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SHFL entertainment Inc. 10-K 2008

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K/A

 

(Mark one)

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

 

OR

 

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)

 

Minnesota

 

41-1448495

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

1106 Palms Airport Drive

 

 

Las Vegas, Nevada

 

89119

(Address of principal executive offices)

 

(Zip Code)

 

702-897-7150

(Registrant’s 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 registrant’s 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):

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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 Registrant’s 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.

 

 



 

EXPLANATORY NOTE

 

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 (“Auditor’s 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 Auditor’s Opinions included in the Original Filing.  Schedule II was included in the Original Filing; however, the Auditor’s Opinions omitted a reference to Schedule II. Additionally, the Auditor’s Opinions were revised to refer to the Company’s 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 Auditor’s 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 Company’s Form 10-Q for the quarter ended January 31, 2008 and the Company’s 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

 

 

Page

 

 

Part II

 

 

 

Item 8.

Financial Statements and Supplementary Data

1

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

38

Item 9A.

Controls and Procedures

38

Item 9B.

Other Information

41

 

 

 

Part IV

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

42

 




 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

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 Company’s 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 Company’s internal control over financial reporting as of October 31, 2007, based on the criteria established in Internal Control—Integrated 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 Company’s internal control over financial reporting.

 

 

Las Vegas, Nevada
January 18, 2008

 

2



 

SHUFFLE MASTER, INC.

 

CONSOLIDATED STATEMENTS OF INCOME

 

(In thousands, except per share amounts)

 

 

 

Year Ended October 31,

 

 

 

2007

 

2006

 

2005

 

Revenue:

 

 

 

 

 

 

 

Product leases and royalties

 

$

56,426

 

$

49,551

 

$

48,571

 

Product sales and service

 

122,315

 

113,202

 

63,997

 

Other

 

110

 

238

 

292

 

Total revenue

 

178,851

 

162,991

 

112,860

 

Costs and expenses:

 

 

 

 

 

 

 

Cost of leases and royalties

 

17,221

 

11,794

 

9,692

 

Cost of sales and service

 

57,764

 

44,927

 

19,568

 

Gross profit

 

103,866

 

106,270

 

83,600

 

Selling, general and administrative

 

61,947

 

51,299

 

30,559

 

Research and development

 

17,337

 

12,910

 

7,784

 

Gain on sale of patent

 

 

(4,566

)

 

In-process research and development

 

 

19,145

 

 

Total costs and expenses

 

154,269

 

135,509

 

67,603

 

Income from operations

 

24,582

 

27,482

 

45,257

 

Other expense

 

(9,974

)

(6,699

)

(657

)

Equity method investment loss

 

(306

)

(416

)

 

Impairment of investments

 

 

(1,655

)

(1,000

)

Income from continuing operations before tax

 

14,302

 

18,712

 

43,600

 

Income tax (benefit) provision

 

(1,999

)

13,373

 

14,496

 

Income from continuing operations

 

16,301

 

5,339

 

29,104

 

Discontinued operations, net of tax

 

78

 

(246

)

76

 

Net income

 

$

16,379

 

$

5,093

 

$

29,180

 

Basic earnings per share:

 

 

 

 

 

 

 

Continuing operations

 

$

0.47

 

$

0.15

 

$

0.83

 

Discontinued operations

 

 

 

0.01

 

Net income

 

$

0.47

 

$

0.15

 

$

0.84

 

Diluted earnings (loss) per share:

 

 

 

 

 

 

 

Continuing operations

 

$

0.46

 

$

0.15

 

$

0.80

 

Discontinued operations

 

 

(0.01

)

 

Net income

 

$

0.46

 

$

0.14

 

$

0.80

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

Basic

 

34,680

 

34,585

 

34,924

 

Diluted

 

35,276

 

36,052

 

36,378

 

 

See notes to consolidated financial statements

 

3



 

SHUFFLE MASTER, INC.

 

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except per share amounts)

 

 

 

October 31,

 

 

 

2007

 

2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

4,392

 

$

8,906

 

Investments

 

 

11

 

Accounts receivable, net of allowance for bad debts of $476 and $1,422

 

35,045

 

32,662

 

Investment in sales-type leases and notes receivable, net

 

9,092

 

10,064

 

Inventories

 

34,081

 

24,658

 

Prepaid income taxes

 

4,110

 

1,138

 

Deferred income taxes

 

7,959

 

6,785

 

Other current assets

 

5,286

 

5,172

 

Total current assets

 

99,965

 

89,396

 

Investment in sales-type leases and notes receivable, net

 

6,124

 

11,510

 

Products leased and held for lease, net of current portion

 

15,886

 

11,282

 

Property and equipment, net

 

11,242

 

9,779

 

Intangible assets, net

 

91,343

 

77,904

 

Goodwill

 

105,354

 

91,700

 

Deferred income taxes

 

14,476

 

4,294

 

Other assets

 

15,377

 

9,342

 

Total assets

 

$

359,767

 

$

305,207

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

11,548

 

$

11,217

 

Accrued liabilities

 

15,015

 

11,326

 

Customer deposits

 

2,213

 

2,017

 

Deferred revenue

 

5,489

 

5,499

 

Income taxes payable

 

 

938

 

Note payable and current portion of long-term liabilities

 

3,932

 

77,294

 

Total current liabilities

 

38,197

 

108,291

 

Long-term liabilities, net of current portion

 

232,698

 

158,753

 

Deferred income taxes

 

1,238

 

5,614

 

Total liabilities

 

272,133

 

272,658

 

Commitments and Contingencies

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, no par value; 507 shares authorized; none outstanding

 

 

 

 

 

Common stock, $0.01 par value; 151,875 shares authorized; 35,198 and 34,895 shares issued and outstanding

 

352

 

349

 

Additional paid-in capital

 

6,492

 

717

 

Retained earnings

 

38,770

 

22,391

 

Accumulated other comprehensive income

 

42,020

 

9,092

 

Total shareholders’ equity

 

87,634

 

32,549

 

Total liabilities and shareholders’ equity

 

$

359,767

 

$

305,207

 

 

See notes to consolidated financial statements

 

4



 

SHUFFLE MASTER, INC.

 

CONSOLIDATED STATEMENTS CHANGES IN SHAREHOLDERS’ EQUITY

 

(In thousands)

 

 

 

Common Stock

 

Additional
Paid-in

 

Deferred

 

Retained

 

Accumulated
Other
Comprehensive

 

Total
Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Compensation

 

Earnings

 

Income

 

Equity

 

Balance, November 1, 2004

 

34,958

 

$

233

 

$

9,593

 

$

(1,765

)

$

698

 

$

5,970

 

$

14,729

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

 

 

 

29,180

 

 

29,180

 

Currency translation adjustment

 

 

 

 

 

 

(4,260

)

(4,260

)

Unrealized loss on investments

 

 

 

 

 

 

(165

)

(165

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

24,755

 

Stock repurchased

 

(1,473

)

(15

)

(26,048

)

 

(12,580

)

 

(38,643

)

Options exercised

 

851

 

9

 

6,283

 

 

 

 

6,292

 

Accelerated vesting of options

 

 

 

60

 

 

 

 

60

 

Tax benefit from stock options

 

 

 

5,287

 

 

 

 

5,287

 

FY 2004 tax (true-up)

 

 

 

229

 

 

 

 

229

 

Issuance of restricted stock

 

193

 

2

 

4,781

 

(4,297

)

 

 

486

 

Amortization of deferred compensation

 

 

 

 

274

 

 

 

274

 

January 2005 stock split

 

(2

)

116

 

(185

)

 

 

 

(69

)

Balance, October 31, 2005

 

34,527

 

345

 

 

(5,788

)

17,298

 

1,545

 

13,400

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

 

 

 

5,093

 

 

5,093

 

Currency translation

 

 

 

 

 

 

7,382

 

7,382

 

Reclassification of loss on investments

 

 

 

 

 

 

165

 

165

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

12,640

 

Reclass deferred compensation to APIC

 

 

 

(5,788

)

5,788

 

 

 

 

Stock repurchased

 

(317

)

(3

)

(8,662

)

 

 

 

(8,665

)

Options exercised

 

697

 

7

 

7,867

 

 

 

 

7,874

 

Shares surrendered and retired for stock option exercises

 

(76

)

(1

)

(2,119

)

 

 

 

(2,120

)

Share-based compensation expense

 

 

 

5,512

 

 

 

 

5,512

 

Tax benefit from stock option exercises

 

 

 

3,908

 

 

 

 

3,908

 

Issuance of restricted stock

 

64

 

1

 

(1

)

 

 

 

 

Balance, October 31, 2006

 

34,895

 

349

 

717

 

 

22,391

 

9,092

 

32,549

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

 

 

 

16,379

 

 

16,379

 

Currency translation

 

 

 

 

 

 

32,850

 

32,850

 

Reclassification of loss on investments

 

 

 

 

 

 

78

 

78

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

49,307

 

Stock repurchased

 

(77

)

(1

)

(1,962

)

 

 

 

(1,963

)

Options exercised

 

229

 

3

 

2,544

 

 

 

 

2,547

 

Shares surrendered and retired for stock option exercises

 

(76

)

(1

)

(750

)

 

 

 

(751

)

Share-based compensation expense

 

 

 

4,812

 

 

 

 

4,812

 

Tax benefit from stock option exercises

 

 

 

1,133

 

 

 

 

1,133

 

Issuance of restricted stock

 

227

 

2

 

(2

)

 

 

 

 

Balance, October 31, 2007

 

35,198

 

$

352

 

$

6,492

 

$

 

$

38,770

 

$

42,020

 

$

87,634

 

 

See notes to consolidated financial statements

 

5



 

SHUFFLE MASTER, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

 

 

Year Ended October 31,

 

 

 

2007

 

2006

 

2005

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

16,379

 

$

5,093

 

$

29,180

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

19,421

 

16,662

 

11,218

 

Amortization of debt issuance costs

 

1,327

 

1,511

 

961

 

Share-based compensation

 

4,812

 

5,512

 

760

 

In-process research and development

 

 

19,145

 

 

Gain on patent sale

 

 

(4,566

)

 

Equity method investment loss

 

306

 

416

 

 

Provision for bad debts

 

(406

)

(537

)

229

 

Write-down for inventory obsolescence

 

1,415

 

345

 

(140

)

Loss on disposal of property

 

 

 

66

 

Gain on sale of leased assets

 

(2,511

)

 

 

Excess tax benefit from stock option exercises

 

(854

)

(3,682

)

5,287

 

Tax benefit from stock option exercises

 

279

 

226

 

 

Impairment of investments

 

 

1,655

 

1,000

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

1,245

 

(2,407

)

(6,526

)

Investment in sales-type leases and notes receivable

 

6,801

 

(2,459

)

(7,942

)

Inventories

 

(5,803

)

(4,033

)

(3,483

)

Accounts payable and accrued liabilities

 

5,505

 

(2,434

)

2,318

 

Customer deposits and deferred revenue

 

(232

)

3,382

 

(48

)

Income taxes, net of stock option exercises

 

(20

)

 

 

Deferred income taxes

 

(8,315

)

(3,042

)

(2,403

)

Prepaid income taxes

 

(2,690

)

3,232

 

6,730

 

Other

 

(3,611

)

2

 

(2,699

)

Net cash provided by operating activities

 

33,048

 

34,021

 

34,508

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of investments

 

 

(32,435

)

(11,847

)

Proceeds from sale and maturities of investments

 

13

 

49,232

 

17,330

 

Proceeds from sale of leased assets

 

4,070

 

1,845

 

1,632

 

Payments for products leased and held for lease

 

(10,085

)

(9,167

)

(9,520

)

Purchases of property and equipment

 

(2,774

)

(2,196

)

(2,210

)

Purchases of intangible assets

 

(2,397

)

(4,313

)

(7,239

)

Acquisition of businesses, net of cash acquired

 

(21,946

)

(114,608

)

(228

)

Net proceeds from patent sale

 

 

7,500

 

9,039

 

Other

 

 

 

(3,483

)

Net cash used by investing activities

 

(33,119

)

(104,142

)

(6,526

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from acquisition financing

 

 

115,000

 

 

Payments on acquisition financing

 

(70,000

)

(45,000

)

 

Proceeds from senior secured revolving credit facility

 

87,680

 

 

 

Payments on senior secured revolving credit facility

 

(12,000

)

 

 

Proceeds from other borrowings

 

1,926

 

4,153

 

 

Repurchases of common stock

 

(1,933

)

(8,665

)

(38,643

)

Proceeds from issuances of common stock, net

 

2,061

 

7,874

 

6,512

 

Debt issuance costs

 

(1,722

)

(554

)

 

Excess tax benefit from stock option exercises

 

854

 

3,682

 

 

Payment on notes payable and other liabilities

 

(10,379

)

(10,567

)

(2,896

)

Net cash provided (used) by financing activities

 

(3,513

)

65,923

 

(35,027

)

Effect of exchange rate changes on cash

 

(930

)

(175

)

(256

)

Net increase (decrease) in cash and cash equivalents

 

(4,514

)

(4,373

)

(7,301

)

Cash and cash equivalents, beginning of year

 

8,906

 

13,279

 

20,580

 

Cash and cash equivalents, end of year

 

$

4,392

 

$

8,906

 

$

13,279

 

 

See notes to consolidated financial statements

 

6



 

Supplemental Disclosures of Cash Flows Information—

 

 

 

Year Ended October 31,

 

 

 

2007

 

2006

 

2005

 

Non-cash Investing and Financing transactions:

 

 

 

 

 

 

 

Mimimum consideration for patent purchase

 

$

 

$

 

$

9,229

 

Accrued direct acquisition costs related to acquisitions

 

792

 

1,750

 

 

Note payable and minimum consideration issued in connection with the acquisition of a business or assets

 

2,922

 

 

880

 

Issuance of restricted stock

 

5,773

 

2,113

 

4,781

 

Recharacterization of prepaid royalty

 

1,750

 

 

 

Cash paid for:

 

 

 

 

 

 

 

Income taxes, net of refunds

 

$

8,475

 

$

11,033

 

$

5,576

 

Interest

 

5,844

 

5,559

 

1,919

 

 

See notes to consolidated financial statements

 

7



 

SHUFFLE MASTER, INC.

 

Notes to Consolidated Financial Statements

 

(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

 

8



 

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 revenue—Lease 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 revenue—We 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

 

9



 

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 PGIC’s 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.

 

10



 

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 customer’s 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 unit’s 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 unit’s identifiable net assets. We would record an impairment charge to the extent that the book value of the reporting unit’s 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 asset’s 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.

 

11



 

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 Taxes—an 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.

 

12



 

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 PGIC’s Table Games Division (“TGD”) business (“Purchase Agreement”), including certain worldwide rights and lease contracts for all of PGIC’s 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 PGIC’s 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 PGIC’s 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 PGIC’s 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 PGIC’s 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:

 

Cash

 

$

19,755

 

Minimum future consideration, non-interest bearing

 

2,922

 

Direct acquisition costs

 

1,233

 

Total purchase price

 

$

23,910

 

 

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:

 

13



 

Inventory

 

$

883

 

Property and equipment

 

1,101

 

Customer relationships, average life of 10 years

 

11,221

 

Backlog, average life of 1 year

 

126

 

Tradenames, trademarks, patents, and copyrights, average life of 10 years

 

2,999

 

Covenant not to compete, life of 7 years

 

207

 

Goodwill

 

7,373

 

 

 

$

23,910

 

 

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:

 

 

 

2007

 

2006

 

United States government and agency obligations

 

$

 

$

11

 

 

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:

 

 

 

2007

 

2006

 

Accounts receivable, net:

 

 

 

 

 

Trade receivables

 

$

35,521

 

$

34,084

 

Less: allowance for bad debts

 

(476

)

(1,422

)

Total

 

$

35,045

 

$

32,662

 

 

 

 

2007

 

2006

 

Investment in sales-type leases and notes receivable, net:

 

 

 

 

 

Minimum sales-type lease payments

 

$

10,715

 

$

15,314

 

Notes receivable—table game licenses

 

7,798

 

11,395

 

Sub-total sales-type leases and notes receivable

 

18,513

 

26,709

 

Less: interest sales-type leases

 

(1,085

)

(1,615

)

Less: deferred service revenue

 

(1,976

)

(2,839

)

Less: allowance for bad debts

 

(236

)

(681

)

Investment in sales-type leases and notes receivable, net

 

15,216

 

21,574

 

Less: current portion sales-type leases

 

(4,266

)

(4,512

)

Less: current portion notes receivable—table game licenses

 

(4,826

)

(5,552

)

Long-term portion investment in sales-type leases and notes receivable

 

$

6,124

 

$

11,510

 

 

14



 

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:

 

 

 

Year Ending October 31,

 

 

 

2008

 

2009

 

2010

 

2011

 

Total

 

Investment in sales-type leases and notes receivable, net:

 

 

 

 

 

 

 

 

 

 

 

Future sales-type lease payments

 

$

6,794

 

$

3,491

 

$

430

 

$

 

$

10,715

 

Notes receivable—table game licenses

 

4,587

 

2,609

 

594

 

9

 

7,799

 

Sub-total sales-type leases and notes receivable

 

11,381

 

6,100

 

1,024

 

9

 

18,514

 

Less: interest sales-type leases

 

(788

)

(262

)

(35

)

 

(1,085

)

Less: deferred service revenue

 

(1,265

)

(641

)

(71

)

 

(1,977

)

Less: allowance for bad debts

 

(236

)

 

 

 

(236

)

Investment in sales-type leases and notes receivable, net

 

$

9,092

 

$

5,197

 

$

918

 

$

9

 

$

15,216

 

 

15



 

5. OTHER BALANCE SHEET DATA

 

The following provides additional disclosure for selected balance sheet accounts as of October 31:

 

 

 

2007

 

2006

 

Inventories:

 

 

 

 

 

Raw materials and component parts

 

$

18,975

 

$

9,585

 

Work-in-process

 

2,141

 

3,051

 

Finished goods

 

12,965

 

12,022

 

Total

 

$

34,081

 

$

24,658

 

 

 

 

2007

 

2006

 

Products leased and held for lease:

 

 

 

 

 

Utility products

 

$

29,678

 

$

21,500

 

Less: accumulated depreciation

 

(22,802

)

(13,864

)

Utility Products, net

 

6,876

 

7,636

 

Proprietary Table Games

 

1,783

 

845

 

Less: accumulated depreciation

 

(703

)

(836

)

Proprietary Table Games, net

 

1,080

 

9

 

Electronic Table Systems

 

12,076

 

4,415

 

Less: accumulated depreciation

 

(4,146

)

(778

)

Electronic Table Systems, net

 

7,930

 

3,637

 

Electronic Gaming Machines

 

222

 

222

 

Less: accumulated depreciation

 

(222

)

(222

)

Electronic Gaming Machines, net

 

 

 

Total, net

 

$

15,886

 

$

11,282

 

 

 

 

2007

 

2006

 

Property and equipment:

 

 

 

 

 

Office furniture and computer equipment

 

$

8,143

 

$

6,835

 

Less: accumulated depreciation

 

(5,273

)

(4,824

)

Property and equipment, net

 

2,870

 

2,011

 

Leasehold Improvements:

 

5,302

 

4,673

 

Less: accumulated depreciation

 

(3,144

)

(2,702

)

Leasehold Improvements, net

 

2,158

 

1,971

 

Production equipment and other:

 

11,669

 

9,672

 

Less: accumulated depreciation

 

(5,455

)

(3,875

)

Production equipment and other, net

 

6,214

 

5,797

 

Total, net

 

$

11,242

 

$

9,779

 

 

 

 

2007

 

2006

 

Other long-term assets:

 

 

 

 

 

Debt issuance costs, net

 

$

2,833

 

$

2,369

 

Deposits

 

3,872

 

3,507

 

Investment in Sona

 

1,749

 

1,931

 

PGIC TGD prepaid royalty

 

4,750

 

 

Other

 

2,173

 

1,535

 

Total

 

$

15,377

 

$

9,342

 

 

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 King’s Gaming Inc. contingent consideration related to the purchase of the Play Four Poker™ patent and trademark. See Note 7 for more information.

 

16



 

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:

 

 

 

Weighted Avg
Useful Life

 

2007

 

2006

 

Amortized intangible assets:

 

 

 

 

 

 

 

Patents, games and products

 

10 years

 

$

62,465

 

$

53,452

 

Less: accumulated amortization

 

 

 

(23,945

)

(15,159

)

 

 

 

 

38,520

 

38,293

 

Customer relationships

 

10 years

 

23,537

 

10,221

 

Less: accumulated amortization

 

 

 

(2,251

)

(767

)

 

 

 

 

21,286

 

9,454

 

Licenses and other

 

6 years

 

5,136

 

6,313

 

Less: accumulated amortization

 

 

 

(1,813

)

(1,661

)

 

 

 

 

3,323

 

4,652

 

Developed technology

 

4 years

 

10,254

 

8,510

 

Less: accumulated amortization

 

 

 

(4,486

)

(1,596

)

 

 

 

 

5,768

 

6,914

 

PGIC Backlog

 

1 Year

 

126

 

 

Less: accumulated amortization

 

 

 

(11

)

 

 

 

 

 

115

 

 

Total

 

 

 

$

69,012

 

$

59,313

 

 

Changes in gross balances relate primarily to foreign currency translation adjustments and the acquisition of PGIC’s TGD.

 

Estimated amortization expense related to recorded intangible assets, excluding the Stargames and CARD trademarks, is as follows:

 

Year ending October 31,

 

 

 

2008

 

$

14,340

 

2009

 

13,894

 

2010

 

10,191

 

2011

 

7,588

 

2012

 

5,107

 

Thereafter

 

17,892

 

 

 

$

69,012

 

 

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:

 

 

 

Utility
Products

 

Proprietary
Table Games

 

Electronic
Table Systems

 

Electronic
Gaming
Machines

 

Total

 

Balance at October 31, 2006

 

$

38,346

 

$

 

$

42,043

 

$

11,311

 

$

91,700

 

Foreign currency translation adjustment

 

5,110

 

 

8,500

 

2,288

 

15,898

 

Adjustments to Stargames purchase price allocation

 

 

 

(7,578

)

(2,039

)

(9,617

)

PGIC TGD Acquisition

 

 

7,373

 

 

 

7,373

 

Balance at October 31, 2007

 

$

43,456

 

$

7,373

 

$

42,965

 

$

11,560

 

$

105,354

 

 

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.

 

17



 

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:

 

 

 

October 31,

 

 

 

2007

 

2006

 

Contingent convertible senior notes (Notes), fixed rate interest at 1.25%, due 2024

 

$

150,000

 

$

150,000

 

Senior secured revolving credit facility (Revolver)

 

75,680

 

 

Bridge loan, due November 2006 (Old Credit Agreement)

 

 

70,000

 

Stargames credit facility

 

 

3,872

 

BTI acquisition contingent consideration

 

2,434

 

4,441

 

ENPAT note payable, non-interest bearing, due in installments through 2007

 

2,985

 

5,823

 

PGIC TGD minimum consideration, non-interest bearing, due in installments through 2011

 

2,922

 

 

Kings Gaming Inc. contingent consideration

 

512

 

 

Bet the Set “21” contingent consideration

 

478

 

526

 

VIP note payable

 

 

329

 

Other

 

1,619

 

1,056