International Game Technology PLC (IGT) 2005 Q1 法說會逐字稿

Welcome to the IGT first quarter fiscal year 2005 earnings release conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. To ask a question, please press star one. I would like to remind parties today's conference is being recorded. If you have any objections, you may disconnect at this time. I am now turning the meeting over to the Director of Investor Relations, Mr. Pat Cavanaugh. Sir, you may begin.

Thank you, operator. And thank all of you for joining us this morning. Before I begin, I'd like to let you know that with me today are Tom Baker, our Chairman, T.J. Matthews, our CEO, and Maureen Mullarkey, our CFO. Before turning the all over to Maureen, I would like to note that during the quarterly earnings conference call, certain statements will contain forward-looking information, such as forecasts of future financial performance.

Although IGT believes that the expectations reflected in any of the 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, including any comments regarding our earnings expectations, 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. You should not assume later in the quarter or year that the comments we make today are still valid. 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 that could cause us not to achieve our forecast are included in our most recent annual report on the 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 with the comparable GAAP results in our 8-K filed with the SEC today, a copy of which can be found at our website at www.igt.com. This call, the webcast of this call, and its replay are the property of IGT; is not for rebroadcast or for use by any other party without prior written consent of IGT. If you do not agree with these terms, please disconnect now. By remaining on the line, you have agreed to be bound by these terms. With that said, I'd like to turn the call over to Maureen Mullarkey, our CFO.

Thanks, Pat, and thank you, everyone, for joining us today on our first quarter conference call. Our financial results for the quarter reflect the commitment of our 5,000 employees to be the leading provider of gaming machines, platforms and systems for worldwide gaming markets.

Notable highlights and records set during the quarter include: Record revenues of 641 million, a 5 percent increase from last year, on consolidated shipments of 55,300 machines worldwide. This resulted from international revenue of 178 million and related operating income of 47 million, both on the strength of unit sales of approximately 41,000 machines, all of which were records set by our IGT international team. Our international results were driven by IGT Japan, with unit sales of 29,600 of our latest games, The Terminator.

We are very pleased with efforts and the results of IGT Japan team. The success of the Terminator follows our previous record-setting game, Nobunaga, in the first quarter of last year, and is also our first game as part of our partnership with Sega Sammy Holdings. Sammy is the most successful manufacturer in the Japanese pachisuro market, and this is a terrific start of what should be a very long and fruitful relationship. In addition to the profitability of international operations, we also continue to execute on our strategy to grow non-machine-related revenues in North America to offset the decline in machine demand from the anticipated maturing of the ticket-in/ticket-out replacement market.

We also successfully grew the install base of our gaming operations by 2600 games to 37,000 machines year-over-year, with a slight decline of 200 machines compared to the prior sequential quarter. The install dates during the remaining quarters of fiscal '05 will see future growth, as we introduce several new and exciting products, including Fort Knox, a multi-level productive game, along with Star Wars and Video Megabucks in Nevada. All of these will be introduced during our second quarter.

For the first quarter, income from continuing operations was 122.4 million or 33 cents per diluted share as compared to 116.7 million or 32 cents a share in the prior year quarter. These operating results yielded quarterly cash flow from operations of 153.7 million. Our ability to consistently generate such strong cash flows give us flexibility to reinvest in our business and to execute on our cash deployment strategies for the benefit of our shareholders. I'll now go into some highlights for both product sales and game operations.

Product sales revenue during the quarter totaled a record 354.3 million, an increase of 7 percent over the prior year. Total quarterly shipments of 55,300 surpassed the prior record of 46,100 in the same quarter last year, due to an exceptional quarter in Japan. While we witnessed a decline in North America related to the replacement market, we did post significant increases in those average revenue per unit and gross margin percentages related to the growing mix of non-machine-related revenues, which includes systems and parts in the quarter.

North America product sales revenue totaled 182 million and was down 23 percent from the prior year. Unit shipments totaled 14,700 during the quarter, including replacement sales of 11,300 and 3400 new and expansion units. Units were down 7900 machines compared to the prior year related to lower replacement demand. We continue to expect this demand to remain below last year's level as anticipated, but do point out that there are approximately 200,000 machines in the market that we still deem as targets for replacement. North America's average revenue per unit, or ARPU, was 12,400 for the quarter as compared to 10,500 in the prior year.

This 1900 increase benefited from our '03 and '04 price increases and increase in the mix of IGT Advantage Systems revenues, additional intellectual property revenues, and greater gain conversion and ancillary equipment sales. North American margins in the first quarter were up at 55 percent, compared to 53 percent in the prior year quarter. While volumes were down, we were able to post higher margins, due to year over year reductions in variable manufacturing costs, material cost reductions, higher prices on our games and the aforementioned mix -- greater mix -- of non-machine-related revenue.

We're also very pleased to mention a number of significant new Advantage Casino System contracts with Pinnacle Entertainment, the Isle of Capri for six of its properties, Hard Rock Biloxy, and Harrah's Entertainment for three Southern Nevada casinos. Of these, three installations will showcase IGT's next gen interactive displays supporting a full set of exciting loyalty-building bonusing tools; and the Fort at Harrah's will showcase TableTouch, IGT's table management tool. IGT bonusing is becoming the standard by which all casino management systems are measured. When combined, bonusing and next gen displays create a powerful marketing tool kit, enabling uniquely branded marketing programs that give our casino customers strategic competitive advantages.

TableTouch, in addition to automating the management of many aspects of table game operations, will allow dealers and pit employees to use touch-screen monitors to enroll, rate and issue complimentaries to table game players in a more timely and accurate manner. The IGT Advantage team is successfully capturing additional market share on the strength of their value-added technology offerings. With these new customers, we now have systems contracts with most of the major gaming operators. International product sales totaled 40,600 units during the current quarter, an increase from 23,500 in the prior year, due again to the success in Japan. International average revenue per unit of $4200 for the quarter was up from $4,000 in the prior year.

This increase was driven by favorable foreign currency exchange rate comparisons. International margins were 37 percent, down compared to 44 percent in the prior year. Going forward, international margins will continue to fluctuate materially, depending upon the geographic mix of gains, especially as it relates to Japan. Pachisuro machines carry lower prices and margins, but benefit from a very large install base of over 1.5 million machines in Japan, of which over 50 percent are replaced annually. As a result, continued success in Japan can and will contribute significantly to operating income, but gross margin percentages will be lower.

For the quarter, international operating income was an all-time record of 47.4 million, an increase of 86 percent over 25.4 million in the prior year. Favorable exchange rates added approximately 2.4 million in operating income for the quarter compared to the prior year. In total, our international division achieved solid results, with total revenues and gross profits posting year-over-year growth of 82 percent and 54 percent, respectively.

Looking forward to fiscal 2005, we anticipate North America product sales gross margins to continue to follow recent trends, coming in between approximately 55 to 57 percent on the continued strength of stronger price utilization, greater mix of systems-related revenues, game conversions and machine [INAUDIBLE]. As we see a greater contribution of revenues and related operating income from international sources in fiscal '05, consolidated margins will fluctuate from quarter to quarter, depending upon the specific geographic mix.

Moving on to game operations, revenue for the quarter totaled 286.9 million, an increase of 9.3 million from Q1 '04, representing growth of 3 percent in the period. It is relevant to remind this audience of the impact in the prior year of the extra week of operations. 14th week last year added approximately 19.9 million in game ops revenue and 11.1 million in associated gross profits. Excluding the extra week, revenues would have been up 7 percent and gross profit dollars 4 percent. Our game operations business is seasonal; and as such, first quarter revenues historically decline as compared to the immediate preceding December quarter. We experienced an 8 percent decline in revenues sequentially, which is consistent with prior trends.

The install base in game operations totalled 30,600 casino games and 6400 casino games, for a total of 37,000. We saw year-over-year growth of 900 games in the casino market category, primarily from increased prices in the emerging Desert Termination markets of Alabama and Oklahoma, and across three Native American markets. Within our casino markets, we are poised and ready with the introduction of our new Fort Knox multi-level progressive games which are actually just -- the first day of installation was yesterday. This week, we have our first installations in Iowa, Michigan and Nevada. And next week, we will commence introduction into several different Native American markets.

During the second quarter, we also plan to introduce Star Wars and Video Megabucks, which will be the largest penny progressive jackpot, with a start amount of $10 million. Growth in games placed in the casino category totalled 1700, including 1200 related to New York, related to the commencement of Video Lottery and Desert Termination at four racetracks. We will benefit in fiscal '05 from the rebalancing of units based on performance, as IGT is slated to gain an additional 65 units in the New York video lottery market, representing the largest reallocation for any vendor. We're also seeing the benefit of expansion into nontraditional gaming markets, including Alabama, Oklahoma, Florida and Washington.

We anticipate that the install base of games will grow significantly, as our backlog for these markets currently stands at the 1800 units. This includes 900 games for Alabama, 200 games for Florida, 500 games currently for Oklahoma, and approximately 80 MegaJackpot placements into the state of Washington. Quarterly gross margins were 52 percent, down from 56 percent in the prior year. Approximately half of the decline, or 200 basis points, relates from the consolidation of our VIEs -- that includes our Trust in Atlantic City and Iowa. As we have discussed many times in the past, this consolidation normally adds from 10 to 12 million in quarterly revenues and costs. This does lower gross margin percentage, but the impact to gross profit dollars is nil.

In advance of some of our new product offerings, we saw continued managed removals from the field. During the quarter, we incurred higher operating expenses, including those related to the managed removal of lower performing games that resulted in additional costs in the areas of fixed asset removals. We will continue to work on improving the play levels of our priced games and will manage the installed base accordingly to maintain the highest performing games in the field. Going forward, we anticipate gross margin percentages at 52 to 55 percent quarterly, depending mostly upon the direction of interest rates.

Moving on to operating expenses, total operating expenses in the quarter, 123 million versus 119 million last year. SG&A expenses of 74 million were up approximately 7 million compared to last year, related to the acquisition of Acres Gaming in late October '03 and higher international expenses. G&A in the quarter total 17 million versus 14 million in the prior year, and was up primarily related to higher intellectual property amortization and greater depreciation related to our ERP implementation. Bad debt totaled 700,000 in the quarter versus 5.6 million in the same quarter last year, related to the higher mix of international receivables.

International receivables were up due to higher volumes in Japan, and carry a lower risk, as they are secured by promissory notes which are paid in the short term. As a percent of total revenues per current quarter, operating expenses were 19 percent as compared to 20 percent in the same quarter of last year. Other income, net was 1.6 million for the quarter compared to an expense of 15.6 million last year, due to the redemption of our senior notes during '04. Going forward, we expect other income to be at 0 or slightly positive. We currently anticipate a tax rate of 36 percent for 2005, with slight fluctuations possible if there are changes in the forecasted mix of North America and international operating income.

Moving on to cash flow and balance sheet commentary: For the quarter, we generated 153.7 million of cash from operations on net income of 122.4 million. Our cash balance was 876.1 million. That's up from 765 million at the end of September. Our long-term debt stands essentially unchanged at 794 million. Working capital statistics remain strong in the fourth quarter. Day sales outstanding were 79 days during the quarter compared to 74 days at fiscal year end 2004, related to the higher Japan receivables.

Inventory turns were 3.8 turns and consistent with prior year, fiscal year end levels. In the area of capital deployment, we continue to return value to our shareholders. We paid a $0.12 per share dividend, or 41.5 million during the quarter, versus 69.2 million in the first quarter last year where we paid both the fourth quarter of '03 and first quarter of '04 dividends. The liquidity on our balance sheet stands at approximately 2.2 billion, with cash on hand and available credit. We continue to target returning at least one-third of our annual free cash flow to shareholders in the form of share repurchases.

Our share repurchase program authorization remains at 35.8 million shares as of December 31, 2004, which may be purchased from time to time in the open market or through privately negotiated transactions. Our capital expenditures for the quarter were 44.4 million, due to increased spending for process plant and equipment related to our Las Vegas campus and facility expansion in Reno. In addition, we saw an increase in our spending to acquire intellectual property, as we continue to strengthen our intellectual property portfolio.

In conclusion, and before I turn it over to T.J., we are very pleased with the first quarter results, and they reflect the success we're having on several fronts -- growing the international business, improving non-machine product sales revenue -- which also expands domestic margins -- and we are also growing our install base in nontraditional markets, while introducing exciting new products into the casino market. Thank you. And T.J., I'll turn it over to you now.

Thank you, Maureen. Before opening the line to questions, I have some closing remarks regarding our outlook for IGT and the remainder of the fiscal year and beyond. We remain very confident in our long-term outlook here at IGT. One of our primary long-term goals that we've expressed to you is to double our EPS during the next five years, which equates to our previously stated guidance within EPS of one-time [AUDIO BREAKING UP] 15 percent. Coming off the record years in fiscal year '04, where we grew our EPS by over 20 percent, and in fiscal '03, where we grew by over 40 percent, we knew this year would be tough to follow those past performances.

We continue to see numerous opportunities to grow our business through increased profit contribution from our international business unit, margin expansion generated by diversified product mix, and increased revenues from non-boxed products. However, we still remain dependent upon gaming market expansion for much of our growth. We enter the year confident, with a number of North American markets who contribute incremental growth for IGT, and help us achieve yet another record year. But unfortunately, these opportunities have been slow in materializing.

While these markets have reduced our visibility for growth in the near term, we can once again assure you that these opportunities are in no way being taken off the board. We still have expectations for the California market that it will grow at close to 90,000 in the next few years. We continue to expect Oklahoma [INAUDIBLE] will see growth as a result of the past November voter approval for compacted gaming, which will include games of skill, such as video poker. We still believe New York will have video lottery terminals in all eight of its planned racetrack operations, including Yonkers and Aqueduct in the New York City area. The question we have to answer is not "if" in each of these jurisdictions, but only "when".

When these opportunities do materialize, they will join the expansion of gaming into Pennsylvania, a market that could eventually reach 61,000 machines. It will join IGT's continued expansions to numerous PDF markets nationwide, including our new direct sales initiatives in Florida and Washington state. They will join the potential future expansion of new markets that are being discussed today legislatively in Maryland, Ohio, Massachusetts, Texas and others. And on top of these North American opportunities, numerous international jurisdictions look ready to expand over the next few years. We still anticipate that market [INAUDIBLE], and numerous jurisdictions in Asia will see growth in machine prices. We continue to see progress, albeit in a very noisy news environment in the UK, in its attempts to modernize current gaming regulations.

Some would still hold the belief that the North American market will reach a new sell base of 1 million machines by the end of the decade. And part of our optimism stems from the continued efforts to move forward in developing the gaming products of the future, which include our server-based gaming initiatives. Coupled with our continued efforts to develop the industry's best games, systems and platforms, we remain confident that we will achieve our long-term growth objectives. With the delays in expansion for fiscal year '05 in mind, we are fine tuning our estimates for the remainder of the fiscal year. We still remain comfortable with our previously announced guidance of $0.30 to $0.35 in the second quarter. Given the delays previously noted, EPS is likely to come in at the lower end of that range. Further, during the second half of the year, we believe these delays will prevent us from seeing the previously anticipated breakout in the EPS when compared to the first half of fiscal year '05.

Therefore, for the third and fourth quarter, we anticipate our earnings per share to be at the top end of the range; again, a $0.30 to $0.35 in each of those quarters. We anticipate that the breakout will be associated with gaming expansion when it starts -- once it starts to manifest itself, and that that will most likely now be at 2006 again. Again, we appreciate all of your interest in IGT and would now like to answer your questions. Operator, if we could open up the line to questions, please.

Thank you, sir. At this time, we will begin the question and answer session of today's call. Once again, if you would like to ask a question, please press star one. The first participant is Harry Curtis of J.P. Morgan. Your line is open.

Good morning, Harry.

Your next participant for questions is David Bain with Merryman.

Hey, guys.

Hey, David.

Can you let us know -- did you notice any market share shifts that you may have experienced overall in the North American marketplace, or were North American results strictly a function of slower replacement cycle due to cash lists and no major new builds or jurisdictions opening up?

Well, I think that obviously we would attribute it primarily to the accelerator replacement that's taking place in previous periods, and the lesser machine sales, you know, mostly being a byproduct of that. That said, as we address the market, there are three primary machine segments. That of spinning reels and video poker comprising two of them, where our market share in excess of 80 percent and 90 percent, respectively, and continues to be very strong. And then the world of video gaming machines, where that is a much more competitive environment. IGT obviously has grown its share in excess of 50 percent. But as product mix shifts a bit, you may see that -- that'll have an effect on, you know, kind of perceived market share due to mix, without necessarily having any real -- there really being any impact on market share in its entirety. But that's that's a crowded place.

Okay, okay. Systems, during the quarter, do you have a machine count length versus the previous quarter, or some way we can track how you did in the systems arena in terms of new casinos and things like that?

I don't think that we've previously announced exactly how many machines that we're monitoring with existing casino systems. It's probably a statistic that we can get in an offline conversation. The thing we have remarked on is that, combined with EZ Pay, our legacy IGT Systems, now the Advantage System, brought to us in the merger with Acres, along with now our efforts in [INAUDIBLE] termination systems and eventually server-based gaming, that we have more connections to more gaming devices than does any other system provider in the industry, which over time we believe will strategically place to us be able to deliver applications via servers in a more robust fashion.

Okay. Okay, great. Thank you.

Thank you.

Aimee Marcel with Jefferies & Company, your line has been opened.

Thank you. I was actually curious, last quarter, you mentioned more about Russia. Is it moving at the same pace as you were expecting, or is it slower to come to fruition?

No, I think it's still something that we talk about a great deal internally. Over the last year, as you know, we re-entered that market after a three-year hiatus. We've established a representative office in the country itself that can provide warranty and service activities. We sell to that market still out of our European operation, and remain optimistic about our ability to grow market share substantially over time in that country. It is a place right now where there's a couple hundred thousand machines that are being operated. It could very well grow to in excess of 300,000 machines. A lot of the existing devices are antiquated technology and over time, we would expect that IGT can farewell them.

Would that be an increase in R&D just to market to that demographic and the people there?

Yes, our folks in the international operations have just done a fantastic job of putting us into a market-leading position in more and more markets. And part of that has been acting locally. Localization being in the form of management, but also in forms of the product itself, so that we no longer are exporting an American product into other countries but rather a product that's been customized for those locations. That would include things like Russian language programming or Russia or Chinese language programming for Macau. And so there is a much more active effort now, and about 60 or so people dedicated to that kind of localization effort of these products to be really presented correctly into each of these new markets.

Okay. And also, I saw a press release about an alliance with Scientific Games in the lottery world, linking the systems. Is there any benefit, or when do you expect to actually see some revenue from that?

Well, the big thing there is that as you know, we sold our video lottery system business to Scientific Games as part of the OES transaction, now a little more than a year ago. With that install base along with the ones they cultivated themselves, as well as some recent, you know, wins by Scientific Games, it's clear to us that they are merging as the market leader for that technology. That for us, that systems environment potentially represents a barred entry should there be any development away from kind of the standard protocols of the industry that we use for deploying gaming devices. So having an agreement with them in which we can support their products as well as ensure our access, and then have subsequent follow-on opportunities, not only for gaming devices to be deployed but for us to be able to sell our system capabilities like bonuses, ticketing, player tracking, I think represents a very substantial opportunity, and it's something that is very good for both companies. But there is no specific revenue figures that have been attached to it at this point.

Okay. And just a specific question. Where did the 200 recurring revenue machines that they came offline from last quarter to this quarter come from?

Well, it's not abnormal for us to suffer a little decline in this December quarter, just due to the seasonality fact. And there is no one place in which they were -- that we would point to. It's also been the result over time that we've been increasing price points by shifting to our wide area progressive pricing away from the 80/20 participation sites, and then so that's put pressure on lower performing units. So I don't know that we can remark on necessarily any specific removal activity. I think that it is important to note that as we talked about central determination systems, that the backlog for that market right now is quite large. A lot of that could be deployed in Q2. And then in this quarter, we're going to be deploying, you know, a substantial array of product geared towards voter-nominated video, with Fort Knox, which was launched yesterday, Video Megabucks, Star Wars which will be launched later in the quarter. And so I think we'll have, you know, a pretty upbeat story on the install base when we gather again in -- at the end of Q2.

All right, thank you.

Thank you, Aimee.

Mr. David Anders, with Merrill Lynch, your line has been opened, sir.

Great, thank you very much. Hey, Maureen, could we get the Barcrest number? Do you have that handy?

Yes, I do, David. Barcrest during the quarter was 6700 units.

Okay, and as a follow-up on the pachisuro, how do we think about kind of unit shipments going forward over the next several quarters. Is the Terminator 2 cycle done? Or how do forecast that?

The Terminator 2 cycle is done for the most part. And the second product introduction, the product called Winning Post. And the current schedule is for that to be introduced in the June time frame, so that would benefit both the June quarter and the September quarter. And, you know, we'd like to think that we could have the same success with Winning Post. At this time, we're putting a more conservative number on that, with total machine shipments in Japan around 40,000 for the year.

40 or they year? And one last question. I missed your New York comment about the shifting market share. Did you actually quantify --

Yes.

-- the new orders in the New York market?

We gained 55 days.

Thank you.

Mr. Joe Greff with Bear Stearns, your line has been opened, sir.

Good morning, guys.

Good morning, Joe.

Maureen, can you just give us a break out of the North American units shipped between California, Nevada, and other?

I don't break out California specifically, but Nevada was 4200. The Eastern region was 5700. Native American was 2700. Public gaming was 900. Canada was 900, Atlanta City was 300, for a total of 14,700 domestically.

Great. Thanks.

Sure.

Celeste Brown with Morgan Stanley, your line has been opened.

Good morning. Can you break out -- I know you gave the Barcrest number, but can you break out more specifically -- will you give the [INAUDIBLE] number, but the AWP number and the casino and club number for the international division for the quarter?

The -- total international shipments were 40,500. Japan was 29,600. Barcrest was 6700 -- so the 6700 and the 29,600 represents the low payout market. Australia, which is the club market is 1300; and Europe had about 1700, and what we call other international -- which is Africa and South America -- had 1300.

And can you discuss the margin on the pachisuro machines in the quarter, please?

Sure. The margin on the pachisuro game was approximately 32 percent, and we had an average revenue per unit Japan of about $3300, and the average gross profit in Japan of about $1,000. Well, about 1050. And that is an increase of about 250 or so on a year-over-year basis.

Great, thanks.

Mr. Bill Lerner with Prudential, your line has been opened, sir.

Thanks. Just a few questions. One, T.J., I think you made some comments about guidance for the balance of the fiscal year? Could you just clarify, because something doesn't seem to add relative to the 15 percent growth.. Did you say bottom end of the $0.30 to $0.35 cent in the second quarter and then top end of the $0.30 to $0.35 cent range of the third and fourth fiscal quarter?

I did, which would, you know, likely indicate that EPS in '05 as compared to '04 will not be a 15 percent increase, but that over the course of five years, still with the idea we can double EPS during that period of time, can still achieve that compounded growth rate.

Okay. And then just a follow up on -- with another couple of questions. One, you made some comments about the long-term outlook as it relates to the company, and kind of outlined some different things. You know, if you believe -- and I don't want to put words in your mouth -- that there is a disconnect between the stockism and what that outlook is, why no buyback in the quarter?

You know, I don't know that there's -- I don't know that there's a specific reason to comment on the quarterly activity for stock repurchase. One thing that I think we've assured folks is that over the course of past years and over the course of 2005, that you can expect us to be active with stock repurchase, that we have an awful lot of liquidity available to us, and that should, beyond kind of a systematic repurchasing activity which represents a third or so of our cash flow, should there be extraordinary opportunities relative to our valuation of the company's prospects with that of the investment community, we'll of course take advantage of that.

Okay, thanks. And then the last follow-up. On the domestic weakness front, would you attribute that to demand slowdowns, specifically with Mandalay and Caesar's as those deals close? In other words, are we going to get those units back?

I think certainly Mandalay and Caesar's, I think that, you know, they would remark on the fact that Cap Ex has been disrupted a bit by the transactions. Both of them maybe -- you know, in the case of Harrah's and Mandalay, you've had people that have been very aggressive early adopters of technology -- changing out their floors, maintaining Cap Ex budgets relative to slot machine purchases. And so you know, there's certainly the possibility in a post merger environment that we see Mandalay and Caesar's invest more heavily to bring their slot machine floors up to date. But I would not attribute that to be the primary issue relative to domestic shipments. I think overall, industry-wide, domestic shipments in '05 will be lower than they were in '04. And it just has to do with how many units were moved forward into '03 and '04 due to what we all talked about as accelerated replacement, because of ticket-in/ticket-out. There still are a lot of more ticket-in/ticket-out machines to sell. There still is replacement markets that are taking place relative to the [INAUDIBLE] nominated machines to the trend towards video; and of course, we're very excited about the initiative of bringing server-based gaming to a casino floor. We're going to add brand new applications, allow for more active management of casino floors, and believe that that's going to be a driver replacement as well, that I think that people are going to have to get used to the idea that more and more of our business is going to be non-box revenue. And because of that, the unit ship count is going to become, you know, less and less of an important number, and us talking about things like game sales and higher margin activity like the implementation of systems or the licensing of our intellectual property -- all of those become more important over time. So there's a lot of things that can grow our business. That unit comp figure is going to get more and more distorted as a measure as to how we're doing.

Okay, thanks.

David Vas with Banc of America Securities, your line has been opened.

David, how are you this morning?

I'm sorry about that. Nice mute button. Maybe we can look ahead a little bit over -- beyond the next six and nine months and think about a system-centric server-based gaming. Can you give us a little bit of an update in terms of your time line for having a system, you know, submitted to GLI, you know, when you'd expect to have a beta test out there, and you know, kind of just how it looks going forward?

Well, as you know, we have really initiated the idea of server-based gaming in a lot of forms. Firstly, through the managing of tickets, the managing of bonusing on the Advantage system, the management of outcomes through a central termination systems. And so we have server distributive events occurring in a number of venues already. We're consolidating those into a single effort that wae call "server-based gaming to bring to a casino floor." I've been working on that now for about a year, and believe that by the end of this calendar year, we will have deployed our first system, be able to kind of prove the technology, conceptually start understanding what are the applications that we need to bring to the floor to actually make the value proposition unique for the player in the casino as we evolve this technology, and that going into '06 that we believe we will be able to actually start, you know, maybe again what we called previously our "campfire strategy" of ticket-in/ticket-out, with the idea we can start placing units on a discreet basis and demonstrating greater efficiencies in terms of revenue production, cost management for our casino operators. We, of course, as part of all of this development effort have been in contact with all of the regulatory community, have been talking to them about the things necessary for us to be able to maintain the integrity of the gaming device on the casino floor, which means that the gaming device, I think, is going to look largely as it does today, with the same kind of security and accounting functions, game recall memory, games resident on the platform of the device itself in most U.S. instances. And that we are going to have the wherewithal to manage active games by matching up better supply and demand in a game-on-demand kind of format, be able to manage pricing for customers, be able to have, as a result, shared activity, because players are now common to a network. And I think all of those things, you know, really start getting worked through the regulatory process, and proof of concepts throughout the remainder of this calendar year, and become part of our business plan in calendar '06.

Okay. Sounds great. That's what we're looking for at this point, as well. Maybe you can talk a little bit, too, about game development. Are there any changes you guys are doing there, either minor or in large scale, in terms of, you know, focus on types of themes or types of volatility or anything like that?

Well, I mean, I think that you see us -- we've expanded the install base of gaming devices, especially in the U.S., that the player has demanded greater and greater entertainment value from their gains. And that means, you know, better, more sophisticated video presentations of games. It means more lines and greater wagering events, so that they can have more winning outcomes kind of in total, in terms of individual handle pools. And so there's certainly those trends that are alive and well. As we move from platform to platform -- you know, in our 8960 environment, we've been operating on what we call the 039 board. That's been moved to an 044 board, which is a higher res, greater memory board. You will see greater improvement in terms of game execution; again, on the video and the audio side. And of course, that really takes a huge leap forward as the ADP product that we have becomes more and more mainstream. ADP now has three games in its library that are in deployed, all in our MegaJackpot business. All of those -- you know, I would say that we've had success with all three of those titles. We anticipate that that number of titles rolled out this coming year, you know, will approach double digits. Eventually, ADP becomes a mainstream platform, and before sale efforts as well. The reason for that is it specifically accommodates high-speed communications. It specifically accommodates more than one monitor, to the extent that you have to not only download a base game, but have to be able to explain it in a point of sale environment to the player, pay tables, glass, bonus events, things of that nature. And so there are definitely things that are taking place that are different in the gaming machine, and that in turn means different kinds of games. You know, whether the players right now who already share pools for bonusing for progressive jackpots in fact start interacting more is a really -- is a definite possibility that could result from server-based gaming initiatives.

Okay. Thanks a lot.

Thank you, David.

Robin Farley with UBS your line has been opened.

Thanks. I had a couple of questions. When you -- with your guidance for the second half of '05 here, I guess I've always known there's more visibility in '06 and '05 for shipments to Florida and Pennsylvania, but where else would you say, just in terms of what's changed in your view from the last time you gave guidance a quarter ago, that's causing you to look at the second half of '05? You know, being fewer U.S. markets? In other words, what had you expected there to be a quarter ago?

You know, I think there may not be any one instance, although we can tell that you California, you know, the compacting effort there has gone slower than we anticipated, that the tribal and some lottery games have certainly gotten away as part of that delay; but there are other issues as well, in terms of just a bigger tribe embracing the process itself. In Oklahoma, I think it's a pleasant surprise, but we initially thought that that could convert more so to a for sale market, and are finding that it's likely to be a recurring revenue market for an extended period of time. That's a preferable model to IGT, but nonetheless affects our near term performance expectation some. And probably just a realization overall that when you look at places like New York, Pennsylvania -- even watching Florida as it unfolds or the debate that take place in so many jurisdictions -- you know, maybe the most notable being Maryland, where gaming expansion seems imminent -- that it's just apparent to us that, you know, really given not only the legislative process but the subsequent process of establishing a gaming commission, forming rules, awarding licenses, building facilities, is just going to take longer in each of these new jurisdictions than I think was previously optimistically thought. And so we really kind of adjusted our numbers throughout our five-year forecast, kind of adjusting for the longer rollout periods. And that, of course, affects the second half of '05 as well.

And you mentioned that there will be less emphasis -- or you think it will become less important to unit sales because of other nonbox revenue like systems and licensing. Does that mean that you'll be giving out more specifics about those revenue streams going forward?

I think that we'll have to assess that. And if required to do so, will. Right now, certainly box units is still a good barometer. And so I don't want to -- I don't want to suggest that that's not a relevant figure. My point is just that as you see kind of ,the average revenue being produced by units sold, that's indicative of good jobs being done beyond boxes, that we're in a business now where we've populated the U.S. floors, at least, with an excess of 500,000, you know, newer units, of which we have much more chance of selling game conversions, parts sales, upgrades, new functionality, new features. You know, maybe even the next generation of replacement being within the same cabinets, but merely the replacement of CPUs to add more of that functionality. And so as those are just as important to us in long-term profitability forecasts as is actual new units shipped. And so as those become each relevant in their own right, some sort of breakout or additional information will be provided.

Okay. Then just to clarify, when you recognize shipments to Japan, is that when they're shipped to operators, or is that when it's shipped to the JV, or just want to clarify?

It would be when we ship -- it's not a joint venture that we have. It's a manufacturing agreement we have with Sammy, so it's when it's shipped to the operator.

Okay, great. And then last clarification, if I could. With the removals here, you mentioned higher game removal costs, and I don't think you specified for the gaming operations kind of where -- what market in particular. And I know you're saying it's only 200 units, but when you think about theoretically, the other small property openings, and where your base sort of grows over all, maybe on a same-store basis, removal's a little bit more than 200 units. If you could just give us a little color on the particular market driving that, and then also why a higher removal cost than in previous quarters?

Well, the big thing about our business in MegaJackpot has just become that the install base is -- it's become more and more fluid. And so you see for us to maintain the existing games outstanding, that the installs have increased dramatically, as have removals. And over time, of course, has caused us to believe that these games will have shorter lives in the market -- and they do. And so, you know, over the course of an average quarter, we're probably installing something like, you know, 3 to 4,000 new games and removing a similar number. Those fluctuate a bit quarter to quarter. Obviously, we believe that we can still grow the business with new game introductions with the expansion of the overall business, which I think that we have seen. And, you know, in the case of an individual quarter, 200 games is, you know, kind of an irrelevant figure, just given that this is so much activity of installs and removals going on. The one thing that we are doing, of course, is through cost of sales always making sure that the stated value of the games deployed in our game operations business, whether they, you know, are being prepared for installation, are on casino floors, or have been removed and potentially can be retrofitted to be deployed once again, that we make sure that those are properly stated on our balance sheet. I think that we've done a very good job of managing that historically. We'll continue to do so. And that's going to result at times in what we would call writedowns through a -- through the account fixed asset removal. And we're going to -- you know, I don't know that it's notable -- any more notable in this quarter than it's been now for the last couple of years. Video gaming machines have shorter lives, and that's something that we've been kind of working with for an extended period about how to actually manage in that environment.

Great, thank you.

Once again, to ask a question at this time, please press star one on your touch-tone phone. At this time, I show no further questions. I'll now turn the conference back over to the speakers.

Well, thank you, everybody, for joining us today. We appreciate your interest in IGT. And we look forward to getting together and being able to tell you about our future performance when we meet again after the end of the second quarter. Thanks again. Bye-bye .

That concludes today's conference. You may disconnect.