WMS Industries Inc. F3Q08 (Qtr End 03/31/08) Earnings Call Transcript

| About: WMS Industries (WMS-OLD)

WMS Industries Inc. (NYSE:WMS-OLD)

F3Q08 Earnings Call

May 7, 2008 8:45 am ET


William Pfund – Vice President, Investor Relations

Brian R. Gamache – President and Chief Executive Officer

Orrin J. Edidin – Executive Vice President and Chief Operating Officer

Scott D. Schweinfurth – Executive Vice President, Chief Financial Officer and Treasurer


Joseph Greff – Bear Stearns

Steven Wieczynski – Stifel Nicolaus & Company, Inc

William Lerner – Deutsche Bank Securities

David Katz – Oppenheimer & Co.

Steven Kent – Goldman Sachs

Steven [Altebrando] - Sidoti and Company


Welcome to the WMS Industries Q3 conference call. (Operator Instructions) It is my pleasure to introduce William Pfund, Vice President, Investor Relations.

William Pfund

Good morning everyone and welcome to WMS Industries’ fiscal 2008 third quarter conference call to discuss the announcements last evening regarding our third quarter results and our board and our board and executive management changes and promotions.

With me this morning are Brian Gamache, President and Chief Executive Officer, Orrin Edidin, Executive Vice President and Chief Operating Officer, and Scott Schweinfurth, Executive Vice President and Chief Financial Officer and Treasurer.

Before we start let me quickly 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 involves certain risks and uncertainty.

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 ending June 30, 2007 and in our more recent reports filed with the SEC. The forward-looking statements made on this call and webcast, and the archived version of the web cast and in any transcripts of this call are only made as of this date, May 7, 2008.

Now, let me turn the call over to Brian.

Brian R. Gamache

Last evening we announced results for our fiscal 2008 third quarter including a 27% increase in total revenues to a record $173 million and a 46% increase in net income to a record $19 million or $0.32 per fully diluted share. Revenues exceeded the high end of our guidance by $7 million, highlighting the strength of WMS’ innovation capability to lead the industry with high performing differentiated products.

In addition we generated a quarterly record of $57 million of operating cash flow and our total cash balance exceeded $112 million at quarter end. In the face of a weak economy and the ongoing challenge of the domestic replacement cycle, these are outstanding accomplishments by almost any standard. These results were not achieved by happenstance, but are the direct results of our forward thinking project and technology planning and continuous improvement in operational execution.

While proud of the significant achievements of last quarter, I am even more pleased with the evolution that has occurred throughout our entire business over the past few years. The foundation supporting our top line revenue growth is the company’s strong culture of innovation and industry leading focus on players and the long term project and technology plan that began to take shape back in 2001 and 2002.

Our most recent focus on continuous improvement in manufacturing, distribution and business processes is resulting in consistent improvement in margins and is also reflected in our earnings through an enhanced cash flow. This improved operating execution is leading directly to better flow-through in profitability. For the first nine months of fiscal 2008 total revenues are up $83 million and our gross profit is up $61 million. WMS is now acknowledged worldwide as an industry leader with a legacy of providing innovative high return products.

As significant as our accomplishments have been, our excitement about the future is even greater as we believe we are just now beginning to realize our potential. In coming years we expect to benefit from an improved replacement cycle, substantial casino and gaming expansions and additional revenue gains resulting from the introduction of new innovative systems applications and services for the network server enabled gaming environment of tomorrow.

As I’ve said before, we clearly believe our best days still lie ahead. I also want to address the board management succession plans that we announced last evening that will take effect July 1, 2008. After more than 40 years as the company’s visionary and Chairman of the Board, Louis Nicastro has decided to retire as Chairman. I am honored the Board has elected me to succeed Lou as Chairman while retaining my responsibilities as CEO.

The great news for our shareholders is that Lou will stay on the Board as founding director and the company will continue to benefit from his vision and insights. The Board also created a new position of lead director and elected Ed Rabin to that position. Everyone on the Board has tremendous respect for Ed and I personally look forward to his perspective and contributions. Presently our EVP and COO will become President of WMS Industries.

In addition the management succession plan expands the operating responsibilities of our current leaders which we believe further positions WMS for continued growth in the years ahead. We have been training and grooming this team for additional responsibilities and the fact that we are able to accomplish this reorganization from within demonstrates the gravity and depth of our team.

Collectively our management team posses a rich and diverse mix of proven industry experience. Under this group’s leadership WMS has grown and prospered during the last three years by emphasizing the creation of new gaming and technology capabilities enabling us to bring market differentiated content in unique products, while concurrently achieving continuous improvement in our operating effectiveness.

I am confident that this team will continue to achieve excellence in products and process and further develop the creative talents that will drive our sustainable revenue and earnings growth enabling an ongoing continuum in the building of stockholder value.

Now let me turn the call over to Orrin, who will share with you our operating performance during the third quarter.

Orrin Edidin

Our strong performance is a direct result of our disciplined focus on five key strategic operating priorities. One, maintaining the growth of our gaming operations business while more efficiently investing our capital deployed in that business. Two, growing our North American market share. Three, expanding the breadth and profitability of our international business. Four, improving margins. Five, elevating our operating cash flow in overall capital returns.

These five priorities share a common strategic focus on creating and leveraging investments in intellectual property and innovative advancements in gaming technology to deliver high value propositions for players and our customers.

In the March quarter revenues and profitability in our gaming operations business once again improved over the prior year period. The average daily revenue increased 15% over a year ago, an increase of more than $8.00 per day and also rose 6% on a quarterly sequential basis. In light of any impact on the present economy, this quarter’s results clearly demonstrate the player attraction and earnings power of our games.

The significant increase in daily revenue reflects the popularity and success of our newest products on our community gaming, sensory merging gaming and transmissive reels gaming platforms, coupled with our strategy to provide a controlled rollout for these games to optimize return on investor capital.

Additionally, the longevity of our games in the field continues to improve which also enhances the profitability and the returns on capital deployed. I should point out that the Wizard of Oz game which was introduced in the December 2007 quarter is continuing to deliver and exceptional level of performance and is the highest performing game in our history.

We are introducing three new participation games in the June quarter. Already out in the market is our Bigger Bang Big Event game; our first game to combine two successful WMS technologies, a server enabled community gaming experience with base units featuring our transmissive reels technology playing for wider and progressive jackpots. We are also launching a Bruce Lee transmissive reels game and a Happy Days multi-level free spins local area progressive game, all of which we previewed at G2E.

In July, 2008 we expect to launch Star Trek, the first game deployed in our fourth foundational technology and category creating adaptive gaming platform. These new games have the unique ability to be personalized by players who will be unable to unlock additional bonus round over time enabling the episodic recognition and reward experience for the player. The player is also able to restart the game where they last left over whenever the player logs back into a game. Collectively these features are expected to enhance the player’s gaming experience and driver higher time on the device which will result in an enhanced earnings performance and longevity of the game.

The early results from a field test we currently have underway at a casino in Las Vegas are very encouraging, with high cash in and player occupancy further supporting our expectations that players will gravitate to these unique experiences on the casino floor. Although we only recently began to take orders there is significant interest among our customers for these innovative gaming machines.

Reflecting the benefit from new product introductions we expect to generate another quarter of solid double digit year-over-year revenue growth in our gaming operations business in the June quarter. This operating momentum is anticipated to extend into fiscal 2009 with the launch of Star Trek as well as additional new games such as Clint Eastwood Dirty Harry theme sensory immersion game that will offer a thrill ride experience of a car chase through the streets of San Francisco.

Our second priority is growing our North American market share, which is especially significant given the current state of the replacement cycle. New unit sales in the March quarter were up 8% or nearly 400 units higher than a year ago and approximately 500 units greater than in the December, 2000 quarter. Our market share growth results from target product development strategies aimed at creating innovative and differentiated games that players love to play.

Developing innovative products enabled by new technologies and intellectual property and benchmarking how we will meet players’ expectations is the backbone of our player driven innovation process and is fundamental to offering casino customers high performing products. Such is the differentiation and success of our innovation and G-plus video offerings. Couple this with our increased breadth of product including the increased variety of new products in the mechanical reel category and we expect to compete for and capture a greater portion of operators’ gaming machine purchases.

Consider our experience in California. As you know amended contracts with five Native American tribes were approved in the March quarter to expand gaming at their casinos. We garnered an estimated ship share of 25% of the first gaming machine purchases by these casinos. While we will achieve varying degrees of success in other casinos, overall we expect to continue to grow our market share based upon our fundamental competitive strike for producing innovative high end products.

Our third priority is to continue to grow our global market presence which we are accomplishing through the simultaneous introduction of new products in both the domestic and international markets to capitalize on the global popularity and success of our newest introductions.

In the March quarter we again achieved exceptional results with 52% growth in new unit shipments to international markets. This growth was driven by strong broad-based demand across the range of international markets from Asia to Latin America to Europe. Shipments to international markets represent 37% of our total new unit shipments on the March, 2008 quarter, compared with 30% of our total new unit shipments in the year ago period.

In addition to the benefits from the simultaneous launch of WMS games globally, we are well positioned to achieve incremental growth in international markets through our Orion and systems in progress or SIP operations. We receive very favorable customer response to the new Orion operating platform and games demonstrated at recent international trade shows, and these products were launched in this quarter.

The games incorporate new bonusing and progressive jackpots enabled by the successful integration of SIPS progressive systems technologies. When combined with the ongoing increase in international customer touch points through our expanded network of local sales and service offices, we now offer international customers a broad range of solutions. We expect to continue expanding our worldwide presence through fiscal 2009.

Our fourth priority is to enhance our operating margin. This quarter our operating margin increased to 17%, which was achieved through a combination of improved total gross profit margin and increased operating leverage on higher revenues. We believe significant opportunities still lie ahead to continue our lean sigma and strategic sourcing initiatives and further improve our operating margin, even as we continue to invest to support our R&D activities to innovate and create intellectual property.

Our fifth priority is to drive higher cash flow. For the first nine months of 2008, our cash flow from operations rose 85% with a record level of $57 million in cash flow from operations achieved in the March quarter. Scott will provide more detail in his discussion on this point, but before that I would like to update you on our network service supported gaming initiatives.

To briefly review, we are pursuing a unique path to the server enabled marketplace that takes elements of our technology roadmap and converts them into fully commercialized revenue producing products in advance of the launch of the full functionality of server based gaming or SBG, and without being tied down to legacy systems platforms that need updating and development support, we’ve dedicated 100% of our server based R&D expenditures to our wage net system and new applications for an open architecture network gaming environment where all the gaming systems can easily communicate in real time on a fully GSA open standards compliant basis.

This is a significant advance for WMS as we enter the systems and systems applications arena in that our development efforts and thinking were not hindered by constraints of older, closed legacy systems. We were able to start with a clean vision and a clean slate and the creating of delivering the high return benefits that our customers desire, while utilizing the increased power and capabilities of a server supported high speed network to create exciting new gaming experiences for players.

At G2E last November we showcased a suite of innovative new systems and systems applications in our casino evolved system of the network casino. One application that attracted significant attention is our account based wagering system application that will create added value for casino operations through the availability of real-time data from the gaming floor and significant decrease in idle cash sitting in all those gaming machines.

More importantly, however, in an account based system we plan to create a host of unique gaming applications to provide new excitement and gaming experience for players. In short, we continue to do what we do best, take advantage of new advanced technologies to enable innovation and create new and exciting highly entertaining gaming experiences for players that result in high returns for our customers.

I will reiterate that we remain fully committed to the open architecture of the GSA communication protocols, allowing for full operability, not just for another manufacturer’s products but importantly also at the same system level. As you aware, in February we announced a cross-licensing agreement with IGT and more recently this week we received GLI approval on the first point release of our wage net server based system incorporating GSA standards and basic server-based functionality which we will now be placing on the gaming floor at a popular tribal casino. While basic in functionality, this system currently installed in the casino’s test lab for training purposes represents the first step in the process.

We are please with the feedback and results thus far and we continue to expect approval of the first commercial wage net system in mid-calendar 2009 as previously discussed. We also remain on track to launch our new completely server-ready Bluebirds2 gaming machine late this calendar year. The launch of the Bluebird2 unit before the launch of the wage net system will allow customers the opportunity to purchase the latest technological capabilities for the slot floors which we believe may result in an improvement in replacement market demand in Calendar 2009.

Now let me turn the call over to Scott to review our financial performance.

Scott D. Schweinfurth

Touching on some of the financial highlights for the March, 2008 quarter, our total revenue has increased 27%, by $36 million year-over-year to a quarterly record of $173 million. Total revenues exceeded the high end of our revenue guidance range, largely due to higher than expected performance in our participation business, international market sales and global market share gains.

New unit sales revenues rose $18 million or 22% year-over-year with the primary contributors being better than anticipated growth in international new unit shipments which were up 52% and an 8% increase in North American unit shipments, reflecting our continued strength in market share growth and sales to the Native American casinos expanding in California.

Other product sales revenue increased $2 million year-over-year, primarily from sales of POP boxes and game conversion kits. Conversion kit sales rose to nearly 2300 units compared to 2100 one year ago and used unit revenue also increase at a higher average selling price more than offset a lower number of units. As Orrin noted, gaming operations revenues rose 39%, reflecting a 15% increase in average daily revenue and a 21% year-over-year increase in the average installed participation footprint. The average install base increased by 2% on a quarterly sequential basis over the December quarter.

We can now launch any significant new participation products during the March, 2008 quarter and this is reflected in the install participation footprint at March 31, 2008, which at 9,027 units declined 159 units from December 31, 2007. The March quarter end figure reflects the transition of 100 Class 2 gaming machines that were removed from a tribal customer’s gaming floors in Florida before the replacement Class 3 units have been placed on the floor. These replacements are scheduled for installation at the end of this quarter.

We set a new mark for quarterly total growth profit of $101 million which was a 31%, or $24 million year-over-year increase and represents a total gross profit margin of 59%. The gross profit on product sales revenues increased nearly $12 million and the gross margin on product sales increased 220 basis points on a year-over-year basis to 48%.

Despite the unfavorable margin impact from the sale at lower prices, our specially built units are in select international markets to utilize some slower turning inventory. At 79% the margin on gaming operations was similar to the level achieved in the December, 2007 quarter, but down slightly from a year ago, reflecting a greater mix of wider and progressive gains in the average installed participation footprint year-over-year.

Turning to our expense items, research and development expenses increased 34% of $5 million year-over-year to nearly $20 million. Total revenues R&D expenses were slightly lower than expected at 11% as revenues exceeded our expectations. Year to date R&D expenses are at 12% of revenues.

The higher year-over-year level of spending reflects our planned development to accelerate new systems and enterprise system-like applications for our casino evolved suite of high value products in preparation for the advent of server enabled network gaming, as well as the continued creation of intellectual property and the ongoing expansion of the company’s product portfolio. Higher payroll related costs resulted from the improved operating performance and the addition of research and development expenses of Systems in Progress which was acquired in July, 2007.

Quarterly depreciation expenses of $18 million was $3 million or 20% higher than a year ago period principally due to the 21% increase in the average number of units that are an installed base of participation games. Selling and administrative expenses declined slightly from the December quarter to $34 million in the March quarter equating to 20% of total revenues. This compares to 21% of total revenues in the December, 2007 quarter and 20% of total revenues in the year ago period.

In dollars the year-over-year increase reflects higher payroll related costs associated with improved operating performance and head count increases during the past twelve months to support our international expansion and overall business growth, and increased field service and customer service costs related to the expansion of our participation installed base and focus on improved customer touch points. We also incurred higher regulatory and legal costs as well as the impact from the consolidation of systems in progress acquired July, 2007.

As expected the effective tax rate increase is from 34% in the March, 2007 quarter to 37% in the March, 2008 quarter principally reflecting the impact of the expiration of the federal R&D tax credit at December 31, 2007. As Orrin mentioned we continue to achieve substantial improvement in cash flow from operations.

In the March quarter we generated a record $57 million in cash flow from operations, and $58 million of 85% year to date for the first 9 months of fiscal 2008. This increase was driven by the growth in net income, higher year-over-year depreciation of non-cash items and a benefit from the change in operating assets and liabilities, despite the substantial growth in revenues. As an example we were able to lower our inventory by nearly $9 million from December, 2007, and inventory is down $14 million from June, 2007.

Another key element in our improved cash flow is the greater return and efficiency being achieved from capital deployed in our gaming operations business. Capital expenditures for gaming operations equipment additions in fiscal 2008 year to date total $38 million, down from the $52 million invested in the first 9 months of fiscal 2007, yet our installed base has grown 9% or 751 units since June 30, 2007, compared with 570 units in the comparable period a year ago.

About a year ago we began to place increased focus on driving better utilization for our working capital, primarily by achieving better inventory terms and lower day sales outstanding. As a result of the progress made during the past four quarters, our total cash and cash equivalents have increased from $32 million a year ago to $112 million at the end of March, 2008. Another successful effort by a collaborative cross-functional team at WMS, and we still have room for further improvement.

At the end of the March quarter we opportunistically repurchased 139,700 common shares at an average price of $35.72, for a total consideration of approximately $5 million. We expect to make additional opportunistic share repurchases under the remaining $35 million authorization that the board has provided. With that let me turn the call back to Brian for final comments.

Brian R. Gamache

As discussed in our press release we increased our total revenue guidance for the fiscal fourth quarter in full year fiscal 2008. This new guidance reflects the ongoing momentum in our gaming operations business, the strength of our international sales, and a better than expected North American product sales revenues achieved in the March quarter. Thanks to the high performing results of our games drive by the innovative game development teams led by Larry Pacey and Phil Gelber, WMS’ products teams remain strong and amongst the most popular high performing newest additions to our customer’s gaming floors.

As a result our revised guidance for fiscal 2008 is for total revenues of $640 million to $645 million, which implies a revenue range of $175 million to $180 million for our June, 2008 quarter. This high level of performance and breadth of our differentiated products offering have also WMS to recently be awarded two significant orders.

An initial order from the Seminole tribe in Florida for their facilities totaling 800 gaming machines plus an additional 100 participation games and 1800 new VLP units by a major domestic lottery. The shipments for these orders will begin in our fiscal fourth quarter with the majority expected to the shipped in the first half of fiscal 2009. We continue to believe that is unlikely that there will be any substantial changes in replacement cycle before the end of calendar 2008.

However, during the December, 2008 quarter we plan to introduce our new fully server ready Bluebird2 gaming machine. We believe this will position is well to take advantage of customers’ capital allocations in calendar 2009 and has the potential to begin to generate an uptick in the overall replacement demand later in calendar 2009.

In addition as already discussed, we fully expect to provide our customers many new high value added benefits that will enable a network gaming environment. With new systems and systems applications under development that are receiving favorable customer response, we continue to move forward with our accelerated R&D activities on the visionary prototype products and applications that we previewed at G2E.

As a result we previously discussed, we expect our R&D expenses to approximate 12% of revenues in fiscal 2008. We believe such investments in our future are the best means of sustaining attainable profitable growth which in turn is expected to translate into growing shareholder value.

In addition, while our operating expenses will increase as a result of our overall global growth, we continue to believe our business model is an opportunity to enhance our operating margin from its present level. For the first nine months of fiscal 2008 our total revenues have grown 22% while we have increased our net income 43% despite a 5% higher effective tax rate. Longer term we remain clearly focused on improving our gross profit margin and realizing anticipated leverage in our infrastructure to enhance operating margin and increase our operating cash flow.

In closing, let me summarize the significant factors supporting our optimism for the remainder of fiscal 2008 and into fiscal 2009. First, the continuing popularity of our games and new products for players. We are seeing strong initial beta test results in the products still in the pipeline that will be introduced in the coming months. Our focus on innovation and differentiation has increasingly moved our products from “nice to have” category into the “must have” category, and with an expanding portfolio of products we continue to expect to effectively compete for a greater share of the customer’s order flow leading to increased market share throughout the world.

Second, having looking into the future of high value benefits made possible in a server supported network gaming environment, we believe we have substantial opportunities to offer players exciting new gaming experiences and therefore provide customers with high return products, content, systems and systems applications and services. WMS is well positioned to help our customers adapt to the benefits of the new technologies, and by helping them, garner new revenue sources and incremental growth for WMS with the realization of the next generation of gaming products and services.

Third, our efforts to improve consistency in margin enhancement and delivery of greater cash flow are still in the early beginnings. Our organization has made good progress in adopting the tools and discipline required to improve our business processes, however, we are only beginning to scratch the surface of what is possible. Just as we targeted the gross product and product profit margins levels that we are achieving today, we will also continue to stretch towards new heights in the future.

As we benchmark industry leaders in this and other industries, we believe we have substantial opportunities to further drive our long term profitability and building increased stockholder value. WMS’ forward focused culture and performance orientated organization has demonstrated that enabled by new technologies we can continuously reinvent our products and our capabilities, ensuring we maintain the competitive strengths needed to meet the needs of all of our stakeholders.

During the past several years we have significantly improved the breadth and depth of our organization for internal development and selective improvement. Our executive leadership changes were accomplished with internal talent, which we trained and groomed for greater responsibilities. This team provides WMS with experienced leadership having the focus and creativity and it gives me great confidence in our collective ability to realize WMS’ full potential.

With significant opportunities to sell to new and expanding jurisdictions, an uptick in the number of new casino openings in the next two years and anticipated improvement in domestic replacement cycles, the advent of new revenue streams made possible in the network gaming environment, coupled with the improvements possible in our operating execution, WMS has a very bright future ahead.

Now we will be happy to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Joseph Greff - Bear Stearns.

Joseph Greff – Bear Stearns

Brian, what was your domestic ship share in the March Quarter?

Brian R. Gamache

We believe that we are taking share, but albeit until the other competitors announce their results Joe, it is just an educated guess. We do know that we shipped 75% of the units in North America that our largest competitor announced recently. That is the highest percentage we have achieved.

So yes we do believe our content is gaining traction and positive income and we expect that trend would continue; so until our other competitors announce their results shortly we’re not sure exactly what that market share is.

Joseph Greff – Bear Stearns

When I look at your 4Q revenue guide and it’s up a little bit, where is that incremental revenue coming from? Are you changing any metrics sold ASP, average installed base?

Brian R. Gamache

I believe it is the continuum of the international success we are achieving; the participation games really taking hold and also the margin improvement things we have going on internally. So that is really the continued growth that we are seeing on additional revenue.

By the way Joe, we do have a seasonality, where the fourth quarter is traditionally our busiest quarter of the year, so that is not unusual for us to see an uptake in the fourth quarter.

Joseph Greff – Bear Stearns

And then can you just remind us how many original Bluebird cabinets are out in North America right now?

Brian R. Gamache

We actually are just approaching the hundred in North America. Worldwide I know we are just approaching the 100,000 unit number. That will go out this quarter.

Joseph Greff – Bear Stearns

You could be, at this point right now we’re certainly I would think by the end of this quarter, having more cash than debt in the net cash position, so how do you view your balance sheet? How do you view this increasing free cash flow and what you do with it?

Brian R. Gamache

Well, I think we have an exceptionally strong balance sheet and as we’ve stated in the past there is three things that we really focus on when we look for uses for that cash. The first is increasing intellectual property and technologies that we will be able to provide in future products which you know I think we’ve got a track record in proving that we’re fairly efficient at using those technologies to create differentiated product. This quarter I think our R&D expenses were up by about $5 million.

We also invested $5 million in licenses for intellectual property that we will be using in future products. We continued to look at M&A activity. Over the last two years we’ve done a couple of small deals and will continue to look at tuck in acquisitions from both a geographic standpoint and from an intellectual property and technology standpoint, and lastly we do have a buy back program in place and so far this year we have bought back $15 million worth of stock and we’ve got $35 million remaining on the authorization.

A point to that, Joe, an interesting note. Q3 revenue is about all the revenue we did in fiscal ’02 and ’03 and for the nine months to date we achieved a higher revenue level and all of fiscal ’06; so Scott’s point about investing in the business – we’re seeing a return that is pretty immediate , so I think we will continue to look along those lines.


Your next question comes from Steven Wieczynski - Stifel Nicolaus & Company, Inc.

Steven Wieczynski – Stifel Nicolaus & Company, Inc

First, in terms of the operating environment out there, what are you guys seeing in terms of your customers and their spending patterns at this point? Are you seeing a slowdown because of the current economic environment or are they basically not out buying because they don’t want to be out buying in front of the next major replacement cycle?

Brian R. Gamache

I think there is some truth to that Steve that they want to make sure that what they are buying is going to be extendable into the server-based world, but this is nothing new. The environment, although challenging, has been challenging for the past 2- 2.5 years, but you know we’ve continued to increase our revenue.

The guidance that we are giving today shows that our revenue is increasing 19% so we believe that people are willing to pay money for content that is performing, so this bodes well for us that when the replacement cycle does go to a more normal 5-6 year replacement cycle, this is going to be a terrific opportunity for our company and our shareholders. So we believe even with the headwinds if we are able to draw our business in the worst of times we are going to be very well positioned when the tide turns.

Steven Wieczynski – Stifel Nicolaus & Company, Inc

Margin and product sales, they basically have been somewhere between 47% and 48.5% for the last four quarters. We kind of reached a level here or do you still there is room to kind of expand those going forward?

Brian R. Gamache

We’ve got internal goals to expand those quite dramatically in the coming years. I think when you look at the job we did in Q3, if it weren’t for that international shipment that Scott described in his comments, we would have been significantly higher; but it was a business decision to actively get rid of some legacy inventory that we thought made business sense for the company and we were willing to do that.

But you will see our continued focus on that execution. We believe with our supply chain, better purchasing, better forecasting that we will be significantly growing at margin going forward.


Your next question comes from Bill Lerner - Deutsche Bank.

William Lerner – Deutsche Bank Securities

What are you hearing on the reinstatement of the R&D tax credit, ultimately maybe say a calendar ’09 event or end of ’08 and can you help quantify that? As I recall you got paid in one quarter for that last year, maybe it was $0.04 when they reinstated it but if you can put some color around that then I’ve got two follow-ups.

Scott D. Schweinfurth

What’s called the expenditure legislation has been introduced, I believe it’s in the House but it’s not been introduced in the Senate. At this point the advice that we are getting is given we are in an election year, it is unlikely that any action will take place before the election takes place and it’s likely to be similar to what happened two years ago where in the session between the election and new people coming on, that there stands a better chance for passage and you can see that our effective tax rate went up about 3% March ’08 versus March ’07, and probably 2% of that is solely do to the lapse of the legislation at the end of December.

William Lerner – Deutsche Bank Securities

On the participation yield front, obviously the high class problem now is new launches have to do well north of $300 per day for you to add incremental placements. I just want to get your thoughts on that. Maybe it’s silly when you think of how strong the yields probably are for something like Wizard of Oz. Scott if you could add some color to that it would be helpful.

Scott D. Schweinfurth

One of our goals this year was to have a better return on invested capital in our gaming operations area and I think we’ve proven we can do that by selectively placing games and not just blowing them out all over the four corners, and by doing that we’ve increased the popularity in the o-rings and coin end of our games, enough the churn is reduced dramatically.

And again when you look at the fact our footprint quarter over quarter, our average footprint increase 2%; that’s the average of a Q2 - Q3 because those takeaways came at the end of Q3. Our revenues were up 9% sequentially for over a quarter so our yield and strategy and our asset allocation strategy is working, Now, going forward we can continue to believe that’s the right thing for us to do.

The fact that we were back of 153 units or whatever in Q3 was planned. That’s not a surprise to use because we didn’t have any new product launches coming out in Q3, whereas we have a variety of them, three new product launches coming in Q4 and we have a backlog of 2200 units for those particular units.

So we are going to be very prudent in placing footprint out there. We are going to continue to prune off the low performing assets and replenish them with refurbishment and new opportunities, but we continue to believe that there is opportunity for us to leverage up this rate and have a greater return on the assets.

And Bill I would add that obviously we believe that longevity is the key to driving the yield and return on invested capital, and when you are relying on certain form factors as opposed to themes in the old days, new themes would drive the turnover of the machinery. Now with the form factor, whether it be adaptive gaming or sensory immersion, we can replace the themes on existing hardware that remains in the field for far longer periods of time.

William Lerner – Deutsche Bank Securities

That’s great, the 200 unit backlog for participation, can you give me a sense of timeframe? Is that 9 months or something like that and how many?

Scott D. Schweinfurth

That’s typically a two quarter type of placement, Bill, but again as you know we churn the footprint. We take off all our low performing games and we have cycles of certain series coming off and certain series being launched. Our backlog has been consistent the last several quarters so we expect that you will see an uptake in that business going forward.

William Lerner – Deutsche Bank Securities

Can you maybe give us a sense of your experience at City Center with that server based gaming order that was announced? My understanding is that you participated at the very least with an account based wagering deal. I’d love to hear you talk about that.

Brian R. Gamache

We haven’t disclosed anything specifically on that other than to say we are working very closely with MGM to be at the City Center opening with server enabled applications and products for the casino floor.

William Lerner – Deutsche Bank Securities

Brian as I look at your press release from last night and listen to your commentary, it strikes me as you being quite conservative with your higher guidance. You just talk about where as you think of your budget, if that’s true, where you’re being conservative and why.

Brian R. Gamache

I wouldn’t use the word conservative Bill, I would use the word realistic and as we said in the release that we are juggling a lot of things here. We have an uncertain economy. We have the operators that are reporting less than desirable results, but we are also seeing great anticipation for our products, so we are trying to meld those into a realistic guidance that we believe makes sense for all of us and we’ve believe we’ve done that in this case and this is the best visibility we have ever had.

Going into our Q4 we’ve got a significant number of these games that have been shipped and built and ordered already, so we are very confident in our guidance given for Q4 and we see continued positive events, so I think when you look at the industry itself we have a little different story than the others do.

We are continuing to see great demand for our products and although maybe people aren’t ordering them in the 300 and 400 lots they used to, although we dumped two big orders today, they are finding capital to put games like Wraparound Reels and Rotating Wilds and Money Bursts on their floor because that’s what’s working.

The innovation series that we’re announcing, there is no question that people will always find capital to put games on their floors when there’s games that are working, so we’ve been very fortunate in that manner.


Your next question comes from David Katz - Oppenheimer.

David Katz – Oppenheimer & Co.

Could we talk a little bit about your participation games and one of the questions that come up a number of times and we took a wild swing at it a few weeks ago. When we look at your installed base of participation games here in the United States, trying to figure out what your exposure is, what the proportion of your gross margin or earnings comes out of variable participation games; you know, the question being driven by potential economic weakness that you cite in your guidance.

Brian R. Gamache

But again, what we’re seeing David is you see a 15% increase in our yield year-over-year is not an unimpressive number and we’re seeing our coin in numbers going up, so what we’re seeing is a customer that is playing just patient games perhaps for a different reason. Maybe it’s an economic reason, maybe it’s a life changing event reason, but we have no reason to believe this patience is going to diminish because of the economy. We believe that money may shift to participation from the regular games but we haven’t seen any trends that would dictate that and we watch this very closely. That being said, Scott, do you want to?

Scott D. Schweinfurth

I think what you’re asking David is what percentage of these games are on sort of a percentage of coin in or percentage of net win and how many are sort of fixed straight leases. Is that what you’re asking?

David Katz – Oppenheimer & Co.

Well yes. I mean of that game ops revenue and/or gross profit, how much of that is on a flat fee versus some kind of a variable…

Scott D. Schweinfurth

It’s about 75% variable and 25% fixed.

David Katz – Oppenheimer & Co.

Of the game ops revenue and profit margin?

Scott D. Schweinfurth

Of the participation installed footprint

David Katz – Oppenheimer & Co.

So is that on a unit basis at 75% of the unit?

Scott D. Schweinfurth


David Katz – Oppenheimer & Co.

Sort of a revenue or profit basis that’s a figure that you’re not disclosing or you don’t have?

Scott D. Schweinfurth

It’s a figure that we’re not disclosing.

David Katz – Oppenheimer & Co.

But just focusing on the international unit sales that were I think $2800 and change in the quarter. Can we talk about the concentration of that? I mean are we talking about 29 units to 100 different places? That’s sort of my impression and it may be an exaggeration, but whatever color you can give us and, again where is that growth going forward, going to come from? Where are we shipping these to?

Orrin Edidin

We have had some great success throughout South America, Latin America in more recent quarters but we continue to show progress throughout Asia and Europe, but I would say that those three regions are the primary contributors for our international business. We continue to see solid growth in our international markets and specifically I will highlight South America. We are doing very very well in markets like Chile, Colombia and other regions through that area.

David Katz – Oppenheimer & Co.

It sounds like there aren’t any lumps of several hundred units in that 2883 for the quarter, right?

Orrin Edidin

Those are mostly, again 12, 15, 20 games that are ordered, David, and certainly well distributed.


Your next question comes from Steve Kent - Goldman Sachs.

Steven Kent – Goldman Sachs

Just a quick question on the way you view a central server role out. Do you think that IGT has to get the ball rolling and really figure placement out there before you really can see some action on some of your products that target , you know, similar services? I just wondering of there is some sort of strategy there?

Orrin Edidin

You know we really don’t have a dependency on IGT’s rollout schedule because our strategy is unique in that we are looking at commercializing server enabling products. In other words we’re not selling technology, we’re selling technology enabled games, applications, products and we will continue in a sequence to commercialize these products in the not to distant future, irregardless of the area rollout or IGT’s plans or anything else that may happen out there.

Steven Kent – Goldman Sachs

Mr. Nicastro’s exit is there any special charge or extraordinary associated with that?

Orrin Edidin

No there’s not Steve. At this point there’s not.


Your next question comes from Steve [Altebrando] from Sidoti and Company.

Steven [Altebrando] - Sidoti and Company

How are you as far as capacity goes heading into what could be some accelerated replacements?

Brian R. Gamache

As you know we almost doubled the size of our Waukegan facility here last year and we built this in anticipation of the next replacement cycle, so we’ve got plenty of capacity and we are operating very efficiently today and can handle probably double the line we are producing today.

Steven [Altebrando] - Sidoti and Company

What percentage or numbers of games are now on the new platforms, transmissive, community, sensory?

Brian R. Gamache

That’s about 45% at this point.


Mr. Gamache, I’ll turn the call back to you sir, for closing remarks.

Brian R. Gamache

Thank you for joining us this morning. We look forward to reporting our additional progress next call when we will discuss our June quarter fiscal year end results and fiscal ’09 outlook. Thank you and have a great day.

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