WMS INVESTING FOR THE FUTURE

As expected, WMS made the quarter and provided revenue guidance slightly below the Street but in-line with us. The only surprise to us was higher R&D guidance which may not be a bad thing.

 

 

The quarter was largely in line with our expectations, not the highest quality we’ve seen, but not bad given the environment.  Top line guidance for FY2011 was also healthy with our $834 million estimate toward the lower end of the guidance range of $830-850 million.  The only material surprise is management’s R&D push in FY2011 which will cost them an additional $0.10 to $0.12 in diluted EPS.  Implied guidance for FY2011 appears to be around $2 in EPS.

 

The news of the R&D acceleration initially brought about a high level of consternation on our part.  Is this catch up/maintenance R&D spend?  However, taking management at its word, we don’t believe that to be the case but we will do some serious digging.  CEO Brian Gamache indicated that they had showed customers some forward looking products that were in test and the response was positive enough that management decided to pull the development forward.  This is the definition of investing in the business and is the right long-term move if it is incremental and not maintenance.

 

While we don’t think investors get as excited about share repurchases – a bear market and credit crisis will do that –, in this case, they should.  Free cash flow is accelerating and the company announced a $300m share repurchase.  WMS is in a positive net cash position so share repurchases will be more accretive than if they had to borrow. 

 

WMS generated $51 million in operating cash flow, a number that will grow substantially next year due to net income growth and a stable customer financing environment.  After ratcheting up the use of its balance sheet to finance customer slot purchases in FY2010, WMS indicated that the company does not expect to be any more aggressive in this area.  A relatively constant accounts receivable balance will boost working capital and cash flow generation in FY2011 relative to FY2010.  Higher investment spend will eat into the operating cash increase somewhat but this is due primarily to Italy.  For now, the only comment we will make is that $40m seems like a high number for the 2.0-2.5k machines we were projecting.  Could management be expecting a larger market for them in Italy?  We will find out.

 

 

Quarter details

Product sales of $135MM were $4MM above our estimate with weaker new unit sales revenue offset by stronger used gaming machine sales.  Gross profit margins were 20 bps above our estimate.

  • New unit sales of 7,076 were in-line with our estimate (with NA shipments weaker than expected offset by stronger international shipments) and pricing was 3% lower
  • For the first time ever, WMS had the highest ship share in a quarter, overtaking IGT
  • Replacement sales were materially weaker than we expected; however, strength in new and expansion unit sales somewhat offset this.
    • WMS shipped units to Sugarhouse this quarter, receiving mid-high 20’s ship share
    • Our best guess is WMS’s share of the North American market was 27% this quarter
  • We believe that the increase in used gaming machines sold is reflective of the cost sensitive environment as more and more casinos are purchasing used games for some portion of their “new floors”
  • WMS should recognize shipments to PENN's Cecil County facility and Cosmo next quarter.  WMS got around the 90 day acceptance clause in Maryland by selling through a distributor.

Gaming operations revenues of $78MM were $2MM below our estimate and gross margins of $63.5MM were $3MM below our estimate.

  • WMS’s install base was 150 units less than we expected due to a higher than estimated removal of standalone games, partly offset by higher WAP & LAP placements.  We assumed that the standalone base was approaching a more stable level.
  • Average revenue per day was below our estimate as were margins – partly because we didn’t take into account last year’s favorable jackpot expense
  • Other gaming operations revenues were $2.4MM higher than our estimate

Other stuff:

  • R&D, SG&A and D&A were $2.7MM below our estimate

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