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We are bullish on the slot supplier segment, not so much based on 2010 but more so because there is a visible and developing domino effect with new markets, leading to neighboring jurisdictions needing to “keep up with the Joneses”.  It is fair to argue that WMS deserves a premium valuation given its stellar performance.  However, we believe that there are cheaper ways to play this trade, with stocks that have lower embedded expectations.

 

WMS 2Q09 EARNINGS CALL

  • 13th consecutive quarter of meeting or beating guidance
  • Over the last 3 years WMS’s net income tripled, despite the decline in industry shipments
  • Results were achieved in the midst of the worst replacement market and weak new openings
  • Capital investment is targeted towards high ROI initiatives
  • Activity in multiple new jurisdictions and eventual replacement cycle makes them optimistic
  • Increased share repurchase program
  • High performing games is helping their gaming operations through more units and higher win per days
    • WAP footprint grew 38%
    • 171MM of gross profit
  • Estimate ship share will be higher than 21% achieved last year
  • International new unit revenue grew 5% for the year
  • CFFO was 179MM
  • Bluebird 2 platform saw some success  - 62% of new shipments, with 25% being mechanical reels (22% for the year), 20% higher price
    • Same gross profit margin % achieved in BB2 as BB1
    • They expect to further increase margins with cost decreases and price increases
    • Can deliver units faster, saving money
    • Aria – 23% of floor will be blue bird 2 – highest flow share for Vegas strip opening
    • 23% in Rivers Pittsburg, and 24% in River City – PNK (shares)

Outlook/ new products:

  • Growth from new international jurisdictions
    • Already shipped first units into Mexico and expect to recognize revenue in New Wales by 1H2010
  • Growth from new platforms like Helios (value oriented cabinets for international markets)
  • Growth from networked gaming contribution
    • Log on feature- player recognition
    • Time machine game/ monopoly games – first participation game on BB cabinet
  • Higher selling prices, despite depressed unit shipments domestically
  • Higher install base and higher average daily win per day in 2010
  • Entry into centrally determined markets – WMS games are already in those markets (like Oklahoma) through 3rd party distributors. Already shipped first units to Washington
  • They have a monopoly license through 2016 (and extension available through 2019)
  • Opened new lab in Seattle – to demonstrate new network gaming products
    • Launch wage-net enable products over the next 6 months (Aria & other casinos)
      • Received approval in Mississippi to conduct trials for downloadable
  • WMS assumes lower Native American expansion opportunities in 2010
  • They aren’t including any new markets that still have a lot of uncertainty around them
  • Lower margin on game ops from higher mix of WAP units
  • Benefit from higher mix of BB2, hurt by higher mix of lower margin product sales like used games and lower # of conversion kits –resulting in lower gross product margins
  • R&D: will continue to grow – ~14% of revenues
  • SG&A:  (June reflected higher headcount from global growth)
  • D&A:  increase modestly and decline as a % of revenues
  • Effective tax rate will be 36-38% (after R&D tax credit expires this year)
  • Remain optimistic given:
    • 18 consecutive quarters of double digit EPS growth
    • 2 week customer order turn around
    • Innovative culture and pipeline = special sauce for boosting demand for products in challenging times
    • “Future ready” for networked gaming

Quarterly highlights:

  • Other product sales (used) created a small drag on margins
  • Operating cash flow in 2009 was same as 2008   
    • Provided financing for more customers in the quarter
  • Inventory turns improved 35% to 4.2x from 3.1x turns
  • Cash grew despite $27MM used in investing activities

Q&A:

  • What are they seeing with their install base, is there more price resistance?
    • No – they continue to see pricing leverage
    • Units – tremendous success with Wizard of Oz not sure that they can replicate that growth
    • “There could be some upside if games are success”
    • Expecting a decline the rate of growth for participation business to slow
  • Assumptions for domestic / international
    • International mix to remain constant next year
    • See first 6 months of 2010 to continue current trends and pick up in back half
  • Why are they comfortable that back half replacements will help them in 2H2010?
    • Had a number of dialogues pre G2E and see a resurgence in demand from some clients that haven’t bought in a while (big players)
    • “loosening of purse strings”
    • Some of it is because there was pent up demand
      • I’m sure that the refinancings are driving this
  • Used games?
    • Great demand for BB1 product – not a lot of inventory so great demand for them… may start to see the BB1 come back to them and go to 2nd tier markets (internationally) so when their customers upgrade to BB2 they get more BB1’s back
    • No used games in their inventory today
    • Used games vs conversions kits moving in the opposite direction
      • NO
      • They are to venues outside the US vs. conversions are to US
  • Is IGT’s increased WAP footprint (BYD/MGM) impacting their guidance –NO
  • Growing excess FCF – above R&D needs – where are the opportunities to deploy that
    • Scour the globe for new technologies/ IT
    • Acquiring a company…
    • Board increased the buyback program by $75MM have $150MM under the program
    • Reinvest in the same range as 09 into gaming operations
  • Backlog?
    •  “healthy”
    • Very comfortable with their guidance
  • Class 2 & Australia cheaper… than BB2 – hence lower ASP growth given higher BB mix
  • Think they had a mid-high 20’s share – mid 30s replacement share
  • Majority of replacement units are competitor units- particularly in mechanical product – fresh market share for them
  • Taking “Price is Right” brand from a competitor
    • Thought they could leverage the brand – not about stealing competitor brands – it came to them  - given server based capabilities
  • Outperformance in operating margins driven by the gaming operations business- that’s where the beat can come from in 2010. On the product sales side, could have upside from new markets.  Replacement cycle improvement would be huge too.
  • Expanding video poker platform
    • Exciting opportunity in IL – but it’s not going to be just video poker. Expect to participate and have a commensurate share of that market
  • Idea behind internal casino Seattle to help sell their server based games – hard to sell on paper –easier to demonstrate
  • Are they sandbagging win per day for 2010?
    • July was the best month ever (June & Sept are seasonally the strongest quarter) but hard to forecast super strong trends continuing
    • Wizard of Oz – new placements – unclear if win per days will hold
      •  typically participation games have falling off win per days as games on the floor age
  • Any chance they get same share of games for new openings as replacements?
    • People forget that existing floor share is in the teens so 30% is getting them closer to new opening share in the low to mid 20s
  • Regional operations have been aggressively  replacing their  machines, and Native American casinos are on a normal 5/6 year cycle… it’s really the multi-property/ strip players  that haven’t been holding up orders
  • Comparing Wizard of Oz to Wheel of Fortune is a stretch …
    • I don’t think people realize how many WoF games are out there… probably about 25,000… whole other league – not to take anything away from WMS
  • Long term – where can margins go:
    • 60% product margins (will depend on conversion kits and software success of “networked gaming”)
    • 25% operating margins