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IGT > SEC Filings for IGT > Form 10-K on 28-Nov-2012All Recent SEC Filings

Show all filings for INTERNATIONAL GAME TECHNOLOGY

Form 10-K for INTERNATIONAL GAME TECHNOLOGY


28-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following MDA is intended to enhance the reader's understanding of our operations and current business environment from the perspective of our company's management. MDA is provided as a supplement to, and should be read in conjunction with, the accompanying Item 1, Business and Item 8, Financial Statements and Notes.

Our MDA is organized into the following sections:
· OVERVIEW

· CONSOLIDATED RESULTS

· BUSINESS SEGMENT RESULTS

· LIQUIDITY AND CAPITAL RESOURCES

· RECENTLY ISSUED ACCOUNTING STANDARDS

· CRITICAL ACCOUNTING ESTIMATES

We sometimes refer to the impact of changes in foreign currency exchange rates, which results from translating foreign functional currencies into US dollars, as well as currency transaction remeasurement, for reporting purposes. The impact of foreign currency exchange rate fluctuations represents the difference between current rates and prior period rates applied to current period activity.

OVERVIEW

International Game Technology is a global gaming company specializing in the design, development, manufacture, and marketing of casino games, gaming equipment and systems technology for land-based and online social gaming and wagering markets. We are a leading supplier of gaming entertainment products worldwide and provide a diverse offering of quality products and services at competitive prices, designed to enhance the player's experience.

We manage our operations in two geographic business segments, North America and International, each incorporating all revenue categories-Gaming Operations, Product Sales, and Interactive. Gaming operations and interactive revenues are generated by providing our products and services under a variety of recurring revenue arrangements. Product Sales revenues are generated by the sale of our products or services. Certain unallocated income and expenses managed at the corporate level, comprised primarily of general and administrative costs and other income and expense, are not allocated to an operating segment. See Item 1-REVENUE CATEGORIES, BUSINESS SEGMENT RESULTS below and Note 18.

Consolidated Results

                                                                           Favorable (Unfavorable)
                       2012          2011          2010              12 vs 11                  11 vs 10
Revenues             $ 2,150.7     $ 1,957.0     $ 1,917.2     $  193.7           10 %   $   39.8            2 %
Operating income     $   421.7     $   504.9     $   424.8     $  (83.2 )        -16 %   $   80.1           19 %
Income from
continuing
operations           $   249.7     $   292.3     $   219.6     $  (42.6 )        -15 %   $   72.7           33 %
EPS from
continuing
operations           $    0.86     $    0.97     $    0.73     $  (0.11 )        -11 %   $   0.24           33 %

Results for our year ended September 30, 2012 reflected a 10% improvement in revenues, primarily due to added contribution from our recent interactive business acquisitions (DoubleDown in late January 2012 and Entraction in late June 2011) and higher North America machine sales. The decrease in operating income, and income and EPS from continuing operations (down 16%, 15%, and 11% respectively) was primarily due to higher operating expenses, largely related to additional investment in emerging interactive markets and technology.

Operating expenses for 2012 also reflected impairment and restructuring charges of $42.5 million, including $14.6 million related to reduced usage of Walker Digital patents, $12.8 million related to further decline in the value of our Alabama notes, and $15.1 million related to the reorganization of our IGTi operations involving the closure of certain Entraction services and facilities. Increased expenses were partially offset by a tax benefit of $44.7 million related to the Entraction closures.


Additionally, our 2012 EPS was favorably impacted by 32.7 million shares repurchased primarily during the latter half of the year. See Note 17 for information about our share repurchases. For a more in-depth analysis of our 2012 results, see CONSOLIDATED RESULTS directly following this OVERVIEW.

Business Update

The gaming industry continues to be negatively impacted by reduced discretionary spending from consumers (players), which in turn reduces spending by our customers (casinos & other gaming operators). A slow global economic recovery has resulted in a slow rate of new casino openings and expansions, along with increased competitive pressures in replacement demand due to constrained capital budgets. We believe replacement demand will improve as the economy recovers and our customers' capital budgets are increased. We also expect increased demand from new casino openings and expansions in the long-term, as new gaming markets develop in both land-based and online jurisdictions. Although the breadth and timing of these opportunities and risks remains uncertain, we expect year-over-year improvement in 2013, primarily attributable to anticipated replacement demand from the Canada Government Lottery.

As the North America market matures, we believe International markets will offer greater prospects for growth. Our business activities in certain International jurisdictions have been challenging during 2012. In some regions, governmental restrictions have caused delays in product delivery, revenue recognition, and the repatriation of cash. Our online real-money wagering operations in Europe have faced unexpected regulatory challenges that caused us to reevaluate our IGTi interactive resources, products, and markets from a commercial and compliance perspective.

During our 2012 fourth quarter, we determined it was prudent to consolidate our IGTi product development and customer service resources in Europe primarily acquired with Entraction, due in part to diminished returns largely related to regulatory challenges. As a result, we began exiting certain online turnkey and poker operations and closing or reducing certain facilities in Europe (Stockholm and Tallinn). We recognized impairment and restructuring charges of $15.1 million in the 2012 fourth quarter and expect to incur up to an additional $5 million of restructuring costs during the first half of 2013. See Note 19.

DoubleDown

In January 2012, we acquired Seattle based Double Down Interactive LLC., developer and operator of the online social gaming DoubleDown Casino® found on Facebook. DoubleDown has a broad and expanding casino-style game portfolio, offering blackjack, slots, slot tournaments, video poker, and roulette to social gamers around the world. This strategic acquisition has established IGT's position in casino-style social gaming and strengthened our core business with added distribution channels for IGT game content. DoubleDown was presented as a component of North America interactive operations. See Note 20.

Strategic Objectives

We continued to partner with our customers in an effort to deliver stronger relationships and innovative gaming products and services. For 2012, we focused on the following strategic short-term and long-term objectives designed to improve our business and shareholder value:

Increase Velocity of Revenue Growth by improving global scalability, increasing our international sales presence, and developing games more aligned with local player preferences.

Continuously Improve Operating Margins by expanding global process efficiencies and leveraging operating expenses.

Develop Next Generation Platforms that will extend IGT offerings beyond our historical product and customer set, as well as converge and connect player experiences across multiple platforms and distribution channels.

Leverage Cash Flows by investing in future growth and platforms, as well as returning capital to shareholders through dividends and share repurchases.

Energize Interactive Business by securing significant online customers and increasing our presence in casino-style social gaming.


Our core objectives for 2013 are designed to build on our 2012 operating improvements by focusing on the following strategic objectives:

Deliver returns through our continued commitment to create leverage by reaching every player, everywhere and focus on our core business.

Grow International revenues by broadening our MegaJackpots® installed base and increasing our localized content and multi-lingual games.

Energize mobile solutions by significantly expanding IGTi and social gaming offerings throughout our mobile/online environment.

Propel best-in-class game content to new levels across all platforms.

CONSOLIDATED RESULTS - A Year Over Year Comparative Analysis

                                                                            Favorable (Unfavorable)
                       2012          2011          2010               12 vs 11                   11 vs 10
Total Revenues       $ 2,150.7     $ 1,957.0     $ 1,917.2     $  193.7            10 %   $   39.8             2 %
Gross margin                58 %          58 %          57 %          -   pp        -            1   pp        2 %

Operating Income     $   421.7     $   504.9     $   424.8     $  (83.2 )         -16 %   $   80.1            19 %
Margin                      20 %          26 %          22 %         (6 ) pp      -23 %          4   pp       18 %

Income from
continuing
operations           $   249.7     $   292.3     $   219.6     $  (42.6 )         -15 %   $   72.7            33 %
Discontinued
operations                (3.8 )        (8.7 )       (33.6 )        4.9             *         24.9             *
Net income           $   245.9     $   283.6     $   186.0     $  (37.7 )         -13 %   $   97.6            52 %

EPS
Continuing
operations           $    0.86     $    0.97     $    0.73     $  (0.11 )         -11 %   $   0.24            33 %
Discontinued
operations               (0.01 )       (0.03 )       (0.11 )       0.02             *         0.08             *
Net income           $    0.85     $    0.94     $    0.62     $  (0.09 )         -10 %   $   0.32            52 %

2012 Compared With 2011

Total revenues grew 10%, driven primarily by increases from interactive (up $107.3 million) and machine sales (up $95.4 million). Changes in foreign currency rates negatively impacted revenues by approximately $15.5 million.

Operating income decreased 16% primarily due to increased operating expenses of $150.0 million related to emerging interactive markets and technology, including additions from the acquisitions of DoubleDown and Entraction. Interactive operating expenses included acquisition related charges primarily for DoubleDown of $69.1 million, mostly related to contingent retention bonus and earn-out liability accruals. Operating income also decreased due to higher impairment and restructuring charges. See OPERATING EXPENSES below for additional information.

Income from continuing operations decreased 15% for the same reasons operating income decreased and included a tax benefit of $44.7 million related to the Entraction closures.

2011 Compared With 2010

Improved operating income was primarily the result of higher product sales volume combined with reduced impairment and restructuring charges (see OPERATING EXPENSES below) and gross margin expansion. Impairment charges in 2011 related to corporate assets held for sale, certain underperforming fixed assets, and additional decline in our Alabama notes receivable. The 2010 impairment charges related to the Alabama charitable bingo market closures.

Favorable foreign exchange rates also contributed approximately $27.6 million (largely Australia) to the increase in revenues. Income from continuing operations also benefited from reduced interest costs and favorable net investment gain, partially offset by higher tax provisions.


Discontinued operations (See Note 21)

As part of our strategic realignment of core objectives, we sold our UK Barcrest Group in 2011 for approximately $47.0 million, which remains subject to contingent consideration related to certain customer arrangements. Loss on sale totaled $2.4 million (or $3.8 million after-tax) in 2012 and $22.6 million (or $12.6 million after-tax) in 2011. During 2010, our Japan operation was closed and DigiDeal was divested in conjunction with changes in our core business strategy. Results for these groups have been classified in discontinued operations for all periods presented.

GAMING OPERATIONS

                                                                                Favorable (Unfavorable)
                             2012          2011          2010              12 vs 11                 11 vs 10
Revenues                   $ 1,040.0     $ 1,036.5     $ 1,044.2     $   3.5            -     $  (7.7 )         -1 %
Gross margin                      61 %          61 %          60 %         -   pp       -           1   pp       2 %

Installed base (units
'000)                           57.1          53.9          52.9         3.2            6 %       1.0            2 %
MegaJackpots® (premium
brand)                          27.1          27.8          27.2        (0.7 )         -3 %       0.6            2 %
Lease (CDS, Racino,
other)                          30.0          26.1          25.7         3.9           15 %       0.4            2 %

Yield (average revenue
per unit)                  $   51.49     $   53.34     $   51.72     $ (1.85 )         -3 %   $  1.62            3 %

2012 Compared With 2011

Gaming operations revenues were essentially flat, with International revenue increases offset by North America decreases. Gross margin remained flat, as lower yield was offset by favorable jackpot expense and royalties. Installed base increased 6% due to lease additions partially offset by decreases in Megajackpots® units. Yield decreased primarily due to lower performance and higher discounting in Megajackpots®, as well as an increasing mix of lower-yield stand-alone units.

2011 Compared With 2010

Our gaming operations installed base increased 2% due to international growth. North America revenue decline, largely due to facility closures in Alabama during 2010, was nearly offset by International increase. Gross margin improved primarily due to yield improvement, attributable to higher play levels, most significant in our MegaJackpot® brands, an increasing mix of newer, higher performing game titles, and the removal of lower-yield Alabama and Mexico units. Gross margin also benefited from favorable expenses, including lower jackpot expense, as well as reduced depreciation, casino service costs, and tax and license fees in CDS and lease operations.

PRODUCT SALES

                                                                           Favorable (Unfavorable)
                            2012        2011        2010              12 vs 11                  11 vs 10
Revenues                   $ 966.8     $ 883.9     $ 843.0     $  82.9              9 %   $  40.9            5 %
Machines                     653.5       558.1       521.3        95.4             17 %      36.8            7 %
Non-machine (systems,
parts, other)                313.3       325.8       321.7       (12.5 )           -4 %       4.1            1 %

Gross margin                    54 %        55 %        53 %        (1 )   pp      -2 %         2   pp       4 %

Machine units recognized
('000) (1)                    43.6        37.5        34.7         6.1             16 %       2.8            8 %

Machine ASP ('000)         $  15.0     $  14.9     $  15.0     $   0.1              1 %   $  (0.1 )         -1 %

Machine units shipped
('000) (2)                    44.2        35.9        32.7         8.3             23 %       3.2           10 %
New/expansion                 12.9        11.4        13.4         1.5             13 %      (2.0 )        -15 %
Replacement                   31.3        24.5        19.3         6.8             28 %       5.2           27 %

(1) correlates with revenues recognized; (2) includes deferred revenue units


2012 Compared With 2011

Product sales grew 9% primarily due to increased replacement machine units sold in North America and higher ASP. Increased machine revenues were partially offset by lower non-machine revenues (down 4%), where lower systems and parts sales (down $21.7 million collectively) were offset by higher license fee revenues (up $9.2 million). Gross margin decline was primarily due to higher international machine component and rework costs. The increase in North America replacement machine units was due in large part to the fulfillment of a large Canadian Lottery contract and significant lease units converted to for-sale. Consolidated ASP increased 1%, due to lower promotional discounts and a greater mix of newer MLD machines in North America.

Deferred revenue increased $1.4 million during 2012 to $60.5 million at September 30, 2011, primarily related to obligations under multi-element contracts. During 2012, we shipped 2,800 units for which revenues were deferred and recognized revenues for 2,100 units previously shipped, for a net increase of 700 units in deferred revenue.

2011 Compared With 2010

Product sales growth in 2011 was driven primarily by higher North America replacement units, fueled by increased promotions. Favorable jurisdiction and product mix, as well as cost efficiencies and lower discounts, further improved gross profit and margin. Increased 2011 fourth quarter promotions contributed to a slower 2012 first quarter.

Deferred revenue decreased $31.1 million during 2011 to $59.1 million at September 30, 2011, primarily related to the completion of obligations under multi-element contracts. During 2011, we shipped 2,400 units for which revenues were deferred and recognized revenues for 4,000 units previously shipped, for a net decrease of 1,600 units in deferred revenue.

INTERACTIVE

                                                                         Favorable (Unfavorable)
                       2012         2011         2010              12 vs 11                   11 vs 10
Revenues             $  143.9     $   36.6     $   30.0     $  107.3           293 %   $    6.6            22 %
Social gaming            87.0            -            -         87.0             -            -             -
IGTi                     56.9         36.6         30.0         20.3            55 %        6.6            22 %

Gross margin               56 %         51 %         53 %          5   pp       10 %         (2 ) pp       -4 %

DoubleDown Average
user statistics
Daily acitve
users/DAU ('000)        1,372
Monthly active
users/MAU ('000)        5,097
Bookings per
DAU(0.00)            $   0.26

2012 Compared With 2011

Interactive revenue growth was primarily the result of recent business acquisitions, primarily DoubleDown's social gaming in late January 2012, as well as Entraction in late June 2011 included in IGTi. Since acquisition, social gaming revenues have increased each quarter due to the combination of higher bookings per DAU (up 49%) and increased DAU (up 6%), largely driven by new IGT content and mobile platform introductions for the DoubleDown Casino®. Other IGTi operations contributed $9.6 million to revenue growth in 2012, primarily due to IGT rgsTM customer expansion, new games released, and player adoption of IGT games, as well as a VAT settlement of $7.4 million.

Interactive gross margin increased 10% primarily due to the favorable contribution from the DoubleDown acquisition, partially offset by additional amortization of acquired intangibles of $5.8 million increased equipment depreciation and transaction costs.

Entraction contributed $15.1 million to 2012 IGTi revenues. As a result of our decision to exit Entraction online turnkey and poker operations, we expect no material Entraction revenues in 2013.


2011 Compared With 2010

Interactive revenue growth in 2011 was primarily the result of the added contributions of $4.5 million from the Entraction acquisition in late June 2011. Other IGTi operations also contributed $2.1 million to revenue growth in 2011, primarily attributable to increased customers, games released, and player adoption of IGT games. Gross margin decline was primarily due to increased equipment depreciation and transaction costs.

OPERATING EXPENSES

                                                                        Favorable (Unfavorable)
                       2012         2011         2010             12 vs 11                  11 vs 10

Selling, general
and administrative   $  410.4     $  353.3     $  330.4     $  (57.1 )        -16 %   $  (22.9 )         -7 %
Research and
development             217.0        194.7        189.4        (22.3 )        -11 %       (5.3 )         -3 %
Depreciation and
amortization             76.9         69.7         74.3         (7.2 )        -10 %        4.6            6 %
Contingent
acquisition
related costs            69.1            -            -        (69.1 )          -            -            -
Impairment and
restructuring            42.5         15.8         68.4        (26.7 )       -169 %       52.6           77 %
Total operating
expenses             $  815.9     $  633.5     $  662.5     $ (182.4 )        -29 %   $   29.0            4 %
Percent of
revenues                   38 %         32 %         35 %

2012 Compared With 2011

Operating expenses increased 29%, primarily due to additional investment in emerging interactive markets and technology. Operating expenses related to interactive initiatives, including additions from Entraction and DoubleDown, increased $150.0 million, of which acquisition related charges (primarily from DoubleDown) totaled $88.2 million, comprised of contingent employee retention bonuses ($41.6 million) and earn-out valuation adjustment ($27.5 million), amortization of acquired intangibles ($13.3 million), and professional consulting fees ($5.8 million).

Impairment and restructuring charges for 2012 included $14.6 million related to Walker Digital patents, $12.8 million related to further decline in the value of our Alabama notes' collateral, and $15.1 million related to the reorganization of our IGTi operations involving the closure of certain Entraction services and facilities. See Note 19 for additional information about these charges. As a result of the Entraction closures, we expect to incur up to an additional $5.0 million of restructuring costs during the first half of 2013.

Other incremental operating costs in SG&A and R&D included settlement charges of $3.1 million related to the early termination of a distributor arrangement.

2011 Compared With 2010

Operating cost increases included development initiatives related to our interactive product line of $12.6 million and $9.4 million for LAC operations. Higher variable compensation was partially offset by lower bad debt (down $2.2 million) and other cost efficiencies maintained from previous restructuring efforts.

Impairment charges for 2011 related to corporate assets held for sale, certain underperforming fixed assets, and additional decline in our Alabama notes receivable. The 2010 impairment charges related to the Alabama charitable bingo market closures. See Note 19 for additional information about these charges.


OTHER INCOME (EXPENSE)

                                                                        Favorable (Unfavorable)
                       2012         2011         2010             12 vs 11                  11 vs 10

Interest Income      $   45.3     $   51.2     $   61.1     $   (5.9 )        -12 %   $   (9.9 )        -16 %
WAP investments          20.0         22.4         24.9         (2.4 )        -11 %       (2.5 )        -10 %
Receivables and
investments              25.3         28.8         36.2         (3.5 )        -12 %       (7.4 )        -20 %

Interest Expense       (122.2 )     (130.8 )     (161.7 )        8.6            7 %       30.9           19 %
WAP jackpot
liabilities             (19.9 )      (22.2 )      (24.6 )        2.3           10 %        2.4           10 %
Borrowings              (69.9 )      (79.0 )     (107.4 )        9.1           12 %       28.4           26 %
Convertible debt
equity discount         (32.4 )      (29.6 )      (29.7 )       (2.8 )         -9 %        0.1            -

Other, including
gain (loss)              (2.0 )        2.6        (19.3 )       (4.6 )       -177 %       21.9          113 %

Total other income
(expense), net       $  (78.9 )   $  (77.0 )   $ (119.9 )   $   (1.9 )         -2 %   $   42.9           36 %

2012 Compared With 2011

The unfavorable variance in total other income (expense) was primarily due to increased foreign currency losses and lower interest income, partially offset by higher investment gains and decreased interest expense on lower average borrowing rates. Interest income decreased on a lower-rate portfolio of receivable and investments. Foreign currency losses increased $8.8 million primarily from UK and Australia currency transactions. Other income in 2011 included $4.3 million of gain on the sale of our CLS equity investment.

WAP interest income and expense relates to previous jackpot winner liabilities and accretes at approximately the same rate. WAP interest income also includes earnings on restricted cash and investments held for future winner payments.

2011 Compared With 2010

The favorable variance in total other income (expense) was primarily due to decreased interest expense on lower debt and favorable net gain/loss on investments, derivatives, and foreign currency, partially offset by decreased interest income from customer financing. Other expense included $4.3 million of gain on the sale of our CLS equity investment during 2011 and loss of $20.5 million related to changes in our CLS notes receivable in 2010.

INCOME TAX PROVISION

                                                               Favorable (Unfavorable)
                           2012       2011        2010       12 vs 11            11 vs 10

    Income tax provision   $ 93.1     $ 135.6     $ 85.3      $     42.5       $      (50.3 )
    Effective tax rate       27.2 %      31.7 %     28.0 %           4.5               (3.7 ) pp

Differences between our effective tax rate and the US federal statutory rate of 35% principally result from the geographical distribution of taxable income, differences between the book and tax treatment of certain permanent items, and changes in unrecognized tax benefits. See Note 14 for additional information about our tax provision.

2012 Compared With 2011

The 2012 effective tax rate on income from continuing operations was favorably impacted by a tax benefit of $44.7 million related to certain Entraction closures. In addition, the 2012 effective tax rate was negatively impacted by the expiration of the R&D tax credit and losses of $31.0 million in foreign jurisdictions for which there were no associated tax benefits.

2011 Compared With 2010

Our 2011 effective tax rate on income from continuing operations increased . . .

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