International Game Technology PLC

NYSE:IGT

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the IGT first quarter 2020 results conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions].

I would now like to hand the conference over to your first speaker today, Jim Hurley, Senior Vice President, Investor Relations. Thank you. Please go ahead, sir.

[Jim Hurley, Senior Vice President of Investor Relations]

Thank you and thank you all for joining us on IGT's First Quarter 2020 Conference Call.

Given the exceptional circumstances created by the COVID-19 outbreak, we are presenting the results from multiple locations. So please bear with us if we encounter any technical difficulties. On today's call are Marco Sala, our Chief Executive Officer and Max Chiara, our newly appointed Chief Financial Officer. After introductory remarks from Marco and Max, we will open the call up for your questions.

During today's call, we will be making some forward-looking statements within the meaning of 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 latest earnings release and in our SEC filings.

During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our Investor Relations website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with the comparable GAAP measures.

Now I will turn the call over to Marco Sala.

[Marco Sala, Chief Executive Officer]

Thank you, Jim and good day to everyone on the call. First, let me say that I hope you and your loved ones are staying safe and keeping healthy in these uncertain times. My heart goes out to those who are dealing with COVID-19. I am grateful for the frontline workers that are helping us all through this pandemic and for the IGT team, who have rallied tremendously over the last several weeks.

Now let me turn to the first quarter. Our focus shifted radically as COVID-19 turned into a global pandemic late in the period. Our business was off to a good start in January and February building on the momentum we had coming out of 2019. Lottery same-store revenues for instant tickets and draw games were up mid single digit. Replacement unit shipments of gaming machines increased over 30% and installed base yields were strong. But since late February, when the virus began to have serious impact on Italy, the safety and well-being of our people, our customers and communities all over the world became our top priority.

The first thing we did was create a cross functional global COVID-19 crisis management team comprised of senior leaders throughout the organization. Groups with dedicated work streams meet daily to ensure we are executing on our priorities. Robust business continuity plans were implemented quickly and we were prepared as the virus spread. In fact, we proactively increased engagement with customers to help them navigate the crisis. We also took swift actions on our cost structure and cash preservation while being careful not to endanger structural elements supporting long term value creation. Combined with the resilient nature of many aspects of our business and the innovative solutions we have in our portfolio, these actions put us in good position for the recovery.

IGT as a business is relatively evenly split between lottery and gaming and largely concentrated in the United States and Italy, which together account for 80% of our annual revenue. Most of the jurisdictions began implementing stricter containment measures in March and many of those measures intensified in April. Italy has had some of the most restrictive regulations, giving the severity of the crisis here. While there is still a good deal of uncertainty around the trajectory of the pandemic, including the potential for a second wave, we see three phases impacting activities in our main markets. We expect customer and player's mindset and behavior to be different in each phase.

Today, we are mostly still in Phase I, handling the outbreak and health emergency. Facing stay-at-home mandates and social distancing measures, we are managing the business with many channels in lockdown or operating with stringent restrictions.

Phase 2, a period of gradual reopening, is just beginning in some jurisdictions. Social distancing protocols remain largely in place, For us, this phase will require a careful scaling up of cost to accommodate growing demand.

Finally, we see a recovery phase, a new normal, requiring agility on our path, but we also see plenty of opportunity at that stage for us to leverage our investments in innovative system solutions and digital capabilities. Our business continuity plans are grounded in clear priorities along three main dimensions, people, cost and liquidity.

Let's start with people. Protecting the health and safety of our people, our customers and the communities we operate in has guided all our actions. In mid-March, we implemented work from home standards globally. Today, 90% of our staff is working remotely. For those who can not work from home, we implemented stringent policies and protocols to help keep them safe. Our business contingency plan has enabled us to maintain high customer service levels around the world. In a period where many are stepping back, IGT is stepping up for our customers, helping them contain with the current environment and prepare for their business to reopen.

Moving on to costs, where our efforts are focused on better aligning our expenses with lower revenues. Our actions are broad in scope. The most difficult have been decisions related to employees. We are not making these lightly. Our approach is grounded in finding equitable ways to share the burden of the current environment, with a goal of bringing things as close to normal as soon as possible. Today, we have introduced temporary base salary reduction ranging from 10% to 50% across the company, cancelled 2020 salary increases and short term incentive compensation programs.

We instituted a hiring freeze and made difficult decision to implement short term furlough programs for employee groups that are not primarily involved in operations and customer support. We continue to pay for health benefits for all furloughed employees and look forward to welcoming them back to work soon. We also made drastic cuts in discretionary spending and deferred all non-essential capital expenditures. In total, we identified approximately $500 million in cost savings and capital spending avoidance in 2020 to help mitigate the near term impact of lower revenues. Our execution priorities are now shifting to structural cost reduction initiatives to maintain the company's fitness as business restarts.

Liquidity is our third main area of focus. The entire organization is focused on cash flow generation and cash preservation. With $2.2 billion in liquidity at the end of Q1, we are confident we have sufficient flexibility to weather the pandemic and we achieved a major milestone regarding our bank facilities last week securing a period of relief and additional flexibility on our financial covenants. All our actions are focused on providing the flexibility to manage through and be well prepared for operating in this new normal.

Now, I would like to give you a sense of the current market situation for our main businesses, beginning with gaming. In March, casinos and gaming halls around the world were shutdown and most remain closed today. While some jurisdictions are preparing to reopen, we expect the process to be gradual. About 65% of our global gaming revenues come from recurring service revenue, most of which is tied to the productivity of our machines. With casinos closed, we are not earning revenues on those machines. The pandemic is forcing our customers, like us, to focus on cash preservation, reducing operating costs and cutting capital expenditures. This impacts sales of gaming machines and systems which account for most of the remaining 35% of our global gaming revenue.

When casinos do reopen, social distancing rules could involve limiting the number of guests in a location, reducing the number of operational machines and enhance the cleaning protocols. These safety measures should impact the pace of recovery. Local and tribal casinos account for about 85% of the North American gaming and interactive segments revenue. We expect these markets to recover quicker than destination markets like the Las Vegas Street and Atlantic City. We also must consider that likely impact of a broader micro economic slow down on consumer spending and player behavior. Slot GGR will be an important barometer to monitor business trends across jurisdictions.

For lotteries, the situation is different. While the main channels of distribution remained largely open around the world, stay at home measures led to lower traffic at the point of sales. As a result, same-store revenue trends vary greatly across jurisdictions. In Italy, the impact has been significant given the severity of the restrictions. During the month of April, the Italian government suspended all games under the lotto license which represent about half of our Italian lottery wagers. That business is now gradually returning to normal as the games were restored in a next phased reopening strategy in early May.

As in gaming, we need to consider how the broader macroeconomic of backdrop and change in player behaviors might affect lottery wagers. Historically, they have been highly resilient to economic cycles. As you can see in the chart here, both Italian and America lottery wagers were stable during the global financial crisis. Early indications from jurisdictions that have eased mobility restrictions suggest that lottery trends can bounce back relatively quickly. We are currently seeing in Italy, in Europe and in most part of the United States.

This brings us to where we are today. The near term revenue outlook for main activities in our main markets remains depressed, especially for the second quarter of the year with a gradual recovery expected in the second half. The circles you see on the slide are meant to illustrate a view of overall market activity. They are not meant to represent any kind of revenue or profit guidance. Based on this perspective, we are using a total zero-based cost assessment to identify structural and contingent cost reductions. In addition, we are reprioritizing our capital investment decisions and the team is a focus on disciplining the working capital management.

Looking to the future. We are withdrawing our previous outlook for the year due to the uncertainty related to the COVID-19. Having said that, we do expect the second quarter to be the most challenging period for revenue, profits and cash flow. Assuming a sustained relaxing on restrictions and no second wave of outbreaks, we expect trends stream progressively in the second half of the year with lottery recovering faster than gaming. Our cost initiatives are expected to deliver $500 million in cost reduction or capital spending avoidance versus our original 2020 plan.

Our focus is not only on cost, we are approaching how we manage the business differently to be nimbler, leveraging on innovation and flexing our business to adapt to changes in customer and player behaviors. As we all adjust to the new normal, our customers need a partner they can trust and that can support their needs on many dimensions. IGT is that partner.

Over the years, we have invested in our digital and systems capabilities, investments that proved particularly well-suited to the current environment. IGT's digital solution stand across lottery, gaming and sports betting. We offer one of the most comprehensive digital content portfolios in the world with more than 180 teams that serve operators and players in nearly 30 countries. In Italy, we provide a full suite of digital games directly to players across all product verticals. While digital still represents a small portion of total Italy wagers, iLottery and interactive casino games wagers are increasing over 40% since the Coronavirus outbreak. That rate of growth is significantly stronger than the pre-COVID levels.

In the rest of the world, we are a B2B provider of digital content and platforms. As in Italy, we have seen a substantial increase in digital wagering on our B2B digital platforms including triple digit increase in North America iLottery. I should note that much of this growth is driven by an expanding base of new players. The opportunity extends beyond the digital world. IGT has sophisticated CRM tools cashless solution like our Intelligent Offer and Resort Wallet applications are likely to become even more essential to land-based casino customers. In fact, our core advantage system already has functionality that notifies the casino when the machine has been vacated and needs cleaning. We are working on additional innovations for the new world we are leaving in.

As challenging as current environment is, IGT is well positioned to emerge from the crisis a stronger, leaner and more competitive organization. Our solid balance sheet foundation provides us with significant liquidity and flexibility to manage the impact of the pandemic. The diversity of our businesses across geographies and products is something that provides a high degree of stability and predictability to our results. This is especially true for the Italy segment and our global lottery business. I expect those characteristics to reemerge in the post-pandemic era.

Finally, the team. As I mentioned at the outset, everyone at IGT has done a remarkable job over the last several weeks and I am grateful for their dedication. At the management level, many of us have steered this business through difficult times, including the global financial crisis and have adapted to many changes coming from new regulations, political instability and changes in player tastes and preferences. We are all extremely motivated and dedicated to executing our action plans to navigate through the crisis.

Speaking of the team. I am very happy to welcome Max Chiara to IGT as our new CFO and member of the Board of Directors. Max has a strong background in corporate finance, operations and capital markets as well as a history of building and leading high-performing teams. Six weeks in under particularly challenging circumstances, he has hit the ground running and provided to be a great partner.

With that, I will turn the call over to Max.

[Max Chiara, Chief Financial Officer]

Thank you, Marco, for the introduction and hello to you all on the call today. This is my first earnings call with IGT since I took office on April 6 and I am excited to have joined the company. I look forward to being a contributor to the future success of an iconic name in the global gaming industry. I also forward to meeting or e-meeting, as the COVID-19 situation would permit, many of you over the next few weeks and months. My plan today is to give you an overview of our financial results for the first quarter, provide an update on our balance sheet and highlight the framework we would like to adopt going forward in our financial priorities.

Now let me jump right into the financial review of your first quarter starting on slide 14. the unfolding of COVID-19 pandemic and the correlated governmental lockdowns to contain the spread of the virus have impacted our performance starting with the last month of the quarter. Prior to that, the business was trending well. We generated consolidated revenue of $940 million, down 18% on a reported basis and 16% at constant currency compared to the previous year. The widespread closure of casinos and gaming halls in addition to reduces traffic to lottery points of sale significantly impacted global service revenue.

Total product sales were slightly above the prior year on strong non terminal product sales, which more than offset lower unit shipments of gaming machines. Operating loss of $197 million compares to operating income of $178 million in the prior year period, primarily reflecting $296 million of non-cash, non-tax-deductible goodwill impairment charges, adjusting the carrying amount of goodwill for our North America gaming and international segments. Lower near term forecasts as a result of COVID-19 were the drivers behind the goodwill impairment calculation. Apart from impairment, revenue mix, particularly lower service revenue, was another driver of lower operating income and there were some benefits from initial actions taken to reduce operating costs across the company in the quarter. Adjusted EBITDA of $309 million was also lower, down 25% at constant currency.

Now let's turn to our operating segments, starting with North America gaming and interactive on slide 15. The decline in service revenue reflects casino closures and the contribution from a multiyear poker contract executed in the prior year. Overall, product sales revenue declined as a result of fewer terminal unit shipment, largely on lower new and expansion activity and to a lesser extent, delays caused by COVID-19. The lower unit shipments were partially offset by non terminal sales related to a multiyear strategic agreement, which includes guaranteed revenue on leased units over the contract period. System product sales were essentially in line with the prior year. Operating income reflects the impact of the casino closures, partially offset by lower operating costs.

On slide 16, you have the results from the North American lottery segment. Beginning in March, widespread stay at home orders significantly affected lottery sales. Lower LMA revenue is the primary driver of the segment's 15% decline in revenue. The reduction in LMA reflects accruals for penalties due to lower jackpot activity over the past three quarters and overall reduced lottery activity due to COVID-19. Lottery service revenue was only modestly below the prior year. The 1.6% same-store revenue growth for instants and draw games for the quarter includes a strong 6.7% increase in the combined January and February period. The closure of VLT venues drove the decline in gaming service revenue. Operating income reflects the LMA dynamics and the closures of VLT venues, partly offset by lower operating costs.

Turning to the international segment on slide 17. At constant currency, total revenue was in line and operating profit more than doubled. Overall, product sales revenue grew 25% as software license sales related to the extension of a long term lottery contract in the Czech Republic and AWP upgrades in Italy overcame fewer unit shipments of gaming machines. Service revenue reflects casino closures impacting gaming service revenue and mobility restrictions injuring lottery sales. Other revenue was lower due to the sale of the Poland commercial service business in prior period. Strong operating income growth was driven by the said software license sales and by lower operating costs despite early COVID-19 impacts in late March.

The results for Italy are shown on slide 18. For the first quarter, lottery wagers declined 20% due to mobility restrictions implemented in March. Machine gaming reflects the impact of gaming hall closures and higher gaming machine taxes. Notably, interactive wagers grew 20% during Q1 although from a low share of total business as players gravitated to our full suite of digital games confirming the high performance of our offering there. Other service revenue reflects growth in commercial services. As a reminder, a large portion of the commercial service revenue is pass-through in nature. Operating income primarily reflects COVID-19 restrictions partially offset by lower operating costs.

As Marco mentioned, we are focused on reducing our cash cost to adapt to lower market demand trends. Slide 19 highlights some of the progress made to date. Prior to the COVID-19 crisis, our average monthly fixed cost and maintenance CapEx were approximately $235 million combined. Over the last two months, the team has successfully reduced that to $185 million, the monthly run rate for March through December expected for this year. This results in approximately $500 million in cost savings or capital spending avoidance compared to the original 2020 plan for the full year.

First, we defer all non-essential capital projects, refocusing our CapEx investment on the highest return initiatives that offer the shortest payback period. This work has led to an over one-third reduction in the 2020 maintenance CapEx plan. Cuts were deepest for gaming activities as most of our lottery CapEx is contractual in nature. Regarding our fixed operating expenses, the biggest savings are the employee-related cost actions that Marco mentioned before.

Discretionary expenses such as travel and marketing and outside service fees have been dramatically curtailed and we are investigating the applicability of government-sponsored relief programs that have been activated around the world. Apart from these near term cuts, we are also working on longer term structural cost savings initiatives to make our organization even more agile and competitive in the new normal.

Turning to the balance sheet. Our debt and leverage profile are included on slide 20. Net debt of $7.2 billion was below both the 2019 year-end and first quarter 2019 levels. During the quarter, we generated $157 million in cash from our operating activities and reduced net debt by $111 million at constant currency. In terms of financing activity, we redeemed our 4.75% senior secured Euro notes in early March. Leverage of 4.47 times increased from 4.31 times at the end of the prior year, primarily driven by the impact COVID-19 had on EBITDA in the first quarter of 2020, but is below the corresponding period last year.

Turning to slide 21. We ended the quarter with approximately $2.2 billion in liquidity comprised of about $1.5 billion in unrestricted cash and $743 million in additional borrowing capacity under our credit facilities. This provides us with ample resources to cover a modest amount of debt maturities through 2021. The average maturity of our debt is four years. Regarding other liquidity initiatives, we established a working capital task force led by several members of the senior management team. The focus is on receivable collections and inventory and payables optimization. At this point, we are targeting receivables and payables to balance out during the course of the year.

Now let's move to slide 22. Last week, we successfully amended our revolving credit facilities and term loan, providing us with some degree of flexibility to operate safely during the height of the pandemic. Modifications to financial covenants include a temporary covenant holiday through the second quarter of 2021 with revised covenant levels thereafter. There is a new minimum liquidity covenant for the interim period. Financial covenants return in Q3 of 2021 with a revised profile through the maturity of the facilities. Dividends and share repurchases are not allowed during the covenant holiday period. Dividends and share repurchases are allowed after the covenant holiday if leverage is less than five times. The amendment demonstrates the strong support that the company has from its RCS and long term banking group.

Finally turning to slide 23, let's wrap up the key takeaways of today's presentation. Our businesses have demonstrated resiliency in past crisis and we expect this time to be no different. The cost reduction measures and the innovative solutions we offer the market put us in a solid position to confront the post-crisis environment. We have strong liquidity and are absolutely focused on cash preservation and we have a balanced philosophy on capital allocation, [indiscernible], protecting our credit rating through the prudent management of our leverage ratio while maintaining access to ample liquidity are key pillars of this philosophy. Returning capital to shareholders remains a key medium term focus but it ought to be managed in sync with a gradual strengthening of our credit profile.

With that, we would like to open the line for your questions.

[Operator]

[Operator Instructions]. I show our first question comes from Carlo Santarelli from Deutsche Bank. Please go ahead.

[Carlo Santarelli, Deutsche Bank]

Good color in the opening remarks and into the year from both of you. I just wanted to dig in a little bit on the cost cuts and $185 million run rate. If you think about maybe what the business looked like in April and including some of the almost close to zero revenue sales side, what does that or could we think about the second half of the year where that $185 million potentially goes to in terms of kind of burn rate as you bring revenue back online, i.e. the variable components of the cost that are kind of present in today's more subdued environment relative to what you are anticipating in the back half of the year as business does start to pick up a little bit?

[Marco Sala, Chief Executive Officer]

Thank you. I provide the overall outlook I have for the Q2, as you mentioned and for the reminder of the year. It's clear that as we said in our prepared remarks, the Q2 is the most challenging one for revenues, profit and cash flow. As you know, most of casinos and gaming halls remain closed around the world and we are just now seeing some jurisdiction reopen, by the way, adapting strict social distancing guidelines. The lottery has been impacted by sty at home orders and some restrictions and this is the reason in we expect to burn cash in Q2. I didn't say that our view is that with a sustained relaxing of restriction, reopening of business and hopefully no second wave of outbreaks, the trends should progressively improve in the second half, ultimately returning to positive cash flow. That is our view at this point in time. And the cost structure will be aligned in the second part of the year and you can see that quite well spread over the quarters and the months. The important point I want to raise is that we expect that we will have the recovery of the business going forward mainly on lotteries that we will provide us a good outlook. If again, no second wave of outbreaks for the second half of the year.

[Carlo Santarelli, Deutsche Bank]

Great. That is helpful. And then if I could just, one follow-up. Clearly, Italy has had a pretty dramatic closure of some of your key businesses in that market going back to March. You commented on it a little bit in terms of what you are seeing. I had kind of a two-part question just in terms of how you foresee things coming back online be it the AWP, VLT games, as well as kind of instant tickets and your lotto games, primarily and some of the points of sale there. What you foresee as how those will cadence as they come back online. And then just briefly, if you could touch a little bit on kind of the upcoming renewals on the gaming side there and how you guys are currently thinking about that?

[Marco Sala, Chief Executive Officer]

Yes. Okay. Let's start with lottery because in Italy the trends improved much. Wagers were down not beyond 80% in April and the last week we are down 42% as lotto games restarted in early May. And we expect these trends to continue. Today, the distribution of Scratch & Win can be enlarged to bars. We expect, in the next days, the monitors of 10eLotto to be reopened and therefore we expect the lottery part to grow over the next weeks. But moving from more than 80% down to minus 42% in a few weeks, it's an important signal.

Regarding the other part of the portfolio, for the time being the activity of gaming halls and sport betting shops is suspended as for other social gathering spaces. We believe that we will not be open before mid-June. It will be open but I can not indicate the week. I think also sports betting in Italy, at least, for the digital distribution, as soon as the live sports events will restart, we will take off. And so I think this is the outlook I can provide you for Italy, positive on lottery, waiting for the opening of the retails, doing well in general for the digital distribution.

[Carlo Santarelli, Deutsche Bank]

Great. Thank you very much. I appreciate it. and be well.

[Marco Sala, Chief Executive Officer]

Thank you Carlo.

[Operator]

Thank you. Our next question comes from Chad Beynon from Macquarie. Please go ahead.

[Chad Beynon, Macquarie]

Hi. Good morning. Thanks for the remarks and Max, welcome. Nice to meet you on this one. Sticking with lottery, I wanted to talk about, I guess, some of the existing new business wins such as Brazil. Can you kind of help us think about the rollout of that? If that's still in place? And then on potential business like Pennsylvania which we have talked about on recent calls, is there any update there? And what the state is planning for the adjusted timeline? And then anything else that is kind of on the horizon, New York or any other big contracts? Should we expect that maybe the RFPs or the timing of the renewals gets pushed back? Or are there opportunities for you to, I guess, renew these just given the uncertainty of the tax revenues and how governments might be thinking about this? It's a multi-partner on lottery. Thank you.

[Marco Sala, Chief Executive Officer]

Thank you Chad. So before entering to the several questions regarding this, let me give you the overall perspective on lottery because with Carlo, we focused on the recovery of lottery in Italy. But I want to offer you a wider perspective because we are encouraged by lottery trends. In the U.S., we have seen a progressive recovery during the month of April. In the first two weeks of May, year-over-year same-store revenues are up mid single digit. So we have seen a peek then a constant recovery in the month of April and in the last two weeks of May, we are over to mid single digit.

In Europe, lottery is only slightly below the prior year. And this is another important indicator. The situation is a little bit more complicated in Latin America because some lotteries have been shut down. But most part of our business is showing encouraging trends. And you have also to keep in mind talking about lottery that the business represents 43% of our total turnover, but an higher percentage of our profit. Having said that, that provides us a good sentiment regarding the recovery of lottery, I will go giving the answers to the question you raise.

Regarding Brazil. We do not have anything to change. We expect to say that is different from the previous discussion. We expect to launch instant ticket games in Q4. We are on track with that. And we still consider, notwithstanding the challenging environment, a great opportunity for our company.

You mentioned regarding Pennsylvania. The bids for the FM contracts were submitted last June and the best and final offers were submitted in April and we are waiting to hear back.

New York. In New York, our New York lottery contract expires in August and we expect the RFP for a new contract to be issued in the second half of the year. So that is the situation regarding the various contracts.

[Chad Beynon, Macquarie]

Okay. Thank you very much, Marco. And then on just on the IT side. There has been a lot of talk about cashless options. I know you guys have shown us the Cardless Connect at the past few G2Es. Do you expect for some of these products to just gain more attention? What are the opportunities for these products? Have they been tested? Can you just kind of help us think about some of your options that are a little bit more social distant or sanitary friendly that you are offering? Thanks.

[Marco Sala, Chief Executive Officer]

No, this is a very good question, Chad, because we are not expecting that they is interest because we are experiencing interest from our customers because we invested in things that are very relevant in general, but specifically in this period of time. We have solutions to take out that the cash from casinos. That is the simple statement because you can do everything with your mobile. We have solutions where you can play in casinos with your mobile at slot games, at sports betting games, at table games. This solution is called PlaySpot.

We have some add-on system capabilities like mobile respond, which provides an alert when a machine needs to be sanitized, meaning when someone is cashing the money out from the machines, there is an alert that can signal to the casino that they cannot provide sanitizing the machines. Those are a set of solution we have been investing on that would have been helpful in any moment. But at this point in time, they are very important for casinos, helping them in reopening their activities in a safe way.

[Chad Beynon, Macquarie]

Thank you very much. I appreciate it.

[Marco Sala, Chief Executive Officer]

Thank you Chad.

[Operator]

Thank you. I show our next question comes from Barry Jonas from SunTrust. Please go ahead.

[Barry Jonas, SunTrust]

Hi guys. Just curious, so that costs that have been removed that may not need to come back, I mean, I guess, ultimately do you believe you will emerge from this more efficient overall?

[Marco Sala, Chief Executive Officer]

Yes. I think we have to learn by this crisis, as everybody has to learn when facing difficult times. As Max said in his remarks, our savings have been concentrated in employee-related expenses, CapEx reduction or deferrals and discretionary costs. We believe that some of the changes we have put in place will become permanent.

We will work on personnel. We can maintain hiring and over time, freeze. We intend to extend beyond the crisis the work from home practices that can reduce our real estate costs. As always, we will refocus our attention on some processes, assessing the possibility to automating some of them and assessing also the span of control of our organization.

So, I think that this is an area where we will learn from what we are doing in these days. And when it comes to R&D, supply chain and CapEx, it's clear that all these costs need to be aligned with market realities. I think that they can be optimized for the new normal and we feel there are opportunities to streamline our product offer and we will be working on it in the preparation of our budget for next year.

And the same regards the discretionary costs. I think that after this experience globally, we will travel less. We will focus more our marketing investments and we will review very carefully the outside services. So, all-in-all, without defining exactly at this point in time which will be the base of our cost structure, we will be working quite seriously in order to learn from what we are doing in order to have a more agile organization going forward.

[Barry Jonas, SunTrust]

Great. And then, Marco, there has been talk about more U.S. states legalizing online gaming or sports betting as a result of the crisis. How realistic is this? And what sort of timing would you expect?

[Marco Sala, Chief Executive Officer]

Are you talking about the U.S.?

[Barry Jonas, SunTrust]

Yes. The U.S.

[Marco Sala, Chief Executive Officer]

Look, I do not have much visibility. According to my colleagues, they feel that everybody should realize the opportunity coming from the digital offering in this period of time. And I think all the government should look into it more, with them paying more attention going forward. But if the question is if I have more visibility, the answer is no, I do not have more visibility. I know that there are more debates. Various states are looking into it. But I can not anticipate how it will evolve going forward.

[Barry Jonas, SunTrust]

Got it. Okay. Then maybe just switching to Italy. Can you give us some perspective of how you think the government may respond to this crisis from the perspective of gaming? In the past, we have seen tax increases or accelerated tenders, requiring cash outlays quicker. On the flip side, is there a potential we could see some relief from the government for gaming or may be opportunities to offer more products? Any perspective there, I think, would be incredibly helpful for investors.

[Marco Sala, Chief Executive Officer]

No, I understand. And for the time being, it's important to understand when they will open the point of sales and I truly hope that will happen in June. But what I can say, it's very difficult as always to predict the decision of the government. But at this point in time, I have to remind that even before the COVID-19, Italy VLT wagers were negatively impacted by lower payouts and higher taxes on player winning. And that's in addition to the implementation of the age verification.

These will impact the proceedings of the government. And for the first time, they are seeing that their actions have such a significant impact on wagers. So they might be inclined to look at this business differently going forward, because this is an important source for the Italian government and I think they know it.

[Barry Jonas, SunTrust]

That's a great point. Thank you so much Marco. Thank you guys.

[Marco Sala, Chief Executive Officer]

Thank you Barry.

[Operator]

Thank you. [Operator Instructions]. I show our next question comes from Domenico Ghilotti from Equita. Please go ahead.

[Domenico Ghilotti, Equita]

Good morning. A few questions. The first is very, very preliminary thoughts on 2021, in the sense I understood that you are quite confident on the recovery on the lottery side. I would like to understand what is your view on the opportunity for a recovery also on the replacement units in North America and international markets? And second is on the cuts in CapEx. Could you elaborate on the areas where you are cutting CapEx? And what is the implication in terms of a medium term perspective for the business what you are cutting? And third is on the leverage. What's your view on the leverage in the new normal? So what is the sustainable level of leverage in 2021 or 2022? And last is on the Q2 outlook that you gave before. So you were saying that basically, if I understand properly, we should expect some cash burn and some deterioration in the net debt. So is it driven by the working capital? Or do you really see also at the EBITDA level some negative contribution?

[Marco Sala, Chief Executive Officer]

Domenico, let's start from the last one. No, I think the issue of the second quarter is the revenues. If you have casino closed, you had Italy shutdown and still a shutdown for some part of businesses. Any way, even though recovery in lottery has been down everywhere in April. So the main reasons for having a negative second quarter comes from the business, from the revenues --

[Domenico Ghilotti, Equita]

Sorry to interrupt you. So we should expect some negative EBITDA, given the very, very poor topline?

[Marco Sala, Chief Executive Officer]

Yes. I mean, you have to consider that I am saying that you are burning cash. And so that is the answer that I am providing. But I am also providing you the sense of where this situation is coming from. If you look across the various businesses, you realize that as I said, most of the casinos and gaming hall remain closed. And you know that in Italy, they have still closed the gaming halls. Lotto reopened in May. So you have the feeling of the overall revenues. So that regards the second quarter.

I will leave Max, later on, to elaborate on the leverage. What were the other two questions Domenico?

[Domenico Ghilotti, Equita]

The CapEx? So the impact on the CapEx? What you are cutting. And the third, the last was on the replacement unit business. So if you see --

[Marco Sala, Chief Executive Officer]

Yes. So I mean let me start from the gaming part of the business. The recovering in the gaming part of the business will be slower. We think that it will be gradual throughout Q2 and Q3 with local and tribal casinos expected to recover faster than destination market. And we have to assess the pace of the recovery, considering the impact of the social distancing measures, the new cleaning protocols and the overall recessionary environment.

So I am expecting this business will need more time to recover over the next quarters. That in general. And regarding the CapEx, I mean we tried to postpone part of our CapEx. And then, you have to consider that we save some money on the CapEx of the installed base, because the market is down in this period of time and we started reviewing the priority in terms of keep on investing in some specific product categories.

Having said that, for the lottery part, it's more difficult to do better because most part of our CapEx are related to contracts we have with lotteries. So, all-in-all, those are the areas, where we are focused our attention, the areas, in other words, where we have more flexibility to reviewing our programs.

[Max Chiara, Chief Financial Officer]

So Marco, let me pick up from here the leverage question. So Domenico, the COVID-19 pandemic has not changed our basic assumptions on our leverage target, which remains anchored around four times EBITDA leverage that we said in the past. This target is also aligned with our goal to strengthen our credit profile. The issue here is that we don't have a specific time frame to give you right now for when we achieve this target. Obviously, the COVID-19 pandemic has provided a lot of uncertainties and the expectation is for probably the leverage to go up towards the end of this year and then start to decrease thereafter.

[Domenico Ghilotti, Equita]

Okay. Thank you. And just a follow-up on the cash flow. Should we expect payments to minority this year? Or you are also refraining from --?

[Max Chiara, Chief Financial Officer]

We executed payments in Q2, but at a much lower degree over the previous years. That also will influence obviously the net debt in Q2. And just to complete on what Marco said before, obviously, based upon the timing of our lottery contracts, there is some locked in CapEx that we will have to pay for in Q2 that also will depress our cash flow performance in the quarter. But we expect then in the second half of the year to turn back to positive cash flow generation.

[Domenico Ghilotti, Equita]

Okay. Thank you.

[Operator]

Thank you. Our next question comes from David Katz from Jefferies. Please go ahead.

[David Katz, Jefferies]

Hi. Good morning everyone. Good to hear everyone's voices. And glad, you are all well.

[Marco Sala, Chief Executive Officer]

Hi David.

[David Katz, Jefferies]

Hi. I wanted to ask about specifically the North American gaming installed base. I see that there were some ins and outs. And what I am trying to get a sense of is that installed base, even with the movements of games to long term leases, it was down a little bit in the quarter? And the degree to which that installed base is impacted by the crisis versus whether there are other competitive forces that are sort of bringing that installed base lower? And just thinking about how that curve should shape irrespective of the crisis?

[Marco Sala, Chief Executive Officer]

Yes. David, I think the first quarter, the unit sequential decline reflects more anticipated removals of old unsupported machines and the impact of corporate actions, only partially related to COVID-19. I think we always acknowledge the pressure on the installed base from the intense competitions. And now even more with customers looking to reduce spaces. It is clear that we do not expect this to go away in the real term, especially given the current situation. But we also know that our portfolio is quite strong and there are very good games that are performing very well.

At this point in time, I think on the installed base, the focus has to be, considering to be with the customers, to have the best products at the time in the floor at the time they reopen the casinos, considering that very likely only a portion of their lease units will be operational due to the social distancing mandate. So it becomes very important to work with the customers to identify the most performing among our machines to remain operational during the reopening of the casinos.

[David Katz, Jefferies]

All right. Thank you for that. And then secondarily, when we look at the Italian business from the perspective of the U.S. market, there is really two ways that we have seen indications from the Italian government to drive revenue. One is obviously expansion and the other is raising gaming taxes or increasing their take of what exists. What are you hearing or what can we reasonably expect in terms of behavior or disposition from the Italian government as it relates to your Italian business at this point?

[Marco Sala, Chief Executive Officer]

Now, look, as I keep on saying, it's very, very difficult to predict it. What I can say is that when it comes to lottery, that is the biggest part of our Italian portfolio. They always approved innovation that allowed us to grow the business over the years. And I do not see this changing in terms of the possibility to innovate in Scratch & Win and to innovate on the lotto family.

Regarding the sports betting, I guess that the business will continue to grow over time. And probably, I mean there is a minor taxation that will be added. But that, I mean, it's usual. It can come as a part of a decree that has not been issued yet. But overall, it's something we can deal with. As always, the most unpredictable part of the Italian portfolio is the gaming machine part.

As I said before, I think that the government has increased taxation over the years, but it's the first time that they are realizing that the increased taxation is bringing their revenues down. So I am expecting this fact will bring them to reconsider the approach on this part of the business because a further increase in taxation is even reducing more their net proceeds.

Having said that, I want to make a point. Consider that the gaming machines in Italy represent, in terms of revenues, about 12% of our 2019 figures for the company and in terms of EBITDA, is less than 5%. So I mean just to provide you a little bit of context, whatever it happens, we will manage it as we have been doing for many, many years. I think that the approach of the government should be more prudent. But we have always, to keep in mind, that we are talking about less than 5% of the IGT EBITDA base of 2019 numbers.

[David Katz, Jefferies]

And so just to make sure I am clear, the focus in terms of gaming taxes and increasing the government's take is entirely or practically entirely on that less than 5% of EBITDA, as it relates to Italy?

[Max Chiara, Chief Financial Officer]

Yes. 5% of EBITDA of the entire company, yes.

[David Katz, Jefferies]

Yes. I understand.

[Max Chiara, Chief Financial Officer]

Thank you.

[David Katz, Jefferies]

Be well and thank you, yes.

[Operator]

Thank you. Our next question comes from John DeCree from Union Gaming. Please go ahead.

[John DeCree, Union Gaming]

Hi everyone. Thanks for taking my question.

[Marco Sala, Chief Executive Officer]

Hi John.

[John DeCree, Union Gaming]

Just one for me, Marco. I wanted to ask about M&A. I know it's probably hard to think about them now as we are all thinking about preserving cash. But you have spent a couple of years building up the balance sheet and have quite a bit of liquidity relative to a lot of your peers. So I was wondering your views on M&A for the lottery and gaming equipment sector? If you expect some consolidation, particularly on the other side of the pandemic? And if it's something IGT would look at to be opportunistic in the future in the next couple of quarters or year after we get past this?

[Marco Sala, Chief Executive Officer]

John, I think when, in any industry, you are facing reduced demand and increased commercial pressure, there is always the possibility for consolidation. And I think this is visible in the gaming part of our sector, especially if you have to keep on investing to keep your pipeline of products and solutions. Having said that, when it comes to IGT, I think that we have already broadened the portfolio of compelling solutions across all aspects of regulated gaming that, by the way, are very consistent with our strategies. So since I do not see any significant missing in our existing capabilities, I do not feel we should have a lot of appetite for M&As right now.

[John DeCree, Union Gaming]

Got it. Thanks Marco. That's all for me.

[Marco Sala, Chief Executive Officer]

Thank you John.

[Operator]

Thank you. And our last question comes from Joe Stauff with Susquehanna. Please go ahead.

[Joe Stauff, Susquehanna]

Good morning everyone. Thanks for taking the questions. I just had a few clarifications, if possible. Max, you had mentioned working capital for the year to be flattish. Are you assuming a higher bad debt provision associated with that?

[Max Chiara, Chief Financial Officer]

So working capital expectations that we mentioned is for the full year. Obviously, in the short term, we see some tensions on the payments, on the collection of our receivables. And so it's possible that our provisions will go up. But we recently moved to the new accounting standard, CECL. And so we have very clear guidance on how to approach that decision. And again, as we said that during the call, we set up a control tower task force that is managing the three components of the working capital on a regular basis. And we made additional efforts to make sure that the collection process is right on top of the agenda of our segment teams.

[Joe Stauff, Susquehanna]

Got you. Thank you. Marco, good morning. I was wondering if you could just kind of fill in a couple of pieces which you already provided some good commentary on. But in the U.S., you had mentioned, U.S. lottery in particular, you had mentioned that May is up mid single digits kind of thus far on a same-store basis. What did April look like for you guys?

[Marco Sala, Chief Executive Officer]

April has been a month where we increased week after week. We moved from a peak of minus, I would say, something around, I am not precise but around, minus 25% to minus 2%, resulting positive in the first two weeks of May. So it has been a real visible progression. The negative peak has been minus 30%. But I do not remember, if it was in April or the last week of March. But since then, we have progressively improved the performance. The last week of April has been minus 2%, minus 3% and first two weeks of May were up mid single digit.

[Joe Stauff, Susquehanna]

I see. And asking something similar just in terms of an analog. Everyone's just trying to figure out how demand reflates and how quickly? And I was wondering, in your Italian business, the tobacco shops or at least the large proportion of tobacco shops have largely remained open throughout the entire quarantine pandemic. And I was wondering if you can give us a sense maybe of the traffic flows to the tobacco shops obviously where you sell a lot of your products in April and May to-date, again similar to some of the commentary that you provided for us in terms of your U.S. lottery business?

[Marco Sala, Chief Executive Officer]

You have to consider that our lotto was shut down and so lotto is entirely sold through tobacconists and was completely shut down. What I can tell you is that lotto, in the overall lotteries in the last week was minus 42% with lottery opened at the beginning of May. Also in this case, it was down more than 80% between the end of March and beginning of April. Then it has improved, especially for scratch-and-win that kept on improving on the tobacconists. And if we look at last week, scratch-and-win was minus 35%, but considering that scratch-and-win is distributed also through bars that were closed. So starting this week, they will be open. And so we expect Scratch & Win to recover the next weeks.

As we expect, lotto will improve progressively over the next weeks. Because to-date, also in terms of lockdown, there has been a relaxation also for citizens because the issue was not very much related to the tobacconists that were open, but the people who were locked down at home. So the mobility of the people was very limited. Now they could move, of course, respecting the health protocol that are common throughout the world. But we expect that the trend, considering this, will improve over the weeks.

[Joe Stauff, Susquehanna]

Understood. Thanks very much.

[Marco Sala, Chief Executive Officer]

Thank you.

[Operator]

Thank you. This concludes our Q&A session. At this time, I would like to turn the call over to Marco Sala, CEO, for closing remarks.

[Marco Sala, Chief Executive Officer]

Thank you all for joining us today. I want to leave you with some key messages. First, a large part of our business, namely lottery in Italy have demonstrated remarkable resilience in past crisis and we are beginning to see positive progress in both areas. Second, we have significantly reduced costs. When coupled with our ample liquidity and enhanced financial flexibility, we have the resources we need to navigate the impact COVID-19 is having on our business.

Finally, we are emphasizing our innovative solutions that are particularly well-suited to the current environment. The net of all our actions position IGT to emerge from the crisis stronger, leaner and even more competitive organization. As always, we appreciate your interest in IGT and I wish you all a good day and please stay safe.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.