International Game Technology PLC
Q3 2007 Earnings Call Transcript

Published: 19 Jul 2007

[Operator:]

Good morning and thank you for standing by. At this time all participants are in listen-only. After the presentation, we will conduct a question-and-answer session (Operator Instructions) I would like to inform participants that today's call is being recorded. If anyone has any objections you may disconnect at this time. I would also like to turn the call over to your conference host this morning. Mr. Pat Cavanaugh. Sir you may begin.

[Patrick Cavanaugh:]

Thank you, operator and good morning everyone, and thank you for joining us today for our Third Quarter Fiscal 2007 Conference Call. Joining me this morning on the call are T.J. Matthews, our Chairman and CEO, and Danny Siciliano, our Chief Accounting Officer and Treasurer. After taking you through some housekeeping items, that like the Safe Harbor, I will walk you through the financial highlights for the quarter and then pass the call over to T.J. for his closing remarks. Before we begin, I'd like to note that during this Earnings Call, certain statements and responses to questions may contain forward-looking information such as forecast of future financial performance. Although IGT believes that the expectations reflected in any of its forward-looking statements are reasonable, actual results could differ materially from those projected or assumed. IGT's future financial condition, the results of operations, as well as, any forward-looking statements are subject to change and to inherent known and unknown risks and uncertainties. IGT does not intend and undertakes no obligation to update our forward-looking statements including any comments regarding our earnings expectations to reflect future events or circumstances although forward-looking statements in this conference call reflect IGT's current analysis of existing trends and information and represent IGT's judgment only as of today. You should not assume later in the quarter or year that the comments we make today are still valid. Actual results may differ from current expectations based on a number of factors affecting IGT's businesses, including our ability to develop and manage frequent introductions of innovative products, slow growth in the number of new casino's rate of replacement of existing gaming trends could limit our -- or reduce our future profits, and demand for the products could be adversely effected by changes in player or operator preferences. More information on factors that could affect IGT's future business and financial results or cause us not to achieve our forecast are included in our most recent annual report on Form 10-K and other public filings made with the Securities and Exchange Commission. During this call today, references may be made to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures, as well as, the reconciliation of these measures to the comparable GAAP results in our 8-K filed with the SEC today, a copy of which can be found in our website at igt.com. This call, the webcast of this call and its replay of the property of IGT, it is not for rebroadcast or used by any other party without the prior written consent of IGT. If you do not agree with these terms, please disconnect now. By remaining on the line you agree to be bound by these terms. With that said, I'm pleased to report that IGT posted record results for the third quarter ended June 30, 2007. Records included revenues of $707 million driven by record levels of both product sales and gaming operations with a gross profit of $397 million, operation income of $216 million, driven by record operating income for our international division of 56 million. EBITDA of $291 million, game operations installed base at the end of June was 58,200 machines. And year-to-date cash flows from operations of $565 million, up 48% from last year. Other noteworthy highlights include net income of $136 million or $0.41 per diluted share. Year-to-date share repurchases of 14.6 million shares at an average cost of $612 million during Q3. We purchased 6.4 million shares for $249 million. And also during the quarter, we shipped 14,900 Reg 5 units in Japan and placed another 1,100 on realty. Our game operations business continues to deliver record results. We achieved record revenues for the quarter at $342 million, up $27 million or 9% from the prior year. Revenue growth was primarily driven by the 26% increase in our installed base which expanded in both casino and lease operations markets. Sequentially, the installed base increased 3,400 units with a majority of these units installed in the last month of the quarter and therefore not contributing a full quarter of revenues. Game ops gross profit totaled $211 million, up 15% in the prior year. Quarterly gross margins were 62% versus 58% last year. Margin improvements were mostly driven by more favorable jackpot expense which fluctuates primarily as a result in variations in play levels and the timing of jackpots as well as the growing mix of the games that don’t carry IGT sponsored jackpots such as our standalone participation and lease operations games. Game ops gross margins going forward are projected to trend within the range of 58% to 61% with fluctuations based on mix, gameplay, and the time of the jackpots and to illustrate end seasonality. Our casino operations installed base ended the quarter at 39,600 units posted a year over increase of 5,100 units with growth primarily driven by incremental placements in Oklahoma, Florida, and California. Sequentially, our casino ops installed base increased 1,500 units mostly due to incremental placements in Florida and Oklahoma. Our lease operations installed base totaled 18,600 units at the end of the quarter representing growth of 6,900 units over the prior year and 1,900 units sequentially. Primary growth drivers’ year-over-year was Mexico and New York. We also saw expansion in Delaware and Rhode Island; sequential growth was realized primarily in Mexico. We anticipate continued growth for installed base during the fourth quarter and fiscal year '08. Our Mexico installed base ended the third quarter at 7,300 units and we are targeting an installed base of 8,000 units in Mexico by fiscal year end and up to 3,000 more units to be added over the course of the fiscal 2008. In Florida, we expect additional installations during the fourth quarter. Consolidated yields in the third quarter were up approximately $66 per game per day versus $76 in the prior year. Lower average yields are the result of the grow in mix of lease op schemes that carry a lower or fix daily fee. We anticipate yields will trend within a range of $65 to $68 heading on seasonality in the mix of our installed base. Moving on to product sales, record product sales revenue of $365 million for the third quarter was fueled by strong shipments in Japan and Macau, as well as more favorable mix of our AVP machine sales. Machine shipments totaled 36,900 units versus 23,500 units with international shipments driving most of the improvement. Non-machine revenues comprise $92 million or 25% of total product sales up from $89 million in the prior year on stronger gaming systems revenues. Average revenue per unit was $9,900 in Q3 compared to $12,600 last year with the decline due to the higher mix of Japan pachisuro sales in the quarter. Product sales gross margins were 51% in the third quarter compared to 50% last year. We expect product sales margins to trend between 48% and 52%, depending on the timing of sales in Japan and trends in overall product mix. Breaking down sales from a domestic versus international standpoint, domestic product sales revenue totaled 213 million on volume of 12,800 units compared to 187 million and 12,200 units in the prior year. Domestic machine volumes was up mostly due to higher new shipments to properties in Michigan, Mississippi and Pennsylvania replacement shipments totaled 6,500 units for the quarter and we anticipate that replacement demand will trend lower over the next several quarters as we get close to the launch of server-base. Bare in mind that Q1 is generally our seasonally softest and is also the quarter on which the industries big trade show takes place, so there is a natural wait-and-see effect that takes place. New unit shipments will fluctuate depending on the timing of new markets and expansions which at the present time we do not see new units getting back to this quarters level, until at least Q3 of our fiscal '08, based on what we know about the current timing of new openings or planned expansions. Domestic non-machine revenues totaled 68 million or 32% of domestic product sales versus 63.3 million in the prior year. The higher gaming systems revenue was partially offset by lower parts and conversion sales. Domestic average revenue per unit was 16,600 unit in third quarter compared to 15,300 in the prior year. Improvement was driven by more favorable mix of AVP sales which comprise 37% of domestic shipments versus 17% last year. Domestic gross margin improved 2 percentage points to 55% mostly due to more favorable pricing mix and stronger gaming system sales. International product sales revenue totaled $152 million on volume of 24,100 units compared to $110 million and 11,300 units in the prior year. We shipped 14,900 Reg 5 units in Japan during the quarter compared to virtually zero last year. And Macau shipments were up 800 units mostly due to the upcoming opening at the Venetian Cotai. International non-machine revenues totaled $24 million or 15% of international product sales versus $25.2 million in the prior year with the decline due to lower parts and conversion sales. International average revenue per unit was $6300 versus $9800 last year as a result of the mix of Japan units during the quarter. International product sales gross margins were 46% versus 45% last year due to a more favorable product mix in international casino markets. Moving on to operating expenses, total operating expenses were $180 million for the quarter and $501 million year-to-date compared to $161 million and $465 million in the prior year respectively. On an annual basis, we expect total operating expenses to be approximately 26% to 27% of total revenues. SG&A expense inclusive of bad debt was up $30 million from last year primarily as a result of higher staffing cost to support business growth initiatives, and higher legal and compliance fees at a number of markets around the world ahead of revenues, partially offset by lower bad debt. Current year-to-date, SG&A expense included a credit of $12 million for business interruption insurance and a credit for $5.8 million for a gain on the sale of a corporate asset during the second quarter. Actually this credit SG&A was basically flat quarter-over-quarter. R&D expense totaled $51 million for the quarter, up $7 million from the prior year due to higher R&D cost related to new platform, cabinets, systems, and game development. IGT will continue to invest heavily in gaming technology innovation and we anticipate R&D will trend at a range of 7% to 9% of total revenues. Depreciation and amortization within operating expenses totaled $22 million for the quarter, and were comparable to the prior year. Total depreciation and amortization inclusive of depreciation on game ops assets was $66 million compared to $61 million last year. The year-over-year increase is largely due to the 12,000 games added to the install base during the year. Other income net totaled $100,000 for the quarter compared to $3 million in the prior year mostly due to lower cash and investment balances, and higher interest expense on our convertible debt. The year to date tax rate inclusive of one time items is 36.8% versus 36.1% last year, which benefited from one time adjustments. We anticipate a rate of approximately 37.5 to 37.7 going forward depending on the geographic mix of operating income. Moving on to the balance sheet, cash and equivalents and short term investments inclusive of restricted amounts totaled $361.4 million at June 30, compared to $589.1 million as of September 30, 2006. Working capital totaled $605.3 million compared to a $129.1 million at the end of the prior year with average day sales outstanding of 79 days and inventory turns of 4.1. The change in working capital was the result of refinancing our convertible debentures in the second quarter that were previously classified as current liabilities at the end of fiscal '06. Debt totaled $1.1 billion at June 30, 2007 compared to $832.4 million at the end of September. Year-to-date IGT generated $565 million in cash from operations, up 48% from the prior year. Capital expenditures totaled $260 million year-to-date compared to 270 million last year with additional investments mostly related to the construction of our Lag Vegas campus. CapEx is expected to trend at a range of $75 million to $100 million per quarter but could fall once the Las Vegas campus is completed later this calendar year. Year-to-date cash supplied back to shareholders in the form of dividends and stock buyback totaled 742 million. We repurchased 14.6 million shares in the nine months ended June 30, 2007 for an aggregate cost of $612 million and continued to view the repurchase of our shares as an attractive use of our excess cash. That concludes my prepared remarks regarding our third quarter results. Now I will now turn the call over to T.J for his closing remarks.

[Thomas Matthews:]

Thank you, Pat and good morning to everyone on the call. Before opening the line to questions I have few comments regarding our business and the outlook for IGT. IGT delivered another quarter of solid results with new records set on a number of fronts, despite lower replacement demand in Japan and a challenging domestic market; ability to post peak operating income, cash flows, and EBITDA on this environment to the testament, to the diversity, and depth of IGT’s businesses, and our product offerings. We remain optimistic on our future prospects for growth in international market, and we'll continue to focus on expanding our international product and services. Our customers and businesses are becoming increasingly international. So in response we are adjusting our organization to ensure we are well positioned to maximize global market opportunities and reflect our emphasis on different types of gaming markets. As such Steve Morro has assumed the position of Chief Operating Officer, important to me and will be responsible for worldwide casino markets. To accomplish this Steve will form global products and functional groups reporting to him and a globalization of our product groups should help us rely on the economies of scale through the more efficient use of IGT resources. [Paul Karkins] will continue to be the President of our global business development effort. He has done a terrific job these last few years where he has lead the international division to several successive record years. In addition we are continuing our search for our Chief Financial Officer. Interviews of potential candidates are ongoing until a new CFO has been appointed. Danny Siciliano, our Chief Accounting Officer and Treasurer will act as the company's Principal Financial Officer and Pat Cavanaugh, our Vice President of Investor Relations, will act as the company's external voice to the investment community. In our efforts to grow our business, we will continue to use our balance sheet strength and free cash flow to ensure access to new markets and improve market positions whenever it makes sense. We believe the international market provide the greatest number of opportunities to do this, and as examples, during the quarter, we made an investment in China LotSynergy Holdings Limited, CLS, forming a strategic alliance that we believe will provide IGT access to the growing Chinese Lottery market while provide CLS in advanced gaming technology support. We view this as a mid to longer terms opportunity and do not foresee any financial impact this fiscal year or next. Also during the quarter we entered into a cooperation agreement with Casino Clubs in Argentina whereby we agree to drive capital to that standard business in return to the purchase of at least 7,000 IGT machines over the next five years. They also agreed to maintain a certain number of MegaJackpot products on their floors and at first Advantage systems for their properties. In Japan where the market is currently going through the mandated replacement of approximately 2 million in pass and slot machines by September 30, due to your change in regulation. That's a bad news, good news story. The bad news is that the number of machines that we put back into the market by September 30 is likely to be much smaller than the industry originally anticipated. Even you're all Reg 4 games must be out of the market by September 30. There is no requirement that Reg 5 games be put back in. As such operators are initially choosing not to replace every unit they remove. The good news is that there will most likely be greater demand in our fiscal '08 than originally anticipated. Current estimates of June 30th suggested about 700, 000 Reg 5 games have been put into the market, that approximately 300,000 units have exited the market due to product closures leaving another million machines to be replaced from July 1st forward. Current thinking is about 400,000 of this amount will be replaced by September 30th and that 300,000 units was still over under the first half of next fiscal year. Given how difficult it is to predict what might happen, we are currently anticipating that our total fiscal '07 sales would be roughly 35,000 to 40,000 units. And by the time we get to the back half of fiscal '08, it is anticipated, the earliest Reg 5 units put into the market during '06 and '07 begin to replace. Current estimates suggest that the activity could account for as many as another 500,000 units during the second half of fiscal '08. Over next several years we anticipate that the replacement demand in the pass slot market will return to pre Reg 5 levels. That is a turnover rate of something less than two years and as to our goal to capture at least 7% to 10% of this market overtime. Also internationally we remain very active in our closely monetary market developments in a number of countries, primarily in Latin America and Asia. Domestically, the number of opportunities for new unit growth continues to improve, the new properties come online in Pennsylvania, Florida, Kansas, Indiana and Nevada, and as tribes have expanded in California, Connecticut, Florida, Michigan, Washington and Wisconsin. The recognition of new tribes creates new markets for class two products which generally translate into the sale of more class three products. Based on current property opening or expansion plans, it appears that a large portion of these new unit opportunities will occur starting in the second half of our fiscal '08. In addition, we feel the political environment is still right for expansion in states like Alabama, Florida, Georgia, Illinois, Kentucky, Maryland, Massachusetts, New Hampshire, Ohio and Texas over the next few years. IGT is committed to delivering industry leading products and services to our global customers. We continue to invest heavily in the new technology; in fact, we'll be spending a $1 billion in the next five years to develop new products for the industry. We continue to add to our global reach while doing our best act locally, and the gaming industry and IGT are ready for the change that we think that all of our product efforts need to be focused on making the player experiences as good as we can for providing operational efficiency to the casino. We believe that bringing the power of the network to the casino floor will enhance the gaming experience, as there has been more operational control of the casino management. So to this end, we continue to make meaningful progress for those server-based efforts and they remain on track to begin commercializing the product in 2009. Game content will become increasingly robust in the SP world, and perhaps new games will be created as multiplayer game start with the network. Transaction at the terminal, whether they are financial, accounting or security will be analyzed to optimize poor performance. There will also be news services that can be provided to the player, such as bonus features personalized to each player, and in this best one networks, gaming will include, the gaming device is a key op for a wide range of services offer on property. For sets, networks require open standards. The Gaming Standards Association has done a good job of establishing open protocols such as G2S and S2S, IGT is the porches approach, as now the best ideas is going to be delivered across the entire casino floor without the incompatibility issues of the industry's previously used propitiatory protocols. While our gaming operations in the international businesses continue to grow, demand for domestic replacements is likely to remain soft for the balance for the year, and throughout fiscal '08. Additionally, newer expense will be below Q3 levels until at least the third quarter of fiscal '08. Based on when properties are currently scheduled to open or expand. Accordingly, we are leaving our earnings per share guidance for at least the next three quarters in the range of $0.35 to $0.40 per quarter. As our visibility improves, we will visit the topic on subsequent earning calls. I want to thank you for your interest in our company. And we will now entertain some questions.

[Operator:]

Thank you. (Operator Instructions). One moment for the first question please.

[Thomas Matthews:]

Tray, are they any questions?

[Operator:]

Yes, one moment. Our first question does come from Steven Kent of Goldman Sachs; you may ask your question.

[Steven Kent:]

Hi. Good morning T.J and Pat. Maybe you could just give us a little bit more color on the change in the Japan outlook, I mean it still sounds like there is this huge opportunity coming but the timing is a little bit different than do you expected even just a few months ago. So may you can give us a little bit more there and then also even your margins continue to be very, very strong. How much more opportunity is there over the next couple of quarters? And then final, just communal games, had a lot of success there, I just wanted to see you give us an update on that?

[Thomas Matthews:]

Sure. Firstly in Japan, I think really all that happened there is just as you remarked that the opportunity would remain substantial but rather than being exclusive to '07 is build into '08. And I think that targets for a number of machines that we capture both in terms of percentage share and absolute unit has remained the same, but it won't all be in this fiscal year instead some of that are still on the Q1, and really we spread out throughout the entire fiscal '08. And in terms of margins, I think although we reported the margin that we did today, we remarked on the fact that going forward we were within the range that we continue to project. The opportunity for us here is we have some benchmarks, I mean we like to always be at 30% or greater percentage of operating income to revenues, we’d like to be at 40% or greater for EBITDA to revenues and so our goal is to continue to manage to those numbers as best we can. Obviously that takes some expense management and so wherever we can cut cost, we will. But it's much more possible to grow revenues and so that's where our focus is; how can we grow revenues, and in turn margins will take care of themselves. As far as communal games go, we have that product Wheel of Fortune Super Spin that has just been fantastic, and really demonstrates I think how much players want some amount of interaction amongst themselves for nothing else than the experience of celebrating a wining moment. And so it really reinforces in our mind the opportunity of what SB gaming is all about

[Steven Kent:]

Okay. Thanks.

[Thomas Matthews:]

Thank you.

[Operator:]

Bill Lerner of Deutsche Bank you may ask your question.

[Bill Lerner:]

Hi guys. Hi T.J. Let me ask you one in follow-up, just to clarify in Japan Pat I think you are saying, you did 14,900 units in the quarter, did you say you did a 11,000 units rentals. So were we back to the 16,000 unit number which is backlog to begin with and then also T.J. just in terms of confidence on why the units that have exited in pachisuro slot are going to come back in. Is it because the (inaudible) your level of comfort is that essentially the (inaudible) is going to take the volatility back up. I understand why your units are not going back in one for one but where is the level of confidence and then a follow-up.

[Patrick Cavanaugh:]

Bill, on your first question you are correct. We had 14,900 for sale units and then another 11,000 that went in on around for a total of 16,000.

[Bill Lerner:]

Okay, great.

[Thomas Matthews:]

And just in terms of where we see the market, we are just using our best estimates and our conversations with customers and trying to understand what your plans are, the thing that gives us confidence in terms of our ability to capture share is that, though we've had some games that haven't working the market for the most part are Reg 5 games then the best, some of the best performers in market. And that was some of the cases again with Three Kingdom Warrior when it was released this last quarter. So we feel comfortable that if units go back into the market that we'll capture them. There is discussion as to whether or not there will be a modification to the regs that will address the volatility issues. Today it's uncertain as to whether or not that's going to occur. But that would if it did occur that would figure in greatly towards that second half fiscal '08 opportunity of 500,000 replacement units that we marked on.

[Bill Lerner:]

Okay. And then T.J. can you just talk about for minute, what you have in mind a little more with China LotSynergy, on the VLT side its fairly obvious, I mean I understand the central ones, at least a 100,000 units in a short period of time there. So could you just talk about your deal, your venture with them maybe it's exclusive to that or it excludes that, I am not sure. and how about potentially in the future manufacturing non-U.S. kind of destined boxes from Mainland China, given the emerging opportunity.

[Thomas Matthews:]

Well, I think that the goal with CLS was to have a very broad relationship and which we could pursue a number of different opportunities and so it begins with kind of just passive investment that's made in their company in a form of purchase of common stock and the convertible bond. But, ultimately it is going to cause us to share technologies with them perhaps I'll share manufacturing capabilities back with us, you may co-develop some products, and establishment of the joint venture between the companies has occurred and so that the 50-50 joint venture for specifically pursuing these kinds of new opportunities. So, I think to that overtime, we will be able to remark on a number of different activities that we have with them in that partnership and we are looking forward to that with any options that they can bring us. In terms of manufacturing, just kind of in general, is a great amount of sourcing by our company for Chinese made stuff assemblies, as well as, some assemblies made in other lower cost labor markets. I think that, we believe for the U.S. market, at least that final assembly in the United States is a strategic advantage and that we will probably continue to do that. But as we become more and more a global company, either having local manufacturing operations or having manufacturing operations that are at lower expense levels, but something that we'll pay attention to and do not know anything to announce on that front today, but it will be something that we continue to pay attention to.

[Bill Lerner:]

Okay. Thanks guys.

[Operator:]

David Barteld of NCPI, you may ask your question.

[David Barteld:]

Thanks. Hey, just a couple of housekeeping things, Pat my hand cramped up, so could you repeat the non-machine revenues for domestic and international, please?

[Patrick Cavanaugh:]

Sure. Let me find it real quick, David.

[David Barteld:]

And I was also seeing if you could break-up bad debt for us?

[Patrick Cavanaugh:]

Okay, David. Domestic non-machine was $68 million versus 63% last year.

[David Barteld:]

Yes.

[Patrick Cavanaugh:]

And bad debt was, I believe a credit, let me find for you, I don’t have here on my script, up $2 million, a credit of $2 million.

[David Barteld:]

Okay. Were there any adjustment to SG&A in insurance or asset tells or anything like that in the third quarter?

[Patrick Cavanaugh:]

There were not, it was a pretty clean quarter.

[David Barteld:]

Great. Thank you very much.

[Patrick Cavanaugh:]

Thanks, David.

[Operator:]

Joe Greff of Bear Stearns, you may ask your question.

[Joe Greff:]

Good morning Pat, good morning T.J.

[Patrick Cavanaugh:]

Good morning.

[Joe Greff:]

Did you mentioned, what the backlog is for Japan as in now?

[Thomas Matthews:]

We didn’t.

[Joe Greff:]

What is that?

[Patrick Cavanaugh:]

We don't comment on it generally.

[Thomas Matthews:]

It's just that we expect to sell 35,000 to 40,000 machines this year is really the only guidance we have for their market.

[Joe Greff:]

Okay. Got you. And then T.J., may be you can just sort of help us maybe what you view as sort of the number of domestic replacement units over the next 12 months, how you kind of see the size of that market?

[Thomas Matthews:]

Just as a remark, that's kind of advance new technology. We had this situation where -- virtually all of the machines are new -- newly replaced because of Easy Pay and whereas the very, very late innings now of there really been any opportunity to that provide that technology, and so the kinds of replacement units that we are getting are primarily game driven and that doesn't create any kind of acceleration in replacement. So, we think that they are probably going to trend down for a little while longer here, and that obviously have an opportunity with some of the introductions of products that will have a G2E this fall with the advent and server-based gaming and people getting ready for maybe the opportunity to finally start seeing that ramp up towards the end of the fiscal year '08 or obviously have talked great deal about there are being enough taken those kind of number in '09.

[Joe Greff:]

Okay, great. And then one final question Pat, what was the share count at the end of the quarter?

[Patrick Cavanaugh:]

334.

[Joe Greff:]

Thank you very much.

[Operator:]

Harry Curtis of J.P. Morgan, you may ask your question.

[Harry Curtis:]

Hey, good morning. I just wanted to return to server-based gaming. A couple of quick questions. First of all, when do you expect to see some customer feedback on the performance of server based gaming, could it be as early as the end of this year? And then going back to the replacement question, at what point where your existing floor or will the existing floor is need to begin being replaced even if server-based gaming sees a descriptive term as a flop. In other words, there are some Ticket-In/Ticket-Out machines that are probably over five years old. And so it's -- at what point would you expect to see that replacement cycle begin, Epson server-based gaming?

[Thomas Matthews:]

Sure, first on kind of timing on server-based gaming and customer feedback, that's what we've been doing really for the last year or so, is we've had, for as many customers as we can get over to our facility to kind of demonstrate our vision of what server-based gaming can be, and has been extraordinarily important because they've helped the shape what that product will become. And I think that we can already say that we have customers that share our enthusiasm for what networks can bring to the casino floor in terms of the way of enhancing services, personalizing gameplay to individual players allowing for remote management of the casino floor on a real-time basis, I mean all of those things, I think are well received. And we've really until, the one customer that isn’t been touched yet much by this is the player. And so we really don't know whether this is going to matter or not until the player get before, and so we'll continue those technology rollouts through the balance of this calendar year, and would anticipate that probably by the end of the calendar year that we have some feedback to able to say, here's what seems to be working with server-based gaming as a relate to managing cost or increasing revenues on the casino floor. And here is where we saw work to do, but it's still really primarily in '09 event for it been a kind of the complete picture of services and products that we intended to be. So there is some time, as far as that goes. In terms of replacement, the difficulty with replacement is there are really only two forms of it. There is either the form of technological obsolescence that there is some brand new technology that requires that all the boxes be replaced by bill validators and EZ Pay Ticketing were example of that or its game driven. And if it is game driven, there will be increases in capabilities of platforms as you’ve seen already as we go video multi-game, multi-denom, I mean as you add features, you are obviously changing or evolving platforms over time as you see a trend from three reel to five reel game at 2000 cabinet. That' been a big driver of replacement. So that kind of replacement is being done right now and its going to occur irrespective or whether or not server based gaming is successful. But it does, the difficulty with that form of replacement is it doesn't necessarily occur on an accelerated basis. It's really technological obsolescence that causes the accelerated replacement and that why we are so keenly focused on bringing new technologies like network to networks to the floor as a means to stimulate product sales.

[Harry Curtis:]

And a separate topic going to Macau, what percentage of Venetian floors, do you think you have and can you give us a sense of where you think you are in terms of your competitive position in that market?

[Thomas Matthews:]

Well, the Venetian like most, every place out there is in that 20% range where we have been now for a while or frustrated by that percentage as we of course think it's too low. But understand that, we are kind of a late moving into that market in terms of establishing the look and feel, and have kind of fed that to a competitor. And so we've got our work cut out for us. We spend more time and effort really in terms of trying to bring products to that market that make sense than really any other product, not because it's the biggest because at this point the install base of that market is 5,000 going to 10,000 machines, but because it is obviously getting so much focus; and it is going to be a 50,000 for greater market at some point in the future. So our multiplayer development that we are doing, a lot of our ability to bring progressive capability like our Fort Knox product, those kind of efforts really have been aggressively pursued and we're hoping that we are going to be on our way to 50% over time, but it is going to take time.

[Harry Curtis:]

That's great. Thanks T.J.

[Thomas Matthews:]

Thank you.

[Operator:]

Celeste Brown of Morgan Stanley, you may ask your question.

[Celeste Brown:]

Hi guys. Just coming back to Japan, based on what you are expecting to slip into your fiscal first quarter and then 500,000 replacements for next year; what do you think is a reasonable number for IGT assuming no change in regs next year, compared to 35 to 40 for fiscal '07?

[Thomas Matthews:]

We are targeting that 7% to 10% range but we are not there yet and we really have probably closer to 5% and that's probably where I'd start in terms of trying to figure out units that we can capture.

[Celeste Brown:]

And that 400, 000 you think might slip into the first fiscal quarter across the 500, 000?

[Thomas Matthews:]

Right.

[Celeste Brown:]

Okay. And then in terms of the participation units in the quarter were they backend loaded or was it a good quarter and a good presentation of average?

[Thomas Matthews:]

They were Celeste, they are about two third of the unit, went in late in the third quarter. But we didn't get a whole lot of contribution from them.

[Celeste Brown:]

Okay. And then you discussed placing into Florida, was that with the tribes and so if the tribes start to, if the tribes get compacts so they can convert to for sales over the next 12 months and then I guess the question I would go with that is what is your expectations for the tribes in terms of replacements, do they in fact have sign compacts?

[Thomas Matthews:]

The units in Florida are both with the race track and the tribes but obviously primarily with the tribes. We expect that they are going to continue to expand those operation, irrespective of those compact status with the date, but that both them and the state have reflected desire to have a compact, and I would anticipate that at some point in time they will announce successful completion of one. There will probably be some pressure then on Class 2 units been converted to Class 3 units, as may occur in California now that some of those compacts have been ratified and it as may occur in Oklahoma where, we've seen it, saw for instance this quarter, some leased up games converted to sale. So that’s just going to be continue to be coming that we are going to have manage we think that sort of could stop nonetheless as it goes to the Class 3 compacts that you could see may be upwards of a 15,000 machine market there.

[Celeste Brown:]

And if we saw that, the tribe sign a compact before you and how long do you think it would take them to convert and so that is it short or is at a longer period of time?

[Thomas Matthews:]

Yeah, I mean, I really can't speak for their plans but I think that they are capable of doing it in a fair to short period of time.

[Celeste Brown:]

Alright, and then just finally on the international side, were the margins at all impacted by the weak dollar and then also can you give us the Barcrest units in a quarter?

[Thomas Matthews:]

I don't believe margins were impacted Celeste by the weak dollar. And Barcrest were down slightly.

[Celeste Brown:]

Okay. Thank you.

[Thomas Matthews:]

Alright, thank you.

[Operator:]

Robin Farley of UBS, you may ask your question.

[Robin Farley:]

Thanks, yeah, I just wanted to clarify a couple things, your North American shipments were better than what you had guided to in April and it sounds like you expect that to be just sort of a one quarter event. That’s not really changing your annualized North America replacement expectation. And also, if you could talk about what you think your market share was for shipments in North America for newer replacements? And then lastly, your international margins in product shipments were up, and I guess given the increase in Japan, I would have thought that would have actually had a lower margins. And so may be we could talk about what else is going on internationally? Thanks.

[Thomas Matthews:]

First Robin, on your first question on replacement units, unfortunately we do view it as a one-time event, if they were up this quarter. The trend going forward does look to be a little bit lower. As far as the international margins, I think they were well within the range. We guided 48% to 52% last year, but because Japan wasn't as strong as we thought, that's why you saw them at the higher end of that range. Had we had more into the Japanese units you would have seen that gravitate more close to the 48% range.

[Robin Farley:]

Okay.

[Thomas Matthews:]

Yeah, and our market share, we are still low about 50% on new units and unfortunately we are something less than 50% on replacement units.

[Robin Farley:]

Okay. Thank you.

[Operator:]

Joe Fath of T. Rowe Price, you may ask your question.

[Joe Fath:]

Hi, guys. Just a couple of follow-ups on Japan, a clarification and if I missed this, I apologize. The 1,100 units, Pat, that were rental, are those showing up now on the game ops units counts?

[Patrick Cavanaugh:]

They don't show up in the unit count.

[Joe Fath:]

They are not, so it's none of that 3,400?

[Patrick Cavanaugh:]

That's correct.

[Joe Fath:]

Okay. So are you guys -- is that going to be the game plan going forward if the rental picks up. Are you going to show those there or not?

[Patrick Cavanaugh:]

We wouldn't include them in the unit count.

[Joe Fath:]

Okay. That's helpful. And then just a clarification question on kind of the model. When I was over there a couple of months ago, definitely seems like Sega Sammy or Rouse, yourselves and others are using a lot of different rental models, but seems like yours has been the most successful. Just a question, when I look at it from an ROIC standpoint, how are you guys structuring it, in terms of recouping the capital that you have into the box? Are you recouping that over -- because Sega's doing it where they are recouping everything in the first month, right, and then they have a lower fee on the monthly, I'll pass that. Are you guys recouping it in the same time period, longer?

[Patrick Cavanaugh:]

I think what we do Joe as we amortize it over year, 12 months.

[Joe Fath:]

Okay. But how does the fee structure work? I mean is that equivalent to how you are recapturing it with the monthly lease fee or [royal] fee that you have with the part of the operators?

[Patrick Cavanaugh:]

That's correct.

[Joe Fath:]

Okay. Thanks guys.

[Patrick Cavanaugh:]

Okay. Thank you.

[Operator:]

David Katz from CIBC, you may ask your question.

[David Katz:]

Hi, good morning. In your last conference call you talked about your share repurchases and $53 million over a three year period. Should we be crunching that down a little bit given how this is gone, I mean in three year really a realistic time period to by that up?

[Thomas Matthews:]

I think that if you -- we said $33 million over the three years, you got at let's say a price of $40 or so. You get to about $170 million worth of spending a quarter. And so that internally the target was to accomplish just that, but as we remarked in the past, we're going to remain opportunistic and so we seen opportunity for accelerating any of that share repurchase activity because we think prices are favorable, then we'll do so. And so although I don't think we are going to change our guidance on share repurchase. I think there was whatever reason some misunderstanding in the market place about our intensions and our intentions are that we are going to continue to be fairly consistent buyers of our stock on a quarter-by-quarter basis, and continue to probably look for opportunities to increase the run rate if we think prices are favorable.

[David Katz:]

Okay. That's all I had. Thanks very much.

[Thomas Matthews:]

Yeah, thank you.

[Patrick Cavanaugh:]

Thanks David.

[Operator:]

(Operator Instructions). Our next question does come from Bill Lerner of Deutsche Bank. You may ask your question.

[Bill Lerner:]

Thanks, just a follow-up. T.J., so right now obviously, we are in that the absolute troth of the domestic cycle, but you are run rating your peak free cash flow and earnings, free cash flow say like $600 million now, just talk a little bit about year I mean, can you just talk a little bit about the model, and what it implies for, when really matters, a year or 18 months from now when you have the dual expansion replacement cycle overlapping?

[Thomas Matthews:]

Well, I mean, we try to break business into four components, three of those businesses are performing very, very well, game op certainly is the most important and for us to continue to grow that installed base is the primary focus around here is kind of dot number one. And the nice thing about that as we aren't growing it domestically, we are now finding opportunities to grow that installed base around the world. And so, that really is the most powerful driver of performance of cash generation. But you also take a look at non-box revenues troupe and derived, both in the United States and outside of it. And you look at international businesses and how that business continues to grow with record operating income again this quarter. That those businesses are also very healthy, and I think that we will be able to continue to grow those. So, the whole focus on our business is domestic replacement issue and that's a one business that’s non-operating at peak performance. I think it is reflective of a business cycle, not reflective of net surveying diminished competitive standing. And I think that there is the opportunity in next couple of years to revisit increased shipments into U.S. casinos. And I agree when that happens. You see this quarter, how much operating leverage we have. I mean we have fixed operating expense environment for the most part. And all of the incremental revenues and all of the incremental margin dollars that comes from those revenues flow pretty well to the bottom-line. And so, if you really believe in our ability to have a great 2009, 2010 because of the stimulus server-based gaming on domestic replacement, then IGT is a great company to own.

[Bill Lerner:]

It's helpful. Thanks.

[Thomas Matthews:]

Thank you.

[Operator:]

David Katz of CIBC, you may ask your question.

[David Katz:]

Hi, one more. Some of your competitors are actually getting a lot of positive attention from new product and rightfully so. Can you talk about sort of where you are with new games, new products and sort of what kind of reaction you are getting and what your strategy is there?

[Thomas Matthews:]

You know the kind of interesting thing about the competitive landscape right now is that at least, there are three very large competitors and on the Aristocrat, WMS, and Bally all are fairly stable in terms of their technology offerings and as a result can focus on incremental product opportunities like new games and new cabinet styles and they are doing a pretty good job given that dual technology environment. I think they are temporary, I mean I really think that every so often you see, disrupted technology comes to the marketplace by ticketing created and you saw how flat footed our competitors were in being to be able to react to that technological change. And as a result how you feel and look forward in enormous opportunity to make very big inroads in market share, server-based gaming is going to be similar. And so, I think that though there is this temporary law where people can be focused on games, and also they have to be focused on technology, they need to be -- the inoperability question on a casino floor is going to be a big task for our competitors. We are going to cooperate with them and we in fact want them to be able to implement some of these ideas because they need to be floor wide and so we’re going to work with them on that. But I think that, the fact that we are going to be able to continue to outspend our competitor's means that we are going to have the best systems offerings that we are going to have the best platforms, we’re going to have the best games over an extended period of time. And certainly, we are not willing to feed, it might give a nod to a job well done here by a competitor, but aren’t willing to feed anything to any other.

[David Katz:]

Thank you.

[Operator:]

At this time we have no further questions.

[Thomas Matthews:]

All right. Well, thank you very much for joining us on this call and we look forward to talking about our entire fiscal year the next time we get together.