Aztec Adventure, Bee Bucks, Bluebird, Classic TV Game Show Series, CPU-NXT, Double Easy Money, Fairy’s Fortune, Grand Hotel, Hot Properties, Instant Winner, Jackpot Party, Jackpot Stampede, Keepin’ Up With the Joneses, Life of Luxury, Milk Money, Money 7’s, Money to Burn, Moneyline, Once Around Deluxe, Pick Your Fortune, Prize Spin, Puzzle Pays, Quackers, Rakin’ It In, Reel ’em In, Rich Little Piggies, Robin Hood’s Sherwood Treasure, Roll Credits, The Jade Monkey, Toast of the Town, Tour of Stars, Wild Chance, Wild Wilderness, Winning Recipe, WMS Gaming and X Marks the Spot are trademarks of our subsidiary WMS Gaming Inc. Product names mentioned in “Item 1. Business — Products” in this report are trademarks of WMS Gaming, Inc., except where they are licensed. 3 WAY ACTION is a trademark of Yehia Awada. BOSE is a trademark of Bose Corporation. HOLLYWOOD SQUARES and THE CENTER SQUARE are trademarks of King World Productions, Inc. JUMBLE is a trademark of Tribune Media Services, Inc. MEGAJACKPOTS is a trademark of International Game Technology, Inc. MEN IN BLACK is a trademark of Columbia Pictures Industries, Inc. MONOPOLY, SCRABBLE, FREE PARKING, MR. MONOPOLY, CHANCE and COMMUNITY CHEST are trademarks of Hasbro, Inc. PAC-MAN and PAC-MAN FRENZY are trademarks of Namco Ltd. PICTIONARY is a trademark of Pictionary Incorporated. SURVIVOR is a trademark of Survivor Productions LLC. MATCH GAME is a trademark of FremantleMedia Operations BV. POWERBALL is a trademark of the Multi-State Lottery Association. RAPID ROULETTE is a trademark of Stargames Corporation Limited and Crown Limited.

PART I

Item 1.     Business.

Development of Our Business

      WMS Industries Inc. (“WMS”) was incorporated in Delaware on November 20, 1974 under the name Williams Electronics, Inc. and succeeded to the amusement game business that had been conducted for almost 30 years prior to 1974 by our predecessors. For the last five years, our business has consisted exclusively of the design, manufacture and marketing of gaming machines and video lottery terminals, or VLTs.

      We conduct our gaming machine business through our subsidiary, WMS Gaming Inc. (“WMS Gaming”), which markets our products under the WMS Gaming trademark. Our fiscal year begins on July 1 and ends on June 30.

      In fiscal 2004, we launched our new generation game platform, CPU-NXT ^TM and our new game cabinet Bluebird ^TM , and we resumed profitable quarterly results in the second half of fiscal 2004. For information about our revenues, net income and assets, see our consolidated financial statements included in this report and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      On June 25, 2003, we completed a private placement of $100 million principal amount of 2.75% Convertible Subordinated Notes due July 15, 2010. On July 3, 2003, we issued an additional $15 million of 2.75% Convertible Subordinated Notes upon exercise of the over-allotment option in the note agreement.

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      Our principal executive offices are located at 800 South Northpoint Blvd., Waukegan, Illinois 60085, and our telephone number is (847) 785-3000. Our Internet website address is www.wmsgaming.com. Through our Internet website, we make available free of charge, as soon as reasonably practical after the information has been filed with or furnished to the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports. We will also provide electronic or paper copies of these reports free of charge upon request to our principal office, Attention: Treasurer. Information contained on our website is not part of this report.

Company Overview

      We design, manufacture and market innovative gaming machines and VLTs for the Class III gaming markets, and we manufacture gaming machines under original equipment manufacturing agreements, or OEM agreements, with Multimedia Games, Inc. for the Class II gaming market. There are three classes of gaming markets as follows:

      We seek to develop gaming machines that offer high entertainment value and generate greater revenues for casinos and other gaming machine operators than the gaming machines offered by our competitors. Our gaming machines feature advanced graphics, digital sound and engaging game themes, and most incorporate secondary bonus rounds. Some of our games use licensed, well-recognized brands such as MONOPOLY ^TM , HOLLYWOOD SQUARES ^TM and MEN IN BLACK ^TM . In designing our gaming machines, our designers, engineers, artists and development personnel build upon our almost 60 years of experience in designing and developing fun, humorous and exciting games. Our gaming machines are installed in all of the major regulated gaming jurisdictions in the United States, as well as in over 50 foreign gaming jurisdictions. For fiscal 2004, 2003 and 2002, we generated $230.2 million, $178.7 million and $174.7 million in total revenue, respectively. The increase in revenues in fiscal 2004 was due to receipt of regulatory approvals and subsequent shipment of our new Bluebird video gaming devices and CPU-NXT upgrade kits.

      We generate revenue in two principal ways. First, we have product sales of gaming machines and VLTs, conversion kits, including theme and/or operating system conversions, parts, used equipment and original manufactured equipment to casinos and other licensed gaming machine operators. For fiscal 2004, 2003 and 2002, we generated $145.9 million, $85.7 million and $75.6 million in product sales revenues, respectively. Second, we have gaming operations where we lease participation games and VLT’s and earn royalties that we receive from third parties under license agreements to use our games. “Participation games,” as used throughout this report, refers to gaming machines that we lease based upon any of the following payment methods: (1) a percentage of the net win of the gaming machines, (2) fixed daily fees, or (3) in the case of wide-area progressive games, a percentage of the amount wagered. For fiscal 2004, 2003 and 2002, we generated $84.3 million, $93.0 million and $99.1 million in gaming operations revenue, respectively. We offer our VLTs either for sale or on a leased basis, but for leased VLT’s, we do not include such gaming devices in our installed base of participation games. In early fiscal 2005, we began offering our customers a new “hybrid” series of gaming devices where the casino can pay a normal participation rate or has an option to buy the base gaming device at the normal price and to pay a lower daily fee for the software and top box.

      Our portfolio of participation games includes games based upon the MONOPOLY, HOLLYWOOD SQUARES, MEN IN BLACK and PAC-MAN brands, and under our Puzzle Pays ^TM series, the JUMBLE ^TM , SCRABBLE ^TM and PICTIONARY ^TM brands, among others. We received our first regulatory approvals for our

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      The products that we offered for sale throughout fiscal 2004 consisted primarily of multi-coin, multi-line video gaming machines. We are one of the original developers of multi-coin, multi-line video gaming machines in the U.S. market. Our video gaming machines include engaging themes, advanced graphics and digital sound effects and music. We have also developed and recently received regulatory approvals for mechanical reel-spinning gaming devices and poker games, which we will ship to customers in fiscal 2005 as part of our efforts to fully serve the gaming device needs of a casino.

      In fiscal 1999, we introduced the first of our participation games, a series of four MONOPOLY themed gaming machines, under our exclusive license to use the widely-recognized MONOPOLY trademark on casino-style gaming machines. Since then, we have continued to introduce additional MONOPOLY and other themed gaming machines.

      In 2001, we experienced software anomalies in the operating system software that drives our gaming devices, and certain of these anomalies permitted player cheating. As a result of these anomalies and the publicity concerning them, we experienced delays in receiving approvals for new games pending completion of regulatory review of upgrades to our operating system software. These delays resulted in both lower game sales and lower participation game revenues because we were unable to refresh our installed base of participation games on our planned schedule. To address the software anomaly issues and to revitalize our technology foundation, in January 2002, we announced a three-part technology improvement plan to improve the stability of the operating system software. In fiscal 2003, we stabilized our existing operating system software and began to receive approvals for new games. We also met key milestones on the mid-term phase of our technology improvement plan, which consisted of developing a new operating system and circuit board called CPU-NXT .

      In fiscal 2004, we began shipping new games using our new CPU-NXT operating system in the Bluebird cabinet. In fiscal 2005, we are expanding our product offerings to include video poker and mechanical reel-spinning games, and we intend to offer an increased number of new game themes. By September 30, 2004 we expect to have received substantially all of the regulatory approvals required in North America to ship CPU-NXT, Bluebird , video poker games and mechanical reel-spinning gaming devices. We believe that this introduction of an increasing number of games and a broader range of new products will enable us to increase product sales, participation game installations and profitability going forward.

Industry Overview

      Casino operators continuously seek to increase revenue growth and profitability at their casinos. The importance of gaming machine revenue to the casino operators’ profitability has created demand for gaming machines that have the ability to generate superior net win. As a result, the pace of innovation in game design has accelerated, and gaming equipment manufacturers have increasingly focused on enhancing the overall entertainment value of gaming machines. We believe that three of the most significant recent developments in gaming machine design have been the development of video gaming machines that simulate mechanical reel-spinning slot machines, the introduction of gaming machines with secondary bonus rounds, and cashless gaming.

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      We expect continued demand for multi-coin, multi-line video gaming machines and other gaming machines that offer the player secondary bonus rounds and other enhanced entertainment features, which we believe result in higher amounts wagered and net win per machine for casinos. As casino operators continue to adopt cashless gaming in their casinos, we believe demand for gaming devices that support cashless gaming will continue to increase.

      Some of the gaming machines with secondary bonusing features and entertaining themes generate significantly more coin in per day than the other gaming machines on the casino floors, allowing gaming machine manufacturers to lease some of the highest-earning machines to casino operators as participation games. This allows gaming machine manufacturers to share in the superior earnings of these games and to generate a recurring revenue stream for themselves.

      Another revenue-sharing model that has been employed by some manufacturers is a wide-area progressive system. A wide-area progressive system (WAP) links gaming machines in multiple casinos within a gaming jurisdiction to contribute to and compete for large system-wide progressive jackpots. WAP systems are designed to increase gaming machine play for participating casinos by giving the players the opportunity to win a larger jackpot than on a non-linked, stand-alone gaming machine. Net win per gaming machine on WAP systems are generally higher than on non-linked gaming machines on a casino floor. We expect the demand for wide-area progressive jackpot games to increase.

      VLTs include both video and mechanical reel-spinning gaming machines. VLTs are sold, leased to, or operated as participation games by government agencies that desire to raise revenue for the jurisdictions in which they operate. Most VLTs are linked to a central computer for accounting and security purposes and are monitored by state lotteries or other government authorities. Unlike gaming machines designed for the casino market, most VLTs are located in places where casino-type gaming is not the principal attraction, such as racetracks, bars and restaurants. In the last decade, several U.S. states such as New York, Delaware, Oregon and Rhode Island have enacted legislation permitting VLTs.

Business Strategy

      Our business strategy is to increase our market penetration in major regulated gaming jurisdictions worldwide by developing entertaining products and providing outstanding service. This strategy includes the following elements:

      Our Technology Foundation: In January 2002, we embarked on a technology improvement plan designed to stabilize and update our existing operating system and position us for future growth. We have received the requisite regulatory approvals for the upgraded version of our legacy operating system software. We have also received approvals for CPU-NXT, our new operating system and gaming platform, from all North American regulators beginning with our first regulatory approval for this platform in September 2003. We continue to work to incorporate new technologies into our software and platforms in anticipation of evolving customer preferences and future regulatory requirements.

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      Leveraging Our Product Development Expertise to Introduce Innovative New Games: We have almost 60 years of experience developing fun, humorous and exciting games. Over the past three years, we have enhanced our game development efforts by adding key management, design personnel and software engineers to our product development group. We have renovated our facilities and organized our game development team into a studio format to help promote innovation while maintaining a focused development approach in an effort to maximize the entertainment value of our products. We believe that our proven game development capabilities, combined with the additional functionalities and enhanced features of our new gaming platform, will enable us to increase our market share.

      Offering our new Bluebird Cabinets: We have received approvals of our new Bluebird cabinets from all North American regulators, beginning with our first regulatory approval of this new cabinet in November 2003. The Bluebird cabinet is used for our video, mechanical reel-spinning, poker and wide-area progressive products. Bluebird cabinets incorporate features such as an ergonomically engineered design, 18-inch digital, high-resolution flat screen monitors for the video version of the product, sound systems by Bose Corporation (“BOSE®”) and simultaneous coin-in/ coin-out and cashless capabilities. At the American Gaming Summit in January 2003, industry experts selected the Bluebird cabinet as one of the top three most innovative new gaming products.

      Expanding the Breadth of Our Product Offerings: We have expanded our product lines to be able to fully serve casino operators’ gaming machine requirements. Our former product line focused primarily on the multi-coin, multi-line video-based market sector. Our new product offerings also include:

      Maximizing the Potential of Our Participation Games and Exclusive Licenses of Popular Themes: As the exclusive licensee of the MONOPOLY brand for use with gaming machines, we have converted a popular board game brand into a successful line of superior-earning gaming machines. We have also licensed additional brands and now have five series of participation game themes with an aggregate installed base of 4,240 participation games as of June 30, 2004. We introduced a new branded series, MEN IN BLACK in late June 2004. The name recognition and creative game design of our branded products have allowed us to lease them to casino operators as participation games, generating a high-margin recurring revenue stream for ourselves, as well as the casinos. We continue to pursue new licensed brands and additional themes based on the guidance of focus group testing of casino patrons.

      Continuing Our Expansion into International Markets: We are authorized to conduct business in over 50 foreign gaming jurisdictions. Revenues from our foreign customers increased by 23.8% to $59.9 million for fiscal 2004 from $48.4 million for fiscal 2003. We anticipate continued growth in foreign markets with the continued penetration of CPU-NXT, Bluebird, and the introduction of mechanical reel-spinning gaming machines and video poker games, wide-area progressive systems and additional game titles.

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      To enhance our focus on foreign markets we recently appointed one of our senior executives as managing director of international operations. We currently have offices in Australia, South Africa, Spain and most recently we have opened an office in the United Kingdom. This new office will house our second internationally focused game development studio and, if gaming regulations are amended in the United Kingdom, would also include sales and distribution functions. The United Kingdom continues in its efforts to modify its gaming legislation, which we believe will turn into revenue opportunities in calendar 2006. We also view Macau and Russia as two markets with high growth potential. We have been an active supplier to the Russian market for the past two years, and in May 2004, we launched the first Bluebird gaming devices there. See Note 4 to our consolidated financial statements included in this report.

Products

      We offer video and mechanical reel-spinning gaming machines and VLTs incorporating highly entertaining game themes and innovative gaming features. Our new CPU-NXT operating system supports added functionality and increased graphical capability and speed of play.

      Our Bluebird gaming cabinet includes a number of features that we believe improve the experience of players, including the Bose Free Field® directed audio system, which reduces peripheral distracting noises; an 18-inch LCD monitor, which can display advanced graphics generated by our new CPU-NXT operating system; and a recessed coin tray to provide players with greater comfort. The Bluebird cabinet supports both video and mechanical reel games and is easier and faster to service than our legacy cabinets, with 80% of the internal components interchangeable between upright and slant models.

      Engaging and humorous themes and a high degree of player interactivity are incorporated into each of our games, particularly in the secondary bonus rounds. We believe that by designing games and gaming machines that are fun and interesting to play and incorporating the latest gaming technologies, we supply games and gaming machines with superior player appeal.

      Our games integrate secondary bonus rounds as additions to the basic game to create a game-within-a-game for more exciting and interactive play. If players achieve various milestones in the game, they move on to play a secondary game without additional wagering for additional bonuses. The secondary game gives the player a sense of investment in the game. The player is encouraged to continue wagering on the basic game in the hope of being awarded a secondary bonus game. The player can win in both the basic game and the secondary game. In our secondary bonus games, the player has various choices to make regarding the bonus features. For example, in some games the player can select from a variety of tokens or characters that will be used to obtain or reveal the bonus. Amusing, entertaining or familiar graphics and musical themes add to the player appeal of our games.

Games for Sale

      We offer the following products for sale:

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      During fiscal 2004 and 2003, we released the following new video games for sale:

      Our sales of new gaming machines, primarily video gaming machines, were 12,661 units in fiscal 2004 compared to 6,867 units in fiscal 2003 and 6,916 units in fiscal 2002. The lower unit levels for the previous two fiscal years resulted from the delay of new game approvals and our customers delaying purchases as they scrutinized our progress in implementing our three-part technology improvement plan to stabilize our operating system software and awaited our new products on our new platform. In September 2003, we received the first approvals for nine video games for sale on our new CPU-NXT operating system. We expect to introduce over 40 games for sale in fiscal 2005, subject to regulatory approval. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of revenues contributed by games for sale and other product sales.

Participation Games

      In fiscal 1999, we introduced the first of our participation games, a series of four MONOPOLY themed games under an exclusive license from Hasbro, Inc. Our game designers use secondary bonus rounds in combination with the actual elements of the MONOPOLY board game to create the highly entertaining games. These elements include MR. MONOPOLY ^TM , CHANCE ^TM , COMMUNITY CHEST ^TM and the distinctive game board and tokens, some set to a background of big band music. Most of our participation games are multi-coin, multi-line video games, although some of the earlier games are mechanical reel-spinning gaming machines.

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      In fiscal 2001, we introduced Puzzle Pays, a second series of participation games, based on popular licensed puzzle game themes. The first game in the Puzzle Pays series was JUMBLE ^TM , based on the popular scrambled word game appearing in newspapers nationwide. Two additional Puzzle Pays gaming machines followed: Bee Bucks ^TM , the sequel to JUMBLE, and a SCRABBLE ^TM themed game.

      In fiscal 2002, we launched three new participation game series: HOLLYWOOD SQUARES , based on the popular television game show, in the winter of 2001; PAC-MAN, based on the popular classic arcade game, in the spring of 2002; and SURVIVOR ^TM , based on the popular television show in the spring of 2002. The SURVIVOR themed game was commercialized in association with International Game Technology, or IGT, which placed these games on its MEGAJACKPOTS ^TM wide-area progressive (WAP) system. WAP systems are inter-casino systems that electronically link gaming machines located in various casinos to a central computer, which controls a progressive jackpot that increases with every wager placed on the linked gaming machines.

      In April 2003, we introduced FREE PARKING ^TM , the eleventh game in the MONOPOLY series. In fiscal 2003, we had limited introductions of two additional Puzzle Pays gaming machines, PICTIONARY ^TM and SCRABBLE Winning Recipe ^TM . In September 2003, we extended our agreement with Hasbro, Inc. for use of their MONOPOLY brand through calendar 2011. As a result, we intend to devote more development efforts and intellectual property to the MONOPOLY brand over the coming years. In October 2003, we introduced Moneyline, the twelfth game in the MONOPOLY series.

      In January 2004, the remaining SURVIVOR WAP themed system was shut down. In February 2004, we introduced Grand Hotel® , the thirteenth game in the MONOPOLY series, and the first MONOPOLY game offered as a CPU-NXT upgrade conversion. In June 2004, we introduced Once Around Deluxe® as the first MONOPOLY game offered as both a CPU-NXT conversion and also in a new Bluebird cabinet. We intend to introduce two new MONOPOLY branded participation games per year to keep the brand fresh and entertaining.

      In addition, we used the MONOPOLY brand for our first wide-area progressive jackpot, called MONOPOLY Money that we launched in May 2004. By May 2004 we received all of the regulatory approvals needed to operate our proprietary WAP system in Nevada casinos and for Native American casinos and introduced our first proprietary WAP jackpot to our customers.

      During fiscal 2004 and 2003, we released the following new participation games:

      After substantially increasing our game development staff over the last 18 months, we expect to launch over 10 new participation games in fiscal 2005, subject to regulatory approval.

      Our installed base of participation games decreased from 5,086 units at June 30, 2003 to 4,240 units at June 30, 2004. Net win per day per gaming device increased from $39.19 in fiscal 2003 to $39.60 in fiscal

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      The average installed base decreased from 5,509 units in fiscal 2003 to 4,430 units in fiscal 2004. At August 27, 2004 we have issued orders for over 2,617 conversions or new units, of which over 2,000 are for placement of new games on Bluebird gaming devices. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of revenues contributed by gaming operations.

Additional Revenue Sources

      In addition to the gaming machine categories described above, we also supply the following products:

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Design, Research and Product Development

      In designing our gaming machines, our designers, engineers and artists build upon almost 60 years of experience that our predecessors and we have in designing and developing fun, humorous and exciting games. We are continually developing new games in order to refresh the installed base of our gaming devices, and implementing new technologies and functionality to enhance player entertainment. Our gaming machines and games are usually designed and programmed by our internal engineering staff and game design studios. Our game design teams operate in a studio environment that encourages creativity, productivity and cooperation among design teams.

      Each of our eight studios works concurrently on multiple games and is staffed with software developers, graphic artists, mathematicians and game developers. In some cases, we may outsource testing and graphic design functions to independent designers under contract to us. Games and gaming machines may be tested by regulatory authorities who must approve the product before it can be shipped to gaming jurisdictions.

      During fiscal 2004, 2003 and 2002, we spent approximately $44.8 million, $40.3 million and $26.0 million, respectively, on design, research and product development. In fiscal 2003, we finished the renovation of our existing Chicago research and design facility to create a state-of-the-art technology campus. We are currently planning expansion of this facility or the purchase and renovation of additional space in fiscal 2005. We substantially increased our staff in fiscal 2004, 2003 and 2002 to execute our technology improvement plan, to expand our product lines and also to increase the number of game themes we offer. As of August 27, 2004, we employed 382 persons in our design, research and development teams. In fiscal 2005, we intend to ship our complete product lines including new mechanical reel-spinning games, using extended odds technology and new video poker games.

      Some of our gaming machines are based on popular brands licensed from third parties, such as Hasbro Inc., CBS Consumer Products and Sony Pictures Consumer Products Inc. Typically, we are obligated to make minimum guaranteed royalty payments over the term of our license and to advance payment against those guarantees. The licensor typically must inspect and approve any use of the licensed property. In addition, each license typically provides that the licensor retains the right to exploit the licensed property for all other purposes, including the right to license the property for use with any products not related to gaming machines.

Sales and Marketing

      We are authorized to sell or lease our gaming machines to casinos in 141 tribal jurisdictions and 75 other gaming jurisdictions worldwide. See “Government Regulation — General” below. Generally, we sell our gaming machines directly, rather than through the use of distributors, which we believe allows us to provide superior customer service and enhances profitability. In some instances, our gaming machines are installed in casinos on a trial basis, and only after a successful trial period are the machines purchased by the customers. In addition, we offer some of our most popular game themes on a participation or lease basis. See “Company Overview” above. We sell or lease VLTs, depending on the jurisdictions where they are placed.

      Since we commenced the sales process last September, as of August 27, 2004, we have issued sales orders or executed agreements to sell 22,285 Bluebird video gaming devices or CPU-NXT upgrade kits representing about 45% of the 50,000+ WMS video units in casinos. Of the 22,285 units for which we’ve issued sales orders or executed agreements, 8,591 of them or 17% of the legacy video gaming devices were installed by June 30, 2004. Of the remaining units, 10,576 are Bluebird units and 3,118 CPU-NXT are upgrade kits. We expect to deliver the balance of these units over the next several quarters.

      We sell and lease our gaming machines through 20 salespeople in offices in several United States locations, and six salespeople in our international offices: two in our office in Spain, two in our office in South Africa, and one in each of Canada and the United Kingdom. Our salespeople earn a salary and commissions. Our gaming machines are primarily marketed through direct sales, trade shows, promotional videotapes, our

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      Our foreign game sales continued to increase in fiscal 2004 with over 5,159 games sold abroad compared to 4,333 in fiscal 2003 and 2,784 in fiscal 2002. We have translated our most popular domestic game themes into Spanish, Portuguese, French, Russian and Italian. Export sales and leases of our products were approximately $59.9 million, or 26.0% of revenues, for fiscal 2004, compared with $48.4 million, or 27.1% of revenues, for fiscal 2003, and $30.7 million, or 17.6% of revenues, for fiscal 2002. Substantially all foreign sales are made in United States dollars. Revenue from participation games has been primarily limited to North America, and we expect this trend to continue.

      Since fiscal 2001, we have developed games in Australia. These games are distributed under our cross-license agreement with Stargames using their PC3 hardware platform, and we receive a royalty payment for each of our games sold by Stargames. Our agreement with Stargames was renewed in December 2003 and extends through January 31, 2006.

      We entered into new licensing agreements with SDG, now a wholly owned subsidiary of Alliance Gaming, and Multimedia in fiscal 2004. We granted SDG non-exclusive rights to distribute the MONOPOLY branded games in Washington State, as well as a non-exclusive license to commercialize our proprietary game themes in Washington State, New York State and the state of Florida. We also granted a non-exclusive license to Multimedia for the HOLLYWOOD SQUARES series of games in Washington State as well as a non-exclusive license to commercialize our proprietary game themes in Washington State. As part of the agreement we signed with Multimedia effective April 1, 2004, we have granted Multimedia an exclusive license to all of our game themes for Class II, Charitable Gaming and, in California, Tribal Instant Lottery Gaming, subject to existing license agreements and, for our licensed participation themes, our licensors’ approvals.

      In addition, we manufacture and sell gaming stations for Multimedia under an OEM agreement. In fiscal 2004 and 2003, we manufactured and sold 2,000 and 1,000 gaming stations, respectively, to Multimedia. Effective April 1, 2004 we entered into a strategic two-year agreement with Multimedia to expand and extend our relationship to address opportunities in Class II and other central determinant system-based gaming markets.

Competition

      The gaming machine market is intensely competitive and is characterized by the continuous introduction of new game titles and new technologies. Our ability to compete successfully in this market is based, in large part, upon our ability to:

      In addition, successful competition in this market is also based upon:

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      We estimate that about 25 companies in the world manufacture gaming machines and VLTs for legalized gaming markets. Of these companies, we believe that International Game Technology (IGT), Bally Gaming, Aristocrat Technologies, Atronic Casino Technology, Gtech Holdings and WMS control a majority of this worldwide market. Our competitors vary in size from small companies with limited resources to a few large corporations with greater financial, marketing and product development resources than ours. The larger competitors, particularly IGT, have an advantage in being able to spend greater amounts than us to develop new technologies and features that are attractive to players and customers. In addition, some of our competitors have developed, sell or otherwise provide to customers security, centralized player tracking and accounting systems which allow casino operators to accumulate slot accounting and performance data about the operation of gaming devices. We do not currently offer these systems. Several of our competitors pooled their intellectual property patents that provide cashless gaming alternatives, specifically ticket-in ticket-out technology so that when a casino patron cashes out from a gaming machine they may receive a printed ticket instead of coins. We license this technology from these competitors and passthrough the license fee to our customers.

      In the video and mechanical reel-spinning gaming machine market, we compete with market leader IGT, as well as Bally Gaming, Sigma Game, Atronic Casino Technology, Mikohn Gaming, Konami, Franco, Unidesa and Aristocrat Technologies. In the VLT market, we compete primarily with IGT, G-Tech Holdings and Scientific Games.

Manufacturing

      We have manufactured all of our gaming devices at our facility in Waukegan, Illinois, since fiscal 2001. This modern facility has allowed us to achieve increased operating efficiencies over our previous facility. We have added additional assembly lines to increase our practical assembly capacity, which we believe will lower our product lead times in fiscal 2005. We intend to expand our Waukegan facility beginning in fiscal 2005 to provide for further production capacity.

      Manufacturing commitments are generally based on sales orders from customers. In some cases, however, component parts are purchased and assembled into finished goods, which are inventoried in order to be able to quickly fill customer orders. Our manufacturing process generally consists of assembling component parts to complete a gaming machine. We generally warrant our gaming machines sold in the U.S. for a period of 90 days.

      The raw materials used in manufacturing our gaming machines include various metals, plastics, wood, glass and numerous component parts, including electronic subassemblies, video monitors and LCD screens. We believe that our sources of supply of component parts and raw materials are generally adequate.

Patent, Trademark, Licenses, Copyright and Product Protection

      Each gaming machine embodies a number of separately protected intellectual property rights, including trademarks, copyrights and patents. We believe these intellectual property rights are significant assets to our business in the aggregate, and three licenses impacted the majority of our consolidated revenue in fiscal 2004. We seek to protect our investment in research and development and the unique and distinctive features of our products and services by maintaining and enforcing our intellectual property rights.

      We have obtained patent rights protection covering many of our products. In fiscal 2004, we were issued 12 U.S. patents, covering a variety of aspects of video and electronic gaming machines and associated equipment. We generally seek to obtain trademark protection in the U.S. for the names or symbols under which we market and license our products. We also rely on our copyrights, trade secrets and proprietary know-how. In addition, some of our most popular gaming machines are based on trademarks and other intellectual property licensed from third parties.

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Government Regulation

General

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

      We believe we hold all of the licenses and permits necessary to conduct our business. In all, we hold over 200 licenses or permits to conduct gaming worldwide, including over 50 foreign licenses or permits.

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

      In some jurisdictions, regulators govern not only the activities within their own jurisdiction but also activities that occur in other jurisdictions to ensure that the entities it licenses are in compliance with local standards on a worldwide basis. Nevada is such a jurisdiction. The Nevada gaming authorities require WMS and our gaming subsidiary, WMS Gaming, to maintain Nevada standards of conduct for all our gaming activities and operations worldwide. To make our compliance efforts more efficient, we have centralized all licensing, compliance and non-product approval gaming regulatory matters, including the shipment of gaming equipment and related software worldwide.

      The gaming industry by its very nature is complex and constantly evolving, particularly in the new jurisdictions. Over the past two years, we have devoted significant resources to ensure regulatory compliance throughout our company. Additionally, we have an active gaming compliance committee of our board of directors that works in concert with our compliance department to avoid any appearances of impropriety as a result of a business relationship or new market opportunity. We have never been denied a gaming-related license, nor have our licenses ever been suspended or revoked.

Nevada Regulations

     Overview of Regulatory Framework:

      The manufacture, sale and distribution of gaming machines for use or play in Nevada or for use outside of Nevada are subject to extensive state and local laws, regulations and ordinances of the Nevada Gaming Commission, the Nevada State Gaming Control Board, and various county and municipal regulatory authorities (collectively, the “Nevada gaming authorities”). The laws, regulations and ordinances primarily cover the responsibility, financial stability and character of gaming equipment manufacturers, distributors and operators, as well as persons financially interested in or involved in gaming operations. We currently hold all necessary gaming licenses to manufacture, distribute and operate a slot route or a wide-area progressive system.

      The laws, regulations and supervisory procedures of the Nevada gaming authorities are based on public policy and seek to:

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     Licensing Requirements:

          Of Our Security Holders

      A holder of our stock or of our issued debt may be required to file an application, be investigated and be subject to a suitability hearing as a beneficial holder if the Nevada Gaming Commission has reason to believe that the holder’s ownership in our securities would be inconsistent with its public policies and those of the State of Nevada. As with any other gaming applicant, the holder will be required to pay all costs associated with any investigation conducted by the Nevada gaming authorities.

      A security holder will have to abide by the following requirements:

      If the person holding our voting securities is a corporation, partnership or a trust, and is required to be found suitable, the entity will be required to submit to the Nevada gaming authorities detailed business and financial information including a list of its beneficial owners.

      Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada gaming authorities may be found unsuitable and may be subject to criminal penalties. The same restrictions apply to a record owner if the record owner, after request, fails to identify the beneficial owner. We are required to render maximum assistance to the Nevada gaming authorities in determining the identity of our beneficial owners.

      If an institutional investor holds more than 10%, but not more than 15%, of our voting securities, that investor can apply to the Nevada gaming authorities for a waiver of the finding of suitability if it holds the voting securities for investment purposes only. Under certain circumstances, an institutional investor may be able to hold up to 19% for a limited period of time. To qualify for this waiver, the institutional investor must have acquired the voting securities in the ordinary course of business. In addition, the institutional investor may not hold the securities for the purpose of causing (1) the election of a majority of the members of our board of directors, (2) a change in our corporate charter, bylaws, management, policies or operations, or those of any of our gaming affiliates, or (3) any other action which the Nevada gaming authorities would find inconsistent with holding our voting securities for investment purposes only.

      Of Our Company:

      We are registered with the Nevada Gaming Commission as a publicly traded corporation. We are required to periodically file detailed financial and operating reports to the agency and furnish any other information which the Nevada gaming authorities may require.

      As a registered company, we also adhere to the following restrictions imposed by the Nevada gaming authorities:

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      Any decision made by the Nevada gaming authorities regarding a person’s suitability or licensing is not subject to judicial review. We believe we have obtained all required licenses and/or approvals necessary to carry on our business in Nevada, including receiving the necessary findings of suitability of our officers, directors and key personnel.

          Of Our Gaming Subsidiary

      WMS Gaming manufactures, sells and distributes gaming devices in Nevada and for use outside Nevada, and recently began to operate a wide-area progressive system in Nevada casinos. WMS Gaming holds the

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      WMS Gaming’s gaming licenses are subject to the following restrictions:

      Changes in Control:

      The Nevada legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and corporate defense tactics affecting Nevada gaming licensees, and publicly traded corporations that are affiliated with those operations, may be injurious to stable and productive corporate gaming. The Nevada Gaming Commission has established a regulatory framework to guard against the potentially adverse effects of these business practices upon Nevada’s gaming industry.

      Approvals are, in certain circumstances, required from the Nevada Gaming Commission before we can make exceptional repurchases of voting securities above their current market price and before a corporate acquisition opposed by management can be consummated. Nevada’s gaming laws and regulations also require prior approval by the Nevada Gaming Commission if we were to adopt a plan of recapitalization proposed by our board of directors in opposition to a tender offer made directly to our stockholders for the purpose of acquiring control of us.

      Gaming Equipment Approvals:

      Nevada has its own laboratory within its agency. Before we can sell a new gaming machine in Nevada, it must first be approved by the Nevada agency. The agency conducts rigorous testing of the gaming device and related equipment, and may require a field trial of the gaming device and platform before determining that the gaming device and platform meet the agency’s strict technical standards. Throughout the course of offering our gaming devices and related software in Nevada, the Nevada gaming authorities may require subsequent modifications and subsequent approvals.

      We do not have any control over the length of time that the agency takes to review our products. However, we work closely with the agency’s staff to timely respond to their inquiries and assist them, where we can, in their evaluation, inspection and review of our products. We also do this for all other state labs (Michigan, Mississippi, New Jersey, Ontario) and Gaming Laboratories International, an independent lab used by many jurisdictions worldwide.

      Taxes and License Fees:

      License fees and taxes are imposed by the Nevada gaming authorities and are either payable quarterly or annually. The fees and taxes are computed in various ways depending on the type of gaming or activity conducted by our subsidiary and on the cities and counties in which our subsidiary conducts operations. Annual fees are payable to the State Gaming Control Board for renewal of licenses as a manufacturer, distributor, operator of a slot machine route and operator of an inter-casino linked system. Nevada law also

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      Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with any such person, and who proposes to participate in the conduct of gaming operations outside of Nevada, is required to deposit with the Nevada Control Gaming Board, and thereafter maintain, a revolving fund to pay the expenses of investigation of the licensee’s participation in foreign gaming. The revolving fund is subject to increase or decrease at the discretion of the Nevada Gaming Commission. As a licensee, we are required to comply with reporting requirements imposed by Nevada law. We are also subject to disciplinary action by the Nevada gaming authorities if we:

Federal Registration

      WMS Gaming is required to register annually with the Criminal Division of the United States Department of Justice in connection with the sale, distribution or operation of gaming equipment. The Federal Gambling Devices Act of 1962 (commonly known as the Johnson Act) makes it unlawful, in general, for a person to manufacture, transport or receive gaming machines, gaming devices or components across interstate lines unless that person has first registered with the U.S. Attorney General of the Department of Justice. We also have various record-keeping and equipment-identification requirements imposed by this act. Violation of the Johnson Act may result in seizure and forfeiture of the equipment, as well as other penalties. Our gaming subsidiary is required to register and renew our registration annually.

Native American Gaming Regulation

      Numerous Native American tribes have become engaged in or have licensed gaming activities on Native American tribal lands as a means of generating revenue for tribal governments. Gaming on Native American lands, including the terms and conditions under which gaming equipment can be sold or leased to Native American tribes, is or may be subject to regulation under the laws of the tribes, the laws of the host state, and the Indian Gaming Regulatory Act of 1988, which is administered by the National Indian Gaming Commission and the Secretary of the United States Department of the Interior. Furthermore, gaming on Native American lands may also be subject to the provisions of statutes relating to contracts with Native American tribes, which are also administered by the Secretary of the United States Department of the Interior.

      The Indian Gaming Regulatory Act of 1988 requires that the tribe and the host state enter into a written agreement called a tribal-state compact, that specifically authorizes Class III gaming, and that the compact has been approved by the Secretary of the United States Department of the Interior, with the notice of approval published in the Federal Register. Tribal-state compacts vary from state to state. Many require that equipment suppliers meet ongoing registration and licensing requirements of the state and/or the tribe and some impose background check requirements on the officers, directors, principals and shareholders of gaming equipment suppliers. Under the Indian Gaming Regulatory Act of 1988, tribes are required to regulate all commercial gaming under ordinances approved by the National Indian Gaming Commission. These ordinances may impose standards and technical requirements on hardware and software and may impose registration, licensing and background check requirements on gaming equipment suppliers and their officers, directors, principals and shareholders.

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      We have the required licenses to manufacture and distribute our products in the Native American jurisdictions in which we do business and to operate our wide-area progressive systems.

International Regulation

      Many foreign jurisdictions permit the importation, sale and/or operation of gaming equipment in casino and non-casino environments. Where importation is permitted, some countries prohibit or restrict the payout feature of the traditional slot machine or limit the operation of slot machines to a controlled number of casinos or casino-like locations. Each gaming machine must comply with the individual jurisdiction’s regulations. Some jurisdictions require the licensing of gaming machine operators and manufacturers. We manufacture and supply gaming equipment to various international markets including Asia, Australia, Canada, Europe, South America and South Africa. We have the required licenses to manufacture and distribute our products in the foreign jurisdictions in which we do business.

Seasonality

      Sales of our gaming machines to casinos are generally strongest in the spring and slowest in the summer months. In addition, quarterly revenues and net income may increase when we receive a larger number of approvals for new games from regulators than in other quarters, when a game or platform that achieves significant player appeal is introduced or if gaming is permitted in a significant new jurisdiction.

Employees

      At August 27, 2004, we employed approximately 1,121 persons domestically and 44 abroad. Approximately 246 of our employees were represented by the International Brotherhood of Electrical Workers (the “IBEW”) at that date. We have a collective bargaining agreement with the IBEW related to our Waukegan, Illinois manufacturing facility, which expires on June 30, 2006. We believe that our relations with our employees are satisfactory.

Risk Factors

      The most significant factors that make an investment in our common stock risky or speculative are discussed below. These factors may cause our operating results to vary from anticipated results or may adversely affect our operating results or the value of our common stock.

Software and hardware anomalies and fraudulent manipulation of our gaming machines and associated software could reduce our revenue, increase our costs, burden our engineering and marketing resources, involve us in litigation and adversely affect our gaming licenses.

      Our success depends on our ability to avoid, detect, replicate and correct software and hardware anomalies and fraudulent manipulation of our gaming machines and associated software. Our gaming machines and software have experienced anomalies and fraudulent manipulation in the past. Gaming machines may be replaced by casinos and other operators if they do not perform according to expectations or may be shut down by regulators. In the event of such issues with our gaming machines and software, substantial engineering and marketing resources may be diverted from other projects to correct these issues, which may delay our other projects. In addition, regulators may not approve new games, which may substantially reduce our revenues. Our games are generally subject to rigorous testing, both internally and by various gaming jurisdictions. We cannot assure you that we will be able to build and maintain software-based gaming devices that are free from anomalies or manipulations and satisfy these tests. Our gaming machines have in the past and could in the future be susceptible to software anomalies and manipulation after the gaming software has been widely distributed.

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

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Our gaming machine business is heavily regulated, and we must obtain and maintain our gaming licenses and regulatory approvals to continue to operate our business and sell our products.

      The manufacture and distribution of gaming machines is subject to extensive federal, state, local and foreign regulations and taxes. The governments of the various gaming jurisdictions amend these regulations from time to time. Virtually all of these jurisdictions require licenses, permits, documentation of qualification, including evidence of financial stability, and other forms of approval for manufacturers and distributors of gaming machines and for their officers, directors, major security holders and key personnel. The gaming authorities in some jurisdictions may investigate any individual who has a material relationship with us and any security holder to determine whether the individual or security holder is acceptable to those gaming authorities. Any security holder investigated by the gaming authorities must pay the costs of the investigation. Each of our games and gaming machine hardware and software must be approved in each jurisdiction in which it is placed, and we cannot assure you that a particular game or hardware or software will be approved in any jurisdiction. Licenses, approvals or findings of suitability may be revoked, suspended or conditioned. The revocation or denial of a license in a particular jurisdiction means that we cannot sell our products in that jurisdiction, and could adversely affect our ability to obtain or maintain licenses in other jurisdictions.

      If we fail to seek or do not receive a necessary registration, license, approval or finding of suitability, we may be prohibited from selling our games or gaming machines for use in the jurisdiction. Some jurisdictions require gaming manufacturers to obtain government approval before engaging in some transactions, such as business combinations, reorganizations, stock offerings and repurchases. Obtaining licenses and approvals can be time consuming and costly. We cannot assure you that we will be able to obtain all necessary registrations, licenses, permits, approvals or findings of suitability in a timely manner, or at all. Similarly, we cannot assure you that our current registrations, licenses, approvals or findings of suitability will not be revoked, suspended or conditioned.

Our profitability depends heavily on recurring revenue from gaming operations, the loss of which could have a material adverse effect on our revenues and profitability.

      Approximately $84.3 million, or 36.6%, of our revenues for fiscal 2004, and $93.0 million, or 52.0%, of our revenues in fiscal 2003, were derived from gaming operations. In addition, for fiscal 2004, our gross margin on gaming operations was 81.9% while our gross margin on product sales was 40.1%. For fiscal 2003, our gross margin on gaming operations was 77.4%, while our gross margin on product sales was 39.2%. Therefore, our level of revenue from gaming operations has a significant effect on our profitability. Participation games are replaced by casino operators if the gaming machines do not meet and sustain revenue and net win expectations. Therefore, these gaming machines are particularly susceptible to pressure from competitors, declining popularity and changes in economic conditions and increased taxation and are at risk of replacement by the casinos, ending the recurring revenues from these machines. We cannot assure you that our participation games will continue to meet the casinos’ revenue requirements.

Patent infringement claims could limit or affect our ability to market some of our gaming machines and subject us to liability.

      Our competitors have been granted patents covering numerous gaming machine features and bonusing techniques. If our products use processes or other subject matter that is claimed under these existing patents, or if other companies obtain patents claiming subject matter that we use, those companies may bring infringement actions against us. We might then be forced to discontinue the affected products or be required to obtain licenses from the company holding the patent, if it is willing to give us a license, to develop, manufacture or market our products. We also might then be limited in our ability to market new products. We might also be found liable for treble damage claims relating to past use of the patented subject matter.

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If we do not obtain and retain licenses to use intellectual properties and licensors’ approvals of new products on a timely basis, our revenues will be adversely affected.

      Some of our most popular gaming machines, including our MONOPOLY branded games, are based on trademarks and other intellectual properties licensed from third parties. Our future success may depend upon our ability to obtain and retain licenses for additional popular intellectual properties. There is competition for these licenses, and we cannot assure you that we will be successful in acquiring or retaining additional intellectual property rights with significant commercial value on acceptable terms. These intellectual properties are licensed for a fixed term and generally provide for minimum guaranteed royalties and other obligations. We cannot assure you that we will be able to maintain or renew the intellectual properties that we currently license. We cannot assure you that we will be able to create games using the intellectual properties that will generate enough revenues for us to cover the minimum guaranteed royalties and other fixed costs. In the event that we cannot renew our existing licenses, we may be required to discontinue the participation games bearing the licensed marks.

      Our intellectual property licenses generally require that we submit new products developed under these licenses to the licensor prior to release for approval of our use of the licensed property at their sole discretion. Rejection or delay in approval of a product design by a licensor could have a material adverse effect on our revenues, operating results and financial condition.

If we are unable to protect or retain our intellectual property and proprietary rights, our revenues may be adversely affected.

      Our success may depend in part on our ability to obtain trademark protection for the names or symbols under which we market our products and to obtain copyright protection and patent protection of our proprietary software and other game innovations. We cannot assure you that we will be able to build and maintain goodwill in our trademarks or obtain trademark or patent protection, that any trademark, copyright or issued patent will provide competitive advantages for us or that our intellectual properties will not be successfully challenged or circumvented by competitors.

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

If we do not continue to introduce new games and gaming machines that achieve and maintain market acceptance, our revenues and profitability will be adversely affected, and we will not recover our development costs.

      Our success depends on continually developing and successfully marketing new games and gaming machines with strong and sustained player appeal. A new game or gaming machine will be accepted by casino operators only if we can show that it is likely to produce more revenues to the operator than competitors’ products. Gaming machines can be installed in casinos on a trial basis, and only after a successful trial period are the machines purchased by the casinos. If a new product does not achieve significant market acceptance, we may not recover our development and promotion costs. We cannot assure you that the new products that we introduce will achieve any significant degree of market acceptance or that the acceptance will be sustained for any meaningful period. We cannot assure you that we will be able to maintain our current schedule of planned introductions.

      In addition, if we are unable to successfully re-market legacy equipment held in inventory and used in participation gaming operations through secondary markets, we may incur charges to earnings.

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If we do not continually adapt to the rapid development of new technologies, we will not be able to successfully compete in our industry.

      The gaming machine business is characterized by the rapid development of new technologies and the continuous introduction of new products using such technologies. We must continually adapt our products to incorporate new technologies. We cannot assure you that we will be able to develop products using these new technologies or that we will be able to license such technologies if owned by others.

Some of our competitors have advantages over us in their ability to finance technology development and in obtaining favorable placement in casinos, which may limit our revenues.

      The gaming machine business is intensely competitive. Some of our competitors are large companies with greater financial, marketing and product development resources than ours. In addition, new competitors may enter our key markets. Obtaining space and favorable placement on casino gaming floors is a competitive factor in our industry. Competitors with a larger installed base of gaming machines than ours have an advantage in retaining the most space and best positions in casinos. These competitors may also have the advantage of being able to convert their installed machines to newer models in order to maintain their share of casino floor space. In addition, some of our competitors have developed and sell or otherwise provide to customers wide-area progressive systems or centralized player tracking and accounting systems which allow operators to accumulate accounting and performance data about the operation of gaming devices. We have just begun to offer a proprietary wide-area progressive system and do not offer a centralized player tracking and accounting system.

The gaming industry is sensitive to declines in the public acceptance of gaming that may lead to the passage of laws to significantly increase gaming taxes or outlaw gaming in affected jurisdictions.

      The gaming industry can be affected by public opinion of gaming. In the event that there is a decline in public acceptance of gaming, either through unfavorable legislation affecting the introduction of gaming into emerging markets, or through legislative and regulatory changes, including tax increases, in existing gaming markets, our ability to continue to sell and lease our games in those markets and jurisdictions would be adversely affected. Recent tax structure changes and rate increases in two jurisdictions have made gaming in general, and specifically participation games, less profitable in those jurisdictions. We cannot assure you that public opinion will continue to support legalized gaming.

If we do not effectively operate our manufacturing processes, we may not be able to fulfill customers’ orders and may incur charges to earnings.

      Our manufacturing process is impacted by our ability to: (1) procure raw materials from our suppliers on a timely basis; (2) effectively manage raw materials during the manufacturing process; (3) accurately configure orders for gaming devices to customers’ specifications; (4) efficiently utilize our manufacturing capacity; (5) manufacture a quality product with minimal defects and warranty issues; and (6) deliver gaming devices to our customers on time. We cannot assure you that we will be able to fulfill customers’ orders timely or at the highest level of quality, and as a result customers could cancel orders and we may incur charges to earnings.

We face risks associated with doing business in foreign markets related to political and economic instability and related foreign currency fluctuations.

      We seek to grow through increasing our presence in foreign markets. Potential political and economic instability in foreign markets may adversely affect our ability to enter into or continue to do business in these markets. Unstable governments and changes in current legislation may affect the gaming market with respect to gaming regulation, taxation, and the legality of gaming in some markets. In addition, fluctuations in foreign exchange rates, tariffs and other barriers may further impede our success in foreign markets. We cannot assure you that foreign markets will remain politically and economically stable enough to continue as a potential source of revenues and profit to us.

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If we do not realize the value of licensed technology commitments, we may incur charges to earnings.

      We have entered into several agreements to license intellectual property related to alternative solutions as part of our technology improvement plan that, as of June 30, 2004, had a total potential commitment of $11.4 million. If we determine that we may not realize the value of any of the commitments, we would record an immediate charge against earnings up to the full amount of these commitments in the period in which such determination is made.

If we do not realize the value of licensed intellectual property and royalty commitments, we may incur charges to earnings.

      We have entered into several agreements to license intellectual property and royalties related to new game development, including an individual license which generated over 20% of our consolidated revenue in fiscal 2004. At June 30, 2004, we had a total potential commitment of $92.7 million, including $11.4 million of licensed technology commitments. If we determine that we may not realize the value of any of the commitments, we would record an immediate charge against earnings up to the full amount of these commitments in the period in which such determination is made.

We may have conflicts of interest with Midway Games Inc.

      Four of our ten directors, including Louis J. Nicastro, our Chairman of the Board, are directors of Midway Games Inc., our former subsidiary. Tax related agreements remain in effect between Midway and WMS. In addition, Sumner Redstone who owns 24% of our common stock and is our largest stockholder also owns a controlling interest of approximately 75% of Midway. As several of our directors have responsibilities to both entities, conflicts between us and Midway may arise, the resolution of which may be less than optimal for us.

Sumner Redstone owns or controls 24% of our outstanding common stock, and he may dispose of all or a portion of his stock at any time, which could cause our stock price to decrease.

      Sumner Redstone beneficially owns 7.5 million shares, or 24%, of our common stock, as reported in a Form 4, filed by Mr. Redstone with the SEC on August 26, 2004. During June and July of 2004, Mr. Redstone reported that he entered into five forward transactions under which he will sell 4.0 million shares of our common stock in several traunches beginning in March 2005 and ending in October 2005. These transactions, if completed, will reduce his ownership to 11.2% of our outstanding common stock by October 2005. In August 2004, Mr. Redstone sold 1.3 million shares of our common stock in open market transactions. Mr. Redstone could sell any or all of his remaining shares at any time on the open market or to a person who wishes to acquire control of WMS. Such a sale may require prior regulatory approval. We cannot assure you that any such person would agree with our strategy and business goals described in this report. Sales by Mr. Redstone of a large number of shares would likely have an adverse effect on the market price of our common stock.

The use of our rights plan or blank check preferred stock would inhibit the acquisition of WMS or have a dilutive effect on our stock.

      Rights plan. Under our rights plan, each share of our common stock has an accompanying right to purchase convertible preferred stock that permits each holder to purchase shares of our common stock at half price. The rights become exercisable if any person or entity who at the time of the adoption of the rights plan did not own 15% or more of our common stock subsequently acquires beneficial ownership of 15% or more of our common stock without approval of our board of directors. We can redeem the rights at $.01 per right, subject to specified conditions, at any time. The rights expire in April 2007. Our board of directors could use this agreement as an anti-takeover device to discourage, delay or prevent a change in control. The use of our rights plan may dilute our common stock.

      Blank check preferred stock. Our certificate of incorporation authorizes the issuance of five million shares of preferred stock with designations, rights and preferences that may be determined from time to time

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The substantial number of shares of common stock available for sale in the future could have an adverse effect on the market price of our common stock.

      We have 100 million authorized shares of common stock. As of August 27, 2004, 32.4 million shares were issued, including 2.0 million shares held in treasury. On that date, we also had outstanding options to purchase an aggregate of 4.1 million shares of our common stock issuable at an average exercise price of $19.05 per share and outstanding warrants to purchase 250,000 shares of our common stock issuable at an exercise price of $35.04 per share. If all of our issued and outstanding stock options and warrants were exercised as of that date, 36.8 million shares of our common stock would be outstanding. If the holders of our convertible subordinated notes converted all of the notes, 5.8 million additional shares of our common stock would be issued. If all of the notes were converted to common stock and all of the outstanding options and warrants were exercised, 57.4 million shares would still be available for issuance. Our board of directors has broad discretion to issue authorized but unissued shares, including discretion to issue shares in compensatory and acquisition transactions. In addition, if we seek financing through the sale of our securities, our then current stockholders may suffer dilution in their percentage ownership of our common stock. The future issuance, or even the potential issuance, of shares at a price below the then current market price may have a depressive effect on the future market price of our common stock.

Item 2.     Properties.

      The following table sets forth our principal properties, and their principal uses, approximate floor space and the annual rental and lease expiration dates, where leased, at August 27, 2004.

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      We believe that the facilities listed in the table above are adequate for our current needs. We own substantially all of the machinery, equipment, tools and dies, furnishings and fixtures used in our businesses, all of which are adequate for the purposes intended.

      Our Waukegan, Illinois facility was built in 1995 and expanded and improved in 1998. It is our sole manufacturing facility and corporate headquarters and includes warehouse space. We have plans to expand this facility beginning in fiscal 2005 to ensure it is adequate in capacity and condition to satisfy our growing

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      Our facility in Chicago, Illinois has been renovated into a research and development center to accommodate the growth of our engineering and game development staff. We are currently planning expansion of this facility and/or the purchase and renovation of additional space in fiscal 2005.

Item 3.     Legal Proceedings.

      On October 2, 2003, La Societe de Loteries du Quebec (Loto-Quebec) filed claims against us and Video Lottery Consultants Inc., a subsidiary of IGT (VLC) in the Superior Court of the Province of Quebec. The pleadings allege that Loto-Quebec would be entitled to be indemnified by the manufacturers of Loto-Quebec’s VLTs, specifically WMS and VLC, if the class action plaintiffs, described below, are successful in the pending class action lawsuit against Loto-Quebec. We are currently proceeding with discovery, and we intend to vigorously defend ourselves against the allegations. We are unable to predict the outcome of these actions, or a reasonable estimate of the range of possible loss, if any.

      The class action lawsuit discussed in Loto-Quebec’s claim was brought on May 18, 2001 against Loto-Quebec in the Superior Court of the Province of Quebec. It alleges that the members of the class developed a pathological gambling addiction by using Loto-Quebec’s VLTs and that Loto-Quebec, as owner, operator and distributor of VLTs, failed to warn players of the alleged dangers associated with VLTs. Class status was granted by the Court on May 6, 2002, authorizing Jean Brochu to act as the representative plaintiff. The class of 119,000 members is requesting damages totaling almost $700 million Canadian dollars, plus interest.

Item 4.     Submission of Matters to a Vote of Security Holders.

      Not applicable.

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