IGT: LOW QUALITY, LOW GUIDANCE, HIGH FCF

The only bright spot in this low quality quarter was free cash flow generation. Lower FQ4 guidance was blamed on software revenue recognition. Wish we had known about that FQ2 Canadian shipment.

 

 

While IGT’s $0.21 EPS number technically is in-line with consensus, with the exception of tight cost controls, there was little to get excited about in the release.  North American (NA) unit shipments, NA ASPs, and install base were all disappointing.  FQ2 ship share now appears overstated given a big Canadian shipment which wasn’t previously disclosed, and share appeared to remain low in FQ3. 

 

Guidance of $0.16 to $0.19 was not good, below consensus estimates of $0.22.  The only bright spots were free cash flow, non-box sales in NA, margins, and lower SG&A.  The S in SG&A has a commission component so it shouldn’t be a surprise that SG&A was low with top-line miss. 

 

The biggest miss vs. our expectations was on North American box sales which came in $28MM below our estimate, largely driven by lower replacement shipments.  June is usually a seasonally better replacement shipment quarter than March and Konami tends to grab a smaller piece of the pie.  So what went wrong?  Possible explanations:

  • We know that Konami shipped fewer units in the June quarter – about 1,250 less than the March quarter so that’s not it.
  • IGT claims that lower sequential shipments into Canada negatively affected their shipments to North America (they shipped 1,100 units into Canada in the March Q), although conversations with WMS and BYI suggested that there was nothing unusual about the Canadian shipments in March.
  • March industry-wide replacements were simply better than June – We didn’t get the sense that this was the case from speaking to operators throughout the quarter.
  • The introduction of the Dynamix package in the March quarter may have pulled forward some of IGT’s demand.  In the March quarter, IGT sold 4,017 units under the Dynamix package, while selling less than 2,300 units under this promotion in the June quarter.
  • IGT lost even more share – if we back out the 1,100 Canadian units from the March quarter, IGT’s market share would’ve been 22%, instead of 27%.  Had we known about the Canadian shipment in March, we would’ve assumed lower IGT ship share going forward.

 

Better North American non-box sales helped offset some of product sale weakness and, we suspect, was the major driver of better margins, since it’s not unusual for this mishmash bucket to have margins of 70%.  As followers of BYI know, systems revenue is almost impossible to model given the revenue recognition issues, and IGT gives no quarterly disclosure of the contents of the non-box sale bucket.

 

Gaming operations revenues came in light of our estimate as did gross margins – although excluding the jackpot funding expense, margins would have been 60.6% - which were only a touch lower than our estimated margins.  The “splendid yield of $51.68” in the quarter, finally showed some stability and even growth – which is encouraging since for at least 5 straight years, yields have declined.  However, given the new exciting games like Sex in the City and Amazing Race, we suspect that most analysts were expecting some stabilization and perhaps even some growth here.  The backlog for mega-jackpots increased by about 200 units sequentially, while the backlog for the “hot” top 4 games decreased by almost 1,000 units sequentially.

 

While earnings were disappointing, the huge improvement in free cash flow generation by IGT is impressive.  Much of this improvement is due to more efficient capex spend through the reduction and streamlining of platforms, better working capital management, and cost cutting.


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