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Despite some embarrassing pleading on the conference call, analysts may have it wrong about IGT’s level of conservatism. Guidance looks realistic to us.

IGT missed on revenues but produced better EPS due to cost controls and some one-time items.  By our math, if you adjust out all the noise and one-time items the actual EPS result was more like $0.22, exactly in-line with our projection.  The revenue miss and unsustainably low SG&A/R&D indicates that fundamentals are a little worse than we expected.  We are particularly concerned with lower than expected yield per game in gaming operations and a market share that appears to be lower than the company indicated on the call.

On the call, one analyst was almost begging IGT to acknowledge that they should do $1 in earnings in fiscal 2010.  His logic was that FQ1 is seasonally slow and they did $0.25.  IGT wasn’t biting.  What should’ve been clear to the analysts is that:

  • slot sales to new/expanded casinos will be way down in FQ2 and FQ3
  • there were a number of one-time items – management acknowledged that the “real” number was $0.22 for FQ1
  • the low levels of SG&A and R&D in FQ1 are not sustainable
  • replacement demand was disappointing in FQ1 so no evidence yet of a v-shaped recovery as projected by some analysts
  • market share may be a concern again

Thus, IGT’s unchanged guidance of $0.77-0.87 seems reasonable.  So what else did we learn from this release?

Product sales takeaways

  • Replacements have troughed but have yet to show real signs of big improvement. 
  • Since IGT gets a higher % share of new and expansion units than replacement units, replacements units need to show some hockey stick like growth in order to get to Goldman Sach’s magic $1.00 number
  • We’re still confused on how IGT came up with over 50% share of new shipments when they only sold 2,500 new and expansion units…. Unless our math is seriously off there is no way that new unit shipments this quarter were only 5,000
  • ASP’s were actually down 6% sequentially – higher priced Multi Layer Display games (MLD) were 32% of the mix vs. 34% in FQ4, and there are two types of MLD’s and there were less of the more expensive ones that sold this quarter
  • International shipments will be up a little y-o-y and assuming anemic Japan sales, pricing should be better

Game operations

  • Game operations continues to suffer from “mix issues” so yields will likely remain depressed from last years’ levels
    • Some of the legacy “higher” yielding units are coming off and being replaced with deals that are more favorable to casinos
    • We’ve been hearing this from the operators for months now and it looks like we’re seeing the “discounting” in the yields now
    • If interest rates trend upwards IGT will continue to have a favorable impact from jackpot funding (higher the interest rate, the lower the PV of the liability)
    • If IGT can continue to manage its install base churn margins should continue to benefit from lower D&A expense, although its sounded like they are doing some refreshing over the next few quarters so this quarter’s margin is not likely to be repeated

Other stuff

  • The amazingly low SG&A and R&D numbers from this quarter are not sustainable and therefore, nor is the $0.25 EPS number at the current revenue run-rate
  • SG&A was unusually low because there was lower incentive comp due to the timing of stock issuance, higher stock forfeitures, and an related $3MM benefit
  • Tax rate will also be “normal” and higher going forward 

 

Bottom line… fundamentals are no better than we thought, possibly a little worse, but cost controls were commendable.  Should IGT sustain this discipline they can approach the high end of their guidance range for the year, which still implies a miss from sell-side expectations.  The question is with such a favorable long-term sector outlook, will it matter?