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| IGT > SEC Filings for IGT > Form 10-Q on 12-Feb-2009 | All Recent SEC Filings |
12-Feb-2009
Quarterly Report
FORWARD LOOKING STATEMENTS
This report contains statements that do not relate to historical or current facts, but are "forward looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information based on forecasts of future results and estimates of amounts not yet determinable. These statements may also relate to future events or trends, our future prospects and proposed new products, services, developments, or business strategies, among other things. These statements can generally (although not always) be identified by their use of terms and phrases such as anticipate, believe, could, would, estimate, expect, intend, may, plan, predict, project, pursue, will, continue, and other similar terms and phrases, as well as the use of the future tense.
Examples of forward looking statements in this report include, but are not limited to, the following categories of expectations about:
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our ability to introduce new products and stimulate replacement demand
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the timing, features, benefits, and expected success of new product introductions
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the timing of the introduction of and revenues from server-based systems
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our ability to acquire, develop, or protect intellectual property
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our market share, competitive advantage, and leadership position
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the advantages offered to customers by our products and product features
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the timing and estimated costs related to our company-wide strategic review and workforce reduction
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gaming growth, expansion, and new market opportunities
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our ability to benefit from and effectively integrate and utilize acquired businesses and assets
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investments in other entities, expanding our product lines, and improving our position in related markets
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factors impacting future gross margins and tax rates
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increasing growth or contributions from certain non-machine products and services
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increasing machine sales or placements
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legislative or regulatory developments and related market opportunities
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available capital resources to fund future operating requirements, capital expenditures, payment obligations, and share repurchases
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timing and amount of future share or debenture repurchases and dividends
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expectations regarding losses from off-balance sheet arrangements
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expectations regarding the outcome and expense of litigation
Actual results could differ materially from those expressed or implied in our forward looking statements. Our future financial condition and results of operations, as well as any forward looking statements, are subject to change and to inherent known and unknown risks and uncertainties. See Item 1A, Risk Factors, in this report for a discussion of these and other risks and uncertainties. You should not assume at any point in the future that the forward looking statements in this report are still valid. We do not intend, and undertake no obligation, to update our forward looking statements to reflect future events or circumstances.
OVERVIEW
The following MDA is intended to enhance the reader's understanding of our operations and current business environment. It should be read in conjunction with our Annual Report on Form 10K for the year ended September 30, 2008. Italicized text with an attached superscript trademark or copyright notation in this document indicates trademarks of IGT or its licensors. For a complete list of trademark and copyright ownership information, please visit our website at www.IGT.com.
International Game Technology is a global company specializing in the design, manufacture, and marketing of computerized gaming equipment, network systems, licensing, and services. We are a leading supplier of gaming products to the world, providing a diverse offering of quality products and services at competitive prices that are designed to increase the potential for operator profits by enhancing the player experience.
Our annual revenues totaled $2.5 billion in fiscal 2008. We operate in two segments, North America and International, with certain unallocated company-wide income and expenses managed at the corporate level. International continues to be a growing contributor at 25% of operating income in fiscal 2008. See BUSINESS SEGMENT RESULTS below and Note 16 of our Unaudited Condensed Consolidated Financial Statements for additional segment information and current quarter financial results.
We are currently operating in a difficult global environment. The combination of economic uncertainty, lower replacement demand, limited opportunities from new or expanding markets, and improved competition has negatively impacted our consolidated results. Our North America gaming operations business has been adversely affected by lower casino patron play levels that operators have largely attributed to unfavorable economic conditions, as well as declining interest rates that have increased jackpot funding costs. Although these challenges are expected to continue to impact our near-term results, we remain focused on strategic long-term initiatives that we believe will maintain our status as a leading provider of innovative gaming products and services.
Our current product development efforts reflect our commitment to the future of gaming industry technology as our business model continues to evolve toward a more systems-centric, networked gaming environment. Our gaming systems in the marketplace continue to grow with approximately 845 systems installed worldwide as of December 31, 2008, versus 730 in the prior year. Additionally, several new machine models were released in fiscal 2008 that support the networked gaming environment. Customer feedback on these models has been positive, and we anticipate replacement demand to increase over the next twelve to eighteen months. However, tight credit markets are currently constraining gaming operator's budgets and expansion projects, which will impact the timing of this demand. Our current replacement demand is below normal and is likely to continue at a reduced pace given economic conditions.
We remain on track for initial deployment of our sbXä applications during the current fiscal year, primarily through sales of the sbX Tier One package, which provides for small scale implementations of sbX Floor Manager and the IGT game library. Venue wide installations will begin in late 2009 and we expect to realize a growing benefit from sbXä technology as we differentiate IGT gaming products with new ways to engage and interact with players.
We are dependent, in part, on new market opportunities to generate growth. We expect to benefit from a number of new or expansion projects that are currently underway, but the extent and timing of such opportunities remains uncertain due to the difficult credit environment and risk of prolonged economic weakness. The uncertainty and lack of liquidity has led some gaming operators to delay or cancel construction projects; however, we believe market opportunities will develop as credit markets recover and new jurisdictions consider gaming tax revenues as one means to address budget shortfalls.
The first quarter of 2009 included new openings or expansions in a number of domestic jurisdictions including Nevada, Oklahoma, Pennsylvania and Washington. In November 2008, voters in Maryland voted to legalize up to 15,000 gaming machines at five locations. Further gaming expansion in international markets, especially in Southeast Asia, is also expected in the future.
We continued to deploy our capital for strategic business combinations and acquisitions of important technologies and IP with our investment in LVGI during the first quarter of fiscal 2009. We anticipate our LVGI relationship will provide additional innovative applications for our server based gaming systems. Additionally, we believe the PGIC asset purchase in January 2009, will provide us with additional market opportunities to augment our current systems product offerings and increase our systems installed base.
We will take a prudent and conservative approach to maintaining our available liquidity while credit market and economic conditions remain unfavorable. We continue to focus on reinvesting in our business through our installed base of gaming operations machines, as well as other strategic capital deployment objectives including investments and alliances to expand our geographic reach, product lines, and customer base. We will cautiously deploy our capital in order to preserve maximum flexibility.
During the current quarter we completed initial restructuring initiatives by reducing our global workforce by approximately 8%, incurring charges of $17.4 million, net of stock-compensation forfeitures, in the first quarter of fiscal 2009. We anticipate we will begin to realize quarterly cost reductions from these efforts ranging from $20.0 million to $25.0 million beginning in the second quarter of fiscal 2009. We also plan to further reduce our workforce by approximately 200 manufacturing-related positions resulting in additional charges of approximately $7.0 million to $9.0 million during the third quarter of fiscal 2009. We will continue to conduct a company-wide strategic review of our costs and organizational structure for further opportunities to maximize efficiency and align our expenses with our current and long-term business outlook.
RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2008, the FASB issued FSP APB 14-1, Accounting For Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement). This FSP requires that convertible debt instruments that may be settled in cash upon conversion be separated into debt and equity components. The adoption of this FSP in the first quarter of fiscal 2010 will increase interest expense related to our Debentures and decrease earnings. This FSP will also require retrospective restatement of all periods presented after adoption. See Note 9 of our Unaudited Condensed Consolidated Financial Statements for additional information about our Debentures.
See Note 1 of our Unaudited Condensed Consolidated Financial Statements for additional information regarding recently issued accounting standards that may impact our financial statements upon adoption.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements were prepared in conformity with accounting principles generally accepted in the US. Accordingly, we are required to make estimates incorporating judgments and assumptions we believe are reasonable based on our historical experience, contract terms, trends in our company and the industry as a whole, as well as information available from other outside sources. Our estimates affect amounts recorded in the financial statements and actual results may differ from initial estimates.
We consider the following accounting estimates to be the most critical to fully understand and evaluate our reported financial results. They require us to make subjective or complex judgments about matters that are inherently uncertain or variable. Senior management discussed the development, selection and disclosure of the following accounting estimates, considered most sensitive to changes from external factors, with the Audit Committee of our Board of Directors:
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revenue recognition
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goodwill, other intangible assets, and royalties
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jackpot liabilities and expenses
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inventory and gaming operations equipment
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income taxes
For a discussion of our critical accounting estimates, please refer to MDA in our Annual Report on Form 10-K for the year ended September 30, 2008. We have made no significant changes to our accounting estimates since September 30, 2008.
CONSOLIDATED OPERATING RESULTS - A Year Over Year Comparative Analysis
Quarters Ended Favorable
December 31, (Unfavorable)
2008 2007 Amount %
(In millions except units & EPS)
Revenues $ 601.6 $ 645.8 $ (44.2 ) -7 %
Gaming operations 313.3 332.3 (19.0 ) -6 %
Product sales 288.3 313.5 (25.2 ) -8 %
Machines 190.9 214.2 (23.3 ) -11 %
Non-machine 97.4 99.3 (1.9 ) -2 %
Gross profit $ 305.9 $ 366.5 $ (60.6 ) -17 %
Gaming operations 161.4 199.4 (38.0 ) -19 %
Product sales 144.5 167.1 (22.6 ) -14 %
Gross margin 51 % 57 % (6 ) pp -11 %
Gaming operations 52 % 60 % (8 ) pp -13 %
Product sales 50 % 53 % (3 ) pp -6 %
Units
Gaming operations installed base (1) 60,900 59,700 1,200 2 %
Fixed 15,700 14,400 1,300 9 %
Variable 45,200 45,300 (100 ) --
Machines sold 15,700 20,200 (4,500 ) -22 %
Operating income $ 100.1 $ 195.7 $ (95.6 ) -49 %
Operating margin 17 % 30 % (13 ) pp -43 %
Net income $ 65.7 $ 113.7 $ (48.0 ) -42 %
Diluted EPS $ 0.22 $ 0.36 $ (0.14 ) -39 %
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Prior year reflects 900 additional international units previously excluded because of change in criteria at September 2008.
Consolidated net income decreased over the prior year on lower gaming operations play levels amid unfavorable economic conditions and weakness in international replacement demand. Additionally, current quarter consolidated revenues were negatively impacted by approximately $21.5 million due to changes in foreign exchange rates. Comparability to the prior year was also significantly affected by restructuring charges related to our workforce reduction as well as interest rate declines impacting jackpot expense. We expect our second quarter to be further impacted by fewer new casino openings and the ongoing economic situation.
Additionally, as a result of our 52/53-week accounting year, our results of operations for the current quarter contained 14 weeks versus 13 weeks in the comparable prior year quarter. The additional week in the current quarter primarily benefited gaming operations and increased operating expenses.
Consolidated Gaming Operations
Revenues were down in the current quarter primarily due to lower play levels in North America. Additionally, our installed base growth is increasingly from stand-alone lease and CDS units which generally provide lower revenues and gross profit per unit compared to WAP units. International revenue and gross profit improvements partially offset declines in North America reflecting the increasing geographic footprint of our gaming operations.
In addition, gross profit and margin in the current quarter were adversely affected by unfavorable interest rate impacts on jackpot expense, unfavorable foreign exchange rates, and obsolescence charges with new product transitions. The extra week of operations in the current quarter contributed approximately $22.4 million and $11.5 million in consolidated revenues and gross profit, respectively.
Consolidated Product Sales
Total product sales revenues and gross profit were down from prior year primarily due to lower international demand partially offset by improved North America shipments into new or expanding markets. Gross margin declines were due to obsolescence charges, less favorable product and jurisdictional mix, and unfavorable exchange
rates. Product sales margins are expected to continue to fluctuate depending on the geographic mix and types of products sold.
Operating Expenses
Quarters Ended Favorable
December 31, (Unfavorable)
2008 2007 Amount %
(In millions)
Selling, general and administrative $ 114.9 $ 100.3 $ (14.6 ) -15 %
Research and development 53.5 51.3 (2.2 ) -4 %
Restructuring charges 17.4 -- (17.4 ) --
Depreciation and amortization 20.0 19.2 (0.8 ) -4 %
Total $ 205.8 $ 170.8 $ (35.0 ) -20 %
Percent of revenues 34 % 26 %
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During the current quarter we implemented restructuring initiatives with the goal of maximizing operational efficiencies and controlling expenses through the reduction our global workforce by approximately 8%. The reduction in employees was accomplished through a combination of early retirement and involuntary employee separation arrangements. Non-recurring restructuring charges during the current quarter included severance and one-time termination costs of $17.4 million, net of stock-compensation forfeitures. We expect this initiative to reduce our quarterly operating costs by $20.0 million to $25.0 million beginning in the second quarter of fiscal 2009.
In addition to the restructuring charges, the current quarter also included approximately $12.6 million in SG&A and R&D expenses associated with the extra week of operations. SG&A also includes an unfavorable fluctuation in bad debt provision of $15.9 million from the prior year due to increased credit risk related to the current economic climate and its impact on certain customers' operations. These unfavorable fluctuations were partially offset by lower incentives related to reduced operating income and a variety of other cost cutting measures.
We also plan to further reduce our workforce by approximately 200 manufacturing-related positions and expect to incur additional severance charges ranging from $7.0 million to $9.0 million in the third quarter of fiscal 2009.
Other Income (Expense) and Taxes
Quarters Ended Favorable
December 31, (Unfavorable)
2008 2007 Amount %
(In millions; * = not meaningful)
Interest income $ 16.5 $ 17.3 $ (0.8 ) -5 %
WAP 7.5 8.6 (1.1 ) -13 %
Other 9.0 8.7 0.3 3 %
Interest expense (30.4 ) (24.8 ) (5.6 ) -23 %
WAP (7.3 ) (7.3 ) -- --
Other (23.1 ) (17.5 ) (5.6 ) -32 %
Other (5.9 ) (0.1 ) (5.8 ) *
Total other income (expense) $ (19.8 ) $ (7.6 ) $ (12.2 ) *
Income tax provision $ 14.6 $ 74.4 $ 59.8
Tax rate 18.2 % 39.6 % 21.4 pp
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WAP interest income and expense related to previous jackpot winners accrete at approximately the same rate. WAP interest income also includes earnings on restricted cash and investments held for future winners.
The fluctuation in total other income (expense) for the quarter was primarily attributable to higher interest expense resulting from increased borrowings under our credit facility. The current quarter also included write-downs of our investments in PGIC and ARS, with related put rights, totaling $5.3 million, partially offset by gains on Debenture repurchases.
Our current quarter tax provision was reduced by significant non-recurring discrete items, as further described in Note 11 of our Unaudited Condensed Consolidated Financial Statements. While our future effective tax rates may continue to be volatile due to changes in uncertain tax positions, we currently estimate our annual effective tax rate (inclusive of discrete items) for fiscal 2009 will be approximately 37%.
BUSINESS SEGMENT RESULTS - A Year Over Year Comparative Analysis
Operating income for each division reflects applicable operating expenses. See
Note 16 of our Unaudited Condensed Consolidated Financial Statements for
additional business segment information.
North America
Quarters Ended Favorable
December 31, (Unfavorable)
2008 2007 Amount %
(In millions except units)
Revenues $ 482.5 $ 462.1 $ 20.4 4 %
Gaming operations 267.5 295.2 (27.7 ) -9 %
Product sales 215.0 166.9 48.1 29 %
Machines 137.4 90.8 46.6 51 %
Non-machine 77.6 76.1 1.5 2 %
Gross profit $ 245.4 $ 265.8 $ (20.4 ) -8 %
Gaming operations 136.8 175.5 (38.7 ) -22 %
Product sales 108.6 90.3 18.3 20 %
Gross margin 51 % 58 % (7 ) pp -12 %
Gaming operations 51 % 59 % (8 ) pp -14 %
Product sales 51 % 54 % (3 ) pp -6 %
Units
Gaming operations installed base 46,900 48,900 (2,000 ) -4 %
Fixed 6,700 6,700 -- --
Variable 40,200 42,200 (2,000 ) -5 %
Machines sold 9,500 7,300 2,200 30 %
Operating income $ 109.4 $ 162.5 $ (53.1 ) -33 %
Operating margin 23 % 35 % (12 ) pp -34 %
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North America operating results declined during the current period primarily due to lower gaming operations, restructuring charges, and increased bad debt provisions despite improved machine shipments. Additionally, lower play levels and interest rate declines in the midst of the current economic downturn unfavorably affected gaming operations.
North America Gaming Operations
Gaming operations revenues and gross profit declined from the prior year due to lower play levels largely attributable to unfavorable economic conditions combined with continued shift in our installed base. With approximately 85% of our installed base made up of variable fee units, a significant portion of our revenues fluctuate directly with casino play levels. Thus, the declines in play levels reported for many US gaming markets adversely affected our gaming operations. In addition, our increasing mix of stand-alone lease and CDS units compared to WAP units also contributed to the decline in revenues. These non-WAP units generally provide lower revenues and gross profit mainly because they carry no IGT sponsored jackpots.
Gaming operations gross profit and margin also declined primarily due to the effect of lower interest rates on jackpot expense. Jackpot expense was negatively impacted by $17.2 million compared to the prior year quarter due to declining interest rates. The additional cost due to interest rate movements was partially offset by fewer WAP units and variations in slot play, for a net increase to jackpot expense of $9.7 million over the prior year period. See MDA-CRITICAL ACCOUNTING ESTIMATES-Jackpot Liabilities and Expenses in our Annual Report on Form 10-K for the year ended September 30, 2008, for additional details regarding the factors affecting jackpot expense.
The extra week of North America operations during the quarter also contributed approximately $19.1 million in revenues and $9.8 million in gross profit.
North America Product Sales
Product sales revenues and gross profit improved during the quarter mainly due to increased machine shipments into new and expanding markets. Machine revenues reflect an increase in the mix of our premium-priced AVP® models, as well as increased gaming systems. The decline in gross margin for the quarter is primarily attributable to obsolescence charges and a less favorable mix of non-machine revenues.
Unit shipments continued to be affected by low replacement demand, but new unit shipments increased during the quarter due to new and expanded casinos in several jurisdictions. New unit shipments were 6,700 during the quarter compared to 4,200 in the prior year quarter. Replacement sales consisted of 2,800 units during the current quarter compared to 3,100 in the prior year.
International
Quarters Ended Favorable
December 31, (Unfavorable)
2008 2007 Amount %
(In millions except units)
Revenues $ 119.1 $ 183.7 $ (64.6 ) -35 %
Gaming operations 45.8 37.1 8.7 23 %
Product sales 73.3 146.6 (73.3 ) -50 %
Machines 53.5 123.4 (69.9 ) -57 %
Non-machine 19.8 23.2 (3.4 ) -15 %
Gross profit $ 60.5 $ 100.7 $ (40.2 ) -40 %
Gaming operations 24.6 23.9 0.7 3 %
Product sales 35.9 76.8 (40.9 ) -53 %
Gross margin 51 % 55 % (4 ) pp -7 %
Gaming operations 54 % 64 % (10 ) pp -16 %
Product sales 49 % 52 % (3 ) pp -6 %
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