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WMS > SEC Filings for WMS > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for WMS INDUSTRIES INC /DE/


9-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K filed with the SEC on August 21, 2012 ("Form 10-K"). This discussion and analysis also contains forward-looking statements and should also be read in conjunction with the disclosures and information contained in "Cautionary Note" and Item 1A. "Risk Factors" in our Form 10-K and our more recent reports filed with the U.S. Securities and Exchange Commission. The following discussion and analysis is intended to enhance the reader's understanding of our business environment, financial condition and results of operations.

As used in this Report, the terms "we", "us", "our", and "WMS" mean WMS Industries Inc., a Delaware corporation, and its subsidiaries. All references to years, unless otherwise noted, refer to our fiscal year, which ends on June 30. All references to quarters, unless otherwise noted, refer to the quarters of our fiscal year.

Product names mentioned in this Report are trademarks of WMS Gaming Inc., except for the following marks: Apple, iPad and iPhone are registered trademarks of Apple Inc.; Facebook is a registered trademark of Facebook, Inc.; G2E is a registered trademark of the American Gaming Association and Reed Elsevier Inc. Used with permission.

OVERVIEW

Our mission is: through imagination, talent and technology, we create and provide the world's most compelling gaming experiences. We are a leading supplier of innovative gaming entertainment products and services worldwide. We design, develop, manufacture, distribute and market casino games and gaming machines, VLTs and interactive gaming products and services. As regulated markets legalize interactive online gaming, we intend to enter and do business in those markets. Our gaming machine products are installed in all of the major regulated gaming jurisdictions in the United States, as well as in approximately 143 international gaming jurisdictions.

On January 30, 2013, WMS entered into the Merger Agreement with Scientific Games, Scientific Games International, Inc., a wholly owned subsidiary of Scientific Games, and Merger Sub. The Merger Agreement provides for the merger of Merger Sub with and into WMS, with WMS surviving as a wholly-owned subsidiary of Scientific Games.


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The Merger Agreement was unanimously approved by our Board of Directors. At the effective time of the Merger, each share of WMS' common stock issued and outstanding immediately prior to such time, other than our treasury shares, shares owned by Scientific Games or Merger Sub, and shares with respect to which appraisal rights are properly exercised and not withdrawn under Delaware law, will be automatically cancelled and converted into the right to receive $26.00 in cash, without interest, on the terms and subject to the conditions set forth in the Merger Agreement. Following consummation of the Merger, our stock will be delisted from the New York Stock Exchange.

Consummation of the Merger is subject to customary conditions, including without limitation (i) approval of the Merger Agreement by WMS' stockholders at a stockholder's meeting which is scheduled to take place on May 10, 2013,
(ii) receipt and effectiveness of specified licenses, permits, and other approvals, issued by certain governmental authorities in relation to our business and (iii) other customary closing conditions. On March 11, 2013, we received notice from the Federal Trade Commission of the early termination of the waiting period applicable to the consummation of the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1974, as amended, so this condition to closing is complete. At this time, we expect to consummate the Merger by the end of calendar 2013. The Merger Agreement contains certain limitations on the operations of WMS during the period prior to the effective time of the Merger, including a prohibition on share repurchases by the Company.

We generate revenue in two principal ways: product sales and gaming operations, as further described below. In fiscal 2012, we expanded our interactive gaming products and services with the launch of our first non-wagering social game on Facebook and the sale of select WMS games for mobile devices and PC's and in July 2012, we grouped together all of our worldwide online wagering, social, casual and mobile gaming products and services in order to focus on their revenue growth, development and market efficiencies and to optimize the benefits of interactive gaming products and services for casino operators and their players. Also, in July 2012 we launched a second non-wagering social game on Facebook titled Jackpot Party® Social Casino. We expect to facilitate the continued expansion, investment, evolution and extension of our interactive products and services and increase our focus on this rapidly evolving growth area. In fiscal 2013, we expect to further penetrate each of the new markets and distribution channels we have entered over the last few years and look to further expand our distribution channels.

The recession and financial market crisis that began in 2008 has continued to disrupt the economy worldwide, reduced consumer discretionary spending and has led to a weakened global economic environment, all of which have been significant challenges for our industry. In calendar 2008 and 2009, some gaming operators delayed or canceled construction projects, resulting in fewer new casino openings and expansions in fiscal 2010 and 2011, coupled with many customers reducing their annual capital budgets for replacing gaming machines. New unit demand for new casino openings and casino expansions increased in fiscal 2012; however, we expect demand for new casino openings and expansions to decrease in fiscal 2013. The economic crisis reduced disposable income for casino patrons and resulted in fewer patrons visiting casinos and lower spending by those patrons who did visit casinos. The economic crisis and operational challenges led to the review of our product plans and business strategies at the end of fiscal 2011 and beginning of fiscal 2012 and increased competition from our competitors lowered the number of new units we shipped over the last three fiscal years, resulting in lower revenues in fiscal 2012 than in fiscal 2011 and 2010. While our revenues for the nine months ended March 31, 2013, were flat with the prior year period, this resulted from increased revenues from our interactive products and services offsetting the decline in product sales and participation revenues.

In late fiscal 2011 and early fiscal 2012, with no leading indicators showing any significant increase in replacement demand, we conducted a thorough review of our business strategies and product plans. As a result of the strategic review, we announced that we would refine our product plans and restructure our organization to sharpen emphasis on our game content and product development strengths. Specifically, we have streamlined our product management and product development functions, simplified product plans and further prioritized on-time commercialization of new game themes, products and portal gaming applications. As part of our restructuring, we implemented a 10% reduction in our workforce. Some of the product, operational and other decisions made in this review led to impairment, restructuring, asset write-downs and other charges, net of $24.0 million pre-tax, or $0.26 per diluted share, recorded in the June 2011 quarter and $27.8 million pre-tax, or $0.28 per diluted share, for fiscal 2011. In the September 2011 quarter, we implemented a broader impairment analysis and restructuring and recorded additional charges amounting to $14.0 million pre-tax, or $0.17 per diluted share.

In the March 2012 quarter, we launched our new Bluebird®2e gaming machine as an upgrade to our Bluebird2 gaming machines. The Bluebird2e gaming machines contain the emotive lighting feature that we launched with the Bluebird xD™ cabinet. In March 2013, we launched our new Blade™ upright cabinet for product sales and new Gamefield xD™ participation cabinet for our participation gaming installed base, and both utilize our next-generation CPU-NXT®3 operating system platform. As we announced these new products and demonstrated them at the G2E® trade show in October 2012, we believe customers may have reduced the quantity ordered of our current products and instead waited for these new products which launched in March 2013. In the December 2012 quarter, we launched the initial placements of My Poker® xD cabinets to address a segment of the casino floor we have little presence in. We believe that as the economy improves and gaming operators see meaningful improvements in their profitability and cash flows, they will increase their annual capital budgets for replacement units, which will improve the replacement demand in future years, although we cannot predict when this will occur or the rate of increase in their capital budgets.

We believe several recent developments fueled by the challenging economic situation could expand our revenue opportunities over the long term. In the United States, legislators have passed or are considering enabling new or expanded gaming legislation in Ohio, Illinois, Kansas, Iowa, Maryland, California, New Hampshire, New York, Florida, Maine and Massachusetts. Internationally, Singapore opened as a new market in fiscal 2010. In addition, legislation has been passed or discussed in Greece, Brazil, Japan and


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Taiwan that could open new market opportunities. In the United States, the States of Nevada, Delaware and New Jersey have adopted legislation to legalize certain forms of online gaming and federal legislators and certain other state legislators and governments in Canada and Europe have legalized or are considering legalizing certain forms of online gaming, which if passed could expand our revenue opportunities. The breadth and timing of these opportunities remain uncertain due to the political process in each of these jurisdictions, as well as the difficult credit environment facing our customers and the risk of continued economic uncertainty.

We review certain financial measures in assessing our financial condition and operating performance not only in connection with creating our forecasts and in making comparisons to financial results from prior periods, but also in making comparisons to our competitors' financial results and our internal plans. We focus on fluctuations in revenue, number of new units sold, average selling price, average participation installed base and average revenue per day, cost on both products sales and gaming operations and also pay close attention to our operating income, operating margin, net income, diluted earnings per share, total cash, total accounts and notes receivable, inventories and accounts payable and cash flows provided by or used in operating activities, investing activities and financing activities, as they are key indicators of our performance. We also measure changes in selling and administrative expenses as a percent of revenue, which indicate management's ability to control costs, as well as research and development costs as a percent of revenue, which demonstrate investment in technology and product development. Finally, we measure depreciation and amortization expense as a percentage of revenues as an indicator of the current cost of capital expenditures, primarily in gaming operations.

The measures listed above are not a comprehensive list of all factors considered by us in assessing our financial condition and operating performance, and we may consider other individual measures as required by trends and discrete events arising in a specific period, but they are the key indicators and these measures are discussed herein.

The priorities for the utilization of our cash flow are to: continue to enhance stockholder value by emphasizing internal and external investments to create and license advanced technologies and intellectual property; seek acquisitions or licensing deals that can extend our presence and product lines, increase our distribution channels, enhance our intellectual property portfolio and expand our earnings potential; and, when appropriate, subject to the restrictions in our Merger Agreement with Scientific Games, repurchase shares in the open market or in privately negotiated transactions. For the nine months ended March 31, 2013, our research and development spending increased $14.0 million compared to the prior year and we spent $47.7 million on property, plant and equipment and $57.5 million on additions to gaming operations equipment, we made payment of $10.2 million to acquire or license intangible and other non-current assets and we funded approximately $5.0 million of common stock repurchases. We also had $25.0 million net borrowings on our credit facility and had $85.0 million long-term debt outstanding at March 31, 2013.

Product Sales

Product sales revenue includes the sale to casinos and other gaming machine operators of new and used gaming machines and VLTs, parts and conversion kits (including game theme, hardware or operating system conversions). We derive product sales revenue from the sale of the following types of gaming machines:

• Multi-line, multi-coin video gaming machines, in our Bluebird2, Bluebird2e, Bluebird xD and Blade branded gaming machines;

• Mechanical reel-spinning gaming machines in our Bluebird2, Bluebird2e and Bluebird xD branded gaming machines;

• Replacement parts and game theme conversion kits for our Bluebird, Bluebird2, Bluebird2e, Bluebird xD, Twinstar™, Twinstar2, Helios™ and CPU-NXT and CPU-NXT2 operating system upgrade kits; and

• Used gaming machines manufactured by us or our competitors that are acquired on a trade-in basis or that we previously leased to casinos as participation gaming machines.

In early October 2012 at our industry's largest trade show, we demonstrated our new Blade cabinet that we began shipping in March 2013. We believe customers may have decided not to purchase our existing cabinets and wait to spend their capital with WMS until the Blade cabinet was approved in their jurisdiction. We also believe that we experienced lower average selling prices of our existing cabinets due to higher discounts off of the list price.


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Gaming Operations

We earn revenues from leasing gaming machines and VLTs to casinos and other licensed gaming machine operators under operating leases; operating an online gaming site, offering non-wagering social games on Facebook, offering our games on third-party online gaming platforms that are interoperable with our game servers; selling select WMS games that have been ported to operate on mobile devices and PC's; we earn revenues from placing our networked gaming system and applications, which is a system that links groups of networked-enabled gaming machines to a server in the casino data center; and earn royalties that we receive from third parties under license agreements to use our game content and intellectual property.

Our gaming operations include the following product lines:

• Participation games, which are gaming machines owned by us that we lease based upon any of the following payment methods: (1) a percentage of the casino's net win, which is the casino's earnings generated by casino patrons playing the gaming machine; (2) fixed daily fees; or (3) a percentage of the amount wagered ("coin-in") or a combination of a fixed daily fee plus a percentage of the amount wagered. We have the ability to lease these gaming machines on a participation basis because of the superior performance of the game and/or the popularity of the brand, which generates higher wagering and net win to the casinos or gaming machine operators than the gaming machines we sell outright. Participation games include:

• Wide-area progressive ("WAP") participation games;

• Local-area progressive ("LAP") participation games; and

• Stand-alone participation games.

• Casino-owned daily fee games, where the casino or gaming machine operator purchases the base gaming machine and pays a lower daily lease fee for the top-box and game;

• Gaming machines and VLT's placed at casinos and other licensed gaming machine operators under operating lease arrangements;

• Revenues from licensing our game content and intellectual properties to third parties;

• Revenues from our online gaming casino in the United Kingdom, which was launched in November 2010, and beginning in fiscal 2012 revenues from our Lucky Cruise™ non-wagering social game on Facebook and in July 2012, our Jackpot Party Social Casino on Facebook, revenues from the sale of select WMS games that have been ported to operate on mobile devices, revenues from the retail sales of CD's containing WMS games or direct downloads of WMS games from internet distributors and revenues when an online player uses a WMS or Jadestone game on one of our customers' online gaming sites; and

• Beginning in June 2011, networked gaming revenues where the casinos or other gaming machine operators use our WAGE-NET ® networked gaming system to link groups of gaming machines to remote servers in their locations that allows casinos and other gaming machine operators to purchase new applications and system-wide features for distribution over the WAGE-NET system. Also in the June 2011 quarter, we received the first regulatory approval of the first family of portal applications, the Ultra Hit Progressive® ("UHP") family, and the first game in the UHP family, the Jackpot Explosion® theme, and since then we have received additional approvals for these products and other networked gaming products in other gaming jurisdictions. At March 31, 2013, we had approximately 2,500 networked gaming machines functioning, primarily on a non-trial basis, at approximately 110 casino properties globally.

OUR FOCUS

We continue to operate in a challenging economic environment and the combination of economic uncertainty, lower demand for replacement products and reduced opportunities from new or expanded casinos has negatively impacted our industry. We expect to benefit from certain new and expansion projects currently in process in calendar 2013, but the breadth and timing of such opportunities remains uncertain due to the difficult credit environment facing our customers and the risk of continued economic uncertainty.

As we navigate these macroeconomic challenges, we are focused on four key strategic priorities: 1) Continue to grow our installed participation product base and improve our daily average revenue; 2) Garner increased ship share in our global product sales by leveraging our product development expertise and developing differentiated, high-earning games, game content and products for our customers worldwide; 3) Invest in the establishment, development and operation of our interactive gaming products and services; and 4) Drive margin improvements:

1. Strategic Priority: Continue to grow our installed participation product base and improve our daily average revenue:

Quarter Ended March 31, 2013, Result: During the quarter ended March 31, 2013, our average installed base of participation gaming machines increased 0.4% over the quarter ended December 31, 2012 while, at March 31, 2013, our total installed participation footprint grew 3.1% to 9,684 units compared to 9,389 units at March 31, 2012. Our average


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revenue per day grew 0.9% to $68.65 in the March 2013 quarter from the March 2012 quarter. Our focus in fiscal 2013 is to increase the percentage of the installed base that are coin-in gaming machines, as they generate the highest profit of our three lease models and to convert a portion of our installed base from Bluebird gaming machines to Bluebird2, Bluebird xD and our new Gamefield xD gaming machines. The percentage of coin-in gaming machines in our installed base was 36.2% of the installed base at March 31, 2013, compared to 39.4% of the installed base at March 31, 2012. The coin-in gaming machines decrease was in our non-WAP gaming machines as our WAP installed base was 3,346 units at March 31, 2013, compared to 3,145 units at March 31, 2012. We have successfully converted approximately 75% of the participation installed base to Bluebird2, Bluebird xDand Gamefield xD gaming machines, although this required a higher capital investment over the last two years. We invested $57.5 million in gaming operations capital in the nine months ended March 31, 2013, and $58.1 million in nine months ended March 31, 2012. We expect that the amount of capital invested in gaming operations will decline modestly for the next two years, as a lower amount of capital spent on our participation gaming machines will be partially offset by increased capital spent on gaming machines for operating leases. In fiscal 2011 and the first half of fiscal 2012, we experienced delays in launching new products due to the new technologies we were imbedding in our participation products; and as a result of not having as many new participation game themes approved, some of our older game theme performance lagged resulting in a higher level of removals of participation gaming machines, which caused a reduction in the installed base. We expect that with an anticipated increase in participation game themes that our installed base will grow in the balance of fiscal 2013 and continue to grow in fiscal 2014.

2. Strategic Priority: Garner increased ship share in our global product sales by leveraging our product development expertise and developing differentiated, high-earning games and products for our customers worldwide.

Quarter Ended March 31, 2013, Result:The replacement cycle for gaming machines has been abnormally low for several years and the challenges facing our industry and the overall global economy have continued, all of which have reduced overall industry demand for gaming machines from previous levels. We believe capital budgets for replacing gaming machines were relatively flat for calendar 2010 and 2011 and increased modestly in 2012. We believe demand from new casino openings and casino expansions declined from fiscal 2010 to fiscal 2011 but grew in fiscal 2012. We expect new unit demand from new casino openings and expansions to be lower in fiscal 2013 than in fiscal 2012 but that replacement demand will increase due to the Canadian provincial lotteries beginning to replace their existing VLTs. We estimate we lost more than 200 new Illinois Video Gaming Terminals (VGTs) in the March 2013 quarter due to our inability to serve the market long-term given existing Illinois law prohibits the supplier of the state monitoring system (currently Scientific Games) from also selling VGTs, which will be the case upon the closing of the acquisition. The average selling price on a VLT is lower than a Class III gaming machine. In this challenging environment, our March 2013 new unit shipments on which we recognized revenue were down 12.2% from the prior-year period due to the decrease in demand of gaming machine sales for new casino openings and expansions which totaled 259 units compared with 1,800 units in the year-ago period more than offsetting the increase in VLT demand driven by higher Canadian VLT shipments. International new unit shipments accounted for 31.2% of global shipments in the March 2013 quarter, compared with 23.3% for the March 2012 quarter. Overall, international new unit shipments increased in fiscal 2011 but shrank in fiscal 2012, as in fiscal 2011 the growth in Mexico and New South Wales, Australia and Singapore coupled with modest growth in Asia and Latin America, more than offset lower shipments to Europe, which remains impacted by the challenging economic environment. In fiscal 2012, demand from Mexico and New South Wales, Australia abated due to unique circumstances in each country and demand from Europe continued to be lower. Demand from Mexican customers was lower following government enforcement actions at certain casinos in Mexico that began in the September 2011 quarter and demand from Australian customers was lower as they await enablement of new national versus state gaming standards. Demand from customers in Mexico has increased modestly in fiscal 2013 and we recently received approvals in New South Wales, Australia for our products that comply with the new national standards so we expect units sales will increase in the coming quarters. Revenues from customers in Argentina were lower in the nine months ended March 31, 2013, as government authorities modified rules related to importing product. We expect international demand in fiscal 2013 to be flat with fiscal 2012. Also, we believe the higher-priced Bluebird2, Bluebird xD, Bluebird2e and Blade units had an impact on the unit volume customers were able to buy with fixed capital budgets. We are still preparing to launch our products in the new VLT market in Italy in the future. Although much effort is still needed before the first revenue-earning WMS gaming machines are placed in Italy, we will have additional development work to complete as a result of new requirements that the regulator has mandated in Italy that will be effective after a transition period. In addition, we continue to achieve benefits from the opening of new international offices and the addition of new geographically dispersed sales account executives.

To further diversify our revenue streams, we directly entered the Class II and central determinant market in fiscal 2010 following expiration of our previous licensing agreements for those markets. We shipped our first gaming machines to a Class II market in the September 2009 quarter, and we have continued to penetrate this market in subsequent quarters. In June 2012, we received approval of a CPU-NXT2 based operating system on our Bluebird2 cabinet for the Class II markets and shipped our first gaming machines operating on this new system in the June 2012 quarter. We expect that shipments to these markets in fiscal 2013 and 2014 will exceed shipments in fiscal 2012.


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We launched our Bluebird xD gaming machine late in the June 2010 quarter and, given customer response, we achieved strong demand for this product throughout fiscal 2012 and 2011. For the three months ended March 31, 2013, Bluebird xD gaming machines accounted for 19.9% of our global new unit sales which compares to 24.1% in the three months ended March 31, 2012. We launched an enhanced version of our Bluebird2 product, the Bluebird2e cabinet with an emotive lighting feature in the March 2012 quarter. During the March 2013 quarter, the majority of the global Bluebird2 product line new unit sales were Bluebird2e units and we would expect this to also occur in future periods. We launched our Bluebird2 lite cabinet in the September 2012 quarter which is a lower cost cabinet for select international markets. In March 2013, we launched our new gaming cabinet, Blade, using the latest version of our operating system software, CPU-NXT3 and Blade units accounted for 18.3% of total unit shipments, even though the product is not approved in certain gaming jurisdictions in the United States or any gaming jurisdictions outside of the United States. We expect that the percentage of our quarterly shipments that are Blade units will increase in future quarters while the percentage of Bluebird2e and Bluebird2 lite units will decrease.

We are dependent, in part, on innovative new products, casino openings and expansions, continued market penetration and new market opportunities to generate growth. We have continued to invest in research and development activities to be able to offer creative and high earning products to our customers and in the three months ended March 31, 2013, such expenses totaled . . .

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