Card game equipment maker and Motley Fool Stock Advisor pick Shuffle Master (NASDAQ:SHFL) reports its fiscal Q3 2006 earnings results tomorrow. Want to know what Wall Street expects to see? Read on. Want to know what really matters? Read on a bit more.

What analysts say:

  • Buy, sell or waffle? The tide has once again turned at Shuffle Master, with analysts turning back into bulls. Eight of the 11 who follow the company now rate it a buy, versus three holds.
  • Revenues. Little wonder. Thanks in part to its acquisition of Stargames, this quarter's sales are, on average, expected to beat last year's number by 71% at $46.6 million.
  • Earnings. Profits are predicted to increase 14% to $0.25 per share.

What management says:
There's an interesting dynamic underlying Shuffle Master's recent sales growth spurt. Organic growth (i.e., ex-Stargames) was negative in the high-margin intellectual property (IP) segment, which Shuffle Master calls "Entertainment Products." The entirety of the $10 million sales growth the firm experienced came out of the Stargames acquisition. Where Shuffle Master did grow organically last quarter was in sales of gaming equipment, which it calls "Utility Products." That segment's sales grew 36% in the second quarter. If that trend continues, it suggests that the Stargames acquisition was pretty prescient on Shuffle Master's part, and that unit's high-margin IP licensing sales will be key to the firm's objective of maintaining 25% year-over-year earnings-per-share growth.

What management does:
The more Shuffle Master has sold physical gaming equipment as opposed to licensing its IP in past quarters, the more its margins have suffered. We can see the results of this shift in sales from intellectual property toward more tangible property below, as gross, operating, and net margins each continue their slide.

Note, however, that things aren't nearly as bad as the net margins make them appear. Shuffle Master took a hefty $20 million charge last quarter for a legal settlement, and that's going to weigh down the rolling net margins for a while. For the rest of this year, you're better off judging the company by its operating results.

Margins %

1/05

4/05

7/05

10/05

1/06

4/06

Gross

76.4

75.2

74.8

74.1

72.5

70.1

Op.

42.2

41.7

41.2

39.4

38.0

35.9

Net

25.8

25.4

26.1

25.9

25.2

7.9

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
In his recent re-recommendation of Shuffle Master to subscribers of our Motley Fool Stock Advisor newsletter, co-Stock Advisor analyst Tom Gardner balanced a generally upbeat assessment of the company (which he calls an "extremely well-run organization") with a caution that the firm's balance sheet is "not immune to trouble."

I'd actually call that last bit an understatement, based on recent trends. Thanks to the acquisition of Stargames, Shuffle Master's sales have jumped 56% year over year in the last six-month period. At that same time, however, inventories have roughly doubled, and accounts receivable are up 140%. Granted, demand in Asian gaming markets for Shuffle Master products is surging, according to reports, and the company is making progress on paying down its debt load (which represented 92% of total capital at last report). But on balance, the rise in inventories and A/R is still a concern.

The management of working capital sapped Shuffle Master's free cash flow over the last six months, leaving it at just barely half the previous year's level -- despite this now being a bigger business, and one with more high-margin IP products to sell. What I'll be looking for tomorrow is evidence that inventories and A/R are falling back into line with the projected stellar (subliminal pun) sales growth, freeing up more free cash flow to be spent on paying down the debt.

Competitors:

  • Bally Technologies (NYSE:BYI)
  • International Game Technology (NYSE:IGT)
  • PokerTek (NASDAQ:PTEK)
  • Vendingdata (AMEX:VNX)
  • WMS Industries (NYSE:WMS)

Balance sheet troubles aside, Shuffle Master has proven a richly rewarding recommendation to Stock Advisor subscribers, beating the S&P's performance 33% to 15% since being recommended a little more than two years ago. Find more stellar stock picks in your first free issue of Stock Advisor -- it's right on the other side of this link.

Fool contributor Rich Smith does not own shares of any company named above. The Fool's disclosure policy doesn't play games.