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International Game Technology (IGT - Analyst Report) reported strong first quarter 2013 results, with earnings beating the Zacks Consensus Estimate by 4 cents.

Revenue

Total revenue surged 17.9% year over year but declined 16.8% sequentially to $525.3 million (excluding royalty payment of $5.0 million) in the quarter. Year-over-year growth was primarily driven by higher product sales and strong performance from interactive businesses. Revenue was slightly ahead of the Zacks Consensus Estimate.

Gaming Operations revenue declined 3.7% year over year and 8.0% from the previous quarter to $242.6 million in the quarter. The decline was primarily due to lower MegaJackpots revenue, partially offset by higher lease operations revenue.

Average revenue per unit (ARPU) per day decreased 7.0% year over year to $46.80. At the end of the quarter, the company’s Gaming Operations installed base totaled 56,800 units, up 1,200 units from the year-ago quarter.

Product Sales soared 29.8% year over year but declined 25.1% on a sequential basis to $234.8 million. Year-over-year growth was primarily attributable to higher North America machine sales related to Canadian and Illinois VLT customers, as well as increased non-machine intellectual property licensing fees. IGT shipped 10,700 machines during the quarter compared with 7,300 units in the year-ago quarter. Average machine sales price was $14,800 versus $15,900 in the year-ago quarter.

Interactive revenue was $52.9 million compared with $12.6 million in the year-ago quarter. On a sequential basis revenue declined 1.9%. Social gaming revenue was $41.3 million while IGTi revenue was $11.6 million in the reported quarter.

Revenues from North America stood at $409.4 million, up 26.9% year over year while international operations revenue decreased 1.6% year over year to $120.9 million in the reported quarter.

Margins

Gross profit increased 22.9% year over year but declined 16.6% sequentially to $309.5 million. Gross margin increased 240 basis points (“bps”) from the year-ago quarter and 10 bps from the previous quarter to 58.9% in the first quarter.

In the first quarter, operating expenses were $169.2 million, up 11.3% year over year but down 7.4% on a sequential basis. Selling, general and administrative expense (SG&A) increased 11.7% year over year but declined 6.1% sequentially to $100.2 million. Research & development (R&D) expense climbed 16.0% year over year but decreased 8.7% sequentially to $54.4 million. Depreciation & amortization (D&A) expense jumped 23.4% year over year but plunged 10.0% from the previous quarter to $19.0 million.

Operating income surged 37.7% year over year to $137.6 million primarily attributed to higher revenue and gross margin base. Operating margin decreased 380 bps to 26.2% in the quarter. However, operating profit declined 27.0% sequentially and operating margin contracted 370 bps from the previous quarter.

Net income increased 54.6% year over year but declined 25.2% sequentially to $76.2 million in the reported quarter. Earnings per share (EPS) increased 69.8% from the year-ago quarter but declined 26.3% sequentially to 28 cents in the first quarter.

Balance Sheet and Cash Flow

As of Dec 31, 2012, cash and investments (including restricted cash) were $277.0 million versus $288.2 million, as of Sep 30, 2012. Long-term debt stood at $1.78 billion, down from $1.85 in the previous quarter. Net operating cash flow was $94.5 million in the quarter. Free cash flow was $56.9 million in the reported quarter.

Guidance Reiterated

For fiscal 2013, IGT continues to expect EPS in the range of $1.20 to $1.30 per share (15.0% to 25.0% year-over-year growth).

Our Take

We believe that increasing investment in product development will increase operating costs going forward. This will remain an overhang on the stock in the near term. Moreover, increased competition from Bally Technologies Inc. (BYI - Snapshot Report), WMS Industries Inc. and Zynga Inc. (ZNGA - Snapshot Report) in its core as well as interactive markets will keep the stock range bound in the near term.

However, improving domestic gaming environment, international expansion opportunities, an impressive product portfolio, cost-cutting initiatives, lesser dependence on the domestic machine replacement cycle, new contract wins, and a strong performance from the interactive business are expected to drive growth going forward.

Currently, IGT carries a Zacks Rank #2 (Buy).

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