The Daily Magic Formula Stock for 11/29/2008 is International Game Technology. According to the Magic Formula Investing Web Site, the ebit yield is 16% and the EBIT ROIC is 50-75 %.
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International Game Technology is a global gaming company specializing in the design, manufacture, and marketing of electronic gaming equipment and network systems, as well as licensing and services. As a leading supplier of gaming products to the world, we maintain a wide array of entertainment-inspired gaming product lines and target gaming markets in all legal jurisdictions worldwide. We are committed to providing quality gaming products at competitive prices, designed to increase the potential for operator profits by serving players better.
Unless the context indicates otherwise, International Game Technology, IGT, we, our, or the Company refers to International Game Technology and its consolidated entities. Italicized text in this document with an attached superscript trademark or copyright notation indicates trademarks of IGT or its licensors. For more information about our trademark and copyright ownership, please visit our website at www.IGT.com.
International Game Technology was incorporated in Nevada in December 1980 to acquire the gaming licensee and operating entity, IGT, and to facilitate our initial public offering. Principally serving the US gaming markets when founded, we expanded into jurisdictions outside the US in 1986. In addition to our main US production facilities in Nevada, we manufacture gaming products in the UK and through a third-party manufacturer in Japan.
We derive our revenues from the distribution of electronic gaming equipment and network systems, as well as licensing and services. Operating results reviewed by our chief decision maker encompass all revenue sources within each geographical customer region. We currently view our business in two operating segments, each incorporating all types of revenues.
North America consists of our operations in the US and Canada, comprising 76% of consolidated revenues in fiscal 2008, 77% in 2007, and 79% in 2006.
International encompasses our efforts in all other jurisdictions worldwide, comprising 24% of consolidated revenues in fiscal 2008, 23% in 2007, and 21% in 2006.
We measure segment profit on the basis of operating income. Certain income and expenses related to company-wide initiatives are managed at the corporate level and not allocated to an operating segment. Other segment and financial information contained in BUSINESS SEGMENT RESULTS of our MDA and Note 18 of our Consolidated Financial Statements is incorporated here by this reference.
We have two revenue streams within each business segment -- gaming operations and product sales.
Gaming operations generate recurring revenues by providing customers with our proprietary gaming equipment and network systems, as well as licensing, services, and component parts. Gaming operations comprised 53% of consolidated revenues in fiscal 2008, 52% in 2007, and 50% in 2006.
Our pricing arrangements are largely variable fees whereby casinos pay service fees to IGT based on a percentage of the gameâ€™s coin-in (amounts wagered) where the arrangement includes linkage to an IGT sponsored WAP jackpot system, and are otherwise based on a percentage of the gameâ€™s net win. Fixed fee pricing arrangements are typically based on a daily or monthly fee. We incur and accrue related jackpot liabilities with every wager on a WAP connected device. A portion of the casino fee paid to IGT is used for the funding and administration of WAP jackpot payments. The cost of funding WAP jackpot payments to winners is subject to interest rate volatility. See Note 1 of our Consolidated Financial Statements and MDAâ€”CRITICAL ACCOUNTING ESTIMATES for additional information about gaming operations revenues and jackpot liability accounting.
A number of factors influence gaming operations revenues and gross margins, including the number and type of machines in service, levels of play (i.e. amounts wagered), and variations in pricing arrangements. Levels of play are dependent on game popularity, casino seasonality trends, economic conditions, and other player preferences. We monitor the productive life cycle of our gaming operations machines and systematically replace units experiencing declining play levels with newer games.
Product sales include the sale of gaming equipment and network systems, as well as licensing, services, and component parts. Product sales comprised 47% of consolidated revenues in 2008, 48% in 2007, and 50% in 2006. As our gaming products become more systems-centric in nature, we anticipate a growing portion of sales from non-machine products.
STRATEGIC BUSINESS ARRANGEMENTS
As part of our ongoing efforts to create shareholder value, we complement our internal resources through strategic alliances, investments, and business acquisitions that:
offer opportunities to diversify our geographic reach
expand our product lines and customer base
leverage our technological and manufacturing infrastructure to increase our rates of return
Our most significant acquisition was the purchase of Anchor in December 2001. This acquisition significantly increased the size of our business and enabled us to consolidate all activities of the Spin For Cash Joint Venture and afforded us opportunities to further integrate complementary resources, primarily the Wheel of Fortune Â® brand and patents.
Over the last five years, we also completed a number of smaller acquisitions, including Acres, WagerWorks and Cyberview. Acres further positioned us as a leading global provider of casino gaming systems, while WagerWorks and Cyberview provided additional opportunities to expand the distribution of content across new channels and mediums.
In addition to acquisitions, we have invested in several companies which we anticipate will further expand our international footprint and/or product lines. Our investments over the last five years included: CLS to use our gaming technology to assist or participate in the development and marketing of products and services to the market in China for lottery related products and services; WDG for access to an expansive portfolio of gaming application concepts; and DigiDeal to expedite access to the market for electronic table games.
We provide a broad range of electronic gaming equipment and network systems, as well as licensing, services, and component parts that may be sold or placed under recurring revenue arrangements. Most of our electronic gaming equipment is increasingly driven by its software components.
We offer our customers a wide variety of video and physical reel slot machines that may be tailored to meet specific needs. Customers can choose from an extensive library of games combined with several new machine cabinet models designed to maximize functionality, flexibility, and player comfort. Additionally, IGTâ€™s AVP Â® machines are designed to support server-based gaming networks. Machine configurations vary by jurisdiction and may include:
Stand-alone casino-style slot machines which determine the game play outcome at the machine, known as Class III in tribal jurisdictions
WAP jackpot systems with linked machines across several casinos
CDS machines connected to a central server which determines the game outcome, encompassing VLTâ€™s used primarily in government-sponsored applications, and electronic aids to the play of bingo machines known as Class II in tribal jurisdictions (also commonly referred to as electronic bingo)
We also offer multi-player community-style configurations with a common display, especially useful in jurisdictions where live table games are not allowed. Our electronic table games include live dealer hosted configurations with digital cards and live chips or virtual chips/electronic credits, as well as a fully virtual platform that can be approved as a slot game, providing table-like gaming for slot only or limited table jurisdictions.
Our international gaming machines also include AWP games in Europe, and pachisuro machines in Japan. These games generally incorporate lower payouts with features that allow players to exercise an element of skill and strategy.
IGT network systems include applications for casino management, CRM, and server-based player management. Our casino management solutions include integrated modules for machine accounting, patron management, cage and table accounting, ticket-in/ticket-out, bonusing (jackpots and promotions), and table game automation. Our CRM solution features integrated marketing and business intelligence modules which provide analytical, predictive, and management tools for maximizing casino operational effectiveness. Our server-based solutions are designed to enable casino operators to increase profits by enhancing the playersâ€™ experience and lower operating costs.
The vision behind IGT product development is to serve players better by utilizing the power of networked gaming, information technology, game design, and services to maximize the potential for operator profitability. The foundation of our business model is built on the creation and delivery of game content through integrated casino systems solutions to machine platforms. Our product innovation reflects the anticipation of consumer needs, as well as customer feedback and market trends.
We support our product development efforts through a considerable emphasis and investment in R&D of future technology, which we believe enables IGT to maintain a leadership position in the industry. We dedicate nearly 1,700 employees worldwide to product development in various disciplines from hardware, software, and firmware engineering to game design, video, multimedia, graphics, and sound. Our investment in R&D totaled $223.0 million in fiscal 2008, $202.2 million in 2007, and $188.5 million in 2006.
Our primary development facilities are located in Nevada, and we have several design centers strategically located worldwide, allowing us to respond to unique market needs and local player preferences. IGT global design centers provide local community presence, customized products, and regional production where beneficial or required. Our UK facility designs and configures AWP and casino games. Our Japan team designs IGT pachisuro games in conjunction with a third-party manufacturer. Our Australia team designs club and casino products. Our corporate R&D group, IGT Labs, is also dedicated to establishing strategic partnerships with key technology providers.
During fiscal 2008, we continued our World Game Platform initiative to unify and standardize our technology, design, and development across all global markets. We anticipate reducing time and cost to market by having standardized development worldwide, enabling content delivery through uniform technologies. We believe this initiative will facilitate development and deployment of games into any combination of gaming markets, including both thick (processing at the machine) and thin (processing at the server) client-server environments.
Our fiscal 2008 R&D activities are described under the following sub-categories: Games, Network Systems, Platforms and Intellectual Property.
We combine elements of math, play mechanics, sound, art, and technological advancements with our library of entertainment licenses and patented intellectual properties to provide gaming products with a high degree of player appeal. We continue to expand our game libraries, emphasizing development of game content to address changing consumer preferences and other market trends. Our objective is to develop games that incorporate exciting winning combinations and appealing graphics and sound.
Our games are created primarily by employee designers and artists, as well as third-party developers. We develop video reel and poker games, as well as enhancements for our classic spinning reel games, such as multi-line, multi-coin configurations. We build on our traditional game development with unique customization for video lottery, CDS, Class II, and international markets. We also continuously upgrade and optimize our proprietary flagship themes, such as Wheel of Fortune Â® and Megabucks Â®, with game refreshers and innovative features to enhance play.
Fiscal 2008 highlights
We installed the first games from our new family of MLDÂ® video slots in the fourth quarter, featuring the visual effect of true depth animation sequences without 3-D glasses. Our REELdepthâ„˘ video slot games are designed with MLDÂ® technology, pioneered by PureDepthâ„˘ Inc., an ingenious layering of two liquid crystal displays. MLDÂ® video slots additionally enable players to choose spinning reel, video slots or video poker all in one machine, as well as allowing server-based game download and configuration functionality for the operators.
Our new S AVPÂ® Upright developed a new look and feel for video spinning reels, providing fresh slot themes, crisper graphics packages, enhanced lighting schemes and sounds, and innovative bonus rounds. New game themes include new features, such as high hit frequency, instant progressive capabilities with CMB option, 50-payline action, Free Games, Easy Bet restricted betting ranges, buy-a-pay bonus wagering, two-for-one wagering, two-level progressive jackpots, and configurable progressive increments and hold percentages.
We tested sixteen new AVPÂ® games successfully for 26 weeks against all other leading manufacturers at selected Power Scoreâ„˘ performance testing locations across North America. IGTâ€™s Power Scoreâ„˘ program is designed to verify the strength of new game themes and, by doing so, supports operator confidence in newly released titles. This comprehensive testing program compares the overall â€śreal worldâ€ť market for up to six months, identifying the potential for slot floor success and assisting in identifying features that contribute to game longevity.
Group play introductions in fiscal 2008 included eBay Ă¤ , Wheel of FortuneÂ® Super Spin Ă¤ Five-Station Ă¤ , and The Price is RightÂ® Multi-Station Ă¤ . Group play products provide a variety of community game play features, such as the eBay Ă¤ feature where multiple players can participate in the same bonus for added player interaction and high-stakes player attraction. MLP and Mystery Bonus MegaJackpotsÂ® releases included Wheel of FortuneÂ® MLP, Star Wars Ă¤ MLP, and Indiana Jones Ă¤ MLP with MLDÂ® . MLP and Mystery Bonus format games offer players free spin bonuses and frequent mid-level wins, as well as a chance to randomly win a higher value jackpot while playing low-denomination themes. In fiscal 2009, we plan to release Wheel of FortuneÂ® MLD and MegabucksÂ® MLDÂ® MLP , as well as Scavenger Hunt Ă¤ MLP , the first server-based bank-to-bank concept.
Our M-P Seriesâ„˘ interactive, multi-player suite of electronic table games arranged in virtual pits continues moving forward with the introduction of roulette and baccarat during fiscal 2008. With virtual cards and virtual chips, these products provide floor-layout flexibility, increased game security, limited staffing requirements, increased hands-per-hour, and decreased operating costs, along with the addition of table game options for slot-only jurisdictions.
We continue to develop our popular game titles for deployment through online and mobile gaming applications. During fiscal 2008, we released the online version of MegabucksÂ® on the internet casino platform and other online versions of our popular MegaJackpotsÂ® themes are expected to follow. Other games migrated to these platforms include CleopatraÂ® , WolfRunÂ®, Elvis-A Little More Actionâ„˘ , Texas TeaÂ® , Hi-5â„˘ , and Elvis Top 20â„˘ .
Games and network systems continue to converge, as operators increasingly require this synergy for regulatory purposes and to manage game performance and player preferences. As we develop and integrate gaming systems, we recognize networks have the power to dramatically change the appearance and improve the usefulness of gaming systems.
Our ongoing server-based gaming development continues to focus on a more comprehensive enterprise-wide network systems solution designed to provide operators with:
tools for more effective casino floor management
new ways to engage and interact with players
During fiscal 2008, IGTâ€™s sb Ă¤ product line became sbX Ă¤ , the Experience Management solution. Our first evolution of sb Ă¤ centered on server-based game management; sbX Ă¤ is being developed into a new integrated modular solution, incorporating input from real-life operators. With sbX Ă¤ , an operator can create, manage, and deliver customized player experiences that drive player loyalty. Coupled with our AVPÂ® technology, sbX Ă¤ provides the flexibility and connectivity needed by operators to keep up with changing player demands and enhance their competitive edge. All this functionality is designed to optimize an operatorâ€™s return and lower operating costs.
During 2008, we opened the IGT Global Technology and Interoperability Center to facilitate third-party manufacturers and strategic partners in the testing of GSA protocol productsâ€™ interface integration, compatibility, and performance. The Center is actively testing our sbX Ă¤ system and its interaction with other vendor systems, as we continue to engineer new applications and demonstrate the security, efficiency, and innovative new casino player marketing features this technology can provide.
We are preparing to move beyond the development and testing phase in 2008 into the commercialization and sales phase in 2009. During fiscal 2009, we expect to introduce both operational and player components of sbX Ă¤ for smaller scale, bank-by-bank installations, allowing operators to test operational and player features prior to floor-wide investments. We anticipate the first casino-wide deployment of our sbX Ă¤ gaming management systems at the new CityCenterâ€™s Aria Casino Resort in Las Vegas scheduled to open in late 2009.
Our five field trials are in the process of upgrading to the latest version of sbX Ă¤ , a milestone step that will incorporate G2S and S2S GSA protocols and enable sbX Ă¤ integration with various other casino management systems. This new version of sbX Ă¤ will allow operators to download multiple games on slot machine drives and configure player menus with our award-winning Service Window interface that will overlay all future sbX Ă¤ applications.
We will continue combining the power of the open network with other server-based applications, including casino transactional systems, business intelligence software, and other unique new gaming products. The integration of sbX Ă¤ with our CRM, business intelligence, and predictive modeling applications will provide the tools designed to help operators better understand and predict player behavior patterns, increase marketing productivity, and analyze customer preferences and game performance. We also continue to support and enhance our legacy gaming systems for casino management (such as Advantage Â®), CRM, Ticket-in/Ticket-out, CDS, and WAP.
Platforms are the means by which players interact with the games, and we support several in order to maximize our game distribution reach. The challenge of platform development is in determining how to effectively use a wide range of technologies to satisfy evolving global markets with the best features, cost points, and delivery dates. The goal is to ensure that our content can be deployed through a number of different channels, including traditional gaming platforms, as well as wireless networks and the internet.
During fiscal 2008, we continued development for delivery through third-party platforms, interactive digital TV, cell phones, the internet, and other mobile gaming outlets, as well as through network technology for remote game management and downloading. We also expanded our Remote Game Serverâ„˘ to facilitate further deployment of our game content to internet platforms.
We incorporated customer feedback in the design of several new cabinet models released in fiscal 2008. The new models were also designed with input from ergonomic and industrial design experts to create a product that is flexible, functional and holds the greatest player appeal. These models diversify our AVPÂ® cabinet styles and are all sbX Ă¤ ready with supporting GSA open communication standards and video capabilities for the service window.
Our AVPÂ® is designed to support the next generation of video games and provide improved graphic capabilities such as:
MLDÂ® virtual 3-D spinning reels
liquid crystal wide- or full- screen live streaming videos
animations with vivid colors
enhanced stereo and surround sound
expanded storage capacity, allowing for complex bonus features
As we transition to AVPÂ® as our standard development platform, we also continue development support for the following platforms:
Game King Ă’ video platform using the 80960 processor
S2000 Ă’ and Reel TouchÂ® 80960 spinning reel platform
VLC 8800â„˘ platform widely used in government-sponsored jurisdictions, with the ability to connect with most major North America video lottery control systems
Blue Chip platform used in Australia and New Zealand
Barcrest MPU5 (soon to be replaced by MPU6) AWP platform produced in the UK
Pachisuro platform used in Japan
We consider our intellectual property portfolio of patents, trademarks, copyrights, and other licensed rights to be a significant asset to our business. We currently own or license over 1,900 patents and over 2,100 trademarks. Our capitalized patents have a weighted average remaining useful life of 8 years and our licensed arrangements have various expiration dates through 2020, frequently with options to extend.
We seek to protect our investment in R&D and the unique, distinctive features of our products by perfecting and maintaining our IP rights. We obtain patent protection covering many of our products and have a significant number of US and foreign patent applications pending. Our portfolio is widely diversified, comprised of both domestic and foreign patents related to a variety of gaming equipment and systems, including game designs, bonus and secondary game features, and device components.
We market most of our products under trademarks and copyrights that provide product recognition and promote widespread acceptance. We seek protection for our copyrights and trademarks in the US and various foreign countries, where applicable. Certain intellectual property litigation is described in Note 16 of our Consolidated Financial Statements.
Robert A. Bittman , 53, has served on our board of directors since May 2000. Mr. Bittman has been IGTâ€™s Executive Vice President, Product Strategy since 2003, and he was IGTâ€™s Executive Vice President, Product Development from 1996 to 2003. Mr. Bittman majored in Systems Analysis at New York University, and Psychology at Queens College and the University of Nevada, Reno. Positions previously held with IGT include:
* Vice President of Marketing
* Director of Marketing
* Marketing Research Analyst
Prior to his tenure with IGT, Mr. Bittman worked for Caesarâ€™s Tahoe in all phases of slot operations management, including two years as Director of Slot Operations.
Richard R. Burt , 60, has served on our board of directors since December 2001, when we acquired Anchor Gaming, and is a member of the Audit and Nominating and Corporate Governance Committees. Mr. Burt has been a Senior Director at Kissinger McLarty Associates in Washington D.C. since April 2007, and he was Chairman of Diligence, Inc. from 2001 to 2007. Mr. Burt holds a BA in Government from Cornell University and an MA in International Relations from Tufts University. Mr. Burt also currently serves as:
* Founder and Chairman of IEP Advisors, Inc. in Washington D.C.
* Director of UBS Mutual Funds
* Trustee of Deutsche Bankâ€™s Closed-End Germany Funds Group
* Director of EADS North America
* Member of Alfa Asset Management (Moscow International Advisory Council)
Positions held previously include:
* Director of the Protective Group, Miami Lakes, FL
* Member of the Textron Corporationâ€™s International Advisory Council
* Trustee of Deutsche Scudder (New York) Mutual Funds
* Director of Hollinger International Inc.
* Director of Archer Daniels Midland (ADM)
* Chairman of the Board of Weirton Steel, Inc.
* Director and Vice Chairman of Anchor Gaming
* Director and Chairman of Powerhouse Technologies, Inc.
* Partner in McKinsey & Co.
* Chief Negotiator in Strategic Arms Reduction Talks (START) with the Former Soviet Union
* U.S. Ambassador to the Federal Republic of Germany
* Assistant Secretary of State for European and Canadian Affairs
* Director of Politco-Military Affairs
Patti S. Hart , 51, has served on our board of directors since June 2006 and is a member of the Audit and Compensation Committees. Ms. Hart was the Chairman and Chief Executive Officer of Pinnacle Systems, Inc. from 2004 to 2005, and of Excite@Home, Inc. from 2001 to 2002. Ms. Hart holds a BS in Marketing and Economics from Illinois State University. Ms. Hart is also a member of the boards of directors for:
* Korn/Ferry International, Inc.
* Spansion LLC
* Lin TV Corp.
Positions held previously include:
* Chairman and Chief Executive Officer of Telocity, Inc.
* President & COO, Long Distance Division, Sprint Corporation
* President, Sprint Business Services Group, Sprint Corporation
* President, Sales & Marketing, Sprint Business Services Group, Sprint Corporation
* Vice President, Sprint Business Services Group
* Area Vice President and General Manager, National & Major Accounts, Sprint, Inc.
* Director, Alternate Distribution, Strategic Planning, InteCom, Inc.
* Consultant, United Technologies Corporation
Former board affiliations:
* EarthLink, Inc.
* Excite@Home, Inc.
* Mariner Networks
* Pinnacle Systems, Inc.
* Plantronics, Inc.
* Telocity, Inc.
* Vantive Corporation
* Pharmaceutical Product Development
Leslie S. Heisz , 46, has served on our board of directors since June 2003 and is a member of the Audit and Nominating and Corporate Governance Committees. Ms. Heisz has been Managing Director of Lazard FrĂ¨res & Co. LLC since 2004, and she was Senior Advisor of Lazard FrĂ¨res & Co. LLC from 2003 to 2004. Ms. Heisz holds a BS degree from the University of California at Los Angeles (UCLA) and an MBA from the UCLA Anderson School of Management. Ms. Heisz is also a member of the boards of directors for:
* Eldorado Resorts LLC
* Ingram Micro Inc.
Positions held previously include:
* Managing Director and Director of Dresdner Kleinwort Wasserstein (and its predecessor, Wasserstein Perella & Co.)
* Vice President and Associate with Salomon Brothers Inc.
* Senior Consultant and Consultant at Price Waterhouse
Robert A. Mathewson , 43, has served on our board of directors since December 2003 and is a member of the Compliance Committee. Since 1992, Mr. Mathewson has been President of RGC Inc., a private investment company, and he was Vice President of Business Development for Televoke, Inc. from 1999 to 2000. Mr. Mathewson holds a BA in Economics and an MBA from the University of California at Berkeley and a Juris Doctorate from University of California Hastings College of the Law. Mr. Mathewson is also a member of the board of directors for FelCor Lodging Trust.
Thomas J. Matthews , 42, was appointed to our board of directors in December 2001 and was named Chairman in March 2005. Mr. Matthews has been IGTâ€™s President and Chief Executive Officer since 2003, and he was IGTâ€™s Chief Operating Officer from 2001 to June 2007. Mr. Matthews held a number of key positions at Anchor Gaming from 1994 until it was acquired by IGT in December 2001, including President, Chief Executive Officer and Chairman of the Board. He previously served as President of Global Gaming Distributors, Inc. until it was acquired by Anchor Gaming in 1994. Mr. Matthews holds a BS in Finance from the University of Southern California.
Robert Miller , 62, has served on our board of directors since January 2000 and is a member of the Compensation and Compliance Committees. Since July 2005, he has been a principal of Dutko Worldwide, a multi-disciplinary government affairs and strategy management firm, and he was a partner at the Jones Vargas law firm from 1999 to 2005. Mr. Miller holds a Juris Doctorate from Loyola Law School, Los Angeles. Mr. Miller is also a member of the boards of directors for:
* Newmont Mining Corporation
* Zenith National Insurance Corp.
* Wynn Resorts, Ltd.
Positions held previously include:
* Governor of the State of Nevada
* Lieutenant Governor of the State of Nevada
* Clark County District Attorney
* Las Vegas Township Justice of the Peace
* First legal advisor for the Las Vegas Metropolitan Police Department
* Clark County Deputy District Attorney
* Uniformed Commissioned Officer for the Clark County Sheriffâ€™s Department and the Los Angeles County Sheriffâ€™s Department
Frederick B. Rentschler , 68, has served on our board of directors since May 1992 and is a member of the Compensation and the Nominating and Corporate Governance Committees. Before his retirement in 1991, Mr. Rentschler was President and Chief Executive Officer of Northwest Airlines. Mr. Rentschler received his undergraduate degree from Vanderbilt University and an MBA from Harvard University. He was also awarded a Doctor of Laws, causa honoris, from the University of Wyoming. Mr. Rentschler also currently serves as:
* Member of the Board of Trustees for Vanderbilt University, Nashville, Tennessee
* Emeritus trustee of the Salk Institute in La Jolla, California
* Emeritus trustee of the Scottsdale Health Care Systems in Arizona
Positions held previously include:
* President and Chief Executive Officer of Beatrice Company
* President and Chief Executive Officer of Beatrice U.S. Foods
* President and Chief Executive Officer of Hunt-Wesson, Inc.
* President of Armour-Dial
Board of Directors and Committees of the Board
During fiscal 2007, our board of directors held seventeen meetings and acted by unanimous written consent on nine other occasions. Each director attended at least 75% of the meetings of the board of directors and of each committee on which he or she served as a member during the period in which he or she served. Our non-management directors met three times during fiscal 2007. We encourage our directors to attend our annual meetings of shareholders. All but one of our directors attended our 2007 annual meeting of shareholders.
Our Corporate Governance Guidelines require that a majority of the board of directors consist of independent directors. For a director to be independent under the listing standards of the New York Stock Exchange (NYSE), the board of directors must affirmatively determine that the director has no material relationship with IGT (either directly or as a partner, shareholder or officer of an organization that has a relationship with IGT). Our board of directors has made an affirmative determination that the following members of the board, constituting a majority of our directors, meet the standards for â€śindependenceâ€ť set forth in our Corporate Governance Guidelines and applicable NYSE rules: Messrs. Burt, Mathewson, Miller and Rentschler and Ms. Hart and Ms. Heisz. During fiscal 2007, each of Ms. Heisz and Mr. Miller was a board member of an IGT customer. The revenues to IGT from these customers comprised less than 1% of our fiscal 2007 gross revenues. Neither Ms. Heisz nor Mr. Miller were involved in the establishment of, or received any special benefits from, these contractual arrangements. During fiscal 2007, IGT sold a company aircraft to a limited liability company owned by Charles Mathewson, a former director and executive officer of IGT and the father of Robert Mathewson, and made payments under a split-dollar life insurance agreement entered into in 1999 for the benefit of Charles Mathewson. See below â€śCertain Transactions with Related Persons.â€ť In addition, during fiscal 2007, IGT paid certain retirement benefits to Charles Mathewson that did not exceed $100,000. After consideration of these matters, the board affirmatively determined that none of these transactions or matters is a material relationship with IGT.
Our board of directors has three standing committees: the Audit Committee, the Compensation Committee, and the Nominating and Corporate Governance Committee.
The Audit Committee , a separately-designated, standing committee established in accordance with section 3(a)(58)(A) of the Securities Exchange Act of 1934, assists our board of directors in overseeing the accounting and financial reporting processes of IGT and audits of our financial statements, including the integrity of our financial statements, compliance with legal and regulatory requirements, our independent registered public accountantsâ€™ qualifications and independence, the performance of our internal audit function and independent registered public accountants, and such other duties as may be directed by our board of directors. The Audit Committee Charter requires that the Audit Committee consist of three or more board members who satisfy the â€śindependenceâ€ť requirements of the SEC and NYSE for audit committee members. The Audit Committee consists of Ms. Hart (Chair), Ms. Heisz and Mr. Burt, each of whom satisfies these requirements. Our board of directors has determined that Ms. Hart and Ms. Heisz both meet the definition of an audit committee financial expert, as set forth in Item 407(d)(5) of SEC Regulation S-K. The Audit Committee held 14 meetings during fiscal 2007. A copy of the report of the Audit Committee is contained in this proxy statement. A copy of the current charter of the Audit Committee is available under the â€śCorporate Governanceâ€ť link of the Investor Relations page of our website at http://www.IGT.com or in print, free of charge, to any shareholder who requests it by writing to the Corporate Secretary, International Game Technology, 9295 Prototype Drive, Reno, Nevada 89521.
The Compensation Committee discharges the responsibilities of our board of directors relating to compensation of IGTâ€™s executives and directors, and operates pursuant to the Compensation Committee Charter. The Compensation Committee Charter requires that the Compensation Committee consist of three or more board members who satisfy the â€śindependenceâ€ť requirements of the NYSE. The Compensation Committee is comprised of Messrs. Rentschler (Chair) and Miller and Ms. Hart, each of whom satisfies these requirements. During fiscal 2007, the Compensation Committee held ten meetings. A copy of the current charter of the Compensation Committee is available under the â€śCorporate Governanceâ€ť link of the Investor Relations page of our website at http://www.IGT.com or in print, free of charge, to any shareholder who requests it by writing to the Corporate Secretary, International Game Technology, 9295 Prototype Drive, Reno, Nevada 89521.
Pursuant to its charter, the Compensation Committeeâ€™s responsibilities include the following:
* reviewing and approving goals relevant to the compensation of our President and Chief Executive Officer (CEO), evaluating the CEOâ€™s performance in light of those goals and objectives, and setting the CEOâ€™s compensation level based on this evaluation;
* approving compensation levels for our other executive officers and senior management, including participation in our incentive, equity, severance and other compensation plans and arrangements, as the Compensation Committee deems appropriate;
* setting the compensation for members of our board of directors and board committees; and
* making recommendations to our board of directors with respect to our non-CEO compensation, incentive-compensation and equity-based plans.
The Compensation Committee may form subcommittees and delegate to its subcommittees such power and authority as it deems appropriate. The Compensation Committee has no current intention to delegate any of its authority to any subcommittee. Our executive officers, including the Named Executive Officers (as identified below), do not have any role in determining the form or amount of compensation paid to our Named Executive Officers and our other senior executive officers. However, our Chief Executive Officer does make recommendations for review by the Compensation Committee with respect to compensation paid to our other executive officers.
Pursuant to its charter, the Compensation Committee is authorized to retain such independent compensation consultants and other outside experts or advisors as it believes to be necessary or appropriate to carry out its duties. For fiscal 2007, the Compensation Committee retained the firm of The Croner Company (â€śCronerâ€ť) as independent compensation consultants to assist it in determining the compensation levels for our senior executive officers. The Compensation Committee made its compensation decisions during fiscal 2007, including decisions with respect to our Named Executive Officersâ€™ compensation, after consultation with Croner. Croner advised the Compensation Committee with respect to trends in executive compensation, determination of pay programs, assessment of competitive pay levels and mix (e.g., proportion of fixed pay to incentive pay, proportion of annual cash pay to long-term incentive pay), and setting compensation levels. Croner also reviewed and identified our appropriate peer group companies for fiscal 2007 and helped the Compensation Committee to obtain and evaluate current executive compensation data for these peer group companies. All compensation decisions were made solely by the Compensation Committee or our board of directors.
Corporate Governance Matters
The Nominating and Corporate Governance Committee , which consists of Ms. Heisz (Chair) and Messrs. Burt and Rentschler, is responsible for identifying qualified candidates to be presented to our board for nomination as directors, ensuring that our board and our organizational documents are structured in a way that best serves our practices and objectives, and developing and recommending a set of corporate governance principles. The Nominating and Corporate Governance Charter requires that the Nominating and Corporate Governance Committee consist of no fewer than three board members who satisfy the â€śindependenceâ€ť requirements of the NYSE. Each member of our Nominating and Corporate Governance Committee meets these requirements. Our Nominating and Corporate Governance Committee held ten meetings during fiscal 2007. A copy of the current charter of the Nominating and Corporate Governance Committee is available under the â€śCorporate Governanceâ€ť link of the Investor Relations page of our website at http://www.IGT.com or in print, free of charge, to any shareholder who requests it by writing to the Corporate Secretary, International Game Technology, 9295 Prototype Drive, Reno, Nevada 89521.
The Nominating and Corporate Governance Committee will consider nominees for our board of directors recommended by shareholders. Notice of proposed shareholder nominations for director must be delivered not less than 120 days prior to any meeting at which directors are to be elected, such as our annual meeting of shareholders. Nominations must include the full name of the proposed nominee, a brief description of the proposed nomineeâ€™s business experience for at least the previous five years, and a representation that the nominating shareholder is a beneficial or record owner of IGT common stock. Any such submission must be accompanied by the written consent of the proposed nominee to be named as a nominee and to serve as a director if elected.
MANAGEMENT DISCUSSION FROM LATEST 10K
The following MDA is intended to enhance the readerâ€™s understanding of our operations and current business environment. MDA is provided as a supplement to, and should be read in conjunction with, our Item 1, Business, and Item 8, Financial Statements and Supplementary Data.
International Game Technology is a global company specializing in the design, manufacture, and marketing of computerized gaming equipment, network systems, licensing, and services. We are a leading supplier of gaming products to the world, providing a diverse offering of quality products and services at competitive prices that are designed to increase the potential for operator profits by serving players better.
Our annual revenues totaled $2.5 billion in fiscal 2008. We operate in two segments, North America and International, with certain unallocated company-wide income and expenses managed at the corporate level. International continues to be a growing contributor at 25% of operating income in fiscal 2008. See BUSINESS SEGMENT RESULTS below and Note 18 of our Consolidated Financial Statements for additional segment information and financial results.
We are currently operating in a difficult domestic environment. The combination of economic uncertainty, lower replacement demand, limited opportunities from new or expanding properties, and improved competition has negatively impacted our North America results. Our gaming operations business has been negatively affected by lower casino play levels which operators have largely attributed to unfavorable economic conditions, as well as declining interest rates which increase jackpot funding costs. In the face of these challenges, we remain focused on strategic initiatives that we believe will maintain our status as a leading provider of innovative gaming products and services.
Our current product development efforts reflect our commitment to the future of gaming industry technology as our business model continues to evolve toward a more systems-centric, networked gaming environment. In support of the networked gaming environment, we released several new machine models during the current year. Initial customer feedback on these models has been positive, and we anticipate replacement demand in fiscal 2009 to exceed 2008 levels. However, the timing and amount of revenues from these releases remains dependent, in part, on our customersâ€™ capital spending, which may continue to be adversely impacted by current economic conditions. We remain on track for initial deployment of our sbX Ă¤ applications in 2009, and expect to realize a meaningful financial benefit from sbX Ă¤ technology beginning in fiscal 2010 as we further differentiate IGT gaming products by offering operators new ways to engage and interact with players.
We are dependent, in part, on new market opportunities to generate growth. We expect to benefit from a number of new or expansion projects that are currently underway, but the extent and timing of such opportunities remains uncertain due to the difficult credit environment and risk of prolonged economic weakness. The uncertainty and lack of liquidity has led some gaming operators to delay or cancel construction projects; however, we believe market opportunities may develop as credit markets recover and governments consider gaming tax revenues as one means to address budget shortfalls.
In the current year, we saw new openings or expansions in a number of domestic jurisdictions including Indiana, Nevada, Oklahoma, and Pennsylvania. During the first half of the year, California voters approved new tribal compacts for 17,000 additional slot machines, and Florida voters approved 6,000 additional machines for three pari-mutuel facilities in Miami-Dade County. In November 2008, voters in Maryland voted to legalize up to 15,000 gaming machines at five locations in that state. We also expect to benefit from further gaming expansion in international markets, especially in Southeast Asia.
During fiscal 2008 we continued to deploy our capital for strategic business combinations and acquisitions of important technologies and IP. We believe the Cyberview asset purchase and license agreement enabled more immediate access to the fixed odds betting market in the UK, strengthened our IP portfolio and enhanced our sbX Ă¤ initiatives. Additionally, we anticipate our acquisition of Million-2-1 will establish new markets and channels for our game content in the mobile gaming business.
We will take a prudent and conservative approach to maintaining our available liquidity while credit market conditions and economic conditions remain unfavorable. We continue to focus on reinvesting in our business through our installed base of gaming operations machines, as well as other strategic capital deployment objectives including investments and alliances to expand our geographic reach, product lines, and customer base. We will judiciously deploy our capital to preserve maximum flexibility.
Amid difficult operating conditions, we are conducting a company-wide strategic review of our costs and organizational structure to maximize efficiency and align our expenses with our current and forecasted business outlook. We anticipate that these efforts will result in quarterly cost reductions ranging from $20.0 million to $25.0 million beginning in the second quarter of fiscal 2009. A large part of our cost-cutting measures relates to workforce reductions that we expect to result in additional charges of $16.0 million to $21.0 million during the first quarter of fiscal 2009. As we move forward in this challenging economic and credit environment, we intend to continuously monitor our costs and make adjustments where necessary and feasible to improve our operating efficiency.
RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2008, the FASB issued FSP APB 14-1, Accounting For Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) . This FSP requires that convertible debt instruments that may be settled in cash upon conversion be separated into debt and equity components. Although we are still quantifying the impact, we expect the adoption of this FSP in the first quarter of fiscal 2010 to increase interest expense related to our convertible debentures with a corresponding decrease to diluted EPS.
See Note 1 of our Consolidated Financial Statements for additional information regarding recently issued accounting standards that may impact IGT upon adoption.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements were prepared in conformity with accounting principles generally accepted in the US. Accordingly, we are required to make estimates incorporating judgments and assumptions we believe are reasonable based on our historical experience, contract terms, trends in our company and the industry as a whole, as well as information available from other outside sources. Our estimates affect amounts recorded in the financial statements and actual results may differ from initial estimates.
We consider the following accounting estimates to be the most critical to fully understand and evaluate our reported financial results. They require us to make subjective or complex judgments about matters that are inherently uncertain or variable. Senior management discussed the development, selection, and disclosure of the following accounting estimates, considered most sensitive to changes from external factors, with the Audit Committee of our Board of Directors.
We receive revenues from the distribution of electronic gaming equipment and network systems, as well as licensing and services. Revenues are recognized when all of the following have been satisfied:
persuasive evidence of an arrangement exists
the price to the customer is fixed and determinable
delivery has occurred and any acceptance terms have been fulfilled
no significant contractual obligations remain
collection is reasonably assured
Determining whether these requirements have been met may require us to make assumptions and exercise judgment that could significantly impact the timing and amount of revenue reported each period. In addition, we may enter into arrangements which include multiple elements or deliverables such as gaming devices, software systems, and services. In such cases additional judgments and estimates are necessary to ensure the appropriate amounts of revenue are recorded in a given period. These judgments relate primarily to the allocation of proceeds based on VSOE or third-party evidence of each elementâ€™s fair value, and may affect the amounts and timing of revenue recorded. If we are unable to establish VSOE for undelivered elements, we may be required to defer all or a portion of the revenues from certain arrangements.
The application of our revenue recognition policies and changes in our assumptions or judgments affect the timing and amounts of our revenues, cost of gaming operations, and cost of product sales. We anticipate an increase in our deferred revenues as we enter into an increasing number of multiple element contracts that include software and more of our product becomes subject to software rules for revenue recognition. Deferred revenue increased to $62.1 million at September 30, 2008 from $28.7 million at September 30, 2007.
Goodwill, Other Intangible Assets, and Royalties
We measure and test goodwill for impairment using the two-step approach under SFAS 142, Goodwill and Other Intangible Assets , at least annually or more often if there are indicators of impairment. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. Our goodwill totaled $1.2 billion at September 30, 2008 and $1.1 billion at September 30, 2007. The last three annual goodwill impairment tests indicate the fair value of each reporting unit is in excess of its carrying value.
In determining the fair value of our reporting units, we apply the income approach using the DCF method. We then compare the implied valuation multiples of a group of comparable competitor gaming companies under the market approach to test the reasonableness of our DCF results. The DCF analysis is based on the present value of two components: the sum of our five year projected cash flows and a terminal value assuming a long-term growth rate. The cash flow estimates are prepared based on our business plans for each reporting unit, considering historical results and anticipated future performance based on our expectations regarding product introductions and market opportunities. The discount rates used to determine the present value of future cash flows are derived from the weighted average cost of capital of a group of comparable companies, considering the size and specific risks of each IGT reporting unit.
Our portfolio of other intangibles substantially consists of finite-lived patents, contracts, trademarks, developed technology, and customer relationships. We regularly monitor events or changes in circumstances that indicate the carrying value of these intangibles may not be recoverable or require a revision to the estimated remaining useful life in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets . Our other intangibles totaled $248.9 million at September 30, 2008 and $245.5 million at September 30, 2007.
If an event or change occurs, we estimate cash flows directly associated with the use of the intangible to test recoverability and remaining useful lives based on the forecasted utilization of the asset and expected product revenues. In developing estimated cash flows, we incorporate assumptions regarding changes in legal factors, related industry climate, regulatory actions, contractual factors, operational performance and the companyâ€™s strategic business plans, as well as the effects of obsolescence, demand, competition, and other market conditions. When the carrying amount exceeds the undiscounted cash flows expected to result from the use and eventual disposition of a finite-lived intangible asset or asset group, we then compare the carrying amount to its current fair value. We estimate the fair value using prices for similar assets, if available, or more typically using a DCF model. We recognize an impairment loss if the carrying amount is not recoverable and exceeds its fair value.
We also regularly evaluate the estimated future benefit of prepaid and deferred royalties to determine amounts unlikely to be realized from forecasted sales or placements of our games. The carrying value of our prepaid and deferred royalties totaled $195.5 million at September 30, 2008 and $104.6 million at September 30, 2007.
Impairment testing for goodwill, other intangibles, and royalties requires judgment, including the identification of reporting units, allocation of related goodwill, assignment of corporate shared assets and liabilities to reporting units, estimated cash flows, and determinations of fair value. While we believe our estimates of future revenues and cash flows are reasonable, different assumptions could materially affect the assessment of useful lives, recoverability and fair value. If actual cash flows fall below initial forecasts, we may need to record additional amortization and/or impairment charges.
Jackpot Liabilities and Expenses
A portion of our gaming operations recurring revenue arrangements incorporate IGT paid WAP jackpots for which we recognize corresponding jackpot liabilities and expense. Changes in our estimated amounts for jackpot liabilities and associated jackpot expense are attributable to regular analysis and evaluation of the following factors:
variations in slot play (i.e. jackpot life cycles and slot play patterns)
volume (i.e. number of WAP units in service and coin-in per unit)
interest rate movements
the size of base jackpots (i.e. initial amount of the progressive jackpots displayed to players)
Interest rates applicable to jackpot funding vary by jurisdiction and are impacted by market forces, as well as winner elections to receive a lump sum payment in lieu of periodic annual payments. Current and non-current portions of jackpot liabilities, as well as jackpot expense, may also be impacted by changes in our estimates and assumptions regarding the expected number of future winners who may elect a lump sum payout.
Changes in prime and/or Treasury and Agency interest rates during a given period cause fluctuations in jackpot expense largely due to the revaluation of future winner liabilities. The value of the liability (and related jackpot expense) increases when rates decline because it increases the cost to fund the liability. Conversely, when rates increase, jackpot liabilities are reduced as it costs less to fund the liability. Our results may be materially affected by significant changes in interest rates such as the 200 bps decline in the prime rate during the second quarter of fiscal 2008.
Our jackpot liabilities increased to $650.7 million at September 30, 2008 compared to $643.1 million at September 30, 2007. Jackpot expense totaled $160.0 million for fiscal 2008, $164.7 million for fiscal 2007, and $184.9 million in fiscal 2006. The decline in jackpot expense for fiscal 2008 resulted from lower volume and variations in slot play partially offset by unfavorable interest rate movements. Fluctuations between fiscal 2007 and 2006 resulted from variations in slot play, fewer WAP units in service, and interest rate movements.
BUSINESS SEGMENT RESULTS, later in this MDA, discusses additional details regarding the fluctuation in jackpot expense. Note 1 of our Consolidated Financial Statements summarizes our accounting policies related to jackpot liabilities and expense.
Inventory and Gaming Operations Equipment
The determination of obsolete or excess inventory requires us to estimate the future demand for our products within specific time horizons, generally one year or less. If we experience a significant unexpected decrease in demand for our products or a higher occurrence of inventory obsolescence because of changes in technology or customer requirements, we would recognize additional obsolescence charges. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times versus the risk of inventory obsolescence because of rapidly changing technology and customer requirements. The increase in inventories to $218.3 million at September 30, 2008 from $144.8 million at September 30, 2007 was primarily related to a build-up in support of the recent release of our newer platforms and cabinets.
We are also required to estimate salvage values and useful lives for our gaming operations equipment. Trends in market demand and technological obsolescence may require us to record additional asset charges which would negatively impact gross profit.
We conduct business globally and are subject to income taxes in US federal, state, local, and foreign jurisdictions. Determination of the appropriate amount and classification of income taxes depends on several factors, including estimates of the timing and probability of realization of deferred income taxes, reserves for uncertain tax positions, and income tax payment timing.
Deferred income taxes reflect temporary differences between the book and tax basis of our assets and liabilities, measured at tax rates expected to apply when taxes are actually paid or recovered. This process involves estimating our current tax position in each jurisdiction, as well as making judgments as to whether our taxable income in future periods will be sufficient to fully realize any deferred tax assets. We reduce deferred tax assets by a valuation allowance when it is more likely than not that some or all of the deferred tax assets will not be realized. Changes in tax laws, enacted tax rates, geographic mix, or estimated annual taxable income could change our valuation of deferred tax assets and liabilities, which in turn impacts our tax provision. Net deferred tax assets totaled $251.3 million at September 30, 2008 and $208.8 million at September 30, 2007.
In the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes â€“ an interpretation of FASB Statement No. 109, during the first quarter of fiscal 2008. This pronouncement provides guidance for recognizing and measuring uncertain tax positions taken or expected to be taken in a tax return. Under FIN 48, we may recognize a tax benefit from an uncertain position if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue. The amount recognized in the financial statements is the largest benefit that we believe is more than 50% likely of being realized upon settlement. We consider many factors when evaluating and estimating our tax positions and related benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. Our income tax provision may be impacted to the extent that the final outcome of these tax positions differs from amounts recorded. As of September 30, 2008, our net unrecognized tax benefits totaled $87.5 million, $53.4 million of which would impact the effective tax rate if recognized.
The implementation of FIN 48 as of the beginning of fiscal 2008 increased our unrecognized tax benefits and related interest and penalties by $89.9 million, increased deferred tax assets by $55.4 million, and decreased retained earnings by $34.5 million. See Notes 1 and 17 of our Consolidated Financial Statements for additional information about FIN 48 and the impact of adoption.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
FORWARD LOOKING STATEMENTS
This report contains statements that do not relate to historical or current facts, but are â€śforward lookingâ€ť statements within the meaning outlined in the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information based on forecasts of future results and estimates of amounts not yet determinable. These statements may also relate to future events or trends, our future prospects and proposed new products, services, developments or business strategies, among other things. These statements can generally (although not always) be identified by their use of terms and phrases such as anticipate, believe, could, would, estimate, expect, intend, may, plan, predict, project, pursue, will, continue, and other similar terms and phrases, as well as the use of the future tense.
Examples of forward looking statements in this report include, but are not limited to, the following categories of expectations about:
ÂŞ our ability to introduce new products and their impact on replacement demand
ÂŞ the timing, features, benefits, and expected success of new product introductions
ÂŞ growth of our business through technology and intellectual property (IP) acquisition
ÂŞ our leadership position in the market
ÂŞ the advantages offered to customers by our anticipated products and product features
ÂŞ gaming growth, expansion, and new market opportunities
ÂŞ fluctuations in future gross margins and tax rates
ÂŞ increasing product sales or machine placements
ÂŞ legislative or regulatory developments and related market opportunities
ÂŞ available capital resources to fund future operating requirements, capital expenditures, payment obligations, and share repurchases
ÂŞ timing and amount of future share repurchases and dividends
ÂŞ expectations regarding losses from off-balance sheet arrangements
ÂŞ financial returns to shareholders related to management of our costs
Actual results could differ materially from those expressed or implied in our forward looking statements. Our future financial condition and results of operations, as well as any forward looking statements, are subject to change and to inherent known and unknown risks and uncertainties. See Item 1A, Risk Factors, in this report for a discussion of these and other risks and uncertainties. You should not assume at any point in the future that the forward looking statements in this report are still valid. We do not intend, and undertake no obligation, to update our forward looking statements to reflect future events or circumstances.
The following Managementâ€™s Discussion and Analysis (MDA) is intended to enhance the readerâ€™s understanding of our operations and current business environment. It should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2007.
Italicized text with an attached superscript trademark or copyright notation in this document indicates trademarks of IGT or its licensors. For a complete list of trademark and copyright ownership information, please visit our website at www.IGT.com.
International Game Technology is a global company specializing in the design, manufacture, and marketing of computerized gaming equipment, network systems, licensing and services. We are a leading supplier of gaming products to the world, providing a diverse offering of quality products and services at competitive prices that are designed to increase the potential for operator profits by serving players better.
Our annual revenues totaled $2.6 billion in fiscal 2007. We operate in two segments, North America and International, with certain unallocated company-wide income and expenses managed at the corporate level. International continues to be a growing contributor, constituting 20% of operating income in fiscal 2007. See BUSINESS SEGMENT RESULTS below and Note 15 of our Unaudited Condensed Consolidated Financial Statements for additional segment information and current quarter financial results.
We are currently operating in a difficult domestic environment. The combination of limited opportunities from new or expanding properties, lower replacement demand, improved competition and economic uncertainty has negatively impacted our North America results. Our gaming operations business has also been affected by lower interest rates, which increase jackpot funding costs. In the face of these challenges, we remain focused on strategic initiatives that we believe will maintain our status as a leading provider of innovative gaming products and services.
Our current product development efforts reflect our commitment to the future of gaming industry technology as our business model continues to evolve toward a more systems-centric, networked gaming environment. In support of the networked gaming environment we released several new machine models during the current quarter, and expect to see more new releases in the fourth quarter of fiscal 2008. The timing of revenues from these releases remains dependent, in part, on our customersâ€™ capital spending, which may be adversely impacted by current economic conditions. We remain on track for initial deployment of our server-based (sb Ă¤ ) applications in 2009, and expect to realize a meaningful financial benefit from sb Ă¤ technology beginning in fiscal 2010 as we further differentiate IGT gaming products by offering operators new ways to engage and interact with players.
We believe market opportunities may arise as operators expand in existing markets and from political action as governments continue to look to gaming to provide tax revenues in support of public programs. In the third quarter, we saw new openings or expansions in a number of domestic jurisdictions including Indiana, Oklahoma and Nevada. During the first half of the year, California voters approved new tribal compacts for 17,000 additional slot machines, and Florida voters approved an additional 6,000 machines for three pari-mutuel facilities in Miami-Dade County. In November, voters in Maryland will have the opportunity to vote on a ballot proposal to legalize up to 15,000 gaming machines at five locations in that state. We also expect to benefit from further gaming expansion in international markets, especially in Southeast Asia.
We continue to utilize our capital for strategic business combinations and acquisitions of important technologies and IP. We anticipate our acquisition of Million-2-1 may establish new markets and channels for our game content in the mobile gaming business. Additionally, we believe the July 2008 Cyberview Technologies, Inc. (Cyberview) asset purchase and license agreement will enable more immediate access to the fixed odds betting market in the United Kingdom (UK), further strengthen our IP portfolio and enhance our sb Ă¤ initiatives. We also remain focused on other capital deployment objectives including investments and alliances to expand our geographic reach, product lines and customer base. We also expect to be prudent and opportunistic in using our available liquidity to return value to our shareholders through continued share repurchases and dividends.
As we move forward in this challenging operating environment, we intend to manage our costs at a level that enables us to deliver innovative products while maximizing financial returns to shareholders.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 1 of our Unaudited Condensed Consolidated Financial Statements for information regarding recently issued accounting standards that may materially impact IGT upon adoption.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States (US). Accordingly, we are required to make estimates incorporating judgments and assumptions we believe are reasonable based on our historical experience, contract terms, observance of known trends in our company and the industry as a whole, as well as information available from other outside sources. Our estimates affect amounts recorded in the financial statements and actual results may differ from initial estimates.
We consider the following accounting estimates to be the most critical to fully understanding and evaluating our reported financial results. They require us to make subjective or complex judgments about matters that are inherently uncertain or variable. Senior management discussed the development, selection and disclosure of the following accounting estimates, considered most sensitive to changes from external factors, with the Audit Committee of our Board of Directors:
ÂŞ goodwill, other intangible assets, and royalties
ÂŞ jackpot liabilities and expenses
ÂŞ inventory and gaming operations equipment
ÂŞ share-based compensation
ÂŞ income taxes
For a discussion of our critical accounting estimates, please refer to MDA in our Annual Report on Form 10-K for the year ended September 30, 2007. Except for income tax estimates related to the adoption of Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48 described below, we have made no significant changes to our critical accounting estimates since September 30, 2007.
We adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, during the first quarter of fiscal 2008. This pronouncement provides a financial statement recognition threshold and measurement attribute for tax positions taken or expected to be taken in a tax return. Under FIN 48, we may recognize a tax benefit from an uncertain position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the issue. The amount recognized in the financial statements is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. The implementation of FIN 48 as of the beginning of fiscal 2008 increased our unrecognized tax benefits by $89.9 million, increased deferred tax assets by $55.4 million and decreased retained earnings by $34.5 million. See Note 11 of our Unaudited Condensed Consolidated Financial Statements for additional information about FIN 48 and the impact of adoption.
We exercise significant judgment when evaluating our uncertain tax positions and the related tax benefits. Although we believe our assumptions are reasonable, there is no guarantee that the final outcome of the related matters will not differ from the amounts reflected in our historical income tax provisions and accruals. We adjust our reserves for uncertain tax positions based on changes in facts and circumstances such as the closing of a tax audit or changes in estimates. Our income tax provision may be impacted to the extent that the final outcome of these tax positions is different than the amounts recorded. As of June 30, 2008, our net unrecognized tax benefits totaled $138.1 million, $90.5 million of which would impact the effective tax rate if recognized.
Consolidated Gaming Operations
Despite continued growth in our installed base of recurring revenue machines, revenues were down compared to the prior year primarily due to lower play levels in North America. Additionally, our installed base growth is increasingly from stand-alone lease and central determination system (CDS) units which generally provide lower revenues and gross profit per unit compared to wide area progressive (WAP) units. International revenue and gross profit improvements partially offset declines in North America reflecting the increasing geographic footprint of our gaming operations.
In addition, year to date gross profit and margin were adversely affected by technological obsolescence charges of $10.4 million related to the transition toward new products, as well as the prior year hurricane property insurance gain of $5.0 million.
Consolidated Product Sales
Total product sales revenues and gross profit were down from the same prior year periods primarily due to fewer machine shipments across most markets. Gross margin improvements were due to a favorable product and jurisdictional mix, including a greater contribution from non-machine sales. IGT increased systems installations from the prior year quarter by nearly 100, with 790 systems installed worldwide as of June 30, 2008.
The fluctuation in other income (expense) for the quarter and year to date period was primarily attributable to higher interest expense resulting from increased borrowings under our credit facility compared to fiscal 2007. In addition, interest income was down for the year to date period due to lower investment balances and interest rates compared to the same period of fiscal 2007.
Our current year tax provision includes additional amounts related to unrecognized tax benefits in connection with the adoption of FIN 48, as well as discrete items affecting the rate. Our future effective tax rates may continue to be volatile due to changes in uncertain tax positions.
Good morning everyone and welcome to IGTâ€™s fourth quarter and fiscal year 2008 earnings conference call. With me this morning are T.J. Matthews, our Chairman and Chief Executive Officer and Danny Siciliano, our Chief Accounting Officer and Treasurer.
Before we begin Iâ€™d like to note that during this earnings call certain statements and responses to questions may contain forward-looking information including forecasts of future financial performance and estimates of amounts not yet determined, the potential for growth of existing and the opening of new markets and products, play levels for our install base of recurring revenue games as well as our future prospects and proposed new products, services, developments or business strategies. Actual results could differ materially from those projected or reflected in our forward-looking statements and reported results should not be considered an indication of future performance. IGTâ€™s future financial condition and results of operation 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 made in this conference reflect IGTâ€™s current analysis of existing trends and information and represent IGTâ€™s judgment only as of today. You should not assume later in the quarter or year that the comments we made today are still valid. Actual results may differ materially from current expectations based on a number of factors affecting IGTâ€™s businesses including unfavorable changes to regulations or problems with the obtaining or maintaining these licenses or approvals, a decrease in popularity of our recurring revenue games or unfavorable changes in player or operator preferences, for general decline in play levels, decreases in interest rates which in turn increase our costs or jackpots, slow growth in the number of new casinos or the rate of replacement of existing gaming machines, failure to successfully develop and manage frequent introductions in innovative products.
More information on factors that could affect IGTâ€™s future business and financial results or cause us not to achieve our forecasts are included in our most recently 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 a 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 re-broadcast or use by any other party without the prior written consent of IGT. If you do not agree with these terms, please disconnect now. By remaining on the line you agree to be bound by these terms.
With that being said, earlier this morning we reported results for the fourth quarter and fiscal year 2008. Net income in the fourth quarter totaled $52.0 million, or $0.18 per diluted share, inclusive of write-downs of $29.0 million, or $0.10 per share, on certain investments, compared to $123.0 million, and $0.38 per diluted share, in the prior-year quarter.
For the year net income was $343.0 million, or $1.10 per diluted share, compared to $508.0 million, or $1.51 per diluted share, in the prior fiscal year.
The fourth quarter and fiscal year were affected by a number of notable items, the details of which are broken out in our earnings press release which went out earlier this morning. Numerous factors led to weaker operating conditions seen in the quarter, including credit market deterioration, wide-spread economic concerns, and inclement weather. Much has changed in the past few months, however, we remain confident that the company is positioned to capitalize on future opportunities.
Moving on to a discussion of our business segments, first with gaming operations. Our gaming operations business generated revenues of $331.0 million in the fourth quarter, which is down 1% sequentially and 6% year-over-year. Gross margins were 58% for the quarter versus 61% in the prior year.
Our gaming operations revenue and margins continue to see challenging operating conditions with lower play levels seen in most key jurisdictions. Normally our fourth quarter gaming operations revenue see at a 3% sequential increase due to seasonality. Once again, we believe the differential between our expected sequential growth and our actual numbers is partially due to macroeconomic factors affecting play levels.
As seen throughout 2008, our business has also been affected by a shift in product mix towards an increased percentage of lower-yielding stand-alone units in our install base.
For the year, revenues were $1.3 billion compared to the prior revenues of $1.4 billion. And gross margins, 58% for the fiscal year compared to 60% last year. Gross margins for the year were negatively impacted by declining interest rates resulting in additional jackpot expense as well as technical obsolescence charges for fixed assets. Without these impacts gross margins would have been essentially flat for the year compared to the prior year.
The decline in interest rates during the course of the year reduced our gross profit by approximately $25.0 million. We expect this impact to continue as rates are expected to remain low by historical standards for the foreseeable future.
Our install base ended the fourth quarter at 60,500 units, up 400 units over the prior year and sequential quarters. Approximately 74% of our install base is comprised of variable-fee games that earn a percentage of machine play levels rather than fixed daily fee.
Install base growth in the international markets and domestic racino markets was partially offset by reductions in Florida and California Class II markets as they transitioned to Class III for-sale games during the year.
Based on yield threshold considerations, the current reported install base and the historical comparisons have been revised to reflect approximately 900 international units previously excluded. Gaming operations revenues were not impacted by this adjustment in our reported install base.
IGT earned an average of $60 in revenue per unit per day versus $66 in the prior-year quarter and $61 sequentially. For the year, average revenue per unit per day came in at $61, down from $69 in the prior year. The decreases in revenue per unit are due to lower play levels resulting from the current economic environment and a growing mix of lower-yielding stand-alone units.
Now moving on to product sales, product sales revenue totaled $301.0 million for the quarter compared to $310.0 million in the prior year. For the fiscal year revenues were $1.2 billion compared to $1.3 billion in the prior year.
World-wide we shipped 20,100 machines during the quarter, down from prior-year shipments of 23,400. In the fiscal year IGT shipped 72, 700 machines, down from shipments of 105,900 machines last year.
Non-machine revenues comprised of gaming systems, game theme conversions, table parts, and intellectual property fees came in at $94.0 million for the quarter, or 31% of total product sales for the quarter, compared to $118.0 million and 38% of total product sales in the prior-year quarter.
For the year, non-machine revenues were $396.0 million, or 33% of total product sales, up from $384.0 million, or 30% in the prior fiscal year.
Product sales gross margins for the quarter and fiscal year were 54%, up 200 basis points from both prior-year periods.
Breaking product sales down, domestic versus international, first with domestic, domestic product sales totaled $184.0 million on volume of 8,900 units for the current quarter, compared to $186.0 million and 8,300 units in the prior-year quarter.
For the fiscal year, domestic product sales revenue was $732.0 million, down from $787.0 million in the prior year. Units shipped domestically for the fiscal year totaled 35,000, down from 43,000 in the prior year.
Replacement demand picked up modestly during the fourth quarter as IGT sold 4,900 replacement units compared to 3,600 units in the sequential quarter and 4,500 units last year, driven by demand for our new AVP models.
We successfully released five of our six new models during the third and fourth quarter and the last new model began shipping in October. Early feedback from our customers has been positive on these new models and based on current market place conditions, we anticipate replacement demand in 2009 will exceed 2008 levels.
We shipped 4,000 new and expansion units in the quarter, up 200 units from the prior-year quarter. Additionally, revenues from approximately 1,800 machines shipped during the fourth quarter are expected to be included in our next fiscal quarter.
Deferred revenue, including these 1,800 machines, increased approximately $38.0 million during the quarter to a total of $62.0 million at September 30, 2008. The increase is the result of our continued shift toward a more multi-element contracts, including systems and software sales.
Domestic non-machine revenues totaled $70.0 million in the quarter, down from $87.0 million in the prior-year quarter. For fiscal 2008 domestic non-machine revenues were $299.0 million, up from $295.0 million in fiscal 2007. The fourth quarter came in lower mostly due to the reduction in part sales comprised mostly of game conversions and system revenues.
We anticipate we will see stronger system sales in 2009 driven by an increased number of installations scheduled. We expect this to be partially offset by reduced parts revenues as conversions sold for legacy platform products will be reduced as a result of our migration of development efforts to the AVP platform.
IGT sold 8,900 domestic units in the quarter and 35,000 for the year compared to 8,300 in the prior quarter and 43,000 in the prior fiscal year. We estimate our ship share on new and replacement orders of 100 units or more at 61% for the quarter.
Domestic average revenue per unit was $20,600 for the fourth quarter compared to $22,400 in the prior-year quarter due to lower non-box revenues in the quarter. Sales from machines used by our AVP platform comprised 78% of total North American machines shipped during the fourth quarter and 63% for the year. We expect AVP machines to comprise well over 80% of our product mix going forward.
International product sales revenue totaled $118.0 million on volume of 11,200 units compared to $124.0 million and 15, 100 units in the prior-year quarter. For the fiscal year, revenues were $459.0 million, down from $474.0 million in the prior fiscal year, while units sold for the year were 37,700, down from 62,900 units in 2007.
The declines in both the quarter and the year were mostly due to Japan, where units shipped in the fourth quarter were 3,000 compared to 7,200 in the prior-year quarter and 6,500 for the year compared to 29,800 in 2007. These declines were somewhat offset by a record year of shipments in Latin America.
International non-machine sales were $25.0 million, down from $31.0 million in the prior-year quarter. Non-machine revenues for the year were $97.0 million, up from $89.0 million in the prior fiscal year. The decrease in the quarter was driven by a decrease in parts demand, while the increase for the year was mostly due to higher system sales.
International average revenue per unit in the fourth quarter was $10,500, up 28% over the prior-year quarter. For the year, international RPU was $12,200, up 64% over the prior fiscal year. The RPU increases were driven by fewer lower priced machines shipped into Japan and the U.K.
Product sales will continue to fluctuate quarter, depending on the geographic mix of sales and the mix of non-machine revenues. With the availability of our new six models and a geographically diverse pipeline of new and expansion projects, we expect to see improved machine shipment levels over the next few quarters.
Moving on to operating expenses and other income, total operating expenses were $204.0 million for the quarter compared to $179.0 million in the prior-year quarter.
SG&A totaled $125.0 million, an increase of $20.0 million over Q4 last year. We saw higher legal and compliance fees as well as higher staffing-related costs in the quarter. Bad debt provisions totaled a net expense of $4.0 million compared to $2.0 million in expense in the prior-year quarter.
R&D expense totaled $60.0 million for the quarter, up $54.0 million from the prior year. For the year our investment in R&D was $223.0 million, up 10% year-over-year.
Depreciation and amortization within operating expenses totaled $20.0 million for the quarter, flat with the prior-year quarter. For 2008 depreciation and amortization was $77.0 million, down from $80.0 million in 2007.
Total depreciation and amortization, inclusive of depreciation on our game ops assets that is recognized in cost of sales, the game ops, was $76.0 million for the quarter, up from $67.0 million in the prior-year [quarter] and $286.0 million in 2008, up from $266.0 million in the prior year.
Operating expenses as a percentage of revenues were 32% this quarter versus 27% in the prior-year quarter and 30% in the sequential quarter. For 2008 operating expenses were 30% of revenues compared to 26% in fiscal 2007.
Our SG&A expenses are being carefully scrutinized in an ongoing company-wide strategic review and we expect them to be at a lower run rate beginning in the second quarter of 2009. We continue to invest in future innovations and our server-based initiatives that is part of this strategic review. We are carefully considering the proper level of R&D spending given the current market place conditions. T.J. will have some further details later in the call on this topic.
While 2008 saw IGT benefit from the weakening of the dollar versus major foreign currencies, the trend has noticeable turned in recent months. IGTâ€™s operating income for 2008 was approximately $19.0 million higher when using exchange rates from 2007 as a benchmark, but due to strong rebound in the dollar we could see a negative impact to our operating income of similar or greater magnitude in 2009.
Other income expense net in the fourth quarter was a net expense of $47.0 million, up from $2.0 million in the prior-year quarter and a net expense of $69.0 million for the year compared to income net of $5.0 million in the prior year.
During the quarter we recognized $29.0 million in write-downs on investments in both China LotSynergy Holdings and Progressive Gaming International, based on the decline in their respective market values driven by tougher market conditions.
Moving on to the tax rate, our tax rate came in at 50% in the fourth quarter and 42% for the year, compared to 37% for both prior-year quarter and the year. The main driver for the increased rates came from non-cash charges related to investments I previously mentioned as we were not able to recognize the tax benefit of these capital losses for tax purposes. Without the charges, the tax rate for the year would have been 40%.
We estimate our annual tax rate for fiscal 2009 will be approximately 40% without any one-time charge backs or nondeductible book charges.
Our tax rate for Q1 should be lower than the remaining quarters of 2009 due to the impact of the extension of the R&D tax credit, which the President recently signed into law.
Moving on to the balance sheet, cash equivalents and short-term investments, inclusive of restricted amounts, totaled $374.0 million at September 30, 2008, compared to $401.0 million at September 30, 2007.
Total debt was $2.3 billion at September 30,2008, compared to $1.5 billion at the end of the previous fiscal year.
IGT will take a prudent and conservative approach to maintaining necessary liquidity in these volatile times. Our credit facility remains at an attractive source of capital for IGT with a current borrowing rate of under 4%. The undrawn capacity on our line totaled $1.2 billion at September 30, 2008. We believe that cash flow from operations and capacity on our line of credit are adequate to finance our future capital deployment.
During 2008 we repurchased 25.5 million shares at an aggregate cost of $780.0 million. Our outstanding share count stood at 294.7 million shares at September 30, 2008. We have 7.7 million shares remaining under our stock repurchase authorization as of September 30, 2008.
During fiscal 2008 IGT deployed back to shareholders a total of $955.0 million through both share buybacks and dividends.
While we believe at todayâ€™s price our stock is an excellent value, the current environment puts a premium on liquidity and as a result, until we see improvement in the credit markets, we will judiciously deploy our capital to preserve maximum flexibility.
Working capital totaled $733.0 million compared to $596.0 million at the end of fiscal 2007 with average days sales outstanding of 98 days and inventory turns of 2.5x.
Inventories have increased by $74.0 million since the end of 2007 as we ramp up production of our new AVP products into fiscal 2009.
In fiscal 2008 IGT generated $516.0 million cash from operations, down from $822.0 million last year. The decrease is primarily attributable to lower net income, changes in working capital, and additional prepayments made to secure long-term licensing rights to recognize brands, which help favorably differentiate our products in the market place.
Capital expenditures for the year totaled $298.0 million compared to $334.0 million in the prior year. The decrease is mainly attributable to the prior-year purchase of a corporate aircraft and construction of our Las Vegas campus.
Capex is expected to trend in a quarterly range of $60.0 million to $75.0 million going forward.
That concludes my prepared remarks regarding IGTâ€™s fourth quarter and fiscal year. Thanks for your time and attention. I will now turn the call over to T.J. for his closing remarks.
Thomas J. Matthews
Good morning to everyone. Before opening the lines to questions I would like to make some comments regarding our business and its outlook.
Obviously this last year we faced some of the most difficult marketing conditions weâ€™ve seen in our history and our current share price clearly reflects that the market conditions demonstrate those concerns of all gaming companies, including the health of the consumer, the health of the operators and our ability to sell to them.
But despite these concerns, IGT saw its second highest year of revenue, up just 4% from last yearâ€™s all-time high. And this was done in a year in which IGT saw the lowest level of North American unit demand since 1993, which obviously speaks well to our efforts to diversify our business and its sources of revenue.
Our fourth quarter EPS after charges is down $0.10 from last year. About $0.05 of this difference comes from the reduced play levels and higher tax rates, factors that are generally beyond our control but which in time could change favorably for IGT. The remaining $0.05 comes from our cost structure which we are targeting in an ongoing review of our organization. We are close to concluding the first phase of this strategic business review that I mentioned in our last earnings call.
We are going to make strategic changes to increase productivity and responsiveness to the customer and its market place needs. We are going to rationalize expenses and we have already started to put that into place. The next step is to adjust headcount, which will reflect current and our expected future market conditions.
We are targeting initial costs savings of about $20.0 million to $25.0 million per quarter compared to our current levels and we expect the impact to begin in the second quarter of 2009. We are continuing to take a look at expenses throughout the year as we continue to have a goal of 30% operating margins.
In terms of trying to give some guidance and what our revenue growth might look like, our visibility is limited at this point. We are confident that we are going to ship more domestic replacement units due to the new AVP machines, due to the early reports of strong performance. Weâ€™re excited about some of the products we have there, not only with the cabinets and game design, but some of the unique technology like the MLD. And we know that there are going to be global opportunities that are going to remain very attractive and are going to be a large part of our business in the future.
So with that, to talk about guidance, we see our customers continue to make purchases of gaming equipment and utilize our gaming machines in their own operations but their financial flexibility is clearly constrained in most cases and we also face numerous head winds that Pat had mentioned, not only reduced play levels from the consumer but lower interest rates and volatility in foreign exchange rates.
Until these head winds subside somewhat, we would anticipate that our EPS would probably come in at the lower end, or maybe even slightly below, our previous guidance of $0.30 to $0.35. thatâ€™s obviously a topic that we will continue to revisit on future earnings calls.
We are hopeful that play levels will start to stabilize and maybe even grow and that the impacts of our cost reductions also favorably impact future guidance that weâ€™re able to give.
With all of that, I am going to open the line to questions.