This note is not really about the "package" but we need to grab your attention. IGT’s Q was pretty much how we thought, not high quality but better than feared. We do have our issues but for now they shouldn’t matter.
The good news: IGT meets formal expectations but beats the whisper number and only cuts the top end of guidance by $0.02. Sure the $0.77-0.85 guidance for the year with only two quarters remaining is big enough to fit the ego of casino CEO, but it didn’t come down as much as feared. IGT also mentioned that it was close to signing two casinos for Server Based Gaming (SBG) and as we’ve discussed, we think one of those is Cosmopolitan.
So where do we go from here? The long-term is so promising for the slot suppliers that we think institutions will want to own this stock now that the dreaded quarter is out of the way and guidance has come down. Replacements look a little better than we thought and while we are not quite ready to call a replacement recovery, investors will flock to IGT (more so than the other names) when they believe we are in a sustainable acceleration. We think WMS is a better intermediate and long-term way to play the slots and we have a lot of concerns with IGT, but over the very near-term IGT may have more juice.
Here are our thoughts on the quarter:
Product sales were stronger than we expected due to more units shipped:
- In North America, IGT shipped 4,100 replacement units, up 37% sequentially and 128% y-o-y. There is usually a seasonal pickup between the December quarter and the March quarter. It does appear that things are improving on the replacement front – although we will have to wait for WMS and BYI to report to confirm that hunch. Our best guess is that roughly 11,500 replacement units shipped in the March quarter. June is also typically a stronger seasonal quarter than March for replacements.
- Better than expected unit shipments to North America were offset by lower than expected ASP pricing, due to discounting through the Dynamix package offer. Despite the confusion on the call about Dynamix, it’s quite simple – IGT is effectively discounting to keep floor share in the hopes of securing the replacements order for those legacy units when they eventually come off the floor. Not only has IGT been supporting legacy platforms which were supposed to be phased out but they are also giving away 2 conversion kits with the purchase of a new AVP unit. So for an $18,000 box you get a $24,000 value…a nice 33% discount. This offer will be out there through May so expect another quarter of pricing with a $14K handle. We'll have to see how the competition responds.
- International shipments benefited from the shipment of 2,200 units to Japan. Apparently IGT went out of Japan with a bang or somewhat of a hit game in the beginning of the quarter. International shipments also included the recognition of 600 units shipped to Marina Bay Sands and Resorts World International in the December quarter.
- Excluding low priced units shipped to Japan and the UK, International ASP’s were quite strong at $16.3K.
- IGT has a backlog of 3,200 for sale games.
However, margins were disappointing:
- Given that IGT has given away 8k conversion kits with the sale of 4k regular priced AVP units, it should be no surprise that margins were weak in North America – despite cost reductions. Conversion kits typically sell for around $3K and have over 90% margins. IGT accounted for the cost of the kits in product sales, with no corresponding revenues.
- International margins were negatively impacted by a $1.9MM inventory write down.
- Margin guidance of 48-50% is also “low” given the costs cuts and the fact that IGT’s product sales includes systems business (in addition to conversion kits, used parts and games, and license fees) which at least for Bally’s carries a 65-75% margin…. What gives?
Gaming operations revenues and margins were better than we expected, despite the install base being a lot lower (even aside from the whole Alabama issue):
- Even adjusting for the Alabama units (which we didn’t subtract from the install base but excluded from revenues), the install base decreased 900 units sequentially. According to IGT, this is just a timing issue of removing some games while their backlog units are installed.
- IGT’s participation backlog was 2,153. Although IGT didn’t confirm it, we’re fairly confident that 1,000 units of that backlog are MegaJackpot games going to Sun International in South Africa (which IGT announced on April 5th). Apparently only 400 of these installs are incremental – so we suspect that some of the international units that came out could be from South Africa. It will be interesting to see how much of this backlog results in net unit placements for IGT – hopefully it will at least replace the 900 units lost this Q.
- Yields were better than we expected, due to seasonality, better performance, and the removal of the pesky low yielding Alabama games. IGT claims that the removal of the Alabama games only benefited yields by 30 cents, but according to our math it was a lot more than that. While 2,500 games were removed at the end of the quarter, those games didn’t come offline until February 4th and if those 57 offline days cost them $5MM - that implies a win per day of $35…. You can do the math too.
- Margins were also a lot better – which again shouldn’t be surprising since IGT’s jackpot (WAP aka % coin in) games are being replaced with 80/20 and premium fixed fee games (a la BYI’s) which despite having lower win per days, have much higher margins. IGT was silent on margin guidance for gaming operations on the call but if we are right, margins will continue to be “high”.
So what about Alabama?
- As IGT plainly stated in their press release (which didn’t stop at least one person from asking the question anyway), 2,500 Alabama units were removed from install base since IGT doesn’t know when those units will come back online and isn’t collecting any revenues on those machines.
- Since there will be no referendum in November on the legality of the electronic bingo games in question, the issue has been kicked back to the judiciary system. No date has been set for a hearing as of yet.
- IGT still has another 1,200 units in Alabama at tribal casinos which are not impacted by the current fiasco.
SG&A was materially below guidance:
- I guess $95-100MM SG&A guidance is a good run rate when IGT makes its unit sales volume targets.
- A large portion (but less than 50%) of IGT’s SG&A is tied to commissions and variable rate compensation plans. So until units pick up we will take a leap of faith and say that SG&A will be below their ‘target’ range
- Another contributing factor to the decline in SG&A are lower legal fees. For those you who didn’t follow it closely, IGT has always been litigious – or as they like to say – defensive of their patents. The largest of the BYI/IGT lawsuits was resolved in late Oct 2009 when the US Court of Appeals for the Federal Circuit affirmed a Nevada court’s ruling that IGT’s Wheel patents were invalid. While there are still open legal cases between IGT and BYI, the activity on those cases has been low of late. Below are the issues that are still outstanding – we suspect that the parties will quietly settle and these two cases will go away.
- Bally’s antitrust and unfair competition suit against IGT, but no date has been set in this trial
- IGT’s “bonusing” lawsuit against BYI claiming that certain BYI’s bonusing programs infringe on IGT patents. IGT’s motion for a permanent injunction against Bally’s infringing products was denied. A trial to determine the amount of damages incurred by IGT as a result of Bally's infringement has not yet been scheduled.