[August 29, 2011] WMS INDUSTRIES INC /DE/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Notes thereto included elsewhere in this Report. 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 this Report. The following discussion and analysis is intended to enhance the reader's understanding of our business environment. 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. OVERVIEW Our mission is: through imagination, talent and technology, we create and provide the world's most compelling gaming experiences. We serve the legalized gaming industry by designing, manufacturing and distributing games, video and mechanical reel-spinning gaming machines and video lottery terminals ("VLTs") to authorized customers in legal gaming venues worldwide. Our products are installed in all of the major regulated gaming jurisdictions in the United States, as well as in approximately 140 international gaming jurisdictions. We generate revenue in two principal ways: product sales and gaming operations, as further described below. In fiscal 2010, we expanded the markets where we directly distribute our products by launching directly into Class II gaming markets in the United States and entering the Mexican and New South Wales, Australia markets and we continued to further penetrate these markets in fiscal 2011. We had previously served these markets through content licensing agreements with third parties for our game themes. In the December 2010 quarter, we launched an online casino site for residents in the United Kingdom, although we did not begin to market the site until February 2011. In the June 2011 quarter we received the first regulatory approval for our WAGE-NET networked gaming system, the first family of portal applications, UltraHit Progressive ("UHP"), and the first game in the UHP family, Jackpot Explosion. In fiscal 2012, we expect to further penetrate each of the new markets and businesses we have entered over the last two 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 37 -------------------------------------------------------------------------------- Table of Contents delayed or canceled construction projects, resulting in fewer new casino openings and expansions in calendar 2010 and even fewer in calendar 2011, coupled with many customers reducing their annual capital budgets for replacing gaming machines. 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 increased competition from our competitors lowered the number of new units we sold in fiscal 2010, and this continued in fiscal 2011. With no leading indicators showing any significant increase in replacement demand for the rest of calendar 2011 or calendar 2012, we conducted a thorough review of our business strategies and product plans late in fiscal 2011 and early fiscal 2012. As a result of the strategic review, we announced that we are refining our product plans and restructuring our organization to sharpen emphasis on our game content and product development strengths. Specifically, we are streamlining our product management and product development functions, simplifying product plans and further prioritizing on-time commercialization of new game themes, products and portal gaming applications for our core product sales and gaming operations businesses. Based upon our decisions stemming from our product and strategy review, in the three-month period ended June 30, 2011, we recorded $24.0 million of net pre-tax charges, or $0.26 per diluted share, which includes $18.4 million, or $0.20 per diluted share, of pre-tax impairment and restructuring charges comprised of $16.0 million or $0.17 per diluted share for non-cash asset impairments (including $11.0 million for impairment of technology licenses, $3.4 million for impairment of the Orion brand name and $1.4 million of impairment of receivables related to government action to close casinos in Venezuela) and $2.4 million or $0.03 per diluted share for restructuring charges (primarily separation costs), along with $9.6 million of pre-tax charges, or $0.10 per diluted share, for asset write-downs and other charges (including inventory charges related to winding down the Orion and original Bluebird product lines), partially offset by $4.0 million or $0.04 per diluted share from cash proceeds of litigation settlement. For the twelve-months ended June 30, 2011, impairment and restructuring charges also include the $3.8 million of pre-tax charges incurred in the September 2010 quarter related to closing WMS' main Netherlands facility that previously had been included in selling and administrative expense, of which $2.4 million was a non-cash, pre-tax charge for the write-down to fair market value of property, plant and equipment and $1.4 million was pre-tax separation charges. Fiscal 2011 also includes a $0.02 per diluted share benefit recorded in income taxes in the December 2010 quarter related to the period January 1, 2010 through June 30, 2010 from the retroactive reinstatement of the Federal research and development tax credit. We also announced that we expected to record between $11 million and $14 million of charges in the September 2011 quarter largely to complete the restructuring, which is expected to reduce our global headcount by about 10%. We had expected that with our launch of the network gaming-enabled Bluebird2 gaming machines in the December 2008 quarter, concurrent with certain of our competitors launching their networked gaming-enabled products, the industry would experience an improvement in the replacement cycle, which has been at an abnormally low level for the past few years. However, as discussed above, the economy slowed just as the new gaming machines were being launched, so we did not see the expected improvement in the replacement cycle. Even with the adverse economic environment and its impact on our industry causing customers to constrain their capital budgets, we launched our Bluebird2 gaming machines in the December 2008 quarter with premium features at a significantly higher price, and demand outpaced our expectations. In late June 2010 we launched another new networked-enabled gaming machine, Bluebird xD, as the replacement for our original Bluebird slant cabinets and it too had a significantly higher price, and once again demand outpaced our expectations. For fiscal 2010, Bluebird2 units accounted for 83% of our total new units shipped and, with the launch of the Bluebird xD product in fiscal 2011, Bluebird xD accounted for 26% of new unit shipments while Bluebird2 units accounted for approximately 69% of new unit shipments in fiscal 2011. 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. In addition, we expect to experience only a modest increase in demand from casino expansions and casino openings in new and expanding gaming jurisdictions beginning in calendar 2012. 38 -------------------------------------------------------------------------------- Table of Contents 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 and gross margin 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, accounts and notes receivable, inventories and accounts payable and cash flows from operations as they are key indicators of our performance. We also measure changes in selling and administrative ("S&A") expenses as a percent of revenue, which indicate management's ability to control costs, as well as changes in research and development ("R&D") costs as a percent of revenue, which demonstrate investment in technology and product development. Finally, we measure depreciation expense as a percentage of revenues an indicator of the current cost of capital expenditures, primarily in our gaming operations business. 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. 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, Maine and Massachusetts. Internationally, Singapore opened as a new market in fiscal 2010 and a new VLT market in Italy has opened in fiscal 2011, although the growth of this market has been delayed due to regulatory requirements. In addition, legislation has been passed or discussed in Greece, Brazil, Japan and Taiwan that could open new market opportunities. In the United States, federal legislators and certain state legislators and governments in Canada and Europe 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. 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). In September 2011 we closed our Orion Financement Company ("Orion Gaming") manufacturing facility and, in June 2011, we sold this facility and began winding down the support of our Orion Gaming product lines, which will occur over fiscal 2012. In July 2011, we sold our Systems In Progress GmbH subsidiary ("SiP"). These two subsidiaries were immaterial to our Consolidated Balance Sheets, Consolidated Statements of Income and Consolidated Statements of Cash Flows. In fiscal 2011, we also notified our customers that we were winding down the support for our Bluebird gaming machines with no new game content available after July 1, 2012 but would continue to service and supply replacement parts through July 2015. We derive product sales revenue from the sale of the following: Ø Multi-line, multi-coin video gaming machines, in our Bluebird, Bluebird2 and Bluebird xD and Orion Gaming Twinstar™, Twinstar2 and Helios™ branded gaming machines; Ø Mechanical reel-spinning gaming machines in our Bluebird, Bluebird2 and Bluebird xD branded gaming machines; Ø Replacement parts and conversion kits for our Bluebird, Bluebird2, Bluebird xD, Twinstar, Twinstar2, Helios and CPU-NXT and CPU-NXT2 upgrade kits; and Ø Used gaming machines manufactured by us or our competitors that are acquired on a trade-in basis or that were previously placed on a participation basis. 39 -------------------------------------------------------------------------------- Table of Contents Gaming Operations We earn gaming operations revenues from leasing participation games, gaming machines and VLTs, and earn royalties that we receive from third parties under license agreements to use our game content and intellectual property. Effective July 1, 2010, we changed the format for the categories that we disclose for our participation installed base from prior years to show the breakout of these gaming machines based on the revenue model that generates the lease payments paid to WMS. We are using this new format because we believe it provides greater transparency as to how we earn our revenues. This new format had no impact on our revenues, our total participation installed base or the average revenue per day of our participation installed base. Our gaming operations include the following product lines: Ø 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 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: Ø Wide-area progressive ("WAP") participation games; Ø Local-area progressive ("LAP") participation games; and Ø Stand-alone participation games. Ø 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; Ø Gaming machines placed at casinos under operating lease arrangements; Ø VLTs; Ø Revenues from licensing our game content and intellectual properties to third parties; Ø Revenues from our online gaming casino in the United Kingdom, which was launched in November 2010; and Ø 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. 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, but the breadth and timing of such opportunities remains uncertain due to the difficult economic environment facing our customers and the lack of meaningful improvement in their profitability and cash flows. We believe that gaming operators' replacement capital budgets will be relatively flat in calendar 2012 from calendar 2011. 40-------------------------------------------------------------------------------- Table of Contents As we navigate these macroeconomic challenges, we remain focused on five key strategic priorities: 1) grow our United States and Canadian market share by innovating differentiated products; 2) expand the breadth and profitability of our international business; 3) drive growth in our gaming operations business, while selectively investing our capital deployed in that business; 4) improve our gross margins and operating margins; and 5) increase our cash flow from operations. 1. Strategic Priority: Grow our United States and Canadian market share by innovating differentiated products. Fiscal 2011 Result: The United States and Canadian replacement cycle has been abnormally low for several years and the challenges facing our industry and the overall economy have continued, all of which have reduced overall industry demand. We believe capital budgets for replacing gaming machines improved modestly for calendar 2011 over calendar 2010; however, new casino openings and casino expansions declined over prior-year levels. In this challenging environment, our year-over-year new unit shipment volume was down 7.8% from the prior-year. To further diversify our revenue streams, in fiscal 2010 we directly entered the Class II and central determinant market following expiration of our previous licensing agreements for those markets. Our first Class II gaming machines were shipped in the September 2009 quarter, and we expect to continue to penetrate this market directly as we receive additional regulatory approvals. In fiscal 2011, we purchased a copy of the central system software from Bluberi Gaming Technologies Inc. ("Bluberi"), and we are now operating the system ourselves, although we have continuing payment obligations to Bluberi. We launched our new Bluebird xD gaming cabinet late in the June 2010 quarter and, given initial customer response, we had strong demand for this new product in fiscal 2011 amounting to 36% of the total units shipped to customers in the United States and Canada. We are dependent, in part, on innovative new products, replacement demand and casino expansions 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 fiscal 2011, such expenses were $117.0 million or 14.9% of revenues, including $3.0 million of write-down charges for intellectual property assets, up $11.1 million, or 10.5%, compared to the prior-year. Expansion and new market opportunities may come from political action as governments look to gaming to provide tax revenues in support of public programs and view gaming as a key driver for tourism. Based on publicly disclosed information, we believe our share of new units shipped among the five major gaming machine companies serving the United States and Canadian gaming market, was flat at 25% in fiscal 2011 and in fiscal 2010, including units shipped and placed under operating lease arrangements. 2. Strategic Priority: Expand the breadth and profitability of our international business. Fiscal 2011 Result: Shipments to international markets represented 38.6% of our total new unit shipments in fiscal 2011, compared with 35.4% for the prior-year, and total units were 9,340 in fiscal 2011 compared to 8,826 in fiscal 2010. During fiscal 2011, international new unit shipments increased 5.8% from the prior-year, as growth in Mexico and New South Wales, Australia, coupled with modest growth in Asia and Latin America, more than offset lower shipments to Europe, which remains impacted by the challenging economic environment. We directly entered two new markets in fiscal 2010 that we had previously served through content licensing arrangements: New South Wales, Australia and Mexico. In the March 2010 quarter in New South Wales, Australia, we began shipping products as our distributor received regulatory approval for our Bluebird2 gaming machine and the first three game themes. We have since received additional game theme approvals and approval of our mechanical reel gaming machines using our Transmissive Reels technology and, due to the popularity and earnings performance of our products, shipments and revenues increased in fiscal 2011. We expect continued growth in fiscal 2012, subject to any adverse change in gaming regulations in that market. We shipped our first direct shipment of gaming machines into Mexico in the June 2009 quarter and expanded shipments to this market in fiscal 2010 and further penetrated this market in fiscal 2011. In November 2010, we signed our first agreement with one of the operators for the new VLT market in Italy. While introduction of product in this market has been delayed and is subject to satisfaction of 41-------------------------------------------------------------------------------- Table of Contents incremental regulatory requirements that were recently introduced, we are continuing to pursue this market and expect to begin a field trial of our products in fall 2011. Although much effort is still needed before the first revenue-earning WMS gaming machines are approved in Italy, we anticipate we will see the first shipments in late fiscal 2012 or fiscal 2013, which will be operating lease agreements rather than product sales. Expansion into the Italian market could be limited however, due to the recent new requirements for all manufacturers, which are being evaluated. Other international markets are also considering VLT's and electronic bingo as a path to gaming expansion and recently VLT legislation was passed in Greece. Also, we continue to achieve benefits from the opening of new international offices and the addition of new geographically dispersed sales account executives. We launched the new Bluebird xDgaming cabinet late in the June 2010 quarter, which are benefiting our shipments into the international markets in fiscal 2011 and accounted for 10% of total new units shipments to international markets in fiscal 2011. 3. Strategic Priority: Drive growth in our gaming operations business, while selectively investing our capital deployed in that business. Fiscal 2011 Result: During the year ended June 30, 2011, our average installed base of participation gaming machines decreased 2.4% over the prior-year and, at June 30, 2011, our total installed participation footprint stood at 9,870 units compared to 10,421 units at June 30, 2010. Our average revenue per day declined 1% in fiscal 2011 from fiscal 2010. Our focus in fiscal 2011 was to increase the percentage of the installed base that were coin-in gaming machines as they generate the highest gross profit dollars of the three lease models and to convert a portion of our installed base from Bluebird gaming machines to new Bluebird2 or Bluebird xD gaming machines. We were successful in increasing the percentage of coin-in gaming machines in our installed base to 38.3% of the installed base at June 30, 2011 from 36.1% of the installed base at June 30, 2010, although this was because of the decrease in the installed base, as the actual number of coin-in units was relatively flat. We were successful in converting a portion of the installed base to new Bluebird2 and Bluebird xD gaming machines, although this required a higher capital investment than the amount invested over the last two years. We invested $65.9 million in gaming operations capital in fiscal 2011 compared to $43.5 million in fiscal 2010. We expect that the amount of capital invested in gaming operations will remain at a higher level for the next two years as we continue converting the remaining two-thirds of the installed base from Bluebird gaming machines to new Bluebird2 and Bluebird xD gaming machines. In fiscal 2011, 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 beginning in mid-fiscal 2012 that we can begin to reverse the trend from fiscal 2011 in the second half of fiscal 2012. 4. Strategic Priority: Improve our gross margins and operating margins. Fiscal 2011 Result: Both our gross margin and operating margin declined in fiscal 2011 from fiscal 2010. For the year ended June 30, 2011, our overall gross margin declined by 390-basis points to 60.1% resulting from a 470-basis point decrease to 48.1% in our product sales gross margin largely attributable to the 100-basis point impact of inventory and asset write-downs and other charges, lower-margins achieved on our new Bluebird xD product line, coupled with a higher amount of lower-margin used gaming machines sales and a declining margin achieved on such sales and a lower amount of high margin conversion sales. We implemented a plan to increase the Bluebird xD gross margin in the September 2010 quarter and realized continued improvement throughout fiscal 2011, although the gross margin is still below that achieved on the Bluebird2 gaming machines. We will continue to work to increase the Bluebird xD gross margin in fiscal 2012. We continue implementing our lean sigma and strategic sourcing initiatives, and we continue to realize positive results. We believe these initiatives will continue to drive margin improvement in future years. Gross margin in our gaming operations business was 80.0% in fiscal 2011 inclusive of the 60-basis point impact of asset write-downs and other 42-------------------------------------------------------------------------------- Table of Contents charges, compared to 80.8% in fiscal 2010. Once the economy improves and replacement demand increases in the future, we would expect to benefit from higher average selling prices and lease revenues coupled with an expanded volume of business that should result in greater volume discounts from our raw material suppliers and enable us to spread our manufacturing overhead costs over a larger number of units thereby reducing average cost per unit. We also expect our gaming operations business will expand beginning in the second half of fiscal 2012 with both the installed base and revenue per day increasing. Our operating margin declined to 14.1% in fiscal 2011 from 21.9% in fiscal 2010. Of this 780-basis point decline in operating margin, 400-basis points resulted from $31.8 million of charges for impairments, restructuring, asset write-down and other charges, coupled with a lower amount of higher-margin gaming operations revenues (37.5% in fiscal 2011 compared to 39.8% in fiscal 2010), lower product sales gross margin and higher operating costs. Through disciplined cost management, we expect to realize operating leverage from higher revenues as our total operating costs are not expected to grow at the same percentage as revenues and we will benefit from lower payroll-related costs as a result of 10% lower headcount upon completion of the restructuring we announced in the September 2011 quarter. Our research and development spending increased to 14.9% as a percentage of revenues in fiscal 2011 and includes the 40-basis impact of the write-down on intellectual property assets and the ongoing investment we are making to create intellectual property and advanced technologies that will power our innovative products in the future and support our existing product lines. We expect that these costs as a percentage of revenue will decline to 13% of revenue in fiscal 2012. We believe our product development capabilities, combined with additional functionalities and enhanced features of our advanced technologies and gaming platforms, enable us to optimize the entertainment value of our products and improve our gross margins and operating margins. We expect selling and administrative expenses to decline as a percentage of revenues in fiscal 2012, but due to higher capital spending in our gaming operations business and the launch of both the networked gaming and online gaming business in fiscal 2011, that depreciation expense will increase as a percentage of revenues in fiscal 2012. 5. Strategic Priority: Increase our cash flow from operations and invest in growing our business. Fiscal 2011 Result: For the year ended June 30, 2011, net cash provided by operations grew 20.6% over the prior-year reflecting an increase of $26.8 million to $157.1 million. The annual results reflect the year-over-year increase in depreciation, the non-cash portion of the impairment and restructuring charges, an increase in other non-cash items (including the impact of the non-cash portion of inventory, other asset write-downs and other charges), a smaller unfavorable impact of tax-related items and a smaller unfavorable impact from changes in operating assets and liabilities (primarily related to a lower increase in fiscal 2011 in total accounts and notes receivable and inventory), partially offset by lower net income, lower amortization and a decline in share-based compensation. Net cash used in investing activities for the year ended June 30, 2011 increased by $48.4 million to $157.0 million from a year ago due to the $22.4 million increase in capital spending on additions to gaming operations equipment during the last year as the Company continues to transition its installed base of participation units to Bluebird2 and Bluebird xD cabinets, a $9.4 million increase in capital expenditures for property, plant and equipment and higher payments of $16.6 million to acquire or license intangible and other assets. Net cash used in financing activities increased by $86.7 million, primarily due to higher stock repurchase activity, which totaled $101.5 million in fiscal 2011 compared to $45.0 million in fiscal 2010 and $32.8 million from lower stock option exercises compared with fiscal 2010. 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; continue to invest in our gaming operations business to convert the installed base to new product lines and for operating lease agreements; seek acquisitions that can extend our presence and product lines, increase our intellectual property portfolio and expand our earnings potential; and, when appropriate, repurchase shares in the 43 -------------------------------------------------------------------------------- Table of Contents open market or in privately negotiated transactions. For the year ended June 30, 2011, our research and development spending increased $11.1 million over the prior-year and we spent $66.2 million on property, plant and equipment, $65.9 million on additions to gaming operations equipment, $24.9 million to acquire or license intangible and other assets, and we funded approximately $101.5 million of common stock repurchases. Networked Gaming We believe that server-enabled networked gaming ("NG") will be the next significant technology development in the gaming machine industry. NG refers to a networked gaming system that links groups of server-enabled gaming machines to a remote server or servers in each casino's data center. Once the gaming machines are connected to the server-enabled network, data can transfer between the servers and the gaming machines in real time and new applications, game functionality and system-wide features can be enabled on the gaming machines from the remote server. These networks will require regulatory approval in each gaming jurisdiction prior to any implementation and, in time, will represent a significant addition to our existing portfolio of products. We have been introducing the foundational technologies and hardware for NG to the market through our new participation product lines since the September 2006 quarter and we continued to implement this strategy in fiscal 2011 leading up to the receipt on April 22, 2011 of our first regulatory approval for the WAGE-NET system, the first portal application family, Ultra Hit Progressive ("UHP") and first UHP theme, Jackpot Explosion, from Gaming Laboratories International, Inc. ("GLI"). In June 2011, we began earning revenues from networked gaming applications after installing the commercial version of the NG software. Since these first approvals we have subsequently received approvals on the second theme in the UHP family, Piggy Bankin', and the first theme in the second portal family, Winner's Share, titled Peng-Wins. Nevada regulators recently approved the commercial version of our Jackpot Explosion portal application; and our field trial - the final step to achieve approval in Nevada on the remote configuration and download portion of our WAGE-NET system was completed in August 2011 and we received approval from the Nevada Gaming Commission related to the interoperability of our NG system with one of the slot accounting systems used by casinos. We expect to receive approval in Nevada for interoperability with other slot accounting systems in the future. We have received additional jurisdictional approval in Michigan, and are progressing with field trials in several additional jurisdictions with approvals expected in the near future. Currently, we have over 300-networked gaming machines running at 17 locations. Our vision for NG expands on the basic functionality of downloadable games, remote configuration of betting denominations and server-based game outcomes, and emphasizes enhanced game play and excitement for the player. In a networked environment, we believe game play will no longer be limited to an individual gaming machine; rather, we believe NG will permit game play to be communal among many players. We also expect that with networked gaming machines we will be able to offer system-wide features and game functionality along with applications that add value to casino operators' operations. We will continue NG development, working with our competitors and customers to ensure the future is powered by an open architecture approach where games, networks, servers and software from multiple suppliers are compatible with each other through the use of industry standard communication protocols. Our path to the NG marketplace takes elements of our technology road map and converts them into commercializable products in advance of the launch of the full functionality of NG systems. Beginning in fiscal 2007, we introduced a series of products and functionalities, all building towards NG systems, including our Community Gaming ® participation product line, our CPU-NXT2 operating system and platform, which is also the basis for our server-enabled Bluebird2 and Bluebird xD gaming machines, Sensory Immersion gaming, Transmissive Reels gaming, Adaptive Gaming, and progress on interoperability of our WAGE-NET system, Bluebird2 gaming machines using the CPU-NXT2 operating system with other manufacturers' products and systems using industry standard communication protocols developed by the Gaming Standards Association ("GSA"): G2S ® and S2S®. In February 2008, we entered into a ten-year non-exclusive, royalty-bearing patent cross-license agreement with International Game Technology Inc. ("IGT"). This agreement provides for a cross license of intellectual property evidenced by certain patents owned by each of us relating to computing and NG infrastructures. In November 2010 we entered into a 7-year royalty free, non-exclusive license agreement with Konami Gaming 44-------------------------------------------------------------------------------- Table of Contents Inc. ("Konami") whereby Konami will adopt our WAGE-NET system as its networked gaming system. Both WMS and Konami will perform additional programming to make our respective games and applications, and, in Konami's case, their slot accounting system interoperable. OTHER KEY FISCAL 2011 ACTIVITIES Common Stock Repurchase Program See Note 12. "Stockholders' Equity-Common Stock Repurchase Program" and Note 19. "Subsequent Events" to our Consolidated Financial Statements. CRITICAL ACCOUNTING ESTIMATES Our Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States. Accordingly, we are required to make estimates incorporating judgments and assumptions we believe are reasonable based on our experience, contract terms, trends in our company and the industry as a whole, as well as information available from other outside sources. Our estimates affect amounts recorded in our Consolidated Financial Statements and actual results may differ from initial estimates. Our accounting policies, including those involving critical accounting estimates, are more fully described in Note 2. "Principal Accounting Policies" to our Consolidated Financial Statements. We consider the following accounting estimates to be the most critical to fully understand and evaluate our reported financial results. They require us to make subjective or complex judgments about matters that are inherently uncertain or variable. Senior management discussed the development, selection and disclosure of the following accounting estimates, considered most sensitive to changes from external factors, with the Audit and Ethics Committee of our Board of Directors. Revenue Recognition We evaluate the recognition of revenue based on the criteria set forth in the following accounting guidance: Financial Accounting Standards Board ("FASB") Topic 605, "Revenue Recognition" ("Topic 605") or FASB Topic 985, "Software" ("Topic 985"). Recent Updates to Topics 605 and 985 In October 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-13, "Multiple-Deliverable Revenue Arrangements" ("ASU No. 2009-13") and ASU No. 2009-14 "Certain Revenue Arrangements That Include Software Elements" ("ASU No. 2009-14"). As permitted under these ASU's, we early adopted both of these ASU's on a prospective basis effective July 1, 2009, the beginning of our 2010 fiscal year. Accordingly, this guidance is being applied to all new or materially modified revenue arrangements entered into since July 1, 2009. While the adoption of these two ASU's changed our revenue recognition policies beginning in fiscal 2010, the impact on our Consolidated Financial Statements was not significant to either the year ended June 30, 2010 or, had these ASU's been applied retroactively, to the fiscal year ended June 30, 2009, as we had vendor specific objective evidence ("VSOE") for all elements of our multiple deliverable arrangements and we had not deferred any hardware revenues because an entire customer arrangement had been accounted for as software. These new revenue recognition standards will have more impact on our revenue recognition as we now launch our networked gaming system and related software applications in fiscal 2012. ASU No. 2009-13 replaces and significantly changes the previous separation criteria for multiple-deliverable revenue arrangements, by eliminating the criteria for objective and reliable evidence of fair value for each deliverable. ASU No 2009-13 also eliminates the use of the residual method of allocation of consideration among deliverables and requires, instead, that arrangement consideration be allocated, at the inception of the 45-------------------------------------------------------------------------------- Table of Contents arrangement, to all deliverables based on their relative selling price (the "relative selling price method"). When applying the relative selling price method, a hierarchy is used for estimating the selling price based first on VSOE, then third-party evidence ("TPE") and finally management's estimate of the selling price ("ESP"). Prior to July 1, 2009, when multiple product deliverables were included under a sales arrangement, we allocated revenue to each unit of accounting based upon its respective fair value against the total contract value and deferred revenue recognition on those deliverables where we did not meet all of the requirements of revenue recognition. We allocated revenue to each unit of accounting, which typically consisted of gaming machines and additional game themes the customer can receive in the future, based on fair value as determined by VSOE. VSOE of fair value for all elements of a multiple deliverable arrangement is based upon the normal pricing and discounting practices for those products and services when sold individually. ASU No 2009-14 amends the scope of software revenue recognition to exclude all tangible products containing both software and non-software components that function together to deliver the product's essential functionality. As a result, certain products that were previously accounted for under the scope of software revenue recognition guidance in Topic 985 will no longer be accounted for as software. Prior to July 1, 2009, we had determined sales of certain of our products, specifically Bluebird2 gaming machines and revenues generated from the sales of gaming related systems, included software that was "more than incidental" to the product as a whole and accordingly were accounted for under the scope of software revenue recognition guidance in Topic 985. Effective July 1, 2009, with the adoption of ASU No. 2009-14, we no longer apply software revenue recognition guidance from Topic 985 to our Bluebird2 gaming machine sales as the software and non-software components of the Bluebird2 gaming machine function together to deliver the product's essential functionality. Topic 985 primarily will impact future networked gaming revenues because networked gaming revenues are derived from computer software applications and systems to be sold or leased. As we begin to fully commercialize networked gaming software applications through multiple deliverable arrangements in fiscal 2012, the application of Topic 985 will require us to obtain VSOE for undelivered networked gaming software applications in a multiple deliverable arrangement before revenue can be recognized on the subsequent delivery of a software application that is part of the multiple deliverable arrangement. This may delay the recognition of revenue and increase deferred revenues and deferred costs. Networked gaming refers to a networked gaming system that links groups of networked-enabled gaming machines to a server in the casino data center. The application of this policy affects that amount of our revenues, accounts and notes receivable and deferred revenues. Other than the adoption of ASU No. 2009-13 and ASU No. 2009-14, effective July 1, 2009 in fiscal 2011, 2010 and 2009, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies - Revenue Recognition" to our Consolidated Financial Statements. Allowances for Slow-Moving and Obsolete Inventories We value inventory based on estimates of potentially excess and obsolete inventory after considering forecasted demand and forecasted average selling prices. However, forecasts are subject to revisions, cancellations and rescheduling. Actual demand may differ from anticipated demand, and such differences may have a material effect on our Consolidated Financial Statements. Demand for parts inventory is subject to technical obsolescence. Inventory on hand in excess of forecasted demand is written down to net realizable value. An active market exists mostly outside of North America for used gaming machines. When we receive a gaming machine on trade-in, we estimate a carrying value for the gaming machine based on the condition of the gaming machine, as well as our experience in selling used gaming machines and such estimates could change due to changes in demand in general for used gaming machines. We sell these trade-ins as-is or refurbish the used gaming machines before resale. We also sell participation gaming machines as used gaming machines. Therefore, we review our used gaming machine inventory for impairment on a quarterly basis. Actual demand 46 -------------------------------------------------------------------------------- Table of Contents for new and used gaming machines may differ from anticipated demand, and such differences may have a material effect on our Consolidated Financial Statements. We sold nearly 9,300 and over 8,500 used gaming machines in fiscal 2011 and 2010, respectively. During fiscal 2011, 2010 and 2009 we recorded provisions for inventory write-downs of $7.1 million, $3.8 million and $13.3 million, respectively. Fiscal 2010 and 2011 reflect lower write-downs as we transition our customer base from Bluebird to Bluebird2 and Bluebird xD gaming machines, but fiscal 2011 does include $4.9 million of inventory and other assets write-downs related to the winding down of our Orion and original Bluebird product lines over the coming year as part of our strategic review. The application of this policy affects the amount of our inventory and cost of product sales. In fiscal 2011, 2010 and 2009, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies - Inventories" and Note 6. "Inventories" to our Consolidated Financial Statements. Participation Gaming Machine Depreciation and Net Realizable Value We depreciate the Bluebird, Bluebird2 and Bluebird xD branded participation gaming machines over a three-year useful life to residual value, while we depreciate the participation top boxes over a one-year useful life. We depreciate refurbishment costs of our gaming operations equipment for periods from 12 months to 36 months. A material adverse impact could occur if the actual useful life of our gaming operations equipment is less than what was used in estimating depreciation expense, or if actual residual value is less than the anticipated residual value. At June 30, 2011 and 2010, we had $86.8 million and $64.7 million net book value of gaming operations equipment recorded in our Consolidated Balance Sheets. On a quarterly basis, we assess the carrying value of our gaming operations equipment and adjust the carrying value to net realizable value as appropriate based on expected future usage. The application of this policy affects the level of our gaming operations equipment, accumulated depreciation on gaming operations equipment, cost of gaming operations, depreciation expense, income tax expense and deferred income tax assets and liabilities. In fiscal 2011, 2010 and 2009, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies - Gaming Operations Equipment and Property, Plant and Equipment" and Note 7. "Gaming Operations Equipment and Property, Plant and Equipment" to our Consolidated Financial Statements. Intellectual Property and Licensed Technology Valuations We license intellectual property and technologies from third parties that we use in our games and gaming machines. At June 30, 2011 and 2010, we had $120.2 million and $68.2 million capitalized on our Consolidated Balance Sheets for such costs, along with commitments not on our Consolidated Balance Sheets for an additional $89.3 million at June 30, 2011. As part of our contracts with the licensors, we typically provide a minimum guaranteed commitment and prepay royalties and license fees, usually at the time the contract is signed, even though the product may not be introduced until months or years later. We capitalize the royalty and license fee advances as intangible assets. When products using the licensed intellectual property or technology begin to generate revenue, we begin amortization of the amount advanced. In cases where the advance represents a paid-up license, the advance is amortized based on the estimated life of the asset. In those cases where the license agreement provides for a royalty to be earned by the licensor for each gaming machine sold or placed on a lease, the advance is amortized based on the royalty rates provided in the license agreement. In both cases, the amortization of the advances is included in cost of product sales if related to product sale revenues or cost of gaming operations if related to gaming operations revenues. We regularly evaluate the estimated future benefit of royalty and license fee 47-------------------------------------------------------------------------------- Table of Contents advances, as well as minimum commitments not yet paid, to determine amounts unlikely to be realized from forecasted product sales revenues or gaming operations revenues. If actual or revised revenue forecasts fall below the initial estimate, then we may need to revise the remaining useful life and/or record a charge to write down any asset recorded to net realizable value or accrue for the shortfall between the guaranteed royalty for the period and the actual amount estimated to be earned. On October 1, 2010, we reclassified $34.4 million of capitalized computer software costs related to our network gaming system from Property, plant and equipment to Intangible assets. In June 2011, we reclassified $13.4 million of capitalized computer software costs related to our online gaming system platform from Property, plant and equipment to Intangible assets. In June 2011, we recorded $17.4 million of impairment charges and other charges to write-down licensed technologies, brand name and intellectual property assets to net realizable value stemming from changes in our business strategy and product plans resulting from a comprehensive review of our business. The application of this policy affects the level of our current assets, non-current assets, current liabilities, cost of product sales, cost of gaming operations, research and development expense and selling and general expense. In fiscal 2011, 2010 and 2009, other than the impairment and other charges recorded in fiscal 2011, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies-Reclassifications and Costs of Computer Software Utilized in Products Sold or Leased", Note 8. "Intangible Assets" and Note 14. "Commitments, Contingencies and Indemnifications" to our Consolidated Financial Statements. Income Tax Accounting We account for income taxes in accordance with FASB Topic 740, "Accounting for Income Taxes". We conduct business globally and are subject to income taxes in U.S. Federal, state, local and foreign jurisdictions. Determination of the appropriate amount and classification of income taxes depends on several factors, including estimates of the timing and probability of realization of deferred income taxes, reserves for uncertain income tax positions and income tax payment timing. We record deferred income tax assets and liabilities based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying U.S., state and applicable foreign jurisdiction enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. The ability to realize the deferred income tax assets is evaluated through the forecasting of taxable income, in each jurisdiction, using historical and projected future operating results, the reversal of existing temporary differences and the availability of tax planning strategies. We apply an estimated annual effective income tax rate to our quarterly operating results to calculate the provision for income tax expense. In the event there is a significant, unusual or infrequent item recognized in our quarterly operating results, the income tax attributable to that item is recorded in the interim period in which it occurs. We modify our annual effective income tax rate if facts and circumstances change between quarters. Our effective income tax rates for fiscal 2011, 2010 and 2009 were 34.5%, 33.8% and 34.3%, respectively. No taxes have been provided on certain undistributed foreign earnings that are planned to be indefinitely reinvested. If future events, including material changes in estimates of cash, working capital and long-term investment requirements necessitate that these earnings be distributed, an additional provision for withholding taxes may apply, which could materially affect our future effective income tax rate. As a matter of course, we are regularly audited by various taxing authorities, and sometimes these audits result in proposed assessments where the ultimate resolution may result in our owing additional taxes. We establish reserves when, despite our belief that our tax return positions are appropriate and supportable under applicable tax law, we believe certain positions are likely to be challenged and we may not succeed in realizing the income tax benefit. We evaluate these reserves each quarter and adjust the reserves and the related interest in 48 -------------------------------------------------------------------------------- Table of Contents light of changing facts and circumstances regarding the probability of realizing tax benefits, such as the progress of a tax audit or the expiration of a statute of limitations. We believe the estimates and assumptions used to support our evaluation of tax benefit realization are reasonable. However, final determinations of prior-year income tax liabilities, either by settlement with tax authorities or expiration of statutes of limitations, could be materially different than estimates reflected in our Consolidated Balance Sheets and historical income tax provisions in our Consolidated Statements of Income. The outcome of these final determinations could have a material effect on our income tax provision, net income or cash flows in the period in which that determination is made. We believe our income tax positions comply with applicable tax law and that we have adequately provided for any known income tax contingencies. We apply FASB Topic 740 "Accounting for Uncertainty in Income Taxes" ("Topic 740") to our uncertain tax positions. Under Topic 740, the benefits of income tax positions that are more likely than not of being sustained upon audit based on the technical merits of the tax position are recognized in our Consolidated Financial Statements; positions that do not meet this threshold are not recognized. For income tax positions that are at least more likely than not of being sustained upon audit, the largest amount of the benefit that is more likely than not of being sustained is recognized in our Consolidated Financial Statements. At this time we believe appropriate provisions for all outstanding tax issues have been made for all jurisdictions and all open years. We are no longer subject to any significant Federal tax examinations by tax authorities for years before fiscal 2008, or state, local or foreign income tax examinations by tax authorities for years before fiscal 2004. The application of this policy affects the level of our income tax expense, current income tax receivables and liabilities and current and non-current deferred income tax assets and liabilities. In the December 2010 quarter, we recorded the benefit from the retroactive reinstatement of the Federal research and development tax credit to January 1, 2010 of which $0.02 applied to periods prior to fiscal 2011. In the March 2010 quarter, we had several discrete income tax items that netted out to a lower effective income tax rate which increased diluted earnings per share by $0.06; primarily the completion of Federal income tax return audits by the Internal Revenue Service for fiscal 2004 through fiscal 2007 that resulted in a reduction of our liability for uncertain tax positions by $4.6 million, or a $0.07 per diluted share benefit, partially offset by the expiration of the Federal research and development tax credit effective as of December 31, 2009 which had the impact of reducing our earnings per diluted share by $0.01. Other than the $4.6 million reduction in the liability for uncertain tax positions as a result of the completion of the audit of our Federal income tax returns through fiscal 2007, in fiscal 2011, 2010 and 2009, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies-Accounting for Income Taxes" and Note 10. "Income Taxes" to our Consolidated Financial Statements. Share-Based Compensation Expense We account for share-based compensation in accordance with the provisions of FASB Topic 718, "Share-Based Payment" ("Topic 718"). Pre-tax share-based compensation expense was $18.7 million, $20.3 million, and $18.0 million for fiscal 2011, 2010 and 2009, respectively. In fiscal 2011, we recorded a provision for equity-based performance units outstanding of $0.8 million that relate to the thirty-six month periods ended June 30, 2011, 2012 and 2013, based on the current assessment of achievement of the performance goals. Additional charges will be recorded in future periods depending on the assessment of achievement of the performance goals. In fiscal 2010, we recorded a provision for equity-base performance units outstanding of $4.0 million that relate to the thirty-six month periods ended June 30, 2010, 2011 and 2012, based on the then current assessment of achievement of the performance goals. In fiscal 2009, we recorded a provision for equity-base performance units outstanding of $3.4 million that relate to the thirty-six month periods ended June 30, 2009, 2010 and 2011, based on the then current assessment of achievement of the performance goals. 49 -------------------------------------------------------------------------------- Table of Contents Under the fair value recognition provisions of Topic 718, stock-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized as expense ratably over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of share-based awards requires judgment, including estimating stock price volatility, forfeiture rates and expected life. If actual results differ significantly from these estimates, share-based compensation expense in our Consolidated Statements of Income could be materially impacted. The application of this policy affects the level of our cost of product sales, cost of gaming operations, research and development expenses, selling and administrative expenses, additional paid-in capital and income tax expense. During fiscal 2011, 2010 and 2009, we had no material changes in the critical accounting estimates arising from the application of this policy and we do not anticipate material changes in the near term. See Note 2. "Principal Accounting Policies - Shared-Based Compensation - Stock Option Assumptions" and Note 13. "Equity Compensation Plan" to our Consolidated Financial Statements. RECENTLY ISSUED ACCOUNTING STANDARDS See Note 2. "Principal Accounting Policies-Recently Issued Accounting Standards" to our Consolidated Financial Statements. RESULTS OF OPERATIONS Seasonality Sales of our gaming machines to casinos are generally strongest in the spring and slowest in the summer months, while gaming operations revenues are generally strongest in the spring and summer. Typically our total revenues are lowest in the September quarter and build in each subsequent quarter with the June quarter generating our highest total quarterly revenues, although in fiscal 2011 revenues were higher in the December quarter than the March quarter. 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 or platform that achieves significant player appeal is introduced, if a significant number of new casinos open or existing casinos expand or if gaming is permitted in a significant new jurisdiction. Impact of Inflation During the past three years, the general level of inflation affecting us has been relatively low. Our ability to pass on future cost increases in the form of higher sales prices will depend on the prevailing competitive environment and the acceptance of our products in the marketplace. Net Charges Given the continuing lower levels of capital spending by casinos over the last three years and with no leading indicators that demand will increase in the near-term, we conducted a thorough review of our product plans and business strategies at the end of fiscal 2011 and beginning of fiscal 2012. We still believe our long-term vision and business strategy is intact but, as a result of this review, we are refining our product plans and restructuring our organization. Specifically we are streamlining our product management and product development functions, simplifying our product plans and further prioritizing on-time commercialization of new game themes, products and portal applications. Some of the product and operational decisions made in this review led to the impairment, restructuring, asset write-downs and other charges, net of $24.0 million, or $0.26 per diluted share, recorded in the June 2011 quarter and $27.8 million, or $0.28 per diluted share, for fiscal 2011. 50-------------------------------------------------------------------------------- Table of Contents The following table summarizes the detail of the net charges recorded in fiscal 2011 (in millions, except per diluted share amounts): Per Pre-tax diluted Description of Charges amounts share Impairment and Restructuring Charges: Non-cash Charges Impairment of licensed technologies and licensed brand $ 14.4 $ 0.15 Impairment of property, plant and equipment and other asset write-downs 4.0 0.05 Total non-cash charges 18.4 0.20 Cash Charges Restructuring charges 3.8 0.04 Total Impairment and Restructuring Charges 22.2 0.24 Charges for Asset Write-Downs: Inventory and other asset write-downs (recorded in cost of product sales) 4.9 0.05 Other asset write-downs ( recorded in cost of gaming operations) 1.7 0.02 Intellectual property asset write-downs (recorded in research and development) 3.0 0.03 Total Charges for Asset Write-downs 9.6 0.10 Total Impairment, Restructuring, Asset Write-downs and Other Charges 31.8 0.34 Proceeds from litigation settlement (recorded in interest income and other income and expense, net) (4.0 ) (0.04 ) Prior period impact from retroactive reinstatement of the Federal research and development tax credit (recorded in provision for income taxes) - (0.02 ) Total Net Charges $ 27.8 $ 0.28 Fiscal 2011 results includes $27.8 million of net pre-tax charges, or $0.28 per diluted share, which includes $22.2 million, or $0.24 per diluted share, of pre-tax impairment and restructuring charges comprised of $18.4 million, or $0.20 per diluted share, for non-cash asset impairments (including $11.0 million for impairment of technology licenses, $3.4 million for impairment of the Orion brand name) $2.6 million for impairment charges to write-down the value of the Orion facility in the Netherlands to fair value upon closing of the facility and $1.4 million for impairment of receivables related to government action to close casinos in Venezuela); and $3.8 million or $0.04 per diluted share for restructuring charges (primarily separation costs); along with $9.6 million of pre-tax charges, or $0.10 per diluted share, for asset write-downs and other charges (including charges for inventory write-downs related to winding down the Orion and original Bluebirdproduct lines); partially offset by $4.0 million or $0.04 per diluted share from cash proceeds of litigation settlement and a $0.02 per diluted share benefit recorded in the December 2010 quarter related to the period January 1, 2010 through June 30, 2010 from the retroactive reinstatement of the Federal research and development tax credit. We expect to record additional charges of $11 million to $14 million in the September 2011 quarter largely to complete our restructuring which is expected to reduce our workforce by about 10%. 51-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended June 30, 2011 Compared to Fiscal Year Ended June 30, 2010 and 2009 Below are our Revenues, Gross Margins and Key Performance Indicators. This information should be read in conjunction with our Consolidated Statements of Income (in millions, except unit, per unit and per day data): Fiscal Year Favorable (Unfavorable) 2011 2010 2009 2011 vs. 2010 2010 vs. 2009 Variance Variance Dollar % Dollar % Product Sales Revenues New units revenues $ 403.2 $ 387.6 $ 375.1 $ 15.6 4.0 $ 12.5 3.3Other product sales revenues 86.0 73.3 63.4 12.7 17.3 9.9 15.6 Total product sales revenues $ 489.2 $ 460.9 $ 438.5 $ 28.3 6.1 $ 22.4 5.1 New units sold 24,216 24,944 26,406 (728 ) (2.9 ) (1,462 ) (5.5 ) Average sales price per new unit $ 16,651 $ 15,540 $ 14,203 $ 1,111 7.1 $ 1,337 9.4 Gross profit on product sales revenue(1) $ 235.3 $ 243.5 $ 225.7 $ (8.2 ) (3.4 ) $ 17.8 7.9 Gross margin on product sales revenue(1) 48.1 % 52.8 % 51.5 % (470 )bp (8.9 ) 130 bp 2.5 Gaming Operations Revenues Participation revenues $ 277.7 $ 287.6 $ 246.7 $ (9.9 ) (3.4 ) $ 40.9 16.6 Other gaming operations revenues 16.4 16.6 21.2 (0.2 ) (1.2 ) (4.6 ) (21.7 ) Total gaming operations revenues $ 294.1 $ 304.2 $ 267.9 $ (10.1 ) (3.3 ) $ 36.3 13.5 Installed Participation Base at Period End with Lease Payments based on: Percentage of coin-in units(2) 3,780 3,765 2,868 15 0.4 897 31.3 Percentage of net win units(2) 3,072 3,334 3,959 (262 ) (7.9 ) (625 ) (15.8 ) Daily lease rate units(2)(3) 3,018 3,322 3,523 (304 ) (9.2 ) (201 ) (5.7 ) Total installed participation base units at period end 9,870 10,421 10,350 (551 ) (5.3 ) 71 0.7 Average participation installed base units 10,046 10,298 9,666 (252 ) (2.4 ) 632 6.5 Average revenue per day per participation units $ 75.76 $ 76.53 $ 69.93 $ (0.77 ) (1.0 ) $ 6.60 9.4 Gross profit on gaming operations revenue(1) $ 235.4 $ 245.9 $ 223.2 $ (10.5 ) (4.3 ) $ 22.7 10.2 Gross margin on gaming operations revenues (1) 80.0 % 80.8 % 83.3 % (80 )bp (0.1 ) (250 )bp (3.0 ) Total revenues $ 783.3 $ 765.1 $ 706.4 $ 18.2 2.4 $ 58.7 8.3 Total gross profit(1) $ 470.7 $ 489.4 $ 448.9 $ (18.7 ) (3.8 ) $ 40.5 9.0 Total gross margin(1) 60.1 % 64.0 % 63.5 % (390 )bp (6.1 ) 50 bp 0.8 Total operating income $ 110.4 $ 167.9 $ 136.6 $ (57.5 ) (34.2 ) $ 31.3 22.9 Total operating margin 14.1 % 21.9 % 19.3 % (780 )bp (35.6 ) 260 bp 13.5 Net income $ 81.0 $ 112.9 $ 92.2 $ (31.9 ) (28.3 ) $ 20.7 22.5 Earnings Per Share: Basic $ 1.40 $ 2.02 $ 1.87 $ (0.62 ) (30.7 ) $ 0.15 8.0 Diluted $ 1.37 $ 1.88 $ 1.59 $ (0.51 ) (27.1 ) $ 0.29 18.2 bp basis points (1) As used herein, gross profit and gross margin exclude depreciation and distribution expense. (2) In prior-years we disclosed the categories of our participation gaming machines based on the type of game placed on the gaming machine; WAP, LAP and Stand-alone. Beginning July 1, 2010, we modified our installed participation base categories to show the breakout of these gaming machines based on the revenue models that generate the lease payments: Percentage of coin-in, percentage of net win and daily lease rate. This change does not impact our total participation revenues or gross profits, nor our total installed base of participation gaming machines or the average revenue per day. We believe these new categories provide stockholders with better perspective about how our participation revenues are generated. The prior-year disclosure of the participation-installed base categories included in this table reflects the current year presentation. (3) Includes only participation game theme units. Does not include units with product sales game themes placed under fixed-term, daily fee operating leases. 52 -------------------------------------------------------------------------------- Table of Contents Fiscal 2011 Compared to Fiscal 2010 Total revenues for fiscal 2011 increased 2.4%, or $18.2 million, over fiscal 2010, reflecting: Ø A $15.6 million, or 4.0%, increase in new unit sales revenue as a result of: Ø A 7.1% increase in the average selling price of new gaming machines to $16,651, principally reflecting a greater sales mix of premium-priced products, including the sale of over 16,600 Bluebird2 and 6,200 Bluebird xD gaming machines, representing in aggregate approximately94.6% of our total new unit sales, compared to over 20,200 Bluebird2 gaming machines sold, or 82.9% of new unit sales in fiscal 2010. Sales of new Bluebird xD units, which were launched in June 2010, accounted for 26.0% of new units sold in fiscal 2011 compared to 1.8% in fiscal 2010. The increase in average selling price was partially offset by; Ø A 728 unit, or 2.9%, decrease in new units sold as: Ø New units sold in the United States and Canada totaled 14,876 units, a decrease of 7.8%, due to a decline in shipments to new casino openings and expansions and replacement market shipments were also lower resulting from the slow economy and our customers' lower capital budgets in calendar 2010 with only a modest increase in capital budgets in calendar 2011. Ø International new units sold increased 5.8% from the prior-year to 9,340 units from 8,826 units in fiscal 2010 and represented 38.6% of global shipments up from 35.4% in the prior-period primarily reflecting increased market penetration in Mexico and New South Wales, Australia, new markets we first entered directly in fiscal 2010, which more than offset the impact of continuing economic challenges across the European markets; and Ø Sales of mechanical reel products totaled 5,018 units, or approximately 20.7% of total new units sold compared to 29.5%of units sold in the prior-year. Ø A $12.7 million, or 17.3%, increase in other product sales revenues, reflecting higher revenues from lower-margin used gaming machines and higher parts sales revenues, partially offset by lower conversion revenues and other product sales revenues: Ø We sold nearly 9,300 used gaming machines during fiscal 2011, compared to over 8,500 used gaming machines in the prior-year period. The average sales price of used gaming machines increased in fiscal 2011 as we sold more of our own used gaming machines which have higher prices and in fiscal 2010 we sold more of our competitors used gaming machines which have lower prices; and Ø We earned revenue on approximately 8,200 conversion kits in fiscal 2011, compared to over 10,100 conversion kits in the prior-yearperiod, and the average selling price achieved was higher than in fiscal 2010 due to more higher-priced hardware conversion sales. Ø Participation revenues were lower by $9.9 million, or 3.4%, due primarily to: Ø The average installed base of participation gaming machines in fiscal 2011 decreased to 10,046 units in fiscal 2011, down 252 units, or 2.4%, from an average of 10,298 units in fiscal 2010. The percentage of coin-in units in the installed base at June 31, 2011, was 38.3% compared to 36.1% at June 30, 2010, although the actual number of such units was about flat between years. The average installed base for the year was negatively impacted in the June 2011 quarter from idleparticipation units in certain casinos that were closed due to flooding along the Mississippi, Missouri and Ohio rivers. The estimated impact from these idle units, including a significant number of high-performing coin-in units, totaled nearly 8,000 unit revenue days. As of August 1, 2011, all of these casinos have reopened. The percentage of net win units decreased by 262 units, or 7.9%, and the daily lease rate units in the installed base as of June 30, 2011 decreased by 304 units, or 9.2%, primarily due to certain game series coming to the end of their product life cycle and our not having enough new participation themes approved to refresh the installed base; and 53 -------------------------------------------------------------------------------- Table of Contents Ø Overall average revenue per day decreased slightly by $0.77, or 1.0%, principally reflecting lower average revenue per day in ourpercentage of coin-in gaming machines. Ø A $0.2 million, or 1.2%, decrease in other gaming operations revenues as we experienced lower royalty revenues, partially offset by higher Class II and initial revenues from our new online gaming and networked gaming operations. Total gross profit, as used herein excluding depreciation and distribution expense, decreased by 3.8%, or $18.7 million, to $470.7 million for fiscal 2011 from $489.4 million for the prior-year period. Our gross margins may not be comparable to those of other entities as we include the costs of distribution, which amounted to $24.7 million and $23.9 million in fiscal 2011 and 2010, respectively, in selling and administrative expenses. Our overall gross margin decreased to 60.1% in fiscal 2011 from 64.0% in the prior-year period reflecting a change in the mix of our revenues as lower-margin product sales amounted to 62.5% of total revenues in fiscal 2011 compared to 60.2% in fiscal 2010 while higher-margin gaming operations revenues amounted to 37.5% of revenues in fiscal 2011 compared to 39.8% in fiscal 2010. In addition: Ø Gross margin on product sales revenues was 48.1% for fiscal 2011, inclusive of the 100-basis point impact of $4.9 million of inventory and asset write-downs and other charges recorded in the June 2011 quarter, compared to 52.8% for the prior-year period. Product sales gross margin for fiscal 2011 also reflects: lower initial gross margin on our new Bluebird xD gaming machines as we rolled out this new product and Bluebird xD units being a higher percentage of total new unit shipments, higher revenues from lower-margin other product sales revenues, particularly higher used gaming machine revenues coupled with a declining margin on such revenues, and lower high-margin conversion revenues; and Ø Gross margin on gaming operations revenues was 80.0% for fiscal 2011, inclusive of the 60-basis point impact of $1.7 million of asset write-down charges recorded in the June 2011 quarter, compared to 80.8% from the prior-year period, reflecting a greater number of percentage of coin-in gaming machines in the installed base, which have a lower gross margin, combined with unfavorable WAP jackpot expense experience and slightly lower average daily revenue per day. We expect to generate modest revenue growth in fiscal 2012 and fiscal 2013 as we increase our global market penetration due to the popularity of our products, launch new products, expand market distribution opportunities, increase our average selling price with our premium Bluebird2 and new Bluebird xD gaming machines, grow our participation installed base and average revenues per day through the introduction of new and innovative participation games and product lines and increase revenues from our online gaming and networked gaming operations that we launched in fiscal 2011. We expect improvements in our product sales gross margin resulting from lower asset write-down charges, the ongoing implementation of process improvements throughout the entire organization with the utilization of lean sigma tools to improve quality and eliminate waste, improved results from our strategic sourcing initiatives and the benefits from higher unit volumes and ongoing efforts to level the production schedule throughout each quarter. Operating Expenses Operating expenses were as follows (in millions of dollars): Year Ended June 30, Increase/ 2011 2010 (Decrease) As % of As % of Dollar Revenue Dollar Revenue Dollar Percent Research and development $ 117.0 14.9 % $ 105.9 13.8 % $ 11.1 10.5 % Selling and administrative 150.0 19.2 148.4 19.4 1.6 1.1 Impairment and restructuring charges 22.2 2.8 - - 22.2 NA Depreciation 71.1 9.1 67.2 8.8 3.9 5.8 Total operating expenses $ 360.3 46.0 % $ 321.5 42.0 % $ 38.8 12.1 % 54 -------------------------------------------------------------------------------- Table of Contents Research and development expenses increased 10.5% to $117.0 million in fiscal 2011, compared to $105.9 million in the prior-year period. The year-over-year increase reflects: Ø Our planned expanded product development initiatives for the continued creation of intellectual property and the ongoing expansion of our product portfolio; Ø Higher costs to accelerate new applications for our Casino Evolved suite of innovative, high-value products in preparation for the launch of networked gaming; Ø $3.0 million of charges to write-down intellectual property assets; Ø Increased payroll-related costs associated with headcount increases to accomplish the initiatives stated above; partially offset by Ø Cost containment measures we implemented, including the impact of lower performance-based incentives. During fiscal 2011, we introduced 80 new WMS branded games for sale and 28 new participation and casino-owned daily fee games, compared to the introduction in fiscal 2010 of 59 new WMS branded games for sale and 29 new participation and casino-owned daily fee games. We expect that research and development expenses will decrease as a percentage of revenues to around 13% in fiscal 2012 as we implement the changes to our product plan resulting from the comprehensive review of our business strategies and product plans at the end of fiscal 2011 and beginning of fiscal 2012. We will continue to spend research and development dollars on projects to ensure we stay at the forefront of innovation and creativity in our industry. Selling and administrative expenses increased 1.1%, or $1.6 million, to $150.0 million in fiscal 2011, compared to $148.4 million in the prior-year period while decreasing by 20-basis points as a percentage of revenues. The year-over-year increase reflects: Ø Increased payroll-related costs primarily related to headcount increases to support international expansion and overall growth in our business; Ø An increase in consulting expense of $3.2 million due to increased technology consulting to upgrade our Oracle ERP system, and higher legal expense due to increased litigation; partially offset by Ø Cost containment measures we implemented, including the impact of lower performance-based incentives. Fiscal 2011 includes $22.2 million of net pre-tax charges, or $0.24 per diluted share, of pre-tax impairment and restructuring charges comprised of $18.4 million or $0.20 per diluted share for non-cash asset impairments (including $11.0 million for impairment of technology licenses, $3.4 million for impairment of the Orion brand name, $2.6 million for the impairment of the Orion facility in the Netherlands and $1.4 million for impairment of receivables related to government action to close casinos in Venezuela) and $3.8 million or $0.04 per diluted share for restructuring charges, primarily separation charges. We expect to record additional charges of $11 million to $14 million in the September 2011 quarter largely to complete our restructuring which is expected to reduce our workforce by about 10%. Depreciation expense increased by $3.9 million to $71.1 million in fiscal 2011, compared to $67.2 million in the prior-year period. The increase in depreciation primarily reflects higher gaming operations equipment expenditures in fiscal 2011 and the depreciation of capitalized software costs for our networked gaming system and our online gaming systems, which we began depreciating in fiscal 2011 upon the launch of these new operations. 55-------------------------------------------------------------------------------- Table of Contents Operating Income Our operating income decreased by $57.5 million, or 34.2%, in fiscal 2011 on a 2.4% increase in total revenues. Our operating margin of 14.1% represented a 780-basis point decrease over the 21.9% operating margin achieved in the prior-year and was negatively impacted by 400-basis points because of the $31.8 million of impairment, restructuring, assets write-downs and other charges recorded in fiscal 2011. This decrease reflects $18.7 million in lower total gross profit inclusive of the $6.6 million of inventory and other asset write-downs and other charges, and $38.8 million in higher operating expenses inclusive of the $22.2 million of impairment and restructuring charges and $3.0 million of intellectual property write-downs included in research and development expenses. For fiscal 2012 and 2013, we expect to achieve improvements in our operating margin as anticipated improvements in revenue and gross profits will be paired with expectations of lower impairment and restructuring charges and that research and development and selling and administrative expenses will be a lower percentage of overall revenues than in fiscal 2011, partially offset by depreciation expense increasing as a percentage of revenues. Interest Expense We incurred interest expense of $1.2 million for fiscal 2011 compared to $3.2 million for the prior-year. The 2010 period includes approximately $0.9 million of expenses related to inducement costs related to the early conversion by note holders of all $115 million of issued our 2.75% Convertible Subordinated Notes ("Notes"), into common stock and related interest expense while these Notes were outstanding during fiscal 2010. Interest Income and Other Income and Expense, Net Interest income and other income and expense, net was income of $14.4 million and $5.8 million for fiscal 2011 and 2010, respectively. The increase is primarily due to increases in interest income from increased extended payment term notes receivable and $4.0 million, or $0.04 per diluted share, from cash proceeds of litigation settlement. Income Taxes The effective income tax rate was 34.5% in fiscal 2011 compared to 33.8% in fiscal 2010. The fiscal 2011 effective tax rate reflects: Ø The retroactive reinstatement of the Federal research and development tax credit to January 1, 2010 of which approximately $0.02 earnings per diluted share related to the period January 1, 2010 through June 30, 2010; Ø Decreased income over fiscal 2010; Ø Higher domestic manufacturing deduction due to a rate increase from 6% to 9%; partially offset by Ø Increased impact of foreign subsidiary startup losses without benefit and permanent tax items in fiscal 2011. The fiscal 2010 effective income tax rate reflects: Ø The favorable impact of the completion of the Internal Revenue Service ("IRS") income tax audits for the fiscal years 2004 through 2007, resulting in a reduction of our liability for uncertain tax positions by $4.6 million or $0.07 per diluted share; and Ø Increased impact of permanent tax items in the fiscal year; partially offset by Ø Increased income over fiscal 2009; and 56 -------------------------------------------------------------------------------- Table of Contents Ø Impact of the expiration of the Federal research and development tax credit as of December 31, 2009, which increased our provision for income taxes by $0.01 per diluted share. In early December 2010, the Federal research and development tax credit was reinstated retroactive to the beginning of calendar year 2010 and will continue through calendar year 2011. As the Federal research and development tax credit is scheduled to expire December 31, 2011, we expect our effective income tax rate for fiscal 2012 and 2013 to be approximately 36% to 37% assuming governments do not change statutory tax rates for those periods or reinstitute the Federal research and development tax credit. Earnings Per Share Diluted earnings per share decreased 27.1%, or $0.51, to $1.37 in fiscal 2011 from $1.88 for prior-year period on a 2.4% increase in revenues. The decrease in earnings per share in fiscal 2011 is attributable to the decrease in net income inclusive of $0.28 per diluted shares of net charges, partially offset by lower diluted shares outstanding due to higher share repurchases in fiscal 2011. Our diluted earnings per share for fiscal 2010, includes a $0.07 per diluted earnings per share benefit from discrete income tax items, primarily related to the favorable completion of the Federal income tax audits through fiscal 2007, partially offset by a $0.01 per diluted earnings per share reduction resulting from the expiration of the Federal research and development tax credit as of December 31, 2009 and $0.02 per diluted share of costs incurred related to the inducement of the Notes. Fiscal 2010 Compared to Fiscal 2009 Revenues and Gross Profit Total revenues for fiscal 2010 increased 8.3%, or $58.7 million, over fiscal 2009, reflecting: Ø A $12.5 million, or 3.3%, increase in new unit sales revenue as a result of: Ø A 9.4% increase in the average selling price of new gaming machines to $15,540, principally reflecting the greater sales mix of premium-priced products, which included the sale of approximately 20,200 Bluebird2 gaming machines, representing 82.9% of our total new unit sales compared to 9,229 Bluebird2 gaming machines sold or 35.0% of new units sold in the prior-year. Ø A 1,462 unit, or 5.5%, decrease in new units sold as: Ø New units sold in the United States and Canada totaled 16,118 units, a decrease of 3.7%, due to lower industry demand resulting from the slow economy and our customers' lower capital budgets in calendar 2009 with only a modest increase in capital budgets in calendar 2010; Ø International new units sold decreased 8.8% from the prior-year to 8,826 units, reflecting economic challenges and tightening credit markets across international regions, especially the European and Latin American markets; and Ø Sales of mechanical reel products totaled 7,348 units, or approximately 29.5% of total new units sold, compared to 24.1% of units sold in the prior-year. We believe our customers reduced their capital spending on this product line in the first half of fiscal 2009 in advance of our launch of the new Bluebird2 mechanical reel gaming machine with Transmissive Reels technology late in the March 2009 quarter. Ø A $9.9 million, or 15.6%, increase in other product sales revenues reflecting higher sales of conversion kits, lower-margin used gaming machines, parts sales, and other revenues as: Ø We earned revenue on sales of approximately 10,100 game conversion kits in fiscal 2010, which were up 7.9% compared to the conversion kit sales in the prior-year, while the average selling price achieved was lower than in fiscal 2009; and 57 -------------------------------------------------------------------------------- Table of Contents Ø We sold approximately 8,500 used gaming machines during fiscal 2010, compared to approximately 4,900 used gaming machines in theprior-year. Ø A $40.9 million, or 16.6%, growth in participation revenues due primarily to: Ø A 6.5% increase, or 632 units, in the average installed base of participation gaming machines in fiscal 2010 driven by thegrowth in our percentage of coin-in gaming machines. The percentage of coin-in units were 36.1% of the installed base at June 30, 2010 and were 897 units, or 31.3% higher than at June 30, 2009, reflecting our focus infiscal 2010 on increasing the percentage of coin-in units in the installed base. We were able to increase the percentage of coin-in installed base due to the continued strong earnings performance of our Sensory Immersion and Transmissive Reels participation product lines. The percentage of net win units in the installed base decreased by 625 units and the daily lease rate units decreased by 201 units primarily due to certain game series coming to the end of their life cycle. Our controlledroll-out strategy for new participation games has led to the desiredresult of a higher level of incremental footprint. Ø Overall average revenue per day increased by $6.60, or 9.4%, principally reflecting the mix shift in the installed base to a higherpercentage of coin-in units which have a higher revenue per day than thepercentage of net win or the daily lease rate units, coupled with our active program to relocate low-performing participation gaming machines to casinos where we expect higher performance, partially offset by lowerlevels of casino play due to a continuing challenging economy. Ø A $4.6 million, or 21.7%, decrease in other gaming operations revenues during fiscal 2010 as we experienced lower royalty revenues as a result of game content license agreements to third parties for certain markets reaching the end of the license term. The reduction in royalty revenues resulting from these expired license agreements was not material to our Consolidated Financial Statements. Total gross profit, as used herein excluding depreciation and distribution expense, increased 9.0%, or $40.5 million, to $489.4 million for fiscal 2010 from $448.9 million for the prior-year. Our gross margins may not be comparable to those of other entities as we include the costs of distribution, which amounted to $23.9 million and $21.4 million in fiscal 2010 and 2009, respectively, in selling and administrative expenses. This improvement reflects a change in mix of our revenue sources as product sales revenues amounting to 60.2% of total revenues in fiscal 2010 compared to 62.1% in fiscal 2009 and gaming operations revenues amounting to 39.8% of total revenues in fiscal 2010 compared to 37.9% in fiscal 2009. In addition: Ø Gross margin on product sales revenues was 52.8% for fiscal 2010, compared to 51.5% for the prior-year. Gross margin for fiscal 2010 reflects continued operating improvements, primarily resulting from our lean sigma and strategic sourcing initiatives, coupled with a higher average selling price due to greater sales of premium gaming machines, including our new Bluebird2 platform and $9.5 million in lower excess and obsolete inventory charges, partially offset by a lower volume of business and a higher amount of lower margin used game sales and parts sales. We incurred higher excess and obsolete inventory charges in the prior-year as we prepared for customers transitioning to our new Bluebird2 gaming cabinet. Ø Gross margin on gaming operations revenues was 80.8% for fiscal 2010, compared to 83.3% from the prior-year, reflecting the impact of higher mix of lower-margin coin-in units and less favorable WAP jackpot expense experience. Gaming operations gross margin was also negatively impacted during fiscal 2010 by 0.3% from lower royalty revenues as a result of license agreements for certain markets reaching the end of the license term and our election not to renew such agreements so we can directly enter these markets. 58 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Operating expenses were as follows (in millions of dollars): Year Ended June 30, 2010 2009 Increase/(Decrease) As % of As % of Dollar Revenue Dollar Revenue Dollar Percent Research and development $ 105.9 13.8 % $ 98.4 13.9 % $ 7.5 7.6 % Selling and administrative 148.4 19.4 145.5 20.6 2.9 2.0 Depreciation 67.2 8.8 68.4 9.7 (1.2 ) (1.8 ) Total operating expenses $ 321.5 42.0 % $ 312.3 44.2 % $ 9.2 2.9 % Research and development expenses increased 7.6% or $7.5 million to $105.9 million in fiscal 2010, compared to $98.4 million in the prior-year and represented 13.8% of fiscal 2010 revenues, which was virtually flat to the prior-year. The increased spending on research and development for fiscal 2010 included: Ø Our planned expanded product development initiatives for the continued creation of intellectual property and the ongoing expansion of our product portfolio; Ø Higher costs to accelerate new systems and enterprise-wide system applications for our Casino Evolved suite of innovative, high-value products in preparation for the launch later in calendar 2010 of networked gaming systems and online gaming in the United Kingdom; Ø Increased payroll-related costs associated with headcount increases to accomplish the initiatives stated above and higher performance-based incentive costs associated with improved operating performance; partially offset by our efforts to contain costs. During fiscal 2010, we introduced 59 new WMS branded games for sale and 29 new participation and casino-owned daily fee games, compared to the introduction in fiscal 2009 of 61 new WMS branded games for sale and 26 new participation and casino-owned daily fee games. Selling and administrative expenses increased 2.0%, or $2.9 million, to $148.4 million in fiscal 2010 compared to $145.5 million in the prior-year. Selling and administrative expenses as a percentage of revenues decreased 120-basis points in fiscal 2010. The year-over-year change includes: Ø Increased payroll-related costs primarily related to headcount increases to support international expansion and overall growth in our business, and higher performance based incentive costs associated with improved operating performance; partially offset by Ø A reduction in legal expense in fiscal 2010 as the litigation cost for insurance claims related to Hurricane Katrina was substantially lower; and Ø A reduction in bad debt expense to $3.1 million in fiscal 2010 from $7.1 million in the prior-year. The expense in fiscal 2009 was higher due to the impact of the economic turndown, which resulted in an increase in customer bankruptcy filings during that period. Depreciation expense declined by $1.2 million to $67.2 million in fiscal 2010 compared to $68.4 million in the prior-year. This reflects improved capital efficiencies achieved in the gaming operations business resulting from the ongoing disciplined rollout of new participation games resulting in lower capital spending and increased longevity of the participation games, coupled with a greater number of participation gaming machines having been depreciated to their salvage value. 59 -------------------------------------------------------------------------------- Table of Contents Operating Income Our operating income increased by $31.3 million, or 22.9%, in fiscal 2010 on an 8.3% increase in total revenues. Our fiscal 2010 operating margin of 21.9% represented a 260-basis point increase over the 19.3% operating margin achieved in the prior-year. This improvement was achieved by the improvements in product sales gross margin and gaming operations gross margin, coupled with higher-margin gaming operations accounting for 39.8% of total revenues in fiscal 2010 compared to 37.9% in the prior-year, partially offset by operating expenses increasing by 2.9%. Interest Expense We incurred interest expense of $3.2 million for fiscal 2010 compared to $4.0 million for the prior-year. The 2010 period includes approximately $0.9 million of expenses related to inducement costs related to the early conversion by Note holders of all $115 million of issued Notes into common stock. In fiscal 2009, we also incurred interest and fees on borrowings under our revolving credit facility but we did not borrow any monies under the facility in fiscal 2010. Fiscal 2010 results include higher amortization of debt issuance costs than fiscal 2009 results as a consequence of the amendment and restatement of our revolving credit agreement effective September 2009. Interest Income and Other Income and Expense, Net Interest income and other income and expense, net decreased by $2.0 million to $5.8 million in fiscal 2010 compared to $7.8 million for the prior-year, primarily due to a pre-tax gain of $5.0 million from a cash settlement of trademark litigation in the fiscal 2009 period, partially offset by interest income rising from a greater amount of extended payment term financings than in fiscal 2009. Income Taxes The effective income tax rate was 33.8% in fiscal 2010 compared to 34.3% in fiscal 2009. The fiscal 2010 effective tax rate reflects: Ø The favorable impact of the completion by the IRS of income tax audits for fiscal years 2004 through 2007 resulting in a reduction of our liability for uncertain tax positions by $4.6 million or $0.07 per diluted share; and Ø Increased impact of permanent tax items in fiscal 2010; partially offset by the Ø Increased income over fiscal 2009; and Ø Impact of the expiration of the Federal research and development tax credit as of December 31, 2009, which increased our provision for income taxes by $0.01 per diluted share. The fiscal 2009 effective income tax rate reflects: Ø Higher domestic manufacturing deduction; and Ø Reinstatement of the Federal research and development tax credit in October 2008, retroactive to the beginning of the calendar year 2008. The effective tax rate includes the credit earned from January 1, 2008 through June 30, 2008, which aggregated $0.02 per diluted share, in addition to the Federal research and development tax credit earned during fiscal 2009. Earnings Per Share Diluted earnings per share increased 18.2% on an 8.3% increase in revenues to $1.88 for year ended June 2010 from $1.59 for prior-year. The increase in earnings per share is attributable to increased net income for the year partially offset by additional diluted common stock and common stock equivalents. 60 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES 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 calendar year 2010 and even fewer in calendar 2011, coupled with many customers reducing their annual capital budgets for replacing gaming machines for calendar 2009 with only modestly higher replacement capital budgets in calendar 2010 and anticipated for calendar 2011. 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. This has resulted in lower industry-wide unit demand from gaming operators and lower play levels on gaming machines in most gaming jurisdictions. We have been faced with these macroeconomic challenges for over two years. Our cash flow from operations is largely dependent on our profitability and the amount of working capital necessary to support our revenue base. Therefore, in any given reporting period, the amount of cash consumed or generated by operations will primarily relate to the rate of revenue and profitability increase or decrease, and the increase or decrease in working capital required to operate our business. In periods when revenues are increasing, the expanded working capital needs will be funded from available cash, cash equivalents, cash flow from operations, and, if necessary, proceeds from our revolving credit facility or additional debt or additional equity offerings. We utilize these sources to fund investments in property, plant and equipment, gaming operations equipment and agreements to license or acquire third-party brands, intellectual properties or technologies that we have not developed internally. Also, we will from time to time issue or retire borrowings or repurchase equity in an effort to maintain a cost-effective capital structure consistent with our anticipated capital requirements. With the ongoing uncertainty in the credit and capital markets, there can be no assurance that other sources of capital will be available to us on acceptable terms or at all. Based on past performance and current expectation, we believe the combination of these resources will satisfy our needs for working capital, jackpot liabilities, capital expenditures and other liquidity requirements associated with our existing operations into the foreseeable future. Our primary sources of liquidity are: Ø Existing cash and cash equivalents; Ø Cash flows from operations; and Ø Debt capacity available under our revolving credit facility and, if necessary, additional debt or equity offerings. Selected balance sheet accounts and data at June 30 are summarized as follows ($ in millions): Increase/(Decrease) 2011 2010 Change Percent Total cash, cash equivalents, and restricted cash(1) $ 105.0 $ 184.6 $ (79.6 ) (43.1 )% Total current assets (A) 497.5 555.0 (57.5 ) (10.4 ) Total assets 1,046.3 1,007.0 39.3 3.9 Total current liabilities (B) 152.4 140.8 11.6 8.2 Stockholders' equity 855.9 833.9 22.0 2.6 Net working capital (A) - (B) $ 345.1 $ 414.2 $ (69.1 ) (16.7 ) Trailing-twelve month statistics: Average days outstanding for total accounts and notes receivable 161 138 23 16.7 Inventory turns 4.1 4.4 (0.3 ) (6.8 ) (1) Pursuant to various state gaming regulations, we maintain certain restricted cash accounts to ensure availability of funds to pay wide-area progressive jackpot awards either in lump sum payments or in installments. Cash, cash equivalents and restricted cash includes restricted cash of $14.3 million and $17.9 million as of June 30, 2011 and June 30, 2010, respectively. Cash required for funding WAP jackpot payments is considered restricted cash and is not available for general corporate purposes. 61 -------------------------------------------------------------------------------- Table of Contents Our net working capital at June 30, 2011 decreased $69.1 million from June 30, 2010, and was primarily affected by the following components: Ø A decrease in cash, cash equivalents and restricted cash of $79.6 million due primarily to $101.5 million of share repurchases in fiscal 2011; Ø An increase in total accounts and notes receivable, net, of $40.0 million, or 12.3%, to $366.2 million compared to $326.2 million at June 30, 2010, reflecting our efforts that began in fiscal 2009 to accommodate the increased demand by our customers for extended payment financing terms given the downturn in the economy coupled with growth in revenues from new markets we entered in fiscal 2010 that traditionally have required extended payment terms, specifically Mexico and New South Wales, Australia. Our days sales outstanding for both current and long-term account and notes receivable were 161 days at June 30, 2011, compared to 138 days at June 30, 2010; Ø An increase in inventories of $9.3 million, or 16.1%, to $67.1 million from $57.8 million at June 30, 2011, due to higher finished goods inventory. Inventory turns were 4.1x at June 30, 2011, compared to 4.4x at June 30, 2010; and Ø An increase in current liabilities of $11.6 million or 8.2% to $152.4 million due to higher current taxes payable and other accrued liabilities partially offset by lower performance-based bonuses as employees were not paid a bonus under our annual cash bonus plan for fiscal 2011. As described in Note 14. "Commitments, Contingencies and Indemnifications" to our Consolidated Financial Statements, we have royalty and license fee commitments for brand, intellectual property and technology licenses of $89.3 million including contingent payments that are not recorded in our Consolidated Balance Sheets. We believe that total cash, cash equivalents and restricted cash of $105.0 million at June 30, 2011, inclusive of $14.3 million of restricted cash, and cash flow from operations will be adequate to fund our anticipated level of expenses, cash to be invested in property, plant and equipment and gaming operations equipment, cash to be used to license or acquire brands, technologies or intellectual properties from third parties, the levels of inventories and accounts and notes receivable required in the operation of our business and any repurchases of common stock for the upcoming fiscal year. We take a prudent and conservative approach to maintaining our available liquidity while credit market and economic conditions remain unfavorable. We continue to focus on reinvesting in our business through our installed base of gaming operations machines, as well as other strategic capital deployment objectives to expand our geographic reach, product lines and customer base. We will cautiously deploy our capital in order to preserve maximum flexibility. For fiscal 2012 and fiscal 2013, we expect cash flow from operations to continue to be strong. We do not believe we will need to raise a significant amount of additional capital in the short-term or long-term, and we have access to our $150-million revolving credit facility through September 30, 2012. We intend to extend or replace this facility prior to its expiration. Due to the current economic conditions and capital markets challenges, we can provide no guarantee that we will be able to negotiate such an agreement or that such agreement would not place further limitations on our operations. We will, however, assess market opportunities as they arise. Total Accounts and Notes Receivable and Bad Debt Reserves Our normal payment terms are 30 to 90 days. We have historically provided extended payment terms to some of our customers for periods from 120 days through 36 months. As a result of the financial market crisis which began in 2008 and disrupted credit and equity markets worldwide and led to reduced consumer discretionary spending and a weakened global economic environment, beginning in the March 2009 quarter we began and have continued to provide a greater amount of extended payment terms to select customers. This expanded extended payment term program is expected to continue until the global economy and consumer discretionary spending improves and customer demand for extended payment terms abates. Typically, these sales result in a higher selling price and, if financed over periods longer than 12 months, incur interest at a rate in excess of our borrowing rate, both of which provide added profitability to the sale. 62 -------------------------------------------------------------------------------- Table of Contents Customers consider numerous factors in determining whether to issue a sales order to us including, among others, expected earnings performance of the gaming machines (which we believe is the most significant decision factor), selling price, the value provided for any trade-in of used gaming machines, parts and game conversion kit support and payment terms. We believe our competitors have also expanded their use of extended payment terms. In aggregate, we believe that by expanding our use of extended payment terms, we have provided a competitive response in our market and that our revenues have been favorably impacted. We are unable to estimate the impact of this program on our revenues because gaming machine performance, rather than selling price and extended payment terms, is the most important driver of our sales process. If we ceased providing an expanded amount of extended payment terms, we believe we would not be competitive for some customers in the market place and that our revenues and profits would likely decrease. The expansion of our use of extended payment terms has increased our current and long-term accounts and notes receivable balances and reduced our cash provided by operating activities. Total accounts and notes receivable increased by $40.0 million from $326.2 million at June 30, 2010 to $366.2 million at June 30, 2011. While a portion of this increase relates to the 2.4% increase, or $18.2 million, in revenues in the fiscal year 2011 compared to the fiscal 2010, we believe a majority of this increase is due to the impact of providing an expanded amount of extended payment terms. The collection of these accounts and notes receivable in future periods will increase the amount of cash flow provided by operating activities and reduce our total accounts and notes receivable and increase our cash balance. We evaluate the adequacy of our allowance for bad debts at least on a quarterly basis. We consider a variety of factors in this evaluation, including the accounts and notes receivable aging and trends thereof for customer balances, past experience with customers who pay outside of payment terms, the legal environment and regulatory landscape and news related to individual customers especially if the news calls into question the customer's ability to fully pay balances owed. Accounts and notes receivables are evaluated individually for impairment (specific reserves) when collectability becomes uncertain due to events and circumstances that cause an adverse change in a customer's cash flows or financial condition. Accounts placed on specific reserve are evaluated for probability of collection, which is used to determine the amount of the specific reserve. Our bad debt expense is most significantly impacted by bankruptcy filings by our customers and pre-bankruptcy reported exposures of individual customers. Due to our successful collection experience and our continuing operating relationship with casino customers and their businesses, it is infrequent that we repossess gaming machines from a customer in settlement of outstanding accounts or notes receivable balances. In those instances where repossession occurs, to mitigate our exposure on the related receivable, the repossessed gaming machines are subsequently resold in the used gaming machine market, however we may not fully recover the receivable from this re-sale. For customers in the United States, at the time a customer files for bankruptcy, we typically have a security interest in the gaming machines for that portion of the total accounts and notes receivable, but our accounts and notes receivable related to all other revenue sources are typically unsecured claims. Due to the significance of our gaming machines to the on-going operations of our casino customers, in a bankruptcy filing we may be designated as a key vendor, which can enhance our position above other creditors in the bankruptcy. During the fiscal year ended June 30, 2011, our bad debt expense totaled $3.9 million plus we recorded $1.4 million as an impairment charge and in aggregate the $5.3 million represents 0.7% of revenues in such fiscal year, which compares to $3.1 million of bad debt expense for the prior fiscal year, which represented 0.4% of revenues in the prior fiscal year. Our bad debt expense was higher in the year ended June 30, 2011 due to government action to close casinos in Venezuela leading to the impairment charge, which increased our total bad debt reserve to $5.5 million at June 30, 2011 compared to $3.4 million at June 30, 2010. 63 -------------------------------------------------------------------------------- Table of Contents Excess and Obsolete Inventories Our inventory write-downs primarily arise from raw material parts becoming obsolete when replaced by a new part and we are unable to fully realize the value of the old part and from excess quantities of raw material inventory purchased for production of gaming machines which we cannot utilize. When we discontinue support of a gaming machine style, make significant changes to an existing gaming machine design or transition to a new gaming machine style, we may experience higher levels of inventory write-downs. We use forecasted demand planning in both purchasing and production processes and conduct quarterly reviews for excess and obsolete inventory. Any inventory write-downs are recorded in the period they are identified to reflect any anticipated inventory losses arising from inventory values in excess of cost or market. As we introduce new gaming machines that utilize new raw material parts, we reduce the quantity of raw material purchases for existing gaming machines based upon anticipated customer demand and expected end-of-life production and support of the global installed base of the existing gaming machines. Favorable customer acceptance in excess of estimated customer demand for the new gaming machines can result in excess quantities of raw materials being on-hand for the existing gaming machines. In the December 2008 quarter, we introduced the new Bluebird2 gaming machine and in June 2010 we introduced the new Bluebird xD gaming machine and in both cases the demand for these new gaming machines exceeded our expectation, resulting in fewer Bluebird gaming machines being sold. We seek to reduce excess raw materials through several strategies such as: (1) reselling them back to the supplier, (2) using them to maintain our installed base of leased gaming operations machines, (3) selling them to customers to support their existing gaming machines which are recorded as part sales, (4) using them to refurbish used gaming machines, (5) selling them to a third party or (6) scrapping them. We have a defined process to control changes in the design of our gaming machines to reduce the possibility that we cannot utilize existing parts before new parts are implemented and therefore reduce the impact of obsolete inventory. We use the same six strategies noted above to reduce the impact of inventory write-downs for obsolete parts. In fiscal 2011, we decided to wind-down our support for our Orion and Bluebird gaming cabinets over fiscal 2012, which led to a higher level of inventory write-downs being recorded. Inventory write-downs for the year ended June 30, 2011 totaled $7.1 million, including $4.9 million of inventory and other assets write-downs in the June 2011 quarter, and compared to $3.8 million of write-downs in fiscal 2010. Revolving Credit Facility and Convertible Subordinated Notes See Note 11. "Revolving Credit Facility and Convertible Subordinated Notes" to our Consolidated Financial Statements. Common Stock Repurchase Program See Note 12. "Stockholders' Equity-Common Stock Repurchase Program" and 19. "Subsequent Events" to our Consolidated Financial Statements. Cash Flows Summary Cash flows from operating, investing and financing activities, as reflected in our Consolidated Statements of Cash Flows, are summarized in the following table (in millions): Year Ended June 30, 2011 to 2010 to 2010 2009 2011 2010 2009 Change Change Net cash provided by (used in): Operating activities $ 157.1 $ 130.3 $ 179.2 $ 26.8 $ (48.9 ) Investing activities (157.0 ) (108.6 ) (113.8 ) (48.4 ) 5.2 Financing activities (77.0 ) 9.7 (29.8 ) (86.7 ) 39.5 Effect of exchange rates on cash and cash equivalents 0.9 (0.4 ) (0.7 ) 1.3 0.3 Net increase (decrease) in cash and cash equivalents $ (76.0 ) $ 31.0 $ 34.9 $ (107.0 ) $ (3.9 ) 64 -------------------------------------------------------------------------------- Table of Contents Operating Activities: The $26.8 million increase in cash provided by operating activities in fiscal 2011 compared to fiscal 2010, resulted from: Ø A $41.3 million positive impact from an $18.4 million increase in non-cash impairment and restructuring charges, $9.0 million of other non-cash items, including an increase in inventory and bad debt write-downs, a $10.0 million positive impact from lower tax benefits from exercise of stock options and a $3.9 million increase in depreciation expense; and Ø A $26.1 million positive impact from lower changes in operating assets and liabilities. This impact is comprised of a positive impact of a $29.9 million net decrease between periods in the growth of total accounts and notes receivable, a $4.9 million decrease between periods in the growth in inventory, combined with a $12.3 million decrease in other assets and liabilities and a $2.5 million increase from reduced restricted cash, partially offset by a $23.5 million decrease between periods in the growth of current liabilities; partially offset by Ø A $40.6 million negative impact from a $31.9 million decrease in net income, a $6.5 million negative impact from higher deferred tax benefit, a $0.6 million decrease in amortization of intangible assets, and a $1.6 million decrease in share based compensation. The $48.9 million decrease in cash provided by operating activities in fiscal 2010 compared to the fiscal 2009 resulted from: Ø A $12.1 million positive impact from the $20.7 million increase in net income, combined with a $3.5 million increase in amortization of intangible and other assets and a $2.3 million increase in share-based compensation, partially offset by a $1.2 million decrease in depreciation and a $13.2 million increase in the deferred income benefit; more than offset by Ø An $18.0 million negative impact from lower other non-cash items. Our bad debt expense was lower by $4.0 million in fiscal 2010 as we had more favorable collection experience, fewer customers filing for protection from bankruptcy and the economy was generally better than in fiscal 2009. We incurred $9.5 million lower excess and obsolete inventory charges in fiscal 2010 than in fiscal 2009 as in fiscal 2009 we prepared for customers transitioning to our new Bluebird2 gaming cabinet partially offset by higher other non-cash items of $0.1 million. The fiscal 2010 period also reflects a $4.6 million non-cash credit arising from a reduction in our reserve for uncertain tax positions as a result of the IRS completing its audit of our Federal income tax returns for fiscal 2004 through fiscal 2007; Ø A $17.3 million negative impact from an increase in the tax benefit from exercise of stock options as more people exercised stock options in fiscal 2010 than in fiscal 2009, primarily due to the increase in our stock price. The exercise of stock options is dependent on individuals' choices to exercise options, which are dependent on the spread of the market price of our stock above the exercise price of vested options; and Ø A $25.7 million negative impact from changes in operating assets and liabilities. This negative impact is comprised of an incremental increase in inventory of $19.2 million primarily due to the advance purchase of computer chips that are used in most of our gaming machines, a $23.2 million incremental increase in total accounts and notes receivable as we granted a greater number of extended-term financing options for select customers and a greater percentage of our quarterly shipments for the June 2010 quarter took place in the month of June than had occurred in June 2009, a $25.1 million net increase in other assets and liabilities and restricted cash, partially offset by an incremental increase of $41.8 million in current liabilities. Investing Activities: The $48.4 million increase in cash used by investing activities for fiscal 2011, compared to fiscal 2010, was primarily due to: Ø A $22.4 million increase in the amount invested in gaming operations machines, top boxes and related equipment during fiscal 2011, to $65.9 million. We expect that capital expenditures for gaming 65 -------------------------------------------------------------------------------- Table of Contents operations equipment will increase in fiscal 2012 and 2013 as we continue to transition our installed base from Bluebird to Bluebird2 and Bluebird xD gaming machines and as we expand the number of operating lease agreements we enter into; Ø A $9.4 million increase in the amount invested in property, plant and equipment during fiscal 2011 to $66.2 million, as we continue to invest in facility expansion, higher spending on information technology, as well as investments in manufacturing tools and internally developed and purchased software. We expect that capital expenditures for property, plant and equipment will increase modestly in fiscal 2012 and 2013; and Ø A $16.6 million increase in payments to develop, license or acquire long-term intangible and other assets as we invested $24.9 million in fiscal 2011 as we identified additional assets to develop, license or acquire. Future investment in intangible and other assets is dependent upon us identifying such assets and successfully negotiating acquisition or license agreements with the owners. The $5.2 million decrease in cash used by investing activities for the year ended June 30, 2010 compared to the prior-year was primarily due to: Ø A $3.5 million decrease in the amount invested in gaming operations machines, top boxes and related equipment in fiscal 2010 to $43.5 million despite the 0.7% increase in the participation-installed base due to better management of these assets; Ø A $5.2 million decrease in payments to acquire or license long-term intangible assets in fiscal 2010 as we identified fewer items to license or acquire; partially offset by Ø A $3.5 million increase in the amount invested in property, plant and equipment during fiscal 2010 to $56.8 million, as we continue to invest in future facility expansion, higher spending on information technology, as well as investments in manufacturing tools and internally developed and purchased software. Financing Activities: The $86.7 million increase in cash used by financing activities for fiscal 2011, compared to fiscal 2010, was primarily due to: Ø A $56.5 million increase in treasury stock repurchases in fiscal 2011 under the new repurchase program approved by our board of directors in August 2010; Ø A $32.8 million decrease in cash received and tax benefits realized from exercised stock options during fiscal 2011. The amount we receive from the exercise of stock options is dependent on individuals' choices to exercise options, which are dependent on the spread of the market price of our stock above the exercise price of vested options; partially offset by Ø The prior-year period included a $1.7 million payment for debt issuance cost to amend and restate our revolving credit facility with no such charges in fiscal 2011; and Ø A $0.9 million payment made in fiscal 2010, as an inducement to the holders of our Convertible Subordinated Notes to early convert them to our common stock with no such charges in fiscal 2011. The $39.5 million increase in cash provided by financing activities in fiscal 2010 compared to fiscal 2009 was primarily due to: Ø A $46.6 million increase in cash received and tax benefits realized from exercised stock options and the employee stock purchase plan; partially offset by Ø A $4.5 million increase in treasury stock repurchases to $45.0 million in fiscal 2010 compared to approximately $40.5 million in the prior-year; Ø A $1.7 million increase in debt issuance cost to amend and restate our revolving credit facility; and Ø A $0.9 million pre-tax payment made as an inducement to the holders of our Notes for early conversion into our common stock. 66 -------------------------------------------------------------------------------- Table of Contents 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 and technologies that are not recorded on our Consolidated Balance Sheets. Typically, we are obligated to make minimum commitment royalty payments over the term of our licenses and to advance payment against those commitments. Our obligations under these arrangements and under other contractual obligations at June 30, 2011, were as follows (in millions): Less More than 1-3 3-5 than Contractual Obligations Total 1 Year Years Years 5 Years Operating leases $ 17.4 $ 4.6 $ 7.8 $ 5.0 $ - Royalty and license fee payments 89.3 17.6 34.5 29.9 7.3 Accrued WAP jackpot liability 8.6 8.6 - - - Non-cancelable raw material purchase orders 6.2 6.2 - - - Performance bonds 5.3 5.3 - - - Other, including guaranteed minimums in employment agreements 28.5 15.0 9.2 1.8 2.5 Total $ 155.3 $ 57.3 $ 51.5 $ 36.7 $ 9.8 The total potential royalty and license fee commitments decreased to $89.3 million at June 30, 2011 from $97.6 million at June 30, 2010, due to advances and payments made on existing commitments exceeding new agreements we entered into for brand and technology licenses. Potential royalty and license fee commitments could increase in the future as we enter into new intellectual property, technology or brand licensing agreements. See Note 14. "Commitments, Contingencies and Indemnifications" to our Consolidated Financial Statements. Non-cancelable raw material purchase orders increased to $6.2 million as of June 30, 2011 from $3.5 million as of June 30, 2010 due to timing of future raw material deliveries. We have performance bonds outstanding of $5.3 million at June 30, 2011, related to product sales, and we are liable to the issuer in the event of exercise due to our non-performance under the contract. Events of non-performance do not include the financial performance of our products. As of June 30, 2011, we had a liability for unrecognized income tax benefits of $4.7 million. We cannot make a reasonable estimate of the period of cash settlement for the liability for uncertain income taxes. See Note 10. "Income Taxes" to our Consolidated Financial Statements. Indemnifications, Special Purpose Entities and Derivative Instruments, Letters of Credit, WMS Licensor Arrangements, Self-Insurance and Product Warranty See Note 14. "Commitments, Contingencies and Indemnifications" to our Consolidated Financial Statements. [ Back To TMCnet.com's Homepage ]