-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TQlRryxcje2qB8LQR8iWVG5//KY6/5uvOF/Dq3QNbi1vKQbw1SjVv7mit+v4IdlX F8Dw6XNVnhyKYTipbV8oGw== 0000950123-99-006579.txt : 19990719 0000950123-99-006579.hdr.sgml : 19990719 ACCESSION NUMBER: 0000950123-99-006579 CONFORMED SUBMISSION TYPE: S-3 PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19990716 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WMS INDUSTRIES INC /DE/ CENTRAL INDEX KEY: 0000350077 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS MANUFACTURING INDUSTRIES [3990] IRS NUMBER: 362814522 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: S-3 SEC ACT: SEC FILE NUMBER: 333-83021 FILM NUMBER: 99665670 BUSINESS ADDRESS: STREET 1: 3401 N CALIFORNIA AVE CITY: CHICAGO STATE: IL ZIP: 60618 BUSINESS PHONE: 3129611111 MAIL ADDRESS: STREET 1: 3401 N CALIFORNIA AVE CITY: CHICAGO STATE: IL ZIP: 60618 FORMER COMPANY: FORMER CONFORMED NAME: WILLIAMS ELECTRONICS INC DATE OF NAME CHANGE: 19870519 S-3 1 WMS INDUSTRIES INC. 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 16, 1999 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 WMS INDUSTRIES INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 36-2814522 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION)
3401 NORTH CALIFORNIA AVENUE, CHICAGO, ILLINOIS 60618 (773) 961-1111 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ ORRIN J. EDIDIN, ESQ. VICE PRESIDENT, SECRETARY AND GENERAL COUNSEL WMS INDUSTRIES INC. 3401 NORTH CALIFORNIA AVENUE, CHICAGO, ILLINOIS 60618 (773) 961-1111 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) COPIES TO: JEFFREY N. SIEGEL, ESQ HOWARD L. SHECTER, ESQ. SHACK & SIEGEL, P.C. MORGAN, LEWIS & BOCKIUS LLP 530 FIFTH AVENUE 101 PARK AVENUE NEW YORK, NY 10036 NEW YORK, NY 10178 (212) 782-0700 (212) 309-6000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [ ] If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [ ] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- PROPOSED PROPOSED MAXIMUM MAXIMUM AMOUNT OF TITLE OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION TO BE REGISTERED REGISTERED PER SHARE(1) OFFERING PRICE FEE - ---------------------------------------------------------------------------------------------------------------------------------- Common Stock, par value $.50(2).............. 4,025,000 shares(3) $15.84 $63,756,000 $17,724.17 - ---------------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee under Rule 457(c) on the basis of the average of the high and low prices of the common stock reported on the New York Stock Exchange on July 15, 1999. (2) In accordance with the Rights Agreement between the registrant and The Bank of New York, dated as of March 5, 1998, all shares of common stock are accompanied by certain stock purchase rights. (3) Includes 525,000 shares of common stock that the underwriters have the option to purchase to cover over-allotments, if any. ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 SUBJECT TO COMPLETION, DATED JULY 16, 1999 THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. 3,500,000 SHARES [WMS LOGO] COMMON STOCK $ PER SHARE - -------------------------------------------------------------------------------- WMS Industries Inc. is offering 3,500,000 shares of common stock by means of this prospectus. This is a firm commitment underwriting. Our common stock is listed on the New York Stock Exchange under the symbol "WMS." On July 9, 1999, the last reported sale price of our common stock on the New York Stock Exchange was $16.75 per share. INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 5.
PER SHARE TOTAL --------- ------- Price to the public.................................. $ $ Underwriting discount................................ Proceeds to WMS......................................
WMS has granted an over-allotment option to the underwriters. Under this option, the underwriters may elect to purchase a maximum of 525,000 additional shares from WMS within 30 days following the date of this prospectus to cover over-allotments. - -------------------------------------------------------------------------------- NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. NEITHER THE NEVADA GAMING COMMISSION, THE NEVADA STATE GAMING CONTROL BOARD, THE MISSISSIPPI GAMING COMMISSION, NOR ANY OTHER GAMING REGULATORY AUTHORITY HAS PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS OR THE INVESTMENT MERITS OF OUR COMMON STOCK. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. CIBC WORLD MARKETS PRUDENTIAL SECURITIES The date of this prospectus is July , 1999. 3 [Collage of color photos of WMS gaming machines] TABLE OF CONTENTS
PAGE ---- Forward-Looking Statements.................................. i Prospectus Summary.......................................... 1 Risk Factors................................................ 5 Use of Proceeds............................................. 10 Capitalization.............................................. 11 Common Stock Market Price Data.............................. 12 Selected Consolidated Financial Data........................ 13 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 15 Business.................................................... 19 Government Regulation....................................... 29 Management.................................................. 36 Certain Relationships and Related Transactions.............. 38 Underwriting................................................ 40 Legal Matters............................................... 41 Experts..................................................... 41 Where You Can Find More Information......................... 42 Index to Consolidated Financial Statements.................. F-1
--------------------------- As used in this prospectus, the terms "we," "us," "our" and "WMS" mean WMS Industries Inc., a Delaware corporation, and its subsidiaries, unless the context indicates a different meaning, and the term "common stock" means our common stock, $0.50 par value per share. Unless we indicate otherwise, the information in this prospectus assumes that the underwriters will not exercise the over-allotment option. WMS Gaming(R) is a trademark of our subsidiary, WMS Gaming Inc. Our product names mentioned in this prospectus are trademarks of WMS Gaming Inc., except where they are licensed. Williams(R), Pinball 2000(TM), DCS Sound System(R), Dotmation(TM) and Revenge from Mars(TM) are trademarks of our subsidiary, Williams Electronics Games, Inc. Monopoly(R), Chance(R) and Community Chest(R) are trademarks of Hasbro, Inc. Star Wars(R) is a trademark of Lucasfilm Ltd. The other trademarks mentioned in this prospectus are the property of their respective owners. The underwriters are offering the shares of common stock subject to various conditions and may reject all or part of any order. The shares should be ready for delivery on or about , 1999 against payment in immediately available funds. See "Underwriting." FORWARD-LOOKING STATEMENTS Some of the information in this prospectus contains "forward-looking statements" within the meaning of the federal securities laws. These statements may be found under the headings "Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Business," among others. These statements describe our beliefs concerning the future based on currently available information. We do not intend to update the forward-looking statements included in this prospectus. Our actual results could differ materially from those contained in the forward-looking statements due to a number of risks and uncertainties. Forward-looking statements typically are identified by the use of terms such as "may," "will," "expect," "anticipate," "believe," "estimate," and similar words, although some forward-looking statements are expressed differently. Important factors that could cause our actual results to differ materially from our expectations expressed in the forward-looking statements are set forth under the caption "Risk Factors" and in other sections of this prospectus. i 4 PROSPECTUS SUMMARY You should read the following summary together with the more detailed information regarding our company and the common stock being sold in this offering, as well as our financial statements and the accompanying notes that appear elsewhere in this prospectus. You should also read the information incorporated by reference in this prospectus. See "Where You Can Find More Information." ABOUT WMS We are a leading designer, manufacturer and marketer of innovative video and reel spinning gaming machines, video lottery terminals and pinball games. Our primary focus is the growth of our gaming machine business. We seek to develop gaming machines that offer greater entertainment value than traditional slot machines and generate greater revenues for casinos and other gaming machine operators. Our gaming machines incorporate secondary bonus rounds, advanced graphics, digital sound and engaging game themes, some of which include popular songs and recognized trademarks. Our gaming machines are installed in all of the major gaming jurisdictions in North America and in several foreign jurisdictions. Our gaming machine revenues increased 127% from $34.8 million in the first nine months of fiscal 1998, to $79.1 million in the first nine months of fiscal 1999. In June 1997, we introduced Reel 'Em In, our first single-themed multi-coin, multi-line video gaming machine that incorporates a secondary bonus game. Our multi-coin, multi-line gaming machines accept up to 90 coins at a time and have up to nine distinct pay lines, giving the players more ways to win. In addition, secondary bonusing creates a "game-within-a-game" that rewards players by offering them a chance to advance from the primary game to a secondary game. The secondary game also gives the players additional payoff opportunities and allows them to interact with the game by choosing from various entertaining options in the bonus round. The success of Reel 'Em In led to our introduction of a series of video gaming machines based on this new-generation design. This series includes Winning Bid, Top Banana, Filthy Rich, Jackpot Party, Life of Luxury, Boom! and Instant Winner, each featuring a unique and entertaining theme. The multi-coin, multi-line and secondary bonus features and our highly-entertaining themes are designed to attract new players, encourage repeat play and increase the average wager per play. In the fall of 1998, we introduced a series of four Monopoly-themed gaming machines that were named the "Most Innovative Gaming Product for 1999" at the American Gaming, Lodging and Leisure Summit. We are the exclusive worldwide licensee of the widely-recognized Monopoly trademark for use on gaming machines. Since their introduction, these machines have typically generated average daily revenue significantly in excess of the average daily revenue of the casinos' other gaming machines. For example, in Nevada during the first quarter of 1999, these machines generated average daily revenue of more than twice the casinos' average daily revenue per machine. As a result of their superior earnings, we have been able to offer our Monopoly-themed gaming machines to casino operators on a revenue participation or daily lease basis. This allows us to share in the superior earnings of these gaming machines and to generate recurring revenues. As of March 31, 1999, we had installed 1,814 Monopoly-themed gaming machines. We are also the world's leading pinball game designer and manufacturer. We recently developed Pinball 2000, which is a new-generation platform for pinball games that integrates a fully-interactive video monitor with the traditional playfield. We introduced our first Pinball 2000 game, Revenge From Mars, in March 1999, and we introduced our second Pinball 2000 game, Star Wars: Episode I, in July 1999. We also manufacture coin-operated video amusement games for Midway Games Inc., our former subsidiary. 1 5 OUR BUSINESS STRATEGY Our business strategy is primarily focused on the growth of our gaming machine business. We seek to increase our market share and profitability by offering an expanding portfolio of entertaining gaming machines with superior earning potential. This strategy includes the following elements: - Leverage our strength in developing gaming machines with enhanced entertainment value: We believe that our 53 years of experience in designing successful arcade-style amusement games with creative and compelling content, together with our use of new technology, allows us to create gaming machines that offer significantly greater entertainment value than traditional gaming machines. Our gaming machine development teams combine the talents of 95 engineers, designers, artists and musicians. We believe that we are well-positioned to develop gaming machines that have superior entertainment value and generate higher revenue for our customers. We are currently developing numerous innovative and entertaining gaming machines, some of which we expect to offer only on a recurring revenue basis. - Maximize the potential of our exclusive license for use of the Monopoly theme on gaming machines: As the exclusive licensee of the Monopoly name for use with gaming machines, we have converted a popular trademark into a successful line of four superior-earning gaming machines. The success of these Monopoly-themed gaming machines has allowed us to lease them to casino operators, generating recurring revenues for us. We are currently developing two new gaming machines based on the Monopoly theme, and we anticipate introducing additional gaming machines based on this theme. - Focus on the multi-coin, multi-line video gaming machine market: We believe that the fastest growing product on the casino floor is the multi-coin, multi-line gaming machine. We believe that the growth of this type of game will continue because these gaming machines offer more interactive entertainment value and because casino managers wish to increase the diversity of the gaming machines on their slot floors. Our portfolio of multi-coin, multi-line gaming machines has established us as a leading supplier of this type of video gaming machine. We are developing a number of additional multi-coin, multi-line video gaming machines and expect to increase the rate at which we introduce these machines in the future. The pinball market has declined significantly in recent years due to the growth of competition from video and other amusement games. Historically, however, the pinball market has been cyclical, recovering when a new generation of pinball technology is introduced. We intend to continue to evaluate the market potential of Pinball 2000 to determine whether this new platform has succeeded in stimulating a recovery in the pinball market. Our principal executive offices are located at 3401 North California Avenue, Chicago, IL 60618. Our telephone number is (773) 961-1111. 2 6 THE OFFERING Common stock offered by WMS................ 3,500,000 shares(1) Common stock to be outstanding after the offering................................... 33,851,309 shares(1)(2) Use of proceeds............................ - General corporate purposes - New product development and rollout - Potential strategic acquisitions of businesses, intellectual property or other assets - Working capital NYSE symbol................................ WMS - --------------------------- (1) Excludes 525,000 shares of our common stock that the underwriters have the option to purchase to cover over-allotments, if any. (2) Based on 30,351,309 shares outstanding on July 9, 1999. Excludes 77,312 treasury shares and 2,404,336 shares issuable upon the exercise of stock options outstanding at July 9, 1999. 3 7 SUMMARY FINANCIAL INFORMATION
FISCAL 1998 FISCAL 1999 THREE MONTHS ENDED THREE MONTHS ENDED ------------------------------------------ ------------------------------ 9/30/97 12/31/97 3/31/98 6/30/98 9/30/98 12/31/98 3/31/99 -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OTHER DATA) (UNAUDITED) STATEMENT OF INCOME DATA Revenues: Gaming........................ $ 8,234 $ 10,841 $ 15,678 $ 22,035 $ 18,844 $ 25,575 $ 34,665 Pinball and cabinets.......... 11,801 12,556 4,833 9,061 5,031 8,904 10,495 Contract manufacturing........ -- -- -- 3,951 2,924 4,512 3,794 -------- -------- -------- -------- -------- -------- -------- Total revenues.............. $ 20,035 $ 23,397 $ 20,511 $ 35,047 $ 26,799 $ 38,991 $ 48,954 ======== ======== ======== ======== ======== ======== ======== Operating income (loss): Gaming........................ $ (4,219) $ (3,125) $ (2,609) $ 363 $ (665) $ 1,568 $ 4,818 Pinball and cabinets.......... (385) (385) (3,526) (3,465) (2,565) (3,404) (2,042) Contract manufacturing........ -- -- -- 347 235 407 333 Charges related to stock option adjustment(1)........ -- -- (59,890) -- -- (601) (539) Unallocated general corporate expenses.................... (365) (354) (416) (635) (578) (880) (553) -------- -------- -------- -------- -------- -------- -------- Total operating income (loss).................... (4,969) (3,864) (66,441) (3,390) (3,573) (2,910) 2,017 Interest and other income....... 589 920 1,015 1,805 922 917 946 Interest expense................ (441) 522 -- -- -- -- -- -------- -------- -------- -------- -------- -------- -------- Income (loss) from continuing operations before income taxes......................... (4,821) (2,422) (65,426) (1,585) (2,651) (1,993) 2,963 Credit (provision) for income taxes......................... 1,832 920 22,076 602 1,007 758 (1,126) -------- -------- -------- -------- -------- -------- -------- Income (loss) from continuing operations.................... (2,989) (1,502) (43,350) (983) (1,644) (1,235) 1,837 Income from discontinued operations, net............... 6,277 15,947 4,522 -- -- -- -- -------- -------- -------- -------- -------- -------- -------- Net income (loss)............... $ 3,288 $ 14,445 $(38,828) $ (983) $ (1,644) $ (1,235) $ 1,837 ======== ======== ======== ======== ======== ======== ======== Basic and diluted earnings (loss) per share of common stock: Income (loss) from continuing operations.................. $ (0.12) $ (0.06) $ (1.62)(2) $ (0.04) $ (0.06) $ (0.04) $ 0.06 ======== ======== ======== ======== ======== ======== ======== Net income (loss)............. $ 0.13 $ 0.54 $ (1.45)(2) $ (0.04) $ (0.06) $ (0.04) $ 0.06 ======== ======== ======== ======== ======== ======== ======== Average number of shares outstanding................... 25,549 26,471 26,843 27,944 27,988 29,039 30,055 OTHER DATA (EXCLUDES VLTS) Gaming machines sold............ 546 1,289 2,020 2,897 2,335 3,078 3,688 Gaming machines leased at end of period........................ -- -- -- -- -- 501 1,814 Pinball games sold.............. 3,654 3,732 1,002 1,926 1,399 2,342 2,240 BALANCE SHEET DATA Total assets.................... $315,095 $335,428 $256,147 $207,522 $207,026 $215,939 $225,506 Working capital................. 74,541 100,672 87,448 112,066 107,877 110,337 104,211 Long-term debt.................. 27,254 -- -- -- -- -- -- Stockholders' equity............ 230,416 276,541 155,336 155,291 153,914 158,122 159,990
- --------------------------- (1) Charges related to adjustment to previously outstanding WMS stock options made in connection with the Midway spinoff. (2) Includes an after-tax charge of $1.49 per share related to the adjustment described in footnote (1) above. 4 8 RISK FACTORS You should carefully consider the following factors and the other information in this prospectus before deciding to invest in the shares. WE HAVE EXPERIENCED LOSSES FROM CONTINUING OPERATIONS. We have experienced operating losses (excluding discontinued businesses) in each of our last three fiscal years due to a variety of factors, including: - market acceptance of our products; - development costs and promotional expenses relating to the introduction of our new generations of gaming machines and pinball games; - adverse litigation rulings that prevented us from selling our older reel spinning slot machine models; and - the decline of the pinball industry and related reorganization costs. Although we had operating income in our most recent fiscal quarter, we cannot assure you that we will achieve profitability on an annual basis or sustain profitability on a quarterly basis. In addition, we may incur expenses relating to the adjustment to previously outstanding stock options made in connection with the Midway spinoff of up to $5.9 million, including interest accrued through July 6, 1999. The timing of the payment of these expenses is unknown, but the expenses will affect quarterly results when incurred. See Note 10 to the Consolidated Financial Statements beginning on page F-17. WE DEPEND ON INTRODUCING NEW GAMING MACHINES THAT ACHIEVE AND MAINTAIN MARKET ACCEPTANCE. Our success depends on developing and successfully marketing new gaming machines with strong and sustained player appeal. A new machine will be accepted by casino operators only if we can show that the machine is likely to produce more revenues to the operator than other machines. Gaming machines are often installed in casinos on a trial basis, and only after a successful trial period are the machines purchased by the casinos. If a new product does not achieve significant market acceptance, we may not recover our development and promotion costs. In addition, we must continually adapt our products to emerging technologies. We cannot assure you that we will be able to develop products using emerging technologies. We cannot assure you that the new products that we introduce will achieve any significant degree of market acceptance or that the acceptance will be sustained for any meaningful period. OUR GROWTH INCREASINGLY DEPENDS ON RECURRING REVENUE LEASE ARRANGEMENTS, RATHER THAN ON OUTRIGHT SALES OF GAMING MACHINES. In October 1998 we began to enter into recurring revenue arrangements, which are either participation leases or other short-term lease arrangements with casinos for our Monopoly-themed machines, rather than selling the machines to the casino operators. Approximately $5.8 million, or 7.3%, of our gaming revenues for the nine months ended March 31, 1999 were derived from these leases, and we expect that lease revenues will constitute an increasing share of our future revenues. Gaming machines under recurring revenue arrangements are replaced by the casinos if they do not meet and sustain revenue expectations. Therefore, these machines are particularly susceptible to pressure from competitors, declining popularity and changes in economic conditions and are at risk of replacement by the casinos, ending the recurring revenues from these machines. We cannot assure you that our gaming machines will continue to meet the casinos' revenue requirements. In addition, casinos in certain jurisdictions have sought and may continue to seek legislation prohibiting or restricting recurring revenue arrangements. We cannot assure you that the various gaming jurisdictions will continue to permit recurring revenue arrangements. 5 9 THE GAMING MACHINE MARKET IS INTENSELY COMPETITIVE, AND OUR COMPETITORS HAVE ADVANTAGES OVER US. The gaming machine business is intensely competitive and is characterized by the rapid development of new technologies and the continuous introduction of new products. 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. Obtaining space and favorable placement on casino gaming floors is a competitive factor in our industry. Competitors with a larger installed base of gaming machines have an advantage in retaining the most space and best placement. These competitors may also have the advantage of being able to convert their installed machines to newer models in order to maintain their share of casino floor space. PATENT INFRINGEMENT CLAIMS COULD LIMIT OR AFFECT OUR ABILITY TO MARKET SOME OF OUR CURRENT OR NEW GAMING MACHINES. Our competitors have been granted patents covering various gaming machine features. If our products use processes or other subject matter that is claimed under these existing patents, or if other companies obtain patents claiming subject matter that we use, those companies may bring infringement actions against us. 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 develop, manufacture or market our products. We also might then be limited in our ability to market new products. We are currently involved in two lawsuits in federal court regarding patent infringement claims concerning products that we no longer manufacture. See "Business -- Legal Proceedings." WE MAY BE UNABLE TO OBTAIN LICENSES TO USE INTELLECTUAL PROPERTIES AND MAY EXPERIENCE DELAYS IN OBTAINING LICENSORS' APPROVALS OF NEW PRODUCTS. Some of our most popular gaming machines and pinball games are based on trademarks and other intellectual properties licensed from third parties. Our future success may depend upon our ability to obtain and maintain licenses for popular intellectual properties. There is competition for these licenses, and we cannot assure you that we will be successful in acquiring and maintaining intellectual property rights with significant commercial value on acceptable terms. Our intellectual property licenses generally require that we submit new products developed under licenses to the licensor for approval prior to release. This approval is generally discretionary. Rejection or delay in approval of a product by a licensor could have a material adverse effect on our business, operating results and financial condition. WE RELY ON OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS. 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 and patent protection of our proprietary software 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 generally enter into confidentiality agreements with our employees regarding our trade secrets and proprietary information, but we cannot assure you that the obligation to maintain the confidentiality of such 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. OUR GAMING MACHINE BUSINESS IS HEAVILY REGULATED, AND WE DEPEND ON OUR ABILITY TO OBTAIN AND MAINTAIN REGULATORY APPROVALS. The manufacture and distribution of gaming machines are subject to extensive federal, state, local and foreign regulations and taxes, and the governments of the various gaming jurisdictions amend these regulations from time to time. Virtually all of these jurisdictions require licenses, permits, documentation 6 10 of qualification, including evidence of financial stability, and other forms of approval for manufacturers and distributors of gaming machines and for their officers, directors, major stockholders and key personnel. The gaming authorities in some jurisdictions may investigate any individual who has a material relationship with us and any stockholder to determine whether such individual or stockholder is acceptable to those gaming authorities. Each of our gaming machines must be approved in each jurisdiction in which it is placed, and we cannot assure you that a particular game will be approved in any jurisdiction. Licenses, approvals or findings of suitability may be revoked, suspended or conditioned. The revocation or denial of a license in a particular jurisdiction could adversely affect our ability to obtain or maintain licenses in other jurisdictions. If we fail to seek or do not receive a necessary registration, license, approval or finding of suitability, we may be prohibited from selling our gaming machines for use in the jurisdiction or may be required to sell them through other licensed entities at a reduced profit to us. Some jurisdictions require gaming manufacturers to obtain government approval before engaging in some transactions, such as business combinations. Obtaining licenses and approvals can be time consuming and costly. We cannot assure you that we will be able to obtain all necessary registrations, licenses, permits, approvals or findings of suitability in a timely manner, or at all. Similarly, we cannot assure you that our current registrations, licenses, approvals or findings of suitability will not be revoked, suspended or conditioned. See "Government Regulation." The National Gambling Impact Study Commission (the "NGIC") was created by the U.S. Congress in August 1996 to conduct a comprehensive legal and factual study of the social and economic impacts of gaming on federal, state, local and Native American tribal governments and on communities and social institutions. The NGIC issued a report to the President, Congress, state governors and tribal leaders containing its findings and conclusions, together with recommendations for legislation and administrative actions on June 18, 1999. The NGIC report calls for a pause in the growth of legalized gambling and encourages state and local governments to form their own gambling study commissions. Although the NGIC has no regulatory or enforcement powers, its recommendations could result in the enactment of new laws and the adoption of new regulations that could adversely impact the gaming industry in general. THE PINBALL MARKET HAS CONTRACTED AND MAY NOT GROW AGAIN. During fiscal 1997, we completed a downsizing of our pinball design and manufacturing operations in response to the industry-wide decline in demand for pinball games over the past few years. Nevertheless, our pinball operations continued to generate an operating loss in fiscal 1998 and the nine months ended March 31, 1999. Pinball games face increased competition from video games and other amusement games for space in their traditional locations, such as arcades and bars, and from home amusement systems. We cannot assure you that demand in the pinball market will increase or that our pinball business will return to profitability. In our experience, it has been essential to introduce new technologies and product innovations in order to stimulate demand for pinball games. We cannot assure you that we will be able to develop successful new pinball technologies in the future. In addition, we may not recover our development costs for a new pinball game unless it achieves significant market acceptance. We cannot assure you that our new pinball games will achieve or sustain consumer acceptance. WE FACE RISKS ASSOCIATED WITH POTENTIAL BUSINESS ACQUISITIONS. We may seek to grow through acquiring other companies, intellectual property or other assets. Our success with this strategy will depend on our ability to identify and negotiate attractive investments that will complement or enhance our business. We cannot assure you that we will be able to: - properly identify and evaluate acquisition opportunities; - control costs and liabilities incurred with the acquisition of the new businesses or assets; - effectively manage growth of operations; or - anticipate and evaluate the numerous risks involved in acquiring and operating a new business or asset. 7 11 The focus on potential acquisitions could divert our management's resources. The acquisition of a costly or unproductive business or asset could materially and adversely affect our business. We are not currently in discussions with any acquisition candidate. WE DEPEND ON OUR KEY PERSONNEL. Our success depends to a significant extent upon the performance of senior management and on our ability to continue to attract, motivate and retain highly qualified game developers. Competition for highly skilled employees with technical, management, marketing, sales, product design and development and other specialized training is intense. We cannot assure you that we will be successful in attracting and retaining these employees. We may also experience increased costs in order to attract and retain skilled employees. OUR CONTRACT MANUFACTURING BUSINESS DEPENDS ON ONE CUSTOMER. We manufacture coin-operated video games for Midway, which is currently our only contract manufacturing customer. Midway may cancel our contract by giving us six months' notice. Midway would then be free to use one or more of our competitors to fulfill its manufacturing needs. We earned approximately $1.3 million of operating income from contract manufacturing over the 12 months ended March 31, 1999. We cannot assure you that Midway will continue to employ our services and keep our agreement in effect. In addition, if Midway were to cancel the contract, we would continue to incur the fixed costs of maintaining our Waukegan, Illinois manufacturing facility. WE MAY HAVE CONFLICTS OF INTEREST WITH MIDWAY. Most of our directors are also directors and stockholders of Midway. In addition, Louis J. Nicastro, our Chairman of the Board, President and Chief Executive Officer, is also a director of Midway. Neil D. Nicastro, one of our directors and a consultant to WMS, is also the Chairman of the Board, President, Chief Executive Officer and Chief Operating Officer of Midway. Neil D. Nicastro is the son of Louis J. Nicastro. Kenneth J. Fedesna, who heads our pinball operations, is also an officer and director of Midway. In addition, Harold H. Bach, Jr., our Chief Financial Officer and Orrin J. Edidin, our General Counsel, are also officers of Midway. Each of these officers has duties and responsibilities with Midway that may conflict with time that might otherwise be devoted to his duties with WMS. These officers must also administer the various contracts and arrangements in effect between Midway and us. For instance, these officers must decide whether to terminate or permit to continue in force various operating agreements between Midway and us that either party may terminate upon six months' notice, including the manufacturing agreement, the cabinet supply agreement and the pinball sales agreement. See "Certain Relationships and Related Transactions." In addition, these officers may be called upon to negotiate new agreements to be entered into in the future between Midway and us. WE MAY EXPERIENCE ADVERSE EFFECTS AS A RESULT OF THE YEAR 2000 COMPUTER PROBLEM. Many currently installed software programs and embedded programs in electronic systems throughout the world will not work properly when processing dates later than 1999. If we experience any Year 2000 failures, or if any suppliers or customers experience a Year 2000 problem affecting us, shipments or orders of our affected products might be delayed. We cannot assure you that we will be free from exposure to legal actions, loss of sales or other unforseen costs relating to the Year 2000 problem. For information about our Year 2000 information system readiness, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUMNER REDSTONE OWNS OR CONTROLS OVER 20% OF OUR COMMON STOCK AND MAY DISPOSE OF IT AT ANY TIME. After this offering is completed, Sumner Redstone will own or control 7,180,200 shares, or approximately 21.2%, of our common stock. Mr. Redstone could sell any or all of these shares at any time on the open market or otherwise. In addition, although Mr. Redstone has stated that he has no plans to acquire control of WMS, he may sell his stock to a person who wishes to acquire control of WMS. We cannot assure you 8 12 that any such person will agree with our strategy and business goals described in this prospectus. The sale by Mr. Redstone of a large number of shares could have an adverse effect on the market price of our common stock. See "Certain Relationships and Related Transactions." OUR BOARD OF DIRECTORS COULD USE OUR RIGHTS PLAN AND BLANK CHECK PREFERRED STOCK TO INHIBIT THE ACQUISITION OF WMS. Rights plan. Under an agreement with The Bank of New York, as rights agent, each share of our common stock has an accompanying right to purchase convertible preferred stock that permits each holder to receive shares of our common stock at half price. The rights become exercisable if any person or entity that did not, before the plan was adopted, own 15% or more of our common stock acquires beneficial ownership of 15% or more of our common stock. We can redeem the rights at $0.01 per right, subject to certain conditions, at any time. The rights expire in 2007. Our board of directors could use this agreement as an anti-takeover device to discourage, delay or prevent a change in control of WMS. The existence of this agreement could adversely affect the market price of our common stock. Blank check preferred stock. Our certificate of incorporation authorizes the issuance of five million shares of preferred stock with designations, rights and preferences that may be determined from time to time by the board of directors. Accordingly, our board has broad power, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of our common stock. Our board of directors could use preferred stock to discourage, delay or prevent a change in control. Our board has no current plans, agreements or commitments to issue any shares of preferred stock. The existence of the blank check preferred stock, however, could adversely affect the market price of our common stock. THE SUBSTANTIAL NUMBER OF SHARES AVAILABLE FOR SALE IN THE FUTURE COULD HAVE AN ADVERSE EFFECT ON THE MARKET PRICE OF OUR COMMON STOCK. We have 100,000,000 authorized shares of common stock, of which 30,351,309 shares were issued and outstanding as of July 9, 1999, excluding 77,312 treasury shares. On that date, we also had outstanding options to purchase an aggregate of approximately 2,404,336 shares of our common stock issuable at an average exercise price of approximately $5.50 per share. If all of our issued and outstanding stock options were exercised as of that date, approximately 32,755,645 shares of our common stock would be outstanding. Our board of directors has broad discretion to issue authorized but unissued shares, including discretion to issue shares in compensatory and acquisition transactions. In addition, if we seek financing through the sale of our securities, our then current stockholders may suffer dilution in their percentage ownership of our common stock. The future issuance, or even the potential issuance, of shares at a price below the then current market price may have a depressive effect on the future market price of our common stock. OUR STOCK PRICE MAY BE VOLATILE. Our stock price has fluctuated between a low of $3.50 and a high of $17.00 in the last 12 months. We may continue to experience volatility in our stock price. 9 13 USE OF PROCEEDS We estimate that the net proceeds from the sale of the shares of common stock we are offering will be approximately $54.9 million. If the underwriters exercise their over-allotment option in full, the net proceeds will be approximately $63.2 million. For the purpose of estimating net proceeds, we are assuming that the public offering price will be $16.75 per share. "Net proceeds" is what we expect to receive after paying the underwriting discount and the other expenses of this offering. We expect to use the net proceeds for general corporate purposes, new product development and rollout, potential strategic acquisitions of businesses, intellectual property or other assets, and working capital. The timing and amount of our actual expenditures will be based on many factors, including the level of our research, development and promotional activities, identification and availability of satisfactory acquisition opportunities and the amount of cash flow from operations. Until we use the net proceeds of the offering, we will invest them in money market securities or other appropriate short-term investments. 10 14 CAPITALIZATION The following table sets forth our capitalization, at March 31, 1999: - on an actual basis; and - as adjusted to reflect the sale of 3,500,000 shares that we are offering by means of this prospectus at an assumed offering price of $16.75 per share and the application of the proceeds, net of the estimated underwriting discounts and our estimated offering expenses.
MARCH 31, 1999 ----------------------- ACTUAL AS ADJUSTED -------- ----------- (IN THOUSANDS) Cash, cash equivalents and short-term investments........... $ 64,090 $118,991 ======== ======== Long-term debt.............................................. $ -- $ -- Stockholders' equity: Preferred stock (5,000,000 shares authorized; none issued)................................................ -- -- Common stock (100,000,000 shares authorized; 30,137,695 shares issued, actual and 33,637,695 shares issued, as adjusted).............................................. 15,069 16,819 Additional paid-in capital................................ 175,340 228,491 Retained earnings (deficit)............................... (30,037) (30,037) Less -- treasury stock, at cost (77,312 shares)........... (382) (382) -------- -------- Total stockholders' equity............................. 159,990 214,891 -------- -------- Total capitalization................................... $159,990 $214,891 ======== ========
11 15 COMMON STOCK MARKET PRICE DATA Our common stock is traded publicly on the New York Stock Exchange under the symbol "WMS." The following table shows the high and low sale prices of our common stock for the periods indicated as reported on the NYSE:
HIGH LOW ---- --- FISCAL YEAR ENDED JUNE 30, 1998 First Quarter............................................. 30 3/16 23 5/8 Second Quarter............................................ 30 3/8 18 Third Quarter............................................. 32 1/4 19 1/16 Fourth Quarter (through April 6)(1)....................... 33 3/4 31 1/2 Fourth Quarter (after April 6)(1)......................... 5 5/8 2 1/2 FISCAL YEAR ENDED JUNE 30, 1999 First Quarter............................................. 8 13/16 3 1/2 Second Quarter............................................ 10 3/8 5 Third Quarter............................................. 9 7/8 6 15/16 Fourth Quarter............................................ 17 7 1/2
- --------------------------- (1) On April 6, 1998, we distributed a tax-free dividend of 1.19773 shares of Midway common stock for each share of our common stock. On July 9, 1999, the last reported sale price of our common stock on the NYSE was $16.75 per share. On that date, there were approximately 1,250 holders of record of our common stock. 12 16 SELECTED CONSOLIDATED FINANCIAL DATA We derived the statement of income data for the fiscal years ended June 30, 1996, 1997 and 1998, and balance sheet data as of June 30, 1997 and 1998 from the audited financial statements in this prospectus. Those financial statements were audited by Ernst & Young LLP, independent auditors. We derived the statement of income data for the fiscal years ended June 30, 1994 and 1995 and the balance sheet data as of June 30, 1994, 1995 and 1996 from audited financial statements that are not included in this prospectus. We derived the statement of income data for the nine months ended March 31, 1998 and 1999 and balance sheet data at March 31, 1999 from the unaudited financial statements included in this prospectus. Our management believes that the unaudited financial statements contain all adjustments needed to present fairly the information included in those statements, and that the adjustments made consist of normal recurring adjustments. Historical results are not necessarily indicative of results of operations to be expected in the future, and the results for the nine months ended March 31, 1999 are not necessarily indicative of results to be expected for the entire year. You should read the following Selected Consolidated Financial Data together with our Consolidated Financial Statements and notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this prospectus.
NINE MONTHS ENDED FISCAL YEARS ENDED JUNE 30, MARCH 31, ------------------------------------------------------ -------------------- 1994 1995 1996 1997 1998 1998 1999 -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OTHER DATA) (UNAUDITED) STATEMENT OF INCOME DATA Revenues: Gaming............................... $ 16,336 $ 22,172 $ 37,523 $ 33,613 $ 56,788 $ 34,753 $ 79,084 Pinball and cabinets................. 144,515 111,843 55,679 42,983 38,251 29,190 24,430 Contract manufacturing............... -- -- -- -- 3,951 -- 11,230 -------- -------- -------- -------- -------- -------- -------- Total revenues..................... $160,851 $134,015 $ 93,202 $ 76,596 $ 98,990 $ 63,943 $114,744 ======== ======== ======== ======== ======== ======== ======== Operating income (loss): Gaming............................... $ (3,648) $ (8,036) $ (9,508) $(12,510) $ (9,590) $ (9,953) $ 5,721 Pinball and cabinets................. 790 (2,590) (17,093) (2,997) (7,761) (4,296) (8,011) Contract manufacturing............... -- -- -- -- 347 -- 975 Provisions related to WMS Gaming Inc. patent litigation.................. -- -- -- (61,925) -- -- -- Charges related to stock option adjustment(1)...................... -- -- -- -- (59,890) (59,890) (1,140) Unallocated general corporate expenses........................... (3,449) (3,260) (3,106) (1,884) (1,770) (1,135) (2,011) -------- -------- -------- -------- -------- -------- -------- Total operating loss............... (6,307) (13,886) (29,707) (79,316) (78,664) (75,274) (4,466) Interest and other income.............. 3,563 4,801 3,705 5,661 4,410 2,605 2,785 Interest expense....................... (3,175) (2,821) (3,306) (3,443) -- -- -- -------- -------- -------- -------- -------- -------- -------- Loss from continuing operations before income taxes......................... (5,919) (11,906) (29,308) (77,098) (74,254) (72,669) (1,681) Credit for income taxes................ 4,162 5,779 11,556 30,301 25,430 24,828 639 -------- -------- -------- -------- -------- -------- -------- Loss from continuing operations........ (1,757) (6,127) (17,752) (46,797) (48,824) (47,841) (1,042) Income from discontinued operations, net.................................. 30,240 25,334 22,291 87,492 26,746 26,746 -- -------- -------- -------- -------- -------- -------- -------- Net income (loss)...................... $ 28,483 $ 19,207 $ 4,539 $ 40,695 $(22,078) $(21,095) $ (1,042) ======== ======== ======== ======== ======== ======== ======== Basic and diluted earnings (loss) per share of common stock: Loss from continuing operations...... $ (0.07) $ (0.25) $ (0.74)(2) $ (1.92)(3) $ (1.85)(4) $ (1.84)(4) $ (0.04) ======== ======== ======== ======== ======== ======== ======== Net income (loss).................... $ 1.19 $ 0.80 $ 0.19(2) $ 1.67(3) $ (0.84)(4) $ (0.81)(4) $ (0.04) ======== ======== ======== ======== ======== ======== ======== Average number of shares outstanding... 24,016 24,102 24,122 24,334 26,446 25,948 29,020 OTHER DATA (EXCLUDES VLTS) Gaming machines sold................... -- 273 4,241 1,907 6,752 3,855 9,101 Gaming machines leased at end of period............................... -- -- -- -- -- -- 1,814 Pinball games sold..................... 53,182 38,068 16,583 12,575 10,314 8,388 5,981
13 17
JUNE 30, ---------------------------------------------------- 1994 1995 1996 1997 1998 MARCH 31, 1999 -------- -------- -------- -------- -------- -------------- (UNAUDITED) BALANCE SHEET DATA Total assets............................ $262,148 $294,190 $295,071 $306,915 $207,522 $225,506 Working capital......................... 118,684 112,891 157,248 103,910 112,066 104,211 Long-term debt.......................... 57,500 57,500 57,500 57,500 -- -- Stockholders' equity.................... 181,472 208,571 210,033 196,000 155,291 159,990
- --------------------------- (1) Charges related to adjustment to previously outstanding WMS stock options made in connection with the Midway spin-off. (2) Includes after-tax restructuring charges related to pinball business downsizing of $2.1 million, or $0.09 per share, and additional after-tax provisions for gaming inventory obsolescence of $1.3 million, or $0.05 per share. (3) Includes an after-tax charge of $1.54 per share related to patent litigation. See Note 13 in the Notes to Consolidated Financial Statements on page F-20. (4) Includes after-tax charges of $1.51 and $1.54 per share in fiscal 1998 and the nine months ended March 31, 1998, respectively, related to the adjustment described in footnote (1) above. 14 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW WMS was incorporated in Delaware on November 20, 1974 under the name Williams Electronics, Inc. and succeeded to the business of designing and manufacturing pinball games, which had been conducted for almost 30 years by our predecessors. Our current businesses are reported in the following three industry segments: gaming; pinball and cabinets; and contract manufacturing. In our gaming business, we design, manufacture and market video and reel spinning gaming machines and video lottery terminals. In our pinball and cabinets business, we design and manufacture coin-operated pinball games and manufacture cabinets for coin-operated games. In our contract manufacturing business, we manufacture coin-operated video games. We conduct our gaming machine business through our subsidiary WMS Gaming Inc., which markets its products under the Williams(R) and WMS Gaming(TM) trademarks. We conduct our pinball and cabinets business through our subsidiary Williams Electronics Games, Inc. ("WEG"), which markets products under the Bally(R) and Williams(R) trademarks, and through our cabinet manufacturing subsidiary, Lenc- Smith Inc. We conduct our contract manufacturing business through WEG. In April 1997, we distributed to our stockholders all of our stock in our former subsidiary, WHG Resorts & Casinos Inc., a Puerto Rico-based hotel, casino and hotel management business. In April 1998, we distributed to our stockholders all of our stock in our former subsidiary, Midway Games Inc., a coin-operated and home video game design, marketing and publishing business. Since this distribution, we manufacture, under a contract, the coin-operated video games designed and sold by Midway. Our fiscal year begins on July 1 and ends on June 30. RESULTS OF OPERATIONS Nine months ended March 31, 1999 compared with nine months ended March 31, 1998 Consolidated revenues increased to $114.7 million, or 79.5%, in the nine months ended March 31, 1999 from $63.9 million in the nine months ended March 31, 1998. Consolidated gross profit increased to $29.9 million in the nine months ended March 31, 1999 from $15.4 million in the nine months ended March 31, 1998 due primarily to increased gaming revenues, including the effects of participation lease revenues, and a higher gaming gross profit margin percentage offset by the effects of lower pinball revenues. Consolidated operating loss decreased to $4.5 million in the nine months ended March 31, 1999 from $15.4 million in the nine months ended March 31, 1998, after excluding a $59.9 million common stock option adjustment expense. Loss from continuing operations decreased to $1.0 million, or $0.04 per share, in the nine months ended March 31, 1999, from $47.8 million, or $1.84 per share, in the nine months ended March 31, 1998. Net income (loss), which included continuing operations and, in the nine months ended March 31, 1998, discontinued operations, was a net loss of $1.0 million, or $0.04 per share, for the nine months ended March 31, 1999, compared to net loss of $21.1 million, or $0.81 per share, for the prior year nine month period. Loss from continuing operations and net loss for the nine months ended March 31, 1999 were increased by $950,000, or $0.03 per share, due to costs from a strike at our cabinet manufacturing facility that was settled during the quarter ended March 31, 1999, and were also increased by $705,000, or $0.02 per share, from the adjustments to previously outstanding WMS stock options that vested during the nine months ended March 31, 1999. Loss from continuing operations and net loss for the nine months ended March 31, 1999 were reduced by $790,000, or $0.03 per share, from a net recovery relating to purchased parts overcharges primarily from certain pinball games suppliers in prior years. Net loss and loss from 15 19 continuing operations for the nine months ended March 31, 1998 included an after tax charge of $39.9 million, or $1.54 per share, related to the common stock option adjustment. Gaming. Gaming revenues increased $44.3 million, or 127.5%, from the prior year's nine-month period. The increase resulted primarily from the availability of a greater number of models of gaming machines in the nine months ended March 31, 1999 and the market acceptance of these models. Gaming had an operating profit of $5.7 million for the nine months ended March 31, 1999, compared to an operating loss of $10.0 million for the nine months ended March 31, 1998 because of the higher revenue and gross margin. Pinball and cabinets. Pinball and cabinets revenues decreased by $4.8 million, or 16.3%, primarily due to decreased industry-wide demand for pinball games, partially offset by initial sales of next-generation pinball games. Pinball and cabinets operating loss increased by $3.7 million because of lower revenues, a strike in the cabinet plant and continued research and development costs for the next generation of pinball games. Contract manufacturing. The nine months ended March 31, 1999 included the contract manufacturing business segment, which generated revenues of $11.2 million and operating income of $975,000. Prior to the Midway spin-off, we recorded these operations as a cost allocation between a parent and a consolidated subsidiary. Fiscal 1998 compared with fiscal 1997 Consolidated revenues increased to $99.0 million, or 29.2%, in fiscal 1998 from $76.6 million in fiscal 1997. Consolidated gross profit increased to $22.0 million in fiscal 1998 from $16.5 million in fiscal 1997 due primarily to increased gaming machine revenues which generated increased gross profit and an increase in the gaming segment gross profit margin due to spreading certain fixed costs over greater production. In fiscal 1998 we recorded a pre-tax charge of $59.9 million for the adjustment to our outstanding stock options to compensate the holders for the lost opportunity value represented by the shares of Midway distributed in the spin-off, in which option holders did not participate. In fiscal 1997 we recorded a provision of $61.9 million relating to patent litigation. See Note 13 to the Consolidated Financial Statements on page F-20. Loss from continuing operations was $48.8 million, or $1.85 per share, in fiscal 1998 compared with $46.8 million, or $1.92 per share, in fiscal 1997. Loss from continuing operations in fiscal 1998 included an after-tax charge of $39.9 million, or $1.51 per share, from the adjustment to our stock options. Loss from continuing operations in fiscal 1997 included after-tax provisions relating to our patent litigation of $37.4 million, or $1.54 per share. After excluding these after tax items, loss from continuing operations was $8.9 million, or $0.34 per share, in fiscal 1998 and $9.4 million, or $0.39 per share, in fiscal 1997. The decreased loss was primarily from the increased gaming segment gross profit, after absorbing the increased selling and administrative expenses. Gaming. Gaming revenues increased to $56.8 million, or 68.9%, in fiscal 1998 from $33.6 million in fiscal 1997, primarily from the increase in the number of gaming machines sold during the year. Gaming revenues in fiscal 1998 included newly-released reel spinning and video gaming machines including slot machines and video lottery terminals. Fiscal 1997 revenues included primarily old model reel spinning slot machines and video lottery terminals. Pinball and cabinets. Pinball and cabinets revenues decreased to $38.3 million, or 11.0%, in fiscal 1998 from $43.0 million in fiscal 1997. The decrease was primarily due to the continuing industry-wide decline in demand for pinball games. The pinball and cabinets operating loss increased to $7.8 million in fiscal 1998 from $3.0 million in fiscal 1997. The increase resulted primarily from lower gross profit due to reduced unit sales prices and continued development expense for the next generation of pinball games. 16 20 Contract manufacturing. In fiscal 1998, contract manufacturing revenues of $4.0 million and operating income of $347,000 include operations for the period April 6, 1998 to June 30, 1998 from the assembly of coin-operated video games for Midway. Fiscal 1997 compared with fiscal 1996 Consolidated revenues decreased to $76.6 million, or 17.8%, in fiscal 1997 from $93.2 million in fiscal 1996. Consolidated gross profit increased to $16.5 million, or 96.4%, in fiscal 1997 from $8.4 million, excluding the $3.4 million in pinball restructuring charges, in fiscal 1996, due primarily to lower cost of sales in fiscal 1997 resulting from the restructuring of the pinball business. In fiscal 1997 we recorded a provision of $61.9 million relating to our patent litigation. See Note 13 to the Consolidated Financial Statements on page F-20. Loss from continuing operations was $46.8 million, or $1.92 per share, in fiscal 1997 compared with $17.8 million, or $0.74 per share, in fiscal 1996. Excluding the after-tax provisions relating to our patent litigation of $37.4 million, loss from continuing operations was $9.4 million, or $0.39 per share in fiscal 1997. The decreased loss was primarily from the reduced pinball and cabinets operating loss. Gaming. Gaming revenues decreased to $33.6 million in fiscal 1997 from $37.5 million in fiscal 1996. Gaming revenues were lower primarily from the negative impact on revenues of our patent litigation. Pinball and cabinets. Pinball and cabinets revenues decreased to $43.0 million, or 22.8%, in fiscal 1997 from $55.7 million in fiscal 1996. The decreased revenues were primarily due to the continuing industry-wide decline in demand for pinball games. The pinball and cabinets operating loss decreased to $3.0 million in fiscal 1997 from $17.1 million in fiscal 1996. The change resulted primarily from the cost reductions resulting from the downsizing of pinball and cabinets operations in June 1996. 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 continue to be dependent on the prevailing competitive environment and the acceptance of our products in the marketplace. LIQUIDITY AND CAPITAL RESOURCES Management believes that cash and cash equivalents and short-term investments totaling $64.1 million at March 31, 1999 will be adequate to fund the anticipated level of inventories and receivables required in the operation of our business, to fund presently anticipated needs and to fund the payment of the judgement in the event that we are unsuccessful in our appeal of our patent litigation. See Note 13 to the Consolidated Financial Statements on page F-20. Cash flows from operating, investing and financing activities during the nine months ended March 31, 1999 resulted in a net cash increase of $4.2 million as compared with net cash provided of $53.0 million during the nine months ended March 31, 1998. The cash increase in 1998 was primarily from the sale of short- term investments. See Condensed Consolidated Statements of Cash Flows on page F-4. Cash provided by operating activities before changes in operating assets and liabilities was $5.4 million for the nine months ended March 31, 1999 as compared with $19.7 million for the nine months ended March 31, 1998. The changes in operating assets and liabilities, as shown in the Condensed Consolidated Statements of Cash Flows, resulted in $4.9 million of cash outflow during the nine months ended March 31, 1999 compared with a cash outflow of $18.4 million during the nine months ended March 31, 1998. Cash outflow in the nine months ended March 31, 1999 was primarily due to the increase in gaming machines used in participation leases and an increase in receivables, offset, in part, by a reduction in income tax receivables and an increase in accounts payable from the comparable balances at June 30, 1998. The cash 17 21 outflow for the nine months ended March 31, 1998 was primarily due to increased inventories and income tax receivables from the comparable June 30, 1997 balances. Cash used by investing activities was $3.2 million for the nine months ended March 31, 1999 compared with cash provided of $37.8 million for the nine months ended March 31, 1998. Cash used for the purchase of property, plant and equipment during the nine months ended March 31, 1999 was $6.3 million compared with $3.6 million for the nine months ended March 31, 1998. Net cash of $3.1 million was provided from the sale of short-term investments during the nine months ended March 31, 1999 compared with $41.4 million from the sale of short-term investments in the prior year's nine-month period. Cash provided by financing activities, which was primarily from common stock option proceeds, for the nine months ended March 31, 1999 was $6.9 million compared with $13.9 million for the nine months ended March 31, 1998. YEAR 2000 UPDATE The term Year 2000 is used to refer to a worldwide computer-related problem where some software programs and embedded programs in electronic systems will not work properly when processing a date after 1999. We began addressing this problem in 1996. We believe that most of the systems utilized for our internal operations have been made Year 2000 ready, at an estimated cost of $1.3 million. The remaining Year 2000-related work is primarily to upgrade our network servers. This work is expected to be completed by September 30, 1999, at a cost estimated to be less than $200,000. We believe that there are no Year 2000 issues with respect to the functionality of our products sold in the past or to be sold in the future. We also believe that our assembly of products will not be affected by malfunctioning tools or equipment using embedded microprocessors, because the assembly process is not heavily reliant on such tools or equipment. We rely on suppliers of components for our gaming machines and pinball games. In the event that they experience a Year 2000-related failure, they may expose us to Year 2000 problems. We have contacted certain suppliers and customers to assess their potential Year 2000 problems. We cannot determine with certainty our customers' or suppliers' levels of Year 2000 readiness. Based on the significant level of responses, however, our suppliers and customers appear to be either Year 2000-ready or working toward becoming Year 2000-ready. We will continue to follow up with those customers and suppliers who have not responded or indicated that their Year 2000 work is in process. If needed, to avoid potential Year 2000 problems detected by our suppliers or customers, we will adjust the shipping dates for products accordingly. At worst, we would expect a short-term delay in shipments. If a delay should occur, we do not expect it to have a material effect on our operating results for any reportable period. We do not have a contingency plan for undetected Year 2000 problems. We intend to respond to those problems if and when they occur. We cannot determine the effect on our business, if any, of any undetected Year 2000 problems. This discussion of Year 2000 risks and readiness contains certain forward-looking statements concerning future conditions and our business outlook based on currently available information that involve risks and uncertainties. The actual state of our Year 2000 readiness and exposure could differ materially from that anticipated in the forward-looking statements as a result of certain risks and uncertainties, including, without limitation, the ability to obtain supplies and energy, to make deliveries, to communicate with business partners and the Year 2000 readiness of suppliers, customers and other business partners. 18 22 BUSINESS COMPANY OVERVIEW We are a leading designer, manufacturer and marketer of innovative video and reel spinning gaming machines, video lottery terminals and pinball games. Our primary focus is the growth of our gaming machine business. We seek to develop gaming machines that offer greater entertainment value than traditional slot machines and generate greater revenues for casinos and other gaming machine operators. Our gaming machines incorporate secondary bonus rounds, advanced graphics, digital sound and engaging game themes, some of which include popular songs and recognized trademarks. Our gaming machines are installed in all of the major gaming jurisdictions in North America and in several foreign jurisdictions. Our gaming machine revenues increased 127% from $34.8 million in the first nine months of fiscal 1998, to $79.1 million in the first nine months of fiscal 1999. In June 1997, we introduced Reel 'Em In, our first single-themed multi-coin, multi-line video gaming machine that incorporates a secondary bonus game. Our multi-coin, multi-line gaming machines accept up to 90 coins at a time and have up to nine distinct pay lines, giving the players more ways to win. In addition, secondary bonusing creates a "game-within-a-game" that rewards players by offering them a chance to advance from the primary game to a secondary game. The secondary game also gives the players additional payoff opportunities and allows them to interact with the game by choosing from various entertaining options in the bonus round. The success of Reel 'Em In led to our introduction of a series of video gaming machines based on this new-generation design. This series includes Winning Bid, Top Banana, Filthy Rich, Jackpot Party, Life of Luxury, Boom! and Instant Winner, each featuring a unique and entertaining theme. The multi-coin, multi-line and secondary bonus features and our highly-entertaining themes are designed to attract new players, encourage repeat play and increase the average wager per play. In the fall of 1998, we introduced a series of four Monopoly-themed gaming machines that were named the "Most Innovative Gaming Product for 1999" at the American Gaming, Lodging and Leisure Summit. We are the exclusive worldwide licensee of the widely-recognized Monopoly trademark for use on gaming machines. Since their introduction, these machines have typically generated average daily revenue significantly in excess of the average daily revenue of the casinos' other gaming machines. For example, in Nevada during the first quarter of 1999, these machines generated average daily revenue of more than twice the casinos' average daily revenue per machine. As a result of their superior earnings, we have been able to offer our Monopoly-themed gaming machines to casino operators on a revenue participation or daily lease basis. This allows us to share in the superior earnings of these gaming machines and to generate recurring revenues. As of March 31, 1999, we had installed 1,814 Monopoly-themed gaming machines. We are also the world's leading pinball game designer and manufacturer. We recently developed Pinball 2000, which is a new-generation platform for pinball games that integrates a fully-interactive video monitor with the traditional playfield. We introduced our first Pinball 2000 game, Revenge From Mars, in March 1999, and we introduced our second Pinball 2000 game, Star Wars: Episode I, in July 1999. We also manufacture coin-operated video amusement games for Midway Games Inc., our former subsidiary. INDUSTRY OVERVIEW Gaming Machine Industry In the 1990's, the proliferation of gaming into new jurisdictions, particularly gulf coast and midwestern states and Native American nations, and the expansion of traditional gaming markets substantially increased the number of gaming machines in North America. We estimate that, as of the end of 1998, the installed base of gaming machines in North America was more than 525,000 units. We expect that the installed base of gaming machines in North America will continue to grow with the opening of new mega-resort casinos in Las Vegas and Atlantic City, the expansion of riverboat and Native American gaming 19 23 markets and the opening of the Detroit market to casino gaming. The demand for gaming machines is increasingly driven, however, by the replacement cycle for the existing base of gaming machines. While the physical useful life of a gaming machine can be up to a decade or more, casino operators tend to replace machines on a shorter cycle in response to changing player preferences and new technology. With fewer opportunities available to develop new casinos, we believe that casino operators are focusing on increasing revenue growth at their existing casinos. In North America, gaming machines produce approximately two-thirds of the typical casino's gaming revenue, with table games representing most of the balance. Additionally, slot operations are significantly less labor intensive than table games, and as a result have higher operating margins. The importance of slot revenue to a casino operator's profitability has created significant demand for gaming machines that have the ability to generate higher revenue per machine. As a result, the pace of innovation in gaming machine design has accelerated, and gaming equipment manufacturers have increasingly focused on enhancing the overall entertainment value of gaming machines. Historically, the gaming machine market was dominated by reel spinning slot machines, which still constitute the majority of machines on casino floors. Video poker gaming machines were introduced in the 1980s. These machines offer the player an interactive gaming experience not offered by traditional reel- spinning slots, because the player makes choices during play that affect the game. We believe that the two most significant recent developments in gaming machine design have been the extension of the video gaming platform beyond video poker and the introduction of secondary bonus rounds: - The introduction of video gaming machines that simulate a reel spinning slot machine on a video screen expanded the video platform beyond video poker. These new-generation video gaming machines are predominantly multi-coin, multi-line gaming machines that offer multiple distinct paylines and allow up to 90 coins to be wagered on a single play. This tends to increase the average wager per play. We believe that multi-coin, multi-line gaming machines are currently the fastest growing segment on the casino floor. - Secondary bonusing, or the game-within-a-game concept, allows a player to advance beyond the primary round into a bonus round if the player obtains a certain result in the primary game. The bonus round is designed to create significant player appeal by giving the player various unique interactive options and a sense of investment in the game. This encourages the player to continue to play the machine in an effort to achieve the bonus round. In addition, the bonus round gives designers an additional opportunity to incorporate entertaining content into gaming machines. Over the next few years, we expect significant demand for multi-coin, multi-line video gaming machines and other gaming machines that offer the player secondary bonus rounds and other enhanced entertainment features, which we believe will result in higher revenue per machine for casinos. Some of the new-generation gaming machines with secondary bonusing features and entertaining themes earn significantly more than the older gaming machines on the casino floors. As a result, the manufacturers have been able to lease some of these machines to casino operators for a revenue participation percentage or, in jurisdictions where this is not permitted, for a fixed daily lease fee. This allows manufacturers to share in the superior earnings of these games and to generate a recurring revenue stream for themselves. We estimate that at least 21,000 gaming machines are currently placed under recurring revenue arrangements throughout North America. Video lottery terminals ("VLTs") include both video and reel spinning gaming machines. VLTs are purchased, leased or operated on a revenue-participation basis to raise revenue for the jurisdictions where they are placed. Most VLTs are linked to a central computer for accounting and security purposes and are monitored by the state lotteries or other government authorities. Unlike gaming machines designed for the casino market, most VLTs are located in places where casino-type gaming is not the principal attraction, such as racetracks, bars and restaurants. 20 24 Pinball Industry Pinball games are found in amusement arcades, family entertainment centers, restaurants, bars, bowling alleys, convenience stores and movie theaters, primarily in Europe and North America. We believe that there are at least several hundred thousand coin-operated pinball games installed throughout the world, although no reliable figures are available. The worldwide pinball market has declined from, we believe, a high of approximately 100,000 units sold in 1993 to a low in 1998 of only about 15,000 units sold. We believe that this decline was caused by increased competition from other forms of entertainment, including coin-operated video games and home entertainment systems, as well as by a lack of design innovation. In our experience, however, the pinball market has been cyclical, recovering when a new generation of pinball technology is introduced. The only manufacturers of pinball games today are WMS, with about a two-thirds market share, and Sega Pinball. BUSINESS STRATEGY Gaming Our business strategy is primarily focused on the growth of our gaming machine business. We intend to increase our market penetration in the major North American gaming jurisdictions. We also plan to expand distribution to new gaming jurisdictions and internationally. We seek to increase our market share and profitability by offering an expanding portfolio of entertaining gaming machines with higher earning potential. This strategy includes the following elements: - Leverage our strength in developing gaming machines with enhanced entertainment value: We believe that our 53 years of experience in designing successful arcade-style amusement games with creative and compelling content, together with our use of new technology, allows us to create gaming machines that offer significantly greater entertainment value than traditional gaming machines. Our gaming machine development teams combine the talents of 95 engineers, designers, artists and musicians. We believe that we are well-positioned to develop gaming machines that have superior entertainment value and generate higher revenue for our customers. We are currently developing numerous innovative and entertaining gaming machines, some of which we expect to offer only on a recurring revenue basis. - Maximize the potential of our exclusive license for use of the Monopoly theme on gaming machines: As the exclusive licensee of the Monopoly name for use with gaming machines, we have converted a popular trademark into a successful line of four superior-earning gaming machines. The success of these Monopoly-themed gaming machines has allowed us to lease them to casino operators, generating recurring revenues for us. We are currently developing two new gaming machines based on the Monopoly theme, and we anticipate introducing additional gaming machines based on this theme. - Focus on the multi-coin, multi-line video gaming machine market: We believe that the fastest growing product on the casino floor is the multi-coin, multi-line gaming machine. We believe that the growth of this type of game will continue because these gaming machines offer more interactive entertainment value and because casino managers wish to increase the diversity of the gaming machines on their slot floors. Our portfolio of multi-coin, multi-line gaming machines has established us as a leading supplier of this type of video gaming machine. We are developing a number of additional multi-coin, multi-line video gaming machines and expect to increase the rate at which we introduce these machines in the future. Pinball We are the world's leading designer and manufacturer of pinball games. The pinball market has declined significantly in recent years, due to the growth of competition from video and other amusement games. Historically, however, the pinball market has been cyclical, recovering when a new generation of pinball 21 25 technology is introduced. Therefore, we have invested in the new technologies behind Pinball 2000. Pinball 2000 games integrate a fully-interactive video monitor with traditional playfield action. Our strategy is to introduce at least two to three new Pinball 2000 games each year in order to offer our distributors and players a continuing variety of new games with engaging game themes. We introduced our first Pinball 2000 game, Revenge From Mars, in March 1999. We have sold approximately 7,000 Revenge From Mars pinball games, which is the largest number of units of any pinball game sold since 1994. We introduced our second Pinball 2000 product, Star Wars: Episode I, in July 1999, and we are developing a third Pinball 2000 game that we intend to introduce in the second half of fiscal 2000. We intend to continue to evaluate the market potential of Pinball 2000 to determine whether this new platform has succeeded in stimulating a recovery in the pinball market. PRODUCTS Gaming We have established a fast-growing line of video and reel spinning gaming machines and VLTs incorporating highly-entertaining themes and innovative gaming features. Our gaming machines' technological features include dotmatrix animation ("Dotmation") displays for reel spinning slot machines, touch-screen video displays for video gaming machines, advanced graphics and our digital compression DCS Sound System ("DCS") music, voice-overs and sound effects. Engaging and humorous themes and a high degree of player interactivity are incorporated into each of our games, particularly in the secondary bonus round. We believe that by designing gaming machines that are fun and interesting to play and incorporate the latest gaming technologies, we supply gaming machines with superior player appeal. Our gaming machines integrate a secondary bonus round with the traditional gaming machine to create a game-within-a-game for more exciting and interactive play. As players achieve various milestones in the primary round, they move on to play a secondary round for additional bonuses. The secondary round gives the player a sense of investment in the game and encouragement to continue wagering in the hope of entering the bonus round. The player can win in both the primary round and the secondary round. In our secondary rounds, the player has various choices to make regarding the bonus features. For example, in some games the player can select from a variety of tokens or characters that will be used to obtain or reveal the bonus. Amusing or familiar graphical and musical themes add to the player appeal of our gaming machines. Monopoly-themed gaming machines. In the fall of 1998, we introduced our first four Monopoly-themed gaming machines in Las Vegas under an exclusive worldwide license from Hasbro. These gaming machines have been well-received by both casinos and players. For example, in Nevada during the first quarter of 1999, these machines generated average daily revenue of more than twice the casinos' average daily revenue per machine. Our Monopoly-themed gaming machines were named the "Most Innovative Gaming Product for 1999" at the American Gaming, Lodging and Leisure Summit in January of 1999. Our game designers used the actual elements of the Monopoly game to create the four highly interactive and entertaining machines. These elements include Mr. Monopoly, Chance, Community Chest and the distinctive game board and tokens, with a big band theme song. To attract additional player attention, the machines are approximately nine feet tall. These gaming machines have now been approved for play in every major gaming jurisdiction in the United States. As of March 31, 1999, we had installed 1,814 of these new gaming machines. The Monopoly-themed gaming machines incorporate secondary bonus rounds and the entertaining themes described below: - Once Around -- a multi-coin, multi-line video gaming machine where the player can build houses and hotels on various Monopoly properties to increase those properties' bonus round payouts. The player then chooses a token that travels around the board landing on various properties to collect bonuses. 22 26 - Reel Estate -- a multi-coin, multi-line video gaming machine where the player picks a token that travels around the Monopoly board. Collecting all the properties in a color group provides a free spin. - Advance to Boardwalk -- a reel spinning slot machine that features up to six trips around a Monopoly board for bonuses and multipliers. - Roll & Win -- a reel spinning slot machine that provides bonus multipliers by rolling oversized mechanical dice. The player accumulates bonuses by moving around a mini-Monopoly board. Multi-coin, multi-line video gaming machines. Our new line of multi-coin, multi-line gaming machines combines advanced graphics, DCS sound effects and music, secondary bonus rounds and a unique entertaining theme for each game. In the primary round, the video screen of these gaming machines simulates traditional reel-spinning slot machines. Depending on the machine, the player can wager up to either 45 or 90 coins per play. This new line of multi-coin, multi-line gaming machines includes the following: - Winning Bid -- Live auction theme. Features necklaces, vases and antique lamp symbols. Three or more gavel symbols begin the bonus round, which simulates a live estate auction. The player selects an auction item and a humorous character to start the bidding. As the characters raise the bids, the bonuses increase. Introduced in June 1999. - Top Banana -- Caribbean party theme. Features beach party symbols of bananas, starfish and tropical fruit. Three or more gorilla, hippo or turtle symbols start the bonus round. In the bonus round, the player has the option to stack a number of different silly monkeys. The player decides when to jump for bananas held by a gorilla in a palm tree. If the monkeys get the bananas, the player wins additional bonuses. There is also a random multiplier bonus possibility. Introduced in April 1999. - Instant Winner -- Instant lottery ticket theme. Features 3-D lottery balls and cash symbols. Three "Scratch & Win" symbols begin the bonus round. The player selects from six WMS-themed scratch-off tickets and scratches off areas of the tickets to reveal the bonus award. There is also a bonus "sweepstakes" check if the player obtains three or more sweepstakes symbols. Introduced in February 1999. - Jackpot Party -- 70's party theme. Features music from KC & the Sunshine Band and The Village People. Three or more party horn symbols start the bonus round and the disco music. The player chooses party gifts for hidden bonuses until hitting a party gift with one of the "party pooper" characters, which ends the bonus round. Introduced in October 1998. - Life of Luxury -- Material extravagance theme with numerous betting options. Features images of sports cars, diamonds and yachts as symbols. Obtain three or more gold coin symbols to receive ten free bonus spins while jazz music plays. Introduced in September 1998. - Boom! -- Fourth of July backyard barbecue theme. Features hotdogs, hamburgers and fireworks. Three or more identical barbecue food symbols start the bonus round. In the bonus round, the player selects a rocket that launches into the sky and explodes to reveal a bonus. Introduced in April 1998. - Filthy Rich -- Barnyard theme. Features cows, chickens and pig symbols. Three or more identical barnyard symbols begin the bonus round. The player then sees a pigpen on the screen and may choose which mud-caked pig to wash off, revealing the amusing bonus pig. Introduced in November 1997. - Reel 'Em In -- Family fishing theme. Features symbols of lures and fish. Three or more fishing lure symbols begin the bonus round. The player then "goes fishing" by choosing a humorous character to hook the bonus fish. Introduced in July 1997. In May 1998, Chance magazine called Reel 'Em In "perhaps the hottest slot machine in the country." 23 27 Other video games. We also offer a selection of other video gaming machines, including Multi-Pay Plus, which premiered our new-generation graphics and sound design. Multi-Pay Plus offers the player a varied menu of engaging themed games on a single machine, including video poker, keno, blackjack and video slot games. Reel spinning slot machines. Our new line of reel spinning slot machines includes Perfect Match, Jackpot Limbo, Jackpot Party, X-Factor, Jackpot Stampede Deluxe, Pharaoh's Fortune, Big Bang Piggy Bankin' and Winning Streak. Each of these gaming machines features engaging and entertaining themes. With secondary bonusing through the use of our Dotmation feature, a player's game experience is enhanced with animated sequences of mermaids diving into the ocean or genies emerging from magic lamps to present the top awards. These reel spinning slot machines also feature DCS sound and exciting glass designs and visuals. Video Lottery Terminals. Our VLTs include both video and reel spinning gaming machines. They feature advanced graphics and DCS sound effects and music and incorporate many of the same features as our other gaming machines. We offer a variety of multi-game and single-themed VLTs. Our VLTs may be operated as stand-alone units or may interface with central monitoring computers operated by governmental agencies. Our VLTs are located in places where casino-type gaming is not the principal attraction, such as racetracks, bars and restaurants. Pinball and cabinets Pinball. We are the world's leading designer and manufacturer of pinball games. For over 50 years, WMS and our predecessors have been making innovative and highly-entertaining pinball games, which are presently sold under the Williams and Bally trademarks. We believe that we obtained our leading market share as a result of the fun and humor that we design into our games, as well as our innovations in design and engineering. These innovations include CD-quality music and sound effects, multi-level playing fields, multi-ball releases and a high level of mechanical reliability. Pinball 2000, our new generation of pinball games, integrates a fully-interactive video monitor with traditional playfield action. Virtual images are projected onto the playfield, allowing the ball to interact with video targets as well as traditional 3-D targets. For example, the ball appears to destroy Martians or space ships, and the video display illustrates the destruction in dramatic fashion. Images on the video screen move and are transformed during the play depending on the movement of the balls. The new stereo sound system places speakers closer to the player for maximum enjoyment at any volume level. There may be multiple balls in play at one time, and the ball may move onto more than one level on the playfield for added excitement. We believe that Pinball 2000 products are the most advanced and entertaining pinball games designed to date. We also believe that our modular Pinball 2000 machines offer the best mechanical reliability and serviceability in the industry for the following reasons: - This new platform is modular, allowing the games to be changed by replacing the software, artwork and removable playfield. Conversion kits are expected generally to be installable in less than half an hour on site and are expected to be less expensive than a new game. Therefore, the machine owners will be able to upgrade to a new game easily and cost effectively. - The location owner can service the machine without calling the operator. For example, the owner can clean the playfield and clear ball jams. This is because, for the first time, the playfield is accessible by the location owner. This feature significantly decreases down time and service costs. - The advanced design of this platform uses fewer moving parts, and therefore these machines require less frequent service than older models. We introduced our first Pinball 2000 game, Revenge From Mars, in March 1999. We have sold approximately 7,000 of these games. We began selling our second Pinball 2000 product, Star Wars: Episode I, in July 1999. 24 28 Cabinets. In addition to manufacturing our own wooden pinball cabinets, we also make and sell wooden cabinets and other wooden products to Midway, under a Cabinet Supply Agreement, and to other third parties from time to time, primarily for coin-operated video games. See "Certain Relationships and Related Transactions." Contract manufacturing We manufacture coin-operated video games for Midway under a manufacturing agreement. See "Certain Relationships and Related Transactions." DESIGN, RESEARCH AND PRODUCT DEVELOPMENT In designing our gaming machines and pinball games, our designers, engineers and artists build upon the more than 50 years of experience that WMS and our predecessors have in designing and developing fun, humorous and exciting games. We are continually developing new games in order to broaden our product line, introduce new technologies and enhance player appeal. Our gaming machines are usually designed by our internal gaming design teams or in some cases by independent designers under contract to us. Gaming machines must be approved and sometimes tested by certain regulatory authorities before being marketed. Our pinball games are designed exclusively by our internal design teams. As of July 9, 1999, 142 persons were employed in our design, research and development teams, of whom 95 were dedicated to gaming. During the fiscal years ended June 30, 1998, 1997, and 1996, we spent approximately $12.9 million, $12.9 million and $13.4 million, respectively, on design, research and product development, of which $7.9 million, $7.4 million and $5.4 million was spent for gaming, in those respective years. While we primarily seek to develop original proprietary games, certain of our gaming machines and pinball games are based on popular intellectual properties licensed from third parties, such as Hasbro and Lucasfilm. Typically, WMS is obligated to make certain minimum guaranteed royalty payments over the term of the license and to advance payment against those guarantees. SALES AND MARKETING Gaming We are authorized to sell our gaming machines directly to casinos in over 90 North American jurisdictions and in several other gaming jurisdictions. Generally, we sell our gaming machines directly in order to maximize customer service and to enhance profitability. Our gaming machines are often installed on a trial basis, and only after a successful trial period are the machines purchased by the customers. In addition, we have begun to place our gaming machines under revenue-participation or daily rental leases. We sell and lease our gaming machines through 15 salespeople in offices in several United States locations and a sales/service consultant in Canada. These salespeople earn a salary and commissions based on sales volume. Our gaming machines are marketed through trade shows, promotional videotapes, our website and advertising in trade journals. Pinball Pinball games are marketed through approximately 50 independent distributors worldwide, coordinated by Midway's coin-operated machine sales team, under our sales agreement with Midway. See "Certain Relationships and Related Transactions." Distributors sell these products to operators of amusement arcades, family entertainment centers, restaurants, bars, bowling alleys, convenience stores and movie theaters. Distributors generally are assigned designated exclusive territories and are generally expected to provide replacement parts and service and to arrange for installment financing. Pinball games are marketed through trade shows, promotional videotapes, our website and advertising in trade publications. In addition, we operate an Internet locator on our website through which players can find the locations of our pinball games throughout the world. 25 29 Distributors/Customers In fiscal 1998, no one customer accounted for greater than 10% of our revenues. However, our largest pinball distributor, Nova Games Import-Export GmbH and affiliates accounted for approximately $12.0 million, or 15.7%, of total revenues for fiscal 1997 and approximately $14.0 million, or 15.0%, of total revenues for fiscal 1996. In our opinion, the loss of a single customer would not have a material adverse effect on our business. If we were to lose a distributor, we believe that we could make arrangements with alternate distributors for the distribution of our products. Export Sales Export sales of our products, primarily of pinball games to Western Europe, were approximately $24.4 million, or 24.6% of total revenues, for fiscal 1998, compared with $33.7 million, or 44.0% of total revenues, for fiscal 1997 and $41.4 million, or 44.4% of total revenues, for fiscal 1996. Substantially all foreign sales are made in United States dollars under letters of credit. COMPETITION Gaming The gaming machine market is intensely competitive and is characterized by the continuous introduction of new titles and the development of new technologies. Our ability to compete successfully in this market is based, in large part, upon our ability to: - continually develop new products with player appeal; - offer machines that consistently out-perform other gaming machines; - identify and obtain rights to commercially marketable intellectual properties; and - adapt our products for use with new technologies. In addition, successful competition in this market is also based upon: - price or lease terms; - mechanical reliability; - brand recognition; and - marketing support. Our competitors vary in size from very small companies with limited resources to large corporations with greater financial, marketing and product development resources than ours. In the video and reel spinning gaming machine market, we compete with market leader International Game Technology ("IGT"), as well as Alliance Gaming, Sigma Game, Casino Data Systems, Silicon Gaming, Atronic Casino Technology, Anchor Gaming and Aristocrat Leisure Systems. In the VLT market, we compete primarily with IGT, G-Tech Holdings, Anchor Gaming and Spielo Gaming International. Pinball and cabinets We are the leading manufacturer of pinball games. Our only competitor in this market is Sega Pinball. We also compete against coin-operated video games and other amusement games for space in bars, arcades and other traditional pinball locations and with home entertainment systems. Competition is based on player appeal, including the use of popular intellectual properties, engaging themes and technological innovation. In addition, successful competition in our pinball market is also based upon: - price; - mechanical reliability; - brand recognition; and 26 30 - access to distribution channels. We also currently supply Midway with cabinets for their coin-operated video games. Midway is not required to purchase cabinets under the agreement and may seek competing third-party bids at any time. MANUFACTURING Gaming We manufacture our gaming machines in our facility in Chicago, Illinois. We believe that this facility is adequate for our current and planned gaming production needs. Manufacturing is generally based on purchase orders from customers. Gaming machines are generally warranted for a period of 90 days. The raw materials used in manufacturing our gaming machines include various metals, plastics, wood and glass obtained from numerous sources. In addition, numerous component parts including electronic subassemblies and video monitors are purchased from suppliers. We believe that our sources of supply of component parts and raw materials are adequate and that alternative sources of materials are available. Pinball and cabinets We manufacture pinball games in our facility in Waukegan, Illinois. We believe that this facility is adequate for our current and planned pinball production needs. Production of pinball games is generally based on advance purchase orders from distributors. Most pinball games are warranted for a period of 60 to 90 days. We manufacture cabinets for our pinball games and Midway's coin-operated video games in our facility in Cicero, Illinois based, in the case of Midway's cabinets, on purchase orders, subject to our acceptance, according to Midway designs and specifications. We believe that this facility is adequate for our current and planned cabinet production needs. Contract manufacturing We manufacture Midway's coin-operated video games in our facility in Waukegan, Illinois. We believe that this facility is adequate for our current and planned contract manufacturing needs. Manufacturing for Midway is based on purchase orders and uses Midway designs and specifications. EMPLOYEES At July 9, 1999, we employed approximately 1,470 persons. Approximately 770 of those employees were represented by the International Brotherhood of Electrical Workers (the "IBEW"), and approximately 140 were represented by the International Union of Electronic, Electrical, Salaried Machine and Furniture Workers (the "IUE"). The collective bargaining agreements with the IBEW relate to our Chicago and Waukegan, Illinois manufacturing facilities, respectively, and expire on June 30, 2000. The collective bargaining agreement with the IUE relates to our Cicero, Illinois manufacturing facility and expires June 30, 2002. We believe that our relations with our employees are satisfactory. LEGAL PROCEEDINGS IGT Litigations In May 1994, we instituted a declaratory judgment action against IGT in the United States District Court for the Northern District of Illinois. The action sought a declaration that a patent issued in 1984 and owned by IGT (the "Telnaes Patent") was invalid, and that certain reel spinning slot machines that we were then manufacturing did not infringe the Telnaes Patent. IGT counterclaimed, alleging that the Telnaes Patent was infringed by our reel spinning slot machines. The Telnaes Patent relates to a particular method of assigning the probability of selecting particular reel stop positions in a computer-controlled reel spinning slot machine, which increases or decreases the probabilities of winning by means of the computer's software, not the mechanical reels themselves. On September 19, 1996, the trial court rendered a decision in favor of IGT, finding that the Telnaes Patent is valid, finding that our Model 400 slot machine infringes the Telnaes Patent, and enjoining us 27 31 from further infringement of the Telnaes Patent. On February 28, 1997, after a hearing on IGT's alleged damages, the court awarded a treble-damage judgment in favor of IGT and against us in the amount of $32,845,189, plus post-judgment interest. Subsequently, the court granted our motion for a stay of proceedings to enforce the money judgment pending disposition of our motion for a new trial and a similar stay pending appeal. On October 1, 1997, the court denied our motion for a new trial. We filed a notice of appeal on October 20, 1997. Since we had previously filed a bond, enforcement of the money judgment has been stayed pending the disposition of the appeal. The appeal is now pending before the United States Court of Appeals for the Federal Circuit. On November 26, 1996, IGT commenced an action against us in the same court. In this action, IGT seeks a judgment declaring that our Model 401 slot machine also infringes the Telnaes Patent. The complaint also seeks a preliminary and permanent injunction and treble damages. On December 18, 1996, the court granted IGT's motion for a preliminary injunction and enjoined us from the manufacture, use and sale of the Model 401 slot machine. On May 5, 1998, the court denied our motion to vacate the preliminary injunction. We filed a notice of appeal on May 7, 1998. The appeal of the preliminary injunction order is now pending before the United States Court of Appeals for the Federal Circuit. In the event that the court ultimately determines that these slot machines infringe upon the Telnaes Patent, and if we are unable to obtain a license to use the Telnaes Patent, we will be unable to develop certain types of reel spinning slot machines, and we may be required to pay additional damages. The Telnaes Patent relates only to reel spinning slot machines that we no longer manufacture and does not relate to our video gaming machines or to our currently marketed reel spinning slot machines. GT Interactive Litigation GT Interactive Software Corp. distributes some of Midway's home video games. On January 25, 1999, GT Interactive filed suit against Midway, WMS and certain of their respective subsidiaries in the Supreme Court of the State of New York, County of New York, alleging breach of contract and other claims arising from the distribution arrangements. In its complaint, GT Interactive seeks compensatory and punitive damages, and injunctive relief. Midway has informed us that it believes that the claims made by GT Interactive are without merit, and Midway intends to vigorously defend against this lawsuit. Under agreements previously entered into between WMS and Midway, we assigned all of our rights under the distribution arrangements to Midway, and Midway is obligated to indemnify and defend us from any liabilities arising from this lawsuit. On May 21, 1999, the court granted a motion to dismiss some of the claims alleged in the complaint and struck the request for punitive damages. On May 27, 1999, Midway and the other defendants filed an answer, together with counterclaims. We anticipate that discovery will begin shortly. Other Litigation We are not currently involved in any legal proceeding that we believe could have a material adverse effect on us other than those described above. 28 32 GOVERNMENT REGULATION GENERAL The manufacture and distribution of gaming equipment is subject to extensive federal, state, tribal, local and foreign regulation. Although the laws and regulations of the various jurisdictions in which we operate vary in their technical requirements and are subject to amendment from time to time, virtually all of these jurisdictions require licenses, permits, documentation of qualification, including evidence of financial stability, and other forms of approval for companies engaged in the manufacture and distribution of gaming machines as well as for the officers, directors, major stockholders and key personnel of those companies. We have obtained the required licenses to manufacture and sell our products to customers in the following domestic gaming jurisdictions: Arizona, Colorado, Connecticut, Delaware, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Jersey, New Mexico, North Dakota, Oregon, Puerto Rico, Rhode Island, South Dakota, West Virginia, Wisconsin, Ak-Chin Indian Community, Bad River Band of Lake Superior Tribe of Chippewa Indians, Bay Mills Indian Community, Boise Forte Band of Minnesota Chippewa (Nett Lake), Chitimacha Tribe of Louisiana, Coushatta Tribe of Louisiana, Flandreau Santee Sioux Tribe, Fond du Lac Band of Minnesota Chippewa, Fort McDowell Mohave-Apache Indian Community, Grand Portage Band of Minnesota Chippewa, Grand Traverse Band of Ottawa & Chippewa Indians, Hannahville Indian Community, Ho-Chunk Nation, Iowa Tribe of Kansas & Nebraska, Keweenaw Bay Indian Community, Kickapoo Tribe of Indians in Kansas, Lac du Flambeau Band of Lake Superior Chippewa, Lac Vieux Desert Band of Lake Superior Chippewa Indians, Leech Lake Band of Minnesota Chippewa, Lower Sioux Indian Community, Mashantucket Pequot Tribe, Menominee Indian Tribe of Wisconsin, Mille Lacs Band of Minnesota Chippewa, Mississippi Band of Choctaw Indians, Mohegan Indian Tribe, Omaha Tribe of Nebraska, Oneida Tribe of Indians of Wisconsin, Pascua Yaqui Tribe, Prairie Band of Potawatomi Indians of Kansas, Prairie Island Community of the Minnesota Mdewakanton Sioux, Pueblo of Acoma, Pueblo of Isleta, Pueblo of Sandia, Pueblo of San Juan, Pueblo of Santa Ana, Pueblo of Tesuque, Red Cliff Band of Lake Superior Chippewa, Red Lake Band of Chippewa Indians, Sac & Fox Nation of Missouri in Kansas and Nebraska, Sac & Fox Tribe of Mississippi in Iowa, Saginaw Chippewa Indian Tribe, Sault Ste. Marie Tribe of Chippewa, Shakopee Mdewakanton Sioux Community, Sisseton-Wahpeton Sioux Tribe, Southern Ute Indian Tribe, Spirit Lake Sioux Tribe, St. Croix Chippewa Indians of Wisconsin, Standing Rock Sioux Tribe, Tunica-Biloxi Tribe of Louisiana, Turtle Mountain Band of Chippewa Indians, Upper Sioux Indian Community, Ute Mountain Ute Tribe, White Earth Band of Minnesota Chippewa, White Mountain Apache Tribe, Winnebago Tribe of Nebraska, Yankton Sioux Tribe of South Dakota, Yavapai-Apache Indian Community. We have also obtained the required licenses to manufacture and sell our products in the following additional gaming jurisdictions: the Canadian provinces of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland, Nova Scotia, Ontario, Quebec and Saskatchewan; Victoria and New South Wales in Australia; the Bahamas; and Greece. To date, we have never been denied any necessary governmental registrations, licenses, permits, findings of suitability or approvals. In addition, we believe that all registrations, licenses, permits, findings of suitability or approvals currently required have been applied for or obtained. We cannot assure you that the required licenses, permits, approvals or findings of suitability will be given or renewed in the future. NEVADA REGULATIONS The manufacture, sale and distribution of gaming machines for use or play in Nevada or for distribution outside of Nevada and the operation of slot machine routes are subject to the Nevada Gaming Control Act and the regulations promulgated under that act (collectively, the "Nevada Act"). The license as an operator of a slot machine route permits a licensee to place slot machines and gaming devices on the premises of other licensees on a participation basis. Our manufacturing, distributing and slot route operations are subject to licensing and regulatory control of the Nevada Gaming Commission (the 29 33 "Nevada Commission"), the Nevada State Gaming Control Board (the "Nevada Board") and, with respect to the operation of slot machine routes, various other county and city regulatory authorities (all of these authorities are collectively referred to as the "Nevada Gaming Authorities"). The laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy which are concerned with, among other things: (1) the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity; (2) the establishment and maintenance of responsible accounting practices and procedures; (3) the maintenance of effective controls over the financial practices of licensees, including the establishment of minimum procedures for internal fiscal affairs, and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Nevada Gaming Authorities; (4) the prevention of cheating and fraudulent practices; (5) providing a source of state and local revenues through taxation and licensing fees; and (6) the strict regulation of all persons, locations, practices, associations and activities related to the operation of licensed gaming establishments and the manufacture and distribution of gaming devices and associated equipment. A change in these laws, regulations and procedures could have an adverse effect on our future Nevada operations. Certain of our subsidiaries that manufacture and distribute gaming devices or operate a slot machine route, or which hold stock of a subsidiary which does so (a "Gaming Subsidiary"), are required to be licensed or registered by the Nevada Gaming Authorities. The licenses require periodic payments of fees and taxes and are not transferable. We are registered by the Nevada Commission as a publicly traded corporation ("Registered Corporation"), and so we are required periodically to submit detailed financial and operating reports to the Nevada Commission and to furnish any other information which the Nevada Commission may require. We have obtained from the Nevada Gaming Authorities the various registrations, findings of suitability, approvals, permits and licenses (collectively, "Licenses") required to engage in slot route operations, and the manufacture, sale and distribution of gaming devices for use or play in Nevada or for distribution outside of Nevada. We cannot assure you that these Licenses will not be revoked, suspended, limited or conditioned. All gaming devices that are manufactured, sold or distributed for use or play in Nevada, or for distribution outside of Nevada, must be manufactured by licensed manufacturers and distributed or sold by licensed distributors. All gaming devices manufactured for use or play in Nevada must be approved by the Nevada Commission before sales distribution or exposure for play. The approval process for gaming devices includes rigorous testing by the Nevada Board, a field trial and a determination as to whether the gaming machine meets strict technical standards that are set forth in the regulations of the Nevada Commission. Associated equipment (as defined in the Nevada Act) must be administratively approved by the Chairman of the Nevada Board before it is distributed for use in Nevada. The Nevada Gaming Authorities may investigate any individual who has a material relationship to, or material involvement with, us in order to determine whether that individual is suitable or should be licensed as a business associate of a licensee. Officers, directors and certain key employees of our Gaming Subsidiaries must file license applications with the Nevada Gaming Authorities. Our officers, directors and key employees who are actively and directly involved in activities of our Gaming Subsidiaries may be required to be licensed or found suitable by the Nevada Gaming Authorities. The Nevada Gaming Authorities may deny an application for licensing for any cause which they deem reasonable. A finding of suitability is comparable to licensing, and both require submission of detailed personal financial information followed by a thorough investigation. The applicant for licensing or a finding of suitability must pay all the costs of the investigation. Changes in licensed positions must be reported to the Nevada Gaming Authorities and, in addition to their authority to deny an application for a finding of suitability or license, the Nevada Gaming Authorities have jurisdiction to disapprove a change in a corporate position. If the Nevada Gaming Authorities were to find an officer, director or key employee unsuitable for licensing or unsuitable to continue having a relationship with us, the companies involved would have to sever all relationships with that person. In addition, the Nevada Gaming Authorities may require us to terminate 30 34 the employment of any person who refuses to file appropriate applications. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Nevada. We are required to submit detailed financial and operating reports to the Nevada Commission. Substantially all material loans, leases, sales of securities and similar financing transactions by our Gaming Subsidiaries must be reported to, and approved by, the Nevada Commission. If the Nevada Gaming Authorities determine that we violated the Nevada Act, our Licenses could be limited, conditioned, suspended or revoked, subject to compliance with certain statutory and regulatory procedures. In addition, we and the persons involved could be subject to substantial fines for each separate violation of the Nevada Act at the discretion of the Nevada Gaming Authorities. The limitation, conditioning or suspension of any License or the appointment of a supervisor could, and the revocation of any License would, materially adversely affect our future operations in Nevada. Any beneficial holder of our voting securities, regardless of the number of shares owned, may be required to file applications, be investigated and have his, her or its suitability as a beneficial holder of our voting securities determined if the Nevada Commission has reason to believe that ownership would otherwise be inconsistent with the declared policies of the State of Nevada. The applicant must pay all costs of investigation incurred by the Nevada Gaming Authorities in conducting any such investigation. The Nevada Act requires any person who acquires beneficial ownership of more than 5% of our voting securities to report the acquisition to the Nevada Commission. The Nevada Act requires that beneficial owners of more than 10% of our voting securities apply to the Nevada Commission for a finding of suitability within 30 days after the mailing of the written notice by the Chairman of the Nevada Board requiring that filing. Under certain circumstances, an "institutional investor," as defined in the Nevada Act, which acquires more than 10% but not more than 15% of our voting securities may apply to the Nevada Commission for a waiver of that finding of suitability if the institutional investor holds the voting securities for investment purposes only. An institutional investor shall not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as an institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of our board of directors, any change in our corporate charter, bylaws, management, policies or operations, or those of any of our gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding our voting securities for investment purposes only. Activities which are not deemed to be inconsistent with holding voting securities for investment purposes only include: (1) voting on all matters voted on by stockholders; (2) making financial and other inquiries of management of the type normally made by securities analysts for informational purposes and not to cause a change in our management policies or operations; and (3) other activities that the Nevada Commission may determine to be consistent with investment intent. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all costs of investigation. Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Commission or the Chairman of the Nevada Board may be found unsuitable. The same restrictions apply to a record owner if the record owner, after request, fails to identify the beneficial owner. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the voting securities of a Registered Corporation beyond that period of time as may be prescribed by the Nevada Commission may be guilty of a criminal offense. We are subject to disciplinary action if, after we receive notice that a person is unsuitable to be a stockholder or to have any other relationship with us, we: (1) pay that unsuitable person any dividend or interest upon our voting securities; (2) allow that person to exercise, directly or indirectly, any voting rights conferred through securities held by that person; (3) pay remuneration in any form to that person for services rendered or otherwise; or (4) fail to pursue all lawful efforts to require the unsuitable person to relinquish voting securities including, if necessary, the immediate repurchase of the voting securities for cash at fair market value. 31 35 The Nevada Commission may in its discretion, require holders of any debt security of a Registered Corporation to file applications, be investigated and be found suitable to own the debt security of a Registered Corporation if the Nevada Gaming Authorities has reason to believe that ownership of theses securities would otherwise be inconsistent with the declared policies of the State of Nevada. If the Nevada Commission determines that a person is unsuitable to own that security, then under the Nevada Act, the Registered Corporation can be sanctioned, including with the loss of its approvals, if, without the prior approval of the Nevada Commission, it: (1) pays to the unsuitable person any dividend, interest or any distribution whatsoever; (2) recognizes any voting right by the unsuitable person in connection with that security; (3) pays the unsuitable person remuneration in any form; or (4) makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction. We are required to maintain a current stock ledger in the State of Nevada which may be examined by the Nevada Gaming Authorities at any time. If any securities are held in trust by an agent or by a nominee, the record holder may be required to disclose the identity of the beneficial owner to the Nevada Gaming Authorities. A failure to make this disclosure may be grounds for finding the record holder unsuitable. We are also required to render maximum assistance in determining the identity of the beneficial owner. The Nevada Commission has the power to require that our stock certificates bear a legend indicating that the securities are subject to the Nevada Act. However, to date, the Nevada Commission has not imposed this requirement on us. We may not make a public offering of our securities without the prior approval of the Nevada Commission if the securities or the proceeds therefrom are intended to be used to construct, acquire or finance gaming facilities in Nevada, or to retire or extend obligations incurred for these purposes. We have filed an application requesting approval for this offering. This approval, if given, does not constitute a finding, recommendation or approval by the Nevada Commission or the Nevada Board as to the accuracy or adequacy of the prospectus or the investment merits of the securities. Any representation to the contrary is unlawful. Changes in control of WMS through merger, consolidation, stock or asset acquisitions, management or consulting agreements, or any act or conduct by a person whereby he or she obtains control, may not occur without the prior approval of the Nevada Commission. Entities seeking to acquire control of a Registered Corporation must satisfy the Nevada Commission and the Nevada Board in a variety of stringent standards prior to assuming control of the Registered Corporation. The Nevada Commission may also require controlling stockholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process relating to the transaction. The Nevada legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and corporate defense tactics affecting Nevada gaming licenses and Registered Corporations that are affiliated with those operations may be injurious to stable and productive corporate gaming. The Nevada Commission has established a regulatory scheme to ameliorate the potentially adverse effects of these business practices upon Nevada's gaming industry and to further Nevada's policy to: (1) assure the financial stability of corporate licensees and their affiliates; (2) preserve the beneficial aspects of conducting business in the corporate form; and (3) promote a neutral environment for the orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the Nevada Commission before we can make exceptional repurchases of voting securities above the current market price thereof and before a corporate acquisition opposed by management can be consummated. The Nevada Act also requires prior approval of a plan of recapitalization proposed by our board of directors in response to a tender offer made directly to the Registered Corporation's stockholders for the purpose of acquiring control of the Registered Corporation. License fees and taxes computed in various ways depending on the type of gaming or activity involved are payable to the State of Nevada and to the counties and cities in which the Nevada licensee's respective operations are conducted. Depending upon the particular fee or tax involved, these fees and taxes are 32 36 payable either quarterly or annually. Annual fees are also payable to the State of Nevada for renewal of licenses as a manufacturer, distributor and operator of a slot machine route. Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with any such person, and who proposes to become involved in a gaming venture outside of Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation by the Nevada Board of their participation in foreign gaming operations. The revolving fund is subject to increase or decrease in the discretion of the Nevada Commission. Thereafter, licensees are required to comply with certain reporting requirements imposed by the Nevada Act. The Nevada Board may require a licensee to file an application for a finding of suitability concerning an actual or intended activity or association of the licensee in a foreign gaming operation. A licensee is also subject to disciplinary action by the Nevada Commission if the licensee knowingly violates any laws of the foreign jurisdiction pertaining to the foreign gaming operation, fails to conduct the foreign gaming operation in accordance with the standards of honesty and integrity required of Nevada gaming operations, engages in activities that are harmful to the State of Nevada or its ability to collect gaming taxes and fees, or employs a person in the foreign operation who has been denied a license or finding of suitability in Nevada on the ground of personal unsuitability. RECENT NEVADA LEGISLATION On May 21, 1999 legislation became effective in the State of Nevada imposing additional requirements on persons who provide gaming machines to casino customers on a revenue participation basis. Among other things, the new law requires these persons to pay their "full proportionate share" of license fees and taxes imposed on gaming revenues generated by these participation gaming machines. Although the new law imposes some additional costs upon us, we do not believe that these costs will be material to our business. NEW JERSEY REGULATION The manufacture, distribution, and operation of gaming machines in New Jersey are regulated by the New Jersey Casino Control Commission (the "New Jersey Commission") under the New Jersey Casino Control Act and the regulations of the New Jersey Commission promulgated thereunder (collectively, the "New Jersey Act"). Under the New Jersey Act, a company must be licensed as a gaming related casino service industry ("CSI"), or fulfill other requirements, in order to manufacture or distribute gaming machines. In order for a CSI license to be issued or maintained, certain directors, officers, key employees and owners of a company must be found by the New Jersey Commission to possess by clear and convincing evidence good character, honesty, integrity and financial stability. We have been issued a CSI license by the New Jersey Commission. This license was issued for a two-year period and, upon proper application and satisfaction of the same requirements for the initial issuance of a license, may be renewed for four-year periods. However, the New Jersey Commission has the discretion to suspend, revoke, or refuse to renew a license if a licensee fails to continue to satisfy the requirements for licensure or violates the New Jersey Act. In addition, all gaming machines used in New Jersey casinos must be approved by the New Jersey Commission. In determining whether to approve gaming machines, the New Jersey Commission will consider various factors, including design, integrity, fairness, and honesty and may require a field test of the machine. MISSISSIPPI The manufacture, sale and distribution of gaming devises for use or play in Mississippi are subject to the Mississippi Gaming Control Act and the regulations promulgated thereunder (collectively, the "Mississippi Act"). These activities are subject to the licensing and regulatory control of the Mississippi Gaming Commission (the "Mississippi Commission") and the Mississippi State Tax Commission. Although not identical, the Mississippi Act is similar to the Nevada Act. 33 37 Our license to manufacture and distribute gaming equipment in Mississippi is not transferable, is issued for a two-year period and must be renewed every two years. As in Nevada, the Mississippi Commission may investigate and find suitable any individual who has a material relationship to, or material involvement with, us, including, but not limited to, record or beneficial holders of any of our voting securities and any other person whom the Mississippi Commission determines exercises a significant influence upon our management or affairs. We are required to maintain a current stock ledger in Mississippi which may be examined by the Mississippi Commission at any time. Any applicant for a finding of suitability must pay all investigative fees and costs of the Mississippi Commission in connection with the investigation. The Mississippi Act requires any person who acquires beneficial ownership of more than 5% of a Registered Corporation's voting securities to report the acquisition to the Mississippi Commission, and that person may be required to be found suitable. The Mississippi Act requires that beneficial owners of more than 10% of a Registered Corporation's voting securities apply to the Mississippi Commission for a finding of suitability. The Mississippi Commission exercises its discretion to require a finding of suitability of any beneficial owner of more than 5% of a Registered Corporation's common stock. Under certain circumstances, an "institutional investor," which acquires more than 5%, but not more than 10%, of the Registered Corporation's voting securities may apply to the Mississippi Commission for a waiver of the finding of suitability if the institutional investor holds the voting securities for investment purposes only and otherwise meets the regulatory requirements of the institutional investor waiver provisions. We may not make a public offering of our securities without the prior approval of the Mississippi Commission if the securities or proceeds therefrom are intended to be used to construct, acquire or finance gaming facilities in Mississippi, or to retire or extend obligations incurred for these purposes. The Mississippi Commission has the authority to grant a continuous approval of securities offerings and has granted this approval to us, which approval covers this offering, subject to an annual renewal of this approval. All loans by us must be reported to the Mississippi Commission and certain loans and other stock transactions must be approved in advance. If it were determined that we violated the Mississippi Act, the licenses that we hold could be limited, conditioned, suspended or revoked, subject to compliance with statutory and regulatory procedures, which action, if taken, could materially adversely affect our manufacturing and distribution of gaming machines. FEDERAL REGISTRATION Any of our subsidiaries that are involved in gaming activities are required to register annually with the United States Department of Justice, Criminal Division, in connection with the sale, distribution or operation of Gaming. The Federal Gambling Devices Act of 1962 makes it unlawful, in general, for a person to manufacture, deliver or receive gaming machines and components across state lines or to operate gaming machines unless that person has first registered with the Attorney General of the United States. We are required to register and renew our registration annually. We have complied with these registration requirements. In addition, various record keeping and equipment identification requirements are imposed by this act. Violation of the Federal Act may result in seizure and forfeiture of the equipment, as well as other penalties. REGULATION IN FOREIGN JURISDICTIONS Certain foreign countries permit the importation, sale and/or operation of gaming equipment. Where importation is permitted, some countries prohibit or restrict the payout feature of the traditional slot machine or limit the operation of slot machines to a controlled number of casinos or casino-like locations. Certain jurisdictions in which we operate require the licensing of gaming machines, gaming machine operators and manufacturers. We and our gaming machines have been properly licensed and approved or have applied for licensure and approval in all jurisdictions where our operations require licensure and approval. 34 38 NATIVE AMERICAN GAMING REGULATION Numerous Native American tribes have become engaged in or have licensed gaming activities on Indian lands as a means of generating tribal governmental revenue. We manufacture and supply gaming equipment for Native American tribes. Gaming on Native American lands, including the terms and conditions under which gaming equipment can be sold or leased to Native American tribes, is or may be subject to regulation under the laws of the tribes, the laws of the host state, the Indian Gaming Regulatory Act of 1988 ("IGRA"), which is administered by the National Indian Gaming Commission (the "NIGC") and the Secretary of the U.S. Department of the Interior (the "Secretary"), and also may be subject to the provisions of certain statutes relating to contracts with Native American tribes, which are administered by the Secretary. As a precondition to gaming involving gaming machines, IGRA requires that the tribe and the state enter into a written agreement (a "tribal-state compact") that specifically authorizes such gaming, and that has been approved by the Secretary, with the notice of approval published in the Federal Register. Tribal-state compacts vary from state to state. Many require that equipment suppliers meet ongoing registration and licensing requirements of the state and/or the tribe and some impose background check requirements on the officers, directors and shareholders of gaming equipment suppliers. Under IGRA, tribes are required to regulate all commercial gaming under ordinances approved by the NIGC. These ordinances may impose standards and technical requirements on main hardware and software and may impose registration, licensing and background check requirements on gaming equipment suppliers and their officers, directors and shareholders. REGULATORY CHANGES AND LICENSE STATUS The laws and regulations of the numerous jurisdictions, foreign and domestic, in which WMS and our gaming subsidiaries do business are subject to change from time to time. In addition, the license status of WMS and our gaming subsidiaries with respect to these jurisdictions is subject to change. The information set forth in this prospectus represents the most current available at the time of filing. 35 39 MANAGEMENT Our officers and directors are as follows:
NAME AGE POSITIONS WITH WMS - ---- --- -------------------------------------------------------- Louis J. Nicastro.................... 70 Chairman of the Board, President and Chief Executive Officer Norman J. Menell..................... 67 Vice Chairman of the Board Kevin L. Verner...................... 40 Vice President and Chief Operating Officer Harold H. Bach, Jr. ................. 66 Vice President -- Finance, Treasurer, Chief Financial and Chief Accounting Officer Orrin J. Edidin...................... 37 Vice President, Secretary and General Counsel Terence M. Dunleavy.................. 42 Vice President, Assistant General Counsel and Chief Compliance Officer William C. Bartholomay............... 70 Director(1)(2)(4) William E. McKenna................... 79 Director(2)(3)(4) Neil D. Nicastro..................... 42 Director(1) Harvey Reich......................... 70 Director(3) David M. Satz, Jr. .................. 73 Director(5) Ira S. Sheinfeld..................... 61 Director(2)
- --------------------------- (1) Nominating Committee member. Mr. Nicastro is chairman of this committee. (2) Audit and Ethics Committee member. Mr. McKenna is chairman of this committee. (3) Stock Option Committee member. Mr. Reich is chairman of this committee. (4) Compensation Committee member. Mr. Bartholomay is chairman of this committee. (5) Chairman of the Negotiating Committee and the Regulatory Compliance Committee. BIOGRAPHICAL INFORMATION Louis J. Nicastro has been our President and Chief Executive Officer since April 6, 1998 and was Chief Operating Officer from April 6, 1998 to May 14, 1998. He served as Chairman of the Board of WMS since our incorporation in 1974. From 1983 to January 1998, Mr. Nicastro was also the Chairman of the Board and Chief Executive Officer of WHG Resorts & Casinos. Mr. Nicastro also served as Co-Chief Executive Officer (1994-1996), Chief Executive Officer (1974-1994), President (1985-1988 and 1990-1991) and Chief Operating Officer (1985-1986) of WMS. Mr. Nicastro is a director of Midway, and he held various executive positions for Midway from 1988 until 1996. Mr. Nicastro is Neil D. Nicastro's father. Norman J. Menell has been Vice Chairman of the Board since 1990 and a director since 1980. He has also served as our President (1988-1990), Chief Operating Officer (1986-1990) and Executive Vice President (1981-1988). Mr. Menell is also a director of Midway. Kevin L. Verner has served as our Vice President and Chief Operating Officer since May 14, 1998, and as Executive Vice President and General Manager of WMS Gaming since February 1997. Previously, Mr. Verner served as Vice President and Director of New Business Development of R.J. Reynolds Tobacco Company from 1993 until February 1997. Harold H. Bach, Jr. has held the positions of Treasurer since 1994 and Vice President -- Finance, Chief Financial and Chief Accounting Officer since 1990. Additionally, Mr. Bach has served as Executive Vice President -- Finance, Chief Financial Officer and a director of Midway since August 1996. He served as Senior Vice President -- Finance and Chief Financial Officer of Midway from 1990 to August 1996, and he has served as Treasurer of Midway since December 1994. Prior to joining WMS, Mr. Bach was a partner in the accounting firms of Ernst & Young (1989-1990) and Arthur Young & Company (1967-1989). 36 40 Orrin J. Edidin has served as our Vice President, Secretary and General Counsel since May 1997. Mr. Edidin served as Associate General Counsel of Fruit of the Loom, Inc. from 1992 until May 1997. Mr. Edidin has also served as Vice President, Secretary and General Counsel of Midway since June 1997. Terence M. Dunleavy joined us in May 1997 and was appointed as Vice President, Assistant General Counsel and Chief Compliance Officer in June 1999. Mr. Dunleavy was Assistant General Counsel/ Director of Compliance of Mikohn Gaming Nevada, Inc. a gaming systems manufacturer, from April 1996 to November 1996, Senior Regulatory Attorney with Madison Gas & Electric Company, from December 1994 to January 1996 and Commissioner of the Wisconsin Gaming Commission from September 1992 to December 1994. William C. Bartholomay is President of Near North National Group, insurance brokers in Chicago, Illinois and Chairman of the Board of the Atlanta Braves. He has served as Vice Chairman of Turner Broadcasting System, Inc., a division of Time Warner Inc., for more than five years. Mr. Bartholomay was elected a director of WMS in 1981. Mr. Bartholomay is also a director of Midway. William E. McKenna has served as a General Partner of MCK Investment Company, Beverly Hills, California for more than five years. He also is a director of Midway, California Amplifier, Inc., Drexler Technology Corporation and Safeguard Health Enterprises, Inc. Mr. McKenna has served as a director of WMS since 1981. Neil D. Nicastro has been Midway's President and Chief Operating Officer for more than five years, Co-Chief Executive Officer since December 1994, Chairman of the Board and Chief Executive Officer since July 1996 and has held various other executive positions for Midway since 1988. Mr. Nicastro was also our President, Chief Executive Officer and Chief Operating Officer for more than five years before his resignation from those positions in April 1998. Mr. Nicastro became a director of WMS in 1986, and he remains a director and a consultant to us. Mr. Nicastro is Louis J. Nicastro's son. Harvey Reich was a member of the law firm of Robinson Brog Leinwand Greene Genovese & Gluck, P.C., New York, New York and its predecessor firms for more than five years until his retirement in July 1998. Mr. Reich was elected a director of WMS in 1983. Mr. Reich is also a director of Midway. David M. Satz, Jr. became a director of WMS in April 1998. Mr. Satz has been a member of the law firm Saiber Schlesinger Satz & Goldstein, Newark, New Jersey, for more than five years. Mr. Satz is also a director of the Atlantic City Racing Association. Ira S. Sheinfeld became a director of WMS in 1993. He has been a member of the law firm of Squadron, Ellenoff, Plesent & Sheinfeld LLP, New York, New York, for more than five years. Mr. Sheinfeld is also a director of Midway. ANTICIPATED EXECUTIVE OFFICER CHANGES We anticipate that, early in fiscal 2000, Harold H. Bach, Jr. and Orrin J. Edidin will begin to devote substantially all of their business time to Midway. We anticipate that Messrs. Bach and Edidin will remain with WMS as consultants. We hired Jeffrey M. Schroeder on June 7, 1999, and we expect that he will assume the office of Chief Financial Officer in the near future. Mr. Schroeder, 42, is a certified public accountant and was, until July 1998, the chief financial officer of Farley Industries, Inc., a management services company. He joined that company in 1985. We are in the process of searching for a new general counsel. 37 41 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Prior to Midway's 1996 initial public offering, Midway was a wholly-owned subsidiary of WMS. As a result of Midway's offering and our 1998 distribution of the remainder of our Midway stock to our stockholders, we do not own any Midway common stock. A majority of our directors, however, are directors of Midway. Additionally, several of our executive officers are officers or directors of Midway. See "Management" and "Risk Factors -- We may have conflicts of interest with Midway." INTERCOMPANY AGREEMENTS WMS and Midway continue to provide certain services and products to each other under a number of agreements, which are discussed in Item 13 of our 1998 Annual Report on Form 10-K, which is incorporated by reference in this prospectus. See "Where You Can Find More Information." The manufacturing agreement, cabinet supply agreement and pinball sales agreement, each effective as of April 6, 1998, between us and Midway, are described briefly below. Manufacturing Agreement. We manufacture coin-operated video games and kits for Midway. The agreement requires us to allocate 65.0% of our combined production and storeroom square footage at our Waukegan plant to perform our obligations under this agreement. Midway provides the designs and purchases most of the materials used in the manufacture of the coin-operated video games. All labor costs, including fringe benefits, directly associated with the manufacturing of coin-operated video games are charged to Midway at our actual cost plus 9.0%. The Waukegan plant's operating costs are either identified as Midway costs or allocated as agreed between the parties and charged to Midway, plus 9.0%. The identified or allocated costs include, without limitation, manufacturing costs, materials management costs, quality assurance costs and administration costs. The agreement may be terminated by either party for any reason upon six months' notice. Cabinet Supply Agreement. We supply coin-operated video game cabinets to Midway. The agreement provides that to initiate the purchase of video game cabinets, Midway issues a pricing inquiry to us, specifying the number of cabinets to be ordered and the cabinet specifications. We then provide a formal quote on the pricing inquiry, and, upon agreement on a final price, a purchase order is issued. We build the cabinets in our Cicero, Illinois facility and ship them to our Waukegan, Illinois plant for use in the manufacture of coin-operated video games. Midway is not required to purchase cabinets from us and may purchase cabinets from other manufacturers if we do not meet competitive bona-fide quotes. Pinball Sales Agreement. Our pinball products are marketed and sold under a sales agreement with Midway, which was amended as of June 15, 1999. Midway markets and field tests all of our pinball games. From May 1, 1999 through December 31, 1999, we have agreed to pay Midway a fixed amount at the rate of approximately $135,000 per month. In addition, we pay Midway a commission of 1.5% on the first $25.0 million of annual net sales by Midway of our products and 1.0% on annual net sales by Midway of our products in excess of $25.0 million. This agreement may be terminated by either party for any reason upon six months' notice. VOTING PROXY AGREEMENT In order for us to manufacture and sell gaming machines in Nevada, our officers are required to be, and have been, registered, licensed or found suitable by the Nevada Gaming Authorities. In addition, under applicable Nevada law and administrative procedure, as a greater than 10% stockholder of WMS, Sumner M. Redstone was required to apply, and has an application pending with the Nevada Gaming Authorities, for a finding of suitability as a stockholder of WMS. Mr. Redstone and National Amusements, Inc. ("NAI"), a company that he controls, collectively own 7,180,200 shares of our common stock. Pending completion of the processing of this application, Mr. Redstone and NAI, on September 21, 1995, voluntarily granted a voting proxy under a voting agreement to Louis J. Nicastro and, if he is unable to perform his duties under the voting agreement, Neil D. Nicastro, individually, to vote all of Mr. Redstone's and NAI's shares of our common stock. The voting agreement is intended to assure that 38 42 the passive investment position of Mr. Redstone and NAI relative to WMS will not change without prior notification to the Nevada Gaming Authorities. Under the voting agreement, Mr. Nicastro votes each share of our common stock owned by Mr. Redstone and NAI at his discretion at meetings of our stockholders or acts as proxy in connection with any written consent of our stockholders. The term of the voting agreement ends August 24, 2004 unless Mr. Redstone terminates it upon 30 days' written notice. It may also be terminated upon a finding by the Nevada Gaming Authorities that Mr. Redstone and NAI are suitable as stockholders of WMS or are no longer subject to the applicable provisions of Nevada gaming laws. 39 43 UNDERWRITING We will enter into an underwriting agreement with the underwriters named below. CIBC World Markets Corp. and Prudential Securities Incorporated are acting as representatives of the underwriters. The underwriting agreement will provide for the purchase of a specific number of shares of our common stock by each of the underwriters. The underwriters' obligations will be several, which means that each underwriter is required to purchase a specified number of shares but is not responsible for the commitment of any other underwriter to purchase shares. Subject to the terms and conditions of the underwriting agreement, each underwriter will severally agree to purchase the number of shares of our common stock set forth opposite its name below:
NUMBER OF UNDERWRITER SHARES ----------- ---------- CIBC World Markets Corp..................................... Prudential Securities Incorporated.......................... ---------- Total.................................................. 3,500,000 ==========
This is a firm commitment underwriting. This means that the underwriters will agree to purchase all of the shares offered by this prospectus, other than those covered by the over-allotment option, if any are purchased. Under the underwriting agreement, if an underwriter defaults in its commitment to purchase shares, the commitments of non-defaulting underwriters may be increased or the underwriting agreement may be terminated, depending on the circumstances. The representatives have advised us that the underwriters propose to offer the shares directly to the public at the public offering price that appears on the cover page of this prospectus. In addition, the representatives may offer some of the shares to securities dealers at the same price less a concession of $ per share. The underwriters may also allow, and those dealers may reallow, a concession not in excess of $0.10 per share to certain other dealers. After the shares are released for sale to the public, the representatives may change the offering price and other selling terms at various times. We have granted to the underwriters an over-allotment option. This option, which is exercisable for up to 30 days after the date of this prospectus, permits the underwriters to purchase a maximum of 525,000 additional shares from us to cover over-allotments. If the underwriters exercise all or part of this option, they will purchase shares covered by the option at the initial public offering price that appears on the cover page of this prospectus, less the underwriting discount. If this option is exercised in full, the total price to public will be $ and the total proceeds to us will be $ . The underwriters have severally agreed that, to the extent the over-allotment option is exercised, they will each purchase a number of additional shares proportionate to the underwriter's initial amount reflected in the table above. The following table provides information regarding the amount of the discount to be paid to the underwriters by WMS:
TOTAL WITHOUT TOTAL WITH FULL EXERCISE OF EXERCISE OF OVER-ALLOTMENT OVER-ALLOTMENT PER SHARE OPTION OPTION --------- -------------- ---------------- WMS.......................................... $ $ $
We estimate that our total expenses of the offering, excluding the underwriting discount, will be approximately $[500,000]. We have also agreed to indemnify the underwriters against some liabilities, including liabilities under the Securities Act. WMS and each of our officers and directors have agreed to a 90-day "lock-up" with respect to an aggregate of 1,140,819 shares of our common stock and other securities of ours that they beneficially own, including securities that are convertible into shares of our common stock and securities that are exchangeable or exercisable for shares of our common stock. This means that, for the period of 90 days following the date of this prospectus, WMS and such persons may not issue, sell, register or otherwise 40 44 dispose of these securities, except for the issuance of securities in connection with our stock option plans or an acquisition, without the prior written consent of CIBC World Markets Corp. Any shares offered by this prospectus will be listed on the New York Stock Exchange, subject to official notice of issuance. Each share is sold together with certain stock purchase rights. These rights are described in a registration statement on Form 8-A that we filed with the SEC on March 25, 1998. See "Where You Can Find More Information." CIBC World Markets Corp., one of the representatives, has provided investment banking and financial advisory services to us. We have paid CIBC World Markets Corp. customary fees for these services. Rules of the Securities and Exchange Commission may limit the ability of the underwriters to bid for or purchase shares before the distribution of the shares is completed. However, the underwriters may engage in the following activities in accordance with the rules: - Stabilizing transactions -- The representatives may make bids or purchases for the purpose of pegging, fixing or maintaining the price of the shares, so long as stabilizing bids do not exceed a specified maximum. - Over-allotments and syndicate covering transactions -- The underwriters may create a short position in our common stock by selling more shares than are set forth on the cover page of this prospectus. If a short position is created in connection with the offering, the representatives may engage in syndicate covering transactions by purchasing our common stock in the open market. The representatives may also elect to reduce any short position by exercising all or part of the over-allotment option. - Penalty bids -- If the representatives purchase shares in the open market in a stabilizing transaction or syndicate covering transaction, they may reclaim a selling concession from the selling group members who sold those shares as part of this offering. Stabilization and syndicate covering transactions may cause the price of our common stock to be higher than it would be in the absence of these transactions. The imposition of a penalty bid might also have an effect on the price of our common stock if it discourages resales of the shares. Neither we nor the underwriters makes any representation or prediction as to the effect that the transactions described above may have on the price of our common stock. These transactions may occur on the NYSE or otherwise. If these transactions are commenced, they may be discontinued without notice at any time. LEGAL MATTERS The validity of the shares offered by this prospectus has been passed upon by our counsel, Shack & Siegel, P.C., New York, New York. As of July 16, 1999, shareholders of Shack & Siegel, P.C. hold a total of 7,585 shares of our common stock and options to purchase 30,000 shares of our common stock. Certain legal matters in connection with this offering will be passed upon for the underwriters by Morgan, Lewis & Bockius LLP, New York, New York. EXPERTS Ernst & Young LLP, independent auditors, have audited our consolidated financial statements and schedule included in our Annual Report on Form 10-K for the year ended June 30, 1998, as set forth in their report, which is incorporated in this prospectus by reference. We have incorporated our consolidated financial statements by reference in this prospectus in reliance on their report, given on their authority as experts in accounting and auditing. 41 45 WHERE YOU CAN FIND MORE INFORMATION We have filed a registration statement on Form S-3 with the Securities and Exchange Commission in connection with this offering (File No. 333- ). In addition, we file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy the registration statement and any other documents we have filed at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. You may also call the SEC at 1-800-SEC-0330 for further information about the Public Reference Room. Our SEC filings are also available to the public at the SEC's Internet site found at "www.sec.gov" and can be inspected at the offices of the NYSE, 20 Broad Street, New York, NY 10005. This prospectus is part of the registration statement and does not contain all of the information included in the registration statement. Whenever a reference is made in this prospectus to any contract or other document of WMS, the reference may not be complete, and you should refer to the exhibits that are a part of the registration statement for a copy of the contract or document. In addition, the SEC allows us to "incorporate by reference" into this prospectus the information we file with it, which means that we can disclose important information to you by referring you to those documents. Information incorporated by reference is part of this prospectus. Later information filed with the SEC will update and supersede this information. We incorporate by reference the documents listed below and any future filings made with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934 until this offering is terminated: - Our annual report on Form 10-K for the year ended June 30, 1998, including exhibits. - Our quarterly reports on Form 10-Q for the fiscal quarters ended September 30, 1998, December 31, 1998 and March 31, 1999. - The description of our common stock and accompanying rights contained in our registration statements on Form 8-A filed on January 21, 1982 and March 25, 1998. We will provide to each person, including any beneficial owner, to whom a copy of this prospectus is delivered, a copy of any or all of the information that we have incorporated by reference in this prospectus. You may request copies of this information, and we will provide it at no cost, by writing or telephoning us at: WMS Industries Inc. 3401 North California Avenue Chicago, IL 60618 Attention: Vice President -- Finance. Telephone: (773) 961-1111 42 46 WMS INDUSTRIES INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- UNAUDITED Condensed Consolidated Statements of Income for the nine months ended March 31, 1999 and 1998...................... F-2 Condensed Consolidated Balance Sheets as of March 31, 1999 and June 30, 1998......................................... F-3 Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 1999 and 1998...................... F-4 Notes to Condensed Consolidated Financial Statements........ F-5 ANNUAL CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors.............................. F-6 Consolidated Balance Sheets as of June 30, 1998 and 1997.... F-7 Consolidated Statements of Income for the years ended June 30, 1998, 1997 and 1996................................... F-8 Consolidated Statements of Changes in Stockholders' Equity for the years ended June 30, 1998, 1997 and 1996.......... F-9 Consolidated Statements of Cash Flows for the years ended June 30, 1998, 1997 and 1996.............................. F-10 Notes to Consolidated Financial Statements.................. F-11
F-1 47 WMS INDUSTRIES INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME
NINE MONTHS ENDED MARCH 31, ---------------------- 1999 1998 --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) Revenues.................................................... $114,744 $ 63,943 Costs and expenses Cost of sales............................................. 84,825 48,518 Research and development.................................. 10,127 9,410 Selling and administrative................................ 23,118 21,399 Adjustment to common stock options........................ 1,140 59,890 -------- -------- Total costs and expenses.................................... 119,210 139,217 -------- -------- Operating loss.............................................. (4,466) (75,274) Interest and other income and expense, net.................. 2,785 2,605 -------- -------- Loss from continuing operations before income taxes......... (1,681) (72,669) Credit for income taxes..................................... 639 24,828 -------- -------- Loss from continuing operations............................. (1,042) (47,841) Income from discontinued operations -- video games segment, net....................................................... -- 26,746 -------- -------- Net loss.................................................... $ (1,042) $(21,095) ======== ======== Earnings per share of common stock -- basic and diluted Loss from continuing operations........................... $ (0.04) $ (1.84) -------- -------- Net loss.................................................. $ (0.04) $ (0.81) -------- -------- Average number of shares outstanding........................ 29,020 25,948 -------- --------
See notes to condensed consolidated financial statements. F-2 48 WMS INDUSTRIES INC. CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30, 1999 1998 ----------- ---------- (IN THOUSANDS OF DOLLARS) (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents................................... $ 41,190 $ 36,943 Short-term investments...................................... 22,900 26,000 -------- -------- 64,090 62,943 Receivables, net of allowances of $3,017 and $2,397......... 40,490 30,432 Inventories, at lower of cost (Fifo) or market: Raw materials and work in progress........................ 21,739 17,523 Finished goods............................................ 19,014 22,097 -------- -------- 40,753 39,260 Income tax receivable....................................... 3,889 10,114 Deferred income taxes....................................... 17,910 18,155 Other current assets........................................ 330 769 -------- -------- Total current assets................................... 167,462 162,033 Property, plant and equipment............................... 63,214 57,327 Less: accumulated depreciation.............................. (27,494) (24,720) -------- -------- 35,720 32,607 Other assets................................................ 22,324 12,882 -------- -------- $225,506 $207,522 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable............................................ $ 19,997 $ 7,818 Accrued compensation and related benefits................... 4,704 3,020 Accrued liability related to WMS Gaming Inc. patent litigation................................................ 34,709 35,372 Other accrued liabilities................................... 3,841 3,757 -------- -------- Total current liabilities.............................. 63,251 49,967 Deferred income taxes....................................... 869 869 Other noncurrent liabilities................................ 1,396 1,395 STOCKHOLDERS' EQUITY: Preferred stock (5,000,000 shares authorized, none issued)................................................... -- -- Common stock (30,137,695 and 28,032,766 shares issued)...... 15,069 14,016 Additional paid-in capital.................................. 175,340 170,418 Retained earnings (deficit)................................. (30,037) (28,995) -------- -------- 160,372 155,439 Treasury stock, at cost (77,312 and 52,312 shares).......... (382) (148) -------- -------- Total stockholders' equity............................. 159,990 155,291 -------- -------- $225,506 $207,522 ======== ========
See notes to condensed consolidated financial statements. F-3 49 WMS INDUSTRIES INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED MARCH 31, ------------------- 1999 1998 ------- -------- (IN THOUSANDS) (UNAUDITED) OPERATING ACTIVITIES Net loss.................................................... $(1,042) $(21,095) Adjustments to reconcile net loss to net cash provided by operating activities: Income from discontinued operations -- video games segment, net........................................... -- (26,746) Depreciation and amortization............................. 5,415 4,456 Receivables provision..................................... 733 611 WMS common stock issued in common stock option adjustment............................................. -- 14,975 Common stock option adjustment accrual.................... -- 44,836 Deferred income taxes..................................... 245 502 Tax benefit from exercise of common stock options......... 75 2,174 Decrease resulting from changes in operating assets and liabilities............................................ (4,934) (18,450) ------- -------- Net cash provided by operating activities................... 492 1,263 INVESTING ACTIVITIES Purchase of property, plant and equipment................... (6,264) (3,591) Net change in short-term investments........................ 3,100 41,400 ------- -------- Net cash provided (used) by investing activities............ (3,164) 37,809 FINANCING ACTIVITIES Cash received on exercise of common stock options........... 6,919 14,089 Redemption of long-term debt................................ -- (178) ------- -------- Net cash provided by financing activities................... 6,919 13,911 DISCONTINUED OPERATIONS Payment of transaction cost -- video games segment.......... -- (168) ------- -------- Net cash (used) by discontinued operations.................. -- (168) ------- -------- Increase in cash and cash equivalents....................... 4,247 52,815 Cash and cash equivalents at beginning of period............ 36,943 1,853 ------- -------- Cash and cash equivalents at end of period.................. $41,190 $ 54,668 ======= ========
See notes to condensed consolidated financial statements. F-4 50 WMS INDUSTRIES INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. FINANCIAL STATEMENTS The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Due to the seasonality of the Company's businesses, operating results for the nine months ended March 31, 1999 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 1999. For further information, refer to the consolidated financial statements and footnotes beginning on page F-6. 2. DISCONTINUED OPERATIONS On August 11, 1997 the Company announced a planned spin-off of its 86.8% interest in Midway Games Inc. Midway Games Inc.'s operations entirely comprised the video game business segment. That spin-off was completed on April 6, 1998. Accordingly, the results of operations for the nine months ended March 31, 1998 of the video game segment has been reflected as discontinued operations in the condensed consolidated statements of income and cash flows. 3. LITIGATION For information regarding litigation, see "Legal Proceedings" beginning on page 27. F-5 51 REPORT OF INDEPENDENT AUDITORS To the Stockholders and Board of Directors WMS Industries Inc. We have audited the accompanying consolidated balance sheets of WMS Industries Inc. and subsidiaries as of June 30, 1998 and 1997 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of WMS Industries Inc. and subsidiaries at June 30, 1998 and 1997, and the consolidated results of their operations and cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Chicago, Illinois August 17, 1998 F-6 52 WMS INDUSTRIES INC. CONSOLIDATED BALANCE SHEETS
JUNE 30, -------------------------- 1998 1997 ----------- ----------- (IN THOUSANDS OF DOLLARS) ASSETS CURRENT ASSETS: Cash and cash equivalents................................... $ 36,943 $ 1,853 Short-term investments...................................... 26,000 70,000 -------- -------- 62,943 71,853 Receivables, net of allowances of $2,397 in 1998 and $5,439 in 1997................................................... 30,432 27,275 Income tax receivable....................................... 10,114 -- Inventories Raw materials and work in progress........................ 17,523 22,087 Finished goods............................................ 22,097 11,502 -------- -------- 39,620 33,589 Deferred income taxes....................................... 18,155 21,013 Other current assets........................................ 769 1,259 -------- -------- Total current assets................................... 162,033 154,989 Investment in marketable equity securities.................. -- 15,000 Property, plant and equipment, net.......................... 32,607 30,744 Net assets of discontinued operations -- video games segment................................................... -- 90,713 Other assets................................................ 12,882 15,469 -------- -------- Total assets........................................... $207,522 $306,915 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable............................................ $ 7,818 $ 5,920 Accrued compensation and related benefits................... 3,020 3,223 Accrued discontinuance costs................................ -- 1,650 Accrued liability related to WMS Gaming Inc. patent litigation................................................ 35,372 37,208 Other accrued liabilities................................... 3,757 3,078 -------- -------- Total current liabilities.............................. 49,967 51,079 Long-term debt.............................................. -- 57,500 Deferred income taxes....................................... 869 629 Other noncurrent............................................ 1,395 1,707 STOCKHOLDERS' EQUITY: Preferred stock (5,000,000 shares authorized, none issued)................................................... -- -- Common stock (issued 28,032,766 shares in 1998 and 24,270,166 shares in 1997)................................ 14,016 12,135 Additional paid-in capital.................................. 170,418 84,673 Retained earnings (deficit)................................. (28,995) 112,098 -------- -------- 155,439 208,906 Treasury stock, at cost (52,312 shares in 1998 and 1997).... (148) (148) Unrealized loss on noncurrent marketable equity securities................................................ -- (12,758) -------- -------- Total stockholders' equity............................. 155,291 196,000 -------- -------- Total liabilities and stockholders' equity............. $207,522 $306,915 ======== ========
See notes to consolidated financial statements. F-7 53 WMS INDUSTRIES INC. CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, ----------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenues................................................... $ 98,990 $ 76,596 $ 93,202 Cost and expenses Cost of sales (including restructuring charges of $3,422 in 1996).............................................. 76,971 60,146 88,202 Research and development................................. 12,908 12,882 13,436 Selling and administrative............................... 27,885 20,959 21,271 Adjustment to common stock options....................... 59,890 -- -- Provisions related to WMS Gaming Inc. patent litigation............................................ -- 61,925 -- -------- -------- -------- Total costs and expenses................................... 177,654 155,912 122,909 -------- -------- -------- Operating loss............................................. (78,664) (79,316) (29,707) Interest and other income.................................. 4,410 5,661 3,705 Interest expense........................................... -- (3,443) (3,306) -------- -------- -------- Loss from continuing operations before income taxes........ (74,254) (77,098) (29,308) Credit for income taxes.................................... 25,430 30,301 11,556 -------- -------- -------- Loss from continuing operations............................ (48,824) (46,797) (17,752) Discontinued operations, net of applicable income taxes: Video games segment Income from discontinued operations................... 28,302 34,813 25,229 Extraordinary gain on early extinguishment of debt.... -- 2,641 -- Costs related to discontinuance, net.................. (1,556) (1,650) -- Gain on initial public offering of subsidiary......... -- 47,771 -- Hotel and casino segments Income from discontinued operations................... -- 4,742 2,953 Costs related to discontinuance....................... -- (825) (5,891) -------- -------- -------- Net income (loss).......................................... $(22,078) $ 40,695 $ 4,539 ======== ======== ======== Basic and diluted per share of common stock: Loss from continuing operations.......................... $ (1.85) $ (1.92) $ (0.74) -------- -------- -------- Net income (loss)........................................ $ (0.84) $ 1.67 $ 0.19 -------- -------- -------- Average number of shares outstanding....................... 26,446 24,334 24,122 -------- -------- --------
See notes to consolidated financial statements. F-8 54 WMS INDUSTRIES INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ADDITIONAL RETAINED TREASURY UNREALIZED TOTAL COMMON PAID-IN EARNINGS STOCK, HOLDING STOCKHOLDERS' STOCK CAPITAL (DEFICIT) AT COST LOSS EQUITY ------- ---------- --------- -------- ---------- ------------- (IN THOUSANDS OF DOLLARS) Balance as of June 30, 1995............ $12,083 $ 81,851 $ 119,367 $(159) $ (4,571) $ 208,571 Net income for the year ended June 30, 1996................................. -- -- 4,539 -- -- 4,539 Issuance of 34,450 shares of common stock through exercise of options.... 17 410 -- -- -- 427 Issuance of 4,000 treasury shares through the treasury share bonus plan................................. -- 89 -- 11 -- 100 Increase in unrealized holding loss on noncurrent investment in marketable equity securities.................... -- -- -- -- (3,750) (3,750) Tax benefit from exercise of common stock options........................ -- 146 -- -- -- 146 ------- -------- --------- ----- -------- --------- Balance as of June 30, 1996............ 12,100 82,496 123,906 (148) (8,321) 210,033 Net income for the year ended June 30, 1997................................. -- -- 40,695 -- -- 40,695 Issuance of 70,104 shares of common stock through exercise of options.... 35 1,325 -- -- -- 1,360 Increase in unrealized holding loss on noncurrent investment in marketable equity securities.................... -- -- -- -- (4,437) (4,437) Tax benefit from exercise of common stock options........................ -- 147 -- -- -- 147 Adjustment to common stock options for distribution of subsidiary........... -- 705 -- -- -- 705 Distribution of subsidiary as a tax-free dividend.................... -- -- (52,503) -- -- (52,503) ------- -------- --------- ----- -------- --------- Balance as of June 30, 1997............ 12,135 84,673 112,098 (148) (12,758) 196,000 Net loss for the year ended June 30, 1998................................. -- -- (22,078) -- -- (22,078) Issuance of 758,385 shares of common stock through exercise of stock options.............................. 379 13,954 -- -- -- 14,333 Issuance of 2,488,855 shares of common stock in conversion of subordinated debentures........................... 1,244 55,090 -- -- -- 56,334 Issuance of 515,360 shares of common stock relating to adjustment of common stock options................. 258 14,717 -- -- -- 14,975 Decrease in unrealized loss on noncurrent investment in marketable equity securities.................... -- -- -- -- 12,758 12,758 Tax benefit from exercise of common stock options........................ -- 1,984 -- -- -- 1,984 Distribution of subsidiary as a tax-free dividend.................... -- -- (119,015) -- -- (119,015) ------- -------- --------- ----- -------- --------- Balance as of June 30, 1998............ $14,016 $170,418 $ (28,995) $(148) $ -- $ 155,291 ======= ======== ========= ===== ======== =========
See notes to consolidated financial statements. F-9 55 WMS INDUSTRIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, -------------------------------- 1998 1997 1996 -------- -------- -------- (IN THOUSANDS) OPERATING ACTIVITIES Net income (loss)........................................... $(22,078) $ 40,695 $ 4,539 Adjustments to reconcile net income (loss) to net cash used by operating activities: Income from discontinued operations -- video games segment................................................ (28,302) (37,454) (25,229) Income from discontinued operations -- gain on initial public offering of subsidiary -- video games segment... -- (47,771) -- Income from discontinued operations -- hotel and casino segments............................................... -- (4,742) (2,953) Costs related to discontinuance........................... 1,556 2,475 5,891 Gain on sale of marketable equity securities.............. (859) -- -- Depreciation and amortization............................. 5,642 6,279 4,741 Receivables provision..................................... 581 335 432 WMS common stock issued in common stock option adjustment............................................. 14,975 -- -- Provisions related to Gaming patent litigation............ -- 60,875 -- Deferred income taxes..................................... 3,098 (21,247) 286 Stock option compensation expense......................... -- 705 -- Tax benefit from exercise of common stock options......... 1,984 147 146 Increase (decrease) resulting from changes in operating assets and liabilities Receivables............................................ (3,738) (4,505) (12,044) Income tax receivable.................................. (10,114) -- -- Inventories............................................ (6,031) (12,207) (14,115) Other current assets................................... 490 3,972 (4,432) Accounts payable and accruals.......................... 2,369 (2,608) (7,394) Current income taxes payable........................... -- -- (5,246) Other assets and liabilities not reflected elsewhere... (763) (527) (5,471) -------- -------- -------- Net cash used by operating activities....................... (41,190) (15,578) (60,849) INVESTING ACTIVITIES Purchase of property, plant and equipment................... (6,192) (3,471) (8,353) Net change in short-term investments........................ 44,000 (42,891) 20,754 Proceeds from sale of marketable equity securities.......... 28,617 -- -- -------- -------- -------- Net cash provided (used) by investing activities............ 66,425 (46,362) 12,401 FINANCING ACTIVITIES Cash received on exercise of stock options.................. 14,333 1,360 427 Redemption of long-term debt................................ (178) -- -- -------- -------- -------- Net cash provided by financing activities................... 14,155 1,360 427 DISCONTINUED OPERATIONS Net transfer from discontinued operations and payment of transaction costs in 1998 -- video games segment.......... (4,300) 50,000 19,493 Net transfer from (to) discontinued operations and payment of transaction costs -- hotel and casino segments......... -- (11,918) 10,542 -------- -------- -------- Net cash (used) provided by discontinued operations......... (4,300) 38,082 30,035 -------- -------- -------- Increase (decrease) in cash and cash equivalents............ 35,090 (22,498) (17,986) Cash and cash equivalents at beginning of year.............. 1,853 24,351 42,337 -------- -------- -------- Cash and cash equivalents at end of year.................... $ 36,943 $ 1,853 $ 24,351 ======== ======== ========
See notes to consolidated financial statements. F-10 56 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BUSINESS OVERVIEW WMS Industries Inc. ("WMS") operates in three business segments: the gaming segment which is engaged in the design, manufacture and sale of slot machines (video and reel type), video lottery terminals and other gaming devices; the pinball, novelty and cabinets segment which is engaged in the design, manufacture and sale of coin-operated pinball and novelty games and cabinets; and the contract manufacturing segment which continues to manufacture under a contract the coin-operated video games designed and sold by Midway Games Inc. ("Midway"). The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Such preparation requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. On April 6, 1998, WMS completed the spin-off, originally announced on August 11, 1997, of its 86.8% ownership interest in Midway consisting of 33,400,000 shares of Midway common stock, to the WMS stockholders. The activities of Midway, which was the video game segment of WMS, were included as discontinued operations at June 30, 1997. On April 22, 1997, WMS completed the spin-off, originally announced on June 26, 1996, of 100% of WMS' Puerto Rico based hotel, casino and hotel management business, WHG Resorts & Casinos Inc. ("WHG Resorts & Casinos"), to the WMS stockholders. Its activities were included as discontinued operations at June 30, 1996. NOTE 2: PRINCIPAL ACCOUNTING POLICIES Consolidation Policy The consolidated financial statements include the accounts of WMS and its majority-owned subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated. Certain prior year balances have been reclassified to conform with the current year presentation. Cash Equivalents All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. Inventories Inventories are valued at the lower of cost (determined by the first-in, first-out method) or market. Property, Plant and Equipment Property, plant and equipment are stated at cost and depreciated by the straight-line method over their estimated useful lives. Advertising Expense The cost of advertising is charged to earnings as incurred and for fiscal 1998, 1997 and 1996 was $633,000, $590,000 and $987,000, respectively. Recent Accounting Pronouncements In December 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". SFAS No. 128 requires dual presentation of basic earnings per share F-11 57 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) ("EPS") and diluted EPS on the face of all statements of earnings for all public companies with complex capital structures. SFAS No. 128 also requires restatement of all prior period statements of earnings using the dual presentation of basic and diluted EPS. Basic EPS is computed by dividing income by the weighted average number of shares outstanding for the period. Diluted EPS reflects, on a pro forma basis, earnings per share for the period assuming the exercise or conversion of all securities which are exercisable or convertible into common stock and which would either dilute or not affect basic EPS. Dilutive securities would have included common stock options and convertible subordinated debentures, which were redeemed during the four months ended October 31, 1997 (see Note 8). In accordance with SFAS No. 128, the incremental shares from these dilutive securities were not included in the denominator of the diluted earnings per share calculation since there was a loss from continuing operations in the periods. The WMS loss from continuing operations in fiscal 1997 previously reported fully diluted EPS. Under SFAS No. 128, the fiscal 1997 loss from continuing operations and net income was restated to $(1.92) and $1.67, respectively, from fully diluted EPS calculated using the prior method of $(1.65) and $1.58, respectively. SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" generally requires that companies report segment information for operating segments which are revenue producing components and for which separate financial information is produced and used internally. The Company plans to adopt SFAS No. 131 for the June 30, 1999 fiscal year, but has not yet completed its analysis of the impact of this statement on the financial statements. NOTE 3: DISCONTINUED OPERATIONS As discussed in Note 1, on April 6, 1998, the Company completed a spin-off of its 86.8% interest in Midway. Accordingly, the financial position, results of operations and cash flows of Midway have been reported as discontinued operations in the consolidated financial statements. Net assets of the video games segment of $119,015,000 at the time of spin-off were included as a reduction of retained earnings from the tax-free dividend. In conjunction with the Midway spin-off, at the request of the Board of Directors, on April 6, 1998 Neil D. Nicastro resigned as President, Chief Executive Officer and Chief Operating Officer of WMS to devote his full time to Midway as Chairman of the Board, President, Chief Executive Officer and Chief Operating Officer. Neil D. Nicastro agreed to the early termination and full settlement of his employment agreement with WMS pursuant to which, in lieu of all future payments of base salary, bonus, retirement and death benefits, he received a payment of $2,500,000 and a 10 year option to purchase 250,000 shares of the Company's common stock. The payment less income tax benefit of $861,000 and amounts previously accrued under his employment agreement are included in discontinuance costs in fiscal 1998. Other discontinuance costs of $150,000 were accrued in connection with the Midway spin-off in addition to the $1,650,000 accrued June 30, 1997. F-12 58 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The condensed balance sheet for Midway at June 30, 1997 is as follows:
1997 -------------- (IN THOUSANDS) ASSETS CURRENT ASSETS: Cash and short-term investments............................. $ 61,862 Receivables, net............................................ 54,477 Inventories................................................. 27,958 Other current assets........................................ 10,108 -------- Total current assets........................................ 154,405 Property and equipment, net................................. 9,498 Excess of purchase cost over amount assigned to net assets acquired, net............................................. 49,150 Other assets................................................ 1,265 -------- Total assets................................................ $214,318 ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable............................................ $ 20,918 Accrued payment on 1994 purchase of Tradewest............... 14,400 Accrued liabilities......................................... 32,777 -------- Total current liabilities................................... 68,095 Other noncurrent liabilities................................ 5,455 Stockholders' equity........................................ 140,768 -------- Total liabilities and stockholders' equity.................. $214,318 ========
The June 30, 1997 net assets of discontinued operations of the video games segment of $90,713,000 included in the WMS consolidated balance sheet is comprised of the Company's 86.8% ownership interest in Midway stockholders' equity of $140,768,000, or $122,121,000, less $31,408,000 of deferred tax liability on the book to tax difference on the investment in Midway Games Inc. The condensed income statement for Midway for the nine months ended March 31, 1998 and for the fiscal years ended June 30, 1997 and 1996 is as follows:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Revenues........................................... $293,144 $388,266 $245,423 Cost and expenses.................................. 242,850 327,693 204,929 -------- -------- -------- Operating income................................... 50,294 60,533 40,494 Interest and other income, net..................... 2,326 2,130 271 -------- -------- -------- Income before tax provision and extraordinary credit........................................... 52,620 62,663 40,765 Provision for income taxes......................... (19,996) (23,812) (15,536) -------- -------- -------- Income before extraordinary credit................. 32,624 38,851 25,229 Extraordinary gain, net............................ -- 3,044 -- -------- -------- -------- Net income......................................... $ 32,624 $ 41,895 $ 25,229 ======== ======== ========
The income from discontinued operations of the video games segment for the nine months ended March 31, 1998 and fiscal 1997 and 1996 shown in the WMS consolidated statements of income is equal F-13 59 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) to income before extraordinary credit of Midway for each year, except that the nine months ended March 31, 1998 and the fiscal 1997 is reduced by minority interest in income of $4,322,000 and $4,038,000, respectively. The extraordinary gain is reduced by minority interest of $403,000. WMS recognized an after tax gain of $47,771,000 on the Midway initial public offering completed on October 29, 1996. On April 22, 1997 the Company completed a spin-off of WHG Resorts & Casinos. Accordingly, the results of operations and cash flows of these business segments have been reported as discontinued operations in the consolidated financial statements for fiscal 1997 and 1996. Net assets of the hotel and casino segments of $52,503,000 at the time of spin-off were included as a reduction of retained earnings from the tax-free dividend. In connection with the spin-off, the Board of Directors of WMS requested Louis J. Nicastro, and Mr. Nicastro agreed, to become the Chairman of the Board and chief executive officer of WHG Resorts & Casinos and to relinquish his position as co-chief executive officer of WMS. Effective July 1, 1996, Mr. Nicastro also agreed to the early termination and full settlement of his employment agreement pursuant to which, in lieu of all future payments of base salary, bonus, retirement and death benefits, Mr. Nicastro received a lump sum payment of $9,125,000, with interest from July 1, 1996. As of June 30, 1996, $1,940,000 had previously been accrued for future payments under his employment agreement. The amount of the settlement involved present valuing certain future payments. Transaction costs incurred in connection with the spin-off were $825,000 in fiscal 1997 and costs incurred in fiscal 1996 were $5,891,000, including the contract settlement payment as well as estimated transaction costs of $1,500,000. The fiscal 1996 costs are net of a $2,794,000 tax benefit. Income from discontinued operations includes the results of WHG Resorts & Casinos for the nine months ended March 31, 1997 and for the fiscal year ended June 30, 1996 as follows:
1997 1996 ------- ------- (IN THOUSANDS) Revenues.................................................... $41,206 $68,694 Costs and expenses.......................................... 30,384 58,601 ------- ------- Operating income............................................ 10,822 10,093 Interest expense, net....................................... (846) (1,859) ------- ------- Income before income taxes and minority interests........... 9,976 8,234 Provision for income taxes.................................. (2,302) (1,645) Minority interests.......................................... (2,932) (3,636) ------- ------- Income from discontinued operations......................... $ 4,742 $ 2,953 ======= =======
NOTE 4: PINBALL BUSINESS DOWNSIZING As a result of the softness of the worldwide coin-operated pinball games market, on June 27, 1996, the Board of Directors authorized the downsizing of the pinball business including the pinball design and manufacturing operations. The Company incurred restructuring charges of $3,422,000 ($2,091,000 after tax) for employee severance and inventory provisions. The costs are included as cost of sales in the June 30, 1996 consolidated statement of income. F-14 60 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5: INVESTMENTS IN SECURITIES All investments are designated as available-for-sale and are recorded at market value with the holding gain or loss reflected in stockholders' equity. A summary of securities held at June 30 were as follows:
GROSS UNREALIZED MARKET COST LOSS VALUE ------- ---------- ------- (IN THOUSANDS) 1998 Securities included as part of cash equivalents...... $ 9,407 $ -- $ 9,407 Short-term investments............................... 26,000 -- 26,000 1997 Securities included as part of cash equivalents...... $ 54 $ -- $ 54 Short-term investments............................... 70,000 -- 70,000 Marketable equity securities noncurrent.............. 27,758 12,758 15,000
Short-term investments consist principally of money market preferred stocks that generally have no fixed maturity dates but have dividend reset dates every 49 days or less. NOTE 6: PROPERTY, PLANT AND EQUIPMENT At June 30 net property, plant and equipment were:
1998 1997 -------- -------- (IN THOUSANDS) Land................................................... $ 3,481 $ 3,481 Buildings and improvements............................. 25,113 21,866 Machinery and equipment................................ 26,626 24,490 Furniture and fixtures................................. 2,107 2,005 -------- -------- 57,327 51,842 Less accumulated depreciation.......................... (24,720) (21,098) -------- -------- Net property, plant and equipment...................... $ 32,607 $ 30,744 ======== ========
NOTE 7: INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the amount of assets and liabilities for financial reporting purposes and the amounts used for income taxes. Deferred tax assets also include the future tax benefit from unrealized capital losses. F-15 61 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Significant components of the Company's deferred tax assets and liabilities at June 30 were:
1998 1997 ------- ------- (IN THOUSANDS) Deferred tax assets resulting from Unrealized capital loss................................... $ -- $ 5,382 Inventory valuation....................................... 2,335 1,444 Accrued items not currently deductible.................... 989 1,240 Accruals relating to Gaming litigation.................... 18,275 22,892 Other..................................................... -- 192 ------- ------- Total deferred tax assets................................. 21,599 31,150 Valuation allowance for unrealized capital loss............. -- (5,382) ------- ------- Net deferred tax assets..................................... 21,599 25,768 Deferred tax liabilities resulting from Tax over book depreciation................................ 924 1,091 Federal tax on deferred state tax......................... 1,682 1,460 Other..................................................... 1,707 2,833 ------- ------- Total deferred tax liabilities............................ 4,313 5,384 ------- ------- Net deferred tax assets..................................... $17,286 $20,384 ======= =======
Significant components of the provision (credit) for income taxes for the years ended June 30, 1998, 1997 and 1996 were:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Current Federal.......................................... $(26,753) $ (7,754) $(10,106) State............................................ (3,759) (1,447) (1,882) -------- -------- -------- Total current................................. (30,512) (9,201) (11,988) Deferred Federal.......................................... 2,679 (17,297) 327 State............................................ 419 (3,950) (41) -------- -------- -------- Total deferred................................ 3,098 (21,247) 286 Provision for tax benefits resulting from stock options.......................................... 1,984 147 146 -------- -------- -------- Credit for income taxes on continuing operations... (25,430) (30,301) (11,556) Provision for income taxes on discontinued operations extraordinary gain.................... -- 2,001 -- Provision for income taxes on discontinued operations....................................... 19,135 57,522 14,386 -------- -------- -------- Income tax (credit) provision, net................. $ (6,295) $ 29,222 $ 2,830 ======== ======== ========
F-16 62 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The credit for income taxes on continuing operations differs from the amount computed using the statutory federal income tax rate as follows:
1998 1997 1996 ---- ---- ---- Statutory federal income tax rate........................... 35.0% 35.0% 35.0% State income taxes, net of federal effect................... 2.7 4.6 4.3 Option adjustment cost not deductible....................... (3.5) -- -- Other, net.................................................. -- (0.3) 0.1 ---- ---- ---- 34.2% 39.3% 39.4% ==== ==== ====
NOTE 8: LONG-TERM DEBT During fiscal 1998, as a result of a call for redemption on September 22, 1997 of 33% of the $57,500,000 in outstanding debentures and a call for redemption on October 29, 1997 of the remaining outstanding debentures, debentures with an aggregate principal amount of $57,322,000 were converted into 2,488,855 shares of WMS common stock and $178,000 of such debentures were redeemed. The amount of interest paid during fiscal 1997 and 1996 was $3,443,000 and $3,306,000, respectively. NOTE 9: STOCKHOLDERS' EQUITY Authorized common stock of the Company consists of 100,000,000 shares of $.50 par value. At June 30, 1998, 5,394,765 shares of common stock were reserved for possible issuance for stock option plans. Additionally, there are 5,000,000 shares of $.50 par value preferred stock authorized. The preferred stock is issuable in series, and the relative rights and preferences and the number of shares in each series are to be established by the Board of Directors. At the date of the Midway spin-off the WMS Rights Agreement became effective. Under the Rights Agreement, each share of WMS common stock has an accompanying Right to purchase, under certain conditions, one one-hundredth of a share of the Company's Series A Preferred Stock at an exercise price of $100, permitting each holder to receive $200 worth of the Company's common stock valued at the then current market price. The Rights are redeemable by the Company at $.01 per Right, subject to certain conditions, at any time and expire in 2007. The Rights are intended to assure fair shareholder treatment in any attempted takeover of the Company and to guard against abusive takeover tactics. NOTE 10: COMMON STOCK PLANS Under the stock option plans the Company may grant both incentive stock options and nonqualified options on shares of common stock through the year 2008. Options may be granted to employees and under certain conditions to non-employee directors and consultants. The stock option committee has the authority to fix the terms and conditions upon which each employee option is granted, but in no event shall the term exceed ten years or generally be granted at less than 100% of the fair market value of the stock at the date of grant. On September 30, 1997, the Company entered into an agreement with each of the holders of all of the common stock options then outstanding, which were exercisable into 4,089,011 shares of WMS common stock, regarding option adjustment in connection with the Midway spin-off. Each option holder agreed not to exercise their stock option through the date of the Midway spin-off (see Note 1). On the spin-off record date of March 31, 1998, the Company recorded a pre-tax charge of $59,890,000 for the adjustment to stock options, pursuant to the anti-dilution provision of the Company's stock option plans, to compensate the holders for the lost opportunity value represented by the shares of Midway distributed in the spin-off which option holders did not participate in. Of that amount, cash payments on April 6, 1998 totaled $35,001,000, and 515,360 pre spin-off shares of WMS common stock were issued F-17 63 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) valued at $14,974,000. An additional $4,179,000 was paid in the fourth quarter of fiscal 1998 and $779,000 was accrued for the Company's portion of payroll tax. Expense related to the adjustment of stock options not vested in the current fiscal year will be recorded and paid in future years consistent with the options' vesting schedule. At June 30, 1998, the maximum additional future pre-tax expense related to non-vested stock options is $7,253,000 plus interest. At the request of the Board of Directors, in lieu of receiving from the Company the adjustment to stock option payment, Louis J. Nicastro, Chairman of the Board, exercised all of his 629,554 WMS common stock options and sold the shares of common stock on March 19, 1998. The cash received by the Company of $13,437,000 from exercise of these options was then available for the stock option adjustment payments. Louis J. Nicastro received $4,957,000 from the Company as compensation for the difference between what the Company would have paid him for his stock option adjustment and the net he received from exercise and sale. The Company accounts for stock options for purposes of determining net income in accordance with APB No. 25. During fiscal 1997, $705,000 was recognized as stock option compensation in connection with the modification by the Board of Directors of the outstanding stock option terms because of the spin-off of the Company's hotel and casino segments. A summary of the status of the Company's stock option plans for the three years ended June 30, 1998 was as follows:
WEIGHTED SHARES AVERAGE (000) EXERCISE PRICE ------ -------------- Outstanding at June 30, 1995................................ 3,058 $24.44 Granted................................................... 156 22.31 Exercised................................................. (34) 12.39 Forfeited................................................. (24) 20.50 ----- Outstanding at June 30, 1996................................ 3,156 24.50 Granted................................................... 215 23.62 Exercised................................................. (53) 20.48 Forfeited................................................. (50) 21.63 ----- Outstanding at modification date (4/22/97).................. 3,268 24.54 ----- Activity after 4/22/97 modification: Outstanding as modified................................... 4,114 19.49 Granted................................................... 25 20.25 Exercised................................................. (17) 16.07 ----- Outstanding at June 30, 1997................................ 4,122 19.51 Exercised................................................... (663) 21.22 ----- Outstanding at modification date (4/6/98)................... 3,459 19.18 ----- Activity after 4/6/98 modification: Outstanding as modified................................... 3,459 3.16 Granted................................................... 1,041 5.16 Exercised................................................. (94) 2.57 ----- Outstanding at June 30, 1998................................ 4,406 3.65 =====
The weighted average remaining contractual life of outstanding options on June 30, 1998 was 6.7 years. At June 30, 1998, 3,799,000 options with a weighted average exercise price of $3.66 per share were F-18 64 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) exercisable, outstanding options have exercise prices that range from $2.26 to $5.44 and 989,000 shares were available for future grants under the plans. At June 30, 1997, 3,506,000 options with a weighted average exercise price of $19.70 per share were exercisable, outstanding options had exercise prices that ranged from $13.70 to $21.34. On April 6, 1998, the Board of Directors reduced the exercise price of each option by approximately 83.5% to reflect the initial post Midway spin-off trading price of WMS common stock. This modification did not result in any additional pro forma compensation expense. On April 22, 1997, the Board of Directors increased the number of outstanding stock options by approximately 26% for each option holder and reduced the exercise price of each option by approximately 20% to reflect the dilution to the outstanding stock options for the distribution of WHG Resorts & Casinos Inc. to the shareholders of WMS. The Company has a Treasury Share Bonus Plan for key employees covering all the shares of common stock held in the treasury. The vesting and other terms of the awards are flexible. No awards of treasury stock were outstanding at June 30, 1998 and 1997. SFAS No. 123 regarding stock option plans permits the use of APB 25 but requires the inclusion of certain pro forma disclosures in the footnotes. Pro forma net income (loss) and net income (loss) per share adjusted for the pro forma expense provisions of SFAS 123 were:
1998 1997 1996 ------------ ----------- ---------- Pro forma net income (loss)................. $(25,850,000) $28,367,000 $4,398,000 Pro forma basic and diluted net income (loss) per share.......................... $ (0.98) $ 1.17 $ 0.18
The fiscal 1997 pro forma net income includes an after tax charge of $7,985,000 relating to the modification of options because of the spin-off of the hotel and casino segments. The fiscal 1998 and 1997 pro forma net income includes an after tax charge of $1,747,000 and $4,343,000 respectively, for the granting of Midway options. The pro forma fair value of each option grant, and in 1997 the modification, is estimated on the date of grant or modification using the Black-Scholes option pricing model with the following weighted average assumptions used for modifications and grants in fiscal 1998, 1997 and 1996: dividend yield 0% for all three years, expected volatility of .37 for all three years; risk free interest rates of 5.65% in 1998 and 6.1% for 1997 and 1996 and expected life of the options of six years for 1998 and three years for 1997 and 1996. The weighted average pro forma fair value, using the Black-Scholes assumptions noted above, of the options granted during fiscal 1998 and 1997 was $2.36 and $5.33, respectively. NOTE 11: CONCENTRATION OF CREDIT AND MARKET RISK AND FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS Financial instruments which potentially subject the Company to concentrations of credit and market risk consist primarily of cash equivalents, short-term investments and trade notes and accounts receivable. By policy, the Company places its cash equivalents and short-term investments only in high credit quality securities and limits the amounts invested in any one security. At June 30, 1998, 20% of trade accounts receivable are from sale of games to the Company's distributors located primarily throughout the United States and Western Europe and because of the number and geographic distribution, concentration is limited. Foreign sales are typically made in U.S. dollars and typically on the basis of a letter of credit. The accounts and notes receivable from the sale of gaming devices are generally from a large number of customers with no significant concentration other than in Nevada. F-19 65 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The amounts reported for cash equivalents and short-term investments are considered to be a reasonable estimate of their fair value. NOTE 12: LEASE COMMITMENTS The Company leases certain of its office facilities and equipment under non-cancelable operating leases with net future lease commitments for minimum rentals at June 30, 1998 as follows:
(IN THOUSANDS) 1999........................................... $ 956 2000........................................... 577 2001........................................... 291 2002........................................... 35 ------ $1,859 ======
Rent expense for fiscal 1998, 1997 and 1996 was $1,699,000, $1,414,000 and $1,594,000, respectively. NOTE 13: PATENT LITIGATION The Company's subsidiary, WMS Gaming Inc. ("WGI"), is currently involved in patent infringement litigation with its competitor International Game Technology ("IGT") regarding a certain slot machine component patent. During fiscal 1997, the U.S. District Court for the Northern District of Illinois ruled that WMS Gaming's Model 400 reel spinning slot machine infringed IGT's patent and issued a permanent injunction prohibiting the sale of Model 400 and entered a judgment in favor of IGT and against WGI in the amount of $32,845,000 in the Model 400 slot machine action. The same District Court issued a preliminary injunction prohibiting the sale of WMS Gaming's reel spinning slot machine Model 401. The Model 400 and Model 401 operate differently and each machine is based on separate and distinct methods of operation, each corresponding to separate patents granted by the U.S. Patent and Trademark Office to WGI. WGI has appealed the decisions of the District Court to the U.S. Court of Appeals for the Federal Circuit. However, due to the fact that obtaining a reversal before the Federal Circuit occurs in only a minority of the patent cases it reviews, as of December 31, 1996, management accrued $61,925,000 to provide for the judgment and other costs and losses noted below. The $61,925,000 loss provision, as adjusted, provides for the judgment award of $32,845,000 and among other things realization of inventory, receivables and legal fees. The major components of the balance of the provision were $6,950,000 for sales returns and uncollectible receivables and $16,300,000 for excess and unusable reel spinning slot machine inventory. Through June 30, 1998, $15,162,000 has been charged to the provisions primarily for uncollectible receivables, inventory and legal fees. The slot machines component which is the subject of the litigation is only used in reel spinning slot machines and not in video lottery terminals and other video gaming machines. If the Company is unable to obtain a reversal of the District Court judgment and preliminary injunction on appeal, and is unable to develop or acquire non-infringing alternate devices or obtain a license to use the patent, further development of the Company's reel spinning slot machine business may be adversely affected. NOTE 14: PENSION PLANS During fiscal 1992 the Company suspended the defined benefit pension plan that covers salaried employees of the amusement game and gaming businesses and corporate headquarters. During fiscal 1998 the Company suspended the defined benefit pension plan covering certain hourly employees of the gaming business. F-20 66 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The suspended defined benefit plans provide pension benefits that are based on a flat monthly rate multiplied by the number of years of service. The Company's funding policy for these plans is to make at least the minimum annual contributions required by ERISA. Plan assets are invested primarily in guaranteed insurance contracts. The components of net periodic pension cost based on an expected long-term rate of return on plan assets of 9% were:
1998 1997 1996 ----- ----- ----- (IN THOUSANDS) Service costs-benefits earned during the year.............. $ 107 $ 185 $ 210 Interest cost on projected obligation...................... 372 395 413 Actual return on plan assets............................... (155) (185) (153) Net amortization of unrecognized net obligation at transition and deferrals................................. (43) (13) (60) ----- ----- ----- Net periodic pension cost for the year..................... $ 281 $ 382 $ 410 ===== ===== =====
The plans' funded status and amounts included in the Company's consolidated balance sheets at June 30 were:
1998 1997 ------- ------- (IN THOUSANDS) Actuarial present value of projected benefit obligation, including vested obligations of $4,059 and $4,114, respectively.............................................. $(4,441) $(4,724) Fair value of plan assets................................... 2,789 3,184 ------- ------- Funded status............................................... (1,652) (1,540) Unrecognized net obligations being recognized over a remaining 5 years......................................... 305 376 Unrecognized net loss....................................... 755 356 Adjustment required to recognize minimum liability.......... (1,031) (725) ------- ------- Accrued pension liability................................... $(1,623) $(1,533) ======= =======
The discount rate used to determine the actuarial present value of the projected benefit obligation was 7.5% at June 30, 1998 and 1997. Other assets include an intangible asset of $1,031,000 and $725,000 at June 30, 1998 and 1997, respectively, resulting from the adjustment required to recognize the minimum pension liability. The Company has two defined contribution employee retirement savings plans. These defined contribution plans cover certain hourly and salaried employees of the amusement game and gaming businesses and corporate headquarters. The Company's contributions to these plans are based on employee participation with certain limitations. The Company may change any of the factors which determine the Company's contribution to such plans. A subsidiary is required to make contributions on behalf of unionized employees to defray part of the costs of the multi-employer pension plan established by its labor union. Such contributions are computed using a fixed charge per employee. Contributions to the defined contribution and multi-employer plans for fiscal 1998, 1997 and 1996 were $207,000, $181,000 and $215,000, respectively. F-21 67 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 15: QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized quarterly financial information for fiscal 1998 and 1997 are as follows:
SEPT. 30 DEC. 31 MAR. 31 JUNE 30 1997 1997 1998 1998 -------- ------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Fiscal 1998 Quarters Revenues................................... $20,035 $23,397 $ 20,511 $35,047 Gross profit............................... 5,350 5,767 4,308 6,594 Loss from continuing operations............ (2,989) (1,502) (43,350) (983) Discontinued operations Video games segment...................... 6,277 15,947 4,522 -- ------- ------- -------- ------- Net income (loss).......................... $ 3,288 $14,445 $(38,828) $ (983) ======= ======= ======== ======= Basic and diluted per share of common stock: Loss from continuing operations.......... $ (0.12) $ (0.06) $ (1.62) $ (0.04) ------- ------- -------- ------- Net income (loss)........................ $ 0.13 $ 0.54 $ (1.45) $ (0.04) ------- ------- -------- ------- Average number of shares outstanding..... 24,549 26,471 26,843 27,944 ------- ------- -------- -------
The June 30, 1998 quarter includes an after-tax gain of $530,000, $0.02 per share, on the sale of non current marketable securities. The March 31, 1998 quarter includes an after-tax charge of $39,917,000, $1.49 per share, for the spin-off related adjustment to WMS outstanding common stock options.
SEPT. 30 DEC. 31 MAR. 31 JUNE 30 1996 1996 1997 1997 -------- -------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Fiscal 1997 Quarters Revenues................................... $15,016 $ 18,623 $18,608 $24,349 Gross profit............................... 2,965 4,127 4,551 4,807 Loss from continuing operations............ (2,507) (39,712) (2,381) (2,197) Discontinued operations Video games segment...................... 6,077 13,409 5,566 10,752 Gain on initial public offering of subsidiary............................ -- 47,771 -- -- Hotel and casino segments................ -- -- 3,917 -- ------- -------- ------- ------- Net income................................. $ 3,570 $ 21,468 $ 7,102 $ 8,555 ======= ======== ======= ======= Basic and diluted per share of common stock: Loss from continuing operations.......... $ (0.10) $ (1.64) $ (0.10) $ (0.09) ------- -------- ------- ------- Net income............................... $ 0.15 $ 0.89 $ 0.29 $ 0.35 ------- -------- ------- ------- Average number of shares outstanding..... 24,156 24,193 24,199 24,449 ------- -------- ------- -------
The December 31, 1996 quarter includes an after-tax charge of $37,361,000, $1.54 per share, for a loss provision related to WMS Gaming Inc. patent litigation. (See Note 13). F-22 68 WMS INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 16: INDUSTRY SEGMENTS
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Revenues Gaming..................................................... $ 56,788 $ 33,613 $ 37,523 Pinball, novelty and cabinets.............................. 38,251 42,983 55,679 Contract manufacturing..................................... 3,951 -- -- -------- -------- -------- Total revenues............................................. $ 98,990 $ 76,596 $ 93,202 ======== ======== ======== Operating income (loss) Gaming..................................................... $ (9,590) $(12,510) $ (9,508) Pinball, novelty and cabinets (including restructuring charges of $3,422 in 1996)............................... (7,761) (2,997) (17,093) Contract manufacturing..................................... 347 -- -- Provisions related to WMS Gaming Inc. patent litigation (Note 13)................................................ -- (61,925) -- Adjustment to common stock options (Note 10)............... (59,890) -- -- Unallocated general corporate expenses..................... (1,770) (1,884) (3,106) -------- -------- -------- Total operating (loss)..................................... (78,664) (79,316) (29,707) Interest and other income.................................. 4,410 5,661 3,705 Interest expense........................................... -- (3,443) (3,306) -------- -------- -------- Loss from continuing operations before income taxes........ $(74,254) $(77,098) $(29,308) ======== ======== ======== Identifiable assets Gaming..................................................... $ 70,517 $ 53,225 $ 59,803 Pinball, novelty and cabinets.............................. 30,855 51,930 53,044 Contract manufacturing..................................... 14,940 -- -- Corporate.................................................. 91,210 111,047 134,645 Net assets of discontinued operations -- hotel and casino segments................................................. -- -- 42,091 Net assets of discontinued operations -- video games segment.................................................. -- 90,713 5,488 -------- -------- -------- Total assets............................................... $207,522 $306,915 $295,071 ======== ======== ======== Depreciation of property, plant and equipment Gaming..................................................... $ 846 $ 612 $ 360 Pinball, novelty and cabinets.............................. 2,967 3,448 3,107 Contract manufacturing..................................... 203 -- -- Corporate.................................................. 15 23 31 -------- -------- -------- Total depreciation of property, plant and equipment........ $ 4,031 $ 4,083 $ 3,498 ======== ======== ======== Capital expenditures Gaming..................................................... $ 1,847 $ 1,499 $ 1,678 Pinball, novelty and cabinets.............................. 4,315 1,953 6,658 Contract manufacturing..................................... -- -- -- Corporate.................................................. 30 19 17 -------- -------- -------- Total capital expenditures................................. $ 6,192 $ 3,471 $ 8,353 ======== ======== ======== Export sales (primarily to Western Europe)................. $ 24,364 $ 33,731 $ 41,392 -------- -------- -------- Sales to major customers................................... $ 7,960 $ 12,099 $ 13,984 -------- -------- --------
F-23 69 - -------------------------------------------------------------------------------- [WMS LOGO] WMS INDUSTRIES INC. 3,500,000 SHARES COMMON STOCK --------------------------- PROSPECTUS --------------------------- July , 1999 CIBC WORLD MARKETS PRUDENTIAL SECURITIES - -------------------------------------------------------------------------------- YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO DEALER, SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE INFORMATION THAT IS NOT CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES. 70 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table itemizes the expenses payable by the registrant in connection with the registration and issuance of the securities being registered hereunder, excluding underwriting discounts and commission. As indicated below, all amounts shown are estimates except for the Commission and NASD registration fee. Registration Fee -- Securities and Exchange Commission...... $ 17,724.17 NASD Filing Fee............................................. 6,875.60 Accounting Fees and Expenses................................ [40,000.00] Legal Fees and Expenses..................................... [200,000.00] NYSE Listing Fees........................................... [15,000.00] Gaming Regulatory Investigation Fees........................ [25,000.00] Blue Sky Fees and Expenses.................................. [5,000.00] Printing Expenses........................................... [150,000.00] Miscellaneous............................................... [40,400.23] ------------ Total................................................ $[500,000.00] ============
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The registrant's authority to indemnify its officers and directors is governed by the provisions of Section 145 of the General Corporation Law of the State of Delaware (the "DGCL"), by its Certificate of Incorporation and bylaws and by indemnification agreements entered into with each of its directors. Under Section 145 of the DGCL, directors and officers as well as other employees and individuals may be indemnified against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement in connection with specified actions, suits or proceedings, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation (a "derivative action")) if they acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the registrant, and with respect to any criminal action or proceeding, had no reasonable cause to believe their conduct was unlawful. A similar standard of care is applicable in the case of derivative actions, except that indemnification only extends to expenses (including attorneys' fees) incurred in connection with defense or settlement of a derivative action, and the DGCL requires court approval before there can be any indemnification where the person seeking indemnification has been found liable to the registrant. The Certificate of Incorporation and bylaws of the registrant provide that it shall, to the fullest extent permitted by Section 145 of the DGCL, (i) indemnify any and all persons whom it shall have power to indemnify under said section from and against any and all of the expenses, liabilities or other matters referred to in or covered by said section, and (ii) advance expenses related thereto to any and all said persons. The indemnification and advancement of expenses provided for is not considered to be exclusive of any other rights to which those indemnified may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in their official capacities and as to action in another capacity while holding their offices, and shall continue as to persons who have ceased to be directors, officers, employees or agents and shall inure to the benefit of those person's heirs, executors and administrators. In addition, the Certificate of Incorporation provides for the elimination of personal liability of directors of the registrant to the registrant or its stockholders for monetary damages for breach of fiduciary duty as a director, to the fullest extent permitted by the DGCL, as amended and supplemented. The indemnification agreements provide for the indemnification of officers and directors to the fullest extent permitted by the laws of the State of Delaware and obligate the registrant to provide the maximum II-1 71 protection allowed under Delaware law. In addition, these agreements supplement and increase the laws' protection in certain respects. The Underwriting Agreement between CIBC World Markets Corp. and the registrant filed as Exhibit 1 hereto provides for the indemnification of officers and directors by CIBC World Markets Corp. under certain circumstances. ITEM 16. EXHIBITS. The following exhibits are being furnished with this filing or incorporated by reference in this filing:
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 1 Form of Underwriting Agreement.* 4.1 Specimen certificate of common stock, incorporated by reference to Exhibit 4(a) to the registrant's Annual Report on Form 10-K (file no. 1-8300) for the fiscal year ended June 30, 1994. 4.2 Rights Agreement dated as of March 5, 1998 between the registrant and The Bank of New York, as Rights Agent, incorporated by reference to Exhibit 1 to the registrant's Registration Statement on Form 8-A (file no. 1-8300), as filed with the Commission on March 25, 1998. 5 Opinion of Shack & Siegel, P.C., counsel for registrant. 23.1 Consent of Shack & Siegel, P.C. (contained in the Opinion filed as Exhibit 5 hereto). 23.2 Consent of Ernst & Young LLP. 24 Power of Attorney (contained on the signature page hereof). 99.1 Worldwide Merchandising Agreement/License Agreement Summary and License Agreement between WMS Gaming Inc., Hasbro, Inc. and Hasbro International, Inc. dated as of the first day of September, 1997. Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed separately with the Commission. 99.2 Amendment to License Agreement between WMS Gaming Inc., Hasbro, Inc. and Hasbro International, Inc. dated 1998. Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed separately with the Commission. 99.3 Employment Agreement between Terence M. Dunleavy and the registrant dated June 1, 1999. 99.4 Employment Agreement between Kevin L. Verner and the registrant dated June 1, 1999. 99.5 Letter agreement dated June 15, 1999 amending Sales Agreement dated as of April 6, 1998 between Williams Electronics Games, Inc. and Midway Games Inc.
- --------------- * To be filed by amendment. ITEM 17. UNDERTAKINGS. 1. The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report under Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 2. The undersigned registrant hereby undertakes that: (a) for purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant under Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of II-2 72 this Registration Statement as of the time it was declared effective; and (b) for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 3. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. II-3 73 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, State of New York on this 16 day of July, 1999. WMS INDUSTRIES INC. By: /s/ LOUIS J. NICASTRO --------------------------------------- Louis J. Nicastro, Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below hereby appoints Louis J. Nicastro, Harold H. Bach, Jr. and Orrin J. Edidin, and each of them acting singly, as his attorney-in-fact, with full power of substitution and resubstitution, to sign on his behalf individually and in the capacity stated below and to file all amendments and post-effective amendments to this Registration Statement, any subsequent Registration Statements pursuant to Rule 462 under the Securities Act of 1933 and any amendments thereto, which amendments or Registration Statements may make such changes and additions to this Registration Statement as such attorney-in-fact may deem necessary or appropriate. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE DATE TITLE --------- ---- ----- /s/ LOUIS J. NICASTRO July 16, 1999 Chairman of the Board, President - --------------------------------------------------- and Chief Executive Officer Louis J. Nicastro (Principal Executive Officer) /s/ HAROLD H. BACH, JR. July 16, 1999 Vice President -- Finance, Chief - --------------------------------------------------- Financial Officer and Treasurer Harold H. Bach, Jr. (Principal Financial and Accounting Officer) /s/ NORMAN J. MENELL July 16, 1999 Vice Chairman of the Board - --------------------------------------------------- Norman J. Menell /s/ WILLIAM C. BARTHOLOMAY July 16, 1999 Director - --------------------------------------------------- William C. Bartholomay /s/ WILLIAM E. MCKENNA July 16, 1999 Director - --------------------------------------------------- William E. McKenna
II-4 74
SIGNATURE DATE TITLE --------- ---- ----- /s/ NEIL D. NICASTRO July 16, 1999 Director - --------------------------------------------------- Neil D. Nicastro /s/ HARVEY REICH July 16, 1999 Director - --------------------------------------------------- Harvey Reich /s/ DAVID M. SATZ, JR. July 16, 1999 Director - --------------------------------------------------- David M. Satz, Jr. /s/ IRA S. SHEINFELD July 16, 1999 Director - --------------------------------------------------- Ira S. Sheinfeld
II-5 75 EXHIBIT INDEX
EXH. DESCRIPTION NO.- ----------- 1 Form of Underwriting Agreement.* 4.1 Specimen certificate of common stock, incorporated by reference to Exhibit 4(a) to the registrant's Annual Report on Form 10-K (file no. 1-8300) for the fiscal year ended June 30, 1994. 4.2 Rights Agreement dated as of March 5, 1998 between the registrant and The Bank of New York, as Rights Agent, incorporated by reference to Exhibit 1 to the registrant's Registration Statement on Form 8-A (file no. 1-8300), as filed with the Commission on March 25, 1998. 5 Opinion of Shack & Siegel, P.C., counsel for registrant. 23.1 Consent of Shack & Siegel, P.C. (contained in the Opinion filed as Exhibit 5 hereto). 23.2 Consent of Ernst & Young LLP. 24 Power of Attorney (contained on the signature page hereof). 99.1 Worldwide Merchandising Agreement/License Agreement Summary and License Agreement between WMS Gaming Inc., Hasbro, Inc. and Hasbro International, Inc. dated as of the first day of September, 1997. Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed separately with the Commission. 99.2 Amendment to License Agreement between WMS Gaming Inc., Hasbro, Inc. and Hasbro International, Inc. dated 1998. Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed separately with the Commission. 99.3 Employment Agreement between Terence M. Dunleavy and the registrant dated June 1, 1999. 99.4 Employment Agreement between Kevin L. Verner and the registrant dated June 1, 1999. 99.5 Letter agreement dated June 15, 1999 amending Sales Agreement dated as of April 6, 1998 between Williams Electronics Games, Inc. and Midway Games Inc.
- --------------- * To be filed by amendment EX-5 2 OPINION OF SHACK & SIEGEL, P.C. 1 EXHIBIT 5 SHACK & SIEGEL, P.C. 530 FIFTH AVENUE NEW YORK, NEW YORK 10036 (212) 782-0700 July 16, 1999 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: WMS Industries Inc. Form S-3 Registration Statement Ladies and Gentlemen: We have acted as counsel to WMS Industries Inc., a Delaware corporation (the "Company"), in connection with the filing with the Securities and Exchange Commission under the Securities Act of 1933, as amended, of a registration statement on Form S-3 (the "Registration Statement") registering the sale of 3,500,000 shares, or 4,025,000 shares if the Underwriters' overallotment option is exercised in full (the "Shares"), of the Company's common stock, par value $.50 per share (the "Common Stock"). In connection with this opinion, we have examined and are familiar with originals or copies, certified or otherwise identified to our satisfaction, of: (i) the Registration Statement; (ii) the Company's Restated Certificate of Incorporation, as amended; (iii) the Company's amended and restated Bylaws; (iv) proceedings of the Board of Directors of the Company; and (v) such other documents as we have considered necessary or appropriate as a basis for the opinion set forth below. In our examination, we have assumed the genuineness of all signatures, the legal capacity of all natural persons, the authenticity of all documents submitted to us as originals, the conformity to the original documents of all documents submitted to us as certified or photostatic copies and the authenticity of the originals of such latter documents. As to any facts material to this opinion that we did not independently establish or verify, we have relied upon statements and representations of officers and other representatives of the Company and others. Based upon and subject to the foregoing, we are of the opinion that the sale and issuance of the Shares has been duly authorized and that such Shares, assuming full payment therefor, when issued and delivered, will be validly issued, fully paid and non-assessable. We consent to the filing of this opinion as Exhibit 5 to the Registration Statement, and we further consent to the reference made to us under the caption "Legal Matters" in the prospectus included in the Registration Statement. Please note that shareholders of this firm hold, in the aggregate, 7,585 shares of Common Stock and options to purchase an aggregate of 30,000 shares. The law covered by the opinions expressed in this letter is limited to the corporate laws of the State of Delaware. Very truly yours, SHACK & SIEGEL, P.C. By: /s/ JEFFREY N. SIEGEL ------------------------------------ Jeffrey N. Siegel EX-23.2 3 CONSENT OF ERNST & YOOUNG LLP. 1 Exhibit 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" in the Registration Statement on Form S-3 (File No. 333- ) and the related Prospectus of WMS Industries Inc. and to the incorporation by reference therein of our reports dated August 17, 1998, with respect to the financial statements of WMS Industries Inc. and subsidiaries incorporated by reference in its Annual Report (Form 10-K) for the year ended June 30, 1998 and the related financial statement schedule included therein, filed with the Securities and Exchange Commission. /s/ ERNST & YOUNG LLP -------------------------------------- Chicago, Illinois July 14, 1999 EX-99.1 4 WORLDWIDE MERCHANDISING AGREEMENT 1 CERTAIN INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. EXHIBIT 99.1 WORLDWIDE MERCHANDISING AGREEMENT LICENSE AGREEMENT SUMMARY NAME: MONOPOLY This Summary is hereby incorporated into and made a part of the attached License Agreement. The specifics detailed below, where numbered as paragraphs or subparagraphs, relate to similarly numbered paragraphs or subparagraphs in the attached License Agreement. The License Agreement is between: Licensor and Licensee - -------- -------- HASBRO, INC. and WMS GAMING INC. HASBRO INTERNATIONAL, INC. 3401 North California Avenue 1027 Newport Avenue Chicago, Illinois 60618 Pawtucket, Rhode Island 02862 1. GRANT OF LICENSE. (a) Licensed Articles. All (i) gaming, goods or products (including, among other things, gaming devices [multiple models]) using the Name except: (A) that class of "amusement with prize" or "skill with prize" games presently found in Europe and called "Fruit Games" or "Fungames" which is not designed for casinos, but rather for pubs, pool halls and arcades, and for which the player's maximum possible payout for any single amount staked is limited to a relatively small amount set by the legislation of the jurisdiction in which such games are operated hereinafter, "Low Payout AWPs or SWPs"); Low Payout AWPs or SWPs does not include video lottery terminals or video lottery machines, (B) gaming tables; (C) pull-tabs, "scratch and win" cards and similar paper goods used in government lotteries other than those which are dispensed by gaming devices such as video lottery terminals, (but not vending machines); (D) amusement games, including, without limitation, amusement games which simulate the play of gaming devices for amusement only (i.e., without payouts or other prizes), whether in coin-operated form or cartridges or CD-ROMs for home play; and (ii) gaming services using the Name which relate to gaming devices. such as services through which gaming devices are linked for progressive jackpots, whether through local area networks, wide area networks or otherwise. During the term of this agreement, Licensee shall have a right of refusal as to any gaming services using the Name. (b) (i) Territory. Worldwide (ii) Channels of Distribution: Casinos and Club Casinos only in the countries of Europe, and in Australia and New Zealand. In all other countries of the Territory, channels of distribution shall be unlimited. (c) Term** Development and Test Period: [*] to [*] Initial Term: [*] to [*] Optional Renewal Tern: [*] to [*] 2. TERMS OF PAYMENT (a) Royalty Rate.(i) For Licensed Articles which are gaming devices which are not sold outright by Licensee, but rather are leased or otherwise - ---------- ** Each date of the Term is subject to extension pursuant to Paragraph I (c) of the Agreement * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -1- 2 placed with third parties under arrangements where Licensee will receive ongoing payments from their operation, and for other Licensed Articles (aside from License Articles which are gaming devices which are sold), Licensee will pay Licensor a royalty equal to [*] of the gross revenue received by the Licensee for the use of such Licensed Articles, less any fees payable to third parties such as government levies, third party commissions, prizes for players (or funds to support such prizes), royalties to other licensors and amounts payable to casinos. (ii) For Licensed Articles which are gaming devices sold by Licensee, the following per unit royalties will be due based on the number of units of each "Type" of Licensed Article sold during each calendar year (for purposes hereof, "Type" shall mean a category or kind of gaming device. Each of slot machines, video lottery terminals and casino video gaming devices is a different Type): Royalty Units ------- ----- [*] Between [*] units of each Type of Licensed Article sold [*] Between [*] units of each Type of Licensed Article sold [*] For each Type of Licensed Article sold in excess of [*] units [*] royalties will be payable for activities during the Development and Test Period; provided, however, that after the Development and Test Period, if Licensee determines through the use of the Test Criteria (as hereinafter defined) that the test was successful, then all applicable royalties will be paid for activities during the Development and Test Period, with such payment to be made with the first royalty statement made by Licensee as required by this Agreement. b) Terms of Payment: Total Royalty Advance Balance Guarantee Payment Due Dates** --------- ------- ----------- Initial Term [*] [*] Upon full execution by both parties [*] 30 days after the Notice Date (as hereinafter defined) [*] Upon Licensor's approval of the first Licensed Article for shipment (subsequent to Notice Date) [*] Upon Licensee's first commercial shipment of the first Licensed Article(subsequent to Notice Date) [*] No later then [*] [*] No later then [*] [*] No later then [*] [*] No later then [*] Optional [*] - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. ** Balance Due Dates are subject to extension pursuant to Paragraph I (c) of the Agreement -2- 3 [*]-Year Renewal [*] No later then [*] [*] No later then [*] [*] No later then [*] The advance royalty payment and the balance of royalty guarantee are due and payable as set forth above. Licensee may offset royalties paid against payments of the balance of the royalty guarantee. To the extent Licensee pays Licensor the balance of the Royalty Guarantee, such payments shall also constitute advance payments against royalties (c) Periodic Statements: Within twenty-five (25) days after the end of the quarter in which the initial shipment of the Licensed Articles occurred (subsequent to the Notice Date), and promptly on the twenty-fifth (25th) day of the month following each calendar quarter thereafter, Licensee shall furnish to Licensor complete and accurate royalty statements. It is expressly understood that any sales in Puerto Rico and all international sales shall be itemized separately on all royalty reporting forms. (d) Royalty Payments: Royalties in excess of any advance payment referenced above shall be due on the twenty-fifth (25th) day of the month following the calendar quarter in which earned, and payment shall accompany statements. Licensee shall pay Licensor interest on a late royalty payment at an interest rate of [*] per month, or the highest rate permitted by law, whichever rate is lower, from the date the royalty should have been received by Licensor until paid. Balance Due Dates are subject to extension pursuant to Paragraph I(c) of the Agreement. (a) Approvals: When seeking Licensor's approval of the Licensed Articles, rather than submitting the Licensed Articles, Licensee may elect to submit artwork therefrom and videotape or other depictions thereof, but if Licensor wishes to examine the Licensed Article itself, Licensee shall make the same available for inspection by Licensor at Licensee's facilities. 8. (a) Labeling: As a condition to the grant of rights hereunder, Licensee agrees that it will cause to appear on or within each Licensed Article sold by it and on or within all packaging, cartons, wrapping material, advertising, promotional or display material bearing the Name, the notice: "Monopoly is a trademark of Hasbro used with permission. (C)[year of first publication] Hasbro. All rights reserved." and any other notice desired by Licensor, and where such article or advertising, promotional or display material bears a trademark or service mark of Licensor, appropriate statutory notice of registration thereof. It is understood that, in the event that any change or changes in the foregoing notices shall be required, such change or changes shall be instituted within ninety (90) days on a running change, go forward basis only after Licensor gives written notice to Licensee of the requested change, and shall not affect Licensee's inventory or parts or product in process existing at the end of such ninety day period and bearing the notice referenced above; provided, however, that no such change need be instituted in the software of the Licensed Articles until Licensee elects to submit a new revision of the software for the necessary regulatory approval, and then such change shall be instituted when and where such approval is received and such revision is incorporated into the Licensed Articles. (b) Approvals: Each and every tag, label, imprint, storyboard, copy and layout or other device containing any such notice and all advertising, promotional or display material bearing the Name, shall be submitted by Licensee to Licensor for its written approval prior to use by Licensee. Licensee must use Licensor's approval form with each submission for Licensor's approval. Licensee shall have the right to affix in or on the Licensed - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -3- 4 Articles and related materials its own notices, legends and markings, as well as those of its third party licensors and developers, those required by law or those required to indicate compliance with regulatory, safety or quality standards (e.g. Underwriters' Laboratory markings) or as a public service, subject to Licensor's approval, not to be unreasonably withheld or delayed. 14. Sell-off Period: One Hundred Twenty (120) days for Licensed Articles which are sold, lease terms for Licensed Articles which are leased shall not exceed the termination of this agreement by more than one (1) year. The aforesaid terms and conditions and those set forth in the attached License Agreement shall only be binding upon Licensor provided that Licensee signs and returns the License Agreement Summary and License Agreement and Licensor countersigns same. AGREED TO AND ACCEPTED: Licensor Licensee - -------- -------- HASBRO, INC. WMS GAMING INC. By: /s/Harold P. Gordon By: /s/Kevin L. Verner Title: Vice Chairman Title: EVP, General Manager Date: 10/3/97 Date: 9/11/97 HASBRO INTERNATIONAL, INC. By: /s/Harold P. Gordon Title: Vice Chairman Date: 10/3/97 -4- 5 LICENSE AGREEMENT This AGREEMENT made this 1st day of September, 1997, by and between HASBRO, INC. and HASBRO INTERNATIONAL, INC., both with a principal place of business at 1027 Newport Avenue, Pawtucket, Rhode Island 02862-1059 (hereinafter jointly called "Licensor") and WMS Gaming Inc., with its principal place of business at 3401 North California Avenue, Chicago, Illinois, 60618 (hereinafter called "Licensee"). WITNESSETH: WHEREAS, Licensor has rights to the name, characters, symbols, designs, likenesses and visual representations of MONOPOLY, and the copyrights and trademarks thereon, as set forth on Schedule "A" hereunto annexed (which names, characters, symbols, designs, likenesses and visual representations and each of the individual components thereof shall hereinafter jointly be called the "Name"); and WHEREAS, Licensee desires to utilize the Name upon and in connection with the manufacture, sale and distribution of articles hereinafter described. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and for other good and valuable consideration, the parties do hereby agree as follows: 1. GRANT OF LICENSE (a)(i) Licensed Articles. Upon the terms and conditions hereinafter set forth, Licensor hereby grants to Licensee and Licensee hereby accepts the exclusive right, license and privilege of utilizing the Name solely upon and in connection with the manufacture, sale, and/or rental, and/or lease distribution and other provision of the articles and services listed in the License Agreement Summary, Paragraph l(a), (hereinafter referred to as the "Licensed Articles"), and no other articles or services of any kind, and Licensee shall only use such trademarks as may be approved, in the manner approved, when the Licensed Articles are submitted for approval. (ii) Right of Refusal. During the term of this Agreement, Licensee shall have a right of refusal as to any gaming services using the Name as follows: Should Licensor enter into negotiations with a third party whereby the third party would receive rights to the Name in connection with gaming services, then, at the completion of such negotiations but prior to Licensor entering into any agreement with such third party, Licensor shall offer to Licensee such rights on the same terms as those then negotiated by Licensor and the third party by sending Licensee written notice of such terms. Licensee shall have thirty (30) days from the date of its receipt of such notice to accept or reject such terms by so notifying Licensor. If Licensee does not notify Licensor of its acceptance of such terms within such thirty days, Licensor may proceed with its agreement with such third party, provided that Licensor and such third party may not materially modify such terms without re-offering such rights to Licensee using the same procedure as provided above. If Licensee notifies Licensor of its acceptance of such terms within such thirty days, Licensor shall not proceed with such third party, but instead Licensor and Licensee shall promptly enter into an agreement under which Licensee is granted such rights on such terms. During the term of this Agreement, Licensor agrees that it will not (either directly or through an affiliate or joint venture) utilize the Name in connection with gaming services. (b) (i) Territory. The license hereby granted extends only to the area listed in the License Agreement Summary, Paragraph l(b)("Territory") and only to sales through the Channels of Distribution, as defined in the License Agreement Summary, Paragraph I (b). Licensee agrees that it will not make or authorize any use, direct or indirect, of the Name in any other area or outside the Channels of Distribution, and that it will not knowingly sell Licensed Articles to persons who intend or are likely to resell them in any other area or outside the Channels of Distribution. Notwithstanding this territorial limitation however, Licensee shall have the right to manufacture the Licensed Articles (or have the Licensed Articles manufactured for it as provided in Paragraph 20 hereof) outside the licensed Territory, provided, -5- 6 however, that the Licensed Articles are sold and distributed only within such licensed Territory. (ii) Licensor's Right to Eliminate Country from Territory. In the event that Licensee and its affiliates have not submitted a Licensed Article for required regulatory approvals in at least one country of a Region within two (2) years of the start of the Initial Term, or in the event that Licensee and its affiliates have not placed Licensed Articles on test or begun commercial shipment of Licensed Articles in at least one country of a Region within six (6) months after receiving all required regulatory approvals to do so, then Licensor shall have the right, upon giving thirty (30) days' prior written notice to Licensee, to terminate Licensee's rights hereunder for all Licensed Articles in such Region. A "Region" is each of the continents of North America, South America, Asia, Africa, Europe and Australia. However, the two (2) year period shall be tolled for any Region in which no country has legal gaming in which the Licensed Articles may be employed. (c) Term. The Licensee shall have a [*] period in which to develop a Licensed Article or Licensed Articles and an additional [*] period in which to test a Licensed Article or Articles ("Development and Test Period" as shown in Paragraph l(c) of the License Agreement Summary): provided, however, that the Development and Test Period shall be extended as follows: (i) where Licensee first submits a model of a Licensed Article to a regulatory body, or an organization designated by a regulatory body, for approval and such body or organization does not give its approval within forty-two (42) days of such submission, the Development and Test Period shall be extended by one day for each day after such forty-two (42) days until such model or another model substituted by Licensee, is approved by such body or organization, and (ii) where Licensee submits materials relating to a model of a Licensed Article to Licensor for approval as required by Paragraph 7(a)(ii), if Licensee does not receive a response (approval or disapproval with required changes) to such submission from Licensor within ten (10) business days of receipt thereof, the Development and Test Period shall be extended by one day for each day after such ten (10) business days until Licensee receives Licensor's response; provided, however that the maximum time that the Development and Test Period may be extended in this manner for delays in obtaining approvals shall be one (1) year. Notwithstanding anything to the contrary in this Agreement, each extension of the Development and Test Period shall result in the movement of each and every date in this Agreement which follows the Development and Test Period, including, without limitation, the start and end dates of the Initial Term and Optional Renewal Term in Paragraph l(c) of the License Agreement Summary, the "Balance Due Dates" in Paragraph 2(b) of the License Agreement Summary, the, and the renewal request date shown in Paragraph l(d), but no date shall be extended by a period greater than one year. For example, the extension of the Development and Test Period by one day shall move the start date of the Initial Term to [*] and the "Balance Due Date" of the first [*] "Advance Payment" to [*]. In the event that Licensee determines that the Licensed Articles meet the following pre-approved, objective and measurable criteria (hereinafter, "Test Criteria"): 1) the Licensed Articles' average earnings levels at test location are significantly above (estimated to be [*] higher) "average" earnings levels at such test locations, or the Licensed Articles' average earnings levels at test locations enable Licensee to obtain gross revenue of approximately [*] per day per Licensed Article; and; 2) the results of a longevity trend analysis indicate that the Licensed Articles continue to have average earnings levels at test locations significantly above "average" earnings levels at such test locations during the last three months of the Development and Test Period; (The testing will be conducted by Licensee in multiple locations selected by - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -6- 7 Licensee in up to three gaming jurisdictions selected by Licensee [expected to be Nevada, New Jersey and Mississippi], with six to twelve Licensed Articles expected to placed at each location [although up to twenty-four may be placed at each location]as determined by Licensee. No more than three locations per city will be used by Licensee for the test except for Las Vegas, where up to six locations may be used) then Licensee shall send written notification to Licensor, no later than the last day of the Development and Test Period (hereinafter "Notice Date"), that the Licensed Articles have met the Test Criteria and Licensee wishes to exercise its option to enter the Initial Term. The Initial Term of the license, if granted, shall be effective as shown in the License Agreement Summary, Paragraph l(c), unless sooner terminated in accordance with the provisions hereof. If Licensee determines that the Licensed Articles do not meet the Test Criteria, Licensee shall notify Licensor, and in the event that Licensee properly gives such notice then this Agreement shall terminate on the last day of the Development and Test Period with the same force and effect as though the term expired on such date and the Licensee shall be under no obligation to pay the [*] balance of the royalty guarantee that would otherwise be due by [*] (or such other date to which payment may be extended pursuant to this paragraph). If Licensee does not give any notice to Licensor by the last day of the Development and Test Period, Licensee will be deemed to have given notice to Licensor that the Licensed Articles do not meet the Test Criteria as of the last day of the Development and Test Period. Every thirty days after the first Licensed Article is placed on test at a location as described above, Licensee shall provide Licensor with copies of the data gathered by Licensee as to the Test Criteria and a summary of Licensee's preliminary analysis thereof. Licensor will have the option exercisable within twenty (20) days following Licensor's receipt of Licensee's notification that the Licensed Articles have met the Test Criteria within which to notify Licensee that Licensor is terminating this license, which termination shall become effective of one hundred twenty (120) days from Licensee's receipt of Licensor's said notification. If Licensor exercises such option, then (i) Licensor will reimburse Licensee, up to a maximum of [*], for Licensee's costs directly related or attributable to the development, production, and marketing of the Licensed Article (including interest from the date of expenditure at the Bank of Boston's Prime or Reference Rate prevailing from time to time) and the cost of the accounting described below (together, "Costs"); provided that any and all amounts of revenue received by Licensee for the Licensed Articles or the use thereof from any source during the Development and Test Period("Revenue") shall be credited against any reimbursement otherwise payable by Licensor hereunder, and (ii) Licensor shall not permit any third party to, or itself (whether directly or indirectly through affiliates, a joint venture, etc.) develop, manufacture, sell distribute or otherwise provide, any Licensed Article in the Territory during the two (2) year period after the date of Licensor's notice to Licensee exercising such option and, (iii) Licensee shall not be required to pay the [*] balance of the royalty guarantee. Prior to any reimbursement becoming payable by Licensor, Licensee shall provide to Licensor a full accounting, performed by a national independent certified public accounting firm, of all Revenue received and all Costs incurred during the Development and Test Period, and which accounting shall be subject to a review conducted by Licensor and/or its independent accountants. Costs will be limited to those which would not have been incurred by Licensee if it had not engaged in the development, production and marketing of the Licensed Article, or provided the accounting required hereby, and will be determined in accordance with Generally Accepted Accounting Principles applied on a consistent basis. Licensee will provide Licensor and/or accountants designated by Licensor with copies of all working papers pertaining to the - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -7- 8 determination of such Costs and will make available to Licensor and its designated accountants all relevant books and records. If the Revenue exceeds the Costs, Licensee shall pay Licensor royalties on the excess Revenue at the rates set forth in Paragraph 2(a) of the License Agreement Summary, less any advances against royalties paid by Licensee. To the extent that the amounts to be paid by one party to the other is not disputed, such payment shall be made by Licensor or Licensee, as appropriate, within thirty (30) days of the receipt of the accounting by Licensor. In the event of a dispute as to the appropriate amount to be reimbursed to Licensee or paid to Licensor, the dispute, upon notice from either party to the other, such notice to be given within thirty (30) days after receipt of the accounting by Licensor, will be submitted within fifteen (15) business days following such notice to a disinterested accounting firm acceptable to both parties (the "Arbitrator") whose determination will be final and binding on both parties and may be enforced as an arbitration award in any court of competent jurisdiction, provided such award may not, in any event, exceed [*]. Each party will bear one half of the fees paid to the Arbitrator (which will be in addition to [*] limit) and will bear the fees of its own accountants and attorneys in connection with such arbitration. Amounts to be paid which are not the subject of a dispute shall be paid as above. The Arbitrator will be a nationally recognized firm of independent certified public accountants which has not within two (2) years prior to the submission of the dispute to it, performed services for either party or their respective affiliates (and will not during the pendency of the proceeding be so engaged by either party or its affiliates); provided that if at the time of submission of the dispute, it meets the aforementioned standard, the parties now agree that the Arbitrator will be Coopers & Lybrand. The arbitration will be held in New York City. (d) Renewal Term. In the event that Licensee is not in default of any of the terms of this Agreement, Licensee may exercise its option to renew this Agreement for the Optional Renewal Term of the License; as shown in the License Agreement Summary, by sending written notice to Licensor by six (6) months prior to the end of the Initial Term. 2. TERMS OF PAYMENT (a) Rate. Licensee agrees to pay to Licensor as royalty, a sum equal to that shown in the License Agreement Summary, Paragraph 2(a), on all payments received by Licensee or any of its affiliated, associated or subsidiary companies for the sale or use of the Licensed Articles. All costs and expenses incurred in the manufacture, sale, distribution or exploitation of the Licensed Articles, or otherwise incurred by Licensee, shall be paid by Licensee, and no such costs or expenses shall be deducted from any royalty payable to Licensor, except as set forth in Paragraph l(c) and License Agreement Summary Paragraph 2(a)(i). All taxes, duties, import charges or assessments levied, assessed or imposed by any government authority with respect to the Agreement on the income of the Licensee (or upon Licensor in respect of such income) shall be borne by the Licensee, except as set forth in Paragraph l(c) and License Agreement Summary Paragraph 2(a)(i) and the Licensee shall indemnify and save harmless Licensor in respect thereof provided that if in accordance with any applicable law any withholding tax is imposed on any royalty, advances or guarantee payment payable by the Licensee to Licensor under the Agreement, the Licensee or the paying bank shall deduct the sum of tax from the royalty payment and pay it to the competent tax authorities. Within sixty (60) days from such deduction and payment, the Licensee or paying bank shall provide Licensor with a receipt voucher or other document, as well as an English language translation thereof, which evidences the receipt by the relevant tax authorities of payment of any tax due. Except as otherwise specified, all payments shall be made in United States Dollars - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -8- 9 calculated monthly using the average rate of exchange for the Currency of the Territory and the United States Dollar based upon the daily rate of exchange quoted by "The Wall Street Journal" during the month when royalties or payments become due. (b) Terms of Payment: Term. Licensee agrees to pay as a minimum guarantee against royalties to be paid Licensor during the Term hereof, and as an advance payment applicable to said minimum guarantee and against royalties, the sums as shown in the License Agreement Summary, Paragraph 2(b). The advance and the balance of the minimum guarantee against royalties shall be payable as shown in the License Agreement Summary, Paragraph 2(b). No part of such minimum royalty shall in any event be repayable to Licensee. (c) Periodic Statements. Within twenty-five (25) days after the end of the quarter in which the initial shipment of the Licensed Articles occurs (subsequent to the Notice Date), and promptly on the twenty-fifth (25th) day of the month following each calendar quarter thereafter, Licensee shall furnish to Licensor complete and accurate statements certified to be accurate by Licensee, or if a corporation, by an officer of Licensee, showing the number, country in which manufactured, country in which sold or to which shipped and description of the Licensed Articles sold, and, where the royalty described in Paragraph 2(a)(i) of the License Agreement Summary applies, the applicable gross revenue received by Licensee and deductible fees payable to third parties relating to the Licensed Articles distributed or otherwise provided by Licensee during the preceding calendar quarter, together with any returns made during the preceding quarter. Such statements shall be furnished to Licensor whether or not any of the Licensed Articles have been sold or otherwise provided during the quarter to which such statements refer. The form attached to this agreement must be used for reporting royalties. Upon demand of Licensor, but not more than once in a calendar year, Licensee shall, at its own expense, furnish to Licensor a detailed statement by an independent certified public accountant or an officer of Licensee, showing the number, country in which manufactured, country in which sold or to which shipped and description of the Licensed Articles distributed and/or sold or otherwise provided by Licensee and, where the royalty described in Paragraph 2(a)(i), of the License Agreement Summary applies, the applicable gross revenue received by Licensee and deductible fees payable to third parties, to the date of Licensor's demand. (d) Royalty Payments. Royalties in excess of any advance payment required and paid hereunder shall be due on the twenty-fifth (25th) day of the month following the calendar quarter in which earned, and payment shall accompany the statements furnished as required above. The receipt or acceptance by Licensor of any of the statements furnished pursuant to this agreement, or of any royalties paid hereunder (or the cashing of any royalty checks paid hereunder) shall not preclude Licensor from questioning the correctness thereof at any time within three (3) years after the expiration and/or termination of this License Agreement, and in the event that any inconsistencies or mistakes are discovered in such statements or payments, they shall immediately be rectified and the appropriate payment made by Licensee. Licensee shall not be permitted to reduce royalty payments for any reason without prior written approval from Licensor. Licensee shall pay Licensor interest on a late royalty payment at an interest rate of [*] per month, or the highest rate permitted by law, whichever rate is lower, from the date the royalty payment should have been received by Licensor until paid. Royalty payments must be remitted to Licensor at the address first set forth above. The parties acknowledge that in certain instances it may be unlawful for License to remit to Licensor the royalties described in this Agreement (e.g. because Licensee would require a license from the relevant gaming authorities, but such license has not been granted). In such instances, Licensee shall so notify Licensor and, at Licensor's option, either (1) - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -9- 10 Licensee shall hold such royalties for the benefit of Licensor until such time as it is lawful to pay such royalties to Licensor, or (2) the parties shall negotiate in good faith an alternate royalty or other payment which may lawfully be paid to Licensor, with the intention that, to the extent legally permitted, Licensor shall be given substantially the benefits of the original royalty. The parties agree that if Licensee makes a lease arrangement with its customer as a means of financing the purchase of a Licensed Article which is a gaming device, such gaming device shall be considered to be sold outright for purpose of this Agreement upon the inception of such lease. The parties acknowledge that the Licensed Articles include accessories which (A) Licensee may provide to its customers in connection with Licensed Articles which are gaming devices or services, and (B) utilize the Name. Examples of such accessories include electric signage which calls players' attention to the presence of gaming devices within a casino. Notwithstanding anything to the contrary in this Agreement, Licensee shall pay Licensor no royalties on such accessories. The parties acknowledge that it is customary in the gaming industry for gaming devices to be sold on a trial basis, meaning the customer has, for a limited period, the right to return the devices and unwind the transaction (the "Trial Period"). For any Licensed Articles placed on such trial basis, the royalty thereon shall be deemed to accrue only after the Trial Period (including any extensions thereof) has terminated, unless the Trial Period exceeds six (6) months, in which case such royalty shall accrue at the end of such six months. 3. EXCLUSIVITY (a) All rights whatsoever in the Name not specifically granted herein are reserved to Licensor and may be freely exercised at any time by Licensor or its designees without accounting to Licensee and without any claim, charge or encumbrance in favor of Licensor. (b) Notwithstanding anything herein to the contrary, Licensor reserves the right to use or license others to use and/or manufacture Licensed Articles, including articles of a type identical to those sold by Licensee, as premiums. (c) It is further understood that, without limiting the foregoing reservations, third parties granted rights for exploitation of the Name after the Term hereof may be granted permission to display proposed product at trade shows during the last [*] of the Term, and/or consult with retailers and other third parties during the last [*] of the Term, with regard to development and manufacturing of Licensed Articles. 4. GOOD WILL Licensee recognizes the great value of the good will associated with the Name, and acknowledges that the Name and all rights therein, including good will pertaining thereto, belong exclusively to Licensor, and that the Name has a secondary meaning in the mind of the public. Licensee further recognizes and acknowledges that a breach by Licensee of any of its covenants, agreements or undertakings hereunder with respect to use of the Name, legal marking requirements, or quality standards may cause Licensor irreparable damage, which cannot be readily remedied in damages in an action at law, and may, in addition thereto, constitute an infringement of Licensor's copyrights in or trademarks of the Name, thereby entitling Licensor to seek equitable remedies, costs and reasonable attorney's fees. Nothing in this Agreement shall be construed as requiring Licensor to promote, advertise, or otherwise use or exploit the Name during the Term, and Licensor shall be under no obligation to sell any products utilizing the Name at any time. 5. LICENSOR'S TITLE AND PROTECTION OF LICENSOR'S RIGHTS (a) Licensee agrees reasonably to assist Licensor, at Licensor's request and expense, to the extent necessary or desirable in the procurement of any protection or to protect any of Licensor's rights to the Name, and Licensor, if it so desires, may commence or prosecute any claims or suits in its own name or, with the prior written consent of the Licensee (not to be - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -10- 11 unreasonably withheld) in the name of Licensee, or, subject to such consent of Licensee, join Licensee as a party thereto. Licensee shall notify Licensor in writing of any infringements or imitations by others of the Name on articles similar to those covered by this agreement which may come to Licensee's attention, and Licensor shall have the sole right to determine whether or not any action shall be taken on account of any such infringements or imitations. Licensee shall not institute any suit or take any action on account of any such infringements or imitations, or otherwise institute any suit or take any action relating to the Name, without first obtaining the written consent of Licensor to do so, such consent not to be unreasonably withheld in instances affecting the exclusivity of this agreement. (b) Except with Licensor's written consent, neither Licensee, its parent or any of its subsidiaries or affiliates, will register or attempt to register copyrights in any country or to register as a trademark, service mark, design patent or industrial design, any of the Name, trademarks or derivations or adaptations thereof, or any word, symbol or design which is so similar thereto as to suggest association with or sponsorship by Licensor or any of its subsidiaries. In the event of breach of the foregoing, Licensee agrees, at its expense and at Licensor's request, immediately to terminate the unauthorized registration activity and promptly to execute and deliver, or cause to be delivered to Licensor, such assignments and other documents as Licensor may require to transfer to Licensor all rights to the registrations, patents or applications involved. 6. INDEMNIFICATION AND PRODUCT LIABILITY INSURANCE (a) The sole responsibility of Licensor for Licensed Articles shall be strictly as the owner of the copyrights and trademarks thereto, and Licensor indemnities Licensee and its officers, agents and employees and agrees to hold them harmless against any claims, damages, losses, expenses, demands or causes of action (including reasonable attorney and other fees and costs) arising out of the use, as authorized in this Agreement, by Licensee of the Name on the Licensed Articles on condition that the Licensee shall promptly notify Licensor in writing of any such claims, demands, or causes of action. Licensor shall have the sole right to control the defense of any such legal action at its own expense (including choice of attorney and settlement). (b) Licensee hereby indemnifies Licensor and undertakes to defend Licensee and/or Licensor against, and to hold Licensor harmless from, any claims, suits, loss and damage arising out of any use of the Licensed Articles (except to the extent arising from the utilization of the Name) or any patent, process, idea, method or device by Licensee in connection with the Licensed Articles, and also from any claims, suits, loss and damage arising out of actual or alleged defects in the Licensed Articles, whether defects in design, manufacture, or otherwise. Licensee agrees to give Licensor prompt written notice of any such claims or suits. In the event that such a claim or suit alleges that a defect in the Licensed Articles caused serious bodily injury or death, and Licensor obtains the opinion of an expert in the relevant field that the claimed defect exists and that in the normal use or reasonably foreseeable abuse of the Licensed Articles such defect poses a more than insubstantial risk of serious bodily injury or death, then, at Licensor's request (which shall be accompanied by such opinion), Licensee shall diligently work to correct such defect in all units of the Licensed Articles to which the owner and possessor thereof will permit Licensee to make the necessary modifications. Licensee agrees that it will obtain, at its own expense, product liability insurance from a recognized insurance company, providing adequate product liability insurance protection (at least in the amount of $2,000,000 combined single limit of Bodily Injury Liability and Property Damage Liability for each occurrence and annual aggregate), naming the Licensee as named insured and Licensor as additional insured against any claims, suits, loss or damage arising out of any such actual or alleged defects in the Licensed Articles. As proof of such insurance, a certificate of insurance naming Licensor as an additional insured will be submitted to Licensor by Licensee for Licensor to verify Licensee's compliance with this -11- 12 paragraph before any Licensed Article is distributed or sold, and at the latest, within thirty (30) days after the date first written above. Licensor shall be entitled to a copy of the then prevailing certificate of insurance, which shall be furnished Licensor by Licensee. As used in the first two sentences of this Paragraph 6, "Licensor" shall also include the officers, directors, agents and employees of Licensor, or any of its subsidiaries or affiliates. The certificate of insurance shall include a provision to notify Licensor in writing, prior to the effective date, of any amendment or cancellation of such insurance before the effective date thereof. (c) In connection with any claim or suit described in Paragraph 6(a) or 6(b), the party indemnifying, under this Paragraph 6 (the "Indemnitor") shall defend, contest or otherwise protect the indemnified party (the "Indemnitee") against such claim or suit at the Indemnitor's own cost and expense. The Indemnitee shall reasonably cooperate with the Indemnitor, at the Indemnitor's request and expense, in the defense of the claim or suit and shall give the Indemnitor full control over the defense and settlement thereof, provided that no such settlement may be made without the Indemnitee's consent, which will not be unreasonably withheld. In the event that the Indemnitor fails timely to defend, contest or otherwise protect against a claim or suit, the Indemnitee shall have the right to defend, contest or otherwise protect against the same, and upon ten (10) days' written notice to the Indemnitor, make any compromise or settlement thereof and recover the entire cost thereof from the Indemnitor, including without limitation, reasonable attorneys' fees, disbursement and all reasonable amounts applied as a result of such suit or claim or compromise or settlement thereof. The obligations of the parties under this Paragraph 6 shall survive the termination or expiration of this Agreement. 7. MERCHANDISE AND MANUFACTURING STANDARDS (a) Quality of Merchandise. Licensee agrees that the Licensed Articles shall be of satisfactory quality sufficient to meet consumer expectations. The Licensed Articles will be of such style and appearance as to be appropriate for and suited to their exploitation to the best advantage and to the protection and enhancement of the Name and the good will pertaining thereto. The Licensee warrants that the Licensed Articles will be designed, produced, sold and distributed in accordance with all applicable United States laws, rules and regulations, including, without limiting the generality of the foregoing, the Federal Food, Drug and Cosmetic Act, the Federal Hazardous Substance Act (FHSA), the Flammable Fabrics Act, the Consumers Products Safety Act, with all other state and local laws and with all federal and state gaming laws. (collectively, the "Acts and Standards"). (i) In order to insure that the Licensed Articles meet the above standards, Licensee shall, prior to the date of first distribution of the Licensed Articles, submit to the Licensor a "test plan" which lists all of the applicable Acts and Standards and which contains a certification by the Licensee that no other Acts and Standards apply to the Licensed Articles. The test plan shall describe in detail the procedures used to test the Licensed Articles, and Licensee shall submit certificates in writing that the Licensed Articles conform to the applicable Acts and Standards. Upon request by the Licensor, Licensee shall provide Licensor with specific test data or laboratory reports. Licensee must secure Licensor's written approval of Licensee's test plan prior to the date of first distribution. Tests on Licensed Articles must be performed by a national testing laboratory or an independent laboratory that is nationally approved unless another laboratory is otherwise approved by the Licensor. Such testing laboratory or independent laboratory will provide written test reports indicating that the Licensed Articles conform to the applicable Acts and Standards. (ii) To this end, Licensee shall, before selling and distributing any of the Licensed Articles, furnish to Licensor free of cost for its written approval, all preliminary artwork, designs, specifications, and final artwork of the Licensed Articles, as well as the cartons, containers and packing and wrapping material related thereto which utilize the Name. The -12- 13 quality and style of such Licensed Articles as well as of any carton, container or packing, or wrapping material related thereto which utilize the Name, shall be subject to the approval of Licensor. After samples have been approved pursuant to this paragraph, Licensee shall not depart therefrom in any material respect without Licensor's prior written consent, and Licensor shall not withdraw its approval of the approved samples. Unless prohibited by laws Licensee shall, without charge, furnish Licensor with one (1) sample of each Licensed Article, which has been modified such that it contains demonstration software and does not accept or dispense money or anything else of value, manufactured hereunder upon completion of the first production run thereof. Any item submitted to Licensor shall not be deemed approved unless and until the same shall be approved by Licensor in writing. Sale of any Licensed Article by Licensee, the quality of which has not been specifically approved by Licensor as hereinabove provided, shall be deemed to constitute a material breach of this agreement. (b) Manufacturing Ethics. Licensee acknowledges that Licensor has a significant interest in ensuring that the Licensed Articles are manufactured, distributed, and sold in accordance with the highest ethical and business standards. Upon at least ten (10) business days prior notice in writing, Licensor shall have the right to inspect any manufacturing facilities for the Licensed Articles owned or controlled by Licensee, subject to Licensee's reasonable security procedures. Furthermore, Licensee confirms that its strict compliance with the following standards and requirements shall be deemed material to this License Agreement. If Licensee knows or is informed by Licensor that any third party manufacturer of the Licensed Articles (as permitted under Paragraph 20 hereinbelow) fails to meet the following manufacturing standards (with such standards being applied to such manufacturer as if it were Licensee), Licensee shall demand that such manufacturer cure such failure within thirty (30) days, and if such manufacturer shall fail to effect a cure of such failure within such time period, Licensee shall replace such manufacturer as soon as practicable, working diligently and expeditiously to locate and put into place an alternative manufacturer (or to itself assume the responsibility of such manufacturer) in consultation with Licensor, through which Licensor and Licensee will work together to ensure that all reasonable efforts are made to reduce the time necessary to accomplish such replacement given the manufacturing schedules for the Licensed Articles. (i) Licensee will comply with the national laws of any country in which the Licensee manufactures Licensed Articles, or any component thereof, as such laws apply to manufacturing, any local laws, regulations, or standards of regulatory authorities applicable to such manufacturing, and any gaming industry trade association manufacturing standards which have been established in said location (hereinafter, collectively, "Local Manufacturing Laws and Standards"). The Local Manufacturing Laws and Standards should include, but not be limited to, laws concerning import, export, certificate licenses, quota allocations, country of origin, safety (including fire code rules), employment standards, wages and benefits, and employee health and safety. (ii) The employment or use by Licensee of children for the manufacture, assembly, or conversion of the Licensed Articles, or any components thereof, either directly or indirectly, will not be permitted hereunder, except in accordance with Local Manufacturing Laws and Standards with respect to child labor. In countries where there are no existing Local Manufacturing Laws and Standards for child labor, Licensee's use of child labor hereunder should be evaluated carefully, taking into account regional and United States standards. (iii) Licensee will not use forced or prison labor. Licensee must maintain a strict policy of employment on a voluntary basis. (iv) Licensee shall comply with Local Manufacturing Laws and Standards concerning working hours and compensation in all of Licensee's manufacturing facilities in which the Licensed Articles are manufactured. In countries where there are no such existing Manufacturing Laws and Standards, working hours and compensation in Licensee's manufacturing facilities -13- 14 hereunder should be evaluated carefully, taking into account regional and United States standards. (v) Licensee shall ensure that all employees in Licensee's manufacturing facilities for the Licensed Articles have a healthy, safe working environment. All such manufacturing locations should be well-ventilated, comfortable and well lit. Fire exits should be well-identified and training in emergency evacuation must be provided by Licensee to all such employees. Licensee should maintain a written safety policy in Licensee's manufacturing facilities for the Licensed Articles which should be available for review by Licensor. Provision of appropriate safety equipment and instruction in its use is strongly encouraged. Licensee will provide adequate medical assistance in the case of emergencies, and, to the extent practicable, shall train such employees in first aid, health, and hygiene. Licensee shall not employ unreasonable mental or physical disciplinary practices, and shall provide employee benefits, such as living quarters and meals which are adequate to meet the standards of the job, if appropriate with respect to such employees. (vi) Licensee must behave and conduct business in an ethical and proper manner, and shall not use gifts or favors to influence employees of either Licensor or Licensee or to influence government officials or customs agents. (Compliance with the laws of the United States, Canada, the European Union or Australia shall be deemed compliance with the provisions of Paragraphs 6(b)(v) and (vi) with regard to the subject matter thereof). (vii) Licensee shall endeavor in the production of the Licensed Articles to seek to minimize waste, recycle raw materials, properly and safely dispose of toxic material, and otherwise maintain sound environmental programs and practices. (viii) In order to assure Licensor of Licensee's compliance with the foregoing, within six (6) months of the execution of this Agreement, Licensee agrees to supply Licensor with a notarized certification as to such compliance substantially in the form of Exhibit 2, attached hereto. (c) In the event that Licensee is contacted in writing by any governmental body or agency (including but not limited to the United States Food And Drug Administration, Federal Trade Commission, Consumer Product Safety Commission, Federal Communications Commission, the U.S. Department of Justice, or any state attorney general's office) concerning any issue of product safety, material product quality defects, allegedly false or deceptive trading or advertising practices, or an alleged failure to comply with governmental regulations or laws, with respect to a Licensed Article which has begun to ship commercially, Licensee shall promptly notify Licensor. Furthermore, except as may be otherwise required by law, if reasonably practicable under the circumstances, Licensee agrees not to contact any such governmental body or agency, in response to any such inquiry, without first notifying Licensor and giving Licensor a right of meaningful consultation as to any such communication and/or response. 8. TRADEMARK AND COPYRIGHT PROTECTION (a) Labeling. As a condition to the grant of the rights hereunder, Licensee agrees that it will cause to appear on or within each Licensed Article sold by it and on or within all packaging, cartons, wrapping material, advertising, promotional or display material bearing the Name, the notice as set forth in the License Agreement Summary, Paragraph 8(a). (b) Approval. Each and every tag, label, storyboard. copy and layout imprint or other device containing any such notice, and all advertising, promotional or display material bearing the Name, shall be submitted by Licensee to Licensor for its written approval prior to use by Licensee. Approval by Licensor shall not constitute a waiver of Licensor's rights or Licensee's duties under any provision of this Agreement, except where Licensor approves a submission which is on its face at variance with the requirements of this Agreement (e.g. has an abbreviated legal notice), in which case only such variance shall be waived. Licensee must use Licensor's approval form with each submission for Licensor's approval. Otherwise, Licensor is not under any obligation to review Licensee's submission. -14- 15 Licensor agrees to notify Licensee if a submission is not submitted on the appropriate form. (c) Ownership. All right, title and interest in and to all copyrights and trademarks in the graphics, artwork and designs of the Licensed Articles to the extent depicting the Name or derived from the Name, and all copyright and trademark registrations based thereon, shall be in Licensor's name and shall be owned exclusively by Licensor, and Licensee covenants and agrees that it shall have no interest in or claim to the Name or to any of the copyrights and trademarks associated therewith, except to the limited extent of the license to use same pursuant to this agreement, and subject to its terms and conditions. Licensee further agrees to provide Licensor with the date of the first use of the Licensed Articles in interstate and in intrastate commerce and to execute and provide Licensor, at Licensor's expense and request, with all reasonable and necessary documents, assignments and signatures which Licensor may request for the purpose of perfecting Licensor's title to all such copyright and trademark registrations. Licensee agrees to secure any assignments of rights which any third party designers of the Licensed Articles or related materials may otherwise claim, where needed to comply with this Agreement. All uses of the trademarks, graphics, artwork or designs of the Licensed Articles, to the extent depicting the Name or derived from the Name, by Licensee hereunder shall inure to Licensor's benefit. Without limiting the foregoing, Licensee hereby assigns to Licensor all copyrights and trademarks in the graphics, artwork or designs of the Licensed Articles to the extent depicting the Name or derived from the Name, together with the good will attaching thereto. Licensee shall follow Licensor's instructions for proper use of the Name in order that protection and/or registrations for the trademarks may be obtained or maintained; provided, however, that in the event that any change or changes in such instructions shall be required, such change or changes shall be instituted within ninety (90) days on a running chance, go forward basis only after Licensor gives written notice to Licensee of the requested change, and shall not affect Licensee's inventory or parts or product in process existing at the end of such ninety day period and bearing the notice referenced in License Agreement Summary Paragraph 8(a); provided, however, that no such change need be instituted in the software of the Licensed Articles until Licensee elects to submit a new revision of the software for the necessary regulatory approval, and then such change shall be instituted when and where such approval is received and such revision is incorporated into the Licensed Articles. Licensor acknowledges that, with the exception of graphics, artwork and designs to the extent depicting the Name or derived from the Name, all patents, copyrights, trademarks and other intellectual property associated with the Licensed Articles and related packaging, cartons, labeling, point-of-sale, promotional, advertising, display or other materials (including, without limitation. the artwork of the Licensed Articles and such materials, the design and mechanism of the Licensed Articles, and the computer software, music and visual and sound effects in the Licensed Articles) are the exclusive property of Licensee or its third party licensors. Notwithstanding anything to the contrary in this Agreement, Licensor acknowledges that Licensee shall have the right to protect and enforce its rights in the Licensed Articles and related materials without restriction, including, among other things, by obtaining registrations of copyrights, trademarks, design patents and industrial designs. Licensor agrees not to, and not to permit others to, use reproduce, display, perform, distribute, make derivative works of, make or sell any graphics, artwork or designs depicting the Name or derived from the Name developed by or on behalf of Licensee, including without limitation in any amusement game, which, in whole or in part, simulates the play of the Licensed Articles. However, Licensee acknowledges that there may be instances where Licensor or its other licensees develop works which incidentally are substantially similar to such graphics, artwork or designs simply because both such works and such graphics, artwork and designs are based upon the Name, and not because of actual copying of such graphics, artwork and designs, this being most likely where such graphics, artwork and designs simply depict the -15- 16 Name, and least likely where such graphics, artwork and designs are derived from the Name but contain substantial modifications or additions thereto. 9. PROMOTIONAL MATERIAL (a) In all cases where Licensee desires artwork involving Licensed Articles to be executed, the cost of such artwork and the time for the production thereof shall be born by Licensee. All artwork and designs involving the Name, or any reproduction thereof, shall be subject to prior written approval of Licensor. (b) Licensor shall have the right, but shall not be under any obligation, to use the Name and/or the name of Licensee so as to give the Name, Licensee, Licensor and/or Licensor's programs full and favorable prominence and publicity; provided, however, that uses of the Licensee's name individually, and not as part of a group of licensees, shall be subject to Licensee's consent, such consent not to be unreasonably withheld or delayed. (c) Licensee agrees not to offer for sale or advertise or publicize any of the Licensed Articles on radio, broadcast, print or television without the prior written approval of Licensor. Licensee also agrees to submit to Licensor for advance approval designed sketches of all advertising and other publicity material which Licensee proposes to use in connection with the promotion and sale of the Licensed Articles. 10. DISTRIBUTION (a) Licensee agrees that during the term of this license it will manufacture, distribute and sell the Licensed Articles and that it will make and maintain arrangements for the distribution of the Licensed Articles, consistent with its customary practices for goods or services of like kind and in accordance with its reasonable business judgment, exercised in good faith. (b) Licensee agrees that it will sell and distribute the Licensed Articles outright or distribute them otherwise as contemplated by Paragraph 2(a)(i) of the License Agreement Summary consistent with its customary business practices and only within the Channels of Distribution specifically permitted under Paragraph I(b) above. Licensee shall not sell or distribute Licensed Articles to whose sales or distribution are or will be made for publicity or promotional tie-in purposes, combination sales, premiums, giveaways, or similar methods of merchandising, or who engages in deceptive, illegal, or immoral business practices as to the use of the Licensed Articles. For purposes of this paragraph, the term "premium" shall include, but not be limited to, free or self-liquidating items offered to the public in conjunction with the sale or promotion of a product or service, or any similar scheme or device, the prime intent of which is to use the Licensed Articles in such a way as to promote, publicize and/or sell services and/or other product(s). Licensee is expressly prohibited from making door to door sales. In the event any sale is made at a special price to any of Licensee's subsidiaries or to any other person, firm or corporation related in any manner to Licensee or its officers, directors or major stockholders, there shall be a royalty paid on such sales based upon the price generally charged the trade by Licensee if price is part of the calculation of the royalty. 11. RECORDS Licensee agrees to keep accurate books of account and records covering all transactions relating to its compliance with Paragraphs 2 and 6(b) (as it relates to insurance), hereof, and Licensor and its duly authorized certified public accountants shall have the right, but not more than once per calendar year, on at least ten (10) business days written notice and during Licensee's normal business hours to an inspection of said books of account and records and of all other documents, materials, and premises in the possession or under the control of Licensee reasonably necessary to determine compliance with the terms of Paragraphs 2and 6(b) (as it relates to insurance) of this Agreement and shall have free and full access thereto for said purposes and for the purpose of making extracts therefrom and ensuring Licensor of Licensee's compliance with Paragraphs 2 and 6(b) (as it relates to insurance) of this Agreement. All such books of account and records shall be kept available for at least two (2) years after the termination of this license. In the event that Licensor or its duly authorized certified public -16- 17 accountants shall discover a royalty payment discrepancy of [*] or more pursuant to any such examination, Licensee shall pay to Licensor the fee for such examination, plus reasonable out of pocket costs. The fee for said examination shall be[*] per day, but in no event shall Licensee be charged in excess of [*] for any individual examination. Royalties found to be due as a result of Licensor's examination of the Licensee's books of accounts should be paid immediately with interest at an interest rate of [*] per month, or the highest rate permitted by law, whichever rate is lower, from the date the royalty amount should have been paid to Licensor until paid. 12. TERMINATION (a) If in any calendar year of the Initial Term or the Optional Renewal Term Licensee fails to lease, sell, or otherwise provide any of the Licensed Articles and derives no revenue subject to royalty payments from the use or operation thereof, Licensor may terminate this license by giving notice of termination to Licensee. Such notice shall be effective when mailed by Licensor. (b) If Licensee becomes insolvent, or if a petition in bankruptcy or for reorganization is filed by or against it (and in the case of a filing against it, such filing is not dismissed within ninety (90) days), or if any insolvency proceedings are instituted by or against it under any state or federal law (and in the case of a filing against it, such filing is not dismissed within ninety (90) days), or if it makes an assignment for the benefit of its creditors, or if a receiver is appointed for its property and business and remains undischarged for a period of ninety (90) days, or if it liquidates its business in any manner whatsoever, or if any distress. execution or attachment is levied on substantially all of its assets and remains undischarged for a period of ninety (90) days, Licensor shall have the right, if it so elects, to terminate this agreement and the license hereby granted, upon thirty (30) days' notice in writing to Licensee. Upon the expiration of such thirty (30) days, this Agreement and the license hereby granted shall cease and terminate. (c) If Licensee shall violate any of its other obligations under the terms of this agreement, and each of such obligations shall be deemed to be material, Licensor shall have the right to terminate the license hereby granted upon thirty (30) days' notice in writing, and such notice of termination shall become effective unless Licensee shall completely remedy the violation within the thirty (30) day period and provide reasonable evidence to Licensor that such violation has been remedied. (d) Termination of the license under the provisions of Paragraph 12 shall be without prejudice to any rights which Licensor may otherwise have against Licensee, including the right to recover royalties due hereunder or damages caused it by Licensee's breach. Upon the termination of this license, notwithstanding anything to the contrary herein, all royalties on sales theretofore made, all unpaid advances, and all minimum guarantee balances shall become immediately due and payable, and shall not be repayable. 13. FINAL STATEMENT UPON TERMINATION OR EXPIRATION Sixty (60) days before the expiration of this license and again, within ten (10) days after such expiration (or, in the event of termination of this license, ten (10) days after receipt of notice of termination or the happening of the event which terminates this agreement where no notice is required), Licensee shall furnish to Licensor a statement showing the number and description of articles covered by this agreement on hand or in process. Licensor shall have the right to take a physical inventory to ascertain or verify such inventory and statement, and refusal by Licensee to submit to such physical inventory by Licensor shall forfeit Licensee's right to dispose of such inventory as provided in Paragraph 14 hereof, Licensor retaining all other legal and equitable rights Licensor may have in the circumstances. 14. DISPOSAL OF STOCK UPON EXPIRATION - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -17- 18 After expiration of this agreement, Licensee, except as otherwise provided in this Agreement, may dispose of Licensed Articles which are completed and on hand at the time of expiration for a period as indicated in Paragraph 14 of the License Agreement Summary, provided that (i) advances and royalties with respect to that period are paid and statements are furnished for that period in accordance with Paragraph 2, (ii) the Licensed Articles had been offered for sale and shipped prior to the expiration of the Term, and (iii) such sales are restricted to the Territory and Channels of Distribution. Notwithstanding anything to the contrary herein, Licensee shall not manufacture, sell or dispose of any Licensed Articles after termination hereof based on the failure of Licensee to affix notice of copyright, trademark, or service mark as specified above, or because of the departure by Licensee from the quality and style approved by Licensor pursuant to Paragraph 7, or by reason of termination for any other causes set forth in Paragraph 12 above. In the event of such termination by Licensor by reason of any cause contained in Paragraph 12, Licensee, its receivers, representatives, trustees, agents, administrators and successors shall have no further right to sell, exploit or in any way deal in or with any of the Licensed Articles, or any advertising matter, packing material, boxes, cartons or other documentation relating thereto which use the Name. 15. EFFECT OF TERMINATION OR EXPIRATION Upon and after the expiration or termination of this license, all rights granted to Licensee hereunder shall forthwith revert to Licensor, and Licensee will refrain from further use of the Name or any further reference to it, direct or indirect, or anything reasonably deemed by Licensor to be confusingly similar to the Name in connection with the manufacture, sale or distribution of Licensee's products, except as provided in Paragraph 14. Notwithstanding anything in this Agreement to the contrary, termination or expiration of this Agreement shall not terminate any lease or other contractual arrangement in place between Licensee (including its affiliates) and its customer as of the date of termination or expiration under which Licensee is providing Licensed Articles to such customer on a basis other than the outright sale (which includes lease financing) of the Licensed Articles, provided that no such lease or other arrangement shall continue beyond one (1) year after such expiration or termination. Licensed Articles which have been sold outright to customers (including through lease financing) shall be unaffected by the expiration or termination of this Agreement. 16. LICENSOR'S REMEDIES (a) Licensee acknowledges that its failure (except as otherwise provided herein) to cease the manufacture, sale or distribution of the Licensed Articles or any class or category thereof at the termination or expiration of this agreement will result in immediate and irremediable damage to Licensor and to the rights of any subsequent licensee. Licensee acknowledges and admits that there is no adequate remedy at law for such failure to cease manufacture, sale or distribution, and Licensee agrees that in the event of such failure, Licensor shall be entitled to equitable relief by way of temporary and permanent injunctions and such other further relief as any court with jurisdiction may deem just and proper. (b) Resort to any remedies referred to in this Agreement shall not be construed as a waiver of any other rights and remedies to which Licensor is entitled under this agreement or otherwise. 17. EXCUSE FOR NONPERFORMANCE Neither party shall have any liability for its delay or failure to perform under this Agreement where caused by national emergency, war, fire, flood, strike, riot, materials shortages, transportation failure or other force majeure beyond its control; provided that if such failure or delay shall continue for a period of one hundred twenty (120) days or more, the other party may terminate this Agreement by giving written notice. In such events, all royalties on sales theretofore made shall become immediately due and payable, and no advance or minimum royalties shall be repayable. 18. NOTICES All notices and statements to be given, and all payments to be made hereunder shall be given or made at the respective addresses of the -18- 19 parties as set forth above, unless notification of change of address is given by certified mail, return receipt requested and the date of mailing shall be deemed the date the notice or statement is given. Notices sent to Licensee must be sent to the attention of the President with copies to the Vice President and General Counsel, WMS Industries Inc., 3401 N. California Avenue, Chicago, Illinois, 60618. 19. NO JOINT VENTURE Nothing herein contained shall be construed to constitute the parties joint venturers, nor shall any similar relationship be deemed to exist between them. Nothing herein contained shall be construed as constituting Licensee as Licensor's agent or as authorizing Licensee to incur financial or other obligations in Licensor's name, and it is specifically understood and agreed that under no circumstances shall any power granted, or which may be deemed to be granted to Licensee, be deemed to be coupled with an interest. It is specifically understood that the rights and powers retained by Licensor to approve the Licensed Articles and advertising, display and promotional material using the Name, all as hereinabove provided, are retained because of the necessity of protecting Licensor's copyrights, trademarks, properties and property rights generally, and specifically to conserve the good will and good name of Licensor's company and of the Name. 20. NO ASSIGNMENT OR SUBLICENSE BY LICENSEE This agreement and all rights and duties hereunder are personal to Licensee and shall not, without the written consent of Licensor, be assigned, mortgaged, sublicensed or otherwise encumbered by Licensee or by operation of law. For purposes of this agreement, the term "assignment" shall, in addition to the transfer of this agreement or the rights or obligations thereunder, whether voluntarily, involuntarily, by operation of law or otherwise, be deemed to include (1) a sale or other transfer by Licensee of all or substantially all of its assets; (ii) the liquidation or dissolution of Licensee; (iii) the merger, amalgamation, consolidation or reorganization of Licensee into or with another corporation or other entity which is not an affiliate of Licensee as a result of which Licensee is not the surviving corporation; or (iv) any transaction (including any of the foregoing transactions, as well as any in which Licensee is the surviving corporation) which, whether by way of sale, gift or other transfer, results in more than a [*] change in ownership of the voting stock of Licensee, except where such stock is transferred to an affiliate of Licensee. Licensee shall not be entitled to sublicense any of its rights under this agreement, except that, in the event Licensee is not a manufacturer of the Licensed Articles, or wishes to use third parties to manufacture the License Articles, Licensee may, subject to the prior written approval of Licensor, utilize a third-party manufacturer in connection with the manufacture and production of the Licensed Articles, provided that such manufacturer shall execute a letter in the form of Exhibit I attached hereto and made a part hereof. In such event and in the event of any permitted assignment, Licensee shall remain primarily obligated under all of the provisions of this Agreement. In no event shall any sublicense agreement include the right to grant any further sublicenses. 21. INTEGRATION No waiver or modification of any of the terms of this Agreement shall be valid unless in writing and signed by the party to be charged. No waiver by either party of a breach or default hereunder, or a continuing breach or default, shall be deemed a waiver by such party of a subsequent breach or default of like or similar nature. Any approval or consent given by Licensor shall not constitute a waiver of any of Licensor's rights or Licensee's duties under any provision of this Agreement, except as provided herein. There are no representations, promises, warranties, covenants or undertakings other than those contained in this Agreement, which represents the entire understanding of the parties. No person, firm, group or - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -19- 20 corporation (whether included in the Name or otherwise), other than Licensee and Licensor, shall be deemed to have acquired any rights by reason of anything contained in this Agreement, except as provided in Paragraph 20. 22. GOVERNING LAW This agreement shall be construed in accordance with the internal laws of the State of Rhode Island. The parties agree that any dispute arising hereunder shall be subject to the exclusive jurisdiction of the courts of such State, including the United States District Court for the District of Rhode Island, and consent to the jurisdiction thereof. 23. HEADINGS The paragraph and other headings in this Agreement are for reference purposes only and will not affect the meaning or interpretation of this Agreement. 24. SEVERABILITY In the event that any provision(s) of this Agreement is adjudicated by a court of competent jurisdiction to be unlawful, unenforceable, invalid, and/or unconscionable, that provision(s) shall be deemed severed from this Agreement and shall not affect the validity or enforceability of the remaining provisions hereof or this Agreement as a whole. 25. SURVIVAL The provisions of Paragraphs l(c) (second and third paragraphs only), 4, 5(b), 6, 7(c), 8(c), II, 12(d), 13, 14, 15, 16, 26 and 29 shall survive the termination or expiration of this Agreement. The provisions of Paragraph 2(a), (c), and (d) shall survive during any period of Licensee's continued exploitation of the Licensed Articles. 26. CONFIDENTIALITY Licensee shall keep in confidence, not disclose to any third party and not use for any purpose except its performance under this Agreement, without the written permission of Licensor, the terms of this Agreement (including, without limitation, the royalty rates) except that Licensee may disclose such terms to its distributors and affiliates as necessary to exercise its rights and perform its obligations under this Agreement. Likewise Licensor shall keep in confidence and not disclose to any third party, without the written permission of Licensee, the terms of this Agreement (including, without limitation, the royalty rates) and the proprietary information of Licensee which may be disclosed to Licensor hereunder (including, without limitation, information about the Licensed Articles and the information learned by Licensor under Paragraphs 2, 7(a), 8(b) and 11 except that Licensor may disclose such terms to its distributors and affiliates as necessary to exercise its rights and perform its obligations under this Agreement. The foregoing obligations shall not apply to information that is (a) in the public domain through no wrongful act of the receiving party; (b) rightfully received by the receiving party from a third party who is not bound by a restriction of nondisclosure; (c) already in the receiving party's possession without restriction as to disclosure, or (d) is required to be disclosed by applicable rules and regulations of government agencies or judicial bodies. 27. PRESS RELEASE Upon execution of this Agreement Licensee may make a press release concerning this Agreement. Such press release shall be subject to the approval of Licensor, which approval will not be unreasonably withheld or delayed. 28. LICENSOR'S APPROVAL RIGHTS As to the exercise by Licensor of its rights to approve the Licensed Articles and any material relating thereto pursuant to Paragraphs 7, 8 and 9 hereof, Licensor shall not unreasonably withhold or delay such approval, and will take into account gaming industry regulations, standards and practices and the technical limitations of the applications involved. -20- 21 29. LIABILITY Neither party shall be liable for incidental, consequential, special or other indirect damages (including, without limitation, lost profits) arising out of or in connection with this Agreement, even if informed of the possibility thereof. IN WITNESS WHEREOF, the parties hereto have caused this instrument to be duly executed as of the day and year first above written. HASBRO, INC. WMS GAMING INC. By: /s/ Harold P. Gordon By: /s/ Kevin L. Verner Title: Vice Chairman Title: EVP, General Manager HASBRO INTERNATIONAL, INC. By: /s/ Harold P. Gordon Title: Vice Chairman -21- 22 Dated:__________________________ EXHIBIT 1 MANUFACTURER'S AGREEMENT The company signing this Agreement (herein referenced as "MANUFACTURER") will be responsible for manufacturing certain articles of merchandise involving licensed material (herein referenced as "LICENSED PROPERTY") that includes, but is not limited to cartoon and/or fictional characters, names and/or logos which are, by reasons of copyright, trademark and/or other property rights, the exclusive property of Hasbro, Inc., a United States corporation with offices at 1027 Newport Avenue, Pawtucket, Rhode Island 02862-1059, USA (herein referenced as "LICENSOR"). MANUFACTURER recognizes and accepts that a License Agreement exists between LICENSOR and the company designated as "LICENSEE" in the "BASIC TERMS" set forth below, authorizing LICENSEE to use the LICENSED PROPERTY in conjunction with the "AUTHORIZED ARTICLES" (as defined in the BASIC TERMS) only in the "TERRITORY AUTHORIZED FOR SHIPMENT" (as defined in the BASIC TERMS) during the "PERIOD OF AUTHORIZATION" (as defined in the BASIC TERMS). MANUFACTURER recognizes that its engagement is subject to LICENSOR's written approval, which approval will be granted upon LICENSOR's timely receipt of this Agreement duly signed by MANUFACTURER. In consideration for its engagement by LICENSEE to manufacture the AUTHORIZED ARTICLES, MANUFACTURER agrees to fulfill the following terms and conditions: 1. It will not manufacture the AUTHORIZED ARTICLES or components of same bearing the Licensed Property for anyone but LICENSEE. 2. It will not manufacture copies of the AUTHORIZED ARTICLES or components of same at any address other than that (or those) indicated as the ADDRESS OF MANUFACTURER, as defined in the BASIC TERMS hereinbelow. 3. It will not authorize any other party to manufacture copies of the AUTHORIZED ARTICLES or any components thereof containing copyrighted material and/or trademarks owned by LICENSOR, for its or LICENSEE's account, without the express prior written consent of LICENSOR. 4. It will manufacture only such quantities of the AUTHORIZED ARTICLES or components of same as are ordered specifically by LICENSEE or authorized in writing by LICENSOR or its agent. 5. It will ship the duly approved quantities of the AUTHORIZED ARTICLES or components of same only to LICENSEE and only within the "TERRITORY AUTHORIZED FOR SHIPMENT" indicated in the BASIC TERMS. 6. It will not, unless LICENSOR otherwise consents in writing, manufacture any merchandise utilizing any of the copyrighted material and/or trademarks of LICENSOR, other than as identified as AUTHORIZED ARTICLES. 7. It will permit the LICENSOR, its agent, auditors or designated Surveillance Firm (or such other firm as LICENSOR may from time to time designate) to inspect the activities and premises of MANUFACTURER and to examine the accounting books and invoices of MANUFACTURER relevant to its manufacture and supply to LICENSEE. MANUFACTURER will, whenever requested, provide copies of all such documents to LICENSOR or its agents. MANUFACTURER acknowledges that if, due to his fault, the manufacture of the AUTHORIZED ARTICLES continues after the PERIOD OF AUTHORIZATION has ended, or after notice of termination from LICENSOR, such manufacture shall infringe upon and damage the rights of LICENSOR. MANUFACTURER therefore recognizes and accepts that LICENSOR has the right to receive relief and money damages by -22- 23 means of judicial resolution and other recourses to stop such production, commercialization or other use of its properties. BASIC TERMS 1. LICENSEE: WMS GAMING INC. 2. MANUFACTURER: 3. LICENSED PROPERTY: MONOPOLY 4. AUTHORIZED ARTICLES: Gaming Products and Gaming Services Related to Gaming Devices 5. PERIOD OF AUTHORIZATION: 6. ADDRESS OF MANUFACTURER: 7. TERRITORY AUTHORIZED FOR SHIPMENT: Worldwide 8. COMPANY designated by LICENSOR to supervise, control and verify the manufacture and delivery of AUTHORIZED ARTICLES: IN WITNESS WHEREOF, the MANUFACTURER has caused this document to be duly signed by its authorized official as of the date set forth above. ________________________ (MANUFACTURER) By:_____________________ Date:___________________ LICENSOR agrees to and accepts the engagement of MANUFACTURER in consideration of MANUFACTURER's promises to be bound by the terms and conditions of this Agreement. HASBRO, INC. (LICENSOR) By:_______________________ HASBRO INTERNATIONAL, INC. (LICENSOR) By:_______________________ -23- 24 EXHIBIT 2 CERTIFICATION The undersigned, on behalf of WMS Gaming Inc. (hereinafter, "Licensee"), hereby certifies and affirms that Licensee has complied with all obligations and requirements of Paragraph 7(b) of its Agreement, dated September 1, 1997, with Hasbro, Inc. regarding Manufacturing Ethics, and that Licensee has taken sufficient steps reasonably calculated to ensure that any third party manufacturers which it may have engaged pursuant to the Agreement are also in compliance with said Paragraph 7(b). AFFIRMED: By:______________________ Title:_____________________ Subscribed and affirmed before me this _________ day of ______________, 19___. _____________________________ Notary Public My Commission Expires__________. -24- 25 SCHEDULE "A" "MONOPOLY" its associated logo, and all related trademarks, copyrights, and characters, including but not limited to the name and likeness of the character known as "Rich Uncle Pennybags." -25- 26 DOMESTIC LICENSE REPORT OF SALES ACTIVITY AND ROYALTIES DUE [FORM] -26- EX-99.2 5 AMENDMENT TO LICENSE AGREEMENT 1 CERTAIN INFORMATION HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. EXHIBIT 99.2 AMENDMENT TO LICENSE AGREEMENT This Amendment to License Agreement ("Amendment") is an amendment to the License Agreement and License Agreement Summary (hereinafter collectively referred to as "Agreement") each dated September 1, 1997 between HASBRO, INC. and HASBRO INTERNATIONAL, INC., both with a principal place of business at 1027 Newport Avenue, Pawtucket, Rhode Island 02862-1059 (hereinafter collectively referred to as "Licensor") and WMS GAMING INC., with its principal place of business at 3401 North California Avenue, Chicago, Illinois 60618 ("Licensee"). RECITALS: A. Pursuant to the Agreement, among other things, Licensor granted a license to Licensee to manufacture, distribute, promote and sell certain gaming products, sold in association with the trademark "MONOPOLY(R)". Capitalized terms used in this Amendment and not otherwise defined shall have the meanings given to such terms in the Agreement. B. Licensor and Licensee desire to modify and amend the Agreement. AGREEMENT: THEREFORE, in consideration of the mutual covenants and agreements in the Agreement and this Amendment, the parties hereby agree as follows: 1. Royalties. Section 2(i) of the License Agreement Summary is hereby deleted in its entirety and replaced with the following text: (i) For all Licensed Articles which are not sold outright by Licensee, but rather are leased or otherwise placed with licensed third parties under arrangements where Licensee will receive ongoing payments from their operation during the term of the Agreement, Licensee shall, where lawful, pay Licensor a royalty equal to [*] of the gross revenue received by the Licensee for the leasing or other use of such Licensed Article, less any fees or taxes payable to third parties such as government levies, third party commissions, prizes for players (or funds to support such prizes), royalties or fees to other licensors and amounts payable to casinos or other licensed gaming establishments. In such jurisdictions where Licensor is precluded by statute, regulation, rule, ordinance or order from receiving royalty payments based upon such percentage of Licensee's revenues as provided above without Licensor first being licensed, approved or found suitable, Licensee shall pay Licensor a Flat Fee royalty (as more fully set forth in the attached Flat Fee Schedule) for each day during the period during which Licensee accrues or is otherwise entitled to payment from which Licensee would otherwise have remitted royalty payments on a percentage basis to Licensor hereunder. The parties agree that due to the novelty of the Licensed Articles and potential changes in market conditions and consumer preferences, the parties shall review the Flat Fee Schedule not less frequently than annually and shall negotiate in good faith to make any adjustments which may be necessary or appropriate to reflect any such changes to market conditions or consumer acceptance of the Licensed Articles, subject to applicable gaming regulatory requirements. Under - ---------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -1- 2 no circumstances may the Flat Fee royalty be adjusted more than once every twelve months. 2. Cooperation with Gaming Authorities and Compliance with Gaming Laws. Licensee and Licensor will cooperate in good faith and will use their best efforts to comply with the requirements of all applicable gaming laws and gaming authorities having jurisdiction over Licensee and the sale or operation of the Licensed Articles (each a "Gaming Authority"). If a Gaming Authority prohibits or restricts the taking of any action, including the payment of monies, which prohibition or restriction frustrates any purpose of the Agreement, the parties will in good faith attempt to modify or amend the Agreement, or take other appropriate action, to obtain the approval of such Gaming Authority to permit payment by Licensee of the amounts due Licensor hereunder. If Licensee is prevented from paying Licensor royalty payments by a Gaming Authority for any reason, Licensee shall deposit such royalty payments into an escrow account established with a mutually agreeable escrow agent for the benefit of Licensor until payment is authorized by such Gaming Authority or otherwise distributed pursuant to an order of a court of competent jurisdiction. The funds deposited in the escrow account shall be invested as directed by Licensor. 3. Quarterly Statements. Licensee shall provide Licensor, with each quarterly statement under Section 2(c) of the Agreement, an updated tally that will break down the exact location (i.e., the name and city of the casino or other establishment where located) of each Licensed Article which is a gaming device and has not been sold by Licensee. 4. Sales and Marketing. Licensee agrees that it shall use reasonable business efforts to engage in discreet sales and marketing efforts for the Licensed Articles, it being acknowledged that Licensee does not have separate sales staff or facilities dedicated solely to the sale and marketing of Licensed Articles. Licensee will not, in any event, condition the sale/placement of Licensed Articles upon the sale/placement of Licensee's other goods or services. 5. Amendment Priority. Except as specifically modified or amended by this Amendment, all of the terms and conditions of the License Agreement and License Agreement Summary are unmodified and shall remain in full force and effect. In the event a discrepancy arises between the terms and conditions of the Agreement and the Amendment, this Amendment shall prevail. IN WITNESS WHEREOF, the parties have hereunto set their hand this ____ day of __________, 1998. HASBRO, INC. WMS GAMING INC. By: /s/Harold P. Gordon By: /s/Kevin Verner Title: Vice Chairman Title: EVP, COO HASBRO INTERNATIONAL, INC. By: /s/Harold P. Gordon Title: Vice Chairman -2- 3 Flat Fee Schedule Listed below are the Flat Fee royalties by jurisdiction to be paid by Licensee to Licensor per Licensed Article per day. Jurisdiction Flat Fee Amount Notes ------------ --------------- ----- 1. Nevada [*] Initial /i/KV Initial ________ - -------- * Certain information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment pursuant to Rule 406 under the Securities Act of 1933, as amended. -3- EX-99.3 6 EMPLOYMENT AGREEMENT 1 Exhibit 99.3 EMPLOYMENT AGREEMENT This Agreement is made as of the 1st day of June, 1999, by and between WMS INDUSTRIES INC., a Delaware corporation, with offices at 3401 North California Avenue, Chicago, Illinois 60618 (hereinafter called the "Corporation") and TERENCE M. DUNLEAVY, an individual residing at 1968 Pleasant Hill Lane, Lisle, Illinois 60532 (hereinafter called "Employee"). W I T N E S S E T H: WHEREAS, the Corporation desires to employ Employee and Employee is willing to accept such employment on the terms and subject to the conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth, the parties hereto agree as follows: 1. Employment by Corporation. The Corporation hereby agrees to employ Employee to perform such duties on behalf of the Corporation and its affiliates as the Chairman of the Board and Chief Executive Officer or such officer as may subsequently be designated by the Board of Directors of the Corporation ("Management"), may from time to time determine, including without limitation duties with respect to regulatory compliance and governmental affairs relating to the design, development and manufacture for the Corporation of gaming devices ("Game[s]") to be manufactured and sold by the Corporation or by one or more of other corporations under common control with the Corporation (its "Affiliates"). The primary assignment of Employee shall be Vice President, Assistant General Counsel and Chief Compliance Officer. 2. Employee's Acceptance of Employment. Employee hereby accepts such employment and agrees that throughout the period of his employment hereunder he will devote his full time, attention, knowledge and skills, faithfully, diligently and to the best of his ability, in furtherance of the business of the Corporation and its Affiliates, he will perform the duties assigned to him pursuant to Paragraph 1 hereof, subject, at all times, to the direction and control of Management and he will do such reasonable traveling as may be required of him in the performance thereof. Employee shall at all times be subject to, observe and carry out such rules, regulations, policies, directions and restrictions as the Corporation shall from time to time establish. During the period of his employment by the Corporation, Employee agrees to be bound by the Corporation's Ethics and Conflicts of Interest Policy and any amendments adopted thereto, a copy of which Employee hereby acknowledges he has received and read, and Employee agrees that he shall not, without the prior written approval of Management, directly or indirectly, accept employment or compensation from or perform services of any nature for, any business enterprise other than the Corporation and its Affiliates and such enterprises previously disclosed to the Corporation in writing. 1 2 3. Term. Employee shall be employed for a term ("Term") of one (1) year commencing on the date hereof; provided, however, that during Employee's employment hereunder, such term shall be deemed to be automatically extended from time to time for an additional one (1) year period such that the term of Employee's employment shall not be less than one (1) year nor greater than one (1) year, unless his employment is terminated voluntarily by Employee or by the Corporation for cause in accordance with Paragraph 6 hereof, in which case such term shall terminate immediately. Each year of the Term is hereafter referred to as an "Employment Year." 4. Compensation/Benefits. 4.1 The Corporation will pay to Employee as compensation for his services hereunder a salary of One Hundred Twenty Thousand Dollars ($120,000). Such salary may be adjusted from time to time as determined by Management and is to be payable in equal installments no less frequently than semimonthly. Employee shall also be entitled to receive an annual discretionary bonus in an amount of up to thirty percent (30%) of Employee's then current base salary. Such bonus shall be within the sole discretion of Management and will be based upon the extent to which Employee achieves mutually agreed corporate and personal performance criteria and objectives during the employment year; two-thirds (2/3) of such bonus calculation shall be based upon Employee's personal performance and one-third (1/3) of such bonus shall be based upon corporate performance criteria. Employee may be included, in the sole discretion of Management, in such other profit sharing, incentive or other bonus arrangements which may be in effect from time to time. 4.2 Employee shall be entitled to participate during the Term, to the extent he is eligible under the terms and conditions thereof, in any pension, retirement, disability, hospitalization, insurance, medical service, or other employee benefit plan which is generally available to all employees of the Corporation (including Execu-Care supplemental medical and life insurance benefits) and which may be in effect from time to time during the period of his employment. The Corporation shall be under no obligation to institute or continue the existence of any such employee benefit plan. 5. Business Expenses. The Corporation shall reimburse Employee for all authorized expenses reasonably incurred by him in accordance with the Corporation's "Travel and Entertainment Policy and Procedure" and any amendment thereof that the Corporation may adopt during his employment. 6. Termination. In addition to all other rights and remedies which the parties may have under applicable law, Employee and the Corporation hereby agree: that the Corporation may terminate this Agreement and the services of Employee, effective upon the occurrence of any of the following events: (i) a material failure by Employee to perform his obligations under this Agreement; (ii) the death of Employee or his disability for a period of three (3) consecutive months; (iii) Employee fails to follow the Corporation's "Ethics and Conflicts of Interest Policy," and any amendment thereof that the Corporation may adopt during his employment; or (iv) in the event that Employee shall act, whether with respect to his employment or otherwise, in a manner which is in violation of the criminal laws of the United States or any State or subdivision thereof 2 3 (excluding minor violations) or which is reasonably likely to result in the loss of a gaming license held by the Corporation or by any Affiliate or in such entity's inability to become so licensed. 7. Non-Competition. In consideration of the Corporation's entering into this Agreement: 7.1 Employee agrees that during the Term hereof and, in the event Employee voluntarily terminates his employment or the Corporation terminates Employee's employment for cause, prior to the expiration of six (6) months following such termination of Employee's employment, he will not directly or indirectly own, manage, operate, join, control, participate in, perform any services for, invest in, or otherwise be connected with, in any manner, whether as an officer, director, employee, consultant, partner, investor or otherwise, any business entity which is engaged in the design, manufacture and/or sale of any gaming devices or any business entity which is engaged in any other business in which the Corporation or any of its Affiliates is engaged. Nothing herein contained shall be deemed to prohibit Employee from investing his funds in securities of a company if the securities of such company are listed for trading on a national stock exchange or traded in the over-the-counter market and Employee's holdings therein represent less than five (5) percent of the total number of shares or principal amount of other securities of such company outstanding. 7.2 Employee agrees that Employee will not, during the Term hereof or prior to the expiration of one (1) year following the termination of the Employee's employment for any reason, without the written consent of the Corporation, directly or indirectly, by action alone or in concert with others, induce or influence, or seek to induce or influence any person who is engaged by the Corporation or any of its Affiliates as an employee, agent, independent contractor or otherwise, to terminate his employment or engagement, nor shall Employee, directly or indirectly, through any other person, firm or corporation, employ or engage, or solicit for employment or engagement, or advise or recommend to any other person or entity that such person or entity employ or engage or solicit for employment or engagement, any person or entity employed or engaged by the Corporation. 8. Confidentiality Agreement. 8.1 As used herein, the term "Confidential Information" shall mean the terms of this Employment Agreement and any and all information of the Corporation and of its Affiliates (for purposes of Paragraphs 8, 9 and 10 of this Agreement, the Corporation's Affiliates shall be deemed included within the meaning of "Corporation"), including, but not limited to, all data, compilations, programs, devices, strategies, or methods concerning or related to (i) the Corporation's finances, financial condition, results of operations, employee relations, amounts of compensation paid to officers and employees and any other data or information relating to the internal affairs of the Corporation and its operations; (ii) the terms and conditions (including prices) of sales and offers of sales of the Corporation's products and services; (iii) the terms, conditions and current status of the Corporation's agreements and relationship with any customer or supplier; (iv) the customer and supplier lists and the identities and business preferences of the Corporation's actual and prospective customers and suppliers or any employee or agent thereof with whom the Corporation communicates; (v) the trade secrets, manufacturing and operating 3 4 techniques, price data, costs, methods, systems, plans, procedures, formulas, processes, hardware, software, machines, inventions, designs, drawings, artwork, blueprints, specifications, tools, skills, ideas, and strategic plans possessed, developed, accumulated OR acquired by the Corporation; (vi) any communications between the Corporation, its officers, directors, shareholders, or employees, and any attorney retained by the Corporation for any purpose, or any person retained or employed by such attorney for the purpose of assisting such attorney in his or her representation of the Corporation; (vii) any other information and knowledge with respect to all gaming developed or in any stage of development by the Corporation; (viii) the abilities and specialized training or experience of others who as employees or consultants of the Corporation during the Employee's employment have engaged in the design or development of any such products; and (ix) any other matter or thing, whether or not recorded on any medium, (a) by which the Corporation derives actual or potential economic value from such matter or thing being not generally known to other persons or entities who might obtain economic value from its disclosure or use, or (b) which gives the Corporation an opportunity to obtain an advantage over its competitors who do not know or use the same. 8.2 Employee acknowledges and agrees that the Corporation is engaged in the highly competitive gaming device business and has expended, or will expend, significant sums of money and has invested, or will invest, a substantial amount of time to develop and maintain the secrecy of the Confidential Information. The Corporation has thus obtained, or will obtain, a valuable economic asset which has enabled, or will enable, it to develop an extensive reputation and to establish long-term business relationships with its suppliers and customers. If such Confidential Information were disclosed to another person or entity or used for the benefit of anyone other than the Corporation, the Corporation would suffer irreparable harm, loss and damage. Accordingly, Employee acknowledges and agrees that, unless the Confidential Information becomes publicly known through legitimate origins not involving an act or omission by Employee: (i) the Confidential Information is, and at all times hereafter shall remain, the sole property of the Corporation; (ii) Employee shall use his best efforts and the utmost diligence to guard and protect the Confidential Information from disclosure to any competitor, customer or supplier of the Corporation or any other person, firm, corporation or other entity; (iii) unless the Corporation gives Employee prior express written permission, during his employment and thereafter, Employee shall not use for his own benefit, or divulge to any competitor or customer or any other person, firm, corporation, or other entity, any of the Confidential Information which Employee may obtain, learn about, develop or be entrusted with as a result of Employee's employment by the Corporation; and 4 5 (iv) except in the ordinary course of the Corporation's business, Employee shall not seek or accept any Confidential Information from any former, present or future employee of the Corporation. 8.3 Employee also acknowledges and agrees that all documentary and tangible Confidential Information including, without limitation, such Confidential Information as Employee has committed to memory, is supplied or made available by the Corporation to the Employee solely to assist him in performing his services under this Agreement. Employee further agrees that after his employment with the Corporation is terminated for any reason: (i) Employee shall not remove from the property of the Corporation and shall immediately return to the Corporation, all documentary or tangible Confidential Information in his possession, custody, or control and not make or keep any copies, notes, abstracts, summaries, tapes or other record of any type of Confidential Information; and (ii) Employee shall immediately return to the Corporation any and all other property of the Corporation in his possession, custody or control, including, without limitation, any and all keys, security cards, passes, credit cards and marketing literature. 9. Invention Disclosure. Employee agrees to disclose to the Corporation promptly and fully all ideas, inventions, discoveries, developments or improvements ("Inventions") that may be made or conceived by him and all "Intellectual Material" (as defined below) that may be created or developed by him (whether such Inventions or "Intellectual Material" are developed solely by him or jointly with others) either during his employment by the Corporation or during a period of one (1) year after the termination of his employment with the Corporation which either (i) in any way is connected with or related to the actual or contemplated business, work, research or undertakings of the Corporation or (ii) results from or is suggested by any task, project or work that he may do for, in connection with, or on behalf of the Corporation. Employee agrees that such Inventions and "Intellectual Material" shall become the sole and exclusive property of the Corporation and Employee hereby assigns to the Corporation all of his rights to any such Inventions and "Intellectual Material." As used herein, "Intellectual Material" shall include, but shall not be limited to, ideas, titles, themes, production ideas, methods of presentation, artistic renderings, sketches, plots, music, lyrics, dialogue, phrases, slogans, catch words, characters, names and similar literary, dramatic and musical material, trade names, trademarks and service marks and all copyrightable expressions in audio visual works, computer software, electronic circuitry and all mask works for integrated circuits. With respect to Inventions and Intellectual Material, Employee shall during the period of his employment hereunder and at any time and from time to time hereafter (a) execute all documents requested by the Corporation for vesting in the Corporation the entire right, title and interest in and to the same, (b) execute all documents requested by the Corporation for filing and prosecuting such applications for patents, trademarks and/or copyrights as the Corporation, in its sole discretion, may desire to prosecute, and (c) give the Corporation all assistance it reasonably requires, including the giving of testimony in any suit, action or proceeding, in order to obtain, maintain and protect the Corporation's right therein and thereto. If any such assistance is required following the termination of Employee's 5 6 employment with the Corporation, the Corporation shall reimburse Employee for his lost wages or salary and the reasonable expenses incurred by him in rendering such assistance. Anything contained in this paragraph to the contrary notwithstanding, this paragraph does not apply to an Invention or Intellectual Material for which no equipment, supplies, facilities, or trade secret information of the Corporation was used and which was developed entirely on the Employee's own time, unless the Invention or Intellectual Material relates: (i) to the business of the Corporation, (ii) to the Corporation's actual or demonstrably anticipated research or development, or (iii) the Invention or Intellectual Material results from any work performed by the Employee for the Corporation. 10. Remedies. Employee acknowledges and agrees that the business of the Corporation is highly competitive and that the provisions of Paragraphs 7, 8 and 9 are reasonable and necessary for the protection of the Corporation and its Affiliates and that any violation of such covenants would cause immediate, immeasurable and irreparable harm, loss and damage to the Corporation not adequately compensable by a monetary award. Accordingly, the Employee agrees, without limiting any of the other remedies available to the Corporation, that any violation of said covenants, or any one of them, may be enjoined or restrained by any court of competent jurisdiction, and that any temporary restraining order or emergency, preliminary or final injunctions may be issued by any court of competent jurisdiction, without notice and without bond. In the event any proceedings are commenced by the Corporation against Employee for any actual or threatened violation of any of said covenants and if the Corporation prevails in such litigation, then, Employee shall be liable to the Corporation for, and shall pay to the Corporation, all costs and expenses of any kind, including reasonable attorneys' fees, which the Corporation may incur in connection with such proceedings. 11. Change of Control. If at any time during the term of this Agreement (i) any individuals who presently constitute the Board of Directors of the Corporation, or who have been recommended for election to the Board of the Corporation by two-thirds of the Board of the Corporation consisting of individuals who are either presently on such Board or such recommended successors cease for any reason to constitute at least a majority of such Board (such event being hereafter referred to as a "Change of Control"), and (ii) thereafter, the Corporation breaches its obligations to Executive under this Agreement (iii) Executive gives written notice to the Corporation within 60 days after such breach of his election to terminate his employment hereunder, the Corporation shall pay to Executive within 15 days after Executive's delivery of such notice, as severance pay and liquidated damages, in lieu of any other rights or remedies which might otherwise be available to him under this Agreement, and without mitigation of any kind or amount, whether or not Executive shall seek other employment, a lump sum equal in amount to the lesser of (i) the annual base salary payable to Executive pursuant to subsection 4.1 of this Agreement or (ii) the maximum amount which could be payable to Executive without any portion of such amount being subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended. In addition, all unexpired options to purchase securities of the Corporation granted to Executive before the Change of Control shall, if unvested, vest fully on the date of the Change of Control, notwithstanding any vesting provisions of such options. The payments provided for this Section 11 shall be paid in full, without discount to present value. 6 7 12. Entire Agreement. This Agreement constitutes the entire agreement of the parties hereto with respect to the matters set forth herein and no amendment or modification hereof shall be valid or binding unless made in writing and signed by both parties hereto. 13. Notices. Any notice, required, permitted or desired to be given pursuant to any of the provisions of this Agreement shall be deemed to have been sufficiently given or served for all purposes if delivered in person or sent by certified mail, return receipt requested, postage and fees prepaid as follows: if to the Corporation at: its address set forth above, Attention: Executive Vice President, General Manager and Chief Operating Officer with a copy to: Vice President & General Counsel WMS Industries Inc. 3401 North California Avenue Chicago, Illinois 60618 and, if to Employee, at his address set forth above. Either of the parties hereto may at any time and from time to time change the address to which notice shall be sent hereunder by notice to the other party given as provided herein. The date of the giving of any notice hereunder shall be the date delivered or if sent by mail, shall be the date of the posting of the mail. 14. Non-Assignability. Neither this Agreement nor the right to receive any payments hereunder may be assigned by Employee. This Agreement shall be binding upon Employee and inure to the benefit of his heirs, executors and administrators and be binding upon the Corporation and inure to the benefit of its successors and assigns. 15. Choice of Law And Forum. This Agreement shall be governed, interpreted and construed under the laws of the State of Illinois without regard to its conflict of law principles. The parties agree that any dispute or litigation arising in whole or in part hereunder shall, at the option of the Corporation, be litigated in any state or Federal court of competent subject matter jurisdiction sitting in Cook County, Illinois, to the jurisdiction of which and venue in which Employee irrevocably consents. 16. Waiver. No course of dealing nor any delay on the part of any party in exercising any rights hereunder shall operate as a waiver of any such rights. No waiver of any default or breach of this Agreement shall be deemed a continuing waiver or a waiver of any other breach or default. 17. Severability. If any provision of this Agreement including any paragraph, sentence, clause or part thereof, shall be deemed contrary to law or invalid or unenforceable in any respect by a court of competent jurisdiction, the remaining provisions of such paragraph, sentence, clause or part thereof shall not be affected, but shall, subject to the discretion of such 7 8 court, remain in full force and effect and any invalid and unenforceable provisions shall be deemed, without further action on the part of the parties hereto, modified, amended and limited to the extent necessary to render the same valid and enforceable. 18. Survival at Termination. The termination of Employee's employment hereunder shall not affect his obligations to the Corporation hereunder which by the nature thereof are intended to survive any such termination including, without limitation, Employee's obligations under Paragraphs 7, 8 and 9. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above set forth. WMS GAMING INC. By: /s/ Kevin L. Verner ---------------------------------------------- Kevin L. Verner Executive Vice President, General Manager & COO EMPLOYEE: /s/ Terence M. Dunleavy ---------------------------------------------- Terence M. Dunleavy 8 EX-99.4 7 EMPLOYMENT AGREEMENT 1 Exhibit 99.4 EXECUTIVE EMPLOYMENT AGREEMENT AGREEMENT made as of the 1st day of June, 1999, by and between WMS INDUSTRIES INC., a Delaware corporation (the "Corporation"), and KEVIN L. VERNER ("Executive"). W I T N E S S E T H: WHEREAS, Executive has been employed as the Vice President and Chief Operating Officer of the Corporation; and WHEREAS, the Corporation desires to continue to employ Executive and Executive is willing to continue such employment on the terms and subject to the conditions hereinafter set forth. NOW, THEREFORE, in consideration of the premises and mutual covenants hereinafter contained, the parties hereto agree as follows: 1. EMPLOYMENT; DUTIES. The Corporation hereby employs Executive to perform such duties on behalf of the Corporation and its affiliates as the Chief Executive Officer or the Board of Directors of the Corporation may from time to time determine relating to the development, manufacture and sale of electronic gaming devices and of coin-operated amusement games and other matters appropriate for a senior executive of the Corporation. 2. ACCEPTANCE AND LOYALTY. Executive hereby accepts such employment and agrees that throughout the period of his employment hereunder, he will devote his full time, attention, knowledge and skills, faithfully, diligently and to the best of his ability, in furtherance of the business of the Corporation and will perform the duties assigned to him pursuant to Section 1 hereof. Executive shall perform all duties and responsibilities in a professional manner consistent with the skill, competence and efficiency expected of an executive employee performing the duties assigned to Executive and subject to the direction and control of the Chief Executive Officer and the Board of Directors of the Corporation. Executive will do such traveling as may be reasonably required of him in the performance of his obligations hereunder. Executive shall at all times be subject to, observe and carry out such rules, regulations, policies, directions and restrictions as the Corporation shall from time to time establish. During his employment hereunder, Executive shall not, without the written approval of the Chief Executive Officer or the Board of Directors of the Corporation first had and obtained in each instance, directly or indirectly, accept employment or compensation from or perform services of any nature for, any business enterprise other than the Corporation or any of its subsidiaries or affiliates. During Executive's employment hereunder, Executive shall not be entitled to additional compensation for serving in any office, including as a director, of the Corporation or any of its subsidiaries or affiliates to which he may be elected. 2 3. TERM. The term of Executive's employment hereunder shall commence on the date hereof and terminate on May 31, 2001 (the "Original Term"); provided, however, that the term of Executive's employment shall be deemed automatically extended from time to time such that the term of such employment shall at no time be less than two years (the "Extended Term"); and provided further, that Executive's services hereunder may be terminated (i) by either party effective upon expiration of the Original Term or the Extended Term upon written notice from the terminating party to the other party dated and received at least two years prior to the respective termination date or (ii) by the Corporation effective upon 30 days' prior written notice if such termination is for "cause" as defined in subsection 8.3 of this Agreement. The Original Term and the Extended Term are hereafter collectively referred to as the "Term" and each year of the Term is hereafter referred to as an "Employment Year." 4. COMPENSATION AND BENEFITS. 4.1 The Corporation shall pay to Executive as compensation for his services and agreements hereunder a base salary at the rate of $250,000 per annum, or such greater amount as the Board of Directors of the Corporation shall from time to time determine. Base salary shall be payable in equal installments in accordance with the Corporation's normal payroll policy, subject to payroll taxes and withholding requirements. 4.2 Executive shall be entitled to participate, to the extent he is eligible under the terms and conditions thereof, in any bonus, pension, retirement, disability, hospitalization, insurance, medical service, or other employee benefit plan which is generally available to executive employees of the Corporation and which may be in effect from time to time during the period of his employment hereunder, including the Exec-U-Care insurance program. The Corporation shall be under no obligation to institute or continue the existence of any such employee benefit plan. 5. BUSINESS EXPENSES. The Corporation shall reimburse Executive for all authorized expenses reasonably incurred by him in accordance with the Corporation's "Travel and Entertainment Policy and Procedure," and any amendments thereof that the Corporation may adopt during the Term hereof. 6. VACATION. Executive shall be entitled to four weeks paid vacation during each Employment Year. Any such vacations are to be taken at times mutually agreeable to Executive and the Chief Executive Officer of the Corporation. Vacation time shall not be accumulated from year to year, unless Executive is requested by the Chief Executive Officer of the Corporation to forego a vacation during any Employment Year. -2- 3 7. KEY-MAN LIFE INSURANCE. The Corporation may purchase and maintain life insurance covering the life of Executive ("Key-man Insurance") in an amount determined by the Corporation. The Corporation shall be the sole owner and beneficiary of the Key-man Insurance and may apply to the payment of premiums thereunder any dividends declared and paid thereon. Executive shall submit himself to such physical examinations as the Chief Executive Officer of the Corporation may deem necessary or desirable in connection with the purchase and maintenance of the Key-man Insurance. 8. NON-COMPETITION AND NON-RAIDING. In consideration of the Corporation's entering into this Agreement: 8.1 Executive agrees that during the Term hereof and for a period of one year after termination for "cause" or after Executive terminates his employment without the written consent of the Corporation, he will not, directly or indirectly, without the prior written consent of the Corporation, own, manage, operate, join, control, participate in, perform any services for, invest in, or otherwise be connected with, in any manner, whether as an officer, director, employee, consultant, partner, investor or otherwise, any business entity which is engaged in the design, importation, manufacture and/or sale of electronic gaming devices or coin-operated amusement games or any business entity which is engaged in any other business in which the Corporation or any affiliate of the Corporation is engaged. Nothing herein contained shall be deemed to prohibit Executive from investing his funds in securities of a company if the securities of such company are listed for trading on a national stock exchange or traded in the over-the-counter market and Executive's holdings therein represent less than five percent of the total number of shares or principal amount of other securities of such company outstanding. 8.2 Executive agrees that during the Term hereof and for a period of one year thereafter, he will not, directly or indirectly, without the prior written consent of the Corporation, induce or influence, or seek to induce or influence, any person who is engaged by the Corporation or any affiliate of the Corporation as an employee, agent, independent contractor or otherwise, to terminate his employment or engagement, nor shall Executive directly or indirectly, through any other person, firm or corporation, employ or engage, or solicit for employment or engagement, or advise or recommend to any other person or entity that such person or entity employ or engage or solicit for employment or engagement, any person or entity employed or engaged by the Corporation or any affiliate of the Corporation. 8.3 For purposes of this Agreement, "cause" means (i) conviction (pursuant to a final or non-appealable judgment) of a felony or any other crime involving fraud, larceny or dishonesty; (ii) failure and refusal to follow a reasonable direction of the Chief Executive Officer or the Board of Directors of the Corporation after notice in writing of such failure or refusal and a cure period of ten days thereafter; or (iii) commission of any dishonest, willful or grossly negligent act which has or is reasonably likely to have a material adverse effect on the Corporation or its customer or trade relationships. -3- 4 8.4 In the event that Executive is terminated for reasons other than "cause," then, for such period (not to exceed one year after termination) as the Corporation either continues to pay the Executive's base salary to him or has made a lump-sum payment to Executive pursuant to Section 12 hereof, Executive agrees that he will not, directly or indirectly, without the prior written consent of the Corporation, take any of the actions prohibited under subsection 8.1 of this Agreement. 8.5 Executive acknowledges that the provisions of this Paragraph 8 are reasonable and necessary for the protection of the Corporation. In the event that any provision of this Paragraph 8, including any sentence, clause or part hereof, shall be deemed contrary to law or invalid or unenforceable in any respect by a court of competent jurisdiction, the remaining provisions shall not be affected, but shall, subject to the discretion of such court, remain in full force and effect and any invalid and unenforceable provisions shall be deemed, without further action on the part of the parties hereto, modified, amended and limited to the extent necessary to render the same valid and enforceable. 9. CONFIDENTIALITY AGREEMENT. 9.1 As used herein, the term "Confidential Information" shall mean any and all information of the Corporation and of its affiliates (for purposes of this paragraph, the Corporation's affiliates shall be deemed included within the meaning of "Corporation"), including, but not limited to, all data, compilations, programs, devices, strategies, or methods concerning or related to (i) the Corporation's finances, financial condition, results of operations, employee relations, amounts of compensation paid to officers and employees and any other data or information relating to the internal affairs of the Corporation and its operations; (ii) the terms and conditions (including prices) of sales and offers of sales of the Corporation's products and services; (iii) the terms, conditions and current status of the Corporation's agreements and relationship with any customer or supplier; (iv) the customer and supplier lists and the identities and business preferences of the Corporation's actual and prospective customers and suppliers or any employee or agent thereof with whom the Corporation communicates; (v) the trade secrets, manufacturing and operating techniques, price data, costs, methods, systems, plans, procedures, formulas, processes, hardware, software, machines, inventions, designs, drawings, artwork, blueprints, specifications, tools, skills, ideas, and strategic plans possessed, developed, accumulated or acquired by the Corporation; (vi) any communications between the Corporation, its officers, directors, stockholders, or employees, and any attorney retained by the Corporation for any purpose, or any person retained or employed by such attorney for the purpose of assisting such attorney in his or her representation of the Corporation; (vii) any other information and knowledge with respect to all products developed or in any stage of development by the Corporation; (viii) the abilities and specialized training or experience of others who as employees or consultants of the Corporation during the Term hereof have engaged in the design or development of any such products; and (ix) any other matter or thing, whether or not recorded on any medium, (a) by which the Corporation derives actual or potential economic value from such matter or thing being not -4- 5 generally known to other persons or entities who might obtain economic value from its disclosure or use, or (b) which gives the Corporation an opportunity to obtain an advantage over its competitors who do not know or use the same. 9.2 Executive acknowledges and agrees that the Corporation is engaged in highly competitive businesses and has expended, or will expend, significant sums of money and has invested, or will invest, a substantial amount of time to develop and maintain the secrecy of the Confidential Information. The Corporation has thus obtained, or will obtain, a valuable economic asset which has enabled, or will enable, it to develop an extensive reputation and to establish long-term business relationships with its suppliers and customers. If such Confidential Information were disclosed to another person or entity or used for the benefit of anyone other than the Corporation, the Corporation would suffer irreparable harm, loss and damage. Accordingly, Executive acknowledges and agrees that, unless the Confidential Information becomes publicly known through legitimate origins not involving an act or omission by Executive: (1) the Confidential Information is, and at all times hereafter shall remain, the sole property of the Corporation; (2) Executive shall use his best efforts and the utmost diligence to guard and protect the Confidential Information from disclosure to any competitor, customer or supplier of the Corporation or any other person, firm, corporation or other entity; (1) (3) unless the Corporation gives Executive prior express written permission, during his employment and thereafter, Executive shall not use for his own benefit, or divulge to any competitor or customer or any other person, firm, corporation, or other entity, any of the Confidential Information which Executive may obtain, learn about, develop or be entrusted with as a result of Executive's employment by the Corporation; and (4) except in the ordinary course of the Corporation's business, Executive shall not seek or accept any Confidential Information from any former, present or future employee of the Corporation. 9.3 Executive also acknowledges and agrees that all documentary and tangible Confidential Information including, without limitation, such Confidential Information as Executive has committed to memory, is supplied or made available by the Corporation to the Executive solely to assist him in performing his services under this Agreement. Executive further agrees that after his employment with the Corporation is terminated for any reason: -5- 6 (1) Executive shall not remove from the property of the Corporation and shall immediately return to the Corporation, all documentary or tangible Confidential Information in his possession, custody, or control and not make or keep any copies, notes, abstracts, summaries, tapes or other record of any type of Confidential Information; and (2) Executive shall immediately return to the Corporation any and all other property of the Corporation in his possession, custody or control, including, without limitation, any and all keys, security cards, passes, credit cards and marketing literature. 10. INVENTION DISCLOSURE. Any invention, improvement, design, development or discovery conceived, developed, created or made by Executive alone or with others, during the period of his employment hereunder and applicable to the business of the Corporation or its affiliates, whether or not patentable or registrable, shall become the sole and exclusive property of the Corporation. Executive hereby assigns to the Corporation, all of his rights to any "intellectual material" created or developed by him during the course of his employment. As used herein, "intellectual material" shall include, but shall not be limited to, ideas, titles, themes, production ideas, methods of presentation, artistic renderings, sketches, plots, music, lyrics, dialogue, phrases, slogans, catch words, characters, names and similar literary, dramatic and musical material, trade names, trademarks and service marks and all copyrightable expressions in audio visual works, computer software, electronic circuitry and all mask works for integrated circuits. Executive shall disclose the intellectual material promptly and completely to the Corporation and shall, during the period of his employment hereunder and at any time and from time to time hereafter (a) execute all documents requested by the Corporation for vesting in the Corporation or any of its affiliates the entire right, title and interest in and to the same, (b) execute all documents requested by the Corporation for filing and prosecuting such applications for patents, trademarks and/or copyrights as the Corporation, in its sole discretion, may desire to prosecute, and (c) give the Corporation all assistance it reasonably requires, including the giving of testimony in any suit, action or proceeding, in order to obtain, maintain and protect the Corporation's right therein and thereto. If any such assistance is required following the termination of this Agreement, the Corporation shall reimburse Executive for his time and the reasonable expenses incurred by him in rendering such assistance. Anything contained in this paragraph to the contrary notwithstanding, this paragraph does not apply to an invention for which no equipment, supplies, facilities, or trade secret information of the Corporation or its affiliates was used and which was developed entirely on the Executive's own time, unless (d) the invention relates: (i) to the business of the Corporation or its affiliates, or (ii) to the Corporation's or any of its affiliates' actual or demonstrably anticipated research or development, or (e) the invention results from any work performed by the Executive for the Corporation or its affiliates. -6- 7 11. REMEDIES. Executive acknowledges and agrees that the business of the Corporation is highly competitive and that violation of any of the covenants provided for in Paragraphs 8, 9 and 10 of this Agreement would cause immediate, immeasurable and irreparable harm, loss and damage to the Corporation not adequately compensable by a monetary award. Accordingly, Executive agrees, without limiting any of the other remedies available to the Corporation, that any violation of said covenants, or any one of them, may be enjoined or restrained by any court of competent jurisdiction, and that any temporary restraining order or emergency, preliminary or final injunctions may be issued by any court of competent jurisdiction, without notice and without bond. In the event any proceedings are commenced by the Corporation against Executive for any actual or threatened violation of any of said covenants and if the Corporation prevails in such litigation, then, Executive shall be liable to the Corporation for, and shall pay to the Corporation, all costs and expenses of any kind, including reasonable attorneys' fees, which the Corporation may incur in connection with such proceedings. 12. CHANGE OF CONTROL. 12.1 If at any time during the term of this Agreement, individuals who presently constitute the Board of Directors of the Corporation, or who have been recommended for election to the Board by two-thirds of the Board consisting of individuals who are either presently on the Board or such recommended successors cease for any reason to constitute at least a majority of such Board (such event being hereafter referred to as a "Change of Control") and Executive gives written notice to the Corporation within 60 days after such Change of Control of his election to terminate his employment hereunder, the Corporation shall pay to Executive within 15 days after Executive's delivery of such notice, as severance pay and liquidated damages, in lieu of any other rights or remedies which might otherwise be available to him under this Agreement, and without mitigation of any kind or amount, whether or not Executive shall seek or accept other employment, a lump sum payment equal in amount three times the annual base salary payable to Executive pursuant to subsection 4.1 of this Agreement. In addition, all unexpired options to purchase securities of the Corporation granted to Executive before the Change of Control shall, if unvested, vest fully on the date of the Change of Control, notwithstanding any vesting provisions of such options. The payments provided for in this Section 12 shall be paid in full, without discount to present value. 12.2 If it shall be determined that any amount payable under Section 12.1 by the Corporation to or for the benefit of Executive (a "Base Payment") would be subject to the excise tax (the "Excise Tax") imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), then Executive shall be entitled to receive an additional payment (the "Gross-Up Payment") in an amount such that the net amount retained by Executive, after the calculation and deduction of any Excise Tax on the Base Payment shall be equal to the Base Payment, less any federal, state and local income taxes. The Gross-Up Payment shall be reduced by income or Excise Tax withholding payments made by the Corporation to any federal, state, or local taxing authority with respect to the Gross-Up Payment that was not deducted from compensation payable to the -7- 8 Executive. All determinations required to be made under this Section 12.2, including whether and when a Gross-Up Payment is required, the amount of such Gross-Up Payment, and the assumptions to be utilized in arriving at such determination, except as specified above, shall be made by the Corporation's auditors (the "Accounting Firm"), which shall provide detailed supporting calculations both to the Corporation and Executive within fifteen business days after the receipt of notice from Executive that there should be a Gross-Up Payment. The determination of tax liability made by the Accounting Firm shall be subject to review by Executive's tax advisor, and, if Executive's tax advisor does not agree with the determination reached by the Accounting Firm, then the Accounting Firm and Executive's tax advisor shall jointly designate a nationally recognized public accounting firm, which shall make the determination. All fees and expenses of the accountants retained by the Corporation or jointly designated and retained shall be borne by the Corporation. Any determination by a jointly designated public accounting firm shall be binding upon the Corporation and Executive. 13. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement of the parties hereto with respect to Executive's employment with the Corporation and no amendment or modification hereof shall be valid or binding unless made in writing and signed by the party against whom enforcement thereof is sought. All prior agreements relating to Executive's employment with the Corporation or any affiliate of the Corporation are hereby terminated and of no further force and effect. 14. NOTICES. Any notice required, permitted or desired to be given pursuant to any of the provisions of this Agreement shall be deemed to have been sufficiently given or served for all purposes if delivered in person or sent by telephone facsimile or sent by certified mail, return receipt requested, or sent by responsible overnight delivery service, postage and fees prepaid, to the parties hereto at their respective addresses set forth below. Either of the parties hereto may at any time and from time to time change the address to which notice shall be sent hereunder by notice to the other party given under this Section 14. The date of the giving of any notice sent by mail shall be three business days following the date of the posting of the mail, if delivered in person, the date delivered in person, if sent by overnight delivery service, the next business day following delivery to an overnight delivery service or if sent by telephone facsimile, the date sent by telephone facsimile. If to the Corporation: 3401 North California Avenue Chicago, IL 60618 Facsimile: 312-961-1099 Attn: Mr. Louis J. Nicastro, President If to Executive: 134 Elmwood Avenue Wilmette, IL 60091 -8- 9 15. NO ASSIGNMENT. Neither this Agreement nor the right to receive any payments hereunder may be assigned by Executive. This Agreement shall be binding upon Executive, his heirs, executors and administrators and upon the Corporation, its successors and assigns. 16. NO WAIVER. No course of dealing nor any delay on the part of the Corporation in exercising any rights hereunder shall operate as a waiver of any such rights. No waiver of any default or breach of this Agreement shall be deemed a continuing waiver or a waiver of any other breach or default. 17. GOVERNING LAW. This Agreement shall be governed, interpreted and construed in accordance with the substantive laws of the State of Illinois applicable to agreements entered into and to be performed entirely therein. 18. SEVERABILITY. If any clause, paragraph, section or part of this Agreement shall be held or declared to be void, invalid or illegal, for any reason, by any arbitrator or court of competent jurisdiction, such provision shall be ineffective but shall not in any way invalidate or affect any other clause, paragraph, section or part of this Agreement. The parties intend that all clauses, paragraphs, sections or parts of this Agreement shall be enforceable to the fullest extent permitted by law. 19. AFFILIATE. As used in this Agreement, "affiliate" means any person or entity controlled by or under common control with the Corporation. 20. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which counterparts, when taken together, shall constitute but one and the same agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed on the day and year first above written. WMS INDUSTRIES INC. By: /s/ Louis J. Nicastro ---------------------------------- Louis J. Nicastro, Chairman of the Board, Chief Executive Officer and President /s/ Kevin L. Verner -------------------------------------- Kevin L. Verner -9- EX-99.5 8 LETTER AGREEMENT 1 Exhibit 99.5 Midway Games Inc. 3401 North California Ave. Chicago, IL. 60618 June 15, 1999 Harold H. Bach, Jr. Senior Vice President-Finance Williams Electronics Games, Inc. 3401 N. California Avenue Chicago, IL. 60618 RE: Sales Agreement ("Agreement") dated as of April 6, 1998, between Williams Electronics Games, Inc. ("WEG") and Midway Games Inc. ("Midway") Reference is made to the Agreement defined above. Capitalized terms not otherwise defined herein shall have the meanings set forth in the Agreement. Pursuant to Section 2 of the Agreement, the parties agreed "to review the Annual Fee on an annual basis and to negotiate in good faith to make adjustments thereto to the extent necessitated by changes to cost structures or market conditions." As a result of increased costs incurred by Midway in the performance of sales and marketing services for WEG relating to new product introductions by WEG, the parties have agreed to adjust the Annual Fixed Fee. Accordingly, only with respect to the period beginning May 1, 1999 and ending December 31, 1999, the Annual Fee shall be increased by the amount of $750,000, payable in equal monthly installments. Except as otherwise provided herein, the Agreement shall remain unchanged and in full force and effect. Please acknowledge your agreement to the foregoing in the space indicated below. MIDWAY GAMES INC. By: /s/ Neil D. Nicastro Neil D. Nicastro, President Accepted and Agreed Williams Electronics Games, Inc. By: /s/ Harold H. Bach, Jr. Harold H. Bach, Jr. Senior Vice President-Finance -----END PRIVACY-ENHANCED MESSAGE-----