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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 December 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 þ     NO o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). YES þ     NO o Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date: 31,133,743 of common stock, $.50 par value, were outstanding at
February 4, 2005, excluding 1,231,460 shares held as treasury shares.




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##### Table of Contents



WMS INDUSTRIES INC. INDEX PageNumberPART I. FINANCIAL INFORMATION:ITEM 1.Condensed Consolidated Statements of Operations -Three months and six months ended December 31, 2004 and 2003
    
    
    3Condensed Consolidated Balance Sheets -
December 31, 2004 and June 30, 2004
    
    
    4Condensed Consolidated Statements of Cash Flows -
Six months ended December 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
    
    
    27ITEM 4.Controls and Procedures
    
    
    27PART II. OTHER INFORMATION:ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28ITEM 4.Submission of Matters to a Vote of Security Holders
    
    
    28ITEM 6.Exhibits
    
    
    29SIGNATURES
    
    
    30Form of Stock Option AgreementForm of Restricted Stock AgreementForm of Equity-Based Performance Award Agreement302 Certification of CEO and CFO906 Certification of CEO and CFO
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS WMS INDUSTRIES INC. 
 Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues:Product sales
    
    $
    69.4
    
    
    $
    30.8
    
    
    $
    122.8
    
    
    $
    55.7Gaming operations
    
    
    24.6
    
    
    
    20.7
    
    
    
    46.3
    
    
    
    42.5Total revenues
    
    
    94.0
    
    
    
    51.5
    
    
    
    169.1
    
    
    
    98.2Costs and expenses:Cost of product sales
    
    
    42.8
    
    
    
    18.9
    
    
    
    74.6
    
    
    
    34.1Cost of gaming operations
    
    
    5.0
    
    
    
    3.3
    
    
    
    9.6
    
    
    
    7.4Research and development
    
    
    13.5
    
    
    
    10.2
    
    
    
    25.6
    
    
    
    20.5Selling and administrative
    
    
    19.3
    
    
    
    13.5
    
    
    
    34.9
    
    
    
    27.1Depreciation and amortization
    
    
    8.7
    
    
    
    6.0
    
    
    
    15.5
    
    
    
    12.3Total costs and expenses
    
    
    89.3
    
    
    
    51.9
    
    
    
    160.2
    
    
    
    101.4Operating income (loss)
    
    
    4.7
    
    
    
    (0.4
    )
    
    
    8.9
    
    
    
    (3.2
    )Interest expense
    
    
    (1.0
    )
    
    
    (1.0
    )
    
    
    (2.0
    )
    
    
    (1.9
    )Interest income, other income and expense, net
    
    
    1.8
    
    
    
    0.8
    
    
    
    2.4
    
    
    
    1.5Income (loss) before income taxes
    
    
    5.5
    
    
    
    (0.6
    )
    
    
    9.3
    
    
    
    (3.6
    )Provision (benefit) for income taxes
    
    
    1.6
    
    
    
    (0.2
    )
    
    
    3.0
    
    
    
    (1.3
    )Net income (loss)
    
    $
    3.9
    
    
    $
    (0.4
    )
    
    $
    6.3
    
    
    $
    (2.3
    )Basic income (loss) per share of common stock
    
    $
    0.13
    
    
    $
    (0.01
    )
    
    $
    0.21
    
    
    $
    (0.08
    )Diluted income (loss) per share of common stock and
common stock equivalents
    
    $
    0.12
    
    
    $
    (0.01
    )
    
    $
    0.20
    
    
    $
    (0.08
    )Weighted-average common shares:Basic common stock outstanding
    
    
    30.6
    
    
    
    29.5
    
    
    
    30.4
    
    
    
    29.4Diluted common stock and common stock
equivalents
    
    
    37.6
    
    
    
    29.5
    
    
    
    31.4
    
    
    
    29.4
 See notes to condensed consolidated financial statements. 3




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WMS INDUSTRIES INC. 
 
 December 31,
    
    
    June 30,2004
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    24.4
    
    
    $
    59.9Restricted cash for progressive jackpots
    
    
    1.1
    
    
    
    0.5Short-term investments
    
    
    46.3
    
    
    
    55.871.8
    
    
    
    116.2Receivables, net of allowances of $2.7 and $2.6, respectively
    
    
    64.0
    
    
    
    52.5Notes receivable, current portion
    
    
    28.3
    
    
    
    17.8Inventories, at lower of cost (FIFO) or market:Raw materials and work-in-process
    
    
    77.6
    
    
    
    47.3Finished goods
    
    
    24.1
    
    
    
    18.1101.7
    
    
    
    65.4Other current assets
    
    
    29.0
    
    
    
    26.1Total current assets
    
    
    294.8
    
    
    
    278.0Gaming operations machines
    
    
    107.8
    
    
    
    80.4Less accumulated depreciation
    
    
    (70.5
    )
    
    
    (55.5
    )Gaming operations machines, net
    
    
    37.3
    
    
    
    24.9Property, plant and equipment
    
    
    87.6
    
    
    
    83.5Less accumulated depreciation
    
    
    (33.7
    )
    
    
    (29.8
    )Property, plant and equipment, net
    
    
    53.9
    
    
    
    53.7Other assets
    
    
    43.2
    
    
    
    38.4Total assets
    
    $
    429.2
    
    
    $
    395.0
 See notes to condensed consolidated financial statements. 4




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WMS INDUSTRIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of dollars, except share amounts) December 31,
    
    
    June 30,2004
    
    
    2004(Unaudited)LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    31.2
    
    
    $
    17.1Accrued compensation and related benefits
    
    
    5.4
    
    
    
    4.4Other accrued liabilities
    
    
    20.4
    
    
    
    19.0Total current liabilities
    
    
    57.0
    
    
    
    40.52.75% Convertible subordinated notes due 2010
    
    
    115.0
    
    
    
    115.0Commitments and contingencies (see Notes 10 and 11)Stockholders equity:Preferred stock (5,000,000 shares authorized, none issued)
    
    
    
    
    
    
    Common stock (100,000,000 shares authorized
and 32,365,203 shares issued)
    
    
    16.2
    
    
    
    16.2Additional paid-in capital
    
    
    214.8
    
    
    
    206.7Retained earnings
    
    
    49.4
    
    
    
    43.1Accumulated other comprehensive income
    
    
    2.0
    
    
    
    1.0Unearned compensation from restricted stock (329,160 shares
at December 31, 2004 and 52,312 shares at June 30, 2004)
    
    
    (8.8
    )
    
    
    (1.3
    )Treasury stock, at cost (1,249,160 shares at December 31, 2004
and 1,998,905 shares at June 30, 2004)
    
    
    (16.4
    )
    
    
    (26.2
    )Total stockholders equity
    
    
    257.2
    
    
    
    239.5Total liabilities and stockholders equity
    
    $
    429.2
    
    
    $
    395.0
 See notes to condensed consolidated financial statements. 5




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WMS INDUSTRIES INC. 
 
 Six Months EndedDecember 31,2004
    
    
    2003CASH FLOWS FROM OPERATING ACTIVITIESNet income (loss)
    
    $
    6.3
    
    
    $
    (2.3
    )Adjustments to reconcile net income (loss) to net cash used
by operating activities:Depreciation and amortization
    
    
    15.5
    
    
    
    12.3Receivables provision
    
    
    0.1
    
    
    
    0.2Deferred income taxes
    
    
    3.0
    
    
    
    (1.3
    )Non-cash expenses
    
    
    1.5
    
    
    
    0.6Tax benefit from exercise of stock options
    
    
    2.7
    
    
    
    3.7Decrease from changes in operating assets and liabilities
    
    
    (53.3
    )
    
    
    (30.8
    )Net cash used by operating activities
    
    
    (24.2
    )
    
    
    (17.6
    )CASH FLOWS FROM INVESTING ACTIVITIESPurchase of property, plant and equipment
    
    
    (4.2
    )
    
    
    (6.0
    )Additions to gaming operations machines
    
    
    (24.3
    )
    
    
    (6.5
    )Net change in short-term investments
    
    
    9.5
    
    
    
    2.6Net cash used by investing activities
    
    
    (19.0
    )
    
    
    (9.9
    )CASH FLOWS FROM FINANCING ACTIVITIESCash received on exercise of common stock options
    
    
    6.8
    
    
    
    6.0Gross proceeds from the issuance of convertible notes
    
    
    
    
    
    
    15.0Debt issuance costs
    
    
    
    
    
    
    (0.7
    )Purchase of treasury stock
    
    
    
    
    
    
    (5.0
    )Net cash provided by financing activities
    
    
    6.8
    
    
    
    15.3EFFECT OF EXCHANGE RATES ON CASH
    
    
    0.9
    
    
    
    0.2Decrease in cash and cash equivalents
    
    
    (35.5
    )
    
    
    (12.0
    )Cash and cash equivalents at beginning of period
    
    
    59.9
    
    
    
    99.6Cash and cash equivalents at end of period
    
    $
    24.4
    
    
    $
    87.6
 See notes to condensed consolidated financial statements. 6




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WMS INDUSTRIES INC. 
 
 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 and six months ended December 31, 2004 are not
necessarily indicative of the results that may be expected for the fiscal year ending June 30,
2005. For further information, refer to the consolidated financial statements and notes thereto
included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2004. 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. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION 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.
Certain prior period balances have been reclassified to conform to the current period presentation. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) revised FASB Statement No. 123,
Accounting for Stock-Based Compensation. This Statement supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees, and its related implementation guidance. This Statement establishes
standards for the accounting for transactions in which an entity exchanges instruments for goods or
services. It also addresses transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the entitys equity instruments or that may
be settled by the issuance of those equity instruments. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in share-based payment
transactions. The provisions of this Statement are effective as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. We are currently evaluating
the two methods of adoption allowed by this Statement, the modified-prospective transition method
and the modified-retrospective transition method. We currently estimate the quarterly impact of
adopting this Statement will range from approximately $0.04 to $0.06 decrease in net income per
diluted share. In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary Assets, an amendment
of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The amendments made by Statement
153 are based on the principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for
nonmonetary exchanges of similar productive assets and replace it with a broader exception for
exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29
required that the accounting for an exchange of a productive asset for a similar productive asset
or an equivalent interest in the same or similar productive asset should be based on the recorded
amount of the asset relinquished. This Statement is effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. Adoption of this Statement is not
expected to have a significant effect on the Companys consolidated results of operations, cash
flows or financial position. 7




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In November 2004, the FASB issued Statement No. 151, Inventory Costs  an amendment of ARB No. 43,
Chapter 4, Inventory Pricing. This Statement clarifies the accounting for some circumstances in
which, items such as idle facility expense, excessive spoilage, double freight, and rehandling
costs may be so abnormal as to require treatment as current period charges. This Statement is
effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Adoption
of this Statement is not expected to have a significant effect on the Companys consolidated
results of operations, cash flows or financial position. In December 2004, the FASB issued a FASB Staff Position 109-1, Application of FASB Statement No.
109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided
by the American Jobs Creation Act of 2004 (the Act). The Act provides a tax deduction on
qualified production activities. The FASB Staff Position 109-1 provides that the deduction should
be accounted for as a special deduction in accordance with FASB Statement No. 109. We adopted FASB
Staff Position 109-1 in the quarter ended December 31, 2004 and the impact was not significant to
the Companys consolidated results of operations, cash flows or financial position. In December 2004, the FASB issued a FASB Staff Position 109-2, Accounting and Disclosure Guidance
for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.
FASB Staff Position 109-2 introduces a special one-time dividends received deduction on the
repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met.
This Position is effective upon issuance. We are currently evaluating FASB Staff Position 109-2 to
determine its impact on our future financial statements, which is expected to be immaterial. 3. EARNINGS (LOSS) PER SHARE The reconciliation of the numerators and denominators of the basic and diluted earnings per share
was
(in millions, except per share amounts): Three Months Ended
    
    
    Six Months EndedDecember 31, 2004
    
    
    December 31, 2004Net
    
    
    
    
    
    
    Per Share
    
    
    Net
    
    
    
    
    
    
    Per ShareIncome
    
    
    Shares
    
    
    Amount
    
    
    Income
    
    
    Shares
    
    
    AmountBasic earnings per share:Earnings applicable to common stock
    
    $
    3.9
    
    
    
    30.6
    
    
    $
    0.13
    
    
    $
    6.3
    
    
    
    30.4
    
    
    $
    0.21Effect of dilutive securities:- options
    
    
    
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    0.9
    
    
    
    (0.01
    )- warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - convertible notes
    
    
    0.6
    
    
    
    5.8
    
    
    
    (0.01
    )
    
    
    
    
    
    
    
    
    
    
    - restricted stock
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    Diluted earnings per share:Earnings applicable to common stock
    
    $
    4.5
    
    
    
    37.6
    
    
    $
    0.12
    
    
    $
    6.3
    
    
    
    31.4
    
    
    $
    0.20
 Three Months Ended
    
    
    Six Months EndedDecember 31, 2003
    
    
    December 31, 2003Net
    
    
    
    
    
    
    Per Share
    
    
    Net
    
    
    
    
    
    
    Per Share(Loss)
    
    
    Shares
    
    
    Amount
    
    
    (Loss)
    
    
    Shares
    
    
    AmountBasic loss per share:Loss applicable to common stock
    
    $
    (0.4
    )
    
    
    29.5
    
    
    $
    (0.01
    )
    
    $
    (2.3
    )
    
    
    29.4
    
    
    $
    (0.08
    )Effect of dilutive securities:- options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - convertible notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted loss per share:Loss applicable to common stock
    
    $
    (0.4
    )
    
    
    29.5
    
    
    $
    (0.01
    )
    
    $
    (2.3
    )
    
    
    29.4
    
    
    $
    (0.08
    )
 8




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For the three months and six months ended December 31, 2003, 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. In addition, for the six months
ended December 31, 2004 and the three months and six months ended December 31, 2003, if sufficient
income had been earned, the total diluted shares outstanding would have assumed 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 (in
millions): Three Months Ended
    
    Six Months EndedDecember 31,
    
    December 31,2004
    
    2003
    
    2004
    
    2003If WMS had recognized income:Impact of incremental stock options that would have resulted
in additional diluted shares outstanding under the treasury stock method
    
    not
    
    
    
    notapplicable
    
    0.8
    
    applicable
    
    0.7If WMS had recognized income in excess of $0.10 and $0.20
per share, respectively:Common stock issuable upon conversion of the 2.75%
    
    notconvertible subdinated notes
    
    applicable
    
    5.8
    
    5.8
    
    5.8Excluded anti-dilutive common stock equivalents due to the
grant price exceeding the market price for WMS common stock:Stock options and warrants
    
    0.6
    
    0.3
    
    0.8
    
    0.6
 4. STOCK OPTION COMPENSATION AND EARNINGS (LOSS) PER SHARE We have elected to continue to follow the intrinsic value based method prescribed by 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 upon the issuance of stock options because the option terms are fixed and the exercise
price equals the market price of the underlying stock on the grant date. The following tables present a comparison of the reported net income (loss), net income (loss) per
share and compensation cost of restricted stock and options granted to employees to the pro forma
amounts that would have been reported if compensation
expense had been determined using the fair value method allowed by SFAS No. 123 for the periods
presented (in millions of dollars, except per share data): Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003As Reported:Net income (loss)
    
    $
    3.9
    
    
    $
    (0.4
    )
    
    $
    6.3
    
    
    $
    (2.3
    )Income (loss) per share:Basic
    
    $
    0.13
    
    
    $
    (0.01
    )
    
    $
    0.21
    
    
    $
    (0.08
    )Diluted
    
    $
    0.12
    
    
    $
    (0.01
    )
    
    $
    0.20
    
    
    $
    (0.08
    )
 9




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Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,Stock based employee compensation cost, net of related tax
effects, included in the determination of net income (loss)
    
    $
    0.4
    
    
    $
    0.1
    
    
    $
    0.6
    
    
    $
    0.2Pro forma amounts if the fair value method had been applied
to all stock compensation awards:Pro forma net income (loss)
    
    $
    2.5
    
    
    $
    (1.8
    )
    
    $
    2.3
    
    
    $
    (7.2
    )Pro forma net income (loss) per share:Basic
    
    $
    0.08
    
    
    $
    (0.06
    )
    
    $
    0.07
    
    
    $
    (0.25
    )Diluted
    
    $
    0.08
    
    
    $
    (0.06
    )
    
    $
    0.07
    
    
    $
    (0.25
    )Stock based employee compensation cost, net of related tax
effects, that would have been included in the determination
of net income (loss)
    
    $
    1.8
    
    
    $
    1.5
    
    
    $
    4.6
    
    
    $
    5.1
 The following weighted average assumptions were used to value the options in the periods indicated: Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Risk-free interest rate
    
    
    4.75
    %
    
    
    3.25
    %
    
    
    4.75
    %
    
    
    3.25
    %Expected life
    
    6 years
    
    6 years
    
    6 years
    
    6 yearsExpected volatility
    
    
    0.36
    
    
    
    0.54
    
    
    
    0.36
    
    
    
    0.54Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 At December 31, 2004 and 2003, the Company had approximately 4.4 and 3.8 million stock options and
warrants outstanding, respectively. In December 2004, the Board of Directors approved the award of 276,848 shares of restricted stock,
with a weighted average fair value at grant date of $8.4 million, including 84,913 shares to our
non-employee Chairman of the Board of Directors and 134,435 shares to certain executive officers
under WMS 2005 Incentive Plan, subject to the individuals continued involvement with WMS. The
restricted stock awards are not performance based and vest equally over a three-year period ending
in December 2007. Under these restricted grants, grantees are entitled to any cash dividends and
to vote their shares, but may not sell or transfer their shares during the vesting period. In January 2005, the Board of Directors approved 52,164 stock-based performance awards under the
WMS 2005 Incentive Plan to certain participants including 33,863 shares to our executive officers.
The stock-based performance awards contain performance goals set by the Board based on levels of
total revenue and free cash flow for the Company over the thirty-month period ending June 30, 2007.
The number of shares of stock awarded to the participant upon the achievement of the performance
goals is dependent on the extent to which each goal is achieved or exceeded. In September 2004, the Board of Directors approved a Director emeritus program for existing
directors who reach age 75 or have served on the Board of Directors for at least 20 years. The
emeritus program is being phased in to maintain continuity and avoid losing the benefit of valuable
experience. In December 2004, 32,000 fully vested five year stock options were issued to two
directors emeritus upon their retirement from the Board. In valuing the stock options at $0.4
million, we used the Black-Scholes model and incorporated the following assumptions: risk free
rate  4.75%; expected volatility  .356; expected life  5 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 stock options issued. Other assumptions,
relating to the stock options life, exercise price and our common stock price were determined at
the date the stock options were issued. 10




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In December 2004, we paid and expensed $0.7 million to our President and Chief Executive Officer
under an obligation to compensate him for deferring a stock option grant from August 2004 for
100,000 shares of our common stock pursuant to his employment agreement. The payment was
calculated as the difference between the stock price in August 2004 on the date the President and
CEO agreed to the deferral and the stock price on the actual grant date in December 2004. In May 2004, 52,312 shares of restricted stock with a weighted average fair value at grant date of
$1.5 million were granted to certain of our executive officers and vice presidents, subject to the
individuals continued employment with WMS, in lieu of any cash bonuses for fiscal 2004. Under
these restricted grants, grantees are entitled to any cash dividends and to vote their shares, but
may not sell or transfer their shares during the one-year vesting period. In June 2003, 29,912 shares of restricted stock with weighted average fair value at grant date of
$0.5 million were granted to four officers in lieu of any cash bonuses for fiscal 2003. The
restricted shares vested on June 11, 2004. The 29,912 shares of unearned restricted stock were not
included in the computation of diluted loss per share for the three and six months ended December
31, 2003. The following summarizes the stock options exercised during the periods indicated (in millions
except per share data): Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Stock options exercised
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.5
    
    
    
    0.6Weighted average exercise price per share
    
    $
    14.22
    
    
    $
    10.33
    
    
    $
    14.35
    
    
    $
    9.48
 5. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions) Six Months EndedDecember 31,2004
    
    
    2003Supplemental Disclosure of Cash Flow Information:Income taxes paid
    
    $
    
    
    
    $
    0.2Income tax refunds received
    
    
    0.1
    
    
    
    0.3Interest paid
    
    
    1.6
    
    
    
    Investment income received
    
    
    0.7
    
    
    
    0.8Schedule of Non Cash Investing Activities:Issuance of 250,000 stock warrants to licensor
    
    
    
    
    
    
    3.9Gaming operations machines transferred to inventory
    
    
    0.5
    
    
    
    0.2
 6. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) consists of net income (loss) and foreign currency translation
adjustments and totaled a net income (loss) of $4.9 million and ($11,000) for the three months
ended December 31, 2004 and 2003, respectively, and totaled a net income (loss) of $7.3 million and
($2.1) million for the six months ended December 31, 2004 and 2003, respectively. 11




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7. INTANGIBLE ASSETS At December 31, and June 30, 2004 intangibles assets were (in millions): December 31,
    
    
    June 30,2004
    
    
    2004Prepaid royalties and licensing advances
    
    $
    41.0
    
    
    $
    37.2Accumulated amortization
    
    
    (10.7
    )
    
    
    (9.7
    )$
    30.3
    
    
    $
    27.5Goodwill
    
    $
    2.3
    
    
    $
    2.3External patents costs
    
    $
    3.6
    
    
    $
    1.9
 At December 31, and June 30, 2004 both goodwill and external patents costs have no accumulated
amortization. Once issued, patents will be amortized over four to seventeen years. Prepaid royalties and licensing advances at December 31, and June 30, 2004 include both current and
non-current asset balances. Amortization expense for prepaid royalties and licensing advances,
which is charged to cost of product sales and costs of gaming operations, was $1.4 million and $0.3
million for the three months ended December 31, 2004 and 2003, respectively, and $2.0 million and
$0.9 million for the six months ended December 31, 2004 and 2003, respectively. The estimated aggregate amortization expense at December 31, 2004 for each of the next five fiscal
years and thereafter is as follows (in millions):  2005
    
    $
    2.82006
    
    
    9.02007
    
    
    9.72008
    
    
    4.82009
    
    
    2.7Thereafter
    
    
    1.3
 The estimated aggregate future intangible amortization as of December 31, 2004 does not reflect the
significant commitments we have for future payments for royalties and licenses. See Note 10. 8. CONVERTIBLE SUBORDINATED NOTES AND LINE OF CREDIT In September 2004, we amended our unused line of credit for $50 million under a revolving credit
agreement ending May 21, 2005, which contains usual credit terms for a bank line, to provide
additional flexibility for common stock repurchases. We did not borrow any amounts on this line
during the six months ended December 31, 2004 or in fiscal 2004 and 2003. Our loan agreement requires that we maintain a minimum net worth and certain financial ratio
covenants, which could limit our ability to declare dividends or make any distribution to holders
of any shares of capital stock, or redeem or otherwise acquire such shares of our Company. At
December 31, 2004, approximately $38.3 million is available for such distributions under the most
restrictive of these covenants. 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 5.8 million
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 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. 12




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9. STOCKHOLDERS EQUITY Common Stock Repurchase Program During the three months ended September 30, 2003, we purchased 0.3 million shares of our common
stock on the open market for $5.0 million at an average price of $16.75 per share under the
existing stock repurchase program authorized by our Board of Directors. No shares were repurchased
since the September 30, 2003 quarter. This plan has now expired. On August 9, 2004, our Board of Directors authorized the repurchase of up to $20 million of the
Companys common stock over the following twelve months. The purchases may be made from time to
time in open market or privately negotiated transactions. The timing and actual number of shares
repurchased will depend on market conditions. No common stock purchases were made during the six
months ended December 31, 2004. 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. 10. 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 December 2004 quarter, we amended licensing agreements and
entered into new licensing agreements, which increased our total potential royalty commitments.
The total potential royalty commitments at December 31, 2004 increased to $95.4 million from $92.7
million at June 30, 2004. The total potential future royalty payments at December 31, 2004
decreased to $54.4 million from $56.5 million at June 30, 2004. At December 31, 2004, we had total royalty commitments, advances and payments made and potential
future royalty payments as follows (in millions): At December 31, 2004TotalGuaranteed
    
    
    Contingent
    
    
    PotentialMinimums
    
    
    Payments
    
    
    PaymentsTotal royalty commitments
    
    $
    94.4
    
    
    $
    1.0
    
    
    $
    95.4Advances and payments made
    
    
    (41.0
    )
    
    
    
    
    
    
    (41.0
    )Future royalty payments
    
    $
    53.4
    
    
    $
    1.0
    
    
    $
    54.4
 Of the $41.0 million total advances and payments through December 31, 2004, $10.7 million has been
charged to expense and the remaining $30.3 million is included in the December 31, 2004 balance
sheet with $5.5 million in other current assets and $24.8 million in other assets. 13




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As of December 31, 2004, we estimate that potential future royalty payments in each fiscal year
will be as follows (in millions): At December 31, 2004TotalGuaranteed
    
    
    Contingent
    
    
    PotentialYear Ended June 30,
    
    Minimums
    
    
    Payments
    
    
    Payments2005
    
    $
    9.7
    
    
    $
    0.5
    
    
    $
    10.22006
    
    
    10.6
    
    
    
    0.5
    
    
    
    11.12007
    
    
    9.5
    
    
    
    
    
    
    
    9.52008
    
    
    9.0
    
    
    
    
    
    
    
    9.02009
    
    
    4.9
    
    
    
    
    
    
    
    4.9Thereafter
    
    
    9.7
    
    
    
    
    
    
    
    9.7Total
    
    $
    53.4
    
    
    $
    1.0
    
    
    $
    54.4
 As part of our technology improvement plan, we have licensed technology from third parties. At
December 31, 2004, we had guaranteed minimum payments related to such technologies aggregating
$10.7 million, all of which had been paid as advances and $0.7 million had been charged to expense.
An additional $0.3 million of contingent payments may become payable based on future events.
These amounts are included in the table above. 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 $10.3 million. 11. LITIGATION On October 2, 2003, La Societe de Loteries du Quebec (Loto-Quebec) filed claims against us and
Video Lottery Consultants Inc., a subsidiary of IGT (VLC) in the Superior Court of the Province of
Quebec. The pleadings allege that Loto-Quebec would be entitled to be indemnified by the
manufacturers of Loto-Quebecs VLTs, specifically WMS and VLC, if the class action plaintiffs,
described below, are successful in the pending class action lawsuit against Loto-Quebec. We are
currently proceeding with discovery, and we intend to vigorously defend ourselves against the
allegations. We are unable to predict the outcome of these actions, or reasonably estimate the
range of possible loss, if any. The class action lawsuit discussed in Loto-Quebecs claim was brought on May 18, 2001 against
Loto-Quebec in the Superior Court of the Province of Quebec. It alleges that the members of the
class developed a pathological gambling addiction by using Loto-Quebecs 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 Court 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. 12. TERMINATION OF MIDWAY AGREEMENT On November 19, 2004, WMS Industries Inc. and Midway Games Inc. terminated (1) the Tax Sharing
Agreement; (2) the Tax Separation Agreement; (3) the Letter Agreement; and (4) the Settlement
Agreement that were entered into in connection with Midways 1996 initial public offering and the
1998 distribution by WMS to its stockholders of its remaining Midway shares. Under the termination
agreement, Midway paid WMS $1.5 million, which is included in interest income, other income and
expense, net. 14




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 has been 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, from January 2002 through November 2003, our
product sales revenues declined from levels experienced in fiscal 2000 and 2001. As we 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 increased. In fiscal 2005, 2006 and 2007, with all of the
approvals in hand for all of our product lines, we expect to grow our 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 plus the casinos regulated by Gaming Laboratories International, Inc. (GLI). Other
jurisdictions may require upgrades in the future. We are making version 2.57 available in other
jurisdictions as an optional upgrade. GLI and Nevada approved version 2.59, our printer upgrade
version, in calendar 2003. 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 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 legacy gaming devices are deployed. We have completed the second phase of our technology improvement plan which consisted of the
development, approval and introduction of our new CPU-NXTcomputer circuit board and operating
system. The commercial version of the CPU-NXToperating system was approved by GLI in September
2003 when we also received GLI approval for nine game themes on this new system. We subsequently
received regulatory approvals for CPU-NXTfrom the other five North American gaming labs. In the third phase, we are evaluating specifications and requirements for an even more advanced
gaming system to 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 more resources to this longer-term effort. 15




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##### Table of Contents



Bluebirdand CPU-NXTCommercialization For our video product line, our focus in the near term is to refresh our legacy installed base of
more than 50,000 video gaming devices in casinos through either replacement with new Bluebirdvideo
gaming devices or through CPU-NXTupgrade kits. We received the first approval from GLI for the
marketable version of the Bluebirdvideo cabinet at the end of November 2003. We have now received
approvals for the Bluebirdvideo cabinet from the other five North American gaming labs. Each
jurisdictional approval of the CPU-NXToperating system has allowed us to submit new game themes
designed for use with that system to the regulators for approval, which enables us to sell and ship
additional CPU-NXTupgrade kits. We now have the approvals from all six North American gaming labs
for hardware peripheral options, such as alternative coin handling, printing and bill accepting
equipment. Customer acceptance of Bluebirdgaming devices and our new game themes continues to be very
favorable. Since we started selling Bluebirdgaming devices in December 2003, we have executed
corporate agreements or issued sales orders for over 30,600 Bluebirdgaming devices and CPU-NXT
kits. Through December 31, 2004, over 21,800 of these orders had been shipped, the remaining 8,800
of these open orders consist of over 7,800 new Bluebirdgaming devices and over 1,000 CPU-NXT
upgrade units, which we expect to ship over the next two quarters. These corporate agreements are
with multi-jurisdictional casino operators along with a number of tribal and individual casino
properties. We expect order levels to continue at a strong pace as the Bluebirdgaming devices and
new game themes are generating strong performance data, and we have all necessary regulatory
approvals. We have 26 video for sale game themes approved in most gaming jurisdictions. We also
expect strength in game conversion revenues over the next several quarters, as operators see the
value and performance benefits of our CPU-NXTupgrade kits and printer upgrades. Product Line Expansion Plan In May 2004, we received Nevada Gaming Control Board and Nevada Gaming Commission approvals for our
WAP. We launched the product in Nevada in late May 2004, one month earlier than our original
expectation. We received GLI approval for our new WAP jackpot system also in May 2004 and launched
the product in Native American casinos in June 2004. We received Colorado Gaming Commission
approval in September 2004 and launched the product in Colorado casinos in September 2004. We
received Mississippi Gaming Commission approval for our WAP product in January 2005 having launched
the product with a field trial in October 2004. We have submitted the WAP to the New Jersey gaming
regulators and expect to receive approval in Summer 2005. The first WAP jackpot we launched was
Monopoly Money. In January 2005, we launched our second WAP jackpot titled A FISTFUL OF DOLLARS
with Clint Eastwood. To date eight jackpot winners in casinos in Nevada, Mississippi and in Native
American Casinos have won an aggregate of over $1.3 million in progressive jackpots. In September 2004, we launched our new mechanical reel product line with six initial game themes
under the Cant Lose®brand name. We have received approvals from all six North American gaming
labs for the mechanical reel-spinning product and in most
jurisdictions we now have 14 game themes
approved. We have begun to receive approvals for the second series of mechanical reel games under
the Scroll Top brand name and the third series under the Ringseries brand name. For our new poker products, our first poker game, 3 WAY ACTION®, was approved by GLI in June 2004, and we shipped our first
game to customers in GLI territories in July 2004. We received approvals from two other gaming
labs in the September 2004 quarter. 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. As a result of the extension, we intend to devote more
development efforts to the MONOPOLYbrand in the coming years. We launched five new MONOPOLY
themed participation games in fiscal 2004 including our first proprietary WAP system featuring the
MONOPOLY Moneyprogressive jackpot. In the March 2004 quarter, we launched the fifth game in the HOLLYWOOD SQUARESthemed series of
participation games called Tour of Stars®,and in July 2004, we launched the sixth game in the
series, Prize Spin. Our seventh game in the series and first game to be in our Bluebirdcabinet,
Premier Night,was submitted to gaming labs in the December 2004 quarter, and initial approvals
are expected in the March 2005 quarter. In September 2003, we announced our agreement with Sony Pictures Consumer Products to develop,
market and distribute MEN IN BLACKbranded games. We introduced this new series of participation
games in our new Bluebirdcabinet in June 2004. 16




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##### Table of Contents



We launched MATCH GAMEas a hybrid game in our new Bluebirdcabinet in July 2004. MATCH GAMEis
the first game in our new Classic TV Game Show Series of hybrid games. We received approvals for
PASSWORD, our second game in the series, in the December 2004 quarter. In October 2003, we entered into an exclusive agreement to develop, market and distribute games
using the lottery brand POWERBALL®that we are developing as a wide-area progressive game for
launch in the March 2006 quarter. Class II Gaming Effective April 1, 2004, we executed a two-year agreement with Multimedia Games Inc. (Multimedia)
to expand and extend our relationship to address opportunities in Class II, Charitable Gaming and
Tribal Instant Lottery Gaming (TILG) markets. Pursuant to the terms of the agreement, we license
to Multimedia our extensive game content library, including branded participation games, for
exclusive placement (subject to our existing commitments) in Multimedias North American central
determination system-based venues offering Class II, Washington State Class III, Charity, and TILG
products. Multimedia has agreed to purchase a specified minimum number of game licenses and gaming
cabinets annually during the two-year term of the agreement. CRITICAL ACCOUNTING POLICIES During the quarter ended December 31, 2004, we made no changes in our critical accounting policies
or in the application of those policies, as reported in our Annual Report on Form 10-K for the year
ended June 30, 2004. Allowances for slow-moving and
obsolete inventories The majority of our new game units now consist of Bluebirdgaming devices, although we are selling
new legacy devices internationally and to VLT customers. We periodically review our inventories to
identify slow moving or obsolete conditions requiring appropriate adjustment to net realizable
value. At December 31, 2004, our inventories included $35.9 million of legacy game raw materials
and new and used finished goods, which compares to $38.4 million at June 30, 2004. An active
market exists mostly outside of North America for used games. In January 2005, we relocated the
refurbishment of used games to our Las Vegas facility to better focus on this business. We
continue to support our customers installed base of legacy games and continue to review our legacy
inventories for impairment. Income taxes During the quarter ended December 31, 2004, the issuance of FASB Staff Position 109-1 provided that
accounting for the tax deduction on qualified production expense arising from the enactment of the
American Jobs Creation act should be treated as a special income tax deduction, rather than a
reduction of the overall statutory Federal tax rate. This allowed us to maintain our deferred tax
assets at the historical Federal and State statutory rates, rather than lower them for the impact
of the American Jobs Creation Act. 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 December 31, 2004, were as follows (in millions): Payment Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 yearsContractual ObligationsOperating leases
    
    $
    21.7
    
    
    $
    1.9
    
    
    $
    5.1
    
    
    $
    4.2
    
    
    $
    10.5Royalty payments
    
    
    53.4
    
    
    
    9.7
    
    
    
    20.1
    
    
    
    13.9
    
    
    
    9.7Non-cancelable raw materials
purchase orders
    
    
    3.0
    
    
    
    3.0
    
    
    
    
    
    
    
    
    
    
    
    Convertible subordinated notes
    
    
    115.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115.0Other, including guaranteed minimumemployment agreements
    
    
    9.2
    
    
    
    7.2
    
    
    
    2.0
    
    
    
    
    
    
    
    Total
    
    $
    202.3
    
    
    $
    21.8
    
    
    $
    27.2
    
    
    $
    18.1
    
    
    $
    135.2
 17




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The total potential royalty commitments made and those contingent upon future events, decreased
from $56.5 million at June 30, 2004 to $54.4 million at December 31, 2004 due to payments of $4.8
million during the six months ended December 2004, partially offset by new and amended brand
licensing agreements. Potential royalty commitments could continue to increase in the future as we
enter into new brand licensing agreements. 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,
restricted stock and performance contingent restricted stock units to our employees, officers,
directors and consultants and warrants to a licensor, and we have issued convertible subordinated
notes. LIQUIDITY AND CAPITAL RESOURCES As ofDecember 31,
    
    
    June 30,
    
    
    Increase2004
    
    
    2004
    
    
    (Decrease)(in millions)Total cash, cash equivalents
and short-term investments
    
    $
    71.8
    
    
    $
    116.2
    
    
    $
    (44.4
    )Total current assets
    
    
    294.8
    
    
    
    278.0
    
    
    
    16.8Total assets
    
    
    429.2
    
    
    
    395.0
    
    
    
    34.2Total current liabilities
    
    
    57.0
    
    
    
    40.5
    
    
    
    16.5Long-term debt
    
    
    115.0
    
    
    
    115.0
    
    
    
    Stockholders equity
    
    
    257.2
    
    
    
    239.5
    
    
    
    17.7Net working capital
    
    
    237.8
    
    
    
    237.5
    
    
    
    0.3
 Our current sources of liquidity for the six months ended December 31, 2004 were:  
    Existing cash, cash equivalents and short-term investments,  
    Our net income of $6.3 million plus $15.5 million of depreciation and amortization, $3.0 of
deferred income taxes and other non-cash expenses of $1.6 million, including a receivables
provision,  
    Proceeds from stock option exercises of $6.8 million, excluding related tax benefits We believe that cash and cash equivalents and short-term investments of $71.8 million at December
31, 2004, inclusive of $1.1 million 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 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. In September 2004, we amended our unused line of credit for $50 million under a revolving credit
agreement ending May 21, 2005, which contains usual credit terms for a bank line, to provide
additional flexibility for common stock repurchases. We did not borrow any amounts on this line
during the six months ended December 31, 2004 or during fiscal year 2004 and 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. 18




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##### Table of Contents



During the six months ended December 31, 2004, our net working capital was essentially unchanged as
cash was used to invest in accounts receivable, inventory and other current assets. Accounts and
notes receivable, net, increased by $22.0 million due to higher new unit sales levels during the
six months ended December 31, 2004. Inventory at December 31, 2004 increased by $36.3 million due
to $30.3 million of higher levels of raw materials as we prepared for an increasing volume of
business and $6.0 million for finished goods due to $3.8 million of new Bluebirdparticipation
gaming devices and top boxes, particularly for the launch of the A FISTFUL OF DOLLARSWAP games,
that were built, but not yet installed. Net royalty advances increased by $2.8 million due to new
technology and brand license agreements we entered into or amended during the six months ended
December 31, 2004. Current liabilities increased by $16.5 million due to higher accounts payable
related to increased inventories and higher compensation related liabilities. 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 six months ended December 31, 2004. Due to our operating losses in fiscal 2004 and 2003, we have recorded $2.2 million of current
income tax receivables on our balance sheets at both December 31, 2004 and at June 30, 2004. This
tax receivable is based on our ability to receive tax refunds from applying our tax losses against
prior years income and for refunds of tax payments relating to foreign withholding taxes made in
fiscal 2004. We also have $18.4 million of deferred tax assets on our balance sheet as of December 31, 2004, a
decrease of $0.3 million from June 30, 2004. These represent taxable temporary differences
expected to reverse in fiscal 2005 and future years, and tax credits and tax operating losses
generated in fiscal 2004, that can be claimed on fiscal 2005 and 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 additional
valuation allowance from that provided at June 30, 2004 related to realizability of such assets as
of December 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 December 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 $92.7 million at June 30, 2004 to $95.4 million at December 31, 2004, of which $41.0
million has been paid. Please refer to the table under Off-Balance Sheet Arrangements and
Contractual Obligations above and Note 10 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 5.8 million
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. Capital Resources The following table summarizes our sources and uses of cash for the periods shown (in millions): Six Months EndedDecember 31,
    
    
    Increase2004
    
    
    2003
    
    
    (Decrease)Cash provided (used) by:Operating activities
    
    $
    (24.2
    )
    
    $
    (17.6
    )
    
    $
    (6.6
    )Investing activities
    
    
    (19.0
    )
    
    
    (9.9
    )
    
    
    (9.1
    )Financing activities
    
    
    6.8
    
    
    
    15.3
    
    
    
    (8.5
    )Effect of exchange rates on cash
    
    
    0.9
    
    
    
    0.2
    
    
    
    0.7Decrease in cash and cash equivalents
    
    $
    (35.5
    )
    
    $
    (12.0
    )
    
    $
    (23.5
    )
 19




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##### Table of Contents



Cash used by operating activities was $24.2 million for the six months ended December 31, 2004, as
compared to cash used of $17.6 million for the six months ended December 31, 2003. The current
period increase relative to the comparable prior year period was due to $53.3 million of cash
invested in operating assets and liabilities due to growth of our business, compared to $30.8
million of cash invested in operating assets and liabilities in the six months ended December 31,
2003. Depreciation and amortization expense provided $15.5 million of cash to operations for the
six months ended December 31, 2004, as compared to $12.3 million for the six months ended December
31, 2003. For the three months ended December 31, 2004, cash used by operating activities was only $0.4
million. 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 six months ended December 31, 2004. Components of the $53.3 million and $30.8 million invested in operating assets and liabilities for
the six month periods ended December 31, 2004 and 2003, respectively, are as follows (in millions): Six Months EndedDecember 31,
    
    
    Increase2004
    
    
    2003
    
    
    (Decrease)Changes in Operating Assets and Liabilities:Decrease (increase) in operating assets:Accounts and notes receivable
    
    $
    (22.1
    )
    
    $
    (14.7
    )
    
    $
    (7.4
    )Raw material and finished goods inventories
    
    
    (35.9
    )
    
    
    (9.5
    )
    
    
    (26.4
    )Income tax receivable
    
    
    
    
    
    
    1.0
    
    
    
    (1.0
    )All other operating assets
    
    
    (11.4
    )
    
    
    (10.3
    )
    
    
    (1.1
    )Increase
(decrease) in operating liabilities:Current liabilities
    
    
    16.1
    
    
    
    2.7
    
    
    
    13.4Net increase in operating assets and liabilities
    
    $
    (53.3
    )
    
    $
    (30.8
    )
    
    $
    (22.5
    )
 For the six months ended December 31, 2004, the $22.1 million increase in accounts and notes
receivable reflects an increasing trend in new unit sales, while raw material and finished goods
inventories increased $35.9 million as we prepared for an increased volume of business. The $11.4
million increase in all other operating assets was due to a $2.8 million of net royalty advances
for new technology and brand license agreements entered into or amended, a $2.7 million increase in
deferred tax asset, a $1.7 million increase in patents, a $1.4 million increase in long-term notes
receivable and a $2.8 million increase in prepaid and other assets during the current six months
ended December 31, 2004. The increase of current liabilities was due to higher accounts payable
related to increases in inventories and higher accrued liabilities, including compensation related
liabilities. For the six months ended December 31, 2003, the increase in accounts and notes receivable reflects
an increasing trend in new unit sales, while raw material inventories increased $9.1 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
$12.8 million of royalty advances for new technology and brand license agreements entered into or
amended during the current six months ended December 2003. 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. 20




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##### Table of Contents



Cash used by investing activities was $19.0 million and $9.9 million for the six months ended
December 31, 2004 and 2003, respectively. Cash used for the purchase of property, plant and
equipment for the six months ended December 31, 2004 was $4.2 million compared with $6.0 million
for the comparable prior year period. We are currently planning the purchase and renovation of
additional space near our technology campus, which we expect to begin in Summer 2005 and an
expansion of our Waukegan manufacturing facility that will begin in Fall 2005. However, on an
overall expenditure basis, we do not anticipate any significant changes in the general trend of our
capital expenditures for property, plant and equipment in fiscal 2005, 2006 or 2007. Cash used for
additions to gaming operation machines was $24.3 million and $6.5 million for the six months ended
December 31, 2004 and 2003, respectively. The current period investment in gaming operation
machines was higher as we refresh our participation games with new technology installed in our new
Bluebirdcabinet. We expect this investment to continue to increase through fiscal 2005, 2006 and
2007 as we roll out new participation games installed in our Bluebirdcabinet. Net cash of $9.5
million was provided from short-term investments for the six months ended December 31, 2004,
compared to $2.6 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 $6.8 million for the six months ended December 31, 2004
compared with cash provided of $15.3 million for the comparable prior year period. We received
$6.8 million and $6.0 million from the exercise of stock options in the six months ended December
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 exercise price of vested options. We also received net cash of
$14.3 million in July 2003 from the exercise of the over-allotment option relating to our
convertible subordinated notes. On August 9, 2004, our Board of Directors authorized the repurchase of up to $20 million of the
Companys common stock over the following twelve months. The purchases may be made from time to
time in open market or privately negotiated transactions. The timing and actual number of shares
repurchased will depend on market conditions. In the six months ended December 31 2004, we did not
repurchase any shares of our common stock. During the six months ended December 31, 2003, we purchased $5.0 million of our common stock for
treasury. At December 31, 2003, 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. Since the inception of our common stock repurchase programs in
January 2002 through December 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. 21




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RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 2003 Revenues, Gross Margins and Key Performance Indicators (in millions, except unit data): Three Months EndedDecember 31,
    
    
    Increase2004
    
    
    2003
    
    
    (Decrease)
    
    
    % ChangeProduct Sales:New unit sales revenue
    
    $
    57.8
    
    
    $
    24.1
    
    
    $
    33.7
    
    
    
    139.8
    %Parts, used games, conversions and OEM revenue
    
    
    11.6
    
    
    
    6.7
    
    
    
    4.9
    
    
    
    73.1Total product sales revenue
    
    $
    69.4
    
    
    $
    30.8
    
    
    $
    38.6
    
    
    
    125.3Total new units sold
    
    
    5,811
    
    
    
    2,873
    
    
    
    2,938
    
    
    
    102.3Average sales price per new unit
    
    $
    9,938
    
    
    $
    8,401
    
    
    $
    1,537
    
    
    
    18.3Total OEM units sold
    
    
    1,500
    
    
    
    0.00
    
    
    
    1,500
    
    
    
    100.0Gross profit on product sales revenue
    
    $
    26.6
    
    
    $
    11.9
    
    
    $
    14.7
    
    
    
    123.5Gross margin on product sales revenue
    
    
    38.3
    %
    
    
    38.6
    %
    
    
    (0.3
    )
    
    
    (0.8
    )Gaming Operations Revenues:Participation revenue
    
    $
    20.1
    
    
    $
    16.1
    
    
    $
    4.0
    
    
    
    24.8Royalties, VLT and other lease revenue
    
    
    4.5
    
    
    
    4.6
    
    
    
    (0.1
    )
    
    
    (2.2
    )Total gaming operations revenue
    
    $
    24.6
    
    
    $
    20.7
    
    
    $
    3.9
    
    
    
    18.8Average installed base
    
    
    4,712
    
    
    
    4,549
    
    
    
    163
    
    
    
    3.6Installed base at period end
    
    
    5,021
    
    
    
    4,538
    
    
    
    483
    
    
    
    10.6Net revenue per day per machine
    
    $
    46.30
    
    
    $
    38.43
    
    
    $
    7.87
    
    
    
    20.5Gross profit on gaming operations revenue
    
    $
    19.6
    
    
    $
    17.4
    
    
    $
    2.2
    
    
    
    12.6Gross margin on gaming operations revenue
    
    
    79.7
    %
    
    
    84.1
    %
    
    
    (4.4
    )
    
    
    (5.2
    )Total Revenues
    
    $
    94.0
    
    
    $
    51.5
    
    
    $
    42.5
    
    
    
    82.5Total Gross Profit
    
    $
    46.2
    
    
    $
    29.3
    
    
    $
    16.9
    
    
    
    57.7Total Gross Margin
    
    
    49.1
    %
    
    
    56.9
    %
    
    
    (7.8
    )
    
    
    (13.7
    )
 The increase in total revenues for the December 2004 quarter compared to the December 2003 quarter
was primarily due to $33.7 million in higher new gaming machine sales, $4.9 million increase in
parts, conversions, used games and OEM revenues, and $3.9 increase in gaming operations revenues. New unit sales increased by 102% to 5,811 units in the December 2004 quarter compared to the
December 2003 quarter as we shipped our new Bluebirdvideo gaming devices to additional
jurisdictions after receiving additional regulatory approvals and as we offered a higher number of
new game themes. In the December 2004 quarter, revenues from used games, parts, conversions and
OEM increased 73% compared to the prior year quarter due to a $5.5 million increase in OEM
revenues, resulting from our expanded agreement with Multimedia Games, and higher conversion units
sold in the current quarter, as we received new game theme approvals for conversion kits with the
CPU-NXToperating system partially offset by lower parts revenues. The average sales price per new
unit increased 18% as higher priced Bluebirdunits more than offset lower priced legacy games sales
during the December 2004 quarter. We expect continued growth in the average selling price over the
next two quarters, as we implemented a 9% increase in list price of Bluebirdvideo units effective
January 1, 2005 and as the percentage of Bluebirdunits sold becomes a higher percentage of our
overall sales mix. In addition, we expect growth in our installed base of participation games and average net revenue
per day of gaming operations in future quarters as we continue to roll out five new participation
games in the Bluebirdcabinet: MONOPOLY Money, MONOPOLY Once Around Deluxe®, MEN IN BLACK, MATCH
GAMEand beginning in January 2005, A FISTFUL OF DOLLARS. The success of these games is
accelerating our transition from games in legacy cabinets to new games in Bluebirdcabinets. The
installed base grew 535 units to 5,021 units at December 31, 2004 from September 30, 2004. New
games in Bluebirdcabinets accounted for 1,994 units, or 40%, of the installed base at December 31,
2004. Net revenue per day increased 22




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##### Table of Contents



$7.87 from the prior year quarter to $46.30 per day for the
December 2004 quarter. Gaming operations revenue also benefited from an increase in royalty
revenue in the December 2004 quarter from the December 2003 quarter, primarily due to our licensees
increased purchases or placement of WMS games. Total gross profit increased to $46.2 million for the December 2004 quarter from $29.3 million in
the December 2003 quarter while total gross margin was 49% in the December 2004 quarter compared to
57% in the corresponding period in 2003. Higher margin gaming operations revenues were only 26% of
total revenues in the December 2004 quarter, compared to 40% in the December 2003 quarter due to
the increase of product sales revenue in the current year quarter. The gross margin on product
sales was 38% for the December 2004 quarter and 39% for the December 2003 quarter reflecting the
mix of products sold and greater overtime and temporary help costs in the December 2004 quarter.
We expect that the gross margin on the Bluebirdgaming devices will improve as production volume
increases because of expected larger volume discounts from our suppliers, expected decreases in the
cost of electrical components over time and an expected decline in overtime and temporary help
costs as we spread the production volume more evenly throughout the quarter. The gross profit
margin on gaming operations decreased to 80% in the December 2004 quarter compared to 84% in the
prior year quarter, reflecting higher royalties payable to licensors and the lower margins on our
wide-area progressive games, partially offset by higher royalties received from licensees. Operating Expenses (in millions of dollars): Three Months EndedDecember 31,2004
    
    
    2003As % of
    
    
    
    
    
    
    As % of
    
    
    Increase$
    
    
    Revenue
    
    
    $
    
    
    Revenue
    
    
    (Decrease)
    
    
    % ChangeResearch and development
    
    $
    13.5
    
    
    
    14.3
    %
    
    $
    10.2
    
    
    
    19.8
    %
    
    $
    3.3
    
    
    
    32.4
    %Selling and administrative
    
    
    19.3
    
    
    
    20.5
    %
    
    
    13.5
    
    
    
    26.2
    %
    
    
    5.8
    
    
    
    43.0
    %Depreciation and amortization
    
    
    8.7
    
    
    
    9.3
    %
    
    
    6.0
    
    
    
    11.7
    %
    
    
    2.7
    
    
    
    45.0
    %Total Operating Expenses
    
    $
    41.5
    
    
    
    44.1
    %
    
    $
    29.7
    
    
    
    57.7
    %
    
    $
    11.8
    
    
    
    39.7
    %
 Research and development expenses increased $3.3 million, or 32.4%, to $13.5 million in the
December 2004 quarter compared to $10.2 million in the prior year quarter due to higher regulatory
approval costs incurred for the final approvals for CPU-NXTand Bluebird, for a greater number of
new game themes and for the final legacy operating system upgrade in GLI territories, plus
headcount increases to fully staff our international game development studios and increased staff
for the long-term portion of the technology improvement plan. We continue to expect quarterly
research and development expenses in fiscal 2005 to exceed those in the comparable prior years
quarters. Selling and administrative expenses increased $5.8 million, or 43.0%, to $19.3 million in the
December 2004 quarter compared to $13.5 million in the December 2003 quarter due to higher
commissions based on substantially higher revenues, additional headcount, overtime and temporary
contract labor for game installs, participation placements and in certain administrative areas due
to increased demand and the timing of shipments, additional trade show and marketing costs to
continue to support the simultaneous launch of three new product lines, and higher equity
compensation costs. We continue to expect selling and administrative expenses to exceed those in
the comparable prior years quarters. Depreciation and amortization expense increased by $2.7 million as the level of investment in
participation gaming devices for gaming operations increased from the December 2003 quarter with
the installation of new games in Bluebirdcabinets during the December 2004 quarter. We expect
that the level of investment in gaming operations equipment will continue to increase throughout
fiscal 2005 due to the ongoing placement of new participation game themes, including WAP game
themes, in our new Bluebirdcabinet. We generated net operating income of $4.7 million in the December 2004 quarter, compared to a net
operating loss of $0.4 million in the December 2003 quarter. The improved operating performance in
the fiscal 2005 second quarter resulted from the $16.9 million increase in gross profit, partially
offset by a $5.8 million increase in selling and administrative expenses, $3.3 million increase in
research and development expenses and a $2.7 million increase in depreciation and amortization
expense. 23




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We incurred interest and issuance cost amortization expense of $1.0 million for both the December
2004 and December 2003 quarters related to our 2.75% convertible subordinated notes issued in
Summer 2003. Offsetting this in the December 2004 quarter, we recorded $1.5 million of pre and
post-tax income related to final settlement of tax advances with our former subsidiary, Midway
Games, which we previously fully reserved, and $0.3 million of net other income including
investment income earned on cash, cash equivalents and short-term investments which amounted to
$71.8 million at December 31, 2004. In the December 2003 quarter, interest expense was partially
offset by $0.8 million of net other income including investment income earned on cash, cash
equivalents and short-term investments which amounted to
$144.8 million at December 31, 2003. The provision for income taxes of $1.6 million, which is comprised of deferred taxes, is based on
our annual estimated effective tax rate of 32.5%, due to the impact of the American Jobs Creation
Act of 2004, foreign tax credits and research and development tax credits in 2005. The 37.5%
estimated effective income tax rate for the December 2003 reflected a benefit of $0.2 million
against pre-tax losses. Net income was $3.9 million or $0.12 per diluted share for the December 2004 quarter compared to
net loss of $0.4 million, or $0.01 per diluted share, for the prior year quarter. SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH SIX MONTHS ENDED DECEMBER 31, 2003 Revenues, Gross Margins and Key Performance Indicators (in millions, except unit data): Six Months EndedDecember 31,
    
    
    Increase2004
    
    
    2003
    
    
    (Decrease)
    
    
    % ChangeProduct Sales:New unit sales revenue
    
    $
    99.1
    
    
    $
    42.6
    
    
    $
    56.5
    
    
    
    132.6
    %Parts, used games, conversions and OEM revenue
    
    
    23.7
    
    
    
    13.1
    
    
    
    10.6
    
    
    
    80.9Total product sales revenue
    
    $
    122.8
    
    
    $
    55.7
    
    
    $
    67.1
    
    
    
    120.5Total new units sold
    
    
    10,031
    
    
    
    5,093
    
    
    
    4,938
    
    
    
    97.0Average sales price per new unit
    
    $
    9,877
    
    
    $
    8,364
    
    
    $
    1,513
    
    
    
    18.1Total OEM units sold
    
    
    1,750
    
    
    
    
    
    
    
    1,750
    
    
    
    100.0Gross profit on product sales revenue
    
    $
    48.2
    
    
    $
    21.6
    
    
    $
    26.6
    
    
    
    123.1Gross margin on product sales revenue
    
    
    39.3
    %
    
    
    38.8
    %
    
    
    0.5
    
    
    
    1.2Gaming Operations Revenues:Participation revenue
    
    $
    36.2
    
    
    $
    34.2
    
    
    $
    2.0
    
    
    
    5.8Royalties, VLT and other lease revenue
    
    
    10.1
    
    
    
    8.3
    
    
    
    1.8
    
    
    
    21.7Total gaming operations revenue
    
    $
    46.3
    
    
    $
    42.5
    
    
    $
    3.8
    
    
    
    8.9Average installed base
    
    $
    4,436
    
    
    $
    4,701
    
    
    
    (265
    )
    
    
    (5.6
    )Installed base at period end
    
    
    5,021
    
    
    
    4,538
    
    
    
    483
    
    
    
    10.6Net revenue per day per machine
    
    $
    44.26
    
    
    $
    39.61
    
    
    $
    4.65
    
    
    
    11.7Gross profit on gaming operations revenue
    
    $
    36.7
    
    
    $
    35.1
    
    
    $
    1.6
    
    
    
    4.6Gross margin on gaming operations revenue
    
    
    79.3
    %
    
    
    82.6
    %
    
    
    (3.3
    )
    
    
    (4.0
    )Total Revenues
    
    $
    169.1
    
    
    $
    98.2
    
    
    $
    70.9
    
    
    
    72.2Total Gross Profit
    
    $
    84.9
    
    
    $
    56.7
    
    
    $
    28.2
    
    
    
    49.7Total Gross Margin
    
    
    50.2
    %
    
    
    57.7
    %
    
    
    (7.5
    )
    
    
    (13.0
    )
 The increase in total revenues for the December 2004 six month period compared to the December 2003
six month period was primarily due to $56.5 million in higher new gaming machine sales, a $10.6
million increase in used games, parts, conversions and OEM revenues, and a $3.8 million increase in
gaming operations. 24




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##### Table of Contents



New unit sales increased by 97% to 10,031 units for the December 2004 six month period compared to
the prior year six month period as we shipped our new Bluebirdgaming devices to additional
jurisdictions after receiving additional regulatory approvals and as we offered a higher number of
new game themes. In the December 2004 six month period, revenues from used games, parts,
conversions and OEM increased 81% compared to the prior year six month period primarily due to a
$6.5 million increase in OEM revenues, resulting from our expanded agreement with Multimedia, and
an increase of conversion units sold in the current six month period, as we received approvals
during fiscal 2004 to sell our new games and conversion kits with the CPU-NXToperating system.
The average sales price per new unit increased 18% as higher priced Bluebirdunits more than offset
lower priced legacy games sales during the December 2004 six month period. We expect continued
growth in the average selling price over the next two quarters, as we implemented a 9% increase in
the list price of Bluebirdvideo units effective January 1, 2005 and the percentage of Bluebird
units sold becomes a higher percentage of our overall sales mix. The average installed base of participation gaming devices decreased to 4,436 units in the December
2004 six month period from 4,701 units in the December 2003 six month period, while the net revenue
per day increased by $4.65 per day from the prior year six month period to $44.26 per day as we
continued to refresh the installed base with new games. The decrease in the average installed base
of participation gaming devices was due to our legacy operating system not supporting the dual port
cashless gaming technology that many customers require and the natural evolution of our older
participation series. The installed base grew 781 units to 5,021 units at December 31, 2004 from
June 30, 2004, as we introduced four new participation games in the Bluebirdcabinet: MONOPOLY
Money, MONOPOLY Once Around Deluxe, MEN IN BLACKand MATCH GAME. The success of these new games is
accelerating our transition from games in legacy cabinets to new games in Bluebirdcabinets as we
have installed 1,994 new games in Bluebirdcabinets. We expect growth in our installed base of
participation games and average net revenue per day of gaming operations in future quarters as we
continue to install new participation games in our new Bluebirdcabinet. Gaming operations revenues
benefited from a 21.7% increase in royalty revenues in the December 2004 six month period from the
December 2003 six month period, primarily due to our licensees increased purchases or placement of
WMS games. Total gross profit increased to $84.9 million for the December 2004 six month period from $56.7
million in the December 2003 six month period while total gross margin was 50% in the December 2004
six month period compared to 58% in the December 2003 six month period. Higher margin gaming
operations revenues were only 27% of total revenues in the December 2004 six month period, compared
to 43% in the December 2003 six month period due to the increase of product sales revenue in the
current year six month period. The gross margin on product sales was 39% for both the December
2004 and 2003 six month periods, reflecting higher margin on the mix of products sold offset by
greater overtime and temporary labor costs in the fiscal 2005 period. We expect that the gross
margin on the Bluebirdgaming devices will improve as production volume increases because of
expected larger volume discounts from our suppliers, expected decreases in the cost of electrical
components over time, and an expected decline in overtime and temporary help costs as we spread the
production volume more evenly throughout the quarter. The gross profit margin on gaming operations
decreased to 79% in the December 2004 six month period compared to 83% in the prior year six month
period, reflecting higher royalties payable to licensors and the lower margins on our wide-area
progressive games, partially offset by higher royalties received from licensees. Operating Expenses (in millions of dollars): Six Months EndedDecember 31,2004
    
    
    2003As % of
    
    
    
    
    
    
    As % of
    
    
    Increase
    
    
    %$
    
    
    Revenue
    
    
    $
    
    
    Revenue
    
    
    (Decrease)
    
    
    ChangeResearch and development
    
    $
    25.6
    
    
    
    15.1
    %
    
    $
    20.5
    
    
    
    20.9
    %
    
    $
    5.1
    
    
    
    24.9
    %Selling and administrative
    
    
    34.9
    
    
    
    20.6
    %
    
    
    27.1
    
    
    
    27.6
    %
    
    
    7.8
    
    
    
    28.8
    %Depreciation and amortization
    
    
    15.5
    
    
    
    9.2
    %
    
    
    12.3
    
    
    
    12.5
    %
    
    
    3.2
    
    
    
    26.0
    %Total Operating Expenses
    
    $
    76.0
    
    
    
    44.9
    %
    
    $
    59.9
    
    
    
    61.0
    %
    
    $
    16.1
    
    
    
    26.9
    %
 Research and development expenses increased $5.1 million, or 24.9%, to $25.6 million in the
December 2004 six month period compared to $20.5 million in the prior year six month period. The
increased costs were due to higher regulatory approval costs incurred for the final approvals for
CPU-NXTand Bluebird, for a greater number of new game themes and for the final legacy operating
system upgrade in GLI territories plus headcount increases to fully staff our international game
development studios and increased staff for the long-term portion of the technology improvement
plan. We continue to expect research and development expenses in fiscal 2005 to exceed those in
the comparable prior years quarters. 25




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Selling and administrative expenses increased $7.8 million, or 28.8%, to $34.9 million in the
December 2004 six month period compared to $27.1 million in the December 2003 six month period.
These cost increases resulted from higher commissions based on substantially higher revenues,
additional headcount, overtime and temporary contract labor for game installs, participation
placements and in certain administrative areas due to increased demand and the timing of shipments,
additional trade show and marketing costs to continue to support the simultaneous launch of three
new product lines and higher equity compensation costs. We continue to expect selling and
administrative expenses in fiscal 2005 to exceed those in comparable prior years quarters. Depreciation and amortization expense increased by $3.2 million as the level of investment in
participation gaming devices for gaming operations increased from the December 2003 six month
period with the installation of new games in Bluebirdcabinets during the December 2004 six month
period. We expect that the level of investment in gaming operations equipment will continue to
increase throughout fiscal 2005 due to the on-going placement of new participation game themes,
including WAP game themes, in our new Bluebirdcabinet. We generated operating income of $8.9 million in the December 2004 six month period, compared to an
operating loss of $3.2 million in the December 2003 six month period. The improved operating
performance in the fiscal 2005 six month period resulted from the $28.2 million increase in gross
profit, partially offset by a $7.8 million increase in selling and administration expenses, $5.1
million increase in research and development expenses and a $3.2 million increase in depreciation
and amortization expense. We incurred interest and issuance cost amortization expense of $2.0 million in the December 2004
six month period compared to $1.9 million in the December 2003 six month periods primarily related
to our 2.75% convertible subordinated notes issued in Summer 2003. Offsetting this in six months
ended December 2004, we recorded $1.5 million of pre- and post-tax income related to final
settlement of tax advances with our former subsidiary, Midway Games, which we previously fully
reserved, and $0.9 million of net other income including investment income earned on cash, cash
equivalents, and short-term investments. For the six months ended December 2003, interest expense
was partially offset by $1.5 million of net other income including investment income earned on
cash, cash equivalents, and short-term investments. The provision for income taxes of $3.0 million, which is comprised of deferred taxes, is based on
our annual estimated effective tax rate of 32.5%. The lower effective tax rate is due to the
impact of the American Jobs Creation Act of 2004, foreign tax credits and research and development
tax credits in 2005. The 37.5% estimated effective income tax rate for the December 2003 six month
period reflected a benefit of $1.3 million against pre-tax losses. Net income was $6.3 million or $0.20 per diluted share for the December 2004 six month period
compared to net loss of $2.3 million, or $0.08 per share, for the prior year six 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, 2004 and in our more recent reports filed with the Securities and Exchange
Commission. 26




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You are advised to consult any further disclosures we make on related subjects in our Form 10-Q and
8-K reports filed with the Securities and Exchange Commission. MONOPOLYis a trademark of Hasbro Inc. ©2005 Hasbro. All rights reserved. Used with
permission. MEN IN BLACK& ©2002 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. ©2005 FremantleMedia North America,
Inc. Licensed by FremantleMedia Licensing Worldwide. PASSWORDis a trademark of FremantleMedia Operations BV. ©2005 FremantleMedia North America, Inc.
Licensed by FremantleMedia Licensing Worldwide. 3 WAY ACTIONis a trademark of Yehia Awada. A FISTFUL OF DOLLARS© 1964 Unidis, S.A.R.L. All rights reserved. CPU-NXT, Bluebird, Classic TV Game Show Series, Once Around Deluxe, Tour of Stars, Cant Lose,
Scroll Top, Prize Spinand Premier Nightare trademarks and registered 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. 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 December 31, 2004, we had $115 million of convertible fixed-rate debt with an interest rate
of 2.75% with a fair value of $195.2 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 December 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 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 continued to update our
internal controls over financial reporting as necessary to accommodate any modifications to our
business processes or accounting procedures, especially in our inventory and manufacturing
processes. There have not been any other changes in our internal controls over financial 27




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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. OTHER INFORMATION 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On December 9, 2004, the Board of Directors awarded 276,848 shares of restricted stock, with a
weighted average fair value at grant date of $8.4 million, including 84,913 shares to our
non-employee Chairman of the Board of Directors and 134,435 shares to certain executive officers,
subject to the individuals continued involvement with WMS. The restriction on the restricted
stock will lapse as to one-third of the shares each year over a three year period ending December
9, 2007. Our Chairman of the Board and our employees are not required to pay any cash
consideration for the restricted stock. The grant was exempt from registration under Section 5 of
the Securities Act since it was made only to our Chairman and specific officers and did not involve
any public offering, under Section 4(2) of the Securities Act. We have registered the resale of
the underlying common stock by our Chairman and executive officers with the SEC on a Registration
Statement on Form S-8 filed on December 30, 2004 (Registration Number 333-121766). 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were submitted to a vote of our stockholders during the Annual Meeting of
Stockholders held on
December 9, 2004: Shares1.
    
    Election of Directors
    
    Shares For
    
    
    WithheldLouis J. Nicastro
    
    
    17,239,097
    
    
    
    12,243,004Norman J. Menell
    
    
    18,348,729
    
    
    
    11,133,372Brian R. Gamache
    
    
    19,139,633
    
    
    
    10,342,468William C. Bartholomay
    
    
    18,054,268
    
    
    
    11,427,833Harold H. Bach, Jr.
    
    
    18,195,395
    
    
    
    11,286,706Neil D. Nicastro
    
    
    18,846,994
    
    
    
    10,635,107Harvey Reich
    
    
    26,873,923
    
    
    
    2,608,178Ira S. Sheinfeld
    
    
    18,703,057
    
    
    
    10,779,044William J. Vareschi, Jr.
    
    
    28,646,633
    
    
    
    835,468
 2. Ratification of the WMS Industries Inc. 2005 Incentive Plan: For
    
    Against
    
    
    Abstain20,870,743
    
    
    6,083,039
    
    
    
    33,663
  3.
    Ratification of Ernst & Young LLP as our independent registered public accountants for our
2005 fiscal year: For
    
    Against
    
    
    Abstain29,252,563
    
    
    182,820
    
    
    
    46,718
 28




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##### Table of Contents



ITEM 6. 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 September 30,
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, incorporated by reference to
WMS Quarterly Report on Form 10-Q for the quarter ended March 31, 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
    
    Letter Agreement, signed November 19, 2004, between Midway Games Inc. and WMS Industries Inc.
terminating tax agreements, incorporated by reference to WMS Current Report on Form 8-K
filed November 23, 2004.10.2
    
    Employment Agreement, dated December 27, 2004, between WMS and Brian R. Gamache, incorporated
by reference to WMS Current Report on Form 8-K filed December 30, 2004.10.3
    
    WMS Industries Inc. Non-Qualified Deferred Compensation Plan, incorporated by reference to
WMS Registration Statement on Form S-8 filed December 13, 2004.10.4
    
    WMS Industries Inc. 2005 Incentive Plan, incorporated by reference to Appendix B of WMS
Proxy Statement for our 2004 Annual Meeting of Stockholders.10.5
    
    Form of Officer and Director Indemnity Agreement, incorporated by reference to WMS Current
Report on Form 8-K filed December 15, 2004.10.6
    
    Form of Stock Option Agreement under the WMS Industries 2005 Incentive Plan.10.7
    
    Form of Restricted Stock Agreement under the WMS Industries 2005 Incentive Plan.10.8
    
    Form of Equity-Based Performance Award Agreement under the WMS Industries 2005 Incentive Plan.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.
 29




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##### Table of Contents



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: February 8, 2005
    
    By:
    
    /s/ Scott D. SchweinfurthScott D. SchweinfurthExecutive Vice President,Chief Financial Officer and Treasurer(Principal Financial and Chief AccountingOfficer)
 30




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##### Table of Contents



EXHIBIT INDEX 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 September 30,
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, incorporated by reference to
WMS Quarterly Report on Form 10-Q for the quarter ended March 31, 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
    
    Letter Agreement, signed November 19, 2004, between Midway Games Inc. and WMS Industries Inc.
terminating tax agreements, incorporated by reference to WMS Current Report on Form 8-K
filed November 23, 2004.10.2
    
    Employment Agreement, dated December 27, 2004, between WMS and Brian R. Gamache, incorporated
by reference to WMS Current Report on Form 8-K filed December 30, 2004.10.3
    
    WMS Industries Inc. Non-Qualified Deferred Compensation Plan, incorporated by reference to
WMS Registration Statement on Form S-8 filed December 13, 2004.10.4
    
    WMS Industries Inc. 2005 Incentive Plan, incorporated by reference to Appendix B of WMS
Proxy Statement for our 2004 Annual Meeting of Stockholders.10.5
    
    Form of Officer and Director Indemnity Agreement, incorporated by reference to WMS Current
Report on Form 8-K filed December 15, 2004.10.6
    
    Form of Stock Option Agreement under the WMS Industries 2005 Incentive Plan.10.7
    
    Form of Restricted Stock Agreement under the WMS Industries 2005 Incentive Plan.10.8
    
    Form of Equity-Based Performance Award Agreement under the WMS Industries 2005 Incentive Plan.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