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International Game Technology (NYSE:IGT)

F2Q10 (Qtr End 03/31/10) Earnings Call Transcript

April 22, 2010 5:00 pm ET

Executives

Patrick Cavanaugh – EVP, CFO and Treasurer

Patti Hart – President and CEO

Eric Tom – EVP, North America Sales and Global Marketing

Analysts

Robin Farley – UBS

Joe Greff – JP Morgan

Steven Kent – Goldman Sachs

Steven Wieczynski – Stifel Nicolaus

David Bain – Sterne, Agee & Leach

Cameron McKnight – Buckingham Research Group

Todd Eilers – Roth Capital Partners

Operator

Welcome and thank you for holding. At this time all lines are in a listen-only status until today’s question and answer session. The call is being recorded. If you have any objections to record a call please disconnect your lines at this time.

I would be turning today’s call over to Patrick. Sir, you may begin.

Patrick Cavanaugh

Thank you, operator, and good afternoon, everyone. Welcome to IGT’s Second Quarter Fiscal 2010 Earnings Call. With me today are Patti Hart, our President and CEO and Eric Tom, our Executive Vice President of Sales and Marketing.

Before we begin, we would like to remind listeners that our discussion reflects management’s views based on the marketplace environment, as of today, April 22, 2010 and will include forward-looking statements, including forecasts of future performance and estimates of amounts not yet determinable, the potential for growth of existing and the opening of new markets for our products, levels for install base of recurring revenue gains as well as future prospects and proposed new products, services, developments or business strategies.

Our future financial condition and results of operation as well as our forward-looking statements are subject to change and to inherent known and unknown risks and uncertainties. We do not intend and undertake no obligation to update our forward-looking statements to reflect future events or circumstances and you should not assume later in the quarter or the year that the comments we made today are still valid.

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 included in our most recent Annual Report on Form 10-K and our reports on Form 10-Q filed during fiscal 2010.

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

With that I will turn to the discussion of the business. This afternoon IGT reported its second quarter results for fiscal 2010. Net income totaled $36 million or $0.12 per diluted share. This compares to $34 million and $0.11 per diluted share in the prior year quarter. The current quarter including restructuring and inventory obsolescence charges of 18 million after tax or $0.06 per diluted share. These were all primarily related to the decision to close our Japan operations as well as an impairment for intellectual property of 7 million with no tax benefits or $0.02 per diluted share, primarily due to uncertainties about how certain patterns sit in with our strategic direction.

The prior year quarter included restructuring charges of 8 million, 5 million after tax or $0.02 per diluted share. So excluding these charges mentioned above, second quarter adjusted net income was 61 million or $0.20 per diluted share for fiscal 2010 and 39 million or $0.13 per diluted share in fiscal 2009.

Additionally, the second quarter comparability 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 of application of new accounting standards associated with our convertible debt.

On a consolidated basis our revenues for the second quarter were $498 million of which 57% was generated from gaming operations and the other 43% from product sales compared to $476 million for the same quarter last year.

For the six months ended March 31, 2010, consolidated revenues were 1 billion compared to 1.1 billion in the same period last year. Consolidated gross profit and operating income for the quarter was $276 million and $95 million respectively and $573 million and $235 million respectively for the six months ended March 31.

During the first fiscal quarter of 2010, we adopted new accounting standards to acquire retrospective application to 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 reduced diluted EPS of $0.01 for the current quarter and $0.02 for the prior year quarter.

Moving on to gaming operations, game op revenues were 285 million in the current quarter which was up 3% sequentially but down 3% year-over-year. Approximately 5 million of the decrease in the revenues in the current quarter was attributed to property closures of electronic charitable bingo terminal being operated in Alabama compared to the same period last year.

Gross margins were 62% for the quarter versus 59% in the prior year quarter. Current quarter margins were positively impacted primarily by lower depreciation. We earned an average of $51 and $0.70 a share in revenue per unit per day which is up 5% sequentially and down from $52.96 in the last year’s second quarter.

This blended yield of $51.70 is an average of the various components of our broad and diverse install base, comprised of our mega jackpots, our central determination, Class II and lease ops units, all of which serve distinct markets and have unique yield characteristics.

Lower year-over-year blended yield is a result of the continued shift towards lower yielding machines. IGT’s install base ended the second quarter at 58,800 units, down 2,500 units over the prior year and down 3,400 compared to the prior sequential quarter. The decline in our installed base is primarily due to the reduction of electronic charitable bingo terminals being operated in Alabama. Approximately 83% of our installed base is comprised of variable fee games which earn a percentage of the machines play levels rather than a fixed daily fee.

Moving to product sales, product sales revenues totaled $213 million for the quarter compared to $181 million in the prior year. Worldwide, we shipped 11,800 machines during the quarter, down from prior year shipments of 12,700. Non-machine revenues comprised of gaming systems, game theme conversions, tables, cards and intellectually property fees came in at $72 million for the quarter or 34% of total product sales for the quarter compared to $70 million and 38% of total product sales in the prior year quarter.

Product sales gross margins were 46% for the quarter, down 200 basis points from the prior year quarter, primarily due to higher obsolescence incurred in the current year quarter, including write-downs related to the closure of our Japanese operations. For a reconciliation of units shipped to equivalent units recognized, please see our earnings release.

Units shipped for the current period reflect all units shipped to customers which include units for which revenues have been deferred. Equivalent units recognized represent units recognized in revenues under Generally Accepted Accounting Principles during the quarter.

Taking breaking up product sales down domestic versus international first domestic product sales revenue totaled $124 million on volume of 5,200 units recognized for the current quarter compared to 120 million and 5,400 units recognized in the prior year quarter. Domestic replacement units shipped totaled 4,100 for the quarter, which is up 2,300 units from the prior year and up 1,100 units sequentially.

While we continue to have limited visibility around replacement demand, we are encouraged by the recent uptick in demand as well as quality and innovation of our product sales segment. Domestic new and expansion shipments totaled 1,800 units in the quarter, down 1,500 sequentially and down 2,900 units from the prior year quarter due to the fact that there are just fewer new openings occurring this fiscal year.

The prospective adoption of revenue recognition accounting standards related to certain software-enabled products and multi element arrangements, as of the beginning of the fiscal 2010 resulted in 13 million of revenues in the current quarter which would have been recognized in later periods under the prior guidance.

Domestic non-machine revenue totaled $50 million in the quarter, down from $52 million in the prior year quarter, primarily due to lower systems revenues. Domestic average selling price was 14,300 in the second quarter compared to 13,700 in the prior year quarter. And domestic average revenue per unit computed on an equivalent unit basis was 23,800 for the second quarter compared to 23,500 in the prior year. Both the ASP and ARPU increases were due to the increase mix of MLDs shipped and sold during the quarter.

We shipped 2,500 MLD units or 51% of total North American shipments in the second quarter compared to 500 units or 8% of total North American shipments in the prior year quarter. Sales of machines utilizing or AVP technology now comprise 95% of total North American machines shipped during the second quarter, a trend we expect to continue as our legacy for sale products continue to be phased out.

International product sales revenue totaled $89 million on volume of 7,400 units recognized for the current quarter compared to $54 million and 7,100 units recognized in the prior year quarter. Our international markets benefited from the opening of Resorts World Santosa in Singapore, improved sales in Europe and favorable foreign currency exchange.

International non-machine sales were $23 million, up from $18 million in the prior year quarter. The quarter was driven primarily by increases in systems revenue.

International ASPs were 9,000 for the second quarter compared to 5200 in the prior year quarter and international ARPU computed on an equivalent units recognized basis in the second quarter was 12,100, up 59% over the prior year quarter. Both the ASP and the ARPU increases were due to a more favorable geographic product mix, i.e., more heavily weighted with Casinos sell products.

Total product sales gross margins for the quarter were 46%, down 200 basis points from the prior year quarter. As the quarter was impacted by higher obsolescence, going forward, we expect product sales gross margins to trend within a range of approximately 48% to 50% depending on product sales mix.

Moving on to operating expenses, second quarter operating expenses totaled $181 million compared to $190 million in the prior year. Current quarter restructuring and other charges of 23 million were comprised of 16 million of severance costs and other asset write-offs, primarily related to the closure of our Japan operations and 7 million of intellectual property impairment, recorded primarily due to uncertainties around how certain bad pattern sits with our product strategy going forward.

Excluding restructuring and other, second quarter operating expenses and operating income margin would have been 158 million and 24% respectively, compared to 182 million and 17% respectively in the prior year quarter primarily due to lower bad debt provisions and lower expenses largely related to cost control efforts.

Update on our cost reduction efforts, we continue to move towards our goal of the previously announced $200 million of cost savings when compared to the fourth quarter of 2008. We feel we are on track to achieve our cost reduction goals, as we move throughout 2010 and exit the year.

SG&A excluding bad debt declined 12 million or 12% to 84 million for the quarter as a result of our continued cost control efforts, including lower legal and compliance fees. We expect quarterly SG&A run rate of $90 million to $95 million.

Bad debt provisions totaled $2 million for the quarter compared to $13 million in last year’s quarter. The bad debt decrease for the quarter primarily stems from fewer specific reserves related to customers which were affected by the economic environment.

R&D expense totaled $53 million for the quarter, flat compared to the prior quarter. We expect a quarterly R&D run rate in the low $50 million area.

Depreciation and amortization within operating expenses totaled $19 million for the quarter which was flat with the prior year. Total depreciation and amortization inclusive of that included in game ops was $58 million for the quarter, down from $69 million in the prior year quarter. The decline in total depreciation and amortization was primarily due to lower depreciation in our domestic mega jackpots business and our Mexico lease operations. Please note that some of this will come back as we refresh our install base with assets.

Other income and expense net in the second quarter was a net expense of $22 million compared to $19 million in the prior year quarter. The change is mostly due to increased borrowing costs, partially offset by less foreign exchange loss. Additional convertible debt amortization required under our accounting guidance adopted retrospectively at the beginning of the fiscal year increased interest expense by 7 million in the quarter and 4 million in the prior year period.

In addition, we expect non-cash interest of approximately $30 million. $19 million after tax or $0.06 per diluted share for fiscal 2010 and approximately $22 million after tax or $0.08 per diluted share for fiscal 2009 as restated, including repurchased gains of 5 million.

Moving on to the tax rate. Our tax rate came in at 50% in the second quarter versus 34% in the prior year quarter. The tax rate during the quarter was impacted due to significant one-time items, i.e., largely the intellectual property impairment and the impairment charges taken in Japan. The current quarter tax rate excluding these one-time items was approximately 38%.

Going forward we expect our quarterly tax rate to trend at approximately 37% to 39% before discrete items. However, we may experience volatility in our quarterly tax rate due to the impact of 1048 and quarterly discrete items including the expected closure of various audit cycles.

Moving on to the balance sheet, cash and equivalents and short term investments inclusive of restricted amounts totaled $259 million at March 31, 2010 compared to $247 million at September 30, 2009. Contractual debt obligations totaled $2 billion with $1.2 billion of available under our line of credit.

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 $138 million at March 31, 2010 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 billion as of March 31, a decrease of $142 million compared to September 30, 2009. Our 3.25% convertible notes and warrants were excluded from the diluted shares outstanding for the period ended March 31, because the conversion price and the exercise price exceeded the average market price for our common stock.

On the balance sheet we made a lot of progress with our working capital ratios and conversion of working capital of free cash flow. Working capital totaled $647 million at March 31 compared to $609 million at September 30.

Average day sales outstanding excluding receivables from our notes and contracts was 54 days down from 58 days as of September 30. Inventory turns averaged 3.7 times, up from three times at September 30.

For the six months ended March 31, IGT generated $277 million in cash flow from operations compared to $206 million for the first six months of last year. During the quarter, we saw continued improvement in working capital efficiencies such as reduced inventory balance, the lowest it’s been in 40 quarters. For the six months ended March 31, 2010, IGT recorded 124 million in free cash flow compared to negative 14 million for the first six months of last year. All of the free cash flow generated in 2010 has been used to pay down debt.

Capital expenditures totaled $64 million for the quarter compared to $53 million in the prior sequential quarter due to higher investments in game ops assets. CapEx is expected to trend in a quarterly range of $65 to $75 million although we continue to come in near the lower end of the range as we more proactively manage our CapEx as part of our efficiency and cost reduction efforts.

We understand that the bill which would have allowed the Alabama voters to decide on a constitutional amendment authorizing Bingo, including electronic charitable Bingo at the state level, did not pass the Alabama House. Notwithstanding this unfortunate legislative outcome we believe the electronic charitable Bingo terminal at our customers Victoryland, Country Crossing and Greentrack are legal.

Despite our belief there does exist some risk that the properties will be able to continue operating or will we open in the case of Country Crossing. We continue to monitor the Alabama charitable market, in the near future, electronic charitable Bingo in the state may be impacted by the outcome of several cases pending before the Alabama Supreme Court or from other developments. As of March 31, 2010 we had approximately 85.5 million on development financing notes, 9.2 million on fixed assets, and 7.2 million on accounts receivable associated with our customers now in Alabama.

That concludes my prepared remarks regarding IGT’s second quarter. And I’ll now turn the call over to Patti.

Patti Hart

Thank you, Pat, and good afternoon everyone. Thank you very much for taking the time to join us as we discuss our fiscal second quarter. As many of you know we have been tempering expectations on the state of the market over the past several quarters as we await a sustained and meaningful increase in customer spending levels. Similar to most of you we remain cautiously optimistic about the macro environment. We are more enthusiastic about several bright spots in certain areas of our business.

In gaming operations, overall yields were $51.70 for the quarter, an improvement of 5% sequentially, reflecting a slight increase in play level. Our mega jackpots yield improved 11% sequentially, with Sex and the City continuing to perform earning up to $1,260 per day for our customers.

In addition, we have now deployed 149 units of Amazing Race and 93 units of Top Dollar, our latest generation of titles in our gaming operations business.

4,100 shipped units are North American replacement sales improved 37% from the prior sequential quarter, a sign of market improvement and a testament to the quality of our latest for sale titles.

We also made progress on several strategic marketing initiatives during the quarter to better respond to the needs of our customers while reinforcing our historical strength, including, a continuation of our program to refresh our market leading Wheel of Fortune brand. The announcement of a backward integration solution for our Service Window functionality and the continued production of certain titles for convergence on our 80960 platform.

Joining us today is Eric Tom, our Executive Vice President of North American Sales and Marketing who would tell you a bit more about these programs and give you a broader overview of our customer facing activities.

Eric Tom

Thank you, Patti. I’m pleased to talk about this quarter’s activity in both games and systems. We believe this activity showcases our innovative talents and maximizes the value proposition to our customers. As Patti mentioned we are highly focused on leveraging our historical strength.

We continue to refresh our signature brand Wheel of Fortune. The first title for our new center stage game series is Wheel of Fortune Experience, available with both three and five real games. Additionally, we recently unveiled Wheel of Fortune multiplay, which allows players to play up to four concurrent base games.

And finally, Wheel of Fortune Secret Spins a game in which the wheel rotates to reveal an extra multiplier will be introduced to market later this year. Additionally, we continue to focus certain aspects of our product strategy on initiative, designed to maximize our share of those lean customer budgets.

Here are three examples. First, our previously announced Service Window solution to a legacy 80960 video machine furthers the company’s commitment to providing our customers with cost effective and flexible solutions for our network floor. This backward integration solution which is scheduled to be deployed in fall 2010 allows our customers to satisfy demand for service window capabilities in our existing 80960 footprint.

Second, so far this year, we released 21 new conversion games, where our legacy 80960 Spring Wheel and video platforms. These games enable our customers to freshen their floors with limited expenditure while reinforcing our existing position in their casino.

And third, we continue to experience success with our dynamic package, which bundles one new AVP slot machine with two 80960 conversion kits, allowing a customer to refresh three machines concurrently. As of March 31, we sold 4,017 units under these customer friendly programs.

I would also like to highlight other important initiatives that we are executing. Patti mentioned our success with Sex and the City, Amazing Race and Top Dollar. And we are excited about the continued improvement in our game operations product portfolio. As of March 31, our backlog for these three themes plus the recently released Wheel of Fortune experience stood at 2,153 units.

In the first two quarters of 2010, for our four sale business, we have released 80 game titles compared to 30 titles during the same period in 2009. These included an even mix of spinning wheel and video slot games. Some of the exciting titles include Pirate Bay, Kodiak King and Majestic Sea. We anticipate another 50 to 70 titles to be released through the remainder of this fiscal year. And as of April 19, we have 3,200 games in the backlog.

We are now over 13,000 AVP units with MLD in the marketplace offering 3D games and enabling spin wheel, video slot and poker slot, all in one machine.

Now, turning to systems, we continue to be encouraged by the performance of our server-based gaming system (inaudible). We believe we have met our customers’ high expectations with the first system of its content.

During the second quarter we announced several key tier one successes including Casino D in Italy, Grand Casino in Helsinki, New Orleans, Colusa and Mohawk. In North America as of March 31, we are in varying contract stages with two other FDX opportunities and seven other tier one opportunities.

Please understand there is no guarantee that we will close all these opportunities. In our traditional systems business we continue to face a challenging new build environment, with few additional casino properties scheduled to open in the near-term. That being said this quarter we have closed three new advantage customers as of March 31, and as of the date we are in varying contract stages with five new advantage customers. Again, no guarantee that we will close all these opportunities.

We are also aggressively focused on marketing FDX to our existing advantage customers who are a deal candidate, delivers the power of this new platform.

More broadly, we continue to receive positive feedback from our customers for our restructured North American sales organization, implemented in September of 2009. This change included the addition of strategic account managers, trained sales personnel who manage our largest customers and are focused on corporate relationships, system and marketing opportunities.

Additionally, we now have each account manager responsible for the entire IGT portfolio. The breadth of which we consider to be a competitive advantage. We also organize our systems, professional services and poker experts to more effectively assist our frontline account managers.

So as we move forward in our sales and marketing strategies we will continue to focus on content quality, product innovation and a customer first approach the market.

With that I will turn it back over to Patti to speak about our broader corporate initiatives and our outlook for the remainder of 2010.

Patti

Thank you, Eric. Last quarter we discussed our measured success. And in the light of a continued challenging environment this quarter I will focus on activities pertinent to those items that are under our control. Our balance sheet metrics continue to improve with working capital reduced by $88 million from the prior year quarter and total contractual debt obligation declining by $80 million sequentially.

We remain extremely focused on free cash flow generation. We continue to actively manage costs in the midst of the challenging environment as evidenced by decline in operating expense of 13% excluding restructuring and other charges and a decline in SG&A of 12% excluding bad debt over the prior year quarter. Additionally, we continue to make forward-looking and occasionally difficult capital allocation decision.

We continue to prepare our products and financing strategies for the impending 35,000 to 40,000 units Illinois expansion. We anticipate that the central system provider will be announced shortly with the associated rules and regulations issue thereafter. And we anticipate units to begin shipping in the first quarter of 2011.

We recently announced our decision to exit from the Japanese (inaudible) market. And while we are never happy to part with employees’ difficult market require difficult decision. Looking forward, Gideon Bierer, our Executive Vice President of New Media continues to establish his organization. And organization that will focus on the emerging opportunities in our industry, while Chris Satchell, our Chief Technology Officer continues to focus on platform improvement, a critical aspect of our future game development efforts. Both Gideon and Chris are implementing initiatives that will have long term impact on our business.

Again, we continue to work tirelessly to improve IGT for our customers, our employees and most importantly, review our shareholders. As I mentioned we remain cautiously optimistic regarding operator budgets and spending. With the seasonally slow first half of the year behind us we are looking forward to an increasingly clear view of the industry prospects for the remainder of the fiscal year. As I previously noting, 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 period.

We have adjusted our guidance to reflect the risk of the potential loss in revenues associated with units in Alabama. As a result of all these factors our guidance for 2010 has changed to a range of $0.77 to $0.85 per diluted share. As always, our guidance excludes a one-time item. Our guidance also assumes no dilution effect from our convertible note.

And with that we will open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Robin. Sir, your line is open.

Robin Farley – UBS

It’s Robin Farley of UBS. I wondered if you could give us a little color on what your market share was (inaudible).

Patrick Cavanaugh

Hi, Robin. Robin’s question was if we had any color on what our market share was. At this point we really follow the same problems as you all do and until at least couple of them the primary competitors reported really hard. From our internal estimates it looks like it’s probably in the 35% to 40% share basis on replacements given that’s largely the bulk of the shipments in this past quarter.

Robin Farley – UBS

And then in terms of the game ops, the yield increase, I wonder if you could quantity what game ops yield change would have been I guess excluding Alabama in both periods kind of more of a same-store comparison?

Patrick Cavanaugh

The yield story I think the two primary areas where we thought definite improvement in yields. Some of this may been largely due to last couple of years, seasonality uptick has been in the February-March timeframe for (inaudible) because there is pent up demand after the Christmas holidays and a slow January. But anyway we’ve seen that now two years in a row where we see a nice uptick but we believe part of that uptick is due to the new products. We have now had Sex and the City in that install base for while, Amazing Race and Top Dollar, started going out this quarter so probably weren’t as impactful. But also in the wide area progressive business we saw yields up nicely sequentially and really without much in a way of new product in area that would come starting this quarter with Wheel of Fortune experience as Eric mentioned.

Patti Hart

And we started I think Robin last quarter to start to see some of the signs of Alabama, so when you look at it sequentially it’s up sequentially and the MegaJackpots carved the business, up 11% sequentially. So that will give you a sense, if you look at same-store sales, looking at MegaJackpots quarter-on-quarter will give you a sense I think of the improvement.

Robin Farley – UBS

Okay, great, and that’s helpful. And then also just you mentioned the backlog when you talked about some of the new games, Amazing Race and some others, backlog of over 2,000 games, what’s the timing you expect to get those games to the floor where they will show up in your quarter?

Patrick Cavanaugh

Generally, Robin, when we introduce a game from an introduction to where we are pretty completely rolled out at least through the bulk of it, usually takes about six months in the normal course. And then I think that’s about what we’re seeing. We continually try and accelerate that wherever we can so there have been a lot of initiatives between manufacturing and the field service organization to accelerate that wherever we can, but it is kind of a function of how many people we have.

Patti Hart

And I think a couple of things, Robin, contribute to it. First is the customers desired delivery date and the second in many cases is the jurisdictional improvement, so currently I think Sex and the City is an example (inaudible) 17 jurisdiction, so some of the backlog is waiting for jurisdictional improvement to move out, some of its waiting for the customer delivery date to be determined.

Eric Tom

And I’ll add in consistent with our philosophy of managing cash where we can influence the shaping of the installed cycle we do, we just assign three people to specifically coordinate with customers to decrease the time to install and see actually scheduled which used to run three to four weeks, we’re trying to narrow down to one to two weeks. So simple things like that are all have been processed.

Robin Farley – UBS

Just to clarify that six months common because the game was introduced back in November-December so it has been almost six months, you’re saying six months from now or six months from the time of it was introduced.

Patrick Cavanaugh

I mean the time of it was introduced. So if you look at that backlog that include the smallest piece of that backlog are the tail end of the units that were demand for Sex and the City, because it was the first introduced. The most recent game was Top Dollar which has got introduced here within say the last month. And then as we say, we will be introducing now, in fact, I think the first units have just start to going on (inaudible) Wheel of Fortune experience. So you will hopefully be able to see that live and a casino with people plans it here one of these days.

Robin Farley – UBS

Okay, great, thank you very much.

Patrick Cavanaugh

You bet.

Operator

And our next question comes from Joe Greff, Your line is open.

Joe Greff – JP Morgan

Good afternoon, everyone.

Patrick Cavanaugh

Hi, Joe.

Joe Greff – JP Morgan

Pat, I think you mentioned that domestic ASPs were 14,300 –

Patrick Cavanaugh

Yes.

Joe Greff – JP Morgan

Which is down sequentially can you help us understand for that sequential decline?

Patrick Cavanaugh

You bet. I think they are down sequentially if my math is right, about $900. And I think we anticipated that as part of the whole dynamics program and the other promotional efforts that we have on, i.e., using our balance sheet to help move more product.

Patti Hart

And I think Joe we talked about this before, but I think we were very focused on really this value creation the delta between the value the customer see when it actually cause us kind of that difference, $4,000 value at a $1,000 cost. And that’s really what’s coming through. It came through in two areas. With an increase in replacement units going out and convergence which are the two things that we were really looking to solidify our position in the casino floor. So what we anticipate in, created and I think (inaudible) kind of outcome for us.

Joe Greff – JP Morgan

And the special pricing or volume, pricing, that’s ongoing, I think when you initially introduced it, it had some undefined time expiration, correct?

Eric Tom

It was to end of February. We extended it for three months and we haven’t decided what we’re going to do beyond that.

Joe Greff – JP Morgan

Okay. Have you seen competitors respond to that with similar types of price concession?

Eric Tom

No, we have not.

Joe Greff – JP Morgan

Okay. And then, Pat, on the topic of Alabama, how many units do you actually have there now at the end of the fiscal second quarter?

Patrick Cavanaugh

At the end of the quarter we had in total 2645, but at the non-natives 2300. You might want to get me or Michael calling chat about that offline just how the units have trended there.

Joe Greff – JP Morgan

Okay, great. And I think I asked this question maybe the last two conference calls about SG&A. I’m getting a lot of e-mails from investors why SG&A would be going up sequentially from here and can you help us explain why that is the case or if that’s just what you’re budgeting and hopefully you come under that?

Patrick Cavanaugh

I think it’s the latter, but also keep in mind that there’s certain variable cost particularly on compensation, so if results don’t go up, maybe in operating income you would anticipate SG&A will kind of run, trend at a lower level than what we’re giving in.

Joe Greff – JP Morgan

Great, thanks, guys.

Operator

Our next question comes from Steven Kent. Your line is open.

Steven Kent – Goldman Sachs

Hi, good afternoon. Hey, Eric or Patti, maybe you could just broadly tell us what your customers are saying out there. Because I guess I’m struggling with some level of replacement sales, how much they are really interested in replacing machine with sort of what are the gating issues that are holding them back and what would make them accelerate or decelerate the replacement sales who are out on the field a lot, I thought it’d be good to hear from you. Secondly, on the incentive, it sounds like you are giving a few more incentives to get to sort of buy a machine then given how many great machines you have out there better products in a couple of years what’s the rationale for doing that?

Patti Hart

Yes, so, let me talk first about my view of the customer sentiment and then I’ll let Eric add his thoughts as well. I think my view and my researches with customers is that they see the value in the new products, they see the value in the MLD products, they see a need to refresh their floors, and the biggest obstacle is their capital budgets. I mean they are under the same pressure we’re all under to manage their returns, their shareholders and so, it’s really in my mind just restricted capital budget and I think I indicated before Steve, when we talked there is a lot more planning going on right now than there is buying but I think when the capital budgets you will see a bit more buying moving up. So anything you want to add?

Eric Tom

I have similar conversations with customers along those lines. They want to refresh their floors, we’ve missed the whole cycle, they see that their floors need that reinvestment, but the capital budgets being controlled so tightly they just don’t have the opportunity. With that we’ve really focused on how we can facilitate the refreshing their floors and minimize the capital budgets.

So one of the reasons why the dynamics package meet sense to us and actually turned out to be very successful is that it combines the refreshing of two older beings which are susceptible to replacement because they are older, they are older being, at the same time you never change the minimal capital budget, they do have to buy in the next generation platform. It’s kind of a win-win, you invest in the future but you solidify the past. It made a lot of sense because these 80960 game themes that we put out the convergence themes don’t cost very much. It’s $500 a piece so $1,000 total. The other area that we’re focused on because the capital budgets are so limited is placing our MegaJackpots themes on the floor, because it’s capital less to the customers, it refreshes the floor, that’s need refreshing and is a lot of energy behind a new labels, so everybody seems to be excited about that, we’re having a good run at it because of that.

Patti Hart

And I think Steve, just getting to your second question was I think it is important to drive and that is that the obstacle between where we are in increased volume has nothing, but it has very little to do with game performance. It’s about capital budgets. So what we’ve to do is help our customer address their biggest strategic issues that we see the dynamics package as strategic, it does protect our installed base and protect our position on the floor, at a point in time, when the replacement environment is at such low level. So we see it as a strategic, that combine with our product performance on the MLD product in particular we’ve been just very strategic in the market.

Steven Kent – Goldman Sachs

Okay, thank you.

Operator

Our next question comes from Steven Wieczynski. Sir, your line is open.

Steven Wieczynski – Stifel Nicolaus

Hey, good afternoon, guys. First question revolves you talked a little bit about Illinois but can you give us an update in terms of Italy, in terms of what you think in terms of the size in the market and timing?

Patrick Cavanaugh

Italy, I think the size in the market hasn’t really changed. Timing I think has moved out. I think if you talk to everybody involve there, including the operators and sales. I will tell you that it’s going slower than they thought. The reason for that is there is not one consistent system solution been offer there and invariably as one person providing maybe the game system but they have the interface to someone else’s is monitoring systems so there’s fair amount of engineering, engineering work that’s happened to go on, on the part of everybody that’s supplying there.

For us, I don’t know if we have much, I think we announced two deals around the time of the London Show that were both done by our UK subsidiary. I don’t know if we have anything yet today to talk about the European operation caters to where they are more casino oriented product. And so probably later this year late part of the summer maybe before the end of the calendar year you might see some shipments starting to go in there.

Steven Wieczynski – Stifel Nicolaus

Okay, got you. And then in terms of the guidance just want to make sure I got this right. You pick the top end down by $0.02, was that fully a function of just Alabama?

Patti Hart

It’s really baking in the risk of revenue on the Alabama that we think is becoming. First of all, it’s difficult for us to control from a timing perspective, for the most part, and to answer the politicians and returning to the state. And so we’re doing everything we can, but our influence there is not as great we would like for it to be. So we decided we will bake in that risk and the guidance to make certain menu all were, seeing what we’re seeing.

Steven Wieczynski – Stifel Nicolaus

That still incorporates basically the replacement market, very similar to what we have seen in the past couple of quarters?

Patti Hart

That’s right.

Patrick Cavanaugh

That’s correct.

Steven Wieczynski – Stifel Nicolaus

And then Pat, real quick, could you just break up the other income line for me?

Patrick Cavanaugh

Sure. Interest income, $15.7 income; interest expense, $39 million; and $1 million of other income. (inaudible).

Steven Wieczynski – Stifel Nicolaus

That’s great, thanks.

Operator

Our next question comes from David Bain. Your line is open.

David Bain – Sterne, Agee & Leach

Great, thank you. I guess just a follow-up on the ASPs one last time. Sorry. Purchases now less about game performance, more about capital budget so if others do follow on bundling deals and these types of arrangement, does that become more of a pretty slow or is there something you can give us a sauce that we kind of the bottom run rate we should be using on ASP?

Patti Hart

I think I will give you my comments and Pat will reply to your request. I think a bundling again the bundling and packaging is focused on splitting the activity between converting the old install base and selling new machines. And as we move out of this level of replacement cycle into the next level of replacement cycle where customers becoming less focused on refreshing the old machines and they become more focused on replacing them, then the dynamics products kind of disappears for us. So if you look at the ASP on a standalone product less discount looking back on the conversion, you ‘d still find the same levels of ASP that we’ve been enjoying but you’re getting the discounts of a convergent package. So they move away from combining convergent with new purchases you will find the ASPs will reflect that.

David Bain – Sterne, Agee & Leach

Okay.

Patrick Cavanaugh

I think David in general if you talk to casino operators which you will do, you can just tell the overall level of demand is much lower than it otherwise might be because of Patti’s point to capital. I think for us our products are getting better and therefore the game performance is swaying more of that business our way, but it’s still you have to assume a pretty competitive environment because you have everybody buying for lower level of demand.

Patti Hart

And in many cases you are not competing with or that more you purchase from us or someone else are they going to purchase or not purchase. And that’s really the decision we need to influence.

David Bain – Sterne, Agee & Leach

Okay, okay, that makes sense, thank you. And then also is there some sort of forecasting if you can give us for ship not recognized in for future quarters and there was some benefit there and it makes a little bit tougher to model going forward, that keeps moving around or is there going to be a steady number that we can kind of –

Patrick Cavanaugh

I think it’s going to become more steady and that’s why in Q1, we are able to early adopt a new, there were two new EITF that come out, both doing with revenue recognition and as you saw this quarter made it easier for us to bifurcate the hardwire and the software so that that we were not having to defer revenue on machines where there really is value earlier than when maybe a system for example, most complicated one. It’s just getting better about making sure that the accounting folks are at the hip with the legal folks and the sales folks as we’re constructing deals rather than letting the deals get put together and then we get stuck having to live with whatever the accounting treatment is.

David Bain – Sterne, Agee & Leach

Okay. And then final one on is it possible for you to give us the number of units Marina Bay Sands?

Patrick Cavanaugh

Marina Bay Sands I don’t have that figure handy.

Patti Hart

We’re happy to give you offline; we don’t have the detail now.

Patrick Cavanaugh

If you know the total, I believe it was a 24%, 25% market share; it was better than what’s done in the –

David Bain – Sterne, Agee & Leach

Starting with 1800, going to 25 or something. All right, well, thank you very much.

Patrick Cavanaugh

You bet.

Operator

Our next question comes from Cameron

Cameron McKnight – Buckingham Research Group

Just a question for you, Patti. You brought in a lot of non-gaming people into the organization over the course of the last year. How was that cultural transformation at IGT tracking?

Patti Hart

We have brought a lot of folks that don’t have wager based gaming experience. Chris Satchel brings a very long history in gaming from Microsoft to the company. So when you look at the senior management team it’s kind of split half and half, we have folks who have been in the industry a very long time and we have new thinkers in the business, but I think with the right balance where the areas where gaming experience is very important from a product development perspective, from a technology investment perspective, from an intellectual property creation perspective, we have aired towards the side of protecting that gaming legacy and in areas of legal and compliance and sales and new media obviously we’ve been less so.

So culturally going well so far, I think again, we’re really relying on both sides to do what they need them to do. The new eyes to really push and challenge why are we doing things this way and the legacy executives including all the legacy in place of IGT should really challenge and help understand why we do things certainly. I think what we’re finding as we’re working through that is we’re moving our decisions to the middle to balance of input from both sides of that equation.

So I would say at this point it’s going well, we’re starting to do some things differently and we’ve invested in marketing, really the third time in this company’s history, really Eric has created a marketing organization and thinks about the four Ps of marketing, in product and placement, promotion and price and bundling and packaging and our brand in ways that we haven’t been thinking about it, we think about routes to market differently than we thought about that before.

And I would say that some of our competitors have done a better job than we have over a lot several years, new thinking and challenges to status quo and we’re at a point and not only our company, but in this industry where we’re destined to do more of that. So I would say at this point I would give a high marks and we’ll see who wears down whom first.

Cameron McKnight – Buckingham Research Group

Okay, great, thanks. And if we look at the reconfiguration you’ve done up the design studios, all of those studies now equally producing products or is that one or two studios producing more products than the rest and how long so some of those other studios are pushing more products out to the field?

Patti Hart

We have all intents and purposes what I would be interested to be five studios today, we have a system studio and then we have our floor games studios and we think less about quantity coming out each of the studios because each play a very different role, that studio that is responsible for video poker product is less about quantity, frankly. And when you think about the game ops business, that’s really about return on capital. We have those folks focused on the performance of their games against the capital that IGT strand in the marketplace. So we don’t think about it is much, its quantity, frankly, as we think about each all that role that each studio plays in the market

Now, I would say always in every quarter you are going to have studios that play stronger than others and we have that at this particular time. That’s based on the needs of the business, less than the talent of the workforce. So when the needs of the business shift you do have to ride and push studios differently. And so we’re doing that. I would say it will never be equal because studios are studios and they are creative people so will never be equal but I think we had each studio playing the role that the company has defined for them to play. Eric, do you have anything to add to that?

Eric Tom

No, I think it does trend, we have actually put a lot of discipline in the product management function in defining the type of the games we believe the marketplace is looking for and there is always it depends upon time, cycles in the marketplace, gaps in our product portfolio. I think in the past we might have developed games based on probably a less disciplined manner so I think that as Patti mentioned as we define different requirements, different studios will play a more significant role for those requirements, but much more sophisticated approach to game development which we are finding to be very productive and probably more effective as we launch these products at the market.

Cameron McKnight – Buckingham Research Group

Okay, thanks, and one last question if I may. If the replacement cycle comes back next year as many expect, do you think that sales conversion case may correspondingly decrease to offset that?

Patrick Cavanaugh

Possibly into that 80960 platform, but you have to keep in mind that we are now starting to get a fair number of AVPs, some of which are getting to be rather long data themselves that are better able to handle some of the new games coming down the line, so this is possible, Cameron. I think probably less so international, I think, international tends to lag the domestic market a little bit.

Patti Hart

I think the other thing, Cameron, as you look forward into 2011, 2012 when you think about convergence, the notion of a convergent for IGT will change pretty dramatically from what today is kind of a hardware, firmware, software changed, over time being various software configurable. So we will think about conversion differently going forward than we think about them today, as we go in to converting that only into our game ops business, but into some of the higher end AVP boxes, will be more of a software conversion than a hardware, firmware conversion.

Cameron McKnight – Buckingham Research Group

Okay, great thanks guys.

Patrick Cavanaugh

You bet, Cameron.

Patti Hart

We will take one more.

Operator

We do have one more from Todd Eilers. Your line is open.

Todd Eilers – Roth Capital Partners

Hi everyone, thanks for taking my question. I wanted to ask a question on the option install base of the 3400 sequential reduction there in units, can you tell us how many of those were removed from the Alabama market?

Patrick Cavanaugh

Sure, I think it was about 2,600 units in total. So all of them at Country Crossing and then you had Victoryland which reduced its work pretty significantly, closed December 31. But quite exit pretty early in the quarter. And then of the balance I want to say there might have been 300 units in the international marketplace and the balance pretty widely distributed across the domestic marketplace.

Todd Eilers – Roth Capital Partners

Okay, great, and then second question is it relates to City Center and your SBX product there, what’s the latest update on the timing for when all third party games will be available on that platform? And secondary question is that once that’s complete can we assume that all new properties that install that system and will also have a 100% installation across all the third-party games.

Patrick Cavanaugh

I think that’s the goal. On your first question, Todd, I do not know if there is a hard date, all is we know is the customers desire is to have a 100% floor or at least any machine that is suitable. So particularly all video-based products. And as far as we know everybody is working towards that goal, but without a real hard stop date as to when that, is that going to be at the end of June or the end of September, I do not know we can really remark.

Patti Hart

I think our expectation is by the end of the fiscal year. Our fiscal year is what we have been working with on with the customer and the various vendors and as all customers do once they get their floor installed, they end up with a lot of other priorities which they are working through right now. So the revenues I am targeting by the end of the fiscal year and I think we are still on track for that at this point.

Patrick Cavanaugh

And to your second question I think that is the goal, I mean that’s why everybody is working towards that, I mean I think ourselves and I think most all of our competitors realize the path forward that makes the more sense as one where we’re all offering an open ended solution, i.e. from a protocol perspective.

Todd Eilers – Roth Capital Partners

Okay, great, thanks guys.

Patrick Cavanaugh

You bet.

Patti Hart

Okay. We thank you for joining us and also for your continued interest in IGT. Thanks very much.

Operator

And that does conclude today’s conference call. You may disconnect your lines at this time.

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Source: International Game Technology F2Q10 (Qtr End 03/31/10) Earnings Call Transcript
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