International Game Technology PLC
Q1 2008 Earnings Call Transcript

Published: 17 Jan 2008

[Operator:]

Welcome and thank you for standing by, at this time all participants are in a listen only mode. During the question and answer session, please press star one on your touchtone phone. This conference is being recorded. If anyone has any objections they may disconnect at this time. I’d like to introduce your host for today’s call, Pat Cavanaugh, Vice President of Investor Relations, you may begin.

[Pat Cavanaugh:]

Thank you operator and good morning everyone. Welcome to IGT’s first quarter 2008 earnings call. Joining me today are T.J. Matthews, our Chairman and Chief Executive Officer, and Danny Siciliano, our Chief Accounting Officer and Treasurer. Before we begin I’d like to note that during this earnings conference call, certain statements and responses to questions may contain forward looking information, including forecasts of future financial performance and estimates of amounts not yet determinable. Potential for growth of existing and the open of new markets for our products as well as future prospects and proposed new products, services, developments and business strategies. Actual results could differ materially from those projecting or are reflected in our forward looking statements and reported results should not be considered an indication of future performance. IGT’s future financial condition, results of operating 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. All forward looking statements made 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 materially from current expectations, based on a number of factors affecting IGT’s businesses, including

[T.J. Matthews:]

Thank you Pat and good morning everyone. Before I open the line for questions I do have a few comments I’d like to make about our business and the outlook here at IGT. Obviously we’ve been operating in a difficult environment, it’s been the weakest replacement demand that we’ve seen since 1998. This is going to continue in Q2 but we expect that we’ll start seeing improvements to replacement demand in Q3 and Q4 coinciding with some of our product efforts. This last quarter, units shipped were down 25%, but nevertheless, product sale revenues were down just 1%, reflects both expansion of pricing and margins on our existing products, largely driven by AVP and better geographic mix as we continue to expand our efforts outside of the United States. We continue at these peak earnings and margins despite these minimal demand levels which really reflects well on what we anticipate in terms of being able to expand that even further when we see an uptick in revenue. There’s going to be three drivers for expanding revenues through our fiscal years 2010. It’s going to be the new and expansion capacity that we’ll see during that period. We’re going to have continued momentum in our international operations and we’ll see the SB commercialization and the subsequent replacement cycle opportunity that is associated with that. So let me describe each of those in a little bit more detail. The new and expanded growth will start in Q3, we’re going to see shipments pick up because we’re going to have units shipped to the race tracks in Indiana, we will have some openings here in Las Vegas for the local market, we’re going to see expansions in Native American casinos in California and Connecticut and beyond that period of time we’re going to have major resorts opening in Las Vegas, Atlantic City, outside of the country in Singapore, we’re going to see the impact from the expanded compacts in California and Washington. There will be the continued build out of the market in Pennsylvania. There is going to be a new market opened in Kansas. As a result o all of this, our estimate is that there will be over 100,000 units of new or expansion units by the end of 2010 created in North America and the international market has a potential to either match or surpass North America for growth. Also you’ll see continued market development efforts for potential new markets. And something to watch here in the next few months will be Maryland where there’s a spot referendum in November. Massachusetts, where the governor has proposed three casinos. Kentucky, where the governor is preparing legislation for the expansion of gaming. And in Florida where the compact discussions between Seminoles and the state have been finalized, approved by the government, still a court challenge so we will be watching that as well as the vote that is going to take place in Miami Dade County later this month. Internationally, we had a very fine quarter and we continue to expect that to expand over time. The operating income year over year was up 88%. We shipped 6,800 casino units throughout the world and we have now nearly a 10,000 game machine install base for our game operations. So due to the size and the number of these international opportunities, both that exist and continue to grow, we expect there is a possibility, at least within product sales, that we will see international contributions surpass that that we realize here in North America. We also continue to keep our eye on the large populations that have minimal or no exposure to gaming, which could provide extensive gaming opportunities in the coming years. Those include mainland China, India and Brazil. In SB, we continue to make progress. That includes discussions with almost all of our operator customers, especially those that are opening a casino within the next few years. And while we expect that SB is going to represent a significant upgrade to casino floors on the systems side, obviously we’re focused on the machine opportunity for a replacement cycle and that really begins in Q3 for us as we introduce new cabinets and platforms that are situated for the future introduction of SB by casino operators. We’re going to see the SB cycle in our minds play out in three phases. That first effort from us is going to be a commercial rollout of new operations where we have existing operators continuing to stand on the sidelines looking for proof of upside and ROI that makes sense. That second phase will be those existing floors starting to install, prove results for themselves, and we anticipate that really is the driver of the replacement cycle. We think that that’s going to start taking place in early 2009 for us. And the third phase is wider adoption that leads to a changed business model for all of the operators and really results in that accelerated placement cycle of which we’ve all spoken. As a result of all of this, IGT will be moving to a more service software revenue orientation that has an expanded margin associated with that and really less reliant on product sales at some point in the future. So our guidance as a result of these drivers is that because of the new product introductions, but also some uncertainties surrounding the future market conditions, especially replacement demand in the second quarter, we think that we keep the range in place at $0.35-$0.40 but we probably operate outside of that range over the course of each of the next three quarters, perhaps a little bit to the weak side in Q2, because of lack of visibility to new and expanse unit, but likely to exceed $0.40 of earnings in both Q3 and Q4 because of reasonably good visibility to the same. And so we’re going to continue to revisit earnings guidance as we have future calls and we gain continued clarity both to the impact of our product introductions on replacement demand as well as our ability to calculate what new and expansion environments mean to us and so we look forward to those future opportunities to speak and appreciate your interest this morning in IGT and will now open the line to questions.

[Operator:]

(Operator Instructions) David Katz of Oppenheimer, you may ask your question.

[David Katz:]

Hi good morning. A couple of quick ones, Pat, in your comments you talked about gross margins I think on product sales ranging between 49-53 and as I look back over the last couple of years you haven’t dipped below 50%, is there something out there that we should think about or be aware of that may sort of drag you down below that 50 mark?

[Pat Cavanaugh:]

David, the primary thing that would cause it to the lower end would be an increase in units to those lower margin markets like Japan and the UK.

[David Katz:]

Got it and one of the things I noticed on your cash flow is that you have D&A that you’re adding back of 78 and change and in your EBITDA reconciliation and in your comments you had 69 and change. What am I missing there?

[Pat Cavanaugh:]

Yeah, the difference is the non-cash items, which would be things like bad debt expense and in the prior year we had the write-off for those of the unamortized discount on the old convertible bond that we replaced a year ago in December.

[David Katz:]

Got it and then the third and last, international sales have been kind of lumpy and we found that it’s obviously great that you have it but we found it a little bit harder to forecast both units and margins, what kind of visibility or help can you give us, I know you said level off, level off from where I guess is what I’m asking?

[Pat Cavanaugh:]

Well, one, we had an exceptional Q1 and we don’t anticipate being able to repeat that again in Q2. Over time we will because the international business continues to grow and provide additional contribution to the business. But seasonally, Q2 internationally is one of our softer quarters. We had a real strong quarter in Australia, Europe, South Africa, Latin America and those will all probably, with the exception maybe Europe, probably be down on Q2, it’s just hard for us to put an exact number on how much they’ll be down.

[David Katz:]

Okay, thanks.

[Operator:]

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

[Joe Greff:]

Good morning Pat, good morning T.J. I was hoping you could give us an update, T.J., on the CFO search and then a couple follow up questions for Pat. You’d mentioned that you’re working on adding more gains on the AVP network, how many do you have right now in the AVP network and where do you need to go to get the critical mass to start an acceleration of AVP platforms being sold and where does play up in the next couple of quarters so we do indeed start to see a list in the third quarter.

[Pat Cavanaugh:]

Right, well we started selling the AVP platform a year ago in January, so about, well no almost two years ago, we’ve been selling that platform for about two years. It’s accounted for something less than 30% of the mix this most recent quarter. It was a little higher than that, so it’s been picking up from probably something that was around 10% and we anticipate that it’s going to continue picking up from here on forward and the reason for that is we’ve now moved all of our game types and cabinet styles over to the AVP. So the AVP will serve as the platform of choice going forward and the reason for that is it’s a PC, so it’s got a hard disk, it’s capable of hooking up to an Ethernet network, et cetera, so that it will be the platform we believe that will be used for server base. And we’re increasing the number of games that we create for that platform. That should help, the increase of mix going forward.

[T.J. Matthews:]

And on the CFO search, I think on the last call we said that we’re aiming for, ourselves, in terms of a goal, was the annual shareholder meeting that’s going to take place at the end of February and although there may be a slippage of a week or two in there, that’s really still the timing of a likely announcement form the company. We continue with the search but as you can imagine we’ve narrowed it down to a pretty small list of final candidates.

[Joe Greff:]

Gotcha and just one clarification Pat, you had mentioned that the revenue per unit per day results in the quarter in gaming ops that that’s solely a function of mix. If you kind of were to do a same box year over year comparison, are you seeing any kind of softening in flat play, is it sort of regional, is it anecdotal or what are your views as you look through the numbers and look across your portfolio?

[Pat Cavanaugh:]

Right, it’s a hard thing to, you know there’s a lot of factors that affect play levels and so it’s hard to isolate any one, but on the surface, alls that we’re seeing at this point is normal seasonality, but we’re also conscious of the fact that without exception, almost every major market in the US has reported down quarter over quarter gaming revenues, but we’ll continue to keep a close eye on it going forward.

[Joe Greff:]

Great, thanks guys.

[Operator:]

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

[Celeste Brown:]

Hi guys, good morning. T.J., you talked about the three different phases of server based gaming, with the third phase really leading to an acceleration in the replacement cycle. Do you think we see some sort of a normalization before acceleration, you know as acceleration implying a shorter span and you know before that we see something more typical of what you would expect?

[T.J. Matthews:]

Well, I mean the driver of replacement will always be some sort of technological obsolescence of the existing install base that occurs because new product has the wherewithal of driving incremental revenues to a casino floor and so, where we are in the cycle is very much the same place we’ve been in past cycles associated with the bill validater and before that other advancements in the gaming devices and so, though disappointing, that there’s a challenging environment, I suppose in some ways it’s not unexpected. The replacement demand we saw in Q1 probably continues in Q2. We start having the wherewithal to control replacement of IGT products in our minds in Q3 Q4 with the introduction of new products because the new products on their own, independent of SB we think are compelling enough that they drive incremental demand from existing operations that we have the opportunity to bring new games that the new cabinet styles provide a different look and feel and in some cases have the opportunity of outdating kind of a fashion model previously sold equipment, and so we’re pretty excited about the idea that we control the opportunity to get upticks in replacement Q3 and Q4 in advance of SB but it really is a technology along the lines of server based gaming that becomes floor wide in nature that has the opportunity to compress what people have argued is a seven to ten year replacement cycle had the opportunity to compress that into a matter of a few years as we saw [TL].

[Celeste Brown:]

So, basically you’re saying that you’re expecting IGT share to pick up in the second half, so maybe the industry overall doesn’t see an acceleration in replacements?

[T.J. Matthews:]

Yeah, our internal model, we show an increase in replacement units both in Q3 and Q4 as well as the tremendous demand of new and expanse units and we think that’s independent of macro demand for replacements.

[Celeste Brown:]

Okay and then, T.J. or Pat, you mentioned California as a driver of the third quarter, are you including that in your non guidance for the back half?

[Pat Cavanaugh:]

We are, but it’s a nominal number of units Celeste.

[Celeste Brown:]

And that’s for the tribes that have the compacts that are being questioned in the referenda next month?

[Pat Cavanaugh:]

That’s correct.

[Celeste Brown:]

Okay and then can you just talk a little bit more about the international markets that drove demand, as David said, quite surprising. If you could just give a little more detail on what specific markets drove your strength in the quarter?

[T.J. Matthews:]

Well the nice thing about it is that we can say every market. We have two kinds of markets outside of the United States, we have the low priced environment that we operate in in Japan and in the United Kingdom. Those continue to be under some pressure, each for their own reason. But in the casino market throughout the world have been extraordinarily healthy, in some cases its continued, replacement activity and expansion as we see in Europe and South Africa, where technologies are still being introduced, in other cases of course it’s the expansion of new units as we see in Asia and to a lesser extent but still nonetheless felt in Latin America. And so it’s really across the board and our ability to continue to expand share in Australia has been very important for the company and so that’s a market where most people are focused on the install base as a measure of share, ourselves included, actually our shipped share has been far in excess of our install share for quite some time there and we’ve felt very comfortable with the fact that we’ve emerged, not only as a legitimate second player in that market, but in many instances feel like we are the preferred player in individual states in Australia.

[Celeste Brown:]

Okay great and then finally just one more question on international, can you just discuss what drove the Mexican, the removal of machines in Mexico?

[T.J. Matthews:]

Those machines are just temporarily removed in that they are still trying to balance their existing locations in terms of being in the right population centers, how they are competitively situated relative to others, our customers, CIE of course had a big head start in terms of rolling out machines in advance of others, but is now starting to compete against new facilities. And so that’s causing them to rebalance their portfolio of locations. That’s the primary driver, to a lesser extend but nonetheless just important is the big effort on our part to continue to develop new games for that market that are specific to the Mexican player, we are seeing some different kinds of demand for products from our competitors and so IGT continues to have a very substantial effort bringing new game introductions. And that will coincide with some of the reintroduction of the existing terminals as well as what we anticipate being the resumption of growth in that market that Pat commented on.

[Celeste Brown:]

Okay, thanks.

[Operator:]

Bill Lerner of Deutsche Bank, you may ask your question.

[Bill Lerner:]

Thanks hey guys. T.J. can you just please clarify the guidance comment, just want to confirm this, you of course mentioned that in next fiscal quarter, of course that’s as expected the trough quarter, you know you’re at the low end of your current range then you start to break out of the range subsequently, beginning in the June quarter and beyond, but with sort of the combination of the change to AVP and then in addition to that all this game expansion bag and tag in the pipeline I would suspect that you can materially accelerate beyond the $0.40, so can you just clarify what you said about breaking out of the range type of number and what aren’t you including in that thinking, I’d appreciate that.

[T.J. Matthews:]

Sure, the fact of the matter is, the range stays in place at $0.35-$0.40 as the official guidance given by the company. No reason for us to change that but we look at immediate prospects for Q2 just given that replacement demand is likely going to reflect that of Q1, that international sales might be slightly down, our expansion and new units might be down, all of that offsets of course the seasonal uptick in game play for game operations, that we would not be surprised if not only do we end, trail towards the lower end of that guidance but that perhaps we even miss on the low end. That said, I think that without changing guidance, we can feel very comfortable we are likely to exceed that range and so as a result have a $0.40 plus quarters in each of Q3 Q4, that’s subject to of course timely delivery of our new products and that having associated demand we can fill and the timing of new and expanse units taking place in accordance with what we have currently forecast. But you know we’re pretty close for instance to a Q3 and so we would be very surprised if there’s a whole lot of movement now between now and the end of June on some of the new and expansion plans that we have. So potentially $0.35 or maybe even slightly below for Q2, $0.40 plus in Q3 and Q4.

[Bill Lerner:]

Okay, thanks T.J.

[Operator:]

Robin Farley of UBS, you may ask your question.

[Robin Farley:]

Thanks, I wonder if you could give us your market share for some of the major orders in the quarter in terms of product sales, like Palazzo and any other large orders to percents of market share?

[T.J. Matthews:]

Yeah I think probably the most visible evidence of market share remain intact especially for new facilities, will be the opening of Palazzo that I think a lot of folks in this call with have an opportunity to see first hand over this weekend and you’ll still see a 70% plus presence of IGT equipment on that floor. Our ship share was a little bit lower as we moved some machines from the Venetian into that floor, but I think that we remain in that category for new facilities. Where we’ve remarked in the past, our struggle is really the fact that IGT has penetrated existing floors so well in the past that we do see that very slight increases of performance from certain of our competitors has allowed them to increase their ship share against our efforts and so that’s really why we talk so much about the idea that we have to have new product offerings for us to not only be able to accelerate replacement but in association with accelerating placement, presumably you’ll see an acceleration of our ship share as well.

[Robin Farley:]

Alright and then in terms of the [winfree] unit and the game op pie I think I know you mentioned seasonality and you mentioned sort of looking for [unintelligible] markets are doing in the US but I wonder if you could comment on, when you look at the year over year just you know [winfree] unit that would help the seasonality factored in and I guess some of the California units were offline for a week or so with the fires in Q4, but is there a way you can give us a sense of what that year over year casino win per unit would have been like if you take out the impact of I guess it’s 800 lost units?

[T.J. Matthews:]

Yeah I mean there certainly would be an impact from the lost units over the course of the week but I’m not sure that we’ve quantified it in a way in which we would remark. The thing for us is that we grew that install base year over year by 10% and we grew gross margin in the same category in ’07 and so we were disappointed by that, it is in line with seasonal play levels and so you know with the domestic alarming about those statistics but nonetheless as Pat had remarked you know where you’re seeing declines in year over year comparisons in individual markets through most of December, we do have our eye on kind of the overall trends throughout all markets and will probably be just as interested as all of you on what operators have to say about what they’re seeing, what kind of trends they’re seeing in player demand. But otherwise, you know play levels are very much in line with what we’d normally see due to seasonal factors.

[Robin Farley:]

Okay and then can you give us a sense of the timing for this field trial for some of the more front facing server based features like the service [unintelligible], when the field trials of that will be taking place. Is that in Q2?

[T.J. Matthews:]

No, I mean we have, we continue to have the field trials that we’ve had in the past out in the market. Right now the timing for our next big delivery on SB is in our third quarter and then we anticipate that the introduction of SB functionality that really makes a difference is going to take place in Q1 next year. So you know the two outstanding questions for SB that I continue to ask both internally and I think it’s reasonable for the investment community to ask is when will it happen and when will it matter? And it will happen really by placement of the technology into some new casino environment and then that new casino environment, you know we have the opportunity to have a big impact on the operations in a way in which we can have a story to tell to existing operators. That’s probably a 2009 event, although there will be expanded tests between now and then and when it will matter is when we actually have feedback that we, because of the access of management of the casino floor, because of the aggregation of existing system offerings, because of the introduction of new applications, better player interfaces, that we’ve actually impacted the operation positively, either by growing revenues and maybe not as important but by increasing the efficiencies of the casino operator that once we’ve done that then we have a real story to tell about accelerated replacement demand over these new technologies but the associated boxes required to implement these new technologies. And so really all the timing that we’ve remarked on in the past remains intact that we continue on technology, regulatory, customer approving throughout this year and 2009 is the year in which we have rolled out and 2010, late 2009, 2010 is when we start really experiencing increased demand because of the effect of SB. But we can start experiencing upticks in replacement demand in advance of that with these new cabinets and platforms that are being introduced in Q3.

[Robin Farley:]

Okay, great, thanks, just the last thing is Pat can you give the [unintelligible] by region, you know a little more detail to break down product sales?

[Pat Cavanaugh:]

Sure. The Western region was 3560, the Central region was 1900, Eastern region was 1370 and Canada was the balance of, some over 500. And then internationally, we had Asia and Australia at 2700 units, Europe at 2,100, UK at 3,100, and Japan at 3,000 and Latin America and others looks like about 2,000.

[Robin Farley:]

Alright, thank you.

[Operator:]

To ask a question, press star one. Our next question comes from Amir Markowitz, JP Morgan.

[Amir Markowitz:]

Hey guys, good morning. Could you just discuss a little bit about your feedback you’ve been hearing from your customers about maybe some of the products, the server based products you had on the show floor at G2E and maybe a little bit as to what they’re telling you, kind of the feedback you’re hearing versus what some of your competitors are offering.

[T.J. Matthews:]

Sure I mean I think we had a great show in November, I think the feedback on our game initiatives, particularly some of the things we did to involve community play, products like Indiana Jones and eBay were very well received. Some of the technologies that were implemented, but in particular that MLD product stood out, that was implemented on the Indiana Jones product. ADP widescreen is something that’s being deployed now with our Wheel of Fortune products and it’s being very well received. We had those multiplayer units that were on display and obviously making advancements would be in the category of both traditional casino games but other forms of multiplayer units using that technology. Some interesting advancements that we had done with the remote game server and our wager works effort, we introduced a deal for the first time formally, so there was a lot going on in that booth. Server based gaming of course getting the most attention as it should. Most of those conversations have been taking place offline, those weren’t show floor conversations. Us continuing to demonstrate how they will be able to use this product, the user interface that we had in place both on the show floor but also we were able to demonstrate really has made huge advancements in terms of us having kind of an intuitive product that really will accommodate the real time management of the casino floor that we’ve been discussing in the past. We have the ability to demonstrate the service window, not only on our product but we had three other manufacturers in our booth that incorporated the service window agreements, we think with other manufacturers beyond that. That’s very important in terms of having the player interface both for player tracking and bonusing functionality as we do now but also some of the promotional activity and some of the new applications that we’ve been discussing that come with server based gaming and so the feedback really is the questions that we’ve asked in the past. A new property has much less of an impediment for them being able to say to this product, they have an obligation to themselves to deploy and administrate a system that tracks their player activities, that provides incentives to players in the form of bonuses that allow them to grant promotion to the casino floor in the form of tournament, all of that being able to be accommodated by server based gaming that in effect you know a pretty close price range to that of existing systems and machines, really allows a new property I think to adopt the technology and get excited behind it. As we anticipated, as I said in the past, we anticipate we’ll have some announcements about new properties embracing server based gaming over the course of this calendar year but hopefully sooner rather than later on that front. And then it’s really existing properties proving to themselves that by deploying the technology that they can justify reinvestment in their existing casino floors. That’s a much greater challenge, I don’t think we really have the opportunity to prove that much until we go into calendar 2009 but we very much expect that like in times past, that once that ball gets rolling it gets rolling in a hurry and in a big way because of the competitive nature of our customers, each wanting to make sure that they stay current with their product offering. So, the timing remains the same, the feedback from customers has been terrific. I think we’re on the right track with all of our SB initiatives.

[Amir Markowitz:]

Thanks.

[Operator:]

We have no further questions.

[T.J. Matthews:]

Well I want to thank everybody for joining us this morning and we look forward to the opportunity to update you on our business again in Q2 and the time between. Thanks.