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WMS INDUSTRIES INC /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(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 in our Annual
Report on Form 10-K filed with the SEC on August 21, 2012 ("Form 10-K"). This
discussion and analysis also contains forward-looking statements and should also
be read in conjunction with the disclosures and information contained in
"Cautionary Note" and Item 1A. "Risk Factors" in our Form 10-K and our more
recent reports filed with the U.S. Securities and Exchange Commission. The
following discussion and analysis is intended to enhance the reader's
understanding of our business environment, financial condition and results of
operations.
As used in this Report, the terms "we", "us", "our", and "WMS" mean WMS
Industries Inc., a Delaware corporation, and its subsidiaries. All references to
years, unless otherwise noted, refer to our fiscal year, which ends on June 30.
All references to quarters, unless otherwise noted, refer to the quarters of our
fiscal year.
Product names mentioned in this Report are trademarks of WMS Gaming Inc., except
for the following marks: Facebook is a registered trademark of Facebook, Inc.;
G2S and S2S are trademarks of the Gaming Standards Association.
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 interactive gaming
("iGaming") products and services include development and marketing of digital
content, products, services and end-to-end solutions that address global online
wagering and play-for-fun social, casual and mobile gaming opportunities. We are
also addressing the next stage of casino gaming floor evolution with our
WAGE-NET® networked gaming solution, a suite of systems technologies and
applications designed to increase customers' revenue generating capabilities and
operational efficiencies. Our gaming machine products are installed in all of
the major regulated gaming jurisdictions in the United States, as well as in
approximately 143 international gaming jurisdictions.
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 and 2012, although demand in fiscal 2012 abated in Mexico and Australia due
to unique circumstances in each market. 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,
the Ultra Hit Progressive® ("UHP") family, and the first game in the UHP family,
Jackpot Explosion®, and since then we have received additional approvals for
these products and other networked gaming products in other gaming
jurisdictions. In fiscal 2012, we expanded our interactive gaming products and
services with the launch of our first social game on Facebook and the sale of
select WMS games for mobile devices and PC's and in July 2012, we grouped
together all of our worldwide online wagering, social, casual and mobile gaming
products and services in order to focus on their revenue growth, development and
market efficiencies and to optimize the benefits of interactive gaming products
and services for casino operators and their players. Also, in July 2012 we
launched a second social game on Facebook titled Jackpot Party®Social Casino. We
expect to facilitate the continued expansion, investment, evolution and
extension of our interactive products and services and increase our focus on
this rapidly evolving growth area. In fiscal 2013, we expect to further
penetrate each of the new markets and distribution channels we have entered over
the last few years and look to further expand our distribution channels.
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The recession and financial market crisis that began in 2008 has continued to
disrupt the economy worldwide, reduced consumer discretionary spending and has
led to a weakened global economic environment, all of which have been
significant challenges for our industry. In calendar 2008 and 2009, some gaming
operators delayed or canceled construction projects, resulting in fewer new
casino openings and expansions in fiscal 2010 and 2011, coupled with many
customers reducing their annual capital budgets for replacing gaming machines.
New unit demand for new casino openings and casino expansion increased in fiscal
2012; however, we expect demand for new casino openings and expansions to
decrease in fiscal 2013. The economic crisis reduced disposable income for
casino patrons and resulted in fewer patrons visiting casinos and lower spending
by those patrons who did visit casinos. The economic crisis, the operational
challenges that lead to the review of our product plans and business strategies
at the end of fiscal 2011 and beginning of fiscal 2012 and increased competition
from our competitors lowered the number of new units we shipped over the last
three fiscal years, resulting in lower revenues in fiscal 2012 than in fiscal
2011 and 2010.
In late fiscal 2011 and early fiscal 2012, with no leading indicators showing
any significant increase in replacement demand, we conducted a thorough review
of our business strategies and product plans. As a result of the strategic
review, we announced that we would refine our product plans and restructure our
organization to sharpen emphasis on our game content and product development
strengths. Specifically, we have streamlined our product management and product
development functions, simplified product plans and further prioritized on-time
commercialization of new game themes, products and portal gaming applications.
As part of our restructuring, we implemented a 10% reduction in our workforce.
As part of the plan, in the three months ended September 30, 2011, we recorded
$14.0 million of pre-tax impairment and restructuring charges, or $0.17 per
diluted share, which includes $9.7 million, or $0.12 per diluted share, of
pre-tax impairment and restructuring charges including $5.9 million of
separation-related charges and $3.8 million of costs related to the decision to
close two facilities, and $4.3 million pre-tax, or $0.05 per diluted share, of
non-cash charges to write-down receivables following government enforcement
actions at certain casinos in Mexico. In the June 2012 quarter, this write-down
of receivables was reduced by $0.7 million, or $0.01 per diluted share, due to
improvements in the situation. This situation has been very dynamic and while
government actions continue to diminish, we continue to closely monitor the
situation.
We had expected that with our launch of the network gaming-enabled Bluebird®2
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. In the March 2012 quarter, we
launched our new Bluebird2e gaming machine as an upgrade to our Bluebird2 gaming
machines. The Bluebird2e gaming machines contain the emotive lighting feature
that we launched with the Bluebird xD cabinet. We expect to launch our new
upright cabinet, Blade™, for product sales and new participation cabinet,
Gamefield xD™, in the March 2013 quarter and both will utilize our
next-generation CPU-NXT®3 operating system platform. We believe that as the
economy improves and gaming operators see meaningful improvements in their
profitability and cash flows, they will increase their annual capital budgets
for replacement units, which will improve the replacement demand in future
years, although we cannot predict when this will occur or the rate of increase
in their capital budgets.
We believe several recent developments fueled by the challenging economic
situation could expand our revenue opportunities over the long term. In the
United States, legislators have passed or are considering enabling new or
expanded gaming legislation in Ohio, Illinois, Kansas, Iowa, Maryland,
California, New Hampshire, New York, Florida, Maine and Massachusetts.
Internationally, Singapore opened as a new market in fiscal 2010. In addition,
legislation has been passed or discussed in Greece, Brazil, Japan and Taiwan
that could open new market opportunities. In the United States, the States of
Nevada and Delaware have adopted legislation to legalize certain forms of online
gaming and federal legislators and certain other state legislators and
governments in Canada and Europe have legalized or are considering legalizing
certain forms of online gaming, which if passed could expand our revenue
opportunities. The breadth and timing of these opportunities remain uncertain
due to the political process in each of these jurisdictions, as well as the
difficult credit environment facing our customers and the risk of continued
economic uncertainty.
We review certain financial measures in assessing our financial condition and
operating performance not only in connection with creating our forecasts and in
making comparisons to financial results from prior periods, but also in making
comparisons to our competitors' financial results and our internal plans. We
focus on fluctuations in revenue, number of new units sold, average selling
price, average participation installed base and average revenue per day, cost on
both products sales and gaming operations and also pay close attention to our
operating income, operating margin, net income, diluted earnings per share,
total cash, total accounts and notes receivable, inventories and accounts
payable and cash flows provided by or used in operating activities, investing
activities and financing activities, as they are key indicators of our
performance. We also measure changes in selling and administrative expenses as a
percent of revenue, which indicate management's ability to control costs, as
well as research and development costs as a percent of revenue, which
demonstrate investment in technology and product development. Finally, we
measure depreciation and amortization expense as a percentage of revenues as an
indicator of the current cost of capital expenditures, primarily in gaming
operations.
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The measures listed above are not a comprehensive list of all factors considered
by us in assessing our financial condition and operating performance, and we may
consider other individual measures as required by trends and discrete events
arising in a specific period, but they are the key indicators and these measures
are discussed herein.
The priorities for the utilization of our cash flow are to: continue to enhance
stockholder value by emphasizing internal and external investments to create and
license advanced technologies and intellectual property; seek acquisitions or
licensing deals that can extend our presence and product lines, increase our
distribution channels, enhance our intellectual property portfolio and expand
our earnings potential; and, when appropriate, repurchase shares in the open
market or in privately negotiated transactions. For the three months ended
September 30, 2012, our research and development spending increased $3.2 million
compared to the prior year and we spent $20.3 million on property, plant and
equipment and $25.6 million on additions to gaming operations equipment, and we
funded approximately $5.0 million of common stock repurchases. We also borrowed
on our credit facility and had $85.0 million long-term debt outstanding at
September 30, 2012.
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
2010, we closed our Orion Financement Company ("Orion Gaming") manufacturing
facility and, in June 2011, we sold this facility and began winding down the
manufacturing of our Orion Gaming product lines, which occurred over fiscal
2012. We will continue to provide support for spare parts related to Orion
Gaming product lines for several years. In July 2011, we sold our Systems In
Progress GmbH subsidiary ("SiP"). These two subsidiaries were immaterial to our
Condensed Consolidated Financial Statements. 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 we 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,
Bluebird2e and Bluebird xD branded gaming machines;
Ø Mechanical reel-spinning gaming machines in our Bluebird, Bluebird2,
Bluebird2e and Bluebird xD branded gaming machines;
Ø Replacement parts and game theme conversion kits for our Bluebird, Bluebird2, Bluebird2e, Bluebird xD, Twinstar™, Twinstar2, Helios™ and
CPU-NXT and CPU-NXT2 operating system upgrade kits; and
Ø Used gaming machines manufactured by us or our competitors that are
acquired on a trade-in basis or that we previously leased to casinos as
participation gaming machines.
In early October 2012 at our industry's largest trade show, we demonstrated our
new Blade cabinet that we expect to begin shipping in the March 2013 quarter.
Customers may delay purchases of our existing cabinets until the Blade cabinet
is approved in their jurisdiction and we may also experience lower average
selling prices of our existing cabinets due to higher discounts off of the list
price.
Gaming Operations
We earn revenues from leasing gaming machines and VLTs to casinos and other
licensed gaming machine operators under operating leases; operating an online
gaming site, offering social games on Facebook, offering our games on
third-party online gaming platforms that are interoperable with our game
servers; selling select WMS games that have been ported to operate on mobile
devices and PC's; we earn revenues from placing our networked gaming system and
applications, which is a system that links groups of networked-enabled gaming
machines to a server in the casino data center; and earn royalties that we
receive from third parties under license agreements to use our game content and
intellectual property.
Our gaming operations include the following product lines:
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;
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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 beginning in fiscal 2012 revenues from our
Lucky Cruise™ social game on Facebook and in July 2012, our Jackpot Party
Social Casino on Facebook, revenues from the sale of select WMS games that
have been ported to operate on mobile devices, revenues from the retail
sales of CD's containing WMS games or direct downloads of WMS games from
internet distributors and revenues when an online player uses a WMS or
Jadestone game on one of our customers' online gaming sites; and
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.
Networked Gaming
We believe that server-enabled networked gaming ("NG") will be a significant
technology deployed 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 require regulatory approval in gaming jurisdictions prior
to any implementation. 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. In the June 2011 quarter, we received the
first regulatory approval for our WAGE-NET networked gaming system, the first
family of portal applications, the UHP family, and the first game in the UHP
family, the Jackpot Explosion theme, and since then we have received additional
approvals for these products and other networked gaming products in other gaming
jurisdictions. Once the NG system is in place in a casino, we also are able to
offer our customers a subscription pricing plan to have access to a library of
our game content. At September 30, 2012, we had approximately 2,000 networked
gaming machines functioning, primarily on a non-trial basis, at approximately
100 casino properties globally.
In June 2011, we began earning revenues from networked gaming applications after
installing the commercialized version of the NG software. Our vision for
networked gaming expands on the basic functionality of downloadable games,
remote configuration of betting denominations and central determination of game
outcomes, and emphasizes enhanced game play and excitement for the player. Since
these first approvals, we have subsequently received approvals on the second
theme in the Ultra Hit Progressive family, Piggy Bankin'®, the first theme in
the second portal family, Winner's Share®, titled Peng-Wins ® and the first
theme in the third portal family, Mega Multiplier ®, titled Super Shot™. Nevada
regulators approved the commercialized 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. Accordingly, 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 and we have subsequently received
approval for other slot accounting systems in Nevada and no additional
interoperability approvals are required. Additionally, we also have developed
and are implementing bank-wide NG solutions for certain customers.
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
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operating system and platform, which is also the basis for our server-enabled
Bluebird2, Bluebird xD and Bluebird2e gaming machines, Sensory Immersion gaming,
Transmissive Reels® technology gaming, Adaptive Gaming® technology, and progress
on interoperability of our WAGE-NET system and Bluebird2 and Bluebird2e 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®.
OUR FOCUS
We continue to operate in a challenging economic environment and the combination
of economic uncertainty, lower demand for replacement products and reduced
opportunities from new or expanded casinos has negatively impacted our industry.
We expect to benefit from certain new and expansion projects currently in
process in calendar 2012, but the breadth and timing of such opportunities
remains uncertain due to the difficult credit environment facing our customers
and the risk of continued economic uncertainty.
As we navigate these macroeconomic challenges, we focused on four key strategic
priorities: 1) Continue to grow our installed participation product base and
improve our daily average revenue; 2) Garner increased ship share in our global
product sales by leveraging our product development expertise and developing
differentiated, high-earning games, game content and products for our customers
worldwide; 3) Drive margin improvements; and 4) Invest in the establishment,
development and operation of our interactive gaming products and services:
1. Strategic Priority: Continue to grow our installed participation product
base and improve our daily average revenue:
Quarter Ended September 30, 2012, Result: During the quarter ended September 30,
2012, our average installed base of participation gaming machines decreased 1.0%
over the quarter ended September 30, 2011 and, at September 30, 2012, our total
installed participation footprint stood at 9,632 units compared to 9,592 units
at September 30, 2011. Our average revenue per day declined 9.0% in the
September 2012 quarter from the September 2011 quarter to $65.23. Our focus in
fiscal 2013 is to increase the percentage of the installed base that are coin-in
gaming machines as they generate the highest profit of our three lease models
and to convert a portion of our installed base from Bluebird gaming machines to
Bluebird2, Bluebird xD and our new Gamefield xD gaming machines. The percentage
of coin-in gaming machines in our installed base was 37.7% of the installed base
at September 30, 2012, consistent with the percentage of the installed base at
September 30, 2011. We have successfully converted approximately 70% of the
participation installed base to Bluebird2 and Bluebird xD gaming machines,
although this required a higher capital investment over the last two years. We
invested $25.6 million in gaming operations capital in the three months ended
September 30, 2012 and $22.1 million in three months ended September 30, 2011.
We expect that the amount of capital invested in gaming operations will decline
modestly for the next two years as a lower amount of capital spent on our
participation gaming machines will be partially offset by increased capital
spent on gaming machines for operating leases as we expect a portion of the new
VLT market in Illinois will be conducted through operating leases. In fiscal
2011 and the first half of fiscal 2012, we experienced delays in launching new
products due to the new technologies we were imbedding in our participation
products and as a result of not having as many new participation game themes
approved, some of our older game theme performance lagged resulting in a higher
level of removals of participation gaming machines, which caused a reduction in
the installed base. We expect that with an anticipated increase in participation
game themes that our installed base will grow in fiscal 2013 and 2014.
2. Strategic Priority: Garner increased ship share in our global product
sales by leveraging our product development expertise and developing
differentiated, high-earning games, game content and products for our
customers worldwide.
Quarter Ended September 30, 2012, Result: The replacement cycle for gaming
machines has been abnormally low for several years and the challenges facing our
industry and the overall global economy have continued, all of which have
reduced overall industry demand for gaming machines from previous levels. We
believe capital budgets for replacing gaming machines were relatively flat for
calendar 2010 and 2011 and increased modestly in 2012. We believe demand from
new casino openings and casino expansions declined from fiscal 2010 to fiscal
2011 but grew in fiscal 2012. We expect new unit demand from new casino openings
and expansions to be lower in fiscal 2013 than in fiscal 2012 but that
replacement demand will increase due to the Canadian provincial lotteries
beginning to replace their existing VLTs and the opening of the new VLT market
in Illinois. The average selling price on a VLT is lower than a Class III gaming
machine.
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In this challenging environment, our September 2012 new unit shipments on which
we recognized revenue were down 3.2% from the prior-year period. International
new unit shipments accounted for 35.3% of global shipments in the September 2012
quarter, about flat with the September 2011 quarter. Overall, international new
unit shipments increased in fiscal 2011 but shrank in fiscal 2012, as in fiscal
2011 the growth in Mexico and New South Wales, Australia and Singapore coupled
with modest growth in Asia and Latin America, more than offset lower shipments
to Europe, which remains impacted by the challenging economic environment. In
fiscal 2012, demand from Mexico and New South Wales, Australia abated due to
unique circumstances in each country and demand from Europe continued to be
lower. Demand from Mexican customers was lower following government enforcement
actions at certain casinos in Mexico that began in the September 2011 quarter
and demand from Australian customers was lower as they await enablement of new
national versus state gaming standards. Revenues from customers in Argentina
were lower in the September 2012 quarter as government authorities modified
rules related to importing product. We expect international demand in fiscal
2013 to be flat with fiscal 2012. Also, we believe the higher-priced Bluebird2,
Bluebird xD and Bluebird2e units had an impact on the unit volume customers were
able to buy with fixed capital budgets. We are still preparing to launch our
products in the new VLT market in Italy in the future. Although much effort is
still needed before the first revenue-earning WMS gaming machines are placed in
Italy, we will have additional development work to complete as a result of new
requirements that the regulator has mandated in Italy that will be effective
after a transition period. In addition, we continue to achieve benefits from the
opening of new international offices and the addition of new geographically
dispersed sales account executives.
To further diversify our revenue streams, we directly entered the Class II and
central determinant market in fiscal 2010 following expiration of our previous
licensing agreements for those markets. Through agreements with Bluberi, a
Canadian-based technology firm, over time we expect to combine our existing
library of for-sale games with the proven system capabilities that we acquired
from Bluberi for the Class II and central determinant markets. We shipped our
first gaming machines to a Class II market in the September 2009 quarter, and we
have continued to penetrate this market in subsequent quarters. We recently
received approval of a CPU-NXT2-based operating system on our Bluebird2 cabinet
for the Class II markets and shipped our first gaming machines operating on this
new system in the June 2012 quarter. We expect that shipments to these markets
in fiscal 2013 and 2014 will exceed shipments in fiscal 2012.
We launched our Bluebird xD gaming machine late in the June 2010 quarter and,
given customer response, we achieved strong demand for this product throughout
fiscal 2012 and 2011. For the three months ended September 30, 2012, Bluebird xD
gaming machines accounted for 31.5% of our global new unit sales which compares
to 32.1% in the three months ended September 30, 2011. We launched an enhanced
version of our Bluebird2 product, the Bluebird2e cabinet with an emotive
lighting feature in the March 2012 quarter. During September 2012 quarter, the
majority of the global Bluebird2 product line new unit sales were Bluebird2e
units and we would expect this to also occur in future periods.
We are dependent, in part, on innovative new products, casino openings and
expansions, continued market penetration and new market opportunities to
generate growth. We have continued to invest in research and development
activities to be able to offer creative and high earning products to our
customers and in the three months ended September 30, 2012, such expenses
totaled 17.4% of revenues or $27.6 million compared to 15.7% or $24.4 million in
the prior-year period. 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.
3. Strategic Priority: Drive Margin Improvements.
Quarter Ended September 30, 2012, Result: Our operating margin increased 570
basis points to 7.9% for the quarter ended September 30, 2012, from 2.2% for the
prior-year period, as the prior year period included $9.7 million of impairment
and restructuring charges and $4.3 million of additional bad debt expense
related to Mexican customer receivables.
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Our research and development costs increased as a percentage of revenues to
17.4% in the quarter ended September 30, 2012 from 15.7% of revenues in the
quarter ended September 30, 2011 and in total increased $3.2 million, or 13.1%,
over the prior year period. The increase is primarily caused by higher
development costs to re-engineer and re-purpose our library of slot gaming
content for distribution as our interactive products and services, along with an
increase in spending for our innovative new casino gaming products. Our selling
and administrative expenses decreased as a percentage of revenue to 21.6% in the
quarter ended September 30, 2012 from 24.6% of revenues in the quarter ended
September 30, 2011 and in total decreased by $3.9 million, or 10.2%, over the
prior year as the prior year included $4.3 million of charges we recorded to
write-down receivables following government enforcement actions at certain
casinos in Mexico, partially offset by ongoing expense containment discipline.
Our depreciation and amortization expense increased as a percentage of revenue
to 17.6% in the quarter ended September 30, 2012 from 14.5% of revenues in the
quarter ended September 30, 2011 and increased $5.4 million, or 23.9%, over the
prior year due to the higher level of capital spent in fiscal 2011 and 2012 to
upgrade the installed base of our participation gaming machines to new Bluebird2
and Bluebird xD gaming machines, depreciation on a new facility that was placed
in service in August 2012 and from amortization of finite-lived intangible
assets from our two acquisitions in the June 2012 quarter. By continuing to
drive margin improvements, we believe we will be able to increase net income and
generate the necessary capital to fund the other elements of our business
strategy.
We are still 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 through disciplined cost
management, especially with the Bluebird xD and new Bluebird2e product line,
where we expect to improve margins to be comparable to our Bluebird2 product
line. Longer term, we expect to benefit from 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 the cost per unit. We also expect our gaming operations
will continue to expand with both the installed base and revenue per day
increasing in fiscal 2013.
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 operating margins. In fiscal 2013 and 2014, we expect to
significantly increase our spending to grow our interactive products and
services and also increase spending to accelerate product innovation efforts and
as a result research and development expenses are expected to increase to 15% to
16% of revenues. We expect selling and administrative expenses to grow modestly
as a percentage of revenues in fiscal 2013 and 2014 primarily due to increased
spending to grow our interactive products and services and as we grow and
support our increased overall revenues. Due to higher capital spending in our
gaming operations over the past two years and the completion of two major
property, plant and equipment projects in early fiscal 2013, we expect that
depreciation and amortization expense will increase as a percentage of revenues
in fiscal 2013 and 2014 in comparison to fiscal 2012.
4. Strategic Priority: Invest in the establishment, development and operation
of our interactive gaming products and services.
Quarter Ended September 30, 2012, Result: In the December 2010 quarter, we
launched a business-to-consumer, online casino website for residents in the
United Kingdom, although we did not begin to market the site until February
2011. Our Jackpotparty.com online casino offers a variety of our popular slot
games and certain card and table games. The success of our gaming content,
technology foundation and iGaming capabilities allows us to provide online
capabilities to consumers in other jurisdictions. In the United States, the
States of Nevada and Delaware have adopted legislation to legalize certain forms
of online gaming and federal legislators and certain other state legislators and
governments in Canada and Europe have legalized or are considering legalizing
certain forms of online gaming, which, if passed, could expand our revenue
opportunities depending on the type of online gaming approved. 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. In fiscal 2012, we
began earning revenues from our Lucky Cruise social game on Facebook and
revenues from the sale of select WMS games that have been ported to operate on
mobile devices and PC's. We further expanded our online, social, casual and
mobile gaming presence through the acquisitions of Jadestone and Phantom for
$33.6 million in late fiscal 2012. We paid $16.4 million at closing, $0.5
million in the September 2012 quarter and have additional consideration of a
maximum of $16.7 million in the future for both acquisitions. These acquisitions
individually and in the aggregate were not material to our Condensed
Consolidated Financial Statements. Additionally, in fiscal 2012 we entered into
an agreement to provide an end-to-end business-to-business ("B2B") online casino
site in Belgium in collaboration with Groupe Partouche and early fiscal 2013 we
created a strategic alliance with Dragonfish, the independent B2B division of
888 Holdings plc, that expands our B2B online product offering in the United
States with one of the world's leading online poker solutions. In July 2012, we
launched Jackpot
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Party Social Casino on Facebook, which enhanced our revenue earning
opportunities. We will focus on the revenue growth, development and market
efficiencies of our worldwide online, social, casual and mobile gaming products
and services to optimize the benefits of iGaming for casino operators and their
players.
Common Stock Repurchase Program
See Note 10. "Stockholders' Equity and Equity Compensation Plan - Common Stock
Repurchase Program" to our Condensed Consolidated Financial Statements and Notes
thereto included in this report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
For a description of our critical accounting policies and estimates, see Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the fiscal year ended June 30,
2012, and Note 2. "Principal Accounting Policies - Revenue Recognition" to the
Consolidated Financial Statements included in that report. We have not made any
changes in critical accounting policies and estimates during the three months
ended September 30, 2012.
RESULTS OF OPERATIONS
Recent Developments
In late October 2012, Hurricane Sandy struck New Jersey, New York, Connecticut
and several other east coast states causing substantial damage and power outages
to the areas. While within a week our customers re-opened their casinos, we
currently expect the aftermath of Hurricane Sandy to reduce casino visitation in
Atlantic City and other affected casinos, which may negatively impact demand for
new gaming machines and the revenue per day for our gaming operations for future
months.
Seasonality
See Note 1. "Basis of Presentation and Business Overview" to the Condensed
Consolidated Financial Statements and Notes thereto included in this report.
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.
Impairment, Restructuring and Other Charges
Given the continuing lower levels of capital spending by casinos over the last
three years and with no leading indicators suggesting 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 is intact but, as a result of this review, we
refined our product plans and restructured our organization. Specifically, we
streamlined our product management and product development functions, simplified
our product plans and further prioritized on-time commercialization of new game
themes, products and portal applications.
In addition, we implemented a broader impairment analysis and restructuring and
recorded additional charges in the September 2011 quarter amounting to $14.0
million pre-tax, or $0.17 per diluted share. These product plan realignment and
restructuring actions are expected to better direct resources and focus on
near-term revenue opportunities and reduced our overall organizational staffing
by approximately 10% to a level that better correlates with the current
operating environment, while maintaining our ability to create great games that
engage current players and attract new players.
The following table summarizes the detail of the charges recorded in the three
months ended September 30, 2011 (in millions, except per diluted share amounts):
Three Months Ended
September 30, 2011
Per
Pre-tax diluted
DESCRIPTION OF CHARGES amounts share IMPAIRMENT AND RESTRUCTURING CHARGES
Non-cash Charges
Impairment of property, plant and equipment $ 0.6 $ 0.01
Cash Charges
Restructuring charges, primarily separation charges 9.1 0.11
Total Impairment and Restructuring Charges 9.7 0.12
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Three Months Ended
September 30, 2011
Per
Pre-tax diluted
DESCRIPTION OF CHARGES amounts shareOTHER CHARGES
Non-cash charges to write-down Mexican customer receivables
(recorded in selling and administrative expenses)
4.3 0.05
TOTAL IMPAIRMENT, RESTRUCTURING AND OTHERCHARGES $ 14.0 $ 0.17
The three month period ended September 30, 2011, includes $14.0 million of
pre-tax charges, or $0.17 per diluted share, which includes $9.7 million, or
$0.12 per diluted share, of pre-tax impairment and restructuring charges
including $5.9 million of separation-related charges and $3.8 million of costs
related to the decision to close two facilities, and $4.3 million pre-tax, or
$0.05 per diluted share, of non-cash charges to write-down receivables following
government enforcement actions at certain casinos in Mexico, which was partially
offset by a $0.7 million, or $0.01 per diluted share, pre-tax reduction in the
reserve for bad debts related to government enforcement actions at certain
casinos in Mexico in the three month period ended June 30, 2012.
Three Months Ended September 30, 2012 compared to Three Months Ended
September 30, 2011
Below are our Revenues and Operating Margins and Key Performance Indicators for
the three months ended September 30, 2012 and 2011. This information should be
read in conjunction with the Condensed Consolidated Statements of Income
included in this report (in millions, except unit and per share data):
Three months ended Favorable
September 30, (Unfavorable)
2012 2011 2012 vs. 2011
Variance
Dollar %
Product Sales Revenues:
New gaming machine sales revenues $ 60.8 $ 64.9 $ (4.1 ) (6.3 )
Other product sales revenues 27.2 22.2 5.0 22.5
Total product sales revenues $ 88.0 $ 87.1 $ 0.9 1.0
Average sales price per new unit $ 16,033 $ 16,574 $ (541 ) (3.3 )
New units sold to the U.S. and Canada 2,453 2,530 (77 ) (3.0 )
New units sold to International markets 1,338 1,388 (50 ) (3.6 )
Total new units on which revenue was recognized 3,791 3,918
(127 ) (3.2 )
Used units sold globally 1,660 2,472 (812 ) (32.8 )
Total units sold globally 5,451 6,390 (939 ) (14.7 )
Conversion kits sold globally 2,400 5,500 (3,100 ) (56.4 )
Gaming Operations Revenues:
Participation revenues $ 57.0 $ 63.3 $ (6.3 ) (10.0 )
Interactive products and services revenues 9.5 0.7 8.8 nm
Other gaming operations revenues 4.6 4.5 0.1 2.2
Total gaming operations revenues $ 71.1 $ 68.5 $ 2.6 3.8
Installed Participation Base at Period End with
Lease Payments based on:
Percentage of coin-in 3,633 3,616 17 0.5
Percentage of net win 2,857 2,952 (95 ) (3.2 )
Daily lease rate(1) 3,142 3,024 118 3.9
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Three months ended Favorable
September 30, (Unfavorable)
2012 2011 2012 vs. 2011
Variance
Dollar %Total Installed Participation Base at Period End 9,632 9,592
40 0.4
Average installed participation units 9,503 9,602 (99 ) (1.0 )
Average revenue per day per participation unit $ 65.23 $ 71.70 $ (6.47 ) (9.0 )
Total revenues $ 159.1 $ 155.6 $ 3.5 2.2
Total operating income $ 12.6 $ 3.5 $ 9.1 260.0
Total operating margin 7.9 % 2.2 % 570bp 259.1
Net income $ 9.3 $ 3.8 $ 5.5 144.7
Earnings Per Share:
Basic $ 0.17 $ 0.07 $ 0.10 142.9
Diluted $ 0.17 $ 0.07 $ 0.10 142.9
bp basis points
(1) Includes only participation game theme units with fixed daily lease rates.
Does not include units with product sales game themes placed under
fixed-term, daily fee operating leases
Revenues
Total revenues for quarter ended September 30, 2012, increased 2.2% or $3.5
million, compared to the September 30, 2011 quarter, reflecting:
Ø A $4.1 million, or 6.3%, decrease in new unit sales revenue as a result of:
Ø A 127 unit, or 3.2%, decrease in new units sold as:
Ø New units sold in the United States and Canada totaled2,453 units,
a decrease of 3.0%, in the September 2012 quarter.Replacement
units shipped to U.S. and Canadian customers increased 7.9% over
the prior-year period to 1,726 units, while new gaming machine
sales for new casino openings and expansions totaled 727 units
compared to approximately 900 units in the September 2011 quarter.
Sales of Bluebird xD units accounted for 31.5% of new units sold in
the September 2012 quarter and 32.1% of new units sold in the
September 2011 quarter.
Ø International new units sold decreased 3.6% from the prior year to
1,338 units, and represented 35.3% of global shipments which was
about the same percentage as in the prior period reflecting
continued low demand in Europe, decreased industry demand in Mexico
because of government enforcement actions that began inAugust 2011
against certain casinos, lower demand in New South Wales, Australia
as operators await implementation of new national gaming standards
and lower revenues in Argentina as government authorities modified
rules related to importing product.
Ø A 3.3% decrease in the average selling price of new gaming machines to
$16,033, principally reflecting a higher mix of lower-priced video
lottery terminals, coupled with the impact of the competitive
marketplace.
Ø A $5.0 million, or 22.5%, increase in other product sales revenues,
reflecting an increase in used game revenues, part sales revenues and
other revenues, including one-time VLT software game set revenues,
partially offset by a decrease in lower conversion kit revenue as:
Ø We earned revenue on approximately 2,400 conversion kits in the
September 2012 quarter, compared to approximately 5,500 conversion
kits in the prior-year period; and
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Ø We sold 1,660 used gaming machines at a higher average price during
the September 2012 quarter, compared to 2,472 used gamingmachines in
the prior-year period. The average sales price of used gaming machines
increased in the September 2012 quarter principally reflecting sales
of Bluebird2 units which are just beginning to enter the used market
and have a higher market value than older used product.
Ø Participation revenues were down $6.3 million, or 10.0%, due primarily to:
Ø A 1.0% decrease, or 99 units, in the average installed base of
participation gaming machines in the September 2012 quarter driven by
the decline in performance of our installed base of gamingmachines as
certain older game series reached their end of life and we did not
have new game themes approved to replace those older games, which has
recently eased. We were able to increase the installed base by
September 30, 2012, up 40 units from September 30, 2011. The
percentage of coin-in units in the installed base at September 30,
2012, was 37.7% which was flat compared to September 30, 2011. As of
September 30, 2012, the percentage of net win units in theinstalled
base decreased by 3.2%, and the daily lease rate units increased by
3.9% from September 30, 2011; and
Ø Overall average revenue per day decreased by $6.47, or 9.0%,
principally reflecting lower average revenue per day in ourpercentage
of coin-in gaming machines.
Ø An $8.8 million increase in interactive products and services revenue,
primarily reflecting the July 2012 launch of our Jackpot Party Social
Casino on Facebook and continued growth in the UK online gaming revenues.
Ø A $0.1 million, or 2.2%, increase in other gaming operations revenue,
primarily reflecting higher royalty revenues from licensing proprietary
intellectual property and technologies and incremental revenue from
networked gaming solutions, partially offset by lower operating lease
revenue.
We expect to generate modest revenue growth in fiscal 2013 and fiscal 2014 as we
increase our global market penetration due to the popularity of our products,
launch new products and gaming cabinets, expand market distribution
opportunities, grow our participation installed base through the introduction of
new and innovative participation games and increase revenues from our
interactive gaming and networked gaming operations. Likewise in fiscal 2013 and
2014, we expect modest improvements in lowering the cost of our gaming machines
resulting from 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 ongoing efforts to level the production schedule
throughout each quarter, which will be partially offset by the impact of higher
VLT sales which have a lower average selling price than our Class III gaming
machines.
Cost of product sales was $41.3 million, or 46.9% of product sales revenues, for
the September 2012 quarter, compared to $42.8 million, or 49.1% of product sales
revenues, for the prior-year period. The September 2012 quarter reflects:
progress on lowering the cost of product and the mix of business, coupled with
lower costs due to a decrease in new gaming machines sold, partially offset by
the additional cost of a one-time VLT software game set.
Cost of gaming operations was $15.2 million, or 21.4% of gaming operations
revenues, for the September 2012 quarter, compared to $14.3 million, or 20.9% of
gaming operations revenues for the prior-year period. The September 2012 quarter
primarily reflects the additional costs associated with interactive products and
services, partially offset by the favorable WAP jackpot experience in the
quarter.
Our cost of product sales and cost of gaming operations may not be comparable to
other companies as they exclude the following amounts of depreciation and
amortization, which are included in the depreciation and amortization line item,
and distribution expenses included in the selling and administration line item
(in millions of dollars):
Three Months
Ended Increase/
September 30, (Decrease)
2012 2011 Dollar Percent Depreciation and amortization
Cost of Product Sales $ 2.0 $ 1.4 $ 0.6 42.9 %
Cost of Gaming Operations 17.6 14.1 3.5 24.8
Distribution expenses 6.1 5.8 0.3 5.2
Operating Expenses
Operating expenses were as follows (in millions of dollars):
Three Months Ended September 30, Increase /
2012 2011 (Decrease)
As % of As % of
Dollar Revenue Dollar Revenue Dollar Percent
Research and development $ 27.6 17.4 % $ 24.4 15.7 % $ 3.2 13.1 %
Selling and administrative 34.4 21.6 38.3 24.6 (3.9 ) (10.2 )
Impairment and restructuring charges 0.0 0.0 9.7 6.2 (9.7 ) nm
Depreciation and amortization 28.0 17.6 22.6 14.5 5.4 23.9
Total operating expenses $ 90.0 56.6 % $ 95.0 61.0 % $ (5.0 ) (5.3 )%
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Research and development expenses increased 13.1% to $27.6 million in the
September 2012 quarter, compared to $24.4 million in the prior-year period. The
year-over-year increase reflects:
Ø Higher development costs for our planned expanded product development
initiatives for the continued creation of intellectual property and the
ongoing expansion of our product portfolio; and
Ø Increase in spending for our interactive products and services; partially
offset by
Ø Decreased payroll-related costs associated with headcount decreases
resulting from the restructuring we announced in August 2011 coupled with
cost containment measures on non-payroll related costs.
Selling and administrative expenses decreased 10.2%, or $3.9 million, to $34.4
million in the September 2012 quarter, compared to $38.3 million in the
prior-year period while decreasing by 300 basis points as a percentage of
revenues to 21.6%. The year-over-year decrease reflects:
Ø $4.3 million of non-cash charges recorded in the September 2011 quarter to
write-down receivables following government enforcement actions at certain
casinos in Mexico; and
Ø Decreased payroll-related costs associated with headcount decreases
resulting from the restructuring we announced in August 2011, coupled with
cost containment measures on non-payroll related costs; partially offset
by
Ø Incremental costs for our networked gaming and interactive gaming operations.
The September 2011 quarter results include $9.7 million, or $0.12 per diluted
share, of pre-tax impairment and restructuring charges including $5.9 million of
separation-related charges and $3.8 million of costs related to the decision to
close two facilities.
Depreciation and amortization expense increased by $5.4 million, or 23.9%, to
$28.0 million in the September 2012 quarter, compared to $22.6 million in the
prior-year period. The increase in depreciation and amortization expense
reflects increased capital spending on gaming operations equipment throughout
fiscal 2011 and 2012 and the September 2012 quarter to upgrade our installed
base of participation gaming machines to Bluebird2 and Bluebird xD gaming
machines, depreciation for a new facility that was placed in service in August
2012 and amortization of finite-lived intangible assets from our two
acquisitions in the June 2012 quarter.
Operating Income and Operating Margin
Our operating income increased by $9.1 million, or 260.0%, in the September 2012
quarter on a 2.2% increase in total revenues. Our operating margin of 7.9%
represented a 570-basis point increase over the 2.2% operating margin achieved
in the prior-year period. This increase reflects:
Ø $4.1 million of higher profit;
Ø $3.9 million of lower selling and administrative costs;
Ø $9.7 million of lower impairment and restructuring costs; partially offset by
Ø $5.4 million of higher depreciation and amortization expense; and
Ø $3.2 million of higher research and development costs, all as discussed
above.
Interest Expense
We incurred interest expense of $0.7 million and $0.4 million, net of amounts
capitalized for construction-in-progress, in the quarters ended September 30,
2012 and 2011, respectively.
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Interest Income and Other Income and Expense, Net
Interest income and other income and expense, net was income of $2.4 million and
$2.7 million for the quarters ended September 30, 2012 and 2011, respectively.
Income Taxes
The estimated effective income tax rates were approximately 35.0% and 34.5% for
the quarters ended September 30, 2012 and 2011, respectively.
The September 2012 quarter estimated effective tax rate in comparison to the
September 2011 quarter effective tax rate reflects:
Ø A lower estimated annualized domestic manufacturing deduction;
Ø A decrease in estimated annual pre-tax income compared to the
September 2011 quarter; and
Ø No U.S. Federal research and development tax credit in the September
2012 quarter, compared to a research and development taxcredit, net
of $0.1 million in the September 2011 quarter.
The September 2011 quarter estimated effective tax rate in comparison to the
September 2010 quarter effective tax rate of 35.9% reflects:
Ø A higher estimated domestic manufacturing deduction of $1.4 million;
Ø A decrease in estimated pre-tax income compared to fiscal 2010;
Ø An estimated reduction of the effective tax rate by $0.1 million due
to the research and development tax credit, which was not in effect in
the prior year period; partially offset by
Ø A decrease in the estimated impact of other permanent tax items in the
first quarter of $1.5 million.
At June 30, 2012, no deferred income tax provision had been recorded for United
States Federal taxes related to approximately $39.3 million of undistributed net
earnings of certain foreign subsidiaries, which are considered to be permanently
reinvested. Determination of the deferred income tax liability on these
unremitted earnings is not practicable because such liability, if any, depends
on the circumstances existing if and when the remittance occurs. We have
approximately $28.0 million of cash and cash equivalents in our international
subsidiaries at September 30, 2012, and we believe we could readily convert such
cash to other currencies including United States Dollars, although based on
current banking and governmental regulations we cannot repatriate all of this
cash, including approximately $15.9 million of cash and cash equivalents in
Argentina. We believe the impact of not being able to fully repatriate this cash
and cash equivalents on the overall liquidity of the Company is immaterial, as
at September 30, 2012, we had $54.9 million of unrestricted cash and cash
equivalents (which includes the $28.0 million of foreign-based cash), and our
annual cash flow from operations was $156.8 million in fiscal 2012 and $21.0
million for the three months ended September 30, 2012. In addition, we have
access to our new $400 million amended and restated revolving credit facility
that we entered into in October 2011 that expires in five years of which only
$85.0 million is borrowed and, if necessary, could access additional debt or
equity offerings.
Earnings Per Share
The increase in earnings per share in the September 2012 quarter is attributable
to the increase in net income for the quarter, largely related to higher
revenues, lower expenses, including no impairment and restructuring charges, and
a lower number of diluted shares outstanding as a result of our share
repurchases over the last twelve months. Diluted earnings per share increased
142.9% to $0.17 for the quarter ended September 30, 2012, from $0.07 for
prior-year period. The share repurchases over the last twelve months favorably
impacted the September 2012 quarter earnings per share by $0.01.
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. 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. As a result, gaming operators
delayed or canceled construction projects, resulting in fewer new casino
openings and expansions in fiscal year 2010 and 2011, coupled with many
customers reducing their annual capital budgets for replacing gaming machines.
New unit demand for new casino openings and casino expansion
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increased in fiscal 2012; however, we expect such demand to decrease in fiscal
2013. The macroeconomic challenges due to the economic crisis, the operational
challenges that lead to the review of our product plans and business strategies
at the end of fiscal 2011 and beginning of fiscal 2012 and increased competition
from our competitors has lowered the number of new units we shipped over the
last three fiscal years, resulting in lower revenues in fiscal 2012 than in
fiscal 2011 and 2010. Although the macroeconomic challenges remained in the
three months ended September 30, 2012, we generated slightly more revenue during
that period than in the three months ended September 30, 2011.
Our cash flow from operations is largely dependent on our profitability, the
amount of working capital necessary to support our revenue base and extended
financing terms. 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 acquisitions, 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. In addition, 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 provided by operating activities; and
Ø Debt capacity available under our $400 million amended and restated
revolving credit facility that we entered into in October 2011 that
expires in five years and, if necessary, additional debt or equity
offerings.
Selected balance sheet accounts are summarized as follows (in millions):
September 30, June 30, Increase / (Decrease)
2012 2012 Dollar Percent
Total cash, cash equivalents, and
restricted cash(1) $ 69.1 $ 76.1 $ (7.0 ) (9.2 )%
Total current assets(A) 454.3 452.3 2.0 0.4
Total assets 1,151.7 1,154.1 (2.4 ) (0.2 )
Total current liabilities(B) 130.3 170.8 (40.5 ) (23.7 )
Long-term debt 85.0 60.0 25.0 41.7
Stockholders' equity 888.7 877.3 11.4 1.3
Net working capital (A) - (B) 324.0 281.5 42.5 15.1
Trailing-twelve month statistics:
Average days outstanding for
total accounts and notes
receivable(2) 190 204 (14 ) (6.9 )
Inventory turns(3) 3.6 3.5 0.1 2.9
(1) Pursuant to various jurisdictional 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 include restricted cash of $14.2
million and $13.8 million as of September 30, 2012, and June 30, 2012,
respectively. Cash required for funding WAP systems jackpot payments is
considered restricted cash and is not available for general corporate
purposes.
(2) Our average days outstanding for total accounts and notes receivable was less
at September 30, 2012, in comparison to June 30, 2012, as the trailing-twelve
month accounts and notes receivable decreased by $24.5 million and the
trailing-twelve month revenue slightly increased.
(3) Our inventory turns increased slightly at September 30, 2012, in comparison
to June 30, 2012, as the decrease in the cost of product sales was slightly
less than the decrease in total inventory in the three months ended
September 30, 2012.
Our net working capital increased $42.5 million from June 30, 2012, and was
primarily affected by the following components:
Ø A decrease in current liabilities of $40.5 million, or 23.7%, to $130.3 million due to $21.9 million of lower other accrued liabilities primarily
due to the timing of tax payments, lower accounts payable of $17.9 million
and $0.7 million of lower accrued compensation and related benefits; and
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Ø A $9.8 million, or 3.0%, aggregate increase in current accounts and notes
receivable and other current assets; partially offset by
Ø A decrease in cash, cash equivalents and restricted cash of $7.0 million; and
Ø A decrease in inventories of $0.8 million, or 1.5%, to $52.5 million from
$53.3 million at September 30, 2012, due to lower raw materials; partially
offset by higher finished goods. Inventory turns were 3.6x at
September 30, 2012, compared to 3.5x at June 30, 2012.
As described in Note 12. "Commitments, Contingencies and Indemnifications" to
our Condensed Consolidated Financial Statements and Notes thereto included in
this report, we have royalty and license fee commitments for brand, intellectual
property and technology licenses of $67.5 million that are not recorded in our
accompanying Condensed Consolidated Balance Sheets.
We believe that total cash, cash equivalents and restricted cash of $69.1
million at September 30, 2012, inclusive of $14.2 million of restricted cash,
and cash flow provided by operating activities 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 develop, license
or acquire intangibles and other assets, technologies or intellectual properties
from third parties, the levels of inventories and receivables required in the
operation of our business and any repurchases of common stock for the upcoming
fiscal year. At September 30, 2012, we held approximately 73.9 million pesos, or
$15.9 million, of cash and cash equivalents in Argentina. Currently, the
Argentine government is imposing restrictions on currency movements that might
make it costly or impossible to convert the pesos into U.S dollars and have
those dollars leave the country. This creates a foreign currency risk in case of
devaluation. We believe that we take a prudent and conservative approach to
maintaining our available liquidity while credit market and economic conditions
remain uncertain. 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. For fiscal 2013 and 2014, we expect cash flow provided by
operating activities 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 as a result of amending and restating our revolving credit agreement in
October 2011, we have access to our $400 million revolving credit facility
through October 2016. We will, however, assess market opportunities as they
arise.
Total Accounts and Notes Receivable
See Note 2. "Principal Accounting Policies - Accounts Receivable and Notes
Receivable, Allowance for Doubtful Accounts and Bad Debt and Credit Quality of
Notes Receivable" to our Condensed Consolidated Financial Statements and Notes
thereto included in this report.
Inventories - Excess and Obsolescence
Our inventory write-downs primarily arise from excess quantities of raw material
inventories purchased for production of gaming machines and 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. 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 historical usage and forecasted demand planning in
both purchasing and production processes and conduct quarterly reviews for
excess and obsolete inventories. 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 Bluebird2
gaming machine and the demand for this gaming machine exceeded our expectations,
resulting in fewer Bluebird gaming machines being sold. In the March 2012
quarter, we introduced the new Bluebird2e product; however, this product was an
enhancement of the Bluebird2 product line using substantially all of the same
parts. In the March 2013 quarter, we expect to introduce our new Blade cabinet,
which continues to utilize elements of the internal componentry in the Bluebird2
and Bluebird2e cabinets. 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.
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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
inventories. We use the same six strategies noted above to reduce the impact of
inventory write-downs for obsolete parts. For the three months ended
September 30, 2012, we recorded raw material and finished goods inventory
write-downs totaling approximately $0.6 million compared to $2.6 million in the
prior-year period.
Revolving Credit Facility
See Note 9. "Revolving Credit Facility" to our Condensed Consolidated Financial
Statements and Notes thereto included in this report.
Common Stock Repurchase Program
See Note 10. "Stockholders' Equity and Equity Compensation Plan - Common Stock
Repurchase Program" to our Condensed Consolidated Financial Statements and Notes
thereto included in this report.
Cash Flows Summary
Our cash is utilized to acquire materials for the manufacture of goods for
resale, to pay payroll, operating expenses, interest, and taxes and to fund
research and development activities, invest in gaming operations, property,
plant and equipment and license or acquire intangibles and other non-current
assets from third parties and fund share repurchases. Cash flows from operating,
investing and financing activities, as reflected in our Condensed Consolidated
Statements of Cash Flows, are summarized in the following table (in millions):
Three Months Ended
September 30, Change
2012 2011 Dollar Percent
Net cash provided by (used in):
Operating activities $ 21.0 $ 13.1 $ 7.9 60.3 %
Investing activities (48.7 ) (42.7 ) (6.0 ) (14.1 )
Financing activities 20.6 8.2 12.4 151.2
Effect of exchange rates on cash and cash
equivalents (0.3 ) (1.0 ) 0.7 70.0
Net decrease in cash and cash equivalents $ (7.4 ) $ (22.4 )
$ 15.0 67.0 %
Operating activities: The $7.9 million increase in cash provided by operating
activities in the three months ended September 30, 2012, compared to the three
months ended September 30, 2011, resulted from:
Ø A $13.6 million positive impact from a $6.1 million increase of
depreciation and amortization expense, a $5.5 million increase in net
income, a $0.2 million positive impact from lower tax benefits from
deferred income taxes and a $1.8 million increase in share-based
compensation; and
Ø A $0.9 million positive impact from the changes in operating assets and
liabilities; partially offset by
Ø A $6.6 million negative impact from a decrease from other non-cash items.
Investing Activities: The $6.0 million increase in cash used by investing
activities for the three months ended September 30, 2012, compared to the three
months ended September 30, 2011, was primarily due to:
Ø A $3.5 million increase in the amount invested in gaming operations
machines, top-boxes and related equipment during the three months ended
September 30, 2012 to $25.6 million as we continued to update our
installed base of participation gaming machines to Bluebird2 and Bluebird
xD gaming machines; and
Ø A $4.4 million increase in the amount invested in property, plant and
equipment during the three months ended September 30, 2012 to $20.3 million, as we continue to invest in facility expansion, higher spending
on information technology, as well as investments in manufacturing tools
and capitalized software development costs; partially offset by
37
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Ø A $1.9 million decrease in payments to develop, license or acquire
long-term intangible and other non-current assets as we invested $2.8
million in the three months ended September 30, 2012.
Financing Activities: The $12.4 million increase in cash provided by financing
activities for the three months ended September 30, 2012, compared to the three
months ended September 30, 2011, was primarily due to:
Ø Lower treasury stock purchases by $22.5 million in the three months ended
September 30, 2012, as $5.0 million of treasury stock was repurchased
compared to $27.5 million in the three months ended September 30, 2011;
partially offset by
Ø Lower net borrowings of $10.0 million under our revolving credit agreement
in the three months ended September 30, 2012.
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; however in the
three months ended September 30, 2011, we provided impairment and restructuring
charges to accrue the costs of abandoning leasehold improvements and lease costs
over the remaining contractual lease life of two leased facilities, aggregating
$4.6 million.
We also have minimum guaranteed royalty payments amounting to $67.5 million at
September 30, 2012 for intellectual property and technologies that are not
recorded on our accompanying Condensed 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 September 30, 2012, were as follows (in millions):
Less More
than 1-3 3-5 than
Contractual Obligations Total 1 Year Years Years 5 Years
Operating leases $ 29.9 $ 6.2 $ 10.7 $ 4.4 $ 8.6
Royalty and license fee payments 67.5 10.6 35.3 21.6 -
Accrued WAP jackpot liability 10.4 10.4 - - -
Non-cancelable raw material purchase orders 2.5 2.5 - - -
Performance bonds 5.3 5.3 - - -
Additional consideration, including imputed
interest, related to acquisitions 18.2 6.7 11.5 - -
Payment of Revolving Credit Facility (a) 85.0 - - 85.0 -
Interest on long-term debt (a) 7.1 1.8 3.6 1.7 -
Other, including guaranteed minimums in
employment agreements 19.7 9.1 6.9 1.8 1.9
Total $ 245.6 $ 52.6 $ 68.0 $ 114.5 $ 10.5
(a) Repayments of principal amounts of borrowings under the revolving credit
facility on September 30, 2012 are assumed to occur at the end of term of our
revolving credit agreement in October 2016. Interest on long-term debt
assumes the amount of debt outstanding at September 30, 2012 remains
outstanding thru the end of term and interest is based on the effective
interest rate at September 30, 2012, which was 2.1%.
As of September 30, 2012, we had a liability for unrecognized income tax
benefits of $4.1 million. We cannot make a reasonable estimate of the period of
cash settlement for the liability for unrecognized income tax benefits. See Note
8. "Income Taxes" to our Condensed Consolidated Financial Statements and Notes
thereto included in this report.
Indemnifications, Special Purpose Entities and Derivative Instruments, Letters
of Credit, Self-Insurance and Product Warranty
See Note 12. "Commitments, Contingencies and Indemnifications" to our Condensed
Consolidated Financial Statements and Notes thereto included in this report.
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