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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
    FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 Commission file number: 1-8300 WMS INDUSTRIES INC.  Delaware
(State or Other Jurisdiction
of Incorporation or Organization)
    
    36-2814522
(I.R.S. Employer Identification No.)
 800 South Northpoint Blvd., Waukegan, IL 60085 
 Registrants telephone number, including area code: (847) 785-3000 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES x NO o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES x NO o Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date: 30,107,496 of common stock,
$.50 par value, were outstanding at May 10, 2004, excluding 2,250,819 shares
held as treasury shares. 1




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WMS INDUSTRIES INC. INDEX  
 PageNumberPART I. FINANCIAL INFORMATION:ITEM 1. Financial Statements:Condensed Consolidated Statements of Operations -
Three months and nine months ended March 31, 2004 and 2003
    
    
    3Condensed Consolidated Balance Sheets -
March 31, 2004 and June 30, 2003
    
    
    4Condensed Consolidated Statements of Cash Flows -
Nine months ended March 31, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    15ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26ITEM 4. Controls and Procedures
    
    
    27PART II. OTHER INFORMATION:ITEM 2. Changes in Securities, Use of Proceeds and Issuer Repurchases
of Equity Securities
    
    
    27ITEM 6. Exhibits and Reports on Form 8-K
    
    
    29SIGNATURES
    
    
    30By-LawsAmended and Restated Employment Agreement302 Certifications of CEO and CFO906 Certifications of CEO and CFO
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS WMS INDUSTRIES INC. 
    Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Revenues:Product sales
    
    $
    42,653
    
    
    $
    20,257
    
    
    $
    98,383
    
    
    $
    57,082Gaming operations
    
    
    21,157
    
    
    
    21,524
    
    
    
    63,648
    
    
    
    70,735Total revenues
    
    
    63,810
    
    
    
    41,781
    
    
    
    162,031
    
    
    
    127,817Costs and expenses:Cost of product sales
    
    
    24,951
    
    
    
    12,816
    
    
    
    58,999
    
    
    
    35,129Cost of gaming operations
    
    
    4,383
    
    
    
    4,625
    
    
    
    11,780
    
    
    
    14,234Research and development
    
    
    11,857
    
    
    
    9,949
    
    
    
    32,339
    
    
    
    29,339Selling and administrative
    
    
    14,776
    
    
    
    12,925
    
    
    
    41,856
    
    
    
    36,452Depreciation and amortization
    
    
    6,596
    
    
    
    6,659
    
    
    
    19,010
    
    
    
    20,704Total costs and expenses
    
    
    62,563
    
    
    
    46,974
    
    
    
    163,984
    
    
    
    135,858Operating income (loss)
    
    
    1,247
    
    
    
    (5,193
    )
    
    
    (1,953
    )
    
    
    (8,041
    )Interest expense
    
    
    (956
    )
    
    
    
    
    
    
    (2,851
    )
    
    
    Interest
income, other income and expense, net
    
    
    454
    
    
    
    851
    
    
    
    1,955
    
    
    
    1,824Income (loss) before income taxes
    
    
    745
    
    
    
    (4,342
    )
    
    
    (2,849
    )
    
    
    (6,217
    )Provision (benefit) for income taxes
    
    
    279
    
    
    
    (2,394
    )
    
    
    (1,070
    )
    
    
    (3,092
    )Net income (loss)
    
    $
    466
    
    
    $
    (1,948
    )
    
    $
    (1,779
    )
    
    $
    (3,125
    )Net income (loss) per share of common stock:Basic
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )Diluted
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )Shares used in per share calculations:Basic
    
    
    29,904
    
    
    
    30,259
    
    
    
    29,574
    
    
    
    30,584Diluted
    
    
    30,834
    
    
    
    30,259
    
    
    
    29,574
    
    
    
    30,584
 See notes to condensed consolidated financial statements. 3




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WMS INDUSTRIES INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS  March 31,
    
    June 30,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    76,728
    
    
    $
    99,640Restricted cash for progressive jackpots
    
    
    470
    
    
    
    2,326Short-term investments
    
    
    55,852
    
    
    
    58,341133,050
    
    
    
    160,307Receivables, net of allowances of $2,513 and $2,354, respectively
    
    
    41,339
    
    
    
    25,073Notes receivable, current portion
    
    
    18,580
    
    
    
    12,033Income tax receivable
    
    
    5,779
    
    
    
    7,722Inventories, at lower of cost (FIFO) or market:Raw materials and work in progress
    
    
    42,806
    
    
    
    13,937Finished goods
    
    
    13,752
    
    
    
    15,86956,558
    
    
    
    29,806Other current assets
    
    
    25,742
    
    
    
    15,766Total current assets
    
    
    281,048
    
    
    
    250,707Gaming operations machines
    
    
    76,851
    
    
    
    76,283Less accumulated depreciation
    
    
    (53,233
    )
    
    
    (48,693
    )Gaming operations machines, net
    
    
    23,618
    
    
    
    27,590Property, plant and equipment
    
    
    81,591
    
    
    
    72,986Less accumulated depreciation
    
    
    (27,955
    )
    
    
    (22,773
    )Property, plant and equipment, net
    
    
    53,636
    
    
    
    50,213Other assets
    
    
    29,083
    
    
    
    22,466Total assets
    
    $
    387,385
    
    
    $
    350,976
 See notes to condensed consolidated financial statements. 4




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WMS INDUSTRIES INC. CONDENSED CONSOLIDATED BALANCE SHEETS  March 31,
    
    June 30,2004
    
    2003(Unaudited)LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    19,302
    
    
    $
    10,717Accrued compensation and related benefits
    
    
    5,129
    
    
    
    3,065Other accrued liabilities
    
    
    14,355
    
    
    
    16,009Total current liabilities
    
    
    38,786
    
    
    
    29,7912.75% Convertible subordinated notes due 2010
    
    
    115,000
    
    
    
    100,000Commitments and contingencies (See note 8 and 9)Stockholders equity:Preferred stock (5,000,000 shares authorized, none issued)
    
    
    
    
    
    
    Common stock (100,000,000 shares authorized and
32,358,315 shares issued)
    
    
    16,179
    
    
    
    16,179Additional paid-in capital
    
    
    204,340
    
    
    
    197,009Retained earnings
    
    
    42,179
    
    
    
    43,958Accumulated other comprehensive income
    
    
    1,225
    
    
    
    1,107Unearned restricted stock (29,912 shares)
    
    
    (316
    )
    
    
    (298
    )Treasury stock, at cost (2,285,644 shares and
2,882,995 shares, respectively)
    
    
    (30,008
    )
    
    
    (36,770
    )Total stockholders equity
    
    
    233,599
    
    
    
    221,185Total liabilities and stockholders equity
    
    $
    387,385
    
    
    $
    350,976
 See notes to condensed consolidated financial statements. 5




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WMS INDUSTRIES INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS   Nine Months EndedMarch 31,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIESNet loss
    
    $
    (1,779
    )
    
    $
    (3,125
    )Adjustments to reconcile net loss to net
cash (used) provided by operating activities:Depreciation and amortization
    
    
    19,010
    
    
    
    20,704Receivables provision
    
    
    159
    
    
    
    10Deferred income taxes
    
    
    (1,070
    )
    
    
    261Non-cash expenses
    
    
    749
    
    
    
    485Tax benefit from exercise of stock options
    
    
    5,185
    
    
    
    141Non-cash write off of licensed technology
    
    
    
    
    
    
    3,150Decrease from changes in operating
assets and liabilities
    
    
    (48,827
    )
    
    
    (6,887
    )Net cash (used) provided by operating activities
    
    
    (26,573
    )
    
    
    14,739CASH FLOWS FROM INVESTING ACTIVITIESPurchase of property, plant and equipment
    
    
    (8,605
    )
    
    
    (10,192
    )Additions to gaming operations machines
    
    
    (9,121
    )
    
    
    (15,591
    )Net change in short-term investments
    
    
    2,489
    
    
    
    11,274Net cash used by investing activities
    
    
    (15,237
    )
    
    
    (14,509
    )CASH FLOWS FROM FINANCING ACTIVITIESGross proceeds from the issuance of convertible notes
    
    
    15,000
    
    
    
    Debt issuance costs
    
    
    (743
    )
    
    
    Cash received on exercise of common stock options
    
    
    9,532
    
    
    
    211Purchase of treasury stock
    
    
    (5,009
    )
    
    
    (21,371
    )Net cash provided (used) by financing activities
    
    
    18,780
    
    
    
    (21,160
    )EFFECT OF EXCHANGE RATES ON CASH
    
    
    118
    
    
    
    521Decrease in cash and cash equivalents
    
    
    (22,912
    )
    
    
    (20,409
    )Cash and cash equivalents at beginning of period
    
    
    99,640
    
    
    
    31,421Cash and cash equivalents at end of period
    
    $
    76,728
    
    
    $
    11,012
 See notes to condensed consolidated financial statements. 6




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WMS INDUSTRIES INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  1. FINANCIAL STATEMENTS The accompanying unaudited condensed consolidated financial statements of WMS
Industries Inc. (WMS, we, us or the Company) have been prepared in
accordance with generally accepted accounting principles for interim
financial information, the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(including normal recurring accruals) considered necessary for a fair
presentation have been included. Sales of our gaming machines to casinos are generally strongest in the spring
and slowest in the summer months. In addition, quarterly revenues and net
income may increase when we receive a larger number of approvals for new
games from regulators than in other quarters, when a game that achieves
significant player appeal is introduced or if gaming is permitted in a
significant new jurisdiction. Operating results for the quarter ended March
31, 2004 are not necessarily indicative of the results that may be expected
for the fiscal year ending June 30, 2004. For further information, refer to
the consolidated financial statements and notes thereto included in our
Annual Report on Form 10-K for the year ended June 30, 2003. Data for product sales and gaming operations is only maintained on a
consolidated basis as presented in our consolidated
financial statements, with no additional separate data maintained for
product sales and gaming operations (other than the
revenue and costs of revenues information included in the consolidated
statement of operations and cost of gaming machines
and related accumulated depreciation included in the consolidated balance
sheet). 2. PRINCIPAL ACCOUNTING POLICIES Consolidation Policy Our condensed consolidated financial statements include the accounts of WMS
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated. We account for our joint operating
agreement with International Game Technology (IGT) for the SURVIVORthemed
wide-area progressive (WAP) systems, for which no legal entity exists, in
our consolidated financial statements by recording our proportionate share of
revenues and expenses from operating activities and the full value of all of
the assets we own and liabilities we owe related to this agreement. The
purpose of the joint operating agreement is to combine our licensing rights
and game design expertise with the proprietary WAP system of IGT. Under the
agreement, we designed and marketed specified games, which were manufactured
by IGT and placed in casinos on IGTs WAP system. In January 2004, the
remaining SURVIVORWAP themed system was shut down. The total assets, total
liabilities, total revenues and total expenses related to the joint operating
agreement were not material to our consolidated financial statements for the
periods presented. Certain prior period balances have been reclassified to conform to the
current period presentation. Use of Estimates The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles. Such
preparation requires management to make estimates and assumptions that
affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Cash and Cash Equivalents, and Restricted Cash All highly liquid investments with maturities of three months or less when
purchased are considered to be cash equivalents.
Restricted cash of $470,000 and $2.3 million at March 31, 2004 and June
30, 2003, respectively, was required for funding
WAP systems jackpot payments. 7




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Short-Term Investments All investments are recorded at cost, which approximates market value.
Short-term investments consist principally of Auction
Market Preferred Stocks that generally have no fixed maturity dates but
have dividend reset dates generally every 49 days or
more. Accounts Receivable, Notes Receivable and Allowance for Doubtful Accounts We carry our accounts and notes receivable at face amounts less an
allowance for doubtful accounts. On a periodic basis, we
evaluate our receivables and establish the allowance for doubtful accounts
based on a combination of specific customer
circumstances, credit conditions and our history of write-offs and
collections. Our policy is to generally not charge interest on
trade receivables after the invoice becomes past due. A receivable is
considered past due if payments have not been received
within agreed upon invoice terms. With regard to notes receivable,
interest income is recognized ratably over the life of the
note receivable and any related fees or costs to establish the notes are
charged to expense as incurred, as they are considered to
be insignificant. Inventories Inventories are valued at the lower of cost (determined by the first-in,
first-out method) or market. Freight and Warehousing Costs Freight-out and warehousing costs are included in costs of product sales
and costs of gaming operations in the statement of
operations. Software Development Costs As a result of the gaming license requirements and regulatory approvals
necessary to commercialize products in our business, our products
reach technological feasibility shortly before products are released to
manufacturing. Accordingly, research and development costs are expensed as
incurred, including software development costs. We do not incur any material
software development costs after we receive regulatory approval. We account for amounts paid to third parties for purchased or licensed
software related to our technology improvement plan
under Statement of Financial Accounting Standards No. 86,  Accounting
for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed. Under these arrangements, we have
alternative future uses for purchased software related to
our technology improvement plan and we generally have the right to
sub-license this software to other third parties.
See Note 8 of the notes to Consolidated Financial Statements. The implementation costs of our Oracle ERP system incurred during the
preliminary project stage were expensed; costs
incurred during the application development stages were capitalized and
costs incurred during the post-implementation /
operation stage were expensed. Due to the extensive use of external
consultants to minimize the burden on our internal staffing,
internal resources used during the application development phases were
limited and we have not capitalized internal costs. Long-Lived Assets Property, plant and equipment and gaming operations machines are stated at
cost and depreciated using the straight-line method over their estimated
useful lives. Significant replacements and improvements are capitalized.
Other maintenance and repairs are expensed. The annual provision for
depreciation has been computed in accordance with the following ranges of
asset lives: buildings and improvements 10 to 30 years; leasehold
improvements over the lease term; machinery and equipment three to eight
years, gaming operations machines two years, and furniture and fixtures 10
years. We review the carrying amount of long-lived assets whenever events or
changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. An impairment loss would be
recognized when estimated future cash flows
expected to result from the use of the asset and its eventual disposition
are less than its carrying amount. When an impairment
loss is to be recognized for an asset, it is measured by comparing the
carrying value to the fair value. Fair value is generally
measured as the present value of estimated future cash flows. 8




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Goodwill and indefinite lived intangible assets are not amortized but are
reviewed annually, or more frequently if an event
occurs or circumstances change, for indications that the asset might be
impaired. Any impairment loss is charged to expense in
the period in which such loss is determined. Identified intangible assets
with finite lives, including licensed technology and
patents, are amortized using the straight line method over their estimated
useful lives. We continually evaluate the
reasonableness of the useful lives of these assets, and any change in the
lives assigned to amortizable assets will impact results
of operations. Other assets include royalty and licensing advances made in connection
with licensing agreements we have for the use of third
party intellectual property. When the products using the licensed
intellectual property or technology begin to generate revenue,
we begin amortization of the amount advanced. In cases where the advance
represents a paid up license, the advance is
amortized based on the estimated life of the asset. In those cases where
the license agreement provides for a royalty to be
earned by the licensor for each gaming device sold or placed on a lease,
the advance is amortized based on the royalty rates
provided in the license agreement. In both cases the amortization of the
advances are included in cost of sales if related to a
product sale or cost of gaming operations if related to placement or lease
of gaming operations. To the extent we determine
that the products developed would not fully recover the guaranteed minimum
amounts, we would record an immediate charge
against earnings at the time of such determination. Revenue Recognition We record revenue on product sales, net of rebates, discounts and
allowances, when persuasive evidence of an
agreement exists, the sales price is fixed or determinable, the product
is delivered and collectibility is reasonably assured.
When multiple product deliverables are included under a sales contract, we
allocate revenue to each product based upon
their respective fair values against the total contract value and defer
revenue recognition on those deliverables where we
have not met all requirements of revenue recognition. Gaming operations revenues under operating type lease agreements are
estimated and recognized as earned when collectibility
is reasonably assured. Lease agreements are based on either a
pre-determined percentage of the daily net win of each gaming
machine or a fixed daily rental fee. WAP revenues are recognized based
upon a percentage of amounts wagered, called
coin-in, on each gaming machine and are recognized as earned when
collectibility is reasonably assured. Under agreements with licensees who are generally located in geographic or
other markets where we are not active, we are paid
royalties based upon our licensees purchase or placement of gaming
devices with our licensed themes, artwork and other
intellectual property. Royalties are recorded as earned when
collectibility is reasonably assured. Advertising Expense The cost of advertising is charged to expense as incurred. Research and Development Costs As a result of the gaming license requirements and regulatory approvals
necessary to commercialize products in our
business, our products reach technological feasibility shortly before
products are released to manufacturing. Accordingly,
research and development expenditures relating to the development of new
products, including improvements to existing
products, are expensed as incurred. Foreign Currency Translation The local currency is the functional currency (primary currency in which
business is conducted) for our operations in Canada,
Spain, Australia and South Africa. Adjustments resulting from translating
foreign functional currency assets and liabilities into
U.S. dollars are recorded in a separate component of stockholders equity.
Gains or losses resulting from transactions in other
than the functional currency are reflected in net income. Accounting for Income Taxes We account for income taxes using the asset and liability method. Under
this method, income taxes are provided for amounts
currently payable and for amounts deferred as tax assets and liabilities
based upon differences between the financial statement 9




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carrying amounts and the tax bases of existing assets and liabilities.
Deferred income taxes are measured using the enacted tax
rates that are assumed will be in effect when the differences reverse. Earnings per share The reconciliation of the numerators and denominators of the basic and
diluted earnings per share was: Three Months Ended March 31, 2004Per ShareIncome
    
    Shares
    
    Amount(in thousands, except per share amounts)Basic EPSEarnings applicable to common
stock
    
    $
    466
    
    
    
    29,904
    
    
    $
    0.02Effect of dilutive securities: options
    
    
    
    
    
    
    900
    
    
    
     restricted stock
    
    
    
    
    
    
    30
    
    
    
    Diluted EPSEarnings applicable to common
stock
    
    $
    466
    
    
    
    30,834
    
    
    $
    0.02
 Recently Issued Accounting Standards In December 2003, the FASB issued SFAS No. 132, Employers Disclosures
about Pensions and Other Postretirement
Benefits. This statement revises the requirements for employers
disclosures about pension and other postretirement benefit plans. The
statement is effective for fiscal years beginning after December 15, 2003. We
have two frozen defined benefit pension plans related to former businesses
that we have previously accounted for as discontinued operations. We adopted
SFAS No. 132 effective January 1, 2004 and such adoption did not have an
impact on our disclosures as the provisions of SFAS No. 132 indicate it
should not be applied to immaterial amounts. 3. STOCK OPTION COMPENSATION AND EARNINGS (LOSS) PER SHARE We have elected to continue to follow APB Opinion No. 25 to account for stock
options granted to employees and directors, as allowed by SFAS No. 123,
Accounting for Stock Based Compensation. Under APB No. 25, we do not
recognize compensation expense because the option terms are fixed and the
exercise price equals the market price of the underlying stock on the grant
date. The following table presents a comparison of the reported net income (loss),
net income (loss) per share and compensation cost of options granted to
employees to the pro forma amounts that would have been reported if stock
option compensation expense had been determined using the fair value method
allowed by SFAS No. 123 (in thousands of dollars, except per share amounts): Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003As Reported:Net income (loss)
    
    $
    466
    
    
    $
    (1,948
    )
    
    $
    (1,779
    )
    
    $
    (3,125
    )Income (loss) per share:Basic
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )Diluted
    
    $
    0.02
    
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )Stock based employee compensation cost, net of related tax
effects, included in the determination of net income
(loss)
    
    $
    12
    
    
    $
    
    
    
    $
    238
    
    
    $
    
 10




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Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Pro forma amounts if the fair value method had been
applied to all stock compensation awards:Pro forma net loss
    
    $
    (1,006
    )
    
    $
    (3,699
    )
    
    $
    (8,220
    )
    
    $
    (8,165
    )Pro forma net loss per share:Basic
    
    $
    (0.03
    )
    
    $
    (0.12
    )
    
    $
    (0.28
    )
    
    $
    (0.27
    )Diluted
    
    $
    (0.03
    )
    
    $
    (0.12
    )
    
    $
    (0.28
    )
    
    $
    (0.27
    )Stock based employee compensation cost, net of related
tax effects, that would have been included in the
determination of net loss
    
    $
    1,484
    
    
    $
    1,751
    
    
    $
    6,679
    
    
    $
    5,040
 The following weighted average assumptions were used to value the options in
the periods indicated: Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    3.25
    %
    
    
    3.25
    %
    
    
    3.25
    %
    
    
    3.70
    %Expected life
    
    6 years
    
    6 years
    
    6 years
    
    6 yearsExpected volatility
    
    
    .54
    
    
    
    .44
    
    
    
    .54
    
    
    
    .44Expected dividend yield
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
 At March 31, 2004 and 2003, the Company had approximately 3,520,000 and
3,610,000 stock options and warrants
outstanding, respectively. Effective March 1, 2002, we issued a restricted stock grant of 250,000 shares
of common stock held in treasury to Mr. Louis
J. Nicastro, Chairman of our Board of Directors and a non-employee director.
On May 7, 2003, we purchased Mr. Nicastros
rights to the 250,000 restricted shares for a purchase price of $14.00 per
share. The diluted loss per share calculation
for the three and nine months ended March 31, 2003 does not include the 250,000
shares under the restricted stock grant. On June 11, 2003, the Board of Directors approved a grant of restricted
stock of 7,478 shares to each of four officers in
lieu of any cash bonuses for fiscal 2003. The restricted shares will vest on
June 11, 2004, subject to the individuals
continued employment with WMS. The 29,912 shares of unearned restricted
stock were not included in the computation of
diluted loss per share for the nine months ended March 31, 2004. The following summarizes the stock options exercised during the periods
indicated: Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Stock options exercised
    
    
    261,062
    
    
    
    1,500
    
    
    
    896,451
    
    
    
    37,046Weighted average exercise price
    
    $
    13.43
    
    
    $
    10.06
    
    
    $
    10.63
    
    
    $
    5.67
 For the periods presented, if WMS had recognized income, the total diluted
shares outstanding would have increased based upon the hypothetical assumed
exercise of stock options and warrants under the treasury stock method and, if
sufficient income had been earned, the conversion of our 2.75% convertible
subordinated notes. The following table describes the number of additional
shares that would have been included in the total diluted shares outstanding
assuming the hypothetical exercise of stock options and warrants under the
treasury stock method and the conversion of our 2.75% convertible subordinated
notes: 11




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003If WMS had recognized income:Impact of incremental stock options and
warrants that
would have resulted in additional diluted shares outstanding under the treasury stock method
    
    Not applicable
    
    
    143,000
    
    
    
    856,000
    
    
    
    186,000If WMS had recognized income in excess of $0.084
and
$0.252, respectively, per share:Common stock issued upon conversion of the 2.75%
convertible subordinated notes
    
    
    5,813,953
    
    
    
    
    
    
    
    5,813,953
    
    
    
    Excluded anti-dilutive common stock equivalents
due to the option grant price exceeding the
market price for WMS common stock:Stock options and warrants
    
    
    250,000
    
    
    
    2,628,000
    
    
    
    667,500
    
    
    
    2,578,000
  4.
    
    SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in thousands of dollars) Nine Months EndedMarch 31,2004
    
    2003Supplemental Disclosure of Cash Flow Information:Income taxes paid
    
    $
    311
    
    
    $
    305Income tax refunds received
    
    $
    1,661
    
    
    $
    6,164Interest paid
    
    $
    1,757
    
    
    $
    Investment income received
    
    $
    1,136
    
    
    $
    1,066Schedule of Non Cash Investing Activities:Issuance of 250,000 stock warrants to licensor
    
    $
    3,905
    
    
    $
    Gaming operations machines transferred
to inventory
    
    $
    735
    
    
    $
    875
 5. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) consists of net income (loss) and foreign currency
translation adjustments and totaled net income (loss) of
$399,000 and ($2.2) million for the three months ended March 31, 2004 and 2003, respectively, and
totaled a loss of ($1.7) million and ($2.6) million for the nine months ended
March 31, 2004 and 2003, respectively. 6. LINE OF CREDIT AND CONVERTIBLE SUBORDINATED NOTES We are currently negotiating
to renew our unused line of credit for $50.0 million under a
revolving credit agreement due May 21, 2004 for a one-year term. No borrowings occurred on this line during the
nine months ended March 31, 2004 or during fiscal year 2003. In June 2003, we issued $100 million of convertible subordinated notes bearing
interest at 2.75% maturing on July 15, 2010. In July 2003, we issued an
additional $15 million of convertible subordinated notes under identical terms
to cover an over-allotment option granted to the initial purchasers of the
notes. The notes are convertible at any time into an aggregate of 5,813,953
shares of our common stock at a conversion price of $19.78 per share, subject
to adjustment. The notes are subordinated in right of payment 12




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##### Table of Contents



to all existing and future senior debt and are effectively subordinated to all
of the indebtedness and liabilities of our subsidiaries. The notes are not
callable. We pay interest on the notes semi-annually on January 15 and July 15
of each year, which commenced on January 15, 2004. None of the holders have
converted any of their convertible subordinated notes into our common stock. We have no maturities of debt or sinking fund requirements through July 15,
2010. 7. STOCKHOLDERS EQUITY Common Stock Repurchase Program In January 2002, our Board of Directors authorized a $20 million plan to
repurchase our common stock in open market transactions from time to time. In
the nine months ended March 31, 2003, 1,022,500 shares were repurchased under
this plan for $11.4 million. By July 31, 2002, this repurchase program was
completed. In total, we repurchased 1,568,000 shares, or approximately 5% of
the previously outstanding shares under this $20 million plan. In September 2002, our Board of Directors authorized a twelve-month plan to
repurchase up to an additional $10 million of our common stock in open market
transactions. As of March 31, 2003, this repurchase plan was completed with
833,200 shares purchased for a cost of $10.0 million during the nine months
ended March 31, 2003. In April 2003, our Board of Directors authorized a new twelve-month plan to
repurchase up to an additional $10 million of our
common stock from time to time in open market or privately negotiated
transactions. In June 2003, in conjunction with the
completion of our private placement of convertible subordinated notes due 2010
to qualified institutional buyers, our Board of
Directors authorized the expansion of this repurchase plan to $25 million.
During the fiscal year ended June 30, 2003, we
repurchased 493,200 shares for an aggregate price of $7.5 million under this
plan. During the nine months ended March 31, 2004, we purchased 299,100 shares
of our common stock on the open market for $5.0 million at an average price of
$16.75 per share. No shares were repurchased since the September 30, 2003
quarter. This plan has now expired. Since the initial buyback program was authorized in January 2002, we have
repurchased 3,193,500 shares, or 9.9% of the previous number of shares
outstanding, for a total expenditure of $42.5 million at an average price of
$13.31 per share. At March 31, 2004, we had 30.1 million shares outstanding. Warrant Grant In September 2003, our Board of Directors, as part of the inducement to a
licensor to extend their license agreement with us, approved a grant of
250,000 common stock purchase warrants valued at $3.9 million. The warrants
exercise price is $35.04 per share of our common stock, subject to adjustment.
The warrants are non-cancelable and vest with respect to 20% of the underlying
shares in each year commencing on January 1, 2007 until fully vested on January
1, 2011, subject to earlier vesting under specified circumstances. The warrants
expire on September 14, 2013. In valuing the warrants, we used the Black-Scholes model and incorporated the
following assumptions: risk free rate - 4.15%; expected volatility  - .54;
expected life - 10 years; and expected dividend - zero. The risk-free rate is
determined based on the interest rate of U.S. Government treasury obligations
with a maturity date comparable to the life of the warrants issued. Other
assumptions, relating to the warrants life, strike price and our common stock
price, were determined at the date the warrants were issued. We recognize
expense based on the terms of the underlying license agreement. 8. COMMITMENTS AND CONTINGENCIES We routinely enter into license agreements with others for the use of their
intellectual properties in our products. These agreements generally provide for
royalty advances when the agreements are signed, and provide for minimum
guaranteed royalty payments as well as additional contingent payments based on
future events. In the September 2003 quarter, we amended licensing agreements
and entered into new licensing agreements, which significantly increased our
total potential royalty commitments. The total potential royalty commitments at
March 31, 2004 increased to $68.9 million from $29.6 million at June 30, 2003.
The total potential future royalty payments at March 31, 2004 increased to
$39.0 million from $13.0 million at June 30, 2003. At March 31, 2004, we had
total royalty commitments, advances and payments made, and potential, future
royalty payments as follows:  13




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##### Table of Contents



At March 31, 2004TotalGuaranteed
    
    Contingent
    
    PotentialMinimums
    
    Payments
    
    Payments(in thousands)Total royalty commitments
    
    $
    64,880
    
    
    $
    4,063
    
    
    $
    68,943Advances and payments made
    
    
    (29,929
    )
    
    
    
    
    
    
    (29,929
    )Future royalty payments
    
    $
    34,951
    
    
    $
    4,063
    
    
    $
    39,014
 Of the $29.9 million total advances and payments through March 31, 2004, $6.8
million has been charged to expense and the remaining $23.1 million is included
in the March 31, 2004 balance sheet with $5.7 million in other current assets
and $17.4 million in other assets. As of March 31, 2004, we estimate that potential future royalty payments in
each fiscal year will be as follows: TotalGuaranteed
    
    Contingent
    
    PotentialYear Ended June 30,
    
    Minimums
    
    Payments
    
    Payments(in thousands)2004
    
    $
    610
    
    
    $
    2,338
    
    
    $
    2,9482005
    
    
    5,816
    
    
    
    1,250
    
    
    
    7,0662006
    
    
    6,025
    
    
    
    475
    
    
    
    6,5002007
    
    
    4,900
    
    
    
    
    
    
    
    4,9002008
    
    
    4,400
    
    
    
    
    
    
    
    4,400Thereafter
    
    
    13,200
    
    
    
    
    
    
    
    13,200Total
    
    $
    34,951
    
    
    $
    4,063
    
    
    $
    39,014
 Subsequent to March 31, 2004, we entered into a new licensing agreement with
contractual obligations totaling $20.0 million, due $4.0 million annually
for each of the next five years. As part of our technology improvement plan, we
have licensed technologies from third parties. At March 31, 2004, we had
incurred guaranteed minimum payments related to such technologies aggregating
$4.1 million, all of which had been paid as advances. These amounts are
included in the table above. An additional $1.4 million of contingent payments
may become payable based on future events. If we determine that we will not
realize the value of a particular licensed technology, we will record an
immediate charge against earnings at the time of such determination. If all of
the contingent payments became due and all of the technologies were to have no
further value to us, we would record a charge of up to $5.5 million. 9. LITIGATION On May 18, 2001, La Societe de Loteries du Quebec (Loto-Quebec) was served with
a class action lawsuit alleging that the members of the class developed a
pathological gambling addiction by using Loto-Quebecs video lottery terminals
(VLTs) and that Loto-Quebec, as owner, operator and distributor of VLTs, failed
to warn players of the alleged dangers associated with VLTs. Class status was
granted by the Superior Court, Province of Quebec, District of Quebec on May 6,
2002, authorizing Jean Brochu to act as the representative plaintiff. The class
of 119,000 members is requesting damages totaling almost $700 million Canadian
dollars, plus interest. On October 2, 2003, Loto-Quebec filed a claim against us and Video Lottery
Consultants Inc., a subsidiary of IGT (VLC), alleging that, in the event that
the class action plaintiffs are successful in the pending class action lawsuit
against Loto-Quebec, Loto-Quebec is entitled to be indemnified by the
manufacturers of the VLTs, specifically us and VLC. We filed our appearance on
October 16, 2003 and are currently proceeding with discovery. We intend to
vigorously defend ourselves against the allegations. At this time, we are
unable to predict the outcome of these actions, or a reasonable estimate of the
range of possible loss, if any, given the status of the litigation. 14




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As used in this quarterly report on Form 10-Q, the terms we, us, our, and
WMS mean WMS Industries Inc., a Delaware corporation, and its subsidiaries.
Gaming operations, as used throughout this report, includes the gaming
machines that we lease, based upon any of the following payment methods: (1) a
percentage of the net win of the gaming machines, (2) fixed daily fees, or (3)
in the case of wide-area progressive gaming machines, a percentage of the
amount wagered, called coin-in. OVERVIEW Our historical product sales strength has been in the multi-line, multi-coin
video product line, which, together with our VLT product, accounted for
substantially all of our new product sales for the past three fiscal years.
Our strategy is to become a full service gaming device provider to casinos by
developing and obtaining regulatory approval for three additional product
lines:  
    
    mechanical reel games,
    
    video poker games and
    
    wide-area progressive (WAP) systems. We believe these new product lines account for approximately 75% of the typical
casino slot floor and represent a significant market share growth opportunity
for us. As a result of software anomalies that were present in our legacy operating
system that ran our gaming devices, in January 2002, we began to execute a
technology improvement plan to first stabilize and then modernize our operating
system software. Customers were apprised of this technology improvement plan
and our intention to introduce our new Bluebirdgaming cabinet and new
CPU-NXTcomputer circuit board and operating system that would provide
features and functionality that our existing products lacked. As a result,
since January 2002, our product sales revenues have declined from levels
experienced in fiscal 2000 and 2001. As we have received regulatory approvals
throughout fiscal 2004 for our new CPU-NXTcomputer circuit board and operating
system,new Bluebirdcabinet and new games from each of the six North American
gaming labs, our product sales revenues have increased, and we expect that they
will continue to grow as we receive additional approvals. In fiscal 2005, 2006
and 2007, with all of the approvals in hand for all of our product lines, well
look to achieve growing market share with our new product lines: mechanical
reel, video poker and wide area progressive jackpots. Technology Improvement Plan In the first phase of this plan, we improved the stability of our operating
system by introducing two upgrades, version 2.57 for hopper-based games and
version 2.59 for printer-based games. Version 2.57 has been approved by all six
of the North American gaming labs, and we were required to and completed an
upgrade of our hopper game operating system to version 2.57 in four
jurisdictions. Gaming Laboratories International, Inc. (GLI) has recently
required us to complete an upgrade of hopper-based games to version 2.57 by
August 2004. The GLI lab tests product for all of the Native American casinos
and the Midwest riverboat casinos where in the aggregate we believe about 50%
of our existing gaming devices are deployed. Other jurisdictions may require
upgrades in the future. We are making version 2.57 available in other
jurisdictions as an optional upgrade. GLI approved version 2.59, our printer
upgrade version, in March 2003. The Nevada gaming authorities approved version
2.59 in September 2003. We have installed version 2.59 in several riverboat and
Native American casinos, which use GLI, and will be upgrading all of our
printer gaming machines installed in casinos in Nevada and GLI to version 2.59.
Nevada and GLI are currently the only jurisdictions requiring all printer games
be upgraded to version 2.59. Other jurisdictions may require upgrades in the
future, and we are making version 2.59 available in other approved
jurisdictions as an optional upgrade. The second phase of our technology improvement plan is to introduce our new
CPU-NXTcomputer circuit board and operating system, and this phase of the plan
continues on schedule. The commercial version of CPU-NXTwas approved by GLI in
September 2003 when we also received GLI approval for nine game themes on this
new system. We can currently ship Bluebirdhopper-based video gaming devices
to customers in GLI markets, Detroit, Michigan, Mississippi, New Jersey, and
Nevada. We can ship Bluebirdgaming devices using each of the
ticket-in-ticket-out printer systems to customers in GLI markets, Detroit,
Michigan casinos, Mississippi and for the Acres and Quickets
ticket-in-ticket-out systems to customers in Nevada and the ACSC and EZ Pay
ticket-in-ticket-out systems in New Jersey. During the third quarter, we
shipped our first Bluebird video games to customers in Nevada and Detroit,
Michigan. We expect to receive approvals for the SDS e-Ticket
ticket-in-ticket-out system in New Jersey by June 30th, along with the start of
the field trial for CPU-NXT, Bluebirdand ticket-in-ticket-out technology in 15




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##### Table of Contents



Ontario. We still have several hardware peripheral options, such as alternative
coin handling, printing and bill accepting equipment for which we also expect
to receive approvals by June 30th. We are evaluating specifications and requirements for an even more advanced
gaming system that will be developed during the third phase of the technology
improvement plan. We continue to refine the design and specifications to
incorporate additional features we desire for this platform and continue to
allocate resources to this longer-term effort. Bluebirdand CPU-NXTCommercialization Our focus in the near term is to refresh our existing installed base of more
than 50,000 video gaming devices in casinos through either replacement with
Bluebirdvideo gaming devices or through CPU-NXTupgrade kits. We received
approval from GLI for the marketable version of the Bluebirdvideo cabinet at
the end of November 2003. We have now completed lab testing in the other five
North American gaming labs. In Nevada and Ontario, we need to complete a field
trial for ticket-in ticket-out printer devices. In Ontario we also have to
complete a field trial for the CPU-NXToperating system and Bluebirdcabinet,
which is being conducted concurrently with the field trial for the ticket-in
ticket-out printer devices. Each jurisdictional approval of the CPU-NXT
operating system also allows us to submit new games designed for use with that
system to the regulators for approval, which enables us to sell and ship
additional CPU-NXTupgrade kits. We still have several hardware peripheral
options, such as alternative coin handling, printing and bill accepting
equipment that we are in the midst of receiving approvals for. We expect to
complete substantially all of these field trials and receive regulatory
approvals by June 30, 2004. Customer acceptance of Bluebirdvideo gaming devices and our new game themes
continues to appear very favorable. Since we started selling Bluebirdvideo
gaming devices in September 2003, we have executed corporate agreements or
issued sales orders for 16,152 Bluebirdvideo gaming devices and CPU-NXTkits,
addressing roughly one-third of the 50,000 plus WMS legacy video gaming devices
in casinos. Through March 31, 2004, 4,705 of these orders had been shipped, or
approximately 9% of the 50,000 WMS legacy gaming devices. These agreements are
with multi-jurisdictional casino operators such as Harrahs, Argosy, Ameristar,
Boyd, Caesars, Stations, Majestic Star, Pinnacle, Aztar, Mandalay Bay and
Isle of Capri, along with a number of tribal and individual casino properties.
We expect order levels to continue at a strong pace now that the first Bluebird
video gaming devices and new games are generating strong performance data, and
we have additional jurisdictional approvals. We also expect strength in game
conversion revenues over the next several months as operators see the value and
performance benefits of our CPU-NXTupgrade kits and printer upgrades. Product Line Expansion Plan In January 2004, we received Nevada regulatory approval for our new mechanical
reel product and three new game themes: two wide area progressive system game
themes and one for sale game theme. We received GLI approval for our
mechanical reel product and three new game themes in March 2004. For our new
mechanical reel product line, we have completed regulatory testing for the
operating system and the modifications for the Bluebirdgaming cabinet in all
six of the North American gaming labs. After receiving customer feedback, we
have, however, delayed the launch of this product line until the September 2004
quarter in order to be able to offer nine initial game themes at once. We
believe it is prudent for us to cluster nine new titles together to
successfully launch this important new product line. We expect to complete
field trials of the ticket-in-ticket-out systems on the mechanical reel
spinning product in time for this important product launch. For our new poker products, our first poker game, 3 WAY ACTION, has been
submitted to GLI and we expect to receive approval in early July so we can ship
product to customers in GLI territories in the September 2004 quarter. The field trials of our wide-area progressive (WAP) system began the first week
of February 2004 in Nevada and the last week of March 2004 for the Native
American WAP link in GLI territories. We recently received Nevada Gaming
Control Board approval for our WAP system and are on the agenda later this
month to obtain approval from the Nevada Gaming Commission. We expect to launch
the product in Nevada in late May 2004, one month earlier than our original
expectation. We continue to expect to receive GLI approval for our new
progressive jackpot system in June 2004 with a product launch in GLI
territories in July 2004. Brand Licenses During the September 2003 quarter, we extended our agreement with Hasbro, Inc.
for the use of their MONOPOLY®brand through calendar year 2011. We launched
one new MONOPOLYthemed participation game in the March 2004 quarter and
expect to introduce another new MONOPOLYthemed participation game by June
2004 and to launch our proprietary WAP systems featuring the MONOPOLY Money
progressive jackpot in June 2004. 16




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##### Table of Contents



In the March 2004 quarter, we launched the fourth game in the HOLLYWOOD
SQUARES themed series of participation games called Tour of Stars. In
September 2003, we announced our agreement with Sony Pictures Consumer Products
to develop, market and distribute MEN IN BLACKbranded games. We plan to
introduce this new series of participation games in our new Bluebirdcabinet
beginning later in our June 2004 quarter. We also plan to launch MATCH GAME
in our new Bluebirdcabinet later in the June 2004 quarter. MATCH GAMEwill be
the first game in our new Classic TV Game Show series of participation games.
In October 2003, we entered into an exclusive agreement to develop, market and
distribute games using the lottery brand POWERBALL®that we intend to develop
as a wide-area progressive game. Class II Gaming With respect to Class II gaming, we continue to evaluate what is in the best
long-term interest of our stockholders. With the popularity of our game library
and Bluebirdcabinet, we are fortunate to have many alternatives to pursue this
market. In the meantime, we continue to actively participate in the Class II
market through content licensing and OEM manufacturing with the two largest
Class II providers. We continue to monitor activity as we finalize our
long-term strategy for this growing market. CRITICAL ACCOUNTING POLICIES During the quarter ended December 31, 2003, we added revenue recognition as a
new critical accounting policy, in addition to those policies reported in our
Annual Report on Form 10-K for the year ended June 30, 2003. We have not made
any changes in the application of this or any other policy. The application of revenue recognition policies has become more critical due to
the variety of product sales contracts that we now use. We record revenue on
product sales, net of rebates, discounts and allowances, when persuasive
evidence of an agreement exists, the sales price is fixed or determinable, the
product is delivered and collectibility is reasonably assured. When multiple
product deliverables are included under a sales contract, we allocate revenue
to each product based upon their respective fair values against the total
contract value and defer revenue recognition on those deliverables where we
have not met all requirements of revenue recognition. Gaming operations revenues under operating type lease agreements are estimated
and recognized as earned when collectibility is reasonably assured. Lease
agreements are based on either a pre-determined percentage of the daily net win
of each gaming machine or a fixed daily rental fee. WAP revenues are
recognized based upon a percentage of amounts wagered, called coin-in, on each
gaming machine and are recognized as earned when collectibility is reasonably
assured. Under agreements with licensees who are generally located in geographic or
operate in other markets where we are not active, we are paid royalties based
upon our licensees purchase or placement of gaming devices with our licensed
themes, artwork and other intellectual property. Royalties are recorded as
earned when collectibility is reasonably assured. The application of this policy affects the level of our sales revenue, cost of
product sold, accounts receivable, deferred revenue and accrued expenses. During the quarter ended March 31, 2004, we added income tax accounting as a
new critical accounting policy, in addition to those policies reported in our
Annual Report on Form 10-K for the year ended June 30, 2003. We have not made
any changes in the application of this or any other policy. We account for income taxes using the asset and liability method. Under this
method, income taxes are provided for amounts currently payable and for amounts
deferred as tax assets and liabilities based upon differences between the
financial statement
carrying amounts and the tax bases of existing assets and liabilities. Deferred
income taxes are measured using the enacted tax
rates that are assumed will be in effect when the differences reverse. At June 30, 2003, we had $1.2 million of research and development tax credit
carry-forwards expiring from 2021 through 2023, $1.3 million of foreign tax
credit carry-forwards expiring from 2006 through 2008, $22.1 million of state
operating loss carry-forwards expiring from 2008 through 2018, and $3.8 million
of federal operating loss carry-forwards expiring in 2023. At March 31, 2004 and June 30, 2003, we believe it is more likely than not that
we will realize the benefit of these net deferred tax assets, including the net
operating loss carry-forwards and research and development tax credit
carry-forwards. Accordingly, we believe that no valuation allowance is required
for the deferred tax assets. We consider the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. However, such valuation 17




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##### Table of Contents



allowances could be recorded against these deferred tax assets and charged
against income in future periods if our future estimates of amounts realizable
are reduced or if the timing of such realization extends beyond our current
expectations. The application of this policy affects the level of our tax expense, current
income tax receivables and liabilities, and current and non-current deferred
tax assets and liabilities. OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS We are not dependent on off-balance sheet financing arrangements to fund our
operations. We utilize financing arrangements for operating leases of equipment
and facilities, none of which are in excess of our current needs. We also have
minimum guaranteed royalty payments for intellectual property used in our
gaming machines. Our obligations under these arrangements and under our
convertible subordinated notes at March 31, 2004, were as follows: Payment Due by Period (in thousands)Less than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    5 YearsOperating Leases
    
    $
    4,447
    
    
    $
    1,149
    
    
    $
    1,571
    
    
    $
    742
    
    
    $
    985Royalty Payments
    
    
    34,951
    
    
    
    610
    
    
    
    11,841
    
    
    
    9,300
    
    
    
    13,200Convertible Subordinated Notes
    
    
    115,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115,000Other, Including Guaranteed Minimum Employment
Agreements
    
    
    9,020
    
    
    
    1,463
    
    
    
    7,557
    
    
    
    
    
    
    
    Total
    
    $
    163,418
    
    
    $
    3,222
    
    
    $
    20,969
    
    
    $
    10,042
    
    
    $
    129,185
 The total potential royalty commitments, including payments already made and
those contingent upon future events, increased from $13.0 million at June 30,
2003 to $39.0 million at March 31, 2004 due to new and amended brand licensing
agreements. Potential royalty commitments could continue to increase in the
future as we enter into new brand licensing agreements. Subsequent to March 31,
2004, we entered into a new licensing agreement with contractual obligations
totaling $20.0 million, due as follows: $4.0 million less than 1 year, $8.0
million 1-3 years, $8.0 million 3-5 years. We do not have any special purpose entities for investment or the conduct of
our operations. We have not entered into any derivative financial instruments,
although we have granted stock options and restricted stock to our employees,
officers, directors and consultants and warrants to a licensor, and we have
issued convertible subordinated notes. We do not currently have any significant
firm purchase commitments for raw material inventory. LIQUIDITY AND CAPITAL RESOURCES As ofMarch 31,
    
    June 30,
    
    Increase(in thousands of dollars)
    
    2004
    
    2003
    
    (Decrease)Total cash and short-term investments
    
    $
    133,050
    
    
    $
    160,307
    
    
    $
    (27,257
    )Total current assets
    
    
    281,048
    
    
    
    250,707
    
    
    
    30,341Total assets
    
    
    387,385
    
    
    
    350,976
    
    
    
    36,409Total current liabilities
    
    
    38,786
    
    
    
    29,791
    
    
    
    8,995Long-term debt
    
    
    115,000
    
    
    
    100,000
    
    
    
    15,000Stockholders equity
    
    
    233,599
    
    
    
    221,185
    
    
    
    12,414Net working capital
    
    
    242,262
    
    
    
    220,916
    
    
    
    21,346
 Our current sources of liquidity for the nine months ended March 31, 2004 were:  
    
    Existing cash, cash equivalents and short-term investments,
    
    $15 million cash received from the issuance of additional 2.75% convertible subordinated notes in July 2003,
    
    Non-cash expenses of $18.8 million more than offsetting our net loss of $1.8 million, and
    
    Proceeds from stock option exercises of $9.5 million, excluding related tax related benefits. We believe that cash and cash equivalents and short-term investments of $133.1
million at March 31, 2004, inclusive of $470,000 18




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##### Table of Contents



of restricted cash, will be adequate to fund our anticipated level of expenses,
capital expenditures, cash to be invested in gaming operations machines, and
the levels of inventories and receivables required in the operation of our
business. For the next twelve months, we do not expect to be dependent on cash
flow from operations and we do not expect to borrow any money under our
revolving credit line. In fiscal 2005, 2006 and 2007 we expect cash flow from
operations to increase significantly as we grow market share in our new product
lines: mechanical reel, poker and wide area progressive systems. We do not
believe we will need to raise additional capital in the short-term or
long-term, however we will assess market opportunities as they arise. We are currently negotiating to renew our unused line of credit for $50.0 million under a
revolving credit agreement due May 21, 2004 for a one-year term. We did not borrow any amounts on this line
during the nine months ended March 31, 2004 or during fiscal year 2003. Our short-term investments primarily consist of Auction Market Preferred Stocks
stated at cost, which approximates market value. These investments generally
have no fixed maturity date but most have dividend-reset dates every 49 days or
longer. These
investments can be liquidated under an auction process on the dividend-reset
dates subject to a sufficient number of bids being submitted. Our policy is to
invest cash with issuers that have high credit ratings and to limit the amount
of credit exposure to any one issuer. During the nine months ended March 31, 2004, our net working capital increased
primarily due to proceeds received from the issuance of $15.0 million of
additional convertible subordinated notes in July 2003. Accounts and notes
receivable, net, increased by $21.9 million due to higher new unit sales levels
during the nine months ended March 31, 2004. Inventory at March 31, 2004
increased by $27.5 million due to higher levels of raw materials as we prepared
for an increasing volume of business. Royalty advances increased by $6.0
million due to new technology and brand license agreements we entered into or
amended during the nine months ended March 31, 2004. Income tax receivables
decreased by $1.9 million primarily due to receipt of prior year tax refunds.
Current liabilities increased by $9.0 million due to higher accounts payable
reflecting higher inventory levels, partially offset by our payment to Midway
Games Inc. of a $4.0 million advance. We have not experienced significant bad
debt expense in any of the periods presented. We expect to continue to invest
in working capital through fiscal 2005 and 2006 albeit at a slower pace than we
have experienced in the nine months ended March 31, 2004. Due to our operating loss in fiscal 2003, we have recorded $5.8 million and
$7.7 million of current income tax receivables on our balance sheets as of
March 31, 2004 and at June 30, 2003, respectively. This tax receivable is based
on our ability to receive tax refunds from applying our fiscal 2003 tax loss
against prior years income and for refunds of tax payments made in fiscal
2003. We also have $16.8 million of deferred tax assets on our balance sheet as of
March 31, 2004, an increase of $7.6 million from June 30, 2003. These represent
taxable temporary differences expected to reverse in future years, and tax
credits and tax operating losses generated in fiscal 2003 and in the nine
months ended March 31, 2004, that can be claimed on future income tax returns
to reduce current tax due in those years. We believe it is more likely than not
that we will realize the benefits of these deferred tax assets. On this basis,
we have not provided any valuation allowance related to realizability of such
assets as of March 31, 2004. However, such valuation allowances could be
recorded against these deferred tax assets and charged against income in future
periods if our future estimates of amounts realizable are reduced or if the
timing of such realization extends beyond our current expectations. We have no material commitments for capital expenditures at March 31, 2004. We
utilize financing arrangements for operating leases of regional office
facilities and for some equipment. We have royalty commitments for brand and
technology licenses that are not recorded in our balance sheet. Our total
potential royalty commitments, including payments contingent upon future
events, increased from $29.6 million at June 30, 2003 to $68.9 million at March
31, 2004, of which $29.9 million has been paid. Please refer to the table under
Off-Balance Sheet Arrangements and Contractual Obligations above and Note 8
to our Condensed Consolidated Financial Statements in Item 1 above. In June 2003, we issued $100 million of convertible subordinated notes bearing
interest at 2.75% maturing on July 15, 2010. In July 2003, we issued an
additional $15 million of convertible subordinated notes under identical terms
to cover an over-allotment option granted to the initial purchasers of the
notes. The notes are convertible at any time into an aggregate of 5,813,953
shares of our common stock at a conversion price of $19.78 per share, subject
to adjustment. The notes are not callable. We pay interest on the notes
semi-annually on January 15 and July 15 of each year aggregating $3.2 million
annually, which commenced on January 15, 2004. Conversion of 2.75% convertible
subordinated notes into shares of common stock would reduce our annual interest
expense. The conversion of the 2.75% convertible subordinated notes to common
stock is dependent on individual holders choices to convert, which is
dependent on the spread of the market price of our stock above the conversion
strike price of $19.78 per share. None of the holders have converted any of
their convertible subordinated notes into our common stock. 19




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##### Table of Contents



Capital Resources The following table summarizes our sources and uses of cash for the periods
shown (in thousands of dollars): For the Nine Month PeriodEndedMarch 31,
    
    Increase2004
    
    2003
    
    (Decrease)Cash provided (used) by:Operating activities
    
    $
    (26,573
    )
    
    $
    14,739
    
    
    $
    (41,312
    )Investing activities
    
    
    (15,237
    )
    
    
    (14,509
    )
    
    
    (728
    )Financing activities
    
    
    18,780
    
    
    
    (21,160
    )
    
    
    39,940Effect of exchange rates on cash
    
    
    118
    
    
    
    521
    
    
    
    (403
    )Decrease in cash and cash equivalents
    
    $
    (22,912
    )
    
    $
    (20,409
    )
    
    $
    (2,503
    )
 Cash used by operating activities was $26.6 million for the nine months ended
March 31, 2004, as compared to cash provided of $14.7 million for the nine
months ended March 31, 2003. The current period decrease relative to the
comparable prior year period was due to $48.8 million of cash invested in
operating assets and liabilities due to growth of our business, compared to
$6.9 million of cash invested in operating assets and liabilities in the nine
months ended March 31, 2003. Depreciation expense provided $19.0 million of
cash to operations for the nine months ended March 31, 2004, as compared to
$20.7 million for the nine months ended March 31, 2003. We anticipate cash to
be provided by operations over the next twelve months, due to anticipated
higher revenues from increased new unit sales, partially offset by higher
research and development expenses related to the ongoing execution of our
technology improvement plan, product approval costs, product line expansion
costs and increased game offerings, as well as higher selling and
administrative costs due to the execution of the re-emergence plan. In
addition, we expect in fiscal 2005 and fiscal 2006 that our cash invested in
operating assets and liabilities will not continue to increase at the rate
experienced in the nine months ended March 31, 2004. Components of the $48.8 million and $6.9 million invested in operating assets
and liabilities for the nine month periods ended March 31, 2004 and 2003,
respectively, are as follows: (in thousands of dollars) For the Nine Month PeriodEndedMarch 31,
    
    Increase2004
    
    2003
    
    (Decrease)Changes in Operating Assets and Liabilities:Decrease (increase) in operating assets:Accounts and notes receivable
    
    $
    (21,878
    )
    
    $
    (650
    )
    
    $
    (21,228
    )Raw material and finished goods inventories
    
    
    (27,487
    )
    
    
    1,026
    
    
    
    (28,513
    )Income tax receivable
    
    
    1,943
    
    
    
    2,024
    
    
    
    (81
    )All other operating assets
    
    
    (10,400
    )
    
    
    (11,265
    )
    
    
    865Increase in operating liabilities:Current liabilities
    
    
    8,995
    
    
    
    1,978
    
    
    
    7,017Net (increase) in operating assets and liabilities
    
    $
    (48,827
    )
    
    $
    (6,887
    )
    
    $
    (41,940
    )
 For the nine months ended March 31, 2004, the increase in accounts and notes
receivable reflects an increasing trend in new unit sales, while raw material
inventories increased $26.9 million as we prepared for an increased volume of
business. The decrease in income tax receivable was primarily due to receipt of
prior year tax refunds. The increase in all other operating assets is due to
$6.0 million of royalty advances for new technology and brand license
agreements entered into or amended during the current nine months ended March
2004. The increase of current liabilities is due to higher accounts payable
reflecting higher inventory levels, partially offset by our payment to Midway
Games Inc. of a $4.0 million tax advance. For the nine months ended March 31, 2003, the cash invested in all other
operating assets was primarily due to an $11.1 million increase in long-term
royalty advances. The increase in royalty advances was due to new and amended
technology and brand license agreements entered into during the nine months
ended March 31, 2003. The reduction of current liabilities was due to a lower
level of business. The decrease in income taxes receivable was due to receipt
of prior years refunds. The decrease in inventories reflects lower sales levels
and activity during the period. 20




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##### Table of Contents



Cash used by investing activities was $15.2 million and $14.5 million for the
nine months ended March 31, 2004 and 2003, respectively. Cash used for the
purchase of property, plant and equipment for the nine months ended March 31,
2004 was $8.6 million compared with $10.2 million for the comparable prior year
period. Presently, we do not anticipate any significant changes in the general
trend of our capital expenditures for property plant and equipment in fiscal
years ending June 30, 2005, 2006 or 2007. Cash used for additions to gaming
operation machines was $9.1 million and $15.6 million for the nine months ended
March 31, 2004 and 2003, respectively. The current period investment in gaming
operation machines is lower because we have delayed investment until we receive
regulatory approval for new participation games installed in our new Bluebird
cabinet. We expect this investment to increase starting in the June 2004
quarter and continue for the fiscal years ending June 30, 2005, 2006 and 2007
as we roll out new participation games installed in our Bluebirdcabinet. Net
cash of $2.5 million was provided by the redemption of short-term investments
for the nine months ended March 31, 2004, compared to $11.3 million provided by
the redemption of such investments in the comparable prior year period.
Presently, we do not anticipate any significant changes in the general trend of
the redemption of investments during the fiscal years ending June 30, 2005,
2006 and 2007. Cash provided by financing activities was $18.8 million for the nine months
ended March 31, 2004 compared with cash used of $21.2 million for the
comparable prior year period. We received net cash of $14.3 million in July
2003 from the exercise of the over-allotment option relating to our convertible
subordinated notes. We also received $9.5 million and $0.2 million from the
exercise of stock options in the nine months ended March 31, 2004 and 2003,
respectively. The amount we receive from the exercise of stock options is
dependent on individuals choices to exercise options, which are dependent on
the spread of the market price of our stock above the strike price of vested
options. In the nine months ended March 31, 2004, we repurchased 299,100 shares of our
common stock for an aggregate price of $5.0 million, all of which was purchased
in the quarter ended September 30, 2003. Since the inception of our common
stock repurchase programs in January 2002 through March 31, 2004, we purchased
3,193,500 or 9.9% of our previously outstanding shares for an aggregate price
of $42.5 million, or $13.31 per share. At March 31, 2004, we had $12.5 million
remaining on the twelve month, $25 million share buyback program approved by
our Board of Directors in April 2003 and expanded in June 2003. This program
expired in April 2004. During the nine months ended March 31, 2003, we purchased $21.4 million of our
common stock for treasury. We completed our twelve-month, $20 million common
stock share repurchase program authorized by our Board of Directors in January
2002. In September 2002, our Board of Directors authorized an additional
twelve-month, $10 million common stock share repurchase program. During the
nine months ended March 31, 2003, we repurchased 1,022,500 shares for an
aggregate price of $11.4 million in completing the $20 million program, and
repurchased 833,200 shares for an aggregate price of $10 million under the $10
million program. 21




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##### Table of Contents



RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2004 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2003 Revenues, Gross Margins and Key Performance Indicators (in thousands of
dollars, except unit data): Three Months EndedMarch 31,
    
    Increase2004
    
    2003
    
    (Decrease)
    
    % ChangeProduct Sales:New unit sales revenue
    
    $
    34,526
    
    
    $
    12,944
    
    
    $
    21,582
    
    
    
    166.7
    %Parts, used games, conversions and OEM revenue
    
    
    8,127
    
    
    
    7,313
    
    
    
    814
    
    
    
    11.1Total product sales revenue
    
    $
    42,653
    
    
    $
    20,257
    
    
    $
    22,396
    
    
    
    110.6Total new units sold
    
    
    3,926
    
    
    
    1,601
    
    
    
    2,325
    
    
    
    145.2Average sales price per new unit
    
    $
    8,794
    
    
    $
    8,085
    
    
    $
    709
    
    
    
    8.8Total OEM units sold
    
    
    1,000
    
    
    
    500
    
    
    
    500
    
    
    
    100.0Gross profit on product sales revenue
    
    $
    17,702
    
    
    $
    7,441
    
    
    $
    10,261
    
    
    
    137.9Gross margin on product sales revenue
    
    
    41.5
    %
    
    
    36.7
    %
    
    
    4.8
    %
    
    
    13.1Gaming Operations Revenues:Total gaming operations revenue
    
    $
    21,157
    
    
    $
    21,524
    
    
    $
    (367
    )
    
    
    (1.7
    )Average installed base
    
    
    4,202
    
    
    
    5,336
    
    
    
    (1,134
    )
    
    
    (21.3
    )Installed base at period end
    
    
    4,216
    
    
    
    5,300
    
    
    
    (1,084
    )
    
    
    (20.5
    )Net revenue per day per machine
    
    $
    37.87
    
    
    $
    37.10
    
    
    $
    0.77
    
    
    
    2.1Gross profit on gaming operations revenue
    
    $
    16,774
    
    
    $
    16,899
    
    
    $
    (125
    )
    
    
    (0.7
    )Gross margin on gaming operations revenue
    
    
    79.3
    %
    
    
    78.5
    %
    
    
    0.8
    %
    
    
    1.0Total Revenues
    
    $
    63,810
    
    
    $
    41,781
    
    
    $
    22,029
    
    
    
    52.7Total Gross Profit
    
    $
    34,476
    
    
    $
    24,340
    
    
    $
    10,136
    
    
    
    41.6Total Gross Margin
    
    
    54.0
    %
    
    
    58.3
    %
    
    
    (4.3
    )%
    
    
    (7.4
    )%
 The increase in total revenues in the March 2004 quarter compared to the March
2003 quarter was due to $21.6 million in higher new gaming machine sales and a
$814,000 increase in parts, used games, conversion and OEM revenues, partially
offset by a $367,000 reduction in gaming operations revenues. New unit sales increased by 145% to 3,926 units as we shipped our new Bluebird
video gaming devices to additional jurisdictions after receiving additional
regulatory approvals and as we offered a higher number of new game themes. In
the March 2004 quarter, revenues from parts, used games, conversions and OEM
revenues increased 11.1% compared to the prior year quarter due to an increase
of 500 units sold under OEM agreements in the current quarter, and higher
levels of game conversion revenues as we received approvals over the last
several months to sell our new games and conversion kits with the CPU-NXT
operating system. The average sales price per new unit increased 8.8% as
higher priced Bluebirdunits more than offset lower priced video lottery
terminal sales during the March 2004 quarter. We expect continued growth in
the average selling price over the next two quarters, as the percentage of
Bluebirdunits sold becomes a higher percentage of our overall sales mix. The average installed base of participation gaming devices decreased to 4,202
units in the March 2004 quarter from 5,336 units in the March 2003 quarter,
while the net revenue per day increased by $0.77 per day from the prior year
quarter to $37.87 per day as we continued to refresh the installed base with
new games. The installed base declined from the March 2003 quarter due to the
fact that our legacy operating system does not support dual port cashless
gaming technology, and the performance of certain of our older participation
series has decreased. In January 2004, the last SURVIVOR themed wide area
progressive jackpot was terminated. We expect growth in our installed base of
participation games when we begin to install two new participation series,
complete with cashless technology  MEN IN BLACKand MATCH GAME on our new
Bluebirdcabinet later in the June 2004 quarter coupled with the late May 2004
launch of our first wide area progressive games in Nevada, subject to
regulatory approval. 22




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##### Table of Contents



Gaming operations revenues benefited from a 338% increase in royalty revenues
in the March 2004 quarter from the March 2003 quarter, primarily due to our
licensees increased purchases or placement of WMS games. Total gross profit increased to $34.5 million for the March 2004 quarter from
$24.3 million in the March 2003 quarter while total gross margin was 54% in the
March 2004 quarter compared to 58% in the March 2003 quarter. Higher margin
gaming operations revenues were only 33% of total revenues in the March 2004
quarter, compared to 52% in the March 2003 quarter due to the increase of
product sales revenue in the current year quarter and an overall decline of
gaming operations revenues. The gross margin on product sales was 42% for the
March 2004 quarter, up from 37% in the prior year quarter, reflecting higher
margin on the mix of products sold. We expect that the gross margin on the
Bluebirdgaming devices will improve as production volume increases because we
should be able to obtain larger volume discounts from our suppliers, and we
anticipate the cost of electrical components will decrease over time. The gross
profit margin on gaming operations remained at 79% in the March 2004 quarter
compared to 79% in the prior year quarter, as an increase in the average net
revenue per day and higher royalties received from licensees was offset by
higher royalty rates payable to licensors. Operating Expenses (in thousands of dollars): Three Months EndedMarch 31,2004
    
    2003As % of
    
    
    
    
    
    As % of
    
    Increase$
    
    Revenue
    
    $
    
    Revenue
    
    (Decrease)
    
    % ChangeResearch and development
    
    $
    11,857
    
    
    
    18.6
    %
    
    $
    9,949
    
    
    
    23.8
    %
    
    $
    1,908
    
    
    
    19.2
    %Selling and administrative
    
    
    14,776
    
    
    
    23.2
    
    
    
    12,925
    
    
    
    30.9
    
    
    
    1,851
    
    
    
    14.3Depreciation and
amortization
    
    
    6,596
    
    
    
    10.3
    
    
    
    6,659
    
    
    
    16.0
    
    
    
    (63
    )
    
    
    (0.9
    )$
    33,229
    
    
    
    52.1
    %
    
    $
    29,533
    
    
    
    70.7
    %
    
    $
    3,696
    
    
    
    12.5
    %
 Research and development expenses increased $1.9 million, or 19% to $11.9
million in the March 2004 quarter compared to $9.9 million in the prior year
quarter, due to ongoing execution of our technology improvement plan, product
approval costs, product line expansion costs and increased game offerings. With
higher regulatory approval costs and a greater number of product lines and game
theme offerings planned throughout fiscal 2004, we expect quarterly research
and development expenses to continue to exceed levels in the comparable prior
year quarters. Selling and administrative expenses increased $1.9 million, or 14%, to $14.8
million in the March 2004 quarter compared to $12.9 million in the March 2003
quarter, due to the ongoing execution of our re-emergence plan. We expect that
selling and administration expenses will increase as we continue to
commercialize the CPU-NXToperating system and Bluebirdcabinet, and continue
our product line expansion efforts. Depreciation and amortization expense decreased by $63,000, as the level of
investment in gaming devices for gaming operations has been lower than in prior
quarters as we await regulatory approvals for new games on Bluebirdcabinets.
We expect such investment to increase starting in the June 2004 quarter as we
prepare for the initial rollout of new participation games installed in our new
Bluebirdcabinet. We generated operating income of $1.2 million in the March 2004 quarter,
compared to an operating loss of $5.2 million in the March 2003 quarter. The
improved operating performance in the fiscal 2004 third quarter resulted from
the $10.1 million increase in gross profit and a decrease of $63,000 in
depreciation and amortization expenses, partially offset by a $1.9 million
increase in research and development expenses and $1.9 million increase in
selling and administrative expenses. We incurred interest expense of $956,000 in the March 2004 quarter related to
our 2.75% convertible subordinated notes issued in Summer 2003. This was
partially offset by $454,000 of other income, primarily interest and investment
income earned on cash and short-term investments, which at March 31, 2004
amounted to $133.1 million. Due to the issuance of our 2.75% convertible
subordinated notes, interest expense will increase in comparison to prior
years quarter for the June 2004 quarter. The benefit for income taxes, which includes both current and deferred taxes,
is based on our annual estimated effective tax rate of 37.5%, due to higher
expected foreign income in 2004. The effective income tax rate for the March
2003 quarter was 55.1% reflecting a benefit of $665,000 from a reduction in
prior year taxes, which were less than amounts previously provided. 23




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##### Table of Contents



Net income was $466,000 or $0.02 per diluted share for the current quarter
compared to net loss of $1.9 million, or $0.06 per diluted share, for the
prior year quarter. NINE MONTHS ENDED MARCH 31, 2004 COMPARED WITH NINE MONTHS ENDED MARCH 31, 2003 Revenues, Gross Margins and Key Performance Indicators (in thousands of
dollars, except unit data): Nine Months EndedMarch 31,
    
    Increase2004
    
    2003
    
    (Decrease)
    
    % ChangeProduct Sales:New unit sales revenue
    
    $
    77,124
    
    
    $
    36,292
    
    
    $
    40,832
    
    
    
    112.5
    %Parts, used games, conversions, and OEM revenue
    
    
    21,259
    
    
    
    20,790
    
    
    
    469
    
    
    
    2.3Total product sales revenue
    
    $
    98,383
    
    
    $
    57,082
    
    
    $
    41,301
    
    
    
    72.4Total new units sold
    
    
    9,019
    
    
    
    4,406
    
    
    
    4,613
    
    
    
    104.7Average sales price per new unit
    
    $
    8,551
    
    
    $
    8,237
    
    
    $
    314
    
    
    
    3.8Total OEM units sold
    
    
    1,000
    
    
    
    1,000
    
    
    
    
    
    
    
    Gross profit on product sales revenue
    
    $
    39,384
    
    
    $
    21,953
    
    
    $
    17,431
    
    
    
    79.4Gross margin on product sales revenue
    
    
    40.0
    %
    
    
    38.5
    %
    
    
    1.5
    %
    
    
    3.9Gaming Operations Revenues:Total gaming operations revenues
    
    $
    63,648
    
    
    $
    70,735
    
    
    $
    (7,087
    )
    
    
    (10.0
    )Average installed base
    
    
    4,535
    
    
    
    5,658
    
    
    
    (1,123
    )
    
    
    (19.8
    )Installed base at period end
    
    
    4,216
    
    
    
    5,300
    
    
    
    (1,084
    )
    
    
    (20.5
    )Net revenue per day per machine
    
    $
    39.09
    
    
    $
    38.51
    
    
    $
    0.58
    
    
    
    1.5Gross profit on gaming operations revenue
    
    $
    51,868
    
    
    $
    56,501
    
    
    $
    (4,633
    )
    
    
    (8.2
    )Gross margin on gaming operations revenue
    
    
    81.5
    %
    
    
    79.9
    %
    
    
    1.6
    %
    
    
    2.0Total Revenues
    
    $
    162,031
    
    
    $
    127,817
    
    
    $
    34,214
    
    
    
    26.8Total Gross Profit
    
    $
    91,252
    
    
    $
    78,454
    
    
    $
    12,798
    
    
    
    16.3Total Gross Margin
    
    
    56.3
    %
    
    
    61.4
    %
    
    
    (5.1
    )%
    
    
    (8.3
    )%
 The increase in total revenues was due to $40.8 million in higher new gaming
machine sales and a $469,000 increase in parts, used games, conversion and OEM
revenues, partially offset by a $7.1 million reduction in gaming operations
revenues. New unit sales in the March 2004 nine-month period increased by 105% to 9,019
units as we shipped our new Bluebirdvideo gaming devices after receiving
regulatory approvals from GLI in November 2003 and as we offered a higher
number of new game themes. Revenues from parts, used games, conversions and
OEM revenues increased 2.3% compared to the prior nine-month period due to
higher levels of game conversion kits sold as we began to receive new game
theme approvals over the last several months. The average installed base of participation gaming devices decreased to 4,535
units in the March 2004 nine-month period from 5,658 units in the March 2003
nine-month period, while the net revenue per day increased by $0.58 per day
from the prior year nine-month period to $39.09 per day as we began to refresh
the installed base with new games. The installed base declined from the March
2003 nine-month period due to the fact that our legacy operating system does
not support dual port cashless gaming technology, and the performance of
certain of our older series has decreased. In January 2004, the last SURVIVOR
wide area progressive jackpot was terminated. We expect growth in our installed
base of participation games when we begin to install two new participation
series, complete with cashless technology  MEN IN BLACKand MATCH GAMEon our
new Bluebirdcabinet later in the June 2004 quarter coupled with the May 2004
launch of our first wide area progressive games in Nevada, subject to
regulatory approval. Gaming operations revenues benefited from a 174% increase
in royalty revenues in the March 2004 nine-month period from the March 2003
nine-month period, primarily due to our licensees increased placement of WMS
games. 24




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Total gross profit increased by $12.8 million to $91.3 million for the March
2004 nine-month period from $78.5 million in the March 2003 nine-month period
while total gross margin was 56% in the March nine-month period compared to 61%
in the March 2003 nine-month period. Higher margin gaming operations revenues
were only 39% of total revenues in the March 2004 nine-month period, compared
to 55% in the March 2003 nine-month period due to the increase of product sales
revenue in the current year nine-month period and an overall decline of gaming
operations revenues. We expect that the gross margin on the Bluebirdgaming
devices will improve as production volume increases because we should be able
to obtain larger volume discounts from our suppliers, and we anticipate the
cost of electrical components will decrease over time. The gross margin on product sales was 40% and 38% for the March 2004 and March
2003 nine-month periods, respectively. The gross margin on gaming operations
was 81% in the March 2004 nine-month period compared to 80% in the prior year
nine-month period, due to an increase in the average net revenue per day,
higher royalties received from licensees and the sale of RAPID ROULETTE
assets previously fully reserved, partially offset by higher royalty rates
payable to licensors. Operating Expenses (in thousands of dollars): Nine Months EndedMarch 31,2004
    
    2003As % of
    
    
    
    
    
    As % of
    
    Increase$
    
    Revenue
    
    $
    
    Revenue
    
    (Decrease)
    
    % ChangeResearch and development
    
    $
    32,339
    
    
    
    20.0
    %
    
    $
    29,339
    
    
    
    23.0
    %
    
    $
    3,000
    
    
    
    10.2
    %Selling and administrative
    
    
    41,856
    
    
    
    25.8
    
    
    
    36,452
    
    
    
    28.5
    
    
    
    5,404
    
    
    
    14.8Depreciation and
amortization
    
    
    19,010
    
    
    
    11.7
    
    
    
    20,704
    
    
    
    16.2
    
    
    
    (1,694
    )
    
    
    (8.2
    )$
    93,205
    
    
    
    57.5
    %
    
    $
    86,495
    
    
    
    67.7
    %
    
    $
    6,710
    
    
    
    7.8
 Research and development expenses increased $3.0 million, or 10%, to $32.3
million in the March 2004 nine-month period compared to $29.3 million in the
prior year nine-month period, which included a $2.8 million write-off of an
operating system license. Excluding this write-off, research and development
expenses increased in the March 2004 nine-month period by $5.8 million due to
ongoing execution of our technology improvement plan, product approval costs,
product line expansion costs and increased game offerings. With higher
regulatory approval costs and a greater number of product lines and game theme
offerings planned, we expect quarterly research and development expenses to
continue to exceed levels in the comparable prior year quarters. Selling and administrative expenses increased $5.4 million, or 15%, to $41.9
million in the March 2004 nine-month period compared to $36.5 million in the
March 2003 nine-month period, due to the ongoing execution of our re-emergence
plan and the implementation of an Oracle ERP system. We expect that selling and
administration expenses will increase as we continue to commercialize the
CPU-NXToperating system and Bluebirdcabinet, and continue our product line
expansion efforts. Depreciation and amortization expense decreased by $1.7 million, as the level
of investment in gaming devices for gaming operations has been lower than in
prior comparable periods. We expect this investment to increase starting in
the June 2004 quarter as we prepare for the initial rollout of new
participation games installed in our new Bluebirdcabinet. We incurred an operating loss of $2.0 million in the March 2004 nine-month
period, compared to an operating loss of $8.0 million in the March 2003
nine-month period. The improved operating performance in the fiscal 2004
nine-month period resulted from the $12.8 million increase in gross profit and
the decrease of $1.7 million in depreciation and amortization expenses,
partially offset by the $3.0 million increase in research and development
expenses and the $5.4 million increase in selling and administrative expenses
described above. We incurred interest expense of $2.9 million in the March 2004 nine-month
period related to our 2.75% convertible subordinated notes issued in Summer
2003. This amount was partially offset by $2.0 million of other income,
primarily interest and investment income earned on cash and short-term
investments, which at March 31, 2004 amounted to $133.1 million. Due to the
issuance of our 2.75% convertible subordinated notes, interest expense will
increase in comparison to prior years quarter for the June 2004 quarter. The benefit for income taxes, which includes both current and deferred taxes,
is based on our annual estimated effective tax rate of 37.5%, due to higher
expected foreign income in 2004. The effective income tax rate for the March
2003 nine month period was 49.7% reflecting a benefit of $665,000 from a
reduction in prior year taxes, which were less than amounts previously
provided. 25




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Net loss was $1.8 million or $0.06 per diluted share for the current year
nine-month period compared to a net loss of $3.1 million, or $0.10 per diluted
share, for the prior year nine-month period. FORWARD LOOKING STATEMENTS AND RISK FACTORS This report contains forward-looking statements concerning our future business
performance, strategy, outlook, plans, liquidity, pending regulatory matters
and outcomes of contingencies including legal proceedings, among others.
Forward-looking statements may be typically identified by such words as may,
will, should, expect, anticipate, seek, believe, estimate, and
intend, among others. These forward-looking statements are subject to risks
and uncertainties that could cause our actual results to differ materially from
the expectations expressed in the forward-looking statements. Although we
believe that, the expectations reflected in our forward-looking statements are
reasonable, any or all of our forward-looking statements may prove to be
incorrect. Consequently, no forward-looking statements may be guaranteed. Factors which could cause our actual results to differ from expectations
include:  
    
    a delay or refusal by regulators to approve our new gaming
platforms, cabinet designs, game themes and related hardware and
software;
    
    a failure to obtain and maintain our gaming licenses and
regulatory approvals;
    
    an inability to introduce in a timely manner new games themes
and gaming machines or product lines that achieve and maintain market
acceptance;
    
    a software anomaly or fraudulent manipulation by third parties of our gaming machines and software;
    
    a failure to obtain the right to use, or an inability to adapt to the rapid development of new technologies; and
    
    an infringement claim seeking to restrict our use of material technologies. These factors and other factors that could cause our actual results to differ
from expectations are more fully described under Item 1. Business  Risk
Factors in our Annual Report on Form 10-K for the year ended June 30, 2003. We make no commitment to update any forward-looking statements, except as
required by law. You are advised, however, to consult any further disclosures
we make on related subjects in our recent Form 10-Q and 8-K reports filed with
the Securities and Exchange Commission. MONOPOLYis a trademark of Hasbro Inc. ©2004 Hasbro. All rights reserved.
Used with permission. MEN IN BLACK& ©2004 Columbia Pictures Industries, Inc. POWERBALLis a trademark of the Multi-State Lottery Association. Used with
permission. SURVIVORis a trademark of Survivor Productions LLC. HOLLYWOOD SQUARESis a trademark of King World Productions Inc. MATCH GAMEis a trademark of FremantleMedia Operations BV. Licensed by
FremantleMedia Licensing Worldwide. RAPID ROULETTEis a trademark of Stargames Corporation Limited and Crown
Limited. CPU-NXT, Bluebird, Classic TV Game Showand Tour of Starsare trademarks of WMS
Gaming Inc. All rights reserved. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are subject to market risks in the ordinary course of our business,
primarily associated with equity price, interest rate and foreign currency
fluctuations. We do not currently hedge any of these risks, or utilize
financial instruments for trading or other speculative purposes, because we do
not view these risks as material. 26




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Interest Rate Risk We have no exposure to interest rate risk from our 2.75% convertible
subordinated notes, but we have exposure to interest rate risk from our
short-term line of credit. The notes bear interest at a fixed rate and the
short-term line of credit bears interest at a variable rate. We have not
borrowed any amount under our short-term line of credit. Equity Price Risk As of March 31, 2004, we had $115 million of convertible fixed-rate debt with
an interest rate of 2.75% with a fair value of $166.3 million due to the
increase in the market value of our common stock underlying the conversion
provisions. Using a discounted cash flow model, we currently estimate that a 50
basis point change in the prevailing market interest rates would impact the
fair value of our convertible fixed rate debt by approximately $3.7 million,
assuming our stock price is held constant. This change in fair value would
have no effect on our cash flows or future results of operations. The fair
value of our convertible fixed-rate debt will fluctuate with changes in the
price of our common stock. Based on the number of shares underlying our
convertible debt, we currently estimate that a 10% change in our stock price,
assuming the prevailing market interest rates are held constant, would impact
the fair value of our convertible fixed rate debt by approximately $14.8
million. This change in fair value would have no effect on our cash flows or
future results of operations. Foreign Currency Risk During the quarter ended March 31, 2004, we had no changes in our foreign
currency risk. 
 ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, our Chief Executive Officer
and our Chief Financial Officer carried out an evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures, as
required by Rule 13a-15 under the Securities Exchange of 1934. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in ensuring that
material information about us and our subsidiaries, including the material
information required to be disclosed in our filings under the Exchange Act, is
recorded, processed, summarized and communicated to them as appropriate to
allow timely decisions regarding required disclosure. As a part of the ongoing implementation of an Oracle ERP system, we have
updated our internal controls over financial reporting as necessary to
accommodate any modifications to our business processes or accounting
procedures. There have not been any other changes in our internal controls
over financial reporting or in other factors that materially affected, or are
reasonably likely to materially affect internal controls over financial
reporting as of the end of the period covered by this report. 
 PART II  
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES On March 10, 2004, the Board of Directors voted by unanimous consent to amend
and restate our Companys By-laws. Prior to this action, our By-laws had not
been amended since June 26, 1996. The Board determined that it was in the best
interest of our Company to adopt the Amended and Restated By-laws to establish
certain procedures relating to our stockholder meetings, clarify certain rights
of our officers and directors and to reflect changes in the Delaware General
Corporation Law. The Amended and Restated By-laws have been filed as an exhibit
to this quarterly report. Material changes to the By-laws are outlined below: Meetings of Stockholders Special Meetings. Under our 1996 By-laws, special meetings of stockholders
could be called by our Board of Directors, President or upon the written
request of the holders of a majority of the outstanding shares of our voting
stock. Under our Amended and Restated By-laws, special meetings of stockholders
may only be called by our Board of Directors, Chairman of the Board or Chief
Executive Officer. Conduct of Meetings. Our Amended and Restated By-laws contain an additional
provision that provides a framework for the conduct of our stockholder meetings
including establishing agendas, maintaining order and determining items that
are properly 27




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brought before the stockholders. The Board of Directors believes that the
Amended and Restated By-laws provision will more clearly provide for the
orderly conduct of meetings of stockholders. Advance Notice of Stockholder Nominations and Proposals. The Amended and
Restated By-laws require that our stockholders submit director nominations and
other business to be considered at meetings of stockholders in accordance with
a specific advance notice procedure. No such procedure was contained in our
By-laws. The Amended and Restated By-laws provide a detailed notice procedure
with regard to the nomination of candidates for election as directors other
than by or at the direction of the Board at meetings of stockholders and with
regard to stockholder proposals to be brought before an annual meeting of
stockholders. Our Amended and Restated By-Laws provide that only persons who
are nominated by or at the direction of the Board, or by a stockholder who has
given timely prior written notice to our Corporate Secretary prior to the
meeting at which directors are to be elected, will be eligible for election as
directors. Our Amended and Restated By-Laws provide that stockholder proposals
must be submitted in writing in a timely manner in order to be considered at
any annual meeting. To be timely, notice for nominations or stockholder proposals for annual
meetings of stockholders must be received not less than 90 days nor more than
120 days prior to the first anniversary of the preceding years annual meeting;
provided, however, that in the event that the date of the annual meeting is
more than 30 days before or more than 70 days after such anniversary date,
notice by a stockholder must be delivered not earlier than the 120th day prior
to an annual meeting and not later than the 10th day following the day on which
we first publicly announce the date of the meeting. Under our Amended and Restated By-Laws, notice to the Company from a
stockholder who proposes to nominate a person at a meeting for election as a
director must contain information about that person, including age, business
and residence addresses, principal occupation, the class and number of shares
of common stock beneficially owned, the consent of such person to be nominated
and such other information as would be required to be included in a proxy
statement soliciting proxies for the election of the proposed nominee, and
certain information about the stockholder proposing to nominate that person.
Under our Amended and Restated By-Laws, notice relating to a stockholder
proposal must contain information about the proposal and about the stockholder
who proposes to bring the proposal before the meeting, including a
representation whether the stockholder intends to deliver a proxy statement or
form of proxy or otherwise solicit proxies in support of the stockholders
nomination or proposal. The purpose of the new nominating procedure is to afford the Board a meaningful
opportunity to consider the qualifications of the nominees proposed by our
stockholders during the period when the Board is focused on nominations. The
purpose of the new stockholder proposal procedures is to provide a more orderly
procedure for conducting annual meetings of stockholders and to provide the
Board with a meaningful opportunity to analyze the proposals and to decide
whether it is appropriate to either (i) include or omit the proposal or (ii)
inform stockholders, prior to a meeting, of any proposal to be introduced at a
meeting, together with any recommendation or the Boards position or belief as
to action to be taken with respect to a proposal, and to enable stockholders
better to determine whether they desire to attend a meeting or grant a proxy to
the Board as to the disposition of a proposal. Although the Amended and Restated By-laws do not give the Board and our
Nominating Committee any power to approve or disapprove stockholder nominations
for the election of directors or any other proposal submitted by stockholders,
the new provision may have the effect of precluding or making more difficult a
stockholder nomination for the election of directors or the submission by
stockholders of proposals at a particular stockholders meeting, because of the
specific timing and information requirements to be followed, and may discourage
a stockholder from conducting a solicitation of proxies to elect its own slate
of directors or otherwise attempting to obtain control of our Company, even if
the conduct of such solicitation or such attempt might be beneficial to us and
our stockholders. For these reasons, the new procedures may have an
anti-takeover effect. The Board, however, is not aware of any efforts to obtain
control of our Company, and the proposal of this measure is not in response to
any such efforts. Moreover, the procedures do provide a means for stockholder
nominations and stockholder proposals to be made. Qualification of Directors. Our 1996 By-laws provided that each director was
required to be at least 18 years of age. The Amended and Restated By-laws
provide that each director must to be at least 21 years of age and shall be
qualified to serve only for so long as no gaming commission, board or similar
regulatory or law enforcement authority has communicated to such individual or
the Company their determination that such individual is not suitable to be
licensed or not licensable by such authority. This provision would prevent any
person who is determined to not be suitable to be licensed or not licensable by
a gaming authority from serving on our Board of Directors in order to protect
our gaming licenses and ability to do business. Officers. The Amended and Restated By-laws contain descriptions of the offices
of Chief Executive Officer, Chief Operating Officer, Chief Financial Officer
and Executive Vice President, clarifying the roles and duties of such officers.
The 1996 By-laws did not contain descriptions of these officer positions. 28




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Indemnification. The Amended and Restated By-laws have been clarified with
respect to the indemnification of our officers and directors to the fullest
extent permitted under the Delaware General Corporation Law, including the
prepayment of expenses. The 1996 By-laws provided for similar indemnification
but did not contain as much detail as the Amended and Restated By-laws. The
Board believes that these clarifications were appropriate to enhance our
ability to attract qualified directors and officers in the future. Please see Exhibit 3.4 to this report for the complete text of the Amended and
Restated By-laws as adopted by our Board of Directors on March 10, 2004. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No.
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation of WMS dated
February 17, 1987; Certificate of Amendment dated January 28, 1993;
and Certificate of Correction dated May 4, 1994, incorporated by
reference to our Annual Report on Form 10-K for the year ended June
30, 1994.3.2
    
    Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of WMS, as filed with the Secretary of the State of
Delaware on February 25, 1998, incorporated by reference to our
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
1998.3.3
    
    Form of Certificate of Designations of Series A Preferred Stock,
incorporated by reference to our Registration Statement on Form 8-A
(File no. 1-8300) filed March 25, 1998 (the Form 8-A)3.4
    
    By-Laws of WMS, as amended and restated through March 10, 2004.4.1
    
    Rights Agreement dated as of March 5, 1998 between WMS and The Bank
of New York, as Rights Agent, incorporated by reference to the Form
8-A.4.2
    
    Indenture dated June 25, 2003 between WMS and BNY Midwest Trust
Company, and Form of Note incorporated by reference to Report on
Form 8-K filed June 25, 2003.10.1
    
    Amended and Restated Employment Agreement between WMS and Seamus
McGill dated February 24, 2004.31
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 (b) Reports on Form 8-K. (1) Current report on Form 8-K filed February 5, 2004, under Items 5, 7
and 12. 29




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. WMS INDUSTRIES INC.Dated: May 14, 2004
    By:
    /s/ Scott D.
SchweinfurthScott D. SchweinfurthExecutive Vice President,
Chief Financial Officer and Treasurer
(Principal Financial and Chief Accounting Officer) 30




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EXHIBIT INDEX ExhibitNo.
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation of WMS dated
February 17, 1987; Certificate of Amendment dated January 28, 1993;
and Certificate of Correction dated May 4, 1994, incorporated by
reference to our Annual Report on Form 10-K for the year ended June
30, 1994.3.2
    
    Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of WMS, as filed with the Secretary of the State of
Delaware on February 25, 1998, incorporated by reference to our
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
1998.3.3
    
    Form of Certificate of Designations of Series A Preferred Stock,
incorporated by reference to our Registration Statement on Form 8-A
(File No. 1-8300) filed March 25, 1998 (the Form 8-A).3.4
    
    By-Laws of WMS, as amended and restated through March 10, 2004.4.1
    
    Rights Agreement dated as of March 5, 1998 between WMS and The Bank
of New York, as Rights Agent, incorporated by reference to the Form
8-A.4.2
    
    Indenture dated June 25, 2003 between WMS and BNY Midwest Trust
Company and Form of Note, incorporated by reference to Report on
Form 8-K filed June 25, 2003.10.1
    
    Amended and Restated Employment Agreement between WMS and Seamus
McGill dated February 24, 2004.31
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 31