United States Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended December 31, 2006

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

For the transition period from                      to                     

International Game Technology

(Exact name of registrant as specified in its charter)

Nevada		88-0173041
(State of Incorporation)		(I.R.S. Employer Identification No.)

9295 Prototype Drive
Reno, Nevada 89521
(Address of principal executive offices)

(775) 448-7777
(Registrant’s telephone number, including area code)

www.IGT.com
(Registrant’s website)

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  þ  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act:

Large accelerated filer  þ     Accelerated filer  o     Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  þ

     The number of shares outstanding of each of the registrant’s classes of common stock, as of January 31, 2007:

338,273,464 shares of common stock at $.00015625 par value

 

 

INTERNATIONAL GAME TECHNOLOGY
TABLE OF CONTENTS

		Page
DEFINITIONS			ii
PART I – FINANCIAL INFORMATION			1
Item 1.   Unaudited Condensed Consolidated Financial Statements			1
CONSOLIDATED INCOME STATEMENTS			1
CONSOLIDATED BALANCE SHEETS			2
CONSOLIDATED CASH FLOWS STATEMENTS			3
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS			5
Item 2.   Management’s Discussion and Analysis			16
Item 3.   Quantitative and Qualitative Disclosures about Market Risk			25
Item 4.   Controls and Procedures			25
PART II – OTHER INFORMATION			26
Item 1.   Legal Proceedings			26
Item 1A. Risk Factors			26
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 3.   Defaults Upon Senior Securities			28
Item 4.   Submission of Matters to a Vote of Security Holders			28
Item 5.   Other Information			28
Item 6.   Exhibits			29
Signature			30
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

DEFINITIONS, abbreviations or acronyms as used in this Form 10-Q

Abbreviation		Definition
Acres		Acres Gaming Incorporated
Anchor		Anchor Gaming
APIC		Additional paid-in capital
AVP®		Advanced Video Platform
bps		basis points
CAD$		Canadian dollars
CCSC		Colorado Central Station Casino
CDS		central determination system
CEO		Chief Executive Officer
CFO		Chief Financial Officer
CRM		customer relationship management
Commission		Nevada Gaming Commission
1.75% Debentures		1.75% Zero-coupon Senior Convertible Debentures
2.6% Debentures		2.6% Senior Convertible Debentures
EITF		Emerging Issues Task Force
EPA		Environmental Protection Agency
EPS		earnings per share
FAS		Financial Accounting Standard
FASB		Financial Accounting Standards Board
FIN		FASB Interpretation
GAAP		generally accepted accounting principles
JV		Spin For Cash Joint Venture
MDA		management’s discussion & analysis
MLP		multi level progressive
NJ		New Jersey
OSHA		Occupational Safety & Health Administration
pp		percentage points
R&D		research and development
Reg		Regulation
SAB		Staff Accounting Bulletin
sbÔ		server based
SEC		Securities and Exchange Commission
SFAS		Statement of Financial Accounting Standards
SG&A		selling, general and administrative
SIP		Stock Incentive Plan
TRO		temporary restraining order
UK		United Kingdom
US		United States
VCAT		Venture Catalyst Incorporated
VIE		variable interest entity
WW or WagerWorks		WagerWorks, Inc.
WAP		wide area progressive
*		not meaningful (in tables)

PART I — FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

CONSOLIDATED INCOME STATEMENTS

Quarters ended December 31,		2006				2005
(In millions, except per share amounts)
Revenues
Product sales		$	317.4			$	324.5
Gaming operations			324.9				291.7
Total revenues			642.3				616.2
Costs and operating expenses
Cost of product sales			152.1				158.0
Cost of gaming operations			138.2				126.2
Selling, general and administrative			98.4				84.6
Research and development			49.3				41.2
Depreciation and amortization			19.1				20.4
Total costs and operating expenses			457.1				430.4
Operating income			185.2				185.8
Other income (expense)
Interest income			19.9				15.8
Interest expense			(16.1	)			(13.6	)
Other			0.7				0.5
Total other income (expense)			4.5				2.7
Income before tax			189.7				188.5
Provision for income taxes			68.7				67.9
Net income		$	121.0			$	120.6
Basic earnings per share		$	0.36			$	0.36
Diluted earnings per share		$	0.35			$	0.34
Cash dividends declared per share		$	0.130			$	0.125
Weighted average shares outstanding
Basic			332.5				337.1
Diluted			343.9				362.7

See accompanying notes.

CONSOLIDATED BALANCE SHEETS

		December 31,				September 30,
		2006				2006
(In millions, except par value)
Assets
Current assets
Cash and equivalents		$	691.9			$	294.6
Investment securities, at market value			499.2				191.7
Restricted cash and investments			105.4				102.8
Accounts receivable, net			367.6				353.1
Current maturities of notes and contracts receivable, net			104.0				93.7
Inventories			148.9				162.1
Jackpot annuity investments			64.8				47.2
Deferred income taxes			42.8				19.7
Prepaid expenses and other			98.7				110.8
Total current assets			2,123.3				1,375.7
Notes and contracts receivable, net			63.3				63.1
Property, plant and equipment, net			515.3				469.8
Jackpot annuity investments			449.9				340.2
Deferred income taxes			136.3				116.9
Intangible assets, net			259.8				257.0
Goodwill, net			1,106.5				1,095.1
Other assets			198.2				184.9
		$	4,852.6			$	3,902.7
Liabilities and Stockholders’ Equity
Liabilities
Current liabilities
Current maturities of notes payable		$	366.1			$	632.4
Accrued Debenture settlements			250.2				—
Accounts payable			111.7				115.5
Jackpot liabilities			193.7				170.0
Accrued employee benefit plan liabilities			24.7				75.9
Dividends payable			43.8				43.4
Accrued income taxes			88.1				36.1
Other accrued liabilities			192.6				173.3
Total current liabilities			1,270.9				1,246.6
Notes payable, net of current maturities			1,100.0				200.0
Non-current jackpot liabilities			482.7				376.7
Other liabilities			39.7				37.4
			2,893.3				1,860.7
Commitments and Contingencies
Stockholders’ Equity
Common stock: $.00015625 par value; 1,280.0 shares authorized; 724.7 and 720.5 shares issued			0.1				0.1
Additional paid-in capital			1,926.5				1,864.2
Treasury stock at cost: 391.3 and 386.3 shares			(2,829.0	)			(2,603.6	)
Retained earnings			2,852.1				2,774.9
Accumulated other comprehensive income			9.6				6.4
			1,959.3				2,042.0
		$	4,852.6			$	3,902.7

See accompanying notes.

CONSOLIDATED CASH FLOWS STATEMENTS

Quarters ended December 31,		2006				2005
(In millions)
Operations
Net income		$	121.0			$	120.6
Adjustments:
Depreciation, amortization, and asset charges			65.3				55.9
Debt discounts and deferred issuance costs			5.2				4.0
Share-based compensation			9.4				9.5
Bad debt provisions			(1.1	)			0.2
Inventory obsolescence			3.7				3.4
Changes in operating assets and liabilities, excluding acquisitions and VIE consolidations/deconsolidations:
Receivables			(3.8	)			(25.7	)
Inventories			11.9				2.8
Accounts payable and accrued liabilities			(45.1	)			(50.2	)
Jackpot liabilities			6.4				(12.4	)
Income taxes, net of employee stock plans			53.9				42.2
Excess tax benefits from employee stock plans			(5.4	)			(1.3	)
Other current assets			5.6				(4.3	)
Other non-current assets			(3.5	)			14.3
Cash from operations			223.5				159.0
Investing
Capital expenditures			(103.8	)			(75.2	)
Investment securities, net			(305.6	)			63.3
Jackpot annuity investments, net			(1.1	)			4.7
Loans receivable cash advanced			(17.3	)			(0.8	)
Loans receivable payments received			2.2				1.5
Proceeds from assets sold			0.2				0.3
Changes in restricted cash			0.5				8.9
Business acquisitions			(18.3	)			—
Cash from investing			(443.2	)			2.7
Financing
Debt proceeds (repayments), net			866.1				(12.6	)
Employee stock plan proceeds			18.1				9.2
Excess tax benefits from employee stock plans			5.4				1.3
Dividends paid			(43.5	)			(42.3	)
Share repurchases			(225.4	)			(73.1	)
Structured share repurchase transactions			—				77.8
Cash from financing			620.7				(39.7	)
Foreign exchange rates effect on cash			(3.7	)			0.5
Net change in cash and equivalents			397.3				122.5
Beginning cash and equivalents			294.6				288.9
Ending cash and equivalents		$	691.9			$	411.4

See accompanying notes.

Supplemental Cash Flows Information

Depreciation, amortization and asset charges reflected in the cash flows statements are comprised of amounts presented separately on the income statements, plus depreciation and asset charges included in cost of product sales and cost of gaming operations.

Quarters ended December 31,		2006				2005
(In millions)
Investment securities
Purchases		$	(474.5	)		$	(142.6	)
Proceeds from sales			168.9				205.9
Net		$	(305.6	)		$	63.3
Jackpot funding
Collections to fund jackpots		$	46.5			$	34.7
Payments to winners			(40.1	)			(47.1	)
Net change in jackpot liabilities			6.4				(12.4	)
Jackpot annuity purchases			(12.9	)			(5.0	)
Jackpot annuity proceeds			11.8				9.7
Net change in jackpot annuity investments			(1.1	)			4.7
Net jackpot funding cash flows		$	5.3			$	(7.7	)
Capital expenditures
Property, plant and equipment		$	(52.2	)		$	(14.8	)
Gaming operations equipment			(45.8	)			(56.1	)
Intellectual property			(5.8	)			(4.3	)
Total		$	(103.8	)		$	(75.2	)
Payments
Interest		$	3.5			$	4.9
Income taxes			16.3				27.1
Non-cash investing and financing items:
Net change in capital expenditure accruals		$	1.0			$	(1.6	)
Interest accretion for jackpot annuity investments			7.5				5.8
Business acquisitions
Fair value of assets		$	21.1			$	—
Fair value of liabilities			2.8				—
VIE deconsolidations
Fair value of assets		$	—			$	139.2
Fair value of liabilities			—				139.2
VIE reconsolidations
Fair value of assets		$	122.8			$	—
Fair value of liabilities			122.8				—
1.75 % Debentures converted
Common stock issued including APIC		$	1.0			$	—
Accrued settlements			250.2				—
Deferred tax liabilities adjusted to APIC			23.5				—

See accompanying notes.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Basis of Presentation and Consolidation

Our fiscal accounting periods end on the Saturday nearest the last day of the quarter end month. For simplicity, we present all fiscal period endings as the calendar month end date. Accordingly, this report presents the following periods:

		Period End
		Actual				Presented as
Current quarter		December 30, 2006				December 31, 2006
Prior year quarter		December 31, 2005				December 31, 2005
Prior fiscal year end		September 30, 2006				September 30, 2006

We prepare our consolidated financial statements in accordance with SEC requirements and include all adjustments of a normal recurring nature that are necessary to fairly present 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 most recent Annual Report on Form 10-K.

Our consolidated financial statements include the accounts of International Game Technology and all majority-owned or controlled subsidiaries and variable interest entities for which we are the primary beneficiary. All appropriate inter-company accounts and transactions are eliminated. We use the equity method to account for investments in unconsolidated affiliates when we exercise significant influence, but do not control the affiliate and when we are not the primary beneficiary of a variable interest entity.

Unconsolidated Affiliate

In February 2006, IGT paid $56.0 million for a 10% equity interest in Casino IP Holdings, LLC (LLC), a variable interest entity formed to hold, develop, and license Walker Digital’s intellectual property identified for gambling use. IGT agreed to cooperatively develop and market products expected to be integral to our operations, using certain LLC innovations. We are not the primary beneficiary of the LLC and apply the equity method of accounting. Our maximum exposure to loss at December 31, 2006, is our net investment in the LLC of $51.6 million, included in other non-current assets. For the quarter ended December 31, 2006, we recognized a loss of $1.2 million for the LLC, primarily related to amortization of intangibles. As the loss is not material to our consolidation, it is presented as a component of SG&A expense.

Consolidated WAP Trust VIEs

We initially consolidated our WAP trusts in Iowa and NJ beginning March 31, 2004 under FIN 46 (revised December 2003), Consolidation of Variable Interest Entities. Prior to consolidation, we recognized revenues from the trusts based on contractual fee arrangements. Consolidated trust assets equal liabilities and relate primarily to jackpot funding. These VIE trust consolidations increase gaming operations revenues and costs by approximately the same amount, resulting in no material impact to gross profit or net income.

In November 2005, IGT assumed direct responsibility for current and future NJ WAP jackpot system operations previously under the control of a third party trust administrator. At this time, IGT was relieved of its contractual guarantee obligation related to the third party administration of past winner payments. Accordingly, we deconsolidated approximately $139.2 million of NJ VIE assets and liabilities related to past winners during the first quarter of fiscal 2006.

In November 2006, IGT executed an agreement with casino trustees to assume responsibility for and administration of the NJ past winner payments formerly under the control of a third party administrator. The resulting reconsolidation of these VIE past winner trusts initially added assets and offsetting liabilities of $122.8 million, as well as increasing interest income and interest expense by $1.8 million during the first quarter of fiscal 2007.

Consolidated trust VIE assets and offsetting liabilities, inclusive of Iowa and NJ, totaled $127.2 million at December 31, 2006 and $4.1 million at September 30, 2006. Trust VIE consolidations contributed revenues of $0.4 million for the current quarter and $1.3 million in the prior year quarter.

Recently Issued Accounting Standards

SFAS 157

In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This statement is effective for us beginning in October 2008. We are evaluating whether adoption of this statement will result in changes to our fair value measurements.

SAB 108

In September 2006, the SEC issued SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment effective for our fiscal year ending September 30, 2007. We do not expect the adoption of this statement to have a material impact on our results of operations, financial position or cash flows.

FIN 48

In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes by defining criteria that a tax position on an individual matter must meet before that position is recognized in the financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, classification, interest and penalties, interim period accounting, disclosures and transition. This interpretation is effective for us beginning in October 2007. We are evaluating the potential impact of adopting this interpretation on our future results of operations, financial position or cash flows.

SFAS 154

In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections, requiring retrospective application to prior-period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines “restatement” as the revising of previously issued financial statements to reflect the correction of errors. This statement was effective for us beginning in October 2006. Although we have no current application for this statement, the adoption of this statement may affect our future results of operations, financial position or cash flows.

2. Balance Sheet Components

    Inventories

		December 31,				September 30,
		2006				2006
(In millions)
Raw materials		$	86.6			$	79.9
Work-in-process			5.6				4.6
Finished goods			56.7				77.6
Total inventories		$	148.9			$	162.1

Property, Plant and Equipment

		December 31,				September 30,
		2006				2006
(In millions)
Land		$	35.5			$	35.4
Buildings			105.0				104.6
Gaming operations equipment			644.0				608.8
Manufacturing machinery and equipment			199.5				194.1
Leasehold improvements			15.5				14.0
Construction in process			124.6				82.6
Total			1,124.1				1,039.5
Less accumulated depreciation			(608.8	)			(569.7	)
Property, plant and equipment, net		$	515.3			$	469.8

Construction in process includes $88.8 million at December 31, 2006 and $57.7 million at September 30, 2006 related to our new facilities under construction in Las Vegas.

3. Share-based Compensation

At December 31, 2006:

	ª		11.0 million shares remain available for grant under the IGT SIP
	ª		unrecognized share-based compensation costs totaled $94.0 million with an expected weighted average life of 2.2 years

We evaluate and revise our option valuation assumptions as necessary to reflect changes in market conditions and experience. New SIP grants in fiscal 2007 began vesting ratably over four years and activity is reflected below as of and for the quarter ended December 31, 2006.

						Weighted Average
										Remaining				Aggregate
						Exercise				Contractual				Intrinsic
Options		Shares				Price				Term				Value
		(thousands)				(per share)				(years)				(millions)
Outstanding at beginning of year			17,553			$	26.45
Granted			1,480				42.72
Exercised			(872	)			20.68
Forfeited			(150	)			31.56
Expired			(1	)			35.70
Outstanding at end of period			18,010			$	28.03				7.0			$	327.3
Exercisable at end of period			7,925			$	23.20				5.9			$	182.3

						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 year			1,570			$	33.45
Granted			336				42.73
Vested			(93	)			33.58
Forfeited			(6	)			35.52
Outstanding at end of period			1,807			$	35.16				3.9			$	83.5

4. Acquisitions

On December 21, 2006, we completed the acquisition of Venture Catalyst Incorporated (VCAT), provider of the Mariposa suite of gaming software products. Following the acquisition, VCAT’s name changed to Mariposa Software, Inc. We anticipate VCAT’s Mariposa CRM software will enhance and complement our upcoming sb™ technology platform and casino systems applications for customer relationship management. We have not provided pro forma financial information for this acquisition, as it was not material to our consolidated results.

At December 31, 2006, with the business valuation not yet complete, we preliminarily allocated the purchase price of $21.8 million to:

	ª		tangible assets of $6.6 million, including $3.5 million in cash
	ª		total liabilities of $2.8 million
	ª		identifiable intangibles of $8.6 million
	ª		$9.4 million in goodwill not deductible for tax purposes

5. Allowances for Receivables

		December 31,				September 30,
		2006				2006
(In millions)
Allowance for doubtful accounts		$	17.7			$	18.2
Allowance for doubtful notes and contracts
Current		$	21.2			$	21.5
Long-term			16.6				17.5
		$	37.8			$	39.0

6. Concentrations of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash or equivalents, short-term investments, and receivables. We place short-term investments in high credit quality financial institutions or in short duration high quality securities. With the exception of US Government and Agency securities, our 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 revenues and resulting receivables are concentrated in specific legalized gaming regions. At December 31, 2006, jurisdictions where our net receivable concentrations were greater than 5% individually included Nevada—22%, Europe—9%, California—8%, and Pennsylvania—7%. The remaining jurisdictions, less than 5% individually, aggregate to North America—41% and International—13%.

7. Goodwill and Other Intangibles

Goodwill

Activity by Segment for the Quarter Ended		North
December 31, 2006		America				International				Total
(In millions)
Beginning balance		$	992.1			$	103.0			$	1,095.1
VCAT- Mariposa acquisition			9.4				—				9.4
Tax benefit of Anchor options exercised (1)			(0.2	)			—				(0.2	)
Foreign currency translation adjustment			—				2.2				2.2
Ending balance		$	1,001.3			$	105.2			$	1,106.5

Other Intangibles

Additions for the Quarter Ended		Business(2)				Other				Weighted
December 31, 2006		Combinations				Additions				Average Life
(In millions, except life)										(Years)
Finite lived intangibles:
Patents(1)		$	0.7			$	5.3				12
Contracts			0.6				—				12
Developed technology			2.9				—				8
Customer relationships			3.8				—				2
			8.0				5.3
Indefinite lived trademarks			0.6				—
Total other intangibles		$	8.6			$	5.3

⁽¹⁾  Patent additions include capitalized legal costs.

⁽²⁾  Includes valuation adjustments subsequent to acquisition.

		December 31, 2006												September 30, 2006
						Accumulated												Accumulated
Balances		Cost				Amortization				Net				Cost				Amortization				Net
(In millions)
Finite lived intangible assets
Patents		$	338.1			$	127.3			$	210.8			$	332.1			$	119.4			$	212.7
Contracts			20.2				10.4				9.8				19.6				9.4				10.2
Trademarks			1.9				1.5				0.4				5.1				4.7				0.4
Developed technology			47.0				16.6				30.4				44.2				14.9				29.3
Customer relationships			10.5				2.7				7.8				6.8				2.4				4.4
Total			417.7				158.5				259.2				407.8				150.8				257.0
Indefinite lived trademarks			0.6				—				0.6				—				—				—
Net carrying amount		$	418.3			$	158.5			$	259.8			$	407.8			$	150.8			$	257.0

Amortization expense totaled $11.1 million in the first quarter of fiscal 2007 versus $11.3 million in the comparable prior year quarter.

		2007				2008				2009				2010				2011
(In millions)
Estimated annual amortization		$	36.2			$	39.5			$	36.1			$	31.6			$	27.3

8. Credit Facilities & Indebtedness

		December 31,				September 30,
Outstanding Balance		2006				2006
(In millions)
Senior credit facility		$	200.0			$	200.0
Foreign credit facilities			4.2				21.3
1.75% Convertible Debentures, net of unamortized discount			361.9				611.1
2.6% Convertible Debentures			900.0				—
Total notes payable, net		$	1,466.1			$	832.4

We continue to be in compliance with all applicable covenants at December 31, 2006.

Senior Credit Facility

Borrowings outstanding under our unsecured $2.5 billion revolving line of credit totaled $200.0 million at December 31, 2006, with $4.4 million reserved for letters of credit. Interest rates and facility fees applicable to the credit facility may fluctuate based on our public credit ratings and/or debt to capitalization ratio. At December 31, 2006, the interest rate was LIBOR plus 37.5 bps or 5.74% with a facility fee of 12.5 bps.

Foreign Credit Facilities

Our foreign credit facilities totaled $66.7 million at December 31, 2006. Of this amount, $4.2 million was drawn with an interest rate of 1.8%. Renewals on these facilities occur annually.

New 2.6% Senior Convertible Debentures

On December 20, 2006, we issued $900.0 million principal amount of 2.6% Senior Convertible Debentures due December 15, 2036 in a private placement. We will pay interest on the Debentures semiannually on June 15 and December 15 of each year, beginning June 15, 2007.

We may also pay contingent interest for the period commencing December 20, 2009 through June 14, 2010 and any six month period thereafter, if the average trading price (as defined in the indenture) per $1,000 principal amount Debenture for the five trading day measuring period ending on the third trading day immediately preceding the first day of the interest period equals 120% or more of an equal principal amount of Debentures. The amount of contingent interest will equal 0.25% per annum of the average trading price of $1,000 principal amount of Debentures during the five trading day measuring period used to determine whether contingent interest must be paid.

Under certain circumstances, each $1,000 principal amount of the Debentures will initially be convertible into 16.1875 shares of IGT Common Stock, representing a stock price of $61.78 or a 35% conversion premium over the market price at issuance. Upon conversion, for each $1,000 principal amount of Debentures, a holder will receive cash up to $1,000 and shares for any excess conversion value determined in a manner set forth in the indenture. We will adjust the conversion rate upon the occurrence of certain events as defined in the indenture.

The Debentures are convertible under any of the following circumstances:

	ª		during any fiscal quarter ending after March 31, 2007 if the closing price of our common stock is more than 130% of the conversion price during any measurement period of the preceding fiscal quarter
	ª		if the Debentures are called for redemption
	ª		if specified corporate transactions occur
	ª		during the last three months prior to maturity

IGT may redeem some or all of the Debentures for cash on or after December 20, 2009, at 100% of their principal amount plus accrued and unpaid interest, if any. If IGT redeems the Debentures, holders will be notified at least 15 days, but not more than 60 days, prior to the redemption date.

Holders have the right to require IGT to redeem the Debentures for cash at 100% of their principal amount plus accrued and unpaid interest, if any, on December 15, 2009, 2011, 2016, 2021, 2026 and 2031.

Under the Debentures Registration Rights Agreement, we agreed to file and keep effective a shelf registration statement with respect to the resale of Debentures and shares of our common stock issuable upon conversion of the Debentures (collectively the Registrable Securities) for specified periods of time. If we fail to comply with our obligations to register the Registrable Securities, we will be required to pay additional interest as liquidated damages ranging from 0.25% to 0.50% of the principal amount to Debenture holders until any default under the Registration Rights Agreement is cured.

In evaluating all features of our 2.6% Debentures for SFAS 133 embedded derivative accounting requirements, we determined the contingent interest feature is an embedded derivative requiring bifurcation. The estimated value of this derivative is not material at December 31, 2006, as such, we recorded no related derivative asset or liability at December 31, 2006.

Old 1.75% Zero-Coupon Debentures

On December 26, 2006, we called for the redemption of our outstanding 1.75% Debentures on January 10, 2007. The call of these Debentures gave holders the right to convert their Debentures before January 10, 2007, and receive aggregate consideration comprised of shares and cash under the terms of the applicable indentures. In conjunction with the redemption and conversion, we will have recorded the following transactions through January 31,2007:

		First Quarter				Second Quarter				Total Fiscal 2007
(In millions)
Cash paid		$	0.2			$	612.5			$	612.7
Net change in accrued Debenture settlements			250.2				(250.2	)			—
Deferred tax adjustment to APIC			23.5				24.2				47.7
Number of shares issued (first quarter estimated as of conversion request date)			2.9				4.4				7.3	(1)

9. Earnings Per Share Reconciliation

		Quarters Ended
		December 31,
		2006				2005
(In millions, except per share amounts)
Net Income		$	121.0			$	120.6
After-tax interest expense on 1.75% Debentures			—				2.4
Diluted EPS Numerator		$	121.0			$	123.0
Weighted average common shares outstanding:
Basic			332.5				337.1
Dilutive effect of stock awards			5.0				5.1
Dilutive effect of 1.75% Debentures			6.4				20.5
Diluted EPS Denominator			343.9				362.7
Basic earnings per share		$	0.36			$	0.36
Diluted earnings per share		$	0.35			$	0.34
Weighted average antidilutive stock award shares excluded from diluted EPS			1.2				9.1

We issued 4.4 million shares or 1% of outstanding shares in conjunction with the 1.75% Debenture conversions in January 2007. There were no other transactions between December 31, 2006 and January 31, 2007 that would have materially changed outstanding shares.

10. 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.

11. Comprehensive Income

		Quarters Ended
		December 31,
		2006				2005
(In millions)
Net income		$	121.0			$	120.6
Currency translation adjustments			3.2				(0.1	)
Comprehensive income		$	124.2			$	120.5

12. 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 financial position or results of future operations.

Bally

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 numbers 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 denies these allegations and discovery is ongoing.

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 numbers 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, unenforceability of the asserted patents, antitrust violations, unfair competition, and intentional interference with prospective business advantage. IGT denies these allegations, and discovery is ongoing.

On September 5, 2006, Bally Gaming, Inc. filed a complaint in US District Court for the District of Nevada alleging that IGT is infringing US Patent No. 7,100,916, entitled “Indicator Wheel System.” The products named in the Complaint are IGT’s gaming machines with “wheel” features, including, without limitation, Wheel of Fortune^®, Wheel of Gold™, The Addams Family™, American Bandstand™, The Apprentice™, Dilbert Wheelbert™, Drew Carey Great Balls of Cash™, Elvira^®, I Dream of Jeannie^®, I Love Lucy^®, Indiana Jones™: Raiders of the Lost Ark™, M*A*S*H*™, Megabucks with Morgan Fairchild^®, Regis On the Town™, Sinatra™ and The Twilight Zone^® gaming machines. The lawsuit seeks unspecified monetary damages and an injunction. On October 6, 2006, IGT filed an answer and counterclaims denying infringement and seeking a declaration that the patent is invalid and non-infringed. IGT intends to vigorously defend this lawsuit. Discovery is ongoing.

Aristocrat

On June 30, 2005, Aristocrat Technologies Australia PTY Ltd. filed a patent infringement lawsuit against IGT. The Complaint was served on IGT on December 13, 2005. Aristocrat alleges that IGT has willfully infringed US Patent No. 6,093,102. Aristocrat contends that the patent covers its Reel Power^® video slot technology and IGT’s Multiway^® video slot games. The lawsuit seeks unspecified damages and an injunction. IGT believes that the patent is invalid and not infringed and intends to vigorously defend the lawsuit. On January 13, 2006, Aristocrat filed a First Amended Complaint adding Aristocrat Technologies, Inc. as a plaintiff. On January 19, 2006, IGT filed its Answer to the First Amended Complaint.

On June 12, 2006, Aristocrat Technologies Australia PTY Ltd. and Aristocrat Technologies, Inc. filed a patent infringement lawsuit against IGT. Aristocrat alleges that IGT has willfully infringed US Patent No. 7,056,215, which issued on June 6, 2006. The IGT products named in the complaint are the Fort Knox^® mystery progressive slot machines. IGT believes that the patent is invalid and not infringed and intends to vigorously defend the lawsuit.

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 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, 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. VLC filed its Plea in Defense in the warranty action in April 2006. The Court scheduled trial of the entire action against Loto Quebec to commence in 2007.

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 a superfund site as a result of contamination from historic mining activity in the area. The EPA is entitled to proceed against current and prior owners and operators of properties located within the site for remediation and response costs associated with their properties and with the entire site. CCSC is located within the drainage basin of North Clear Creek, Colorado and is therefore subjected to potentially contaminated surface and ground water from upstream mining related sources. Soil and ground water samples on the site indicate that several contaminants exist in concentrations exceeding drinking water standards. Under the guidance in Statement of Position 96-1 “Environmental Remediation Liabilities”, we determined no liability has been incurred.

Miller

In June 2003, a class action lawsuit was filed in Clark County, Nevada, District Court against Acres and its directors, entitled Paul Miller v. Acres Gaming Incorporated, et al. The complaint alleged that Acres directors breached their fiduciary duties to their stockholders in connection with the approval of the merger transaction between Acres and IGT and sought to enjoin and/or void the merger agreement among other forms of relief. On September 19, 2003, the Court denied plaintiff’s motion for a TRO to prevent Acres stockholders from voting on the merger. On September 24, 2003, plaintiff petitioned the Nevada Supreme Court to vacate the denial of the TRO and to enjoin Acres from holding its stockholder vote on the merger. The Nevada Supreme Court denied the petition on September 25, 2003.

On November 5, 2003, the plaintiff amended his complaint to recover damages. On December 23, 2003, defendants filed a motion to dismiss plaintiff’s second amended complaint for failure to state a claim on which relief may be granted. On May 7, 2004, the Court issued an order denying defendants’ motion to dismiss.

Pursuant to stipulation of the parties, plaintiff filed a third amended complaint on September 9, 2004. Defendants filed a motion to dismiss the third amended complaint on September 14, 2004. On March 15, 2006, the Court issued an order denying defendants motion to dismiss the third complaint. On April 7, 2006, defendant filed a Notice of Removal to United States District Court, D. Nev. (Las Vegas). Plaintiff filed a motion to remand the action to state court, which was granted by order dated August 15, 2006. On November 30, 2006, the case was transferred to business court and discovery continues.

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 2001. The former employees also allege that the acquired patents are 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 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, which is currently pending before the US District Court. IGT believes that the allegations are without merit and intends to vigorously defend this matter.

Related to 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 December 31, 2006 totaled $92.0 million, with a remaining life of approximately 10 years.

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, guarantees and product warranties not reflected in our balance sheet. We do not expect any material losses to result from these arrangements, and we are not dependent on off-balance sheet financing arrangements to fund our operations.

Performance Bonds

Performance bonds outstanding related to gaming operations totaled $28.7 million at December 31, 2006. 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 line of credit to ensure payment to certain vendors and governmental agencies totaled $4.4 million at December 31, 2006.

IGT Licensor Arrangements

Our sales agreements that include software and intellectual property licensing arrangements may provide a clause whereby IGT indemnifies the third party licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement. 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

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

Quarters ended December 31,		2006				2005
(In millions)
Balance at beginning of year		$	8.3			$	6.0
Reduction for payments made			(1.4	)			(1.6	)
Accrual for new warranties issued			3.0				3.5
Adjustments for pre-existing warranties			(0.7	)			(0.3	)
Balance at end of period		$	9.2			$	7.6

Self-Insurance

We are self-insured for various levels of workers’ compensation, directors’ and officers’ liability, 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 of claims incurred but not reported.

State and Federal Taxes

We are subject to sales, use, income and other tax audits and administrative proceedings in various federal, state, and local 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.

13. Foreign Currency Derivatives

Our net foreign currency exposure related to our monetary assets and liabilities totaled $105.5 million at December 31, 2006 and $151.0 million at September 30, 2006. The fair value of foreign currency contracts hedging this exposure totaled $101.8 million at December 31, 2006 and $148.7 million at September 30, 2006.

14. Business Segments

We view our business in two regional operating segments, each incorporating all types of revenues:

	ª		North America consists of our operations in the US and Canada.
	ª		International encompasses our efforts in Asia, Australia, New Zealand, Europe, Japan, Latin America, Russia, South Africa, and the UK.

Additionally, certain income and expense is managed at the corporate level and not allocated to any operating segment. We do not recognize inter-company revenues or expenses upon the transfer of gaming products between our operating segments. Segment profit reflects income before tax.

Our business segments are designed to allocate resources within a framework of management responsibility. We continually evaluate the alignment of our business development and administrative functions for reporting purposes, which may result in changes to segment allocations. Prior year amounts are reclassified to conform to the current management view and presentation.

		Quarters Ended
		December 31,
		2006				2005
(In millions)
NORTH AMERICA
Revenues		$	504.9			$	483.5
Product sales			207.3				206.7
Gaming operations			297.6				276.8
Gross profit			284.3				267.4
Product sales			114.8				111.9
Gaming operations			169.5				155.5
Segment profit			191.0				186.9
INTERNATIONAL
Revenues		$	137.4			$	132.7
Product sales			110.1				117.8
Gaming operations			27.3				14.9
Gross profit			67.7				64.6
Product sales			50.5				54.6
Gaming operations			17.2				10.0
Segment profit			39.5				32.4
CORPORATE
Net unallocated expenses		$	(40.8	)		$	(30.8	)
CONSOLIDATED
Revenues		$	642.3			$	616.2
Product sales			317.4				324.5
Gaming operations			324.9				291.7
Gross profit			352.0				332.0
Product sales			165.3				166.5
Gaming operations			186.7				165.5
Segment profit			189.7				188.5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains statements which 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, believe, could, would, estimate, expect, intend, may, plan, predict, project, pursue, will, continue, and other similar terms and phrases, as well as the use of the future tense.

Examples of forward looking statements in this report include, but are not limited to, the following categories of expectations about:

	ª		our ability to introduce new products and stimulate replacement demand
	ª		the timing and expected success of new product introductions
	ª		future gaming product developments
	ª		our ability to acquire, develop or protect intellectual property
	ª		our market share, competitive advantage, and leadership position
	ª		the advantages offered to our customers by our products
	ª		gaming expansion and new market opportunities
	ª		our ability to effectively integrate and utilize acquired businesses
	ª		future gross margins and tax rates
	ª		increasing growth or contributions
	ª		legislative and regulatory developments
	ª		available capital resources to fund future operations
	ª		expectations regarding losses from off-balance sheet arrangements

Although we believe as of today that the expectations reflected in any of our forward looking statements are reasonable, actual results could differ materially from those expressed or implied. Our future financial condition and results of operations, as well as any forward looking statements, are subject to change and to inherent known and unknown risks and uncertainties. See Item 1A, Risk Factors, in this report for a discussion of these and other risks and uncertainties. You should not assume at any point in the future that the forward looking statements in this Quarterly Report on Form 10-Q are still valid. We do not intend, and undertake no obligation, to update our forward looking statements to reflect future events or circumstances.

COMPANY OVERVIEW

The following MDA is intended to enhance the reader’s understanding of our company operations and present business environment. It should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2006.

Italicized text with an attached superscript trademark or copyright notation in this document indicates trademarks of IGT or its licensors. For a complete list of trademark and copyright ownership information, please visit our website at www.IGT.com.

Our MDA is organized into the following sections:

	ª		OUR BUSINESS — a general description of our business and operating segments
	ª		OUR FOCUS — a summary of our strategies and opportunities
	ª		RECENTLY ISSUED ACCOUNTING STANDARDS — a discussion of recently issued accounting standards with significance to our business
	ª		CRITICAL ACCOUNTING ESTIMATES — a discussion of accounting policies that require critical judgments and estimates
	ª		CONSOLIDATED OPERATING RESULTS — a first quarter year-over-year comparative analysis of net income
	ª		BUSINESS SEGMENT RESULTS — a first quarter year-over-year comparative analysis of business segment results
	ª		LIQUIDITY AND CAPITAL RESOURCES — a first quarter year-over-year comparative analysis of cash flows and capital resources
	ª		FINANCIAL CONDITION –- analysis of significant changes in our financial position

OUR BUSINESS

International Game Technology is a global company specializing in the design, manufacture, and marketing of computerized gaming equipment, systems and services. Our goal is to be the preeminent supplier of gaming products to the world. We strive to maintain a wide array of entertainment inspired gaming product lines, targeting gaming markets in all legal jurisdictions worldwide. We are committed to providing quality products at competitive prices, designed to increase the potential for operator profits by serving players better.

Our annual revenues totaled $2.5 billion in fiscal 2006. We derive our revenues in two ways, either from the sale (product sales) or placement (gaming operations) of our gaming products, services and/or intellectual property. Operating results reviewed by our chief decision makers encompass all revenue sources within each geographical customer region. We currently view our business in two regional operating segments, each incorporating all types of revenues.

	ª		North America consists of our operations in the US and Canada.
	ª		International encompasses our efforts abroad in Asia, Australia, New Zealand, Europe, Japan, Latin America, Russia, South Africa, and the UK.

Additionally, certain income and expenses related to company-wide initiatives are managed at the corporate level and are not allocated to an operating segment. See the BUSINESS SEGMENT RESULTS below and Note 14 of our Unaudited Condensed Consolidated Financial Statements for additional segment information and financial results.

OUR FOCUS

We remain dedicated to generating financial growth by continuing to focus on the three cornerstones of our success: product development, market development and capital deployment.

Product Development

We consider the driving force behind our success to be the ability to offer the best games, platforms and systems through dedicated product development efforts and superior customer service. In our view, we invest a great deal more in product development than our competitors and believe this will help us deliver the broadest product lines across the most markets. We continue pioneering innovation centered on serving players better by utilizing the power of networked gaming, information technology, game design, and services to maximize the potential for operator profitability.

We continuously update our game libraries to address changing player preferences and other market trends. We strive to develop games that incorporate exciting winning combinations and appealing graphics and sound while keeping within our development standards intended to expedite time to market. In spite of intense competition in video games, we expect to maintain a leading share of the total population of gaming devices on North America casino floors over the long-term.

Given the favorable player reaction to the introduction of Wheel of Fortune^® Super Spin™, we plan further multi-player interactive game development with the introduction of our M-P Seriesä of multi-player products in 2007 based on player favorites including baccarat and roulette. Popularity of our MLP games continues to be a driver of incremental growth in our gaming operations installed base with strong performance by our newest MLP brand, Red Hot Jackpotsä , and the continued strength of Fort Knox^®, our MLP flagship brand.

During fiscal 2007, we plan to introduce Guaranteed Playä Poker, providing players a new option for purchasing game play and is our first product developed in collaboration with Walker Digital. We anticipate future product offerings incorporating this feature will give operators the ability to package slot play with other promotional offerings.

Our share of gaming systems in the marketplace continues to grow. At December 31, 2006, 642 IGT slot systems were installed worldwide, compared to 525 this time last year. Our Table iDä products continue gaining momentum in the market, further extending our reach into table games.

Our ongoing server-based development continues to focus on comprehensive enterprise-wide solutions designed to enhance the player experience and improve operator efficiencies. As part of our commitment to lead the industry through the networked gaming transformation, we are intent on developing server-based systems that will offer customers a seamless interface with a variety of hardware platforms. We believe our applications will differentiate our products in this area and offer the operator new ways to engage and interact with their players, as well as market cross-functional products and player conveniences. With four commercial field trials in progress and our first large scale test installation anticipated in fiscal 2008, we expect sbä technology will become more significant in 2009 and 2010.

Market Development

We are dependent in part on new market opportunities to generate growth. We continue with initiatives directed at enhancing this growth rate and accommodating entry into new areas of gaming.

After a relatively quiet period for new market opportunities in North America, we realized the first shipments into Pennsylvania, Florida racetracks and Arkansas during the current quarter and expect future development of these new markets. In addition, we continue expanding our installed base in non-traditional markets, most significantly in Oklahoma, New York and California.

In our view, the addition of machines at Florida racetracks may result in tribes expanding their slot operations to include Class III machines generating significant replacements in that market. We also believe potential remains for new tribal compacts in California, further increasing the number of Class III machines allowed in the state. Although the timing of these opportunities is uncertain, we anticipate developments over the next couple of years.

Prospects for growth in international markets are favorable. We continue expanding our presence in Mexico with increased CDS placements. We continue to prepare for the mandated replacement of approximately 1.5 million pachisuro machines in Japan as the market fully transitions to a Reg-5 environment by the end of fiscal 2007. Recent efforts to prove ourselves as a leading Reg-5 provider have been successful and we are well positioned to capitalize on the replacement demand expected to accelerate during the June to September timeframe.

Capital Deployment

We continue to generate substantial operating cash flows, enabling us to reinvest in our business and generate returns to our shareholders through dividends and share repurchases. See the LIQUIDITY AND CAPITAL RESOURCES section that follows for current share repurchase and dividend activity.

We enter into strategic business combinations and alliances to complement our internal resources. We consider businesses that offer opportunities to expand our geographic reach, product lines and customer base, as well as prospects that may leverage our existing infrastructure through economies of scale. During the first quarter of 2007, we invested $21.8 million in the acquisition of Venture Catalyst Incorporated (VCAT), renamed Mariposa Software Inc. We anticipate VCAT’s Mariposa software will enhance our position as a leading provider of integrated solutions for casino customer relationship management. See Note 4 of our Unaudited Condensed Consolidated Financial Statements for additional information regarding this acquisition.

RECENTLY ISSUED ACCOUNTING STANDARDS

IGT keeps abreast of new generally accepted accounting principles and disclosure reporting requirements issued by the SEC and other standard setting agencies. Recently issued accounting standards affecting our financial results are described in Note 1 of our Unaudited Condensed Consolidated Financial Statements.

CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements were prepared in conformity with accounting principles generally accepted in the US. 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 and related disclosures. Actual results may differ from initial estimates.

We consider the following accounting estimates to be the most critical to aid in fully understanding and evaluating our reported financial results and they require us to make difficult, subjective or complex judgments about matters that are inherently uncertain or variable. Senior management has discussed the development, selection and disclosure of the following accounting estimates, considered most sensitive to changes from external factors, with the Audit Committee of our Board of Directors.

	ª		intangible assets including goodwill and prepaid royalties
	ª		jackpot liabilities and expenses
	ª		inventory and gaming operations equipment
	ª		share-based compensation
	ª		income taxes

For a discussion of our critical accounting estimates, please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations presented in our Annual Report on Form 10-K for the year ended September 30, 2006. We have made no significant changes to our accounting estimates since September 30, 2006.

CONSOLIDATED OPERATING RESULTS — A Year Over Year Comparative Analysis

		Quarters Ended								Favorable
		December 31,								(Unfavorable)
		2006				2005				Amount				%
(In millions, except units & EPS)
Total
Revenues		$	642.3			$	616.2			$	26.1				4	%
Gross profit			352.0				332.0				20.0				6	%
Gross margin			55	%			54	%			1		pp		2	%
Operating income		$	185.2			$	185.8			$	(0.6	)			—
Operating margin			29	%			30	%			(1	)	pp		-3	%
Net income		$	121.0			$	120.6			$	0.4				—
Diluted EPS		$	0.35			$	0.34			$	0.01				3	%
Product sales
Machines		$	232.6			$	231.5			$	1.1				—
Non-machine			84.8				93.0				(8.2	)			-9	%
Total product sales			317.4				324.5				(7.1	)			-2	%
Gross profit		$	165.3			$	166.5			$	(1.2	)			-1	%
Gross margin			52	%			51	%			1		pp		2	%
Units sold			26,800				29,100				(2,300	)			-8	%
Gaming operations
Revenues		$	324.9			$	291.7			$	33.2				11	%
Gross profit			186.7				165.5				21.2				13	%
Gross margin			57	%			57	%			—		pp		—
Installed base units			53,100				43,300				9,800				23	%

First quarter consolidated results included improved total revenues and gross profit, comparable net income and improved EPS versus the prior year. Continued growth in our gaming operations sector offset lower product sales.

Consolidated Product Sales

Despite lower volumes, quarterly machine revenues were comparable to the prior year as a result of the North America product mix. Reduced revenues and gross profits during the current quarter are attributable to lower non-machine sales. Higher license fees partially offset fewer gaming systems installations during the current quarter. Gross margin improvement is related to variations in product mix. We estimate product sales margins will fluctuate between 49% and 51% for the remainder of fiscal 2007, depending on the geographical mix and types of products sold.

Consolidated Gaming Operations

Growth in our installed base of recurring revenue machines is the driving factor behind current quarter revenue and gross profit improvements. Year-over-year casino operations placements grew most significantly in Oklahoma, California, Florida and Alabama, and lease operations units grew primarily in Mexico, New York and Delaware. Continuing expansion into CDS and Class II markets is increasing our mix of lower yielding units and reducing average revenues per device.

First quarter gross margins remain consistent with the prior year. We estimate gaming operations margins will trend between 57% and 59% for the rest of fiscal 2007, depending on installed base mix, play levels, interest rate movement and the timing of jackpots.

Operating Expenses

		Quarters Ended								Favorable
		December 31,								(Unfavorable)
		2006				2005				Amount				%
(In millions)
Selling, general and administrative		$	98.4			$	84.6			$	(13.8	)			-16	%
Research and development			49.3				41.2				(8.1	)			-20	%
Depreciation and amortization			19.1				20.4				1.3				6	%
Total		$	166.8			$	146.2			$	(20.6	)			-14	%
Percent of revenues			26	%			24	%

Increasing operating expenses are primarily due to:

	ª		additional staffing costs of $11.7 million in support of business growth
	ª		rising legal and compliance fees of $6.4 million, largely related to intellectual property protection and the growing complexity of product submissions
	ª		additional investments in R&D supporting development of new technology and products

Other Income (Expense) and Taxes

		Quarters Ended								Favorable
		December 31,								(Unfavorable)
		2006				2005				Amount				%
(In millions)
Interest income		$	19.9			$	15.8			$	4.1				26	%
Interest expense			(16.1	)			(13.6	)			(2.5	)			-18	%
Other			0.7				0.5				0.2				*
Other income (expense), net		$	4.5			$	2.7			$	1.8				*
Income tax provisions		$	68.7			$	67.9			$	(0.8	)
Tax rate, net of one-time items			36.2	%			36.0	%			(0.2	) pp

Interest income improvement in the current quarter is primarily due to higher investment and receivables balances. The reconsolidation of our NJ trusts also contributed to increases in WAP interest income and interest expense in the current quarter. This reconsolidation will have no material impact to net income. See Note 1 of our Unaudited Condensed Consolidated Financial Statements for further information about the NJ trusts reconsolidation.

Our effective tax rate, before net one-time items of $1.7 million, increased to 37.1% from 36.7% in the prior year quarter, mainly due to changes in our forecasted geographical mix of taxable income. We estimate our tax rate (exclusive of one-time items) for the remainder of fiscal 2007 will range between 36.5% and 37.5% depending on variations in the geographic mix of taxable income.

BUSINESS SEGMENT RESULTS – A Year Over Year Comparative Analysis

Operating income for each division below reflects applicable operating expenses. See Note 14 of our Unaudited Condensed Consolidated Financial Statements for additional information related to our business segments.

North America

		Quarters Ended								Favorable
		December 31,								(Unfavorable)
		2006				2005				Amount				%
(In millions, except units)
Total segment
Revenues		$	504.9			$	483.5			$	21.4				4	%
Gross profit			284.3				267.4				16.9				6	%
Gross margin			56	%			55	%			1	pp			2	%
Operating income		$	184.6			$	181.9			$	2.7				1	%
Operating margin			37	%			38	%			(1	) pp			-3	%
Product sales
Machines		$	138.1			$	133.3			$	4.8				4	%
Non-machine			69.2				73.4				(4.2	)			-6	%
Total product sales			207.3				206.7				0.6				—
Gross profit		$	114.8			$	111.9			$	2.9				3	%
Gross margin			55	%			54	%			1	pp			2	%
Units sold			12,200				14,300				(2,100	)			-15	%
Gaming operations
Revenues		$	297.6			$	276.8			$	20.8				8	%
Gross profit			169.5				155.5				14.0				9	%
Gross margin			57	%			56	%			1	pp			2	%
Installed base units			45,300				39,100				6,200				16	%