified at about 13 trillion yen, 2 trillion yen of which is JGBs. As a result of these measures, the total size of the Asset Purchase Program will be increased by about 10 trillion yen in 2014 and is expected to be maintained thereafter.” (source: BOJ; unanimous decision)

 

With the inclusion of these latest measures, Chief Cabinet Secretary Yoshihide Suga was out suggesting that the need to revise the 1998 Bank of Japan Act had “lessened”. From our purview, Governor Masaaki Shirakawa and his fellow board members met Prime Minister Shinzo Abe & Finance Minister Taro Aso halfway at best on this one amid his constant struggle to protect BOJ independence.

 

On the explicitly dovish front (i.e. incrementally bearish for the yen) is their well-telegraphed +2% CPI target (as forecasted by 21 of 23 economists), their less-telegraphed accelerated time frame (i.e. “at the earliest possible time”) and the fact that the recently revived Council on Economic and Fiscal Policy will now monitor the BOJ’s progress at achieving this end until the target is reached.

 

What we found quite hawkish (i.e. bullish for the yen), relative to expectations, is their commitment to seeing their current ¥76 trillion Asset Purchase Program through to its culmination at the end of calendar 2013, prior to actually implementing the open-ended Asset Purchase Program – which initially targets ¥13 trillion ($146.5B) per month of mostly low-impact securities (¥10 trillion will be Japanese Treasury bills, which are more-or-less cash substitutes in Japan).

 

Since delaying the start of such a program is particularly contrary to adopting an accelerated time frame for achieving the now-joint price stability target, we interpret this maneuver as the outgoing Shirakawa's issuance of somewhat of a proverbial "middle finger" to the Cabinet; it appears that he does not want his already-lackluster legacy further tainted by politicized money printing.

 

Also hawkish for the yen, Economics Minister Akira Amari recently said at the World Economic Forum Davos that the Japanese government has no political intention to guide the yen lower or higher. This bold-faced lie is a clear signal that Japan is increasingly attentive to the heightened political push-back upon their beggar-thy-neighbor policies of late. To the extent they want to calm the markets, they may slow their implementation of further reflationary measures with respect to the next 2-3 months.

 

Additionally, it was reported that the Japanese government wants to cut its sovereign debt/GDP ratio by half of the FY10 level by FY15 (i.e. three years from now). In addition, fiscal policymakers are said to desire a primary balance surplus by 2020. We won’t even dignify these outlandish targets with any degree of analysis (i.e. Japan’s debt/GDP ratio isn’t going to drop by ~100 percentage points in three years), but just the mere mention of fiscal sobriety out of Japan could and should be interpreted as bullish for the yen – at least in the short term.

 

All told, currency market (speculators are still net short) didn’t like this latest iteration of Delaying the Drugs, which is why into and through this latest BOJ board meeting we have anchored on what is likely to become of Japanese monetary POLICY after Shirakawa and his two deputy governors are replaced in late-MAR/early-APR. For more details here, please review our 1/16 note titled: “BEST IDEAS UPDATE: RE-SHORTING THE YEN HERE” (a position we’ve since booked for a ~1.7% gain).

 

QUADRILL-YEN: NOT YET, AT LEAST - 1

 

It is well-documented that Shirakawa fundamentally believes that Japan cannot overcome deflation with monetary POLICY alone, so we look for the Diet to replace him and his loyal deputies with candidates that support the new Cabinet’s pledge for bold monetary easing. Japanese bureaucrats are right sick of Shirakawa being one-upped by Ben Bernanke and Mario Draghi.

 

QUADRILL-YEN: NOT YET, AT LEAST - 2

 

We continue to affirm that Japanese monetary POLICY must, and likely will, get dramatically more aggressive in pursuit of the Abe/Aso agenda (i.e. +5% “monetary math”).

 

QUADRILL-YEN: NOT YET, AT LEAST - 3

 

In light of all this, we continue to look towards mid-to-late FEB when the Diet is expected to start reviewing candidates for the pending openings. From our purview, the top three candidates out to an early lead among consensus chatter include former BOJ Deputy Governor Toshiro Muto, Asian Development Bank President Haruhiko Kuroda and former BOJ Deputy Governor Kazumasa Iwata.

 

QUADRILL-YEN: NOT YET, AT LEAST - 4

 

Elsewhere in the realm of Japanese POLICY, Prime Minister Shinzo Abe sent a letter to Chinese leaders via an envoy who suggested that the dispute should be shelved and "left for future generations" to resolve; additionally, the envoy requested a face-to-face meeting between Abe and new Chinese Communist Party General Secretary Xi Jinping.

 

This is the first major step in the right direction with regards to alleviating the Senkaku/Diaoyu Islands dispute and, to the extent it is appropriately follow up upon, should paint a brighter picture for Japanese GROWTH over the intermediate term via increased manufacturing and export activity.

 

All told, our TREND and TAIL bearish thesis on the Japanese yen continues to play out in spades. And while we expect the pace of depreciation to slow over the next couple of months, we do think early 2Q and early 3Q catalysts will  continue to perpetuate a weaker yen over the intermediate term. As we suggested back on DEC 17th, ¥100 on the USD/JPY cross continues to be a reasonable target to hit prior to any major reassessment of Japanese monetary and fiscal POLICY.

 

Darius Dale

Senior Analyst

 

QUADRILL-YEN: NOT YET, AT LEAST - 5


MCD SALES PREVIEW

McDonald’s is set to report December sales, along with 1Q earnings, tomorrow before the market open.

 

 

General View

 

Recently, we’ve been vocal on our view that McDonald’s earnings are likely to disappoint in 2013.  We are continuing to advise clients to be patient on the long side of MCD until expectations for next year come down. We believe that, aside from the macro environment and lapping difficult partially-weather-driven comps, self-inflicted wounds, that management has not yet owned up to, are also likely to impede earnings growth over the next twelve months.

 

 

Sales Preview

 

McDonald’s reports December sales, along with 1Q earnings, tomorrow before the market open.  Consensus is anticipating a sequential deceleration in two-year average trends for global trends.

 

Below, we go through what we would view as good, bad, or neutral comparable restaurant sales numbers for McDonald’s three regions in December.  For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).

 

Compared to December 2011, December 2012 had one additional Monday, one additional Sunday, one less Thursday, and one less Friday.  In 2012, Christmas fell on a Tuesday versus Sunday in 2011.   We expect a modestly positive impact on the headline numbers for December. 

 

MCD SALES PREVIEW - mcd preview

 

 

United States – facing a compare of 9.8%, including a calendar shift of roughly 0.7%, varying by area of the world:

 

GOOD: A print higher than -1% would be received as a positive result as it would imply, on a calendar-adjusted basis, an acceleration in two-year average trends versus November’s strong result.  November’s same-restaurant sales growth overstated true trends in the US, to a degree, as a sizeable calendar shift boosted the headline numbers.  A heavy focus on the Dollar Menu also aided results in November.  The question for December will be how much of an impact the McRib will have had.  Our expectation is for a print of -1.7%.

 

NEUTRAL: A result between -1% and -2% would imply calendar-adjusted two-year average trends roughly flat versus November.   Decelerating trends would arguably lend credence to our contention that self-inflicted wounds, and not only macro, have been impacting MCD sales in recent quarters.

 

BAD: Same-restaurant sales growth less than -2% would imply a sequential deceleration in two-year average trends in the United States.  We would expect the stock to react negatively to such a result.

 

MCD SALES PREVIEW - mcd us preview

 

 

Europe – facing a compare of 10.8%, including a calendar shift of roughly 0.7%, varying by area of the world:

 

GOOD: Better than -3% would be viewed as a stronger-than-expected result.  On a calendar-adjusted basis, such a result would imply a sequential acceleration in two-year average trends.  Soft economic conditions persisted in Europe during November with Germany one of the underperforming markets.  We would note the sequentially improving “Zew Germany Expectations of Economic Growth” index as being a positive sign for MCD Europe in December, but we continue to expect sluggish trends across the pond.  Our expectation is for a print of -3.3%.

 

NEUTRAL: A print between -3% and -4% would be received as neutral as it would imply calendar-adjusted two year average trends roughly flat versus November.

 

BAD: Weaker-than- -4% same-restaurant sales growth would imply, on a calendar-adjusted basis, two-year average trends in line with the weakest months of 2012: February and August.

 

MCD SALES PREVIEW - mcd europe preview

 

 

APMEA – facing a compare of 6.5%, including a calendar shift of roughly 0.7%, varying by area of the world:

 

GOOD: A print of better than 0.5% would be a positive result for MCD APMEA.  Weakness in Japan is ongoing and we are not expecting much from this division in December as the fallout continues around the KFC Chicken scandal.  While MCD is a competitor of KFC’s, we feel that some impact may follow through to other western chains.  Our expectation is for a print of 0.5%.

 

NEUTRAL: A print between -0.5% and 0.5% would be received as neutral by investors as it would imply calendar-adjusted two year average trends roughly flat versus November.

 

BAD: Same-restaurant sales growth slower than -0.5% in December would imply sequential deceleration in two-year average trends.

 

MCD SALES PREVIEW - mcd apmea preview

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 

 


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