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Edited Transcript of IGT earnings conference call or presentation 7-Mar-19 1:00pm GMT

Q4 2018 International Game Technology PLC Earnings Call

London Mar 11, 2019 (Thomson StreetEvents) -- Edited Transcript of International Game Technology PLC earnings conference call or presentation Thursday, March 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alberto Fornaro

International Game Technology PLC - Executive VP & CFO

* James Hurley

International Game Technology PLC - SVP of IR

* Marco Sala

International Game Technology PLC - CEO & Executive Director

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Conference Call Participants

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* Barry Jonathan Jonas

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Cameron Philip Sean McKnight

Crédit Suisse AG, Research Division - Research Analyst

* Carlo Santarelli

Deutsche Bank AG, Research Division - Research Analyst

* Chad C. Beynon

Macquarie Research - Head of US Consumer, SVP and Senior Analyst

* David Brian Katz

Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure

* Domenico Ghilotti

Equita SIM S.p.A., Research Division - Analyst

* Joseph Robert Stauff

Susquehanna Financial Group, LLLP, Research Division - Credit Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the IGT 2018 Fourth Quarter and Full Year Results Conference Call. (Operator Instructions)

As a reminder, today's conference is being recorded.

I would now like to turn the call over to Jim Hurley, Senior Vice President of Investor Relations. Sir, you may begin.

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James Hurley, International Game Technology PLC - SVP of IR [2]

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Thank you. Thank you for joining us on IGT's Fourth Quarter and Full Year 2018 Conference Call, which is hosted by Marco Sala, our Chief Executive Officer; and Alberto Fornaro, our Chief Financial Officer.

After we make some introductory remarks, we'll open the call for your comments.

During today's call, we'll be making some forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are not guarantees, and our actual results may differ materially from those expressed or implied in the forward-looking statements. The principal risks and uncertainties that could cause our results to differ materially from our current expectations are detailed in our SEC filings.

And now I'll turn the call over to Marco Sala.

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Marco Sala, International Game Technology PLC - CEO & Executive Director [3]

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Thank you, Jim, and good day, everyone. We are pleased to be reporting full quarter and full year results that are in line with the improved outlook we provided last October.

On a currency-adjusted basis, we reached the top end of our initial full year EBITDA guidance. We delivered mid-single-digit EBITDA growth on stable revenue in 2018 at constant currency and scope. Our profits also benefited from overall operating expenses discipline, particularly the optimization of R&D.

Global Lottery performance was strong, and Italy was resilient despite increased pressure on the sector. In addition, we achieved a nice recovery in our North American Gaming segment.

The International segment did not meet our expectation for the year based on its fourth quarter results.

Thanks to the recurring nature of most of our revenue base and the diversity of products and geographies, we met our financial objectives despite some incremental headwinds during the year. These included foreign exchange, higher taxes on Italy gaming machines and shifts in timing of certain product sales. Of course, we also had some unexpected benefits from elevated North American jackpot activity.

As I mentioned, our global Lottery results were impressive in 2018. Total Lottery same-store revenues outside of Italy rose nearly 8%, reflecting 5% growth in instant and draw-based games and a nearly 30% increase in multistate jackpot (sic) [Multistate Jackpots] games.

North America Lottery performance was especially robust with the same-store revenues up 9% in the year, supported by October's $1.5 billion Mega Million jackpot. Draw-based and instant ticket games also performed well with the same-store revenues up 5%. Many of the jurisdictions with the highest annual per capita lottery spending, including Florida, Michigan and New Jersey, generated strong increases, confirming the long-term vitality of the business. With the current revenue-weighted average contract duration of 8 years, including extension in North America, we have significant visibility and a stable base to grow from.

International lottery same-store revenues rose 3% in 2018, led by the EMEA region. A recovery in U.K. Lottery wagers was an important contributor to growth, thanks to the new scratch cards and instant win games. We also had good results in the Czech Republic and benefited from the continued success of the EuroMillions game.

Italy lottery results were very good in 2018, a true testament to innovation driving growth. Lotto wagers were up 7%, led by 11% growth for 10eLotto and the incremental contribution from the new MillionDAY game. We also achieved a 2% increase in Scratch & Win wagers, the second consecutive year of growth on the successful relaunch of the Miliardario and the Multiplier games.

Innovation is the most important driver of Lottery growth. We are constantly developing ways to drive industry expansion and reach a new generation of players. These efforts have earned IGT the International Gaming Awards' Lottery Product of the Year for 2 years in a row.

In Gaming, full year results were mixed. Total Gaming revenues were stable with the prior year on an underlining basis. Encouraging progress in North America and stability in Italy were offset by lower International revenue. Global shipments of gaming machines rose slightly in 2018.

In North America, total replacement units were up more than 6% as we are completing a full refresh of our hardware and bringing these cabinets to market with better-performing games. Scarab, Solar Disc, Mistress of Egypt and Ocean Magic Grand were among the most popular titles we sold and are currently recognized as some of the best-performing games in the market. As a result, we have successfully upgraded our standing in the core video market. This is evident in the record number of replacement unit shipments in North America in the fourth quarter, including a more than 20% increase to casino customers. Demand for our Crystal Series cabinets and the new gaming content also drove higher ASPs for the fourth quarter and the full year period.

By contrast, International Gaming machine shipments were down for the fourth quarter and full year. This is largely due to market dynamics in Argentina and Peru and to lower replacement demand in certain European markets against robust unit sales in 2017.

This being said, it is worth mentioning that we are making headway in some important strategic markets like Australia and Eastern Europe. In Australia, for example, our Gaming machine unit sales were up more than by 25% in the year. The CrystalCurve and Crystal 27 cabinets are driving this growth, particularly with successful new games Star Stax and Fortune Gong. We will build on Star Stax' success in Australia by introducing it to additional international markets.

The recovery in the North American installed base during 2018 was achieved by executing on our main strategies. We reinforced the Wheel of Fortune franchise with new hardware and games. We increased our commitment to multilevel progressive games. Going forward, we intend to leverage more of our achievements in core video reel games by integrating the most impactful test banking sites and game mechanics into the premium portfolio.

The International installed base declined in 2018 due a large -- due to a large South Africa conversion sales in the first quarter, partially offset by higher Greece VLTs. We have seen good improvement in productivity in Greece related to the successful introduction of new fruit games in the second half of 2018. We expect to add more than 1,000 Greece VLTs in 2019.

In Italy, the installed base of gaming machines was significantly lower on the government-mandated reduction in AWPs that was largely completed in the first half of 2018. Despite the unit reduction and the impact of higher taxes, total gaming machines wagers were modestly above the prior year. We managed this by improving productivity of the remaining AWP fleet and VLTs.

For many of you, new government restrictions imposed on the Italian gaming sector have been frustrating. I think it is important to stay grounded in the fact that player demand across all gaming verticals remains quite solid, confirming the resilience of the market. The Italy team has done a great job managing through these challenges over the past few years and delivered higher profit in 2018.

We won several high-profile central casino management system contracts in 2018 around the world. While the industry pipeline of new casino openings is not as strong as in 2019, we do have important new Advantage installations planned for the year. There is also considerable opportunity for us to leverage innovative add-on system products such as Cardless Connect, Resort Wallet and Intelligent Offer (sic) [Mobile Intelligent Offer] with our existing customers.

It was a year of important progress for the North American Sports Betting business. To date, IGT's Sports Betting platform is operational in all jurisdictions that are live: 24 land-based locations across 5 states and mobile in 3 states. We also established important strategic partnership with FanDuel and William Hill. The QuickBet kiosks and CrystalBetting terminals we launched at G2E are in the regulatory certification process. We recently received approval for the QuickBet kiosk in New Jersey and have just begun rolling them out.

IGT is well positioned to continue to provide technology and services for commercial casinos, tribal casino or lottery sports betting operators across retail, digital and mobile channels.

As we look to 2019, we expect to see continued underlining growth in our core Lottery and Gaming business. There are some specific items to consider when comparing the P&L to 2018, but the underlining business is expected to grow.

Over the last 4 years, we have established a solid foundation to build from, securing large, long-term lottery contracts, stabilizing the North American Gaming business and investing in new growth opportunities like Sports Betting. All of that should result in a meaningful improvement in free cash flow starting in 2019.

Now I'll turn the call over to Alberto.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [4]

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Thank you, Marco, and hello to all of you on the call today.

On Slide 8, we summarize the full year results.

Revenue was stable with the prior year at constant currency and scope, which reflects the sale of DoubleDown. This was achieved despite the reclassification of $73 million of jackpot expense as a contra-revenue item under ASC 606. Underlying core business improvement in North America for both Gaming and Lottery and strength in Italy offset lower International revenues.

Adjusted EBITDA was $1.74 billion and 4% higher than the prior year and within the updated October outlook after normalizing for foreign exchange.

Adjusted operating income was below the prior year due to the higher depreciation associated with long-term Lottery contract wins and extension as well as increased investment in the Gaming installed base.

Our fourth quarter financial results are summarized on Slide 9.

Consolidated revenue increased (sic) [decreased] 4% at constant currency. Gaming and Lottery revenue were stable with the decline coming from certain Sports Betting dynamics in the prior year, including an exceptional low payout in Italy and large International product sales.

Adjusted EBITDA was down 6% at constant currency, primarily due to lower revenues. Additionally, higher SG&A in the fourth quarter was partly a result of some timing difference in various expense accruals between the 2 years and partly higher bad debt, legal and other personnel costs for 2018. The higher SG&A is not reflective of a structural increase in operating costs and partly reflects a higher seasonal increase.

Once again, adjusted operating income includes higher depreciation from recent lottery wins as well as the upgrading of our global gaming machine installed base.

Let's turn now to our operating segments.

North America Gaming & Interactive is shown on Slide 10. Adjusted for jackpot expense reclass, revenue rose 3%. Product sales were up double digits, thanks to a 27% increase in gaming machine unit shipments, coupled with higher ASPs. In fact, ASPs in the fourth quarter were the highest since 2015. Customer demand for our field-tested products, such as Scarab, Temple of Fire, Ocean Magic, Solar Disc and Mistress of Egypt, is driving these results. Net of the jackpot expense reclass, service revenue was relatively stable. The year-over-year increase in the installed base was offset by lower yields due to a shift in the overall mix of jurisdictions and machines.

The decline in operating income is entirely due to depreciation. This includes depreciation of new cabinets we are installing as well as accelerated depreciation on older units. Additionally, in the prior year, we had a significant contribution from high-margin IP revenues.

Slide 11 shows the results on North American Lottery segment. The fundamental of this business are very sound. Same-store revenue was up over 20% in the quarter, driven by October $1.5 billion Mega Million jackpot, the second-largest multistate jackpot ever. Same-store revenues from instant ticket and draw games was also good, up 5% in the quarter primarily on the success of high price point, instant ticket and large customers like Texas and Michigan.

The decline in product sales is related to higher Lottery terminal sales and the large Canadian VLT Central System in the prior year. Product sales in the North America Lottery business are highly variable and represent a small percentage of annual revenues for this segment.

The 21% increase in operating income reflects the stronger profit flow-through, a robust same-store revenues that was partially offset by higher depreciation associated with recent contract wins and extensions.

Now let's turn to the International segment on Slide 12.

While the results of this segment were below our expectation, it is worth noting that the quarterly cadence of revenue and profit differed greatly in '18 versus 2017. We delivered much stronger International results in the first 9 months of 2018, assisted by the shift in timing of the Finland contract for -- from Q4 to Q3. As previously said, we also saw a timing shift from Q4 to 2019 of a very large VLT project in Sweden.

2017 was very back-end loaded with a concentration of both product sales and contract milestone-driven service revenue as well as operating expense benefit in the fourth quarter. Altogether, these dynamics contributed to a very significant change in the year-to-year comparison for the fourth quarter.

In Lottery, same-store revenue grew by over 4%, driven by contribution from instant ticket, draw-based games and jackpot games. This underlying core growth in the business was overshadowed by the prior year benefits associated with the contract milestone-driven service revenue I just mentioned.

Gaming service revenue was down for the same reason. The decline in the installed base reflects a nearly 1,500-unit conversion sale in South Africa, partially offset by growth in Greece VLT units.

Turning to product sales, we shipped fewer units to Europe and Latin America, where challenging foreign exchange rates as well as gaming taxes in Argentina and Peru impacted customer spending. This was partly mitigated by the South Africa conversion sales where the units reached the end of their -- almost the end of their contract. Excluding this sale, ASP were up sharply in the period.

Operating income reflects decreased revenue and the high-margin mix of items in the prior year as well as the differential timing of certain operating expenses across periods.

The $119 million impairment charges we recorded in the quarter was primarily a reduction of the carrying amount of goodwill in our International segment. Our underlying outlook for International has not changed, and our expectation for growth remain about the same as before. But we are starting from a lower base with the 2018 results, and this, coupled with other factor, including a higher weighted average cost of capital, impacted the goodwill calculation.

Italy is here on Slide 13. Results continue to be strong in Italy with fundamentals continuing to improve across all core businesses. In Lottery, we continue to see strength in 10eLotto wagers, which rose by 8%. Scratch & Win wagers were up 2%, primarily driven by a relaunch of the Multiplier family.

In machine gaming, overall wager increased once again due to strong productivity gains from both AWP and VLT machines. These helped to mitigate the impact of mandatory reduction in the number of AWP, higher gaming machine taxes and certain regional restrictions.

The decline in Sports Betting revenue is exclusively due to the comparison with the unusually low payout in 2017. Wager for their part were stable, and the payout realized in the fourth quarter of 2018 is indicative of a more normalized level.

Operating income reflects broad-based wager growth with high-profile flow-through, partially offset by the differential Sports Betting payout and increased taxes on gaming machines.

Our debt-to-leverage profile is included on Slide 14.

Leverage increased to 4.47x. This was primarily due to the net $559 million in upfront payments for the Italy Scratch & Win license that were paid during the year.

Cash flow for the full year is shown here on Slide 15.

Cash from operation totaled $30 million, including $878 million in gross upfront payments related to the Italian Scratch & Win license. The final installment of the upfront payments related to this license was made in October 2018. As a reminder, we have secured Scratch & Win through September 2028, and there are no significant capital demands for this license until the next tender.

CapEx was $533 million, coming in lower than the expected range, $575 million to $625 million.

Gross dividend and return of capital payments to minority partners totaling $212 million were offset by $322 million in partner contribution to fund the Scratch & Win upfront payments.

Our initial outlook for 2019 is included here on Slide 16.

We currently expect adjusted EBITDA of $1.7 billion to $1.76 billion for the full year period at a euro-dollar rate of $1.15. Our outlook assumes underlying growth for the core Lottery and Gaming business. As you are aware, there are several dynamics that impact comparison with our 2018 results. This represents over $100 million in headwinds that are included in our 2019 outlook. FX is worth about $25 million. The impact of the new Italy gaming taxes is approximately $40 million. The large Mega Million jackpot in the fourth quarter of 2018 provided $20 million in incremental EBITDA that we do not plan to recur. The balance is the loss of the Illinois supply contract.

At constant currency, EBITDA will likely be slightly below the prior year in the first half and up in the second half. Along those lines, EBITDA should be a little bit more concentrated in the second half of the year. This reflects the timing of certain product sales, including the 4,000 Sweden VLT, which are now planned for the second half. We will work to change this profile, as we did in 2018, but this is our best estimate at this time.

Capital expenditure is expected to be $450 million -- between $450 million and $550 million, with maintenance CapEx of $400 million to $500 million and growth CapEx of approximately $50 million. In terms of timing, we expect approximately 60% of the CapEx to occur in the first half of the year.

The RFP for the Brazilian instant ticket and Italy SuperEnalotto tenders are active. Our current outlook does not include the additional investment that would be required if we secure either or both of these opportunities.

So to summarize, 2018 was a year of continued global strengths in Lottery, resiliency in Italy and stabilization in the North American business. We achieved our objective despite those that we have not anticipated when we set them. With no major upfront payments ahead of us, we expect to return to significant free cash flow generation in 2019.

At this point, we'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Carlo Santarelli from Deutsche Bank.

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Carlo Santarelli, Deutsche Bank AG, Research Division - Research Analyst [2]

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If I could start, maybe, Alberto. If you could maybe think about, like we go back to the end of October. You guys obviously took your guidance range up to the $1.74 billion to $1.80 billion range. And it obviously provided an implication for the fourth quarter, which you came in slightly below the low end of. I know you talked about it a little bit, but if you could just kind of highlight the 1 to 2 things that maybe really differed from what your expectations were at that time, I think it would be helpful.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [3]

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Carlo, I would say that there are 2 main reason. The most important one is, as I mentioned, the performance in International. We were expecting higher product sales. And particularly in Latin America and the EMEA region, they are a little bit short of our expectation. The other -- compared to what we said in the prior call, the SG&A, abnormally higher in Q4 but this time were a little bit higher for a series of circumstances that are related to some accrual that we did at the end of -- right at the quarter and we didn't factor because we're -- they were not forecasted simply at that time that were related to some accrual that we did in the last part of the quarter. But that was slightly higher than that. And then in general, we achieved in terms of net debt a better results than what we were expecting, and that increased the management variable compensation, as well as we had a one-off at year-end in the overall personnel cost. So these are the 2 major items that were unforeseen and that are reflected in the current -- compared to our conversation we had in November.

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Carlo Santarelli, Deutsche Bank AG, Research Division - Research Analyst [4]

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That's helpful. And then just obviously, with the new guidance that you guys put forth for 2019, you talked a little bit about some of your CapEx. I just wanted to kind of confirm that the Analyst Day targets that you guys laid out with respect to your annual free cash flow net of minority distributions of $450 million to $550 million are still something you're able to stand by right now given kind of your outlook from here.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [5]

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Carlo, at the Investor Day in August, we -- as you remember, we presented an overall framework of assumption regarding the main driver of our business. We are still comfortable with that set of assumption and the resulting improvement in the cash flow generation that we mentioned for 2019 with one exception, which is related to the impact of the Italian tax, gaming tax increase that's happened at year-end. Our assumptions were based on the expected growth of the various business segments, on the profitability trends and so on. These are all unchanged. And therefore, we remain convinced that our cash flow generation profile will be significantly different from what we looked in the past 3 years.

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Carlo Santarelli, Deutsche Bank AG, Research Division - Research Analyst [6]

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Okay. And sorry, just to confirm, with respect to the Italy, you called out a $40 million headwind. So you're saying as that -- as we think about that $450 million to $550 million of annual free cash flow net of distributions, we need to make an adjustment for the Italy piece?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [7]

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What I'm saying is that, that was not in the numbers at that time. That is the only change compared to that. I made a very large -- provided a very large framework regarding the growth of the different business, the profitability, the construction. That is not changed at all.

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Carlo Santarelli, Deutsche Bank AG, Research Division - Research Analyst [8]

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Oh, okay. And then just, sorry, on that last point, with respect to the $40 million Italy headwind in your guidance. That, obviously, is very limited mitigation in 2019. How do you think about that impact in 2020?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [9]

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I think that the impact in 2020 will be limited. There is still a small increase in the taxes. But for now, it is -- it will be very, very small.

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Operator [10]

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Our next question comes from Chad Beynon from Macquarie.

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Chad C. Beynon, Macquarie Research - Head of US Consumer, SVP and Senior Analyst [11]

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I wanted to focus on International for a second. I believe in 2018, part of the reason why North America was so strong was because of your test bank process and going back to the core product. I thought that your International approach was pretty similar. So could you just kind of talk a little bit more about what could change in 2019 for International Gaming services, if maybe this was kind of a one-off year and if a lot of the learnings and successes in North America can be applied to International and have that segment grow in 2019?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [12]

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Thank you, Chad. It's Marco. I think we are positive in the -- in regard 2019 also because next year, we will benefit from the Sweden VLT. But in the core part of the business, as your were perfectly pointing out, I think there is room for improvement in the international market. The reason are the following. In Australia, we did very well. We grew quite substantially, and we developed a set of new games that can be exported in Asia, where we are historically quite weak and I think we can improve our performance there. The same games from Australia can be used as titles to reinforce our offering in other international markets. In addition to that, we have a very clear strategy in the second half of the year to improve our position in the Eastern countries in Europe, and we think that we will have better performance also in the western country. We had a couple of geographies where we did not perform very well, but we think that the programs in those couple of geographies in Europe are already showing good momentum. More challenging will be Latin America, notwithstanding, we believe, that we can improve with our titles also in that area. Don't forget that we will continue deploying our now very well performing games in Greece. For obvious reasons, we believe that we will improve our performance in North America. In addition to that, and to conclude, of course we will use some of the titles that are doing very well in North America also in the international market.

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Chad C. Beynon, Macquarie Research - Head of US Consumer, SVP and Senior Analyst [13]

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Okay, great. Very comprehensive. And then separately, with respect to the 2 contracts that you said aren't in the 2019 outlook right now, so Brazil and the super lotto (sic) [SuperEnalotto] in Italy, how are you thinking about returns? And then can you just remind us on the timing of the SuperEnalotto contract?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [14]

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Now the timing, I mean, in the next few months, we'll know about the award. And regarding the returns, Alberto can elaborate on it.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [15]

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We are talking about 2 contracts that have an upfront fees. So as we have spelled out in the past, when there is an upfront fee, the risk -- the financial risk is higher and then we tend to factor higher returns. And therefore, in certain cases, for example, we have not participated to certain bids, or normally we acquire a higher premium for -- in terms of returns overall. That's the way we look at this opportunity.

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Operator [16]

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Our next question comes from Domenico Ghilotti from Equita.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [17]

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Three questions. Three questions. The first is on the -- a follow-up on the cash generation. So if you can remind us what can be the cash taxes for '19 in order for us to, say, to elaborate on the bridge. And second question is on the Italian tax increases. I would like to understand, what are the actions that have already been taken to mitigate these -- the impact? I have the impression that all the markets is running faster to reduce the payout, so I would like to have your comments. And then my last question is on the inorganic options. So you were mentioning the SuperEnalotto in Brazil. Well, on the SuperEnalotto, I'm wondering why you decided to go alone, while in the past, you bid with partners on lotteries? And in Brazil, I'm wondering if you have already taken a decision on this front.

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Marco Sala, International Game Technology PLC - CEO & Executive Director [18]

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Okay, I will take the answers on the bids. Let's start from Brazil. I mean, the bids are due by March 20. Then as you know, there is a lot to consider when investing in a greenfield opportunity like this, especially when there is a significant upfront payment. Having said that, for us, it's a compelling opportunity, and we are assessing it seriously with the rigorous parameters we use to evaluate any bid. So we will come up with our thinking in the next days and weeks. Regarding SuperEnalotto, again we assess every opportunity individually. In this case, we decided not to enter in any partnership and bid alone. Having said that, we continue to have a very strong relationship with our partners. It has been -- I mean, you cannot decide bid by bid what is the approach you intend to have. Regarding the question on the recovery of the tax increase in Italy, we are doing as the rest of the market. We are trying to reshape the -- our games and changing the payout for the players, and that is what it will be done over the next month. In addition to that, we continue to look at our cost structure to streamline our cost in order to recover part of the cost increase that is due to the taxation.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [19]

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Regarding...

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [20]

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Just a follow-up.

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Marco Sala, International Game Technology PLC - CEO & Executive Director [21]

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Yes?

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [22]

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Just a follow-up on this last point. What is embedded in the guidance that you are providing on the impact of Italian taxation? So are you expecting to, say, recover -- to pass the higher taxes by year-end or sooner? So is there any guidance you can provide?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [23]

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The $40 million includes the pace we have defined technically. I mean, we will do along the year, but the $40 million are the $40 million that will impact the full year.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [24]

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Yes, I was trying to understand how prudent you had been in this assumption or...

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Marco Sala, International Game Technology PLC - CEO & Executive Director [25]

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In the next calls, I will tell you.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [26]

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Okay. Quarter-by-quarter, okay.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [27]

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Domenico, the only comment -- additional content is expect that the mitigation action is going to take a little bit of time, so the impact will be higher in the first quarter and lower in the future quarter because we will have the time to implement that. That's the only comment we can make. And going back to your question regarding the cash flow, we expect the cash taxes to be a little higher than this year, but we expect the interest, the cash paid, to be lower, okay?

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Operator [28]

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Our next question comes from Barry Jonas from SunTrust.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [29]

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Just how should investors think of longer-term risks to IGT in the Italian market? And with that, given you're bidding on SuperEnalotto, what do you think is the right mix of business in Italy longer term for you?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [30]

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Well, I think that we feel very comfortable in Italy. When I look at the performance over the last years, we have seen that the market is very resilient. The demand is very strong. The assets we have in the market in terms of brand, network, ability to have a strong CRM, the digital offering is giving us all the tools to deal with an increased complexity. So I'm very positive regarding the business, regarding the demand. The -- of course, the uncertainty of the political situation cannot be factored in the next several years. But when I look at the market at the end of the day, I look at the need of the government to get this money year-after-year. I continue to be positive regarding the Italy.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [31]

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Okay, great. And then just given some of the pressures on VLTs, AWPs, I'm wondering if the product at some point becomes less competitive. Do you think there's overlap in the player base with your other offerings in Italy? Hence, could you see some player shifts over time to different gaming or lottery products you offer?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [32]

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Now this is a very good question, Barry. The fact is I've been monitoring the Italian market for 15 years. As a matter of fact, if you look at the evolution of the Italian market, all the new regulation have provided additional wager revenues for the government and for the operators with a very minimal cannibalization. Reality is that the target of the players are different. And even when you have a player that is playing more games, they do following different attitudes, and they tend to sum up the -- their behavior instead of making choices. And it happened when there have been the digital offering. It happened at the time of the gaming machines. And we are monitoring the trends among the different players, and we see that there is a good, different positioning about the games. And when the games are overlapped, the players are playing the games with different attitudes that are producing very minor cannibalization.

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Barry Jonathan Jonas, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [33]

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That's helpful. And then last one for me. Look, you've said in the past you could see increasing capital returns once 4x leverage is in sight. So now with the license fees in Italy complete and having good visibility into free cash flow generation from here, do you have a better sense when that may be?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [34]

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I mean, we have said we'll be progressive. We will see how things will move forward. But now you understand we also have some of these in. It will also depend on these opportunity growth that we have if we decide to take them or not. So I think what is going to be important is to start the deleveraging, start reducing the debt and improve our profitability to get there as quickly as possible. That is our target.

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Operator [35]

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Our next question comes from David Katz from Jeffries.

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [36]

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Alberto, I just wanted to talk a bit more about the cadence of cash flow this year. I think in your prepared remarks, you said that more of the CapEx would be front loaded to this year and the EBITDA might be a bit more back-end loaded. Could you maybe give us a bit more color on the cadence of those 2, please?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [37]

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I mean, regarding the CapEx, I said it's going to be in the first -- is going to be in the first 6 months, so 60%. And then regarding -- this year is -- at the beginning, similar to what we said last year, that we see an increase in the EBITDA in the second half. In 2018, we were able, during the year, to improve and to accelerate some of the deals and the transaction that allow us to reduce that kind of seasonality. We will try to do the same, but that is where we are today. Obviously, I have more visibility on the CapEx because we work according to a schedule that -- regarding what we can do on the EBITDA. I think that also, let me anticipate that probably the minority -- some of the minority payments that normally are done in the second quarter could be done in the first quarter that they will not -- but it doesn't mean that there is anything else than timing at this point regarding those payments. So I would suggest to look for the cash flow at our -- for the different component what we see for the full year rather than be focused on the first half.

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [38]

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Understood. And just one follow-up. Given the heightened focus on cash flow and the prospects for capital return, I hope you don't mind if I take one more swing at that, which is, if I'm hearing correctly, the growth opportunities that are out there are really the one variable or barrier to you being able to start returning some capital -- more capital sooner rather than later. There's no other barrier out there that we should be contemplating, correct?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [39]

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No, I mean, we anticipated what we are -- what is our forecast in general for the cash flow, consistent with the assumption that we said. And nothing has changed compare like that. We kept -- regarding the leverage, we kept out of the group CapEx because simply, it cannot be forecasted. And right now, what we are seeing are the 2 opportunity we just mentioned, which is the SuperEnalotto in Brazil. So this is it. No change.

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Operator [40]

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(Operator Instructions) And our next question comes from Cameron McKnight from Crédit Suisse.

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Cameron Philip Sean McKnight, Crédit Suisse AG, Research Division - Research Analyst [41]

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Question for Alberto first. In terms of thinking about 2019 levered free cash flow, how should we think about working capital needs in 2019? Do you expect working capital be a source or use of cash?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [42]

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I expect to be more or less neutral so far. That will be my expectation. This year, in the first 9 months, we had a series of items that impacted negatively, some of which were related to the commercial services in Italy. So we not expect that, that happens for next year. So think about the net working capital as neutral. We have some initiatives that partly have generated some benefits. Also this year, we have reduced our inventory. We have streamlined our supply chain. So that is what is driving my forecast for 2019 on working capital.

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Cameron Philip Sean McKnight, Crédit Suisse AG, Research Division - Research Analyst [43]

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Okay, sure. And then on the North American Gaming business, the accelerated depreciation of the older units, have you decreased the useful life on participation units generally? Or is that just a group of units that you've chosen to effectively get down to 0 or some lower level?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [44]

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Now as you can imagine, with the change in the cabinets and the change in the content, obviously we are replacing some of the machines with the new title and the new cabinet. And so in certain cases, for the old ones, we have decided basically at the end of life of the product to basically take a charge and move on.

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Cameron Philip Sean McKnight, Crédit Suisse AG, Research Division - Research Analyst [45]

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Okay, sure. And then thirdly, a question for Marco. Would you mind commenting on the change in the DOJ's opinion on the Wire Act, particularly as it pertains to Powerball and Internet lottery sales?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [46]

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Okay, Cameron, I will provide you our view on the overall DOJ opinion. And our understanding is that the intent of the opinion was to clarify DOJ's position on interstate Internet-based wagering. However, as written, the new opinion might potentially apply to a much broader scope of gaming activity. It might even encompass technology infrastructure used to support the traditional retail-based lottery and gaming transaction. And as you were saying, also multistate and WAPs, that did not exist in 1961 where the Wire Act was enacted. Several lawsuits challenging and seeking clarification of the DOJ opinion have been filed. DOJ recently extended its original non-prosecution period 60 days to June 14. We are evaluating the opinion and monitoring the lawsuits and industry response to it. We are also engaging with the customers and other members of the industry to understand the potential impacts on our businesses and to determine the best course of action, and that is all I can say at this juncture.

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Operator [47]

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And our next question comes from Joe Stauff from Susquehanna.

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Joseph Robert Stauff, Susquehanna Financial Group, LLLP, Research Division - Credit Analyst [48]

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I wanted to ask on North American Gaming in particular in the fourth quarter. Replacement unit sales were up huge, right? The numbers in terms of just both the installed base were up as well as unit shipments. But the conversion into revenue, with revenue being down, can you just talk about that relationship and how to think about the model going forward, especially in 2019, with an improvement in your North American Gaming segment, in particular your product sales?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [49]

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Alberto, yes, when you look at the revenues of the North American Gaming, first of all you need to consider that in the comparison year-over-year, we have $50 million of revenues that are due to an accounting reclass for the ASC 606. What it really mean is that revenues are up 3%. The revenues for terminals sold are up significantly. The units were up 27%. We had better ASPs, so revenues are up 34% in the quarter. Last year, we had in the systems and in the other parts of our business in North America higher revenues than now. That's why you don't see the full impact of the increase in terminals in the bottom line. But again, on the systems side, it could be erratic from quarter-to-quarter, the overall revenue. That's why we feel very positive about the performance of North American Gaming in terms of revenue.

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Joseph Robert Stauff, Susquehanna Financial Group, LLLP, Research Division - Credit Analyst [50]

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And wouldn't -- I guess going -- following up on an earlier question regarding working capital, with that turn basically in North American Gaming, wouldn't you expect basically a -- working capital to be a source of cash from this segment in particular? But I guess your commentary about flat working capital for the year is -- offset in other parts of your business? Is that fair to say?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [51]

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Now what I was implying is the following. First of all, we have -- the working capital is impacted by the different business model of our businesses. So in Italy, it's -- it moves, it fluctuate. But in the Gaming business, normally the working capital is linked to the overall volume. So again, we mentioned that we are expecting some growth for next year. So I would expect the working capital to go up. But because we have taken several initiatives to streamline our supply chain, overall we think that we -- the working capital could be stable on a year-over-year basis.

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Joseph Robert Stauff, Susquehanna Financial Group, LLLP, Research Division - Credit Analyst [52]

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Okay. And I guess just kind of one follow-up. I know, again, it's been asked a couple times, but I just -- Marco, if you could just comment a little bit more maybe -- or maybe I'll just take a different angle on the mitigants in terms of the tools that you have at your disposal in Italy. Obviously, on AWPs and VLTs, those take time, as you suggested. Is -- does it take 6 months? Are you able to implement some of the mitigants earlier maybe on the AWPs? Or -- and again, just relative to that Italian headwind of $40 million, if we assume no mitigants, what would that number look like?

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Marco Sala, International Game Technology PLC - CEO & Executive Director [53]

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Higher. No, I'm joking. The -- now Alberto will tell the number. But talking about the way the mainstream to reduce the impact comes from the fact that you change the payout of the games. On AWPs, to do that, you have to change the motherboard. For the VLTs, it's easier and faster because you can download it from the Central System. But it takes months. It does not take years. It's something that you have to look progressively over the months, and we are very active and consider that we have already done in some occasions. So that is the best answer we -- I can provide. And of course, you are also trying to intervene with the best features in the game structure in order to minimize the perception for the player of the reduced payout because that is the challenge. And we have been successful in doing that in the previous cases where we maintained in reality the demand at the same level and notwithstanding a decrease in terms of payout. And as I said before, we are trying also to look at all the structure of our costs when we serve our distributor or the overall supply chain, trying to optimize the situation accordingly to the new profile on profitability of the game -- of the business.

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Operator [54]

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And we'll take our final question from Domenico Ghilotti from Equita.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [55]

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Yes. I have a question on the leakage that you have out of P&L on the minority that is growing year after year. So I'm wondering, if in this year -- so in 2018 number, there is also a significant contribution from the strong performance of the North American Lottery. So if I should expect -- so if you can provide any indication for 2019 or if you can extrapolate from the 2018 number the exceptional part.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [56]

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I would say the major driver, Domenico, is the performance of the lotto. It's clear if the lotto continue to perform very well, we will see -- and continue to grow, we will see the component of the minority in terms of their portion of the dividend or the units to go up. That is the main driver.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [57]

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So it could continue to go up if the lotto is performing as well as in the past few years?

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [58]

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That is what has happened in the last 2 years. That has grown above our expectation and, therefore, it's having an increase on the minority.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Analyst [59]

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Okay. And just the last question. You are currently clearly introducing so the new -- in Italian market the new machines. I'm trying to understand, what is level of payout in VLTs in particular that you are testing on the market just to understand what is the initial, say, assumption or initial tests that you are doing.

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Alberto Fornaro, International Game Technology PLC - Executive VP & CFO [60]

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Honestly, I do not know the number. The -- what I know is that the first feedback I'm receiving from the Italian team is that the products are performing quite well and they're improving the quality and the performance of our offer. So we are pretty satisfied with what we have done so far.

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Operator [61]

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Thank you. And that does conclude our question-and-answer session for today's conference. I'd now like to turn the conference over to Marco Sala for any closing remarks.

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Marco Sala, International Game Technology PLC - CEO & Executive Director [62]

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Thank you all for your question and for your interest in IGT. 2018 was a year of good progress in reinforcing our positions in the growing global markets we operate on. We look forward to updating you on our efforts on our next call in May. With that, I wish you all a good day.

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Operator [63]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.