Sluggish Sales Spoil IGT's 1Q

International Game Technology (IGT - Analyst Report) reported weak first quarter 2012 results, with earnings per share (EPS) of 17 cents per share missing the Zacks Consensus Estimate by a nickel. EPS decreased 19.0% year over year, primarily attributed to sluggish revenue growth and higher operating expenses in the quarter.

Revenue

Total revenue decreased 1.3% year over year to $445.5 million in the first quarter and missed the Zacks Consensus Estimate of $488.0 million. Gaming Operations contributed 59.4% to the total revenue whereas Product Sales accounted for the remaining 40.6%. The year-over-year decline in revenue was primarily attributed to fewer new casino openings in North America.

Revenues from North America stood at $322.6 million, down 8.3% year over year, while revenue from international operations increased 23.6% year over year to $122.9 million in the reported quarter.

Segment Details

Gaming Operations revenues increased 4.6% year over year to $264.6 million in the first quarter, primarily attributed to strong performance from the interactive business and higher installed base. Average revenue per unit (ARPU) in the reported quarter crept up 1.0% year over year to $53.11.

At the end of the quarter, the company’s Gaming Operations installed base totaled 55,600 units, up 300 units from the year-ago quarter. The year-over-year growth was due to strong additions in international operations.

Product Sales declined 8.8% year over year to $180.9 million, primarily due to lower domestic replacement sales. The company shipped 7,300 machines during the quarter, down from the prior-year shipment of 8,300 units.

Average revenue per unit (ARPU) in the reported quarter was $24,800 versus $23,900 in the prior-year quarter. Average machine sales price was $15,800 versus $14,300 in the year-ago quarter.

Operational Performance

Non-GAAP gross profit was $251.9 million, down 6.5% year over year. However, gross margin decreased 320 basis points (bps) to 56.5% in the first quarter, primarily due to weak product sales and gaming margin in the quarter.

Gaming gross margin decreased 220 bps year over year to 60.6%, while Product sales gross margin contracted 520 bps on a year-over-year basis to 50.6% in the quarter, due to lower domestic volumes and product mix.

Operating expenses were $152.0 million, up 1.9% year over year and as a percentage of revenue, operating expenses increased 100 bps to 34.1% in the reported quarter. Selling, general and administrative (SG&A) expense climbed 9.1% year over year, while research & development (R&D) expense declined 4.1% in the quarter.

Operating income plunged 16.9% year over year to $99.9 million, primarily on the back of sluggish revenue growth and higher operating expenses in the quarter. Net income on a non-GAAP basis came in at $50.3 million, down 30.9% year over year. Net income margin declined 480 bps to 11.3% in the reported quarter.

Balance Sheet

As of December 31, 2011, cash and investments (including restricted cash) were $587.3 million versus $552.0 million, as of September 30, 2011. Long-term debt was $1.66 billion versus $1.65 billion in the prior quarter. During the quarter, IGT repurchased 263,000 shares, at an average price of $16.74 per share, for a total cost of $4.0 million.

Guidance

For fiscal 2012, IGT continues to expect EPS in the range of 93 cents to $1.03 per share. However, the guidance was well below the Zacks Consensus Estimate of $1.06 for fiscal 2012.

Our Recommendation

The casino sector continues to face macroeconomic challenges due to high unemployment levels. This has forced many casino operators to reduce their costs in an attempt to preserve liquidity, subsequently resulting in a slower machine replacement cycle. This trend appears to be hurting IGT’s growth.

In order to boost its dwindling growth, IGT is expanding its presence in the online and social gaming market. In this regard, IGT’s acquisition of Double Down and Stockholm-based Entraction Holding AB will boost the company’s online presence and position in the legalized interactive gaming market.

The company recently ventured into the cloud computing arena through its IGT Cloud. With the IGT Cloud, we expect the company to gain traction in the casino gaming industry, as it would likely be well accepted by new casino operators, thereby improving the company’s top-line going forward.

However, sluggish macroeconomic conditions, fewer new openings and increasing competition from Bally Technologies Inc. (BYI - Snapshot Report) and WMS Industries Inc. (WMS - Snapshot Report) will keep the stock range bound in the near term.

We have a Neutral recommendation on the stock over the long term (6-12 months). Currently, IGT has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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