10-K 1 igt_10k-092912.htm FORM 10-K igt_10k-092912.htm
United States Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-K

[X]           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended September 29, 2012
OR

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to          

Commission File Number 001-10684

International Game Technology
 
Nevada  88-0173041
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
 
6355 South Buffalo Drive, Las Vegas, Nevada 89113
(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code: (702) 669-7777

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class  Name of each exchange on which registered
Common Stock, Par Value $.00015625 New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [X] No [   ]
 
Indicate by check mark if registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes [   ] No [X]
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [   ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X] No [   ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K:  [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer [X]                                                                                                                        Accelerated filer [   ]
Non-accelerated filer [   ] (Do not check if a smaller reporting company)                 Smaller reporting company [   ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [   ] No [X]
 
The aggregate market value of voting stock held by non-affiliates of the registrant on March 31, 2012:  $5.0 billion.
 
The number of shares outstanding of each of the registrant’s classes of common stock, as of November 23, 2012:
266.1 million shares of common stock at $.00015625 par value.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
Portions of our Proxy Statement relating to the 2013 annual shareholders meeting are incorporated by reference in Part III. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the conclusion of the registrant’s fiscal year ended September 29, 2012
 
 
1

 
 
TABLE OF CONTENTS

GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
3
   
PART I
 
Item 1.
Business
6
     
Item 1A.
Risk Factors
15
     
Item 1B.
Unresolved Staff Comments
22
     
Item 2.
Properties
22
     
Item 3.
Legal Proceedings
22
     
Item 4.
Mine Safety Disclosures
23
     
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
23
     
Item 6.
Selected Financial Data
25
     
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
     
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
48
     
Item 8.
Financial Statements and Supplementary Data
50
     
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
98
     
Item 9A.
Controls and Procedures
98
     
Item 9B.
Other Information
99
     
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
99
     
Item 11.
Executive Compensation
99
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
99
     
Item 13.
Certain Relationships and Related Transactions, and Director Independence
99
     
Item 14.
Principal Accountant Fees and Services
99
     
PART IV
     
Item 15.
Exhibits and Financial Statement Schedules
100
 
 
2

 
 
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
 
Fiscal dates—actual:
Fiscal dates—as presented:
 
September 29, 2012
September 30, 2012
 
October 1, 2011
September 30, 2011
 
October 2, 2010
September 30, 2010
 
October 3, 2009
September 30, 2009
 
September 27, 2008
September 30, 2008
 
Abbreviation/term
Definition
Anchor
Anchor Gaming
APAC
Asia, Australia, New Zealand, and the Pacific
APIC
additional paid-in-capital
ASP
average sales price (machines)
ASR
accelerated share repurchase transaction
ASU
Accounting Standards Update
5.5% Bonds
5.5% fixed rate notes due 2020
7.5% Bonds
7.5% fixed rate notes due 2019
B2B
Business-to-business
B2C
Business-to-customer/consumer
bps
basis points
CCSC
Colorado Central Station Casino
CDS
central determination system
CEO
chief executive officer
CFO
chief financial officer
CLS
China LotSynergy Holdings, Ltd.
DAU
Daily Active Users
DCF
discounted cash flow
DoubleDown
Double Down Interactive LLC
EBITDA
earnings before interest, taxes, depreciation, and amortization
EMEA
Europe (including the UK), the Middle East, and Africa
Entraction
Entraction Holding AB
EPA
Environmental Protection Agency
EPS
earnings per share
ERISA
Employee Retirement Income Security Act
Exchange Act
Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards Board
GAAP
generally accepted accounting principles
IGT, we, our, the Company
International Game Technology and its consolidated entities
IFRS
International Financial Reporting Standards
IGT rgsTM 
IGT Remote Game ServerTM
IP
intellectual property
IRS
Internal Revenue Service
LAC
Latin America (Mexico, South and Central America) and the Caribbean
LIBOR
London inter-bank offered rate
MAU
Monthly Active Users
MDA
management’s discussion and analysis of financial condition and results of operations
MLD®
Multi-layer-display
Notes
3.25% convertible notes due 2014
OSHA
Occupational Safety & Health Administration
pp
percentage points
R&D
research and development
 
 
3

 
 
Abbreviation/term
Definition
SEC
Securities and Exchange Commission
SIP
2002 Stock Incentive Plan
SG&A
sales, general and administrative
UK
United Kingdom
US
United States
VAT
value added tax
VIE
variable interest entity
VWAP
average daily volume weighted average price
WAP
wide area progressive
Yield
average revenue per unit per day
*
not meaningful (in tables)

 
4

 
 
FORWARD LOOKING STATEMENTS
 
This report contains statements that do not relate to historical or current facts, but are “forward looking” statements within the meaning of 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, appear, believe, could, would, estimate, expect, indicate, 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:
 
 
·
our ability to successfully introduce new products and their impact on replacement demand
 
·
the timing, features, benefits, and expected continued or future success of new product introductions and ongoing product, marketing, and strategic initiatives
 
·
our expected future financial and operational performance
 
·
our strategic and operational plans
 
·
our leadership position in the gaming industry
 
·
the advantages offered to customers by our anticipated products and product features
 
·
economic conditions and other factors affecting the gaming industry
 
·
gaming growth, expansion, and new market opportunities
 
·
expected trends in the demand for our products
 
·
developments with respect to economic, political, regulatory and other conditions affecting our international operations
 
·
mergers, acquisitions and divestitures, including the expected benefits of completed acquisitions and expectations for, possible acquisitions of, or investments in, businesses, products, and technologies
 
·
expected restructuring costs incurred in connection with our cost saving efforts
 
·
research and development activities, including anticipated benefits from such activities
 
·
fluctuations in future gross margins, tax rates, and liabilities
 
·
increasing product sales or machine placements
 
·
legislative, legal or regulatory developments and related market opportunities
 
·
available capital resources to fund future operating requirements, capital expenditures, payment  obligations, acquisitions, and share repurchases
 
·
losses from off-balance sheet arrangements
 
·
financial returns to shareholders related to management of our costs
 
·
the impact of recently adopted accounting pronouncements
 
·
the outcome and expense of litigation
 
·
anticipated increased revenue yields and operating margin if general economic conditions improve
 
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 Part 1, 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.
 
 
5

 
 
PART I
 
 
Item 1.          Business
 
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.
 
International Game Technology was incorporated in Nevada in December 1980 to facilitate our initial public offering in 1981. Principally serving the US gaming markets when founded, we expanded into jurisdictions outside the US beginning in 1986.
 
Our fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to September 30. For simplicity, this report presents all fiscal years using the calendar month end as outlined in the table below.
 
Fiscal Year
Ended
 
Weeks
   
Actual
 
Presented as
   
2012
 
September 29, 2012
 
September 30, 2012
 
52
2011
 
October 1, 2011
 
September 30, 2011
 
52
2010
 
October 2, 2010
 
September 30, 2010
 
52
2009
 
October 3, 2009
 
September 30, 2009
 
53
2008
 
September 27, 2008
 
September 30, 2008
 
52
 
Unless otherwise indicated in this report:
 
·
International Game Technology, IGT, we, our, or the Company refers to International Game Technology and its consolidated entities
 
·
italicized text with an attached superscript trademark or copyright notation indicates trademarks of IGT or its licensors, and additional IGT trademark information is available on our website at www.IGT.com
 
·
references to years relate to our fiscal years ending September 30
 
·
current refers to the fiscal year ended September 30, 2012
 
·
Note refers to the Notes of our Consolidated Financial Statements in Item 8 of this report
 
·
references to EPS are on a diluted basis
 
·
table amounts are presented in millions, except units and EPS
 
·
discussion and analysis relates to results for the current fiscal year as compared with the prior year
 
BUSINESS SEGMENTS
 
We derive our revenues from the distribution of casino games, gaming equipment and systems technology for land-based and online social gaming and wagering markets. Operating results reviewed by our CEO encompass all revenue sources within each geographical customer region. We currently view our business in two operating segments, North America and International, each incorporating all revenue categories. Unless otherwise noted, prior year amounts throughout this report have been adjusted for operations discontinued during 2011 and 2010, as further described in Note 21.
 
 
·
North America consists of our operations in the US and Canada, comprising 76% of consolidated revenues from continuing operations in 2012, 76% in 2011, and 75% in 2010.
 
·
International consists of our operations in all other jurisdictions worldwide, comprising 24% of consolidated revenues from continuing operations in 2012, 24% in 2011, and 25% in 2010.
 
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 contained in our MDA BUSINESS SEGMENT RESULTS and Note 18 is incorporated here by this reference.
 
 
6

 
 
REVENUE CATEGORIES
 
We recognized revenues in three major categories — Gaming Operations, Product Sales and Interactive. See Footnote 1 for additional information about accounting for our revenues.
 
Gaming Operations
 
Comprising 48% of consolidated revenues in 2012, 53% in 2011, and 54% in 2010, gaming operations generates recurring revenues by providing customers with proprietary land-based casino gaming equipment, systems, content licensing, and services under a variety of recurring revenue arrangements. Our gaming operations pricing arrangements are largely variable where casinos pay service fees to IGT based on a percentage of amounts wagered (also referred to as coin-in) or net win. Variable fee units comprised 82% of our gaming operations installed base at September 30, 2012.  Fixed fee units comprised 18% of our installed base at September 30, 2012 and pricing arrangements are typically based on a daily or monthly fee.
 
Casinos with IGT WAP machines paid a percentage of the coin-in for IGT services related to the design, assembly, installation, operation, maintenance, and marketing of the WAP systems, as well as funding and administration of the progressive jackpot.  The cost of funding progressive jackpots is subject to interest rate volatility as further described in Note 1, MDA CRITICAL ACCOUNTING ESTIMATES and related risks included in Part I, Item 1A.
 
Gaming operations revenues are affected by variations in the number and type of machines in service, levels and frequency of player wagers, and pricing arrangement terms. Levels of play are dependent on game popularity, casino seasonality trends, economic conditions, and other player preferences. Seasonal trends generally show higher play levels in the spring and summer months and lower in the fall and winter months. We monitor the productive life cycles of our gaming operations machines and systematically replace units experiencing declining play levels with newer games.
 
The IGT owned gaming operations installed base was comprised of our MegaJackpots® premium branded gaming machines, including WAP and stand-alone units, as well as other lease or rental units, including CDS and racino machines. IGT owned units were recorded on our balance sheet as part of property, plant and equipment. Casino owned units represent machines sold to our customers that also provide a recurring royalty fee. Prior year casino owned units increased by 3,600 in 2012, 2,900 in 2011 and 1,500 in 2010 due to a change in management’s installed base criteria. Gaming operations revenues are generated from the units reflected in the table below, as well as from other service fees for systems access, game content, and other gaming equipment lease or rental.
 
Gaming Operations Units ('000)
 
2012
   
2011
   
2010
 
IGT owned units - MegaJackpots® (Premium brand)
    27.1       27.9       27.2  
IGT owned units - Lease (CDS, racino, other)
    30.0       26.0       25.7  
IGT installed base
    57.1       53.9       52.9  
Casino owned
    21.6       20.4       19.4  
Total
    78.7       74.3       72.3  
 
 
Product Sales
 
Comprising 45% of consolidated revenues in 2012, 45% in 2011, and 44% in 2010, product sales include land-based gaming machines and non-machine gaming related equipment, systems, services, licensing and royalty fees, and component parts (including kit conversions).
 
Product Sales Composition
 
2012
   
2011
   
2010
 
Slot machines
    67 %     63 %     62 %
Non-machine
    33 %     37 %     38 %
Gaming systems
    20 %     22 %     22 %
Parts & conversions
    10 %     12 %     13 %
Other fees & services
    3 %     3 %     3 %
 
 
7

 
 
Interactive
 
Comprising 7% of consolidated revenues in 2012, 2% in 2011, and 2% in 2010, interactive revenues are generated from online social gaming and wagering products and services, presented in the following two groups.
 
Social Gaming
 
Our North America based DoubleDown social casino-style gaming operation was acquired in January 2012 and generates revenues from the sale of virtual casino chips to players for use within the DoubleDown Casino® for additional play or game enhancements. Costs of revenues are comprised mainly of payment processing fees paid to Facebook or land-based casino hosts on a revenue participation basis. Social gaming metrics include:
 
 
DAU measures the number of active users that play games games at the DoubleDown Casino® each day. Average DAU is the average of the DAUs for each day during the period.
 
MAU measures the number of active users that played games at the DoubleDown Casino®  at least once in the last 30 days. Average MAU is the average of the MAUs each day during the period.
 
DAU/MAU is a ratio used to monitor user engagement.
 
Bookings represent the total amount of virtual casino chips sold during the period, as opposed to revenues, which include deferral adjustments based on the estimated period of service or chip consumption.
 
Unlike many other online social casino-style games where each game is a unique application, DoubleDown operates as a single casino application with multiple games where all games are available to the player within a single application. As a result, DoubleDown’s reported number of active users is the equivalent of the number of unique users reported by many other online social casino-style game operators. Our DoubleDown strategy focuses on increasing DAU as an indicator of user engagement and average bookings per DAU. For 2012 since acquisition in January 2012, DoubleDown had average DAU of 1.4 million and  average bookings per DAU of $0.26.
 
IGTi
 
IGTi collectively refers to all of our other online and mobile gaming solutions. IGTi encompasses primarily real money wagering casino and mobile gaming systems infrastructure and applications, content licensing, and back office operational support services, including WAP jackpot funding and administration. IGTi solutions are generally provided under revenue sharing arrangements based on a percentage of net win.
 
IGTi solutions are provided in one of two ways. In B2B arrangements, IGTi provides content and services to a partnering business, which then connects to the player through the partner’s own site. In B2C arrangements, IGTi runs the online website on behalf of the customer, connecting directly with the player. IGTi costs of revenues includes transaction costs incurred to run the sites, including player verification checks, banking transaction fees, data center costs to host servers, internet bandwidth fees, royalties, and server support/maintenance fees.
 
STRATEGIC BUSINESS ACQUISITIONS AND AFFILIATES
 
We aim to complement our internal resources through strategic alliances, investments, and business acquisitions that:
 
·
diversify our geographic reach
 
·
expand our product lines and customer base
 
·
leverage our technological and manufacturing infrastructure to increase our rates of return
 
In January 2012, we acquired Seattle based Double Down Interactive LLC., developer and operator of the social gaming DoubleDown Casino® found on Facebook. DoubleDown has a broad and expanding game portfolio, offering blackjack, slots, slot tournaments, video poker, and roulette to social gamers around the world. This strategic acquisition is establishing IGT’s position in social casino-style gaming and strengthening our core business with added distribution channels for IGT game content. DoubleDown is presented as a component of our North America segment.
 
Acquisitions and affiliate investments are also discussed in Notes 2 and 20. Discontinued operations, and material asset losses or impairment recognized during the last three years are discussed in our MDA—OVERVIEW, MDA—CONSOLIDATED RESULTS, and Notes 19 and 21. Risks related to business combinations and investments are described in Part I, Item 1A.
 
 
8

 
 
PRODUCTS
 
We provide a broad range of casino games, gaming equipment and systems technology for land-based and online social gaming and wagering markets under for-sale or revenue sharing arrangements.
 
Games
 
We combine elements of math, play mechanics, sound, art, and technological advancements with our library of entertainment licenses and patented IP to provide gaming products designed to provide a high degree of player appeal. We continuously expand our game library with new content, popular brands, and appealing bonuses to address player preferences and other market trends.
 
We offer a wide array of casino-style games for land-based, online social gaming, online real-money wagering and mobile gaming markets with multi-line, multi-coin and multi-currency configurations.
 
Land-Based
Interactive
Premier (MegaJackpots®)
Social - DoubleDownCasino®
Multi-Level Progressive
Slots
Wide-Area Progressive
Video Poker
Stand-Alone
Table Games
Core
Online
Video Reel
MegaJackpots®
Spinning Reel
Slots
Video Poker
Table Games
Multi-Game (Game King®)
Fixed Odds
Game Families
Video Poker
Central Determination System
Bingo & Keno
Bingo (Class II)
 
VLT
Mobile
Multi-Player
Slots
Electronic Table
Table Games
Virtual Racing
Video Poker
 
Cabinet Configurations
 
Land-based customers can combine our extensive library of games with several gaming machine cabinets designed to maximize functionality, flexibility, and player comfort. Our AVP® machines support server-based gaming networks with G2S open industry standards. Slot machine configurations vary by jurisdiction and may include:
 
·
Stand-alone casino-style slot machines that determine the game play outcome at the machine, known as Class III in tribal jurisdictions
 
·
WAP jackpot systems with machines linked across several casinos
 
·
CDS machines connected to a central server that determines the game outcome, encompassing VLT’s (video lottery terminals) used primarily in government-sponsored applications and electronic or video bingo machines, known as Class II in tribal jurisdictions
 
Systems
 
IGT systems products include infrastructure and applications for casino management, customer relationship management, player management, and server-based gaming. Our casino and customer relationship management solutions include integrated modules for:
·        machine accounting
·        bonusing (jackpots and promotions)
·        patron management
·        table game automation
·        cage accounting
·        payment processing
·        table accounting
·        reporting
·        ticket-in/ticket-out
·        regulatory compliance
 
 
9

 
 
Our player management solutions feature customized player messaging, tournament management, and integrated marketing and business intelligence modules that provide analytical, predictive, and management tools for maximizing casino operational effectiveness. Our server-based solutions enable electronic game delivery and configuration for slot machines, as well as providing casino operators with opportunities to increase profits by enhancing the players’ experience, connecting with players interactively, and creating operational efficiencies.
 
Interactive
 
IGT’s Double Down online social gaming operation provides a unique opportunity for casino entertainment to reach a broader audience, while complementing IGT’s other existing offerings and the core casino audience. DoubleDown Casino® is available online through Facebook and www.DoubleDownCasino.com on a variety of personal computer and mobile devices. Additionally, our land-based casino customers can integrate the DoubleDown Casino® link into their own website providing players with access to a large portfolio of popular social casino-style games. The DoubleDown Casino® link provides casino operators with an opportunity to engage their customers when they are not physically present in the land-based casino.
 
IGT also provides wager-based online casino and mobile gaming systems infrastructure and applications, content licensing, and back office operational support services. The IGT Remote Game Server® (IGT rgs™) seamlessly integrates onto an operator’s interactive platform, allowing access to our portfolio of game content that allows for real money wagering in legalized jurisdictions. These systems are primarily focused on the management of digital patron wallets, responsible gaming functionality, fraud detection and prevention, patron credentials, customer relationship management, player accounting, and player analytics. With these solutions, we deploy a full service platform capable of supporting the main games associated with online wagering (casino games, sports betting, multi-player poker and bingo).
 
RESEARCH & DEVELOPMENT
 
We support our product development efforts through a considerable emphasis and investment in the R&D of emerging technology trends, which we believe enables us to maintain a leadership position in the industry. Our product innovation reflects a combination of customer research, design experience and engineering excellence utilizing our game design resources, IP portfolio, and next-generation game development tools. The focus of our product development is to enhance the player experience through interactive networked gaming, information technology, innovative game design, and customer relationship services, thereby maximizing the potential for casino operator profitability.
 
We dedicate approximately 1,700 employees worldwide to R&D efforts covering multiple engineering disciplines, including hardware, electrical, systems and software. We specialize in progressive creative game development including design, math, graphics and audio. Our primary development facilities are located in Nevada (Reno and Las Vegas), California (San Francisco), Washington (Seattle), China (Beijing), and Australia (Sydney). Additional global design centers provide local community presence, customized products, and regional production where beneficial or required.
 
Our games are created primarily by employee designers, engineers, and artists, as well as third-party content creators. We also use third-party technologies to improve the yield of our development investment and concentrate increased resources on product differentiation engineering. A significant amount of our R&D efforts during 2012 continued to focus on expanding interactive online opportunities. Our investment in R&D totaled $217.0 million in 2012, $194.7 million in 2011, and $189.4 million in 2010.
 
Intellectual Property
 
Our IP portfolio of patents, trademarks, copyrights, and other licensed rights are significant to our business. At September 30, 2012, we held approximately 5,800 patents or patent applications and approximately 3,800 trademarks filed and registered worldwide. The weighted average remaining useful life of our capitalized patent costs at September 30, 2012 was approximately 3.5 years. Our brand licensing arrangements have various expiration dates through 2020 and commonly contain options to extend.
 
 
10

 
 
We seek to protect our investment in R&D and the new and original 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 with patents related to a variety of gaming products, including game designs, bonus and secondary imbedded game features, device components, and online or mobile functionality.
 
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. We use IP assets offensively and defensively to protect our innovation and license it to others under terms designed to promote standardization in the gaming industry. IP litigation is described in Note 13 and related risk factors are discussed in Part I, Item 1A.
 
SALES AND MARKETS
 
We market our products and services worldwide. We have a substantial presence in the US and growing international operations. We promote our products through a worldwide network of sales associates, as well as third-party distributors and agents in certain markets under arrangements that generally specify no minimum purchase and require specified performance standards be maintained. We offer equipment contract financing for qualified customers and development financing loans to select customers for new or expanding gaming facilities.
 
As of September 30, 2012, we maintained 60 offices across six continents to respond to customer needs and our Global Support Center is staffed with experts in technical issue resolution. We provide access to product information and 24-hour customer service through our website and offer a variety of customer training designed to ensure success in using our products to their full potential.
 
North America
 
The gaming industry installed base in the US and Canada has been relatively flat over the last few years, at just over 900,000 legal gaming devices by our estimates. Growth of legalized gaming is largely driven by new jurisdictions considering gaming tax revenues as a means to address budget shortfalls. Sales or placements of gaming machines are also affected by new openings or expansion of existing gaming properties and the machine replacement cycle, as well as economic conditions. Additionally, we expanded into online social gaming with the acquisition of DoubleDown in January 2012.
 
International
 
Markets outside of North America are expected to grow faster than those in  North America, and we are localizing our sales presence in these markets, as we increase scalability and prepare for new opportunities. Our international strategy capitalizes on our North America experience, while customizing products for foreign languages, other unique local preferences and regulatory requirements.
 
Our international gaming markets included the following customer regions at September 30, 2012:
 
·
Europe (including the UK), the Middle East, and Africa (EMEA)
 
·
Latin America (Mexico, South and Central America) and the Caribbean (LAC)
 
·
Asia, Australia, New Zealand, and the Pacific (APAC)
 
As the legalization and regulation of online gaming continues to unfold, our strategic intent is to enter and do business in those regulated markets that offer attractive return characteristics and build on our existing capabilities. In conjunction with an evaluation of 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). Resulting impairment and restructuring charges are discussed in our MDA-CONSOLIDATED RESULTS, MDA--BUSINESS SEGMENT RESULTS, and Note 19.
 
 
11

 
 
OPERATIONAL OVERVIEW
 
Manufacturing and Suppliers
 
In addition to our main production facility in Nevada, we manufacture our products using third-party manufacturers in China. We also provide reconditioning and re-manufacturing processes in our Las Vegas facility for our gaming operations installed base. Our manufacturing operations primarily involve the configuration and assembly of electronic components, cables, harnesses, video monitors, and prefabricated parts purchased from outside sources. We also operate facilities for silkscreen manufacturing and digital design.
 
We use a variety of raw materials to manufacture our gaming devices including metals, wood, plastics, glass, electronic components, and LCD screens. We have a broad base of material suppliers and utilize multi-sourcing practices to ensure component availability. We believe the availability of materials used to manufacture our products is adequate and we are not substantially dependent on any single supplier.
 
We currently devote approximately 626,000 square feet in our Reno facilities and approximately 228,000 square feet in our Las Vegas facility to product development, manufacturing, warehousing, shipping, and receiving.  Maintaining our commitment to quality, we maintained our ISO 9001.2008 Quality Management System certification at all of our manufacturing facilities during 2012. ISO standards represent an international consensus with respect to the design, manufacture, and use of practices intended to ensure ongoing customer satisfaction with consistent delivery of products and services.
 
We generally carry a sufficient amount of inventory related to the breadth of our product lines. We reasonably expect to fill our manufacturing product order backlog for both gaming operations and product sales within the next fiscal year. Backlog for gaming operations machine units totaled 7,800 at October 31, 2012 and 7,500 at October 31, 2011. Product sales backlog totaled approximately $197.3 million at October 31, 2012 and $122.1 million at October 31, 2011.
 
Employees
 
As of September 30, 2012, we employed 4,800 individuals worldwide, 3,900 in our North America segment and 900 in our International segment. We continue to review our costs and organizational structure to maximize efficiency and align expenses with the current and long-term business outlook.
 
COMPETITION AND PRODUCT DEMAND
 
IGT operates within an increasingly competitive market. The markets for our gaming products and services are constantly evolving and technological advances increasingly employ personal computers, mobile communication, and other digital media devices. Our competitors range from small, localized companies to large, multi-national corporations in every jurisdiction in which we conduct business. Our most significant competitors include Aristocrat Leisure Limited, Bally Technologies, Inc., and WMS Industries, Inc.
 
We believe replacement sales are driven by customer strategies to upgrade casino floors with newer games and technologies that combine higher yields with cost savings, convenience, and other benefits. Emerging technologies that improve operators’ profitability, such as delivery platforms with increased capabilities, game features that increase player appeal, or application modules which increase operator efficiencies, can accelerate the replacement cycle.
 
New or expanding casinos generate new product demand and stimulate replacement demand at neighboring properties compelled to upgrade their gaming floors to remain competitive. New jurisdictions establishing legalized gaming also create product demand and continue to grow the overall installed base of gaming devices.
 
We endeavor to create gaming products with superior functionality and features, using innovative architecture and technologies, resulting in a high degree of customer acceptance and player preference. We also strive to maintain an edge in our quality of customer support and efficient product implementation. The breadth of our gaming products and diversity of our innovative game library contribute to our competitive advantage.
 
 
12

 
 
We believe IGT has competitive advantages resulting from broad alliances and lengthy business relationships with our customers, the financial strength to aggressively invest in R&D, and an extensive IP portfolio. Our historically high levels of customer service and support, extensive and well-established infrastructure of sales and manufacturing, worldwide name recognition, and geographic diversity are also competitive assets. We believe our reputation for consistently delivering and supporting quality products will encourage operators to select our products and enable us to maintain a substantial market position.
 
AVAILABLE INFORMATION
 
IGT’s principal corporate executive offices are located at:   6355 South Buffalo Drive
Las Vegas, Nevada 89113
(702) 669-7777
 
All reporting information filed with or furnished to the SEC is available free of charge through the Investor Relations link on our website at www.IGT.com as soon as reasonably practicable after we electronically file or furnish such information to the SEC.
 
The public may read and copy any materials filed by the company with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy  and information statements, and other information regarding issuers that file electronically with the SEC available at www.sec.gov .
 
Additionally, the following IGT information is available through the Investor Relations link of our website and will be mailed in print form free of charge to any shareholder upon request:
 
·
code of conduct
 
·
corporate governance guidelines
 
·
code of ethics for our principal executive officer and senior financial officers
 
·
conflict of interest guidelines for members of our board of directors
 
·
charters for our Audit, Capital Deployment, Compensation, and Nominating and Corporate Governance Committees
 
GOVERNMENT GAMING REGULATION
 
We conduct business worldwide and are subject to licensing and other regulatory requirements. The manufacture and distribution of casino games, gaming equipment, systems technology, and related services, as well as the operation of casinos, is subject to regulation by a variety of federal, state, international, tribal, and local agencies, with the majority of oversight provided by individual state gaming control boards.
 
While the regulatory requirements vary from jurisdiction to jurisdiction, most require:
 
·
licenses and/or permits
 
·
findings of suitability for the company, as well as individual officers, directors, major shareholders, and key employees
 
·
documentation of qualification, including evidence of financial stability
 
·
specific approvals for gaming equipment manufacturers and distributors
 
Our operating entities and key personnel have obtained or applied for all required government licenses, permits, registrations, findings of suitability, and approvals necessary to manufacture and distribute gaming products in all jurisdictions where we do business. Although many regulations at each level are similar or overlapping, we must satisfy all conditions individually for each jurisdiction.
 
 
13

 
 
Gaming laws and regulations serve to protect the public and ensure that gaming related activity is conducted honestly, competitively, and free of corruption. Regulatory oversight additionally ensures that the local authorities receive the appropriate amount of gaming tax revenues. As such, our financial systems and reporting functions must demonstrate high levels of detail and integrity.
 
Certain regulators not only govern the activities within their jurisdiction, but also monitor our activities in other jurisdictions to ensure that we comply with local standards on a worldwide basis. As a Nevada licensee, state regulatory authorities require us to maintain Nevada standards for all operations worldwide. Violations of laws in one jurisdiction could result in disciplinary action in other jurisdictions. A more detailed description of the regulations to which we are subject is provided in Exhibit 99 of this Annual Report on Form 10-K, incorporated herein by reference.
 
The nature of the industry and our worldwide operations make this process very time consuming and require extensive resources. We employ additional community staff members and legal resources familiar with local customs in certain jurisdictions to assist in keeping us compliant with applicable regulations worldwide. Through this process, we seek to assure both regulators and investors that all our operations maintain the highest levels of integrity and avoid any appearance of impropriety. We have never been denied a gaming related license, nor have our licenses ever been suspended or revoked.
 
Risk factors related to gaming regulation are discussed in Part 1, Item 1A. Changes in or new interpretations of existing gaming laws and regulations may hinder or prevent us from continuing to operate in certain jurisdictions. Regulatory challenges related to our interactive operations in Europe are discussed in our MDA-CONSOLIDATED RESULTS, MDA--BUSINESS SEGMENT RESULTS, and Note 19.
 
 
14

 
 
Item 1A.       Risk Factors
 
Our business is vulnerable to changing economic conditions and to other factors that adversely affect the gaming industry, which have negatively impacted and could continue to negatively impact the play levels of our participation games, our product sales, and our ability to collect outstanding receivables.
 
Demand for our products and services depends largely upon favorable conditions in the gaming industry, which is highly sensitive to players’ disposable incomes and gaming activities. Discretionary spending on entertainment activities could further decline for reasons beyond our control, such as continued negative economic conditions, natural disasters, acts of war or terrorism, transportation disruptions or health epidemics. Any prolonged or significant decrease in consumer spending on entertainment activities could result in reduced play levels on our participation games, causing our cash flows and revenues from a large share of our recurring revenue products to decline. Unfavorable economic conditions have also resulted in a tightening in the credit markets, decreased liquidity in many financial markets, and significant volatility in the credit and equity markets.
 
A decline in the relative health of the gaming industry and the difficulty or inability of our customers to obtain adequate levels of capital to finance their ongoing operations reduces their resources available to purchase our products and services, which adversely affects our revenues. If we experience a significant unexpected decrease in demand for our products, we could also be required to increase our inventory obsolescence charges.
 
Further, changes in existing gaming laws or regulations or new interpretations of existing gaming laws or regulations, both with respect to land-based and online gaming activities, may hinder or prevent us from continuing to operate in those jurisdictions where we currently do business, which would harm our operating results. In particular, the enactment of unfavorable legislation or government efforts affecting or directed at manufacturers or gaming operators, such as referendums to increase gaming taxes or requirements to use local distributors, would likely have a negative impact on our operations.  Additionally, evolving laws and regulations regarding data privacy could adversely impact opportunities for growth in our online business, and could result in additional compliance-related costs.
 
Our ability to operate in our existing land-based or online jurisdictions or expand into new land-based or online jurisdictions could be adversely affected by new or changing laws or regulations, new interpretations of existing laws or regulations, and difficulties or delays in obtaining or maintaining needed licenses or approvals.
 
The gaming industry is subject to extensive governmental regulation by US federal, state and local governments, as well as tribal officials or organizations and foreign governments. While the regulatory requirements vary by jurisdiction, most require:
 
 
·
licenses and/or permits
 
·
findings of suitability
 
·
documentation of qualifications, including evidence of financial stability
 
·
other required approvals for companies who manufacture or distribute gaming equipment and services, including but not limited to approvals for new products
 
·
individual suitability of officers, directors, major shareholders and key employees
 
Any license, permit, approval or finding of suitability may be revoked, suspended or conditioned at any time.  We may be unable to obtain or maintain all necessary registrations, licenses, permits or approvals, and could incur fines or experience delays related to the licensing process which could adversely affect our operations and our ability to retain key employees.
 
To expand into new jurisdictions, we may need to be licensed, obtain approvals of our products and/or seek licensure of our officers, directors, major stockholders, key employees or business partners. If we fail to seek, do not receive or receive a revocation of a license in a particular jurisdiction for our games and gaming machines, hardware or software, we cannot sell or place on a participation or leased basis our products in that jurisdiction and our issued licenses in other jurisdictions may be impacted. Any delays in obtaining or difficulty in maintaining regulatory approvals needed for expansion within existing markets or into new jurisdictions can negatively affect our opportunities for growth.
 
Further, changes in existing gaming laws or regulations or new interpretations of existing gaming laws or regulations, both with respect to land-based and online gaming activities, may hinder or prevent us from continuing to operate in those jurisdictions where we currently do business, which would harm our operating results. In particular, the enactment of unfavorable legislation or government efforts affecting or directed at manufacturers or gaming operators, such as referendums to increase gaming taxes or requirements to use local distributors, would likely have a negative impact on our operations.  Additionally, evolving laws and regulations regarding data privacy could adversely impact opportunities for growth in our online business, and could result in additional compliance-related costs.
 
 
15

 
 
Slow growth in the establishment of new gaming jurisdictions or the number of new casinos, declines in the rate of replacement of existing gaming machines and ownership changes and consolidation in the casino industry could limit or reduce our future profits.
 
Demand for our products is driven substantially by the establishment of new land-based and/or online gaming jurisdictions, the addition of new casinos or expansion of existing casinos within existing gaming jurisdictions and the replacement of existing gaming machines. The establishment or expansion of gaming in any jurisdiction, whether land-based or online, typically requires a public referendum or other legislative action. As a result, gaming continues to be the subject of public debate, and there are numerous active organizations that oppose gaming. Opposition to gaming could result in restrictions on or even prohibitions of gaming operations or the expansion of operations in any jurisdiction.
 
In addition, the construction of new casinos or expansion of existing casinos fluctuates with demand, general economic conditions and the availability of financing. Slow growth in the establishment of new gaming jurisdictions or delays in the opening of new or expanded casinos and declines in, or low levels of demand for, machine replacements could reduce the demand for our products and our future profits. Because a substantial portion of our sales come from repeat customers, our business could be affected if one or more of our customers is sold to or merges with another entity that utilizes more of the products and services of one of our competitors or that reduces spending on our products or causes downward pricing pressures.  Such consolidations could lead to order cancellations, a slowing in the rate of gaming machine replacements, or require our current customers to switch to our competitors’ products, any of which could negatively impact our results of operations.
 
Demand for our products and the level of play of our products could be adversely affected by changes in player and operator preferences.
 
As a supplier of gaming machines, we must offer themes and products that appeal to gaming operators and players. There is constant pressure to develop and market new game content and technologically innovative products.  Our revenues are dependent on the earning power and life span of our games. We therefore face continuous pressure to design and deploy new and successful game themes to maintain our revenue and remain competitive.  If we are unable to anticipate or react timely to any significant changes in player preferences, such as a negative change in the trend of acceptance of our newest systems innovations or jackpot fatigue (declining play levels on smaller jackpots), the demand for our gaming products and the level of play of our gaming products could decline. Further, our products could suffer a loss of floor space to table games or other more technologically advanced games or operators may reduce revenue sharing arrangements, each of which would harm our sales and financial results. In addition, general changes in consumer behavior, such as reduced travel activity or redirection of entertainment dollars to other venues, could result in reduced demand and reduced play levels for our gaming products.
 
The gaming industry is intensely competitive. We face competition from a growing number of companies and, if we are unable to compete effectively, our business could be negatively impacted.
 
Competition among gaming and systems providers, including manufacturers of electronic gaming equipment and systems products, is intense.  Competition in our industry is primarily based on the amount of profit our products generate for our customers, together with cost savings, convenience, and other benefits. Additionally, we compete on the basis of price, pricing models, and financing terms made available to customers, the appeal of game content and features to the end player, and the features and functionality of our hardware and software products. Our competitors range from small, localized companies to large, multi-national corporations, several of which have substantial resources.
 
Competition in the gaming industry is intense due to the increasing number of providers, combined with the limited number of operators and jurisdictions in which they operate. In particular, we have observed an influx of small gaming equipment manufacturers entering the market over the last few years. This combination of a growing number of providers and a limited number of operators has resulted in an increased focus on price to value.  To compete effectively, providers must offer innovative products, with increasing features and functionality benefiting the operators along with game content appealing to the end player, at prices and, in certain cases, financing terms that are attractive to operators.
 
 
16

 
 
Obtaining space and favorable placement on casino gaming floors is also a competitive factor in our industry. In addition, the level of competition among equipment providers has increased significantly due to consolidation among casino operators and cutbacks in capital spending by casino operators resulting from the economic downturn and decreased player spend.
 
Our online social gaming and wagering operations are also subject to intense competition. In particular, the online  social gaming casino operated by DoubleDown is relatively new and has lower barriers to entry. Several companies have launched social casino offerings, and new competitors are likely to continue to emerge, some of which may be operated by social gaming companies with a larger base of existing users, or by casino operators with more experience in operating a casino. If the products offered through our online businesses do not maintain their popularity, or fail to grow in a manner that meets our expectations, our results of operations and financial condition could be harmed.
 
Our success in the competitive gaming industry depends in large part on our ability to develop and manage frequent introductions of innovative products.
 
The gaming industry is characterized by dynamic customer demand and technological advances, both for land-based and online gaming products. As a result, we must continually introduce and successfully market new themes and technologies in order to remain competitive and effectively stimulate customer demand.   To remain competitive, we have invested resources towards our research and development efforts to introduce new and innovative games with dynamic features to attract new customers and retain existing customers.
 
We intend to continue investing resources toward our research and development efforts.  There is no assurance that our investments in research and development will lead to successful new technologies or timely new products.  We invest heavily in product development in various disciplines: platform hardware, platform software, online services, content (game) design and casino software systems. Because our newer products are generally more technologically sophisticated than those we have produced in the past, we must continually refine our design, development and delivery capabilities across all channels to meet the needs of our product innovation.  If we cannot efficiently adapt our processes and infrastructure to meet the needs of our product innovations, our business could be negatively impacted.
 
Our customers will accept a new game product only if it is likely to increase operator profits more than competitors’ products. The amount of operator profits primarily depends on consumer play levels, which are influenced by player demand for our product.  There is no certainty that our new products will attain this market acceptance or that our competitors will not more effectively anticipate or respond to changing customer preferences. In addition, any delays by us in introducing new products could negatively impact our operating results by providing an opportunity for our competitors to introduce new products and gain market share ahead of us.
 
The risks related to operations in foreign countries and outside of traditional US jurisdictions could negatively affect our results.
 
We operate in many countries outside of the US and in tribal jurisdictions with sovereign immunity which subjects us to certain inherent risks.  A significant portion of our revenues is derived from our International business segment.  Developments such as noted below could adversely affect our financial condition and results of operations:
 
 
·
social, political or economic instability
 
·
additional costs of compliance with international laws or unexpected changes in regulatory requirements
 
·
the effects that evolving regulations regarding data privacy may have on our online operations
 
·
tariffs and other trade barriers
 
·
volatility of financial markets and fluctuations in foreign exchange rates outside the US
 
·
adverse changes in the creditworthiness of parties with whom we have significant receivables or forward currency exchange contracts
 
·
expropriation, nationalization and restrictions on repatriation of funds or assets
 
·
difficulty protecting our intellectual property
 
·
recessions in foreign economies
 
·
difficulties in maintaining foreign operations
 
·
changes in consumer tastes and trends
 
·
acts of war or terrorism
 
·
US government requirements for export
 
 
17

 
 
We may be unable to protect our IP.
 
A significant portion of our revenues is generated from products using certain IP rights and our operating results would be negatively impacted if we are unsuccessful in protecting these rights from infringement. In addition, some of our most popular games and features are based on trademarks, patents and other IP licensed from third parties. Our future success may depend upon our ability to obtain, retain and/or expand licenses for popular IP rights with reasonable terms in a competitive market. In the event that we cannot renew and/or expand existing licenses, we may be required to discontinue or limit our use of the games or gaming machines that use the licensed technology or bear the licensed marks.
 
Our success may depend in part on our ability to obtain trademark protection for the names or symbols under which we market our products and to obtain copyright protection and patent protection of our proprietary technologies, intellectual property and other game innovations. We may not be able to build and maintain goodwill in our trademarks or obtain trademark or patent protection, and there can be no assurance that any trademark, copyright or issued patent will provide competitive advantages for us or that our intellectual properties will not be successfully challenged or circumvented by competitors.
 
We also rely on trade secrets and proprietary know-how to protect certain proprietary knowledge and have entered into confidentiality agreements with our employees and independent contractors regarding our trade secrets and proprietary information. However, there can be no guarantees that our employees and consultants will not breach these agreements, and if these agreements are breached it is unlikely that the remedies available to us will be sufficient to compensate us for the damages suffered.  Additionally, despite various confidentiality agreements and other trade secret protections, our trade secrets and proprietary know-how could become known to, or independently developed by, competitors.
 
We may be subject to claims of IP infringement or invalidity and adverse outcomes of litigation could unfavorably affect our operating results.
 
Competitors and others may infringe on our intellectual property rights, or may allege that we have infringed on theirs. Monitoring infringement and misappropriation of intellectual property can be difficult and expensive, and we may not be able to detect infringement or misappropriation of our proprietary rights. We may also incur significant litigation and other expenses protecting our intellectual property or defending our use of intellectual property, reducing our ability to bring new products to market in the future. These expenses could have an adverse effect on our future cash flows and results of operations.  Our assessment of current IP litigation could change in light of the discovery of facts not presently known to us or determinations by judges, juries or others that do not agree with our evaluation of the possible liability or outcome of such litigation.  If we are found to infringe on the rights of others we could be required to discontinue offering certain products or systems, to pay damages, or purchase a license to use the intellectual property in question from its owner. Litigation can also distract management from the day-to-day operations of the business. There can be no assurances that certain of our products, including those with currently pending patent applications, will not be determined to have infringed upon an existing third party patent.
 
Business combinations and investments in intellectual properties or affiliates present risk, and we may not be able to realize the financial and strategic goals that were contemplated at the time of the transaction, which could materially affect our financial results.
 
We have invested and may continue to invest in strategic business combinations and acquisitions of important technologies and IP that we believe will expand our geographic reach, product lines, and/or customer base.  We may encounter difficulties in the assimilation of acquired operations, technologies and/or products, or an acquisition may prove to be less valuable than the price we paid, or we may otherwise not realize the anticipated benefits of an acquisition. We also may encounter difficulties applying our internal controls to an acquired business. Any of these events or circumstances may have an adverse effect on our business by requiring us to, among other things, record substantial impairment charges on goodwill and other intangible assets, resulting in a negative impact on our operating results.
 
 
18

 
 
Moreover, as we continue the process of evaluating our business in conjunction with an assessment of our long-term strategic goals, we will also further evaluate past and potential investments to determine if and how they will fit into our organizational structure going forward. If an event or change occurs in affiliate relationships or agreements associated with business combinations, we may be required to reassess cash flows, recoverability, useful lives, and fair value measurements, which may result in material impairment charges.
 
As we enter into new lines of business and expand our online offerings, there may be unintended adverse effects on our land-based business. For example, our online social gaming DoubleDown Casino® may be offered on Facebook alongside existing or planned online  social gaming casino offerings by one or more of our casino customers. One or more of such casino customers could view our online social gaming casino offering as competing with its offering. If, as a result of this view, one or more of such customers modifies, reduces or terminates its business relationship with us with respect to our land-based products and services, it could have a negative impact on our business and our operating results.
 
Failure to attract, retain and motivate key employees may adversely affect our ability to compete.
 
Our success depends largely on recruiting and retaining talented employees. The market for qualified executives and highly skilled, technical workers is intensely competitive. The loss of key employees or an inability to hire a sufficient number of technical staff could limit our ability to develop successful products and cause delays in getting new products to market.
 
Our gaming machines and online operations may experience losses due to technical problems or fraudulent activities.
 
Our success depends on our ability to avoid, detect, replicate and correct software and hardware anomalies and fraudulent manipulation of our gaming machines, systems, and online offerings. We incorporate security features into the design of our gaming machines and other systems, including those responsible for our online operations, which are designed to prevent us and our patrons from being defrauded. We also monitor our software and hardware to avoid, detect and correct any technical errors. However, there can be no guarantee that our security features or technical efforts will continue to be effective in the future. If our security systems fail to prevent fraud or if we experience any significant technical difficulties, our operating results could be adversely affected. Additionally, if third parties breach our security systems and defraud our patrons, or if our hardware or software experiences any technical anomalies, the public may lose confidence in our gaming products and online operations or we could become subject to legal claims by our customers or to investigation by gaming authorities.
 
Our gaming machines and online offerings have experienced anomalies and fraudulent manipulation in the past. Games and gaming machines may be replaced by casinos and other gaming machine operators if they do not perform according to expectations, or may be shut down by regulators. The occurrence of anomalies in, or fraudulent manipulation of, our games, gaming machines, systems, or online games and systems may give rise to claims for lost revenues and related litigation by our customers and may subject us to investigation or other action by gaming regulatory authorities including suspension or revocation of our gaming licenses, or disciplinary action.
 
Our online social gaming casino offering is conducted almost entirely through Facebook, and our business and our growth prospects would suffer if we fail to maintain a good relationship with Facebook, or if Facebook were to alter the terms of our relationship.
 
DoubleDown Casino®, which is our online  social gaming casino offering, operates almost entirely through Facebook.  Consequently, our operating platform, growth prospects and future revenues from this online offering are dependent on our relationship with Facebook.  While DoubleDown has historically maintained a good relationship with Facebook, our online social gaming casino offering would suffer if we are unable to continue this relationship in the future.
 
 
19

 
 
In addition, our relationship with Facebook is not governed by a contract, but rather by Facebook’s standard terms and conditions for application developers. Facebook modifies these terms and conditions as well as its privacy policies from time to time, and any future changes, including any changes required as a result of government regulation, could have a material adverse impact on our business.  For example, if Facebook were to increase the fees that it charges application developers, our gross profit and operating income would suffer.  Additionally, if users were to limit our ability to use their personal information, if Facebook were to develop competitive offerings, either on its own or in cooperation with another competitor, or if Facebook were to alter their operating platform to our detriment, our growth prospects would be negatively impacted.
 
Our online offerings are part of a new and evolving industry, which presents significant uncertainty and business risks.
 
Online gaming, including social casino-style gaming, is a relatively new industry that continues to evolve.  The success of this industry and our online business will be affected by future developments in social networks, mobile platforms, legal or regulatory developments (such as the passage of new laws or regulations or the extension of existing laws or regulations to social casino-style gaming activities), data privacy laws and regulations, and other factors that we are unable to predict, and are beyond our control.  This environment can make it difficult to plan strategically and can provide opportunities for competitors to grow revenues at our expense. Consequently, our future operating results relating to our online offerings may be difficult to predict and we cannot provide assurance that our online offerings will grow at the rates we expect, or be successful in the long term.
 
Systems, network or telecommunications failures or cyber-attacks may disrupt our business and have an adverse effect on our results of operations.
 
Any disruption in our network or telecommunications services could affect our ability to operate our games or financial systems, which would result in reduced revenues and customer down time. Our network and databases of business or customer information are susceptible to outages due to fire, floods, power loss, break-ins, cyber-attacks, network penetration, data privacy or security breaches, denial of service attacks and similar events. Despite our implementation of network security measures and data protection safeguards, including a disaster recovery strategy for back office systems, our servers and computer resources are vulnerable to viruses, malicious software, hacking, break-ins or theft, third-party security breaches, employee error or malfeasance, and other potential compromises. Disruptions from unauthorized access to or tampering with our computer systems in any such event could have a material adverse effect on our business, reputation, operating results and financial condition.
 
Our outstanding domestic credit facility subjects us to financial covenants which may limit our flexibility.
 
Our domestic credit facility subjects us to a number of financial covenants, including a minimum ratio of Adjusted EBITDA to interest expense minus interest on jackpot liabilities and a maximum ratio of Net Funded Debt to Adjusted EBITDA. Our failure or inability to comply with these covenants will cause an event of default that, if not cured, could cause the entire outstanding borrowings under our domestic credit facility, 5.5% Bonds, 7.5% Bonds and Notes to become immediately due and payable. In addition, our interest rate under the domestic credit facility can vary based on our public credit rating or our Net Funded Debt to Adjusted EBITDA ratio. Each of these measures may be adversely impacted by unfavorable economic conditions.  The domestic credit facility also includes restrictions that may limit our flexibility in planning for, or reacting to, changes in our business and the industry.
 
Our outstanding Notes subject us to additional risks.
 
Our Notes issued in May 2009 contain a net settlement feature, which entitles holders to receive cash up to $1,000 per Note and shares for any excess conversion value as determined by the respective governing indentures. Consequently, if a significant number of Notes are converted or redeemed, we would be required to make significant cash payments to the holders who convert or redeem the Notes.
 
In connection with the offering of the Notes, we entered into additional separate transactions for note hedges and warrant transactions. In connection with these transactions, the hedge counterparties and/or their respective affiliates may enter into various derivative transactions with respect to our common stock and may enter into or unwind various derivative transactions and/or purchase or sell our common stock in secondary market transactions prior to maturity of the Notes. These activities could have the effect of increasing or preventing a decline in, or having a negative effect on, the value of our common stock and could have the effect of increasing or preventing a decline in the value of our common stock during any conversion reference period related to a conversion of the Notes. The warrant transactions could separately have a dilutive effect from the issuance of our common stock pursuant to the warrants.
 
 
20

 
 
A decline in and/or sustained low interest rates causes an increase in our jackpot expense which could limit or reduce our future profits.
 
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. When rates increase, jackpot liabilities are reduced as it costs less to fund the liability. However, when interest rates decline the value of the liability (and related jackpot expense) increases because the cost to fund the liability increases. Our results may continue to be negatively impacted by continuing low interest rates or further declines in interest rates, resulting in increased jackpot expense and a reduction of our investment income, which could limit or reduce our future profits.
 
We may not be able to generate sufficient cash flows to meet our debt service obligations.
 
Our ability to make payments on and to refinance our indebtedness, including the Notes, and to fund planned capital expenditures will depend on our operating performance, financial results and ability to generate cash from our operations. These variables, to a certain extent, are subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations and future sources of capital under our credit facilities or otherwise may not be available to us in an amount sufficient to enable us to pay our indebtedness, including the Notes, or to fund our other liquidity needs. The Notes mature on May 1, 2014, unless repurchased earlier or converted.  We may need to refinance or restructure all or a portion of our indebtedness, including the Notes, on or before maturity and may not be able to do so on commercially reasonable terms, or at all.  Any default on our debt obligations would have a material adverse effect on our business, operating results and financial condition.
 
New products may be subject to complex and dynamic revenue recognition standards, which could materially affect our financial results.
 
As we introduce new products and transactions become increasingly complex, additional analysis and judgment is required to account for and recognize revenues in accordance with generally accepted accounting principles. Transactions may include multiple element arrangements, software components, and/or unique new product offerings, such as our online social casino games at our DoubleDown Casino®, and applicable accounting principles or regulatory product approval delays could further change the timing of revenue recognition and could adversely affect our financial results for any given period. Fluctuations may occur in our deferred revenues and reflect our continued shift toward more multiple element contracts that include systems and software.
 
Our results of operations could be affected by natural events in the locations in which we or our customers or suppliers operate.
 
We, our customers, and suppliers have operations in locations subject to natural occurrences such as severe weather and geological events including hurricanes, earthquakes, floods or tsunamis that could disrupt operations.  Any serious disruption at any of our facilities or the facilities of our customers or suppliers due to a natural disaster could have a material adverse effect on our revenues and increase our costs and expenses. If there is a natural disaster or other serious disruption at any of our facilities, it could impair our ability to adequately supply our customers, cause a significant disruption to our operations, cause us to incur significant costs to relocate or reestablish these functions and negatively impact our operating results. While we insure against certain business interruption risks, such insurance may not adequately compensate us for any losses incurred as a result of natural or other disasters.  In addition, any natural disaster that results in a prolonged disruption to the operations of our customers or suppliers may adversely affect our business, results of operations or financial condition.
 
 
21

 
 
Investments and development financing loans could adversely impact liquidity or cause us to incur loan losses or record a charge to earnings if our investments become impaired.
 
We invest in and/or provide financing for expansion or construction of gaming locations and other business purposes, particularly in our international operations. Such investment and financing activities subject us to increased credit risk in certain regions, which could be exacerbated by current unfavorable economic conditions or other political or economic instability in those regions. We monitor our investments and financing activities to assess impairment on a quarterly basis.
 
We have in the past and may in the future incur losses on these types of investments and loans. Our results of operations, liquidity or financial position may be negatively impacted if we are unable to collect on loans or derive benefit from our investments.
 
Current environmental laws and regulations, or those enacted in the future, could result in additional liabilities and costs.
 
The manufacturing of our products may require the use of materials that are subject to a variety of environmental, health and safety laws and regulations (such as climate change legislation). Compliance with these laws could increase our costs and impact the availability of components required to manufacture our products. Violation of these laws may subject us to significant fines, penalties or disposal costs, which could negatively impact our results of operations, financial position or cash flows.
 
Item 1B.       Unresolved Staff Comments
 
None
 
Item 2.          Properties
 
Our properties consist primarily of facilities worldwide used for manufacturing, engineering, sales, corporate administration, customer service and technical support. We own our corporate headquarters in Las Vegas, Nevada, which serves as our primary sales and service facility. We also own a Reno, Nevada campus, which serves as our primary manufacturing, engineering and warehousing facility. Additional sales and service facilities worldwide are occupied under leases that expire at various times through 2022.
 
Square Footage Of Facilities At September 30, 2012
 
   
Approximate
Square Footage
 
   
Owned
   
Leased
 
(in thousands)
           
North America (US and Canada)
    1,840       787  
                 
International
               
EMEA
    146       129  
LatAm
    -       60  
AsiaPac
    15       211  
 
We expect our current properties will be adequate for our near-term business needs and the productive capacity of our facilities is substantially utilized.
 
Item 3.          Legal Proceedings
 
IGT has been named in and has brought lawsuits in the normal course of business. A description of certain of these matters is contained in Note 13 and incorporated herein by this reference.
 
 
22

 
 
Item 4.          Mine Safety Disclosures
 
Not Applicable

 
 
PART II
 
Item 5.          Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common stock is listed and traded on the New York Stock Exchange under the symbol “IGT.” As of November 26, 2012, there were approximately 2,000 record holders of IGT’s common stock and the closing price was $12.98.
 
   
Quarters
 
   
First
   
Second
   
Third
   
Fourth
 
2012
                       
Stock price - high
  $ 18.17     $ 18.10     $ 17.25     $ 16.07  
Stock price - low
    13.42       14.15       13.12       10.92  
Dividends declared
  $ 0.06     $ 0.06     $ 0.06     $ 0.06  
                                 
2011
                               
Stock price - high
  $ 17.82     $ 19.11     $ 18.63     $ 19.15  
Stock price - low
    14.00       15.13       14.86       13.38  
Dividends declared
  $ 0.06     $ 0.06     $ 0.06     $ 0.06  
 
In our 2013 first quarter, we declared a cash  dividend of $0.07 per share, payable on December 31, 2012 to shareholders of record on December 19, 2012.
 
 
IGT transfer agent and registrar
 
Wells Fargo Shareowner Services
1110 Centre Pointe Curve, Suite 101
MAC N9173-010
Mendota Heights, MN  55120
(800) 468-9716
www.wellsfargo.com/contactshareownerservices
 
 
23

 
 
Share Repurchases
 
The purpose of our common stock repurchase plan is to increase shareholder value and to reduce outstanding share count dilution.  As announced on June 14, 2012, our Board of Directors authorized share repurchases of up to $1.0 billion beginning on June 13, 2012 with no specified expiration date. We may use open market or privately negotiated transactions, as well as Rule 10b5-1 trading plans, depending on market conditions and other factors. See Note 17 for a description of our $400.0 million ASR transaction executed in June 2012.
 
2012 Fourth Quarter
 
Total (a)
Number
of Shares
Purchased
   
Average Price Paid Per Share ($0.00)
   
Total Number of Shares Purchased as Part of a Publicly Announced Plan
   
Approximate Dollar Value of Shares Still Available for Purchase Under the Plan
 
July 1 - July 28, 2012
    1.7     $ 13.09       1.7     $ 600.0  
July 29 - August 25, 2012
    4.0       13.09       4.0       600.0  
August 26 - September 29, 2012
    1.0       13.09       1.0       600.0  
Total
    6.7       13.09       6.7       600.0  
 
 
(a)
Total includes 6,200 of restricted shares or units tendered by employees at fair value at vesting for tax withholding obligations.
 
Performance Graph
 
The following graph reflects the cumulative total return (change in stock price plus reinvested dividends) of a $100 investment in our common stock for five fiscal years ended September 30, 2012 relative to the Standard and Poor’s 500 Composite Index and a customized peer group of four companies that includes Bally Technologies, Inc., Scientific Games Corporation, SHFL entertainment, Inc., and WMS Industries, Inc.
 
The following graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any filing by us under the Securities Act of 1933, as amended (the Securities Act), or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. The stock price performance included in this graph is not necessarily indicative of future stock price performance.
 
 
 
24

 
 
Item 6.          Selected Financial Data
 
The following selected financial highlights should be read in conjunction with Item 7, MDA, and Item 8, Financial Statements and Supplementary Data. See Note 21 for additional information about discontinued operations reclassified in the income statement for all periods presented.
 
As of and for Years Ended September 30,
 
2012
   
2011
   
2010
   
2009
   
2008
 
                               
Revenues
  $ 2,150.7     $ 1,957.0     $ 1,917.2     $ 2,018.8     $ 2,430.0  
Gross profit
    1,237.6       1,138.4       1,087.3       1,113.6       1,383.4  
Operating income
    421.7       504.9       424.8       332.4       671.7  
Income from continuing operations, before tax (1)
    342.8       427.9       304.9       213.1       578.7  
Income from continuing operations, net of tax
    249.7       292.3       219.6       148.7       335.8  
Discontinued operations, net of tax
    (3.8 )     (8.7 )     (33.6 )     (21.9 )     (7.8 )
Net income
    245.9       283.6       186.0       126.8       328.0  
                                         
Basic earnings per share
                                       
Continuing operations
  $ 0.86     $ 0.98     $ 0.73     $ 0.50     $ 1.09  
Discontinued operations
  $ (0.01 )   $ (0.03 )   $ (0.11 )   $ (0.07 )   $ (0.03 )
Net income
  $ 0.85     $ 0.95     $ 0.62     $ 0.43     $ 1.06  
                                         
Diluted earnings per share
                                       
Continuing operations
  $ 0.86     $ 0.97     $ 0.73     $ 0.50     $ 1.08  
Discontinued operations
  $ (0.01 )   $ (0.03 )   $ (0.11 )   $ (0.07 )   $ (0.03 )
Net income
  $ 0.85     $ 0.94     $ 0.62     $ 0.43     $ 1.05  
                                         
Weighted average shares outstanding
                                       
Basic
    288.8       298.2       296.3       293.8       308.0  
Diluted
    290.4       299.8       297.8       294.0       310.2  
                                         
Cash dividends declared per share
  $ 0.24     $ 0.24     $ 0.24     $ 0.33     $ 0.57  
                                         
Net operating cash flows
  $ 446.5     $ 612.4     $ 591.0     $ 547.9     $ 486.5  
Net investing cash flows
    (308.8 )     (118.3 )     (117.7 )     (288.4 )     (365.7 )
Net financing cash flows
    (392.6 )     (190.8 )     (462.1 )     (381.2 )     (115.2 )
Capital expenditures
    208.7       205.1       240.2       257.4       298.2  
Cash used for share repurchases
    475.2       50.1       -       -       779.7  
                                         
Cash and short-term investments (2)
  $ 288.2     $ 552.0     $ 248.9     $ 247.4     $ 374.4  
Working capital
    633.0       875.2       620.1       609.2       733.4  
Total assets
    4,285.1       4,154.4       4,007.0       4,328.1       4,546.9  
Debt, net (current and non-current)
    1,846.4       1,646.3       1,674.3       2,020.0       2,235.4  
Jackpot liabilities (current and non-current)
    481.0       508.4       570.9       588.1       650.7  
Non-current liabilities
    2,457.0       2,174.9       2,190.4       2,640.0       2,881.9  
Total equity (3)
    1,197.8       1,444.8       1,234.3       1,063.6       928.3  
 
(1)
2010, 2011 and 2012 were significantly impacted by impairment and restructuring charges. See Note 2 and Note 19.
 
2009 included a loss on other assets of $78.0 million ($48.8 million after tax) associated with Walker Digital IP, restructuring charges of $33.9 million ($21.2 million after tax), and losses of $15.4 million ($14.2 million after tax) associated with affiliate investments.
 
(2)
Restricted amounts included in cash and short-term investments. See Note 1.
 
(3)
2012 and 2008 equity was significantly reduced by shares repurchased.

 
25

 
 
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.
 
 
26

 
 
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.
 
 
27

 
 
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.
 
 
28

 
 
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
 
 
29

 
 
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.
 
 
30

 
 
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.
 
 
31

 
 
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 largely due to changes in certain discrete tax items. The 2011 provision included favorable discrete tax items of $7.0 million related to the manufacturer’s deduction and retroactive reinstatement of the R&D tax credit and $15.1 million resulting from a lapse in the statute of limitations for 2007. The 2010 provision was positively impacted by $36.7 million as a result of settlements with tax authorities and the closure of IRS examinations for years 2002 through 2005, partially offset by other changes in uncertain tax positions.
 
 
32

 
 
BUSINESS SEGMENT RESULTS (See Note 18)
 
NORTH AMERICA SEGMENT RESULTS
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
                                                         
Total Revenues
  $ 1,644.1     $ 1,480.3     $ 1,428.4     $ 163.8       11 %   $ 51.9       4 %
Gross margin
    58 %     58 %     56 %   -   pp   -     2   pp   4 %
                                                         
Operating Income
  $ 425.8     $ 476.6     $ 345.9     $ (50.8 )     -11 %   $ 130.7       38 %
Margin
    26 %     32 %     24 %   (6 ) pp   -19 %   8   pp   33 %
 
2012 Compared With 2011
 
North America revenues grew 11% primarily due to added contribution from DoubleDown’s social gaming business acquired in late January 2012 and increased replacement machines sales. Operating income decreased 11% due to increased operating costs, primarily due to additional expenses from DoubleDown. Operating expenses included acquisition related charges primarily related to DoubleDown of $82.4 million for contingent employee retention bonus and earn-out liability accruals and $13.3 million for the amortization of acquired intangibles.
 
2011 Compared With 2010
 
North America operating income improvement was primarily the result of higher product sales volume combined with reduced impairment and restructuring charges (see CONSOLIDATED RESULTS – OPERATING EXPENSES above) and gross margin expansion. Impairment charges for 2011 included $7.9 million related to corporate assets held for sale and $3.6 million related to additional decline in our Alabama notes receivable. The 2010 impairment charges related to the Alabama charitable bingo market closures.
 
NORTH AMERICA GAMING OPERATIONS
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
Revenues
  $ 907.8     $ 913.8     $ 933.0     $ (6.0 )     -1 %   $ (19.2 )     -2 %
Gross margin
    60 %     59 %     58 %   1   pp   2 %   1   pp   2 %
                                                         
Installed base (units '000)
    43.4       40.9       40.9       2.5       6 %     -       -  
MegaJackpots® (premium brand)
    23.8       23.9       23.8       (0.1 )     -       0.1       -  
Lease (CDS, racino, other)
    19.6       17.0       17.1       2.6       15 %     (0.1 )     -1 %
                                                         
Yield (average revenue per unit)
  $ 59.19     $ 61.44     $ 59.35     $ (2.25 )     -4 %   $ 2.09       4 %
 
2012 Compared With 2011
 
North America gaming operations revenues decreased 1% primarily due to lower yield. Gross margin increased 2%, primarily due to lower jackpot expense and royalties. Installed base increased 6% due to expansion in lease operations, partially offset by decreases in MegaJackpots® units. Yield decreased 4% primarily due to lower performance and higher discounting in MegaJackpots®, as well as an increasing mix of lower-yield stand-alone units.
 
 
33

 
 
2011 Compared With 2010
 
North America interactive revenues grew $87.8 million primarily due to the recent acquisition of DoubleDown in late January 2012. DoubleDown’s social gaming revenues have increased each quarter since acquisition, primarily due to the combination of higher bookings per DAU (up 49%) and increasing DAU (up 6%). These improvements were driven by new IGT content and mobile platform introductions for the DoubleDown Casino® . Other IGTi operations revenue growth of $0.8 million in 2012 related to an online partner in Canada initiated in late 2011. Gross margin decrease of 9% included $5.8 million for the amortization of acquired developed technology.
 
NORTH AMERICA PRODUCT SALES
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
Revenues
  $ 648.2     $ 566.2     $ 495.4     $ 82.0       14 %   $ 70.8       14 %
Machines
    421.3       324.7       268.2       96.6       30 %     56.5       21 %
Non-machine (systems, parts, other)
    226.9       241.5       227.2       (14.6 )     -6 %     14.3       6 %
                                                         
Gross margin
    57 %     56 %     52 %     1   pp   2 %     4   pp   8 %
                                                         
Machine units recognized
    29.1       22.8       18.6       6.3       28 %     4.2       23 %
                                                         
Machine ASP ('000)
  $ 14.5     $ 14.2     $ 14.4     $ 0.3       2 %   $ (0.2 )     -1 %
                                                         
Machine units shipped ('000)
    29.3       20.9       18.1       8.4       40 %     2.8       15 %
New/expansion
    7.3       4.9       5.7       2.4       49 %     (0.8 )     -14 %
Replacement
    22.0       16.0       12.4       6.0       38 %     3.6       29 %
 
2012 Compared With 2011
 
Revenues from North America product sales improved 14% primarily due to increased machine units sold, partially offset by lower non-machine sales. Non-machine revenues decreased $14.6 million primarily due to lower Advantage® systems sales and fewer promotional parts conversion kits, partially offset by increased licensing fees. Gross margin improvement was attributable to lower machine costs due to favorable production volume and cost efficiencies, as well as increased ASP. Machine ASP improved due to lower discounts and a favorable mix of newer MLD models.
 
Machine units recognized increased 28% driven by higher demand for replacement units, as well as new/expansion units including new Ohio jurisdiction properties. Replacement units recognized included certain units under contract with the Canada Government Lottery and units under lease-to-purchase conversions. Although quarterly units can vary widely depending on the timing of customer needs and the level of promotional programs offered, we expect our 2013 annual units will increase over 2012.
 
2011 Compared With 2010
 
Product sales revenues improved with increased replacement machines driven by successful promotional programs, as well as higher IP licensing fees, and network systems sales. Gross margin improvement was primarily due to an increased mix of higher-margin systems and IP revenues, lower promotional discounts, and reduced obsolescence and warranty costs.
 
NORTH AMERICA INTERACTIVE
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
Revenues
  $ 88.1     $ 0.3     $ -     $ 87.8       *     $ 0.3       -  
Social gaming
    87.0       -       -       87.0       -       -       -  
IGTi
    1.1       0.3       -       0.8       267 %     0.3       -  
                                                     
Gross margin
    61 %     67 %     0 %   (6 ) pp   -9 %   67   pp   -  
                                                         
DoubleDown statistics
                                                       
Daily active users/DAU ('000)
    1,372                                                  
Monthly active users/MAU ('000)
    5,097                                                  
Bookings per DAU (0.00)
  $ 0.26                                                  
 
 
34

 
 
2012 Compared With 2011
 
North America interactive revenues grew $87.8 million primarily due to the recent acquisition of DoubleDown in late January 2012. DoubleDown’s social gaming revenues have increased each quarter since acquisition, primarily due to the combination of higher bookings per DAU (up 49%) and increasing DAU (up 6%). These improvements were driven by new IGT content and mobile platform introductions for the DoubleDown Casino®. Other IGTi operations revenue growth of $0.8 million in 2012 related to an online partner in Canada initiated in late 2011. Gross margin decrease of 9% included $5.8 million for the amortization of acquired developed technology.
 
INTERNATIONAL SEGMENT RESULTS
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
Total Revenues
  $ 506.6     $ 476.7     $ 488.8     $ 29.9       6 %   $ (12.1 )     -2 %
Gross margin
    55 %     59 %     59 %     (4 )
pp
  -7 %     -  
pp
  -  
                                                         
Operating Income
  $ 103.6     $ 138.4     $ 170.2     $ (34.8 )     -25 %   $ (31.8 )     -19 %
Margin
    20 %     29 %     35 %     (9 )
pp
  -31 %     (6 )
pp
  -17 %
 
2012 Compared with 2011
 
International revenues grew 6%, primarily due to increases from interactive (up $19.5 million) and gaming operations (up $9.5 million). Changes in foreign currency rates negatively impacted 2012 revenues by approximately $13.1 million. Operating income decreased primarily due to increased interactive operating costs, including $15.1 million of impairment and restructuring charges related to the Entraction closures. We expect to incur up to an additional $5.0 million of Entraction restructuring costs during the first half of 2013.
 
2011 Compared With 2010
 
International operating income decreased primarily due to lower product sales volume and higher operating costs largely related to additional infrastructure development for our interactive product line and LAC operations, and impairment of $4.3 million related to certain underperforming fixed assets. Favorable foreign exchange rates increased international revenues by approximately $25.5 million. In 2011 we sold our UK Barcrest Group and during 2010 our Japan operation was closed. Results for these groups have been classified in discontinued operations for all periods presented.
 
INTERNATIONAL GAMING OPERATIONS
 
                     
Favorable (Unfavorable)
 
   
2012
   
2011
   
2010
   
12 vs 11
   
11 vs 10
 
Revenues
  $ 132.2     $ 122.7     $ 111.2     $ 9.5       8 %   $ 11.5