WMS Industries Inc. F2Q10 (Qtr. End 12/31/09) Earnings Call Transcript

 |  About: WMS Industries Inc. (WMS-OLD)
by: SA Transcripts


Welcome to the WMS Industries second quarter fiscal 2010 conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded Tuesday, January 26, 2010.

I would now like to turn the conference over to Bill Pfund, Vice President of Investor Relations. Please go ahead, sir.

Bill Pfund

Thank you, Benjamin. Good afternoon and welcome to WMS Industries conference call to discuss our fiscal 2010 second quarter results. With me are Brian Gamache, Chairman and Chief Executive Officer; and Scott Schweinfurth, Executive Vice President, Chief Financial Officer, and Treasurer. Orrin Edidin, our President is in London this week heading our presence at the International Gaming Expo trade show or IGE perhaps better known under its former acronym of ICE. Although it is already been a long day for him, he is joining us to share his perspective on the show and answer questions following our prepared remarks.

First, let me review our Safe Harbor language. Our call today contains forward-looking statements concerning the outlook for WMS and future business conditions. These statements are based on currently available information and involve certain risks and uncertainties.

The company’s actual results may differ materially from those anticipated in the forward-looking statements depending on the factors described under Item 1, Business Risk Factors, in the company’s annual report on Form 10-K for the year-ended June 30, 2009 and in our more recent filings with the SEC. The forward-looking statements made on this call and webcast, the archived version of the webcast, and in any transcripts of this call, are only made as of this date, January 26, 2010.

Now, let me turn the call over to Brian.

Brian Gamache

Thank you, Bill. Good afternoon, everyone. Today we reported our best ever financial results for a December quarter. This represents the sixth consecutive December quarter that we’ve delivered significantly stronger year-over-year operating and financial performance which started in the December 2003 with the launch of our original Bluebird gaming machine.

We also have achieved meaningful higher year-over-year company performance in each quarter during the challenging calendar 2009. The only one amongst our competitors set to do so and we accomplished it despite our customers’ constrained capital budgets and the impact of the economy on consumer discretionary spending.

These record results are due to the collective and unselfish contribution, passion and talent of our entire organization. Our people and our culture of innovation are the very foundation of our abilities to consistently grow the company and to overcome difficult challenges. It is this strength and consistency that bode well for our continued near and long-term success.

In the December 2009 quarter, our total revenue was at the high end of our guidance and increased 6% over the prior year. Our operating income reflecting the benefit of ongoing continuous improvement initiatives grew a robust 30%. As a result, our diluted earnings per share increased to $0.44 from $0.41 last year. Recall the last year’s results included two unusual items, a $0.05 per share benefit from the settlement of a trademark litigation and an additional $0.02 benefit from a retroactive reinstatement of the Federal R&D tax credit.

We achieved excellent operating leverage on our increase in revenues, as improved gross margins and relatively flat operating expenses resulted in the 9.2 million increase in operating income on $10.5 million increase in revenues, pretty good flowthrough. Importantly, our strong operating execution favorably positions the company for future sustainable growth. We continue to focus on investments in R&D initiatives to support a steady flow of innovative new products and to expand our distribution channels.

The high return we continue to achieve on the innovative products we have already commercialized demonstrates the success of our past R&D spending. Our current spending on R&D projects support the development of innovative products in our future vision, while we further ramp up our company wide innovation efforts for games, products, systems and form factors, we are also simultaneously expanding the global distribution channels for our products, thus leveraging our R&D efforts across more opportunities and providing new sources of revenues that compliment our existing global growth potential. We continue to [expect] steady demand for our premium feature Bluebird 2 platform launched commercially just over a year ago.

This strong preference along with the enthusiastic customer response to our new products at G2E last November, has solidified our belief that we remain at the forefront of product innovation, while providing further visibility that we are in track to achieve continued revenue growth.

We are quite pleased to note that once again as in four of our last five quarters, we believe that we've had the leading [shipped] share of unit replacement sales, while in North America replacement sale is increasing 10% year-over-year and 33% sequentially over the September 2009 quarter.

And we continue to generate growth in our participation business, reflecting the strength of our growing install base of wide-area-progressive games in spite of the weakened economy and low gaming revenue in several markets.

In the December quarter, we returned value to our shareholders by reinvesting $ 50 million in WMS through share repurchases. We also improved the strength of our already pristine balance sheet with a conversion of the $25 million of convertible debt into equity.

As such, at quarter end, we had less than $10 million of debt and a total cash balance of $159 million, we have a current market cap of approximately $2.5 billion. As a result from the company’s record first half results, the positive response by customers to our products at both G2E and initially this week at ICE and our expectations for achieving continuous improvements in our operations.

We increased the low end and high end of our annual revenue guidance to a new range of $765 million to $785 million and because of strong operating performance in the first half of fiscal 2010 and our expectance for the continuing operating improvement in the second half, we anticipate to be at slightly above the top end of our fiscal 2010 operating margin guidance of 20.5% to 21%. Our team continues to be committed to providing enhanced value for shareholders.

Now, let me turn the call to Orrin who as Bill mentioned is in London, heading our team at the International Gaming Expo. Orrin?

Orrin Edidin

Thanks, Brian and let me add my best wishes from here in London. Today, was the first day of the International Gaming Expo and I'm pleased to report that activity at our booth was quite brisk to borrow a local phrase. Customer response to our product portfolio is very favorable and in fact very similar to the terrific response we generated at G2 in November for our new products. In particular the Lord of the Rings, THE PRICE IS RIGHT, MONOPOLY Advance to Boardwalk, Goldfish 2 and our portal applications from our Ultra Hit Progressive family to the Metascreen family of applications in our new Bluebird xD platform look to be sure winners.

And speaking of the new Bluebird xD platform, the customer response has exceeded our expectations. When this gaming machine receives regulatory approval with a commercial launch expected in the June quarter, we believe it should prove instrumental in keeping our momentum strong for increasing our market share based upon the high play of preference and earnings performance being achieved at our beta test side.

Here in London this still is much more targeted to our global non-North American customers and one of the highlights this week is the introduction of our Helios platform with an array of great game content. This platform is a value-price compliment to our premium Bluebird platform and provides the product at a price point that will open select new markets for WMS. I'm pleased to note positive customer response to our value pack Helios platform as well as to our premium feature Bluebird 2 platform even in more traditional price-sensitive international markets.

In addition, another favorable factor arising from our recent discussions with casino operators here is that the improved economic environment in Europe seems to be translating in to an increased sentiment toward expanding their capital budgets. This is similar to what we are hearing from our North American customers, so overall I'm very pleased with the results from the first day of the show. We're also encouraged by the progress being achieved in the opening of the VLC opportunity in Italy.

We expect to begin our first technical testing with the concessionaire in the coming weeks and are in discussions with several other concessionaires that are likely to lead to additional technical trials. Because of our efforts previously directed at entering Class II markets through our work with Blueberry Technologies, we are in a favorable position to tap the emerging Italian VLC opportunity.

Our initial assessment is that the market is likely to focus on a lease rather than for sale pricing model due to the heavy upfront capital contributions required of the concessionaires before they even place their first gaming machines. Much effort is still needed before the first products are placed which is anticipated to start this summer and we will keep you updated on our progress.

Another meaningful development is our progress in entering the large Australian market, we completed the second of the two required field trials in New South Wales in early January and our application for approval is on the agenda this week for consideration by the regulators. We believe our field trial successfully demonstrated the appropriate functionality and thus we continue to expect that we will be able to begin the commercial launch in the back half of our fiscal year.

As we demonstrate the player feel and earnings performance to a greater number of club operators, we anticipate shipments will ramp in the June quarter and continue thereafter. As many of you know this market has experienced a slower replacement cycle than in North America for many years, but our research and the results from our initial test site indicate that with the introduction of our innovative video content and our unique Bluebird 2 gaming machines, we believe we should have an opportunity to capture a growing share in this very large market.

Through these two important new market opportunities coupled with ongoing success in Mexico and other international jurisdictions, plus the launch of our Helios gaming cabinet, we expect to continue to expand our global presence and achieve further growth. As you all know MGM’s massive City Centre project opened in December with the ARIA hotel and casino being the first casino floor to open with network gaming capabilities.

With WMS having captured approximately 23% initial floor share, ARIA casino represents the largest floor allocation for WMS on any opening of a [strip] property. A portion of our gaming machines have been interoperable with the network systems since the opening and we look forward to Nevada regulators, approving connectivity to the network system for the remainder of our gaming machines in the near term.

The opening of ARIA is the next step along an evolutionary path that we believe will be an ongoing and truly game changing transition in coming quarters and years that plays well to our strengths in developing and deploying forward-looking technologies married with our innovative content. Because regulators focus was on getting the casino open, the initial network functionality was as expected rather limited.

In coming quarters, we expect to see additional functionality added, including the introduction of our first portal game application, the Ultra Hit Progressive family of applications. The true significance of this opening is the important step that represents in our industry’s transition to an open technology and interoperability, a vision and position we’ve been perceiving and advocating for years to the development of WAGE-NET and the applications that we expect to run across the interoperable network gaming systems.

The commercial version of WAGE-NET is presently in several regulatory labs, is on trial in multiple casino floors. As we receive regulatory approval for WAGE-NET and our initial portal applications in the coming months and quarters, we expect to benefit from the rollout of our network gaming strategy in numerous regional and travel casinos across the country.

Now, let me turn this call over to Scott to provide his perspective on our financial results. Scott?

Scott Schweinfurth

Thanks, Orrin and good afternoon everyone. Our record financial results are again attributable to our steady focus and continued successful execution against the five key operating priorities we have previously reviewed. I will focus my comments today on a few of our key performance metrics for the December 2009 quarter and record results for the first six months of fiscal 2010.

First, gaming operations revenues increased 20%, reflecting a 13% year-over-year increase in the average daily revenue per unit to $75.23 and a 9% increase in the average installed participation footprint to a record 10,357 units. We've achieved a constructive balance of remaining highly disciplined in our deployment of capital and the rollout of new products during the last three years, while increasing our total footprint by 40% from December 31 2006. Importantly and reflecting our company-wide focus on delivering new dynamic players entertainment experiences, our average daily revenue has increased 35% during the same three-year period.

The most important factor in this daily revenue growth has been the expansion of our install base of high-performing WAP units, which is up 50% from a year ago and now comprises 30% of our installed base mix, compared with 21% a year ago. With the upcoming rollout in the March and June quarters of THE PRICE IS RIGHT and The Wizard of Oz, Ruby Slippers, we expect continued momentum in growing our total footprint and the WAP installed base.

As a result, we are on track to achieve our guidance range for the average installed participation footprint for fiscal 2010. With average daily revenue of $76.23 for the first 6 months of fiscal 2010 are 13% higher than the comparable year ago period, we're pacing well ahead of the high end of our expectations for annual average revenue per day. Supported by the high mix of WAP units and typical seasonal influences that generally favorably impact the March and June quarters, we expect to remain above the high end of our average revenue per day guidance and record further modest gains throughout the balance of fiscal 2010.

Second, reflecting the continued higher than expected demand for our premium featured network ready Bluebird 2 gaming machines, which represented 82% of total global new units shipped in the December 2009 quarter, we achieved another record average selling price of $15,428 in the December 2009 quarter. For the first 6 months, the 15,270 average selling price per unit exceeds the high end of our annual guidance. With the continued strong performance of our Bluebird 2 gaming machines and the positive response by customers for the new Bluebird xD gaming machines which will carry a premium price on launch this spring, we expect the upward trend in ASPs will continue.

I note that the expected future ASP increase will be partially mitigated, particularly in the current quarter by the introduction of the value priced Helios gaming machines and the launch of products in Australia through a distributor. These new-to-WMS market initiatives coupled with the growing success of our Class II products are providing incremental sales albeit at lower average selling prices than the standard Bluebird 2 gaming machines.

However on an overall basis, we expect the average selling price to continue to remain above the high end of our guidance of 15,000 per unit through to the second half of our fiscal year. Customers continue to indicate their expectations for higher calendar 2010 capital budget, which would drive improvements in the replacement cycle throughout calendar 2010 and expectationally first communicated to you last August. The improving trend in the replacement cycle is likely to offset the lower number of units, we expect from new casino openings and major expansions compared to calendar 2009.

Specifically, we expect WMS’s new unit volumes to increase year-over-year in the March quarter and further ramp upwards in the June quarter, reflecting one; incremental and growing volume from distribution to new markets for WMS such as Mexico, Class II, Australia and the launch of the Bluebird xD and Helios gaming cabinets. Two; further growth to our ship share. Three; the improving replacement cycle.

Reflecting this improving trend for the second half of fiscal 2010, but also the slower pace of unit sales in the first half of the year, we expect unit volumes to be at or just below the low end of our annual guidance for unit sales. Our average selling prices will exceed the higher end of our guidance.

Third, our margins continue to show steady year-over-year progress, with total gross margin at 62.5% in the December quarter, up a 110 basis points aided in part by a higher percentage of gaming operation revenue and higher gross margins in products sales.

Demonstrating the ongoing benefits from our continuous improvement in strategic sourcing initiatives that our team have and continuous to successfully implement, our product sales gross margin in the December 2009 quarter increased to 50.9% from 50.3% a year ago. Despite the impact from a higher volume of lower margin used gaming machines, primarily competitor products taken as trade-in, coupled with the lower sales of high margin game conversion kits and new unit sales into new distribution channels with lower initial average gross margins, partially offset by lower inventory writedown charges.

Our operating margin expanded once again, this time by 390 basis points to 20.9% and we are on track to achieve further improvement. Our progress in improving margins is notable as it provides the means to continue to aggressively support R&D initiatives that fuel our powerful innovation engine. Based on positive customer feedback, we returned from G2E with an accelerated development program for certain R&D projects, including the ramp up in the March quarter. As a result, we expect our fiscal 2010 R&D expense will run slightly higher than originally targeted, which will result in R&D expenses in a range of 14% to 15% of total revenues for the full year.

However even with this accelerated support of our future growth initiatives, largely due to the higher margins from our gaming operations business, fueling a larger than expected mix of total revenues, we also expect our annual operating margin to be at or slightly above the high end of our original guidance of a range of 20.5% to 21% for the full year. With continued revenue growth and margin improvement, we drove strong cash flow while continuing to support select customers with extended term financing option.

For the December 2009 quarter, our net cash provided by operating activities was $47 million, a meaningful improvement from the September 2009 quarter and only modestly below the $53 million provided in the December 2008 quarter despite the increase in operating assets and liabilities from higher customer financing and the advanced purchase of computer chips.

Cash flows from investing activities remained essentially flat year-over-year, even as we continued to grow our gaming operations business and invest in future growth. I would note that in future quarters, we may see an upward bias in additions to gaming operations capital spending as we rollout the first Bluebird 2 participation gaming machine and pursue attractive expansion opportunities to invest our capital in the Italian VLT business

As noted in the press release, we purchased a total of 367,760 shares for approximately $15 million in the December quarter at an average price of $40.78. Since we began our repurchase program, we have acquired approximately 8.6 million shares at a cost of $143 million on an average price of just $16.69 per share. [Authorized] share repurchases remain an attractive use of funds for WMS and we have approximately a $135 million remaining for share repurchases under our current authorization.

Let me call your attention to a couple of items on the balance sheet, which continues to be in excellent shape. Out total cash, cash equivalents and restricted cash amounted to $159 million at December 31 2009, an increase of $4 million from September 30, 2009 and an increase of $24 million over December 31 2008.

Total accounts and notes receivable at December 31 2009, are $267 million compared to $255 million at September 30 2009. The $12 million quarterly sequential increase occurred, while revenues increased $24 million on a quarterly sequential basis from the September 2009 quarter. The trend in notes receivable longer than 12 months continues to decline as the amount of long-term notes receivable at December 31 2009 was $39 million down from September 30 2009 and essentially flat with June 30 2009.

We view this trend toward shorter terms as an overall positive, although we are still above our normal mix of payment terms. Overall, day sales outstanding on total accounts and notes receivable was 111 days at December 31 2009, down 8 days from 119 days at June 30, 2009 and importantly the percentage of receivables that are current was at an all-time high at December 31, 2009. As that trend demonstrates and from customer discussions regarding that purchase plans for calendar 2010, we believe that over time fewer customers will choose extended-term financing.

As you probably know many casino customers over the past year have improved their financial position and has better access to alternative financing options. As they step up their purchase volumes, we expect them to be reluctant to pass up for larger discounts available with shorter payment terms.

Reflecting the final payment of an advanced buy of the specific computer chip, which amounted to $9 million in the quarter and $18 million in the first six months of fiscal 2010. Inventory was $57 million compared to $49 million a year ago, even with this increase our inventory turns at December 31st, 2009 were a healthy 4.0 times.

As previously reported in October of 2009, we early induced another 25.7 million of our convertible debt in to common stock leaving us with only 9.9 million of remaining convertible debt that we expect will convert in to equity upon maturity in July 2010.

The inducement charge for the quarter, coupled with the related write off of deferred financing cost was 0.4 million pre-tax in the December quarter and 1.4 million pre-tax for the first six months for fiscal 2010. These charges were less than the present value of the remaining interest payments and thus represent an attractive cash savings through maturity.

I'll now turn the call back to Brian for his closing comments.

Brian Gamache

Thanks, Scott. From our first six months results in our commentary today it should be clear that fiscal 2010 is off to a solid start. And that we have the appropriate strategies, products and personal to extend our growth. The fiscal year is turning out largely as projected in our August conference call, with a slower start to our first half being followed by an uptick in the back half of our fiscal year which is consistent with the trends over the last several years.

Simply put, we are optimistic about our opportunities for further growth and operating improvements. With record six months results in hand and a solid outlook for the remainder of the fiscal year, we have increased the bottom and top end of our revenue guidance to a new range of 765 to 785. We also increased our expectations for improving operating margin to be at the top end of the slightly above guidance range of 20.5% to 21%. Even as we now expect higher R&D spending to further support our innovation driven growth model.

Additionally, we initiated revenue guidance for the March quarter of 195 million to 205 million which represents year-over-year revenue growth of 8% to 13% and of course expected acceleration of what we've achieved thus far in fiscal 2010.

Our third quarter revenue guidance also implies the fourth quarter revenue range of 216 million to 226 million, representing year-over-year growth of 10% to 15%, which is a further acceleration revenue growth based upon the timing of the commercial launch to ramp up of Australia, Class II and Helios unit sales. And a very strong customer response to the Bluebird xD cabinet.

Our revenue guidance reflects our realistic assessment based on the visibility we have for existing organic growth trends as well as our sensitivity for typical favorable seasonal inputs is on both average daily revenue and our gaming operations business and unit sales demands by our customers.

With the economy stronger and our customers' capital budgets for calendar 2010 increasing over calendar 2009 will establish realistic expectations for the near-term revenue growth. Our established product excellence continues to drive market share, average selling price in revenue per day increases which will be complimented by an overall improved replacements re-cycle, new distribution channels.

Benefits from our focus and past investments at network gaming solutions, and an expanding number of global markets to revise us with new revenue and profit sources, in the near term and beyond. As we look at the remainder of fiscal 2010 and into fiscal 2011 the start of which is less than six months away. We are optimistic about the substantial opportunities unique to WMS with few prospects for continued profitable growth as well as channel industry opportunities.

In North America new jurisdictional opportunities are already on a solid path forward, such as Ohio and the addition VLPs Illinois and the prospects for additional new jurisdictions like Massachusetts provide meaningful opportunities for new unit growth.

In Illinois, while licensing the expensive number of operators and sight owners of the VLPs will take time. We continue to move business forward, just recently we invest in Midwest who will be our distributor here in Illinois has an open house at our [Keygen] headquarters for potential operators. We had over 100 new amusement operators from all over the state to visit us and the feedback was very positive.

Our rich history and legacy as the leading pinball company in the amusement industry provides us an incredible awareness factor and reputational advantage. That advantage is multiplied further by a strong recognition as a leader in the gaming and innovation of videogame machines and our whole field advantage to work directly with our distributor and the operators to find best solutions.

On a global scale new jurisdictions such as the Italian VLP opportunity an opportunity to build a strong presence in Australia, offers significant near to intermediate term growth potential, while the expansion of gaming taking place around the world and the longer term prospects for truly major new markets to emerge such as Brazil, Greece and Japan provide an exciting opportunity for the industry in place for us to threshold a renaissance period we look forward to in 2011 and 2012.

Now, we are happy to take your questions. Operator

Question-And-Answer Session


Thank you ladies and gentlemen. [Operator Instruction]. Our first question comes from the line of Steven Kent with Goldman Sachs. Please go ahead.

Steven Kent - Goldman Sachs

Okay just a couple of question. First, could you just comment a little bit about your home state of Illinois and sort of your opportunity there? Also your strategy for online gaming in UK if you could expand a little bit more on that? And then may be most importantly on wide area progressive opportunities, it sounds like you are making significant traction there do you think that this is in industry wide phenomena with the operators maybe a more receptive to participation games? Or is it something that is also combined with just some winning product that you seem to have right now?

Brian Gamache

Okay let me go to the Illinois question first, we have a very strong presence here in Illinois, we have a very strong brand recognition here Steve. And the customers know us from our Williams pinball days. And have had a strong rich relationship with the company in years past. And we think we are one of the premium distributors in the country at (inaudible) we have previous gaming experience in the Pennsylvania and have proven to be a great partner of ours and we look forward to working with them to come in here and [blanket] the market, and we would be very disappointed if we didn't do even better than we done in North American market share total. So, we are very excited about that, we think its going to be a great opportunity for the company and we look for that to start kicking in around Q2 of next year, sometime in the fall of horizon god willing.

Online, we've been planning for our online strategies now for quite sometime we took network enabled products to market back in '06 with our first Monopoly Big Event game you recall and then in '09 we talked about the Casino Evolved and all along we've been talking about the third step of that is to really transcend the four walls of a casino. And we have an online gaming strategy which is our jackpotparty.com that we've talked about in the last few days. And then we have an online game [issued] that which is basically players like the web services that we've talked about at G2E and that's really our online gaming brand here its not our gambling mechanism, but its really a brand to build a [fanity] for WMS brands and deepens the casino and player relationship here in United States.

So, as far as our UK initiative, we've been investing in right now for the past few years, Richard Schwartz and his team have put together a terrific business model with license and developed technology that we are very proud of and we'll be taking this out sometime in the fall of 2010. I would not look for that to be accretive for probably a year thereafter to get ramped up and operating efficiently, but this is going to be a business that's going to roll and prosper over time. And I think the investments and the time enough we've taken to build this platform is going to pay huge dividends for our shareholders going forward. And as far as the WAP, we've had great success in the WAP it's really due to innovation and differentiation, I don’t think that the WAP footprint is growing per say but I think our share of that footprint is growing dramatically. And as Scott mentioned in his remarks we have several significant products coming up in the second half of the year, whether it be The Wizard of Oz, Ruby Slippers, THE PRICE IS RIGHT, MONOPOLY Advance to Boardwalk and then down the road in Q4, the Lord of the Rings which we believe has a chance to be the best game we have ever rolled out, which is setting the [block] pretty high, but we have great hopes that, that footprint will continue to grow and be refreshed and continue to have great yield opportunities for us as well.

Steven Kent - Goldman Sachs

Scott, your comment about balance sheet improving broadly for casinos, it sounds they are just as likely to purchase and they [won’t need] participation games or wide-area progressive in order to sort of backward fund getting more machines out onto the floor. It’s just simply the quality of the machines that seems to be doing it rather than a financial decision.

Brian Gamache

I think it’s the quality of the coin in and if the games can drive coin in, Steve, the customers don’t mind putting them on the floor. It’s really two different issues. To Scott’s point I think we have seen a decrease in the financing recently because they have to give up a discount and they have to pay interest and if they can do it more efficiently with their sources of capital it’s probably a better situation that they buy the games outright and not finance them.

So it is really two different issues, I think we have a hot hand in the participation business and we have customers that are healthier today and therefore don’t mind paying for the games outright.


Our next question comes from the line of David Katz with Oppenheimer Capital. Please go ahead.

David Katz - Oppenheimer Capital

Scott gave some commentary about the international markets, but one of the challenges we always face is evaluating how pricing and profitability are going to evolve in places like Australia and Europe and South America and other areas around. And so, we look at our model and trying and decide how we feel about our numbers and it’s obviously a little harder. So is there anything else that you can share to that and with particularly what’s embedded in your guidance for the remainder of this year. And I just have one other quick follow-up.

Brian Gamache

Well we don’t have the same models that some of our competitors do, David and the fact that we don’t have the Pachislo-Pachinko business and we don’t have the AWP business, the majority of our units will be sold internationally at a similar price point margin to what we get here in North America. That being said, there are going to be opportunities down the road for us to enter markets that offer that opportunity.

Scott Schweinfurth

Well, we have a couple of things that are let’s say happening, in the second half of the year, we have the launch of the Helios platform which we’ve said is a value price platform, so relative to ASC, it will have a downward impact on that.

And then secondly, on a gross margin percentage basis, the target is launching that at something that’s pretty similar to what we’ve achieved for our other products. The other thing that will be occurring is our entrance into the Australian market as we are doing that through a distributor. And with the distributor, they too are in the business for profit. So because of the volumes, I will be purchasing, they will get a little bit lower ASPs that will have an impact on ASP and the margin will be a little bit pinched on that. None of that is going to have an overall impact on the guidance number that we provide and that’s what I was talking.

Brian Gamache

This is all baked into the guidance that we gave, David and the fact that 82% of our games shipped in Q2 were Bluebird 2, I think bodes well for the second half of the year that’s only going to grow from there.

David Katz - Oppenheimer Capital

You made some commentary about Italy and I guess (inaudible) what to expect if that’s going to be part of the game op segment. And can you talk about what reasonable expectation is as to what that would do to the yield on your installed base, is that something that would create some downward pressure on it and we don’t have that much of a sense to what a good win for day in Italy really is.

Scott Schweinfurth

Right so David we've kept our participation installed base pure to only have participation games in it. The games that will be going into Italy would be games that we would otherwise sell outright to customers, so they are for sale product. So it’s likely that those games are going to appear and those revenues will appear in the other gaming operations line item, rather then be included in the participation installed base and then in the average rate because they are participation games, they are just straight leases.

David Katz - Oppenheimer Capital

Perfect and assuming I did hear some of Orrin's comments and it was in and out a bit, assuming and assessing those well, when would that unit opportunity be falling out on the calendar?

Scott Schweinfurth

Yes, I think the regulator in Italy has a fairly aggressive schedule to try and get some of these units in during the June 2010 quarter, but the concessionaires and the suppliers have to go through a bit of testing before, then so I would think hopefully by summer this year, you would start to see some movement forward, but we will keep you appraised of where we are getting to with that particular testing and remember because these are going to be leased units. Even if we are placing the units, we are going to be getting a daily rate and so it’s not going to have some sort of huge immediate impact as a result of that.

Brian Gamache

And it will be a mix of new and used products over there too, I would imagine, Scott.

Orrin Edidin

And David, I think you can look forward to Australia coming online before Italy. So we will have those approvals in hand sooner.


Our next question comes from the line of Steve Altebrando with Sidoti & Co. Please go ahead.

Steve Altebrando - Sidoti & Co

The market share in the quarter, it looks like you are nearing basically 30% and it looks like a lot of it is coming from replacements, is that a level that you guys think is sustainable?

Brian Gamache

Yes, we would hope so. We have said previously that we would be disappointed if we couldn’t get above that 30% replacement share. We think we did very well for the quarter, but until we review reports, we are not going to know. I believe that if we did compare favorably to our biggest competitor who announced last week, but until the others report, we won’t know exactly what our share is, but we are guessing it’s in the low 30s

Steve Altebrando - Sidoti & Co

Then the margins and the game ops, I assume most of the sequential shift is due to mix, but it wasn’t that significant of a mix, was there any jackpot issues in the quarter?

Scott Schweinfurth

Yes, it was a mix with the increase in the WAP units and the installed base coupled with a little bit unfavorable jackpot experience just based upon what hit during the quarter.

Brian Gamache

I think there was also an impact of a little bit lower higher margin royalty revenue in the quarter.


Our next question comes from the line of Carlo Santarelli with JPMorgan. Please go ahead.

Carlo Santarelli - JPMorgan

Obviously with the growth in your average sales price in the period of 13%, from looking at your margins in product sales, I would have expected maybe a little bit more on that line, just on the margin. Is there any color you guys can give around that and maybe where we should be thinking about the back half of the year on a product sales margin basis.

Brian Gamache

Again I think that we talked about higher number of used games for the quarter and a lower amount of convergence in part sales which are typically a higher margin. So it’s a combinations, it’s really a mix of business issue, Carl and for the second half for the year, you should look at additional volume would creep up to the mid 50s range, it would be our goal.


Our next question comes from the line of David Bain with Sterne Agee. Please go ahead.

David Bain - Sterne Agee

Last quarter you guys commented on Wizard of Oz, specifically as it related to guidance and I was just wondering adjusted for seasonality in your view of, when per day from that game was in your view stable in December, retracing a little bit ahead of any refresher title or any of thoughts specifically related to Wizard of Oz.

Brian Gamache

Wizard of Oz continues to hold up very well, again Q2 was our sequential slowest quarter of the year for our gaming ops, Q1 is our slowest quarter of the year for unit sales. So I think, all-in-all when you look at the overall 13% increase in our daily yield, it did hold up well. We have seen a slight degradation in the past quarter, but nothing that alarms us. The game has been out there for quite a while now and is still holding up and is amongst the top performing games still on the floor today. So, we believe that the game has plenty of legs, we think that Ruby Slippers is going to be a great addition to that family of product. It should be accretive according to our gaming operations team, so that would be a wonderful thing and so, yes we think it’s got lots of legs still.


(Operators Instructions). Our next question comes from the line of Todd Eilers with ROTH Capital Partners. Please go ahead.

Todd Eilers - ROTH Capital Partners

I was just wondering if you guys could maybe give us an update on how your Class II expansion is going, maybe what markets are you guys now selling units into, maybe how many units were reflected in your overall shipments for the quarter and then maybe any lessons learned since you’ve entered those markets.

Brian Gamache

Yes, we shipped, recalled a few hundred games upto Waukegan state thus far. We’ve sent some down to the tribal gaming in Alabama, but nothing else. We've got something in Oklahoma, it’s going slower than we'd hope at this point and it’s going to ramp up sequentially in the Q3-Q4 timeframe where we’ve got some very nice orders on line here. So yes it’s going well, a little bit slower than we'd like, but we should see an uptick here in the second half along with the other initiatives.

Todd Eilers - ROTH Capital Partners

Are you guys predominantly selling units, still for the Class IIs, are you also doing some rev share?

Brian Gamache

We will consider a rev share, but right now, that predominantly is a sales model.


Our next question comes from the line of Joe Greff with JPMorgan. Please go ahead.

Joe Greff - JPMorgan

You may have mentioned it, before but Brian I heard you mention or speak optimistically about Lord of the Rings, can you talk about when that is going to be released and is the strategy there really to replace Wizard of Oz or how do you think that plays out.

Then a question for you Scott, I don’t know if you talked about it, but I am looking on my Blackberry, the cash flows from operating activities, I see for the 6-months period that the change in operating efforts and liabilities is such a big measured number, can you just talk about what that really is.

Brian Gamache

First of all, Lord of the Rings, Joe is coming out in June-July timeframe. It probably will get out in Q4, but not enough to make an impact on our Q4. We have a lot of customers that are anxious to write those orders and so we have great expectations that this could be another hit on our hands. So the focus group testing, the G2E response and the ICE response has been very encouraging and we think this is going to be along the lines of a Wizard of Oz potentially. So we think it’s the best game we have ever done, but time will certainly tell. Scott, you want to handle that?

Scott Schweinfurth

Yes and then on the change in operating assets and liabilities, that big negative number show almost all of that occurred during the September quarter and for the December quarter, I think it was $5 million to $7 million, that was the negative and most of the increase comes from our receivables, total receivables continuing to increase. Payables and accrued liabilities have actually decreased since June 30, it’s typically the trend.

Inventories have increased by about $14 million since the end of the year, mostly because of this advanced purchase of computer chip that we did and then we also had some other assets, mostly royalty agreements that we entered into that were greater in cost, some drag. So I think the thing that we were trying to point out in the prepared remarks is that for the second quarter, the cash flow from operating activities was a positive $47 million, just down $6 million from the prior year comparable period. So, we are hopeful most of the drag is behind us.


(Operator Instructions). And our last question comes from the line of Dennis Forst with KeyBanc. Please go ahead.

Dennis Forst - KeyBanc

I had two questions. First, I am trying to get my arms around the guidance for the third quarter revenues, 195 to 205, yes which would be somewhere $10 million plus more revenue than the sequential second quarter and I'm wondering if that's going to come from more product sales or it doesn't look like the installed base of participation games is going to change dramatically, there should be a pick up I guess in the win per day on a seasonal basis but is it going to be a combination of both of those factors or we would focus more on one than the other?

Brian Gamache

I believe it'll be a combination of the two it might be 60-40 in terms of product sales versus gaming ops, but it's going to be a combination of the two and this is if you go back and look at our history this is not an unusual event to happen in Q3 and Q4.

Dennis Forst - KeyBanc

Okay, and am I right to assume that the number of participation games is probably going to stay relatively static and for a while it's been somewhere around 10,300 for three quarters in a row now.

Scott Schweinfurth

Yeah that’s true and the guidance we actually had provided for the year was that the average for the year would be in the range of 10,000 to 10,500 and in the prepared remarks we said we're comfortable that we are going to achieve that range.

Dennis Forst - KeyBanc

Okay that’s pretty wide range and is it possible to go down by the end of the year, isn’t that highly unlikely that it would be closer to 10,000 than 10,500.

Brian Gamache

It would be highly unlikely given the fact that we have such a strong product launch schedule in the second half of the year

Dennis Forst - KeyBanc

Yeah and you are all ready almost 10,400.

Brian Gamache

And again but I just want to make sure you understand in order to get these are all planned sequences right you have launched themes you have games that are coming off the game has a lifecycle and we kind of try to mix them and match them so we don't have the ups and downs and the variations so this is all as Scott said very predictable for us and we work very hard to keep that footprint some what consistent.

Dennis Forst - KeyBanc

And then my last question had to do with the depreciation in the games up division it looks like depreciation continues to come down sequentially quarter-over-quarter for now almost 10 quarters in a row, yet the number of units installed-base continues to go up and a lot of those games coming off depreciation and that's why the dollars of depreciation come down?

Brian Gamache

That's exactly right and then you couple that with the game staying out longer and staying on the floor longer and having to be refreshed less frequently and that's where you get the savings.

Scott Schweinfurth

That would be the capital spend over that same period and you will see that cash I think in fiscal '09 and fiscal '08 we spent about 50 million in capital and gaming ops and the two years prior to that we were closer to 75 million, so that's obviously has an impact on it too.

Dennis Forst - KeyBanc

Can you remind us of the depreciation terms on those participation games?

Scott Schweinfurth

What we call the base unit gets depreciated to a residual value over a three year period and the top box gets depreciated to zero over a one year period.

Dennis Forst - KeyBanc

One year to zero. And what's the residual number typically?

Scott Schweinfurth

I don’t think we have disclosed that but it's a relatively low mount.


There are no further questions at this time. I'll now turn the call back over to you, please continue with your presentation or closing remarks.

Brian Gamache

Thank you for joining us today. We look forward to updating you our additional progress on our call we discussed on March 2010 quarter results have a nice evening.


Ladies and gentlemen that does conclude the conference call for today. We thank you for you participation and ask that you please disconnect your lines.

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