SHFL entertainment Inc. 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2007
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. (0-20820)
SHUFFLE MASTER, INC.
(Exact name of registrant as specified in our charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $.01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes o No x
If this report is annual or transition, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2). Yes o No x
As of January 11, 2008, 35,247,755 shares of Common Stock of the Registrant were outstanding. The aggregate market value of Common Stock beneficially owned by non-affiliates on that date was $302,073,260 based upon the last reported sale price of the Common Stock on that date by The NASDAQ National Market.
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and III of this Annual Report on Form 10-K incorporate by reference information from the Registrants Proxy Statement for its Annual Meeting of Shareholders to be held on March 26, 2008 (Fiscal 2007 Proxy Statement) to be filed with the SEC within 120 days of the end of the fiscal year covered by this report.
Shuffle Master, Inc. (the Company) amended its Annual Report on Form 10-K for the fiscal year ended October 31, 2007 (Form 10-K/A) that was previously filed with the Securities and Exchange Commission (the SEC) on January 18, 2008 (Original Filing). The Form 10-K/A was filed in order to add language in the Reports of Independent Registered Public Accounting Firm (Auditors Opinions) to indicate that the nature, timing and extent of audit tests were also applied to the financial statement schedule (Schedule II) which reference was inadvertently excluded from the Auditors Opinions included in the Original Filing. Schedule II was included in the Original Filing; however, the Auditors Opinions omitted a reference to Schedule II. Additionally, the Auditors Opinions were revised to refer to the Companys changed methodology of accounting for share-based compensation to conform to Statement of Financial Accounting Standards No. 123(R), Share-Based Payment in November 2005. No revisions and / or adjustments were made to the audited Consolidated Statements of Income, Consolidated Balance Sheets, Consolidated Statements of Changes in Shareholders Equity and Consolidated Statements of Cash Flows or to Schedule II as part of this amendment.
As a result of the amendment related to the Auditors Opinions, the Company also included expanded discussion in Note 7 -Debt and Long-Term Liabilities, Note 14 - Operating Segments and Note 15 Commitments and Contingencies to the audited consolidated financial statements included in Item 8 in the Form 10-K/A in response to a comment letter received from the SEC in connection with its review of the Original Filing, the Companys Form 10-Q for the quarter ended January 31, 2008 and the Companys Definitive Proxy Statement filed on February 15, 2008 (the Comment Letter). In Note 7, we included the debt compliance covenant ratios and respective limitations as defined in our Senior Secured Revolving Credit Facility Agreement. In Note 14, we added discussion related to unallocated corporate expenses included in segment operating income. In Note 15, we added clarification language to each of the pending litigation under legal proceedings. The Comment Letter recommended including expanded discussion, where relevant, in any future filings. This amendment is deemed a future filing.
All information in the amendment is as of January 18, 2008 and does not reflect any subsequent information or events other than the expanded discussion as noted above. In addition, in accordance with Rule 12b-15 promulgated under the Securities and Exchange Act of 1934, as amended, this amendment also includes updated certifications from our Chief Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2, 32.1 and 32.2.
SHUFFLE MASTER, INC.
ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED OCTOBER 31, 2007
TABLE OF CONTENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
To the Board of Directors and Shareholders of
Shuffle Master, Inc.
Las Vegas, Nevada
We have audited the accompanying consolidated balance sheets of Shuffle Master, Inc. and subsidiaries (the Company) as of October 31, 2007 and 2006, and the related consolidated statements of income, shareholders equity, and cash flows for each of the three years in the period ended October 31, 2007. Our audits also included financial statement Schedule II Valuation and Qualifying Accounts for each of the three years in the period ended October 31, 2007. These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Shuffle Master, Inc and subsidiaries as of October 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 8 to the consolidated financial statements, on November 1, 2005, the Company changed its method of accounting for share-based compensation to conform to Statement of Financial Accounting Standards No. 123(R), Share-Based Payment.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Companys internal control over financial reporting as of October 31, 2007, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 18, 2007 expressed an unqualified opinion on the Companys internal control over financial reporting.
Las Vegas, Nevada
SHUFFLE MASTER, INC.
(In thousands, except per share amounts)
See notes to consolidated financial statements
SHUFFLE MASTER, INC.
(In thousands, except per share amounts)
See notes to consolidated financial statements
SHUFFLE MASTER, INC.
See notes to consolidated financial statements
SHUFFLE MASTER, INC.
See notes to consolidated financial statements
Supplemental Disclosures of Cash Flows Information
See notes to consolidated financial statements
SHUFFLE MASTER, INC.
(In thousands, except per share amounts)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business. We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor. Our products primarily relate to our casino customers table game activities and focus on either increasing their profitability, productivity and security or expanding their gaming entertainment offerings. Our business is segregated into the following four product segments: Utility Products, Proprietary Table Games, Electronic Table Systems, and Electronic Gaming Machines.
Our Utility Products include a full line of automatic card shufflers for use with the vast majority of card table games as well as chip sorting machines for use on roulette tables. We also have acquired and/or have developed other products that automatically gather data to enable casinos to track table game play, such as Table iD (part of our Intelligent Table System), currently in development with International Game Technology (IGT) and Progressive Gaming International Corporation (PGIC).
Our Proprietary Table Games (PTG) include our portfolio of live table games including poker, blackjack, baccarat, and pai gow poker-based table games, progressive table games with bonusing options, side bets and proprietary table game licensing for other gaming media, such as legal internet gaming licenses.
Our Electronic Table Systems (ETS) include e-Table platforms such as Table Master, Vegas Star®, Rapid Table Games®, as well as our wireless gaming.
Our Electronic Gaming Machines (EGM) include our PC-based video slot machines with an extensive selection of video slot titles, which include a range of bonus round options.
We lease, license or sell our products. When we lease or license our products, we generally negotiate a month-to-month operating lease. When we sell our products, we offer our customers a choice between a sale, a longer-term sales-type lease or other long-term financing. We offer our products worldwide in markets that are highly regulated. We manufacture our products at our headquarters and manufacturing facility in Las Vegas, Nevada, as well as at our Australian headquarters in Milperra, New South Wales. In addition, we outsource the manufacturing of certain of our products in the United States, Europe and Asia Pacific.
All of our product lines compete or will compete with other gaming products, such as slot machines, blackjack tables, keno, craps, and roulette, for space on the casino floor.
Principles of consolidation. Our consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and in accordance with accounting principles generally accepted in the United States of America (GAAP) and include all adjustments necessary to fairly present our consolidated results of income, financial position and cash flows for each period presented.
Our consolidated financial statements include the accounts of Shuffle Master, Inc. and our wholly-owned domestic and foreign subsidiaries. All significant inter-company accounts and transactions have been eliminated. We have no unconsolidated subsidiaries.
Investment in Sona and Other Investments. Our investment in and the operating results of Sona Mobile Holdings Corp. (Sona) which is not required to be consolidated in our consolidated financial statements, was previously accounted for in accordance with Accounting Principles Board (APB) Opinion No. 18 (APB 18), The Equity Method of Accounting for Investments in Common Stock, based on our assessment of our relationship with Sona at the time of the investment. In our initial assessment, we concluded that we had the ability to exercise significant influence over Sona due to our President having a seat on the Sona Board of Directors. Due to the resignation of our President from the Sona Board of Directors on June 12, 2007, using the guidance of APB 18, we have now concluded that we no longer have the ability to exercise significant influence over Sona and that the equity method of accounting is no longer appropriate for our investment. As of June 12, 2007, we have accounted for our investment under the cost method of accounting on a prospective basis and
as an available for sale marketable security using the guidance of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities.
We review our investments for other than temporary impairment whenever events or changes in business circumstances indicate that the carrying amount of the investments may not be fully recoverable. There was no such impairment loss recorded during the year ended October 31, 2007. During fiscal 2006 we recognized pre-tax impairment charges of $1,655 related to our investment in Sona.
As of October 31, 2005, we analyzed our cost method investment using the methodology described above and determined that such investment was impaired. Accordingly, we recorded a $1,000 impairment write-down equal to the full amount of the investment. Such impairment charge is reflected in impairment of investments.
Use of Estimates and Assumptions. The preparation of our consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are used for, but not limited to: (1) allowance for doubtful accounts; (2) asset impairments, including goodwill and indefinite lived trade names; (3) depreciable lives of assets; (4) useful lives of intangible assets; (5) income tax valuation allowances; (6) fair value of stock options; and (7) contingency and litigation reserves. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis. Actual results could differ from those estimates.
Inventories. Inventories are stated at the lower of cost, determined on a first-in-first-out basis, or market. Inventory write-downs totaled $1,415, $345 and ($140) for fiscal years ended 2007, 2006 and 2005.
Revenue recognition. We recognize revenue when the following criteria are met:
· persuasive evidence of an arrangement between us and our customer exists,
· shipment has occurred or services have been rendered,
· the price is fixed or determinable, and
· collectibility is reasonably assured.
We earn our revenue in a variety of ways. We offer our products for lease or sale. We also sell service and warranty contracts for our sold equipment. Proprietary table games are sold under lifetime licensing agreements or licensed on a monthly or daily fee basis. We recognize revenues net of any taxes collected from our customers that are later remitted to governmental authorities.
Product lease and royalties revenueLease and royalty revenue is earned from the leasing of our tangible products and the licensing of our intangible products, such as our proprietary table games. We recognize revenue monthly, based on a monthly fixed fee or on participation arrangements, generally through indefinite term operating leases. Lease and royalty revenue commences upon the completed installation of the product. Lease terms are generally cancellable with 30 days notice.
Product sales and service revenueWe generate sales revenue through the sale of equipment in each product segment, including sales revenue from sales-type leases and the sale of lifetime licenses for our proprietary table games. Financing for intangible property and sales-type leases for tangible property have payment terms ranging generally from 30 to 60 months and are interest-bearing at market interest rates. Revenue from the sale of equipment is recorded upon shipment. If a customer purchases existing leased equipment, revenue is recorded on the effective date of the purchase agreement. Revenue on service and warranty contracts is recognized over the terms of the contracts, which are generally one year. Revenue from the sale of lifetime licenses, under which we have no continuing obligations, is recorded on the effective date of the license agreement.
Certain of our products contain software, and as such we have considered the guidance contained in Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition, as modified by SOP No. 98-9, Software Revenue
Recognition, With Respect to Certain Transactions. Under this guidance when leasing or selling software, we consider whether the software component is incidental to the product as a whole based on the following criteria:
· Whether the software is a significant focus of the marketing effort or is sold separately
· Whether post-contract customer support or PCS (PCS includes the right to receive services or unspecified upgrades/enhancements, or both, offered to users or resellers) is provided
· Whether the development and production costs of the software as a component of the cost of the product is incidental, as defined in SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed
· Whether an agreement includes service elements (other than PCS related services), such as training or installation, and whether such services are essential to the functionality of the software or whether such software is considered off-the-shelf (off-the-shelf software is software that is marketed as a stock item that can be used by customers with little or no customization). Conversely, core software requires significant customization of the software in order for the software to be used by the end customer
Some of our revenue arrangements contain multiple deliverables, such as a product sale combined with a service element or the delivery of a future product. If an arrangement requires the delivery or performance of multiple elements, we apply the guidance from SOP 97-2, as amended, Emerging Issues Task Force (EITF) 03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software and FASB Emerging Issues Task Force (EITF) No. 00-21, Revenue Arrangements with Multiple Deliverables. Deliverables are divided into separate units of accounting if:
· The delivered items have value to the customer on a stand alone basis
· We have objective and reliable evidence of the fair value of the undelivered item
Delivery of any undelivered item is considered probable and substantially in our control
If these criteria are not met, we do not recognize revenue until all essential elements have been delivered. If the installation of the product is not considered inconsequential and perfunctory, then we defer revenue recognition until installation is complete.
Business combinations. We account for business combinations in accordance with SFAS No. 141, Accounting for Business Combinations (SFAS 141) and SFAS No. 142, Accounting for Goodwill and Other Intangible Assets (SFAS 142), and related interpretations. SFAS 141 requires that we record the net assets of acquired businesses at fair value, and we must make estimates and assumptions to determine the fair value of these acquired assets and assumed liabilities.
During fiscal 2007 and 2006, we acquired PGICs Table Game Division (TGD) and Stargames Limited (Stargames), respectively. As a part of the valuation process, we applied significant judgment and utilized a variety of assumptions in determining the fair value of acquired assets and liabilities assumed, and in-process research and development, including market data, estimated future cash flows, growth rates, current replacement cost for similar capacity for certain fixed assets, market rate assumptions for contractual obligations and settlement plans for contingencies and liabilities.
The PGIC TGD purchase price allocation is preliminary and may be adjusted for up to one year after the acquisition. Changes to the assumptions we used to estimate fair value could impact the recorded amounts for acquired assets and assumed liabilities and significant changes to these balances could have a material impact to our future reported results. For instance, lower or higher fair values assigned to certain amortizable intangible assets could result in lower or higher amounts of income statement charges.
Advertising costs. We expense advertising and promotional costs as incurred, which totaled approximately $2,353, $2,069, and $576, for the fiscal years ended October 31, 2007, 2006 and 2005, respectively.
Research and development costs. We incur research and development costs to develop our new and next-generation products. Our products generally reach technological feasibility when we receive gaming regulatory product approval which generally occurs concurrent with our products being made available to our customers. Accordingly, research and development costs are expensed as incurred.
Concentration of credit risk. Our financial instruments that have potential concentrations of credit risk include cash and cash equivalents, accounts receivable, investments in sales-type leases and notes receivable. We place our cash and cash equivalents with high credit quality institutions. Accounts receivable, investments in sales-type leases and notes receivable have concentration of credit risk because they all relate to our customers in the gaming industry. From time to time, we make significant sales to customers that exceed 10% of our then-outstanding accounts receivable balance. As of October 31, 2007, no customer balances exceeded 10% of our net trade accounts receivable. No single customers balance exceeded 10% of our investment in sales-type leases and notes receivable. For the year ended October 31, 2007, no individual customer accounted for more than 10% of consolidated revenue.
Installation Costs. Installation costs for leased products are expensed as incurred.
Products leased and held for lease. Our products are primarily leased to customers pursuant to operating leases. Products leased and held for lease are stated at cost, net of depreciation. Depreciation on leased products is calculated using the straight-line method over the estimated customer life of one to five years. We provide maintenance of our products on lease as part of our normal lease agreements. Leases of shufflers generally require prepayment of two months lease payments, which are included in the consolidated balance sheets as customer deposits.
Property and equipment. Property and equipment is stated at cost. Depreciation is recorded using the straight-line method over the estimated useful life of the asset of three to eight years, or lease terms, if shorter, for leasehold improvements.
Goodwill and Other Intangible assets. We account for goodwill and other intangibles under the guidance of SFAS 141 and SFAS 142.
We review our goodwill for impairment using a two step impairment test. The reviews are performed at the reporting unit level, which we have determined is the equivalent to our reportable segments. In the first step, we estimate the fair value of the reporting unit and compare it to the book value of the reporting unit, including its goodwill. If the fair value is less than the book value, then we would perform a second step to compare the implied fair value of the reporting units goodwill to its book value. The implied fair value of the goodwill is determined based on the estimated fair value of the reporting unit less the fair value of the reporting units identifiable net assets. We would record an impairment charge to the extent that the book value of the reporting units goodwill exceeds its fair value. We are required to test goodwill and other indefinite lived intangibles for impairment at least annually, or upon the occurrence of a triggering event. Absent any impairment indicators, we perform our goodwill impairment testing during October of each year. No goodwill impairments were recorded in any periods presented.
Intangible assets include intellectual property for games, patents, trademarks, copyrights, licenses, developed technology, customer relationships and non-compete agreements that were purchased separately or acquired in connection with a business combination. Except for the trademarks related to the Stargames and Casinos Austria Research & Development GmbH & Co KG (CARD) acquisitions, which are not subject to amortization, all of our significant intangible assets are definite lived and, accordingly, amortized over their expected useful lives which range from 1 to 15 years. We amortize substantially all of our intangible assets proportionate to the related projected revenue from the utilization of the intangible asset. We believe this method reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. For certain other intangibles, we use the straight-line amortization method. See Note 6 for more information. We also review these intangible assets for impairment in accordance with SFAS No. 144 whenever events or changes in circumstances indicate that we may not be able to recover the assets carrying amount (see below).
Impairment of long-lived assets. We estimate the useful lives of our long-lived assets, excluding goodwill, based on historical experience, estimates of products commercial lives, the likelihood of technological obsolescence and estimates of the duration of commercial viability for patents, licenses and games.
We review our long-lived assets, excluding goodwill, for impairment whenever events or circumstances indicate the carrying value may not be recoverable or warrant a revision to the estimated remaining useful life, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), and SFAS 142. We would record an impairment loss if the carrying amount of the asset or asset group is not recoverable (as determined by undiscounted cash flows) and the carrying amount exceeds its estimated fair value. Fair value is determined based on discounted expected future cash flows. As of October 31, 2007, we did not have any such impairment loss. Impairments were recognized in fiscal years 2006 and 2005 as discussed above.
Deferred revenue. Deferred revenue consists of amounts collected or billed in excess of recognizable revenue.
Foreign currency translation. Our foreign subsidiaries asset and liability accounts are translated into U.S. dollar amounts at the exchange rate in effect at the balance sheet date. Foreign exchange translation adjustments are recorded as a separate component of shareholders equity. Revenue and expense accounts are translated at the average exchange rates. Transaction gains and losses are included in other expense on our consolidated statements of income.
Earnings per common share. Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding and issuable during the year. Diluted earnings per share is similar to basic, except that the weighted average number of shares outstanding is increased by the potentially dilutive effect of outstanding stock options, restricted stock and contingent convertible notes, if applicable, during the year, using the treasury stock method.
Recently issued or adopted accounting standards. In August 2007, the Financial Accounting Standards Board (FASB) proposed FASB Staff Position (FSP) APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP APB 14-a). If approved, FSP APB 14-a will require us to separately account for the liability and equity components of our Notes and recognize additional interest expense at our nonconvertible debt borrowing rate. If the FSP is issued as drafted, it will be effective for fiscal 2009 and will require retrospective application. We are currently evaluating the proposed FSP and it may result in higher interest expense related to our Notes for all periods presented.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS 141R), which establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and interim periods within those fiscal years. SFAS 141R will become effective for our fiscal year beginning November 1, 2009. We are currently evaluating the effect the adoption of SFAS 141R will have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 expands the use of fair value measurement by permitting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This statement is effective for us beginning in November 2008. We have not yet determined whether we will elect to measure any items at fair value under SFAS 159.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This statement is effective for us beginning in November 2008. We are evaluating whether adoption of this statement will result in a change to our fair value measurements.
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes the recognition threshold and measurement criteria for determining the tax benefit amounts to recognize in the financial statements. This interpretation is effective for us beginning in November 2007. We are evaluating the potential impact of adopting this interpretation on our future results of operations, financial position or cash flows. FIN 48 requires that tax positions be assessed using a two-step process. A tax position is recognized if it meets a more likely than not threshold, and is measured at the largest amount of benefit that is greater than 50 percent likely of being realized. Uncertain tax positions must be reviewed at each balance sheet date. Liabilities recorded as a result of this analysis must generally be recorded separately from any current or deferred income tax accounts, and are classified as current (Other accrued liabilities) or long-term (Other long-term liabilities) based on the time until expected payment. A cumulative effect adjustment to retained earnings was not required as a result of the implementation of FIN 48. At this time, the Company estimates a range of $1,000 to $3,000 of unrecognized tax liability as a result of the implementation of FIN 48.
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB 108 was effective for our fiscal year 2007. The adoption of this statement did not have a material impact on our results of operations, financial position or cash flows.
2. ACQUISITIONS, OTHER SIGNIFICANT TRANSACTIONS AND DISPOSITIONS
PGIC Table Games Division. On September 26, 2007, we entered into a purchase agreement for the acquisition of PGICs Table Games Division (TGD) business (Purchase Agreement), including certain worldwide rights and lease contracts for all of PGICs table game titles including Caribbean Stud® and Texas Hold Em Bonus®, as well as a software distribution license agreement (Software Distribution License Agreement). Further, we also entered into an amended and restated license agreement with PGIC amending the current license agreement originally entered into on September 29, 2006, which granted us certain expanded rights.
The acquisition grants us all of PGICs rights, title, and interest, on a worldwide basis (except for certain defined carved-out customers and of electronic and video rights to the acquired games), in and to all of the assets in or part of the table games division including, without limitation, all intellectual property, hardware, software, existing customer agreements, installed table game base and inventory.
Under the terms of the Purchase Agreement, we paid to PGIC an upfront payment of approximately $19,800. The Purchase Agreement also provides for future earn-out payments, where permitted, beginning in calendar 2008, including $3,500 in total non-interest bearing guaranteed minimum payments over a 4-year period, as follows: For each of 2008 and 2009, the guaranteed minimum amounts are $1,000 each year, paid quarterly; and for 2010 and 2011, are $750 each year, also paid quarterly. The future earn-out payments are based on the growth of the acquired TGD business in excess of annual baseline revenue of approximately $4,800. For 2008 and 2009, the earn-out will be 23% of revenue above the baseline amount; for 2010 and 2011, the earn-out will be 19% of revenue above the baseline; and for 2012 to 2016, 10.75% of revenue above the baseline. Actual earn-out payments are applied against the annual guaranteed minimum amounts. Future earn-out payments in excess of the minimum guaranteed payments will be added to the purchase price in accounting for the business combination. The recurring revenue for the twelve months ended June 30, 2007 of the acquired TGD business totaled approximately $4,800. The acquired installed lease base as of September 1, 2007, totaled approximately 600 tables.
Under the Software Distribution License Agreement, we acquired PGICs Game Manager software and related table hardware (collectively, the GMS). The Software Distribution License Agreement provides a framework for us to further utilize the GMS, as well as use PGICs Casinolink® Jackpot System for installations where the GMS cannot handle the total number of tables and/or properties being managed. We paid PGIC a $3,000 advance of royalties due under the Software Distribution License Agreement within 10 days of signing the Purchase Agreement. Once the $3,000 advance is recouped, PGIC will receive recurring quarterly royalty payments for the placement of PGICs progressive technology on our proprietary table games, subject to our further recoupment of $1,750 related to an earlier licensing transaction with PGIC. The royalty rate for our proprietary games is 15% of the net incremental revenue attributable to adding the progressive element.
The following table sets forth the determination of the consideration paid for the PGIC TGD at the date of acquisition:
In accordance with SFAS 141, the transaction was accounted for as a business combination and, accordingly, the preliminary purchase price was allocated to the underlying assets acquired based upon their estimated fair values at the date of the acquisition. No liabilities were assumed in this transaction. We are currently in the process of determining the fair values based on discounted cash flows and estimates. The purchase price allocation is preliminary and may be adjusted for up to one year after the acquisition. The following table sets forth the preliminary allocation of the purchase price:
The acquisition of the PGIC TGD enhances the product offering in our PTG segment. These factors result in the recognition of certain intangible assets and goodwill. Backlog and covenant not to compete are being amortized on a straight-line basis over their useful lives. Customer relationships and tradenames, trademarks, patents, and copyrights are being amortized based on their projected revenue streams. Backlog and tradenames, trademarks, patents, and copyrights are charged to cost of leases and royalties, a component of gross margin. Customer relationships and covenant not to compete are reflected in selling, general and administrative expenses in the condensed consolidated statements of income.
3. FINANCIAL INSTRUMENTS
Cash and cash equivalents. Cash and cash equivalents include short-term investments with maturities of three months or less from their date of purchase. We maintain cash balances that exceed federally insured limits; however, we have incurred no losses on such accounts.
Investments. We classify all of our securities as available-for-sale. Our investments are recorded at fair market value, which, as of October 31, 2007 and 2006, includes $0 of unrealized gains.
Investments at fair value consisted of the following as of October 31:
Fair value disclosures of financial instruments. We estimate that the fair values of accounts receivable, the current portion of investment in sales-type leases and notes receivable, accounts payable and short term borrowings approximate their carrying values due to the relatively short-term nature of the instruments. It is impracticable to estimate the fair value of the long-term portion of our investment in sales-type leases and notes receivable.
We estimate that the fair value of our $150,000 Contingent Convertible Senior Notes (the Notes) as of October 31, 2007, was $138,353 based on quoted market prices.
4. RECEIVABLES AND INVESTMENT IN SALES-TYPE LEASES
The following provides additional disclosure for accounts receivable, notes receivable and investment in sales-type leases as of October 31:
We maintain provisions for bad debts for estimated credit losses that result from the inability of our customers to make required payments. The provisions for bad debts are estimated based on historical experience and specific customer collection issues.
Sales-type leases are interest-bearing at fixed market interest rates, require monthly installment payments over periods ranging generally from 30 to 60 months and contain bargain purchase options. Notes receivable includes financing arrangements for sales of our intellectual property products. Amounts are interest-bearing at fixed market interest rates and require monthly installments ranging generally from 30 to 60 months. Future minimum lease payments (principal, deferred revenue and interest) to be received for both sales-type leases and notes receivable are as follows:
5. OTHER BALANCE SHEET DATA
The following provides additional disclosure for selected balance sheet accounts as of October 31:
Total debt issuance costs incurred with the issuance of long-term debt are capitalized and amortized as interest expense using the effective interest method over the term of the related debt. Amortization of debt issuance costs were $1,327 and $1,511 for the year ended October 31, 2007 and 2006, respectively. Debt issuance costs related to the $100,000 senior secured revolving credit facility (the Revolver) obtained in November 2006 were $1,742.
Deposits are primarily comprised of a $3,000 security deposit related to our patent infringement lawsuit against Elixir Gaming Technologies, Inc., (formerly VendingData) and deposits associated with equipment purchases. See Notes 15 and 16 for more information related to the Elixir Gaming Technologies, Inc., (formerly VendingData) litigation.
Other long term assets of $2,173 and $1,535, respectively, principally include $1,659 and $1,433, respectively, of prepaid corporate development fees and $512 and $0, respectively, of restricted cash related to the Kings Gaming Inc. contingent consideration related to the purchase of the Play Four Poker patent and trademark. See Note 7 for more information.
We classify our investment in Sona as available-for-sale. Our investment is recorded at fair market value, which, as of October 31, 2007 and October 31, 2006, was $1,749 and $1,931, respectively.
6. INTANGIBLE ASSETS AND GOODWILL
Amortized intangible assets. All of our recorded intangible assets, excluding goodwill and the Stargames and CARD trademarks, are subject to amortization. Amortization expense was $19,421, $9,045, and $5,954 for each of the years ended October 31, 2007, 2006, and 2005, respectively.
Amortized intangible assets are comprised of the following as of October 31:
Changes in gross balances relate primarily to foreign currency translation adjustments and the acquisition of PGICs TGD.
Estimated amortization expense related to recorded intangible assets, excluding the Stargames and CARD trademarks, is as follows:
Trademarks. Intangibles with an indefinite life consisting of the Stargames and CARD trademarks are not amortized and were $22,331 and $18,591 as of October 31, 2007 and 2006, respectively.
Goodwill. Changes in the carrying amount of goodwill for the year ended October 31, 2007, are as follows:
Our goodwill originated from our acquisitions of foreign subsidiaries and the PGIC TGD. For both domestic and foreign income tax purposes, goodwill is amortized using the straight-line method and deducted over its statutory fifteen year life. Goodwill has been assigned to our Utility Products, PTG, ETS and EGM reporting units, as defined under SFAS 142.
Adjustments to goodwill for the year ended October 31, 2007, related to the final purchase price allocation for the Stargames acquisition as well as an adjustment at Stargames related to the reversal of an approximately $1,550 pre-acquisition liability, included in accrued liabilities, for a potential Australian Goods and Services Tax (GST) liability associated with export of sales in the period December 2001 through November 2006. Goodwill was also impacted by approximately $400 of other Stargames tax-related adjustments.
For the fiscal year ended October 31, 2007, a $7,659 decrease to goodwill and corresponding decrease to deferred tax liability was recognized. This adjustment relates to recording additional tax basis for the Stargames PC3 and other non-amortizable identified intangibles acquired in the acquisition. These financial accounting assets had originally been recorded without a corresponding tax asset as the availability of a deduction was dependent on interpretation of newly enacted Australian tax consolidation rules which were unclear. During the fourth quarter, we concluded our Australian consolidation process and performed additional research to confirm whether certain assets would qualify for a tax deduction or amortization. Based on these efforts, we adjusted goodwill to reflect the existence of a tax asset and hence the corresponding reduction in the deferred tax liability originally recorded.
7. DEBT AND LONG-TERM LIABILITIES
Debt and long-term liabilities consisted of the following as of October 31:
Contingent Convertible Senior Notes. In April 2004, we issued $150,000 of Notes due 2024 through a private placement under Rule 144A of the Securities Act of 1933. The Notes are unsecured and bear interest at a fixed rate of 1.25% per annum. Interest is payable semi-annually in arrears on April 15 and October 15 of each year, beginning October 15, 2004.
Holders may convert any outstanding Notes into cash and shares of our common stock at an initial conversion price per share of $28.07. This represents a conversion rate of approximately 35.6210 shares of common stock per $1,000 in principal amount of Notes. The value of the cash and shares of our common stock, if any, to be received by a holder converting $1,000 principal amount of the Notes will be determined based on the applicable Conversion Rate, Conversion Value, Principal Return, and other factors, each as defined in the indenture covering these Notes.
The Notes are convertible, at the holders option, into cash and shares of our common stock, under any of the following circumstances:
· during any fiscal quarter commencing after the date of original issuance of the Notes, if the closing sale price of our common stock over 20 trading days, during the previous quarter, is more than 120% of the conversion price of the Notes on the last trading day of the previous quarter;
· if we have called the Notes for redemption and the redemption has not yet occurred;
· during the five trading day period immediately after any five consecutive trading day period in which the trading price of the Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of our common stock on such day multiplied by the number of shares of our common stock issuable upon conversion of $1,000 in principal amount of the Notes, provided that, if on the date of any conversion pursuant to this trading price condition, our common stock price on such date is greater
than the conversion price but less than 120% of the conversion price, then the holder will be entitled to receive Conversion Value (as defined in the indenture covering these Notes) equal to the principal amount of the Notes, plus accrued and unpaid interest including liquidated damages, if any; or