United States
Securities and Exchange Commission

FORM 10-Q

For the Quarterly Period Ended December 31, 2004

OR

For the transition period from ____ to ___

Commission File Number 001-10684

International Game Technology

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 an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

International Game Technology

Table of Contents

i

ABBREVIATIONS LISTING

Certain abbreviations or acronyms used in this Form 10-Q have the following meanings:

 ii 

PART I – FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

CONSOLIDATED INCOME STATEMENTS

The accompanying notes are an integral part of these consolidated financial statements.

1

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

2

CONSOLIDATED CASH FLOWS STATEMENTS

The accompanying notes are an integral part of these consolidated financial statements.

3

Supplemental Cash Flows Information

Depreciation and amortization reflected in the statements of cash flows includes the amounts presented separately on the statements of income, plus depreciation that is classified as a component of cost of product sales and cost of gaming operations.

The accompanying notes are an integral part of these consolidated financial statements.

4

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Basis of Presentation and Consolidation

Our consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC and include all adjustments necessary to fairly present our consolidated results of operations, financial position, and cash flows for each period presented. Results for interim periods are not necessarily indicative of results for the full year. This quarterly report should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2004. Certain prior period amounts have been reclassified to be consistent with the presentation used in the current period.

Our consolidated financial statements include the accounts of International Game Technology and all majority owned or controlled subsidiaries and variable interest entities of which we are the primary beneficiary. All appropriate inter-company accounts and transactions have been eliminated. We account for investments in 50% or less owned joint ventures using the equity method.

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 of presentation, all fiscal periods are presented as ending on the calendar month end. The results of operations for fiscal 2005 will contain 52 weeks versus 53 weeks in fiscal 2004. The results of operations for the quarter ended December 31, 2004 contained 13 weeks versus 14 weeks in the prior year quarter.

Recently Issued Accounting Standards

EITF 04-8

In December 2004, the FASB issued and we adopted EITF 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, requiring the inclusion of convertible shares in diluted EPS regardless of whether the market price trigger has occurred for all periods presented. We restated the first quarter of fiscal 2004 to reduce diluted EPS from continuing operations by $0.01 related to an additional 20.5 million outstanding debenture shares previously excluded because the conversion event had not occurred. IGT will also be required to restate diluted EPS from continuing operations for the last three quarters of fiscal 2003, resulting in a reduction of approximately $0.03 in fiscal year 2003.

SFAS 123(R)

In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment, replacing SFAS 123, Accounting for Stock-Based Compensation, and superseding APB 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires recognition of share-based compensation in the financial statements. SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005 and will be adopted by IGT in the fourth quarter of fiscal 2005. We continue to evaluate our compensation practices, as well as other available valuation models for valuing our stock options. See Note 2.

SFAS 151

In November 2004, the FASB issued SFAS 151, Inventory Costs, amending ARB 43 Chapter 4, Inventory Pricing. SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight and handling costs, and wasted material (spoilage). SFAS 151 introduces the concept of “normal capacity” requiring allocation of fixed production overheads to inventory based upon normal capacity of production facilities. Unallocated overhead costs must be expensed in the period in which they are incurred. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, IGT’s fiscal 2006. We anticipate no material impact on our results of operations or financial position as a result of adopting this statement.

SFAS 153

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, amending APB 29, which treated nonmonetary exchanges of similar productive assets as an exception from fair value measurement. SFAS 153 replaces this exception with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. Nonmonetary exchanges have commercial substance if the future cash flows of an entity are expected to change significantly as a result of the exchange. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, and will be adopted by IGT in the fourth quarter of fiscal 2005. We anticipate no material impact on our results of operations or financial position as a result of adopting this statement.

5

2. Stock Based Compensation

As permitted by SFAS 123, we continue to account for stock based compensation plans in accordance with APB 25 which determines the compensation cost of stock options issued for non-variable plans like ours as the difference between the quoted market value at the measurement date and the amount, if any, required to be paid by employees. Our stock-based compensation plans are predominantly plans where the option price is equal to or greater than the price the stock would be in an offer to all shareholders and therefore, no compensation cost is recorded. We do record stock-based compensation for the intrinsic value of restricted shares issued and when terms of an outstanding option are modified or converted in an acquisition.

The following pro forma financial information reflects the difference between stock compensation costs charged to operations under the APB 25 intrinsic value method and pro forma stock compensation costs that would have been recorded if the SFAS 123 fair value method had been applied to all awards granted, modified, or settled since the beginning of fiscal 1996.

3. Inventories

Inventories consisted of the following:

6

4. Property, Plant and Equipment

Property, plant and equipment consisted of the following:

Construction in process includes $30.5 million at December 31, 2004 and $22.1 million at September 30, 2004 related to new facilities under construction in Las Vegas and Reno.

5. Acquisitions, Divestitures and Discontinued Operations

We have not provided pro forma financial information for the following acquisitions, as they were not material to our consolidated results.

Friendly Matrix

On December 16, 2004, IGT acquired substantially all assets of Friendly Matrix, with several products that will enhance our IGT Advantage™ systems functionality and extend our reach into key markets. Total purchase consideration of $1.5 million was preliminarily allocated mostly to developed technology.

Hi-Tech

On December 31, 2004, IGT agreed to acquire substantially all of the assets of Hi-Tech, our former distributor of gaming equipment and services in Canada. This asset acquisition will allow us to further develop our Canadian customer relationships, integrating Hi-Tech’s employees with IGT’s resources. Total preliminary purchase consideration of $11.2 million has been allocated to accounts receivable, inventories, and intangibles. The final purchase consideration is subject to adjustment based on the net book value of assets acquired.

Acres

On October 27, 2003, we completed the acquisition of Acres, specializing in the development of gaming systems technology designed to assist casino operators in increasing patron loyalty. This business combination provided IGT the ability to work more closely with the Acres gaming systems technology to develop more integrated gaming systems products, as well as increasing our competitive marketing capacity. The aggregate purchase price of $134.0 million was allocated to net tangible assets of $9.7 million, identifiable intangibles and goodwill of $122.5 million, and in-process R&D of $1.8 million charged immediately to expense.

7

Divestitures and Discontinued Operations

Subsequent to the completion of the Anchor acquisition on December 30, 2001, we divested certain acquired operations inconsistent with IGT’s core business strategy. In fiscal 2004, we completed the sale of IGT OnLine Entertainment Systems, Inc. and the lottery systems business of VLC, Inc., collectively referred to as OES, for total cash proceeds of $151.5 million resulting in a gain of $56.8 million, net of tax. The gain in discontinued operations for the first quarter of fiscal 2004, summarized below, reflected a preliminary estimated receivable for the working capital settlement finalized in the third quarter of fiscal 2004.

6. Notes and Contracts Receivable

Allowances for doubtful notes and contracts:

7. Concentrations of Credit Risk

The financial instruments that potentially subject us to concentrations of credit risk consist principally of cash or equivalents and receivables. We maintain cash balances at several financial institutions in amounts, which may at times be in excess of the Federal Deposit Insurance Corporation insurance limits.

Our revenues and resulting receivables are concentrated in specific legalized gaming regions. The table below shows the composition of our accounts, contracts, and notes receivable at December 31, 2004.

8

8. Intangibles and Goodwill

The additions below include $4.1 million of contracts and customer relationships acquired from Hi-Tech and $1.4 million of developed technology acquired from Friendly Matrix. Patent additions include purchased patents and capitalized legal costs for patent applications.

Intangible Balances

Amortization of Intangibles

Our aggregate amortization expense totaled $9.2 million in the current quarter and $7.8 million in the comparable prior year quarter.

Goodwill Changes and Balances by Segment

9

9. Debt

We continue to be in full compliance with all covenants contained in all debt agreements at December 31, 2004.

Senior Credit Facility

The interest rate on the $200.0 million term loan was 2.2% at September 30, 2004, reset to 2.67% on October 15, 2004, and reset to 3.26% on January 18, 2005. Of the $1.3 billion revolver portion of the credit facility, $4.0 million was reserved for letters of credit at December 31, 2004.

Foreign Credit Facilities

Our foreign credit facilities totaled $56.8 million, with $32.6 million borrowed at interest rates ranging from 1.82% to 1.83% and $24.2 million available at December 31, 2004. Renewals occur annually in January and July.

Senior Convertible Debentures

The market price condition for convertibility of our debentures was not met during the measurement periods ended October 18, 2004 and January 18, 2005. With the adoption of EITF 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share in the first quarter of 2005, we included all outstanding debenture shares in diluted EPS. See Note 10.

10. Earnings Per Share

The reconciliation of basic to diluted EPS from continuing operations below reflects the adoption of EITF 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, in our first quarter of 2005. Accordingly, as of December 31, 2004, our outstanding debenture shares have been included in diluted EPS for all periods presented. Since the end of the current period through February 8, 2005, we repurchased 2.0 million additional common shares or approximately 1% of outstanding shares. There were no other transactions in the same period that would have materially changed the number of basic or diluted shares outstanding.

10

11. 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.

12. Comprehensive Income

13. Commitments and 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.

Alliance

On December 7, 2004, IGT filed a complaint in US District Court for the District of Nevada (Case No. CV-S-04-1676-RCJ-RJJ), alleging that defendants Alliance Gaming Corp., Bally Gaming Int’l, Inc., and Bally Gaming, Inc. infringed six US patents held by IGT including 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 to IGT’s complaint that raised 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, unenforceability of the asserted patents and for intentional interference with prospective business advantage.

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 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. We have applied the guidance in Statement of Position 96-1 “Environmental Remediation Liabilities” and determined that a liability has not 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., (Case No. 470016). 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. The plaintiff’s action also seeks 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 April 29, 2004, the Court issued a ruling denying defendant’s motion to dismiss the second amended complaint. On May 12, 2004 the Court issued an order denying defendants motion to dismiss. Pursuant to stipulation of the parties on August 13, 2004, plaintiff filed a third amended complaint. Defendants have filed a motion to dismiss the third amended complaint. The Court has not yet ruled on this motion.

11

Nevada Sales/Use Tax Matter

In February 2003, an IGT employee, presently on administrative leave, filed a sealed complaint under Nevada’s False Claims Act (State of Nevada ex rel. James McAndrews v. International Game Technology, Anchor Coin and Spin for Cash Wide Area Progressive, CV03 — 01329, 2d Jud. Dist. Court of Nevada) alleging that IGT failed to pay requisite Nevada sales/use taxes on certain Wheel of Fortune^® games placed in Nevada since 1997 and in connection with royalties received under intellectual property licensing agreements related to the placement of Action Gaming games in Nevada since 1997.

The Attorney General and IGT both filed motions to dismiss the complaint in January 2004, and the Court unsealed the action in February 2004. The Court denied both motions to dismiss the complaint on July 1, 2004. A Petition for Writ of Mandamus was filed with the Nevada Supreme Court in September 2004. The Court granted the petition. A stay of the lower court proceedings was granted by the trial court in September 2004.

In October 2004, NDT advised IGT that it had a good-faith legal basis for its position that no sales tax was payable on royalties received, but also advised IGT that NDT believed that sales tax may be payable on some amount of the royalties. IGT disagrees with NDT’s position that sales tax may be payable on any part of the royalties and continues to correspond with NDT on this issue.

OSHA 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 the Board of Directors, reviewed the allegations and found them to be entirely without merit.

In the purchase price allocation, IGT used the relief of royalty valuation methodology to estimate the fair value of the patents at $164.4 million, which is being amortized over the useful economic life. The carrying value of the patents at December 31, 2004 totaled $120.8 million, with a remaining life of approximately 11 years. 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. IGT believes that the allegations are without merit and intends to vigorously defend this matter.

Poulos

Along with a number of other public gaming corporations, IGT is a defendant in three class action lawsuits: one filed in the US District Court of Nevada, entitled Larry Schreier v. Caesars World, Inc., et al, and two filed in the US District Court of Florida, entitled Poulos v. Caesars World, Inc., et al. and Ahern v. Caesars World, Inc., et al., which have been consolidated into a single action. The Court granted the defendants’ motion to transfer venue of the consolidated action to Las Vegas. The actions allege that the defendants have engaged in fraudulent and misleading conduct by inducing people to play video poker machines and electronic slot machines, based on false beliefs concerning how the machines operate and the extent to which there is an opportunity to win on a given play. The amended complaint alleges that the defendants’ acts constitute violations of the Racketeer Influenced and Corrupt Organizations Act, and also give rise to claims for common law fraud and unjust enrichment, and seeks compensatory, special, incidental and punitive damages of several billion dollars. In December 1997, the Court denied the motions that would have dismissed the Consolidated Amended Complaint or that would have stayed the action pending Nevada gaming regulatory action. The defendants filed their consolidated answer to the Consolidated Amended Complaint in February 1998. In March 2002, the Court directed that certain merits discovery could proceed. In June 2002, the Court denied the plaintiffs’ motion for class certification. An appeal of that denial was filed timely with the US Court of Appeals for the Ninth Circuit. All briefings were completed and oral arguments were heard in January 2004. On August 10, 2004, a three-judge panel of the Ninth Circuit Court of Appeals upheld US District Court Judge Roger Hunt in his denial of class certification. The class plaintiffs did not appeal the decision and are proceeding with only their individual claims. A jury trial has been set for September 12, 2005.

Siena

In November 2001, Wild Games NG, LLC, owner and operator of the Siena Hotel Spa Casino, filed suit against Acres in Washoe County Nevada District Court. Siena alleges Acres failed to perform obligations under an Equipment Sale Agreement and seeks consequential damages largely comprised of lost profits. Acres believes that Siena’s claims are unfounded and not permitted by the Equipment Sales Agreement. Acres has filed a counterclaim seeking payments due from Siena. All discovery has been completed. A jury trial has been set for March 14, 2005.

12

Off-Balance Sheet Arrangements

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 off-balance sheet arrangements, and we are not dependent on off-balance sheet financing arrangements to fund our operations.

Performance Bonds

Performance bonds outstanding related to our gaming operations totaled $6.8 million at December 31, 2004. We are liable to reimburse the bond issuer in the event the bonds are exercised as a result of our nonperformance.

Letters of Credit

Outstanding letters of credit issued under our line of credit to ensure payment to certain vendors and governmental agencies totaled $4.0 million at December 31, 2004.

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. We are not able to estimate the maximum potential amount of future payments under this guarantee because it depends on the occurrence of future events.

Product Warranties

We accrue for warranty costs based on historical trends in product failure rates and the expected material and labor 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. The following table summarizes the activities related to our product warranty liability.

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

14. Derivatives

We recognize all derivatives as either assets or liabilities at the fair value of the instruments. Accounting for changes in the fair value of derivatives depends on the intended use and resulting designation. We use derivative financial instruments to minimize our market risk exposure resulting from fluctuations in foreign exchange rates and interest rates. The primary business objective of our hedging program, as defined in our corporate risk management policy, is to minimize the impact of transaction, remeasurement, and specified economic exposures to our net income and earnings per share. The counterparties to these instruments are major commercial banks and we believe that losses related to credit risk are remote. We are not party to leveraged derivatives and do not hold or issue financial instruments for speculative purposes.

Foreign Currency Hedging

We routinely use derivative financial instruments to hedge our net exposure, by currency, related to our monetary assets and liabilities denominated in nonfunctional foreign currency. Fluctuations in the value of these derivative instruments are generally offset by the value of underlying exposures. Our forward currency contracts are not designated FAS 133 hedging instruments and resulting gains or losses are recognized in current earnings. At December 31, 2004, we hedged $36.6 million of net foreign currency exposure with $32.6 million in forward currency contracts compared to $53.1 million of exposure hedged with $43.8 million in forward contracts at September 30, 2004.

Interest Rate Management

In the fourth quarter of fiscal 2003, we entered into four interest rate swap agreements with a combined notional amount of $350.0 million, primarily to diversify a portion of our debt portfolio between fixed and variable rate instruments. These swaps were cancelled on July 9, 2004 in conjunction with the early redemption of our 2009 senior notes on July 16, 2004.

Under the terms of the interest rate swaps, we made payments based on a specific spread over six-month LIBOR and received payments equal to the interest rate on our fixed rate senior notes. These interest rate swaps were fair value hedges, which qualified for the shortcut method of accounting under SFAS 133, allowing for an assumption of no ineffectiveness in the hedging relationship. Accordingly, we recorded the change in the fair value of the swap instruments as non-current assets or liabilities with an offsetting adjustment to the carrying value of the related debt.

Debentures Yield Adjustment

The yield adjustment feature of our debentures requires contingent cash interest payments that are triggered by our stock price and is considered a FAS 133 embedded derivative requiring bifurcation. However, since IGT could exercise its redemption right in anticipation of an upward adjustment, we expect that an investor would attribute no economic value to this feature. Accordingly, we have ascribed no value and recorded no derivative asset or liability for this embedded derivative.

14

15. Business Segments

We currently view our business in two regional operating segments, each incorporating all relevant revenues from product sales and gaming operations:

Our business segments are designed to allocate resources within a framework of management responsibility. Operating costs from one segment may benefit the other segments. We continually evaluate the alignment of our business development and sales organizations for reporting purposes, which may result in changes to segment allocations. Prior year amounts have been reclassified to conform to the current management view and presentation.

The Corporate Division manages certain unallocated income and expenses related to company-wide initiatives, including capital deployment, treasury and cash management, as well as administrative and oversight functions such as human resources, information systems, and legal. The Corporate Division includes all income and expenses related to debt, investment securities, hedging and other corporate assets.

On a consolidated basis we do not recognize inter-company revenues or expenses upon the transfer of gaming products between divisions. IGT’s segment profit reflects income from continuing operations before tax.

15

The following MDA is intended to enhance the reader’s understanding of changes in the financial condition and results of operations of International Game Technology. It should be read in conjunction with our Annual Report on Form 10-K for the year ended September 30, 2004. Throughout this section, the tables are presented with dollars in millions, except ARPU and EPS and variance amounts may not cross foot due to rounding.

Unless the context indicates otherwise, reference throughout this report to “International Game Technology,” “IGT,” “we,” “our,” “management” or “the Company” includes International Game Technology and its consolidated subsidiaries and VIEs. 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:

OUR BUSINESS

International Game Technology is a global company specializing in the design, development, manufacturing, distribution and sales of computerized gaming machines and systems products. We strive to maintain a diverse portfolio of gaming products that span a wide range of categories and target customer markets with a variety of games, platforms and systems offered across a continuously expanding network of gaming jurisdictions worldwide.

We are a Standard and Poor’s 500 company with annual revenues of $2.5 billion in fiscal 2004. We derive our revenues in two ways, either from sales of our products (product sales) or from recurring revenues based on customer usage of our products (gaming operations). We currently view our business in two regional operating segments:

Additionally, our Corporate Division administers certain unallocated income and expenses related to company-wide initiatives. See the BUSINESS SEGMENT RESULTS below and Note 15 of our Unaudited Condensed Consolidated Financial Statements for additional information and financial results.

16

OUR FOCUS

Product Demand

Demand for our products is driven principally by:

Following several consecutive years of record growth, largely related to the TITO accelerated replacement cycle, we expect fiscal 2005 will be a transitional year. However, we estimate that 200,000 machines remain unconverted in the market and are potential TITO replacement candidates. Offsetting the decline in machine demand from the maturing of the TITO replacement market in North America, we anticipate:

However, we still remain dependent upon gaming market expansion for growth, and opportunities have been slower to materialize than previously expected.

Product Development

Our business can be explained as the creation of game content and the delivery of these games to the consumer via platforms and systems. We are a prominent designer of games, platforms and systems in the gaming industry. We accomplish this by anticipating client needs, responding to feedback and marketing trends, and pioneering innovative gaming machines and reliable systems solutions. Our product development efforts are supported by a considerable emphasis and investment in research and development, which has enabled us to maintain a leadership position in the industry.

We continue to move forward in developing gaming products of the future, including system-centric SBG. To date, we have introduced a number of casino-wide integrated products that enhance the players’ gaming experience and provide operational efficiencies for our customers. We are now leveraging on this experience and our CDS technology in developing SBG products. SBG developments under way for the rest of 2005 will bring new applications for more active casino floor management, “games-on-demand”, player-shared interactive games, as well as provide us with tools to better manage customer pricing. As the market shifts toward a more system-centric gaming environment, we expect a growing portion of our business will come from non-box revenues.

We anticipate additional fiscal 2005 growth in our casino market gaming operations installed base through new video game introductions, including Fort Knox©, a multi-level progressive game, along with Star Wars©, and Video Megabucks©. Additionally, we expect to realize the benefit of expansion into non-traditional gaming markets, given the current outstanding orders for over 1,500 CDS gaming operations units. We also continue our strategy to improve gaming operations revenues by managing the types of games and jurisdictions where games are placed.

Market Opportunities

We market our gaming products to legalized gaming jurisdictions around the world. While our most significant markets are in North America, we continue to pursue additional opportunities in international areas. The opportunities, challenges and our successes, vary across these jurisdictions.

We continue to monitor expanding and emerging markets in North America, including California, Oklahoma and New York. We also track gaming legislation in potential new markets, such as Ohio, Maryland, and Massachusetts, all facing fiscal budget needs with previous legislative activity surrounding the legalization of machine gaming. Gaming expansion is ongoing in Pennsylvania and numerous CDS markets nationwide, including our new direct sales initiatives in Florida and the state of Washington.

Over the next few years, we anticipate growing international market expansion opportunities in Russia, numerous jurisdictions in Asia and the UK. We are concentrating an increasing level of management and development resources toward product localization, so that we export a US manufactured product that has been customized for local cultures into foreign countries.

17

Competition

We maintain a global competitive advantage with our abilities to:

We also have the added benefit of our:

Our market share in spinning reel and video poker machines remains stable, but we expect increased competitive pressures in the video spinning reel gaming machine markets, especially in North America.

Sales of our IGT Advantage^TM systems is successfully capturing additional market share with its value added technology offerings. With a number of significant new IGT Advantage^TM systems contracts, including Pinnacle Entertainment, six Isle of Capri properties, Hard Rock in Biloxi and three southern Nevada Harrah’s properties, we now have systems contracts with most major gaming operators.

Capital Deployment

We continued to generate substantial operating cash flows in the current quarter, affording us the flexibility to reinvest in our business through capital expenditures and business acquisitions, as well as generate returns to our shareholders through dividends and share repurchases. We use cash available from operations after capital expenditures for our share repurchase plan, dividends to our shareholders, and strategic business acquisitions. See the LIQUIDITY section that follows for current share repurchase and dividend activity.

Strategic Business Acquisitions and Alliances are part of our ongoing efforts to create shareholder value designed to complement our internal resources. In keeping with efforts to diversify and expand, we entered into agreements for the following strategic business acquisitions during the first quarter of 2005:

We expect these business acquisitions will facilitate incremental future growth and eventual economies of scale, although they were not material and are not expected to produce near-term earnings accretion. See Note 5 of our Unaudited Condensed Consolidated Financial Statements for additional financial details of these acquisitions.

Additionally, on January 14, 2005, IGT agreed to formalize terms with Scientific Games Corporation for a worldwide, long-term strategic alliance to jointly develop gaming systems products. In the near term, we will cooperate in a Louisiana procurement submission for a central monitoring system featuring a comprehensive combined solution to fit the needs of the Louisiana market.

18

CONSOLIDATED OPERATING RESULTS

Quarter Ended December 31, 2004 vs Quarter Ended December 31, 2003

IGT improved financial results in the first quarter of 2005, attributable to record international revenues and shipments. International improvements were driven by the success of our latest pachisuro game in Japan, The Terminator™. This accomplishment demonstrates the strength of our geographic diversity compensating for the slowing replacement demand in North America.

Consolidated gaming operations revenues grew in the first quarter of fiscal 2005 primarily due to the increase in our installed base of machines and improvements in the game placement mix leading to higher yields per game placed. The consolidation of the VIE operations beginning in the third quarter of fiscal 2004 also increased revenues and expenses in the current quarter by $10.7 million over the prior year quarter. The VIE consolidations had no material impact to gross profit dollars or net income.

As a result of our 52/53-week accounting year, the current quarter contained 13 weeks versus 14 weeks in the comparable prior year quarter. The additional week in the prior year quarter primarily benefited gaming operations and increased our operating expenses. Excluding the extra week in the prior year quarter and the effect of the VIE consolidations in the current quarter, gaming operations revenues would have grown by 7% and gross profit by 4%.

Income and EPS from continuing operations grew in the current year quarter in spite of the additional week in the prior year quarter. Consolidated ARPUs decreased in the current quarter compared to the prior year quarter due to the increased volume of lower priced pachisuro machines.

In the current quarter, we declared cash dividends of $0.12 per share to be paid in January 2005 and paid out $41.5 million for dividends declared in September 2004.

Discontinued operations in the prior year quarter related to certain Anchor operations divested subsequent to acquisition. See Note 5 of our Unaudited Condensed Consolidated Financial Statements.

In the current quarter, we adopted EITF 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings Per Share, requiring that convertible shares be included in diluted earnings per share regardless of whether the market price trigger has occurred. Accordingly, we restated the prior year quarter EPS to include the impact of an additional 20.5 million shares related to our outstanding convertible debentures, previously excluded because the conversion event had not occurred.

19

Operating Expenses

Quarter Ended December 31, 2004 vs Quarter Ended December 31, 2003

Current quarter operating expenses increased over the prior year quarter as a result of the following:

These increases were partially offset by decreased provisions for bad debt required to maintain our bad debt allowance and a higher mix of international receivables. Increased receivables in Japan carry lower collections risk as they are secured by promissory notes.

Additionally, the prior year quarter included approximately $8.0 million in additional operating expense as a result of an extra week related to the timing of our 52/53-week accounting year.

Other Income (Expense) and Taxes

Quarter Ended December 31, 2004 vs Quarter Ended December 31, 2003

Total other income (expense), net, improved in the current quarter as a result of reduced interest expense relating to the early redemption in fiscal 2004 of our 2004 and 2009 senior notes that were outstanding in the prior year quarter.

Interest income and expense related to the operation of our WAP systems are similar and increase at approximately the same rate based on the growth in total jackpot winners electing installment payments. Our WAP operations also hold a significant amount of cash investments on which we earn interest income. Interest income related to our WAP systems operations totaled $9.1 million in the current quarter and $6.3 million in the prior year quarter. Interest expense related to our WAP systems operations totaled $7.8 million in the current quarter and $5.8 million in the prior year quarter. The increases in WAP interest were related primarily to the consolidation of the progressive system trust VIEs.

Our effective tax rate decreased to 36.0% in the current quarter compared to 37.5% in the prior year quarter based on changes to the geographic mix of estimated annual taxable income and higher R&D tax credits.

20

BUSINESS SEGMENT RESULTS

IGT’s operating segments’ profit reflects income from continuing operations before tax, including applicable operating expenses, and other income and expense. Prior year amounts have been reclassified to conform to the current management view and presentation. See Note 15 of our Unaudited Condensed Consolidated Financial Statements for additional information about our business segments.

North America Division