IGT Reports Strong 2Q

International Game Technology ( IGT - Analyst Report ) reported strong second quarter 2012 results, with earnings of 27 cents per share beating the Zacks Consensus Estimate by a couple of cents. Earnings increased 22.7% year over year, primarily attributed to higher revenue growth in the quarter.

Revenue

Total revenue increased 13.5% year over year to $541.2 million in the second quarter and beat the Zacks Consensus Estimate of $519.0 million. The better-than-expected result was primarily driven by higher North America product sales and interactive businesses.

Gaming Operations contributed 55.5% to the total revenue whereas Product Sales accounted for the remaining 44.5%. Revenues from North America stood at $415.5 million, up 13.0% year over year, while revenue from international operations increased 15.2% year over year to $125.7 million in the reported quarter.

Segment Details

Gaming Operations revenues increased 11.3% year over year to $300.4 million in the second quarter, primarily attributed to strong performance from the interactive business and higher installed base. Average revenue per unit (ARPU) in the reported quarter increased 4.8% year over year to $59.09. At the end of the quarter, the company’s Gaming Operations installed base totalled 56,100 units, up 3,600 units from the year-ago quarter.

Product Sales surged 16.2% year over year to $240.8 million, primarily due to higher domestic replacement sales (up 32.0% year over year). The company shipped 10,200 machines during the quarter, down from the prior-year shipment of 9,000 units. Average revenue per unit (ARPU) in the reported quarter was $23,600 versus $23,000 in the prior-year quarter. Average machine sales price was $15,800 versus $14,600 in the year-ago quarter.

Operational Performance

Non-GAAP gross profit increased 11.0% year over year to $313.6 million. However, gross margin decreased 120 basis points (bps) to 57.9% in the second quarter. Gaming gross margin decreased 150 bps year over year to 60.5%, while Product sales gross margin contracted 80 bps on a year-over-year basis to 54.8% in the quarter.

Operating expenses were $171.7 million, up 13.5% year over year and as a percentage of revenue, operating expenses remained flat on a year-over-year basis in the reported quarter. Selling, general and administrative (SG&A) expense climbed 22.7% year over year, while research & development (R&D) expense increased 13.6% in the quarter.

Operating income increased 9.8% year over year to $144.2 million, primarily on the back of strong revenue growth. However, operating margin decreased 100 bps to 27% in the quarter due to higher-than-expected operating expenses. Net income on a non-GAAP basis came in at $79.5 million, up 17.4% year over year. Net income margin increased 50 bps to 14.7% in the reported quarter.

Balance Sheet

As of March 31, 2012, cash and investments (including restricted cash) were $360.6 million versus $587.3 million, as of December 31, 2011. Long-term debt stood at $1.66 billion at the end of the quarter. During the quarter, IGT repurchased 3.0 million shares, at an average price of $15.43 per share, totaling $46.0 million.

Acquisition

During the quarter, IGT announced the acquisition of online social gaming company Double Down Interactive LLC for approximately $500.0 million. Seattle, Washington-based Double Down is famous for its online casino game on Facebook. The game has been ranked among the top four social games last year by Facebook.

We believe that the IGT-Double Down combination will boost the company’s online presence, driving top-line growth going forward. Moreover, the acquisition will also expand its gaming portfolio beyond the casino floor to Facebook that in turn will lower IGT’s dependence on physical product sales going forward.

Guidance

For fiscal 2012, IGT expects earnings in the range of 98 cents to $1.04 per share (prior outlook 93 cents to $1.03 per share). Currently, the Zacks Consensus Estimate is pegged at $1.00, slightly above the mid-point of the guided range.

For fiscal 2012, IGT expects global gaming operations installed base to grow in the high-single digit range and revenues to grow in the low-single digit range, excluding the impact of interactive businesses. Gaming operations gross margins is expected to improve in the second half of the year. For fiscal 2012, IGT expects gaming operations gross margin to exceed the last year level of 60.7%.

For the second half of 2012, IGT expects continued growth in units and average selling prices, both domestically and internationally. The company expects gross margin to be at or slightly below last year's strong margin performance, mainly due to unfavorable product mix.

Our Take

We believe that IGT’s strong second quarter results reflect an improving domestic gaming environment. We believe that international expansion, an impressive product portfolio, cost-cutting initiatives, lesser dependence on the domestic machine replacement cycle, new contract wins, and strong growth from the interactive business will drive growth over the long term.

IGT is expanding its presence in the online and social gaming market. Besides Double Down, the company also acquired Stockholm-based Entraction Holding AB in order to supplement its position in the legalized interactive gaming market. We believe that the addition of poker, bingo, casino and sports betting will boost IGT’s interactive gaming portfolio going forward.

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

However, we believe that fewer new openings and increased 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 carries a Zacks #3 Rank, which implies a ‘Hold’ rating in the short term.