United States
Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended December 28, 2013
(Presented as December 31, 2013)

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

(Exact name of registrant as specified in its charter)
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

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 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 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 Exchange Act).
Yes [ ] No [X]

The number of shares outstanding of each of the registrant's classes of common stock, as of January 31, 2014:
246.7 million shares of common stock at $.00015625 par value.

1


TABLE OF CONTENTS


GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
3
 
PART I – FINANCIAL INFORMATION
 
 
 
Item 1.       Unaudited Consolidated Interim Financial Statements
4
 
 
 
Item 2.       Management's Discussion and Analysis of Financial Condition and Results of Operations
22
 
 
 
Item 3.       Quantitative and Qualitative Disclosures about Market Risk
34
 
 
 
Item 4.       Controls and Procedures
34
 
 
 
PART II – OTHER INFORMATION
 
Item 1.       Legal Proceedings
35
 
 
 
Item 1A.    Risk Factors
35
 
 
 
Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds
35
 
 
 
Item 3.       Defaults Upon Senior Securities
35
 
 
 
Item 4.       Mine Safety Disclosures
35
 
 
 
Item 5.       Other Information
35
 
 
 
Item 6.       Exhibits
 36

 
2
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)


Fiscal dates -- actual:
Fiscal dates--as presented:
December 28, 2013
December 31, 2013
December 29, 2013
December 31, 2012
September 28, 2013
September 30, 2013
 
 
Abbreviation/term 
Definition 
AOCI
accumulated other comprehensive income (loss)
APIC
additional paid-in-capital
ASP
average sales price per machine unit
ASU
Accounting Standards Update
5.35% Bonds
5.35% fixed rate notes due 2023
5.5% Bonds 
5.5% fixed rate notes due 2020
7.5% Bonds 
7.5% fixed rate notes due 2019
bps
basis points
CEO
chief executive officer
CFO
chief financial officer
DAU
Daily Active Users
DCF
discounted cash flow
DoubleDown
Double Down Interactive LLC
EBITDA
earnings before interest, taxes, depreciation, and amortization
EPS
earnings per share
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
IGT rgs® 
IGT Remote Game Server® 
IP
intellectual property
IRS
Internal Revenue Service
LBG
Lightning Box Games Pty
LIBOR
London inter-bank offered rate
MAU
Monthly Active Users
MDA
management's discussion and analysis of financial condition and results of operations
pp
percentage points
R&D
research and development
SEC
Securities and Exchange Commission
SIP
2002 Stock Incentive Plan
SG&A
sales, general and administrative
UK
United Kingdom
US
United States
UTBs
unrecognized tax benefits
VIE
variable interest entity
VWAP
average daily volume weighted average price
VLT
video lottery terminal
WAP
wide area progressive
WMS
WMS Gaming, Inc.
Yield
average revenue per unit per day
*
not meaningful (in tables)

3

PART I – FINANCIAL INFORMATION
 
Item 1.
Unaudited Consolidated Interim Financial Statements
 
 
 
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
5
 
 
CONSOLIDATED BALANCE SHEETS
6
 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
7
 
 
SUPPLEMENTAL CASH FLOWS INFORMATION
8
 
 
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
9
 
 
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
9
 
 
 
2.
VARIABLE INTERESTS AND AFFILIATES
10
 
 
 
3.
RECEIVABLES
11
 
 
 
4.
CONCENTRATIONS OF CREDIT RISK
12
 
 
 
5.
INVENTORIES
12
 
 
 
6.
PROPERTY, PLANT AND EQUIPMENT
13
 
 
 
7.
GOODWILL AND OTHER INTANGIBLES
13
 
 
 
8.
FAIR VALUE MEASUREMENTS
14
 
 
 
9.
FINANCIAL DERIVATIVES
16
 
 
 
10.
CREDIT FACILITIES AND INDEBTEDNESS
17
 
 
 
11.
CONTINGENCIES
17
 
 
 
12.
INCOME TAXES
20
 
 
 
13.
EMPLOYEE BENEFIT PLANS
21
 
 
 
14.
EARNINGS PER SHARE
22
 
 
 
15.
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
22
 
 
 
16.
BUSINESS SEGMENTS
22
 
 
 
17.
SUBSEQUENT EVENT
23



4



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions except per share amounts)

First Quarters Ended December 31,
  
2013
    
2012
  
 
  
   
 
Revenues
  
   
 
Gaming operations
  
$
223.0
    
$
242.6
  
Product sales
    
243.6
      
234.8
  
Interactive
    
74.6
      
52.9
  
Total revenues
    
541.2
      
530.3
  
Costs and operating expenses
                
Cost of gaming operations
    
86.8
      
89.5
  
Cost of product sales
    
116.7
      
109.2
  
Cost of interactive
    
27.9
      
22.1
  
Selling, general and administrative
    
117.8
      
100.2
  
Research and development
    
60.3
      
54.4
  
Depreciation and amortization
    
16.7
      
19.0
  
Contingent acquisition-related costs
    
11.3
      
17.5
  
Total costs and operating expenses
    
437.5
      
411.9
  
Operating income
    
103.7
      
118.4
  
Other income (expense)
                
Interest income
    
10.1
      
11.3
  
Interest expense
    
(36.4
)
    
(31.7
)
Other
    
(1.9
)
    
(0.3
)
Total other income (expense)
    
(28.2
)
    
(20.7
)
Income before tax
    
75.5
      
97.7
  
Income tax provision (benefit)
    
(3.7
)
    
32.4
  
Net income
  
$
79.2
    
$
65.3
  
Other comprehensive income (loss)
                
Foreign currency translation adjustment
    
(2.3
)
    
3.4
  
Unrealized gain (loss), net of tax
    
(0.2
)
    
-
  
Comprehensive income
  
$
76.7
    
$
68.7
  
Basic earnings per share
  
$
0.31
    
$
0.25
  
Diluted earnings per share
  
$
0.31
    
$
0.24
  
Cash dividends declared per share
  
$
0.11
    
$
0.07
  
Weighted average shares outstanding
                
Basic
    
252.6
      
265.9
  
Diluted
    
255.3
      
267.9
  





See accompanying notes
 
5
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
 
  
December 31,
    
September 30,
  
 
  
2013
    
2013
  
Assets
  
   
 
Current assets
  
   
 
Cash and equivalents
  
$
480.6
    
$
713.3
  
Investment securities
    
99.5
      
28.8
  
Restricted cash and investment securities
    
66.7
      
64.9
  
Restricted cash and investment securities of VIEs
    
1.2
      
2.1
  
Jackpot annuity investments
    
43.7
      
44.1
  
Jackpot annuity investments of VIEs
    
12.2
      
12.4
  
Accounts receivable, net
    
338.0
      
348.6
  
Current maturities of contracts and notes receivable, net
    
236.7
      
229.3
  
Inventories
    
74.5
      
90.1
  
Deferred income taxes
    
118.6
      
111.1
  
Other assets and deferred costs
    
106.6
      
131.3
  
Total current assets
    
1,578.3
      
1,776.0
  
Property, plant and equipment, net
    
467.3
      
483.9
  
Jackpot annuity investments
    
232.1
      
234.5
  
Jackpot annuity investments of VIEs
    
32.3
      
34.1
  
Contracts and notes receivable, net
    
166.5
      
165.6
  
Goodwill
    
1,470.8
      
1,471.1
  
Other intangible assets, net
    
117.2
      
130.6
  
Deferred income taxes
    
122.7
      
128.8
  
Other assets and deferred costs
    
160.3
      
188.2
  
Total Assets
  
$
4,347.5
    
$
4,612.8
  
Liabilities and Shareholders' Equity
                
Liabilities
                
Current liabilities
                
Short-term debt
  
$
836.4
    
$
826.6
  
Accounts payable
    
96.9
      
110.0
  
Jackpot liabilities, current portion
    
126.0
      
131.7
  
Accrued employee benefits
    
10.9
      
40.2
  
Accrued income taxes
    
3.2
      
7.8
  
Dividends payable
    
27.5
      
25.9
  
Other accrued liabilities
    
359.5
      
366.3
  
Total current liabilities
    
1,460.4
      
1,508.5
  
Long-term debt
    
1,356.4
      
1,366.3
  
Jackpot liabilities
    
286.7
      
293.3
  
Other liabilities
    
139.1
      
190.6
  
Total Liabilities
    
3,242.6
      
3,358.7
  
Commitments and Contingencies
                
Shareholders' Equity
                
Common stock: $0.00015625 par value; 1,280.0 shares authorized;274.0 and 271.4 issued; 250.1 and 256.2 outstanding
    
-
      
-
  
Additional paid-in capital
    
1,445.7
      
1,433.1
  
Treasury stock at cost: 23.9 and 15.2 shares
    
(486.0
)
    
(274.9
)
Retained earnings
    
139.5
      
87.7
  
Accumulated other comprehensive income
    
5.7
      
8.2
  
Total Equity
    
1,104.9
      
1,254.1
  
Total Liabilities and Shareholders' Equity
  
$
4,347.5
    
$
4,612.8
  

 See accompanying notes
 
6
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)

Three Months Ended December 31,
  
2013
    
2012
  
Operating
  
   
 
Net income
  
$
79.2
    
$
65.3
  
Adjustments:
                
Depreciation and amortization
    
51.3
      
57.7
  
Acquisition-related contingent earn-out costs
    
4.5
      
2.1
  
Discounts and deferred issuance costs
    
11.6
      
11.0
  
Share-based compensation
    
9.0
      
8.6
  
Excess tax benefits from employee stock plans
    
(6.4
)
    
(0.3
)
Other non-cash items
    
8.0
      
10.9
  
Changes in operating assets and liabilities, excluding acquisitions:
                
Receivables
    
(13.2
)
    
14.4
  
Inventories
    
15.6
      
2.6
  
Accounts payable and accrued liabilities
    
(51.0
)
    
(83.5
)
Jackpot liabilities
    
(16.6
)
    
(24.2
)
Income taxes, net of employee stock plans
    
(11.4
)
    
29.1
  
Other assets and deferred costs
    
(4.5
)
    
0.8
  
Net operating cash flows
    
76.1
      
94.5
  
Investing
                
Capital expenditures
    
(24.6
)
    
(37.6
)
Proceeds from assets sold
    
3.3
      
4.6
  
Investment securities, net
    
(70.6
)
    
-
  
Jackpot annuity investments, net
    
9.0
      
9.9
  
Changes in restricted cash
    
(0.8
)
    
5.7
  
Loans receivable payments received
    
6.4
      
7.6
  
Net investing cash flows
    
(77.3
)
    
(9.8
)
Financing
                
Debt repayments
    
-
      
(75.0
)
Debt issuance costs
    
(0.5
)
    
-
  
Employee stock plan proceeds
    
1.9
      
1.5
  
Excess tax benefits from employee stock plans
    
6.4
      
0.3
  
Share repurchases, including net shares
    
(211.0
)
    
-
  
Dividends paid
    
(25.9
)
    
(16.1
)
Net financing cash flows
    
(229.1
)
    
(89.3
)
Foreign exchange rates effect on cash and equivalents
    
(2.4
)
    
(1.0
)
Net change in cash and equivalents
    
(232.7
)
    
(5.6
)
Beginning cash and equivalents
    
713.3
      
206.3
  
Ending cash and equivalents
  
$
480.6
    
$
200.7
  



 See accompanying notes

7

SUPPLEMENTAL CASH FLOWS INFORMATION
(In millions)

Three Months Ended December 31,
  
2013
    
2012
  
Investment securities
  
   
 
Purchases
  
$
(99.5
)
  
$
-
  
Proceeds from sale
    
28.9
      
-
  
Net
  
$
(70.6
)
  
$
-
  
Jackpot funding
                
Change in jackpot liabilities
  
$
(16.6
)
  
$
(24.2
)
Jackpot annuity purchases
    
(2.0
)
    
(1.8
)
Jackpot annuity proceeds
    
11.0
      
11.7
  
Net change in jackpot annuity investments
    
9.0
      
9.9
  
Net jackpot funding
  
$
(7.6
)
  
$
(14.3
)
Capital expenditures
                
Property, plant and equipment
  
$
(7.6
)
  
$
(7.3
)
Gaming operations equipment
    
(16.9
)
    
(30.1
)
Intellectual property
    
(0.1
)
    
(0.2
)
Total
  
$
(24.6
)
  
$
(37.6
)
Payments
                
Interest
  
$
27.8
    
$
28.4
  
Income taxes
    
9.6
      
0.4
  
Acquisition-related retention bonuses
    
-
      
29.3
  
Non-cash investing and financing items:
                
Accrued capital asset additions
  
$
0.3
    
$
(1.6
)
Interest accretion for jackpot annuity investments
    
4.1
      
4.6
  


Depreciation and amortization

Amounts reflected in operating cash flows are comprised of operating expenses shown separately on the income statements, plus those amounts included within cost of product sales, cost of gaming operations, and cost of interactive.






 See accompanying notes
 
8

NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

Our fiscal year is reported on a 52/53-week period ending on the Saturday nearest to September 30. Similarly, our quarters end on the Saturday nearest to the last day of the quarter end month. For simplicity, fiscal periods in this report are presented using the calendar month end as outlined in the table below.

 
Period End
 
Actual
 
Presented as
Current quarter
December 28, 2013
 
December 31, 2013
Prior year quarter
December 29, 2012
 
December 31, 2012
Prior year end
September 28, 2013
 
September 30, 2013

Our consolidated interim financial statements include the accounts of International Game Technology, including all majority-owned or controlled subsidiaries and VIEs for which we are the primary beneficiary. All inter-company accounts and transactions have been eliminated.

Our consolidated interim financial statements for the first quarter ended December 31, 2013 were prepared without audit on a basis consistent with the comparative prior year quarter ended December 31, 2012, and as appropriate, with the audited financial statements for the year ended September 30, 2013. Certain information and footnote disclosures have been condensed or omitted in conformity with SEC and US GAAP guidance for interim reviews.

Our consolidated interim financial statements include all adjustments of a normal recurring nature necessary to fairly state our consolidated results of operations, financial position, and cash flows for all periods presented. Interim period results are not necessarily indicative of full year results. This Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2013.

Unless otherwise indicated in this report:

 ● references to years relate to our fiscal years ending September 30
 ●     dollar amounts in tables are presented in millions, except per share amounts and par value
 ●     current refers to the quarter ended December 31, 2013
 ● 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
 
Use of Estimates

We are required to make estimates, judgments and assumptions that we believe are reasonable based on our historical experience, contract terms, observance of known trends in our company and the industry as a whole, and information available from other outside sources. Our estimates affect reported amounts for assets, liabilities, revenues, expenses, and related disclosures. Actual results may differ from initial estimates.

Recently Adopted Accounting Standards or Updates

Offsetting Assets and Liabilities

In December 2011, the FASB issued an ASU to require new disclosures associated with offsetting financial instruments and derivative instruments on the balance sheet that will enable users to evaluate the effect on an entity's financial position.  In January 2013, the FASB issued an ASU to clarify the scope of disclosures about offsetting assets and liabilities. The scope of the new disclosures was narrowed to include derivatives, repurchase agreements and securities borrowing and lending that are offset or subject to an enforceable master netting arrangement or similar agreement. Both ASUs were effective for our 2014 first quarter and had no material impact on our financial statements.
 
 
9
Recently Issued Accounting Standards or Updates—Not Yet Adopted

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward Exists

In July 2013, the FASB issued an ASU requiring the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax position. This ASU will be effective for our 2015 first quarter and is not expected to have a material impact on our financial statements.

Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries

In March 2013, the FASB issued an ASU requiring the release of cumulative translation adjustment into net income when an entity either sells a part or all of its investment in or no longer holds a controlling financial interest in a foreign entity. This ASU will be effective prospectively for our 2015 first quarter and is not expected to have a material impact on our financial statements.

Obligations Resulting from Joint and Several Liability Arrangements

In February 2013, the FASB issued an ASU to require new disclosures for an entity that is jointly and severally liable to measure the obligation as the sum of the amount the entity has agreed with co-obligors to pay and any additional amount it expects to pay on behalf of a co-obligor. This ASU will be effective for our 2015 first quarter and is not expected to have a material impact on our financial statements.

2.  VARIABLE INTERESTS AND AFFILIATES

Variable Interest Entities

New Jersey Trusts

New Jersey regulation requires that annuitized WAP jackpot payments to winners be administered through an individual trust set up for each WAP system. These trusts are VIEs and IGT is the primary consolidating beneficiary, because these VIE trusts are designed for the sole purpose of administering jackpot payments for IGT WAP winners and IGT guarantees all liabilities of the trusts. The assets of these consolidated VIEs can only be used to settle trust obligations and have been segregated on our balance sheet.

The consolidation of these VIEs primarily increases jackpot liabilities and related assets, as well as interest income and equivalent offsetting interest expense. Consolidated VIE trust assets and equivalent liabilities totaled $45.7 million at December 31, 2013 and $48.6 million at September 30, 2013.

Latin America Distributor

In March 2012, we contracted with a third party distributor in Latin America to sell IGT products. The distributor is a VIE as it was unable to finance its activities without additional support from IGT; however, the distributor was not consolidated because IGT does not have contractual or implied control.  This arrangement was terminated by mutual agreement in January 2014.

Under the agreement, our maximum exposure at December 31, 2013 consisted of $0.5 million in note financing provided for operating costs and contract financing under a revolving line of credit of $13.0 million for IGT product purchases. Revenues recognized related to this distributor totaled $2.2 million for the 2014 first quarter. Contracts and notes receivable due from this distributor totaled $12.0 million at December 31, 2013 ($9.8 million current and $2.2 million non-current).

3.  RECEIVABLES

Accounts Receivable


 
December 31,
 2013
  
September 30,
 2013
  
Allowances for Credit Losses
  
$
26.5
    
$
22.3
  


10
Customer Financing (Contracts and Notes)
 
  
December 31,
    
September 30,
  
 
  
2013
    
2013
  
Recorded Investment (principal and interest due, net of deferred interest and fees)
  
   
 
Individually evaluated for impairment
  
$
82.5
    
$
82.4
  
Collectively evaluated for impairment
    
400.7
      
391.0
  
Total
  
$
483.2
    
$
473.4
  
 
                
Allowances for Credit Losses
                
Individually evaluated for impairment
  
$
63.6
    
$
63.4
  
Collectively evaluated for impairment
    
16.4
      
15.1
  
Total
  
$
80.0
    
$
78.5
  

Reconciliation of Allowances for Credit Losses
  
   
 
 
  
   
 
First Quarters Ended December 31,
  
2013
    
2012
  
Beginning balance
  
$
78.5
    
$
72.8
  
Charge-offs
    
-
      
-
  
Recoveries
    
-
      
-
  
Provisions
    
1.5
      
3.8
  
Ending balance
  
$
80.0
    
$
76.6
  
Current
  
$
73.2
    
$
56.8
  
Non-current
  
$
6.8
    
$
19.8
  



Age Analysis of Recorded Investment
    
 
 
  
December 31, 2013
    
September 30, 2013
  
 
  
Contracts
    
Notes
    
Total
    
Contracts
    
Notes
    
Total
  
Past Due:
  
   
   
   
   
   
 
1-29 days
  
$
17.7
    
$
1.3
    
$
19.0
    
$
18.4
    
$
1.5
    
$
19.9
  
30-59 days
    
5.6
      
1.3
      
6.9
      
5.1
      
1.4
      
6.5
  
60-89 days
    
3.2
      
1.2
      
4.4
      
4.5
      
1.3
      
5.8
  
Over 90 days
    
14.9
      
55.2
      
70.1
      
16.1
      
54.9
      
71.0
  
Total past due
  
$
41.4
    
$
59.0
    
$
100.4
    
$
44.1
    
$
59.1
    
$
103.2
  
Total current (1)
    
357.8
      
25.0
      
382.8
      
339.1
      
31.1
      
370.2
  
Grand total
  
$
399.2
    
$
84.0
    
$
483.2
    
$
383.2
    
$
90.2
    
$
473.4
  
 
                                                
Over 90 days, accruing interest
  
$
1.2
    
$
0.2
    
$
1.4
    
$
-
    
$
1.3
    
$
1.3
  
Nonaccrual status
    
11.8
      
75.0
      
86.8
      
13.5
      
76.2
      
89.7
  

 (1) includes impaired Alabama note of $16.2 million at December 31, 2013 and $18.8 million at September 30, 2013

Recorded Investment by Credit Quality Indicator Using Credit Profile by Internally Assigned Risk Grade
  
 
 
 
 
December 31, 2013
  
September 30, 2013
  
 
Contracts
  
Notes
  
Total
  
Contracts
  
Notes
  
Total
  
Low
  
$
155.0
    
$
-
    
$
155.0
    
$
126.1
    
$
-
    
$
126.1
  
Medium
    
96.8
      
-
      
96.8
      
100.2
      
0.1
      
100.3
  
High (2)
    
147.4
      
84.0
      
231.4
      
156.9
      
90.1
      
247.0
  
Total recorded investment
  
$
399.2
    
$
84.0
    
$
483.2
    
$
383.2
    
$
90.2
    
$
473.4
  

(2) includes $75.0 million of impaired Alabama note receivable
 
11

Impaired loans
  
December 31, 2013
    
September 30, 2013
    
 
 
  
Contracts
    
Notes
    
Total
    
Contracts
    
Notes
    
Total
  
Recorded investment
  
$
5.9
    
$
75.0
    
$
80.9
    
$
5.7
    
$
75.0
    
$
80.7
  
Unpaid principal face
    
6.0
      
75.0
      
81.0
      
5.8
      
75.0
      
80.8
  
Related allowance
    
2.8
      
60.8
      
63.6
      
2.6
      
60.8
      
63.4
  
Average recorded investment
    
2.9
      
75.0
      
77.9
      
4.1
      
75.0
      
79.1
  

Interest income recognized on impaired contracts totaled $0.1 million (accrual basis) for the three months ended December 31, 2013 and $0.4 million during the comparable prior year period.

 
4.  CONCENTRATIONS OF CREDIT RISK

Net Receivables By Region At December 31, 2013
 
 
 
 
 
 
 
 
 
 
Nevada
11 %
 
Argentina
13 %
 
 
California
7 %
 
Europe
7 %
 
 
Illinois
6 %
 
Australia
7 %
 
 
New Jersey
5 %
 
Mexico
6 %
 
 
Other (less than 4% individually)
26 %
 
Other (less than 4% individually)
12 %
 
 
North America
55 %
 
International
45 %
 
 
 
 
 
 
 
 
 


5.  INVENTORIES

 
  
December 31,
    
September 30,
  
 
  
2013
    
2013
  
Raw materials
  
$
48.8
    
$
51.2
  
Work-in-process
    
1.4
      
2.7
  
Finished goods
    
24.3
      
36.2
  
Total
  
$
74.5
    
$
90.1
  


6.  PROPERTY, PLANT AND EQUIPMENT

 
  
December 31,
    
September 30,
  
 
  
2013
    
2013
  
Land
  
$
61.2
    
$
61.2
  
Buildings
    
231.6
      
231.3
  
Leasehold improvements
    
16.5
      
16.4
  
Machinery, furniture and equipment
    
308.9
      
309.0
  
Gaming operations equipment
    
774.4
      
785.9
  
Total
    
1,392.6
      
1,403.8
  
Less accumulated depreciation
    
(925.3
)
    
(919.9
)
Property, plant and equipment, net
  
$
467.3
    
$
483.9
  


12
7.  GOODWILL AND OTHER INTANGIBLES



Goodwill

Activity By Segment
North
    
   
 
For the Three Months Ended December 31, 2013
America
  
International
  
Total
  
Beginning balance
  
$
1,275.4
    
$
195.7
    
$
1,471.1
  
Foreign currency
    
-
      
(0.3
)
    
(0.3
)
Ending balance
  
$
1,275.4
    
$
195.4
    
$
1,470.8
  


Other Intangibles


 
  
December 31, 2013
    
September 30, 2013
  
Ending Balances
  
Cost
    
Accumulated
Amortization
    
Net
    
Cost
    
Accumulated
Amortization
    
Net
  
Patents
  
$
375.8
    
$
339.4
    
$
36.4
    
$
376.1
    
$
334.1
    
$
42.0
  
Developed technology
    
129.1
      
83.5
      
45.6
      
129.1
      
79.9
      
49.2
  
Contracts
    
20.1
      
18.8
      
1.3
      
20.1
      
18.6
      
1.5
  
Reacquired rights
    
14.7
      
5.6
      
9.1
      
14.7
      
5.2
      
9.5
  
Customer relationships
    
61.2
      
43.1
      
18.1
      
61.2
      
40.1
      
21.1
  
Trademarks
    
12.5
      
5.8
      
6.7
      
12.5
      
5.2
      
7.3
  
Total
  
$
613.4
    
$
496.2
    
$
117.2
    
$
613.7
    
$
483.1
    
$
130.6
  


 


 
First Quarters
  
 
 
Ended December 31,
  
Future Annual Estimates
  
 
  
2013
    
2012
    
2014
    
2015
    
2016
    
2017
    
2018
  
  Aggregate Amortization
  
$
13.5
    
$
15.6
    
$
47.4
    
$
36.4
    
$
20.2
    
$
10.1
    
$
5.2
  


 
8.  FAIR VALUE MEASUREMENTS

Financial Assets (Liabilities) Carried at Fair Value

 
  
Fair
Value
    
Level 1
    
Level 2
    
Level 3
  
December 31, 2013
  
   
   
   
 
Money market funds
  
$
144.8
    
$
144.8
    
$
-
    
$
-
  
Investment securities
    
99.5
      
-
      
99.5
      
-
  
Derivative assets
    
57.0
      
-
      
57.0
      
-
  
Derivative liabilities
    
(61.4
)
    
-
      
(61.4
)
    
-
  
Acquisition contingent earn-out payable
    
(110.9
)
    
-
      
-
      
(110.9
)
 
                                
September 30, 2013
                                
Money market funds
  
$
168.0
    
$
168.0
    
$
-
    
$
-
  
Investment securities
    
28.8
      
-
      
28.8
      
-
  
Derivative assets
    
67.0
      
-
      
67.0
      
-
  
Derivative liabilities
    
(72.2
)
    
-
      
(72.2
)
    
-
  
Acquisition contingent earn-out payable
    
(106.4
)
    
-
      
-
      
(106.4
)

Valuation Techniques and Balance Sheet Presentation

Money market funds were primarily money market securities valued based on quoted market prices in active markets.

Investment securities were commercial paper debt securities valued based on quoted market prices for similar instruments, using observable market based inputs.

Derivative assets and liabilities were valued using quoted forward pricing from bank counterparties, LIBOR credit default swap rates for non-performance risk, forward yields for the 10-year treasury sourced from Bloomberg, and net settlement amounts where appropriate. These are presented primarily as components of other assets, other liabilities, notes payable, and AOCI. See Note 9.
 
13
 
Acquisition contingent earn-out payable related to DoubleDown reaching certain earnings targets was valued with a DCF model applied to the expected payments determined based on probability-weighted internal earnings projections. We applied a rate of probability (10% - 90%) to each outstanding scenario, as well as a risk-adjusted discount rate of 18%, to derive the estimated fair value at December 31, 2013. Changes in the projections and/or the probabilities are the most significant assumptions and result in directionally similar changes in the fair value. Discount rate changes cause a directionally opposite change in the fair value. Acquisition contingent earn-out payable was presented as a component of other liabilities, $60.0 million current and $50.9 million noncurrent at December 31, 2013 versus $57.6 million current and $48.8 million noncurrent at September 30, 2013. The payable fair value increased $4.5 million during the first quarter ended December 31, 2013 primarily due to the time-value of money.

Reconciliation of Items Carried at Fair Value Using Significant Unobservable Inputs (Level 3)

Acquisition Contingent Consideration Payable
  
   
 
Three Months Ended December 31,
  
2013
    
2012
  
Beginning balance
  
$
(106.4
)
  
$
(116.4
)
Accretion (interest and fair value adjustment)
    
(4.5
)
    
(2.1
)
Ending balance
  
$
(110.9
)
  
$
(118.5
)
 
                
Net change in unrealized gain (loss) included in earnings related to instruments still held
  
$
-
    
$
-
  

Financial Assets (Liabilities) Not Carried at Fair Value

 
  
Carrying
    
Fair
    
   
   
   
Unrealized
  
 
  
Value
    
Value
    
Level 1
    
Level 2
    
Level 3
    
Gain (Loss)
  
December 31, 2013
  
   
   
   
   
   
 
Jackpot investments
  
$
320.3
    
$
354.1
    
$
354.1
    
$
-
    
$
-
    
$
33.8
  
Contracts & notes receivable
    
403.2
      
397.6
      
-
      
-
      
397.6
      
(5.6
)
Jackpot liabilities
    
(412.7
)
    
(409.5
)
    
-
      
-
      
(409.5
)
    
3.2
  
Debt
    
(2,131.8
)
    
(2,305.9
)
    
(2,305.9
)
    
-
      
-
      
(174.1
)
 
                                                
September 30, 2013
                                                
Jackpot investments
  
$
325.1
    
$
366.3
    
$
366.3
    
$
-
    
$
-
    
$
41.2
  
Contracts & notes receivable
    
394.9
      
388.3
      
-
      
-
      
388.3
      
(6.6
)
Jackpot liabilities
    
(425.0
)
    
(425.2
)
    
-
      
-
      
(425.2
)
    
(0.2
)
Debt
    
(2,121.9
)
    
(2,346.6
)
    
(2,346.6
)
    
-
      
-
      
(224.7
)

Valuation Techniques and Balance Sheet Presentation

Jackpot investments were valued based on quoted market prices.

Contracts and notes receivable were valued using DCF, incorporating expected payments and market interest rates relative to the credit risk of each customer (low 7.5 %, medium 8.0 %, high 9.5 % - 11.25 %). Credit risk is determined on a number of factors, including customer size, type, financial condition, historical collection experience, account aging, and credit ratings derived from credit reporting agencies and other industry trade reports. Contracts are secured by the underlying assets sold and notes are secured by the developed property and/or other assets. The high risk category includes most of our development financing loans in new markets and customers in regions with a history of currency or economic instability, such as Latin America. See Notes 3 and 4.

Jackpot liabilities were valued using DCF, incorporating expected future payment timing, estimated funding rates based on the treasury yield curve, and IGT's nonperformance credit risk. Expected annuity payments over 1-25 years (average 10 years) were discounted using the 10-year treasury yield curve rate (3.00%) for the estimated funding rate and the 10-year credit default swap rate (1.65%) for nonperformance risk. The present value (carrying value) of the expected lump sum payments were discounted using the 1-year treasury yield curve rate (.11%) with the 1-year credit default swap rate (.22%) for the current amounts and the 2-year treasury yield curve rate (.39%) with the 2-year credit default swap rate (.34%) for noncurrent amounts. Significant increases (decreases) in any of these inputs in isolation would result in a lower (higher) fair value measurement. Generally, changes in the estimated funding rates do not correlate with changes in nonperformance credit risk.

The majority of our debt was level 1 and valued using quoted market prices or dealer quotes for the identical financial instrument when traded as an asset in an active market. Outstanding borrowings, if any,  under our revolving credit facility are level 2 and fair value is determined using DCF of expected payments at current borrowing rates. Carrying values in the table excluded swap adjustments and equity components of convertible debt.
 
14

Level 3 Valuation Process

Our valuation policies and procedures are determined by the Accounting Department, which ultimately reports to the Chief Financial Officer, in coordination with appropriate business asset owners and third-party valuation services when needed. Changes in fair value and methods for calibration, back testing, and other testing procedures of pricing models are evaluated through analytical review by managers of the responsible Accounting Department quarterly, by the Global Controller at inception and periodically with significant changes. Material valuations are discussed with the Audit Committee at inception and periodically if changes are significant or if impairment charges are recorded. Third-party information is evaluated for consistency with the FASB ASC for fair value measurement through analytical review and in-depth discussions with a variety of valuation experts.

Unobservable inputs are used only to the extent that observable inputs are not available and reflect management assumptions that cannot be corroborated with observable market data about what market participants would use in pricing the asset or liability, including assumptions about risk. Our unobservable inputs consist primarily of expected cash flows, stock price volatility, and other rates derived through extrapolation or interpolation. These inputs are developed based on the best information available, including trends deduced from available historical information and future expectations, using company specific data and market or industry published data. These inputs are validated for reasonableness by analytic comparison to other relevant valuation statistics whenever possible. Unobservable inputs depend on the facts and circumstances specific to a given asset or liability and require significant professional judgment.

9.  FINANCIAL DERIVATIVES

Foreign Currency Hedging

The notional amount of foreign currency contracts hedging our exposure related to monetary assets and liabilities denominated in nonfunctional currency totaled $44.3 million at December 31, 2013 and $91.9 million at September 30, 2013.

Presentation of Derivative Amounts

Except for net interest receivable related to our interest rate swaps, all derivatives are recorded on a gross basis.

Balance Sheet Location and Fair Value

 
  
December 31, 2013
    
September 31, 2013
  
 
  
Assets
    
Liabilities
    
Assets
    
Liabilities
  
Non-designated Hedges -- Foreign Currency Contracts
  
   
   
   
 
Other assets and deferred costs (current)
  
$
1.6
    
$
-
    
$
0.5
    
$
-
  
Other accrued liabilities
    
-
      
0.4
      
-
      
1.1
  
 
                                
Designated Hedges - Interest Rate Swaps
                                
Other assets and deferred costs (noncurrent)
    
55.4
      
-
    
$
66.5
      
-
  
Long-term debt
    
-
      
61.0
      
-
      
71.1
  
Swap interest receivable
    
2.0
      
-
      
15.6
      
-
  
Gross Derivatives
  
$
59.0
    
$
61.4
    
$
82.6
    
$
-
  
 
                                
Swap interest receivable offset
    
(1.1
)
)
    
-
      
(8.0
)
)
    
-
  
 
                                
Net Derivatives
  
$
57.9
    
$
61.4
    
$
74.6
    
$
72.2
  

Income Statement Location and Income (expense)


First Quarters Ended December 31,
  
2013
    
2012
  
Non-designated Hedges --Foreign Currency Contracts
  
   
 
Other income (expense)
  
$
1.2
    
$
(0.1
)
 
                
Designated Hedges -- Interest Rate Swaps
                
Ineffectiveness: Other income (expense)
  
$
(1.1
)
  
$
1.4
  
Effectiveness: Interest expense
    
6.8
      
5.0
  



15

10.  CREDIT FACILITIES AND INDEBTEDNESS


 
  
December 31,
    
September 30,
  
 
  
2013
    
2013
  
Credit facility
  
$
-
    
$
-
  
3.25% Convertible Notes (due May 2014)
    
850.0
      
850.0
  
7.5% Bonds (due June 2019)
    
500.0
      
500.0
  
5.5% Bonds (due June 2020)
    
300.0
      
300.0
  
5.35% Bonds (due October 2023)
    
500.0
      
500.0
  
Total principal debt obligations
    
2,150.0
      
2,150.0
  
Discounts:
                
3.25% Convertible Notes
    
(13.6
)
    
(23.3
)
7.5% Bonds
    
(1.7
)
    
(1.8
)
5.5% Bonds
    
(0.9
)
    
(0.9
)
5.35% Bonds
    
(2.0
)
    
(2.1
)
Swap fair value adjustments:
                
7.5% Bonds
    
42.6
      
48.4
  
5.5% Bonds
    
18.4
      
22.6
  
Total outstanding debt, net
  
$
2,192.8
    
$
2,192.9
  

IGT was compliant with all covenants and embedded features required no bifurcation at December 31, 2013.

Credit Facility

At December 31, 2013, no borrowings were outstanding under our $1.0 billion revolving credit facility, $972.2 million was available, and $27.8 million was reserved for letters of credit and performance bonds.

3.25% Convertible Notes

First Quarter Ended December 31,
  
2013
    
2012
  
Contractual interest expense
  
$
6.9
    
$
6.9
  
Discount amortization
    
9.8
      
8.9
  
Remaining discount amortization period (in months)
    
4
          
 

 
11.  CONTINGENCIES

Litigation

From time to time, in the normal course of its operations, the Company is a party to litigation matters and claims. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company's view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a provision for contingent losses when it is both probable that a liability will be incurred and the amount or range of the loss can be reasonably estimated. Except as otherwise stated below, we have concluded that we cannot estimate the reasonably possible loss or range of loss, including reasonably possible losses in excess of amounts already accrued, for each specific matter disclosed below. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company's operations or its financial position, liquidity or results of operations.

Atlantic Lotteries

In an action brought in the Supreme Court of New Foundland and Labrador by Babstock and Small as representatives of a purported class of persons allegedly harmed by VLT gaming in the Province of New Foundland and Labrador. Atlantic Lottery Corporation has impleaded VLC, Inc., IGT-Canada, Inc., International Game Technology and other third party defendants seeking indemnification for any judgment recovered against Atlantic Lottery Corporation in the main action. Plaintiffs filed a motion for class action certification on September 17, 2012. The Court has decided to address the motion for certification in two phases. Under Phase 1, the Court will determine whether the Plaintiffs have pleaded a cause of action. Hearings on Phase 1 were held on June 6 and 7, 2013. The Court has not yet issued a decision.  Should the Court conclude that Plaintiffs have pleaded a cause of action, then, under Phase 2, the Court would determine the appropriateness of certification of the putative class.
 
16

Shareholder Actions

On April 8, 2011, the Company was nominally sued in a derivative complaint filed in the US District Court for the District of Nevada, captioned Arduini v. Hart, et al., Case No. 3:11-cv-00255. Plaintiff purportedly brought this action on behalf of the Company. The complaint asserts claims against various current and former officers and directors of the Company, for breaches of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement, waste of corporate assets, and contribution and indemnification. The complaint sought an unspecified amount of damages. A motion to dismiss was filed. On March 14, 2012, defendants' motion to dismiss the action was granted. On April 3, 2012, the plaintiff appealed to the US Court of Appeals for the Ninth Circuit. Oral argument has been scheduled for April 10, 2014.

Lightning Box Games

On July 30, 2013, IGT was sued in US District Court for the Northern District of Illinois for patent infringement by Lightning Box Games (LBG), captioned Lightning Box Games PTY LTD. v. International Game Technology and Caesars Entertainment Corporation, Case No. 13-cv-5423. LBG alleges infringement of two related patents for "Electronic System for Playing of Reel-Type Games," and specifically accuses IGT's MultiPLAY video slot machines of infringing one or more claims of the patents. LBG is seeking, among other items, preliminary and permanent injunctive relief, monetary damages resulting from the infringing conduct (including pre- and post-judgment interest), and court costs. IGT intends to vigorously defend against the claims asserted in this lawsuit.

Mark E Pollack Arbitration

In January 2013, IGT notified Mark E Pollack that it was terminating eight agreements between IGT and Mr. Pollack relating to services provided by Mr. Pollack (e.g., providing ideas for gaming machines and initiating and arranging meetings with various artists and intellectual property owners).  Mr. Pollack disagreed that IGT could terminate the agreements and the parties entered mediation pursuant to the dispute resolution provisions in the respective agreements.  On October 22, 2013, the parties filed arbitration demands submitting the dispute to arbitration before Judicial Arbitration Mediation Services (JAMS), captioned International Game Technology v. Pollack, Case No. 1260002648 and Pollack v. International Game Technology, Case No. 1260002648.  Mr. Pollack is requesting unspecified monetary damages and injunctive relief.  IGT is currently working with Mr. Pollack on the selection of an arbitrator to hear the dispute.
 
WMS Gaming, Inc.

2013 Northern District of Illinois 

On July 2, 2013, IGT was sued by WMS Gaming, Inc. in US District Court for the Northern District of Illinois, captioned WMS Gaming, Inc. v. IGT, Case No. 1:13-cv-4788.  The suit relates to a contract between the parties.  WMS alleges that IGT breached the contract, anticipatorily repudiated the contract, breached the implied covenant of good faith and fair dealing, and violated the Nevada Unfair Trade Practices Act.  WMS sought a temporary restraining order, which was denied.  WMS is seeking, among other things, declaratory judgment, specific performance, injunctive relief, unspecified monetary damages, and attorneys' fees and costs.  IGT intends to vigorously defend against the claims asserted in this lawsuit.

2013 Arbitration

Related to foregoing lawsuit, on September 10, 2013 IGT filed an arbitration with the American Arbitration Association (AAA) against WMS, captioned IGT v. WMS Gaming, Inc., No. 79 517 112 13.  IGT and WMS have a license agreement for Ticket-In-Ticket-Out (TITO) enabled gaming machines.  IGT alleges WMS failed to pay license fees owed on certain products covered by the agreement.  IGT is seeking a judgment that WMS must pay license fees on certain products and monetary damages of $50.0 million resulting from WMS's failure to pay license fees on those products. 

2013 District of Nevada

Related to the foregoing lawsuit and arbitration, on October 22, 2013, WMS filed suit in the US District Court for the District of Nevada, captioned WMS Gaming, Inc. v. IGT, Case No. 3:13-cv-00583.  WMS is seeking, among other things, a declaratory judgment that the arbitration provision of the license agreement is unenforceable, alleging that IGT is seeking to arbitrate non-arbitrable issues, and seeking a refund of royalties WMS has allegedly overpaid.  WMS has filed a motion for preliminary injunction, seeking to enjoin the arbitration. IGT intends to vigorously defend against the claims asserted in this lawsuit.
 
17

Global Draw Ltd

On September 17, 2013, Global Draw Limited (an English company) issued proceedings in London against IGT-UK Group Limited (a wholly owned subsidiary of IGT) and IGT, captioned 2013 High Court of Justice (Commercial Court) in London, England, Case No. 2013, Folio 1246. The claim arises out of a Sale and Purchase Agreement dated April 26, 2011 (SPA) pursuant to which Global Draw purchased from IGT-UK all of the shares in an English company called Barcrest Limited. Global Draw seeks to claim against IGT-UK under the terms of indemnities and warranties contained in the SPA, and against IGT under the terms of a guarantee given by IGT in respect of the liabilities of IGT-UK. On November 7, 2013 IGT-UK filed and served a defense and counterclaim in response to the claim and IGT has also entered its defense. The claims assert damages of £1.3 million and US $2.9 million excluding interest, plus other unquantified damages. IGT intends to vigorously defend against the claims asserted in this lawsuit.

Arrangements with Off-Balance Sheet Risks

In the normal course of business, we are party to financial instruments with off-balance sheet risk, such as performance bonds not reflected in our balance sheet. We do not expect any material losses to result from these arrangements and are not dependent on off-balance sheet financing arrangements to fund our operations.

Performance Bonds

Performance bonds outstanding related to certain gaming operations equipment totaled $19.5 million at December 31, 2013. We are liable to reimburse the bond issuer in the event of exercise due to our nonperformance.

Letters of Credit

Outstanding letters of credit issued under our domestic credit facility to ensure payment to certain vendors and governmental agencies totaled $8.3 million at December 31, 2013.

IGT Licensor Arrangements

Our sales agreements that include software and IP licensing arrangements may require IGT to indemnify the third-party licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark infringement, or trade secret misappropriation. Should such a claim occur, we could be required to make payments to the licensee for any liabilities or damages incurred. Historically, we have not incurred any significant settlement costs due to infringement claims. As we consider the likelihood of incurring future costs to be remote, no liability has been recorded.

Self-Insurance

We are self-insured for various levels of workers' compensation, directors' and officers' liability, and electronic errors and omissions liability, as well as employee medical, dental, prescription drug, and disability coverage. We purchase stop loss coverage to protect against unexpected claims. Accrued insurance claims and reserves include estimated settlements for known claims, and actuarial estimates for claims incurred but not reported.

State and Federal Taxes

We are subject to sales, use, income, gaming and other tax audits and administrative proceedings in various US federal, state, local, and foreign jurisdictions. While we believe we have properly reported our tax liabilities in each jurisdiction, we can give no assurance that taxing authorities will not propose adjustments that increase our tax liabilities.

Product Warranties

The majority of our products are generally covered by a warranty for periods ranging from 90 to 180 days. We estimated accrued warranty costs in the table below based on historical trends in product failure rates and expected costs to provide warranty services.

Three Months Ended December 31,
  
2013
    
2012
  
Beginning balance
  
$
4.4
    
$
4.2
  
Reduction for payments made
    
(1.4
)
    
(2.5
)
Accrual for new warranties issued
    
2.6
      
3.9
  
Adjustments for pre-existing warranties
    
(1.5
)
    
(1.4
)
Ending balance
  
$
4.1
    
$
4.2
  


18
12.  INCOME TAXES

Our provision for income taxes is based on an estimated effective annual income tax rate, as well as the impact of discrete items, if any, occurring during the period. The provision differs from income taxes currently payable because certain items of income and expense are recognized in different periods for financial statement purposes than for tax return purposes. We reduce deferred tax assets by a valuation allowance when it is more likely than not that some or all of the deferred tax assets will not be realized.

Our effective tax rate for the three months ended December 31, 2013 decreased to -4.9 % from 33.2% for the same prior year period. The current year effective tax rate was positively impacted by the settlement of income tax audits for fiscal years 1999, and 2006 through 2009.

At December 31, 2013, our gross UTBs totaled $69.2 million, excluding related accrued interest and penalties of $11.1 million. At December 31, 2013, $52.3 million of our UTBs, including related accrued interest, penalties, and indirect effects in other jurisdictions, would affect our effective tax rate if recognized. During the three months ended December 31, 2013, our UTBs decreased $40.0 million and related interest and penalties decreased $12.2 million. We do not believe our total UTBs will change significantly during the next twelve months.

As of December 31, 2013 we effectively settled audits with the US tax authorities related to our fiscal year 1999 and 2006 through 2009 tax years.  As a result of the settlement, we reduced our tax provision by $29.6 million and our UTBs by $33.1 million, inclusive of related interest, penalties and indirect effects in other jurisdictions.

We are also subject to examination in various state and foreign jurisdictions. We believe we have recorded all appropriate provisions for outstanding issues for all jurisdictions and open years. However, we can give no assurance that taxing authorities will not propose adjustments that increase our tax liabilities.


13.  EMPLOYEE BENEFIT PLANS

Share-based Compensation

SIP As Of And For The Three Months Ended December 31, 2013

 
  
   
Weighted Average
    
 
Options
  
Shares
    
Exercise
Price
    
Remaining
Contractual
Term
    
Aggregate
Intrinsic
Value
  
 
  
(thousands)
    
(per share)
    
(years)
    
(millions)
  
Outstanding at beginning of fiscal year
    
9,088
    
$
18.57
    
   
 
Granted
    
-
      
-
    
   
 
Exercised
    
(135
)
    
14.26
    
   
 
Forfeited
    
(41
)
    
17.03
    
   
 
Expired
    
(50
)
    
22.83
    
   
 
Outstanding at end of period
    
8,862
    
$
18.62
      
5.0
    
$
14.7
  
 
                                
Vested and expected to vest
    
8,766
    
$
18.65
      
4.9
    
$
14.6
  
 
                                
Exercisable at end of period
    
7,888
    
$
18.93
      
4.7
    
$
13.0
  


 
  
   
Weighted Average
    
 
Restricted Shares/Units
  
Shares
    
Grant
Date
Fair Value
    
Remaining
Vesting
Period
    
Aggregate
Intrinsic
Value
  
 
  
(thousands)
    
(per share)
    
(years)
    
(millions)
  
Outstanding at beginning of fiscal year
    
6,350
    
$
14.55
    
   
 
Granted*
    
3,318
      
16.35
    
   
 
Vested
    
(2,495
)
    
14.32
    
   
 
Forfeited
    
(114
)
    
14.84
    
   
 
Outstanding at end of period
    
7,059
    
$
15.46
      
1.8
    
$
124.6
  
 
                                
Expected to vest
    
6,115
    
$
15.47
      
1.8
    
$
108.0
  

* certain awards require satisfaction of a combination of performance and market conditions

Other Information
  
 
Shares available for future grant
    
18.3
  
Unrecognized costs for outstanding awards
  
$
106.9
  
Weighted average future recognition period (in years)
    
2.0
  


19
 
14.  EARNINGS PER SHARE

First Quarters Ended December 31,
  
2013
    
2012
  
Net income available to common shares
  
$
79.2
    
$
65.3
  
Basic weighted average shares outstanding
    
252.6
      
265.9
  
Dilutive effect of non-participating share-based awards
    
2.7
      
2.0
  
Diluted weighted average common shares outstanding
    
255.3
      
267.9
  
 
                
Basic EPS
  
$
0.31
    
$
0.25
  
Diluted EPS
  
$
0.31
    
$
0.24
  
 
                
Weighted average shares excluded from diluted EPS because the effect would be anti-dilutive:
  
Share-based awards
    
5.1
      
12.7
  
Notes
    
42.6
      
42.6
  
Note hedges
    
(42.6
)
    
(42.6
)
Warrants
    
42.6
      
42.6
  

Accelerated Share Repurchase

On November 7, 2013, we executed an accelerated share repurchase transaction for $200.0 million of IGT common stock effective through January 22, 2014. We received an initial delivery of 8.2 million shares on November 8, 2013 and 11.6 million total shares were delivered based on the VWAP over the transaction period for an average discounted price of $17.22 per share.

15.  ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 
  
   
Unrealized
    
 
 
  
Foreign
    
Gain on
    
 
 
  
Currency
    
Treasury
    
 
First Quarter Ended December 31, 2013
  
Translation
    
Locks
    
Total
  
 
  
   
   
 
AOCI beginning balance
  
$
0.2
    
$
8.0
    
$
8.2
  
 
                        
OCI before reclassifications (no tax)
    
(2.3
)
    
-
      
(2.3
)
Reclassifications to earnings:
                        
Amount before tax (interest expense)
    
-
      
(0.3
)
    
(0.3
)
Income Tax at 37%
    
-
      
0.1
      
0.1
  
Amount net of tax
    
-
      
(0.2
)
    
(0.2
)
Net other comprehensive income
    
(2.3
)
    
(0.2
)
    
(2.5
)
AOCI ending balance
  
$
(2.1
)
  
$
7.8
    
$
5.7
  
 
                        

16.  BUSINESS SEGMENTS

We view our business in the following two operating segments:

 ●
North America includes our operations associated with land-based and online-real money customers located in the US and Canada, as well as US-based online social gaming operations
 ●
International includes our operations associated with customers located in all other jurisdictions

Certain income and expenses related to company-wide initiatives primarily comprised of general and administrative costs and other income (expense) are managed at the corporate level and not allocated to an operating segment. We do not recognize inter-company revenues or expenses upon the transfer of gaming products between operating segments. Segment accounting policies are consistent with those of our consolidated financial statements and segment profit is measured on the basis of operating income. Impairment and restructuring charges, if any, are reflected within the segment where actions occurred.
 
20

Our business segments are designed to allocate resources within a framework of management responsibility. Operating costs included in one segment may benefit other segments. Realignment of our business development and administrative functions may result in ongoing changes to allocations of operating cost amongst our operating segments.

Business Segments Financial Information

First Quarters Ended December 31,
  
2013
    
2012
  
NORTH AMERICA
  
   
 
Revenues
  
$
427.4
    
$
409.4
  
Gaming operations
    
191.6
      
208.6
  
Product sales
    
170.0
      
158.9
  
Interactive
    
65.8
      
41.9
  
Gross profit
    
244.6
      
244.2
  
Gaming operations
    
113.7
      
129.7
  
Product sales
    
90.0
      
89.2
  
Interactive
    
40.9
      
25.3
  
Operating income
    
105.9
      
112.4
  
 
                
INTERNATIONAL
                
Revenues
  
$
113.8
    
$
120.9
  
Gaming operations
    
31.4
      
34.0
  
Product sales
    
73.6
      
75.9
  
Interactive
    
8.8
      
11.0
  
Gross profit
    
65.2
      
65.3
  
Gaming operations
    
22.5
      
23.4
  
Product sales
    
36.9
      
36.4
  
Interactive
    
5.8
      
5.5
  
Operating income
    
24.9
      
28.4
  
 
                
CORPORATE (unallocated)
                
Operating expenses
  
$
(27.1
)
  
$
(22.4
)
 
                
CONSOLIDATED
                
Revenues
  
$
541.2
    
$
530.3
  
Gaming operations
    
223.0
      
242.6
  
Product sales
    
243.6
      
234.8
  
Interactive
    
74.6
      
52.9
  
Gross profit
    
309.8
      
309.5
  
Gaming operations
    
136.2
      
153.1
  
Product sales
    
126.9
      
125.6
  
Interactive
    
46.7
      
30.8
  
Operating income
    
103.7
      
118.4
  


17.  SUBSEQUENT EVENT

In January 2014, the Argentina peso currency was devalued. Based on our net position at December 31, 2013, we expect to record an estimated currency exchange loss of approximately $4.0 million during our 2014 second quarter as a result of remeasuring our peso-based assets and liabilities.

21

Item 2. 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.The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2013, as well as the accompanying Consolidated Interim Financial Statements and Notes included in Item 1 of this Form 10-Q. Information posted on our website is not incorporated into this Form 10-Q.

Our MDA is organized into the following sections:

 ●                  FORWARD LOOKING STATEMENTS

 ●                  OVERVIEW

 ●                  CONSOLIDATED RESULTS

 ●                  BUSINESS SEGMENT RESULTS

 ●                  LIQUIDITY AND CAPITAL RESOURCES

 ●                  RECENTLY ISSUED ACCOUNTING STANDARDS

 ●                  CRITICAL ACCOUNTING ESTIMATES

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 our fiscal first quarter ended December 31, 2013

 ● Note refers to the Notes of our Consolidated Interim Financial Statements in Item 1 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 periods as compared with the prior year fiscal periods

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

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.
 
22

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, including our ability to implement and manage cost reduction initiatives

 ● our leadership position in the gaming industry or in online casino-style social gaming

 ● 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

 ● research and development activities, including anticipated benefits from such activities

 ● fluctuations in future gross margins, tax rates, and liabilities

 ● expectations regarding 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, dividends, 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

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. Further information on potential factors that could affect our financial condition, results of operations and business are included in this report and our other filings with the SEC. 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.
 
23
 
 
OVERVIEW

International Game Technology is a global gaming company specializing in the design, development, manufacture, and marketing of casino-style gaming equipment, systems technology, and game content across multiple platforms—land-based, online real-money and online social. We are a leading supplier of gaming entertainment products worldwide and provide a diverse offering of quality products and services at competitive prices, designed to enhance the gaming player experience.

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

We measure segment profit on the basis of operating income. Certain income and expenses are managed at the corporate level and not allocated to an operating segment. Other segment and financial information is contained in our BUSINESS SEGMENT RESULTS below and Note 16.

SUMMARY RESULTS

First Quarters Ended December 31,
  
2013
    
2012
    
C h a n g e
  
Revenues
  
$
541.2
    
$
530.3
    
$
10.9
      
2
%
Operating income
    
103.7
      
118.4
      
(14.7
)
    
-12
%
Net Income
    
79.2
      
65.3
      
13.9
      
21
%
EPS
  
$
0.31
    
$
0.24
    
$
0.07
      
29
%

Quarters ended December 31, 2013 and 2012 compared

Revenues for our first quarter ended December 31, 2013 improved primarily due to an increase of $18.0 million or 4% in North America, partially offset by a decrease of $7.1 million or 6% in International. Interactive revenues increased $21.7 million or 41%, primarily due to growing contributions from social gaming, and product sales revenues increased $8.8 or 4%, primarily due to higher machine unit volume. These increases were partially offset by a decrease of $19.6 million or 8% in gaming operations revenues, primarily due to installed base decline along with lower yield.

Operating income decreased as higher expenses outpaced revenue growth. Net income and EPS increased primarily due to a lower effective income tax rate of -4.9% versus 33.2% in the prior year quarter, primarily due to audit closures that reduced our provision for income taxes by $29.6 million. EPS also benefitted from fewer shares outstanding due to share repurchases.

For a more in-depth analysis of our results, see CONSOLIDATED RESULTS directly following this OVERVIEW.

BUSINESS TRENDS

Declines in gross gaming revenues adversely impacted our first quarter results, with weakness in most domestic casino markets and a particularly sharp decline in December. In addition, economic uncertainty continues to inhibit our customers' willingness to purchase gaming machines and increasing competition continues to pressure market share. Moreover, government regulation and restrictions, such as import restrictions and regulatory compliance delays, are impeding our ability to satisfy market demand for our products in certain international jurisdictions. In this market environment, we plan to re-evaluate our operating structure and implement cost reduction initiatives while investing in opportunities that we believe will drive growth.

We are addressing challenges in gaming operations by delivering innovative new game content and mitigating yield pressure through disciplined capital deployment. Product sales machine shipments improved in the first quarter; however, for the full fiscal year we anticipate a decline in new casino openings in the domestic market and do not foresee any replacement cycle opportunities of the scale presented by the Canadian government lottery contracts in 2013. In international markets, we are expanding our portfolio of localized content and believe more long-term growth opportunities exist outside of North America, particularly in Asia.

We expect our interactive business will continue to provide growth opportunities. With respect to online social gaming, our DoubleDown Casino® substantially grew revenues year-over-year and produced positive earnings in the first quarter.  The dynamic growth of social networking and entertainment consumption on mobile devices, such as smart phones and tablets, continues to fuel growth in online social gaming. We believe that online gaming appeals to a broader consumer demographic than land-based gaming. Our November 2013 launch of online real-money games in New Jersey provides optimism for additional domestic opportunities.
 
24

STRATEGIC OBJECTIVES

We continue to partner with our customers to build stronger relationships and deliver innovative gaming products and services. We remain focused on the following strategic objectives for 2014, designed to improve our business and increase shareholder value, with adjustments as new opportunities arise and the industry evolves:

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

(2)
Expanding and managing the broadest distribution network globally

(3)
Maximizing shareholder value through the efficient operation of our business, the optimal generation of cash flow, and the responsible, dependable return of capital through dividends and share repurchases


CONSOLIDATED RESULTS – A Year Over Year Comparative Analysis

First Quarters Ended December 31,
  
2013
    
2012
    
C h a n g e
  
Revenues
  
$
541.2
    
$
530.3
    
$
10.9
      
2
%
Gross margin
    
57
%
    
58
%
    
(1
)
pp
  
Operating income
  
$
103.7
    
$
118.4
    
$
(14.7
)
    
-12
%
Margin
    
19
%
    
22
%
    
(3
)
pp
  
Net income
  
$
79.2
    
$
65.3
    
$
13.9
      
21
%
EPS
  
$
0.31
    
$
0.24
    
$
0.07
      
29
%

Quarters ended December 31, 2013 and 2012 compared

Total revenues improved primarily due to an increase of $18.0 million in North America, partially offset by a decrease of $7.1 million in International. Increases of $23.5 million in social gaming revenues and $8.8 million in product sales revenues were partially offset by a decrease of $19.6 million in gaming operations revenues. Total gross margin decreased due to margin decline in gaming operations and product sales, partially offset by interactive margin improvement.

Operating income and margin declined primarily due to increased operating expenses outpacing revenue growth. See OPERATING EXPENSES below for additional information.

Net Income and EPS increased primarily due to a tax benefit of $29.6 million resulting from audit closures discussed below under INCOME TAX PROVISIONS. EPS also benefitted from fewer shares outstanding due to share repurchases.

GAMING OPERATIONS

First Quarters Ended December 31,
  
2013
    
2012
    
C h a n g e
  
Revenues
  
$
223.0
    
$
242.6
    
$
(19.6
)
    
-8
%
Gross margin
    
61
%
    
63
%
    
(2
)
pp
  
Installed base (units '000)
    
54.3
      
56.8
      
(2.5
)
    
-4
%
MegaJackpots® (premium brand)
    
24.9
      
26.6
      
(1.7
)
    
-6
%
Lease (CDS, racino, other)
    
29.4
      
30.2
      
(0.8
)
    
-3
%
Yield (average revenue per unit per day - $0.00)
  
$
44.99
    
$
46.80
    
$
(1.81
)
    
-4
%

Quarters ended December 31, 2013 and 2012 compared

Gaming operations revenues decreased, driven primarily by lower yields, most significant in MegaJackpots®, along with installed base decline. Gross margin decline was primarily due to lower yield, driven by reduced play levels.
 
25

PRODUCT SALES

First Quarters Ended December 31,
  
2013
    
2012
    
C h a n g e
  
Revenues
  
$
243.6
    
$
234.8
    
$
8.8
      
4
%
Machines
    
167.0
      
157.5
      
9.5
      
6
%
Non-machine (systems, parts, other)
    
76.6
      
77.3