Shares of International Game Technology (IGT) were up 9.31% ($1.52) in after-hours trading due to a year-over-year earnings growth of 21.1% in the second quarter of 2011. Earnings per share (EPS) in the second quarter of 2011 surpassed the Zacks Consensus Estimate of 20 cents by three cents.

Operational Performance

In the second quarter, IGT reported non-GAAP earnings of 23 cents per share, up from 19 cents reported in the prior-year quarter. Net income on a non-GAAP basis was $69.6 million, up 18.0% year over year. Net income margin shot up 200 basis points (bps) to 14.1% on a year-over-year basis.

Non-GAAP gross profit was $292.0 million, up 7.4% year over year. Gross margin rose 340 bps to 59.3% in the second quarter, primarily due to lower cost of gaming operations and product sales.

Gaming gross margin of 62.0% was flat compared with the prior-year quarter, as improvement in per unit yield was fully offset by a lower installed base in the quarter.

Product sales gross margin increased to 55.0% in the second quarter from 52.0% in the prior-year quarter, attributable to an improvement in product mix and cost efficiencies.

Operating expenses were $161.0 million, up from $154.5 million reported in the prior-year quarter. The increase was attributable to higher selling, general and administrative (SG&A) expense (up 9.8% year over year).

Operating income increased 11.5% year over year to $130.9 million. Operating margin was up 250 bps on a year-over-year basis, primarily due to lower operating expenses and higher revenue growth in the quarter.

Revenue

Total revenue was up 1.1% year over year to $492.3 million in the second quarter. Gaming Operations contributed 56.4% to the total revenue whereas Product Sales accounted for the remaining 43.6%.

Segment Details

Gaming Operations revenues dipped 0.8% year over year to $277.6 million in the second quarter, primarily due to a lower installed base. Average revenue per unit (ARPU) in the second quarter was $53.62, up from $50.96 in the year-ago quarter; driven by an increased mix of newer, higher-yielding games, higher play level and expected normal seasonality.

At the end of the quarter, the company’s Gaming Operations installed base totaled 57,100 units, a decrease of 1600 units from the year-ago quarter, but up 400 units from the preceding quarter. The year-over-year decline was due to weak results in North America, given the regulatory issues in Alabama and the conversion of leased games to for-sale units in Mexico.

Product Sales were up 3.9% year over year to $214.7 million, primarily due to higher new shipments in both International and North American regions.

North American revenues increased 9.1% year over year to $135.0 million in the quarter. However, International revenues decreased 4.0% year over year to $79.7 million.

The company shipped 10,000 machines during the quarter, up from the prior-year shipment of 9,500 units.

Balance Sheet

As of March 31, 2011, cash and investments (including restricted cash) were $373.4 million versus $253.6 million as of December 31, 2010. Long-term debt was $1.55 billion versus $1.57 billion in the prior quarter.

During the second quarter of fiscal 2011, IGT paid all of the outstanding borrowings under its credit facility. Most recently, IGT entered into a five-year revolving credit facility worth $750 million with a syndicate of banks replacing its previous $1.2 billion revolving credit facility. The new unsecured facility provides a lower all-in drawn interest rate and extends the maturity from June 2012 to April 2016. IGT may request an increase in the facility size up to an additional $250 million at any time during the life of the facility.

In the second quarter of 2011, cash flow from operations was $161.3 million compared with $102.4 million in the prior quarter.

Guidance

IGT believes that it will continue to achieve moderate revenue and earnings growth for the remainder of fiscal 2011 and in fiscal 2012. Management believes visibility is limited and expects continued pressure from the macroeconomic environment during the second half of 2011.

IGT expects EPS in the range of 84 cents to 90 cents per share (up from the previous guidance of 79 cents to 87 cents per share), excluding a gain of 4 cents from certain discrete tax items and a penny per share gain on an investment sale.

Recommendation

After a lackluster first quarter 2011, IGT gained some momentum in the second quarter primarily due to higher new shipments.

We believe that international expansion, an innovative product pipeline, lower debt obligations (over the last two years IGT reduced contractual debt obligations by nearly $600.0 million), focus on reducing dependency on the domestic machine replacement cycle and strong growth from the interactive business will drive growth over the long term.

However, sluggish macroeconomic conditions, lack of visibility on replacement sales, very few new openings and increasing competition particularly from Scientific Games Corp. (SGMS) 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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