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IGT > SEC Filings for IGT > Form 10-K on 26-Nov-2013All Recent SEC Filings

Show all filings for INTERNATIONAL GAME TECHNOLOGY

Form 10-K for INTERNATIONAL GAME TECHNOLOGY


26-Nov-2013

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 the translation of foreign functional currencies into US dollars and foreign currency transactions remeasurement. 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-style gaming equipment, systems technology, and game content across multiple platforms-land-based, online real-money and online social. 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 gaming player experience.

We derive our revenues from the distribution of casino games, gaming equipment and systems technology for land-based and online (social and real-money) markets. Operating results reviewed by our CEO encompass all revenue sources within each geographical region. We currently view our business in two operating segments, North America and International, each incorporating all revenue categories-Gaming Operations, Product Sales, and Interactive.

We measure segment profit on the basis of operating income. Certain income and expenses are managed at the corporate level and not allocated to an operating segment. Other segment and financial information is contained in our BUSINESS SEGMENT RESULTS below and Note 19. Unless otherwise noted, prior year amounts throughout this report have been adjusted for operations discontinued during 2011, as further described in Note 22.

Consolidated Results

                             Years Ended September 30,                           C h a n g e
                         2013          2012          2011             13 vs 12                 12 vs 11
Revenues               $ 2,341.6     $ 2,150.7     $ 1,957.0     $  190.9          9 %   $   193.7         10 %
Operating income       $   494.1     $   421.7     $   504.9     $   72.4         17 %   $   (83.2 )      -16 %
Income from
continuing
operations             $   272.7     $   249.7     $   292.3     $   23.0          9 %   $   (42.6 )      -15 %
EPS from continuing
operations             $    1.03     $    0.86     $    0.97     $   0.17         20 %   $   (0.11 )      -11 %

Results for our year ended September 30, 2013 above improved over the prior year, primarily due to an increase of $191.0 million or 12% in North America revenues, attributable to an increase of $133.0 million in interactive social gaming from DoubleDown acquired in late January 2012 and $111.6 million or 17% in product sales. These increases were partially offset by a decrease of $53.6 million or 6% in North America gaming operations.


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Operating income also improved because revenue growth outpaced increased operating expenses. Income and EPS from continuing operations was negatively impacted by a higher effective income tax rate primarily due to a prior year tax benefit of $44.7 million related to Entraction closures. EPS from continuing operations also benefitted from fewer shares outstanding due to share repurchases discussed further in Note 17. For a more in-depth analysis of our 2013 results, see CONSOLIDATED RESULTS directly following this OVERVIEW.

Business Update

Increased VLT demand from various government lotteries in Canada and gaming expansion in Illinois, as well as new openings in Ohio, contributed significantly to improved machine sales during 2013. VLT shipments into Canada were substantially completed in 2013. Worldwide economic uncertainty continues to impact the willingness of our customers to purchase electronic gaming machines at an increased pace. Additionally, market impediments have hampered sales in certain international regions. We remain committed to expanding our portfolio of localized content and continue to believe growth in the international markets will outpace North America in the long term.

In gaming operations, we also continue to be challenged by increasing competition that is investing heavily in this product line. Additionally, industry-wide gross gaming revenues remain challenged by lower discretionary spending influenced by global macroeconomic uncertainty. These challenges are most evident in the reduction of our gaming operations yields. We are addressing these challenges with added team resources in MegaJackpots®, an increased mix of franchise titles such as Wheel of Fortune®, social media marketing programs, and focused releases of innovative new game content. We also remain committed to disciplined capital deployment and attempting to offset some of the yield pressures through greater operational efficiency.

Technological advances in and the increasing popularity of wireless mobile technology, such as smart phones, tablets, and social networking, have led to growth in online gaming. Online games can appeal to a broader consumer demographic of players. With the acquisition of DoubleDown in January 2012, we established a leading position in interactive online casino-style social gaming, adding new distribution channels for IGT game content, and providing players access to our games across multiple platforms and devices. Our 2013 social gaming revenues increased 151% over last year, largely attributable to the introduction of IGT content to the DoubleDown Casino®. With the recent legalization of online real-money gaming in Nevada, New Jersey, and Delaware, we expect interactive online gaming to continue to be an important strategic part of our business and intend to enter and do business in those markets that offer attractive return characteristics and build on our existing capabilities.

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 is presented as a component of North America interactive operations. See Note 21.

Strategic Objectives

We continue to partner with our customers to build stronger relationships and deliver innovative gaming products and services. For 2013, we focused on the following strategic objectives designed to improve our business and increase shareholder value:

· Propelling our game content across the broadest possible global network

· Reinforcing a leadership position in our core business

· Increasing revenues and profitability in international markets

· Returning capital to shareholders in a consistent, efficient manner


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We will continue to execute our strategy, adjusting it as opportunities arise and the industry and business evolves. As we enter our new fiscal year 2014, we are focused on three strategic objectives:

(1) Assembling the most compelling and highest performing game library available-serving both the operators and players

(2) Expanding and managing the broadest distribution network globally

(3) Maximizing value through the efficient operation of our business, the optimal generation of cash flow, and the responsible, dependable return of capital to shareholders

CONSOLIDATED RESULTS - A Year Over Year Comparative Analysis

                           Years Ended September 30,                                 Change
                       2013          2012          2011               13 vs 12                    12 vs 11
Revenues             $ 2,341.6     $ 2,150.7     $ 1,957.0     $  190.9              9 %   $  193.7             10 %
Gross margin                57 %          58 %          58 %         (1 ) pp                      -   pp
Operating income     $   494.1     $   421.7     $   504.9     $   72.4             17 %   $  (83.2 )          -16 %
Margin                      21 %          20 %          26 %          1    pp                    (6 ) pp
Income from
continuing
operations           $   272.7     $   249.7     $   292.3     $   23.0              9 %   $  (42.6 )          -15 %
Discontinued
operations                   -          (3.8 )        (8.7 )        3.8              *          4.9              *
Net income           $   272.7     $   245.9     $   283.6     $   26.8             11 %   $  (37.7 )          -13 %
EPS
Continuing
operations           $    1.03     $    0.86     $    0.97     $   0.17             20 %   $  (0.11 )          -11 %
Discontinued
operations                   -         (0.01 )   $   (0.03 )   $   0.01              *     $   0.02              *
Net income           $    1.03     $    0.85     $    0.94     $   0.18             21 %   $  (0.09 )          -10 %

2013 Compared With 2012

Total revenues improved due to an increase of $191.0 million in North America revenues, attributable to an increase of $133.0 million in interactive, mostly from the growing social gaming revenues of DoubleDown acquired in late January 2012, and $111.6 million in product sales. These increases were partially offset by a decrease in North America gaming operations revenues of $53.6 million. Changes in foreign currency rates negatively impacted revenues by approximately $9.9 million. Total gross margin declined due to lower product sales margins, partially offset by improved margins in interactive and gaming operations.

Operating income and margin improved because revenue growth outpaced increased operating expenses discussed below under OPERATING EXPENSES. Income and EPS from continuing operations was negatively impacted by a higher effective income tax rate primarily due to a prior year tax benefit of $44.7 million related to Entraction closures as discussed below under INCOME TAX PROVISIONS. EPS additionally benefitted from fewer shares outstanding due to share repurchases discussed further in Note 17.

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. 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.

Discontinued operations (See Note 22)

Due to a strategic realignment, our UK Barcrest Group was sold in 2011 for approximately $47.0 million and the resolution of contingent consideration over the next two years may result in additional gain or loss.


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GAMING OPERATIONS

                          Years Ended September 30,                                 Change
                       2013         2012          2011               13 vs 12                    12 vs 11
Revenues             $  991.4     $ 1,040.0     $ 1,036.5     $   (48.6 )          -5 %   $     3.5             -
Gross margin               62 %          61 %          61 %           1   pp                      -   pp
Installed base
(units '000)             54.6          57.1          53.9          (2.5 )          -4 %         3.2             6 %
MegaJackpots®
(premium brand)          25.1          27.1          27.8          (2.0 )          -7 %        (0.7 )          -3 %
Lease (CDS,
Racino, other)           29.5          30.0          26.1          (0.5 )          -2 %         3.9            15 %
Yield (average
revenue per unit
per day - $0.00)     $  48.74     $   51.49     $   53.34     $   (2.75 )          -5 %   $   (1.85 )          -3 %

2013 Compared With 2012

Gaming operations revenues decreased primarily driven by lower yields, most significant in MegaJackpots®, as well as installed base decline. The installed base decrease was primarily from North America MegaJackpots® units, and to a lesser extent from International lease units. Gross margin improvement was primarily due to lower jackpot expense in correlation with lower WAP revenues and lower depreciation related to fewer machine builds. Yield decreased primarily due to lower performance, most significant in North America MegaJackpots® WAP games, and continued installed base shift into lower-yield lease units.

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 promotional discounting in MegaJackpots®, as well as an increasing mix of lower-yield stand-alone units.

PRODUCT SALES

                          Years Ended September 30,                                Change
                        2013          2012         2011              13 vs 12                   12 vs 11
Revenues             $  1,085.2     $  966.8     $  883.9     $  118.4            12 %   $   82.9             9 %
Machines                  755.5        653.5        558.1        102.0            16 %       95.4            17 %
Non-machine (a)           329.7        313.3        325.8         16.4             5 %      (12.5 )          -4 %
Gross margin                 52 %         54 %         55 %         (2 ) pp                    (1 ) pp
Machine units
recognized ('000)
(1)                        57.2         43.6         37.5         13.6            31 %        6.1            16 %
Machine ASP ('000)   $     13.2     $   15.0     $   14.9     $   (1.8 )         -12 %   $    0.1             1 %
Machine units
shipped ('000) (2)         55.6         44.2         35.9         11.4            26 %        8.3            23 %
New/expansion              13.6         12.9         11.4          0.7             5 %        1.5            13 %
Replacement                42.0         31.3         24.5         10.7            34 %        6.8            28 %

(a) non-machine revenue includes systems, license fees, parts/service/other
(1) correlates with revenues recognized; (2) includes deferred revenue units

2013 Compared With 2012

Product sales revenue grew primarily due to increased North America machines and systems sales. Machine units recognized increased primarily driven by 6,000 additional VLT replacement units in Canada, 4,400 new VLT units in Illinois, and 4,600 poker replacement units sold under a multi-property corporate contract. Machine ASP decreased primarily due to promotional discounting and a higher mix of lower-priced VLT and poker units. Non-machine revenue increase was primarily due to an increase of $14.0 million in systems sales and higher IP license fees, primarily due to a patent royalty settlement of $5.0 million. Gross margin decreased primarily due to increased promotional discounting.

Deferred revenue decreased $23.1 million during 2013 to $37.4 million at September 30, 2013, primarily related to the completion of obligations under multi-element contracts. During 2013, we shipped 800 units for which revenues were deferred and recognized revenues for 2,400 units previously shipped, for a net decrease of 1,600 units in deferred revenue.


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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 MLDTM 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.

INTERACTIVE

                           Years Ended September 30,                                Change
                       2013            2012         2011              13 vs 12                   12 vs 11
Revenues             $   265.0       $  143.9     $   36.6     $  121.1            84 %   $  107.3           293 %
Social gaming            218.5           87.0            -        131.5           151 %       87.0             -
IGTi                      46.5           56.9         36.6        (10.4 )         -18 %       20.3            55 %
Gross margin                61 %           56 %         51 %          5   pp                     5   pp
DoubleDown average user metrics*
DAU ('000)               1,636          1,372            -          264            19 %          *             *
MAU ('000)               6,141          5,097            -        1,044            20 %          *             *
Bookings per DAU
($0.00)              $    0.37       $   0.26            -     $   0.11            42 %          *             *

*as a single application with multiple games, active users equal unique users

2013 Compared With 2012

Interactive revenue grew primarily as a result of growth in our DoubleDown Casino®. Social gaming revenues continue to improve as a result of increases in both bookings per DAU and DAU. These improvements were driven primarily by the introduction of IGT content to the DoubleDown Casino® and overall growth in desktop and mobile platform applications.

IGTi revenues decreased $14.3 million related to the closures of certain European online turnkey and poker operations and $7.4 million due to the prior year VAT settlement. These decreases were partially offset by an increase of $11.3 million in online casino revenues, primarily due to a 36% increase in the number of IGT rgs® customers. Additionally, mobile applications generated 21% of IGTi online casino revenues compared to 10% in the prior year.

Gross margin improvement was primarily due to the favorable contribution from social gaming. Amortization in cost of sales for DoubleDown acquired developed technology totaled $9.2 million in 2013 and $5.0 million in 2012.

2012 Compared With 2011

Interactive revenue growth was primarily the result of business acquisitions, with DoubleDown in social gaming in late January 2012 and Entraction in late June 2011 in IGTi. Since acquisition, the social gaming revenues of DoubleDown 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 site.


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IGTi online casino operations contributed $9.6 million to revenue growth in 2012, primarily due to IGT rgs® customer expansion, new games released, and player adoption of IGT games, as well as a VAT settlement of $7.4 million. Entraction contributed $15.1 million to 2012 IGTi revenues. However, due to diminished returns largely related to regulatory challenges in Europe, we began efforts in late 2012 to consolidate our IGTi product development and customer service resources, exit Entraction online turnkey and poker operations by December 2012, and close or reduce certain facilities in Stockholm and Tallinn.

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

OPERATING EXPENSES

                                                                          C h a n g e
                       2013        2012        2011            13 vs 12                 12 vs 11

Selling, general
and administrative    $ 460.4     $ 410.4     $ 353.3     $ (50.0 )       -12 %   $  (57.1 )       -16 %
Research and
development             235.0       217.0       194.7       (18.0 )        -8 %      (22.3 )       -11 %
Depreciation and
amortization             77.4        76.9        69.7        (0.5 )        -1 %       (7.2 )       -10 %
Subtotal
SG&A-R&D-D&A            772.8       704.3       617.7       (68.5 )       -10 %      (86.6 )
Percent of revenue         33 %        33 %        32 %
Contingent
acquisition-related
costs                    73.9        69.1           -        (4.8 )        -7 %      (69.1 )         -
Impairment and
restructuring             3.6        42.5        15.8        38.9           *        (26.7 )         *
Total operating
expenses              $ 850.3     $ 815.9     $ 633.5     $ (34.4 )        -4 %   $ (182.4 )       -29 %

2013 Compared With 2012

SG&A expenses increased largely due to an increase of $34.5 million in advertising and promotion expenses, which included $27.1 million related to player marketing in correlation with growing social gaming revenues, as well as higher gaming show costs in part due to timing changes that caused the occurrence of two major annual shows to fall into our fiscal 2013. SG&A increases also included $7.7 million for proxy contest fees, $7.7 million in bad debt provisions mostly related to certain international customer receivables, and $2.4 million for a legal settlement, partially offset by prior year settlement charges of $3.1 million related to early cancellation of a distributor agreement. The remaining increase in SG&A and R&D expenses generally related to higher employee headcount.

Acquisition related charges noted in the table below increased $3.4 million primarily related to DoubleDown.

                                                       2013       2012
               Earn-out                               $ 35.0     $ 27.5
               Retention                                38.9       41.6
               Total contingent costs                   73.9       69.1
               Amortization of acquired intangibles     17.7       13.3
               Professional fees                           -        5.8
               Total                                  $ 91.6     $ 88.2

Lower impairment and restructuring charges partially offset the increases in SG&A and R&D. Current year impairment included $1.3 million for a UK building held for sale and $2.3 million related to our Alabama notes receivable and associated property collateral. See Note 20 for additional information about our Alabama impairment.

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, as noted in the table above.


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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 Entraction services and facilities. See Note 19 for additional information about these charges. 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.

OTHER INCOME (EXPENSE)

                                                                                Change
                       2013         2012         2011              13 vs 12                  12 vs 11

Interest Income      $   44.4     $   45.3     $   51.2     $   (0.9 )         -2 %   $   (5.9 )        -12 %
WAP investments          17.8         20.0         22.4         (2.2 )        -11 %       (2.4 )        -11 %
Receivables and
investments              26.6         25.3         28.8          1.3            5 %       (3.5 )        -12 %
Interest Expense       (123.4 )     (122.2 )     (130.8 )       (1.2 )         -1 %        8.6            7 %
WAP jackpot
liabilities             (17.7 )      (19.9 )      (22.2 )        2.2           11 %        2.3           10 %
Borrowings              (70.1 )      (69.9 )      (79.0 )       (0.2 )          -          9.1           12 %
Convertible debt
equity discount         (35.6 )      (32.4 )      (29.6 )       (3.2 )        -10 %       (2.8 )         -9 %
Other, including
gain (loss)             (12.8 )       (2.0 )        2.6        (10.8 )       -540 %       (4.6 )       -177 %
Total other income
(expense), net       $  (91.8 )   $  (78.9 )   $  (77.0 )   $  (12.9 )        -16 %   $   (1.9 )         -2 %

2013 Compared With 2012

The change in total other income (expense) was unfavorable primarily due to increased foreign currency losses of $6.2 million primarily from Latin America and Australia currencies and an additional fair value loss adjustment of $4.7 million on our interest rate swaps. Lower interest income and higher interest expense on debt also contributed to the unfavorable change.

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.

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 . . .

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