igt_10q-063010.htm


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 July 3, 2010
 
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.)
 
9295 Prototype Drive
Reno, Nevada 89521
(Address of Principal Executive Offices)(Zip Code)

(775) 448-7777
(Registrant’s Telephone Number, Including Area Code)
 
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 (§232.405 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 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 [   ]     Smaller reporting company [   ]
(Do not check if a 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]

At August 9, 2010, there were 298.1 million shares of our $.00015625 par value common stock outstanding.
 
 

 

TABLE OF CONTENTS
 
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
iii
PART I – FINANCIAL INFORMATION
1
Item 1.
Unaudited Condensed Consolidated Financial Statements
1
CONSOLIDATED INCOME STATEMENTS
1
CONSOLIDATED BALANCE SHEETS
2
CONSOLIDATED STATEMENTS OF CASH FLOWS
3
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
FORWARD LOOKING STATEMENTS
29
OVERVIEW
30
RECENTLY ISSUED ACCOUNTING STANDARDS
31
CRITICAL ACCOUNTING ESTIMATES
31
CONSOLIDATED OPERATING RESULTS – A Year Over Year Comparative Analysis
32
BUSINESS SEGMENT RESULTS – A Year Over Year Comparative Analysis
37
LIQUIDITY AND CAPITAL RESOURCES
39
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
43
Item 4.
Controls and Procedures
43
PART II – OTHER INFORMATION
44
Item 1.
Legal Proceedings
44
Item 1A.
Risk Factors
44
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49
Item 3.
Defaults Upon Senior Securities
49
Item 4.
(Removed and Reserved)
49
Item 5.
Other Information
49
Item 6.
Exhibits
50
 
 
ii

 
 
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
 
Fiscal dates as presented:
 
Fiscal dates -- actual:
June 30, 2010
 
July 3, 2010
June 30, 2009
 
July 4, 2009
September 30, 2009
 
October 3, 2009
     
Abbreviation/term as presented
 
Definition
Anchor
 
Anchor Gaming
ARS
 
auction rate securities
ASU
 
accounting standards update
AVP®
 
Advanced Video Platform®
5.5% Bonds
 
5.5% notes due 2020
7.5% Bonds
 
7.5% notes due 2019
bps
 
basis points
CAD
 
Canadian dollars
CCSC
 
Colorado Central Station Casino
CDS
 
central determination system
CEO
 
Chief Executive Officer
CFO
 
Chief Financial Officer
CLS
 
China LotSynergy Holdings, Ltd.
DCF
 
discounted cash flow
Debentures
 
convertible debentures, 1.75% or 2.65% as noted
EBITDA
 
earnings before interest, tax, depreciation, and amortization
EPA
 
Environmental Protection Agency
EPS
 
earnings per share
ERISA
 
Employee Retirement Income Security Act
FASB
 
Financial Accounting Standards Board
GAAP
 
generally accepted accounting principles
ICR
 
interest coverage ratio
IGT, we, our, the Company
 
International Game Technology and its consolidated entities
IP
 
intellectual property
IRS
 
Internal Revenue Service
LIBOR
 
London Inter-Bank Offering Rate
MBE
 
management’s best estimate
MDA
 
management’s discussion and analysis
Notes
 
3.25% Convertible Notes due 2014
OSHA
 
Occupational Safety & Health Administration
pp
 
percentage points
SEC
 
Securities and Exchange Commission
SIP
 
Stock Incentive Plan
TLR
 
total leverage ratio
TPE
 
third-party evidence
UK
 
United Kingdom
US
 
United States
VIE
 
variable interest entity
VSOE
 
vendor specific objective evidence
WAP
 
wide area progressive
*
 
not meaningful (in tables)
 
 
iii

 
 
PART I – FINANCIAL INFORMATION
 
Item 1.
Unaudited Condensed Consolidated Financial Statements
 
CONSOLIDATED INCOME STATEMENTS
   
Quarters Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
(In millions, except per share amounts)
                       
Revenues
                       
Gaming operations
  $ 276.6     $ 286.7     $ 834.4     $ 886.1  
Product sales
    213.1       230.6       658.1       695.1  
Total revenues
    489.7       517.3       1,492.5       1,581.2  
Costs and operating expenses
                               
Cost of gaming operations
    115.3       108.4       326.5       375.9  
Cost of product sales
    98.5       113.1       321.8       346.3  
Selling, general and administrative
    82.3       94.8       254.4       315.2  
Research and development
    51.6       51.3       149.4       155.2  
Depreciation and amortization
    19.1       19.7       57.5       58.8  
Impairment and restructuring
    2.7       3.0       63.4       28.7  
Total costs and operating expenses
    369.5       390.3       1,173.0       1,280.1  
Operating income
    120.2       127.0       319.5       301.1  
Other income (expense)
                               
Interest income
    15.2       15.1       46.6       46.4  
Interest expense
    (42.7 )     (43.2 )     (124.9 )     (110.8 )
Other
    3.3       2.1       3.2       (7.7 )
Total other income (expense)
    (24.2 )     (26.0 )     (75.1 )     (72.1 )
Income from continuing operations before tax
    96.0       101.0       244.4       229.0  
Income tax provision
    1.4       38.8       55.1       69.4  
Income from continuing operations
    94.6       62.2       189.3       159.6  
Loss from discontinued operations, net of tax
    (2.5 )     (1.6 )     (23.2 )     (4.2 )
Net income
  $ 92.1     $ 60.6     $ 166.1     $ 155.4  
                                 
Basic earnings per share
                               
Continuing operations
  $ 0.32     $ 0.21     $ 0.64     $ 0.54  
Discontinued operations
    (0.01 )     (0.01 )     (0.08 )     (0.01 )
Net income
  $ 0.31     $ 0.20     $ 0.56     $ 0.53  
                                 
Diluted earnings per share
                               
Continuing operations
  $ 0.32     $ 0.21     $ 0.63     $ 0.54  
Discontinued operations
    (0.01 )     (0.01 )     (0.08 )     (0.01 )
Net income
  $ 0.31     $ 0.20     $ 0.55     $ 0.53  
                                 
Cash dividends declared per share
  $ 0.06     $ 0.06     $ 0.18     $ 0.27  
                                 
Weighted average shares outstanding
                               
Basic
    297.0       294.3       296.0       293.7  
Diluted
    298.9       294.6       298.1       293.8  
 
See accompanying notes
 
 
1

 
 
CONSOLIDATED BALANCE SHEETS
   
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions, except par value)
           
Assets
           
Current assets
           
Cash and equivalents
  $ 164.9     $ 146.7  
Investment securities
    -       21.3  
Restricted cash and investment securities
    87.0       79.4  
Jackpot annuity investments
    65.7       67.2  
Accounts receivable, net
    275.4       334.3  
Current maturities of notes and contracts receivable, net
    189.8       154.8  
Inventories
    114.6       157.8  
Deferred income taxes
    95.2       82.8  
Other assets and deferred costs
    152.5       189.4  
Total current assets
    1,145.1       1,233.7  
Property, plant and equipment, net
    574.1       558.8  
Jackpot annuity investments
    372.4       396.9  
Notes and contracts receivable, net
    186.6       249.4  
Goodwill
    1,149.2       1,151.5  
Other intangible assets, net
    216.2       259.2  
Deferred income taxes
    166.1       172.2  
Other assets and deferred costs
    275.9       306.4  
Total Assets
  $ 4,085.6     $ 4,328.1  
Liabilities and Stockholders' Equity
               
Liabilities
               
Current liabilities
               
Short-term debt
  $ -     $ 5.3  
Accounts payable
    85.5       90.5  
Jackpot liabilities, current portion
    168.1       155.5  
Accrued employee benefits
    17.3       32.8  
Accrued income taxes
    2.0       9.4  
Dividends payable
    17.9       17.8  
Other accrued liabilities
    245.2       313.2  
Total current liabilities
    536.0       624.5  
Long-term debt
    1,813.2       2,014.7  
Jackpot liabilities
    402.8       432.6  
Other liabilities
    124.2       192.7  
Total Liabilities
    2,876.2       3,264.5  
Commitments and Contingencies
               
Stockholders' Equity
               
Common stock: $.00015625 par value; 1,280.0 shares authorized; 339.0 and 337.2 issued; 298.1 and 296.6 outstanding
    0.1       0.1  
Additional paid-in capital
    1,463.2       1,417.8  
Treasury stock at cost: 40.9 and 40.6 shares
    (801.8 )     (799.3 )
Retained earnings
    549.9       437.3  
Accumulated other comprehensive income
    (1.1 )     6.1  
Total IGT Stockholders' Equity
    1,210.3       1,062.0  
Noncontrolling Interests
    (0.9 )     1.6  
Total Equity
    1,209.4       1,063.6  
Total Liabilities and Stockholders' Equity
  $ 4,085.6     $ 4,328.1  
 
See accompanying notes
 
 
2

 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended June 30,
 
2010
   
2009
 
(In millions)
           
Operations
 
 
   
 
 
Net income
  $ 166.1     $ 155.4  
Adjustments:
               
Depreciation and amortization
    179.4       212.3  
Discounts and deferred issuance costs
    36.8       23.8  
Inventory obsolescence
    13.2       10.1  
Bad debt provisions
    6.1       25.0  
Share-based compensation
    31.3       30.1  
(Gain) loss on investments
    (0.2 )     2.1  
Gain on redemption of debt
    -       (1.3 )
Impairment
    59.8       -  
Other non-cash items
    (1.3 )     (5.7 )
Excess tax benefits from employee stock plans
    (8.3 )     -  
Changes in operating assets and liabilities, excluding acquisitions:
               
Receivables
    35.6       73.1  
Inventories
    35.3       30.8  
Other assets and deferred costs
    49.5       11.2  
Income taxes, net of employee stock plans
    (54.2 )     (50.1 )
Accounts payable and accrued liabilities
    (90.4 )     (90.7 )
Jackpot liabilities
    (34.9 )     (71.7 )
Cash from operations
    423.8       354.4  
Investing
               
Capital expenditures
    (178.2 )     (175.8 )
Proceeds from assets sold
    7.2       7.7  
Proceeds from investment securities
    21.6       -  
Jackpot annuity investments, net
    44.9       37.6  
Changes in restricted cash
    (7.9 )     31.7  
Loans receivable cash advanced
    (17.7 )     (85.4 )
Loans receivable payments received
    10.4       6.1  
Investments in unconsolidated affiliates
    (4.9 )     (11.9 )
Business acquisitions/VIE deconsolidation
    (1.4 )     (15.7 )
Cash from investing
    (126.0 )     (205.7 )
Financing
               
Debt proceeds
    1,350.3       2,789.4  
Debt repayments
    (1,593.4 )     (2,749.8 )
Debt issuance costs
    (0.1 )     (63.5 )
Warrant proceeds
    -       66.8  
Convertible note hedge purchases
    -       (177.3 )
Employee stock plan proceeds
    15.2       5.5  
Excess tax benefits from employee stock plans
    8.3       -  
Dividends paid
    (53.5 )     (103.5 )
Cash from financing
    (273.2 )     (232.4 )
Foreign exchange rates effect on cash and equivalents
    (6.4 )     1.3  
Net change in cash and equivalents
    18.2       (82.4 )
Beginning cash and equivalents
    146.7       266.4  
Ending cash and equivalents
  $ 164.9     $ 184.0  
 
See accompanying notes
 
 
3

 
 
Supplemental Cash Flows Information
 
“Depreciation and amortization” reflected in the cash flows statements are comprised of amounts presented separately on the income statements, plus “depreciation and amortization” included in cost of gaming operations, cost of product sales and discontinued operations.
 
Nine Months Ended June 30,
 
2010
   
2009
 
(In millions)
           
Jackpot funding
 
 
   
 
 
Change in jackpot liabilities
  $ (34.9 )   $ (71.7 )
                 
Jackpot annuity purchases
    (3.8 )     (10.9 )
Jackpot annuity proceeds
    48.7       48.5  
Net change in jackpot annuity investments
    44.9       37.6  
Net jackpot funding
  $ 10.0     $ (34.1 )
Capital expenditures
               
Property, plant and equipment
  $ (15.9 )   $ (33.2 )
Gaming operations equipment
    (159.9 )     (136.7 )
Intellectual property
    (2.4 )     (5.9 )
Total
  $ (178.2 )   $ (175.8 )
Payments
               
Interest
  $ 83.3     $ 71.4  
Income taxes
    109.3       117.8  
Non-cash investing and financing items:
               
Accrued capital asset additions
  $ 2.1     $ 4.7  
Interest accretion for jackpot annuity investments
    18.7       20.9  
                 
Business acquisitions/purchase price adjustments and VIE deconsolidations
               
Fair value of assets
  $ (0.8 )   $ 21.9  
Fair value of liabilities
    (2.2 )     6.2  
 
See accompanying notes
 
 
4

 
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1.   BASIS OF PRESENTATION AND CONSOLIDATION
 
Our consolidated financial statements include the accounts of International Game Technology (IGT, we, our, or the Company), including all majority-owned or controlled subsidiaries and VIEs for which we are the primary beneficiary. All appropriate inter-company accounts and transactions are eliminated.
 
We prepare our consolidated financial statements in accordance with SEC and US GAAP requirements and include all adjustments of a normal recurring nature that are necessary to fairly present 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 should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2009 and our Current Report on Form 8-K filed on June 3, 2010, which revised and recast certain financial information from our Annual Report on Form 10-K for the year ended September 30, 2009, to reflect the retrospective application of accounting standards adopted at the beginning of 2010 for convertible debt, noncontrolling interests and participating securities.
 
Our fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to September 30 each year. Similarly, our quarters end on the Saturday nearest to the last day of the quarter end month. For simplicity, this report presents all fiscal periods using the calendar month end as outlined in the table below.  Fiscal 2010 will contain 52 weeks and our results for the first nine months contained 39 weeks versus 40 weeks in the prior year period.
 
 
Period End
 
Presented as
 
Actual
Current quarter
June 30, 2010
 
July 3, 2010
Prior year quarter
June 30, 2009
 
July 4, 2009
Prior fiscal year end
September 30, 2009
 
October 3, 2009
 
Use of Estimates
 
Our consolidated financial statements are prepared in conformity with US GAAP. Accordingly, 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.
 
2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Revenue Recognition
 
We recognize revenues when all of the following have been satisfied:
 
ª  
persuasive evidence of an arrangement exists
 
ª  
the price to the customer is fixed and determinable
 
ª  
delivery has occurred and any acceptance terms have been fulfilled
 
ª  
no significant contractual obligations remain
 
ª  
collection is reasonably assured
 
Revenues are reported net of incentive rebates, discounts, sales taxes, and other taxes of a similar nature. Amounts billed prior to completing the earnings process are deferred until revenue recognition criteria are met.
 
Gaming Operations
 
Gaming operations revenues are generated from providing customers with our proprietary electronic gaming equipment and related network systems, licensing, and services under a variety of recurring revenue arrangements, including WAP, CDS, stand-alone participation and flat fee, equipment leasing and rental, and online gaming solutions.
 
 
5

 
 
WAP systems consist of linked slot machines located in multiple casino properties, connecting to an IGT central computer system. WAP games differ from stand-alone units in that a progressive jackpot increases with every wager until a player wins the top award combination. Casinos with IGT WAP machines pay a percentage of the coin-in (amounts wagered) 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.
 
Revenues from CDS, stand-alone and other equipment leasing or rentals are recognized based on a percentage of the net win or on a fixed daily/monthly fee or rental basis. Online gaming solutions encompass online casino gaming software and content licensing, as well as back office operational support services. All online gaming solutions are provided under revenue sharing arrangements based on net gaming revenues.
 
Product Sales
 
Our product sales revenues are generated from the sale of electronic gaming equipment and network systems, as well as licensing, services, and component parts. Time-based licensing and maintenance fees are typically recognized ratably over the term of the agreement. Our credit sales terms are predominately 90 days or less. We also grant extended payment terms under contracts of sale secured by the related equipment sold, and these contracts are typically paid within their terms.
 
Our gaming machines and certain other tangible products, containing both software and nonsoftware components that function together to deliver the product’s essential functionality, were previously subject to software revenue recognition. Under ASUs adopted for new and materially modified arrangements entered into after the beginning of our first quarter of fiscal 2010 (discussed below under Recently Issued Accounting Standards – Adopted), our gaming machines and certain other tangible products no longer fall under the scope of software revenue recognition and are generally recognized upon delivery and customer acceptance.
 
Multi-element Arrangements
 
The majority of our multiple element contracts are for some combination of machines, network systems, license fees, maintenance, training, and other services. Revenues for individual deliverables are recognized when the recognition criteria for that element has been met. We elected to early adopt ASUs for revenue recognition related to certain software-enabled products and multi-element arrangements on a prospective basis for new or materially modified arrangements entered into after the beginning of our fiscal year 2010. Most of our products and services qualify as separate units of accounting, and the ASUs do not change this premise. The terms of performance, cancellation, termination, or refunds in our multiple element contracts are similar to those for individual stand-alone deliverables.
 
Under the ASUs, arrangement consideration is allocated among multiple deliverables based on relative selling prices. In order of preference, relative selling prices are estimated based on VSOE, TPE, or MBE, and the residual method is not allowed for nonsoftware elements. VSOE is determined by the net price charged for each deliverable when it is sold separately. VSOE for maintenance agreements is determined based on the annual renewal rates. When VSOE or TPE is not available, generally for new or highly customized offerings, the estimated selling price is the amount we would sell the product or service for individually. The determination of MBE is made based on our standard pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs, and profit objectives.
 
Under the ASUs, revenues for machines and other software-enabled equipment in certain bundled arrangements are no longer deferred because VSOE is not available for an undelivered element. Generally, revenues allocated to non-software elements will be recognized upon delivery and customer acceptance, and only revenues allocated to software elements require deferral and recognition over a lease or license term.
 
Prior to the beginning of fiscal 2010, if we were unable to establish VSOE for any undelivered element, revenue was generally deferred until all elements were delivered or until VSOE could be determined. If we did not have VSOE for a delivered element, VSOE for the undelivered elements was deferred, and the residual amount constituted the revenues recognized for the delivered elements. Additionally, when machines were sold in combination with a leased system on which the machines depend for essential functionality, machine revenues were recognized ratably over the system lease contract term.
 
 
6

 
 
Deferred Revenue
 
Deferred revenue consists of amounts received or billed after products are delivered or services are rendered, but prior to meeting all of the requirements for revenue recognition. Complex systems and/or multi-element contracts may take several months to complete and our deferred revenues may increase as our products evolve toward a more systems-centric environment.
 
Deferred revenue balances in the table below related primarily to product sales where the installation was not yet complete or we were obligated to perform future services. At June 30, 2010, $17.0 million remains deferred because it is subject to prior revenue recognition criteria in effect before the beginning of fiscal 2010.
 
   
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions)
           
Other accrued liabiltites (current)
  $ 77.8     $ 101.7  
Other liabilities (noncurrent)
    14.0       20.3  
Total
  $ 91.8     $ 122.0  
 
Recently Issued Accounting Standards - Adopted
 
Revenue Recognition For Software-enabled Products and Multi-element Arrangements
 
In October 2009, the FASB issued ASUs about revenue recognition for certain software-enabled products and multi-element arrangements. Under these ASUs, tangible products, containing both software and nonsoftware components that function together to deliver a tangible product’s essential functionality, are no longer subject to software revenue accounting. These ASUs also established a more economically aligned model for allocating revenues among deliverables in a multi-element arrangement, based on relative selling prices.
 
We elected to early adopt these ASUs prospectively for new or materially modified arrangements entered into on or after the beginning of our fiscal 2010. See our revenue recognition accounting policies above for additional information about our application of these ASUs. Although this adoption is not currently expected to have a material effect on the timing or amount of future revenues, the impact is dependent upon the prevalence of multi-element arrangements and the implementation of new sales arrangements.
 
Pro forma revenues that would have been reported under the prior accounting guidance are reflected in the table below.
 
   
Quarter Ended
   
Nine Months Ended
 
   
June 30, 2010
   
June 30, 2010
 
   
As
Reported
   
Pro
Forma
 
Increase
(decrease)*
 
As
Reported
   
Pro
Forma
   
Increase
(decrease)*
 
(In millions)
                                   
Revenues
                                   
Gaming operations
  $ 276.6     $ 276.6     $ -     $ 834.4     $ 827.5     $ 6.9  
Product Sales
    213.1       205.2       7.9       658.1       633.3       24.8  
Total
  $ 489.7     $ 481.8     $ 7.9     $ 1,492.5     $ 1,460.8     $ 31.7  
                                                 
* Additional revenues recognized which would have been recognized in other periods under prior quidance
                 
 
Fair Value Measurements
 
In September 2006, an accounting standard was issued which refined the definition of fair value, established a framework for measuring fair value, and expanded disclosures about fair value measurements. The adoption of this accounting standard for non-financial assets and liabilities at the beginning of fiscal 2010 did not have a material impact on our results of operations, financial position or cash flows.
 
In January 2010, the FASB issued an ASU requiring added disclosures related to assets and liabilities carried at fair value to identify significant transfers between Level 1 and Level 2, techniques and inputs used, and any significant changes to techniques and inputs. See Note 16 for additional information about fair value measurements. This adoption in our second quarter of fiscal 2010 did not have a material impact on our results of operations, financial position or cash flows.
 
 
7

 
 
Participating Securities in Share-Based Payment Transactions
 
At the beginning of fiscal 2010, we adopted an ASU issued in June 2008 for determining whether instruments granted in share-based payment transactions are participating securities which should be included in the computation of EPS using the two-class method (see Note 13). Certain restricted stock granted under our employee SIP (see Note 6) is considered a participating security because it carries non-forfeitable rights to dividends. This adoption did not have a material impact on our financial statements and the effect of the required retrospective application for prior periods presented is summarized in the table at the end of this section.
 
Business Combinations and Noncontrolling Interests
 
At the beginning of fiscal 2010, we adopted accounting standards issued in December 2007 revising the method of accounting for a number of aspects of business combinations and noncontrolling interests (i.e. minority interests), such that more assets and liabilities will be measured at fair value as of the acquisition date. Certain contingent consideration liabilities will require remeasurement at fair value in each subsequent reporting period. Noncontrolling interests will initially be measured at fair value and classified as a separate component of equity.
 
Acquisition related costs, such as fees for attorneys, accountants, and investment bankers, will be expensed as incurred and no longer be capitalized as part of the business purchase price. For all acquisitions, regardless of the consummation date, deferred tax assets and uncertain tax position adjustments occurring after the measurement period will be recorded as a component of income tax expense, rather than adjusted through goodwill. For business combinations and asset purchases, the impact of this guidance on our results of operations or financial position will vary depending on the specifics of each transaction.
 
This adoption did not have a material impact on our consolidated financial position, results of operations or cash flows. Income attributable to the noncontrolling interests is presented as a component of other income (expense) as it was not significant to our consolidated operating results. The required retrospective presentation of noncontrolling interests as a separate component of stockholders’ equity, rather than liabilities, is summarized in the table at the end of this section.
 
Convertible Debt Instruments
 
At the beginning of fiscal 2010, we adopted an ASU issued in May 2008 requiring the separation of liability (debt) and equity (conversion option) components for convertible debt instruments that may settle in cash upon conversion to reflect an effective nonconvertible borrowing rate when the debt was issued. We estimated fair value of our Debentures (1.75% and 2.6%) and Notes using similar debt instruments at issuance that did not have a conversion feature and allocated an equity component included in paid-in capital that represents the estimated fair value of the conversion feature at issuance.
 
The effects of the required retrospective application for prior periods presented as it relates to our Debentures (1.75% and 2.6%) and Notes are summarized in the table at the end of this section. See Note 10 for additional information related to our 2.6% Debentures and Notes. The adjustment to long-term debt represents the unamortized balance of the revised discount. Additionally, this adoption decreased long-term debt, deferred tax assets and deferred offering costs and increased stockholders’ equity.
 
In addition to the retrospective adjustments noted in the table at the end of this section, this adoption increased noncash interest expense for the three and nine months ended June 30, 2010 by $6.8 million and $22.8 million, respectively. On an annual basis, we expect this adoption to increase noncash interest by approximately $30.0 million for both fiscal years 2010 and 2009, decrease Debenture repurchase gains by $5.2 million for fiscal 2009, and reduce diluted EPS $0.06 for fiscal 2010 and $0.08 for fiscal 2009.
 
 
8

 
 
Retrospective Application of Accounting Standards Adopted at the Beginning of Fiscal 2010
(Including Discontinued Operations Reclassification – see  Note 19)
 
               
Retrospective Adjustments
       
   
As Previously Reported
   
Discontinued Operations Reclass
   
Convertible Debt
   
Non-
controlling Interest
   
Partici-
pating Securities
   
As Currently Presented
 
(In millions except per share amounts)
                                   
INCOME STATEMENTS
                                   
Three Months Ended June 30, 2009
                                   
Interest expense
  $ (34.2 )   $ -     $ (9.0 )   $ -     $ -     $ (43.2 )
Income tax provision
    40.4       1.7       (3.3 )     -       -       38.8  
Net income
    66.3       -       (5.7 )     -       -       60.6  
                                                 
Basic EPS
  $ 0.23       -     $ (0.03 )     -       -     $ 0.20  
Diluted EPS
  $ 0.22       -     $ (0.02 )     -       -     $ 0.20  
                                                 
Diluted weighted average shares outstanding
    295.0       -       -       -       (0.4 )     294.6  
                                                 
Nine Months Ended June 30, 2009
                                               
Interest expense
  $ (92.6 )   $ 0.1     $ (18.3 )   $ -     $ -     $ (110.8 )
Income before tax
    245.5       7.0       (23.5 )     -       -       229.0  
Income tax provision
    75.2       2.8       (8.6 )     -       -       69.4  
Net income
    170.3       -       (14.9 )     -       -       155.4  
                                                 
Basic EPS
  $ 0.58       -     $ (0.05 )     -       -     $ 0.53  
Diluted EPS
  $ 0.58       -     $ (0.05 )     -       -     $ 0.53  
                                                 
Diluted weighted average shares outstanding
    294.2       -       -       -       (0.4 )     293.8  
                                                 
BALANCE SHEET
                                               
September 30, 2009
                                               
Deferred income taxes (noncurrent)
  $ 227.3     $ -     $ (55.1 )   $ -     $ -     $ 172.2  
Other assets and deferred costs (noncurrent)
    311.4       -       (5.0 )     -       -       306.4  
Total assets
    4,388.2       -       (60.1 )     -       -       4,328.1  
                                                 
Long-term debt
    2,169.5       -       (154.8 )     -       -       2,014.7  
Other liabilities
    194.3       -       -       (1.6 )     -       192.7  
Total liabilities
    3,420.9       -       (154.8 )     (1.6 )     -       3,264.5  
                                                 
Additional paid-in capital
    1,264.1       -       153.7       -       -       1,417.8  
Retained earnings
    496.3       -       (59.0 )     -       -       437.3  
Total Equity
    967.3       -       94.7       1.6       -       1,063.6  
                                                 
STATEMENT OF CASH FLOWS
                                               
Nine Months Ended June 30, 2009
                                               
Operations:
                                               
Net income
  $ 170.3     $ -     $ (14.9 )   $ -     $ -     $ 155.4  
Adjustments:
                                               
Other non-cash items
    (4.7 )     -       -       (1.0 )     -       (5.7 )
Discounts and deferred issuance costs
    5.5       -       18.3       -       -       23.8  
Gain on redemption of debt
    (6.5 )     -       5.2       -       -       (1.3 )
Changes in operating assets and liabilities:
                                               
Income taxes, net of employee stock plans
    (41.5 )     -       (8.6 )     -       -       (50.1 )
Accounts payable and accrued liabilities
    (91.7 )     -       -       1.0       -       (90.7 )
 
 
9

 
 
Recently Issued Accounting Standards  - Not Yet Adopted
 
Consolidation of Variable Interest Entities
 
In June 2009, the FASB issued an ASU which requires us to reassess our primary beneficiary position for all VIE arrangements based on qualitative factors on an on-going basis. This ASU is effective beginning with our first quarter of fiscal 2011 and must be adopted through a cumulative-effect adjustment (with a retrospective option). We continue to evaluate the extent to which this ASU will impact our results of operations, financial position, or cash flows.
 
Fair Value Measurement Disclosures
 
In January 2010, the FASB issued an ASU which will require supplemental disclosures related to purchases, sales, issuances, and settlements within the Level 3 reconciliation. This ASU is effective for interim and annual reporting periods beginning with our first quarter of fiscal 2012 and is not expected to have a material impact on our financial statements.
 
Accruals for Casino Jackpot Liabilities
 
In April 2010, the FASB issued an ASU on jackpot liabilities clarifying that an entity should not accrue jackpot liabilities (or portions thereof), specifically addressing base jackpot liabilities, before they are won if the payout can be avoided. The ASU will be applied prospectively with a cumulative-effect adjustment in retained earnings at the beginning of the period of adoption and is effective beginning with our first quarter of fiscal 2012. We continue to evaluate the extent to which this guidance will impact our results of operations, financial position, or cash flows.
 
Revenue Recognition – Milestone Method for Research and Development Transactions
 
In April 2010, the FASB issued an ASU related to defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research and development transactions. This ASU generally allows milestone payments to be recognized as revenue in their entirety when specific milestone results are achieved. The ASU will be applied prospectively to milestones achieved as of the beginning of our fiscal year 2011. We continue to evaluate this ASU, but do not expect it to have a material impact to our results of operations, financial position or cash flows.
 
Credit Quality of Financing Receivables and the Allowance for Credit Losses
 
In July 2010, the FASB issued an ASU to address concerns about the sufficiency, transparency, and robustness of credit risk disclosures for finance receivables and the related allowance for credit losses. This ASU is effective for disclosures as of our first quarter in fiscal 2011. Additional disclosures require information at disaggregated levels, including the nature of the credit risk and how it is analyzed in arriving at the allowance for credit losses, a roll-forward schedule of and reasons for changes in the allowance, credit quality indicators, an aging of past due amounts, the nature and extent of modifications, and significant purchases or sales. Other than the enhanced disclosures, this ASU will have no impact on our results of operations, financial position, or cash flows.
 
3.   VARIABLE INTEREST ENTITIES AND AFFILIATES
 
Variable Interest Entities
 
As the primary beneficiary, we consolidate our VIE WAP trusts in New Jersey that are responsible for administering jackpot payments to winners. The VIE trust consolidations increase jackpot liabilities and related assets, as well as interest income and equivalent offsetting interest expense. Consolidated VIE trust assets and equivalent liabilities totaled $83.0 million at June 30, 2010 and $91.3 million at September 30, 2009.
 
 
10

 
 
Investments in Unconsolidated Affiliates
 
China LotSynergy Holdings, Ltd.
 
At June 30, 2010, our investments in CLS stock and convertible notes were accounted for as available-for-sale securities reflected in the aggregate table below. We determined that no features of the convertible notes met the definition of a derivative requiring bifurcation at June 30, 2010. See Note 15 about related foreign currency derivatives and Note 16 for factors related to fair value measurements.
 
For our equity method joint ventures with CLS, IGT Synergy Holding Ltd. and Asiatic Group Ltd., as of and for the nine months ended June 30, 2010, we recognized a loss of $0.3 million and $8.4 million remains to be funded on our capital commitment.
 
Aggregate Available-for-sale Investments in Unconsolidated Affiliates
 
   
Adjusted
   
Unrealized
   
Fair
 
June 30, 2010
 
Cost
   
gain (loss)
   
Value
 
(In millions)
                 
CLS Stock
  $ 12.2     $ 2.9     $ 15.1  
CLS Convertible Note
    79.8       6.1       85.9  
Total
  $ 92.0     $ 9.0     $ 101.0  
 
4.   INVENTORIES
 
   
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions)
           
Raw materials
  $ 59.9     $ 74.9  
Work-in-process
    5.9       6.7  
Finished goods
    48.8       76.2  
Total
  $ 114.6     $ 157.8  
 
5.   PROPERTY, PLANT AND EQUIPMENT
 
   
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions)
           
Land
  $ 62.6     $ 62.7  
Buildings
    230.1       230.0  
Leasehold improvements
    13.5       14.5  
Machinery, furniture and equipment
    285.7       300.2  
Gaming operations equipment
    838.8       832.4  
Total
    1,430.7       1,439.8  
Less accumulated depreciation
    (856.6 )     (881.0 )
Property, plant and equipment, net
  $ 574.1     $ 558.8  
 
6.   SHARE-BASED COMPENSATION
 
The amount, frequency, and terms of share-based awards may vary based on competitive practices, operating results, and government regulations. New IGT common shares are issued upon option exercises or restricted share grants and vesting of restricted share units. Our current practice is generally to grant restricted share awards in the form of units without dividends. Forfeitures are typically due to employee terminations.
 
On November 4, 2009, IGT granted 2.7 million employee stock options with an exercise price of $18.60 per share in exchange for the 5.3 million underwater employee stock options surrendered in a shareholder approved exchange offer that expired on November 3, 2009. The newly granted options have a six-year contractual term and will vest ratably over two years. The exchange ratio was calculated based on the fair values of the options surrendered and issued under a value-for-value exchange and incremental compensation expense recognized was not material. In connection with the exchange, we recorded $1.4 million of deferred tax benefits.
 
 
11

 
 
At June 30, 2010, shares available for grant under the IGT SIP totaled 17.2 million and we expect to recognize $79.9 million of unrecognized share-based compensation over a weighted average period of 1.8 years. SIP activity is reflected below as of and for the nine months ended June 30, 2010.
 
 
       
Weighted Average
       
               
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
Options
 
Shares
   
Price
   
Term
   
Value
 
   
(thousands)
   
(per share)
   
(years)
   
(millions)
 
Outstanding at beginning of fiscal year
    18,022     $ 26.88              
Granted
    3,982       18.99              
Exercised
    (579 )     12.29              
Forfeited
    (705 )     19.17              
Expired
    (907 )     33.59              
Stock options exchange:
                           
Granted
    2,653       18.60              
Cancelled
    (5,306 )     36.35              
Outstanding at end of period
    17,160     $ 21.29       6.4     $ 19.7  
                                 
Vested and expected to vest
    16,682     $ 21.40       6.4     $ 18.9  
                                 
Exercisable at end of period
    7,071     $ 26.42       4.4     $ 4.9  
 
 
       
Weighted Average
       
         
Grant
   
Remaining
   
Aggregate
 
         
Date
   
Vesting
   
Intrinsic
 
Restricted Shares/Units
 
Shares
   
Fair Value
   
Period
   
Value
 
   
(thousands)
   
(per share)
   
(years)
   
(millions)
 
Outstanding at beginning of fiscal year
    2,000     $ 22.60              
Granted
    1,372       18.37              
Vested
    (687 )     24.91              
Forfeited
    (255 )     28.40              
Outstanding at end of period
    2,430     $ 19.02       1.6     $ 37.6  
                                 
Expected to vest
    2,298     $ 19.01       1.7     $ 35.5  
 
7.   ALLOWANCE FOR RECEIVABLES
 
   
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions)
           
Allowance for doubtful accounts receivable
  $ 28.2     $ 23.4  
                 
Allowance for doubtful notes and contracts
               
Current
  $ 41.2     $ 22.6  
Non-current
    39.5       10.6  
    $ 80.7     $ 33.2  
 
See Note 18 regarding allowance recorded for Alabama-related notes and accounts receivable.
 
 
12

 
 
8.   CONCENTRATIONS OF CREDIT RISK
 
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and equivalents, investments, and receivables. We place short-term investments in high credit quality financial institutions and in short-duration high-quality securities. With the exception of US Government and Agency securities, our short-term investment policy limits the amount of credit exposure in any one financial institution, industry group, or type of investment. Cash on deposit may be in excess of Federal Deposit Insurance Corporation limits.
 
Our receivables were concentrated in the following legalized gaming regions at June 30, 2010. See Note 18 regarding Alabama charitable bingo receivables.
 
North America
       
International
     
Nevada
    9 %  
Argentina
    24 %
Alabama
    6    
Europe
    9  
Oklahoma
    6    
Other Latin America
    8  
Pennsylvania
    5    
Other (less than 5% individually)
    6  
Other (less than 5% individually)
    27           47 %
      53 %            
 
Auction Rate Securities
 
We held no ARS or corresponding put rights at June 30, 2010. During the first nine months of fiscal 2010, we sold $21.6 million par of ARS. The following changes in fair value were included in other income (expense):
 
ª  
zero net gain ($1.0 million ARS gain and $1.0 million put loss) for the quarter ended June 30, 2010 and $0.5 million net gain ($0.7 million ARS gain and $0.2 million put loss) for the prior year quarter
 
ª  
$0.3 million net gain ($3.8 million ARS gain and $3.5 million put loss) for the nine months ended June 30, 2010 and $0.5 million net loss ($4.2 million ARS loss and $3.7 million put gain) for the prior year period
 
9.   GOODWILL AND OTHER INTANGIBLES
 
Goodwill
 
Activity by Segment
 
North
             
Nine Months Ended June 30, 2010
 
America
   
International
   
Total
 
(In millions)
                 
Beginning balance
  $ 1,042.8     $ 108.7     $ 1,151.5  
Foreign currency adjustments
    -       (2.3 )     (2.3 )
Ending balance
  $ 1,042.8     $ 106.4     $ 1,149.2  
 
 Other Intangibles
 
During the nine months ended June 30, 2010, we added $1.8 million for capitalized patent legal costs with a weighted average life of 6 years. Additionally, during the second quarter of fiscal 2010, we recorded $6.7 million of impairment, presented in impairment and restructuring, primarily related to uncertainties surrounding the usage of DigiDeal patents in our future product strategies (see Note 18).
 
 
13

 
 
   
June 30, 2010
   
September 30, 2009
 
         
Accumulated
               
Accumulated
       
   
Cost
   
Amortization
   
Net
   
Cost
   
Amortization
   
Net
 
(In millions)
                                   
Patents
  $ 397.4     $ 238.4     $ 159.0     $ 396.3     $ 205.7     $ 190.6  
Developed technology
    76.5       44.9       31.6       76.7       37.3       39.4  
Contracts
    26.4       17.4       9.0       26.4       15.7       10.7  
Reacquired rights
    13.4       0.9       12.5       13.4       0.1       13.3  
Customer relationships
    8.8       5.5       3.3       8.8       4.8       4.0  
Trademarks
    3.5       2.7       0.8       3.6       2.4       1.2  
Total other intangibles
  $ 526.0     $ 309.8     $ 216.2     $ 525.2     $ 266.0     $ 259.2  
 
Aggregate amortization expense totaled $13.2 million in the current quarter versus $13.3 million in the prior year quarter, and $38.6 million in the nine months ended June 30, 2010 versus $37.1 million for the prior year period.
 
 
2010
2011
2012
2013
2014
(In millions)
         
Estimated annual amortization
$51.7
$43.7
$38.6
$35.2
$31.1
 
10.   CREDIT FACILITIES AND INDEBTEDNESS
 
Outstanding Debt
 
June 30,
   
September 30,
 
   
2010
   
2009
 
(In millions)
           
Domestic credit facility
  $ 270.0     $ 100.0  
Foreign credit facilities
    -       5.3  
Debentures
    -       707.0  
Notes
    850.0       850.0  
7.5% Bonds
    500.0       500.0  
5.5% Bonds
    300.0       -  
Total principal
    1,920.0       2,162.3  
Debentures discount
    -       (2.7 )
Notes discount
    (131.2 )     (152.1 )
7.5% Bonds discount
    (2.5 )     (2.6 )
5.5% Bonds discount
    (1.3 )     -  
7.5% Swap fair value adjustment (see Note 15)
    23.5       15.1  
5.5% Swap fair value adjustment (see Note 15)
    4.7       -  
Total outstanding debt, net
  $ 1,813.2     $ 2,020.0  
 
IGT was in compliance with all applicable debt covenants at June 30, 2010. Embedded features of all debt agreements were evaluated and did not require bifurcation or had nominal value at June 30, 2010.
 
At the beginning of fiscal 2010, we adopted accounting standards requiring the separation of liability (debt) and equity (conversion option) components of our convertible debt instruments to reflect an effective nonconvertible borrowing rate at issuance. See Note 2 for amounts retrospectively recast in conjunction with this recently adopted accounting standard.
 
Domestic Credit Facility
 
In conjunction with new bonds issued in June 2010 discussed below, we reduced the total amount of our domestic credit facility from $1.8 billion to $1.5 billion, leaving the non-extended portion due December 2010 at $0.2 billion and the extended portion due June 2012 at $1.3 billion. At June 30, 2010, $0.3 billion was drawn ($0.1 billion non-extended and $0.2 billion extended), $1.2 billion was available, and $3.6 million was reserved for letters of credit. The amounts drawn carried a 2.7% weighted average interest rate.
 
 
14

 
 
Interest under the credit facility is paid at least quarterly with rates and facility fees based on our public debt ratings or debt to capitalization ratio. As of June 30, 2010, extended commitments bear interest at LIBOR plus 260 bps with a facility fee of 65 bps and non-extended commitments bear interest at LIBOR plus 37.5 bps with a facility fee of 12.5 bps.
 
Foreign Credit Facilities
 
At June 30, 2010, $8.4 million was available under a revolving credit facility in Australia which generally renews annually with maturity in March and is guaranteed by the parent company, International Game Technology. No amounts were drawn at June 30, 2010. Our former credit facilities in Japan were cancelled during the second quarter of fiscal 2010 with the closure of operations (see Note 19).
 
2.6% Convertible Debentures
 
On December 15, 2009, 2.6% Debentures of $701.2 million aggregate principal were validly tendered under the holders’ put option and accepted by IGT for payment. On February 4, 2010, IGT completed final redemption of the remaining $5.8 million aggregate outstanding principal of Debentures.
 
As recast, the equity component of the 2.6% Debentures totaled $43.7 million and the effective interest rate was 6.2% on the debt component. As of December 31, 2009, the discount was fully amortized. The table below reflects contractual interest expense, discount amortization in interest expense, and repurchase gain (loss) included in other income (expense), as recast for the prior year periods.
 
   
Quarters Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
(In millions)
                       
Contractual interest expense
  $ -     $ 4.6     $ 3.8     $ 15.5  
Discount amortization
    -       5.0       2.7       14.8  
Gain (loss) on repurchases
    -       -       -       1.3  
 
3.25% Convertible Notes
 
As recast, the equity component of the Notes totaled $99.7 million and the effective interest rate was 8.7% on the debt component. The remaining discount amortization period was 3.9 years at June 30, 2010. The table below reflects contractual interest expense and discount amortization in interest expense, as recast for the prior year periods.
 
   
Quarters Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
(In millions)
                       
Contractual interest expense
  $ 6.9     $ 4.1     $ 20.7     $ 4.1  
Discount amortization
    7.1       4.1       20.9       4.1  
 
The market price condition for convertibility of our Notes was not met and there were no related note hedges or warrants exercised at June 30, 2010.
 
7.5% Bonds
 
Interest rate swaps executed in conjunction with our 7.5% Bonds due 2019 are described in Note 15.
 
5.5% Bonds
 
On June 8, 2010, we issued $300.0 million aggregate principal amount of 5.5% Bonds due 2020, under our March 2009 shelf registration statement and June 3, 2010 prospectus supplement pursuant to an underwriting agreement dated June 3, 2010. We received net proceeds of $295.7 million after a discount of $1.3 million and deferred offering costs of approximately $3.0 million, both of which will be amortized to interest expense over the bond term. Interest is payable semiannually on June 15 and December 15, beginning December 15, 2010. Net proceeds from the 5.5% Bonds were used to reduce outstanding amounts under our domestic credit facility.
 
15

 
 
The 5.5% Bonds are general unsecured obligations of IGT, ranking equal with all existing and future unsecured and unsubordinated obligations. The 5.5% Bonds rank junior to all existing and future liabilities, including trade payables, of our subsidiaries. The 5.5% Bonds mature on June 15, 2020, unless IGT redeems them earlier by paying the holders 100% of the principal amount plus a make-whole redemption premium as described further in the related indenture.
 
The 5.5% Bonds contain covenants which may, in certain circumstances:
 
ª  
restrict our ability to incur additional debt
 
ª  
limit our ability to enter into sale and leaseback transactions
 
ª  
restrict our ability to sell, transfer, lease or dispose of substantially all assets
 
ª  
require us to grant a lien on equity interests if certain downgrades by rating agencies occur
 
The 5.5% Bonds specify a number of events of default (some of which are subject to applicable grace or cure periods), including the failure to make timely principal and interest payments or satisfy the covenants. Upon the occurrence of an event of default under the 5.5% Bonds, the outstanding amounts may become immediately due and payable.
 
Interest rate swaps executed in conjunction with our 5.5% Bonds due 2020 are described in Note 15.
 
11.   CONTINGENCIES
 
Litigation
 
IGT has been named in and has brought lawsuits in the normal course of business. We do not expect the outcome of these suits, including the lawsuits described below, to have a material adverse effect on our future results of operations, financial position, or cash flows.
 
Bally
 
2004 Federal District Court of Nevada
 
On December 7, 2004, IGT filed a complaint in US District Court for the District of Nevada, alleging that defendants Alliance Gaming Corp., Bally Gaming Int'l, Inc., and Bally Gaming, Inc. infringed six US patents held by IGT: US Patent Nos. 6,827,646; 5,848,932; 5,788,573; 5,722,891; 6,712,698; and 6,722,985. On January 21, 2005, defendants filed an answer denying the allegations in the complaint and raising various affirmative defenses to IGT's asserted claims. Defendants also asserted fourteen counterclaims against IGT, including counterclaims for a declaratory judgment of non-infringement, invalidity, and unenforceability of the asserted patents, and for antitrust violations and intentional interference with prospective business advantage. IGT has successfully moved for partial summary judgment on defendants’ counterclaims for intentional interference with prospective business advantage and defendants’ antitrust allegations related to the gaming machine market. IGT denies the remaining allegations. On May 9, 2007, the Court issued an order construing disputed terms of the asserted patent claims. On October 16, 2008, the Court issued summary judgment rulings finding certain of IGT’s patents, including patents that IGT believes cover bonus wheel gaming machines, invalid as obvious. The rulings also found that Bally was not infringing certain patents asserted by IGT. Bally’s antitrust and unfair competition counterclaims remain pending. On November 7, 2008, the Court issued an order staying the proceedings and certifying the summary judgment and claim construction rulings for immediate appeal. On December 1, 2008, IGT appealed the rulings to the US Court of Appeals for the Federal Circuit. On January 8, 2009, Bally moved to dismiss the appeal on jurisdictional grounds. On February 2, 2009, the Federal Circuit denied the Bally motion without prejudice to the parties raising jurisdictional issues in their merits briefs. On October 22, 2009, the Federal Circuit affirmed the District Court’s summary judgment rulings. On December 7, 2009, Bally filed a motion to lift the stay and schedule a trial on the remaining issues. A hearing on the motion was held on February 1, 2010, at which the Court indicated that it would revisit earlier motions for summary judgment on the issues not addressed on appeal, including IGT’s motions for summary judgment on Bally’s antitrust and unfair competition counterclaims. The Court has under consideration motions for summary judgment or dismissal of all remaining claims pending in the case.
 
 
16

 
 
2006 Federal District Court of Delaware
 
On April 28, 2006, IGT filed a complaint in US District Court for the District of Delaware, alleging that defendants Bally Technologies, Inc., Bally Gaming Int'l, Inc., and Bally Gaming, Inc. infringed nine US patents held by IGT: US Patent Nos. RE 38,812; RE 37,885; 6,832,958; 6,319,125; 6,244,958; 6,431,983; 6,607,441; 6,565,434; and 6,620,046. The complaint alleges that the “BALLY POWER BONUSING™” technology infringes one or more of the claims of the asserted IGT patents. The lawsuit seeks monetary damages and an injunction. On June 30, 2006, defendants filed an answer denying the allegations in the complaint and raising various affirmative defenses to IGT’s asserted claims. Defendants also asserted twelve counterclaims against IGT, including counterclaims for a declaratory judgment of non-infringement, invalidity, and unenforceability of the asserted patents, antitrust violations, unfair competition, and intentional interference with prospective business advantage. IGT denies these allegations. Pursuant to stipulation of the parties, all claims and counterclaims except those relating to US Patent Nos. RE 37,885 ("the '885 patent"), RE 38,812 ("the '812 patent"), and 6,431,983 have been dismissed. All proceedings relating to Bally’s antitrust, unfair competition, and intentional interference counterclaims have been stayed. On April 28, 2009, the court issued a summary judgment ruling finding the '885 and '812 patents valid. The court also ruled that Bally's "Power Rewards" and "ACSC Power Winners" products infringe certain claims of the '885 and '812 patents. The court granted Bally's motion for summary judgment that Bally's "SDS Power Winners" does not infringe the '885 patent and "Power Bank" and "Power Promotions" do not infringe the '983 patent. The court denied Bally's motion for summary judgment that the '983 patent is invalid. The parties have agreed that Bally's counterclaim for a declaratory judgment on invalidity of the '983 patent will be dismissed without prejudice. IGT’s motion for a permanent injunction against Bally’s infringing products was denied. On April 28, 2010, the court entered an order dismissing without prejudice Bally’s remaining counterclaims (antitrust, unfair competition and intentional interference with business relationships) and entered final judgment in favor of IGT and against the Bally defendants. An appeal from the liability judgment is proceeding.  A trial to determine the amount of damages incurred by IGT, and related matters, as a result of Bally's infringement has not yet been scheduled.
 
Aristocrat
 
2006 Northern Federal District Court of California
 
On June 12, 2006, Aristocrat Technologies Australia PTY Ltd. and Aristocrat Technologies, Inc. filed a patent infringement lawsuit against IGT. Aristocrat alleged that IGT willfully infringed US Patent No. 7,056,215, which issued on June 6, 2006. On December 15, 2006, Aristocrat filed an amended complaint, adding allegations that IGT willfully infringed US Patent No. 7,108,603, which issued on September 19, 2006. The IGT products named in the original and amended complaints were the Fort Knox® mystery progressive slot machines. On June 13, 2007, the US District Court for the Northern District of California entered an order granting summary judgment in favor of IGT declaring both patents invalid. The US Court of Appeals for the Federal Circuit reversed this decision on September 22, 2008. IGT’s request for a rehearing was denied on November 17, 2008. This case has recommenced in the District Court.  On May 13, 2010, the District Court entered an Order granting IGT’s motion for summary judgment of non-infringement.  Aristocrat is appealing this judgment.  Proceedings on IGT’s claim that Aristocrat committed inequitable conduct in reviving a related patent application are continuing in the District Court.  A trial is set on this issue for April 4, 2011.
 
Brochu v. Loto Quebec
 
Loto Quebec commenced an action in warranty against VLC, Inc., a wholly-owned subsidiary of IGT, and another manufacturer of video lottery machines in October 2003, in the Superior Court of the Province of Quebec, District of Quebec, seeking indemnification for any damages that may be awarded against Loto Quebec in a class action suit, also filed in the Superior Court of the Province of Quebec. The class action claim against Loto Quebec, to which neither IGT nor any of its affiliates are parties, was filed by Jean Brochu on behalf of himself and a class of other persons who allegedly developed pathological behaviors through the play of video lottery machines made available by Loto Quebec in taverns and other public locations. In this action, the plaintiff seeks to recover on behalf of the class damages of approximately CAD$578.7 million, representing CAD$4,863 per class member, and CAD$119.0 million in punitive damages. Loto Quebec filed its Plea in Defense in the main action in February 2006. On August 1, 2008, Loto Quebec filed a discontinuance of the action in warranty against VLC. Notwithstanding the discontinuance, Loto Quebec may still pursue the claims it asserted, or could have asserted, in the action in warranty through arbitration against VLC. Settlement of the class action was approved by the Superior Court on March 23, 2010. In a letter, dated May 5, 2010, Loto Quebec’s counsel referred to the settlement of the class action and the settlement agreement between Loto Quebec and VLC under which Loto Quebec discontinued its warranty action against VLC but reserved a right to pursue claims via arbitration (the “Settlement Agreement”) and advised VLC that “Loto Quebec does not intend to proceed against Video Lottery Consultants, Inc. under the terms of the Settlement Agreement.
 
 
17

 
 
Piercey  v Atlantic Lotteries
 
In May 2010, Atlantic Lotteries commenced an action against International Game Technology, VLC, Inc. and IGT-Canada, wholly-owned subsidiaries of International Game Technology, and other manufacturers of video lottery machines in the Supreme Court of New Foundland and Labrador seeking indemnification for any damages that may be awarded against Atlantic Lotteries in a class action suit also filed in the Supreme Court of New Foundland and Labrador. A motion to certify the putative class is pending.
 
Shareholder Actions
 
Securities Class Action
 
On July 30, 2009, International Brotherhood of Electrical Workers Local 697 filed a putative securities fraud class action in the US District Court for the District of Nevada, alleging causes of action under Sections 10(b) and 20(a) of the Securities Exchange Act against IGT and certain of its officers, one of whom is a director. The complaint alleges that between November 1, 2007 and October 30, 2008, the defendants inflated IGT's stock price through a series of materially false and misleading statements or omissions regarding IGT's business, operations, and prospects. The Court has appointed a lead plaintiff. The plaintiffs filed an amended complaint on April 26, 2010 and the defendants moved to dismiss that complaint on June 17, 2010.
 
Derivative Actions
 
Between August 20, 2009 and September 17, 2009, the Company was nominally sued in a series of derivative lawsuits filed in the US District Court for the District of Nevada, captioned Fosbre v. Matthews et al., Case No. 3:09-cv-00467; Calamore v. Matthews et al., Case No. 3:09-cv-00489-ECR-VPC; Israni v. Bittman, et al., Case No. 3:09-cv-00536; and Aronson v. Matthews et al., Case No. 3:09-cv-00542-RCJ-VPC. Plaintiffs purportedly brought their respective actions on behalf of the Company. The complaints assert 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 complaints seek an unspecified amount of damages and allege similar facts as the securities class action lawsuit. The complaints additionally allege that certain individual defendants engaged in insider trading and that the director defendants improperly handled Thomas J. Matthews’ resignation as Chief Executive Officer of the Company. The actions were consolidated and subsequently a consolidated derivative complaint was filed in December 2009. Defendants have moved to dismiss that complaint. On July 6, 2010, the Court granted the defendants’ motion to dismiss, with leave to amend.
 
On September 30, 2009, the Company was nominally sued in a derivative lawsuit filed in the Second Judicial District Court of the State of Nevada, County of Washoe. Plaintiff purportedly filed the action on behalf of the Company. The lawsuit, captioned Kurz et al. v. Hart et al., Case No. cv-0-9-02982, asserts claims against various current and former officers and directors for breach of fiduciary duties and unjust enrichment. The complaint generally makes the same allegations as the federal derivative complaints and seeks an unspecified amount of damages. The parties have stipulated to stay this action pending the motions to dismiss in the above-mentioned consolidated federal derivative action.
 
In a letter dated October 7, 2009 to the Company’s Board of Directors, a shareholder made factual allegations similar to those set forth in the above derivative and securities class actions and demanded that the Board investigate, address and remedy the harm allegedly inflicted on IGT. In particular, the letter alleges that certain officers and directors grossly mismanaged the Company by overspending in the area of R&D of server-based game technology despite a looming recession to which the Company was particularly vulnerable; by making or allowing false and misleading statements regarding the Company’s growth prospects and earnings guidance; and by wasting corporate assets by causing the Company to repurchase Company stock at inflated prices. The letter asserts that this alleged conduct resulted in breaches of fiduciary duties and violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5. On July 9, 2010, the Company was nominally sued in a derivative lawsuit filed in the US District Court for the District of Nevada, captioned Sprando v. Hart, et al., Case No. 3:10-cv-00415-RCJ-VPC and asserting claims as set forth above.
 
 
18

 
 
ERISA Actions
 
On October 2, 2009, two putative class action lawsuits were filed on behalf of participants in the Company’s employee pension plans, naming as defendants the Company, the IGT Profit Sharing Plan Committee, and several current and former officers and directors. The complaints (which seek unspecified damages) allege breaches of fiduciary duty under the Employee Retirement Income Security Act, 29 U.S.C §§ 1109 and 1132. The complaints allege similar facts as the securities class action lawsuit. The complaints further allege that the defendants breached fiduciary duties to Plan Participants by failing to disclose material facts to Plan Participants, failing to exercise their fiduciary duties solely in the interest of the Participants, failing to properly manage Plan assets, failing to diversify Plan assets, and permitting Participants to elect to invest in Company stock. The actions, filed in the US District Court for the District of Nevada, are captioned Carr et al. v. International Game Technology et al., Case No. 3:09-cv-00584, and Jordan et al. v. International Game Technology et al., Case No. 3:09-cv-00585. In October 2009, plaintiffs moved for consolidation of the two actions which motion was granted. On April 9, 2010, defendants moved to dismiss the consolidated complaint.
 
Environmental Matters
 
CCSC, a casino operation sold by IGT in April 2003, is located in an area that has been designated by the EPA as an active Superfund site because of contamination from historic mining activity in the area. In order for Anchor Coin, an entity IGT acquired in December 2001, to develop the CCSC site, it voluntarily entered into an administrative order of consent with the EPA to conduct soil removal and analysis (a requirement imposed on similarly situated property developers within the region) in conjunction with re-routing mine drainage. The work and obligations contemplated by the agreement were completed by Anchor in June 1998, and the EPA subsequently issued a termination of the order.
 
The EPA, together with other property developers excluding CCSC, continues remediation activities at the site. While we believe our remediation obligations are complete, it is possible that additional contamination may be identified and we could be obligated to participate in remediation efforts. Under accounting guidance for environmental remediation liabilities, we determined the incurrence of additional remediation costs is neither probable nor reasonably estimable and no liability has been recorded.
 
OSHA / Wrongful Termination Matter
 
On July 8, 2004, two former employees filed a complaint with the US Department of Labor, OSHA alleging retaliatory termination in violation of the Sarbanes-Oxley Act of 2002. The former employees allege that they were terminated in retaliation for questioning whether Anchor and its executives failed to properly disclose information allegedly affecting the value of Anchor's patents in connection with IGT's acquisition of Anchor in December 2001. The former employees also allege that the acquired patents were overvalued on the financial statements of IGT. Outside counsel, retained by an independent committee of our Board of Directors, reviewed the allegations and found them to be entirely without merit.
 
On November 10, 2004, the employees withdrew their complaint filed with OSHA and filed a notice of intent to file a complaint in federal court. On December 1, 2004, a complaint was filed under seal in the US District Court for the District of Nevada, based on the same facts set forth above regarding their OSHA complaint. IGT filed a motion for summary judgment as to all claims in plaintiffs’ complaint. On June 14, 2007, the US District Court for the District of Nevada entered an order granting summary judgment in favor of IGT as to plaintiffs’ Sarbanes-Oxley whistle-blower claims and dismissed their state law claims without prejudice. Plaintiffs’ motion for reconsideration of the District Court’s decision was denied. Plaintiffs appealed to the US Court of Appeals for the Ninth Circuit. Oral argument was heard on March 12, 2009, and on August 3, 2009, the Ninth Circuit reversed the District Court’s decision. IGT’s motion for summary judgment on plaintiffs’ state law claims was argued on October 22, 2009 and granted in IGT’s favor on December 8, 2009. On April 13, 2010, the District Court granted IGT’s motion to strike the plaintiffs’ jury demand and granted IGT’s motion to retax costs and fees. It denied plaintiffs’ motion for certification and/or reconsideration. Trial was scheduled to begin on June 1, 2010, but was rescheduled to begin on January 23, 2011.
 
In conjunction with the Anchor acquisition purchase price allocation as of December 31, 2001, IGT used the relief of royalty valuation methodology to estimate the fair value of the patents at $164.4 million. The carrying value of the patents at June 30, 2010 totaled $44.1 million.
 
 
19

 
 
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 and guarantees 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 gaming operations totaled $7.0 million at June 30, 2010. We are liable to reimburse the bond issuer in the event of exercise due to nonperformance.
 
Letters of Credit
 
Outstanding letters of credit issued under our domestic line of credit to ensure payment to certain vendors and governmental agencies totaled $3.6 million at June 30, 2010.
 
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 costs due to infringement claims. As we consider the likelihood of incurring future costs to be remote, no liability has been recorded.
 
Product Warranties
 
The majority of our products are generally covered by a warranty for periods ranging from 90 days to one year. We estimate accrued warranty costs in the table below based on historical trends in product failure rates and expected costs to provide warranty services.
 
Nine Months Ended June 30,
 
2010
   
2009
 
(In millions)
           
Balance at beginning of year
  $ 7.9     $ 8.4  
Reduction for payments made
    (7.9 )     (5.6 )
Accrual for new warranties issued
    6.7       7.8  
Adjustments for pre-existing warranties
    (0.8 )     (1.9 )
Balance at end of period
  $ 5.9     $ 8.7  
 
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.
 
 
20

 
 
12.   INCOME TAXES
 
Our provision for income taxes is based on estimated effective annual income tax rates. 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 nine months ended June 30, 2010 decreased to 22.5% from 30.3% for the same prior year period, primarily due to settlement of the IRS audit for fiscal years 2002 through 2005 partially offset by changes in our uncertain tax liabilities.
 
As of June 30, 2010, we had $39.6 million of gross unrecognized tax benefits excluding related accrued interest and penalties of $16.8 million. As of June 30, 2010, $48.1 million of our unrecognized tax benefits, including related accrued interest and penalties, would affect our effective tax rate, if recognized. During the nine months ended June 30, 2010, our unrecognized tax benefits decreased $28.2 million, and related interest and penalties decreased $29.7 million. The decrease in unrecognized tax benefits relating to settlements with tax authorities was $45.2 million. The increase in unrecognized tax benefits as a result of tax positions taken during a prior period was $13.0 million. The increase in unrecognized tax benefits as a result of tax positions taken in the current nine-month period was $4.0 million.
 
On April 30, 2010, the IRS concluded its examination of our consolidated US tax return for the fiscal years 2002 through 2005. In accordance with the final settlement reached with the IRS, we paid the IRS approximately $12.4 million, including interest of $4.3 million during the third quarter of fiscal 2010.
 
We are also subject to examination in 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.
 
<