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International Game Technology (NYSE:IGT)

F4Q07 (Qtr End 09/30/07) Earnings Call

November 1, 2007 9:00 am ET

Executives

Pat Cavanaugh - VP of CF and IR

T.J. Matthews - Chairman and CEO

Analysts

Bill Lerner - Deutsche Bank

David Katz - CIBC World Markets

Robin Farley - UBS

Joe Greff - Bear Stearns

Steve Kent - Goldman Sachs

Celeste Brown - Morgan Stanley

Steve Wieczynski - Stifel Nicolaus

Adam Steinberg - Morgan Joseph

Bill Lerner - Deutsche Bank

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time.

And now, I will turn today's meeting over to Pat Cavanaugh, Vice President of Investor Relations. Thank you. You may begin.

Pat Cavanaugh

Thank you, Candy, and good morning everyone. Thank you for joining us for IGT's fourth quarter and fiscal 2007 conference call. Joining me today on the call are T.J. Matthews, our Chairman and Chief Executive Officer, and Danny Siciliano, our Chief Accounting Officer and Treasurer.

Before I go over the financial highlights for the quarter and year, and before I turn the call over to T.J., I'm pleased to be able to share with you the Safe Harbor language.

Accordingly, before we begin, I'd like to note that during this Earnings Call, certain statements and responses to questions may contain forward-looking information, including forecasts of future financial performance and estimates of amounts not yet determined as well as our future prospects and proposed new products, services, developments, or business strategies.

Actual results could differ materially from those projected or reflected in our forward-looking statements, and reported results should not be considered an indication of future performance. IGT's future financial condition results of operations as well as any forward-looking statements are subject to change and to inherent known and unknown risks and uncertainties. IGT does not intend and undertakes no obligation to update our forward-looking statements including any comments regarding our earnings expectations, future events, or circumstances.

All forward-looking statements made in this conference call reflect IGT's current analysis of existing trends and information, and represent IGT's judgment only as of today. You should not assume later in the quarter or year that the comments we make today are still valid. Actual results may differ materially from current expectations based on a number of factors affecting IGT's businesses, including unfavorable changes to regulations or problems with obtaining needed licenses or approvals, a decrease in the popularity of our reoccurring revenue gains, or unfavorable changes in player and operator preferences, slow growth in a number of new casinos or the rate of replacement of existing gaming machines. Failure to successfully develop and manage frequent introductions of innovative products, more information on factors that could affect IGT's business and financial results or cause us not to achieve our forecast are included in our most recent annual report on Form 10-K and other public filings made with the Securities and Exchange Commission.

During this call today, references may be made to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as the reconciliation of these measures to the comparable GAAP results in our 8-K filed with the SEC today, a copy of which can be found on our website at IGT.com.

This call, the webcast, and this call and its replay are the property of IGT and is not for rebroadcast or use by any other party without the prior written consent of IGT. If you do not agree with these terms, please do disconnect now. By remaining on the line you agree to be bound by these terms. With that said, I will now go over the financial highlights for the quarter and year just ended.

Today, we reported results for the fourth quarter and fiscal 2007. We not only realized another record quarter for our game and operations business, but we also posted record results for non-machine sales and cash flows from operations. For the year, IGT delivered record results on nearly every financial measure and returned a significant amount of capital to our shareholders. We generated over 70% of our revenues, operating income and cash flow without shipping a single unit.

Financial accomplishments for fiscal 2007, all of which our records include, revenues of $2.6 billion driven by results of gaming operations and non-machine sales; gross profits of $1.5 billion with a consolidated gross margin of 56%; gaming operations revenues of $1.4 billion, and an installed base of gaming operations assets of 59,200 up 19% from the prior year; non-machine revenues of 384 million representing 30% of total product sales; operating income of $800 million, of which our international division generated 20%. Just five years ago, the international division contributed 5% of operating income. EBITDA of $1.1 billion, cash flow from operations of $822 million, up 32% from prior year; net income of $508 million or $1.51 per diluted share.

These accomplishments coupled with the strength of our balance sheet allowed IGT to return $1.3 billion to shareholders in the form of share repurchases and dividends in fiscal 2007. During the fourth quarter, IGT bought back 13.5 million shares at a total cost of $507 million at $37.47 per share. For the year, we repurchased 28.2 million shares at a total cost of $1.1 billion.

Moving on to our business discussion: Gaming operations: The gaming operations business generated record revenues of $353 million in the fourth quarter and $1.4 billion for the year. Revenue growth on a quarterly basis was 6% compared to the same quarter last year and 3% sequentially. For the year, revenue was up 9%. Our installed base ended the year at a record 59,200 units and earned $69 in revenue per unit per day. During the year, we added 9,600 incremental units during the fourth quarter, and during the fourth quarter our installed base increased by 1,000 units.

In the casino operations sector of our installed base, we ended the year at 40,400 units, up 4,400 units for the year and 800 units sequentially. Installed base growth mostly came from additions in Florida, Oklahoma, California, and Pennsylvania.

In the lease operations sector, our installed base totaled 18,800 units at the end of the year representing growth of 5,200 units for the year and 200 units sequentially. Domestically, New York with 2,000 units, generated much of the growth, but we also saw a 300-unit expansion in Rhode Island as well during the year. International growth came mostly from Mexico with 2,400 additional units.

Gross profit on gaming operations totaled a record $215 million for the quarter and $823 million for the year. Gross margins were 61% for the quarter and 60% for the year; both outperforming prior year results by 200 basis points.

Margin improvements were mostly driven by favorable jackpot expense, which fluctuates primarily as a result of variations in play levels and the timing of jackpots, as well as a growing mix of stand-alone participation and lease operation games, which don't carry IGT-sponsored jackpots.

As a reminder, margins and gross profit came in slightly lower when interest rates go down and they increase when the rates go up, as the cost of fun jackpots is inversely related to movements in interest rates.

Game ops gross margins going forward are projected to trend within a range of 60% to 62% with fluctuations based on the timing of jackpots, interest rates, and the mix of games in our installed base. Our game operations have historically been affected by seasonal trends with the first quarter of the fiscal year experiencing 5% to 10% lower revenues due to seasonality.

The first quarter of 2008 might be further impacted by the temporary loss of revenues from 800 machines due to the fires in Southern California that caused the closure of several casinos for four to six days. While we expect the installed base to increase during fiscal 2008, we believe it may remain relatively flat during Q1 due to temporary removals at certain locations as these removals are reinstalled to floors and anticipate newer expanded casinos begin to open over the course of fiscal '08 and into '09. We expect the installed base to grow to a rate of 500 to 1,500 machines per quarter during the last three quarters of fiscal '08.

Moving on to product sales: Product sales revenue totaled $310 million for the quarter and $1.3 billion for the year. For the quarter, revenues were up 2% from last year, and on a full-year basis, total product sales revenue was consistent with the prior year. Worldwide, we shipped 23,400 machines in the fourth quarter and 105,900 machines for the full year, which compares to prior year shipments of 22,400 and 112,000 machines, respectively.

For the year, IGT continued to see a market-wide reduction in North American replacement demand as 13,700 fewer replacement units were shipped, offset partially by an additional 5,600 new units shipped.

Non-machine revenues comprised of gaming systems, game theme conversions and parts and intellectual property fees, totaled a record $118 million for the quarter, and a record $384 million for the year, or 38% of total product sales for the quarter and 30% for the year. Non-machine revenues carry higher margins than machine sales and we expect them to continue to trend at approximately 30% of total product sales.

Average revenue per unit for the year was 11,900 compared to 11,300 in the prior year. The mix of non-machine revenues was mostly offset by the greater mix of international low payout machine sales during the year.

Product sales gross margins were 52% for both the quarter and the full year. For the year, margins improved to 100 basis points due to a stronger mix of higher margin non-machine sales.

For fiscal 2008, we expect product sales margins to trend between 49% and 52%. Breaking down product sales between domestic/international: Domestic product sales revenue in the fourth quarter totaled $186 million on volume of 8,300 units compared to $209 million and 11,700 units in the prior year. For the full year, domestic product sales totaled $787 million on volume of 43,000 units, compared to $804 million and 51,100 units in fiscal 2006.

Domestic non-machine revenues totaled $87 million in the fourth quarter, up 15% from the prior quarter. And for the year, revenues totaled $295 million up 4% over the prior fiscal year. The quarter and year were up due to strong system sales partially offset by lower parts sales.

Domestic replacement shipments totaled 4,500 units for the quarter and 22,500 units for the year. We anticipate quarterly replacement shipments to remain within a range of 3,500 to 5,500 units during fiscal 2008. New unit shipments fluctuate depending on the timing of new markets and expansions, and we expect new unit shipments to accelerate in the second half of fiscal 2008 due to the timing of new and expansion opportunities across all regions.

Domestic average revenue per unit was 18,300 for the year compared to 15,700 in fiscal 2006.

Improvement was driven by an increase in the share of ABP sales and stronger domestic non-machine sales. We anticipate ABP sales to continue growing and share of total machine sales as well as continued consistent contribution from non-machine sales.

International product sales revenue for the fourth quarter totaled $124 million on volume of 15,100 units compared to $96 million on 10,700 units in the prior year.

For the full year, international product sales revenues totaled a record $474 million on volume of 62,900 units compared to $456 million and 60,900 units in the fiscal 2006.

For the year, stronger machine shipments in Japan and Asia were offset by lower shipments in the U.K. For the quarter, international non-machine sales were 31 million, up 75% over the prior year quarter. For the year, international non-machine sales were 89 million, up 11% over the previous year.

Both the quarter and year were driven by record U.K. convergence sales due to a regulatory change, which drove a one-time conversion opportunity for the mandatory removal of Section 16 and 21 machines, which are similar to our domestic versions of electronic bingo.

In the Japanese Pachisuro market, the removal of Reg-4 games is complete. Currently, there are about 1.2 million Reg-5 games installed, down from 2 million mostly Reg-4 games installed at the end of 2006. IGT sold 7,200 machines in the fourth quarter, up from 1,900 units in last year's quarter and 29,800 machines for the year, up from 13,800 units in fiscal 2006.

Despite the market size reduction, IGT Japan was profitable in 2007 with an operating income of approximately 14 million and we foresee continued profitability from this operating region. International average revenue per unit totaled 7,500 for the year, consistent with fiscal 2006.

Higher realized prices and casino markets were partially offset due to an increase in lower price Pachisuro machines shipped in Japan.

Moving on to operating expenses: Total operating expenses were $179 million for the quarter, and $681 million for the year, compared to $182 million, and $647 million in the prior year, respectively. Pre-tax items affecting comparability include an $11.3 million charged R&D for the buyout of a third-party development contact realized in the fourth quarter of the previous year, a $12 million insurance settlement related to the gulf coast hurricanes received in the second quarter of fiscal 2007, a $5.8 million gain on the sale of a corporate asset realized in the second quarter of fiscal 2007. Excluding these items, higher expenses were the result of increased staffing costs to support business growth, higher legal and compliances fees and more significant investments in innovative gaming technology.

SG&A expense, inclusive of bad debt, totaled $105 million for the quarter and $398 million for the year. Excluding the hurricane insurance settlement and the gain on the sale of the corporate asset, SG&A expense for the year was up 11% from the previous year due to higher staffing costs to support business growth initiatives and higher legal and compliance fees, partially offset by reduced bad debt expense.

R&D expense totaled $54 million for the quarter and $202 million for the year. Excluding the $11.3 million contract buyout charge last year, our full-year investment in R&D increased 14% from the prior year as we furthered our development of server-based gaming and new games, platforms, cabinets, and systems.

Gaming technology innovation is a key component of our business strategy, and we will continue to make significant investments in R&D. For fiscal 2008, we expect our total operating expenses to remain between 26% and 28% of total revenues.

The results of our investment in R&D are seen on casino floors worldwide. Some of the products we are most excited about that will debut in the IGT booth at the upcoming global game expo, commonly referred to as G2E, include our latest version of server-based gaming, a complete line-up of new platforms and cabinets, covering all product categories, our newest version of Wheel of Fortune Super Spin; Indiana Jones and the Last Crusade are featured in a pure-depth multi-layered display, eBay video slots, our new diamond jackpots multi-leveled progressive system, the MP series including the DigiDeal electronic table games and a host of new games throughout our for-sale and MegaJackpot offerings.

These are just a few of the many new and innovative ideas across all product lines visitors to G2E will get a first look at. For a complete preview, I recommend you go to our website at www.IGT.com and look at our latest issue of slot lines to see what we have in store for you at G2E.

Depreciation and amortization within operating expenses totaled $20 million for the quarter and $80 million for the year. Total depreciation and amortization inclusive of depreciation on game ops machines was $67 million for the quarter and $266 million for the full year. Compared to the prior year quarter, total depreciation and amortization increased 9%. On a full-year basis it increased 13%. This is largely due to additional depreciation associated with the 9,600 games added to game ops during the year.

Other income and expense net was an expensive $2 million for the quarter and an income of $5 million for the year, compared to income of $11 million and $22 million in the prior year, respectively. The change in other income expense is primarily related to additional interest expense associated with our new 2.6% convertible bonds that were issued in December of '06 and additional borrowings on our line of credit partially offset by higher interest income.

The tax rate for fiscal 2007 was 36.9%, which was up 30 basis points compared to the prior year. We anticipate a rate of 36.5% to 37.5% going forward, depending on the geographic mix of our operating income.

Moving on to the balance sheet: Cash equivalence and short-term investments, inclusive of six months, totaled $401 million at September 30, 2007, compared to $589 million at September 30, 2006. Debt totaled $1.5 billion at September 30, 2007, compared to $832 million last year.

The reduction in cash levels and increasing debt are directly related to the company's share repurchase efforts. In 2007, we repurchased $28.2 million shares for an arrear cost of $1.1 billion or $39.70 per share.

We have 33.2 million shares remaining under the share repurchase authorization. And we continue to expect this authorization to be exhausted by the end of March 2010.

For the year, cash deployed back to shareholders totaled $1.3 billion consisting of $1.1 billion in share repurchases and $174 million in cash dividends.

Working capital totaled $596 million compared to $129 million at the end of the prior year, with average day sales up withstanding of 79 days and inventory turns at 4.2 times. The change in working capital was the result of refinancing our convertible debentures in the second quarter that were previously classified as current liabilities at the end of last year.

IGT generated a record $822 million in cash from operations, up 32% from the prior year. Capital expenditures totaled $344 million compared to $311 million last year. With additional investments, including the construction of our Las Vegas campus and the purchase of a corporate aircraft, CapEx for fiscal 2008 is expected to trend at a more normalized quarterly range of 65 to 75 million as we finish up construction on the Las Vegas campus.

That concludes my prepared remarks regarding IGT's fourth quarter and fiscal 2007 results. Thank you for your time and attention. I will now turn the call over to T.J. for his closing remarks.

T.J. Matthews

Thank you, Pat and good morning to everyone. Before opening the line to questions, I have a few comments regarding our business and the outlook for IGT.

In 2007, we achieved record results, despite relatively few new casino openings and flowing market-wide demand for replacement machines. IGT not only achieved financial success in 2007, but we made significant strides towards developing the innovative products, which are expected to drive market growth in the coming years.

We continue to produce all returns for shareholders. Despite the increased competition among gaming suppliers and the moderate growth of the slot-installed base, over the last five years, IGT has generated a 15% compounded annual growth rate in our earnings per share.

This is made possible by the efforts of all 5,400 IGT employees worldwide who keep the company in the vanguard of the marketplace. Daily operational execution and innovative products assure that IGT's future prospects remains solid.

Our game operations and our non-machine product sales contributed nearly 70% of the total revenues in 2007 and we expect that we'll have continued growth from these higher margin sources in 2008 and beyond. These reflect our efforts to emphasize our software and service businesses, which deliver value to IGT's customers through higher revenue realization and IGT shareholders through increased financial performance, thus continuing to reduce IGT's reliance on the sale of gaming machines.

Looking forward, the install base of game machines is expected to enter a new growth phase with numerous casino openings and expansions. One prominent Wall Street investment bank has projected 114,000 new machines in the United State being added over the next three years. In addition, they estimate 177,500 additional gaming machines across a large number of international markets.

Our diversity and the depth of our innovative products, combined with the worldwide sales and distribution capacity, will allow us to compete for significant market share in this coming expansion of nearly 300,000 games.

Some of the expected expansion may come from political action, which has also picked up in recent months. In Massachusetts, the governor has proposed legalizing three resort casinos. And early polls indicate public support for the proposal, which likely will be a key legislative issue in 2008.

In Maryland, the governor has just called a special legislative session to address a $1.7 billion budget deficit. His plan to reduce that deficit includes the legalization of 15,000 gaming devices and likely be put to a public referendum in November 2008.

In California new tribal gaming compacts were signed, which will eventually lead to the expansion in the number of machines in that state by over 22,000. And all these compacts may face the referendum in 2008, they point to a willingness of tribes and the state to expand machine counts in return for some form of revenue sharing.

In Kentucky, the election for governor will be held next Tuesday. Leading the polls is Steve Beshear, who supports the public vote on expanding gaming in the state. In addition, we feel the political environment is still ripe for expansion in states like Alabama, Florida, Illinois, New Hampshire, Ohio, and Texas, and you'll see debates take place there over the next few years.

The increasing financial contribution of international markets was demonstrated in 2007 as our international operations generated 20% of IGT's operating income compared with just 5% five years ago. Many countries see gaming as a key driver of foreign tourism, which favors resort casino developments like those commonly found in North America.

Asia remains a key in casino market focus for IGT. Macau, Singapore, Korea, and the Philippines are all expected to contribute meaningful sales from newly expanded casinos over the next three years. Japan and Taiwan have also begun political discussions for legalizing casino gaming.

In China IGT continues to believe our previously announced alliance with China LotSynergy will provide us future access to serve this evolving market. IGT is in the process of creating that partnership to deliver product and services into mainland China, but, the timing in that market still remains unclear.

We are committed to delivering industry leading products and service to our global customers. We will continue to plan on spending over $1 billion during the next five years to develop new technology. And while we consider our R&D efforts worthwhile long-term investments, we are especially excited about the returns we anticipate in the next few years as our server-based technology is rolled out.

At the upcoming G2E, we will be showing our newest machines and game themes that reflect the full diversity of our product lines worldwide. Many of the machines displayed will feature the AVP platform, which allows for the higher quality video and game play experience. Most of IGT's game developments are now shifted to the AVP platform, which will allow us to serve as the delivery portal the connection to server-based gaming environments.

In addition, new AVP versions of video poker and spinning real slot will also be on display at G2E to help customers round out their gaming floors in preparation for the coming of SB.

During 2007, IGT made meaningful progress with our SB efforts and remain on target to begin commercializing this product in 2009.

At G2E, we plan to illustrate our business for the slot four in the not-so-distant future, complete with connectivity to gaming machines from multiple manufacturers. We will demonstrate how a casino will be able to manage spot mix and price points from a central server, as well as, marketing a wide range of services offered on property directly to the player.

Most of the products will be comprised of earlier versions of SB that have existed in various forms. So, the most important addition will be the network and its capability. In the end, SB is all about building connections to guests wherever possible.

To further the SB development in an open network environment, IGT will soon open our new $10 million global technology center. This facility will be open to all product providers for SB environment including systems away from the gaming floors of hotel management and point-of-sale systems to conduct compatibility tests of the GSA protocol-based products. Products will receive IGT certification, giving customers greater comfort that any non-IGT products they install will work, as intended, alongside IGT's product lines.

Lastly, on the topic of guidance: While our gaming operations in the non-machine revenues and our international businesses continue to grow, the demand for domestic replacement is likely to remain soft throughout fiscal '08 ahead of these new technologies that just were described.

Accordingly, we are maintaining our earnings per share guidance for the next two quarters in the range of $0.35 to $0.40. However, we believe there is a good likelihood that our EPS will break out of this range in the second half of '08. So, we will revisit this topic on subsequent earnings call as our visibility improves regarding the timing of the new and expanding casino opening.

We thank you for your interest in IGT. We will now open the line for your questions. Thanks.

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. We have our first question from Bill Lerner, Deutsche Bank. Your line is open.

Bill Lerner - Deutsche Bank

Thanks, guys. How are you doing?

T.J. Matthews

Good morning.

Bill Lerner - Deutsche Bank

Two questions: One, as I think about the domestic new unit, sorry, new casino openings in the calendar fourth quarter, you should have, I think, shipped into this quarter, it looks like, some major property is got to be delayed.

I'm not sure what you want to say there, all right, because we know M.G.M. Grand Detroit opened, we know Mount Airy opened. A lot of the smaller openings wouldn't have moved the needle, but whether it's Palazzo or mere or something, can you, what can you say about that? Because that's a penny in EPS and obviously that's a timing issue at worst, if that's true.

Number two: can you just talk about Japan for a second? We saw the 7,200 units, but that's sales. What, just talk for a second about rental assuming that that would be incremental over 7,200. And that'll give us some perspective.

T.J. Matthews

Sure. You are right about there having been some large shipments that moved from Q4 to Q1. Palazzo was the most notable of those. In Japan, we sold about 30,000 machines this last year.

We have another 3,000 machines that are in our rental program. We have expectations that we'll exceed those numbers next fiscal year and so, although disappointed in what has become a much smaller install base, we actually think that some of the delays in the market will allow for longer-term sustained growth into that market. So, we're glad for that.

One of the big things that we think about our business is you kind of take a look at how we're shifting away from boxes into software solutions was really focusing a lot on those non-machine sales. And to give you a little more color of those, those included this last year 24,000 convergence and existing install base.

That gets lost sometimes when people are thinking about units, because those really are units with very high margin percentages, slightly lower margin dollars. And we also installed 83 systems this year. Now, have an install base over 700,000 systems. Had the opportunity to have additional sales to another 135 systems that were upgraded over the course of the year. That also was going to be a growing part of our business and really, I think, predicts fairly well our ability to continue to start expanding that install base with SB products.

Bill Lerner - Deutsche Bank

Thanks, T.J. So, just a follow-up, just to clarify: Japan 1,700 new unit shipments. What would this have been, if you include rental?

T.J. Matthews

Most of those 3,000 rental units happened in this last quarter.

Bill Lerner - Deutsche Bank

That's included in the 7,200?

T.J. Matthews

That's not included in 7,200. We do not count those as sale units.

Bill Lerner - Deutsche Bank

Okay. A little more than 10. Thank you.

T.J. Matthews

You bet.

Operator

Thank you. Next question David Katz, CIBC. Your line is open.

David Katz - CIBC World Markets

Hi, good morning. Two questions: One, if you could, T.J., or Pat, talk a little bit about your AVP platform and how that's doing and in terms of game content? And we've talked about this before, but if you could update us on what changes you're making in your product development process, of new titles and new themes, etcetera, and give us a little more depth as to what we should expect to see specifically on those at G2E?

T.J. Matthews

Sure. If you take a look at the composition of machines shipped this last year, there's no doubt that we were the beneficiary of a resurgence in real slots, particularly in some replacement opportunities and expanding to five reels as new properties open, being able to maintain shares in excess of 50% because of the strength in real slots and poker, all bode well for us and what this future expansion has before us. That world of video remains very competitive. I think the good news for us is that, we have moved towards an IGT branding strategy, so we have a common interface to the players, some recognition of our games across the casino floor then, that if you take a look at individual titles and ask casino operators: how they're performing? Products like Wolf Run, Coyote Moon will be among the very best performers, if not the best performers, on the casino floors on which they're installed.

Mainstays like Cleopatra are still something that exist in very large numbers on both existing and new casino floors. Our Fort Knox product, we have an MLP business now that 6,600 machines in the install base, most of that video driven. Super Spin, which has been an incredible success over the last 18 months, all video driven.

So, I think, if you take a look at individual titles, you can feel very comfortable about where we are. The next big iteration of product will be at G2E. Some of it's already out in the field. And that's some of the widescreen AVP deployments that we have so that Wheel of Fortune MLP, for instance is on the casino floors now doing very well. You'll see that same technology incorporated in the Indiana Jones product, into the eBay product. You'll see a lot of different cabinets, as we try to bring a little bit more fashion to the industry in that, there's different looks and feels trying to accommodate a wide variety of player taste. And so, it's not just about the game. It is about the comfort that we are able to provide individual customers. The big thing for us that has change this competitive dynamic is that, I think, we've educated our competitors that games matter. And I think you see them focusing on that. We're trying to move forward of that.

We are trying to move to a place where technology matters. And technology is going to be embodied in surveys gaming in a way we can bring floor-wide application that change the player experience as opposed to doing it just at each individual box.

The intellectual property library that's associated with that, of course matters and so, we feel very good right now that although they are still a little bit more lull here to get through, that once you start seeing the implementation of 3.0 on the trials. As we start approaching 4.0 with server-based gaming towards the end of the fiscal year, that you will see a lot of momentum gained in our ability to start realizing increased share again.

David Katz - CIBC World Markets

Right. And if I can just ask one more to the degree that you can help. If we look at North America and IGT's slot machines that are out in the field at this point: how would we break that down between ones that are on, say, AVP or updated platforms versus ones that are on your older platforms that may be more than three, or four, or five years old? And just trying to highlight or quantify: what that replacement opportunity will be for you going out the next few years?

Pat Cavanaugh

Sure, David. This is Pat. If you look, we introduced AVP for sale, I believe, it was in early calendar '06. So, we've only been selling that platform for a year and nine months now. First, probably three quarters, the mix of AVP probably was less than 20% of product sold.

And it's now picked up in '07. For '07, it represented 26% of the units we sold in North America. So, if you do the math on that for the last year and nine months, you're going to come up with the number. My guess is somewhere around 50,000 or 60,000 AVP units in the market. There's still a fairly good opportunity out there for units that are non-AVP. And AVP really just means PC based with a hard drive in it.

David Katz - CIBC World Markets

Okay. Thanks very much. I'll give someone else a chance.

T.J. Matthews

Okay. Thank you.

Operator

Thank you. Next Robin Farley, UBS, your line is open.

Robin Farley - UBS

Thanks. A couple questions: One is: can you give us an update in terms of the CFO search? Has there been a change in your parameters in last few months or can you give us a little color on that?

T.J. Matthews

No. I think that the search remain along the lines of the same parameters that we previously discussed that we're looking for adding somebody to the organization that has international experience that can help us with completion of transactions that it can act as an ambassador of the company to external entities, including the investment community, of course, but also including our customers, our peers, our partners and competitors at times, since we have business relations with them. And we, of course, expect that we should be able to have a very high standard of the kind of person that we're able to attract to the company.

Absent our ability to do that here, probably with not too much more time to pass, since we are approaching a one-year anniversary and we really don't want to go past that time. Absent our ability to do that, we of course have been very comfortable with the internal makeup of our finance and accounting capabilities and so, we have a number of people that have expanded their responsibilities.

Danny has taken on the CAO role and become the Principal Financial Officer. Pat has expanded his responsibilities not only with the Investment Community, but internally by overseeing some of the forecasting and transactional activity that we have.

People like Eric Vetter and Sandy Shoals, manage the day-to-day operation, either on the internal finance side or on the accounting side extraordinarily well.

And so, I think that we can be fairly deliberate here and making sure that we still get the right person that fits from a personality perspective.

But we realize that a lot of time has passed, and so probably have a deadline on ourselves, at the very latest a deadline on ourselves by our shareholder meeting that would take place March 1st. And I would be surprised if it takes that long.

Robin Farley - UBS

Okay. Great, thanks. And then, I wanted to clarify two other things. You commented in your outlook for the first quarter in the game ops that the number of units probably would not go up sequentially in Q1 because of some units being replaced or removed. Can you just clarify what that is?

T.J. Matthews

Sure, Robin. We have from time-to-time customers that remove product, as they are remodeling, etcetera and just coupled with where we're at Mexico. We probably garnished most of the low hanging fruit. And now we're moving into the second phase of that.

Robin Farley - UBS

Okay. So, is there is it mostly one property where they are being removed?

T.J. Matthews

No. I think it's a couple.

Pat Cavanaugh

There are a couple things going on. It however, is not really cause for concern relative to the performance in that area, but it is going to flatten as a result the growth for this first quarter.

Robin Farley - UBS

Okay. Great. And then, also then the other clarification that's just your comments about the market in Japan, and maybe the fourth quarter, coming in a little bit less than maybe where you expect a quarter ago.

Can you talk about what kind of unit expectations you have for Japan in '08? And, I guess: whether it's unit sales and rentals or whatever, we should be thinking about the units?

Pat Cavanaugh

Yes. Probably similar expectations for Q1 to what you saw in Q4, Robin. The difficulty in Japan is you've got an entire market that's been forced to go through a change. And so I think the entire market is still feeling its way through this.

And so it's probably going to take a period of time for it to digest these changes. And so the honest answer is, I think, from everybody in the market is it's still a little unclear.

Robin Farley - UBS

But, so --

Pat Cavanaugh

So, we would anticipate that you'd probably see units start to pick up as we move throughout fiscal '08 that I would keep expectations modest.

Robin Farley - UBS

So, you're comfortable that they won't go down sequentially in the December quarter?

Pat Cavanaugh

It's hard to say. They very easily could. I mean, it really is an unpredictable market at this point.

Robin Farley - UBS

Okay. Great. Thank you.

Operator

Thank you. Your next question, Joe Greff, Bear Stearns. Your line is open.

Joe Greff - Bear Stearns

Good morning, T.J. Good morning, Pat.

T.J. Matthews

Good morning, Joe.

Joe Greff - Bear Stearns

I was hoping, Pat or T.J, you can help us kind of quantify the AVP opportunity. As we see it, it's fairly significant particularly with the 8960 platform. What is the installed base for the 8960 platform in North America? And maybe you can kind of describe it in two ways, non-video poker and video poker?

Pat Cavanaugh

Well, Joe, if you look at the Game King is an 8960 platform and then we also have a platform called the iGame, the iGame is the one that's generally speaking dedicated to video slots. And that platform, I believe, if my memory serves me right, at the time of our last census, we had 82,000 or 83,000 of those out in the field. Those are probably the most susceptible, because the video poker has a much longer life so down in the Game King platform, so probably, somewhere in that 80,000 unit range.

Joe Greff - Bear Stearns

Great, excellent. And what's the share count at quarter end, Pat?

Pat Cavanaugh

316 million.

Joe Greff - Bear Stearns

Okay, great. And then my final question is, I think, the initial results of guaranteed play at some of the station local's properties, I guess you could describe weren't exactly great.

Can you just comment on some of the changes that you're making there and how you are looking at that product?

T.J. Matthews

I think that test was just that; a test for us to see: how can you affect pricing to the consumer? And it's the kind of application that we know works best when enabled by a server. That it's an option that you make available to the entire floor as opposed to a subset of the floor that in this case is just poker machines, which is the most price sensitive customer that a casino might have.

And so, I think that we still feel that we've done an okay job as far as having some sense of how this guaranteed play would work, that it would best work in a packaging environment or you're bringing consumers to the casino to experience a wide variety of things within the casino environment, not only the casino products but, obviously the food and beverage and the rooms, that you package this with those kinds of promotions.

And then on the casino floor, it's going to be down to player taste; that poker player is going to be the hardest change, the way that they buy into gaming experiences. But, I think on the video slots and on the reel slots, as we're able to get that product onto the floor via server that you're going to see a decent percentage of the players prefer to buy into their games that way.

The way that we've been tracking the guaranteed play, obviously, you've got to track win. And I agree, that your win is a little bit less than hoped for but if you take a look at the number of hands that people are opting into, probably the issue for us is just too many devices as opposed to not a very specific demand for this product.

And I think that gets all recalibrated overtime, and with servers probably is the right penetration rate, but probably a different mix.

Joe Greff - Bear Stearns

Great. Thank you, guys.

T.J. Matthews

Thanks, Joe.

Operator

Thank you. Next Steve Kent, Goldman Sachs, your line is open.

Steve Kent - Goldman Sachs

Hi. I think it was Pat, who mentioned that the gaming ops at the margins were going to improve. It sounds like to the range of 60 to 62 from 58 to 61.

Can you just talk a little bit about that? Was it mix change? Is it expenses? Is it some other driver that's out there?

Pat Cavanaugh

Yes, Steve, it's largely mix. If you look at where we're growing, a lot of non-jackpot varying installations both in central determination market, so Class II, New York, places like that. Also, the MLP business is all non-IGT jackpot varying those all carry higher margins.

Steve Kent - Goldman Sachs

So, then this should, this trend of higher margins should continue. I guess, I'm not sure why it should be a continued evolution to higher margins of that line of the business, I'm assuming over the next few years?

Pat Cavanaugh

To a degree, there's a limit to the margin on those items. But I think that 60% to 62% is probably a safe range for the next year or so.

Steve Kent - Goldman Sachs

Okay. And then just finally on server-based, you're going to be introducing lots of product to G2E. Is that also going to include a discussion on pricing on server base and how that would roll out?

T.J. Matthews

My guess is that, pricing will remain a private conversation that we're having with a number of prospective customers. It remains the same as we remarked before in terms of the composition that there's going to be an opportunity for us to ship hardware.

There's probably going to be some change in the way that we price game applications, so they're worldwide as opposed to individually box driven as they've been in the past.

Certainly, there's the opportunity for us to deploy networks and charge for that as well as their ongoing maintenance, an opportunity to introduce worldwide applications to that same floor, maybe even manage services in some instances.

And intellectual property is going to be required for certain other providers to be able to provide access to certain features. And so, I think, all of those are still in the mix.

We remain, very much targeting some of the new properties that we anticipate being part of that big growth of '09 and '10 that's been identified that with those properties. We actually have a much lower hurdle rate of adoption, because they're already going to be in the business of buying new gaming devices, new systems. And actually our product is fairly cost competitive with what is the traditional buy that they would be facing today in a non-SB environment.

So, we feel fairly comfortable that the pricing is going to sort itself out in a way in which the operators feel as if they're paying for something that truly gains them efficiencies and increases the activity on their casino floor and at the same time is fair to us for bringing what is really such an expensive innovation to the industry.

Steve Kent - Goldman Sachs

Okay. Thanks.

Operator

Thank you. Next Celeste Brown, Morgan Stanley. Your line is open.

Celeste Brown - Morgan Stanley

Hi, guys. Good morning.

T.J. Matthews

Good morning.

Pat Cavanaugh

Good morning.

Celeste Brown - Morgan Stanley

T.J., you mentioned that you thought you could break out of the range in the second half of fiscal 2008, yet, you kind of are expecting lower replacements throughout the year. Can you tell us how you could break out what would drive that, please?

T.J. Matthews

Sure. There's going to be a couple things that are game operations are going to continue to grow within our overall business. (inaudible) with the year-over-year comparisons up plus 9,600 units over this last year. But also the idea that we believe that we're going to grow those unit count for the Q2 through 4 of this year as well. So I think that that's one area of growth. I think that you're going to continue to see growth and strength in our non-machine sales. There's still an opportunity for to us sell a lot of convergence in that existing install base. Intellectual property licenses to others are still a big source of relatively high margin dollars. The systems business continues to grow. And so, we're going to grow there. You are going to see growth internationally as we continue to expand our footprint in a number of new markets, especially, some of the emerging areas that are exciting in Asia and Latin America and us paying attention to what other new markets might exist.

And then you're going to see, I think, an up tick in new unit demand in that back half of the year. And not just in the back half of '08 but carrying through '09 and into '10 because of what has been that identified expansion in North America, which quite frankly might be modest. I mean, the 117,000 units that have been identified in that one instance didn't include a lot of markets that are under consideration, places like Florida where compact negotiations are taking place and a vote takes place at the beginning of the year, compacts in California, which have yet to be ratified by a popular vote.

The debates are taking place in Maryland and Massachusetts, expansion that might take place in Illinois. So, there's a lot that could still happen that increases new machine demand even further.

So, really, we're in pretty good position these days to have decent visibility to an improved outlook, but it's still not ready to declare like to get through these next couple of quarters, which are going to look probably a lot like the last few quarters have looked. And then we'll be ready to really talk about what is potentially a breakout from that range.

Celeste Brown - Morgan Stanley

How do you think about share buybacks from here? You would be opportunistic?

T.J. Matthews

I think on both, just like the past, that we still are going to have a fairly disciplined approach to returning some dollars to the shareholders kind of irrespective of the share price just as we try to recalibrate our capital structure so that we optimize the weighted average cost of capital. But, at the same time, there is a big opportunistic aspect to our share repurchase; you saw that this last quarter. We purchased $507 million worth of shares in Q4, did so at an average price of $37.50. So, I mean, gives you a pretty good idea of where we would get much more aggressive. Certainly, as we get greater visibility, that threshold increases with time of where we would get aggressive and so we will continue to monitor that as well.

There was some thought that the share repurchase benefited this quarter. The Q4 activity really didn't. The Q4 activity, of course, will benefit '08, but most of the share count reduction that you thought was realized in Q4 was the “product of share” repurchase activities in Q1, 2 and 3. So, I think that's still part of what we do here.

The thing that we feel very good about in our business is that at these low unit counts, I mean, to the extent that we really want to move away from the boxed-shipped metric as a company, given that so much of our revenue and profit is generated otherwise, it's still a big metric. 41,000 units in North America was a disappointing one.

And despite that, we still had record revenues, that we are able to produce 40-plus percent margins at the EBITDA line, 30-plus percent margins at the operating income line, would have been at 20% operating income or at pre-tax margin had it not been for our change in other income due to our share repurchase activity. So, we feel very good about where we in terms of the efficiency of the P&L.

When we have a revenue uptick, you're going to see dollars flow to the bottom much more effectively than maybe they even have in times past of kind of big revenue uptick. So, we feel pretty good about where we are. We're glad about the visibility that we have and usually that kind of confidence bodes well in share repurchase activity

Celeste Brown - Morgan Stanley

Okay. Great. And then just one final question: What do you estimate your share was in Japan in the quarter including the leased units?

T.J. Matthews

That 4% to 8% range seems to be really where we still are that, earlier on that's going to be so hit driven. We have one pretty good game this last quarter, but we probably been a couple of quarters now since we've had a top-performing game. So, we're looking forward to a couple of new games being introduced in Q1. And we'll have pretty steady game introductions throughout the year, so that we hopefully can have top performers. But I think that 4% to 8% range is where you can expect us to be.

Celeste Brown - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Next Steve Wieczynski, Stifel Nicolaus. Your line is open.

Steve Wieczynski - Stifel Nicolaus

Hi. Good morning, guys.

T.J. Matthews

Good morning.

Steve Wieczynski - Stifel Nicolaus

One question for you: Just back to the margin, especially on the product sales margins, looks like you've grown by 130 basis points from '06 to '07. And Pat, you said: guidance for next year is going to be somewhere between 49% and 52%.

If, in fact, I mean: you guys are getting away from more and you are trying to de-emphasize the actual unit sales and going more towards non-machine sales. Do you think ultimately that guidance can be pretty conservative?

Pat Cavanaugh

Possibly. But I think for '08, that's probably a good range to be in.

Steve Wieczynski - Stifel Nicolaus

I'm looking down in like '09 and 2010 you could see that pushing more towards say the mid-50s?

Pat Cavanaugh

Possibly. I think: there's opportunity for margin expansion, but I think: yet to be determined.

Steve Wieczynski - Stifel Nicolaus

Okay. Great. Thanks, guys.

Pat Cavanaugh

Thank you, Steve.

Operator

Alright. Thank you. Next Adam Steinberg, Morgan Joseph, your line is open.

Adam Steinberg - Morgan Joseph

Yeah, hi. Just two real quick questions: Pat, when you were talking about Japan, I missed the numbers for: how many Reg 4 machines there were, and how many Reg 5 machines there currently are?

Pat Cavanaugh

Correct. Adam, there were 2 million machines at the end of calendar '06. Some of those were Reg 5 already. So, in install base there was 2 million. It's now we estimate it's about 1,200,000. That is an estimate, but it's somewhere in that range.

Adam Steinberg - Morgan Joseph

Alright. And do you think all of those machines are going to eventually become Reg 5 or some of those machines kind of lost to that market with close down to some of their facilities?

Pat Cavanaugh

Well, what we see, and you saw, the market shrank by literally 800,000 machines or there about. That's largely due to the uncertainty about the performance of those devices. So, as operators get more comfortable with the earnings of those devices, then hopefully you'll see that market start to grow again.

Adam Steinberg - Morgan Joseph

Alright. But do you think it'll get back to 2 million or is it going to be some fraction of there now?

Pat Cavanaugh

I think: it's unclear at this point. It's really depending on what happens with the regulators and the operators in terms of the game play characteristics.

Adam Steinberg - Morgan Joseph

Okay. And then, regarding your international operations: can you quantify how much of that growth in international operations is from units shift and just your standard price increases and how much can be attributed to changes in currency?

Pat Cavanaugh

It's probably about $4 million in currency. And the rest would be, its really broad-based growth across all areas, as you know, three years ago, we had very few, if any, game operations assets in the international market.

Adam Steinberg - Morgan Joseph

Right.

Pat Cavanaugh

And now we've got an install base there that's probably close to 10,000 units. And that will continue to grow. Most of the opportunities that we see internationally with new markets like Latin America and Asia, lot of those are game operations type opportunities.

Adam Steinberg - Morgan Joseph

So: is that also what's driving, say the 400 basis pickup, in the international gross profit?

Pat Cavanaugh

Well, it is. But it is also mix. Keep in mind, so lighter units into Japan obviously favored the margin. And we've had very strong non-machine revenues internationally as we start to see more and more ticket-in-ticket-out game conversions and the like. Those all carry higher margins. So, those are all benefiting the margin.

Adam Steinberg - Morgan Joseph

Okay. Thank you.

Pat Cavanaugh

You bet.

Operator

All right. Thank you. The last question, Bill Lerner, Deutsche Bank, your line's open.

Bill Lerner - Deutsche Bank

Thanks guys, just one more follow-up. So, just want to try to understand something for a second. So, three of your four businesses -- international, game ops, non-box sales are strong. That obviously continues into the next cycle.

Domestic replace and new unit expansion in the pipeline looks good, the domestic replacement as you would and we would have expected is weak, maybe, new opening like you say perhaps Palazzo timing pushes that out a little bit. So that sort of colors this quarter. And the stock is down 5-6%, whatever the number is right now. So, the market must be concerned that, that last prong, new domestic replacement units aren't going to happen going forward would be my guess.

That said: what should we be looking for as, sort of, I don't know, kind of catalyst or to changing that sentiment? Might a major casino operator embrace server-based gaming in some way that we can sort of relieve this sentiment? If you guys can elaborate that would be helpful.

T.J. Matthews

Sure. I think one of the things that's weighing on replacement sales over at least in our own internal forecast is the idea that there is so much new technology kind of waiting in the wings. And that unfortunately freezes the market a little bit in terms of pursuing decisions. Despite the fact that, all the products that we're selling now are clearly compatible with an SB environment, and I think there is a wait-and-see mindset exist that will be clarified for most when you start seeing announcements of customer commitments. And we anticipate that certainly in this fiscal year that we will have more than one customer commitment to SB gaming, that it is through technology that we can stimulate future replacement activity that at G2E you have an opportunity to see the interface for 3.0, and I think that people will be very impressed because historically people have measured us by the quality of our games. And people will walk through that show or gone into other environment and try to predict what games they think would be best and try to determine as a result which vendor might be best situated for the coming period.

I am very comfortable with the fact that when you come to this show this year, you're going to see that we are the clear technology leader. You're going to leave that environment thinking that we are best-in-class in terms of being able to develop new technologies.

The user interface is going to come across as a very intuitive interface and be much like the interfaces that you're familiar with and a whole host of other favorite products that exist in other industries. And I think that doubt maybe lingers as to will floors be networked and what kind of applications will be delivered is going to be a debate for only a little bit while longer here. I think that maybe even as early as the next call but certainly maybe by the end of our Q2 call. That today is going to be largely called because people are going to see in the field 3.0 working on a test and I think starting to have the opportunity to get excited about it because of firsthand viewings as opposed to hearing us talk about it so much.

Bill Lerner - Deutsche Bank

All right. Thanks, T.J.

T.J. Matthews

Thank you, Bill. Well, I think that was our last question of the morning, so I want to thank all of you for joining us on this call. This was a big year for us. We had all those records that we got to remark on and yet more importantly, have the opportunity for us to achieve those records all over again in fiscal '08 and beyond.

And so we're looking forward to that challenge and giving you continuous updates throughout the year. Thank you very much.

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