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International Game Technology (NYSE:IGT)

F1Q10 Earnings Call

January 21, 2010 5:00 pm ET

Executives

Patrick W. Cavanaugh – Chief Financial Officer, Executive Vice President & Treasurer

Patti S. Hart – President, Chief Executive Officer & Lead Director

Analysts

Steven Wieczynski – Stifel Nicolaus & Company, Inc.

Joseph Greff – J. P. Morgan

Steven Kent – Goldman Sachs

Robin Farley – UBS

David Katz – Oppenheimer & Co

Todd Eilers – Roth Capital Partners, LLC

David Bain – Sterne, Agee & Leach

Operator

You will be on a listen only mode until the question and answer session of today’s conference call. The call is being recorded. If you have any objections you may disconnect at any time. I would now like to turn the call over to Mr. Pat Cavanaugh.

Patrick W. Cavanaugh

Welcome to IGT’s first quarter fiscal 2010 earnings call. With me this afternoon is Patti Hart, our President and CEO. Before I go in to a discussion of the results for the quarter I would first like to remind our listeners our discussion reflects management’s views based on the marketplace environment as of today, January 21, 2010 and will include forward-looking statements including forecasts of future performances and estimates of amounts not yet determinable, the potential for growth existing and the opening of new markets for our products, levels for our install base of recurring revenue gains as well as our future prospects and proposed new products, services, developments and business strategies.

We do not intend and undertake no obligation to update our forward-looking statements to reflect future events or circumstances. Actual results may differ materially. Additional information about factors which could potentially impact our financial results is included in today’s press release and our filings with the SEC including our most recent annual report on Form 10K and our reports on Form 10Q filed during fiscal 2009.

During this call we may discuss certain non-GAAP financial measures. In our press release and in our filings with the SEC, each of which is posted on our website at www.IGT.com you will additional disclosures regarding any non-GAAP measures including reconciliations of these measures with comparable GAAP measures.

With that said, this afternoon IGT reported its first quarter results for fiscal 2010. Net income totaled $73 million or $0.25 per diluted share. This compares to $61 million and $0.21 per diluted share in the prior year quarter. The first quarter benefitted from $0.01 of EPS related to the adoption of the new revenue recognition rules i.e. we were effectively able to recognize some revenue that had been schedule do occur later in this fiscal year so it was really just swapping it from one quarter to the next. Then we also benefitted from $0.01 of EPS related to discrete tax items.

Additionally, the first quarter was affected by a number of notable items, the details of which are broken out in our earnings press release which went out this afternoon. The prior year quarter includes certain restated amounts due to the required retrospect application of new accounting standards associated with our convertible debt. On a consolidated basis our revenues for the quarter were $516 million of which 64% came from gaming operations and the balance from product sales compared to $602 million for the same quarter last year.

Consolidated gross profit and operating income for the quarter was $297 million and $147 million respectively compared to $306 million and $100 million respectively in the prior year quarter. Revenue comparisons for last year were impacted by an extra week in the prior year quarter which contributed $22.4 million to revenues and $11.5 million at the gross profit line at our consolidated operations as well as lower play level and fewer new openings.

During the current quarter we adopted new accounting standards requiring retrospective application of prior periods associated with our convertible debt and with equity classification of non-controlling interest. The retrospective adjustments are outlined in the supplemental schedule at the end of our press release. The new accounting standards for convertible debt resulted in diluted EPS of $0.02 and $0.01 in the current and prior periods. Additionally, we adopted new accounting guidance during the quarter related to revenue recognition for certain software enabled products and multi element arrangements on a prospective basis.

The adoption of the new revenue recognition guidance for transactions in the first quarter of fiscal 2010 resulted in $10.4 million of revenues which would have been recognized in later periods this fiscal year under the prior guidance. Approximately $6.9 million of this amount was accumulated in lease fees that had not yet been recognized pending execution of the final contract which occurred in Q1 of ’10.

Increased revenues of $10.4 million which were recognized because we met the accounting requirements for revenue recognition earlier than anticipated resulted in approximately $0.01 of incremental EPS.

Moving on to gaming operations, our gaming operations continue to feel the impact of challenging marketplace conditions. Game op revenues were $277 million in the quarter which was down 2% sequentially and 5% year-over-year excluding the extra week in the prior year quarter. Gross margins were 62% in the quarter versus 52% in the prior year quarter. Current quarter margins were positively impacted by reduced jackpot expense associated with interest rate changes and lower depreciation on the install base.

The prior year quarter margins were impacted by $14.1 million unfavorable adjustment to jackpot expense related to interest rate reductions as well as $3.5 million in fixed asset charges that occurred in that prior quarter. The fluctuation in these rates leads to a quarterly revaluation of the balance sheet liability and impacts margins. Excluding these items gross margins in the prior year quarter would have been 57%.

We earned an average of $49 a day in revenue per unit which is slightly below the revenue per unit of the last four sequential quarters and down from $53 in last year’s first quarter. This blended yield of $49 is an average of the various components of our broad and diverse install base comprised of our mega jackpots, central determination products, Class II and lease ops units, all of which serve distinct markets and have unique yield characteristics.

Lower year-over-year blended yield are the combined results of the decline in play level and the continued shift in the installed base mix to include more lower yielding lease machines. IGT’s install base ended the first quarter at 62,200 units, up 1,300 units over the prior year and up 800 sequentially. Our installed base in both the domestic and international markets showed modest growth during the quarter. Approximately 85% of our installed base is comprised of variable fee games that earn a percentage of machine play levels rather than a fixed daily fee.

Moving on to product sales, product sales revenues totaled $238 million for the quarter compared to $288 million in the prior year. Worldwide we shipped 11,200 machines during the quarter down from prior year shipments of 14,000. Non-machine revenues comprised of gaming systems, game conversion, tables, cards and intellectually property fees came in at $77 million for the quarter or 32% of total product sales for the quarter compared to $97 million and 34% of total product sales in the prior year quarter.

Product sales gross margins were 52% for the quarter, up 200 basis points from the prior year primarily due to reduced material costs and less obsolesce as well as an increased mix of higher margin products. For a reconciliation of units ships to equivalent units recognized, please see our earnings release.

Breaking product sales down domestic versus international first with domestic revenues totaled $135 million on volume of 5,500 units recognized for the current quarter compared to $215 million and 9,500 units recognized in the prior year quarter. Domestic replacement units shipped totaled 3,000, up 200 units from the prior year and down 800 sequentially. Patti will give you a little additional color on some of the factors that affect first quarter seasonality.

While we continue to have limited visibility around replacement demand, we believe future demand will exceed trough levels experienced in the early part of 2009. Domestic new and expansion shipments totaled 2,300 units in the quarter flat sequentially and down 2,700 units from the prior year quarter due to the fact that we had fewer new openings occurring this past fiscal quarter.

As we continue to pursue our sales strategy we will continue to experience deferred revenues from multi element contracts including systems, software and machines bundled together. Unit ships for the current periods reflect all units shipped to customers which include units for which revenues have been deferred. Equivalent units recognized represent units recognized in revenues under general accepted accounting principles during the quarter.

Domestic non-machine revenue totaled $52 million in the quarter, down from $78 million in the prior year quarter primarily due to lower systems revenues and slightly less parts and conversions. Domestic deferred non-machine revenue decreased approximately $3 million during the quarter to a total of $78 million as of December 31, 2009. The majority of this decrease relates to the completion of obligations under multi owned contracts.

The domestic average revenue per unit computed on an equivalent unit recognized basis was 24,600 for the first quarter compared to 22,600 in the prior year due to the increase mix of MLP products. We shipped about 1,700 MLPs during the quarter or roughly 32% of total North American shipments in the first quarter compared to 900 units or 12% of total North American shipments in the prior year quarter. Sales of machines utilizing or AVP technology comprised 92% of total North American machines shipped during the first quarter, a trend we expect to continue as our legacy for sale products are phased out.

International product sales revenue totaled $103 million on volume of 6,400 units recognized for the current quarter compared to $73 million and 6,000 units recognized in the prior year quarter. Our international markets benefitted from recognized revenues associated with the Casino Rosario in Latin America and increased sales in Europe. International non-machine sales were $26 million up from $20 million in the prior year quarter. The quarter was driven by increases in systems revenue.

International deferred revenue decreased $12 million during the quarter to a balance of $29 million at December 31, 2009. International average revenue per unit computed on an equivalent unit recognized basis in the first quarter was 16,100 up 32% over the prior year quarter due to a favorable product mix but a smaller proportion of lower margin units.

Total product sales gross margins for the quarter were 52% up 200 basis points from the prior year quarter. The quarter was impacted due to reduced material costs and less obsolesce as well as an increase mix in higher margin products. Going forward we expect product sales gross margins to remain in the low 50% range bolstered by our cost savings initiatives and impact of product sales mix.

Operating expenses and other; first quarter operating expenses and other totaled $156 million compared to $206 million on the prior year period. Excluding restructuring costs and the extra week in the prior year, operating expenses decreased 11% primarily due to our cost reduction efforts, reduced bad debt provisions and lower legal and compliance fees.

We continue to move towards our goal of the previously announced $200 million of cost cuts when compared to the fourth quarter of 2008. We feel we are on track to achieve our cost reduction goals as we move throughout fiscal 2010. SG&A excluding bad debt restructuring charges and the extra week in the prior year SG&A declined $9 million or 9% to $87 million for the quarter as a result of our cost reduction efforts and lower legal and compliance fees. We expect a quarterly SG&A run rate in the range of $95 to $100 million.

Bad debt provisions for the quarter totaled $3 million compared to $11 million in last year’s quarter. The bad debt decrease in the quarter primarily stems from fewer specific reserves related to customers which were affected by the economic downturn. R&D expense totaled $47 million for the quarter, a decline of $7 million or 13% from the prior year quarter. We expect a quarterly R&D run rate in the low $50 million.

Depreciation and amortization within operating expenses totaled $20 million for the quarter which was roughly flat with the prior year. Total depreciation and amortization inclusive of depreciation on game ops that is recognized in our game ops expense line was $63 million for the quarter down from $79 million in the prior year quarter. The decline in total depreciation and amortization was primarily due to lower depreciation in our domestic mega jackpots and Mexico lease operations. Please note that some of this will come back as we refresh our install base with assets over time.

Other income and expense net in the first quarter was a net expense of $28 million compared to $27 million in the prior year quarter. The change is mostly due to increased borrowing costs on our refinancing nearly offset by reduced investment write downs and less foreign exchange loss. Beginning in this quarter our new accounting guidelines required us to bifurcate our convertible debt instruments in to their debt and equity components. Interest on the debt component will be calculated using a borrowing rate for similar non-convertible bonds resulting in higher recorded interest than actual coupon rate.

This resulted in an increase in interest expense of $9 million in the current quarter and $5 million in the prior year quarter due to additional convertible debt amortization. In addition, we expect the difference between these two amounts to be non-cash interest of approximately $30 million or $0.07 per diluted share for fiscal 2010 and approximately $30 million or $0.07 per diluted share for 2009 as restated.

Our tax rate was 35% in the first quarter versus 16% in the prior year quarter. The tax rate during the quarter benefitted from $2.9 million of favorable discrete items primarily related to the stock exchange that we did earlier in Q1 and totaled approximately $0.01 of EPS. The current quarter tax rate excluding discrete items was 37%. Going forward we expect our quarterly tax rate to trend at approximately 37% to 39% before discrete items.

Moving on to the balance sheet cash, equivalents and short term investments inclusive of restricted amounts totaled $277 million a December 31, 2009 compared to $247 million at September 30, 2009. Contractual debt obligations totaled $2.1 billion with $1.1 billion of availability under our $1.8 billion line of credit at December 31, 2009. It is important to note that the adoption of the new accounting rules for convertible debt which I mentioned earlier decreased our book debt by approximately $145 million at December 31, 2009 and $155 million at September 30, 2009.

This amount is the unamortized discount related to the implied value of the equity options in our converts which was recorded in equity. For purposes of bank covenants we will continue to use contractual debt obligations which totaled $2.1 billion as of December 31, 2009, a decrease of $63 million compared to September 30, 2009. On December 15, 2009 holders of IGT’s 2.6% convertible note exercised their put right which resulted in us repurchasing $701.2 million of face value of bonds at par and $5.8 million par value of the bonds remain outstanding and have been called for redemption on February 4, 2010.

Our 3.25% convertible notes and warrants were excluded from diluted shares outstanding for the period ended December 31, 2009 because the conversion price and the exercise price exceeded the average market price for common stock. The weighted average stock price during the first quarter was $19.71.

On the balance sheet we made a lot of progress with our working capital ratios and conversion of working capital in to free cash flow. Working capital totaled $643 million at December 31 compared to $609 million as of September 30, 2009. Average day sales outstanding excluding receivables from our notes and contracts was 54 days down from 58 days as of September 30, 2009. Inventory turns averaged 2.9 times down from three times at September 30, 2009.

For the quarter we generated $169 million in cash from operations compared to $150 million in the prior year period. During the quarter we saw improved working capital efficiencies such as reduced account receivables, the lowest it has been in 32 quarters. Reduced inventory balance the lowest it has been in eight quarters and strong free cash flow, the highest it’s been in nine quarters.

Capital expenditures totaled $53 million for the quarter compared to $76 million in the prior year period due to lower investments in [EP&E]. Cap ex is expected to trend in the range of $50 to $75 million although we continue to come in near the lower end of the range as we more proactively manage our cap ex as part of our efficiency and cost reduction efforts.

That concludes my prepared remarks regarding IGT’s first quarter. Thanks for your time and attention. I’ll now turn the call over to Patti for her comments.

Patti S. Hart

Thank you very much for taking the time to join us as we discuss our fiscal first quarter. Achieving these results in what continues to be a relatively challenging market is a testament to the measure progress we are making at IGT. While there is still much work for us to do I am proud of our accomplishments this quarter, a quarter in which we rolled out new market leading products at G2E, installed the very first large scale deployment of server based gaming and achieved the highest operating margin we have experienced in some time.

On the heels of the successful launch at G2E, our Sex in the City units are outperforming our expectations with the highest performing unit averaging up to $900 in win per unit per day and an average daily yield to IGT of up to $180. Our go to market strategy for these units which focuses on selective placement is designed to make this product as productive as possible for our operator customers.

In product sales the first quarter has historically been our lowest due to the holiday and the tendencies for customer to carefully consider their options after G2E and ahead of the release of their annual budgets. Despite this, we shipped 200 more replacement units this quarter than we did in the first quarter of 2009. However, we do remain cautiously optimistic about operator demand.

We would like to congratulate the folks at MGM Mirage on the opening of City Center. We are extremely pleased with the performance of our server based system both during and after the opening of Aria. The system performed flawlessly through the peak on opening night and through the holidays including New Years.

Finally, our first quarter operating margin of 27% is the highest since the third quarter of 2008 while our balance sheet metrics continued to improve with working capital declining by $102 million from the prior year quarter and our bank leverage ratio declining by 2/10ths of a turn sequentially. We remain focused on the efficiency of capital in all aspects of our business.

Looking forward we continue to make progress on numerous fronts which will positively impact our business in the future. We continue to add talent to our management ranks. In the first quarter [Harold Dice] from AT&T Wireless as our new Vice President of Core Products. With a background in both content and product development Harold brings a fresh perspective to our game development process.

We also recently announced the addition of Susan Macke as our Chief Marketing Officer. Susan joins us from Hewlett-Packard and brings a wealth of experience in brand development and marketing communication. Both of these recent additions highlight our continued focus on enhancing our customer facing activities at the product level and at the corporate level. We are genuinely pleased to have both Harold and Susan with us.

As many of you saw yesterday we announced that Gideon Bierer will join IGT as our Executive Vice President of New Media. As a market leader we are intent on helping shape the changes that the Internet, mobile and social networking technologies bring to our business and to that of our customers. Gideon brings with him a wealth of experience repurposing content for multiple platforms a process that will be critical to our future growth.

In the new year we announced the election of Pajet Alves a seasoned technology executive to our board of directors. We also continue to work through our process improvement activities. Through our ease of doing business program we are focused on reducing the order to revenue cycle. Our product development program is focused on bringing more innovative products to market faster and at a lower cost. Both of these projects will make IGT a better business partner for our operator customers.

Again, this was a quarter of measured progress for us and we continue to work relentlessly to improve IGT for our customers, our employees and importantly for you our shareholders. We remain cautiously optimistic regarding operator budgets and spending. With the seasonally slow first quarter behind us we are looking forward to an increasingly clearer view of the industry prospects for 2010.

As previously mentioned there have been significant changes to our capital structure and certain changes in accounting principles which impact our current quarter results relative to our prior periods. As a result of all of these factors our guidance for 2010 remains a range of $0.77 to $0.87 per diluted share. As always our guidance excludes onetime items like the first quarter tax benefit of $0.01 which resulted primarily from our recent option exchange program. Our guidance also assumes no dilution impact from our convertible notes.

We will now open the call for questions.

Question-and-Answer Session

Operator

Your first question comes from Steven Wieczynski – Stifel Nicolaus & Company, Inc.

Steven Wieczynski – Stifel Nicolaus & Company, Inc.

A couple of questions here, first Pat can you break out the other income line for me real quick?

Patrick W. Cavanaugh

Interest income was $16 million, interest expense was $43.2 million and other expense was $1 million even. Hopefully that all adds to an expense of $28.2.

Steven Wieczynski – Stifel Nicolaus & Company, Inc.

I’m not sure if you’re going to be able to answer this but when you look at the yields you guys got on the participation side of the business, is there any way to quantify the decline? What came from lower yielding machines versus lower play level? Is there any way to not quantify it but give an indication of which contributed more?

Patrick W. Cavanaugh

Yes it is hard because in a normal year which unfortunately I don’t think we’ve had now for a year and a half or so, we would normally see sequential from Q4 to Q1 declines in yields up to and including 10% which this is we’re well within that range. So I am sure some of the softer play is due to just normal seasonality but we do have a mix shift going on that has led to some of that as well.

Steven Wieczynski – Stifel Nicolaus & Company, Inc.

Then last question, I guess just maintaining the guidance at this point will probably be viewed pretty conservatively by investors at this point so can you give just a little more color in terms of what you’re expecting through the remainder of the fiscal year in terms of replacement levels?

Patrick W. Cavanaugh

Yes. I mean if you look at it just everything else constant we know that new or expansion units will be off year-on-year pretty heavily just because there aren’t as many new properties opening or expanding during the fiscal year so everything else constant would say that you have to make that up in replacements. So you can already assume that we do assume in our guidance a decent uplift in replacements but visibility to that is pretty limited I’d have to say at this point. Give we have three quarters yet to go in the year hopefully we’ll have a little better visibility and we’ll revisit guidance each quarter for that reason.

Steven Wieczynski – Stifel Nicolaus & Company, Inc.

Then maybe one more quick one if I could. You talked a little bit Patti about the server based product and maybe you can give a little more color in terms of what you’ve heard back from MGM so far but then also has there been other interest at this point from other operators?

Patti S. Hart

I mean we’re hearing very good feedback from the folks at MGM and Aria. I actually spent about half a day with them last week and I would say they are very pleased with the way the transition went, the opening went and the way that the floor is playing currently. There certainly then is a significant amount of interest not just on the heels of the opening of Aria but there’s been significant interest in our Tier-1 product which we have deployed and continued to deploy and certainly now more customers looking at the impact of a full floor deployment.

So at the risk of overburdening our friends at MGM with too many visits from potential customers there has been a lot of interest in looking at the floor and understanding the impact to Aria and then the potential impact for them. So, a lot of interest but both in the Tier-1 product as well as the full floor deployment.

Operator

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

Joseph Greff – J. P. Morgan

A question on the cost side and one of the standout items in the quarter you just reported was the cost reductions particularly on the SG&A and the R&D side. I guess my question for you is why is that carrying forward and looking ahead why I think Pat you mentioned that SG&A and R&D would be sequentially per quarter ahead of what you just reported. Can you help me understand that? Then Patti can you give us some feedback I guess on your dynamics bundling approach from customers and just how that might be translating in to backlog or in to future orders?

Patrick W. Cavanaugh

First Joe on the op ex, R&D and SG&A, as it relates to R&D Q1 is naturally lower just due to the fact that the team is largely preoccupied with G2E and we do have some initiatives under way that we know will require us to uptick that a little bit going forward. I would guess R&D probably overtime is going to run somewhere around a couple of million. I don’t think we can get it much lower than that given the sheer number of things we do but we know we can get a lot more efficiency out of it so that is where we are really focused.

Then, as it relates to SG&A we did have a couple of items during the quarter that favorably impacted that that won’t be recurring i.e. we had a couple accruals in the compensation area I want to say maybe to the tune of about $3 million that obviously was kind of a onetime thing as we adjusted to our new comp plan.

Patti S. Hart

On the dynamics just a bit of an update on that Joe so just to refresh everyone’s memory our dynamics promotional offer that we introduced at G2E had basically two different options but fundamentally the philosophy is focused on acquiring one new product and receiving backwards looking conversions on the 8960, the older platform. The response from the market has been very positive. We don’t typically disclose obviously order numbers at that level.

I would say that it is resulting in more focus and as you see in our average revenue per unit numbers. More of a focus on the MLP product and so we expect both MLP and AVP products to participate in the replacement cycle at a higher rate that we had expected. We think the benefit of it is pulling through the higher average revenue per unit is what we’ll see going forward. But, great response from the marketplace processing both on the conversion side and on the new product side.

Operator

Your next question comes from Steven Kent – Goldman Sachs.

Steven Kent – Goldman Sachs

I just want to go back to the guidance, I guess what I am struggling with is this, revenues are seasonally at a low, revenues are probably at a trough for the cycle, replacement sales seem to be going up, your expenses have been reduced dramatically, you’ve committed to continue to reduce expenses on a go forward basis and if you print a $0.25 quarter in the first quarter how can it not get to over almost $1.00 easily in the next year?

I mean I understand you guys want to be conservative and beat the number but gosh there must be something that we’re missing because it sounds like things are going much better and this quarter was a good example of you controlling the things you can control and keeping things tight in front of what looks to be a pretty good year on the revenue side as we move forward.

Patti S. Hart

Pat and I both want to jump on your question there Steve. First of all, thank you for recognizing the good work that we’re doing because we are really very diligently working through the expense side and getting our product lined up for the replacement cycle. I would say a couple of things, I think we look at this more as a $0.22 to $0.23 quarter with an adjustment for some of the onetime events. When you look at the risk adjusted work that we’re doing in the business we feel very good that the replacement cycle will make its way back from the trough lows. It is timing that is less obvious to us.

So we are managing ourselves, we’re managing our company, we’re managing all of you to be a bit agnostic to when the market comes back and lining our products up so when the market does come back and lining our products up so that when the market does come back we participate from a market share perspective as we would hope to beyond what our expectations are. We’re risk adjusting obviously the business for the replacement cycle. We have a bit of risk adjustment for the worst case scenario in Alabama.

We’re working through that, we’re working through some firmware changes in Alabama but there is we think on the downside of our guidance a worst case scenario there but some risk. We think we’re being very prudent in the way we’re approaching the business and communicating with you in a way where we would have closed the guidance up from a range if we had felt that we had visibility that would have allowed us to do that.

Patrick W. Cavanaugh

That is really you have two things, if you look at the games ops business we’re still experiencing a fair amount of mix shift so until we get that stabilized which I think some of the new products that’s coming so things like Sex in the City and the new incarnation of Wheel of Fortune, i.e. the center stage products that we’ll start rolling out later this quarter, etc. that should help. But, I think until we see that, that causes us one area to be cautious.

Then the other area is really on the replacements. Patti pointed that it is not so much that we don’t believe that there is going to be an uptick in it, it is just the timing of it because when you talk to our customers most of them are still fairly conservative about what they are seeing in their businesses given the consumer isn’t quite as healthy as maybe the folks in Washington would like us to believe.

Steven Kent – Goldman Sachs

But you have reduced your expenses and just to be clear there is a program within IGT to continue to look for opportunities and find opportunities for expense reduction and margin improvement?

Patrick W. Cavanaugh

Most definitely. I don’t think the work there we can ever say is done so you can count on us to remain focused there. But, if you notice the revenue number wasn’t in our eyes something that we were overly proud of I guess.

Operator

Your next question comes from Robin Farley – UBS.

Robin Farley – UBS

I had a couple of questions, one is if you can give us some idea of where you think you market share, your ship share in the quarter was in product sales? I know you haven’t seen everybody’s numbers out there but just in terms of the customer level what you feel your market share is in terms of product sales?

Patrick W. Cavanaugh

We kind of compute it the same way you do Robin and that is once everybody has reported than we’re able to add up the numbers and do the math. But, our internal estimates just based on tracking of one order to the next would suggest we’re somewhere around 40% on the replacement side which is consistent with where we were for Q4.

Robin Farley – UBS

And for new and expansions?

Patrick W. Cavanaugh

Some north of 50% and it kind of varies widely. I think Aria for example we were right at 50% but most are at that number if not a little bit higher.

Robin Farley – UBS

Then just me back of the envelop it looked like maybe your domestic average selling price or participant revenue per box was down a little bit sequentially. If I did the math right, there were a lot of numbers you were turning out there so if you can just confirm that? Then also, is that just because maybe it was a lower percentage of MLP sequentially? I’m just trying to clarify that.

Patrick W. Cavanaugh

First, it was down sequentially but up year-on-year and that has to do with two factors one, the mix of MLP was about the same quarter-over-quarter sequentially but we had a much higher number of non-machine non-box revenue in Q4 versus Q1 and that would have been largely because that non-box is pretty high value stuff.

Robin Farley – UBS

So would the ASP adjust for the non-box revenue?

Patrick W. Cavanaugh

ASPs sequentially were $1,000 lower, $16,200 in Q4 to $15,200 in Q1 but up from $14,500 in the prior year quarter.

Robin Farley – UBS

So that’s not including non-box revenue so I’m just trying to understand what was driving the lower sequential ASP?

Patrick W. Cavanaugh

I would have to look in to it a little deeper Robin.

Robin Farley – UBS

Then on the game ops and the revenue per unit I know you said there’s some mix impact in there as well as actual declines sequentially, can you give us any kind of ball park what the declines look like on sort of the same casino games revenue yield decline versus lease ops gains revenue yield decline just to get a sense of whether those declines are stabilizing at this point?

Patrick W. Cavanaugh

What we saw if you just looked at the various components is I think about a 7.5% decline sequentially in yields in kind of the units that are in casinos so things like Wheel of Fortune, Mega Bucks and those. So, it makes it kind of hard to discern is that just normal seasonality which it may very well be because yields seem to be somewhat stable for the most part and have for the last five or six months. Unfortunately, we’re not seeing them go up though which would be the nice thing. Once we see that I think we start to get a little bit more confident that the economy is starting to turn and consumers are starting to feel a little bit better about themselves.

Robin Farley – UBS

Then my last question is just in terms of serve based systems that you have at City Center and potential for other full floor and in particular for example Bellagio looking to replace – MGM has talked about Bellagio having a full floor refresh this year and I guess in terms of timing though I imagine that is going to be somewhat limited by the fact that when City Center opens that Valley and Aristocrat were not ready to be on the server based system. I am assuming that you wouldn’t actually be able to do a full floor refresh of Bellagio until Bally and Aristocrat and others are able to be working fully on the server based system? So I’m wondering if you can talk about what do you think the timing is for that to happen so that if that is sort of a gating issue for other full floor replacements?

Patrick W. Cavanaugh

I definitely think it is. The other manufacturers have to be ready. It think they are all working to that end but I think the bigger limiting factor to full floor deployment is more capital availability. There still is a big scarcity of capital on the part of many of our customers particularly those who have a higher leverage.

Patti S. Hart

Robin, as far as the kind of timing goes on full interoperability we’re working with the customer and obviously with Valley and Aristocrat as well on a timing that gets the full interoperable capabilities in to the labs in about the March time frame and then has the full floor deployed in kind of the June time frame. That is the current target that we’re working towards.

Operator

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

David Katz – Oppenheimer & Co

If I’m thinking about your uses of capital and obviously kudos for getting City Center open and working so well but how do we think about what your deployment of capital is going to be toward the systems part of your business? Is it fair to assume that a good portion of the heaving lifting is behind you for the moment? How do we think about your strategy for capital spending in that area specifically?

Patti S. Hart

I think as far as R&D spending in the systems part of our business, we’re moving now from what I would consider to be the infrastructure work to the application layer and so continuing to invest on behalf of our customers to really begin the development of the application layer to really exercise the service window and to really breath life in to the floor the application layer. It would be our expectation that the $200 million we spend in R&D will shift slightly towards games but over time you’ll find that there will be less delineation between systems and games because it is really that interface between the system and the game where we think a lot of the value is created.

So, I would expect that our R&D spending will look not dissimilar to the way it has looked over the last couple of years with a slight move from what I would consider to be infrastructure in the systems to application.

David Katz – Oppenheimer & Co

It sounds like you’re encouraging us not to think about capital spent on systems and then my follow up question would be something like how do we think about a return on that capital spend and when that in and of itself becomes an important earnings driver? It sounds like you would encourage us not to think about it that way?

Patti S. Hart

I would think about it as a total system as opposed to the systems business stand alones from the games business. The systems business at IGT is a means to an end and that end is to sell more games and distribute more game content. So really working on that place where the game and the systems comes together where there’s less definition around buckets of R&D spending and it becomes one spending of R&D against future growth for the business. That is the way we’re thinking about it.

David Katz – Oppenheimer & Co

If I can just ask one more issue and follow up Steve’s question earlier, Pat I think your point is a good one that we all spend a great deal of time counting slot machines with the installed base and how that performs is I think at this moment given some of the initiatives you’re doing a little harder for us to model the operating leases, etc. It sounds like and I just want to make sure I’m hearing you right that the yield on that installed base, based on your guidance is likely to continue trending downward for a bit offset obviously by adding some units in to that based on new stuff rolling out?

Patrick W. Cavanaugh

I think there’s two things going on there David, one what we see we see yields kind of stabilizing in this area in total where there’s a lot of uncertainty is, is how quickly can you grow that install base which would be the counter. Then just on the replacement side of the business there just isn’t a lot of near term visibility to demand. Let’s face it, we’re just listening to what our customers are telling us about how they intend to spend capital and how much of it and neither of those two comments would suggest that you should have a real hockey stick kind of uptick in replacement activity. This should stay flat with prior year, we’ve got to have a pretty significant uptick in replacement units just to offset the loss that will definitely be there from new or expansions.

Patti S. Hart

I would just add to that on the game ops side of the business I mentioned in my comments the approach to the deployment of Sex in the City in to game ops. I think you should expect it will be more prudent about the deployment of our own capital in to the game ops side of our business ensuring that we see returns for not only our customers but for ourselves as we do that. At the same time to the extent there is opportunities to add lower yielding but significantly returning product in to the marketing game ops. We will continue to do that in places like Illinois, in places like Alabama where you have more lower yielding fixed fee products but the returns for IGT is adequate and the continued expansion of that franchise continues to be a focus for us. So there has to be a combination for us of yield, top line yield out of game ops and profitability and return and we’ll focus on both of those.

David Katz – Oppenheimer & Co

One last question if I may, on the international side can you help us to some degree just get a sense for what you are thinking in your guidance for this year and to any degree that you can share with us where it comes from because it is hard for us to track would be helpful.

Patrick W. Cavanaugh

One, we see improvement in Europe. Last year was a horrible year in Europe. Latin America will be a big contributor as it was in Q1 for the year and then I think we see stability in places like South Africa and Australia where they have been consistent providers and I think the same for the UK consistent contribution. But again, we’re not forecasting huge year-on-year improvements internationally given that many of the international markets are suffering the same economic and credit whoas that the US has felt.

Operator

Your next question comes from Todd Eilers – Roth Capital Partners, LLC.

Todd Eilers – Roth Capital Partners, LLC

Pat I’m not sure if you gave this or not but can you break down your gaming ops metrics by North America and international I guess revenue, gross margin and maybe end of period games?

Patrick W. Cavanaugh

I think I did let me just look for the page where we talked about that.

Patti S. Hart

We can get it to you offline.

Patrick W. Cavanaugh

If you want to just call Michael offline Todd he can give you that break down.

Todd Eilers – Roth Capital Partners, LLC

Then just quickly a couple of other questions, first would be timing on potential Illinois VLT shipments, maybe just a quick update on that. Then also you mentioned Alabama, can you maybe give us a sense of what your exposure is in that market maybe in terms of how many games you have installed in that market?

Patrick W. Cavanaugh

First on the timing of Illinois I think consistent with our previous remarks. We view that as probably a 2011 event before you see shipments. There is progress being made but the rules and regulations that they still have to procure the central system and get that in place, still have to get products approved, etc. So given how things normally go that sounds like a 2011 kind of at the early side before we see shipments there.

Regarding Alabama we currently have about 3,600 units in that total market. The bulk of those between a couple of properties Victory Land and Country Crossing and I want to say probably have somewhere in the neighborhood of $100 million of capital tied up in that market.

Operator

Your last question comes from David Bain – Sterne, Agee & Leach.

David Bain – Sterne, Agee & Leach

Could the lower ASPs be due to sort of the dearth of new openings in the September quarter? Do you typically give volume discounts on a new opening?

Patrick W. Cavanaugh

I’ll have to look at that David. Again, if you want to call us offline so I can look in to it. It is probably some combination of some of the promotional programs we have going on as part of G2E, coupled with the mix between new and replacements.

David Bain – Sterne, Agee & Leach

Then one of the issues we deal with here is the upcoming deployment of the Valley wheel product, the new Valley wheel product and how that may impact your gaming op lines in the later quarters. Can you tell us how you view that going forward?

Patti S. Hart

I mean from my perspective we adjusted ourselves to the notion of Valley having a wheel product a long time ago and our product development process has never been dependent upon the notion that we would own that space in its entirety. So we feel like the adjustment we made a long time ago not depending upon Valley being out of that space so our forecast hasn’t been adjusted based on the Valley litigation coming to a conclusion at all. We think our wheel products will continue to play and Valley will play in the marketplace as they always have. But, we think the adjustment has been made a while ago as I said.

Patrick W. Cavanaugh

As it always is it is always a function of we all come up with different games at different times and it all boils down to ultimate performance on the floor whether it’s got a wheel on it or not.

Patti S. Hart

We really appreciate everyone taking some time this afternoon to spend with us. We are delighted with the first quarter results that we delivered and are confident that our fiscal 2010 will perform as we expect. Thanks very much and we’ll talk to you in the next quarter.

Operator

This concludes today’s conference call. We’d like to thank all participants for attending. You may disconnect at any time.

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Source: International Game Technology F1Q10 (Qtr End 12/25/09) Earnings Call Transcript
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