International Game Technology PLC (IGT) 2005 Q2 法說會逐字稿

Good morning and thank you for standing by. Welcome to the IGT second-quarter fiscal year 2005 earnings release conference call. (OPERATOR INSTRUCTIONS) Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to your host, Ms. Maureen Mullarkey. Ma'am, and you may begin.

Thank you for joining us today on our second-quarter fiscal 2005 conference call. I'm going to actually turn it over to Pat Cavanaugh, Director of IR, for some opening comments.

Good morning and thank you. With me on the call today, or with us on the call, are TJ Matthews, our Chairman and Chief Executive Officer, and Maureen Mullarkey, our Chief Financial Officer.

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 future financial performance. Although IGT believes 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 conditions and results of operations, as well as any forward-looking statements, are subject to change and to and 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 circumstance.

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, or cause us not to achieve our forecasts, are included in our most recent Annual Report on Form 10-K and other public filings made with the Securities and Exchange Commission.

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

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 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 said, I will now turn the call over to Maureen.

Thanks, Pat.

For the second quarter net income was 93.9 million, or $0.26 per diluted share, which compared to 116.9 million, or $0.32 for the prior-year quarter. The second quarter included charges related to technological obsolescence of certain gaming operations assets due to shifting market demand towards IGT's newer products that incorporate innovative features such as updated cabinet designs and the addition of LCDs to both our spinning-reel and video product lines. These charges, including less significant charges related to severance costs, collectively totaled 21.8 million before tax or 13.9 million after-tax or $0.04 per fully diluted share.

While Q2 was a challenge for us, we were not without operational highlights that were meaningful. We posted revenue growth on game operation of 9% due to increases in install base and due to improved revenue yields. We also grew our non-machine related revenues to 76 million or 30% of total product sales. This improve average revenue per unit, in addition to greater pricing realization, which helped sustain domestic margins despite lower volumes.

Last, but certainly not least, these results yielded cash flows from operations for the first six months of the year of 343.2 million, up from 148.1 million during the first six months of fiscal 2004. Our ability to consistently generate such strong cash flows gives us flexibility to reinvest in our business and to execute our cash deployment strategies for the benefit of our shareholders. During the first six, months uses of cash for share repurchases totaled 97 million, 124.5 million for dividends and 105.1 million for capital expenditures.

I will move on now to the income statement and open up with game operations.

As I mentioned earlier, we posted 9% revenue growth for game operations. Game operations revenues came in at 298.9 million. Quarterly gross margins were 49%, down from 54% in the prior year. Approximately 2% of the decline, or 200 basis points, resulted from the consolidation of our VIEs that include our trusts in Atlantic City and Iowa. As we have discussed in the past two quarters, this consolidation normally adds 10 to 12 million in quarterly revenues and costs, thus it lowers gross profit margin percentage, while the impact to gross profit dollars is nil.

Our current gross profit margins in game operations was significantly impacted by adjustments we made to our game operations assets. As mentioned before, we have seen noticeable shifts in marketplace demand with a transition to our newer, more technologically advanced gaming operations products. As a result, we took pre-tax asset obsolescence charges of 19.9 million during the quarter, which compares to total game operations success of 415 million at the end of March. Going forward I anticipate gross margins to trend between 55 to 57% for game operations quarterly, depending on mostly on the direction of interest rates.

On a positive note, our rollout of exciting new games continues to drive improvement in our daily yields per machine placed on casino floors. During the quarter our daily revenue yields per recurring revenue unit placed was $87.78. This is up from $84.89 in the prior sequential quarter.

With the marketplace for recurring revenue units becoming more competitive, our increasing yield points to our ability to continue to offer compelling products which generate higher revenue for both our customers and for IGT. We're confident that our newest games will help us maintain a leading market share. We also continue to proactively manage our install base in order to offer the strongest performing games placed on slot floors.

Our total install base of IGT-owned games stands at a record 37,900, up 2400 units over the prior-year quarter, and up 900 units over the sequential quarter. We saw year-over-year growth of 1800 games in the casino market category, primarily from increased price moves (indiscernible) markets of Alabama and Florida.

During the quarter we introduced our new Fort Knox multilevel progressive system. At the end of the quarter we had placed 700 Fort Knox units on casino floors across several jurisdictions, including Nevada, Missouri, Louisiana, Arizona, Iowa and several Native American jurisdictions. We also introduced our Star Wars and Video Megabucks titles during the quarter with 200 and 400 units respectively on casino floors. We are extremely pleased by the high level of customer acceptance that these products have already generated and note that we are seeing growing backlog.

Games priced in the racino category totaled 6400 units at end of the quarter, representing growth of 600 units over the prior year. Recent legislation passed in New York could lead to long anticipated opening of large casinos at Yonkers and Aqueduct. We're also continuing to see the benefit of expansion into non-traditional gaming markets including Alabama and Florida. During the quarter we installed an additional 900 units in Alabama and 100 units and Florida. In both of these markets we're able to offer both our standard games, as well as premium products such as Wheel of Fortune.

During the coming quarter we anticipate the first placements of IGT games on IGT central determination systems into the Washington State market. IGT titles have been in this market for a number of years due to our prior agreement with Sierra Design Group. This market has approximately 18,000 machines operating under tribal contracts with the state.

Moving on to product sales, product sales revenue during the quarter totaled 252 million. That was a decrease of 30% over the prior year, due primarily to lower replacement demand. North American replacement shipments totaled 10,100 versus the record 23,400 shipments in the prior-year period.

We continue to see a winding down of the replacement cycle, which was driven by ticket-in ticket-out technology, and as a result expect demand to remain below last year's level. We estimate that approximately 200,000 machines in North America remain targets for replacement.

International product sales totaled 9400 units during the quarter, a decrease from 18,200 in the prior year, primarily due to decreased sales volume in low payout markets. The most significant impact came from Japan, where, as anticipated, we sold no units during the quarter compared to 5900 units in the prior year. Barca (ph) saw a decline of 2000 units from the prior year.

Consolidated markets for the quarter came in at 51%, down from 53% in the prior-year quarter, primarily due to lower domestic sales volumes not completely offset by the benefit of higher non-machine related revenues.

International margins at 45% showed little change from the prior year.

Year-to-date, product margins of 48% were down from 52% last year due to the greater mix of international low payout sales. North American margins at 54% were actually flat year-over-year for the six months, despite lower volumes. Looking forward, we think that consolidated margins will trend at or around the 50% mark.

Average revenue per unit was certainly a highlight in the quarter of 11,100, and we continued to benefit from price increases realized in the last 12 months, a greater contribution of non-machine related revenue, and because of a lower mix of international low payout machine volumes.

Consolidated non-machine related revenue totaled 76.1 million during the quarter, or 30% of total product sales. While traditional full machine replacement sales have shown a declining trend, revenues from a combination of systems, game conversions and intellectual property fees (ph) are on the rise and provide IGT with higher margin revenues.

Total operating expenses for the quarter were 127.5 million versus 133.1 million in the prior-year period. That's a reduction of 5.6 million, mostly due to lower bad debt expense. SG&A expenses for the quarter were 75.9 million, down 3.6 million compared to the prior year due to lower spending across several categories.

During the quarter we recognized 1.9 million in charges, principally consisting of severance costs associated with our international operations and a reorganization of our North American sales and service group, including the integration of our Rapid City, South Dakota distribution facility. These operational changes were undertaken to move IGT closer to our customer base and to further enhance our market responsiveness.

Bad debt expense was a credit of 1.7 million in the quarter versus an expense of 5.7 million in the same quarter last year because of lower bad debt reserves, reflecting an improved credit risk profile and lower receivable balances. Bad debt reserves ended the quarter at 12% of gross receivables, essentially unchanged from the same levels in December and at end of fiscal year 2004.

Other income net was nil for the quarter compared to an expense of 20.7 million last year because of reduced interest expense due to the redemption of our senior notes during 2004.

We continue to anticipate a tax rate of 36% for the remainder of fiscal 2005 with slight fluctuations possible for changes in forecasted mix of North America and international property income.

As required by new FASB Regulations, we will begin to recognize stock option expenses in the first quarter of our fiscal 2006 using the modified retrospective method, meaning we will restate prior periods for consistent comparability. We currently estimate the run rate of stock-based compensation expense at 40 million pretax, or approximately $00.07 to $0.08 impact to diluted EPS on an annual basis. This is consistent with our filings for FAS 123-R in our federal filings. The adoption of this statement will impact our cost of product sales, cost of gaming operations, SG&A and R&D expense. We do not expect to make significant changes to our equity-based compensation practices.

Moving on to cash flow and the balance sheet, cash, cash equivalent and investment securities totaled 830.4 million at March 31, 2005 compared to 766.6 million at September 30, 2004. For the first six months of fiscal 2005 IGT generated 343 million of cash from operations on net income of 216.4 million. Year-to-date cash flows deployed back to shareholders totaled 221.5 million in the form of dividends and share repurchase. 100% of our 3.3 million in share repurchase took place during the quarter for a total cost of 97 million.

We continue to target returning at least one-third of our annual free cash flows back to our shareholders in the form of share repurchase. We remain focused on opportunistic buybacks in order to return value to our shareholders. Our share repurchase program authorization stands at 32.6 million shares as of March 31st, which may be purchased from time to time in the open market or through privately negotiated transactions.

During the first half of fiscal 2005 cash deployed for dividends was 124.5 million compared to 104 million in the same prior-year period. Capital expenditures totaled 105.1 million in the first half compared to 93.3 million in the prior year. Construction costs for our Reno facility expansion and Las Vegas development totaled 13.6 million for the six months ended March.

Working capital statistics were consistent with both December 2004 and fiscal year end 2004, with days sales outstanding at 73 days and inventory turns at 3.7 times.

Our liquidity stands at approximately 2.1 billion with cash, investments and availability under our credit facility.

In conclusion, our second-quarter results reflect the challenging market conditions that face all slot manufacturers for the near-term. We remain pleased with the significant cash flows our business generates, and believe our investment in R&D and focus on technology will allow us to continue to maintain our leadership position as a leading supplier of games, platforms and systems to the worldwide gaming legalized market.

Thank you, and I will now turn the call over to T.J.

Thanks, Maureen, and good morning. Before opening the line to questions, I have some closing remarks regarding our outlook for IGT.

As a result of the slowdown in customer demand for slot machines, as well as our relative position in the current replacement cycle, the second quarter marks a low point in our recent earnings history. Despite the marketplace conditions we have seen little change to our installed base market share.

For casinos slated to open during the next 12 months, we've received significant market share amounts ranging from approximately 60% up to 100% of new slot machine floors committed to IGT products. This reflects well on our belief that we will continue to have the leading long-term installed base share despite quarterly fluctuations that might occur from time to time.

Looking out over the next five years, we remain very confident in the prospects for growth in the installed base for machines in North America and that it will reach at least 1 million machines by the end of the decade, as we have been remarking. Major new and expanding market prospects continue to include California, Pennsylvania, Florida, Washington, Oklahoma and most recently Texas.

Despite our optimism, the exact timing of these markets is beyond our control, thus limiting the visibility we have on earnings growth. Previously we estimated that new markets would materialize throughout our fiscal 2006, but current market dynamics suggest that they could be delayed until 2007. Until our visibility improves we are confident in our ability to generate a baseline quarterly EPS of $0.30, but reluctant to move this up until these new market opportunities materialize. That said, expansion in existing markets, new market creation and expand success in markets like Japan would be incremental to this outlook. With the organizational changes we have made and the resources that we have at our disposal, IGT will be able to fully capitalize on these opportunities when they do finally occur.

We continue to remain confident in the strength of our Company as IGT continues to generate strong levels of cash flows. And while there are many operating metrics one can use to look at any business, consistently generating strong cash flows from a relatively modest amount of investment remains one of the best indicators of a great company. We fit that description well.

I would like to thank everyone for your interest in our Company, and we now are ready for some questions.

(OPERATOR INSTRUCTIONS) Aimee Marcel, Jefferies & Co.

I actually have a couple of general questions. I know RFID technology with table management is a new popular thing right now. I know when you guys run the system, and they have committed to all their chips over $25 have RFID in them, is your system compatible with the RFID technology? And if so, are you planning on developing any relationships with other companies involving this?

Right now we have actually the industry-leading position for table management on the back end with our Table Touch product and full win (ph) on the advantage system developed a brand-new module that addresses cage credit and table game management, and so feel comfortable with our leadership there as well.

On the front end, things that measure player activity and game activity, that's where RFID comes into play. And it is a very interesting technology and we are watching what Shuffle Master, Mikohn and other companies are doing to see whether or not our product and theirs might be compatible in some manner.

Another general question. Downloadable games, are you still seeing testing in '06 for general use in '07, or are you changing that?

As you know, as -- to our belief on systems becoming more prevalent on the casino floor, in some ways (indiscernible) gaming has already arrived. It certainly exists relative to our central determination markets and where we distribute outcomes from a system. It exists in our advantage product where we're ringing unique bonus theme to the casino floor again through a system. And we are going to continue to evolve that where we think that we may have some kind of real-life lab work with an install this year that we have the opportunity in '06 to start proving out incremental applications that truly make a difference, both for the casino operator, as well as the player. And it might be '07 in which we can say the initiation of a new replacement cycle is upon us due to that technology being introduced.

Do you have any placement guidance for the next couple of quarters?

What was that?

Placement guidance for recurring revenue payments.

For the next couple of quarters we will see essentially flat recurring revenue base. We will see growth from the casino central determination markets related to Oklahoma and a little bit from New York. So I think that the installed base of recurring revenue games, including all of our different sources, will be up and over 40,000 games by the end of the year.

Maureen's remarks (indiscernible) was flat in the casino space.

Okay, great. Thank you.

Steve Kent, Goldman Sachs.

A couple of questions. First, can you just give us some more color on the $0.04 of technical obsolescence? Was that specific titles? Was that specific technology? I guess I still don't totally understand that and why that's a onetime versus a recurring revenue -- or recurring expense.

And then the second thing is, just system sales, which is not a huge driver, but it was very significant this quarter. It was up, I think about -- it was about 76 million, and I think normally you sell about 100 million in every year. Is there something shifting in that business? Is that business starting to grow faster and maybe become a bigger part of your overall story?

On obsolescence fact question, the fact is that that is an expense in the ordinary course. So certainly we remarked on the fact that GAAP EPS of $0.26, but called it out because it was nonrecurring and kind of (indiscernible) what the run rate would be.

The issue relative to kind of our installed base is you know there's a lot of technology moving forward so that we're migrating from CRTs to LCDs; we're migrating on our CPU from our 039 Version to our 044 Version. And we are finding ourselves with -- as we churn product in and out of market with more and more of an inventory of assets that really it's more economical for us to build new than it is to refurbish these existing games. So that really is the bulk of what occurred to cause us to kind of a revalue some amount of the fixed asset that we had outstanding.

In terms on the $76 million, that $76 million represents all non-box revenues. Of that, about 63 million is domestic; about 13 million international. And systems is a component of that, but really the big driver this quarter was conversions. And that's something that we've been remarking on for a period of time, that with 70% share installed on the casino floor, our aftermarket sales opportunities for us to resell to those existing gaming positions is very great, particularly within video where we're going to see shorter and shorter shelf life, both for the games, as well as the hardware. So our opportunity to sell on both sides of that is going to manifest itself, I think, more so in future periods as well.

Systems certainly had a good quarter. I think it's going to have a better second half then first half, however, because most of its insulation are kind of bunched up into the second half. And of course IP royalties continue to be a decent part of our business as well as we continue to be the industry leader in bringing new ideas to market.

Thank you.

Joe Greff, Bear Stearns.

A question for you on the installed base. Did you mention that sequential growth in the installed base on the commercial casino side was flat?

The casino installed base was 31,500. That compares to 30,600 in Q1 of this year and 29,700 last year. The racino installed base was 6400 at the end of March; it was 5400 at the end of December and it was 5800 at the end of September.

It grew 900 units sequentially in the casino market. What you might take from that is that that was primarily driven by new market environments like Alabama and Florida.

So if we take out the new markets and just kind of look at existing markets --

You'd come to a pretty flat figure.

Flat figure. Okay. So, okay, I got that. Maureen, in terms on SG&A and R&D expense for the full-year, can you give us some help on what kind of a level you see yourself finishing the year at?

Our SG&A expenses should trend at similar levels that you have seen in this quarter. And in R&D I would imagine -- and our current estimate is -- that it inches up maybe $1 million a quarter for the next two quarters. And that bad debt will remain low. We have a very healthy risk profile related to really the health of our customers across many, many markets. So from a balance sheet approach, we will look to maintain that 12% reserve level going forward.

And D&A shouldn't see much change.

And kind of going back to international, or going to international product sales, you mentioned that the second half is when you would introduce a second game with Sega Sammy. Should we look at that more of a fiscal fourth quarter?

I think that that's correct.

Great. Thank you.

George Smith, Davenport.

I'm just trying to get a better feel going forward for the magnitude of product sales declines and wondering what type of visibility you have in the second half of the year. Do you expect declines to continue to be around the 30% area? It would seem our comparisons are getting a little bit easier, but what new property openings can you point towards? What could cause such declines to moderate and do you expect them to near-term?

The domestic unit sales outlook for the remainder of the year will be pretty consistent with what you have seen in the current quarter, around 13,000 machines.

George, I think what we've been frustrated by more than anything this year was lack of new shipments to California. And although that didn't play a huge role in our initial forecast, it played a big enough role that basically the fact that no new shipments have taken place has had some impact on this year's forecast and has caused us just to come to the conclusion, having seen the events of Pennsylvania, California, the UK, Florida, that gaming expansion, although alive and well and definitely bunching up on the horizon, is going to take a little longer than anticipated. So we're really reliant on replacement sales for the remainder of this fiscal year and probably still into next fiscal year, and have a much smaller universe of games at 200,000 units from which we can go out and replace units. So this is about the sales level that you can expect for awhile.

Just to clarify, you said gaming operations gross margins for the next couple of quarters ramp up to a level of around 55%, is that right?

That's right, 55 to 57, which is not inconsistent with past trends.

Last thing, in terms of -- you seemed to intimate that newer games are performing well. I guess I'm particularly interested in how you guys are progressing in terms of penny-denominated games and what customer feedback has been in regards to Fort Knox, for example. And do you see yourself getting back some share from the likes of Aristocrat?

We had Fort Knox games of about 700 at the end of March and have a good backlog. We have over 1000 -- or actually close to 1500 games -- in backlog. And they're across all markets, or most markets, currently. And I would say, our current view internally is that the performance is in the exceptional category, and it is performing well not only against jurisdictional averages, but also the competition.

We also started the deployment of Star Wars with very good customer acceptance. And Video Megabucks, the penny game, the only way you can win a starting jackpot of $10 million.

We will move forward with these products. We have good backlogs. We will introduce The Apprentice during the summer, which is in the Wheelionaire category, which is -- not only allows for multi-level progressive, but also the larger progressives as well.

Our view of other entrants into the recurring revenues space is a little different than maybe conventional wisdom in that for us really our competitors are raising prices by entering into this space. You see that we have continued to be able to grow our installed base. We've been able to continue to grow our revenues. We've maintained deals. And so despite the fact that you can measure dollars paid in this form of business, or you can measure units, we are obviously glad about the fact that we're continuing to grow.

What is different about our business focus that has had a change over this last quarter is that we were first to low-denomination video. It happened that we were first to nickel low-denomination video. If you take a look our installed base right now, 45% of the games in our recurring revenue space are nickel-denominated and only about 12% of our games are penny-denominated. And that 12% really now getting the focus on being -- growing substantially, and so again the product introductions of this last quarter -- Fort Knox, Video Megabucks, Star Wars -- being augmented throughout the year with more and more focus on that space I think is going to yield continued (indiscernible) amount of continued growth in both yields and installed base for our entire recurring revenue game base.

Last thing, have you bought back anymore stock since quarter end?

We've been in a quiet period since about three weeks or so before the end of the quarter. That quiet period ends at the end of close today, and so we can be in market as soon as tomorrow.

Thanks a lot.

David Bain, Merriman Curhan Ford & Co.

Just to retouch on the downloadable aspect, can you give us your outlook on BOB protocol versus Super SASS (ph), and what you're looking at in terms of recurring revenue and a revenue scheme there?

Sure. The BOB/Super SASS is kind of an interesting question. As you know, IGT is basically the Company responsible for having created standard protocols in the industry. And in fact, our SASS 601 protocol is the standard. It has been adopted by the Gaming Standards Association and is the most recent protocol that has accommodated all of the cashless replacement cycle.

Super SASS is the next extension for us in terms of being able to bring new functionality to market, primarily system deliverables from bonus scene configuration, things of that nature. And we have said to the 145 licensees of our SASS Protocol who realize that free of charge that they will continue to be able to realize the expansion to Super SASS free of charge as well. So of course that make it the likely de facto standard protocol for future functionality.

That said, there is a competing protocol out there known as BOB, where some number of people have tried to promote that as the preferred means. It largely not is a base that IGT needs to weigh into because if there are multiple protocols in market, we've proven historically that we can accommodate such. It is very difficult upon our competitors to do so, and so my guess is that we will see a migration to a single protocol, and we would be surprised if it's not Super SASS I guess on the front.

In terms of what we think the business model will be for system-driven gaming, that's to be determined. Certainly we think that we have the opportunity for us to become more and more software oriented, more game oriented, in terms of our pricing and that right now the business model that best captures that is our game operations business. But that pricing model only works for really a fairly small percentage of the machines placed. So we need a business model that probably captures the similar elements, which is getting game delivery very inexpensively to the casino operators in exchange for some sort of shared success in the subsequent game performance, but probably at a more modest rate than presently exists in game ops.

Okay. Are you still attempting to get a class field opinion (ph) letter in the wake of potential NIGC definition of Class II change? Especially given your frustration it looks like in California, would you still be pressing forward with that?

We're very interested in NIGC being able to articulate final Class II rules because for us until there is regulation in the market and its being enforced, we compete at a disadvantage because of course we try to conform to regulations whether they're being enforced or not. That certainly is the case somewhat in Oklahoma. It has been a frustration for people trying to bring Class II gaming to California, and is probably an issue elsewhere for us too. So yes, we continue to work with the NIGC.

Okay great. Thanks guys.

Bill Lerner, Prudential.

Just one. Can you qualify the baseline $0.30 EPS -- $0.30 number per quarter that you mentioned before, T.J.? My thinking is if participation base is, as you say, going to grow 5 to 6% to get you to that 40,000 installed base by year end, and Japan, as we all know, obviously is scheduled to come in, are you still comfortable with that high end of the $0.30 to $0.35 per quarter range? I don't see how you couldn't get there.

I think it's just for us a matter of timing. I think the baseline has been indicated to imply just that; that at this level of business we're comfortable that that's about the EPS that we're going to be able to derive. To the extent that we can grow the installed base within game ops, we can continue to successfully grow our non-boxed revenues, that we can have upside realize in the four big international markets that we have discussed, which are the UK even though it's much more modest than anticipated, it is doubling the number of machines in all the existing casinos, is establishing eight small casinos, eight regional casinos, and one destination casino. Our entry into Russia -- re-entry into Russia continues. Our expectations for success in Japan continue to be really geared towards '06 where we think we can introduce four games instead of two, but nonetheless optimistic that Macau and things that are going on in Asia are interesting. So all of those act as drivers of international opportunities.

And so really the last of the big upsides is what happens domestically with product shipment. And that's just one new market for substantial expansion, whether it be in a new market like Pennsylvania or expansion in a market like California, when they finally manifest themselves. And I do think all of those present some an amount of incremental upside to that baseline figure.

That's helpful. One follow-up, actually, as I think about it. What are you seeing on -- I don't know, maybe you call it kind of the smaller replacement cycle? But are you seeing your customers move a little more aggressively to penny, away from other denoms, and so maybe it's a bit more of an accelerated replacement cycle in that respect? I'm talking about just on the installed base -- not on the participation side, just the fixed units on the floor?

At any given time there's multiple replacement cycles that are occurring. So the replacement cycle that got so much focus was ticket-in ticket-out, because it accelerated purchases dramatically. And in some cases machines were replaced with similar game themes with all the incremental functionality being ticket-in ticket-out. But there is this ongoing replacement cycle that is derived from Video Reel increasing their position on the casino floor at the expense of physical reel, and low denomination, which really affects both products. It affects Video Reel to the extent that any penny drives more lines, more need to increase coin count on average wages (ph), but also affects physical reel where you want to accommodate low denominations as well, which is meaning some migration of the number of reels to increase so that we can increase line count.

So at any given time there's a lot of replacement cycles, a lot of replacement drivers that are going on. Ticket-in ticket-out got a lot of focus, but I think you're right that there is other things that are occurring that are going to allow us to have replacement sale opportunities prospectively.

Thank you.

Harris Curtis, JPMorgan.

Good morning. Sorry to beat a dead horse; on the baseline earnings, does that assume that the 37,900 installed base is static at that level? Or does that baseline assume any movement at all in the installed base?

That baseline obviously was derived from an average installed base that was slightly lower than where we ended of the quarter. And the product sales that took place in both domestic and international at the level in which they took place in the quarter. And so those are going to fluctuate a little bit in both directions, but I would anticipate that over time there's potentially more upside drivers than there are downside drivers to that figure. But until we have visibility to shipments in the United States beyond replacement, this is the number that we're kind of comfortable talking to.

So that baseline number, does it or does it not take into account the projected installed base expanding to 40,000 by the end of the year?

The 40,000 number would contain most of the growth from the central determination markets, including Oklahoma. To date the growth has been from Alabama and Florida, and we will have a little bit in Rhode Island; we will have a little bit in New York; and then we are hopeful that we will place bingo games in the Oklahoma market. The Oklahoma market by all accounts has been a challenging market related to the confusion in Class II. But there is a new law in place and there are tribes with Contex (ph) allowing for the bingo, and we're ready to go with it.

But if we can grow the installed base and maintain yields, that will be additive to that baseline.

Okay, that was what I was after. And then can you give us a sense of -- just a wild guess of timing on Aqueduct and Yonkers? And how would that yields on those two racinos compare to the yield that you get on casinos?

The racino pricing model is so much different than what we realize in a casino environment because in a casino environment it is 95% for sale and 5% or 90/10, some sort of split, of recurring revenue, where 100% of the placements in a racino market are recurring revenue. So the splits are much different.

The realization, I think, into the racino market has been, and we talked about revenue figures in the past, it's in the neighborhood of 15 to $25 a day just depending on the relative performance of that gaming location. And certainly Yonkers and Aqueduct have a chance of being at the upper end of that range. That obviously is lower than the amount that we realize in casino environments.

Do you have a sense of what the timing could be?

I think that Yonkers has actually said that they think they will be open 10 months from the finalization of their plan, and so we would anticipate that meaning perhaps in 12 months or so. And then I think Aqueduct has indicated a similar timeframe.

Okay.

And they both have indicated that they will start with about 2500 machines, and that they will be looking to grow to 5000 machines at each location within 6 or 12 months thereafter.

Any sense of what your share in that number ought to be?

Our initial share had been -- our initial allocation was just shy of 24% based on our original bid price. We have since expanded our share a little bit in the recent allocation period, although it was modest; it was 80 machines -- just shy of 80 machines or so. But our game performance recently has demonstrated itself to be very much superior to the other participants in market. So we would anticipate that our market share is going to continue to grow as we continue to get through these six-month measurement periods.

Very good. Thanks very much.

Robin Farley, UBS Equities.

A couple of questions. Some of your competitors haven't reported yet, so I'm wondering if you can tell us what you expect your market share will be for the March quarter. I know you do some work with your customers to try and get a sense of that, so I wonder if you could tell us what you expect that to be for the March quarter.

The market share that we can measure readily as our share of the floor; our share new facilities. So we're confident that our share of the floor is still 70%. Our share of the win is still something greater than that. Our share of new locations, like win, will reflect that kind of share.

As to where people stand relative to their own replacement opportunities, it's difficult for us to measure. And so I'm not sure that we can predict what our share of shift machines is this quarter. Certainly our share of recurring revenue units placed is still going to be in the 70% range and our share of dollars realized in those placements is going to continue to be in the 80% range.

And then in terms of the large amount of non-machine related revenue this year in product sales, I don't know if you broke that figure out a year ago in the quarter. So I wonder if you can tell us how much of the increase in revenue per unit was from specific price increases; in other words, just the machine related revenue per unit going up.

Sure, I can do that for you. Machine-related revenue for North American -- North America -- let's see -- machine-related revenue only was about $9100. That's 12% ahead of last year, 2% up sequentially. And the remainder came from the non-machine related revenue. So last year, machine averages in North America were $8100. They were just under $9000 at end of December and just over $9000 at the end of March.

And the international?

The international is mostly driven by the mix of Japan and Barcrest. I think there is 13 million in non-machine related revenue. I don't have that split for your right here.

Do you have last year's -- you're saying that's the figure you don't have last year's non-machine --?

Right.

Okay. And then, I guess if you could also give a little color on some of the jurisdictions that you ship to, just your product sales in this quarter.

Nevada was 4600 (indiscernible) is 2900, Native American was 3400, public gaming was 1700, total domestic to 13.3, and Australia was 900, Barcrest was 6200, Europe was 1600, all the rest about 700 for 9350 international, total 22600.

Great. Thank you.

David Barteld, Wells Fargo.

Two things. One, there is a lot of investors out there who are under the impression that there is significant market share shifts in the domestic market. You addressed that briefly a couple of seconds ago, but I was wondering -- I'm not the brightest bulb in the field, but when I look at what your competitors are selling and break out international sales, replacement sales, third party sales, etc., it doesn't seem like there is a possibility that there can be significant market share shift, even over the course of a year. You're talking about maintaining share; can you just talk about for us in a little bit greater detail what you think the market share shift potential could be among yourself and your competitors?

We break out our marketplace into three primary categories, that of video poker, physical reels and video reels. And if you take a look our market share in the first two categories, video poker and physical reels, we're 90% plus and 80% plus respectively, and don't expect to see really any competitive pressures in that area. We're going to continue to bring the most product to that market, and in some cases have very limited number of competitors that even address that space.

In the case of video reels, that's a crowded place. And to some extent the technology to date has been somewhat ordinary, which has lowered the barriers to entry for bringing games to market than we have traditionally faced. It's our job increase the technology requirements of that product effort so that we make the barrier to entry for others greater. It's our job to make sure that we continue to overwhelm that space with the best ideas, and so that as we do so we're comfortable that we're going to add market share that is reasonable there -- let's say, greater than 50% -- but that competitive environment is willing to restrict our ability to have quite the same share in that area as we do elsewhere in the present configuration. We think technology might change that dramatically in our favor over time.

Right now what is occurring in terms of where people are kind of misperceiving market shift is we have competitors that, quite frankly, missed ticket-in ticket-out for the first couple of years that it existed. And we were able to disproportionately shift our share in the market in advantage -- taking advantage of that fact, and establish very large percentage of the floors installed. But a certain amount of that equipment that was previously provided by certain of our competitors was preserved for it to be replaced when those competitors could finally bring product to market. And so certain of our competitors are in a different spot in this replacement cycle than are we. And I think that is causing people to kind of measure incorrectly profit or market share shifting.

The only thing that in our mind has actually affected share at all has been the trend to penny video. And we have remarked in the past that we were a little late to penny video, and that our response is to overwhelm that space with good product development prospectively, and that we fully expect that that is going to re-establish our market share expectations internally, which hopefully means externally as well, over the course of this calendar year.

That's helpful. Thank you. Secondly, Maureen, as far as foreign exchange, is there anything that we should be aware of in the quarter going forward?

No, de minimus impact from foreign exchange.

Thank you very much.

David Anders, Merrill Lynch.

T.J., just so I can be clear, taking out to 2006, so we take our run rate of $0.30 a quarter and then we add on top of that, did you say you think you're going to get some new jurisdictions, like Pennsylvania will start shipping, or that is what the wild-card is?

Right. We just lack clarity on timing for expansion in California, initiation of operations in Pennsylvania and Florida, whether or not new markets will be created in places like Texas and elsewhere, what really is the timing for UK, what is the prospect for really increasing our share in Japan, again timing in places like Macau. So many things lack clarity right now that it's difficult for us to migrate guidance away from that baseline, and yet all of those things represent upside to that baseline. And your guess as to when they occur is probably every bit as good as any guess that we can offer.

Thank you.

David Vas, Banc of America Securities.

T.J., can you talk a little bit about server-based gaming in terms of do you have enough or all the intellectual property either cross-licensing or whatnot that you need there? And are things on target for beta later this year?

To answer the second half of that first, we're on target with the development of that product. But for us the big issue is we think that the baseline functionality is interesting, but not enough. And until we're in kind of a real world lab and bringing incremental applications to the market that affect game play for the players, then we aren't going to know really what is the timing of us being able to affect some sort of big rollout of that product. And so we're working towards understanding that better this calendar year with the idea that we will bring incremental applications in the next calendar year, and really understand whether or not in 2007 we can roll this out in kind of a meaningful manner.

In terms of intellectual property, the intellectual property landscape is interesting in that certainly the bulk of intellectual property required is owned by IGT or is accessible by IGT. But as you enter into the world of networks, there is non-traditional competitors or non-traditional owners of intellectual property that we have to be mindful of as well. So we certainly are doing the things necessary to map out how our technology fits non-gaming environments as well and trying to make sure that we can source intellectual property there too.

Okay. Second thing, what are you guys seeing in terms of pricing in terms of competitors' pricing issues on games both for sale and in participation right now?

So many of our competitors have migrated to a recurring revenue price, as well as migrate to video, that has really caused most of them to become better pricers and to increase prices in some way. So we're not seeing competition by undercutting price too much. Certainly some of the smaller companies and some of the companies that have struggled with game design efforts continue to be competing in that manner. But companies that bring quality product to market, I think are recognizing the fact that the product that they bring is quite valuable to the marketplace and can be priced accordingly.

Can you talk a little bit in terms of strategy some of the changes you've made internally in the organization at the mid and upper levels? Can you talk about how The Street should think about what that means going forward?

There is a couple things that we're doing. First, outside of the United States is just reorganizing operations so that they're closer to the market. As you know, we've been talking for a couple years know about the theme of being more local, and being more local meaning that within the sales and the service organizations that you have people from that area that within game design you're doing things that accommodate those particular player tastes; things as simple as language translation, but sometimes more complex in terms of game preferences.

In the United States, the effort is twofold. Firstly, it's to get us closer to our customer. And so we have had a stand-alone entity, for instance, within our organization to address Native American. We're going to continue to treat that customer uniquely, because they are in terms of the construct of those operations. But that said, we can obviously internally integrate that into our greater sales and service effort.

We are going to do things that allow us to be more responsive and more decisive within the organization. So one of the things that we did was we really separated corporate strategic planning from the day-to-day planning of the business and execution of the business, which has at any given time maybe a 6 to 18 month outlook in terms of things that it needs to do to maintain its competitive stature. And our changes are meant hopefully to cause a very serious impact and improve what I think is already the industry-leading relationship between us and the casino operators.

Just a couple of little questions here. I understand one of your competitors is having an enormous amount of success with a certain product that you have a product coming out in direct response called MultiWay. Can you tell me when that product will be available in different markets?

MultiWay is in market now. It is in fact on our WAM (ph) test. And so we're starting to get feedback from the marketplace on that product. And the early returns have been that it will be very successful.

Last thing, cash allocation. Maybe a question for Maureen. You guys have had an enormous amount of cash on your balance sheet for several quarters now. At what point do you really put that money to work?

As I mentioned, we have been putting the cash to work -- this year 197 million share repurchase, dividends, and then 105 million for CapEx. And I think a lot of questions that we get are regarding share repurchase, and we've been active. The cost of the -- the per-share cost of the buyback this year has been just under $30. So there's been no change in philosophy of the Company as far as deploying cash flows back to the shareholders in form of share repurchase and dividend. And we will continue to invest in the business in order to grow our earnings.

Thanks a lot.

Steven Kroll, Monness, Crespi & Hardt & Co.

Just three quick questions. I'm trying to get a better feel and more color on international unit sales. What sort of run rate is baked into your number to sort of achieve that 30% EPS run rate? Two, were there any sales to Russia during the quarter? And three, as far as your Fort Knox and Star Wars games, are there any units in the Reno market? And if so, where would they be?

On the Russian question, I think we sold about 350, 400 games into Russia. The big change in international unit shipments would be related to the Japan market. And as we stated last quarter and this quarter, is that we had two product introductions; the first The Terminator in December and second in the latter half. And our best guess is that we will ship about 11,000 of those games at this juncture.

If you're here in Reno and you want to see the Fort Knox product, for sure you can see it at The Atlantis, Peppermill, Western Village and The El Dorado.

Great. Thank you.

Thank you, and now I'd like to turn the call back over back to the speakers.

Okay, well we're at the top of the hour. We thank everyone for your time and attention and your support. And we will be back at you in July for our third quarter. Thank you very much.

Thank you for joining today's conference call and have a great day.