International Game Technology PLC
Q1 2009 Earnings Call Transcript

Published: 22 Jan 2009

[Operator:]

Welcome and thank you for standing by. (Operator Instructions) Now we’ll turn the meeting over to Patrick Cavanaugh. You may begin.

[Patrick Cavanaugh:]

Thank you operator and good morning everyone. Welcome to our first quarter 2009 earnings call. With me this morning is T. J. Mathews, our Chairman and Chief Executive Officer. And as customary 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; the potential of existing and the opening of new markets for our products; play levels for our install base of recurring revenue games, as well as our future prospects and proposed new products, services, development or business strategies. Actual results could differ materially from those projected or reflected in our forward-looking statements and reported results should not be considered an indication of future performance. IGT’s future financial condition and 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. 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 unfavorable changes to regulations or problems with obtaining or maintaining these licenses or approvals; decline in the popularity of IGT games or unfavorable changes in player and operator preferences; or a decline in play levels, including play levels of recurring revenue games; unfavorable economic conditions which may reduce our product sales and the play levels of our participation games; decreases in interest rates which in turn increase our cost of jackpots; slow growth in the number of new casinos or the rate of replacement of existing gaming machines; failure to successfully develop and manage frequent introductions of new innovative products. More information on factors that could affect IGT’s future business and financial results or cause us not to achieve our forecasts 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 comparable GAAP results in our 8-K filed with the SEC today, a copy of which can be found on our website at igt.com. This call, the webcast of this call and its replay are the property of IGT. It is not for re-broadcast or use 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, this morning IGT reported first quarter results for 2009 and the company generated $0.29 in earnings per share excluding a number of significant items we detailed in our press release and on which I will provide more color later in the call. Our results reflect the challenging operating conditions that currently exist in our industry; of credit market conditions and the global economic slowdown have led to changes in the purchasing and strategies of our casino customers; and constrained the visitation and spending habits of casino patrons. Macro issues driving these conditions are both complex and unpredictable, but we have responded to these challenges by reevaluating our organizational structure and initiated a cost rationalization effort to better align our operating costs with the current business environment. Moving into some of the more specific areas of our business, first gaming operations. Our gaming operations continue to see the most immediate effects of the marketplace conditions, with revenues down 5% sequentially and 6% year-over-year. We earned an average of $53.00 in revenue per unit per day versus $62.00 in the prior year quarter, and $60.00 in the immediately sequential quarter. Lower yields are primarily the result of a decline in industry play levels that have reduced average yields on variable fee games combined with the growth and the mix of lower yielding fixed fee games in our install base. IGT’s install base ended the first quarter at 60,900 units which was up 1,200 year-over-year and 400 units sequentially. Approximately 74% of our install base is comprised of variable fee games that earn a percentage of machine play levels rather than a fixed daily fee. Install base growth in the international and domestic lease market was partially offset by reductions in Florida and California Class II operations as Native American operators were granted the permission to install Class III and as such have been moving to the Class III for sale model. Gross profit on gaming operations declined 19% year-over-year, primarily as a result of interest rate reductions during the quarter that contributed $17.2 million in additional jackpot expense due to the higher cost to fund jackpot liabilities. In addition, the current quarter also included $4 million in fixed asset charges related to technological obsolescence. If we excluded significant items from comparable periods, gross margin on gaming ops would have been 58% versus 61% in the prior year, with the dealt in those two largely due to lower play, lower volumes and thus the larger – a heavier carry [pos] in overhead. Regarding jackpot expense and its impact to margins, lower interest rates result in higher costs to playing jackpots. During the quarter, we saw a continued decline in interest rates with a 75 basis point drop in prime and an approximately 100 basis point drop in Treasury and agencies. We expect the margin impact to continue as a result as rates are anticipated to remain low by historical standards for the foreseeable future, making it now more expensive to fund jackpots, tied to our wide area of progressive machines without any accompanying increase in revenue. Also of note for comparability purposes, due to a fiscal year calendar adjustment our first quarter had an extra week of operations that contributed approximately $22 million of additional revenue and $12 million in additional gross profit. Looking ahead we anticipate continued modest growth in our install base in the coming quarters, albeit mostly coming from lower yielding markets. Visibility on overall yields trends is not clear and under the current operating conditions as a result we are expecting yields to remain mostly flat over the next several quarters, even though in a normalized environment we would see an up-tick in second quarter yields due to seasonality factors. It is also important to note that as a result of our significant footprint in the gaming operations states, especially in traditional casino markets where variable fee games are more prominent, IGT has a greater degree of exposure to industry play levels. Moving into product sales, domestic product revenue sales totaled $215 million on volume of 9,500 units for the current quarter compared to $167 million or 7,300 units in the prior year quarter. Replacement demand decreased during the first quarter as IGT sold 2,800 replacement units compared to 4,900 in the sequential quarter. Replacement demand across the industry is down due to customer capital constraints and balance sheet issues. We shift 6,700 new and expansion units in the quarter, up 2,400 units from the prior year quarter due to a strong pipeline of new openings here in the quarter. The calendar of new and expansion openings subsides for the next two quarters before picking up again at the end of the fiscal year. Domestic non-machine revenues totaled $78 million in the quarter, up from $76 million in the prior year quarter. With an expanded footprint of network systems we anticipate higher demand for upgrades with lower demand for new system installations in the coming quarters. Network systems revenues are always volatile from quarter-to-quarter depending on the timing of the projects. We expect to see continued lower demand for conversions sold for our legacy platform products as a result of our migration of development efforts to the AVP platform. Domestic average revenue per unit was $22,600 for the quarter, flat to the prior year quarter. Sales of machines utilized in our AVP platform comprised 90% of total North American machines. Shift during the first quarter and likely will remain at this level or higher in the future as our legacy for sale products are phased out. International product sales revenue totaled $73 million on volume of 6,200 units compared to $147 million and 12,900 units in the prior year quarter. First quarter of 2008 saw record results in most regions, while this year’s quarters results were challenged by unfavorable global economic conditions affecting most regions. Last year also saw a weak dollar benefit, while this year the dollar has significantly strengthened and acted as a headwind on our international results due to less favorable foreign currency translation rates. International non-machine sales were $20 million, down from $23 million in the prior year quarter. The decrease in the quarter was driven by a decrease in parts and game conversion demand. International average revenue per unit in the first quarter was $11,800 up 4% from the prior year quarter. The increase was driven by pure lower priced machines shipped into Japan and the UK. On a worldwide basis, product sales revenue totaled $288 million for the quarter compared to $314 million on the prior year. Worldwide we shipped 15,700 machines during the quarter, down from the prior year shipments of 20,200. Non-machine revenues comprised of gaming systems, game theme conversions, tables, cards and intellectual property fees came in at $97 million for the quarter or 34% of total product sales compared to $99 million or 32% of total product sales in the prior year quarter. Product sales gross margins for the quarter were 50%, down 3 percentage points from the prior year primarily due to a less favorable product sales mix. We anticipate product sales will continue to feel the effects of marketplace conditions for the next few quarters. However, early reports on our six new machine models, especially the multi-layer displayer, MLD as it’s referred, have been promising. Even in this challenging environment a number of customers in diverse geographies continue to refresh their slot force to stay competitive. To the extent necessary we will work with our customers to use our balance sheet to get these new products onto the floors. Operating expenses and other income expense first with SG&A totaled $132 million for the quarter which included $17 million in restructuring charges. In addition bad debt provisions totaled a net expense of $11 million compared to a $5 million credit in the previous prior year quarter. Excluding significant items affecting variability, SG&A would have totaled $104 million on the current quarter compared to $105 million in the prior year quarter. On the expense total $54 million for the quarter, up from $51 million in the prior year. Depreciation and amortization within operating expenses totaled $20 million for the quarter, up from $19 million on the prior year quarter. Total depreciation and amortization inclusive of depreciation on game ops machines that is recognized in our game ops gross margin was $79 million for the quarter, up from $69 million on the prior year quarter due to higher install base machines. Total operating expenses were $206 million for the quarter compared to $171 million in the prior year quarter. In addition to the restructuring charges, we also saw $13 million in additional expenses associated with an extra week of operations. Excluding these items comparable operating expenses would have been approximately $176 million. We have completed our previously announced headcount reductions which represented approximately 8% of total headcount and we expect our quarterly OpEx run rate to come in 10 to 20% lower going forward, excluding the restructuring charges this quarter. We will continue to look for additional ways to enhance the alignment of our operating expenses with the business and would anticipate taking another $100 million out of our cost structure over the next 12 to 18 months. Other income expense net in the first quarter was $20 million, up from $8 million in the prior year quarter. The increase was mostly driven by higher interest on increased borrowings and investment write-downs. Interest income was $16.5 million. Interest expense was $34.4 million and other was $5.9 million of expense. The biggest piece of that was $3.8 million of a loss reported on an investment. On the tax rate, our tax rate came in at 18% the first quarter compared to 40% in the prior year. The main driver for the decreased rate came from the closure of our 2000 and 2001 audits, retroactive R&D tax credits and other discrete tax items. We expect our quarterly tax run rate for the remainder of fiscal 2009 to come in between 40 and 42%, inclusive of one time items, or 38% excluding these items. Moving on to the balance sheet cash equivalents and short term investments inclusive of restricted amounts totaled $381 million at December 31, 2008 compared to $374 million at December 30, 2008. Debt totaled $2.3 billion at December 31 and is comparable to September 30. Adjusted EBITDA was $209 million for the quarter. However, a more realistic view would add back the impact to jackpot expense of $17.2 million, inventory write-downs of $2.6 million and the bad debts of $11.3 million or a more realistic view of $240.1 million of EBITDA. Moving on talking about the debt refinancing, as of December 31 IGT had drawn $1.4 billion on its $2.5 billion credit facility. Our convertible has a high likelihood of being put back to us in December of 2009. To date we have repurchased $71 million of this issue, leaving $829 million outstanding on the convertible bonds. While we anticipate having sufficient capacity to pay off the convertible bonds with the availability on our line of credit, we are actively monitoring the credit market. During this calendar year we will likely access the credit markets to satisfy the potential put of the convertible bonds and the expiration of our credit facility in December 2010. Working capital totaled $745 million compared to $733 million at September 30, with average days sales outstanding at 95 days and inventory turns at 2.6 times. All improved sequentially from days sales outstanding of 98 days and inventory turns of 2.5 times. Inventories have decreased by $11 million since the end of 2008 as we have completed the ramp up of production leading to the introduction of our new AVP products. During the quarter we generated $150 million of cash flow from operations, up from $120 million prior year quarter, although we saw a reduction in net income year-over-year of cash flow and the prior year quarter was burdened by additional pre-payments for long term license and [rights]. Capital expenditures for the quarter totaled $76 million compared to $63 million in the prior year quarter. CapEx is expected to trend in the quarterly range of $50 to $75 million and will be managed carefully as part of our efficiency and cost reduction efforts. Our default use of free cash flow is to return it to the shareholders by buybacks and dividends. While we remain committed to these strategies that allow for IGT to greater deploy capital to the shareholders, we have suspended our share buyback program until market conditions and visibility improves. This concludes my prepared remarks regarding IGT’s first quarter results. Thanks for your time and attention. I will now turn the call over to T.J.

[Thomas J. Matthews:]

Thank you Pat and good morning to everyone. Before we open the line for questions, I’d like to make some comments that regard our efforts to guide our business through these uncertain times. As you all know, this is the worst economy in decades and it clearly affects our spot customers with unemployment and the economic stagnation overshadowing the positive of lower gas prices and inflation. Further we have credit markets that are constraining the gaming operator budgets and the future of their growth projects. And so these large customers continue to face balance sheet issues which need resolution before they’re going to be able to spend at normalized levels. So we’ve had to respond to this changed environment. We’ve completed our initial cost reduction efforts and will continue to look for more ways to save. Pat in the CFO role is going to continue to look more closely at our business efforts and make sure that we use cash to insure the appropriate returns and find ways we can save money wherever possible. With Rich in the product strategy role, we are going to continue to look for ways to invigorate our game offerings and our opportunities to leverage the coming convergence of games and systems. And with the purchase of assets of Progressive Gaming which we announced earlier this week, we’ve expanded our footprint of systems products and now we’ll look for ways to grow our systems business with this acquired technology. The opportunities that we have before us are the facts that the new machines that we have introduced this last year are dong very well, particularly the MLD’s which are getting good customer feedback and despite the financial limitations that we see with our customers they continue to make purchases and they need to refresh their floors to remain competitive. Although new market openings are always difficult to predict, it’s these kind of environments the weak economic environment that usually is most favorable for expanding gaming. Replacement cycle remains well below normal levels and it will probably continue at a reduced pace until the economy and credit conditions improve, when we expect it will not only normalize at some point in the future but there will also be a catch-up period in which operators kind of rush to update their floors given any suspension of CapEx in this interim period. We also believe that we’ll have our SB Tier 1 deployments on target for this latest string and have the first commercialization of our SB products of SB. We had some important approvals earlier this week, 3.1 SBX was approved by the Nevada Gaming Board. We also expect our full floor server based gaming to still be installed at [City Center] on track for Q1, 2010 opening our fiscal year, with the regulatory process going smoothly for the necessary approvals there. And so despite what looks like a challenging fiscal year, we remain poised to take advantage of our present and our future opportunities. We’re working hard to find solutions for our customers with financing options, to innovate new machines to keep their businesses competitive, and soon we believe that SB will be changing the way that gaming operators run their slot floors; interact with their customers; and while we unfortunately cannot avoid the impact of economic conditions affecting people around the globe, we can address the issues that are challenging us while we continue to lead the industry forward. We’ve overcome difficult conditions and significant marketplace changes in the past. I’m confident we’re going to do so again. And so the remark on guidance, the credit market and economic conditions have increased the uncertainty of timing of gaming machine orders, although our steady base of over $3 million per day in recurring revenues as well as the revamped for sale product line make it reasonable to expect that EPS, including significant items for 2009, will come in at $1 higher based on our current view of marketplace conditions. Further, we expect the second quarter to be the weakest of the fiscal year due to a few New York casino openings and the effects on the ongoing economic situation, particularly play levels, and that we generally anticipate that our results are going to improve incrementally each quarter after that for the remainder of the calendar year with the normal seasonality patterns. With all of that said, we will now open up the line for questions.

[Operator:]

(Operator Instructions) Your first question comes from William Lerner - Deutsche Bank Securities.

[William Lerner:]

Can you talk for a second about North American units? That was of course better than I suspect most anticipated. Where did it come from? Was it just market share in general? Was it shared a couple of openings? Was it recognition of recent openings? And then also on MLD, where is that actually rolled out? I mean, where are you waiting approvals for that as well?

[Thomas J. Matthews:]

On the North America we had a good quarter just generally speaking. I mean we had some seasonality and some pay level impacts on game operations but in total had a fine quarter when compared to the prior year and compared to the previous sequential quarter. And so felt good about the number of units that were shipped and it really is reflective of the two shares that we remarked on in the past which is in the new and expansion unit environment, our share remains very much intact. And so we get large percentages of shares. This last quarter, for instance, saw the opening and shipment to Alliante where we had in excess of 70% share and there were a number of other openings in Native American properties really across the country. Unfortunately for us it does look like a lot of the new and expansion activity was bunched into that December quarter and it will be at a slower pace for the remainder of the fiscal year. There still are some big openings, of course. In Pennsylvania, for example. And we still expect reasonably good share in those environments and so we’ll anticipate that new expansion units to the extent we don’t control those, we will still achieve large shipment when they’re made available to us. In the replacement market, there’s two things that drive that. And the replacement market firstly demand is created by advancing technology. And as you know we’ve been working on advancing technology on a number of fronts with the boxes first, AVP and MLD and with a system effort that would really allow for a more intensive replacement activity across an entire casino floor. And then share is dictated by the quality of games. And so in these mature environments where floors are largely dictated by this historical activity, there is some share effort that happens on the margin and you see that reflected in ship share where some of our competitors in their ability to introduce good game content have the need to ship boxes to facilitate that. Whereas you see our ability to grow the non-box revenues, a reflection of the fact that a lot of our game content has resulted in conversion of existing boxes. So last year for instance as you know we sold 25,000 conversions in addition to the number of boxes that we shipped. That’s going to change here a little bit, because with these new platforms we again will be in the business of having to ship new boxes and so we would expect that there’s a third share that people should start thinking about. And that’s not the historical or the current ship share, that’s really the next share. What is the share the casino is going to be after the next big replacement market, understanding that the outstanding question is still when is that big replacment market going to occur? We think big progress is going to be made towards that as we remarked due to surveys, gaming, installations that take place this year. And we feel very comfortable that with our existing machine products line, our renewed focus on the game library, and the advances on network gaming that the next share is going to favor IGT once again and that we will have the ability to be remarking on our 50 to 70% historical share, kind of depending on the marketplace. MLD is a big effort towards that. We have now just shy of 1,000 MLD’s in the market. For the most part those are in Nevada and GLI jurisdictions. There are a couple of other jurisdictions in which we’re still waiting for approval. But I don’t think it’s approvals that are in the way at this point for deployment. We really have had the opportunity over the last 90 days to have a product that has been really well received, doing very well in the marketplace, offers a lot more flexibility in terms of the kind of game configurations that customers can have; has a very substantial library, both with initial shipment and on the ongoing effort that is associated with it. And so I think in that product, distinct from all of our efforts, we truly have a hit.

[William Lerner:]

T. J. or Pat, on this guidance of $1 plus for this year in this fiscal year, what basis are you using for your [inaudible] this first quarter that you just reported, your GAAP $0.22 or your adjusted $0.29?

[Thomas J. Matthews:]

Well, I think as you know we’ve always felt comfortable that GAAP’s the number. And that’s the number on a year-over-year basis that applied – that has all the same rules applied to it. In this quarter I think that we – and it’s just like in the fourth quarter. You know there was a number of one time things that some might consider in the ordinary course, others might consider for adjustment. And so we wanted to write those out and realize that people categorize things differently. For instance, the large severance associated with the expense reduction is a one time event, does allow us to have a lower run rate for expenses going forward. The interest rates have moved 400 basis points year-over-year. A great amount of that had to do in this December quarter. As you know that causes us to have to re-value all the jackpot liabilities that are on the books, the non-cash charge, but nonetheless a substantial charge. We had the opportunity for us to go in in this environment and increase the specific reserves or some receivables, mark down some inventory; again that was really kind of market specific in some instances or in most instances. And so a lot of those things I think are going to be behind us and so we would probably take somewhere between the 22 and the 29 in our Q1 number to kind of feel comfortable getting over that dollar. But the fact is visibility is what it is and Q3, Q4 we have some work to do here, to fill the order book and make sure we go out and get the orders and that we see play levels rebound due to both the economic climate and normal seasonality. There are some things that we want to make sure that we do. And if we do those things, then $1 probably by either measure is achievable.

[William Lerner:]

That sounds like if you adjust your $0.26 based on very limited visibility obviously at least $0.26 a quarter for the next few quarters if my math is right.

[Thomas J. Matthews:]

Yes. That’s one way to get there. I think the only thing we cautioned is that Q2 is going to be a little bit like Q1 and Q4 have been in that they’re going to be a little noisy and there’s a little weakness in terms of new and expanded units. We see better visibility in new and expanded units as the year progresses and as a result and with normal seasonality in game plays we would expect that EPS continues to improve during the course of the year.

[Operator:]

Your next question comes from Felicia Hendrix - Barclays Capital.

[Felicia Hendrix:]

I just want to get back to your cash needs. You lay that out nicely in the beginning of your comments. Just wondering what the board view is and what your view is on your dividends and the potential for discontinuing it just to have some extra cash there?

[Thomas J. Matthews:]

Well, I don’t think that – well actually I’ll say the management philosophy at IGT has been extraordinarily consistent about what will we do with cash. As you know we still have a business that generates cash. That was the case again this quarter. In fact, cash flow from operations were quite healthy and one of the reasons again for having an adjusted EPS just as a kind of interesting way to delineate kind of odd activity in the quarter is to remark on the fact that you’ve really got to look at cash earnings of the company anyway and the cash flow statement is a good place to be concentrating. And so we generated $150 million from operating cash. We did reinvest a fair amount of that back into the business. We’re always glad for that to be the first use of capital but we have said that when we generate excess cash and we do in the normal course that we don’t have a reason in our mind to build up large cash balances and we want to return that cash to the shareholders for them to deploy otherwise. And that we have at a very defined return of money to the shareholders in the way of the dividend, and that we’ve had a more flexible return of money for the shareholders via the share repurchase. Just given the environment of the credit markets being as difficult as they are to access as you know we’ve suspended the share repurchase. The underlying philosophy relative to the dividend hasn’t changed, but I will tell you that our priority over the course of the next three months or so is to refinance our existing borrowing, at least understand what it would take to refinance them. And so as Pat remarked we anticipate probably approaching the bank market about extending the maturity of either the existing facility or replacing that facility prior to its going current, which it will at the end of the calendar year. And that we have a need to prepare ourselves for the convertible being put back to us at the end of this year. And so though we don’t expect to have to change our dividend policy, given that the first priority is refinancing that could impact our thoughts on that policy short term. And so I guess we make no commitments either other than remind folks that the philosophical bent of management hasn’t changed at all and it will work very hard as a result not to change the dividend or its commitment to return cash.

[Felicia Hendrix:]

So given the state of the credit markets, I’m wondering have you gotten any kind of early indication from your bankers that accessing the market would be something doable at this point?

[Thomas J. Matthews:]

Yes, we feel comfortable. I mean IGT is investment grade or leverage ratio low, certainly by comparison to other industrial [foreign] companies across the industries. We’ve been obviously good credit. So I don’t think that we have any issue with necessarily refinancing in the ordinary course. The difficulty is that this isn’t ordinary times. And so I think working out what are reasonable terms and what’s reasonable pricing and what kind of timeline you can really expect in terms of achieving those things, I think we are still working very hard to fully understand. But we fully expect to be able to refinance the bank facility and we fully expect to be able to access whatever additional monies we need beyond that to be able to take advantage of or take care of the redemption of the convertible. And so I don’t think we have any particular concerns there other than what is the cost? What are the terms? And to make sure that we’ve timed this right, because you do have the issue of the bank market is consolidated. And in our space in particular we have a lot of lenders that have difficult credit and they’re trying to work out those difficult scenarios with the various borrowers. We are caught up in the timing of all that. We are caught up as a member of this industry. We have in our credit, for instance, just the consolidation of Bank of America with Merrill, or with Wells Wachovia. People probably have larger sized portions of our facility than they originally intended to hold. So we have to sort through those kinds of issues, but no we feel very comfortable that we can refinance all of our outstanding obligations without any real issue other than that we’re going to have to pay more money for those facilities than it’s historically been.

[Felicia Hendrix:]

And just in terms of gaming operations, I’m just wondering have you seen the environment become more promotional and have you had to – what kind of incentives are you offering operators if any? And I was just wondering if you could give us the domestic ship share data.

[Thomas J. Matthews:]

As far as the suppliers to the operators for promotions being promotional purposes – is that what you’re talking about?

[Felicia Hendrix:]

Yes.

[Thomas J. Matthews:]

No, I mean, I think that we remarked before that we think that our competitors have done a better job of understanding how to price their products, particularly in the premium space. There’s always going to be some jockeying around on individual transactions and so we have seen some people relax terms or expand discounts here and there on a discrete basis. But nothing that necessarily is going to adversely impact average revenues, either that are realized on a per day basis in the game ops business or per unit basis in the gaming machine business. And so nothing that’s had any substantial downward pressure. And then on market ship share, I’ll defer to Pat.

[Patrick Cavanaugh:]

This past quarter and of course, Felicia, we have to accumulate that data the same way you do and that is wait until everyone’s reported. But our internal assessment would gauge that at about 47% for this past quarter.

[Felicia Hendrix:]

And then in terms of new shipments in versus? Is that what –

[Patrick Cavanaugh:]

That’s a blended average between new and replacement. Replacement is probably 35 to 40%. New or expansion is probably north of 50%.

[Operator:]

Your next question comes from David Katz - Oppenheimer & Co.

[David Katz:]

On the international side, I know that’s always been from our perspective more of a black box and this quarter’s a little lower. We’ve certainly had prior quarters where you come in considerably higher. Whatever you can share with us in terms of where that’s going and what you’re assuming in there looking out the next few quarters would be really helpful.

[Thomas J. Matthews:]

Sure. I mean in the quarter was the lack of international activity. We had no shipments into Japan. We had much lower activity in both Europe and Australia on a year-over-year basis. And we had substantial fluctuations in the currency exchange rates that hurt both the current quarter and also the carrying values of some of the assets deployed. All of those as far as the currency pressure, those are going to continue. Australia is mostly a seasonality issue that you would expect that you’ll see shipments really kind of resume the ordinary course as their year progresses. Europe is a reflection of the fact that they also are suffering the same kind of economic environment. And that we’ve had just some extraordinary year last year in terms of continuing to expand share, find new markets, and continue replacement activities that was still [Tito] driven. And so that market is going to be slower this year. And we are going to have to work just all the harder to try to find opportunities to kind of keep that consistent. And we obviously will be able to grow it from Q1 level. And in Japan we expect that we’ll probably have at least a product introduction this quarter and next quarter and hopefully in the fourth quarter too. So that will give us the opportunity to have revenues from that market where there were none this past quarter. So international has become much more predictable in terms of game ops and that’s a good thing, but again the machine shipment level will probably remain very lumpy and a little bit hard to predict.

[David Katz:]

So it sounds like the conservative approach might be for us to keep that in terms of units down year-over-year in aggregate this year versus last year. And is there any comment you can make in terms of mix that would affect the ASP assumptions we should be making in there? As I recall Japan is lower relative price –

[Thomas J. Matthews:]

Yes, really the big issue there on mix which will affect average revenues per unit is the reduction in units in Europe. Those are just given the euro dollar exchange rates of last year and the decline those rates as well as the decline in units, that will negatively impact average revenue. Otherwise the goal would be that Japan and Australia, South America, Africa all look somewhat similar by the year’s end as they did last year.

[David Katz:]

Just quickly on the PGIC assets that you’ve acquired, can you just give us some insight in terms of what your plans are for that? I think there’s certainly an RFID component on the table management side and then some other technologies on the slot side you can use. Can you tell us what you paid for those by the way? I don’t know if that was disclosed. And what your plans are for it?

[Thomas J. Matthews:]

We have not disclosed yet what we paid for PGIC. It will be likely discernible in the 10-Q filing. It was relative to our existing investment. It was not necessarily a substantial amount of incremental funds that were deployed. The reason for us incorporating those assets is that we have a longstanding relationship with them on three fronts. We had the RFID partnership with table cuts and table length as still the premier system for managing table activity and RFID really becoming the standard for being able to read bets and get real time information at a table. So our ability to internalize and fully control the intellectual property there was of interest. As you know we’ve asked them to be a application provider to SB, particularly use their casino jackpot system capability to plug into SB. And so being able to take over that development and making sure that we have those capabilities for our own SB offering was important. And probably the biggest opportunity for us had been that they have 70,000 devices that are connected to their various systems around the world. Casinolink was particularly successful in Canada and to a lesser extent in the Asian markets and their acquired index is to become part of Casinolink has a very substantial European presence for smaller casino environments. They actually have a unique system and that is very concentrated on smaller casino presence, casinos that have 500 machines or less. And they have the ability to monitor multiple locations with that system. And so those are capabilities and kind of a product that we did not historically have as part of our systems offering. And so as you know we aligned with them to be able to sell front end displays, next gen displays for their systems as well as provide them an SB upgrade path with application delivery kind of from the back end of their system. And so we enjoyed the fact that they were an independent company and that we had those opportunities with their inability to stay a going concern, we obviously needed to internalize their install base for us to be able to pursue those same opportunities. And so all of the reasons we were originally aligned with them are the same reasons why we have chosen to internalize their assets.

[David Katz:]

I don’t think you mentioned anything about the RFID aspect of it. Is that sort of right where it is or do you have bigger plans for that?

[Thomas J. Matthews:]

No. I mean, RFID is just part of that table touch, table link, table ID effort. And I think that is becoming the adopted standard. We will now own all of the intellectual property and control it further than we have so that as it becomes standard we have the opportunity to be involved in its deployment.

[David Katz:]

You talked about leasing terms and using your balance sheet, etc. Can you sort of give us some parameters of what you have in mind? Are you categorizing your customers? Are you allocating an amount of money? How are you planning to use that to compete?

[Thomas J. Matthews:]

Well, I think it falls in the bucket of whenever we can redeploy cash into our existing businesses we want to. And that would include the ability to finance our customers. You see in the balance sheet we actually had a very good quarter in terms of collecting on the outstanding receivables in the current account. We did expand those receivables a little bit and that reflects the past efforts of IGT capital and the ongoing arrangement that we have in place there. And what I would anticipate is that the conversations that we’ve been having all along about how networks will change pricing is the idea that the hardware is ultimately going to carry a lower price point in terms of it being the delivery mechanism of this capability, applications, content, games, software and the like. And that more and more value is going to shift towards that latter half, all of the games and the applications to which we remarked. And you’re going to see that pricing distinguished from each other over time. And that we would like to see of course probably a more recurring stream of revenues attached to the games and the software. And so I think there’s an opportunity for us to maybe have this current environment give people comfort that they may be a better pricing mechanism for them, too. That said, it’s not going to look a lot different on our income statement and whether we carry operating leases or capitalize leases or a higher pricing model to which I remarked, for the time being the income statement is not going to change much in terms of how it reflects the machine sales.

[Operator:]

Your next question comes from Celeste Brown - Morgan Stanley.

[Celeste Brown:]

First, does your guidance include an assumption for refinancing or will you wait to adjust that as you get more clarity in the marketplace?

[Thomas J. Matthews:]

It includes an assumption for refinancing in the back half of the year.

[Celeste Brown:]

Are you willing to clarify that or do you want to leave that? I guess you don’t want to disclose to the banks how much you expect to pay.

[Thomas J. Matthews:]

Yes. I mean, obviously we expect to pay more and it’s going to be more. It’s going to be in the hopefully only in the couple hundred basis point range. But that remains to be seen. That’s a negotiation still to be had.

[Celeste Brown:]

Were there any units that you shipped in the quarter but the revenue will be deferred to future quarters? I know it’s been a challenge for some of your competitors with the systems and the games combined. Did you have any of that?

[Patrick Cavanaugh:]

We did Celeste. But it was a relatively small number and in Q4 we had a fairly good sized number, in fact. You know Alliante which we recognized in this quarter, Q1, was one of those that got deferred into Q1. We recognized it in this quarter. In this quarter I think it was a smaller number. I think it was about 300 units. I apologize, I don’t have the dollar figures attached to it. I want to say it was maybe $2 million at the margin.

[Thomas J. Matthews:]

But where dollars are really getting trapped on deferred revenue is on the systems side. And so we are carrying a much larger deferred revenue balance than we’ve historically had. Expected that coin to continue to grow, but one of the very strong points that Pat brings to the CFO role is the ability kind of to fully address all of the revenue recognition issues with our shifts toward a more software oriented system based pricing model.

[Celeste Brown:]

Pat, normally you give your expectation for normalized game ops margins. There’s still a lot of noise in the quarter. Can you provide that number again?

[Patrick Cavanaugh:]

Yes. I think a more normalized level, Celeste, giving suppressed play levels is probably 57 to 58%.

[Celeste Brown:]

And then your interest expense was much higher in the quarter. I know there were some one time items. Can you just go through – there are a lot of moving pieces in the press release. Can you just go through or maybe you want to do this offline the different things that drove it higher in the quarter?

[Patrick Cavanaugh:]

I think the biggest driver there was just looking at it quarter over quarter was the increased borrowings on the credit facility is the biggest piece. Convertible debt relatively consistent and the M&J piece of our game ops business is relatively consistent as well.

[Celeste Brown:]

We should see the benefit to your interest expense in this coming quarter though from the lower interest rates that hurt you on the game ops side. Is that correct?

[Patrick Cavanaugh:]

That’s correct.

[Thomas J. Matthews:]

And the big charge or the big increase in jackpot expense, that really is more of a one op than given that we only have 25 basis points to go. We shouldn’t see any more big hits like we had this quarter and previously in the March quarter. You remember when we had the 200 basis point move down? That had a fairly dramatic impact to jackpot expense. The ongoing drag on the accrual will be much less probably only a quarter at the most.

[Operator:]

Your next question comes from Robin Farley – UBS.

[Robin Farley:]

I wanted to clarify a couple things. One is just going back to the issue of unit shipments in the quarter. Product sales were maybe a little better than people had expected. I wonder if you can give that sort of rough shipments by geography that maybe then we can sort of figure out if something shipped in this quarter that we might not have expected until a later quarter?

[Patrick Cavanaugh:]

Certainly Robin. For the domestic market, the western region was 5,600 units; central region was 2,300 units; eastern region was 1,050 units and Canada was 550 units for a total of 9,500 or 9,600. And then internationally we had Europe at 337; Australia at 1,700; the UK at 2,900; South America at 800 and then Asia and other was the balance.

[Robin Farley:]

In terms of the add backs in the quarter just trying to think about how to think about your guidance going forward. I guess there were a couple of things that seemed like they would be pretty ongoing, pretty much a regular cost of business rather than kind of a one time non-recurring and so maybe you could just clarify? I mean, the FX impact you’re just saying it was because of the change. In other words you expect to have a negative FX impact in the next few quarters as well, right? You were just saying the December quarter was a little larger because of the Delta? But that would be a recurring.

[Patrick Cavanaugh:]

I think our logic here, Robin – we’ll leave it up to you folks to determine which of these items are really most appropriately added back to get what is a truly adjusted EPS number. The reason we called these things out was just given the dramatic, you know, if you looked at FX rates particularly we’ve benefited from those for the better part of this whole decade gradually over time. And that all reversed course within the span of three or four months, if you looked at the Euro and the pound where we have a lot of dollars denominated. And so that has significantly impacted us. That’s really the reason for calling that out. But some of the others like the interest rate things, like we remarked earlier, hopefully we’re not going to see that again as long as 25 basis points to go. I think that’s probably legitimate. Work force reduction again is another item that we would hope is a pretty infrequent thing. Fixed asset charges again hopefully that’s an infrequent thing.

[Robin Farley:]

Obviously the restructuring, obviously there are some things here that do seem one time in nature. It was just the currency. The lower interest rates would be ongoing as well. I guess the $17 million includes some Delta for crude liabilities but I mean going forward you would have that –

[Thomas J. Matthews:]

Robin, just to clarify that real quickly, it doesn’t. Those are two different buckets. And same with currency charges. The charges that we’ve broken out are the one time charges due to the change in rates as affect the existing assets and liabilities on the books. And so the interest rate effect that we’ve called out is simply the revaluation of the jackpot liabilities. The currency devaluation that we called out has to do with the carrying value of the hedging instrument that we use to manage that business. They do not – it’s not some attempt to try to reflect normalized business as if interest rates had been – would be at a different rate that we’d have earned a different amount or had currency rates been at a different level we’d have earned a different amount. Those are just absorbed in the normal course and will continue to be absorbed in the normal course. And so for interest rates I think one of the things we remarked on is the carrying cost now for an annuity on a jackpot won will be 67% going forward as compared to I think 58% last quarter. And that delta is not broken up or included in the one time adjustment that we remarked on.

[Robin Farley:]

And then also the bad debt provision and the $11.3 million that you’re highlighting as a one time item. Is that some kind of revaluation as well rather than just obviously the fact that that was a benefit in a prior quarter? That would have been unusual. That would have been the December ’07 quarter right? Not this quarter? Or is there something unusual?

[Thomas J. Matthews:]

The same thing there. Obviously it’s a non-cash charge so the idea of trying to give some sense of the idea that you’re trying to adjust to some form of cash earnings, we called it out. It’s unique in that the level of it breaks a trend. I mean the trend actually has been we’ve been recovering a little bit from bad debt because we’ve had a very stable environment for collections. And this past quarter I had the opportunity just given the economic climate to really go through the receivables on a specific basis and that’s a reflection of us changing the specific reserves of a few customers as opposed to any changed general view or any changed normal course of operations process. And so that’s probably what called that out to be unique. But we understand. As you know we understand that GAAP is the number that people that we really would guide people to. We’re comfortable with GAAP of $0.22. That’s the number that’s the best apples to apples comparison. But I think that a lot of people don’t trade or invest in our stock based on just GAAP EPS. Cash earnings or our ability to generate cash flow is important to note. And so calling out things that are unique and non-cash in orientation is important to do.

[Robin Farley:]

Lastly on the SBX Tier 1 you mentioned late spring and I think on the last call or earlier you guys had talked about that being in March. Is there anything into an approval timeline that’s caused that to slip a little bit? Or is it cash constraints on the part of your customers? I guess that little bit of slippage we might be seeing is what may be driving that.

[Thomas J. Matthews:]

It’s been four years, Robin, and to me spring is I’m going to go ahead and say that spring is defined as March, April, May. And we’re comfortable that we really are kind of on that original timeline. As you know the adoption of SBX and the strategy is a different strategy for us. That’s only been somewhat recently adopted. And that we have this view that we were going to be able to have a real wide proposition that really makes sense, there were going to be a lot of casinos that were going to come onboard that were going to kind of act as our Beta sites and prove the concept for existing customers to consider. That’s obviously not going to occur now with the economic environment in which we operate, so this partial core solution has to be more actively pursued. I think we feel very comfortable that the timelines that we previously stated are still being met. And this is a movement of a few weeks here. It’s not material.

[Operator:]

Your next question comes from Steven Wieczynski - Stifel Nicolaus & Company, Inc.

[Steven Wieczynski:]

Just one in terms of cost cutting. It looks like that started to show up here in the first quarter, but if you could talk about where the opportunities are going to be going forward to get to your target that would be pretty helpful for me.

[Thomas J. Matthews:]

Well, the target of course is 30% operating income margins. And so we’ve remarked on the fact that we think gross margins are sustainable at 55%, which means that the plug is that you have to have 25% or so of operating expenses carried that that is kind of volume driven as to what becomes our target. And not just current volume, but expected volumes. And so we feel comfortable that we made very good progress in kind of the across the board efforts of this last quarter that from this point forward for the remainder of the calendar year that it’ll be a lot of targeted efforts as it relates to SG&A and R&D. In the case of R&D for instance I don’t necessarily expect dollars to change there much. I will just tell you we do too much. And the fact is our strength is the number of markets we serve and the number of products that we have but at the same time that breadth costs us in terms of our ability to focus on being the best in certain of those efforts. And so there will be a much more targeted effort in R&D over the course of the year. There’s always going to be opportunities for us to I think become more efficient with SG&A. And then on the other cost lines, like cost of sales for instance, that’s volume driven. And so to the extent that we see volumes whether they’re going up or down, we’re going to have a need to constantly size that organization, that activity relative to – it’s much more correlated to kind of the current activity. So there’s probably going to be some reasons for us to be concentrating on that portion of the line as well.

[Operator:]

Your next question comes from Joseph Greff - J.P. Morgan.

[Joseph Greff:]

I have a question for you on the participation side. I know certain of your customers last year significantly removed participation and particularly the wheel games. And I know certain of them are adding that back. Are you amending or changing the terms of that?

[Thomas J. Matthews:]

No. I mean pricing is not really impacted game ops revenues. It’s not to say that we don’t have unique discussions with each and every one of our customers, but the ability to support a game is not driven by any particular pricing decision. That said I will say that our customers have the ability to make pricing decisions on their own. They can rotate from wide area progressive, for instance, to a stand alone product. And generally speaking lower their cash outlay. And the good news on the Wheel of Fortune and other products for that matter is that to the extent that there’s been a lot of publicity attached to some high profile removals in some cases, certain of that activity has reversed course and I think that’s gone potentially under noticed.

[Operator:]

Your last question comes from Todd Eilers – Roth Capital Partners.

[Todd Eilers:]

In the press release you guys mentioned the benefit that you got from the extra week in the quarter, I think on the gaming ops side and also highlighted the expense, the added expenses from the extra week. I’m wondering how much maybe you guys got on the product sale side just so we can kind of get the total revenue benefit from the extra week or if you’re willing to give I guess an EPS impact from the added week that would be helpful.

[Patrick Cavanaugh:]

Todd, it’s really we just quantified the game op business because product sales is it happens very lumpy throughout the quarter; i.e., most of the product sales may occur in one week, etc. So rather than try and guesstimate product sales it’s excluded. So the impact really is largely confined to game ops and OpEx.

[Thomas J. Matthews:]

I would say the EPS impact was just the two numbers that we published were actually negative, so I would say it’s negligible.

[Todd Eilers:]

You know we’ve had a couple months since G2E and the start of the year here and talking with your customers. Can you maybe give us a sense what your expectations are in general for the replacement market? How much do you think operators will replace as a percent of their overall floor space this coming year?

[Thomas J. Matthews:]

That is going to be lower than it was last year. And that’s due to capital constraints. You know, for us we’ve always said that our biggest competition is not the other providers of gaming devices, but it’s the previously sold equipment from us. I mean, the 510,000 machines that we have deployed in North America, 480,000 of those are legacy units; 89/60 based, the games work, they have all the functionality necessary to continue to operate on the floor. And realistically if you ask the operator, his preference he’d rather sustain that box through conversions and software upgrades than replace it with a new box. And so we have a big effort to try and prove that technology deployment on a new box via a new system is compelling. And I think over the course of the year we will do a very good job of that. And you will see replacement demand grow in response to our technology effort. But we don’t control the economic climate and we don’t control independently derived budgets from the casino operators. And we would just expect given the fact that it’s now been five consecutive quarters of declining gaming wins in most markets, and though I think we’re seeing a lot of signs of stability in the regional market, the fact is some of the key markets like Atlantic City and Nevada to which most of our big customers are exposed that they have yet to stabilize. And so the result I think they are going to be sitting on budgets for awhile. Hopefully that undoes itself by the middle of the year, because we start seeing the consumer return not necessarily to 2007 levels but just return to the activity in a way in which you start seeing better quarter-over- quarter sequentially in the comparisons.

[Patrick Cavanaugh:]

Well with that last question I think we are done for the day and so I thank you all for your participation and your interest in IGT and look forward to continuing to give you updates on our business and progress being made in our products over the course of the year. Thank you.

[Operator:]

This concludes today’s conference. We thank you for your participation. At this time you may disconnect your lines.