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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 Commission file number: 1-8300 WMS INDUSTRIES INC.  Delaware
(State or Other Jurisdiction
of Incorporation or Organization)
    
    36-2814522
(I.R.S. Employer Identification No.)
 800 South Northpoint Blvd., Waukegan, IL 60085   Registrants telephone number, including area code: (847) 785-3000 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES   [X]   NO   [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES   [X]   NO   [   ] Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date: 30,547,999 of common stock,
$.50 par value, were outstanding at November 1, 2004, excluding 1,817,204
shares held as treasury shares.




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WMS INDUSTRIES INC. INDEX PageNumberPART I. FINANCIAL INFORMATION:ITEM 1.Financial Statements:Condensed Consolidated Statements of Operations -
Three months ended September 30, 2004 and 2003
    
    
    3Condensed Consolidated Balance Sheets -
September 30, 2004 and June 30, 2004
    
    
    4Condensed Consolidated Statements of Cash Flows -
Three months ended September 30, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7ITEM 2.Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    14ITEM 3.Quantitative and Qualitative Disclosures About Market Risk
    
    
    23ITEM 4.Controls and Procedures
    
    
    23PART II. OTHER INFORMATION:ITEM 6.Exhibits
    
    
    24SIGNATURES
    
    
    25302 Certifications of CEO and CFO906 Certifications of CEO and CFO
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS WMS INDUSTRIES INC.  
 
 Three Months EndedSeptember 30,2004
    
    2003Revenues:Product sales
    
    $
    53.4
    
    
    $
    24.9Gaming operations
    
    
    21.7
    
    
    
    21.8Total revenues
    
    
    75.1
    
    
    
    46.7Costs and expenses:Cost of product sales
    
    
    31.8
    
    
    
    15.2Cost of gaming operations
    
    
    4.6
    
    
    
    4.1Research and development
    
    
    12.1
    
    
    
    10.3Selling and administrative
    
    
    15.6
    
    
    
    13.6Depreciation and amortization
    
    
    6.8
    
    
    
    6.3Total costs and expenses
    
    
    70.9
    
    
    
    49.5Operating income (loss)
    
    
    4.2
    
    
    
    (2.8
    )Interest expense
    
    
    (1.0
    )
    
    
    (0.8
    )Interest income, other income and expense, net
    
    
    0.6
    
    
    
    0.6Income (loss) before income taxes
    
    
    3.8
    
    
    
    (3.0
    )Provision (benefit) for income taxes
    
    
    1.4
    
    
    
    (1.1
    )Net income (loss)
    
    $
    2.4
    
    
    $
    (1.9
    )Basic income (loss) per share on common stock
    
    $
    0.08
    
    
    $
    (0.06
    )Diluted income (loss) per share of common stock and common stock
equivalents
    
    $
    0.08
    
    
    $
    (0.06
    )Weighted-average common shares:Basic common
stock outstanding
    
    
    30.3
    
    
    
    29.3Diluted common stock and common stock equivalents
    
    
    31.0
    
    
    
    29.3
 See notes to condensed consolidated financial statements. 3




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WMS INDUSTRIES INC.  
 
 September 30,
    
    June 30,2004
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    26.2
    
    
    $
    59.9Restricted cash for progressive jackpots
    
    
    0.8
    
    
    
    0.5Short-term investments
    
    
    56.0
    
    
    
    55.883.0
    
    
    
    116.2Receivables, net of allowances of $2.5 and $2.6, respectively
    
    
    57.5
    
    
    
    52.5Notes receivable, current portion
    
    
    22.8
    
    
    
    17.8Inventories, at lower of cost (FIFO) or market:Raw materials and work in progress
    
    
    60.8
    
    
    
    47.3Finished goods
    
    
    25.8
    
    
    
    18.186.6
    
    
    
    65.4Other current assets
    
    
    28.9
    
    
    
    26.1Total current assets
    
    
    278.8
    
    
    
    278.0Gaming operations machines
    
    
    90.6
    
    
    
    80.4Less accumulated depreciation
    
    
    (62.3
    )
    
    
    (55.5
    )Gaming operations machines, net
    
    
    28.3
    
    
    
    24.9Property, plant and equipment
    
    
    84.9
    
    
    
    83.5Less accumulated depreciation
    
    
    (31.7
    )
    
    
    (29.8
    )Property, plant and equipment, net
    
    
    53.2
    
    
    
    53.7Other assets
    
    
    40.2
    
    
    
    38.4Total assets
    
    $
    400.5
    
    
    $
    395.0
 See notes to condensed consolidated financial statements. 4




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WMS INDUSTRIES INC.  
 September 30,
    
    June 30,2004
    
    2004(Unaudited)LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    15.4
    
    
    $
    17.1Accrued compensation and related benefits
    
    
    6.5
    
    
    
    4.4Other accrued liabilities
    
    
    20.7
    
    
    
    19.0Total current liabilities
    
    
    42.6
    
    
    
    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
    
    
    206.9
    
    
    
    206.7Retained earnings
    
    
    45.5
    
    
    
    43.1Accumulated other comprehensive income
    
    
    1.0
    
    
    
    1.0Unearned restricted stock (52,312 shares at both
September 30, and June 30, 2004)
    
    
    (0.9
    )
    
    
    (1.3
    )Treasury stock, at cost (1,961,780 shares at September
30, 2004 and 1,998,905 shares at June 30, 2004)
    
    
    (25.8
    )
    
    
    (26.2
    )Total stockholders equity
    
    
    242.9
    
    
    
    239.5Total liabilities and stockholders equity
    
    $
    400.5
    
    
    $
    395.0
 See notes to condensed consolidated financial statements. 5




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WMS INDUSTRIES INC.  
 
 Three Months EndedSeptember 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIESNet income (loss)
    
    $
    2.4
    
    
    $
    (1.9
    )Adjustments to reconcile net income (loss) to net
cash used by operating activities:Depreciation and amortization
    
    
    6.8
    
    
    
    6.3Deferred income taxes
    
    
    1.4
    
    
    
    (1.1
    )Non-cash expenses
    
    
    0.7
    
    
    
    0.2Tax benefit from exercise of stock options
    
    
    0.1
    
    
    
    1.2Decrease from changes in operating
assets and liabilities
    
    
    (35.2
    )
    
    
    (18.5
    )Net cash used by operating activities
    
    
    (23.8
    )
    
    
    (13.8
    )CASH FLOWS FROM INVESTING ACTIVITIESPurchase of property, plant and equipment
    
    
    (1.5
    )
    
    
    (1.7
    )Additions to gaming operations machines
    
    
    (8.8
    )
    
    
    (4.7
    )Net change in short-term investments
    
    
    (0.2
    )
    
    
    2.9Net cash used by investing activities
    
    
    (10.5
    )
    
    
    (3.5
    )CASH FLOWS FROM FINANCING ACTIVITIESGross proceeds from the issuance of convertible notes
    
    
    
    
    
    
    15.0Debt issuance costs
    
    
    
    
    
    
    (0.7
    )Cash received on exercise of common stock options
    
    
    0.6
    
    
    
    1.6Purchase of treasury stock
    
    
    
    
    
    
    (5.0
    )Net cash provided by financing activities
    
    
    0.6
    
    
    
    10.9EFFECT OF EXCHANGE RATES ON CASH
    
    
    
    
    
    
    (0.2
    )Decrease in cash and cash equivalents
    
    
    (33.7
    )
    
    
    (6.6
    )Cash and cash equivalents at beginning of period
    
    
    59.9
    
    
    
    99.6Cash and cash equivalents at end of period
    
    $
    26.2
    
    
    $
    93.0
 See notes to condensed consolidated financial statements. 6




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WMS INDUSTRIES INC.  
 
  1.
    
    FINANCIAL STATEMENTSThe accompanying unaudited condensed consolidated financial statements of WMS
Industries Inc. (WMS, we, us or the Company) have been prepared in
accordance with generally accepted accounting principles for interim
financial information, the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(including normal recurring accruals) considered necessary for a fair
presentation have been included.Sales of our gaming machines to casinos are generally strongest in the spring
and slowest in the summer months. In addition, quarterly revenues and net
income may increase when we receive a larger number of approvals for new
games from regulators than in other quarters, when a game that achieves
significant player appeal is introduced or if gaming is permitted in a
significant new jurisdiction. Operating results for the quarter ended
September 30, 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 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 PRESENTATIONOur condensed consolidated financial statements include the accounts of WMS
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated. We accounted for our joint operating
agreement with International Game Technology (IGT) for the SURVIVORthemed
wide-area progressive (WAP) systems, for which no legal entity existed, in
our consolidated financial statements by recording our proportionate share of
revenues and expenses from operating activities and the full value of all of
the assets we owned and liabilities we owed related to this agreement. The
purpose of the joint operating agreement was to combine our licensing rights
and game design expertise with the proprietary WAP system of IGT. We designed
and marketed specified games, which were manufactured by IGT who placed such
games in casinos on IGTs WAP system. In January 2004, the remaining SURVIVOR
themed WAP system was shut down. The total assets, total liabilities, total
revenues and total expenses related to the joint operating agreement were not
material to our consolidated financial statements for the periods presented.Certain prior period balances have been reclassified to conform to the
current period presentation. 7




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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
September 30, 2004Per ShareIncome
    
    Shares
    
    AmountBasic EPSEarnings applicable to common
stock
    
    $
    2.4
    
    
    
    30.3
    
    
    $
    0.08Effect of dilutive securities: options
    
    
    
    
    
    
    0.6
    
    
    
     warrants
    
    
    
    
    
    
    
    
    
    
     convertible notes
    
    
    
    
    
    
    
    
    
    
     restricted stock
    
    
    
    
    
    
    0.1
    
    
    
    Diluted EPSEarnings
applicable to common stock
    
    $
    2.4
    
    
    
    31.0
    
    
    $
    0.08
 Three Months Ended
September 30, 2003Per ShareLoss
    
    Shares
    
    AmountBasic EPSLoss applicable to common
stock
    
    $
    (1.9
    )
    
    
    29.3
    
    
    $
    (0.06
    )Effect of dilutive securities: options
    
    
    
    
    
    
    
    
    
    
     warrants
    
    
    
    
    
    
    
    
    
    
     convertible notes
    
    
    
    
    
    
    
    
    
    
     restricted stock
    
    
    
    
    
    
    
    
    
    
    Diluted EPSLoss applicable to common
stock
    
    $
    (1.9
    )
    
    
    29.3
    
    
    $
    (0.06
    )
 For the September 30, 2003 quarter, 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.
For both the September 30, 2004 and 2003 periods, if sufficient income had been
earned, the total diluted shares outstanding would have assumed the conversion
of our 2.75% convertible subordinated notes. 8




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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 EndedSeptember 30,2004
    
    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 applicable
    
    
    0.7If WMS had recognized income in excess of $0.10
per shareCommon stock
issuable upon conversion of the 2.75%
convertible subordinated notes
    
    
    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
    
    
    1.0
    
    
    
    0.8
  4.
    
    STOCK OPTION COMPENSATION AND EARNINGS (LOSS) PER SHAREWe 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 table presents 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 amounts): Three Months EndedSeptember 30,2004
    
    2003As Reported:Net income (loss)
    
    $
    2.4
    
    
    $
    (1.9
    )Income (loss) per share:Basic
    
    $
    0.08
    
    
    $
    (0.06
    )Diluted
    
    $
    0.08
    
    
    $
    (0.06
    )Stock based employee compensation cost, net of related tax
effects, included in the determination of net income (loss)
    
    $
    0.2
    
    
    $
    0.1
 9




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Three Months EndedSeptember 30,2004
    
    2003Pro forma amounts if the fair value method had been
applied to all stock compensation awards:Pro forma net loss
    
    $
    (0.0
    )
    
    $
    (5.5
    )Pro forma net loss per share:Basic
    
    $
    (0.00
    )
    
    $
    (0.19
    )Diluted
    
    $
    (0.00
    )
    
    $
    (0.19
    )Stock based employee compensation cost, net of related
tax effects, that would have been included in the
determination of net loss
    
    $
    2.6
    
    
    $
    3.7
 The following weighted average assumptions were used to value the options in
the periods indicated: Three Months EndedSeptember 30,2004
    
    2003Risk-free interest rate
    
    
    4.75
    %
    

    
    3.25
    %Expected life
    
    6 years
    
    6 yearsExpected volatility
    
    
    .36
    
    
    
    .54Expected dividend yield
    
    
    0
    
    
    
    0
 At both September 30, 2004 and 2003, the Company had approximately 4.3 million
stock options and warrants outstanding, respectively. 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 to vice presidents on our executive committee, 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, the Board of Directors approved a grant of restricted stock of
7,478 shares 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 months ended September 30, 2003. The following summarizes the stock options exercised during the periods
indicated (in millions except per share data): Three Months EndedSeptember 30,2004
    
    2003Stock options exercised
    
    
    0.1
    
    
    
    0.2Weighted average exercise price per
share
    
    $
    23.14
    
    
    $
    7.72
 10




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5. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions of dollars) Three Months EndedSeptember 30,2004
    
    2003Supplemental Disclosure of Cash Flow Information:Income taxes paid
    
    $
    
    
    
    $
    0.2Income tax refunds received
    
    $
    
    
    
    $
    0.3Interest paid
    
    $
    1.6
    
    
    $
    - -Investment income received
    
    $
    0.4
    
    
    $
    0.5Schedule of Non Cash Investing Activities:Issuance of 250,000 stock warrants to licensor
    
    $
    
    
    
    $
    3.9Gaming operations machines transferred
to inventory
    
    $
    0.6
    
    
    $
    0.2
  6.
    
    COMPREHENSIVE INCOME (LOSS)Comprehensive income (loss) consists of net income (loss) and foreign
currency translation adjustments and totaled net income
(loss) of $2.4 million and ($2.0) million for the three months ended
September 30, 2004 and 2003, respectively.7.
    
    INTANGIBLE ASSETSAt September 30, and June 30, 2004 intangibles assets were (in millions): September 30,
    
    June 30,2004
    
    2004Prepaid royalties and licensing advances
    
    $
    40.5
    
    
    $
    37.2Accumulated amortization
    
    
    (9.3
    )
    
    
    (9.7
    )$
    31.2
    
    
    $
    27.5Goodwill
    
    $
    2.3
    
    
    $
    2.3Patents costs
    
    $
    2.8
    
    
    $
    1.9
  At September 30, and June 30, 2004 both goodwill and patents costs have no
accumulated amortization. Once
issued, patents
will be amortized over four to seventeen years.Prepaid royalties and licensing advances at September 30, 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 products sales and
costs of gaming operations, was $0.5 million and $0.6 million for the
September 30, 2004 and 2003 quarters, respectively.The estimated aggregate amortization expense as of September 30, 2004 for
each of the next five years and thereafter is as
follows (in
millions of dollars): 2005
    
    $
    5.72006
    
    
    11.02007
    
    
    9.92008
    
    
    3.12009
    
    
    0.9Thereafter
    
    
    0.6
  The estimated aggregate future intangible amortization as of September 30,
2004 does not reflect the significant commitments
we have for future payments for royalties and licenses. See Note 10. 11




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8.
    
    CONVERTIBLE SUBORDINATED NOTES AND LINE OF CREDITIn September 2004, we amended our unused line of credit for $50.0 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 three months ended
September 30, 2004 or in fiscal 2004 and 2003.In June 2003, we issued $100 million of convertible subordinated notes
bearing interest at 2.75% maturing on July 15, 2010. In
July 2003, we issued an additional $15 million of convertible subordinated
notes under identical terms to cover an over-allotment option granted to the initial purchasers of the notes. The notes
are convertible at any time into an aggregate of 5.8
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.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 September 30, 2004, approximately $70.0
million is available for such distributions under the
most restrictive of these covenants.9.
    
    STOCKHOLDERS EQUITYCommon Stock Repurchase ProgramDuring 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 three months ended September 30, 2004.Warrant GrantIn September 2003, our Board of Directors, as part of the inducement to a
licensor to extend their license agreement with us,
approved a grant of 250,000 common stock purchase warrants valued at $3.9
million. The warrants exercise price is $35.04
per share of our common stock, subject to adjustment. The warrants are
non-cancelable and vest with respect to 20% of the
underlying shares in each year commencing on January 1, 2007 until fully
vested on January 1, 2011, subject to earlier vesting
under specified circumstances. The warrants expire on September 14, 2013.In valuing the warrants, we used the Black-Scholes model and incorporated
the following assumptions: risk free rate  4.15%;
expected volatility   .54; expected life  10 years; and expected
dividend  zero. The risk-free rate is determined based on the
interest rate of U.S. Government treasury obligations with a maturity date
comparable to the life of the warrants issued. Other
assumptions, relating to the warrants life, strike price, and our common
stock price, were determined at the date the warrants
were issued. We recognize expense based on the terms of the underlying
license agreement.10.
    
    COMMITMENTS AND CONTINGENCIESWe routinely enter into license agreements with others for the use of
their intellectual properties in our products. These
agreements generally provide for royalty advances when the agreements are
signed, and provide for minimum guaranteed
royalty payments as well as additional contingent payments based on future
events. In the September 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 September 30, 2004 increased to
$95.6 million from $92.7 million at June 30, 2004. The
total potential future royalty payments at September 30, 2004 decreased to
$55.1 million from $56.5 million at June 30, 2004. 12




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At September 30, 2004, we had total royalty commitments, advances and
payments made and potential future royalty payments
as follows (in millions): At September 30, 2004TotalGuaranteed
    
    Contingent
    
    PotentialMinimums
    
    Payments
    
    PaymentsTotal royalty commitments
    
    $
    93.8
    
    
    $
    1.8
    
    
    $
    95.6Advances and payments made
    
    
    (40.5
    )
    
    
    
    
    
    
    (40.5
    )Future royalty payments
    
    $
    53.3
    
    
    $
    1.8
    
    
    $
    55.1
  Of the $40.5 million total advances and payments through September 30,
2004, $9.3 million has been charged to expense and
the remaining $31.2 million is included in the September 30, 2004 balance
sheet with $7.0 million in other current assets and
$24.2 million in other assets.As of September 30, 2004, we estimate that potential future royalty
payments in each fiscal year will be as follows (in
millions): TotalGuaranteed
    
    Contingent
    
    PotentialYear Ended June 30,
    
    Minimums
    
    Payments
    
    Payments2005
    
    $
    9.3
    
    
    $
    1.3
    
    
    $
    10.62006
    
    
    10.7
    
    
    
    0.5
    
    
    
    11.22007
    
    
    9.3
    
    
    
    
    
    
    
    9.32008
    
    
    8.9
    
    
    
    
    
    
    
    8.92009
    
    
    4.9
    
    
    
    
    
    
    
    4.9Thereafter
    
    
    10.2
    
    
    
    
    
    
    
    10.2Total
    
    $
    53.3
    
    
    $
    1.8
    
    
    $
    55.1
  As part of our technology improvement plan, we have licensed technology
from third parties. At September 30, 2004, we had
guaranteed minimum payments related to such technologies aggregating $10.7
million, all of which had been paid as advances
and $0.5 million had been charged to expense. An additional $1.0 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 $11.2 million.11.
    
    LITIGATIONOn 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 a reasonable estimate of 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. 13




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##### Table of Contents



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-NXT
computer circuit board and operating system,new Bluebirdcabinet and new games
from each of the six North American gaming labs, our product sales revenues
increased, and we expect that they will continue to grow as we introduce new
products on our new CPU-NXToperating system and obtain additional approvals.
In fiscal 2005, 2006 and 2007, with all of the approvals in hand for all of our
product lines, we expect growing market share with our new product lines:
mechanical reel, video poker and wide-area progressive jackpots. Technology Improvement Plan In the first phase of this plan, we improved the stability of our operating
system by introducing two upgrades, version 2.57 for hopper-based games and
version 2.59 for printer-based games. Version 2.57 has been approved by all six
of the North American gaming labs, and we were required to and completed an
upgrade of our hopper game operating system to version 2.57 in four
jurisdictions. Other jurisdictions may require upgrades in the future. We are
making version 2.57 available in other jurisdictions as an optional upgrade.
Gaming Laboratories International, Inc. (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.
GLI required us to complete an upgrade of hopper-based games to version 2.57
and our printer based games to version 2.59 by December 2004. The GLI lab tests
product for all of the Native American casinos and the Midwest riverboat
casinos where in the aggregate we believe about 50% of our existing gaming
devices are deployed. The second phase of our technology improvement plan 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 from the other five North American gaming labs. We also have received ticket-in ticket-out approvals and alternative peripheral
equipment approvals from the six North American gaming labs, except for one
ticket-in ticket-out approval in Nevada which we expect to receive in the
December 2004 quarter. 14




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##### Table of Contents



We are evaluating specifications and requirements for an even more advanced
gaming system that will be developed during the third phase of the technology
improvement plan. We continue to refine the design and specifications to
incorporate additional features we desire for this platform and continue to
allocate resources to this longer-term effort. Bluebirdand CPU-NXTCommercialization Our focus in the near term is to refresh our existing installed base of more
than 50,000 video gaming devices in casinos through either replacement with 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 from the
other five North American gaming labs. Each jurisdictional approval of the
CPU-NXToperating system also allows us to submit new games designed for use
with that system to the regulators for approval, which enables us to sell and
ship additional CPU-NXTupgrade kits. We now have the approvals for hardware
peripheral options, such as alternative coin handling, printing and bill
accepting equipment. Customer acceptance of Bluebirdvideo gaming devices and our new game themes
continues to be very favorable. Since we started selling Bluebirdvideo gaming
devices in September 2003, we have executed corporate agreements or issued
sales orders for over 25,000 Bluebirdvideo gaming devices and CPU-NXTkits,
addressing roughly 50% of the 50,000 plus WMS legacy video gaming devices in
casinos. Through September 30, 2004, over 15,000 of these orders had been
shipped, or approximately 30% of the 50,000 WMS legacy gaming devices. 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 Bluebirdvideo gaming devices and new game
themes are generating strong performance data, and we have all necessary
regulatory approvals. 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 January 2004, we received Nevada regulatory approval for our new mechanical
reel product and three new game themes, including two wide area progressive
system game themes and one for sale game theme. We received GLI approval for
our mechanical reel product and three new game themes in March 2004. We have
now received regulatory approvals for our new mechanical reel operating system
and the modifications for the Bluebirdgaming cabinet in all six of the North
American gaming labs. We launched this product line in September 2004 with six
initial game themes. In Nevada, we have completed field trials and received
approvals for three of the four ticket-in-ticket-out systems on the mechanical
reel-spinning product for this important product. 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 and expect to receive approval from the remaining
three gaming labs in the December 2004 quarter. 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 progressive jackpot system also in May 2004 and launched the
product in Native American casinos in June 2004. We received Colorado
Department of Gaming approval in September 2004 and launched the product in
Colorado casinos in September 2004. We have submitted the WAP to the
Mississippi and New Jersey gaming regulators and expect to receive approval
from each jurisdiction in Spring 2005 and Summer 2005, respectively. 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 MONOPOLY
brand in the coming years. We launched five new MONOPOLYthemed 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. 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. 15




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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. 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 late 2005. Class II Gaming Effective April 1, 2004, we executed an 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.
Through this new two-year agreement, Multimedia will license additional WMS
game themes, and we will serve as Multimedias primary original equipment
manufacturer of gaming cabinets. Pursuant to the terms of the agreement, we will license to Multimedia our
extensive game content library, including branded participation games, for
exclusive placement (subject to our existing commitments) in Multimedias
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 annually during the two-year term of
the agreement. Additionally, Multimedia will purchase minimum quantities of our
new gaming cabinets for placement in the above noted markets in the form of
either legacy cabinets or our award-winning Bluebird gaming cabinet, including
slim-line versions of both cabinet styles. CRITICAL ACCOUNTING POLICIES During the quarter ended September 30, 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. 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 September 30, 2004, were as follows (in
millions): Payment Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    5 YearsOperating Leases
    
    $
    19.1
    
    
    $
    1.5
    
    
    $
    4.4
    
    
    $
    3.8
    
    
    $
    9.4Royalty Payments
    
    
    53.3
    
    
    
    9.3
    
    
    
    20.0
    
    
    
    13.8
    
    
    
    10.2Non-cancelable Raw MaterialPurchase
Orders
    
    
    3.0
    
    
    
    3.0Convertible Subordinated Notes
    
    
    115.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115.0Other, Including GuaranteedMinimum EmploymentAgreements
    
    
    8.4
    
    
    
    7.3
    
    
    
    1.1
    
    
    
    
    
    
    
    Total
    
    $
    198.8
    
    
    $
    21.1
    
    
    $
    25.5
    
    
    $
    17.6
    
    
    $
    134.6
 The total potential royalty commitments, including payments already made and
those contingent upon future events, decreased from $56.5 million at June 30,
2004 to $55.1 million at September 30, 2004 due to payments of $4.3 million
during the September 2004 quarter, 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 and restricted stock to our employees,
officers, directors and consultants and warrants to a licensor, and we have
issued convertible subordinated notes. 16




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES As ofSeptember 30,
    
    June 30,
    
    Increase(In millions of dollars)
    
    2004
    
    2004
    
    (Decrease)Total cash,
cash equivalents and short-term investments
    
    $
    83.0
    
    
    $
    116.2
    
    
    $
    (33.2
    )Total current assets
    
    
    278.8
    
    
    
    278.0
    
    
    
    0.8Total assets
    
    
    400.5
    
    
    
    395.0
    
    
    
    5.5Total current liabilities
    
    
    42.6
    
    
    
    40.5
    
    
    
    2.1Long-term debt
    
    
    115.0
    
    
    
    115.0
    
    
    
    Stockholders equity
    
    
    242.9
    
    
    
    239.5
    
    
    
    3.4Net working capital
    
    
    236.2
    
    
    
    237.5
    
    
    
    (1.3
    )
 Our current sources of liquidity for the three months ended September 30, 2004
were:  
    
    Existing cash, cash equivalents and short-term investments,
    
    Non-cash expenses of $8.9 million and our net income of $2.4 million, and
    
    Proceeds from stock option exercises of $0.6 million, excluding related tax benefits. We believe that cash and cash equivalents and short-term investments of $83.0
million at September 30, 2004, inclusive of $0.8 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 significantly as we grow market share in our new product lines:
mechanical reel, poker and wide area progressive systems. We do not believe we
will need to raise additional capital in the short-term or long-term
however,
we will assess market opportunities as they arise. In September 2004, we amended our unused line of credit for $50.0 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 three months
ended September 30, 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. During the three months ended September 30, 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 $10.0 million due to higher new unit sales levels during the three
months ended September 30, 2004. Inventory at September 30, 2004 increased by
$20.6 million due to $10.0 million of higher levels of raw materials as we
prepared for an increasing volume of business and $10.6 million for finished
goods primarily due to $9.9 million of gaming operations machines and top boxes
completed but not yet installed in casinos. Net royalty advances increased by
$3.7 million due to new technology and brand license agreements we entered into
or amended during the three months ended September 30, 2004. Current
liabilities increased by $2.1 million due to higher accrued liabilities,
including accrued royalties and 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 three months ended
September 30, 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
September 30, 2004 and at June 30, 2004, respectively. 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 $17.3 million of deferred tax assets on our balance sheet as of
September 30, 2004, a decrease of $1.4 million from June 30, 2004. These
represent taxable temporary differences expected to reverse in fiscal 2005 and
future years, and tax credits 17




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##### Table of Contents



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
September 30, 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 September 30, 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 $95.6 million at
September 30, 2004, of which $40.5 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 $100.0 million of convertible subordinated notes
bearing interest at 2.75% maturing on July 15, 2010. In July 2003, we issued an
additional $15.0 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 of dollars): For the Three Month Period EndedSeptember 30,IncreaseCash provided (used) by:
    
    2004
    
    2003
    
    (Decrease)Operating activities
    
    $
    (23.8
    )
    
    $
    (13.8
    )
    
    $
    (10.0
    )Investing activities
    
    
    (10.5
    )
    
    
    (3.5
    )
    
    
    (7.0
    )Financing activities
    
    
    0.6
    
    
    
    10.9
    
    
    
    (10.3
    )Effect of exchange rates on cash
    
    
    
    
    
    
    (0.2
    )
    
    
    0.2Decrease in cash and cash equivalents
    
    $
    (33.7
    )
    
    $
    (6.6
    )
    
    $
    (27.1
    )
 Cash used by operating activities was $23.8 million for the three months ended
September 30, 2004, as compared to cash used of $13.8 million for the three
months ended September 30, 2003. The current period decrease relative to the
comparable prior year period was due to $35.2 million of cash invested in
operating assets and liabilities due to growth of our business, compared to
$18.5 million of cash invested in operating assets and liabilities in the three
months ended September 30, 2003. Depreciation expense provided $6.8 million of
cash to operations for the three months ended September 30, 2004, as compared
to $6.3 million for the three months ended September 30, 2003. We anticipate
cash to be provided by operations over the next twelve months, due to
anticipated higher revenues from increased new unit sales, partially offset by
higher research and development expenses related to the ongoing execution of
our technology improvement plan, product approval costs, product line expansion
costs and increased game offerings, as well as higher selling and
administrative costs due to the execution of the re-emergence plan. In
addition, we expect in fiscal 2005 and fiscal 2006 that our cash invested in
operating assets and liabilities will not continue to increase at the rate
experienced in the three months ended September 30, 2004. 18




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##### Table of Contents



Components of the $35.2 million and $18.5 million invested in operating assets
and liabilities for the three-month periods ended September 30, 2004 and 2003,
respectively, are as follows (in millions of dollars): Changes in Operating Assets and Liabilities: For the Three Month PeriodEndedSeptember 30,Increase2004
    
    2003
    
    (Decrease)Decrease (increase) in operating assets:Accounts and notes receivable
    
    $
    (10.0
    )
    
    $
    (6.1
    )
    
    $
    (3.9
    )Raw material and finished goods inventories
    
    
    (20.6
    )
    
    
    (0.9
    )
    
    
    (19.7
    )Income tax receivable
    
    
    
    
    
    
    (1.2
    )
    
    
    1.2All other operating assets
    
    
    (6.7
    )
    
    
    (7.8
    )
    
    
    1.1Increase (decrease) in operating liabilities:Current liabilities
    
    
    2.1
    
    
    
    (2.5
    )
    
    
    4.6Net increase in operating assets and liabilities
    
    $
    (35.2
    )
    
    $
    (18.5
    )
    
    $
    (16.7
    )
 For the three months ended September 30, 2004, the increase in accounts and
notes receivable reflects an increasing trend in new unit sales, while raw
material and finished goods inventories increased $20.6 million as we prepared
for an increased volume of business. The increase in all other operating assets
is primarily due to $3.7 million of net royalty advances for new technology and
brand license agreements entered into or amended during the current three
months ended September 2004. The increase of current liabilities is due to higher accrued liabilities, including accrued royalties and compensation
related liabilities. For the three months ended September 30, 2003, the cash invested in all other
operating assets was primarily due to a $7.8 million increase in royalty
advances. The increase in royalty advances was due to new and amended
technology and brand license agreements entered into during the three months
ended September 30, 2003. The reduction of current liabilities was due to a
lower level of business. The decrease in income taxes receivable was due to
receipt of prior years refunds. The increase in inventories reflects additional
raw materials as we prepared for increased sales activity. Cash used by investing activities was $10.5 million and $3.5 million for the
three months ended September 30, 2004 and 2003, respectively. Cash used for the
purchase of property, plant and equipment for the three months ended September
30, 2004 was $1.5 million compared with $1.7 million for the comparable prior
year period. We are currently planning an expansion of our technology campus or
the purchase and renovation of additional space in fiscal 2005 and an expansion
of our Waukegan manufacturing facility that will begin in fiscal 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 $8.8 million and $4.7 million for the three months ended
September 30, 2004 and 2003, respectively. The current period investment in
gaming operation machines is higher as we refresh our participation games with
new technology installed in our new Bluebirdcabinet. We expect this investment
to continue to increase for the fiscal 2005, 2006 and 2007 as we roll out new
participation games installed in our Bluebirdcabinet. Net cash of $0.2
million was invested in short-term investments for the three months ended
September 30, 2004, compared to $2.9 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 $0.6 million for the three months
ended September 30, 2004 compared with cash provided of $10.9 million for the
comparable prior year period. We received $0.6 million and $1.6 million from
the exercise of stock options in the three months ended September 30, 2004 and
2003, respectively. The amount we receive from the exercise of stock options is
dependent on individuals choices to exercise options, which are dependent on
the spread of the market price of our stock above the strike price of vested
options. 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 three months ended September 30, 2004, we did not
repurchase any shares of our common stock. 19




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##### Table of Contents



Since the inception of our common stock repurchase programs in January 2002
through September 30, 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. During the three months ended September 30, 2003, we purchased $5.0
million of our common stock for treasury. At September 30, 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. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2003 Revenues, Gross Margins and Key Performance Indicators (in millions of
dollars, except unit data): Three Months EndedSeptember 30,
    
    Increase2004
    
    2003
    
    (Decrease)
    
    % ChangeProduct Sales:New unit sales revenue
    
    $
    41.3
    
    
    $
    18.5
    
    
    $
    22.8
    
    
    
    123.2
    %Parts, used games, conversions and OEM revenue
    
    
    12.1
    
    
    
    6.4
    
    
    
    5.7
    
    
    
    89.1Total product sales revenue
    
    $
    53.4
    
    
    $
    24.9
    
    
    $
    28.5
    
    
    
    114.5Total new units sold
    
    
    4,220
    
    
    
    2,220
    
    
    
    2,000
    
    
    
    90.1Average sales price per new unit
    
    $
    9,793
    
    
    $
    8,316
    
    
    $
    1,477
    
    
    
    17.8Total OEM units sold
    
    
    250
    
    
    
    
    
    
    
    250
    
    
    NAGross profit on product sales revenue
    
    $
    21.6
    
    
    $
    9.7
    
    
    $
    11.9
    
    
    
    122.7Gross margin on product sales revenue
    
    
    40.4
    %
    
    
    39.0
    %
    
    
    1.4
    %
    
    
    3.6Gaming Operations Revenues:Participation revenue
    
    $
    16.1
    
    
    $
    18.2
    
    
    $
    (2.1
    )
    
    
    (11.5
    )Royalties, VLT and other lease revenue
    
    
    5.6
    
    
    
    3.6
    
    
    
    2.0
    
    
    
    55.6Total gaming operations revenue
    
    $
    21.7
    
    
    $
    21.8
    
    
    $
    (0.1
    )
    
    
    (0.5
    )Average installed base
    
    
    4,161
    
    
    
    4,853
    
    
    
    (692
    )
    
    
    (14.3
    )Installed base at period end
    
    
    4,486
    
    
    
    4,797
    
    
    
    (311
    )
    
    
    (6.5
    )Net revenue per day per machine
    
    $
    41.95
    
    
    $
    40.72
    
    
    $
    1.23
    
    
    
    3.0Gross profit on gaming operations revenue
    
    $
    17.1
    
    
    $
    17.7
    
    
    $
    (0.6
    )
    
    
    (3.4
    )Gross margin on gaming operations revenue
    
    
    78.8
    %
    
    
    81.2
    %
    
    
    (2.4
    )%
    
    
    (3.0
    )Total Revenues
    
    $
    75.1
    
    
    $
    46.7
    
    
    $
    28.4
    
    
    
    60.8Total Gross Profit
    
    $
    38.7
    
    
    $
    27.4
    
    
    $
    11.3
    
    
    
    41.2Total Gross Margin
    
    
    51.5
    %
    
    
    58.7
    %
    
    
    (7.2
    )%
    
    
    (12.3
    )%
 The increase in total revenues for the September 2004 quarter compared to the
September 2003 quarter was primarily due to $22.8 million in higher new gaming
machine sales and a $5.7 million increase in conversion, used games and parts
revenues, partially offset by a $0.1 million reduction in gaming operations
revenues. New unit sales increased by 90% to 4,220 units as we shipped our new Bluebird
video gaming devices to additional jurisdictions after receiving additional
regulatory approvals and as we offered a higher number of new game themes. In
the September 2004 quarter, revenues from parts, used games, conversions and
OEM revenues increased 89% compared to the prior year quarter due to an
increase of conversion units sold in the current quarter, 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 September 2004 quarter. We expect continued growth in the
average selling price over the next three quarters, as the percentage of
Bluebirdunits sold becomes a higher percentage of our overall sales mix. 20




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##### Table of Contents



The average installed base of participation gaming devices decreased to 4,161
units in the September 2004 quarter from 4,853 units in the September 2003
quarter, while the net revenue per day increased by $1.23 per day from the
prior year quarter to $41.95 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 dual port cashless gaming technology that many customers require and
the natural evolution of our older participation series. The installed base
grew 246 units to 4,486 units at September 30, 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 723 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 56% increase in royalty revenues in
the September 2004 quarter from the September 2003 quarter, primarily due to
our licensees increased purchases or placement of WMS games. Total gross profit increased to $38.7 million for the September 2004 quarter
from $27.4 million in the September 2003 quarter while total gross margin was
52% in the September 2004 quarter compared to 59% in the September 2003 quarter.
Higher margin gaming operations revenues were only 29% of total revenues in the
September 2004 quarter, compared to 47% in the September 2003 quarter due to
the increase of product sales revenue in the current year quarter. The gross
margin on product sales was 40% for the September 2004 quarter, up from 39% in the
prior year quarter, reflecting higher margin on the mix of products sold. We
expect that the gross margin on the Bluebirdgaming devices will improve as
production volume increases because we should be able to obtain larger volume
discounts from our suppliers, and we anticipate the cost of electrical
components will decrease over time. The gross profit margin on gaming
operations decreased to 79% in the September 2004 quarter compared to 81% 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 EndedSeptember 30,2004
    
    2003As % of
    
    
    
    
    
    As % of
    
    Increase$
    
    Revenue
    
    $
    
    Revenue
    
    (Decrease)
    
    % ChangeResearch and development
    
    $
    12.1
    
    
    
    16.1
    %
    
    $
    10.3
    
    
    
    22.1
    %
    
    $
    1.8
    
    
    
    17.5
    %Selling and administrative
    
    
    15.6
    
    
    
    20.8
    
    
    
    13.6
    
    
    
    29.1
    
    
    
    2.0
    
    
    
    14.7Depreciation and
amortization
    
    
    6.8
    
    
    
    9.0
    
    
    
    6.3
    
    
    
    13.5
    
    
    
    0.5
    
    
    
    7.9$
    34.5
    
    
    
    45.9
    %
    
    $
    30.2
    
    
    
    64.7
    %
    
    $
    4.3
    
    
    
    14.2
    %
 Research and development expenses increased $1.8 million, or 18%, to $12.1
million in the September 2004 quarter compared to $10.3 million in the prior
year quarter, due to ongoing execution of our technology improvement plan,
product approval costs, product line expansion costs and increased game
offerings. We continue to expect quarterly research and development expenses in
fiscal 2005 to exceed those in the comparable prior years quarters. Research
and development expenses in the September 2004 quarter decreased $0.4 million,
or 3%, from the June 2004 quarter, as the growth rate of such expenses has
begun to level off. Selling and administrative expenses increased $2.0 million, or 15%, to $15.6
million in the September 2004 quarter compared to $13.6 million in the
September 2003 quarter due to the ongoing execution of our re-emergence plan
and higher marketing costs to support the launch of three new product lines and
an increased number of new games. We expect selling and administrative
expenses to continue to rise over the prior years quarters as we market the
CPU-NXToperating system and Bluebirdcabinet in more jurisdictions and support
our diversification into multiple product lines. Selling and administrative
costs decreased slightly, $0.1 million or 1%, from the June 2004 quarter. Depreciation and amortization expense increased by $0.5 million as the level of
investment in participation gaming devices for gaming operations increased from
the September 2003 quarter with the installation of new games in Bluebird
cabinets during the September 2004 quarter. 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. 21




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We generated operating income of $4.2 million in the September 2004 quarter,
compared to an operating loss of $2.8 million in the September 2003 quarter.
The improved operating performance in the fiscal 2005 first quarter resulted
from the $11.3 million increase in gross profit, partially offset by a $1.8
million increase in research and development expenses, $2.0 million increase in
selling and administrative expenses and a $0.5 million increase in depreciation
and amortization expense. We incurred interest expense of $1.0 million in the September 2004 quarter
compared to $0.8 million in the September 2003 quarter primarily related to our
2.75% convertible subordinated notes issued in Summer 2003. This was partially
offset by $0.6 million and $0.6 million of other income in the September 2004
and 2003 quarters, respectively, primarily interest and investment income
earned on cash, cash equivalents and short-term investments, which at September 30, 2004 and 2003
amounted to $83.0 million and $150.5 million, respectively. The provision for income taxes, which is comprised primarily of deferred taxes,
is based on our annual estimated effective tax rate of 37.5%, due to state tax
rates and higher expected income in 2005. The estimated effective income tax rate for the
September 2003 quarter was 37.5% reflecting a benefit of $1.1 million against
pre-tax losses. Net income was $2.4 million or $0.08 per diluted share for the September 2004
quarter compared to net loss of $1.9 million, or $0.06 per share, for the
prior year quarter. 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 later filings with the Securities and Exchange Commission. 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. ©2004 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. ©2004
FremantleMedia North America, Inc. Licensed by
FremantleMedia Licensing Worldwide.3 WAY ACTIONis a trademark of Yehia Awada.CPU-NXT, Bluebird, Classic TV Game Show Series, Once Around Deluxe, Tour of
Starsand Prize Spinare trademarks of WMS Gaming Inc. All rights reserved. 22




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##### Table of Contents



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 September 30, 2004, we had $115 million of convertible fixed-rate debt
with an interest rate of 2.75% with a fair value of $172.5 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 September 30, 2004, we had no changes in our foreign
currency risk. 
 ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, our Chief Executive Officer
and our Chief Financial Officer carried out an evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures, as
required by Rule 13a-15 under the Securities Exchange of 1934. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in ensuring that
material information about us and our subsidiaries, including the material
information required to be disclosed in our filings under the Exchange Act, is
recorded, processed, summarized and communicated to them as appropriate to
allow timely decisions regarding required disclosure. As a part of the ongoing implementation of an Oracle ERP system, we have
updated our internal controls over financial reporting as necessary to
accommodate any modifications to our business processes or accounting
procedures. There have not been any other changes in our internal controls
over financial reporting or in other factors that materially affected, or are
reasonably likely to materially affect internal controls over financial
reporting as of the end of the period covered by this report. 23




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##### Table of Contents



PART II. OTHER INFORMATION 
 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 of Amendment to Employment Agreement between Brian R. Gamache
and WMS dated as of August 11, 2004, incorporated by reference to
WMS Annual Report on Form 10-K for the year ended June 30, 2004.10.2
    
    WMS Industries Inc. Nonqualified Deferred Compensation Plan,
incorporated by reference to WMS Current Report on Form 8-K filed
September 15, 2004.10.3
    
    Revolving Note, dated September 21, 2004, made by WMS to LaSalle Bank
National Association, incorporated by reference to WMS Current
Report on Form 8-K filed September 24, 2004.31
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 24




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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: November 5, 2004
    
    By: /s/ Scott D. SchweinfurthScott D. SchweinfurthExecutive Vice President,Chief Financial Officer and Treasurer(Principal Financial and Chief AccountingOfficer)
 25




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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 of Amendment to Employment Agreement between Brian R. Gamache
and WMS dated as of August 11, 2004, incorporated by reference to
WMS Annual Report on Form 10-K for the year ended June 30, 2004.10.2
    
    WMS Industries Inc. Nonqualified Deferred Compensation Plan,
incorporated by reference to WMS Current Report on Form 8-K filed
September 15, 2004.10.3
    
    Revolving Note, dated September 21, 2004, made by WMS to LaSalle Bank
National Association, incorporated by reference to WMS Current
Report on Form 8-K filed September 24, 2004.31
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32
    
    Certifications of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 26