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Industry Overview. The gaming industry is a large and dynamic worldwide marketplace, subject to extensive local jurisdictional regulations. Casino and other legal gaming operators continuously seek to increase their revenue growth and profitability. As a result, gaming equipment manufacturers have increasingly focused on enhancing the overall entertainment value and appeal of games and gaming machines, which drives the demand for the replacement of older games and gaming machines.

Table of Contents believe that earnings performance of our products is the primary driver of customer demand. Demand for our products and services is also driven by:. The replacement cycle of gaming machines at existing casinos;. Casino expansions and new casino openings;. Opening of new gaming jurisdictions;. Expansion of our product line and introduction of new technologies;.

Entering new distribution channels and markets not previously served; and. Our reputation, reliability and after-sales service support. The recession and financial market crisis that began in 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 and , some gaming operators delayed or canceled construction projects, resulting in fewer new casino openings and expansions in fiscal and , coupled with many customers reducing their annual capital budgets for replacing gaming machines. New unit demand for new casino openings and casino expansions increased in fiscal ; however, decreased in fiscal The economic crisis has reduced disposable income for casino patrons and resulted in fewer patrons visiting casinos and lower spending by those patrons who did visit casinos.

The economic crisis and operational challenges led to the review of our product plans and business strategies at the end of fiscal and beginning of fiscal Additionally, 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 than in fiscal and In the United States, Native American casinos represent a significant portion of the gaming market.

Native American gaming differs from the traditional commercial casino market in that it is regulated under the Indian Gaming Regulatory Act of , which classifies legalized gaming as follows:. Class I gaming includes traditional Native American social and ceremonial games. Class I gaming is regulated exclusively at the Native American tribe level. We do not compete in the Class I industry;. Class II gaming includes bingo, electronic aids to bingo, and, if played at the same location where bingo is offered, pull-tabs and other games similar to bingo.

We expect technology to continue to be a significant element that drives demand, along with the emphasis for casinos on the types of gaming products that deliver higher net win per gaming machine. Once the gaming machines are connected to a networked gaming system, data can pass in real. Table of Contents time between the servers and the gaming machines, which will enable new applications, game functionality and system-wide features. These networks will require regulatory approval in each gaming jurisdiction prior to any implementation and will represent an important addition to our existing portfolio of product offerings.

Business Strategy. In order to continue to grow revenues, profits and cash flow, we have been executing on key business strategic priorities throughout the last three fiscal years; however, given the continuing lower levels of capital spending by casinos over the three years ended June 30, , 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 and the beginning of fiscal We still believe our long-term vision is intact but, as a result of this review, we refined our business strategies in fiscal as discussed below.

Our four business strategic priorities are as follows:. Strategic Priority One: Continue to grow our installed participation product base and improve our daily average revenue. Certain of our games and products are only available through lease arrangements where we earn a daily lease rate that is based on either a percentage of the net win, a percentage of the coin-in or a fixed daily lease rate.

We invest our capital in the placement of these leased gaming machines; our business strategy has been to maximize our return on invested capital for our participation installed base. A key element of our success has been to limit the number of units of each game theme installed in each casino. The result is that due to the popularity of the games, with a limited supply, the performance of the games has remained high for a longer period. We have also removed participation gaming machines from lower performing casinos and placed them in higher performing casinos to enhance our return on investment.

Most of our new participation game themes that we launched during the last three fiscal years resulted in replacing existing participation gaming machines, as during this period, we also upgraded a major portion of our installed base from Bluebird gaming machines to Bluebird2 , Bluebird xD and Gamefield xD gaming machines. We experienced delays in getting approvals for certain of our new participation game themes in fiscal and the first half of fiscal and, by not having new game themes to replace some of our older game themes, we experienced a higher level of removals of participation gaming machines than in the prior two years.

In mid-fiscal , we began to see increases in the installed base of participation games and in fiscal , we began seeing increases in the average revenues per day over prior year quarterly periods. Our revenues from the installed base of participation gaming machines, along with the return on capital deployed also are key contributors to the cash flow provided by our operating activities.

We believe the enhanced capabilities of this new platform will enable us to develop games with higher earnings performance. We expect to migrate development of all of our participation games to this new platform over the next several years, while we will continue to support previous platforms.

By continuing to focus on return on invested capital in our participation installed base and introducing innovative new participation games and cabinets we intend to continue to grow our participation revenues, profitability and cash flows. Strategic Priority Two: 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.

During the past nine years, we have enhanced our product development efforts by adding key management, design personnel and software engineers to our product development group. We added facilities and organized our game development group into a studio team structure that continues to promote innovation while driving a more focused development approach. We place substantial emphasis on our Player.

Table of Contents Driven Innovation process that incorporates player feedback and market research into our development process to create game content and gaming experiences that appeal to casino patrons. We develop, acquire and license intellectual property and advanced technologies that we believe enable innovative and appealing games which, coupled with a focused product portfolio management plan, allows us to expand our selection of differentiated products to casino operators.

We offer our products in several different cabinet styles, which help increase overall demand and substantially all of the games we have developed over the last two years are designed to be used on our Bluebird2 , Bluebird xD, Bluebird2e and Blade cabinet styles. The major areas of hardware development include cabinet style, technical capability, circuit board design and related programming and button panel decks and displays.

We are dependent, in part, on innovative new products, new casino openings, casino expansions, replacement of older gaming machines, continued market penetration, new market opportunities and new distribution channels to generate growth in product sales. Each gaming machine requires a game software platform to manage the gaming machine hardware and deliver the game theme software.

Gaming software platforms are constantly updated to keep pace with the increasing complexity of game play requirements, regulatory requirements and expected future game theme software releases. In March , we launched our new Blade gaming cabinet, using the latest version of our operating system software, the CPU-NXT3 platform, which we believe will enable us to offer games with higher earnings performance.

After the restructuring we announced in the September quarter, we now have seven game development studios, which are based around the globe, that utilize the results of the market research in the ongoing development of new games and gaming experiences. By offering this new product line, we believe we will increase our share of poker game shipments, which should help increase our share of new unit shipments.

We believe these fluctuations in ship share relate to the popularity of our products with players and the resulting earnings performance that our products have generated for casino operators. For the first eight months of fiscal , we had the oldest gaming cabinet amongst our competitors until we launched the new Blade gaming cabinet in March We did not compete in the Illinois VGT market for half of the fiscal year due to the Illinois law that existed and shipped a smaller share of Canadian VLT replacement units than some of our competitors.

Beginning in March , we now have one of the newest platforms and gaming cabinets amongst our competitors and that has resulted in a positive momentum in ship share in the second half of fiscal We are authorized to sell and lease our gaming machines in approximately international gaming jurisdictions.

We continue to achieve benefits from the opening of new international offices and the addition of new geographically dispersed sales account executives. Table of Contents In fiscal , we expect that demand from new casino openings and expansions to be slightly higher and replacement demand will be flat as a result of much lower demand from the Canadian VLT operators who had begun a cyclical replacement of all of their VLTs in fiscal will be offset by higher U.

We expect to ship a larger number of VGTs to Illinois in fiscal than we did in fiscal We expect to grow our global product sales revenues, profits and cash flow and increase our ship share as a result of our continued focus on creating innovative new games and products, our direct launch into new markets worldwide, the expansion of existing casinos and opening of new casinos and new jurisdictions and continued penetration of existing markets and entering new distribution channels and by offering a new poker product line.

Strategic Priority Three: Invest in the establishment, development and operation of our interactive gaming products and services. In the December 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 We believe the success of our gaming content, technology foundation and interactive capabilities allows us to provide online capabilities to consumers in other jurisdictions.

These acquisitions individually and in the aggregate were not material to our Consolidated Financial Statements. Additionally, in fiscal we entered into an agreement to provide an end-to-end B2B online casino site in Belgium in collaboration with Groupe Partouche, and beginning in the June quarter now provide a fully managed, end-to-end casino site in Belgium.

Federal legislators and certain other state legislators, as well as, 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. In July , we launched Jackpot Party Social Casino on Facebook and in the March quarter, we launched this application on the Apple iOs system for iPhone and iPad platforms and in the June quarter, we launched this application on the Android platform, all of 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 our interactive gaming products and services for casino operators and their players.

As regulated markets legalize interactive online gaming, we intend to enter and do business in those markets. We have cross-functional teams focused on margin improvement and several of our strategy deployment projects focus on different aspects of margin improvement. We continue to implement lean sigma initiatives i.

We also benefit from raw material sourcing initiatives and, once the replacement cycle shortens, we expect to benefit from an expanded volume of business, which should result in greater volume discounts of raw material component parts from our suppliers and enable us to spread our manufacturing overhead cost over a larger number of units thereby reducing cost per unit.

We believe these initiatives will continue to drive margin improvement in future years, especially with the margin improvement. Table of Contents progress on our Bluebird xD , Bluebird2e and Blade product lines, where we expect to improve margins to be more comparable to our Bluebird2 product line.

Design, Research and Product Development. We are continually developing new games to refresh the installed base of our gaming machines and implementing new hardware, operating system and software technologies and functionality to enhance player entertainment. We utilize our unique Player Driven Innovation approach to develop new games and technologies, which has resulted in the creation of innovative products.

We also perform market tests of our products with the cooperation of casino operators to assess reliability and player appeal of new games, new hardware, new operating system and software technologies. Our gaming machines and games are usually designed and programmed by our internal engineering staff and game development studios.

Our game design teams operate in a studio environment that encourages creativity, productivity and cooperation among designers. Our Chicago research and development facility is a state-of-the-art technology campus that houses most of our research and development team, including four game development studios and in July , we completed construction of a new , square foot facility to provide for further growth. We have additional game development studios in Las Vegas, Sydney and Pune with additional research and development staff in Atlanta, Las Vegas and Reno.

Each of our game development studios works concurrently on multiple games and is staffed with producers, software developers, graphic artists, mathematicians, composers and game designers. In some cases, we may outsource testing and graphic design functions to independent firms under contract to us. In addition, we have a defined process to review new game ideas submitted by third parties for consideration by us to license, develop and commercialize.

Sales and Marketing. We are authorized to sell or lease our gaming machines to casinos in tribal jurisdictions, 33 state jurisdictions and international gaming jurisdictions worldwide. In most gaming jurisdictions, we sell our gaming machines directly, rather than through distributors, which we believe allows us to provide superior customer service and enhances profitability.

We also distribute WMS games that are ported to online, social, casual and mobile gaming platforms. We sell and lease our gaming machines through 32 salespeople in offices in several United States locations, and 21 salespeople in international locations. Our salespeople earn a salary and commissions on both product sales and gaming operations revenues generated. The sale and lease of gaming machines takes place throughout our fiscal year and the order sizes typically range from a small quantity of units to several hundred units.

We conduct one-on-one meetings with our customers to demonstrate our products at their locations, host customers at private demonstrations in our offices and at other locations and participate in various trade shows domestically and internationally each year. In certain cases, we respond to competitive requests for proposals from private and public entities who are seeking to purchase gaming machines. We advertise in trade and consumer publications that appeal to casino operators, their employees and casino patrons.

Usually, with the launch of a featured product or product category, we will design web-based learning experiences for both employees and customers. Table of Contents We use thematic and interactive web-based micro sites as a means to educate our customers and players about our products, and allow them to learn and explore different aspects of our products at their convenience, while also providing instant win and sweepstakes prizes.

Our field service team is a customer-focused organization, responsible for attending to the needs of our customers. For international markets, we have translated our most popular games into Spanish, Portuguese, French, Italian and Mandarin Chinese. Geographic revenue information is determined by country of destination.

Substantially all international sales are made in United States dollars. Revenue from participation games has been primarily limited to Canada and the United States, and we expect this trend to continue. About half of our product sales revenues are sold on normal payment terms of 30 to days and half are sold with extended payment terms for periods up to one year and beyond, and in some cases for terms up to three years, with interest at market rates in excess of our borrowing rate recognized for terms greater than twelve months.

Our international expansion has required us to provide, in certain jurisdictions, a greater amount of financing terms of 18 to 36 months. Also, as a result of the financial market crisis, which began in and led to reduced consumer discretionary spending and a weakened global economic environment, beginning in the March quarter we began and have continued to provide a greater amount of extended payment terms to customers.

This expanded extended payment term program is expected to continue for the foreseeable future, until the global economy and consumer discretionary spending improve and customer demand for extended payment terms abates.

Typically, these sales result in a higher selling price which provides added profitability to the sale. We believe our competitors have also expanded their use of extended payment terms to finance customer receivables.

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. We have 3 sales people for our interactive gaming products and services. Our marketing activity relating to interactive gaming products and services is unique to each distribution channel:. Our marketing activities are primarily focused on online advertising and use of affiliates in order to increase traffic to our website.

Additionally, we utilize bonusing and promotions much like a traditional casino. Operating a white-label, B2B website on behalf of a licensed casino operator. Depending on the particular agreement, we may conduct marketing activities much like we do for business-to-consumer website. Providing WMS games to legalized online gaming operators. As we do not operate the online gaming websites, and are just a content provider, we typically do not spend a significant amount on marketing our products directly to operators or players.

We currently have one social casino game, Jackpot Party Social Casino, that players can access via Facebook and various mobile platforms. A majority of our marketing spend is with Facebook , in which we design ads that are then seen by Facebook desktop and mobile users. The gaming machine and interactive gaming products and services markets are highly competitive and these markets are characterized by the continuous introduction of new games and new technologies, and for the gaming machines market, new gaming machines.

Our ability to compete successfully in these markets is based, in large part, upon our ability to:. Develop and offer games and gaming machines with higher earnings performance than the games and gaming machines offered by our competitors;. Create an expanding and constantly refreshed portfolio of games;. Identify and develop or obtain rights to commercially marketable intellectual properties;.

Adapt our products for use with new technologies;. Implement product innovation;. Offer mechanical and electronic reliability;. Generate brand recognition;. Implement effective marketing and customer support; and. Offer competitive prices, payment terms and lease terms. We estimate that about 25 companies in the world manufacture gaming machines, VLTs and VGTs for legalized gaming markets.

Our competitors vary in size from small companies with limited resources to a few large multi-national corporations with greater financial, marketing and product development resources than ours. The larger competitors, particularly IGT, have an advantage in being able to spend greater amounts than us to develop new technologies, games, products and invest in online, social, casual and mobile gaming. In addition, some of our competitors have developed, sell or otherwise provide to customers security, centralized player tracking and accounting systems, which allow casino operators to accumulate accounting and performance data about the operation of gaming machines, and we do not offer such products.

Our interactive gaming products and services competitors are as follows:. Business-to-consumer and managed services: Our primary competition is other operators that offer online gaming to UK residents. While there are hundreds of such operators, we estimate the largest competitors to be: Playtech, William Hill, Redfinger Trading Ltd. We currently manufacture substantially all of our gaming machines at our facility in Waukegan, Illinois.

We are continuously reconfiguring our assembly lines in order to lower our manufacturing lead times, eliminate wasteful activities, improve productivity and effectively increase our production capacity. We also refurbish used gaming machines at our Las Vegas facility. We implemented a few finishing lines in both our Las Vegas and Barcelona offices in fiscal that will allow us to be more responsive to customer demand.

These lines will allow for the completion and testing of our gaming machine assemblies, which will be mostly assembled in our Waukegan facility. Manufacturing commitments are generally based on expected quarterly sales orders from customers. Due to uneven order flow from customers, component parts common to all gaming machines are purchased and assembled into a partial product that are inventoried to be able to quickly fill final customer orders. Our manufacturing processes generally consist of assembling component parts and sub-assemblies into a complete gaming machine.

Through the use of lean sigma processes in the design of our Bluebird2 , Bluebird xD , Bluebird2e, Blade and Gamefield xD gaming machines and setting up the supply chain processes for these gaming machines, we expect to achieve our operating and strategic sourcing initiatives, and we currently can ship a standard black Bluebird2 gaming machine within less than two weeks of receiving the signed customer order, which is less than the lead time for our original Bluebird cabinet product.

We generally warrant our new gaming machines sold in the U. Our warranty costs have not been significant. We provide several after-sale services to our customers including customer education programs, hour customer service telephone hot line, a website for technical support, field service support programs and spare parts programs. We also sell used gaming machines, including products made by us as well as those produced by our competitors which we have taken back as trade-ins from our customers.

Generally, we acquire used gaming machines as trade-ins toward the purchase of new gaming machines. We also sell participation gaming machines, after refurbishment, as used gaming machines when we no longer need them in our gaming operations and we also harvest parts from Bluebird participation gaming machines to sell to customers as spare parts to support the estimated over 50, of such gaming machines still in casinos today.

While a small secondary market exists in the United States, used gaming machines are typically sold direct by us internationally or to United States-based distributors and then resold in international markets where the higher price point of a new gaming machine may be too costly. Where appropriate, we incur costs to recondition our used gaming machines for resale or we may elect to destroy the used gaming machines. The raw materials used in manufacturing our gaming machines include various metals, plastics, wood, glass and numerous component parts, including electronic subassemblies, computer boards and LCD screens.

We believe that our sources of supply of component parts and raw materials are generally adequate and we have few sole-sourced parts. We continue to implement cost savings and efficiency initiatives and focus on best practices, including lean sigma, to improve the efficiency of our manufacturing processes and reduce time to fulfill orders.

We continue to make improvements in sourcing and supply management, in inventory and warehouse management and other. Table of Contents manufacturing processes. We are implementing a new sales operations strategy in an effort to produce gaming machines more ratably throughout the quarter, with the goal of significantly reducing quarter-end compression in manufacturing. We also have ongoing initiatives, such as new product introduction, enhanced strategic sourcing and supplier management, value engineering the products and designing products for both ease of manufacturability and installation, that we expect will help improve margins in future years.

Each game, gaming machine and associated equipment embodies a number of separately protected intellectual property rights, including trademarks, copyrights and patents. We believe these intellectual property rights are significant assets to our business in the aggregate. During fiscal , and , we utilized three technologies licensed from two separate third parties in substantially all of our gaming machine products we sold or leased.

We seek to protect our investment in research and development and the unique and distinctive features of our products and services by maintaining and enforcing our intellectual property rights. Our capitalized patents, trademarks and licenses have remaining useful lives of up to 10, 5 and 10 years, respectively.

We believe that the expiration of those patents, trademarks and licenses with expiration dates in the near future will not have a material impact on our business. See Note 9. We have obtained patent protection covering many of our products. We were granted U. We have approximately patent applications pending in the United States as well as in many foreign countries. We generally seek to obtain trademark protection in the U. We also rely on our copyrights, trade secrets and proprietary know-how.

In addition, some of our most popular gaming machines are based on trademarks and other intellectual property licensed from third parties. Brand Licenses and Technology. We believe that our use of licensed brand names and related intellectual property contributes to the appeal and success of our products, and that our future ability to license, acquire or develop new brand names is important to our continued success. Therefore, we continue to invest in the market positioning of WMS and the awareness and recognition of our brand names and brand names that we license.

Certain of our games are based on popular brands licensed from third parties, such as Hasbro International, Inc. Consumer Products Inc. Typically, we are obligated to make minimum guaranteed royalty payments over the term of the license agreement and to make advance payments against those commitments. The licensor typically must inspect and approve any use of the licensed property. We have the right to extend the license for an additional three-year term if certain conditions are satisfied.

We amended this agreement in July so that it now runs through The following three licensed technologies are utilized in substantially all of our gaming machine products:. Several of our competitors have pooled their intellectual property patents that provide cashless gaming capabilities, specifically ticket-in ticket-out technology. Using this technology, when casino patrons cash out from a gaming machine they receive a printed ticket instead of coins.

We have a non-exclusive, royalty-bearing license for certain patents related to this technology with IGT through the expiration date of the relevant patents and we pass through the license fee to our customers for product sales. We have a perpetual license to use this technology and have no continuing payment obligation for this license. In February , we entered into a ten-year non-exclusive, royalty-bearing patent cross-license agreement with IGT. This agreement provides for a cross license of intellectual property evidenced by certain patents owned by each of us relating to computing and networked gaming infrastructures.

Government Gaming Regulation. We sell our games and gaming machines in legal gaming jurisdictions worldwide. The manufacture and distribution of gaming equipment and related software is subject to regulation and approval by various city, county, state, provincial, federal, tribal and foreign agencies.

We believe we hold all of the licenses and permits necessary to conduct our business. In all, we are authorized to sell or lease our gaming machines to casinos, including jurisdictions that do not require licensing, in jurisdictions worldwide, including approximately international gaming jurisdictions.

We and our key personnel have obtained or applied for all approvals necessary to maintain compliance with these regulatory agency requirements. The regulatory requirements vary among jurisdictions, but the majority of jurisdictions require licenses, permits or findings of suitability for our company, individual officers, directors, major stockholders and key employees, and documentation of qualification.

We must satisfy all conditions for each gaming license or permit. Our gaming equipment and software also must be approved either by a gaming agency laboratory or a private laboratory authorized by the gaming authority.

In some jurisdictions, regulators monitor not only the activities within their own jurisdiction but also activities that occur in other jurisdictions to ensure that the entities it licenses are in compliance with local standards on a worldwide basis.

Nevada is such a jurisdiction. The Nevada gaming authorities require us and our gaming subsidiary, WMS Gaming, to maintain Nevada standards of conduct for all of our gaming activities and operations worldwide. To make our compliance efforts more efficient, we have centralized all licensing, compliance and non-product approval gaming regulatory matters, including the shipment of gaming equipment and related software worldwide. The gaming industry is complex and constantly evolving, particularly in new jurisdictions.

We continue to devote significant resources to ensure regulatory compliance throughout our company. Additionally, we have an. Table of Contents active gaming compliance committee consisting of one outside consultant and two members of our board of directors that works in concert with our regulatory compliance department to avoid any appearances of impropriety as a result of a business relationship or new market opportunity.

We have never been denied a gaming-related license, nor have our licenses ever been suspended or revoked. Since the gaming law requirements of many jurisdictions are similar, we are not including descriptions of all jurisdictions due to the number of jurisdictions to which we are subject. For more information concerning the regulatory schemes to which we are subject, we have filed as an exhibit to this Annual Report on Form K a description of the Nevada regulations.

The description of the Nevada regulations is a representative example of the gaming regulations to which we are subject. See Exhibit We believe that our relations with our employees are satisfactory. As a result of the restructuring we announced in the September quarter, 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.

We continue to review our costs and organizational structure to maximize efficiency and align expenses with the current and long-term business outlook. We urge you to carefully review the following discussion of the specific risks and uncertainties that affect our business. These include, but are not limited to, the following:. We may not be able to obtain satisfaction of all conditions to complete our Merger with a subsidiary of Scientific Games in the anticipated timeframe:. There are a number of risks and uncertainties associated with the Merger, and completion of the Merger is contingent upon customary closing conditions, including receipt of required regulatory approvals.

There can be no assurance that the required regulatory approvals will be obtained or that such approvals will be obtained without conditions that are not anticipated, that the other conditions of the Merger will be. Furthermore, certain lawsuits have been filed challenging the Merger.

These lawsuits could result in the Merger not being completed or in a delay in the completion of the Merger. We can give no assurance that the conditions to the Merger will be satisfied. Failure to complete the Merger may adversely affect WMS. While the Merger is pending, we are subject to business uncertainties and contractual restrictions that could disrupt our business:.

As we have already experienced and whether or not the pending Merger is completed, the pending Merger may disrupt the current plans and operations of WMS, which has had and could continue to have an adverse effect on our business and financial results. Our employees and other key personnel may have uncertainties about the effect of the pending Merger and the uncertainties may impact our ability to retain, recruit and hire key personnel while the Merger is pending or if it fails. We have incurred and may continue to incur unexpected costs, charges or expenses while the Merger is pending or resulting from the Merger.

Furthermore, we cannot predict how our suppliers, customers and other business partners will view or react to the pending Merger and some have been and may in the future be hesitant to do business with us in light of uncertainties about our ability to perform due to the pending Merger. If we are unable to reassure our customers, suppliers and other business partners to continue transacting business with us, our financial results may be adversely affected. The pursuit of the Merger and preparations for integration have placed and will continue to place a significant burden on many employees and internal resources.

If, despite our efforts, key personnel depart because of these uncertainties and burdens, or because they do not wish to remain with a combined company, our business and financial results may be adversely affected. For these and other reasons, the pendency of the Merger could adversely affect our business and financial results.

The conditions to the completion of the Merger may not be satisfied as noted above. If the Merger is not completed for any reason, we would still remain liable for significant transaction costs and the focus of our management would have been diverted from seeking other potential strategic opportunities, in each case without realizing any benefits of a completed Merger.

For these and other reasons, a failed Merger could adversely affect our business and financial results. Gaming licenses, regulatory approvals and gaming legislation impact the ability to operate our business and sell and lease our products:. The manufacture and distribution of gaming machines, games, the operation of our online casino and remote game servers is subject to extensive federal, state, local and foreign regulations and taxes.

Most of the jurisdictions in which we operate require licenses, permits, documentation of qualification, including evidence of financial stability and other forms of approval of our company and our officers, directors, major security holders and key personnel, along with our products. Licenses, approvals or. The loss of a license in one jurisdiction could trigger the loss of a license or affect our eligibility for a license in another jurisdiction.

In addition, gaming authorities may levy fines against us or seize our assets if we violate gaming laws or regulations. We cannot assure you that we will be able to obtain or maintain all necessary registrations, licenses, permits or approvals, that the licensing process will not result in delays or adversely affect our operations and our ability to maintain key personnel, that we can comply with any new requirements or regulations adopted, or that complying with these regulations will not increase our costs.

The laws and regulations governing gaming in various jurisdictions evolve and change over time. These changes may require us to make changes to our gaming machines and games, levy additional taxes and fees on our revenues, increase our cost of compliance, or could cause restrictions on operations and reduce our profitability in certain jurisdictions.

Changes in regulations may also create uncertainty and cause our customers to delay purchasing decisions. We cannot guarantee that we will not be adversely impacted by changes in gaming regulations. The gaming authorities in some jurisdictions may investigate companies or individuals who have a material relationship with us or our security holders to determine whether the selected individual or security holder is acceptable to those gaming authorities.

Any such investigated company, individual or security holder must pay the costs of the investigation and such an investigation may be time consuming and distracting to our operations. Failure of companies, individuals or security holders to cooperate with any such investigation could negatively impact our ability to obtain or maintain our licenses.

Additionally the regulatory review process and licensing requirements may preclude access to new third-party technologies if those parties either are not willing to subject themselves to review or do not meet regulatory requirements.

Each of our games and gaming machine hardware and software and our interactive gaming products and services must, when required, be approved in the jurisdictions in which it is operated, and we cannot assure you that a particular game and gaming machines, hardware, software or our interactive gaming products and services will be approved in any jurisdiction.

Our networked gaming technology requires regulatory approval in gaming jurisdictions prior to any shipment or implementation and, although we have received approvals from some jurisdictions, we cannot assure you that we will receive the additional approvals we would need to offer the product or service in other gaming jurisdictions. If we fail to seek, do not receive or receive a revocation of a license in a particular jurisdiction for our games, gaming machines, hardware, software or interactive gaming products and services, we cannot operate, sell or place on a participation or leased basis our products in that jurisdiction.

Delays in, amendments to or repeals of legislation approving gaming or the expansion of gaming in jurisdictions in which we operate or plan to commence operations may adversely affect our operations. Some jurisdictions require gaming manufacturers to obtain regulatory approval before engaging in certain transactions, such as business combinations, reorganizations, borrowings, stock offerings and share repurchases.

Obtaining regulatory approvals can be time consuming and costly. We cannot assure you that we will be able to obtain or maintain all necessary approvals or that the approval process will not result in delays or changes to our business plans. Our business is vulnerable to changing economic conditions and current unfavorable economic conditions have impacted and could continue to negatively impact our business:. Existing unfavorable general economic conditions reduce disposable income of casino patrons and result in fewer.

This decline in disposable income could result in reduced play levels on our participation gaming machines, causing our cash flows and revenues from these products to decline. Current unfavorable economic conditions have also resulted in a tightening in the credit markets, decreased liquidity in many financial markets and resulted in significant volatility in the credit and equity markets.

Any significant or prolonged decrease in consumer spending on leisure activities could greatly affect the casino industry, causing some or all of our customers to decrease spending or ultimately declare bankruptcy, each of which would adversely affect our business. A decline in the relative health of the gaming industry and the difficulty or inability of our customers to obtain adequate levels of capital to finance their ongoing operations reduces their resources available to purchase our products and services, which adversely affects our revenues.

If we experience a significant unexpected decrease in demand for our products, we could incur losses and also be required to increase our inventory obsolescence charges. Furthermore, current unfavorable economic conditions have and could continue to impact the ability of our customers to make timely payments to us.

In mid-fiscal , we began implementing a program to provide a greater than historical amount of extended payment term financing arrangements to our customers, which could increase our collection risk. We have continued this program throughout fiscal and this program will likely continue until the economy and consumer discretionary spending improves.

We experienced fewer customers filing for protection under the bankruptcy laws in fiscal than in fiscal We did however experience a higher level of customer refinancings in fiscal than in fiscal Financing to customers in connection with sales also increased in fiscal and as a result of a competitive marketplace and a slow, challenging economic recovery.

If customers are not able to pay us, we may incur additional provisions for bad debt related to lack of collectability of certain receivables. The workforce reduction and any future workforce or other expense reductions may have an adverse impact on our development activities, costs and our ability to attract and retain key personnel.

Our revenue and profitability depend on our ability to continue to timely develop new technologies and high earning products and services that appeal to the player and are free from hardware or software anomalies and cannot be fraudulently manipulated:.

The gaming business is characterized by the rapid development of new technologies and the introduction of new products using such technologies. We must continually adapt our products to incorporate new technologies and if we cannot adapt, or do not timely adapt new technologies, our operations may be adversely impacted.

Delays in acceptance by our customers of new technologies have and may continue to adversely affect our operations. Our success depends upon our ability to adapt our manufacturing capabilities and processes to meet the demands of producing new and innovative products. Because our newer products are generally more technologically sophisticated than those we have produced in the past, we must continually refine our production capabilities to meet the needs of our product innovation.

If we cannot efficiently adapt our manufacturing infrastructure to meet the needs of our product innovations, or if we are unable to make upgrades to our production capacity in a timely manner, our business could be negatively impacted. We are under continuous pressure to anticipate player preferences to gain acceptance of our new products, avoid jackpot fatigue declining play levels on smaller jackpots and continue to provide successful products which garner a high level of play.

Gaming machines can be installed in casinos on a trial basis, and only after a successful trial period are the gaming machines purchased by the casinos. Additionally, we are at risk that customers may cancel pending orders for products that are not performing to expectations at other casinos. If a new product does not achieve significant market acceptance, we may not recover our development, regulatory approval and promotion costs.

Participation gaming machines are replaced on short notice by casino operators if the gaming machines do not meet and sustain revenue and profitability expectations. Therefore, these gaming machines are particularly susceptible to pressure from competitors, declining popularity, changes in economic conditions and increased taxation and are at risk of replacement by the casinos, which would end our recurring revenues from these gaming machines unless they can be placed with another customer or repurposed.

Our success depends on our ability to avoid, detect, replicate and correct software and hardware anomalies and fraudulent manipulation of our gaming machines and our interactive gaming products and services. All of our games are designed with security features to prevent fraudulent activity. However, we cannot guarantee that these features will effectively stop all fraudulent activities.

If our security features do not prevent fraud, we could adversely be affected. Our gaming machines have experienced anomalies and fraudulent manipulation in the past. Games and gaming machines may be replaced by casinos and other gaming machine operators if they do not perform according to expectations, or may be shut down by regulators.

The occurrence of anomalies in, or fraudulent manipulation of, our gaming machines and our interactive gaming products and services may give rise to claims for lost revenues and earnings and related litigation by our customers and may subject us to investigation or other action by gaming regulatory authorities including suspension or revocation of our gaming licenses, or other disciplinary action.

Additionally, in the event of such issues with our gaming machines and our interactive gaming products and services, substantial engineering and marketing resources may be diverted from other projects to correct these issues, which may delay our other projects. In the past, we have experienced delays in launching new products due to the complexity or innovative technologies imbedded in our products.

Especially in our gaming operations, such delays can cause a decrease in our revenue. As a result of not having as many new participation game themes approved as we anticipated, performance of some of our older game themes have lagged resulting in a higher level of removals of participation gaming machines, which can cause a reduction in the installed base and our revenues and profits. Our network gaming applications, game platforms and the related computer systems are constantly updated and revised to keep pace with the ever-increasing complexity of modern game play, technology and regulatory requirements.

We cannot assure you that we will be able to obtain, maintain or manage the level of complexities arising from network gaming applications and gaming platforms and obtain all necessary approvals or that the approval process will not result in costly delays, lost network gaming application revenue or changes to our business plans.

Table of Contents We are dependent on our intellectual property and trade secrets and must ensure we are licensed to use intellectual property and trade secrets owned by others:. Our competitors have been granted patents covering, among other items, numerous gaming machine features, bonusing techniques and related technologies. We might then be forced to discontinue the affected products or be required to obtain licenses from the company holding the patent, if it is willing to give us a license, to continue to develop, manufacture or market our products.

We might also be found liable for treble damage claims relating to past use of the patented subject matter if the infringement is found to be willful. Substantially all of our gaming machines and our interactive gaming products and services utilize trademarks, technologies and other intellectual properties licensed from third parties.

Our success may depend in part on our ability to obtain trademark protection for the names or symbols under which we market our products and to obtain copyright protection and patent protection of our proprietary technologies, intellectual property and other game innovations.

We cannot assure you that we will be able to build and maintain goodwill in our trademarks or obtain trademark or patent protection, that any trademark, copyright or issued patent will provide competitive advantages for us or that our intellectual properties will not be successfully challenged or circumvented by competitors.

We also rely on trade secrets and proprietary know-how. We enter into confidentiality agreements with our employees and independent contractors regarding our trade secrets and proprietary information, but we cannot assure you that the obligation to maintain the confidentiality of our trade secrets or proprietary information will be honored. Despite various confidentiality agreements and other trade secret protections, our trade secrets and proprietary know-how could become known to, or independently developed by, competitors.

If we determine that we may not realize the value of any of the finite-lived intangible assets, net or commitments, we would record an immediate charge against earnings up to the full amount of these net assets or commitments in the period in which such determination is made.

Our future profits may be limited or reduced due to the slow growth of new gaming jurisdictions or additional casinos in existing jurisdictions, declines in the replacement cycle of gaming machines, and ownership changes and consolidation in the casino industry:. Demand for our products is driven by the establishment of new land-based or online gaming jurisdictions, the opening of additional casinos in existing jurisdictions or expansion of existing casinos and the replacement of existing gaming machines.

Governments usually require a public referendum and legislative action before establishing or expanding gaming, whether in a land-based or online jurisdiction. The debate over gaming is extensive with various organizations actively opposing gaming. Opposition to gaming could restrict or prohibit the approval, continuation or expansion of our gaming operations and thereby limit or reduce our future profits. Slow growth in the opening or expansion of casinos, or low levels of demand for gaming machine replacements, could reduce the demand for our products and our future profits.

Moreover, because repeat customers represent a substantial part of our sales, our business and profits could be affected if our customers are sold to or merge with other entities. Such entities may purchase more products and services of our competitors, or reduce spending on our products, or cause downward pricing pressures. Our industry is competitive:.

The gaming business is intensely competitive. We compete on price, pricing models, financing terms, and the content, features and functionality of our hardware and software products and services. Some of our competitors are large companies with greater financial, marketing and product development resources than ours.

In addition, new competitors may enter our key markets, as evidenced by an influx of small gaming equipment companies that have entered the market over the last few years. This increase in equipment companies has increased competition in recent years. Additionally, the consolidation of casino operators, and reduction in capital expenditures by casino operators resulting from the economic downturn and decreased player activity has significantly increased the level of competition among both casino operators and equipment companies.

This increased level of competition has caused more customers to focus on price in addition to performance, longevity, and player acceptance when selecting gaming equipment. Another competitive factor in our industry is the competition to obtain space and favorable placement on casino gaming floors.

Competitors with a larger installed base of gaming machines and game themes than ours have an advantage in obtaining and retaining the most space and best positions in casinos and established online casinos have the advantage of an established player network. In addition, some of our competitors have developed and sell or otherwise provide to customers centralized player tracking and accounting systems, which allow casino operators to accumulate accounting and performance data about the operation of gaming machines.

By not having such systems, we are at a competitive disadvantage. Our profitability is somewhat dependent on our ability to successfully enter into new markets and new channels of distribution, such as networked gaming software applications and interactive gaming. We currently operate an online casino and offer other interactive gaming products and services, but we cannot guarantee user acceptance, expansion of markets or profitability for our interactive gaming products and services.

While we have expanded into social gaming, several of our competitors and other companies have also entered the market and we expect to see more companies explore this opportunity in the coming years. We cannot assure you that our interactive gaming products and services will continue to be popular or that we will be able to attract the attention of players as the market becomes flooded with new offerings.

We cannot be sure that competitive pressure will not cause us to increase the number of free gaming machines and conversion kits that we are expected to offer to our customers, which would decrease the revenue we expect to receive. We believe that our competitors have also increased the amount of extended payment term financings offered to customers. In addition, both extended payment term financing and operating leases result in a delay in our receipt of cash, which reduces our cash balance and financial flexibility to respond to changing economic events.

Our business is subject to political, market and financial risks:. The gaming industry can be affected by public opinion of gaming. In the event that there is a decline in public acceptance of gaming, either through unfavorable legislation affecting the introduction of gaming into emerging markets, or through legislative and regulatory changes, including tax increases in existing gaming markets, our ability to continue to sell and lease our gaming machines and operate our interactive gaming products and services in those markets and jurisdictions would be adversely affected.

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