International Game Technology PLC (IGT) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the IGT Third Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session with instructions given at that time.

(Operator Instructions.)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Director of Finance and Investor Relations, Mr. Rich Baldwin. Please go ahead, Mr. Baldwin.

Thank you, Dave. Good morning, everybody, and thank you for joining us today. Also on the call today from IGT is Tom Baker, our Chairman; TJ Matthews, our CEO; and Maureen Mullarkey, our CFO.

Before we begin, I'd like to note that, during the quarterly earnings conference call, certain statements will contain forward-looking information, such as forecasts of financial information. Although IGT believes that the expectations reflected in any of its forward-looking statements are reasonable, actual results could differ materially from those projected or assumed.

IGT's future financial condition and results of operations as well as any forward-looking statements are subject to change and to inherent known and unknown risks and uncertainties. IGT does not intend and undertakes no obligation to update our forward-looking statements to reflect future events or circumstances.

All forward-looking statements in this conference call reflect IGT's current analysis of existing trends and information and represent IGT's judgment only as of today. Actual results may differ from current expectations based on a number of factors affecting IGT's businesses. Information on factors that could affect IGT's future business and financial results are included in our Annual Report on Form 10-K for the year ended September 30, 2003 and other public filings made with the Securities and Exchange Commission.

This call, the webcast of this call, and its replay are the property of IGT. It 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 disconnect now. By remaining on the line, you agree to be bound by these terms.

With that, I will now turn the call over to our CFO, Maureen Mullarkey.

Thanks, Rich, and thank you for joining us today on our third quarter conference call for fiscal 2004. Once again, our strong earnings reflect the commitment we've made to our customers to be the leading provider of gaming machines, platforms and systems.

During the quarter, we generated top line revenues of $619 million, representing a 10% increase over the prior year quarter. In addition, adjusted income from continuing operations per fully diluted share of $0.35 increased 21% over the prior year quarter. Please refer to our Q3 press release for a reconciliation of adjusted EPS to GAAP EPS.

These increases were primarily due to record gaming operations revenue and related margins, higher pricing realization on our product sales, growing international revenues and related profits, and a greater mix of systems sales due to the inclusion of Acres Gaming.

Our game operations reached record levels due to increased game placements in both casino and racino segments and coin-in per day improved by 4% during the quarter on our wide-area progressive games on the strength in Nevada play. These improvements reflect our market share leadership position and that our game scenes remain favorites among casino players.

We ended the quarter at 36,400 games, that's up 2,800 from last year and 900 sequentially.

The third quarter financial results also reflect IGT's ongoing focus on operational efficiencies, which translated into higher margins in both segments. We posted Q3 gross margins of 54% in product sales, as compared to 48% last year, due primarily, to lower material costs, followed by higher average sales prices, and finally, due to a growing mix of systems and game conversion sales.

Gross margins in game operations segment, at 55%, benefited from our ongoing strategy to increase the mix of our wide-area progressive jackpot games, and due to higher interest rates that lower our costs to fund jackpots to players.

Operating income during the quarter came in at a record $211 million, increasing 22% over the prior year quarter. Also, current quarter operating margins totaled 34%, versus 31% in the prior year. Current quarter net income totaled $141 million or $0.38 per diluted share.

Year-to-date operating cash flows totaled $400 million, an increase of 70% from the $235 million in the prior year, due to record operating results, the efficient management of working capital, and a lower tax rate, due to higher foreign source income.

Before I drill down into the segment highlights, I do want to comment on our concurrent release this morning. Today we responded to an allegation filed earlier this month with OSHA by two former IGT employees alleging wrongful termination. These former employees allege that patents acquired in connection with our 2001 purchase of Anchor Gaming are overvalued on IGT's balance sheet. We take these allegations seriously and an independent committee of our board retained outside council to examine these charges.

After a thorough review outside council found the allegations to be entirely without merit. In fact, we believe these allegations are nothing more than an opportunistic ploy by disgruntled former employees to extract personal financial gains. IGT is confident in the value and strength of our patent portfolio and will act swiftly to protect our intellectual property against any infringements. And of course, we'll fully cooperate with OSHA in their investigation of this matter.

Moving on to segment highlights, I'll kick off the conversation with gaming operations. Revenue for the quarter totaled 303 million, that's an increase of 41.5 million from Q3 of last year or 16%. As we mentioned in our press release, the VIE consolidation favorably impacted our current quarter revenues by approximately $11.2 million with an equal amount added to expenses. Consolidated revenue per day was up 7% and post VIE adjustments up 3%.

Quarterly gross margins were 55%, up 52% from the prior year. Note that the VIE consolidations reduced the quarterly gross margin by 2%. It had no impact on gross profit dollars. We continue to grow our mix toward wider and progressive and instant-winner games, as well as improving our jurisdictional mix.

We are also seeing the benefit of expansion into new racino and central determination gaming market. The installed base of IGT owned recurring revenue gains which is comprised of both machines in casinos and racinos, as I mentioned, ended the quarter at 36,400, again, an increase year-over-year of 2,800 games and 900 games sequentially.

The year-over-year growth of 1,000 games in the casino category, primarily resulted from increased placements across various Class III Native American markets. And most of these placements were in the wide-area progressive format. Recent popular game introductions include, "Wheel of Fortune Special Edition," "Rodney Reel Respect," "Twilight Zone" and "Dilbert."

New game introductions planned for the next quarter include "Animal House," "I Dream of Jeannie," the third brand extension, Marilyn Monroe's dollar brand extension - and this is our first Marilyn game offered in the dollar denomination.

Year-over-year growth at 1,800 games in the racino category resulted from 1,200 additional games placed in New York, the latest being Monticello where IGT placed 400 games in June. In addition, our other racino markets of Delaware and Rhode Island, we saw year-over-year growth of 600 units, due do the strong game performance.

In product sales, revenue during the quarter totaled $316 million, that's an increase of 5% over the prior year. Total quarterly shipments at 35,100 were comprised of 22,500 domestic shipments and 12,600 international shipments. Consolidated average prices were 9,000 for the quarter, that's an increase of 13% over 8,000 -- over the 8,000 in the prior year and sequential quarter, due to improvements, both within our domestic and international jurisdictions.

Domestic ASPs totaled 10,800 for the quarter, an increase from 10,000 in the prior year, and an increase from 10,100 in the sequential quarter, due to stronger domestic pricing realizations, and a greater domestic gaming systems revenue.

International ASPs were 5,700 for the quarter, up 4,300 in the prior year, and 4,800 in the sequential quarter, due to improved geographical mix, primarily, with a greater percentage of sales into the European casino markets and Latin America. The current ASP benefited from favorable foreign exchange rates by approximately $500, as compared to the prior year.

Product sales gross profit margins in the quarter, as I mentioned, were a record 54% versus 48%, again, due to ongoing, lower material costs, improving operational efficiencies, as well as the increase in ASPs mentioned above.

During the quarter, we produced 31,500 machines in our Reno manufacturing facility, versus 28,600 in the prior year and 33,500 in the preceding sequential quarter. Looking forward, due to strong pricing realizations, a greater mix of systems revenue and continued material cost reduction, we expect that, for the full year, fiscal 2004, gross profit margins and products will be between 52% and 53%.

Domestic product sales revenue totaled $243 million, up slightly from the prior year. Unit shipments totaled 22,500 during the quarter, including replacement sales of 17,800 and 4,700 new and expansion units. Units were down slightly from last year, due to fewer shipments to new casino properties and the timing of new markets coming online.

IGT's market share of quarterly shipments was strong in the quarter at over 75%. Large replacement shipments for the quarter included Harrah's. We shipped 2,500 games in Q3. Year-to-date, we've shipped 13400 to Harrah's and for the fiscal year '04 we anticipate 14,100 machine to this customer. Manitoba lottery, we shipped the first 900 units of the 5,400 unit order of which we received 100% market share.

We anticipate that most of the remainder of this order will go in Q4. We shipped 822 games to the HoChunk tribe for a 100% market share. We shipped 618 units to the Fiesta Casino in Las Vegas, that's a 90% market share and the Power Station for 532 units for 100% market share.

Even our strong replacement sales performance for both the quarter and the year, we are raising our domestic replacement sales target to 70,000 to 75,000 machines for fiscal '04 from the previously communicated target of 65,000 to 70,000 games. New and expansion units totaled 4,700 during the quarter. New and expansion shipments in the quarter included the British Columbia lottery of 460 units, The Turning Stone casino in New York for 404 and The Ocean Jewel of St. Petersburg, a Florida cruise ship, for just under 400 games.

Our top-selling video spinning real games included "Hexbreaker," "Alien" and "Used Cars." Our top selling spinning real themes for the quarter included "Triple Stars," "Triple Double Wild Cherry" and "Triple-Double Stars." The past quarter was also our first full quarter of deployment of our new video real touch machines with three themes currently available "Bucks Ahoy," "Lucky Larry's Lobster Mania" and "Tabasco."

Turning to our gaming systems business, our EZ Pay Cheetah system continues to be one of the primary drivers of domestic replacement sales. At the end of the quarter, there were 165 Cheetah systems in operation. And looking at total gaming systems, which is inclusive of Acres, there are 186 systems in operation at the end of the quarter communicating with approximately 224,000 machines.

Internationally, product sales totaled 12,600 units during the quarter, a decrease from 13,400 in the prior year, due primarily to fewer machine sales in Japan and the United Kingdom, offset partially by continued strong sales to the European Casino and Latin American markets.

Additionally, we benefited from favorable foreign exchange rates for the quarter. International operating income was $17.7 million. That's an increase of 30% over the 13.6 million in the prior year. For the year, for the year-to-date period operating income was $65 million versus $36 million. That's an increase of 80% on a year-over-year basis.

Favorable exchange rates added approximately $1.4 million of operating income for the quarter compared to the prior year quarter. In total, our international division achieved solid results during the quarter, despite slightly lower volume due to improved geographical mix with total revenues and gross profits posting year-over-year growth of 46% and 48% respectively.

Total operating expenses for the quarter were $127.2 million versus $105.5 million in the prior year. SG&A expenses for the quarter were $72.9 million, that's an increase up from $68 million in the prior year. R&D expenses for the quarter were $32.8 million up from $23.7 million last year.

These increases primarily related to the acquisition of Acres Gaming in late October 2003, along with additional investment in research and development and due to foreign exchange rate fluctuations that increased expenses internationally. Depreciation and amortization expense for the quarter totaled $16.6 million versus $11.3 million in the prior year, primarily due to the increased amortization associated with Acres.

Bad debt expense increased to $4.8 million in the current quarter versus $2.5 million in the same quarter last year, primarily due to the recovery of bad debt in Latin America that reduced bad debt in the third quarter of last year.

As a percent of total revenue, currents operating expenses totaled 21%, up from 19% last year. Note that for the year, our operating expenses are approximately 20% of our total revenues and in line with last year.

Other expense net was $8 million for the quarter down from $16.1 million last year, primarily due to a reduction in interest expense, resulting from our 400 million senior note redemption in the second quarter of fiscal 2004. On July 16, we redeemed the remaining 570 million in senior notes due 2009.

As mentioned in our press release, in the fourth quarter of the current fiscal year, we will recognize a loss on this early redemption of $76.3 million, net of tax.

For the year, we generated significant operating cash flow. We generated $400.5 million of cash on income from operations of approximately $375 million. Our cash balance is $1.2 billion, down from $1.3 billion at the end of fiscal '03. Our debt has been reduced to $1.1 billion at the end of June from $1.6 billion at the end of fiscal 2003, again, resulting from the 400 million senior note redemption in February.

Working capital statistics remained quite strong in the third quarter. Day sales outstanding were 79 days during the quarter compared to 106 days in the prior year quarter and 87 days in the sequential quarter, primarily, due to collection of outstanding trade notes during the previous quarters.

Inventory turns grew 3.7 times during the quarter. That compared to 3.7 times in the prior year and 4.1 turns in the sequential quarter. This sequential decrease came as a result of the production of the large Manitoba order, which will mostly ship during the fourth quarter.

We were also active in several areas of capital deployment during the third quarter. As mentioned in our press release, we entered into a $1.5 billion credit facility with a syndicate of banks. The credit facility consists of a five-year $1.3 billion revolver and a five-year $200 million term loan. The new credit facility replaces IGT's existing $260 million credit facility.

Using the proceeds of the $200 million term loan and available cash, we redeemed, as I mentioned, our $569 million in principal amount outstanding of our 8 3/8% senior notes due May 2009 and canceled the corresponding interest rate swaps for a total payment of $682.5 million.

As a result of our new credit facility and subsequent redemption of our senior notes, we have increased our liquidity by approximately $550 million. We also paid cash dividend of $0.10 per share that was paid in early July and intend to review our current dividend level during our next board meeting in September of 2004. Share repurchases in the quarter totaled $670,000 shares for $24.1 million at an average price of $35.86.

As of June 30, 2004, the remaining share repurchase authorization under IGT's stock repurchase program totaled 39.2 million shares.

Our capital expenditures for the year were approximately $141.3 million due to increased spending in all three of our CapEx categories, $24 million in property, plant and equipment, $94 million in game ops and $22 million for intellectual property.

Before I turn over the call to TJ. I'd like to reiterate that we're extremely pleased with the operating results of Q3 not only on the revenue line but with the efficiency of earnings and the translation into significant cash flows for the company. Thank you very much. TJ?

Thank you, Maureen. And I guess, before we open the line to questions and answers, I just wanted to talk briefly about the growth drivers for IGT. Our take on the forward outlook for the gaming industry and for IGT is positive due to the successful outcome of this year's legislative session and the expectations for continuing new market growth.

The continued strength in our game operation segment and its growing contribution to our business and the momentum that we have in the international markets and, of course, because of our continuous progress in game design, platform developments and new technology deployments.

As we are all aware the gaming industry is a highly regulated and new market. Development can be subject to complicated and lengthy legislative negotiations as well as an evolving regulatory processes. Cognizant of this backdrop, the fact that California and Pennsylvania have recently moved forward with the new Native-American compact and enabling legislation respectively is very significant for our business.

These two new markets are poised to add almost 100,000 games in the North American installed base of gaming machines. The Pennsylvania potential market size is well documented at approximately 60,000 machines and represents the largest new slot machine market opportunity since the late 1990's when California legalized Class III Native-American gaming.

And the recent signing of the amended gaming compact in California between the Governor and the five tribes effectively removes the cap of 2,000 Class III gaming machine per location which had existed under the old compact, and the signing of these recent compact amendments really represents a very important step that likely makes optimistic for us that additional tribes will do the same.

As a result, our best estimate of the California opportunity is an additional slot capacity will be at least 35,000 Class III slot machines, which would result in the total California slot machine market of about 90,000 machines. These two jurisdictions will benefit not only our product sales but also our games operations business, as we'll be active in placing on most popular wide-area progressive theme in both of these markets.

As has been the case over the past 10 to 15 years, we believe additional states will continue to evaluate gaming as a legitimate industry adding jobs for local economy as a viable means to raise tax revenues versus tax increases on residents or spending cuts on vital state programs. The domino effect also impacts new market development and for this reason, expansion does not stop after California and Pennsylvania.

We believe that there is a realistic set of assumptions which grow the current domestic slot machine installed base from its existing approximate 780,000 units to 1 million units over the next five years which will represent a compounded growth rate of about 5% to 6%.

While the majority of this growth should come from California and Pennsylvania, there are several other existing gaming markets with expansion opportunities. These include Delaware, Nevada, Illinois, Indiana, Maine, Michigan, and New York, to name a few.

And in addition to the expanding opportunities to existing markets we remain optimistic for new market opportunities in several states such as Maryland, Ohio, Nebraska, and Florida. Expected growth in both expanding and new markets will be important growth drivers for both segments of our business.

We also anticipate gaming expansion within the international markets over the next five years. As widely known some of the larger opportunities include the UK, the Asia Pacific region, which includes Macau, and Eastern Europe, which includes Russia. Italy and Poland are opportunities in what we term as the low-payout market and could be good sources for AWP demand from our Barcrest subsidiary.

Our success in Japan is also important to our overall international strategy. And we believe that family relationship provides us with the needed platform to continue to grow our presence in that market. With that as a backdrop, we are currently targeting $175 million operating income for our international operations in fiscal 2009 as compared to about $75 million in this fiscal year.

In addition to the legalized markets just mentioned, we continue to move forward with our market and product development strategies, focused around the deployment of central determination based systems and related game. That means that we will be able to grow into Class II, video lottery and charitable gaming markets.

As we have communicated in the past over the next few years, we see gaming systems technology, reshaping casino floors to that of a more system centric server based gaming environment versus the current machine centric environment. At this time, our central determination system and Acres Gaming system represent the building blocks from which we will internally develop a more robust complete sever based gaming system solution, which will ultimately provide our customers with capabilities to manage their slot floors in ways never imagined.

And as a result our server based gaming initiative will help to drive our business more towards the higher margin, software delivery business that requires periodic upgrades to the existing hardware with less frequent updates to the cabinet. As always we continue to raise the bar in the industry by providing our customers with the best game content and gaming machine platforms in the industry. We consistently demonstrate that our size and scale enables us to outspend our competitors in game development, which, in turn, enables us to secure our industry leading market share.

Lastly, a few comments on our balance sheet strength. The significant cash flow generation of our business and our prudent history of capital deployment means that we will continue to leverage our dual investment grade balance sheet strength to maximize business opportunities. Our recent balance sheet recapitalization is a good example of such. And our new $1.5 billion credit facility provides us with significant flexibility going forward.

We also expect our cash flows to remain very strong and that our default use of cash will be to return it to our shareholders, which we've done over the five years in the amount of $1.2 billion of share repurchases and more recently $130 million on dividends. In addition to share repurchases and dividends we also remain committed to acquisition opportunities both domestically and internationally as we've had a long, successful acquisition history which has augmented our growth over these past five years.

In conclusion, for all of the reasons I just mentioned we remain confident in the long-term outlook of IGT. And we will continue to target 15% annual earnings per share growth rate over the next five years. However, quarterly results could be a little lumpy due to the timing of new and expanding market opportunities.

With regard to fiscal 2005 specifically, it will, again be a record year for IGT but also a year of transition. Both product sales and the replacement of recurring revenue games in the new and expanding markets will become leading growth drivers for the company. We do expect the domestic replacement sales market to remain strong for the next three years. But it will be at a slower pace in fiscal '05 than the record levels experienced this year.

With that, our initial target for fiscal 2005 domestic product sales is 75,000 to 80,000 units consisting of approximately 60,000 replacement units and 40% new or expansion units.

In addition, we expect continued growth in product sales, average selling prices, and gross margins due to stronger price realization and increased convergence sales as well as material cost productions in our Reno manufacturing facility. At this time, we remain comfortable with our target 15% growth in fiscal 2005 earnings per share.

Based on the information currently available, we expect both unit shipment and game operation unit placements to trend higher in the latter half of fiscal 2005 due to the timing of new market opportunities, primarily California and Pennsylvania. As a result our current view is that we will realize 40 to 45% of the expected fiscal 2005 earnings in the first half of '05 and 55 to 60% in the second half of '05 and would ask that you note that with the exception of this fiscal year, this split is consistent with the historical seasonality trends we realize in our business.

At this time, we also remain comfortable with the current mean street estimate of $1.32 for fiscal 2004 excluding the effect of the loss on early debt retirement in Q4, which was mentioned in our press release. What we're really saying is that we expect the next three quarters to be within the range of $0.30 to $0.35 which is consistent with recent performance with a chance to breakout of this range in the second half of '05 as we expect expansion of shipments into California and so much lesser degree, perhaps, in shipments into Pennsylvania.

I would like to thank everyone for your interest in our company. And we will now open the line for questions and answers.

(Operator Instructions.)

And that will come from the line of Steve Kent with Goldman Sachs. Please go ahead, sir.

Hi. Good morning.

Hey, T.J, it sounds like you're being exceptionally conservative on the cashless rollout. We know that's been a focus number, now, for a couple of quarters. With that, I mean maybe could you give us a reason why you're being so conservative on that rollout given the wide, wide acceptance of it across the industry.

But maybe you could talk, in a little bit more detail, about the Class II opportunity, sort of how that rolls out, the opportunity for low denomination games and how that can roll out and then, if you look out into '05 and you use that 15% EPS growth rate, how much of it will be cash flow usage for more share buyback? I thought this quarter's share buyback was modest, relative to the potential?

Well Steve, you've left me with a lot to address there. In terms of kind of the cashless rollout schedule I mean, generally speaking, we agree with your assessment that it still has long legs. It's still a universe of about 250,000 machines or so out there that we think are ready candidates for upgrades to -- or for replacement for cashless technology and there's probably about another 100,000 machines or so that are eligible for upgrades so they can be cashless enabled.

And, so, I would agree there's the possibility that we've been conservative there. But, the reasons for that, is that it is a shrinking market. And we have to be cognizant of that fact. And there is, with the outstanding mergers, probably some frozen capital expenditures at the sites of -- a couple of very large customers, including one customer that, in Mandalay that has still yet to make a very substantial transition of their floor to cashless gaming.

And so there is some reason for us to be cautious in that regard. In terms of how we go about using capital, as you know, we've been, I think, prudent stewards of capital on behalf of the shareholders, expect we will return it to the shareholders. We had a shift this past year for kind of tax reasons that we were more dividend focused than share repurchase. But, we're cognizant of the fact that we purchased over $100 million of our stock every year now for about seven years running.

And we would expect that that kind of continued behavior continues into the future. Not the primary driver of EPS growth but, certainly, contributing to EPS growth in a good way. What is a primary driver of EPS growth is new markets. And it's not just new markets like California and Pennsylvania; it is new markets that are encompassed under this broad umbrella of the central determination systems.

Central determination systems has historically meant that we've put games through a distributor into Washington and, recently, games directly in the New York market. But we are now deployed with central determination systems games in Class II environments like Florida and Oklahoma, and into charitable gaming markets like Alabama.

And, we anticipate that that technology is going to continue, really, in the direction of server-based gaming and that IGT will be a leader in the regards of system delivery of game content, as well as a terminal-based delivery. And so, we expect to make new markets for ourselves.

One other little class -- central determination market probably not well known to people is that Turning Stone Casino that we identified as a new market. It's actually a casino that existed for a while, had its own internal system, but has never been available to IGT technology. We've obviously resolved that with our recent technical efforts as well.

And then, I'm not sure, did you have a question specifically on the games operations business as well?

No. I -- actually I was focusing more on the opportunity for low denomination games, which seems to be taking greater and greater market share in the Bin Brushed (ph) and particular in whether, do you think, that could be the second surge in replacement, even before you get to downloadable and central determination games?

Well, certainly, the replacement cycle is driven by two things. You know, we said that the replacement cycle is driven, either by the needs of the game, or by the needs of delivering the game to the player. And, so, game creation is a constant -- is what really creates that constant replacement cycle that exists. And so that would include the trend of real slots over time being displaced by video reel.

And, in particular, I -- we're very well aware, as you know, we've been the leader in low denominated video. That's recently made a shift, again, from a concentration of nickels, which we've had well we've overwhelmed that space, to now pennies being the new emerging denomination. And as you would expect, IGT's going to overwhelm that space as well, with game titles, configurations, and different kinds of -- kind of player addressing.

And so, yes, I would anticipate that you're going to see games continue to drive replacements -- new replacements that, you're going to still see cashless gaming continue to drive replacement. We're not going to stop bringing new platforms to market. This Reel Touch is a brand new platform that's going to require some replacement with the advent of the price increase this fall.

We're introducing the 04 floor board and our i960, which replaces the old 90 or the 039 board, which add more graphic capability, more memory, better sound, and allows us to do, as a result, more robust games. We'd anticipate that that's probably going to drive some hardware upgrades within existing cabinet.

Of course, we're incredibly focused on continuing to have game conversions on the existing population of games. We have a Barcrest product line, to have a second brand out in the marketplace, which will allow us to, maybe, move the price point. Those are games that priced right now at $24,500 as their list price.

And so there's a lot of things that we're doing to create replacement beyond cashless gaming. Yes, I think there are reasons to be optimistic there. That said, you know, the guidance is as it stands.

OK. Thank you.

Thank you. Next we'll hear from the line of Amy Marcell (ph) with Jeffries & Company. Please go ahead.

Thank you. Good quarter. I was actually curious; I noticed your domestic average sales price was pretty high this quarter. I was wondering what your response is to the question of the manufacturers losing pricing power in the face of all this industry consolidation?

Well, we anticipate that good relationships that we have with all four of the big name companies that are involved in the mergers is going to continue in the post merger environment as well. We have good relationships with both MGM and Harrah's as reflected in the big orders that we've filled for both of those companies in the last couple of years.

And, we anticipate that, as you would expect, we will take volume and that we're going to continue that behavior in the future, but that its impact will not be that great on our ability to continue to have substantial margin realization for both our product sale and gaming operations businesses.

OK. As for Pennsylvania, you guys might have a better idea on timing or if you're bidding for the central system, or how that's going to work?

Well, I think that the biggest thing that has to happen here is, within 60 days of the Legislation, they're required to establish a Gaming Control Board.

Really, it's with the establishment of that Gaming Control Board that ground rules become known to everyone in terms of are they going to fast track the system RFP, or are they going to, maybe, give it to the existing lottery provider? Are they going to start the licensing process immediately by virtue of adopting regulations from another jurisdiction and putting people on kind of a fast track for opening?

We don't know those facts yet, and so, until we do, that market is difficult to predict. Generally speaking, things take longer than anticipated for businesses to get started in this industry. We think that there is the chance that we will see some activity in our fiscal year, 2005 but, certainly, are not counting on that.

OK. Thank you very much.

Thank you. And next, we'll hear from the line of George Smith in Davenport -- pardon me, with Davenport. Please go ahead.

What percent of product sales was comprised of systems, and then, if you could break out the margins on the systems business versus the game sales business?

On a 12-month basis systems -- the IGT systems and the Acre systems are approximately $100 million, and that's been -- no, they're growing. And the margins on the systems business are north of 60%, generally speaking. And then, within the systems business, we also have intellectual property related revenue mostly related to EZ Ticket, and those are very high margins as well.

And TJ, when you were talking about the outlook for fiscal 2005, I think you may have referenced what you guys expect in terms of product sales margins. Could you repeat that number?

Product sales, I can say that. The product sales margin in '04, we think will be approximately 52% -- maybe 53% for the full year. I mean, we do have margin expansion opportunities in both domestic and international markets, probably more so domestically.

So we do see margins going up, but taking a conservative view of what might happen with foreign exchange rates and, of course, we are looking for increased mix from Japan. So, I would say that next year, maybe 100 to 200 basis point improvement in product margin improvement at this time.

OK. And then just kind of dovetailing on the prior question, Harrah's has always been the outspoken critic of participation games. That seems to have moderated a bit recently but -- with them now, potentially wielding so much power, do you think that they will be able to, I guess, renew that fight with more vigor? And how would you guys respond to that?

Well, we certainly hope not. And we certainly hope that over the last two years and really throughout the history of our relationship with Harrah's that we've proven ourselves to be a steady supplier of the best games to their casino environment and anticipate that, although they will be bigger that they will continue to recognize the quality of our product.

To give you -- without, I suppose, having too much public negotiation of pricing, you know, we are comfortable with the idea that, even though they represent a very big customer on a combined basis when you combine Caesar's that they still are only about 10% or so of the installed base.

And so, we have an awful big customer universe and as a result, believe that we should be able to maintain margins in this company.

In both of the mega mergers taking place, do you do better systems business with one company than the other?

Well, we have -- we are the primary system providers to both MGM and Mandalay. And so -- and obviously their combination probably means long term, a continued expansion of our systems business with that company.

And then for Harrah's and Caesar's...

Harrah's and Caesar's both have systems that are sourced from Alliance Gaming.

OK. Thank you very much.

Thank you. Next, we'll hear from the line of Robin Farley with UBS. Please go ahead.

Thanks. I wondered you were clarifying -- Maureen, you were describing some of the changes in units year-over-year and the revenue sharing business. In terms of the change just from the sequential -- from the March quarter, is it just 400 games in New York that was added in the VLT section and the rest of the increase is all on the casino floor?

That's correct.

OK, great. And can you give a little bit more of the geographic breakdown in product sales? Sometimes you give a little more detail.

I can follow back up with you, Robin, on the unit sales breakdown.

OK. I -- and then, also you made a reference in the release to the gaming operations business, saying that the play in the majority of domestic gaming markets had increased. Can you just kind of highlight the ones where it didn't increase?

Really, we had a fantastic game last quarter. And we saw every statistic was very high as far as unit placements and broad-based unit placements, achievements, you know, with the ongoing goal of having more wide-area progressive games and good game placements for some of the new themes. The play levels were up across the board.

I would say probably the highest and best improvement was in the Nevada market, very strong statistics out of Nevada. We've been very, very pleased with the game operations, operating statistics overall and see that those trends will continue.

The trends are certainly nice, both in the numbers of units and in the revenue per unit. I was just curious if there were one or two markets where it didn't grow, if it were market specific, for some reason.

No, the biggest markets were all up, very good.

OK. Great, thank you.

Thank you. Next we'll have a question from the line of Harry Curtis of JP Morgan. Please go ahead, sir.

Hi, TJ. I wanted to go back to the -- some of the numbers you threw out a little faster that I could -- than I could write on '05 unit sales and replacement sales. Can you just review those for me, please?

Sure. We expect that we will sell 75,000 to 80,000 units next year. We have said that we expected about 60% of those will be replacement units and 40% of those will be new or expansion units.

That's 75,000 to 80,000 domestic?

Correct.

Yes.

OK. All right. And then, turning to Japan, any update please on your joint venture? And what new products you're putting into the pipeline? Do you have any sense that there could be additional success in the near-term with Sammy?

Yes, this is Tom Baker. As far as Japan, we don't expect anything to happen this year. That's an '05 event. The first game will be introduced in the early part of '05. And we'll have more to comment on what we think about the Japanese market in the next conference call.

There's really nothing more that I could tell you now. Because -- except of what we're doing and what we expect to be more successful in Japan than we have been in the past. But that's about all that I can say at this point.

When it comes to the 175 million or so that we see in 2009, the four primary drivers of that are expanded business opportunities in Japan, the initiation of operations in the UK, the operations that are now taking place in Macau, and maybe other southeast Asian opportunities that result from that and our re-entry into the Russian market. And so Japan certainly, we believe, plays a bigger role in our future.

OK, very good. Thank you.

Thank you very much. Next we'll hear from the line of Bill Lerner with Prudential. Please go ahead.

Thanks, guys. Two questions. One, could you just talk a little bit more about the participation business? Lots of strength on the yield front seems better than expected. I mean it seems like it wasn't too long ago when both levers, you know, unit placements or growth in unit placements sequentially, as well as yields were thought to be moving in the other direction now over the last two quarters, you really turned it around.

Can you talk about really why the notable strengths in yield? Is it a function of mix or more a function of gaming budget improvement and what you see there and then a follow-up?

Sure. I mean, in particular, that part of the business got a lot of scrutiny in the last quarter. But certainly -- and a lot of questions have been pointed to it for a couple of years now. And we have continued, kind of, with the fact that we have multiple strategies to both expand yield and expand placement of games on the casino floor.

To expand yield, as you know, we really reverted from a participation model back to our progressive wide-area model, which does yield higher fees per game deployed for us. We've also shifted from a focus from lower-performing markets, from a win per unit measurement perspective, which would include a market like Nevada and, rather, focused on markets that are a Native-American environment. And I think in each of the last two years have increased the installed base in Native-American casinos by over 1,000 units.

And so I just meant some really good focus on yields. And in terms of trying to increase placement, of course, at the cornerstone of that is games. And we continue to bring out ever more games to this space, continuing to try to make sure that we are novel with our invention; that we capitalize on things that work and of course, are the company that tries the most new ideas in the marketplace.

And I think that we continue to capture primarily -- to be the primary capture of imagination in the playing public by having such a robust game effort and then, of course, there's some new market creation force as well. Not only is New York a big driver in terms of incremental racino market and their continued increased percentage of the floor share in Delaware, Rhode Island, which really reflects us getting to what is our accustomed market share. But we've made some new markets for ourselves with that systems effort most notably, this quarter, putting games into Florida.

And so I think that we feel comfortable that those efforts are alive and well with IGT, and are going to continue to be able to expand that business as a result into the future.

OK. Thanks, TJ. And then one follow-up, actually, for TJ. You maybe don't realize that your stock is down 5% right now. I think a lot of it is a function of people pointing to, let's say, moderated growth relative to historical levels, say 15%. Is your comfort level in fiscal '05. Clearly it reaccelerates because of new opportunities in fiscal '06 and beyond, maybe doubling that level.

But can you kind of address it head-on right now? People don't seem to care as much about unit strength unfortunately here. They're looking at the growth going forward, moderating. So what could you say? What are the levers to beat the 15% number? Where are you being conservative? It would be a great opportunity for you to just address it right now.

Hopefully, we're always being conservative. We've been pretty public about 15% being our target for a long time now. And, of course, succeeded that 15% pretty regularly here over the last four years. Again, the goal today was to reiterate to people, not only do we feel comfortable with 15% guidance into '05, although there will be some shift in the way that we go about accomplishing that, given less replacement units to be sold. But that we also feel comfortable with that goal being outstanding for over the next five years.

And have really mentioned to people that that's going to come because the market growth of the installed base of slot machines is flourishing both in the US and international market is going to grow. It's not only going to grow because of California, Pennsylvania, and the UK, it is going to grow in multiple jurisdictions beyond that.

We said it will get over a million slot machines in the US. We're very comfortable that that's going to happen. But we think, there's going to be perhaps some surprises in new jurisdictions, both here and internationally that, perhaps, increases that figure and that would be the upside opportunity. We're going to continue to work on expanding our margins. We've done a very good job of that in this last year.

I think that we continue to focus on cost expense management here, that we continue to try to focus on fairly regular price increases when our product suits that and makes it appropriate. And so I think that we'll continue to be good stewards in that regard. We certainly have the wherewithal to use capital deployment to our advantage. And we'll continue to do that.

And then of course, probably the biggest wild card is what does product development mean? Do we have the wherewithal to increase the amount of convergence sales? Do we have the wherewithal to increase the amount of intellectual property that we licensed? Do we have the wherewithal to require new cabinet, new hardware upgrades? We, of course, are optimistic that we have the wherewithal to do all of those things. that the driver of our business towards the system-oriented environment is going to aid us in all of those areas.

And so -- you know our -- the view that we're really trying to share is that, yes, our business mix is going to change a bit here near-term but long-term IGT is poised to grow very robustly. And there's not a lot of companies that can give a five-year look with the possibility of continued 15% growth.

OK. Thanks, TJ.

Thank you.

Thank you. Next we'll take the question from the line of Michael Rietbrock, with Smith Barney. Please go ahead.

Hi guys. TJ, just a question on Class II. Can you spend a minute discussing how you feel about the competitiveness of your games there? Any more thoughts on the potential market size than where you stand at this point in the buy versus build equation?

Well we -- on the first question, of course, we believe that game content is the most important aspect of our business that we are the best at it and that it ultimately is the driving factor of success. However, before you can be in the game content doesn't mean you have to be in the game delivery business. Previously you could be -- you had to be in the game delivery business to be a slot machine. Now it turns out you have to be -- have both a gaming terminal and a gaming system to be in the gaming delivery business.

We have since put product into as I said Alabama, Florida, and Oklahoma. We believe that we are the win per unit market leaders in both Alabama and in Florida. And that in Oklahoma, it's too early for us to tell but, that we fully expect, you know, we are going to have the formula to overwhelm that space. You know, every new market in which we enter with more games than anyone else, the best games. People immediately recognize their favorite game in the form of Wheel of Fortune.

And so I think we feel very optimistic about our ability to succeed there. Of course, the buy alternative is always outstanding. But two years ago we made a very specific decision that we would build in-house and are very satisfied with our results, to date. And now that we're in each of the three kind of major Class II environments or charitable gaming environments, as well as the Class III determination markets of Washington and New York, we think that those are really going to be good models for other states to look to adopt, as we discussed, you know, recently in Texas and I think it's going to be explored otherwise as well.

But, really, as said before, we think that the Class II debate is a catalyst for Class III legislation. And of course, if we are correct about that directionally then, of course, IGT stands to benefit the most from Class III legislation.

Thanks.

Thank you. Next we'll hear from the line of Joe Greff with Fulcrum Global Partners. Please go ahead.

Good morning guys. A question for you, Maureen. Did you talk about fiscal '04, your target gross operating margin on the participating game side? And then if you could talk about what margin opportunities you have as you look into next year, as well, please.

Sure. The margin opportunity I mentioned for product sales. I did mention product sales. On the game-op side we've been consistent at a goal of I think 53% to 55%. I think that, in the fourth quarter, we'll come in somewhere in that range, maybe around the mid-part of that range. And then, right now in fiscal '05, we're assuming that, you know, an increase in margins related to the geographic strategy and the wide-area progressive strategy that we have this year. We don't forecast for interest rates.

So that is -- so what that means is about a consistent percentage at around 55% for '05.

So assuming interest rates don't move, you would expect sort of flattish for this year?

Correct.

OK. And then TJ, just a question on your second half fiscal '05 outlook. You've included some shipments to Pennsylvania. Can you give us a sense, I guess, of how much of the new unit target is related to Pennsylvania?

It's, actually, a very modest amount that is attributed to, both, Pennsylvania and California. But there some units that we anticipate, primarily for California.

Primarily. So if Pennsylvania just pushes back into fiscal year '06?

We think it's primarily an '06 event.

So just to make it very clear. If Pennsylvania just takes a while for things to get organized there and it becomes more of a fiscal year '06 event, you're still comfortable with 15% EPS growth in fiscal year '05?

We are. I mean, we think California is going to be an '05, '06 event. We think that Pennsylvania and the UK are '06 events, UK maybe even spilling into '07. We think that, of course, there is a lot of -- what people sometimes overlook in terms of new and expansion units is, just how much expansion takes place within existing jurisdictions, and so Nevada is going to have new properties next year. There's going to be more Native American properties.

Of course, there's a new jurisdiction that's going to open next year in Maine. There is the possibility that Oklahoma with the successful vote in November is going to double the number of gaming units installed. Nebraska is going to vote and have the opportunity to become a new market, that maybe in '05 or more likely an '06 event, depending on the build schedules of - on the operators. There was a casino award this week to Trump for the 11th license in Indiana that, perhaps is going to be a 10th license granted and opened at some point in Illinois.

And so there are -- there is an awful lot of new facilities that we continue to expect. And that is what primarily comprises or composes our new gaming device market. And then, you know, we are -- I think we have probably a kind of rational view of how long it takes to get new jurisdictions up and running.

OK. And then, sort of, back then to the inclusion of new California tribal slots in '05, can you give us a sense of how much you're banking on that market?

Well, in'05 - you know, this November is really going to be, kind of, an interesting thing, event to watch here, because, of course, you have vote on two initiatives. And those two initiatives would mean very substantial increases in number of devices very quickly. If both of those initiatives fail and the governor of California has said that he would lobby against them, then you'll also rely on the existing new compact discussions to, kind of, take hold.

You have five tribes that have already compacted. They are very successful casinos. They themselves can grow, you know, a fair number of units, but, you know, maybe you're talking about the universe of five being able to contribute somewhere between 5 and 10,000 units amongst themselves. So you really need a broader number of tribes to take on compacts. If that happens, we said 35,000 units could be the total universe, but we would expect just a small fraction of that, really to take place in '05.

OK. Great. And - can you just let us -- remind us again, I guess, when can you guys be back in the market to buy back shares, I guess, with the lift in restriction after reporting earnings?

The quiet period ends for employees in the company ends two days after the press release.

Great. Thank you, guys.

Thank you. Next we'll hear from the line of David Barteld with Wells Fargo. Please go ahead.

Good morning. All of my questions have been answered. Thank you.

Very good. Thank you, Sir. Next we'll take a question from the line of David Anders of Merrill Lynch. Please go ahead.

OK. Thanks. Maureen some housekeeping, do you have the absolute interest income and interest expense line items along with Packaser (ph) and Barcrest shipments?

David, I'll follow-up with that with you later.

OK. Another question, as far as the Manitoba order in the fourth quarter, are you considering that new or replacement kind of in your guidance?

That is replacement, because we -- prior to this order, we had 100% of that market. And we were very pleased with the order for the 5,400 games, which also represents 100%.

OK. Lastly just clarifications, TJ, I'm still confused. The 75 to 80,000 units domestically for next year, did you say 60,000 were replacement or 60% would be replacement?

60% would be replacement.

Thank you.

Thank you. And ladies and gentlemen, once again, if you would like to ask a question, simply press, "star" "one" at this time. Next we'll take a question from the line of David Bain with Miriam Kurham (ph). Please go ahead.

Yes, thanks. Just to clear upon the Florida placement Class II. Is that on the SDG platform with your content? Is that what you guys are talking about or is this a new placement of your games.

Well, in Florida as you know, we primarily, installed most of the devices on the SDG platform. We continue to do so. But it's the first installation of wide-area progressive units on the same. And of course, we have announced our intentions to be able to have our own central determination system distribution into that market.

OK. And, also, when you mentioned Oklahoma. As of now, you don'ts have an NGIC letter matching to a particular game. How do you intend on handling that situation?

I think the NIGC is working very hard to establish technical regulations. We have been cooperating in that process; have a role in that process. We have, certainly, some guidance in some of the opinions that they've already rendered for other parties. And of course, we have our good sense. And so, you know, we think that over time, if that's going to get sorted out, may get sorted out on its own in November with the initiatives.

Right. But you're going into that market pre-letter?

Everybody is going into that market pre-letter.

OK. Are you in one facility right now?

We are in one facility with the Kickapoo.

All right. OK. Thank you.

Thank you.

Thank you very much. Next we'll take a question from the line of Jeff Martin with Roth Capital. Please go ahead.

Thanks. I had a question on the central determination system model. Obviously, that's driven by the video lottery in the Government-sponsored markets. But how do you see that transitioning into the mainstream Class III commercial side?

Well, it's just what we said about the fact that functionality is moving from a terminal only environment to one that requires both terminal and systems. If you look, there was really big -- been three big events in that regard, to date. There's the Acres bonusing effort, which allows for system driven bonuses to be displayed through a gaming device. There has been the EZ Pay implementation, which has allowed cashless gaming, ticket in and ticket out to take hold. And there is the Central Determination System environment in which the outcome of a game is determined at a central system, rather than on the R&G that's housed within the terminal.

All of those represents components of what is server-based gaming. Those all server-based events. We anticipate that that's going to continue to evolve into accommodating things that will put more functionality at a system level including eventually I guess, what people talk about the most is game download.

OK. And is that going to require any hardware purchases on the behalf of the casinos? Or is that all a retrofit?

Well, what we've told people is that we are going to continue to provide hardware upgrade pads within our existing cabinets. And so it may be that people have to replace their CPU to accommodate certain functionality into the future. But they aren't necessarily going to have to replace the cabinet in which it's housed.

OK. And are you seeing a lot of interest from the major commercial casinos for a Central Determination Model yet? Or do you think we're still a year or two away from that yet?

Well, I think the place where we see the most interest is in wide-area gaming environments. And what I mean by that is a place where you're going to have some sort of Central Government repository of the information wanting to monitor what's going on, wanting to ensure the integrity of the game, but have games spread out in an enormous, geographic area. Good jurisdictions along those lines are Quebec where they have 14,500 machines at 4,500 distinct locations in a province that is huge or Norway or Sweden.

You also central determinations as being I mean as they confirmed to existing lottery laws like the pool tab laws in Washington, like the instant ticket laws in New York, or being able to conform to the Bingo laws, charitable gaming, or Class II as it uses the Bingo Laws.

And so there's a lot of different environments that suit Central Determination Systems. It's really is being able next generation of server based technology that's probably going to put it in the traditional casino environments.

OK. Great. Very helpful. Thank you.

Thank you. Our final question and will come from the line of David Vas with Banc of America Securities. Please go ahead.

Yes. Hi, thanks. Actually a couple of things. TJ, can you talk about in 2005, your guidance of 15% earnings growth, how do you reconcile that between the domestic units guidance that you've given? And I've a couple of follow-ups.

Well, the way that we have reconciled that is we say the growth drivers we expect to be the games operations business, that we expect that we will continue to have strong margin realizations from the domestic products business, that we expect that we'll continue to grow internationally, that we expect that we're going to be able to keep operating expenses in line.

And on top of that, there's certainly the possibility -- there's some realization of incrementally PS from capital initiatives like recapitalization of the debt on the balance sheets and also some opportunities obviously for us to do something with continued share repurchases. For us, we think there's a lot of different moving parts that allow us to get comfortable with 15%.

OK. Separate questions. Can you talk about the split, if you could, of your annual R&D between game development on current platforms and future platforms, including system-centric?

I think that we've said historically that we think that we spend about 50% of our time making games and 50% of our time delivering those games to the marketplace. And I would say that in terms of the 50% that is spent on game delivery, certainly, a larger and larger percentage is being spent on system development.

I would say that maybe that's in the neighborhood of two-third one-third next year, maybe one-third being dedicated towards systems.

OK. The last question. Can you give us a feel for how your games -- yours and others, I guess, are being played in Macau? How are things going there, compared to levels of play in the US and your expectations?

Well, it's too early on that. There's only 600 machine universe really in kind of the new Macau machines. But the early returns are that our machines are performing very well and that we're very satisfied with their performance.

Would you say that level of play there is -- what jurisdiction, maybe, would it be comparable to?

You know, what we've been hearing win per unit numbers that make it comparable to the average jurisdiction in the US with the exception of the high flyers and the lower ones in Nevada. So I mean it would be representative as to US style play. There would be a question as to how big however that slot machine universe can be.

That is going to get tested a little bit here in the future because there is going to be more and more, kind of, US style casinos that will be developed in that marketplace. You'll probably see the probably the advent of some amount of slot parlors in that market.

I would say that we're reasonably optimistic that market gets bigger in terms of gaming devices. Although I don't think it's analogous, I mean I would say its worthwhile that note that in Japan there's an effect 3 million gaming devices.

And so there's always been this misconception that, somehow, the folks that populate Asia are not predisposed to gaming devices, in fact, its at least in one example, Japan, there's very good evidence to the contrary.

OK. Thanks a lot.

All right. Well, thank you very much for your participation today.

OK. Thank you very much.

(Operator Instructions.)

That concludes our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.