**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K/A**

**Amendment No. 2**

**(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, 2006**

**OR**

| o | ** ** | **TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|-----------------------------------------------------------------------------------------------|

 

**Commission File No. (0-20820)**

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**SHUFFLE MASTER, INC.**

(Exactname of registrant as specified in our charter)

| **Minnesota**                                                    |   | **41-1448495**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **1106  Palms Airport Drive  Las Vegas, Nevada**                 |   | **89119**                             |
| (Address of principal  executive offices)                        |   | (Zip Code)                            |

 

**702-897-7150**

(Registrant’stelephone number, including area code)

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**Securitiesregistered pursuant to Section 12 (b) of the Act:** None

Securities registeredpursuant to Section 12 (g) of the Act:

CommonStock, par value $.01 per share

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Indicateby check mark if the registrant is a well-known seasoned issuer as defined in Rule 405of the Securities Act.  Yes o  No x

Ifthis report is annual or transition, indicate by check mark if the registrantis not required to file reports pursuant to Section 13 or Section 15(d) ofthe Securities Exchange Act of 1934.  Yes o  No x

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer x | Accelerated filer o | Non-accelerated  filer o |
|---------------------------|--------------------------|--------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2). Yes o  No x

As ofJanuary 12, 2007, 35,024,433 shares of Common Stock of the registrant wereoutstanding. The aggregate market value of Common Stock beneficially owned bynon-affiliates on that date was $910,285,014 based upon the last reported saleprice of the Common Stock on that date by The NASDAQ National Market.

**DOCUMENTSINCORPORATED BY REFERENCE**

PartsII and III of this Annual Report on Form 10-K incorporate byreference information from the Registrant’s Proxy Statement for its AnnualMeeting of Shareholders to be held on March 14, 2007 (“Fiscal 2006 ProxyStatement”) to be filed with the SEC within 120 days of the end of thefiscal year covered by this report.

 

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**EXPLANATORY NOTE—RESTATEMENTOF FINANCIAL INFORMATION**

This Amendment No. 2 on Form 10-K/A (“AmendmentNo. 2”) is being filed to effect a restatement of the previously issuedconsolidated financial statements of Shuffle Master, Inc. (either the “Company,”“we” or “our”), as of October 31, 2006 and for the year ended October 31,2006 and the unaudited selected quarterly financial information for the threemonths ended October 31, 2006 included in our Form 10-K/A filedwith the Securities and Exchange Commission (the “SEC”) on January 17,2007 (the “Original Filing”). The Company is restating its previously issuedconsolidated financial statements to correct an error which resulted from theinadvertent failure to eliminate inter-company profit on inventory that wepurchased from our wholly-owned subsidiary Casinos Austria Research &Development GmbH & Co KG (“CARD”), resulting in a $1,616 overstatementof inventory as of October 31, 2006, a $1,616 understatement of cost ofsales and service and a $1,211 overstatement of our net income from continuingoperations for the three-month and twelve-month periods ended October 31,2006. In conjunction therewith, the Company has made certain othermiscellaneous adjustments. For further discussion regarding the restatement,see Note 2 to the consolidated financial statements, Restatement of ConsolidatedFinancial Statements, included in Item 8 of this Amendment No. 2.

All information in this Amendment No. 2 is as of January 17,2007 and does not reflect any subsequent information or events other than therestatement discussed in Note 2 to the consolidated financial statements. Forthe convenience of the reader, this Amendment No. 2 sets forth theoriginally filed Form 10-K/A in its entirety, and amended solely asthe result of, and to reflect the restatement.

This Amendment No. 2 amends and restates Item 1of Part I and Items 6,7,8, and 9A of Part II of the Original Filingto reflect the effects of the restatement. In addition, in accordance with Rule 12b-15promulgated under the Securities and Exchange Act of 1934, as amended, thisAmendment No. 2 also includes updated certifications from our ChiefExecutive Officer and Chief Financial Officer as Exhibits 31.1, 31.2 and 32.1and 32.2.

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**SHUFFLE MASTER, INC.ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED OCTOBER 31, 2006**

**TABLE OFCONTENTS**
|                   | ** ** | ** **                                                                                                          | ** ** | **Page** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
| **Part I**   | ** ** | ** **                                                                                                          |
| Item 1.           |       | Business                                                                                                            |       | 1        |   |
| Item 1A.          |       | Forward Looking Statements  and Risk Factors                                                                        |       | 19       |   |
| Item 1B.          |       | Unresolved Staff Comments                                                                                           |       | 27       |   |
| Item 2.           |       | Properties                                                                                                          |       | 27       |   |
| Item 3.           |       | Legal Proceedings                                                                                                   |       | 27       |   |
| Item 4.           |       | Submission of Matters to a  Vote of Security Holders                                                                |       | 27       |   |
| **Part II**  | ** ** | ** **                                                                                                          | ** ** |
| Item 5.           |       | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |       | 28       |   |
| Item 6.           |       | Selected Financial Data                                                                                             |       | 30       |   |
| Item 7.           |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         |       | 32       |   |
| Item 7A.          |       | Quantitative and Qualitative  Disclosures about Market Risk                                                         |       | 65       |   |
| Item 8.           |       | Financial Statements and  Supplementary Data                                                                        |       | 65       |   |
| Item 9.           |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                               |       | 114      |   |
| Item 9A.          |       | Controls and Procedures                                                                                             |       | 114      |   |
| Item 9B.          |       | Other Information                                                                                                   |       | 120      |   |
| **Part III** | ** ** | ** **                                                                                                          | ** ** |
| Item 10.          |       | Directors and Executive  Officers of the Registrant                                                                 |       | 121      |   |
| Item 11.          |       | Executive Compensation                                                                                              |       | 121      |   |
| Item 12.          |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                     |       | 121      |   |
| Item 13.          |       | Certain Relationships and  Related Transactions                                                                     |       | 121      |   |
| Item 14.          |       | Principal Accounting Fees  and Service                                                                              |       | 121      |   |
| **Part IV**  | ** ** | ** **                                                                                                          | ** ** |
| Item  15.         |       | Exhibits  and Financial Statement Schedules                                                                         |       | 122      |   |

 

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**PART I**

**(Dollars in thousands,except per share amounts)**

**ITEM 1. BUSINESS**

**OUR IDENTITY**

We are a gaming supply company that specializes inproviding our casino customers Utility Products, including automatic cardshufflers, Table iDTM components, and roulette chip sorters, to improve ourcasino customers’ profitability, productivity and security, and EntertainmentProducts, including live proprietary table games, electronic multi-player tablegame platforms, traditional video slot machines for select markets, live tablegame tournaments and wireless gaming solutions to expand our casino customers’gaming entertainment content. As of October 31, 2006, we had an installedunit base of approximately 22,000 shufflers, approximately 4,000 table gamesand approximately 21,000 electronic wagering seats. Installed unit base is thesum of the product units or seats under lease or license agreements andinception-to-date sold units or seats. We believe that installed units is animportant gauge of segment performance because it measures historical marketplacements of leased and sold units or seats and it provides insights intopotential markets for service and next generation products. Some sold units orseats may no longer be in use by our casino customers or may have been replacedby other models. Accordingly, we are unable to determine precisely the numberof units or seats currently in use.

We are a Minnesota corporation formed in 1983. Weconducted our initial public offering and became a Nasdaq-listed public companyin 1992. Our corporate offices are located at 1106 Palms Airport Drive, LasVegas, Nevada 89119 and our telephone number is 702-897-7150.

We maintain an Internet website atwww.shufflemaster.com and we make available on the website, free of charge, ourAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Qand Current Reports on Form 8-K, and amendments to those reportsfiled or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, as amended, as soon as reasonably practicableafter filing such material electronically with the Securities and ExchangeCommission. We also provide a variety of other information including all of ourpress releases. We have included our website address in this filing only as atextual reference. The information contained on our website is not incorporatedby reference into this Annual Report on Form 10-K/A.

We group our productofferings into two business segments, summarized as follows:

·       ***UtilityProducts.  ***Our strategy in the Utility Products segment isthe development of products for our casino customers that enhance table gamespeed, productivity, profitability and security. Currently, Utility Productssegment revenue is derived substantially from our automatic card shufflers. We develop and market a full complement ofautomatic card shufflers for use with the vast majority of card-based tablegames placed in casinos and other gaming locations, including our ownproprietary table games. In addition to selling and servicing, we also leaseshufflers, which provides us with recurring revenue. Automatic shufflersincrease table game productivity and security, which increases profitabilityfor the casinos and other table game operators. We also offer chip-sortingproducts that simplify the handling of gaming chips on high volume chip tablessuch as Roulette. Additionally, we have acquired or are developing products,such as our Automated Bloodhound® and Table iD products, to gather data and toenable casinos to track table game players, such as our. These products areintended to cost-effectively provide casinos and our other customers with dataon table game play for security and marketing purposes, which in turn allowsthem to increase their profitability. To enhance our Table iD productofferings, we entered into a worldwide product integration agreement withInternational Game Technology (“IGT”) and Progressive Gaming InternationalCorporation (“PGIC”) to create a comprehensive, automated table 

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management solution usingcomplementary capabilities, technologies and resources of the three companies.

·       ***EntertainmentProducts.***   Our strategyin the Entertainment Products segment is the development and delivery ofproprietary live table game content, electronic content delivery systems, videoslot machines for select markets, live table game tournaments and wirelessgaming solutions which enhanceour casino customers’ table game operations. Currently, Entertainment Productssegment revenue is derived substantially from our live proprietary table gamecontent selection and our multiple electronic content delivery systems. We develop or acquire and market a broadrange of proprietary table game entertainment content to casinos and otherlicensed operators. Products in this segment include our traditional live proprietarypoker based, baccarat, pai gow poker and blackjack table games. The majority ofthese products are licensed to our customers, which provides us with recurringrevenue. We also produce and distribute multiple electronic content deliverysystems including the Table MasterTM, Vegas StarTM, and Rapid Table Gamesmulti-terminal electronic table game platforms, and video slot machines forselect markets. Products in this segment focus on cost-effectively deliveringto casinos and other licensed operators popular table game content on eitherlive table, multi-player video platforms, or wireless platforms. We also offerlive table game tournaments developed and managed under our Shuffle UpProductionsTM (“Shuffle Up”) subsidiary formed in January 2005 toleverage our intellectual property and develop live and broadcast tournamentevents as well as licensed merchandise based on our extremely popular gamingofferings.

The tablebelow presents our product lines and the percentage of total revenue fromcontinuing operations contributed by each product line in the fiscal yearsended October 31:

| ** **                     | ** ** | **Percentage of Total Revenue** | ** ** |                                         |
|--------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|
| **Product Line**          | ** ** | ** **                                     | ** ** | **   2006   ** | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** |
| **Utility Products:**          |       |                                           |       |                                         |   |   |   |   |   |   |   |   |   |
| Shufflers                      |       |                                           | 49.0       | %                                            |   |   | 55.6 | % |   |   | 52.9 | % |   |
| Chippers                       |       |                                           | 3.6        | %                                            |   |   | 2.6 | % |   |   | * |   |   |
| Table iD and Bloodhound        |       |                                           | *          |                                         |   |   | * |   |   |   | * |   |   |
| **Entertainment Products:**    |       |                                           |       |                                         |   |   |   |   |   |   |   |   |   |
| Proprietary Table Games        |       |                                           | 23.4       | %                                            |   |   | 35.4 | % |   |   | 44.4 | % |   |
| Multi-Terminal Gaming Machines |       |                                           | 10.2       | %                                            |   |   | 4.3 | % |   |   | 1.2 | % |   |
| Electronic Gaming Machines     |       |                                           | 12.9       | %                                            |   |   | 1.0 | % |   |   | * |   |   |
| Other Entertainment            |       |                                           | *          |                                         |   |   | * |   |   |   | * |   |   |
| **Other  revenue**             |       |                                           | *          |                                         |   |   | * |   |   |   | * |   |   |
|                           |       |                                           | 100.0      | %                                            |   |   | 100.0 | % |   |   | 100.0 | % |   |
|                                |            |                                                |            |                                              |  |  |  |  |  |  |  |  |  |  |  |  |

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* Less than 1%

For additional informationabout our segments, including segment revenue, operating income and assets, see“Item 6. Selected Financial Data,” “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and “Item 8.Financial Statements and Supplementary Data” included elsewhere in this AnnualReport.

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**OUR STRATEGY**

We are proud of theproducts that we have developed and market and are pleased with our success aswe continue our growth and expansion. Our product strategies, in no particularorder, for the future are:

·       Tofocus our development, manufacturing and marketing on products that increasethe profitability, productivity and security of our casino and other customersin their table game operations;

·       Todevelop and market the third generation of our shufflers, including featureslike optical card recognition, deck validation and integration with the TableiD System, to replace older generation shufflers and to further penetratedomestic and foreign markets for these products;

·       To market our next generation chip sortingdevice, the Easy Chipper® and the Intelligent Chip TreeTM chip tracking device to simplify theprocess of handling gaming chips and accurately track chip volume and value forour casino and other customers in their table game operations;

·       Toenhance our Table iD product offerings and increase our market share throughthe contribution of our shuffler and intelligent shoe products pursuant to ourworldwide product integration agreement with IGT and PGIC. This alliance isdesigned to create a comprehensive, automated table management solution usingcomplementary capabilities, technologies and resources of the three companies;

·       Tobroaden our Entertainment Products segment by developing or acquiringadditional table game content to increase our penetration of casino customers’table game operations;

·       Tomarket our multiple electronic content delivery systems to provide acost-effective brand extension of our proprietary table game content toexisting casino or new racino customers (race tracks that also offer slotgames) and to explore other venues in which the platform could be reasonablymodified to fulfill market demands;

·       Tofurther leverage our intellectual property and develop live and broadcasttournament events as well as merchandise through Shuffle Up;

·       Toincrease our international sales through specific product development oracquisitions and penetration of new markets;

·       Todevelop or acquire patents, licenses, or other intellectual property both tobroaden our product offerings and to vigorously protect our patents andproducts from infringers;

·       To continue our strongcommitment to research and development of new product technologies in both ourUtility Products and Entertainment Products segments.

**OUR UTILITY PRODUCTSSEGMENT**

Since our founding, we have developed and marketedproducts that increase the productivity, security and profitability of thetable game operations of our casino and other customers. Our automatic cardshufflers were the first such product. We expect to soon add additionalmodules, such as our Automated Bloodhound products, to our Table iD System(described below) now under development, and we have added our chip sorting andtracking devices to this product segment. We believe that our casino and othercustomers are seeking to increase the operating returns of their table game operations.By introducing a combination of technologies our Utility Products increase the profitability, productivity andsecurity for casino and other customers in their table game operations.

***Our Shuffler Products.******  ***We currently market acomplete range of shufflers, including both batch and continuous shufflers.Single deck shufflers are generally used on proprietary table games such as ourown Let It Ride® and Three Card Poker® games. Multi-deck shufflers, which includecontinuous and 

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batch versions, are most commonly used in multi-deckblackjack and mini-baccarat table games. Additionally, we offer a singledeck/double deck shuffler, the Deck Mate®, for use on live stakes poker tables andsingle or double deck table games.

Our shufflers significantly reduce the opportunity forcard manipulation by dealers, resulting in increased security. By allowingcards to be shuffled continuously or in frequent batches, our shufflers reduceor eliminate card counting and shuffle tracking. Because our shufflers shuffleone or more decks while a game is being played, down-time related to dealershuffling is also significantly reduced, with the potential for a correspondingincrease in playing time and win for the casino.

Ourexisting shuffler products, in no particular order, are the following:

| *ACE*®        | A second generation single  deck shuffler which uses an innovative card distribution mechanism and  sophisticated software featuring random number algorithms and movements to  shuffle cards and form hands or groups of cards. The ACE was introduced in January 1999.                             |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Deck  Mate*® | A single deck/double  deck batch shuffler where cards are randomly shuffled and placed onto a  platform according to computer-generated instructions. The unit may be flush  mounted in either a poker table or on an extension to a blackjack table. The  Deck Mate was introduced in October 2002. |
| *iDeal*TM      | A third generation  single deck shuffler using technology similar to the one2sixTM that features several key  enhancements including card recognition technology that reads the rank and  suit of each card being dealt. The iDeal was introduced in November 2006.                              |
| *King*®       | A multi-deck  continuous shuffler using technology similar to the ACE, with up to five  decks of shuffled cards that are dealt continuously and directly from the  machine and that are reloaded immediately after a hand is played. The King  was introduced in January 2000.                       |
| *one2six*TM    | A multi-deck  continuous shuffler that accommodates up to six decks of cards and can be  used for almost every casino card game. Acquired as part of the acquisition  of CARD in May 2004, the one2six shuffler was first introduced  internationally in 2002.                                       |
| *MD1*TM        | A multi-deck batch  shuffler that shuffles from two to eight decks, used primarily for multiple  deck blackjack or mini-baccarat games. The MD1 was introduced in late fiscal  1994.                                                                                                                      |
| *MD2*®        | A next generation  multi-deck batch shuffler that shuffles from two to eight decks and features  optional optical card recognition that verifies that the deck or group of  decks are intact and integrates with our Table iD system (discussed below).  The MD2 was introduced in September 2003.   |

 

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***Our Chip Sorting Machine Products.******  ***As part of the CARDacquisition in May 2004, we acquired a next generation chip sortingmachine, the Easy Chipper. The Easy Chipper simplifies the handling of gamingchips and accurately tracks chip volume and value, which increases theproductivity and security on tables with high chip volume, such as Roulette.

| *Easy Chipper*® | This chip sorting device  simplifies the process of handling gaming chips on Roulette tables by  directly ejecting the chips from the hopper wheel into the tubes with its  state-of-the-art ejection system. It has a color reading system that quickly  and accurately sorts up to ten different colored chips while separating  non-programmed ones. When equipped with the optional Intelligent Chip Tree,  the Easy Chipper enables accurate tracking of the chip volume and value. |
|----------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*** ***

***Our Other UtilityProducts.******  ***Wehave acquired or are developing technology to enable casinos and othercustomers to track and analyze play on their table games. This technologycombines computer software and hardware, Radio Frequency Identification (“RFID”)and the optical card reading features of our next generation of shufflers.

Our otherUtility Products are the following:

| *Table iD*TM**       | This system is currently  under joint development with IGT and PGIC and will be a comprehensive,  automated table management solution using complementary capabilities,  technologies and resources of the three companies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| * *                 | Under the terms of  the arrangement, we will provide automatic card shufflers, card reading  intelligent shoes, card and chip sorters, and verifiers. IGT will provide  back-end table gaming management systems including player tracking, patron  loyalty and rewards, as well as bonusing applications. PGIC will provide RFID  bet recognition, automated gaming chip tracking and payoff recognition. Each  company will cooperatively interface their respective products into a  combined product offering known as Table iD (formerly known as the  Intelligent Table SystemTM).  Additionally, the arrangement also provides a framework for the cooperative  development of new technologies and products that build on automated table  management and real-time monitoring of player activity. |
| *MD2TM  Workstation* | The MD2 Workstation  combines the MD2 batch shuffler with proprietary software that counts, reads  and verifies each card as it is being shuffled to produce detailed reports  that reveal the accuracy and composition of each deck for off-table and  back-of-house verification.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

*** ***

***Customers andMarketing.******  ***We market our Utility Products tolegal casinos and other gaming establishments around the world with our directdomestic and international sales force and several domestic and internationaldistributors.

Our products and the locations in which we may sellare subject to the licensing and product approval requirements of variousnational, state, provincial, or tribal jurisdictional agencies that regulategaming around the world (see additional discussion under “Gaming Regulation”).We sell and lease our Utility Products. When we lease our products, wegenerally negotiate a month-to-month operating lease. When we sell ourproducts, we offer our customers a choice between a sale or a longer-termsales-type lease or other financing arrangements, depending on the needs ofeach customer.

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Historically, we marketed our shufflers in the tablegame areas of casinos. With the commercialization of the Deck Mate shuffler, wehave extended the market for shufflers into casino poker rooms and single deckor double deck blackjack tables. As a result, we now market a full line ofshufflers to accommodate virtually all of our customer’s shuffler needs.

***Competition.******  ***Wecompete with other gaming utility products and gaming supply companies forspace on the casino customer’s floor, as well as for our customer’s capitalspending. We compete with VendingDataCorporation (“VendingData”), a U.S. company that markets batch and continuousversions of its multi-deck shuffler, the Random Ejection ShufflerTM, theirsingle deck shuffler, the Poker OneTM, and their Deck CheckerTM card verificationdevice. Historically, VendingData has attempted to compete with our shufflerproducts on the basis of price. We compete on this basis as well as on thebasis of offering a complete line of shufflers, product reliability, a superiorservice network, the strength of our intellectual property, and the breadth ofour sales, regulatory, and distribution channels. Additionally, other companies may develop and marketshufflers and seek to develop and obtain regulatory approvals of additionalshuffler products. We cannot provide assurances that a competitive product willnot gain substantial placements or cause price erosion of our shufflers in thefuture.

With respect to our Easy Chipper roulette chip sortingproduct, several companies also manufacture and sell competitive chipperproducts. We believe the most successful of these products is the Chipper ChampPlusTM, sold by TCSJohn Huxley.

***Product Supply.******  ***We obtainmost of the parts for our Utility Products from outside suppliers, includingboth off-the-shelf items as well as components manufactured to ourspecifications. We also manufacture a small number of parts in-house that areused both for product assembly and for servicing existing products. Wegenerally perform final assembly ourselves and then warehouse and ship ourproducts from our facilities in Las Vegas. Warehousing, quality control,final assembly and shipping are conducted primarily at our Las Vegasfacility, although small inventories are maintained and repairs are performedby our field service employees. Our one2six and Easy Chipper products aremanufactured by a subcontract manufacturer, located in Salzburg, Austria, whichalso inventories and ships these products. We believe that our sources ofsupply for components and raw materials are adequate and that alternativesources of materials are available.

***Research and Development.******  ***We employ a staff ofelectrical, mechanical and software engineers to support, improve and upgradeour existing shufflers, to develop new shufflers, to develop technology andproducts related to the Table iD system, and to explore other potentialtable-related Utility products. We perform the majority of our domesticresearch and development ourselves. We also use a foreign, third partydeveloper for certain of our international product offerings.

**OUR ENTERTAINMENTPRODUCTS SEGMENT**

Our Entertainment Products segment includes ourproprietary table games and side bets, our multiple electronic table gamecontent delivery systems, and a diverse line of Electronic Gaming Machines (“EGMs”)developed for select markets.

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***Our Live Table Games and Side Bets.***   Theproducts in our Entertainment Products segment include proprietary table gamecontent delivered on different live-dealt and electronic platforms. We arecontinuously developing new table games and have numerous other games invarious stages of development to complement our existing offerings and toextend our penetration of the proprietary table game market. Our existing proprietary table gamesand side bets, in no particular order, are the following:

| *Let It Ride*®        | Players place three separate  but equal bets and are dealt three cards face down. Two community cards are  also dealt face down in front of the dealer. After looking at their cards,  players then have the option to withdraw their first bet. The dealer then  turns over one of the community cards, which becomes a common fourth card to  all players at the table, and the players each have the opportunity to  withdraw their second bet (the third bet always remains on the table and  cannot be withdrawn). The dealer then turns over the second community card,  which becomes a common fifth and final card to all players and winning hands  are paid according to a predetermined payout schedule.   |
|----------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Let It  Ride Bonus*® | The Let It Ride Bonus  game provides a format that adds a bonus bet and pay table bonuses to the  basic Let it Ride table game. It is played in the same manner as the basic  game except that the player has an option to make an additional side wager,  known as the bonus bet. The bonus bet qualifies the player to be eligible to  receive large bonus payouts from a separate payout schedule, in addition to  the underlying payouts of the basic game. Additionally, the game now offers a  3 Card BonusTM  side bet which rewards players if their first three cards are a pair or  better. This wager is made at the beginning of the game when the standard and  Let It Ride Bonus wagers are placed. |
| *Three  Card Poker*®  | Players place wagers  on three-card stud hands, with options to bet against the dealer hand, bet on  the value of their own hand, or both. Winning hands are paid according to a  predetermined payout schedule and bonus payouts may be earned on certain high  ranking hands. Three Card Poker is also now available with a progressive  jackpot that is triggered when players receive a three-of-a-kind or higher.                                                                                                                                                                                                                                                                                                |
| *Four  Card Poker*®   | Players receive five cards to make a best four-card poker  hand. The game features head-to-head play versus the dealer and an optional  bonus bet. Players may “triple down” against the dealer, providing high game  volatility.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *Crazy 4  Poker*®     | Players receive five cards to make a best four-card poker  hand. The game features head-to-head play versus the dealer and an optional  bonus bet. Players may “triple down” against the dealer when their hand  contains a pair of Aces or higher, providing high game volatility.                                                                                                                                                                                                                                                                                                                                                                                                                         |

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| *Ultimate Texas Hold’em*TM  | Players receive two hole  cards that will be combined with five community cards to make their best  five-card poker hand. The game features head-to-head play versus the dealer  and an optional bonus bet that pays odds if the player’s final five-card hand  is a three-of-a-kind or higher and players have the option to check through  the river.                                                                                                                                                                                 |
|--------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Mississippi  Stud*TM            | Players receive two  cards that will be combined with three community cards to make a five-card  poker hand. The players compete against a paytable rather than the dealer and  win if their hand is a pair of 6s or better.                                                                                                                                                                                                                                                                                                                 |
| *Casino  War*®                  | Players make a wager  and if their card is higher than the dealer’s card, they win even money. If a  player’s card matches the dealer’s card, they are at war and can either quit  play by surrendering half of their wager or can continue to play by going to  war. If the player chooses to go to war, both the player and the dealer match  the original wager and receive another card. The highest card wins the hand.                                                                                                  |
| *Bad  Beat Texas Hold’em*TM | Players receive two  hole cards that are combined with five community cards to make their best  five-card hand. The game features head-to-head play against the dealer, an  optional three of a kind bonus bet that pays when a player receives a  three-of-a-kind or higher, and a Bad Beat bonus that pays if a player loses  with four of a kind or higher.                                                                                                                                                                               |
| *Hi-Lo  Stud Poker*®            | Players receive three  cards that are combined with two community cards to make a five-card poker  hand. The game is played against a pay table rather than against the dealer  and pays if the player’s hand is really good or really bad. It also features  an optional 3 Card Bonus side bet that pays if a player’s first three cards  contain a pair or better.                                                                                                                                                               |
| *Hit and  Run*TM                 | Players receive two  cards dealt face up and the dealer receives two cards dealt one face up and  one face down. As long as each of the player’s consecutively drawn cards are  higher in rank than the previous card, he may choose to receive additional  cards or may stand. The game rewards the player for having a longer run of  consecutively higher cards than the dealer.                                                                                                                                                     |
| *Blackjack  Press*TM             | Players make equal  wagers on two blackjack positions and the Press bet which enables them to  play two separate blackjack hands and “press” the one that they think can  beat the dealer.                                                                                                                                                                                                                                                                                                                                         |
| *Fortune  Pai Gow Poker*®       | Fortune Pai Gow Poker  is an optional bonus side bet that considers the best hand possible among the  player’s seven cards. Players may bet any amount within table limits; however,  a Fortune bet of at least five dollars qualifies them for Envy Bonus payouts.  Players win the Envy Bonus when someone else at the table receives a four of  a kind or higher. Fortune Pai Gow Poker is also now available with a  progressive jackpot that is triggered when a player receives either five aces  or a seven card straight flush. |

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| *Royal Match 21*®              | Royal Match 21 is an  optional bonus side bet for blackjack that considers the first two cards the  player receives. If the cards are the same suit or a Royal Match (a King and  Queen in suit), the player wins. An optional Crown Treasure bonus wager may  be made which awards the player if they and the dealer each receive a Royal  Match. |
|-------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Bet the  Set “21”*TM | Bet the Set “21” is  an optional bonus side bet for blackjack that considers the first two cards  the player receives. If the player’s first two cards are a pair or a suited  pair, the player wins.                                                                                                                               |
| *Fortune  Blackjack*TM          | Fortune Blackjack is  an optional side bonus bet for blackjack that considers the first two cards  the player receives. If the player’s first two cards total 20 or 21, the  player wins.                                                                                                                                                     |
| *Dragon  Bonus*®               | Dragon Bonus is an  optional side bonus bet for baccarat where players win when their selected  hand is a natural winner or wins by at least four points.                                                                                                                                                                                          |
| *Streak  Shooter*TM             | Streak Shooter is an  optional side bonus bet for Craps where players win if the shooter makes at  least three points before a seven-out. The more points the shooter makes, the  higher the payouts, and if the shooter makes 10 points, the Streak Shooter  bet pays the top award and the sequence ends.                                        |

*** ***

***Our Electronic Content Delivery Systems.***   Inaddition to offering our customers our live proprietary table games, we havealso developed or acquired other technology or platforms to deliver our orothers’ proprietary table game content or public domain games. We aredeveloping these platforms to enable the marketing of our table game contentinto previously unpenetrated international and domestic casino, racino, andother gaming markets. These different platforms are described below:

| *Table Master*TM | The Table Master unit is an  electronic version of a card table game which features a video screen that  projects a virtual video dealer who interacts with players on each of five  included betting stations. The unit also possesses a video tabletop that virtually  shows player cards, play and bets and uses a player-activated button panel  that simulates the player options of a live table game.                                                                                                                    |   |
|----------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| * *             | Important features of  this product include its ability to offer our proprietary table game content  without a live dealer and the ease of cost-efficient conversion to different  content. We acquired this platform as part of our acquisition of certain  assets and intellectual property from Sega Gaming Technology, Inc. (“Sega”)  in April 2003. In the future, we may develop new gaming products from  the other multi-player games acquired from Sega under the Table Master brand  name.        |   |
| *Vegas  Star*TM  | Vegas Star is a  state-of-the-art multi-player table game that combines an animated virtual  dealer with up to 16 individual touch screen betting terminals per server.  During game play, players sit at individual stations that are linked together  giving them the feel of a live table game, and an animated representation of  table activity is shown on a 50” plasma screen. The Vegas Star platform is  also available in a three-station Nova configuration and in the  single-station satellite configuration. |

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|                           | Important features of this  product include its ability to offer our proprietary table game content  without a live dealer and the ease of cost-efficient conversion to different  content. We acquired this platform as part of our acquisition of Stargames  Limited (“Stargames”) in February 2006.                                                                                                                                                                                           |
|---------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Rapid  Table Games*      | Rapid Table Games  combine a dealer and a live game with electronic touch screen betting stations  to dramatically increase game frequency and security by automating all  aspects of the wagering process on high volume games like Roulette, Baccarat  and Craps. Rapid Table Games offer a variety of installation configurations  that can accommodate additional player positions as traffic increases  including Rapid SatelliteTM  terminals that enable remote play from other areas of the casino. |
|                      | Important features of  this platform include its ability to incorporate other Shuffle  Master-developed products on select games like Baccarat. We acquired this  platform as part of our acquisition of Stargames in February 2006.                                                                                                                                                                                                                                                                       |
| *Casino  On Demand*TM | Casino On Demand is a  wireless and mobile gaming solution that enables table gaming content  including several of our proprietary titles to be offered on handheld  wireless devices. Built on the Sona Wireless Platform developed by Sona  Mobile, Inc., Casino On Demand can accommodate a virtually unlimited  number of players.                                                                                                                                                                     |

*** ***

***Our Electronic GamingMachines.***   Developed by our Australian subsidiaryStargames, we offer an extensive selection of video slot titles developed forselect markets including Australia/New Zealand, Asia and Latin America.Featuring a wide variety of denominations and configurations, our EGM titlesinclude a wide range of bonus round options and can be configured as a networkof machines or as stand-alone units. Utilizing SAS 6.01 with support for AFT,all EGM titles are offered in the ergonomic eStar® cabinet and are compatible with a variety ofback of house systems.

***Customers andMarketing.******  ***We market our Entertainment Productsto the same customers to whom we market our Utility Products. We first beganoffering table games in 1993 to increase the demand for our shuffler productsand we still routinely install shufflers and proprietary table games together.We design our proprietary table games to have broad appeal to players who enjoya more casual and social card game or who are new to or intimidated bytraditional table games. Our various table games offer casinos and players awide variety of betting propositions and risk and reward trade-offs.

Because they do not utilize a live dealer, our TableMaster and Vegas Star electronic table game platforms also enable us to marketour proprietary table game content in jurisdictions that only allow slot games,such as racinos (race tracks that also offer slot games). We also market theseplatforms to casinos who want more cost-effective table game products or whowant to offer lower stakes table games.

We typically market our live table games directly tocasinos by licensing the games for a monthly fixed fee. In fiscal 2003, webegan selling lifetime licenses to some of our live table games including LetIt Ride and Three Card Poker. We also license our table games in internationaljurisdictions.

***Competition.******  ***We competewith other gaming and entertainment products and gaming supply companies forspace on the casino customer’s floor, as well as for our customer’s capitalspending. Some of the larger gaming supply companies with whom we compete within this regard are IGT, Bally Technologies, Inc., WMS Industries, Inc.,and Aristocrat Leisure Limited.

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The market for live table games is characterized bynumerous competitors who develop and license proprietary table games. Some of ourcompetitors’ widely known proprietary table game titles include PGIC’sCaribbean Stud® andTexas Hold’em BonusTM, GalaxyGaming’s Lucky LadiesTM andMasque Publishing’s Spanish 21®.

Competition in the table game market is typically onthe basis of price, brand recognition, and the strength of underlyingintellectual property. Smaller developers and vendors are more able toparticipate in developing and marketing table games, compared to other gamingproducts, because of the lower cost and complexity associated with thedevelopment of these products. We compete on these bases, as well as on thestrength of our extensive sales, service and distribution channels. We havebeen able to increase our placements of table games not only because of thegrowth of the proprietary table game market, but also by displacing other tablegame products. In the future, table game competitors could market table gamesthat might displace our products.

There are also numerous other companies thatmanufacture and/or sell multi-player games, which are similar to our TableMaster and Vegas Star products. These companies include, but are not limited to, Elektroncek (also knownas Interblock), Aruze Corporation, Novomatic Group Companies, IGT, PokerTek, Inc.and TableMAX Holdings.

***Product Supply.******  ***We obtainmost of the parts for our Entertainment Products from outside suppliers,including table game felts, signs, and accessories, as well as components forour side bet systems. We also manufacture a small number of parts in-house thatare used both for product assembly and for servicing existing products. Wegenerally perform final assembly ourselves and then warehouse and ship ourproducts from our facilities in Las Vegas. Warehousing, quality control,final assembly and shipping are conducted primarily at our Las Vegasfacility, although small inventories are maintained and repairs are performedby our field service employees. Our Table Master units are manufactured by asubcontract manufacturer who also inventories and ships this product. Our VegasStar, Rapid Table Games and EGMs are generally assembled and shipped from theStargames premises in Sydney, Australia. Parts and components for theseproducts are sourced from outside suppliers primarily from Asia. We believethat our sources of supply for components and raw materials are adequate andthat alternative sources of materials are available.

***Research and Development.******  ***Our primary Entertainment Product research anddevelopment efforts have involved re-engineering and improving the TableMaster, Vegas Star and Rapid Table Game multi-player platforms as well as theEGM platform. This development work involved re-engineering the Table Mastercabinet, betting stations and electronics as well as improving video qualityand game interface options. Several games are currently available on TableMaster including Three Card Poker, Let It Ride Bonus with 3 Card Bonus, DragonBonus and Royal Match 21, and we are continually developing software to allowour other proprietary table games to operate on this platform. The Vegas Starproduct development focused on the development of proprietary game titlesincluding Dragon Bonus, Bet the Set “21” and Casino War along with theredevelopment of other non-proprietary titles such as Roulette and Blackjack.Rapid Table Games have been developing Rapid BaccaratTM,including the Dragon Bonus side bet, as well as Rapid CrapsTMto add to the current titles of Roulette, Sic Bo and Big Wheel. The EGM productdevelopment produced a large range of new titles including a selection ofjackpot games for the diverse international market. The cabinet and platformtechnology for Vegas Star, Rapid Table Games and EGM have undergone a programof continuous improvement to the design and capabilities of the technology.

**INTELLECTUALPROPERTY**

We believe that our patents,trademarks, licenses, copyrights and trade secrets are significant assets thatprovide us with a competitive advantage and are critical to our futureprofitability and growth. We protect our investment in research and developmentby seeking patent, trademark and copyright 

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protection for ourtechnologies. We also acquire and license patents and other intellectualproperty from third parties. Infringement claims, patent invalidity orexpiration, license non-renewal, failure to stop infringers, delays in usingour intellectual property to develop products or the costs of protecting ourintellectual property could adversely affect our future results of operationsand our financial position.

***Patents.***   Weown numerous United States and international patents and applications relatedto our existing products and methods, future products that have not yet been introduced,potential product modifications and improvements and to products we do notcurrently sell. A majority of these technologies are internally developed. Someof our technology is purchased and licensed.

In 2006, we purchased Stargames Limited of Sydney,Australia. Stargames has a broad range of intellectual property thatcomplements our existing portfolio. In particular, the intellectual propertyrelating to multi-player gaming platforms significantly expands the types ofproprietary game systems that are now available to our customers.

We purchased a license from PGIC that allows us toinstall progressive side bet systems on our table games. We also sold our halfinterest in two RFID chip patents to the co-owner of the patents, IGT. Most ofthe patents we own have a life of 20 years from the filing date of the patentapplication and none of our patents covering current products will expirebefore 2009. A majority of our patents expire on 2011 or well beyond that date.The patents which expire in 2009 are no longer important to our business. Wealso have numerous patent applications pending for our existing, planned andpotential products. No assurance can be given that any such patents will beissued or that the patents we currently hold or have licensed or any newpatents that we acquire will be or remain valid or will provide any competitiveprotection for our products.

***Trademarks.******  ***We own numerous United Statesand international trademark registrations and common law trademarks. Some ofthe more important marks include: Shuffle Master, Incorporated®, the Shuffle Master 4-square logoTM, Shuffle Master Gaming®, Let It Ride®, Let It Ride Bonus®, Let It Ride The Tournament®, Three Card Poker and design®, Four Card Poker and design®, Crazy 4 Poker®, Fortune Pai Gow Poker®, Royal Match 21®, Casino War®, 61¤2 Card PokerTM, Bad Beat Texas Hold ‘EmTM, Bringing More to the TableTM, Casino On DemandTM, Free RollTM, Big Raise Hold ‘Em®,Ultimate Texas Hold ‘EmTM, 6 CardPoker®, Dakota Stud®, Dragon Bonus®, Jack Magic®, Single 21 and design®, Blackjack PressTM, Table MasterTM,ACE®, King®, Deck Mate®, MD1TM,MD2®, iDealTM, Bloodhound®, iShoeTM, and mCasinoTM.We also license trademarks from others. We have not only aggressively soughtprotection of our current trademarks, but have also sought protection for anumber of names we plan to use in the future.

***Intellectual PropertyLicenses.******  ***Weobtain licenses to intellectual property from third parties. These licenses aresubject to various conditions and restrictions and typically involve us payingroyalties on a fixed or unit basis. As mentioned above, we acquired a paid-uplicense in the PGIC Progressive Side Bet patents this year. While we do notbelieve that any of these current license agreements are in jeopardy of beingterminated, we can make no assurance that all of these license agreements willremain in effect or that such licenses can be extended under terms favorable tous.

In addition, when we license our products to ourcustomers, we also license the right to use our intellectual property to casinocustomers. We typically earn license royalties on a periodic basis or on apaid-up lifetime basis. We do not license our intellectual property to othergaming equipment suppliers, except occasionally as part of a cross-license arrangement.

We granted a multiple game license to Delta Rangers, Inc.for the play of a number of our proprietary games on internet gaming sitesoutside of the United States.

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***Other IntellectualProperty.******  ***Inaddition to patents, we also protect much of our intellectual property withcopyrights, trademark registrations, and as trade secrets. No assurance can begiven that we will be successful in maintaining the confidentiality of ourproprietary information. Further, costs associated with defending and pursuinginfringement claims can be substantial. In the absence of valid patent,copyright, trademark or trade secret protection, we would be vulnerable tocompetitors who could lawfully copy our products and technology.

***Product-RelatedAgreement.***   Weare party to certain cross-licensing agreements. Under these agreements, wehave certain rights to third party intellectual property. There are no royaltyobligations with respect to any of these agreements that are material to ourresults of operations. Further, none of the royalties that we receive fromthese agreements are material to our results of operations.

***Infringement and Litigation.******  ***We do not believe that any ofour products, methods or technologies infringe the patents and otherintellectual property rights of others. However, we have been and are subjectto litigation claiming that we have infringed the rights of others. We havealso brought actions against others to protect our rights. For a discussion ofthese cases see “Item 3. Legal Proceedings,” included elsewhere in this AnnualReport.

**GAMING REGULATION**

***Overview.***   We****are subject to a wide range of complexgaming laws and regulations in over 200 jurisdictions, both foreign anddomestic, in which we are licensed or have applications pending. Jurisdictionsrequire us to be licensed, our key personnel to be found suitable, qualified orlicensed, and our products to be reviewed and approved before placement.Additionally, gaming laws and regulations of most jurisdictions provide thatbeneficial owners of 5% or more of our common stock are subject to reportingprocedures and may be subject to licensure that includes suitabilityinvestigations and submission of personal and financial information asrequired. Furthermore, most jurisdictions have ongoing reporting requirementsfor certain transactions and are concerned with our accounting practices,internal controls, business relationships, and the fair operation of ourproducts. Gaming regulatory requirements vary from jurisdiction to jurisdictionand licensing, approval, and processes related to findings of suitability, qualificationsor licensure of the Company, our products, key personnel, and certainshareholders can be lengthy and expensive.

***General RegulatoryLicensing and Approvals.***   We intend tomaintain our existing licenses and to seek the necessary licenses, approvals,qualifications and findings of suitability for us, our products and ourmanagement personnel in new jurisdictions where we anticipate salesopportunities. We have never been denied a license, permit or approvalnecessary to do business in any jurisdiction, nor had a license suspended orrevoked. However, there can be no assurance that new licenses, approvals,qualifications or findings of suitability will be obtained or that our existinglicenses will not be revoked, suspended or conditioned. If a license, approval,qualification or finding of suitability is required by a regulatory authorityand we fail to seek or do not receive the necessary license, qualification orfinding of suitability, then we may be prohibited from distributing ourproducts for use in the respective jurisdiction or may be required to provideour products through other licensed entities at a reduced profit to us. Therecan also be no assurance that we will be able to obtain the necessary approvalsfor our products as they are developed. In addition, changes in legislation orin judicial or regulatory interpretations could occur which could adverselyaffect us.

We are licensed as a manufacturer and distributor ofgaming devices, an operator of inter-casino linked systems and a slot routeoperator in Nevada. We are a gaming-related casino service industry licensee inNew Jersey and hold supplier, manufacturer and distributor licenses in numerousother jurisdictions throughout North America and elsewhere. Due to variationsin jurisdictional regulatory transaction reporting, as well as manufacturer,distributor, and product licensing****requirements,only the specifics of Nevada gaming law requirements are provided below asbeing representative of gaming regulations to which we are subject in otherjurisdictions.

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***Nevada RegulatoryMatters.******  ***We are subject to the Nevada GamingControl Act (the “Nevada Act”) and to the licensing and regulatory control ofthe Nevada State Gaming Control Board (the “Nevada Board”), the Nevada GamingCommission (the “Nevada Commission”), and various local, city and countyregulatory agencies (collectively, the “Nevada Gaming Authorities”).

The laws, regulations and supervisory procedures ofthe Nevada Gaming Authorities are based upon declarations of public policywhich are concerned with, among other things: (i) the character of personshaving any direct or indirect involvement with gaming to prevent unsavory orunsuitable persons from having a direct or indirect involvement with gaming atany time or in any capacity; (ii) application of appropriate accountingpractices and procedures; (iii) maintenance of effective control over thefinancial practices and financial stability of licensees, including proceduresfor internal controls and the safeguarding of assets and revenues; (iv) record-keepingand reporting to the Nevada Gaming Authorities; (v) fair operation ofgames; and (vi) the raising of revenues through taxation and licensingfees.

We are registered with the Nevada Commission as apublicly traded corporation and are licensed as a manufacturer and distributorof gaming devices, an operator of inter-casino linked systems and a slot routeoperator. Such licenses are not transferable and require periodic payment offees. The Nevada Gaming Authorities may limit, condition, suspend or revoke alicense, registration, approval or finding of suitability for any cause deemedreasonable by such licensing agency. If it were determined that we violatedgaming laws, then the approvals and licenses we hold could be limited,conditioned, suspended or revoked, and we, and the individuals involved, couldbe subject to substantial fines for each separate violation of the gaming lawsat the discretion of the Nevada Commission. Each type of gaming device, slotgame, slot game operating system, table game or associated equipmentmanufactured, distributed, leased, licensed or sold in Nevada must first beapproved by the Nevada Board and, in some cases, the Nevada Commission. We mustregularly submit detailed financial and operating reports to the Nevada Board.Certain loans, leases, sales of securities and similar financing transactionsmust also be reported to or approved by the Nevada Commission.

Certain officers, directors and key employees arerequired to be found suitable by the Nevada Commission and employees associatedwith gaming must obtain work permits which are subject to immediate suspensionunder certain circumstances. An application for suitability may be denied forany cause deemed reasonable by the Nevada Commission. Changes in specified keypositions must be reported to the Nevada Commission. In addition to itsauthority to deny an application for a license, the Nevada Commission has jurisdictionto disapprove a change in position by an officer, director or key employee. TheNevada Commission has the power to require licensed gaming companies to suspendor dismiss officers, directors or other key employees and to severrelationships with other persons who refuse to file appropriate applications orwhom the authorities find unsuitable to act in such capacities.

The Nevada Commission may also require anyone having amaterial relationship or involvement with us to be found suitable or licensed,in which case those persons are required to pay the costs and fees of theNevada Board in connection with the investigation. We customarily reimbursesuch costs and fees. Any person who acquires more than 5% of our votingsecurities must report the acquisition to the Nevada Commission. Any person whobecomes a beneficial owner of more than 10% of our voting securities isrequired to apply for a finding of suitability. Under certain circumstances, an“Institutional Investor,” as such term is defined in the regulations of theNevada Commission, which acquires more than 10% but not more than 15% of ourvoting securities, may apply to the Nevada Commission for a waiver of suchfinding of suitability requirements, provided the Institutional Investor holds the voting securities forinvestment purposes only. The Nevada Commission has amended its regulationspertaining to Institutional Investors to temporarily allow an InstitutionalInvestor to beneficially own more than 15%, but not more than 19%, if the ownershippercentage results from a stock repurchase program. These InstitutionalInvestors may not acquire any additional shares and must reduce their holdingswithin one year from constructive notice of exceeding 15%, or must file a 

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suitability application. An Institutional Investorwill be deemed to hold voting securities for investment purposes only if thevoting securities were acquired and are held in the ordinary course of businessas an Institutional Investor and not for the purpose of causing, directly orindirectly, the election of a majority of our board of directors, any change inour corporate charter, bylaws, management, policies or operations, or any ofour gaming affiliates, or any other action which the Nevada Commission finds tobe inconsistent with holding our voting securities for investment purposesonly.

Any person who fails or refuses to apply for a findingof suitability or a license within 30 days after being ordered to do so by theNevada Commission may be found unsuitable based solely on such failure orrefusal. The same restrictions apply to a record owner if the record owner,when requested, fails to identify the beneficial owner. Any security holderfound unsuitable and who holds, directly or indirectly, any beneficialownership of the common stock beyond such period of time as may be prescribedby the Nevada Commission may be guilty of a gross misdemeanor. We are subjectto disciplinary action if, after we receive notice that a person is unsuitableto be a security holder or to have any other relationship with us, we: (i) paythat person any dividend or interest upon our voting securities; (ii) allowthat person to exercise, directly or indirectly, any voting right conferredthrough securities held by that person; or (iii) give remuneration in anyform to that person. If a security holder is found unsuitable, then we may befound unsuitable if we fail to pursue all lawful efforts to require suchunsuitable person to relinquish his or her voting securities for cash at fairmarket value.

The Nevada Commission may also, in its discretion,require any other holders of our equity securities or any holders of our debtsecurities to file applications, be investigated and be found suitable to ownour debt or equity securities. The applicant security holder is required to payall costs of such investigation. If the Nevada Commission determines that aperson is unsuitable to own such security, then pursuant to the regulations ofthe Nevada Commission, we may be sanctioned, including the loss of our approvals,if, without the prior approval of the Nevada Commission, we: (i) pay tothe unsuitable person any dividends, interest or any distribution whatsoever; (ii) recognizeany voting right by such unsuitable person in connection with such securities; (iii) paythe unsuitable person remuneration in any form; or (iv) make any paymentto the unsuitable person by way of principal, redemption, conversion, exchange,liquidation or similar transaction.

We are required to maintain a current stock ledger inNevada which may be examined by the Nevada Commission at any time, and to filewith the Nevada Commission, at least annually, a list of our shareholders. TheNevada Commission has the power to require our stock certificates to bear alegend indicating that the securities are subject to the Nevada Act and theregulations of the Nevada Commission. However, to date, the Nevada Commissionhas not imposed such a requirement on us.

We may not make certain public offerings of oursecurities without the prior approval of the Nevada Commission. Such approval,if given, does not constitute a finding, recommendation or approval by theNevada Commission or the Nevada Board as to the accuracy or adequacy of theprospectus or the investment merits of the securities offered. Anyrepresentation to the contrary is unlawful.

On December 22, 2005, the Nevada Commissiongranted us prior approval to make public offerings for a period of two years,subject to certain conditions (the “Shelf Approval”). However, the ShelfApproval may be rescinded for good cause without prior notice upon the issuanceof an interlocutory stop order by the Chairman of the Nevada Board. The ShelfApproval does not constitute a finding, recommendation or approval by theNevada Commission or the Nevada Board as to the accuracy or adequacy of theprospectus or the investment merits of the securities offered. Anyrepresentation to the contrary is unlawful.

Changes in control of us through merger,consolidation, acquisition of assets, management or consulting agreements orany form of takeover cannot occur without prior investigation by the NevadaBoard and approval by the Nevada Commission. Entities seeking to acquirecontrol of us must satisfy the Nevada Board and the Nevada Commissionconcerning a variety of stringent standards prior to assuming control of us.The Nevada Commission may also require controlling shareholders, officers, 

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directors and other persons having a materialrelationship or involvement with the entity proposing to acquire control, to beinvestigated and licensed as part of the approval process of the transaction.

Approvals are required from the Nevada Commissionbefore we can make exceptional repurchases of voting securities above thecurrent market price and before a corporate acquisition opposed by managementcan be consummated. Nevada’s gaming regulations also require prior approval bythe Nevada Commission if we adopt a plan of recapitalization proposed by ourBoard of Directors in opposition to a tender offer made directly to ourshareholders for the purpose of acquiring control of us.

We have formally adopted a compliance plan andappointed a compliance committee in accordance with Nevada Commissionrequirements. Our compliance committee meets quarterly and is responsible forimplementing and monitoring our compliance with regulatory matters. Thiscommittee also reviews information and reports regarding the suitability ofpotential key employees or other parties who may be involved in materialtransactions or relationships with us.

***Federal Registration.******  ***As amanufacturer and distributor of gaming devices, including Table Master productsand slot machines, we are registered pursuant to and have complied with theFederal Gambling Devices Act of 1962 (the “Federal Act”). In order tomanufacture, sell, deliver or operate our gaming devices, including our TableMaster product, we must renew our federal registration annually and comply withits various record-keeping and equipment identification requirements. TheFederal Act makes it unlawful for a person or business entity to manufacture,deliver, receive, operate, lease or sell gaming devices in interstate orforeign commerce unless that person or entity has first registered with theAttorney General of the United States. Violation of the Federal Act may resultin seizure and forfeiture of the equipment, as well as other penalties.

***Native American GamingRegulation.******  ***Gaming on Native American lands isgoverned by the Federal Indian Gaming Regulatory Act of 1988 (“IGRA”) andspecific tribal ordinances and regulations. Class III gaming, as definedunder IGRA, also requires a Tribal-State Compact, which is a written agreementbetween a specific tribe and the respective state. This compact authorizes thetype of Class III gaming activity and the standards, procedures andcontrols under which the Class III gaming activity must be conducted. TheNational Indian Gaming Commission (“NIGC”) has oversight authority over gamingon Native American lands and generally monitors tribal gaming including theestablishment and enforcement of required minimum internal control standards.Each Tribe is sovereign and must have a tribal gaming commission or officeestablished to regulate tribal gaming activity to ensure compliance with IGRA,NIGC, and its Tribal-State Compact. We have complied with each of the numerousvendor licensing and specific product approval and shipping notificationrequirements imposed by Tribal-State Compacts and enforced by tribal and/orstate gaming agencies under IGRA in the Native American lands in which we dobusiness.

***Other Jurisdictions.******  ***We haveobtained or are in the process of obtaining all licenses/permits required byjurisdictions having legalized gaming. In general, such requirements aresimilar to Nevada in that there are company approvals as well as individual andproduct approvals.

***Product Approvals.******  ***Each of ourproducts is subject to extensive testing and review by multiple state,jurisdictional or third party laboratories. The detail and extent of the reviewgenerally depends upon the classification of the product by the respectivegaming authority as a new game, game variation, associated equipment, gamingequipment or gaming device. The time required for product testing can beextensive and is subject to a wide range of formal and informal standards thatcan lead to great uncertainty as to the length of the regulatory approvalprocess. Additionally, product testing is subject to changing standards, as aresult of which, we may be required to upgrade or revise our products. Webelieve the laboratories responsible for testing are handling a great number ofproduct submissions and are under the pressure of limited funding andresources. Such limitations could cause our product approvals to be delayed forunknown periods of time. A description of regulatory status and issues relatedto each of our product segments follows:

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*UtilityProducts—We*have obtained approvals for our shufflerproducts, excluding developmental models*,*inall gaming markets in North America where casino and poker gaming is legalized.We have also received or filed (directly or through our internationaldistributors) for approval of our shuffler products and related software inadditional international jurisdictions where required. Our shufflers andrelated software are typically classified and approved as associated equipmentor as gaming equipment, depending on the particular jurisdiction and theirregulations. Associated equipment is equipment that is not classified as agaming device or gaming equipment but, which due to its integral relationshipto the conduct of licensed gaming, regulatory authorities have discretion torequire manufacturers and distributors to meet licensing or suitabilityrequirements prior to or concurrent with the use of such equipment in therespective jurisdiction. Although the classifications of shufflers vary amongjurisdictions, most, if not all, jurisdictions require specific hardware andsoftware approvals and certain licenses or permits to be held by companies,their key personnel, and service technicians in connection with themanufacture, distribution, service, and repair of such equipment.

*EntertainmentProducts—Our*Let It Ride and Three Card Poker tablegames are approved in all major casino gaming markets in North America andnumerous other international gaming jurisdictions. Four Card Poker, UltimateTexas Hold’em, Fortune Pai Gow Poker, and Royal Match 21 are approved in mostjurisdictions in North America, with additional approvals expected throughoutfiscal 2007. We intend to submit Black Jack Press, Streak Shooter, andprogressive versions Three Card Poker and Fortune Pai Gow Poker to regulatorylaboratories for approvals in the first two quarters of fiscal 2007. Similarapprovals will be required for any future table games and related equipment.

Our Table Master multi-player video table game unitwith blackjack was first submitted for regulatory testing in the third quarterof fiscal 2004 and is currently approved in multiple jurisdictions.Additionally, our Table Master unit with Three Card Poker and Let It Ride Bonuswas approved in certain jurisdictions in fiscal 2005. We will continue tosubmit Table Master with other proprietary games to various regulatorylaboratories for testing during fiscal 2007.

Our Vegas Star multi-playervideo table game unit with Roulette was first submitted for regulatory testingin the fourth quarter of fiscal 2003 and is currently approved in keyAustralian jurisdictions, tribal North American jurisdictions and Macau.Additional games have included Sic Bo, Dragon Bonus, Blackjack, Bet the Set “21”and a Wide Area Progressive Blackjack. Vegas Star is currently submitted forapproval for Gaming Laboratories International, Inc. markets acrossNorth America and has a variety of new games under development for allmarkets.

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**OTHERBUSINESS INFORMATION**

***Customer Service.******  ***As part of ourstrategy to maintain and expand our market position, we have made a commitmentto maintain a high level of service to our customers. We have numerous fieldservice centers in the United States and internationally, including our mostrecently opened service center in Macau. Within our service areas, we provideregular preventative maintenance service and on-demand repair service for ourleased equipment, provide service training to our customers, and provideback-up units to our lessees. For casinos that purchase our products, we offerservice contracts providing service benefits similar to those of leased unitsor parts-only warranty contracts.

***Research andDevelopment Costs.******  ***Because we believe that one of ourstrengths is identifying new product opportunities and developing new products,we expect to continue to spend a significant portion of our annual revenues onresearch and development, including the acquisition of intellectual propertyfrom third parties. Our total research and development expenses for continuingoperations were $12,910, $7,784, and $6,185 in fiscal 2006, 2005, and 2004,respectively.

***Significant CustomerSales, Foreign Sales and Foreign Assets.*****  **For the years ended October 31, 2006, 2005 and2004, sales to customers outside the United States accounted for 44%, 23%, and23%, respectively, of consolidated revenue. At October 31, 2006, onecustomer’s balance accounted for 12% of our trade accounts receivable, net. Nosingle customer’s balance exceeded 10% of our investment in sales-type leasesand notes receivable. At October 31, 2006, no individual customeraccounted for more than 10% of consolidated revenue. As of October 31,2006, approximately 72% of our long-lived assets, primarily acquired intangibleassets, were outside the United States. Additional information regarding ourforeign sales and long-lived assets by geographic region is included in Note 15to our consolidated financial statements.

***Seasonality and Business Fluctuations.*****  **Quarterly revenue and net income mayvary based on the timing of the opening of new gaming jurisdictions, theopening or closing of casinos or the expansion or contraction of existingcasinos, gaming regulatory approval or denial of our product and corporatelicenses, the introduction of new products or the seasonality of customercapital budgets.

***Employees.*****  **As of October 31, 2006, we had approximately 550employees. We are not subject to any collective bargaining agreement and webelieve that our employee relations are good.

***Stargames.******  ***As discussed in Note 3 to ourconsolidated financial statements, on February 1, 2006, our wholly ownedindirect subsidiary, Shuffle Master Australasia Pty. Ltd., completed itsacquisition of Stargames by purchasing 95% of the outstanding Stargames sharesfor AU$1.55 per share. We began consolidating Stargames’ operating results asof February 1, 2006. Effective March 8, 2006, we had acquired 100% ofthe outstanding Stargames shares. The shares purchase was funded by temporarybridge financing and we secured permanent financing in November 2006. Foradditional information on the financing related to the Stargames acquisition,see Note 8 and Note 17 to our consolidated financial statements.

Stargames is based in Sydney,Australia and develops, manufactures and distributes a wide range of innovativeelectronic entertainment gaming products to worldwide markets. Its productofferings include Rapid Table Games, Vegas Star multi-terminal gaming machines,and a broad line of traditional video slot machines designed most specificallyfor the Australian, Asian and Latin American gaming markets. The Rapid seriesof games, which we previously distributed in the Americas and the Caribbean,combines a live dealer with multi-terminal electronic wagering. Currentofferings include Rapid RouletteTM, Rapid Sic-BoTM and Rapid Big WheelTM. VegasStar multi-terminal gaming machines feature animated dealers and a selection ofpublic domain table games. The Vegas Star Nova line utilizes Stargames’existing slot cabinet to extend the number of wagering terminals for a VegasStar game, while minimizing the footprint required on the gaming floor.Stargames has approximately 210 employees including 80 in design anddevelopment.

Additional information regarding our acquisition ofStargames is included in Note 3 to our consolidated financial statements.

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**ITEM 1A. FORWARDLOOKING STATEMENTS AND RISK FACTORS**

There are statements herein which are forward-lookingstatements that are based on management’s beliefs, as well as on assumptionsmade by and information available to management. We consider suchstatements to be made under the safe harbor created by the federal securitieslaws to which we are subject, and, other than as required bylaw, we assume no obligation to update or supplement such statements.

These statements can be identified by the fact that theydo not relate strictly to historical or current facts, and are based onmanagement’s current beliefs and expectations about future events, as well ason assumptions made by and information available to management. Theseforward-looking statements include statements that reflect management’sbeliefs, plans, objectives, goals, expectations, anticipations, and intentionswith respect to our financial condition, results of operations,future performance and business, including statements relating to our businessstrategy and our current and future development plans. When used inthis report, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,”“project,” “plan,” “predict,” “might,” “may,” “could,” “will”, “feel” andsimilar expressions or the negative thereof, as they relateto us or our management, identify forward-lookingstatements.

Forward-lookingstatements reflect and are subject to inherent known and unknown risks anduncertainties that could cause actual results to differ materially from thoseexpressed or implied. Risk factors that could cause actual results to differmaterially from expectations include, but are not limited to, the following:

·       changesin the level of consumer or commercial acceptance of our existing productsand new products as introduced;

·       increasedcompetition from existing and new products for floor space in casinos;

·       continuedconsolidation of gaming operators which could negatively impact our productpricing;

·       accelerationand/or deceleration of various product development, promotion and distributionschedules;

·       productperformance issues;

·       higherthan expected manufacturing, service, selling, legal, administrative, productdevelopment, promotion and/or distribution costs;

·       changesin our business systems or in technologies affecting our products oroperations;

·       relianceon strategic relationships with distributors and technology and manufacturingvendors;

·       currentand/or future litigation, claims and costs or an adverse judicial finding;

·       taxmatters including changes in state, federal, or foreign state tax legislationor assessments by taxing authorities;

·       acquisitionsor divestitures by us or our competitors of various product lines orbusinesses and, in particular, integration of businesses that we may acquire;

·       changesto our intellectual property portfolio, such as the issuance of newpatents, new intellectual property licenses, loss of licenses, claims ofinfringement or invalidity of patents;

·       regulatoryand jurisdictional issues (e.g., technical requirements and changes, delays inobtaining necessary approvals, or changes in a jurisdiction’s regulatory schemeor approach, etc.) involving us and our products specifically or thegaming industry in general;

·       generaland casino industry economic conditions;

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·       thefinancial health of our casino and distributor customers, suppliers anddistributors, both nationally and internationally;

·       ourability to meet debt service obligations, including our senior convertiblenotes and our senior secured revolving credit facility, which will dependon our future performance and other conditions or events and will besubject to many factors that are beyond our control;

·       adversechanges in the creditworthiness of parties with whom we have significantreceivables;

·       variousrisks related to our customers’ operations in countries outside the UnitedStates, including currency fluctuation risk, which could increase thevolatility of our results from such operations; and

·       ourability to successfully and economically integrate the operations of anyacquired companies such as Stargames.

Additional information onthese and other risk factors that could potentially affect our financialresults may be found in other documents filed with the Securities and ExchangeCommission, including our quarterly reports on Form 10-Q and currentreports on Form 8-K. We urge you to carefully read the followingdiscussion of specific risks and uncertainties that could affect our business.These include, but are not limited to, the following:

***Our intellectualproperty may be infringed, misappropriated or subject to claims of infringementor invalidity.***

Our intellectual property rights are protected under acombination of patent, trademark, copyright and trade secret laws, as well aslicensing agreements and third-party nondisclosure and assignment agreements.Because of the differences in foreign patent, trademark and other lawsconcerning proprietary rights, our intellectual property may not receive thesame degree of protection in foreign countries as it would in the UnitedStates. This risk is increased due to our expansion in Australasia through ouracquisition of Stargames. Our failure to obtain or maintain adequate protectionof our intellectual property rights for any reason could have a materialadverse effect on our business, results of operations and financial condition.

We have numerous patents and trademarks, and utilizepatent protection in the United States relating to certain existing andproposed processes and products. We cannot assure you that all of our existingpatents are valid or will continue to be valid, or that any pending patentapplications will be approved. Our competitors have in the past challenged, arecurrently challenging, and may in the future challenge the validity orenforceability of our patents. The patents we own could be challenged,invalidated or circumvented by others and may not be of sufficient scope orstrength to provide us with any meaningful protection or commercial advantage.We cannot assure you that competitors will not infringe on any of our patentsor that we will have adequate resources to enforce our patents.

We also rely on unpatented proprietary technology. Itis possible that others will independently develop the same or similartechnology or otherwise obtain access to our unpatented technology. To protectour trade secrets and other proprietary information, we require employees,consultants, advisors and collaborators to enter into confidentialityagreements. We cannot assure you that these agreements will provide meaningfulprotection for our trade secrets, know-how or other proprietary information inthe event of any unauthorized use, misappropriation or disclosure of such tradesecrets, know-how or other proprietary information. If we are unable tomaintain the proprietary nature of our technologies, it could have a materialadverse effect on our business.

We rely on our trademarks,trade names, and brand names to distinguish our products from the products ofour competitors, and have registered or applied to register many of thesetrademarks. We cannot assure you that our trademark applications will beapproved. Third parties may oppose our trademark applications, or otherwisechallenge our use of the trademarks. In the event that our 

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trademarks are successfullychallenged, we could be forced to rebrand our products, which could result inloss of brand recognition and could require us to devote resources towardsadvertising and marketing new brands. Further, we cannot assure you that competitorswill not infringe our trademarks or that we will have adequate resources toenforce our trademarks.

We also face the risk that wehave infringed third parties’ intellectual property rights. We have manycompetitors in both the United States and foreign countries, some of which havesubstantially greater resources and have made substantial investments incompeting technologies. Some competitors have applied for and obtained, and mayin the future apply for and obtain, patents that may prevent, limit or otherwiseinterfere with our ability to make and sell our products.

Significantlitigation regarding intellectual property rights exists in our industry. Wehave in the past made, are currently making, and may in the future make,enforcement claims against third parties, and third parties have in the pastmade, are currently making, and may in the future make, claims of infringementagainst us or against our licensees or manufacturers in connection with theiruse of our technology. For information on Legal Proceedings, see Note 16 to ourconsolidated financial statements included in Item 8 of this Annual Report on Form 10-K/Afor the year ended October 31, 2006. As discussed in Note 16 to ourconsolidated financial statements for the fiscal year ended October 31,2006, we are currently in litigation over various intellectual propertymatters. Any claims, even those which are without merit, could:

·       beexpensive and time consuming to defend;

·       causeone or more of our patents to be ruled or rendered unenforceable or invalid;

·       causeus to cease making, licensing or using products that incorporate the challengedintellectual property;

·       requireus to redesign, reengineer or rebrand our products;

·       divertmanagement’s attention and resources;

·       requireus to pay significant amounts in damages;

·       requireus to enter into royalty or licensing agreements in order to obtain the rightto use a necessary product, process or component; or

·       limitour ability to bring new products to the market in the future.

Any royalty or licensingagreements, if required, may not be available to us on acceptable terms or atall. A successful challenge to or invalidation of one of our patents ortrademarks, or a successful claim of infringement against us or one of ourlicensees in connection with its use of our technology, could adversely affectour business.

***The gaming industry ishighly regulated, and we must adhere to various regulations and maintain ourlicenses to continue our operations.***

Our products are subject to extensive regulation underthe laws, rules and regulations of the jurisdictions in which they areused. We will also become subject to regulation in any other jurisdiction whereour customers operate in the future. These laws, rules and regulationsgenerally concern the responsibility, financial stability and character of theowners, managers, and persons with financial interests in gaming operations,including makers of gaming equipment such as ourselves. Some jurisdictions,however, empower their regulators to investigate participation by licensees ingaming outside their jurisdiction and require access to and periodic reportsconcerning gaming activities. Violations of laws in one jurisdiction couldresult in disciplinary action in other jurisdictions. For a summary of gamingregulations that affect our business, see “Gaming Regulation” in Item 1 of thisAnnual Report on Form 10-K/A for the year ended October 31,2006.

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In addition, legislative andregulatory changes may affect demand for our products. Such changes couldaffect us in a variety of ways. Legislation or regulation may introducelimitations on our products or opportunities for the use of our products, and couldfoster competitive games or technologies at our or our customers’ expense. Forexample, current regulations in a number of jurisdictions where our customersoperate limit the amount of space allocable to slot machines, and substantialchanges in those regulations may adversely affect demand for our products. Ourbusiness will also suffer if our products became obsolete due to changes inlaws or regulations or the regulatory framework.

Legislative or regulatorychanges negatively impacting the gaming industry as a whole or our customers inparticular could also decrease their demand for our products. Opposition togaming could result in restrictions or even prohibitions of gaming operationsin any jurisdiction, or could result in increased taxes on gaming revenues. Areduction in growth of the gaming industry or in the number of gamingjurisdictions or delays in the opening of new or expanded casinos could reducedemand for our products. We cannot assure you that changes in current or futurelaws or regulations or future judicial intervention in any particularjurisdiction would not have a material adverse effect on our existing andproposed foreign and domestic operations.

***Litigation may subjectus to significant legal expenses and liability.***

We are currently engaged inlitigation on a variety of matters, including, in particular, several suitsregarding our intellectual property rights. For information on our currentmaterial litigation and our current assessments, see Note 16 to ourconsolidated financial statements included in Item 8 of this Annual Report onForm 10-K/A for the year ended October 31, 2006. As discussedin Note 16 to our consolidated financial statements for the fiscal year endedOctober 31, 2006, we are currently in litigation over various intellectualproperty matters. Our current assessment of each matter may change based onfuture unknown or unexpected events. Litigation requires the expenditure ofsignificant time and resources, and is inherently unpredictable. If anylitigation were to have an unanticipated adverse result, there could be amaterial impact on our results of operations or financial position.

***Our products currentlyin development may not achieve commercial success.***

We have a number of productsin various stages of development. We believe that our future success willdepend in large part upon our ability to enhance our existing products and todevelop, introduce and market new products and improvements to our existingproducts. As a result, we expect, as needed, to continue to make significantinvestments in product development. Our development of products is dependent onfactors such as reaching definitive agreements with third parties and obtainingrequisite governmental approvals.

Future technological advancesin the gaming products industry may result in the availability of new productsor increase the efficiency of existing products. We may not be able to accessor finance capital expenditures for new technologies that are morecost-effective or create superior products. We cannot assure you that existing,proposed or as yet undeveloped technologies will not render our technology lessprofitable or less viable, or that we will have available the financial andother resources to compete effectively against companies possessing suchtechnologies.

While we are pursuing and willcontinue to pursue product development opportunities, there can be no assurancethat such products will come to fruition or become successful. Furthermore,while a number of those products are being tested, we cannot provide anydefinite date by which they will be commercially available. We cannot assureyou that these products will prove to be commercially viable, or that we willbe able to obtain the various gaming licenses necessary to distribute them toour customers. We may experience operational problems with such products aftercommercial introduction that could delay or defeat the ability of such productsto generate revenue or operating profits. Future operational problems couldincrease our costs, delay our plans or adversely affect our 

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reputation or our sales ofother products which, in turn, could have a material adverse effect on oursuccess and our ability to satisfy our obligations with respect to ourindebtedness, including the notes and the senior secured revolving creditfacility. We cannot predict which of the many possible future products willmeet evolving industry standards and consumer demands. We cannot assure youthat we will be able to adapt to such technological changes, offer suchproducts on a timely basis or establish or maintain a competitive position.

***We compete in a single industry, and our businesswould suffer if our products become obsolete or demand for them decreases.***

We derive substantially all ofour revenues from the sale, lease, licensing and other financing arrangementsof products for the gaming industry. Our business would suffer if the gamingindustry, in general, and table games in particular, suffered a downturn orloss in popularity, if our products became obsolete or if use of our productsdecreased. Our operating lease agreements with our customers are typicallymonth-to-month leases and provide for termination upon 30 days’ priornotice by either party. Accordingly, consistent demand for and satisfactionwith our products by our customers is critical to our financial condition andfuture success, and problems, defects or dissatisfaction with our productscould cause us to lose customers or revenues from leases with minimal notice.Additionally, our success depends on our ability to keep pace withtechnological changes and advances in our industry and to adapt and improve ourproducts in response to evolving customer needs and industry trends. If demandfor our products weakens due to lack of market acceptance, technologicalchange, competition or other factors, it could have a material adverse effecton our business, financial condition and results of operations and our abilityto achieve sufficient cash flow to service our indebtedness, including thesenior notes and the senior secured revolving credit facility.

***We operate in a verycompetitive business environment.***

There is intense competitionin the gaming products industry, and it is characterized by dynamic customerdemand and rapid technological advances. The development of new competitiveproducts or the enhancement of existing competitive products in any market inwhich we operate could have a negative impact on our business in that market.

In general, we compete withother gaming and entertainment products for space on the casino customer’sfloor, as well as for our customers’ capital spending. Some of the largergaming supply companies with whom we compete with are IGT, BallyTechnologies, Inc., WMS Industries, Inc., and Aristocrat Leisure Limited.

In the Utility Productssegment, we compete with VendingData Corporation, a United States company thatmarkets batch and continuous versions of its multi-deck shuffler, the RandomEjection ShufflerTM and more recently their single deck shuffler, the PokerOneTM. Additionally, other companies may develop and market shufflers and seekto develop and obtain regulatory approvals of additional shuffler products. Wecannot provide assurance that a competitive product will not gain substantialplacements or cause price erosion of our shufflers in the future. Severalcompanies also manufacture and sell chipper products which are competitive withour recently-introduced Easy Chipper product. We believe the most successful ofthese products is the Chipper Champ PlusTM, sold by TCS John Huxley.

In our Entertainment Productssegment, the market for live table games is characterized by numerouscompetitors who develop and license proprietary table games. Some of ourcompetitors’ widely known proprietary table game titles include PGIC’sCaribbean Stud® andTexas Hold’em BonusTM, Galaxy Gaming’s Lucky LadiesTM and Masque Publishing’sSpanish 21®. Competitionin the table game market is typically based on price, brand recognition, andthe strength of underlying intellectual property. There is more competitionfrom smaller developers and vendors in the table games segment 

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because of the lower cost andcomplexity associated with the development of these products. In the future,table game competitors could market table games that might displace ourproducts.

With our acquisition of Stargames, we have increasedour Entertainment product lines to expand our multi-player table games. Thisproduct line has significantly more competition than our traditional Utilityand Entertainment product offerings. There are numerous other companies thatmanufacture and/or sell multi-player table games, which are similar to ourTable Master, Vegas Star and Rapid Table Games products. These companiesinclude, but are not limited to, Elektroncek (also known as Interblock), AruzeCorporation, PacificNet Inc., Novomatic Group Companies, IGT,PokerTek, Inc. and TableMAX Holdings. Lastly, our Electronic GamingMachines also compete for casino floor space with gaming suppliers such as IGTand Aristocrat Leisure Limited.

We are working to developplayer tracking and data gathering technologies of Table iD, and we believethat several existing gaming companies are working to develop similarcompetitive technologies. These companies, or others, may own intellectualproperty that is superior to ours, has priority over ours or prevents us frommarketing Table iD without a license arrangement concerning such intellectualproperty. We cannot assure you that we will be able to compete effectively inthis market, or that our competitors will not develop superior technologies orproducts.

***If we do not retain ourkey personnel and attract and retain other highly skilled employees, ourbusiness may suffer.***

If we fail to retain, recruit and motivate thenecessary personnel, our business and our ability to obtain new customers,develop new products and provide acceptable levels of customer service couldsuffer. The success of our business is heavily dependent on the leadership ofour key management personnel and on our key employees. Our employment contractswith our corporate officers and certain other key employees are primarily “atwill” employment agreements, under which the employee or we may terminateemployment. If any of these persons were to leave our company it could bedifficult to replace them, and our business could be harmed. We do not havekey-man life insurance.

Our success also depends onour ability to recruit, retain and motivate highly skilled service, sales,marketing and engineering personnel. Competition for these persons in ourindustry is intense and we may not be able to successfully recruit, train orretain qualified personnel.

***A downturn in generaleconomic conditions or in the gaming industry or a reduction in demand forgaming may adversely affect our results of operations.***

Our business operations areaffected by international, national and local economic conditions. A recessionor downturn in the general economy, or in a region constituting a significantsource of our customers, or a reduction in demand for gaming, could harm thehealth of casino operators and our other customers, and consequently result infewer customers purchasing or leasing our products, which would adverselyaffect our revenues.

***Acts of terrorism aswell as other factors affecting discretionary consumer spending and travel,have impacted our industry and may harm our operating results.***

The terrorist attacks ofSeptember 11, 2001 and other recent terrorist incidents have had asignificant impact on the travel, tourism and gaming industries in which ourcustomers operate. The significant reduction in both business and leisuretravel following the September 11th event significantly reduced patronage of orvisits to our customers’ properties, particularly in Las Vegas, with the resultthat many of our customers’ operating results declined significantly. Theseevents, the potential for future terrorist attacks, the national andinternational responses to terrorist attacks and other acts of war or hostilityhave created many economic and political uncertainties that could adverselyaffect our 

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business and results ofoperations. Future acts of terror or hostilities may again reduce ourcustomers’ guests’ willingness to travel, with the result that our customers’operations will suffer, which could have an impact on our operating results.

***Economic, political andother risks associated with our international sales and operations couldadversely affect our operating results.***

Since we sell ourproducts worldwide, our business is subject to risks associated with doingbusiness internationally. Our sales to customers outside the United States,primarily Canada, Europe and Australasia, accounted for approximately 44% ofour consolidated revenue in fiscal 2006. We expect the percentage of ourinternational sales to increase in fiscal 2007 and thereafter due to ouracquisition of Stargames in February 2006. Accordingly, our future resultscould be harmed by a variety of factors, including:

·       changesin foreign currency exchange rates;

·       exchangecontrols;

·       changesin regulatory requirements;

·       changesin a specific country’s or region’s political or economic conditions;

·       tariffs,other trade protection measures and import or export licensing requirements;

·       potentiallynegative consequences from changes in tax laws or application of such tax laws;

·       difficultyin staffing and managing widespread operations;

·       changinglabor regulations;

·       requirementsrelating to withholding taxes on remittances and other payments bysubsidiaries;

·       differentregimes controlling the protection of our intellectual property;

·       restrictionson our ability to own or operate subsidiaries, make investments or acquire newbusinesses in these jurisdictions; and

·       restrictionson our ability to repatriate dividends from our subsidiaries.

Our international operations are affected by globaleconomic and political conditions. Changes in economic or political conditionsin any of the countries in which we operate could result in exchange ratemovement, new currency or exchange controls or other restrictions being imposedon our operations.

Fluctuations in the value of the U.S. dollar, the Euroor the Australian dollar may adversely affect our results of operations.Because our financial results are reported in dollars, if we generate sales orearnings in other currencies, the translation of those results into dollars canresult in a significant increase or decrease in the amount of those sales orearnings.

We also have agreements withcasinos in Native American jurisdictions, which may subject us to sovereignimmunity risk and could subject us to additional compliance costs.

***We could face considerable business and financial riskin implementing acquisitions.***

As part of our overall growth strategy, we have in thepast acquired, and will continue to seek to acquire, complementary products,assets and businesses. We regularly engage in discussions with respect to andinvestigate possible acquisitions. Future acquisitions could result inpotentially dilutive issuances of equity securities, significant expendituresof cash, the incurrence of debt and contingent 

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liabilities and an increase in amortization expenses,which could have a material adverse effect upon our business, financialcondition and results of operations.

The risks associated with acquisitions could have a materialadverse effect upon our business, financial condition and results ofoperations. We cannot assure that we will be successful in consummating futureacquisitions on favorable terms or at all or that any future acquisition willwork out as we expect.

Our acquisition ofStargames, and any other future potential acquisitions, may not produce therevenues, earnings or business synergies that we anticipate, and theacquisition of Stargames may not perform as expected for a variety of reasons,including:

·       difficultiesin the integration of the operations, financial reporting, technologies,products and personnel, including those caused by national, geographic andcultural differences;

·       risksof entering markets in which we have no or limited prior experience;

·       difficultiesin the use, development or sale of intellectual property or future or presentproducts;

·       potentialloss of employees;

·       currencyfluctuations or changes in exchange rates in connection with sales to customersin foreign currencies;

·       diversionof management’s attention away from other business concerns; and

·       expensesof any undisclosed or potential legal liabilities.

Both Stargames, an Australiancompany, and CARD, an Austrian company, substantially increase our exposure tothe risks of international operations. Additionally, all of the risksapplicable to our business also apply to Stargames and CARD. Any one or acombination of these factors may cause our revenues or earnings to decline.

***If our products containdefects, our reputation could be harmed and our results of operations adverselyaffected.***

Some of our products arecomplex and may contain undetected defects. The occurrence of defects ormalfunctions could result in financial losses for our customers and in turntermination of leases, cancellation of orders, product returns and diversion ofour resources. Any of these occurrences could also result in the loss of ordelay in market acceptance of our products and loss of sales.

***Our business is subject to quarterly fluctuation.***

Historically, our operatingresults have been highest in our fourth fiscal quarter ending October 31and lowest in our first fiscal quarter ending January 31, primarily due tothe seasonality of customer capital budgets. Our quarterly operating resultsmay vary based on the timing of the opening of new gaming jurisdictions, theopening or closing of casinos, the expansion or contraction of existingcasinos, approval or denial of our products and corporate licenses under gamingregulations, the introduction of new products, the seasonality of customercapital budgets, the mix of domestic versus international sales and the mix ofSales and Service revenue versus Lease and Royalty revenue. As a result, ouroperating results and stock price could be volatile, particularly on aquarterly basis.

***Our ability to meetdebt service obligations is subject to many factors that are beyond our controland may affect future operations.***

On November 30,2006, we entered into a $100,000 senior secured revolving credit facility (the “NewCredit Agreement”) with Deutsche Bank AG Cayman Islands Branch, as a Lender,Deutsche Bank 

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Trust Company Americas,as Administrative Agent, Deutsche Bank Securities Inc. and Wells Fargo, N.A.,as Joint Lead Arrangers and Book Managers and Wells Fargo, N.A. as SyndicationAgent. We drew $71,180 on the facility, which was used to repay in its entiretythe Old Credit Agreement (as defined below). Any remaining amount availableunder the revolving credit facility will be used for working capital, capitalexpenditures and general corporate purposes, including share repurchases. Therevolving credit facility under the New Credit Agreement will mature on November 30,2011. Our ability to meet debt service obligations, including ourconvertible notes and the New Credit Agreement, will depend on our futureperformance and other conditions or events and will be subject to many factorsthat are beyond our control. Our debt service obligations may:

·       increaseour vulnerability to general adverse economic and industry conditions;

·       limitour flexibility in planning for, or reacting to, changes in our business andindustry;

·       placeus at a competitive disadvantage compared to other less leveraged competitors;and

·       limitour ability to borrow additional funds.

**ITEM 1B. UNRESOLVEDSTAFF COMMENTS**

None.

**ITEM 2. PROPERTIES**

We lease facilities with approximately 83,000 squarefeet in Nevada for our corporate headquarters, manufacturing, research anddevelopment and field service. In addition, we lease an approximately 11,000square foot facility in Vienna, Austria and an approximately 32,000 square footfacility in Sydney, Australia.

We also own an approximately 48,000 square footfacility in Sydney, Australia that we use for research and developmentactivities as well as manufacturing.

We have other shuffler research and development andother administration activities located in an approximately 5,000 square footfacility in Minnesota.

We believe that our existingproperties are suitable and adequate for our current needs and that additionalfacilities are available in our current locations to support expansion, ifrequired.

**ITEM 3. LEGALPROCEEDINGS**

For information on Legal Proceedings, see Note 16 toour consolidated financial statements included in Item 8 of this Annual Report.

Litigation is inherentlyunpredictable. Our current assessment of each matter may change based on futureunknown or unexpected events. If any litigation were to have an adverse resultthat we did not expect, there could be a material impact on our results ofoperations or financial position. We believe costs associated with litigationwill not have a material impact on our financial position or liquidity, but maybe material to the results of operations in any given period. We assume noobligation to update the status of pending litigation, except as may berequired by applicable law, statute or regulation. We believe that the finaldisposition of these matters will not have a material adverse effect on ourfinancial position, results of operations or liquidity.

**ITEM 4. SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

No matters were submitted to a vote of our securityholders during the fourth quarter of the fiscal year ended October 31,2006.

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**PART II(Dollars in thousands, except per share amounts)**

**ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

***Stock Listing.******  ***Our common stock is traded on TheNASDAQ National Market under the symbol SHFL. As of January 12, 2007, wehad approximately 260 shareholders of record. There are a significantly greaternumber of shareholders whose shares are held in street name. Based oninformation we collected as of January 12, 2007, we estimate that we haveapproximately 14,000 beneficial holders in total. The following table setsforth quarterly high and low prices for trades of our common stock duringfiscal 2006 and 2005:

| ** **     | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 28.90      |     | $          | 23.88 |   | $ | 32.26 |   | $ | 26.47 |   |
| Second Quarter |       | 38.35    |       | 22.49    |       | 33.77 |   | 23.78 |   |
| Third Quarter  |       | 40.75    |       | 26.62    |       | 30.00 |   | 25.32 |   |
| Fourth Quarter |       | 30.53    |       | 24.09    |       | 29.21 |   | 22.77 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

The closing price of our common stock on January 12,2007, was $25.99 per share.

***Dividend Policy.******  ***We have not paid dividends onour common stock.

***Transfer Agent.******  ***Our stock transfer agent andregistrar is Wells Fargo Bank Minnesota, N.A., Shareowner Services, 161 NorthConcord Exchange, South St. Paul, Minnesota 55075, (800) 468-9716.

***Securities Authorized forIssuance Under Equity Compensation Plans.*****  **The information under the caption “EquityCompensation Plan Information” in our 2006 Proxy Statement is incorporatedherein by reference.

***Stock Splits.******  ***In December 2004,our board of directors approved a three-for-two common stock split, with newshares distributed in the form of a dividend on January 14, 2005, toshareholders of record on January 3, 2005 (the “January 2005 Split”).Share and per share amounts have been adjusted for all periods presented hereinto reflect the January 2005 Split. In connection with the January 2005Split, we paid cash of $68 for fractional shares and reclassified to commonstock the par value of $0.01 per newly issued share.

In****March 2004, our board of directors had earlier approvedanother three-for-two common stock split, with new shares distributed in theform of a dividend on April 16, 2004, to shareholders of record on April 5,2004 (the “April 2004 Split”). Share and per share amounts have beenadjusted for all periods presented herein to reflect the April 2004 Split.In connection with the April 2004 Split, we paid cash of $138 forfractional shares and reclassified to common stock the par value of $0.01 pernewly issued share.

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***Stock Repurchases.******  ***The following table providesmonthly detail regarding our share repurchases during the three month periodended October 31, 2006 (in thousands, except per share amounts):

| **Period**          | ** ** | ** ** | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price  Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Dollar  Value of Shares  that May Yet Be  Purchased Under  the Plans or  Programs *** | ** ** |
|---------------------|------------|------------|------------|------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Aug 1 – Aug 31 |       |       | 91         |                                                 |       |                                         | $          | 28.35                                                                                                                            |       |                                                                                                                                              |       | 91 |   |   |   | $ | 2,712 |   |   |
| Sep 1 – Sep 30 |       |       | 100        |                                                 |       |                                         | $          | 25.46                                                                                                                            |       |                                                                                                                                              |       | 100 |   |   |   | $ | 30,166 |   |   |
| Oct 1 – Oct 31 |       |       | —     |                                                 |       |                                         | $          | —                                                                                                                           |       |                                                                                                                                              |       | — |   |   |   | $ | 30,166 |   |   |
| Total               |       |       | 191        |                                                 |       |                                         |       |                                                                                                                             |       |                                                                                                                                              | 191        |   |   |   |   |   |   |

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*                    InSeptember 2006, our board of directors authorized management to repurchaseup to $30,000 of our common stock in the open market under a share repurchaseprogram with no expiration. As of October 31, 2006, $30,166 remainedoutstanding under our board authorizations.

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**ITEM 6.SELECTED FINANCIAL DATA**

| ** **                                            | ** ** | **Year Ended October 31,**                                                              | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share, ratios, and unit amounts)** | ** ** |
| **Operating Results:**                                |       |                                                                                                   |       |   |   |   |   |   |   |   |   |
| Total revenue                                         |       | $                                                                                                      | 162,991    |   | $ | 112,860 |   | $ | 84,783 |   | $ | 58,351 |   | $ | 48,677 |   |
| Cost of revenue                                       |       | 56,721                                                                                                 |       | 29,260 |   | 19,403 |   | 11,599 |   | 11,092 |   |
| Gross profit                                          |       | 106,270                                                                                                |       | 83,600 |   | 65,380 |   | 46,752 |   | 37,585 |   |
| Selling, general and  administrative                  |       | 51,299                                                                                                 |       | 30,559 |   | 22,953 |   | 15,788 |   | 12,890 |   |
| Research and  development                             |       | 12,910                                                                                                 |       | 7,784 |   | 6,185 |   | 4,183 |   | 2,667 |   |
| Gain on sale of  patent                               |       | (4,566                                                                                                 | )          | — |   | — |   | — |   | — |   |
| In-process research  and development                  |       | 19,145                                                                                                 |       | — |   | — |   | — |   | — |   |
| Income from  operations                               |       | 27,482                                                                                                 |       | 45,257 |   | 36,242 |   | 26,781 |   | 22,028 |   |
| Other (expense)  income                               |       | (6,699                                                                                                 | )          | (657 | ) | (1,600 | ) | 256 |   | 650 |   |
| Equity method investment  loss                        |       | (416                                                                                                   | )          | — |   | — |   | — |   | — |   |
| Impairment of  investments                            |       | (1,655                                                                                                 | )          | (1,000 | ) | — |   | — |   | — |   |
| Income from  continuing operations before tax    |       | 18,712                                                                                                 |       | 43,600 |   | 34,642 |   | 27,037 |   | 22,678 |   |
| Provision for income  taxes                           |       | 13,373                                                                                                 |       | 14,496 |   | 12,125 |   | 9,458 |   | 7,937 |   |
| Income from continuing  operations                    |       | $                                                                                                      | 5,339      |   | $ | 29,104 |   | $ | 22,517 |   | $ | 17,579 |   | $ | 14,741 |   |
| **Earnings  per share — continuing operations:** |       |                                                                                                   |       |   |   |   |   |   |   |   |   |
| Basic                                                 |       | $                                                                                                      | 0.15       |   | $ | 0.83 |   | $ | 0.63 |   | $ | 0.47 |   | $ | 0.37 |   |
| Diluted                                               |       | $                                                                                                      | 0.15       |   | $ | 0.80 |   | $ | 0.60 |   | $ | 0.45 |   | $ | 0.36 |   |
| Weighted average  shares, basic                       |       | 34,585                                                                                                 |       | 34,924 |   | 35,955 |   | 37,626 |   | 39,821 |   |
| Weighted average  shares, diluted                     |       | 36,052                                                                                                 |       | 36,378 |   | 37,308 |   | 38,661 |   | 41,211 |   |
| Dividends declared                                    |       | $                                                                                                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| **Balance  Sheet as of October 31:**             |       |                                                                                                   |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents, and investments              |       | $                                                                                                      | 8,917      |   | $ | 34,088 |   | $ | 47,038 |   | $ | 10,425 |   | $ | 19,422 |   |
| Working capital                                       |       | $                                                                                                      | (18,895    | ) | $ | 57,634 |   | $ | 65,671 |   | $ | 25,809 |   | $ | 31,775 |   |
| Total assets                                          |       | $                                                                                                      | 305,207    |   | $ | 193,117 |   | $ | 185,292 |   | $ | 59,418 |   | $ | 60,603 |   |
| Long-term obligations                                 |       | $                                                                                                      | 164,367    |   | $ | 162,659 |   | $ | 157,648 |   | $ | 250 |   | $ | 1,518 |   |
| Shareholders’ equity                             |       | $                                                                                                      | 32,549     |   | $ | 13,400 |   | $ | 14,729 |   | $ | 47,723 |   | $ | 50,267 |   |
| Common shares  outstanding                            |       | 34,895                                                                                                 |       | 34,527 |   | 34,958 |   | 37,072 |   | 38,871 |   |
| Current ratio                                         |       | 0.8                                                                                                    |       | 4.4 |   | 6.2 |   | 3.3 |   | 4.6 |   |
| Book value per share  as of October 31           |       | $                                                                                                      | 0.93       |   | $ | 0.39 |   | $ | 0.42 |   | $ | 1.29 |   | $ | 1.29 |   |
| **Cash  Flow Data:**                                  |       |                                                                                                   |       |   |   |   |   |   |   |   |   |
| Cash provided by  operating activities                |       | $                                                                                                      | 34,021     |   | $ | 34,508 |   | $ | 26,587 |   | $ | 20,630 |   | $ | 18,957 |   |
| Cash (used) provided  by investing  activities        |       | $                                                                                                      | (104,142   | ) | $ | (6,526 | ) | $ | (56,540 | ) | $ | 754 |   | $ | (6,006 | ) |
| Cash (used) provided  by financing  activities        |       | $                                                                                                      | 65,923     |   | $ | (35,027 | ) | $ | 47,859 |   | $ | (22,314 | ) | $ | (12,429 | ) |
| Depreciation and  amortization                        |       | $                                                                                                      | 18,173     |   | $ | 12,179 |   | $ | 8,042 |   | $ | 8,126 |   | $ | 7,406 |   |
| Capital expenditures                                  |       | $                                                                                                      | (15,676    | ) | $ | (18,969 | ) | $ | (7,143 | ) | $ | (5,584 | ) | $ | (5,976 | ) |
| **Installed  Unit Base by Product:**                  |       |                                                                                                   |       |   |   |   |   |   |   |   |   |
| Shufflers                                             |       | 22,347                                                                                                 |       | 18,589 |   | 15,289 |   | 11,090 |   | 9,475 |   |
| Proprietary Table  Games                              |       | 4,219                                                                                                  |       | 3,681 |   | 3,233 |   | 1,732 |   | 1,527 |   |
| Multi-Terminal Gaming  Seats                          |       | 4,576                                                                                                  |       | 510 |   | 100 |   | — |   | — |   |
| Electronic Gaming Machine  Seats                      |       | 16,279                                                                                                 |       | — |   | — |   | — |   | — |   |

 

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See Note 2 to the Consolidated Financial Statements,Restatement of Consolidated Financial Statements, for a description of therestatement of our previously filed consolidated financial statements as of October 31,2006 and for the year then ended.

Earnings per share and weighted average share amountsreflect the effect of the January 2005 Split and the April 2004Split.

Effective February 1, 2006, we acquiredStargames. Effective May 1, 2004, we acquired Casinos Austria Research &Development GmbH & Co KG and its wholly-owned subsidiaries (“CARD”).Effective February 24, 2004, we acquired certain assets of BET Technology, Inc.(“BTI”). These acquisitions, in addition to less significant acquisitions, areincluded in our consolidated financial statements beginning on the effectivedate of the transactions; see Note 3 to our consolidated financial statementsfor further detail on our acquisitions.

Installed Unit Base is the sum of product units orseats under lease or license agreements and inception-to-date sold units orseats. We believe that installed units is an important gauge of segmentperformance because it measures historical market placements of leased and soldunits or seats and it provides insight into potential markets for service andnext generation products. Some sold units or seats may no longer be in use byour casino customers or may have been replaced by other models. Accordingly, weare unable to determine precisely the number of units or seats currently inuse.

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**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

As discussed in Note 2 to theconsolidated financial statements, our financial statements as of and for theyear ended October 31, 2006 have been restated. The accompanyingmanagement’s discussion and analysis gives effect to that restatement.

**BUSINESS OVERVIEW(In thousands, except units)**

We develop, manufacture and market technology andentertainment-based products for the gaming industry for placement on the casinofloor. Our products primarily relate to our casino customers’ table gameactivities and focus on either increasing their profitability, productivity andsecurity or expanding their gaming entertainment offerings.

Our Utility Products include a full line of automaticcard shufflers for use with the vast majority of card table games as well aschip sorting machines for use on Roulette tables. We also have acquired and/orare developing other products that automatically gather data to enable casinosto track table game play, such as Table iD (part of our Intelligent TableSystemTM), currently in development with International Game Technology (“IGT”)and Progressive Gaming International Corporation (“PGIC”).

Our Entertainment Products include our portfolio oflive proprietary poker, blackjack, baccarat, and pai gow poker-based tablegames and side bets as well as several electronic content delivery systemplatforms including Table MasterTM, Vegas StarTM, Rapid Table Games and wirelessCasino On DemandTM.

We sell, lease or license our products. When we sellour products, we offer our customers a choice between a sale, a longer-termsales-type lease or other long-term financing. When we lease or license ourproducts, we generally negotiate a month-to-month operating lease. We offer ourproducts worldwide in markets that are highly regulated. We manufacture ourproducts 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 withother gaming products, such as slot machines, blackjack tables, keno, craps,and roulette, for space on the casino floor.

Our internet address is *www.shufflemaster.com*.Through the “Investor Relations” page on our internet website, our AnnualReport on Form 10-K, Proxy Statement, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K, and amendments to those reports filedor furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act are available free of charge, as soon as reasonablypractical after such information has been filed or furnished to theSecurities and Exchange Commission. Additional information regardingShuffle Up Productions can be accessed at *www.shuffleupproductions.com*.

Management’s Discussion andAnalysis contains forward-looking statements. These statements are based oncurrent expectations and assumptions that are subject to risks anduncertainties. Actual results could differ materially because of factorsdiscussed in “Forward Looking Statements and Risk Factors” elsewhere in thisAnnual Report.

**ACQUISITIONS, OTHERSIGNIFICANT TRANSACTIONS AND DISPOSITIONS**

***Stargames.******  ***On February 1, 2006, weannounced that our wholly owned indirect subsidiary, Shuffle Master AustralasiaPty. Ltd., had substantially completed its acquisition of Stargames, a gamingcompany that develops, manufactures and distributes a wide range of innovativeelectronic 

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entertainment gaming products to worldwide markets, bypurchasing 95% of the outstanding Stargames shares. Effective March 8,2006, we had acquired 100% of the outstanding Stargames shares for AU $1.55 pershare. Accordingly, the results of Stargames have been included in ourconsolidated financial statements beginning February 1, 2006.

Stargames product offerings are classified asEntertainment Products and include Rapid Table Games and Vegas Starmulti-terminal gaming machines, and a broad line of traditional video slotmachines designed for the Australian, Asian and Latin American gaming markets.The Rapid series of games, which we previously distributed in the Americas andthe Caribbean, combines a live dealer with multi-terminal electronic wagering.Current offerings include Rapid Roulette, Rapid Sic-Bo and Rapid Big Wheel.Vegas Star multi-terminal gaming machines currently feature animated dealersand a selection of public domain table games. The Vegas Star Nova line utilizesStargames’ existing slot cabinet to extend the number of wagering terminals fora Vegas Star game, while minimizing the footprint required on the gaming floor.

***IGT Agreement.******  ***On April 28, 2006, weentered into an agreement (“April Agreement”) with IGT whereby we assigned,transferred, and conveyed to IGT, our 50% share of future royalties from thelicensing of the ENPAT patents to any third party or from otherwise permittingany third party to use the ENPAT patents. The total royalties to be received byIGT is limited to an amount equal to a net present value of $3,000 utilizing adiscount factor of 12% (the “Royalty Amount”). Upon the receipt by IGT of theRoyalty Amount, all royalty payments with respect to our 50% share of the ENPATpatents shall resume and be paid to us. The total non-refundable considerationpaid to us was $3,000.

On July 31, 2006, we entered into anotheragreement with IGT whereby we sold to IGT our remaining 50% ownership in theENPAT patents. This agreement rescinded certain provisions of the April Agreementwhereby we assigned, transferred, and conveyed to IGT our 50% share of thefirst $3,000 of future royalties from the licensing of the ENPAT patents to anythird party or from otherwise permitting any third party to use the ENPATpatents. The consideration for the remaining 50% ownership of the ENPAT patentswas the $3,000 previously received from IGT pursuant to the April Agreementbetween us and IGT, plus a payment of an additional $4,500. This payment was inlieu of the $4,875 that would have been due, at IGT’s discretion, under thepatent purchase agreement entered into on June 13, 2005 between us andIGT. As a result, IGT shall receive 100% of the future royalties on the ENPATpatents until IGT has earned a total of $17,400 in gross royalties; thereafterIGT will pay us 17 1⁄2% of any gross royalties. The transaction has beenreflected in the accompanying consolidated statements of income by recording again on sale of patent of $4,566.

***Sona Mobile.******  ***In January 2006, weentered into a licensing and distribution agreement with Sona Mobile HoldingsCorp. (“Sona”) to license, develop, distribute and market “in-casino” wirelesshandheld gaming content and delivery systems to casinos and through other legalgaming modes throughout the world. On January 25, 2006, we completed aprivate equity investment and purchased approximately 2,300 shares of Sona’scommon stock at the price of $1.30 per share for approximately $3,000. Thisprivate equity investment is pursuant to a stock option agreement between usand Sona dated December 29, 2005. Additionally, as part of our investmentin Sona, we received one seat on the Sona Board of Directors and 1,200 warrantsto purchase shares of Sona’s common stock at a discount to the grant date fairvalue. On June 30, 2006, we purchased approximately 1,667 additionalshares of Sona’s common stock at the price of $0.60 per share for approximately$1,000. These shares were purchased through a private equity investment alongwith other accredited investors. As part of the second private equityinvestment, we also received an additional 833 warrants to purchase shares ofSona’s common stock at prices as specified in the agreement. The investment inSona is accounted for under the equity method of accounting in accordance withFinancial Accounting Standards Board (“FASB”) APB No. 18 (“APB 18”), “*The Equity Method of Accounting for Investments in Common Stock”*and is included in Other long-term assets in our consolidated balance sheet asof October 31, 2006. Accordingly, we recognized Equity method investmentlosses of $416 for the twelve 

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months ended October 31, 2006, which representsour pro rata share of Sona’s net loss for the period.

As of October 31, 2006, we determined that thedecline in fair value below the carrying value of our investment in Sona wasother than temporary. To evaluate the fair value of our investment in Sona, weused the market price of a share of Sona common stock as of October 31,2006, multiplied by the number of shares owned. In making that determination,we considered forecasts about Sona’s financial performance and near-termprospects. As a result, we recognized a pre-tax impairment charge totaling$1,655 during the quarter and year ended October 31, 2006.

***Progressive Gaming Licenses.******  ***On September 29, 2006,we entered into an agreement whereby we obtained the “last license” rights toutilize an extensive portfolio of jackpot wagering hardware and method patentsheld by PGIC. Under the terms of the agreement, we have the right to utilizethe suite of over forty patents on tables and other games in any form includinglive tables, electronic single and multi-player units, and wireless wageringdevices. Under the agreement, we also acquired the right to sub-license use ofthe technology. PGIC has further agreed that it will not grant or permit anyadditional licenses to other manufacturers or suppliers to the technology inthe future. In exchange for a fully-paid, royalty-free, fully-transferableworld-wide license to the complete patent suite, we paid $3,500 to PGIC duringthe three months ended October 31, 2006.

**DISPOSITIONS**

In December 2003, our board of directors approvedand we committed to a plan to divest our North America slot productsoperations and assets, based on our determination that this product line was nolonger a strategic fit with our refocused core business strategy of providingproducts and services for the table game area of casinos. Revenues and costsassociated with our slot products are reported as discontinued operations forall periods presented. In January 2004, we entered into agreementspursuant to which we sold substantially all of our slot products’ assets andsubstantially completed our divestiture plans.

As a part of the Stargamesacquisition, we acquired Professional Vending Services Pty Ltd (“PVS”), awholly-owned subsidiary of Stargames. PVS designs, develops and manufacturesautomatic vending machines. PVS offers exclusive equipment in all main vendingsegments including snacks, cold drinks, food (hot and cold), coffee andcigarettes. We have determined that the operations of PVS are non-core to ourEntertainment Products and Utility Products segments. Accordingly, we enteredinto an agreement to sell Stargames’ equity interests in PVS includingsettlement of all existing liabilities of PVS. The estimated liabilitiesexceeded assets in the amount of approximately $654. The fair value of PVS’working capital has been valued at zero in our preliminary purchase priceallocation. The results of operations for PVS were included in DiscontinuedOperations until the disposition was completed in September 2006.

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**CONSOLIDATEDRESULTS OF OPERATIONS(In thousands, except per share amounts)**

| ** **                                    | ** ** | **Year Ended October 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Utility products                              |       | $                                         | 86,792     |   | 53.2% |   | $ | 67,029 |   | 59.4% |   | $ | 45,947 |   | 54.2% |   |
| Entertainment  products                       |       | 75,961                                    |       | 46.7% |   | 45,539 |   | 40.3% |   | 38,705 |   | 45.7% |   |
| Other                                         |       | 238                                       |       | 0.1% |   | 292 |   | 0.3% |   | 131 |   | 0.1% |   |
| Total revenue                                 |       | 162,991                                   |       | 100.0% |   | 112,860 |   | 100.0% |   | 84,783 |   | 100.0% |   |
| Cost of revenue                               |       | 56,721                                    |       | 34.8% |   | 29,260 |   | 25.9% |   | 19,403 |   | 22.9% |   |
| Gross profit                                  |       | 106,270                                   |       | 65.2% |   | 83,600 |   | 74.1% |   | 65,380 |   | 77.1% |   |
| Selling, general and  administrative          |       | 51,299                                    |       | 31.5% |   | 30,559 |   | 27.0% |   | 22,953 |   | 27.1% |   |
| Research and  development                     |       | 12,910                                    |       | 7.9% |   | 7,784 |   | 6.9% |   | 6,185 |   | 7.3% |   |
| Gain on sale of  patent                       |       | (4,566                                    | )          | -2.8% |   | — |   | 0.0% |   | — |   | 0.0% |   |
| In-process research  and development          |       | 19,145                                    |       | 11.7% |   | — |   | 0.0% |   | — |   | 0.0% |   |
| Income from  operations                       |       | 27,482                                    |       | 16.9% |   | 45,257 |   | 40.2% |   | 36,242 |   | 42.7% |   |
| Other expense                                 |       | (6,699                                    | )          | (4.1%) |   | (657 | ) | (0.6%) |   | (1,600 | ) | (1.9%) |   |
| Equity method  investment loss                |       | (416                                      | )          | (0.3%) |   | — |   | 0.0% |   | — |   | 0.0% |   |
| Impairment of  investments                    |       | (1,655                                    | )          | (1.0%) |   | (1,000 | ) | (0.9%) |   | — |   | 0.0% |   |
| Income from  continuing operations before tax |       | 18,712                                    |       | 11.5% |   | 43,600 |   | 38.7% |   | 34,642 |   | 40.8% |   |
| Provision for income  taxes                   |       | 13,373                                    |       | 8.2% |   | 14,496 |   | 12.8% |   | 12,125 |   | 14.3% |   |
| Income from  continuing operations            |       | 5,339                                     |       | 3.3% |   | 29,104 |   | 25.9% |   | 22,517 |   | 26.5% |   |
| Discontinued  operations, net of   tax        |       | (246                                      | )          | (0.2%) |   | 76 |   | 0.1% |   | 1,627 |   | 1.9% |   |
| Net income                                    |       | $                                         | 5,093      |   | 3.1% |   | $ | 29,180 |   | 26.0% |   | $ | 24,144 |   | 28.4% |   |

 

Our revenue and results of operations are mostaffected by unit or seat placements, through sale or lease, of our products.The number and mix of products placed and the average lease or sales price arethe most significant factors affecting our gross margins. These factors are, inturn, affected by the gaming industry generally and our customers’ assessmentof our products. To a lesser extent, our overall financial results are affectedby fluctuations in selling, general and administrative expenses and ourcontinued investment in research and development activities. Our results forthe year ended October 31, 2006, also include a one-time charge recordedin the three months ended April 30, 2006 related to the acquisition ofStargames of $19,145 for in-process research and development (“IPR&D”). Ourmargins are also negatively impacted by the amortization of product relatedintangibles through our acquisition of CARD and Stargames.

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**REVENUE AND GROSS MARGIN**

| ** **           | ** ** | **Year Ended October 31,** | ** ** | **Percentage Change** | ** ** |
|----------------------|------------|-------------------------------------------|------------|----------------------------|------------|
| ** **           | ** ** | **2006**                                  | ** ** | **2005**                   | ** ** | **2004** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| **Revenue:**         |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Leases and royalties |       | $                                         | 49,551     |                       | $          | 48,571 |   | $ | 43,115 |   |   | 2.0 | % |   |   | 12.7 | % |   |
| Sales and service    |       | 113,202                                   |       | 63,997                     |       | 41,537 |   |   | 76.9 | % |   |   | 54.1 | % |   |
| Other                |       | 238                                       |       | 292                        |       | 131 |   |   | (18.5 | %) |   |   | 122.9 | % |   |
| Total                |       | $                                         | 162,991    |                       | $          | 112,860 |   | $ | 84,783 |   |   | 44.4 | % |   |   | 33.1 | % |   |
| **Cost of revenue:** |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Leases and royalties |       | $                                         | 11,794     |                       | $          | 9,692 |   | $ | 8,206 |   |   | 21.7 | % |   |   | 18.1 | % |   |
| Sales and service    |       | 44,927                                    |       | 19,568                     |       | 11,197 |   |   | 129.6 | % |   |   | 74.8 | % |   |
| Total                |       | $                                         | 56,721     |                       | $          | 29,260 |   | $ | 19,403 |   |   | 93.9 | % |   |   | 50.8 | % |   |
| **Gross profit:**    |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Leases and royalties |       | $                                         | 37,757     |                       | $          | 38,879 |   | $ | 34,909 |   |   | (2.9 | %) |   |   | 11.4 | % |   |
| Sales and service    |       | 68,275                                    |       | 44,429                     |       | 30,340 |   |   | 53.7 | % |   |   | 46.4 | % |   |
| Other                |       | 238                                       |       | 292                        |       | 131 |   |   | (18.5 | %) |   |   | 122.9 | % |   |
| Total                |       | $                                         | 106,270    |                       | $          | 83,600 |   | $ | 65,380 |   |   | 27.1 | % |   |   | 27.9 | % |   |
| **Gross margin:**    |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Leases and royalties |       | 76.2%                                     |       | 80.0%                      |       | 81.0% |   |   |   |   |   |   |   |   |   |
| Sales and service    |       | 60.3%                                     |       | 69.4%                      |       | 73.0% |   |   |   |   |   |   |   |   |   |
| Total                |       | 65.2%                                     |       | 74.1%                      |       | 77.1% |   |   |   |   |   |   |   |   |   |

 

We earn our revenue in severalways, including leasing or licensing our products to casino customers,generally under month-to-month fixed fee contracts. Product lease contractstypically include parts and service. We also offer a majority of our productsfor sale with an optional parts and service contract. A more detaileddiscussion of our revenue components and related revenue recognition policiesis included under the heading “Critical Accounting Policies.”

Our overall revenue growth wasdue to increases in both leased and sold units installed base in both ourproduct segments. The increase in the number of units leased and sold resultedfrom the introduction of new products, greater placements of existing products,acquisitions of products, and the expansion of legal gaming into newjurisdictions. A more detailed discussion of our revenue is included for eachof our operating segments under the heading “Segment Operating Results.”

***Fiscal 2006 compared toFiscal 2005***

Overall, total revenueincreased for the year ended October 31, 2006 as compared to the prioryear period. Consolidated revenue for the year was $162,991 as compared to$112,860 in the prior year. The increase was a result of strong performance inboth operating segments as well as our lease and royalties and sales andservice business models. We experienced strong results in our sold unitsinstalled base within our Utility segment. Our Entertainment segment wasfavorably impacted by organic growth as well as our acquisition of Stargameseffective February 1, 2006. The increase in the number of units soldresulted from greater placements of our products, acquisitions of products,market growth and the expansion of operations both domestically andinternationally. A more detailed discussion of our revenue is included for eachof our operating segments under the heading “Segment Operating Results.”

Overall gross margin dollarsincreased for the year ended October 31, 2006. However, as a percentage ofrevenue, our gross margin percentage decreased 8.9% for the year ended October 31,2006 as compared to the same prior year period. The decline in our gross marginpercentages are attributed to a shift in product mix year-over-year and theinclusion of the results of Stargames. The margins of the Stargames productsare lower than those traditionally experienced in our 

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Entertainment Productssegment. Additionally, amortization of Stargames product related intangibles of$1,545 is included in cost of sales and service in our consolidated statementsof income for the year ended October 31, 2006 compared to $0 for the sameprior year period. Our sales of Easy Chipper® and Table Master, which arehigher cost products, have also increased year-over-year and have unfavorablyimpacted our overall margin. Additionally, we had fewer lifetime license salesthan in the prior period which resulted in an unfavorable impact on grossmargin dollars.

***Fiscal 2005 compared to Fiscal 2004***

Overall, total revenue increased for the year ended October 31,2005 as compared to the prior year period. Consolidated revenue for the yearwas $112,860 as compared to $84,783 in the prior year. Our overall revenuegrowth of $28,077 is attributable to sales and service revenue in both theUtility and Entertainment segments, and to a lesser extent lease and royaltyrevenue for both operating segments. Additionally, a full year of results forCARD contributed to the year over year growth. Revenue contributed by CARD wasapproximately $16,089 in fiscal 2005 compared to approximately $7,100 in fiscal2004. A more detailed discussion of our revenue is included for each of ouroperating segments under the heading “Segment Operating Results.”

Overall gross margin dollarsincreased for the year ended October 31, 2005. However, as a percentage ofrevenue, our gross margin percentage decreased 3.0% for the year ended October 31,2005 compared to the same prior year period. The decrease in gross marginpercentage year over year is primarily attributed to increased sales of ourTable Master and Easy Chipper products which carry slightly lower margins.Additionally, intellectual property amortization expense associated withproducts related to our CARD and other acquisitions is recorded as cost ofsales which reduces our gross margin percentage. Amortization expense relatedto these products was $4,090 and $1,832 for the years ended October 31,2005 and 2004, respectively, which resulted in a 3.6% and 2.2% decrease ingross margin percentage for the years ended October 31, 2005 and 2004, respectively.

**OPERATING EXPENSES**

| ** **                           | ** ** | **Year Ended October 31,** | ** ** | **Percentage Change** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **2006**                                  | ** ** | **2005**                   | ** ** | **2004** | ** ** | **06 vs. 05** | ** ** | **05 vs. 04** | ** ** |
| Selling, general and  administrative |       | $                                         | 51,299     |                       | $          | 30,559 |   | $ | 22,953 |   |   | 67.9% |   |   |   | 33.1% |   |   |
| Percentage of revenue                |       | 31.5%                                     |       | 27.0%                      |       | 27.1% |   |   |   |   |   |   |   |   |   |
| Research and development             |       | $                                         | 12,910     |                       | $          | 7,784 |   | $ | 6,185 |   |   | 65.9% |   |   |   | 25.9% |   |   |
| Percentage of revenue                |       | 7.9%                                      |       | 6.9%                       |       | 7.3% |   |   |   |   |   |   |   |   |   |
| In-process research and development  |       | 19,145                                    |       | —                     |       | — |   |   | 100.0% |   |   |   | 0.0% |   |   |
| Percentage of revenue                |       | 11.7%                                     |       | 0.0%                       |       | 0.0% |   |   |   |   |   |   |   |   |   |
| Total operating expenses             |       | $                                         | 83,354     |                       | $          | 38,343 |   | $ | 29,138 |   |   | 117.4% |   |   |   | 31.6% |   |   |
| Percentage of revenue                |       | 51.1%                                     |       | 33.9%                      |       | 34.4% |   |   |   |   |   |   |   |   |   |

 

***Selling, General and Administrative Expenses (“SG&A”).******  ***SG&Aincreased at a higher rate than our revenues during the year ended October 31,2006. For fiscal 2006 compared to fiscal 2005, the dollar increase primarilyreflects the following factors:

·       Theacquisition of Stargames as of February 1, 2006. SG&A related toStargames was $10,520 for the year ended October 31, 2006 compared to $0in the same prior year period. Included in SG&A for the year ended October 31,2006 is $743 of intangible amortization related to customer relationships.

·       SG&Awas also negatively impacted for the year ended October 31, 2006 byadditional professional fees related to the delayed filing of our Form 10-Kfor fiscal year 2005 of approximately $800.

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·       Corporatelegal fees were $4,946 and $3,825 for the years ended October 31, 2006 and2005, respectively. The legal fees in the prior year were favorably impacted bythe $800 legal settlement related to the VendingData I litigation and a $1,471reimbursement of certain legal fees pursuant to the terms of the patentpurchase agreement with IGT. Current period legal fees relate predominately tothe MP Games I and II litigation (See Note 16 to our consolidated financialstatements). We expect that our legal fees will continue to vary from period toperiod depending on our level of legal activity to protect our intellectualproperty and our involvement in non-routine transactions.

·       Share-basedcompensation expense under SFAS 123R allocated to SG&A was $5,108,including $1,997 of amortization of restricted stock compensation, for the yearended October 31, 2006, compared to $759, in the same prior year period.

·       Payrolland related expenses, excluding Stargames, increased approximately $3,300, or14.5%, from fiscal 2005, primarily due to an increase in the number ofemployees in order to support the growth of our business.

·       Favorablecollections efforts, primarily at Stargames, resulted in a credit of ($537) inthe provision for bad debts for the year ended October 31, 2006 comparedto $229 for the same prior year period.

Excluding the impact of thecosts associated with the expensing of share-based compensation and ouradditional professional fees related to the delayed filing of our Form 10-Kfor fiscal 2005, SG&A as a percentage of revenue for the year ended October 31,2006 and 2005 was 27.8% and 26.4%, respectively.

On April 28, 2006, weentered into the April Agreement with IGT whereby we assigned,transferred, and conveyed to IGT, our 50% share of future royalties from thelicensing of the ENPAT patents to any third party or from otherwise permittingany third party to use the ENPAT patents. The total royalties to be received byIGT is limited to an amount equal to a net present value of $3,000 utilizing adiscount factor of 12% (the “Royalty Amount”). Upon the receipt by IGT of theRoyalty Amount, all royalty payments with respect to our 50% share of the ENPATpatents shall resume and be paid to us. The total non-refundable considerationpaid to us was $3,000.

On July 31, 2006, weentered into a second agreement with IGT whereby we sold to IGT our remaining50% ownership in the ENPAT patents. This agreement rescinded certain provisionsof the April Agreement whereby we assigned, transferred, and conveyed toIGT our 50% share of the first $3,000 of future royalties from the licensing ofthe ENPAT patents to any third party or from otherwise permitting any third partyto use the ENPAT patents. The consideration for the remaining 50% ownership ofthe ENPAT patents was the $3,000 previously received from IGT pursuant to the April Agreementbetween us and IGT, plus a payment of an additional $4,500. This payment was inlieu of the $4,875 that would have been due, at IGT’s discretion, under thepatent purchase agreement entered into on June 13, 2005 between us andIGT. As a result, IGT shall receive 100% of the future royalties on the ENPATpatents until IGT has earned a total of $17,400 in gross royalties; thereafterIGT will pay us 17 1⁄2% of any gross royalties. The transaction has beenreflected in the accompanying consolidated statements of income by recording again on sale of patent of $4,566.

***Research and Development Expenses (“R&D”).******  ***OurR&D in all periods presented is distributed among all of our product lines,as we have continued to invest in new product development. For fiscal 2006,R&D increased primarily due to the acquisition of Stargames. R&Dexpense related to Stargames for the year ended October 31, 2006 was$5,359 compared to $0 for the same prior year period. Additionally, share-basedcompensation expense allocated to R&D under SFAS 123R was $302 for the yearended October 31, 2006 compared to $0 for the same prior year period.

R&D includes amortization of our patents forproducts still under development. Amortization for the year ended October 31,2006 included amortization of our 50% ownership interest in the ENPAT 

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patents. Our R&D costs will be favorably impactedin the future by the sale of our remaining 50% ownership interest in the ENPATpatents to IGT on July 31, 2006. See Note 3 to our consolidated financialstatements.

As required by FASB Interpretation No. 4, “*Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*” (“FIN 4”), the portion of thepurchase price allocated to IPR&D of $19,145 was immediately expensedduring the three months ended April 30, 2006.

A project-by-project valuation using the guidance inFASB Statement of Financial Accounting Standard No. 141, “*Business Combinations*” (“SFAS 141”) and the AmericanInstitute of Certified Public Accountants (“AICPA”) Practice Aid “*Assets Acquired in a Business Combination to Be Used In Research and DevelopmentActivities: A Focus on Software, Electronic Devices and PharmaceuticalIndustries*” is in the process of being performed by us with theassistance of a valuation specialist to determine the fair value of researchand development projects of Stargames.

IPR&D is defined as adevelopment project that has been initiated and achieved material progress buthas not yet resulted in a commercially viable product and has no alternativefuture uses. The fair value was determined using the income approach on aproject-by-project basis. This method is based on the present value of earningsattributable to the asset or costs avoided as a result of owning the assets.This method includes risk factors, which include applying an appropriatediscount rate that reflects the project’s stage of completion, the nature ofthe product, the scientific data associated with the technology, the currentpatent situation and market competition. The expensing of IPR&D throughpurchase accounting allows for the expensing of certain R&D efforts at theacquisition date consistent with the expensing of R&D efforts as they areincurred for in-house development efforts. This charge is preliminary pendingcompletion of our final purchase price allocation which will be finalizedwithin one year from the date of acquisition. Any adjustments to this chargewill be adjusted to the income statement caption IPR&D when finalized.

**OTHER EXPENSE**

Otherincome (expense) is comprised of the following for the years ended October 31:

| ** **                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income               |       | $        | 1,998      |     | $          | 2,336    |       | $ | 888 |   |
| Interest expense              |       | (8,374   | )          | (3,263   | )          | (1,497   | )          |
| Foreign currency gain  (loss) |       | (414     | )          | 215      |       | (992     | )          |
| Other                         |       | 91       |       | 55       |       | 1        |       |
|                          |       | $        | (6,699     | )        | $          | (657     | )          | $ | (1,600 | ) |

 

Interest income decreased primarily as a result of areduction in our investment portfolio. Proceeds of matured investments were notre-invested, but were used to pay down the bridge financing associated with theacquisition of Stargames and stock repurchases. This decrease was partiallyoffset by an increase in interest income attributable to increased interestbearing sales-type leases and notes receivable as of October 31, 2006. Forthe years ended October 31, 2006, 2005 and 2004, respectively, interestincome related to our investment in sales type leases and notes receivable was$1,229 ,$948 and $480.

Interest expense for the periods ended October 31,2006, 2005 and 2004 is primarily related to the $150,000 of Notes due in April 2024.Interest Expense in 2006 also includes interest expense on the Bridge Loanwhich matures in November 2006. A more detailed discussion of the Notesand the Bridge Loan are included below under the heading “Liquidity and CapitalResources.”

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Priorto the completion of our CARD acquisition in fiscal 2004, we entered intoforeign currency exchange contracts to fix the U.S. dollars estimated tobe required to fund the Euro-denominated cash component of the CARD purchaseprice which resulted in a foreign currency exchange loss of $703. Suchcontracts do not meet the accounting criteria for hedge accounting, andaccordingly, the foreign currency exchange loss is included in our operatingresults for the year ended October 31, 2004. As of October 31, 2006and 2005, we had no outstanding foreign exchange contracts.

**INCOME TAXES**

Oureffective income tax rate for continuing operations for the years ended October 31is as follows:

| ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal income tax at the  statutory rate   |       | 35.0%    |       | 35.0%    |       | 35.0%    |       |
| In-process research and  development        |       | 35.8%    |       | 0.0%     |       | 0.0%     |       |
| Foreign dividend inclusion                  |       | 9.9%     |       | 0.0%     |       | 0.0%     |       |
| Other permanent differences                 |       | (6.0%)   |       | (1.9%)   |       | (1.4%)   |       |
| State income taxes, net of  federal benefit |       | 2.5%     |       | 2.1%     |       | 2.0%     |       |
| Tax credits                                 |       | (8.4%)   |       | (1.8%)   |       | (1.4%)   |       |
| Effect from foreign tax rate  differences   |       | 1.4%     |       | 0.7%     |       | 0.9%     |       |
| Other                                       |       | 1.3%     |       | (0.8%)   |       | (0.1%)   |       |
| Effective tax rate                          |       | 71.5%    |       | 33.3%    |       | 35.0%    |       |

 

Excluding the impact of theone-time IPR&D charge in relation to the Stargames acquisition, which isnon-deductible for tax purposes, the effective tax rate for the year ended October 31,2006 would have been 35.3%.

Looking forward, our annualeffective tax rate may fluctuate due to changes in our amount and mix of U.S.and foreign income, changes in tax legislation and changes in our estimates offederal tax credits and other tax deductions. We estimate that our fiscal 2007annual effective tax rate will be approximately 35.0%.

We have not provided U.S.Federal income tax on $4,258 of undistributed earnings of our foreignsubsidiaries because we intend to permanently reinvest such earnings outsidethe United States. Upon distribution of these earnings in the form of dividendsor otherwise, we would be subject to U.S. income taxes, subject to adjustmentfor foreign tax credits. Determination of the amount of unrecognized deferredU.S. income tax liability is not practicable because of the complexitiesassociated with its hypothetical calculation.

In October 2006, ourwholly-owned subsidiary, Shuffle Master Management - Service GmbH, the parententity to CARD, transferred $8,000 to Shuffle Master, Inc. in the form ofa dividend. This dividend is subject to United States tax based upon earningsand profits of Shuffle Master Management - Service GMBH. This dividend resultedin $733 of net additional income taxes which is comprised of additional UnitedStates tax of approximately $1,855 and a corresponding foreign tax creditbenefit of $1,122.

During each of the years endedOctober 31, 2006, 2005 and 2004, we recorded income tax benefits of$3,908, $5,287 and $5,388, respectively, related to deductions for employeestock option exercises. These tax benefits, which reduced income taxes payableand increased additional paid-in capital by an equal amount, had no effect onour provision for income taxes. Additionally, as part of the fiscal 2004 incometax provision to tax return true-up, we recorded a $229 tax benefit related toemployee stock option exercises which reduced income taxes payable andincreased additional paid-in capital by an equal amount.

We record deferred incometaxes to reflect the income tax consequences in future years between thefinancial reporting and income tax bases of assets and liabilities, and futuretax benefits such as net 

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operating loss carryforwardsand other tax credits. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in which thedifferences are expected to reverse. We provide valuation allowances to reducedeferred tax assets to an amount that is more likely than not to be realized.We evaluate the likelihood of recovering our deferred tax assets by estimatingsources of future taxable income. The provision for income taxes is the sum ofthe tax currently payable and the change in deferred taxes during the year.Additional information regarding income taxes is included in Note 14 to ourconsolidated financial statements.

**EARNINGS PER SHARE**

| ** **                                            | ** ** | **Year Ended October 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income from  continuing operations                    |       | $                                         | 5,339      |   | $ | 29,104 |   | $ | 22,517 |   |
| Basic earnings per  share, continuing operations      |       | $                                         | 0.15       |   | $ | 0.83 |   | $ | 0.63 |   |
| Diluted earnings per  share, continuing operations    |       | $                                         | 0.15       |   | $ | 0.80 |   | $ | 0.60 |   |
| Weighted average  shares data:                        |       |                                      |       |   |   |   |   |
| Basic                                                 |       | 34,585                                    |       | 34,924 |   | 35,955 |   |
| Dilutive impact of stock options and restricted stock |       | 1,176                                     |       | 1,343 |   | 1,353 |   |
| Dilutive effect of contingent convertible notes       |       | 291                                       |       | 111 |   | — |   |
| Diluted                                               |       | 36,052                                    |       | 36,378 |   | 37,308 |   |
| Outstanding shares  data:                             |       |                                      |       |   |   |   |   |
| Shares outstanding, beginning of year                 |       | 34,527                                    |       | 34,958 |   | 37,072 |   |
| Options exercised                                     |       | 697                                       |       | 851 |   | 1,445 |   |
| Shares repurchased                                    |       | (317                                      | )          | (1,473 | ) | (4,797 | ) |
| CARD acquisition                                      |       | —                                    |       | — |   | 1,151 |   |
| Other                                                 |       | (12                                       | )          | 191 |   | 87 |   |
| Shares outstanding,  end of year                      |       | 34,895                                    |       | 34,527 |   | 34,958 |   |

 

In December 2004, our board of directors approveda three-for-two common stock split, with new shares distributed in the form ofa dividend on January 14, 2005, to shareholders of record on January 3,2005 (the “January 2005 Split”). Share and per share amounts have beenadjusted for all periods presented herein to reflect the January 2005Split.

In****March 2004, our board of directors had earlierapproved another three-for-two common stock split, with new shares distributedin the form of a dividend on April 16, 2004, to shareholders of record on April 5,2004 (the “April 2004 Split”). Share and per share amounts have been adjustedfor all periods presented herein to reflect the April 2004 Split.

We account for the $150,000 of contingent convertible seniornotes due 2024 (the “Notes”) in accordance with FASB Emerging IssuesTask Force No. 04-08 (“EITF 04-08”), “The Effect of ContingentlyConvertible Debt on Diluted Earnings Per Share” which requires us to includethe dilutive effect of our outstanding Notes shares in our diluted earnings pershare calculation, regardless of whether the market price trigger or othercontingent conversion feature has been met. Because our Notes include amandatory cash settlement feature for the principal payment, we applied thetreasury stock method. This method results in incremental dilutive shares whenthe average fair value of our common stock for a reporting period exceeds theinitial conversion price per share of $28.07. EITF 04-8 also requires restatement of all prior periods. Becausethe average fair value of our common stock did not exceed the initialconversion price in any period prior to the year ended October 31, 2005,no restatement of prior periods was required. For certain quarters during theyears ended October 31, 2006 and 2005, the average fair value of ourcommon stock exceeded $28.07, and accordingly, the dilutive effect is includedin our diluted shares calculation.

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**SEGMENT OPERATINGRESULTS(Dollars in thousands, except per unit amounts)**

**SEGMENT OVERVIEW**

We have two reportable segments which are classifiedas continuing operations, Utility Products and Entertainment Products. UtilityProducts include our shufflers, chip sorting machines and ITSTM product lines.Entertainment Products include our Proprietary Table Games, electronicmulti-terminal gaming products, electronic gaming machines, and Shuffle UpProductions. Each segment’s activities include the design, development,acquisition, manufacture, marketing, distribution, installation and servicingof its product lines.

***Utility Products.******  ***Our strategy in the UtilityProducts segment is the development of products for our casino customers thatenhance table game speed, productivity and security. Currently, UtilityProducts segment revenue is derived substantially from our automatic cardshufflers. We develop and market a full complement of automatic card shufflersfor use with the vast majority of card-based table games placed in casinos andother gaming locations, including our own proprietary table games. In additionto selling and servicing, we also lease shufflers, which provides us withrecurring revenue. Our current shuffler product portfolio consists of 7distinct models, including both second and third generation shufflers, in thecategories of single deck, multi-deck batch and multi-deck continuous cardshufflers. As of October 31, 2006, our shuffler installed base totaled22,347 units, a 20.2% increase from 18,589 as of October 31, 2005. Ourgrowth strategy for our shuffler business is the development and distributionof next generation, patent protected shufflers which enhance the valueproposition for our customers through technological advancements. As a result,we expect to replace our older generation shufflers over time, while at thesame time, increasing the penetration of our shufflers in the marketplace.

As part of the CARD acquisition in May 2004, weacquired a next generation chip sorting machine, the Easy Chipper. The EasyChipper simplifies the handling of gaming chips and accurately tracks chipvolume and value, which increases the productivity and security on high volumechip tables such as Roulette. During May 2005, we announced our first EasyChipper orders, the first release of a new product developed by CARD since theacquisition. During the year ended October 31, 2006, we sold 225 EasyChipper units, and placed 5 Easy Chipper units on lease. For fiscal 2006, totalrevenue contribution from the Easy Chipper was approximately $4,667 as comparedto $2,600 for the same prior year period.

Our Table iD product remains in the development stage,including our Intelligent Shoe which increases table game security by readingeach card as it is removed from the shoe to reduce game manipulation.

***Entertainment Products.******  ***Our strategy in theEntertainment Products segment is the development and delivery of proprietarytable game content, which enhances our casino customers’ table game operations.Currently, Entertainment Products segment revenue is derived substantially fromour live proprietary table game content. We develop and market a fullcomplement of poker, pai gow poker, baccarat and blackjack table game content.Our current table game portfolio consists of 21 revenue generating titles,including industry leading brands such as Three Card Poker® *,* Let It Ride®,Four Card Poker® and Fortune Pai Gow Poker®. The majority of these games are licensedto our customers, which provides us with recurring revenue. In fiscal 2003, webegan selling lifetime licenses of certain of our proprietary table games. Asof October 31, 2006, our proprietary table game installed base totaled4,219 games, a 14.6% increase from 3,681 games as of October 31, 2005. Ourgrowth strategy for our live proprietary table games business is to broaden ourcontent through increased development and/or acquisition. As a result, weexpect to further increase the penetration of our content in the marketplace,as well as create a longer-term replacement opportunity.

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As discussed above, our multi-terminal gaming productsconsist of Table Master, and the Vegas Star and Rapid Table Games productswhich we acquired through our acquisition of Stargames effective February 1,2006. These multi-terminal gaming products allow us to expand the distributionof our proprietary table game portfolio. Some of our multi-terminal gamingproducts enable us to offer table game content into markets where live tablegames are not permitted, such as racino, video lottery and arcade markets. Ourgrowth strategy for the multi-terminal gaming products is to position theseproducts as a more cost-effective way to offer lower stakes table games to ourcasino customers.

Table Master is a fixed five station, electronic tablegame featuring a video screen with a virtual dealer who interacts with players.In addition to selling and servicing, we also lease our Table Master product,which provides us with recurring revenue. In October 2006, we signed amulti-terminal video lottery machine agreement with the Delaware State LotterySystem. Under the terms of the agreement, the initial placement consists of 54units or 270 seats of our Table Master electronic table game platform. TheTable Master units will feature a diverse mix of blackjack and poker-basedproprietary table game content, including Royal Match 21 Blackjack, Three CardPoker, Let It Ride Bonus with 3 Card Bonus and Dragon Bonus Baccarat.

The Vegas Star multi-terminal gaming machines featureanimated virtual dealers, touch screen player betting and a selection of publicdomain table games including Roulette, Baccarat and Sic-Bo. The Vegas Star hasa modular design which makes it easy to add additional play stations asterminal demand increases. Originally designed for the Australian and Asianmarkets where its market shares exceed 60% and 35% respectively, Vegas Star hasrapidly become an integral part of casinos within its two primary markets. EachVegas Star configuration can accommodate up to 16 player stations, and willeventually offer all of our proprietary game content.

The Rapid Table Games product line combines a livedealer with multi-terminal electronic wagering for popular games like Rouletteand Sic-Bo. With over 85% of its installed base currently installed inAustralia and Asia, the Rapid Table Games product line focuses on combiningpopular high-volume gaming content with unparalleled game play, operatorusability, systems integration and technical support. Rapid Roulette, theproduct line’s signature offering, currently has the leading Australian marketshare and accounts for over 90% of the automated Roulette multi-player productscurrently in use.

Through the acquisition of Stargames, we also acquireda broad line of traditional video slot machines designed more specifically forthe Australian and Asian gaming markets where over 90% of the installed base islocated. The Electronic Gaming Machines (“EGMs”) feature a variety of gameselections including licensed content provided by WMS Industries. In additionto selling the full EGM complement, we sell conversion kits which allowexisting EGM terminals to be converted to other games on the Stargamesplatform.

Segment revenues include sale, lease or licensing ofproducts within each reportable segment. We measure segment revenue performancein terms of dollars and Installed Unit Base. Installed Unit Base is the sum ofproduct units or seats under lease or license agreements and inception-to-datesold units or seats. As discussed above, we have combined the presentation ofour Table Master, Rapid Table Games and Vegas Star products as multi-terminalgaming seats. Due to their modular design, both the Rapid Table Games and VegasStar products are best analyzed based upon number of seats sold or leased. Asour Table Master is a fixed five seat station, we have converted units intofive seats rather than one unit. We believe that Installed Base is an importantgauge of segment performance because it measures historical market placementsof leased and sold seats and it provides insight into potential markets forservice and next-generation products. Some sold units or seats may no longer bein use by our casino customers or may have been replaced by other models orproducts. Accordingly, we are unable to determine precisely the number of unitsor seats currently in active use.

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Segment operating incomeincludes revenues and expenses directly and indirectly associated with theproduct lines included in each segment. Direct expenses primarily includedepreciation of leased assets, amortization of intangible assets, cost ofproducts sold, shipping, installation, commissions, product approval costs,research and development and product related litigation. Indirect expensesinclude an activity-based allocation of other general product-related costs,the most significant of which are service and selling expenses andmanufacturing overhead. Corporate general and administrative expenses are notallocated to segments.

**UTILITY PRODUCTSSEGMENT OPERATING RESULTS**

***Fiscal 2006 compared toFiscal 2005***

| ** **                                     | ** ** | **Year Ended October 31,**                            | ** ** | **Increase**                                                         | ** ** | **Percentage** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------|------------|
| ** **                                     | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| **Utility  Products segment revenue**          |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease                                          |       |                                                                 | $          | 24,048                                                               |       |           |       | $ | 23,721 |   |   |   | $ | 327 |   |   |   | 1.4 | % |   |
| Sales — Shuffler                          |       |                                                                 | 50,363     |                                                                 |       |           | 34,868     |   |   |   | 15,495 |   |   |   | 44.4 | % |   |
| Sales — Chipper                           |       |                                                                 | 5,367      |                                                                 |       |           | 2,930      |   |   |   | 2,437 |   |   |   | 83.2 | % |   |
| Service and other                              |       |                                                                 | 7,014      |                                                                 |       |           | 5,510      |   |   |   | 1,504 |   |   |   | 27.3 | % |   |
| Total sales and service                        |       |                                                                 | 62,744     |                                                                 |       |           | 43,308     |   |   |   | 19,436 |   |   |   | 44.9 | % |   |
| Total Utility Products segment revenue         |       |                                                                 | $          | 86,792                                                               |       |           |       | $ | 67,029 |   |   |   | $ | 19,763 |   |   |   | 29.5 | % |   |
| **Utility Products segment operating income**  |       |                                                                 | $          | 42,445                                                               |       |           |       | $ | 32,595 |   |   |   | $ | 9,850 |   |   |   | 30.2 | % |   |
| **Utility  Products segment operating margin** |       |                                                                 | 48.9%      |                                                                 |       |           | 48.6%      |   |   |   |   |   |   |   |   |   |   |
| **Shufflers installed base (end of year)**     |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease units                                    |       |                                                                 | 4,717      |                                                                 |       |           | 4,809      |   |   |   | (92 | ) |   |   | (1.9 | %) |   |
| Sold units, inception-to-date                  |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              |       |                                                                 | 13,780     |                                                                 |       |           | 11,151     |   |   |   | 2,629 |   |   |   | 23.6 | % |   |
| Sold during year                               |       |                                                                 | 4,297      |                                                                 |       |           | 3,062      |   |   |   | 1,235 |   |   |   | 40.3 | % |   |
| Less trade-ins and exchanges                   |       |                                                                 | (447       | )                                                                    |       |           | (433       | ) |   |   | (14 | ) |   |   | 3.2 | % |   |
| End of year                                    |       |                                                                 | 17,630     |                                                                 |       |           | 13,780     |   |   |   | 3,850 |   |   |   | 27.9 | % |   |
| Total installed base                           |       |                                                                 | 22,347     |                                                                 |       |           | 18,589     |   |   |   | 3,758 |   |   |   | 20.2 | % |   |
| **Chipper  installed base (end of year)**      |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease units                                    |       |                                                                 | 15         |                                                                 |       |           | 10         |   |   |   | 5 |   |   |   | 50.0 | % |   |
| Sold units, inception-to-date                  |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              |       |                                                                 | 122        |                                                                 |       |           | —     |   |   |   | 122 |   |   |   | 100.0 | % |   |
| Sold during year                               |       |                                                                 | 225        |                                                                 |       |           | 122        |   |   |   | 103 |   |   |   | 84.4 | % |   |
| Subtotal                                       |       |                                                                 | 347        |                                                                 |       |           | 122        |   |   |   | 225 |   |   |   | 184.4 | % |   |
| Total installed base                           |       |                                                                 | 362        |                                                                 |       |           | 132        |   |   |   | 230 |   |   |   | 174.2 | % |   |

 

Utility Products segment revenue is derivedsubstantially from our shuffler product line and secondarily from our chipperproduct line.

For the year ended October 31, 2006, UtilityProducts segment revenue increased 29.5%, compared to the prior year, primarilydue to a 44.9% increase in Utility Products sales and service revenue.Additionally, Utility Products lease revenue increased by 1.4% as compared tothe prior year.

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The slight increase inUtility Products lease revenue for the year ended October 31, 2006,compared to the prior year, primarily reflects:

·       Anet decrease of 92 shuffler units on lease from 4,809 to 4,717, a 1.9%decrease.

·       Ashift in product mix from lower average lease price models to higher averagelease price models. Placements in the current period were predominately ourthird generation shuffler products, including the Deck Mate®,one2sixTMand MD2® shufflers. Net shuffler lease additionsinclude the conversion of 1,122 leased units to sold units in the currentperiod and 1,105 leased units to sold units in the prior year period. Shufflerconversions for the current and prior year periods were comprised primarily ofsecond generation ACE® shufflers, in anticipation of introducing thenext generation specialty table game shuffler, the iDealTM, and Deck Mate.

·       Thedecrease in leased units was partially offset by a slight increase in averagemonthly lease price from $419 to $422. The increase was predominatelyattributable to increased lease pricing for the MD2, DeckMate and one2six.

The increase in UtilityProducts sales and service revenue for the year ended October 31, 2006,compared to the prior year, primarily reflects:

·       Anincrease of 1,235 shuffler units sold from 3,062 to 4,297, a 40.3% increase.

·       Theincrease in sold shuffler units was comprised primarily of additional sales ofDeck Mate, one2six and MD2 shufflers of 1,187, 1,155 and 1,087, respectively,in the current period compared to 784, 775 and 423, respectively, in the prioryear.

·       Fiscal2006 included a greater percentage of sales of our higher-priced models,including the one2six and MD2 shufflers, resulting in a 3.0% increase in theaverage shuffler sales price per unit from approximately $11,380 toapproximately $11,720.

·       Anincrease in Easy Chipper units sold, from 122 to 225. Chipper sale revenue of$5,367 includes $784 attributable to our legacy chipper product acquired fromCARD. The 27 sold units from this product are excluded from the chipper unitssold table above. For the year ended October 31, 2006, Easy Chipper salesrevenue was approximately $4,583 as compared to $2,600 in the same prior yearperiod.

Utility Products segmentoperating income for the year ended October 31, 2006, increased 30.2%,compared to the same prior year period, and operating segment margin increasedfrom 48.6% to 48.9%, primarily due to greater sales volume of our shufflerbusiness and increased sales of the Easy Chipper product. Gross margin includesamortization expense associated with the one2six shuffler and Easy Chipper of$3,534 for the year ended October 31, 2006, compared to $2,799 for thesame prior year period.

45

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***Fiscal 2005 compared toFiscal 2004***

| ** **                                     | ** ** | **Year Ended October 31,**                            | ** ** | **Increase**                                                         | ** ** | **Percentage** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------|------------|
| ** **                                     | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| **Utility Products segment  revenue**          |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease                                          |       |                                                                 | $          | 23,721                                                               |       |           |       | $ | 19,415 |   |   |   | $ | 4,306 |   |   |   | 22.2 | % |   |
| Sales — Shuffler                          |       |                                                                 | 34,868     |                                                                 |       |           | 22,860     |   |   |   | 12,008 |   |   |   | 52.5 | % |   |
| Sales — Chipper                           |       |                                                                 | 2,930      |                                                                 |       |           | 260        |   |   |   | 2,670 |   |   |   | 1,026.9 | % |   |
| Service and other                              |       |                                                                 | 5,510      |                                                                 |       |           | 3,412      |   |   |   | 2,098 |   |   |   | 61.5 | % |   |
| Total sales and service                        |       |                                                                 | 43,308     |                                                                 |       |           | 26,532     |   |   |   | 16,776 |   |   |   | 63.2 | % |   |
| Total Utility Products segment revenue         |       |                                                                 | $          | 67,029                                                               |       |           |       | $ | 45,947 |   |   |   | $ | 21,082 |   |   |   | 45.9 | % |   |
| **Utility Products segment operating income**  |       |                                                                 | $          | 32,595                                                               |       |           |       | $ | 21,361 |   |   |   | $ | 11,234 |   |   |   | 52.6 | % |   |
| **Utility  Products segment operating margin** |       |                                                                 | 48.6%      |                                                                 |       |           | 46.5%      |   |   |   |   |   |   |   |   |   |   |
| **Shufflers  installed base (end of year)**    |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease units                                    |       |                                                                 | 4,809      |                                                                 |       |           | 4,138      |   |   |   | 671 |   |   |   | 16.2 | % |   |
| Sold units,  inception-to-date                 |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              |       |                                                                 | 11,151     |                                                                 |       |           | 9,108      |   |   |   | 2,043 |   |   |   | 22.4 | % |   |
| Sold during year                               |       |                                                                 | 3,062      |                                                                 |       |           | 2,165      |   |   |   | 897 |   |   |   | 41.4 | % |   |
| Less trade-ins and exchanges                   |       |                                                                 | (433       | )                                                                    |       |           | (122       | ) |   |   | (311 | ) |   |   | 254.9 | % |   |
| End of year                                    |       |                                                                 | 13,780     |                                                                 |       |           | 11,151     |   |   |   | 2,629 |   |   |   | 23.6 | % |   |
| Total installed base                           |       |                                                                 | 18,589     |                                                                 |       |           | 15,289     |   |   |   | 3,300 |   |   |   | 21.6 | % |   |
| **Chipper  installed base (end of year)**      |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Lease units                                    |       |                                                                 | 10         |                                                                 |       |           | —     |   |   |   | 10 |   |   |   | 100.0 | % |   |
| Sold units,  inception-to-date                 |       |                                                                 |       |                                                                 |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Beginning of year                              |       |                                                                 | —     |                                                                 |       |           | —     |   |   |   | — |   |   |   | 100.0 | % |   |
| Sold during year                               |       |                                                                 | 122        |                                                                 |       |           | —     |   |   |   | 122 |   |   |   | 100.0 | % |   |
| Subtotal                                       |       |                                                                 | 122        |                                                                 |       |           | —     |   |   |   | 122 |   |   |   | 100.0 | % |   |
| Total installed base                           |       |                                                                 | 132        |                                                                 |       |           | —     |   |   |   | 132 |   |   |   | 100.0 | % |   |

 

For the year ended October 31, 2005, UtilityProducts segment revenue increased 45.9%, compared to the prior year, primarilydue to a 63.2% increase in Utility Products sales and service revenue.Additionally, Utility Products lease revenue increased 22.2% compared to theprior year.

The increase in UtilityProducts lease revenue for the year ended October 31, 2005, compared tothe prior year, primarily reflects:

·       Anet increase of 671 shuffler units on lease.

·       Theincrease in net shuffler lease additions was comprised primarily of additionalplacements of Deck Mate, one2six and MD2 shufflers. Due to the timing of theCARD acquisition in May 2004, there were no placements of the one2sixshuffler until the third quarter of fiscal 2004. Net shuffler lease additionsinclude the conversion of 1,105 leased units to sold units in the currentperiod and 543 leased units to sold units in the prior year period. Shufflerconversions for the current period were comprised primarily of ACE and DeckMate shufflers; shuffler conversions for the same prior year period werecomprised primarily of ACE and MD1 shufflers.

·       Aslight increase in the average shuffler lease rate per unit to approximately$420 per month from approximately $415 per month in the prior year.

46

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The increase in UtilityProducts sales and service revenue for the year ended October 31, 2005,compared to the prior year, primarily reflects:

·       Anincrease of 897 shuffler units sold from 2,165 to 3,062.

·       Theincrease in sold shuffler units was comprised primarily of additional sales ofACE, Deck Mate, one2six and MD2 shufflers of 715, 784, 775 and 423,respectively, in the current period compared to 394, 472, 518 and 98,respectively, in the prior year.

·       Fiscal2005 included a greater percentage of sales of our higher-priced models,including the ACE, one2six, Deck Mate and MD2 shufflers, resulting in a 7.6% increase inthe average shuffler sales price per unit from approximately $10,600 toapproximately $11,400.

·       Contributingto the increases during fiscal 2005 is the sale of 122 units of our EasyChipper, which contributed approximately $2,600 in sales revenue.

Utility Products segment operating income for the yearended October 31, 2005, increased 52.6% compared to the prior year,primarily due to greater volume. Additionally, operating margin increased 2.1% from the prior year,primarily due to a reduction in legal fees related to the VendingData I legalsettlement and the reimbursement of certain legal fees pursuant to the IGTpatent purchase agreement. The reduction in legal fees contributed a 3.3%increase in operating margin for fiscal 2005. This increase was partiallyoffset by amortization expense related to the acquired CARD products.Amortization expense associated with the one2six shuffler and the Easy Chipperwas $2,799 for the year ended October 31, 2005, compared to $1,165 for theprior year.

47

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**ENTERTAINMENT PRODUCTSSEGMENT OPERATING RESULTS**

***Fiscal 2006 compared toFiscal 2005***

| ** **                                                        | ** ** | **Year Ended October 31,** | ** ** | **Increase** | ** ** | **Percentage** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                                        | ** ** | **2006**                                  | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| **Entertainment Products segment revenue**                        |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Royalties and leases — Table  games                          |       | $                                         | 23,858     |         | $          | 24,119         |       |   | $ | (261 | ) |   |   | (1.1%) |   |   |
| Royalties and leases — Multi-Terminal  Gaming Products       |       | 1,616                                     |       | 650          |       |           | 966        |   |   |   | 148.6% |   |   |
| Royalties and leases — Electronic  Gaming Machines           |       | —                                    |       | —       |       |           | —     |   |   |   | 0.0% |   |   |
| Other                                                             |       | 29                                        |       | 81           |       |           | (52        | ) |   |   | (64.2%) |   |   |
| Total royalties and leases                                        |       | 25,503                                    |       | 24,850       |       |           | 653        |   |   |   | 2.6% |   |   |
| Sales — Table games                                          |       | 14,083                                    |       | 15,503       |       |           | (1,420     | ) |   |   | (9.2%) |   |   |
| Sales — Multi-Terminal  Gaming Products                      |       | 14,617                                    |       | 4,990        |       |           | 9,627      |   |   |   | 192.9% |   |   |
| Sales — Electronic Gaming  Machines                          |       | 13,687                                    |       | —       |       |           | 13,687     |   |   |   | 100.0% |   |   |
| Service and other                                                 |       | 8,071                                     |       | 196          |       |           | 7,875      |   |   |   | 4,017.9% |   |   |
| Total sales and service  revenue                                  |       | 50,458                                    |       | 20,689       |       |           | 29,769     |   |   |   | 143.9% |   |   |
| Total Entertainment Products  segment  revenue                    |       | $                                         | 75,961     |         | $          | 45,539         |       |   | $ | 30,422 |   |   |   | 66.8% |   |   |
| **Entertainment  Products segment operating income**              |       | $                                         | 17,341     |         | $          | 33,529         |       |   | $ | (16,188 | ) |   |   | (48.3%) |   |   |
| **Entertainment Products segment  operating margin**              |       | 22.8%                                     |       | 73.6%        |       |           |       |   |   |   |   |   |   |
| **Table games installed base (end of year)**                      |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Royalty units                                                     |       | 2,986                                     |       | 2,913        |       |           | 73         |   |   |   | 2.5% |   |   |
| Sold units, inception-to-date                                     |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Beginning of year                                                 |       | 768                                       |       | 365          |       |           | 403        |   |   |   | 110.4% |   |   |
| Sold during year                                                  |       | 465                                       |       | 403          |       |           | 62         |   |   |   | 15.4% |   |   |
| Subtotal                                                          |       | 1,233                                     |       | 768          |       |           | 465        |   |   |   | 60.5% |   |   |
| Total installed base                                              |       | 4,219                                     |       | 3,681        |       |           | 538        |   |   |   | 14.6% |   |   |
| **Multi-Terminal  Gaming Products installed base (end of year)**  |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Lease seats                                                       |       | 424                                       |       | 200          |       |           | 224        |   |   |   | 112.0% |   |   |
| Sold seats,  inception-to-date                                    |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Beginning of year                                                 |       | 310                                       |       | 75           |       |           | 235        |   |   |   | 313.3% |   |   |
| Sold during year                                                  |       | 811                                       |       | 235          |       |           | 576        |   |   |   | 245.1% |   |   |
| Stargames acquired base                                           |       | 3,031                                     |       | —       |       |           | 3,031      |   |   |   | 100.0% |   |   |
| Subtotal                                                          |       | 4,152                                     |       | 310          |       |           | 3,842      |   |   |   | 1,239.4% |   |   |
| Total installed base                                              |       | 4,576                                     |       | 510          |       |           | 4,066      |   |   |   | 797.3% |   |   |
| **Electronic  Gaming Machines installed base (end of year)** |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Lease seats                                                       |       | —                                    |       | —       |       |           | —     |   |   |   | 0.0% |   |   |
| Sold seats,  inception-to-date                                    |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Beginning of year                                                 |       | —                                    |       | —       |       |           | —     |   |   |   | 0.0% |   |   |
| Sold during year                                                  |       | 1,607                                     |       | —       |       |           | 1,607      |   |   |   | 100.0% |   |   |
| Stargames acquired base                                           |       | 14,672                                    |       | —       |       |           | 14,672     |   |   |   | 100.0% |   |   |
| Subtotal                                                          |       | 16,279                                    |       | —       |       |           | 16,279     |   |   |   | 100.0% |   |   |
| Total installed base                                              |       | 16,279                                    |       | —       |       |           | 16,279     |   |   |   | 100.0% |   |   |

 

48

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For the year ended October 31, 2006,Entertainment Products segment revenue increased 66.8%, compared to the sameprior year period primarily due to a $33,162 contribution from the Stargamesproduct line. These increases were partially offset by decreases in lifetimelicense sale revenue.

The increase inEntertainment Products royalty and lease revenue for the year ended October 31,2006, compared to the prior year, primarily reflects:

·       Anet increase of 73 table game royalty units on lease.

·       Theincrease in net table game lease additions comprised primarily of unitincreases in Royal Match 21, Bet the Set “21”TM, Dragon Bonus® andUltimate Texas Hold’emTM. These side bet table games have a lower monthly average leaseprice than our premium table games resulting in a decline in the averagemonthly lease price from $951 to $669. The table game royalty unit increaseswere offset by the conversion of 434 royalty units to lifetime license sales,consisting primarily of Three Card Poker and Fortune Pai Gow Poker whichcurrently yields higher average monthly lease prices than our more recent gameintroductions. These conversions are consistent with our replacement salesstrategy of selling our older proprietary table games to allow access toexpanded casino floor space for our newer table game introductions. Priorperiod conversions totaled 393 royalty units and consisted primarily ofThree Card Poker and Let It Ride.

·       Anet increase in multi-terminal gaming products of 224 seats on lease.

As discussed above, theincrease in Entertainment Products sales and service revenue for the year endedOctober 31, 2006, compared to the same prior year period is primarilyattributed to the Stargames product line contribution. Other contributionsinclude:

·       Additionsof Table Master, Rapid Table Games and Vegas Star seats of 576.

·       Additionsof EGM seats of 1,607.

·       Anincrease in lifetime license sales of 62 units. Offsetting this increase inunits is a reduction in the average sales price per unit. The average salesprice per unit decreased from approximately $38,500 to approximately $30,300 aswe sold more side bet lifetime licenses than premium game lifetime licenses.

·       Anincrease in service and other revenue which predominately relates to EGMconversion kits and other EGM parts of $7,875.

Entertainment Products segmentoperating income for the year ended October 31, 2006 decreased $16,188 or48.3% and operating margin for the year ended October 31, 2006 decreasedto 22.8% from 73.6% for the same prior year period. The decrease in segmentoperating income as well as segment operating margin was predominantly causedby the one-time IPR&D charge recognized during the three months ended April 30,2006 related to the acquisition of Stargames. Entertainment Products segmentoperating margin, excluding IPR&D, for the year ended October 31,2006, decreased to 48.0% from 73.6%. Entertainment Product margins werenegatively impacted by amortization expense of $1,545 and a book to physicalinventory adjustment of $1,300 related to Stargames for the year ended October 31,2006. No comparable expenses were incurred for the year ended October 31,2005. Additionally, the products contributed by Stargames have a loweroperating margin than our traditional Entertainment Products. Shuffle Up’soperating results were not material to fiscal 2006.

49

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***Fiscal 2005 compared toFiscal 2004***

| ** **                                                      | ** ** | **Year Ended October 31,** | ** ** | **Increase** | ** ** | **Percentage** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                                      | ** ** | **2005**                                  | ** ** | **2004**     | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| **Entertainment  Products segment revenue**                     |       |                                      |       |         |       |           |       |   |   |   | ** ** |   |   |
| Royalties and leases — Table games                         |       | $                                         | 24,119     |         | $          | 23,531         |       |   | $ | 588 |   |   |   | 2.5% |   |   |
| Royalties and leases — Multi-Terminal Gaming Products      |       | 650                                       |       | 123          |       |           | 527        |   |   |   | 428.5% |   |   |
| Royalties and leases — Electronic Gaming Machines          |       | —                                    |       | —       |       |           | —     |   |   |   | 100.0% |   |   |
| Other                                                           |       | 81                                        |       | 46           |       |           | 35         |   |   |   | 76.1% |   |   |
| Total royalties and leases                                      |       | 24,850                                    |       | 23,700       |       |           | 1,150      |   |   |   | 4.9% |   |   |
| Sales — Table games                                        |       | 15,503                                    |       | 14,103       |       |           | 1,400      |   |   |   | 9.9% |   |   |
| Sales — Multi-Terminal Gaming Products                     |       | 4,990                                     |       | 647          |       |           | 4,343      |   |   |   | 671.3% |   |   |
| Sales — Electronic Gaming Machines                         |       | —                                    |       | —       |       |           | —     |   |   |   | 100.0% |   |   |
| Service and other                                               |       | 196                                       |       | 255          |       |           | (59        | ) |   |   | (23.1%) |   |   |
| Total sales and service revenue                                 |       | 20,689                                    |       | 15,005       |       |           | 5,684      |   |   |   | 37.9% |   |   |
| Total Entertainment Products segment  revenue                   |       | $                                         | 45,539     |         | $          | 38,705         |       |   | $ | 6,834 |   |   |   | 17.7% |   |   |
| **Entertainment Products segment operating income**             |       | $                                         | 33,529     |         | $          | 29,586         |       |   | $ | 3,943 |   |   |   | 13.3% |   |   |
| **Entertainment  Products segment operating margin**            |       | 73.6%                                     |       | 76.4%        |       |           |       |   |   |   |   |   |   |
| **Table games installed base (end of year)**                    |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Royalty units                                                   |       | 2,913                                     |       | 2,868        |       |           | 45         |   |   |   | 1.6% |   |   |
| Sold units, inception-to-date                                   |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Beginning of year                                               |       | 365                                       |       | 72           |       |           | 293        |   |   |   | 406.9% |   |   |
| Sold during year                                                |       | 403                                       |       | 293          |       |           | 110        |   |   |   | 37.5% |   |   |
| Subtotal                                                        |       | 768                                       |       | 365          |       |           | 403        |   |   |   | 110.4% |   |   |
| Total installed base                                            |       | 3,681                                     |       | 3,233        |       |           | 448        |   |   |   | 13.9% |   |   |
| **Multi-Terminal Gaming Products installed base (end of year)** |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Lease seats                                                     |       | 200                                       |       | 25           |       |           | 175        |   |   |   | 700.0% |   |   |
| Sold seats, inception-to-date                                   |       |                                      |       |         |       |           |       |   |   |   |   |   |   |
| Beginning of year                                               |       | 75                                        |       | 30           |       |           | 45         |   |   |   | 150.0% |   |   |
| Sold during year                                                |       | 235                                       |       | 45           |       |           | 190        |   |   |   | 422.2% |   |   |
| Subtotal                                                        |       | 310                                       |       | 75           |       |           | 235        |   |   |   | 313.3% |   |   |
| Total installed base                                            |       | 510                                       |       | 100          |       |           | 410        |   |   |   | 410.0% |   |   |

 

Entertainment Products segment revenue was derivedsubstantially from our proprietary table game products, including Table Master.Total revenue contributionfrom Table Master was approximately $4,900. During fiscal year 2005, welaunched Shuffle Up and held our first Three Card Poker National Championship® tournament. Shuffle Up’soperating results were not material to fiscal 2005. Effective June 29,2005, we acquired Bet the Set “21” side bet table game from Magnum Gaming, Inc.The acquired installed base of the Bet the Set “21” side bet table game was 205units as of the acquisition date and was 184 units as of October 31, 2005.Effective August 1, 2005, we purchased certain assets from Spur GamingSystems and as a result we own the underlying patents and trademarks for five 

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additional proprietary games including Jackpot Pai GowPoker® and Progressive JackpotPai Gow Poker. The acquired installed base of games was 53 units asof the acquisition date and 51 units as of October 31, 2005.

For the year ended October 31, 2005,Entertainment Products segment revenue increased 17.7%, compared to the prioryear, primarily due to a 37.9% increase in sales revenue related to both ourtable games and Table Master products. Additionally, royalty and lease revenueincreased 4.9%, compared to the prior year.

The increase inEntertainment Products royalty and lease revenue for the year ended October 31, 2005,compared to the prior year, primarily reflects:

·       A full yearof royalty revenue from the table games acquired from BTI in late February 2004.

·       Ahigher average monthly royalty rate for Three Card Poker, Four Card Poker andFortune Pai Gow Poker.

·       Anet increase of 45 table game royalty units on lease.

·       Theincrease in net table game lease additions comprised primarily of unitincreases in Four Card Poker, Dragon Bonus, Fortune Pai Gow Poker, and ourrecently acquired games, including Bet the Set “21”, Jackpot Pai Gow Poker andProgressive Jackpot Pai Gow Poker. The table game royalty unit increases wereoffset by the conversion of 393 royalty units to lifetime license sales,consisting primarily of Let It Ride and Three Card Poker which both currentlyyield higher average monthly royalty rates than our more recent gameintroductions. Prior year conversions totaled 212 royalty units and consistedprimarily of Let It Ride and Three Card Poker.

·       Netlease additions of our Table Master products of 175 seats for fiscal 2005,compared to 15 seats in fiscal 2004.

The increase inEntertainment Products sales and service revenue for the year ended October 31, 2005,compared to the prior year is primarily attributed to:

·       403lifetime license sales during fiscal 2005, compared to 293 lifetime licensesales in fiscal 2004.

·       Additionalsales of our Table Master products which totaled 235 seats in fiscal 2005compared to 45 seats in fiscal 2004.

Entertainment Products segment operating income increased13.3% for the year ended October 31, 2005, compared to the prioryear. However, as a percentage of Entertainment Products segment revenue,operating margin decreased slightly from the prior year period. Operatingmargin was unfavorably impacted by amortization expense related to the BTIgames of $1,291 for fiscal 2005, compared to $910 for fiscal 2004. Thisunfavorable impact was partially offset by lower allocated manufacturingoverhead and sales expenses in the current period, as these allocated expensesdid not increase at the same rate as revenue. Additionally, we incurredre-engineering and improvement costs related to the Table Master platformduring fiscal 2004; such costs were significantly less for fiscal 2005.

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**LIQUIDITY AND CAPITALRESOURCES(In thousands, except ratios and per share amounts)**

Our primary historical sourceof liquidity and capital resources has been cash flow generated by ourprofitable operations. We use cash to fund growth in our operating assets,including accounts receivable, inventory, sales-type leases and notesreceivable and to fund new products through both research and development andstrategic acquisitions of businesses and intellectual property.

**LIQUIDITY**

***Working Capital.******  ***The following summarizes ourcash, cash equivalents and working capital:

| ** **                               | ** ** | **October 31,** | ** ** | **Increase** | ** ** | **Percentage** | ** ** |
|------------------------------------------|------------|----------------------|------------|--------------|------------|----------------|------------|
| ** **                               | ** ** | **2006**             | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Cash, cash  equivalents, and investments |       | $                    | 8,917      |         | $          | 34,088         |       |   | $ | (25,171 | ) |   |   | (73.8 | %) |   |
| Working capital                          |       | $                    | (18,895    | )            | $          | 57,634         |       |   | $ | (76,529 | ) |   |   | (132.8 | %) |   |
| Current ratio                            |       | 0.8                  |       | 4.4          |       |           | (3.6       | ) |   |   | (81.8 | %) |   |

 

As of October 31, 2006, the Bridge Loan was dueto mature November 30, 2006; accordingly it has been classified in currentliabilities. This current maturity results in negative working capital. On November 30, 2006, we entered into a$100,000 senior secured revolving credit facility. We drew $71,180 on thefacility, which was used to repay in its entirety the existing CreditAgreement, dated as of January 25, 2006. See Note 17 to our consolidatedfinancial statements.

Excluding the short-termbridge financing of $70,000, the current ratio was approximately 2.3 as of October 31,2006.

***Cash Flows.***

*Operating Activities—**Significant*itemsincluded in cash flows from operating activities are as follows:

| ** **                                                   | ** ** | **Year Ended October 31,**                            | ** ** | **Increase**                                                         | ** ** | **Percentage** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------|------------|
| ** **                                                   | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Income from  continuing operations                           |       |                                                                 | $          | 5,339                                                                |       |           |       | $ | 29,104 |   |   |   | $ | (23,765 | ) |   |   | (81.7 | %) |   |
| Non-cash items                                               |       |                                                                 | 38,488     |                                                                 |       |           | 13,028     |   |   |   | 25,460 |   |   |   | 195.4 | % |   |
| Income tax related  items                                    |       |                                                                 | (3,266     | )                                                                    |       |           | 9,614      |   |   |   | (12,880 | ) |   |   | (134.0 | %) |   |
| Loss on investments  and disposal of assets                  |       |                                                                 | 1,655      |                                                                 |       |           | 1,066      |   |   |   | 589 |   |   |   | 55.3 | % |   |
| Investment in  sales-type leases & notes receivable |       |                                                                 | (2,459     | )                                                                    |       |           | (7,942     | ) |   |   | 5,483 |   |   |   | (69.0 | %) |   |
| Other changes in  operating assets and  liabilities          |       |                                                                 | (5,490     | )                                                                    |       |           | (10,438    | ) |   |   | 4,948 |   |   |   | (47.4 | %) |   |
| Discontinued  operations, net of tax                         |       |                                                                 | (246       | )                                                                    |       |           | 76         |   |   |   | (322 | ) |   |   | (423.7 | %) |   |
| Cash flow provided by  operating activities                  |       |                                                                 | $          | 34,021                                                               |       |           |       | $ | 34,508 |   |   |   | $ | (487 | ) |   |   | (1.4 | %) |   |

 

·       Netincome for the year ended October 31, 2006, includes the before-taximpairment write-down of $1,655 related to an equity method investment.

·       Non-cashitems are comprised of IPR&D, gain on sale of patent, depreciation and amortization,share-based compensation expense, provision for bad debts, equity methodinvestment loss, and provision for inventory obsolescence. The increase innon-cash items for the year ended October 31, 2006, is substantially dueto a charge for IPR&D related to the Stargames acquisition of $19,145 andshare-based compensation of $5,512 for the year ended October 31, 2006,compared 

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to $759 in the same prior year period. Additionally,amortization of intangible assets was $9,045 and $5,954 for the years ended October 31,2006 and 2005, respectively.

·       Incometax related items include deferred income taxes, tax benefit from stock optionexercises, prepaid income taxes and is net of excess tax benefit from stockoption exercises.

·       Withthe adoption of SFAS 123R the benefit of tax deductions in excess of thecompensation cost recognized for those options are classified as financing cashinflows rather than operating cash inflows.

·       Weutilize sales-type leases and notes receivable as a means to provide financingalternatives to our customers. It is our intent to continue offering a varietyof financing alternatives, including sales, sales-type leases and notesreceivable, and operating leases, to meet our customers’ product financingneeds, which may vary from quarter to quarter. We expect that some of ourcustomers will continue to choose sales-type leases and notes receivable astheir preferred method of purchasing our products. The volume of sales-typeleases and notes receivable in any period may fluctuate, largely due to ourcustomers’ preferences.

·       Otherchanges in operating assets and liabilities primarily consisted of net changesin accounts receivable, inventories, and accounts payable and accruedliabilities including the impact of changes related to the acquisition ofStargames.

*Investing Activities—**Significant*itemsincluded in cash flows from investing activities are as follows:

| ** **                                   | ** ** | **Year Ended October 31,**                            | ** ** | **Increase**                                                         | ** ** | **Percentage** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------|------------|
| ** **                                   | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net maturities of investments                |       | $                                                                    | 16,797     |                                                                 |       | $              | 5,483      |   |   | $ | 11,314 |   |   | 206.3 | % |   |
| Capital expenditures                         |       | (15,676                                                              | )          |                                                                 | (18,969    | )              |       | 3,293 |   |   | (17.4 | %) |   |
| Business  acquisitions, net of cash acquired |       | (114,608                                                             | )          |                                                                 | (228       | )              |       | (114,380 | ) |   | 50,166.7 | % |   |
| Proceeds from sale of  leased assets         |       | 1,845                                                                |       |                                                                 | 1,632      |           |       | 213 |   |   | 13.1 | % |   |
| Net proceeds from  sale of intangibles       |       | 7,500                                                                |       |                                                                 | 9,039      |           |       | (1,539 | ) |   | (17.0 | %) |   |
| Other                                        |       | —                                                               |       |                                                                 | (3,483     | )              |       | 3,483 |   |   | (100.0 | %) |   |
| Cash flow used by  investing activities      |       | $                                                                    | (104,142   | )                                                                    |       | $              | (6,526     | ) |   | $ | (97,616 | ) |   | 1,495.8 | % |   |

 

·       Netmaturities of investments consist primarily of a $4,000 equity methodinvestment related to Sona and the net proceeds from the sale and maturities ofinvestments of $20,798.

·       Purchaseprice and direct acquisition costs associated with the acquisition of Stargamesin February 2006.

·       Capitalexpenditures include purchases of product for lease, property and equipment,and intangible assets.

·       Duringthe year ended October 31, 2005, we posted a security deposit of $3,000related to a preliminary injunction that we were granted by a judicial court.

·       Proceedsfrom the sale of the ENPAT Patents of $7,500.

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*Financing Activities—**Significant*itemsincluded in cash flows from financing activities are as follows:

| ** **                                           | ** ** | **Year Ended October 31,** | ** ** | **Increase** | ** ** | **Percentage** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                           | ** ** | **2006**                                  | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Repurchases of common  stock                         |       | $                                         | (8,665     | )            | $          | (38,643        | )          |   | $ | 29,978 |   |   |   | (77.6 | %) |   |
| Proceeds from stock  option exercises, net           |       | 7,874                                     |       | 6,512        |       |           | 1,362      |   |   |   | 20.9 | % |   |
| Proceeds from bridge  financing, net of issue  costs |       | 114,446                                   |       | —       |       |           | 114,446    |   |   |   | 100.0 | % |   |
| Proceeds from other  borrowings                      |       | 4,153                                     |       | —       |       |           | 4,153      |   |   |   | 100.0 | % |   |
| Excess tax benefit  from stock option exercises      |       | 3,682                                     |       | —       |       |           | 3,682      |   |   |   | 100.0 | % |   |
| Payments on bridge  financing                        |       | (45,000                                   | )          | —       |       |           | (45,000    | ) |   |   | 100.0 | % |   |
| Payment of notes  payable and other liabilities      |       | (10,567                                   | )          | (2,896       | )          |           | (7,671     | ) |   |   | 264.9 | % |   |
| Cash flow provided  (used) by financing activities   |       | $                                         | 65,923     |         | $          | (35,027        | )          |   | $ | 100,950 |   |   |   | (288.2 | %) |   |

 

·       Duringthe year ended October 31, 2006, we repurchased 317 shares of our commonstock at an average cost of $27.39 per share, compared to 1,473 shares of ourcommon stock at an average cost of $26.24 per share for the same prior yearperiod.

·       Ouremployees and directors exercised 697 options during fiscal 2006, at an averageexercise price of $11.30 per share, compared to 851 options during thecomparable prior year period at an average exercise price of $7.28 per share.

·       Wereceived $114,446 proceeds, net of debt issuance costs, from the Bridge Loanused for the Stargames acquisition.

·       Withthe adoption of SFAS 123R the benefit of tax deductions in excess of thecompensation cost recognized for those options are classified as financing cashinflows rather than operating cash inflows.

·       Duringthe year ended October 31, 2006, we paid $45,000 on the Bridge Loan and madeinstallment payments of $2,609 for the ENPAT note payable and $1,726 for BTIliabilities.

See discussion under “Item 7.Long-Term Liabilities” for information related to our Bridge Loan and our$100,000 senior secured revolving credit facility.

**LONG-TERM LIABILITIES**

***Contingent convertiblesenior notes.******  ***In April 2004,we issued $150,000 of contingent convertible senior notes due 2024 (the “Notes”)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 15of each year, beginning October 15, 2004.

Holders may convert any outstanding Notes into cashand 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 ofcommon stock per $1,000 in principal amount of Notes. The value of the cash andshares 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 applicableConversion Rate, Conversion Value, Principal Return, and other factors, each asdefined in the indenture covering these Notes.

The Notes areconvertible, at the holders’ option, into cash and shares of our common stock,under any of the following circumstances:

·       duringany fiscal quarter commencing after the date of original issuance of the Notes,if the closing sale price of our common stock over a specified number oftrading days during the previous quarter 

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is more than 120% of the conversion price of the Noteson the last trading day of the previous quarter;

·       ifwe have called the Notes for redemption and the redemption has not yetoccurred;

·       duringthe five trading day period immediately after any five consecutive trading dayperiod in which the trading price of the Notes per $1,000 principal amount foreach day of such period was less than 95% of the product of the closing saleprice of our common stock on such day multiplied by the number of shares of ourcommon stock issuable upon conversion of $1,000 in principal amount of theNotes, provided that, if on the date of any conversion pursuant to this tradingprice condition, our common stock price on such date is greater than theconversion price but less than 120% of the conversion price, then the holderwill be entitled to receive Conversion Value (as defined in the indenturecovering these Notes) equal to the principal amount of the Notes, plus accruedand unpaid interest including liquidated damages, if any; or

·       uponthe occurrence of specified corporate transactions.

We may call some or all of the Notes at any time on orafter April 21, 2009, at a redemption price, payable in cash, of 100% ofthe principal amount of the Notes, plus accrued and unpaid interest and includingliquidated damages, if any, up to but not including the date of redemption. Inaddition, the holders may require us to repurchase all or a portion of theirNotes on April 15, 2009, 2014 and 2019, at 100% of the principal amount ofthe Notes, plus accrued and unpaid interest and including liquidated damages,if any, up to but not including the date of repurchase, payable in cash. Upon achange in control, as defined in the indenture governing the Notes, holders mayrequire us to repurchase all or a portion of their Notes, payable in cash equalto 100% of the principal amount of the Notes plus accrued and unpaid interestand liquidated damages, if any, up to but not including the date of repurchase.

***Bridge loan.******  ***On January 25, 2006, weentered into a credit agreement (the “Old Credit Agreement”), which has nowbeen paid off, with Deutsche Bank AG Cayman Islands Branch, as a Lender,Deutsche Bank AG New York Branch, as Administrative Agent, and Deutsche BankSecurities Inc., as Sole Arranger and Book Manager, pursuant to which weobtained a bridge loan (the “Bridge Loan”) in the amount of $115,000, in orderto finance the acquisition of Stargames. On April 24, 2006, we enteredinto Amendment No. 1 (the “Amendment”) to the Old Credit Agreement. TheAmendment extended the maturity date for the Bridge Loan to July 24, 2006and we agreed to use our commercially reasonable efforts to secure the loanextended under the Old Credit Agreement. On July 24, 2006, we entered intoAmendment No. 2 (“Amendment No. 2”) to the Old Credit Agreement.Amendment No. 2 extended the maturity date for the Bridge Loan to September 30,2006. On July 31, 2006, we entered into a security agreement, as requiredby Amendment No. 2, with Deutsche Bank AG New York Branch, as collateralagent. On September 29, 2006, we entered into Amendment No. 3 (“AmendmentNo. 3”) to the Old Credit Agreement. Amendment No. 3 extended thematurity date for the Bridge Loan to October 31, 2006. On October 31,2006, we entered into Amendment No. 4 (“Amendment No. 4”) to the OldCredit Agreement. Amendment No. 4 extended the maturity date for theBridge Loan to November 30, 2006.

As of October 31, 2006, we were in compliancewith all of the affirmative and negative covenants pursuant to the Old CreditAgreement. Additional information on these covenants may be found in Section 7and Section 8 of the Old Credit Agreement included in our Current Reporton Form 8-K, dated January 25, 2006. The principal balance onthe Bridge Loan as of October 31, 2006 was $70,000.

On November 30, 2006, we entered into a $100,000senior secured revolving credit facility (the “New Credit Agreement”) withDeutsche Bank AG Cayman Islands Branch, as a Lender, Deutsche Bank TrustCompany Americas, as Administrative Agent, Deutsche Bank Securities Inc. and 

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Wells Fargo, N.A., as Joint Lead Arrangersand Book Managers and Wells Fargo, N.A. as Syndication Agent. We drew $71,180on the facility, which was used to repay in its entirety the Old Credit Agreement.Any remaining amount available under the revolving credit facility will be usedfor working capital, capital expenditures and general corporate purposes,including share repurchases. The revolving credit facility under the New CreditAgreement will mature on November 30, 2011.

The interest rate underthe New Credit Agreement is based on the sum of the relevant Base Rate orEurodollar Rate plus the Applicable Margin, as defined, each as in effect fromtime to time. The obligations under the revolving credit facility areguaranteed by each wholly-owned domestic subsidiary of ours that is not animmaterial subsidiary and each wholly-owned domestic subsidiary that is not animmaterial subsidiary of the Company established, created or acquired after November 30,2006, if any. The New Credit Agreement contains customary affirmative andnegative covenants for transactions of this nature, including but not limitedto restrictions and limitations on the following:

·       Permittedacquisitions;

·       Incurrenceof indebtedness;

·       Grantingor incurrence of liens;

·       Paydividends and make other distributions in respect of our equity securities;

·       Acquireassets and make investments;

·       Salesof assets;

·       Transactionswith affiliates;

·       Mergers;

·       TotalLeverage Ratio

·       InterestExpense Coverage ratio; and

·       Agreementsto restrict dividends and other payments from subsidiaries.

Total debt issuance costs incurred with the issuanceof long-term debt and the Bridge Loan are capitalized and amortized as interestexpense using the effective interest method. Amortization of debt issuancecosts were $1,511 and $961 for the year ended October 31, 2006 and 2005,respectively. Unamortized debt issuance costs of $2,369 and $3,328 as of October 31,2006 and 2005, respectively, are included in Other long term assets on theconsolidated balance sheets.

***Stargames creditfacility.***   Stargames has banking facilitieswith the Australia and New Zealand Banking Group (“ANZ”). The facilities have aborrowing capacity of AU $12,700; amounts outstanding as of October 31,2006 were AU $5,000 or US $3,872 at a weighted average interest rate of 6.45%.The banking facilities are comprised of two main components: a flexible bankoverdraft that acts as a working capital facility and a bank loan facilitywhich is an interchangeable facility comprised of commercial bills, overdraftsand advances. Interest rates are based on the bank bill swap yield, as defined,plus a margin.

The facilities are secured by a cross guarantee andindemnity between all the operating entities of the Stargames group. Theagreements provide for collateralization of all the assets and operations ofall members of the Stargames group as well as the operating facilities ofStargames based in Milperra, New South Wales, Australia.

The facilities include certain financial covenantswhich are tested annually by ANZ at the end of each financial year. Thesefinancial covenants include a minimum working capital ratio, a minimum ratio of

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net profit, as defined, to interest expense andminimum liabilities to equity ratio. As of June 30, 2005, the most recentdate of review, Stargames was in compliance with all financial covenants. Thefacilities are subject to the next compliance assessment as of October 31,2006.

***BTI liabilities.***   Inconnection with our acquisition of certain assets from BTI, we recorded aninitial estimated liability of $7,616 for contingent installment paymentscomputed as the excess fair value of the acquired assets over the fixedinstallments and other direct costs. In November 2004, we began payingmonthly note installments based on a percentage of certain revenue from BTIgames for a period of up to ten years, not to exceed $12,000. The balance ofthis liability as of October 31, 2006 and 2005 was $4,441 and $6,167,respectively.

***ENPAT note payable.******  ***In December 2004, wepurchased two Radio Frequency Identification (“RFID”) technology patents fromENPAT for $12,500. The purchase price was comprised of an initial payment of$2,400 followed by a $1,100 payment in January 2005 and non-interestbearing annual installments through December 2007. The balance as of October 31,2006 and 2005, of $5,823 and $8,518, respectively, represents the discountedpresent value of the future payments, including imputed interest ofapproximately $265 and $352, respectively. Principal and interest payments of$3,000 each are due in December 2006 and 2007.

***Bet the Set “21”contingent consideration.******  ***Inconnection with our acquisition of Bet the Set “21”, we recorded contingentconsideration of $560. The contingent consideration consists of quarterlypayments of 22.5% of “adjusted gross revenues,” as defined, attributed to theBet the Set “21” side bet table games up to a maximum of $560. The balance ofthis liability as of October 31, 2006 and 2005, was $526 and $549,respectively.

***VIP note payable.******  ***In connection with our acquisition of VIP in August 2005,we recorded a note payable with annual installments due each July through2007. The balance of the liability as of October 31, 2006 and 2005 was$329 and $318, respectively.

**CAPITAL RESOURCES**

Excluding any significant acquisitions of businesses,and considering the $100,000 senior secured revolving credit facility enteredinto on November 30, 2006, we believe our existing cash, investments, debtfinancing and projected cash flow from future operations will be sufficient tofund our operations, long-term obligations, capital expenditures, and new productdevelopment for the foreseeable future. Projected cash flows from operationsare based on our estimates of revenue and expenses and the related timing ofcash receipts and disbursements. If actual performance differs from estimatedperformance, projected cash flows could be positively or negatively impacted.

We have not provided U.S.Federal income tax on $4,258 of undistributed earnings of our foreignsubsidiaries because we intend to permanently reinvest such earnings outsidethe United States. Upon distribution of these earnings in the form of dividendsor otherwise, we would be subject to U.S. income taxes, subject to adjustmentfor foreign tax credits. Determination of the amount of unrecognized deferredU.S. income tax liability is not practicable because of the complexitiesassociated with its hypothetical calculation.

**STOCK REPURCHASEAUTHORIZATIONS**

In December 2004, our board of directors approveda three-for-two common stock split, with new shares distributed in the form ofa dividend on January 14, 2005, to shareholders of record on January 3,2005 (the “January 2005 Split”). In connection with the January 2005Split, we paid cash of $68 for fractional shares and reclassified to commonstock the par value of $0.01 per newly issued share.

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In****March 2004, our board of directors had earlierapproved another three-for-two common stock split, with new shares distributedin the form of a dividend on April 16, 2004, to shareholders of record on April 5,2004 (the “April 2004 Split”). In connection with the April 2004Split, we paid cash of $138 for fractional shares and reclassified to commonstock the par value of $0.01 per newly issued share.

Share and per share amounts have been adjusted for allperiods presented herein to reflect both the January 2005 Split and the April 2004Split.

Our board of directors periodically authorizes us torepurchase shares of our common stock. Under our existing board authorizations,during the year ended October 31, 2006, we repurchased 317 shares of ourcommon stock for a total cost of $8,665 at an average price of $27.39 pershare. Under our board authorizations, during the years ended October 31,2005 and 2004, we repurchased 1,473 and 1,991 shares of our outstanding stockat total costs of $38,643 and $42,524, respectively. We cancel shares that werepurchase. In addition, in April 2004, our board of directors authorizedand we repurchased, in private transactions, an additional 2,806 shares of ourcommon stock at a total cost of $57,500 with funds provided from the issuanceof our contingent convertible senior notes.

On September 5, 2006, our board of directorsvoted a new authorization to repurchase shares of our common stock by anadditional $30,000. As of October 31, 2006, $30,166 remained outstandingunder our board authorizations.

The timing of our repurchasesof our common stock pursuant to our board of directors’ authorization isdependent on future opportunities and on our views, as they may change from timeto time, as to the most prudent uses of our capital resources, including cashand borrowing capacity. Alternatives that we consider as possible uses of ourcapital resources include investment in new products, acquisitions, principalpayments on our long term obligations, funding of internal growth in workingcapital, and investments in sales-type leases and notes receivable.

**CONTRACTUAL OBLIGATIONSAND OFF-BALANCE SHEET ARRANGEMENTS**

***Contractual Obligations.***   Thefollowing table summarizes our material obligations and commitments to makefuture payments under certain contracts, including long-term debt obligations,purchase commitments and operating leases.

| ** **                                     | ** ** | ** ** | ** ** | **Less than** | ** ** | **1 - 3** | ** ** | **3 - 5** | ** ** | **More than** | ** ** |
|------------------------------------------------|------------|------------|------------|--------------------|------------|---------------------|------------|---------------------|------------|--------------------|------------|
| ** **                                     | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **Years**           | ** ** | **Years**           | ** ** | **5 Years**   | ** ** |
| Long-term obligations:                         |       |       |       |               |       |                |       |                |       |               |       |   |   |   |   |
| Contingent convertible notes                   |       | $          | 150,000    |               |       | $                   | —     |                |       | $                  | 150,000    |   | $ | — |   |   | $ | — |   |   |
| Interest on convertible notes                  |       | 4,688      |       |               | 1,875      |                |       | 2,813               |       | —             |       |   | — |   |   |
| Bridge Loan                                    |       | 70,000     |       |               | 70,000     |                |       | —              |       | —             |       |   | — |   |   |
| BTI acquisition contingent consideration       |       | 4,441      |       |               | —     |                |       | —              |       | —             |       |   | 4,441 |   |   |
| Stargames credit facility                      |       | 3,872      |       |               | 3,872      |                |       | —              |       | —             |       |   | — |   |   |
| ENPAT note payable, including imputed interest |       | 6,000      |       |               | 3,000      |                |       | 3,000               |       | —             |       |   | — |   |   |
| Magnum Gaming                                  |       | 526        |       |               | —     |                |       | —              |       | —             |       |   | 526 |   |   |
| VIP Note Payable                               |       | 329        |       |               | 329        |                |       | —              |       | —             |       |   | — |   |   |
| Other                                          |       | 1,057      |       |               | 119        |                |       | 363                 |       | 303                |       |   | 272 |   |   |
| Purchase commitments                           |       | 14,703     |       |               | 14,703     |                |       | —              |       | —             |       |   | — |   |   |
| Operating leases                               |       | 3,914      |       |               | 1,360      |                |       | 1,726               |       | 589                |       |   | 239 |   |   |
| Total                                          |       | $          | 259,530    |               |       | $                   | 95,258     |                |       | $                  | 157,902    |   | $ | 892 |   |   | $ | 5,478 |   |   |

 

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Our contingent convertible notes may be called onApril 15, 2009 as discussed in Note 8 to our consolidated financialstatements. As such, the table above does not reflect interest related to theNotes of $28,047 which amount would be paid if the Notes are outstanding to thematurity in April 2024.

***Purchase commitments.***   Fromtime to time, we enter into commitments with our vendors to purchase inventoryat fixed prices or in guaranteed quantities. As of October 31, 2006, oursignificant inventory purchase commitments totaled $14,703.

***Operating leases.*****  **Amounts payable under operating lease agreementsrelate primarily to our Las Vegas headquarters, Stargames facilities and otherfield service facilities.

***Bridge loan.******  ***On January 25, 2006, weentered into a Credit Agreement with Deutsche Bank AG Cayman Islands Branch, asa Lender, Deutsche Bank AG New York Branch, as Administrative Agent, andDeutsche Bank Securities Inc., as Sole Arranger and Book Manager (the “CreditAgreement”), pursuant to which we obtained a bridge loan (the “Bridge Loan”) inthe amount of $115,000, in order to finance the acquisition of Stargames. On April 24,2006, we entered into Amendment No. 1 (the “Amendment”) to the CreditAgreement. The Amendment extended the maturity date for the Bridge Loan to July 24,2006 and we agreed to use our commercially reasonable efforts to secure theloan extended under the Credit Agreement. On July 24, 2006, we enteredinto Amendment No. 2 (“Amendment No. 2”) to the Credit Agreement.Amendment No. 2 extended the maturity date for the Bridge Loan to September 30,2006. On July 31, 2006, we entered into a security agreement, as requiredby Amendment No. 2, with Deutsche Bank AG New York Branch, as collateralagent. On September 29, 2006, we entered into Amendment No. 3 (“AmendmentNo. 3”) to the Credit Agreement. Amendment No. 3 extended thematurity date for the Bridge Loan to October 31, 2006. On October 31,2006, we entered into Amendment No. 4 (“Amendment No. 4”) to theCredit Agreement. Amendment No. 4 extended the maturity date for theBridge Loan to November 30, 2006. The balance of the liability as of October 31,2006, was $70,000. See Note 8 to our consolidated financial statements for moreinformation.

***Stargames creditfacility.***   Stargames has banking facilitieswith the Australia and New Zealand Banking Group (“ANZ”). The facilities have aborrowing capacity of AU $12,700; amounts outstanding as of October 31,2006 were AU $5,000 or US $3,872 at a weighted average interest rate of 6.45%.

***BTI liabilities.***   Inconnection with our acquisition of certain assets from BTI, we recorded aninitial estimated liability of $7,616 for contingent installment paymentscomputed as the excess fair value of the acquired assets over the fixed installmentsand other direct costs. In November 2004, we began paying monthly noteinstallments based on a percentage of certain revenue from BTI games for aperiod of up to ten years, not to exceed $12,000. The balance of this liabilityas of October 31, 2006 and 2005 was $4,441 and $6,167, respectively.

***ENPAT note payable.******  ***In December 2004, wepurchased two RFID technology patents from ENPAT for $12,500. The purchaseprice was comprised of an initial payment of $2,400 followed by a $1,100payment in January 2005 and a non-interest bearing note with annualinstallments due through December 2007. The balance as of October 31,2006 and 2005, of $5,823 and $8,518, respectively, represents the discountedpresent value of the future payments, including imputed interest ofapproximately $265 and $352, respectively. Principal and interest payments of$3,000 each are due in December 2006 and 2007.

***Bet the Set “21”contingent consideration.******  ***Inconnection with our acquisition of Bet the Set “21”, we recorded contingentconsideration of $560. The contingent consideration consists of quarterlypayments of 22.5% of “adjusted gross revenues,” as defined, attributed to theBet the Set “21” side bet table games up to a maximum of $560. The balance ofthis liability as of October 31, 2006 and 2005, was $526 and $549,respectively.

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***VIP note payable.******  ***In connection with our acquisition of VIP in August 2005,we recorded a note payable with annual installments due each July through2007. The balance of the liability as of October 31, 2006 and 2005 was$329 and $318, respectively.

***Employment agreements.***   Wehave entered into employment contracts with our Corporate Officers and certainother key employees with durations ranging from one to three years. Significantcontract provisions include minimum annual base salaries, healthcare benefits,bonus compensation if performance measures are achieved, and non-competeprovisions. These contracts are primarily “at will” employment agreements,under which the employee or we may terminate employment. If we terminate any ofthese employees without cause, then we are obligated to pay the employeeseverance benefits as specified in their individual contract. As of October 31,2006, minimum aggregate severance benefits totaled $5,123.

***Off-Balance Sheet Arrangements.******  ***We do not have any materialoff-balance sheet arrangements with unconsolidated entities or other persons.

**IMPACT OF INFLATION**

To date, inflation has not hada material effect on our operations.

**CRITICAL ACCOUNTINGPOLICIES**

The preparation of our consolidated financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires that we adopt accounting policies and makeestimates and assumptions that affect our reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities, and ourreported amounts of revenue and expenses. We periodically evaluate ourpolicies, estimates and related assumptions, including: revenue recognition;the amortization, depreciation, and valuation of long-lived tangible andintangible assets; inventory obsolescence and costing methods; provisions forbad debts; accounting for stock-based compensation; and contingencies. We baseour estimates on historical experience and expectations of the future. Actualreported and future amounts could differ from those estimates under differentconditions and assumptions.

We believe that the following accounting policies andrelated estimates are critical to the preparation of our consolidated financialstatements.

***Revenue recognition.******  ***We recognize revenue when thefollowing criteria are met:

·       persuasiveevidence of an arrangement between us and our customer exists,

·       shipmenthas occurred or services have been rendered,

·       theprice is fixed or determinable, and

·       collectibilityis reasonably assured.

We earn our revenue in a variety of ways. We offer ourproducts for lease or sale. We also sell service and warranty contracts for oursold equipment. Proprietary table games are sold under lifetime licensingagreements or licensed on a monthly or daily fee basis.

*Lease androyalty revenue*—Lease and royalty revenue is earned from theleasing of our tangible products and the licensing of our intangible products,such as our proprietary table games. We recognize revenue monthly, based on amonthly fixed fee, generally through indefinite term operating leases. Leaseand royalty revenue commences upon the completed installation of the product.

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*Sales and service revenue*—Wegenerate sales revenue through the sale of equipment in each product segment,including sales revenue from sales-type leases and the sale of lifetimelicenses for our proprietary table games. Financing for intangible property andsales-type leases for tangible property have payment terms ranging generallyfrom 30 to 60 months and are interest-bearing at market interest rates. Revenuefrom the sale of equipment is recorded upon shipment. If a customer purchasesexisting leased equipment, revenue is recorded on the effective date of thepurchase agreement. Revenue on service and warranty contracts is recognizedover the terms of the contracts, which are generally one year. Revenue from thesale of lifetime licenses, under which we have no continuing obligations, isrecorded on the effective date of the license agreement.

Certain of our productscontain software, and as such we have considered the guidance contained in Statement of Position (“SOP”) 97-2, “*Software Revenue Recognition*”,, as modified by SOP No. 98-9,“*Software Revenue Recognition, With Respect toCertain Transactions*”. Under this guidance when selling or leasing software weconsider whether the software componentis incidental to the product as a whole based on the following criteria:

·       Whetherthe software is a significant focus of the marketing effort or is soldseparately.

·       Whetherpost-contract customer support or PCS (PCS includes the right to receiveservices or unspecified upgrades/enhancements, or both, offered to users orresellers) is provided.

·       Whetherthe development and production costs of the software as a component of the costof the product is incidental (as defined in FASB Statement of FinancialAccounting Standard (“SFAS”) No. 86, “*Accounting for the Costsof Computer Software to Be Sold, Leased, or Otherwise Marketed*”).

·       Whetheran agreement includes service elements (other than PCS related services), suchas training or installation, and whether such services are essential to thefunctionality 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 canbe used by customers with little or no customization). Conversely, “coresoftware” requires significant customization of the software in order for thesoftware to be used by the end customer.

Some of our revenuearrangements contain multiple deliverables, such as a product sale combinedwith a service element or the delivery of a future product. If an arrangementrequires the delivery or performance of multiple elements, we apply theguidance from SOP 97-2, as amended, Emerging Issues Task Force (“EITF”)03-05, “*Applicability of AICPA Statement of Position97-2 to Non-Software Deliverables in an Arrangement ContainingMore-Than-Incidental Software.*” Deliverables are divided intoseparate units of accounting if:

·       Thedelivered items have value to the customer on a stand alone basis

·       Wehave objective and reliable evidence of the fair value of the undelivered items

·       Deliveryof any undelivered item is considered probable and substantially in our control

If these criteria are not met, we do not recognizerevenue until all essential elements have been delivered. If the installationof the product is not considered inconsequential and perfunctory, then we deferrevenue recognition until installation is complete.

***Business combinations.***   Weaccount 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 thenet assets of acquired businesses at fair value, and we must make estimates andassumptions to determine the fair value of these acquired assets and assumedliabilities.

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In determining the fair value of acquired assets andassumed liabilities in the Stargames acquisition, we used valuation specialiststo assist us with certain fair value estimates, primarily related to intangibleassets, including IPR&D, developed technology, tradename and customerrelationships, as well as inventory and land, property and equipment. We andthe valuation specialists applied significant judgment and utilized a varietyof assumptions in determining the fair value of acquired assets and liabilitiesassumed, and in-process research and development, including market data,estimated future cash flows, growth rates, current replacement cost for similarcapacity for certain fixed assets, market rate assumptions for contractualobligations and settlement plans for contingencies and liabilities.

The Stargames purchase price allocation is preliminaryand may be adjusted for up to one year after the acquisition. Changes to theassumptions we used to estimate fair value could impact the recorded amountsfor acquired assets and assumed liabilities and significant changes to thesebalances could have a material impact to our future reported results. Forinstance, lower or higher fair values assigned to in-process research anddevelopment and certain amortizable intangible assets could result in lower orhigher amounts of income statement charges.

***Intangible Assets andGoodwill.******  ***Wehave significant investments in intangible assets and goodwill. Intangibleassets primarily include values assigned to acquired products, patents,trademarks, licenses and games. Significant accounting policies that affect thereported amounts for these assets include the determination of the assets’estimated useful lives and the evaluation of the assets’ recoverability basedon expected cash flows and fair value.

Except for the trademarks related to the Stargames andCARD acquisitions, which are not subject to amortization and are testedperiodically for impairment, all of our significant intangible assets aredefinite lived and amortized over their expected useful lives. We estimateuseful lives based on historical experience, estimates of products’ commerciallives, the likelihood of technological obsolescence, and estimates of theduration of commercial viability for patents, trademarks, licenses and games.We amortize substantially all of our intangible assets proportionate to therelated projected revenue from the utilization of the intangible asset. Webelieve this method reflects the pattern in which the economic benefits of theintangible asset are consumed or otherwise used up. For certain otherintangibles, we use the straight-line amortization method. Should the actualuseful life of an asset differ from the estimated useful life, future operatingresults could be positively or negatively affected.

We review our intangible assets for impairment whencircumstances indicate that the carrying amount of an asset may not be fullyrecoverable from undiscounted estimated future cash flows. We would record animpairment loss if the carrying amount of the intangible asset is notrecoverable and the carrying amount exceeds its estimated fair value.

We review our goodwill for impairment in October annuallyusing a two step impairment test. The review is performed at the reporting unitlevel, which we have determined is the equivalent to our reportable segments. Inthe first step, we estimate the fair value of the reporting unit and compare itto the book value of the reporting unit, including its goodwill. If the fairvalue is less than the book value, then we would perform a second step tocompare the implied fair value of the reporting unit’s goodwill to its bookvalue. The implied fair value of the goodwill is determined based on theestimated fair value of the reporting unit less the fair value of the reportingunit’s identifiable assets and liabilities. We would record an impairmentcharge to the extent that the book value of the reporting unit’s goodwillexceeds its fair value.

Tests for impairment and recoverability of assetsinvolve significant estimates and judgments regarding products’ lives andutility and the related expected future cash flows. While we believe that ourestimates are reasonable, different assumptions could materially affect ourassessment of useful 

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lives, recoverability and fair values. An adversechange to the estimate of these cash flows could necessitate an impairmentcharge that could adversely affect operating results.

***Inventory Obsolescenceand Costing Methods.******  ***Wevalue our inventory at the lower of cost, determined on a first-in-first-outbasis, or market and estimate a provision for obsolete or unsalable inventoriesbased on assumptions about the future demand for our products and marketconditions. If future demand and market conditions are less favorable than ourassumptions, additional provisions for obsolete inventory could be required.Likewise, favorable future demand could positively impact future operatingresults if fully-reserved-for inventory is sold.

***Provisions for BadDebts.******  ***Wemaintain provisions for bad debts for estimated credit losses that result fromthe inability of our customers to make required payments. Provisions for baddebts are estimated based on historical experience and specific customercollection issues. Changes in the financial condition of our customers couldresult in the adjustment upward or downward in the provisions for bad debts,with a corresponding impact to our operating results.

***Share-BasedCompensation.******  ***BeginningNovember 1, 2006, we account for share-based compensation in accordancewith the provisions of SFAS No. 123 (revised 2004) (“SFAS 123R”), “*Share-Based Payment*”, and SEC Staff Accounting Bulletin No. 107(“SAB 107”), “*Share-Based Payment*”. Under thefair value recognition provisions of SFAS No. 123R, stock-basedcompensation cost is estimated at the grant date based on the fair value of theaward and is recognized as expense ratably over the requisite service period ofthe award. Determining the appropriate fair value model and calculating thefair value of share-based awards requires judgment, including estimating stockprice volatility, forfeiture rates and expected life. If actual results differsignificantly from these estimates, share-based compensation expense and ourresults of operations could be materially impacted.

The application of this policy affects the level ofour cost of sales, research and development expenses, selling andadministrative expenses, and additional paid-in capital. During fiscal 2006, wehad no material changes in the critical accounting estimates arising from theapplication of this policy and we do not anticipate material changes in thenear term.

***Contingencies.******  ***We assess our exposures toloss contingencies including legal and income tax matters and provide for anexposure if it is judged to be probable and reasonably estimable. If the actualloss from a contingency differs from our estimate, there could be a materialimpact on our results of operations or financial position. Operating expenses,including legal fees, associated with contingencies are expensed when incurred.

**RECENTLY ISSUED ORADOPTED ACCOUNTING STANDARDS**

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes aframework for measuring fair value in GAAP, and expands disclosures about fairvalue measurements. SFAS 157 does not require any new fair value measurements,but provides guidance on how to measure fair value by providing a fair valuehierarchy used to classify the source of the information. This statement iseffective for us beginning in November 2008. We are evaluating whetheradoption of this statement will result in a change to our fair valuemeasurements.

In September 2006, the SEC issued SAB 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”). SAB 108 requires analysis ofmisstatements using both an income statement (rollover) approach and a balancesheet (iron curtain) approach in assessing materiality and provides for aone-time cumulative effect transition adjustment. SAB 108 is effective for ourfiscal year 2007 annual financial statements. We do not expect the adoption ofthis statement to have a material impact on our results of operations,financial position or cash flows.

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In June 2006, the FASB issued FIN 48, “Accountingfor Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109”(“FIN 48”). FIN 48 prescribes the recognition threshold and measurementcriteria for determining the tax benefit amounts to recognize in the financialstatements. This interpretation is effective for us beginning in November 2007.We are evaluating the potential impact of adopting this interpretation on ourfuture results of operations, financial position or cash flows.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS 154”), requiring retrospectiveapplication to prior-period financial statements of changes in accountingprinciples, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS 154 also redefines “restatement”as the revising of previously issued financial statements to reflect thecorrection of errors. This statement is effective for us beginning in November 2006.We applied the provisions of SFAS 154 in these financial statementspresented as we are revising previously issued financial statements to reflectthe correction of an error. See Note 2 for further discussion of therestatement.

In March 2005, the SECissued SAB 107, “Share-Based Payment” (“SAB 107”), providing interpretiveguidance on SFAS 123R valuation methods, assumptions used in valuation models,and the interaction of SFAS 123R with existing SEC guidance. The additional SAB107 requirement for the classification of stock compensation expense to thesame financial statement line as cash compensation affected our cost of productsales and gaming operations, related gross profits and margins, R&D, andSG&A expenses. We adopted the provisions of SFAS 123R and SAB 107 in thefirst quarter of fiscal 2006. See Note 9 for additional information.

**SUBSEQUENT EVENTS**

***$100,000 RevolvingCredit Facility.******  ***OnNovember 30, 2006, we entered into a $100,000 senior secured revolvingcredit facility (the “New Credit Agreement”) with Deutsche Bank AG CaymanIslands Branch, as a Lender, Deutsche Bank Trust Company Americas, asAdministrative Agent, Deutsche Bank Securities Inc. and Wells Fargo, N.A., asJoint Lead Arrangers and Book Managers and Wells Fargo, N.A. as SyndicationAgent. We drew $71,180 on the facility, which was used to repay in its entiretythe Old Credit Agreement, dated as of January 25, 2006. Any remainingamount available under the revolving credit facility will be used for workingcapital, capital expenditures and general corporate purposes, including sharerepurchases. The revolving credit facility under the New Credit Agreement willmature on November 30, 2011.

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**ITEM 7A. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

We are exposed to market risks, which arise during thenormal course of business from changes in interest rates and foreign exchangerates. A discussion of our primary market risks are presented below.

***Contingent ConvertibleSenior Notes.******  ***We estimate thatthe fair value of our Notes, as of October 31, 2006, is $172,313**.**The fair value of our Notes issensitive to changes in both our stock and interest rates. Assuming interestrates are held constant, we estimate a 10% decrease in our stock price woulddecrease the fair value of our Notes by $9,878. Assuming our stock price isheld constant; we estimate a 10% increase in interest rates would decrease thefair value of our Notes by $848.

***Foreign Currency Risk.****  *We operate in numerous countries around the world.Historically, our business has been denominated in U.S. currency, andaccordingly, our exposure to foreign currency risk has been immaterial. Withour acquisition of CARD in May 2004 and our recent acquisition ofStargames, we expect to continue to increase our volume of business that isdenominated in foreign currency. As such, we expect an increase in the exposureto our cash flows and earnings that could result from fluctuations in foreigncurrency exchange rates. When appropriate, we may attempt to limit our exposureto changing foreign exchange rates by entering into foreign currency exchangecontracts.

**ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

|                                                                                                                                                | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                                       |       |     | 66         |   |   |
| Consolidated  Statements of Income for the years ended October 31, 2006 (as restated),  2005, and 2004                                    |       |     | 67         |   |   |
| Consolidated Balance  Sheets as of October 31, 2006 (as restated) and 2005                                                                |       |     | 68         |   |   |
| Consolidated  Statements of Changes in Shareholders’ Equity for the years ended  October 31, 2006 (as restated), 2005, and 2004 |       |     | 69         |   |   |
| Consolidated  Statements of Cash Flows for the years ended October 31, 2006 (as  restated), 2005, and 2004                           |       |     | 70         |   |   |
| Notes to Consolidated Financial Statements                                                                                                     |       |     | 72         |   |   |
| Quarterly  Financial Data (unaudited)                                                                                                          |       |     | 112        |   |   |
| Financial Statement Schedule  II—Valuation and Qualifying Accounts for the years ended October 31,  2006, 2005 and 2004              |       |     | 113        |   |   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Shareholders ofShuffle Master, Inc.

We have audited the accompanying consolidated balancesheets of Shuffle Master, Inc. and subsidiaries (the “Company”) as ofOctober 31, 2006 and 2005, and the related consolidated statements ofincome, shareholders’ equity, and cash flows for each of the three years in theperiod ended October 31, 2006. Our audits also included the financialstatement schedule listed in the Index at Item 8. These consolidated financialstatements and the financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theconsolidated financial statements and the financial statement schedule based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, 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 statementspresent fairly, in all material respects, the financial position of ShuffleMaster, Inc. and subsidiaries as of October 31, 2006 and 2005, andthe results of their operations and their cash flows for each of the threeyears in the period ended October 31, 2006, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, the financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly, inall material respects, the information set forth therein.

As discussed in Note 1, the Company adopted theprovisions of Statement of Financial Accounting Standards No. 123(R), *Accounting for Stock-Based Payment*, on November 1,2005.

As discussed in Note 2, the accompanying 2006consolidated financial statements have been restated.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of October 31, 2006, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated January 16, 2007 (April 23, 2007 as to theeffect of the second material weakness identified and described in Management’sReport on Internal Control over Financial Reporting), expressed an unqualifiedopinion on management’s assessment of the effectiveness of the Company’sinternal control over financial reporting and an adverse opinion on theeffectiveness of the Company’s internal control over financial reportingbecause of material weaknesses.

/s/ Deloitte & Touche LLP

Las Vegas, NevadaJanuary 16, 2007 (April 23, 2007 as to the effect of the restatementdiscussed in Note 2)

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**SHUFFLEMASTER, INC.CONSOLIDATED STATEMENTS OF INCOME(In thousands, except per share amounts)**

| ** **                                                                   | ** ** | **Year Ended October 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | **(As restated,**                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **see Note 2)**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue:**                                                                 |       |                                      |       |   |   |   |   |   |   |
| Utility products leases                                                      |       |                                      | $          | 24,048 |   |   | $ | 23,721 |   | $ | 19,415 |   |
| Utility products sales and service                                           |       |                                      | 62,744     |   |   | 43,308 |   | 26,532 |   |
| Entertainment products leases and royalties                                  |       |                                      | 25,503     |   |   | 24,850 |   | 23,700 |   |
| Entertainment products sales and service                                     |       |                                      | 50,458     |   |   | 20,689 |   | 15,005 |   |
| Other                                                                        |       |                                      | 238        |   |   | 292 |   | 131 |   |
| **Total revenue**                                                            |       |                                      | 162,991    |   |   | 112,860 |   | 84,783 |   |
| **Costs and expenses:**                                                      |       |                                      |       |   |   |   |   |   |   |
| Cost of leases and royalties                                                 |       |                                      | 11,794     |   |   | 9,692 |   | 8,206 |   |
| Cost of sales and service                                                    |       |                                      | 44,927     |   |   | 19,568 |   | 11,197 |   |
| Selling, general and administrative                                          |       |                                      | 51,299     |   |   | 30,559 |   | 22,953 |   |
| Research and development                                                     |       |                                      | 12,910     |   |   | 7,784 |   | 6,185 |   |
| Gain on sale of patent                                                       |       |                                      | (4,566     | ) |   | — |   | — |   |
| In-process research and development                                          |       |                                      | 19,145     |   |   | — |   | — |   |
| **Total costs and expenses**                                                 |       |                                      | 135,509    |   |   | 67,603 |   | 48,541 |   |
| **Income from operations**                                                   |       |                                      | 27,482     |   |   | 45,257 |   | 36,242 |   |
| **Other  expense**                                                           |       |                                      | (6,699     | ) |   | (657 | ) | (1,600 | ) |
| **Equity  method investment loss**                                           |       |                                      | (416       | ) |   | — |   | — |   |
| **Impairment  of investments**                                               |       |                                      | (1,655     | ) |   | (1,000 | ) | — |   |
| **Income  from continuing operations before tax**                            |       |                                      | 18,712     |   |   | 43,600 |   | 34,642 |   |
| **Provision  for income taxes**                                              |       |                                      | 13,373     |   |   | 14,496 |   | 12,125 |   |
| **Income  from continuing operations**                                       |       |                                      | 5,339      |   |   | 29,104 |   | 22,517 |   |
| **Discontinued  operations, net of tax**                                     |       |                                      | (246       | ) |   | 76 |   | 1,627 |   |
| **Net  income**                                                              |       |                                      | $          | 5,093 |   |   | $ | 29,180 |   | $ | 24,144 |   |
| **Basic  earnings per share:**                                               |       |                                      |       |   |   |   |   |   |   |
| **Continuing operations**                                                    |       |                                      | $          | 0.15 |   |   | $ | 0.83 |   | $ | 0.63 |   |
| **Discontinued operations**                                                  |       |                                      | —     |   |   | 0.01 |   | 0.04 |   |
| **Net income**                                                               |       |                                      | $          | 0.15 |   |   | $ | 0.84 |   | $ | 0.67 |   |
| **Diluted  earnings per share:**                                             |       |                                      |       |   |   |   |   |   |   |
| **Continuing operations**                                                    |       |                                      | $          | 0.15 |   |   | $ | 0.80 |   | $ | 0.60 |   |
| **Discontinued operations**                                                  |       |                                      | (0.01      | ) |   | — |   | 0.04 |   |
| **Net income**                                                               |       |                                      | $          | 0.14 |   |   | $ | 0.80 |   | $ | 0.64 |   |
| **Weighted  average shares outstanding****(adjusted for any stock splits):** |       |                                      |       |   |   |   |   |   |   |
| **Basic**                                                                    |       |                                      | 34,585     |   |   | 34,924 |   | 35,955 |   |
| **Diluted**                                                                  |       |                                      | 36,052     |   |   | 36,378 |   | 37,308 |   |

 

See notes toconsolidated financial statements

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**SHUFFLEMASTER, INC.CONSOLIDATED BALANCE SHEETS(In thousands)**

| ** **                                                                                                  | ** ** | **October 31,**      | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| ** **                                                                                                  | ** ** | **(As restated,**    | ** ** | ** ** | ** ** |
| ** **                                                                                                  | ** ** | **see Note 2)** | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                  | ** ** |                      | ** ** | ** ** |   | ** ** | ** ** |
| **Current assets:**                                                                                         |       |                      |       | ** ** |   |   |   |
| Cash and cash equivalents                                                                                   |       |                      | $          | 8,906 | ** ** |   | $ | 13,279 |   |
| Investments                                                                                                 |       |                      | 11         | ** ** |   | 20,809 |   |
| Accounts receivable, net of  allowance for bad debts of $1,422 and $283                                     |       |                      | 32,662     | ** ** |   | 17,865 |   |
| Investment in sales-type  leases and notes receivable, net                                                  |       |                      | 10,064     | ** ** |   | 8,219 |   |
| Inventories                                                                                                 |       |                      | 24,658     | ** ** |   | 9,428 |   |
| Prepaid income taxes                                                                                        |       |                      | 1,138      | ** ** |   | — |   |
| Deferred income taxes                                                                                       |       |                      | 6,785      | ** ** |   | 1,837 |   |
| Other current assets                                                                                        |       |                      | 5,172      | ** ** |   | 3,255 |   |
| **Total  current assets**                                                                                   |       |                      | 89,396     | ** ** |   | 74,692 |   |
| **Investment in sales-type leases  and notes receivable, net**                                              |       |                      | 11,510     | ** ** |   | 11,136 |   |
| **Products leased and held for  lease, net**                                                                |       |                      | 11,282     | ** ** |   | 9,163 |   |
| **Property and equipment, net**                                                                             |       |                      | 9,779      | ** ** |   | 4,144 |   |
| **Intangible assets, net**                                                                                  |       |                      | 77,904     | ** ** |   | 48,477 |   |
| **Goodwill**                                                                                                |       |                      | 91,700     | ** ** |   | 36,017 |   |
| **Deferred income taxes**                                                                                   |       |                      | 4,294      | ** ** |   | 2,400 |   |
| **Other assets**                                                                                            |       |                      | 9,342      | ** ** |   | 7,088 |   |
| **Total  assets**                                                                                           |       |                      | $          | 305,207 | ** ** |   | $ | 193,117 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                              | ** ** |                      | ** ** | ** ** |   | ** ** | ** ** |
| **Current liabilities:**                                                                                    |       |                      |       | ** ** |   |   |   |
| Accounts payable                                                                                            |       |                      | $          | 11,217 | ** ** |   | $ | 3,540 |   |
| Accrued liabilities                                                                                         |       |                      | 11,326     | ** ** |   | 6,547 |   |
| Customer deposits                                                                                           |       |                      | 2,017      | ** ** |   | 2,023 |   |
| Deferred revenue                                                                                            |       |                      | 5,499      | ** ** |   | 1,495 |   |
| Income taxes payable                                                                                        |       |                      | 938        | ** ** |   | 371 |   |
| Note payable and current portion  of long-term liabilities                                                  |       |                      | 77,294     | ** ** |   | 3,082 |   |
| **Total  current liabilities**                                                                              |       |                      | 108,291    | ** ** |   | 17,058 |   |
| **Long-term liabilities, net of  current portion**                                                          |       |                      | 158,753    | ** ** |   | 162,659 |   |
| **Deferred income taxes**                                                                                   |       |                      | 5,614      | ** ** |   | — |   |
| **Total  liabilities**                                                                                      |       |                      | 272,658    | ** ** |   | 179,717 |   |
| **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; 34,895 and 34,527 shares issued and  outstanding |       |                      | 349        | ** ** |   | 345 |   |
| Additional paid-in capital                                                                                  |       |                      | 717        | ** ** |   | — |   |
| Deferred compensation                                                                                       |       |                      | —     | ** ** |   | (5,788 | ) |
| Retained earnings                                                                                           |       |                      | 22,391     | ** ** |   | 17,298 |   |
| Accumulated other  comprehensive income                                                                     |       |                      | 9,092      | ** ** |   | 1,545 |   |
| **Total  shareholders’ equity**                                                                        |       |                      | 32,549     | ** ** |   | 13,400 |   |
| **Total liabilities and shareholders’ equity**                                                         |       |                      | $          | 305,207 | ** ** |   | $ | 193,117 |   |

 

See notes toconsolidated financial statements

68

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**SHUFFLEMASTER, INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY(In thousands)**

| ** **                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|--------------|------------|-------------------|------------|-------------------|------------|------------|------------|
| ** **                                                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Deferred** | ** ** | ** **        | ** ** | **Other**         | ** ** | **Share-** | ** ** |
| ** **                                                    | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Compen-**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **holders’** | ** ** |
| ** **                                                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **sation**   | ** ** | **Earnings**      | ** ** | **Income**        | ** ** | **Equity** | ** ** |
| **Balance,  November 1, 2003**                           |       |                  | 37,072     |        |       |           | 165        |         |       |              | —     |              |       |       | —     |   |   |   | 47,558 |   |   |   | — |   |   | 47,723 |   |
| *Comprehensive Income:*                                       |       |                  |       |        |       |           |       |         |       |              |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income                                                    |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | 24,144 |   |   |   | — |   |   | 24,144 |   |
| Currency translation  adjustment                              |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | — |   |   |   | 5,970 |   |   | 5,970 |   |
| *Total  comprehensive income*                                 |       |                  |       |        |       |           |       |         |       |              |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   | 30,114 |   |
| Stock repurchased                                             |       |                  | (4,797     | )           |       |           | (32        | )            |       |              | (21,357    | )                 |       |       | —     |   |   |   | (78,635 | ) |   |   | — |   |   | (100,024 | ) |
| Options exercised                                             |       |                  | 1,445      |        |       |           | 9          |         |       |              | 2,339      |              |       |       | —     |   |   |   | 4,570 |   |   |   | — |   |   | 6,918 |   |
| Tax benefit from stock  options                               |       |                  | —     |        |       |           | —     |         |       |              | 2,107      |              |       |       | —     |   |   |   | 3,281 |   |   |   | — |   |   | 5,388 |   |
| Issuance of restricted  stock                                 |       |                  | 90         |        |       |           | 1          |         |       |              | 1,955      |              |       |       | (1,765     | ) |   |   | — |   |   |   | — |   |   | 191 |   |
| April 2004 stock  split                                  |       |                  | (3         | )           |       |           | 82         |         |       |              | —     |              |       |       | —     |   |   |   | (220 | ) |   |   | — |   |   | (138 | ) |
| CARD acquisition                                              |       |                  | 1,151      |        |       |           | 8          |         |       |              | 24,549     |              |       |       | —     |   |   |   | — |   |   |   | — |   |   | 24,557 |   |
| **Balance,  October 31, 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 (As  restated, see Note 2)                    |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | 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 for  stock option exercises                |       |                  | (76        | )           |       |           | (1         | )            |       |              | (2,119     | )                 |       |       | —     |   |   |   | — |   |   |   | — |   |   | (2,120 | ) |
| Share-based  compensation  expense                            |       |                  | —     |        |       |           | —     |         |       |              | 3,515      |              |       |       | —     |   |   |   | — |   |   |   | — |   |   | 3,515 |   |
| Tax benefit from stock  option exercises                      |       |                  | —     |        |       |           | —     |         |       |              | 3,908      |              |       |       | —     |   |   |   | — |   |   |   | — |   |   | 3,908 |   |
| Issuance of restricted  stock                                 |       |                  | 64         |        |       |           | 1          |         |       |              | (1         | )                 |       |       | —     |   |   |   | — |   |   |   | — |   |   | — |   |
| Amortization of  deferred compensation                        |       |                  | —     |        |       |           | —     |         |       |              | 1,997      |              |       |       | —     |   |   |   | — |   |   |   | — |   |   | 1,997 |   |
| **Balance,  October 31, 2006 (As restated, see Note 2)** |       |                  | 34,895     |        |       |           | $          | 349          |       |              |       | $                 | 717        |       |       |   | $ | — |   |   |   | $ | 22,391 |   |   |   | $ | 9,092 |   |   | $ | 32,549 |   |

 

See notes to consolidated financial statements

69

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**SHUFFLE MASTER, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)**

| ** **                                                                     | ** ** | **Year Ended October 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | **(As restated,**                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                     | ** ** | **see Note 2)**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cash flows from operating activities:**                                      | ** ** |                                      | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                     |       |                                      | $          | 5,093 |   |   | $ | 29,180 |   | $ | 24,144 |   |
| Adjustments to reconcile net income to cash provided  by operating activities: |       |                                      |       |   |   |   |   |   |   |
| Depreciation and amortization                                                  |       |                                      | 18,173     |   |   | 12,179 |   | 8,042 |   |
| Share-based compensation                                                       |       |                                      | 5,512      |   |   | 760 |   | — |   |
| In-process research and  development                                           |       |                                      | 19,145     |   |   |   |   |   |   |
| Gain on patent sale                                                            |       |                                      | (4,566     | ) |   |   |   |   |   |
| Equity method investment loss                                                  |       |                                      | 416        |   |   | — |   | — |   |
| Provision for bad debts                                                        |       |                                      | (537       | ) |   | 229 |   | 503 |   |
| Provision for inventory  obsolescence                                          |       |                                      | 345        |   |   | (140 | ) | 1,230 |   |
| Excess tax benefit from stock  option exercises                                |       |                                      | (3,682     | ) |   | 5,287 |   | 5,388 |   |
| Tax benefit from stock option  exercises                                       |       |                                      | 226        |   |   | — |   | — |   |
| Loss on disposal of property                                                   |       |                                      | —     |   |   | 66 |   | — |   |
| Impairment of investments                                                      |       |                                      | 1,655      |   |   | 1,000 |   | — |   |
| Gain before tax on slot  disposition                                           |       |                                      | —     |   |   | — |   | (2,495 | ) |
| Changes in operating assets and liabilities:                                   |       |                                      |       |   |   |   |   |   |   |
| Accounts receivable                                                            |       |                                      | (2,407     | ) |   | (6,526 | ) | (722 | ) |
| Investment in sales-type  leases and notes receivable                          |       |                                      | (2,459     | ) |   | (7,942 | ) | (6,071 | ) |
| Inventories                                                                    |       |                                      | (4,033     | ) |   | (3,483 | ) | (1,168 | ) |
| Accounts payable and accrued  liabilities                                      |       |                                      | (2,434     | ) |   | 2,318 |   | (3,259 | ) |
| Customer deposits and  deferred revenue                                        |       |                                      | 3,382      |   |   | (48 | ) | 1,009 |   |
| Deferred income taxes                                                          |       |                                      | (3,042     | ) |   | (2,403 | ) | 938 |   |
| Prepaid income taxes and  income taxes payable                                 |       |                                      | 3,232      |   |   | 6,730 |   | (1,084 | ) |
| Other                                                                          |       |                                      | 2          |   |   | (2,699 | ) | 132 |   |
| **Net cash  provided by operating activities**                                 |       |                                      | 34,021     |   |   | 34,508 |   | 26,587 |   |
| **Cash flows from investing activities:**                                      | ** ** |                                      | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Purchases of investments                                                       |       |                                      | (32,435    | ) |   | (11,847 | ) | (32,672 | ) |
| Proceeds from sale and  maturities of investments                              |       |                                      | 49,232     |   |   | 17,330 |   | 13,965 |   |
| Proceeds from sale of leased  assets                                           |       |                                      | 1,845      |   |   | 1,632 |   | — |   |
| Payments for products leased  and held for lease                               |       |                                      | (9,167     | ) |   | (9,520 | ) | (3,846 | ) |
| Purchases of property and  equipment                                           |       |                                      | (2,196     | ) |   | (2,210 | ) | (2,381 | ) |
| Purchases of intangible  assets                                                |       |                                      | (4,313     | ) |   | (7,239 | ) | (916 | ) |
| Acquisition of businesses                                                      |       |                                      | (114,608   | ) |   | (228 | ) | (38,594 | ) |
| Proceeds from disposition of  slot assets                                      |       |                                      | —     |   |   | — |   | 8,858 |   |
| Net proceeds from patent sale                                                  |       |                                      | 7,500      |   |   | 9,039 |   |   |   |
| Other                                                                          |       |                                      | —     |   |   | (3,483 | ) | (954 | ) |
| **Net cash  used by investing activities**                                     |       |                                      | (104,142   | ) |   | (6,526 | ) | (56,540 | ) |
| **Cash flows from financing activities:**                                      | ** ** |                                      | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Proceeds from issuance of  convertible Notes                                   |       |                                      | —     |   |   | — |   | 150,000 |   |
| Proceeds from acquisition  financing                                           |       |                                      | 115,000    |   |   | — |   | — |   |
| Payments on acquisition  financing                                             |       |                                      | (45,000    | ) |   |   |   |   |   |
| Proceeds from other  borrowings                                                |       |                                      | 4,153      |   |   | — |   | — |   |
| Repurchases of common stock                                                    |       |                                      | (8,665     | ) |   | (38,643 | ) | (100,024 | ) |
| Proceeds from issuances of  common stock, net                                  |       |                                      | 7,874      |   |   | 6,512 |   | 6,780 |   |
| Debt issuance costs                                                            |       |                                      | (554       | ) |   | — |   | (4,792 | ) |
| Excess tax benefit from stock  option exercises                                |       |                                      | 3,682      |   |   |   |   |   |   |
| Payment on notes payable and  other liabilities                                |       |                                      | (10,567    | ) |   | (2,896 | ) | (4,105 | ) |
| **Net cash  provided (used) by financing activities**                          |       |                                      | 65,923     |   |   | (35,027 | ) | 47,859 |   |
| **Effect of exchange rate changes  on cash**                                   |       |                                      | (175       | ) |   | (256 | ) | — |   |
| **Net increase (decrease) in cash  and cash equivalents**                      |       |                                      | (4,373     | ) |   | (7,301 | ) | 17,906 |   |
| **Cash and cash equivalents,  beginning of year**                              |       |                                      | 13,279     |   |   | 20,580 |   | 2,674 |   |
| **Cash and cash equivalents, end of year**                                     |       |                                      | $          | 8,906 |   |   | $ | 13,279 |   | $ | 20,580 |   |

 

Seenotes to consolidated financial statements

70

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**SHUFFLE MASTER, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)**

**Supplemental Disclosures of Cash Flows Information—**

| ** **                                                                                                    | ** ** | **Year Ended October 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Non-cash Investing and  Financing transactions:**                                                           | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Note payable for  patent purchase                                                                             |       | $                                         | —     |   | $ | 9,229 |   | $ | — |   |
| Accrued direct  acquisition costs related to Stargames acquisition                                            |       | 1,750                                     |       | — |   | — |   |
| Note payable and  contingent consideration issued in connection with the acquisition of a  business or assets |       | —                                    |       | 880 |   | 11,616 |   |
| Common stock issued  for acquisition of CARD                                                                  |       | —                                    |       | — |   | 24,557 |   |
| Issuance of  restricted stock                                                                                 |       | 2,113                                     |       | 4,781 |   | 1,956 |   |
| **Cash  paid for:**                                                                                           | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income taxes, net of refunds                                                                                  |       | $                                         | 11,033     |   | $ | 5,576 |   | $ | 7,370 |   |
| Interest                                                                                                      |       | 5,559                                     |       | 1,919 |   | 906 |   |

 

See notes toconsolidated financial statements

71

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**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 ofbusiness.******  ***Wedevelop, manufacture and market technology and entertainment-based products forthe gaming industry for placement on the casino floor. Our products primarilyrelate to our casino customers’ table game activities and focus on eitherincreasing their profitability, productivity and security or expanding theirgaming entertainment offerings.

Our Utility Products include a full line of automaticcard shufflers for use with the vast majority of card table games as well aschip sorting machines for use on roulette tables. We also have acquired and/orare developing other products that automatically gather data to enable casinosto track table game play, such as Table iDTM (formerly known as IntelligentTable SystemTM), currently in development with International Game Technology (“IGT”)and Progressive Gaming International Corporation (“PGIC”).

Our Entertainment Products include our portfolio oflive proprietary poker, blackjack, baccarat, and pai gow poker-based tablegames and side bets as well as several electronic content deliverysystem platforms including Table MasterTM, Vegas StarTM , Rapid Table Gamesand wireless Casino On DemandTM.

We sell, lease or license our products. When we sellour products, we offer our customers a choice between a sale, a longer-termsales-type lease or other long-term financing. When we lease or license ourproducts, we generally negotiate month-to-month operating leases. We offer our productsworldwide in markets that are highly regulated. We manufacture our products atour headquarters and manufacturing facility in Las Vegas, Nevada, as well as atour Australian headquarters in Milperra, New South Wales. In addition, weoutsource the manufacturing of certain of our products in the United States,Europe and Asia Pacific.

On February 1, 2006, we substantially completedour acquisition of Australian-based Stargames Limited (“Stargames”), a gamingcompany that develops, manufactures and distributes a wide range of innovativeelectronic entertainment gaming products to worldwide markets. Accordingly, theresults of Stargames have been included in our consolidated financialstatements beginning February 1, 2006. Stargames product offeringsare classified as Entertainment Products and include Rapid Table Games andVegas Star multi-terminal gaming machines, and a broad line of traditionalvideo slot machines designed for the Australian, Asian and Latin Americangaming markets. The Rapid series of games, which we previously distributed inthe Americas and the Caribbean, combines a live dealer with multi-terminalelectronic wagering. Current offerings include Rapid RouletteTM, Rapid Sic-BoTMand Rapid Big WheelTM. Vegas Star multi-terminal gaming machines currentlyfeature animated dealers and a selection of public domain table games. TheVegas Star Nova line utilizes Stargames’ existing slot cabinet to extend thenumber of wagering terminals for a Vegas Star game, while minimizing thefootprint required on the gaming floor. See Note 3 for more information relatedto the Stargames acquisition.

***Principles ofconsolidation.******  ***Ourconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) and in accordancewith accounting principles generally accepted in the United States of Americaand include all adjustments necessary to fairly present our consolidatedresults of operations, financial position, and cash flows for each periodpresented.

72

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Ourconsolidated financial statements include the accounts of Shuffle Master, Inc.and our wholly-owned domestic and foreign subsidiaries. All significant inter-company accounts and transactionshave been eliminated. We have no unconsolidated subsidiaries.

***Investments in UnconsolidatedAffiliate.******  ***Ourinvestment in and the operating results of our 50%-or-less-owned entity that isnot required to be consolidated is included in the consolidated financialstatements on the basis of the equity method of accounting.

We review our investments in unconsolidated affiliatesfor other than temporary impairment whenever events or changes in businesscircumstances indicate that the carrying amount of the investments may not befully recoverable. Evidence of an impairment loss that is other than temporarymight include, but would not necessarily be limited to, a decline in the marketprice of an investees common stock that is long in duration and severe innature, the absence of an ability to recover the carrying amount of theinvestment, or the inability of the investee to sustain an earnings capacitywhich would justify the carrying amount of the investment.

***Share-basedcompensation expense.******  ***EffectiveNovember 1, 2005, we account for stock-based compensation in accordancewith Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS123R”), “Share-Based Payment”, and SEC Staff Accounting Bulletin No. 107 (“SAB 107”),“Share-Based Payment”, requiring the measurement and recognition of allshare-based compensation under the fair value method. We previously accountedfor stock-based compensation in accordance with Accounting Principles BoardOpinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”, andthe Financial Accounting Standards Board’s Interpretation No. 44, “Accountingfor Certain Transactions involving Stock Compensation, an interpretation of APBOpinion No. 25”, and disclosed supplemental information in accordance withStatement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accountingfor Stock-Based Compensation.” Under these standards, we did not incurcompensation expense for employee stock options when the exercise price was atleast 100% of the market value of our common stock on the date of grant.SFAS 123R requires that all stock-based compensation, including shares andshare-based awards to employees, be valued at fair value. We measure thefair value of share-based awards using the Black-Scholes model.

Under SFAS 123R, compensation is attributed to theperiods of associated service. For awards granted prior to November 1,2005, such expense is being recognized on an accelerated basis since that isthe method that we previously applied in our supplemental disclosures.Beginning with awards granted on November 1, 2005, such expense is beingrecognized on a straight-line basis over the vesting period of the awards.Forfeitures are estimated at the time of grant, with such estimate updated periodicallyand with actual forfeitures recognized currently to the extent they differ fromthe estimate.

We adopted SFAS 123R by applying themodified-prospective transition method and reclassified previously recordeddeferred compensation to additional paid-in capital. Under this method, webegan applying the valuation and other criteria of SFAS 123R on November 1,2005, and began recognizing expense for the unvested portion of previouslyissued grants at the same time, based on the valuation and attribution methodsoriginally used to calculate the disclosures.

In addition, SFAS 123R requires the excess tax benefitfrom stock-option exercises—tax deductions in excess of compensation costrecognized—to be classified as a financing activity. Previously, all tax 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

benefits from stock option exercises were classifiedas operating activities. We have evaluated the provisions of SFAS 123R-3,“Transition Election Related to Accounting for Tax Effects of Share-BasedPayment Awards” and have elected the alternative method for establishing theAPIC pool. Accordingly, the $3,682 of excess tax benefits are classified as anoperating cash outflow and a financing cash inflow. See Note 9 for moreinformation.

***Use of estimates.******  ***We use estimates andassumptions in preparing financial statements in accordance with accountingprinciples generally accepted in the United States of America. Those estimatesand assumptions affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities, and the reported revenue andexpenses. Actual results could vary from the estimates that were used.

***Inventories.******  ***Inventories are stated at thelower of cost, determined on a first-in-first-out basis, or market.

***Revenue recognition.******  ***We recognize revenue when thefollowing criteria are met:

**·**       persuasiveevidence of an arrangement between us and our customer exists,

**·**       shipmenthas occurred or services have been rendered,

**·**       theprice is fixed or determinable, and

**·**       collectibilityis reasonably assured.

We earn our revenue in a variety of ways. We offer ourproducts for lease or sale. We also sell service and warranty contracts for oursold equipment. Proprietary table games are sold under lifetime licensingagreements or licensed on a monthly or daily fee basis.

*Lease and royalty revenue—**Lease*and royaltyrevenue is earned from the leasing of our tangible products and the licensingof our intangible products, such as our proprietary table games. We recognizerevenue monthly, based on a monthly fixed fee, generally through indefiniteterm operating leases. Lease and royalty revenue commences upon the completedinstallation of the product.

*Sales andservice revenue*—We generate sales revenue through the sale ofequipment in each product segment, including sales revenue from sales-typeleases and the sale of lifetime licenses for our proprietary table games.Financing for intangible property and sales-type leases for tangible propertyhave payment terms ranging generally from 30 to 60 months and areinterest-bearing at market interest rates. Revenue from the sale of equipmentis recorded upon shipment. If a customer purchases existing leased equipment,revenue is recorded on the effective date of the purchase agreement. Revenue onservice and warranty contracts is recognized over the terms of the contracts,which are generally one year. Revenue from the sale of lifetime licenses, underwhich we have no continuing obligations, is recorded on the effective date ofthe license agreement.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Certain of our productscontain software, and as such we have considered the guidance contained in Statement of Position 97-2 (“SOP 97-2”),“*Software Revenue Recognition*”, asmodified by SOP No. 98-9, “*Software RevenueRecognition, With Respect to Certain Transactions*”. Under thisguidance when selling or leasingsoftware we consider whether thesoftware component is incidental to the product as a whole based on thefollowing criteria:

**·**       Whetherthe software is a significant focus of the marketing effort or is soldseparately.

**·**       Whetherpost-contract customer support or PCS (PCS includes the right to receiveservices or unspecified upgrades/enhancements, or both, offered to users orresellers) is provided.

**·**       Whetherthe development and production costs of the software as a component of the costof the product is incidental (as defined in FASB Statement of FinancialAccounting Standard (“SFAS”) No. 86, “*Accountingfor the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed*”).

**·**       Whetheran agreement includes service elements (other than PCS related services), suchas training or installation, and whether such services are essential to the functionalityof 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 canbe used by customers with little or no customization). Conversely, “coresoftware” requires significant customization of the software in order for thesoftware to be used by the end customer.

Some of our revenuearrangements contain multiple deliverables, such as a product sale combinedwith a service element or the delivery of a future product. If an arrangementrequires the delivery or performance of multiple elements, we apply theguidance from SOP 97-2, as amended, Emerging Issues Task Force (“EITF”)03-05, “*Applicability of AICPA Statement of Position97*-*2 to Non-SoftwareDeliverables in an Arrangement Containing More-Than-Incidental Software”*.Deliverables are divided into separate units of accounting if:

·        Thedelivered items have value to the customer on a stand alone basis

·        Wehave objective and reliable evidence of the fair value of the undelivered items

·        Deliveryof any undelivered item is considered probable and substantially in our control

If these criteria are not met, we do not recognizerevenue until all essential elements have been delivered. If the installationof the product is not considered inconsequential and perfunctory, then we deferrevenue recognition until installation is complete.

***Business combinations.***   Weaccount 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 thenet assets of acquired businesses at fair value, and we must make estimates andassumptions to determine the fair value of these acquired assets and assumedliabilities.

In determining the fair value of acquired assets andassumed liabilities in the Stargames acquisition, we used valuation specialiststo assist us with certain fair value estimates, primarily related to intangibleassets, including IPR&D, developed technology, tradename and customerrelationships, as well as inventory and land, property and equipment. We andthe specialists applied significant 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

judgment and utilized a variety of assumptions indetermining the fair value of acquired assets and liabilities assumed, andin-process research and development, including market data, estimated futurecash flows, growth rates, current replacement cost for similar capacity forcertain fixed assets, market rate assumptions for contractual obligations andsettlement plans for contingencies and liabilities.

The Stargames purchase price allocation is preliminaryand may be adjusted for up to one year after the acquisition. Changes to theassumptions we used to estimate fair value could impact the recorded amountsfor acquired assets and assumed liabilities and significant changes to thesebalances could have a material impact to our future reported results. Forinstance, lower or higher fair values assigned to in-process research anddevelopment and certain amortizable intangible assets could result in lower orhigher amounts of income statement charges.

***Advertising costs.******  ***We expense advertising andpromotional costs as incurred, which totaled approximately $2,069, $576, and$1,150 for the fiscal years ended October 31, 2006, 2005 and2004, respectively.

***Research anddevelopment costs.******  ***Weincur research and development costs to develop our new and next-generationproducts. Our products reach technological feasibility when we receive gamingregulatory product approval which occurs concurrent with our products beingmade available to our customers. Accordingly, research and development costsare expensed as incurred.

***Concentration of creditrisk.******  ***Ourfinancial instruments that have potential concentrations of credit risk includecash and cash equivalents, accounts receivable, investments in sales-typeleases and notes receivable. We place our cash and cash equivalents with highcredit quality institutions. Accounts receivable, investments in sales-typeleases and notes receivable have concentration of credit risk because they allrelate to our customers in the gaming industry. From time to time, we makesignificant sales to customers that exceed 10% of our then-outstanding accountsreceivable balance. At October 31, 2006, one customer’s balance accountedfor 12% of our trade accounts receivable, net. No single customer’s balanceexceeded 10% of our investment in sales-type leases and notes receivable. Forthe year ended October 31, 2006, no individual customer accounted for morethan 10% of consolidated revenue.

***Products leased andheld for lease.******  ***Our******products are primarily leased tocustomers pursuant to operating leases. Products leased and held for lease arestated at cost, net of depreciation. Depreciation on leased products iscalculated using the straight-line method over a period of two to five years.We provide maintenance of our products on lease as part of our normal leaseagreements. Leases of shufflers generally require prepayment of two months’lease payments, which are included on the consolidated balance sheets ascustomer deposits.

***Property and equipment.******  ***Property and equipment isstated at cost. Depreciation is recorded using the straight-line method overthe estimated useful life of the asset of three to eight years, or lease terms,if shorter, for leasehold improvements.

***Intangible assets.******  ***Intangible assets includeintellectual property for games, patents, trademarks, copyrights, licenses andnon-compete agreements that were purchased separately or acquired in connectionwith a business combination. Except for the trademark related to the Stargamesand CARD acquisitions, which is not subject to amortization and is testedperiodically for impairment, all of 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

our significant intangible assets are definite livedand, accordingly, amortized over their expected useful lives which range from 2to 15 years. We amortize substantially all of our intangible assetsproportionate to the related projected revenue from the utilization of theintangible asset. We believe this method reflects the pattern in which theeconomic benefits of the intangible asset are consumed or otherwise used up.For certain other intangibles, we use the straight-line amortization method.See Note 7 for more information.

***Impairment oflong-lived assets.******  ***We estimate the useful lives ofour long-lived assets, excluding goodwill, based on historical experience,estimates of products’ commercial lives, the likelihood of technologicalobsolescence, 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 maynot be recoverable or warrant a revision to the estimated remaining usefullife, in accordance with the SFAS 144,*“Accountingfor the Impairment or Disposal of Long-Lived Assets”,* and SFAS 142,*“Goodwill and Other Intangible Assets”*.We would record an impairment loss if the carrying amount of the asset or assetgroup is not recoverable (as determined by undiscounted cash flows) and thecarrying amount exceeds its estimated fair value. Fair value is determinedbased on discounted expected future cash flows.

***Goodwill.******  ***In accordance with SFAS 142,goodwill is no longer amortized.

We review, with the assistance of a specialist, ourgoodwill for impairment annually, in October, using a two step impairment test.The reviews are performed at the reporting unit level, which we have determinedis the equivalent to our reportable segments. In the first step, we estimatethe fair value of the reporting unit and compare it to the book value of thereporting unit, including its goodwill. If the fair value is less than the bookvalue, then we would perform a second step to compare the implied fair value ofthe reporting unit’s goodwill to its book value. The implied fair value of thegoodwill is determined based on the estimated fair value of the reporting unitless the fair value of the reporting unit’s identifiable assets andliabilities. We would record an impairment charge to the extent that the bookvalue of the reporting unit’s goodwill exceeds its fair value. No goodwillimpairments were recorded in any period presented.

***Deferred revenue.******  ***Deferred revenue consists ofamounts collected or billed in excess of recognizable revenue.

***Foreign currencytranslation.******  ***Ourforeign 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 componentof shareholders’ equity. Revenue and expense accounts are translated at theaverage exchange rates for the year. Transaction gains and losses, the amountsof which are not significant for all periods presented, are included in otherexpense on our consolidated statements of income.

***Earnings per commonshare.******  ***Basicearnings per share is calculated by dividing net income by the weighted averagenumber of common shares outstanding and issuable during the year. Dilutedearnings per share is similar to basic, except that the weighted average numberof shares outstanding is increased by the potentially dilutive effect ofoutstanding stock options, restricted stock and contingent convertible notes,if applicable, during the year, using the treasury stock method.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

***Recently issued oradopted accounting standards.******  ***InSeptember 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements*” (“SFAS 157”), which defines fairvalue, establishes a framework for measuring fair value in GAAP, and expandsdisclosures about fair value measurements. SFAS 157 does not require any new fairvalue measurements, but provides guidance on how to measure fair value byproviding a fair value hierarchy used to classify the source of theinformation. This statement is effective for us beginning in November 2008.We are evaluating whether adoption of this statement will result in a change toour fair value measurements.

In September 2006, the SEC issued SAB 108, “*Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*” (“SAB 108”). SAB108 requires analysis of misstatements using both an income statement(rollover) approach and a balance sheet (iron curtain) approach in assessingmateriality and provides for a one-time cumulative effect transitionadjustment. SAB 108 is effective for our fiscal year 2007 annual financialstatements. We do not expect the adoption of this statement to have a materialimpact on our results of operations, financial position or cash flows.

In June 2006, the FASB issued FIN 48, “*Accounting for Uncertainty in Income Taxes-an interpretation of FASBStatement No. 109*” (“FIN 48”). FIN 48 prescribes therecognition threshold and measurement criteria for determining the tax benefitamounts to recognize in the financial statements. This interpretation iseffective for us beginning in November 2007. We are evaluating thepotential impact of adopting this interpretation on our future results ofoperations, financial position or cash flows.

In May 2005, the FASB issued SFAS No. 154, “*Accounting Changes and Error Corrections*” (“SFAS 154”),requiring retrospective application to prior-period financial statements ofchanges in accounting principles, unless it is impracticable to determineeither the period-specific effects or the cumulative effect of the change. SFAS154 also redefines “restatement” as the revising of previously issued financialstatements to reflect the correction of errors. This statement is effective forus beginning in November 2006. We applied the provisions of SFAS 154 inthese financial statements presented as we are revising previously issuedfinancial statements to reflect the correction of an error. See Note 2 forfurther discussion of the restatement.

In March 2005, the SEC issued SAB 107, “*Share-Based Payment”*(“SAB 107”*)*,providing interpretive guidance on SFAS 123R valuation methods, assumptionsused in valuation models, and the interaction of SFAS 123R with existing SECguidance. The additional SAB 107 requirement for the classification of stockcompensation expense to the same financial statement line as cash compensationaffected our cost of product sales and gaming operations, related gross profitsand margins, R&D, and SG&A expenses. We adopted the provisions of SFAS123R and SAB 107 in the first quarter of fiscal 2006. See Note 9 for additionalinformati

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**2. RESTATEMENT OFCONSOLIDATED FINANCIAL STATEMENTS**

***Restatement ofpreviously issued financial statements.***   On March 9,2007, and subsequent to the issuance of our consolidated financial statementsfor the year ended October 31, 2006, the audit committee in consultationwith management determined that those financial statements contained thefollowing errors. 

***Intercompany profiteliminations.***   In conjunction with thepreparation of our quarterly financial statements for the three-month periodended January 31, 2007, we discovered that an error existed in ourpreviously issued financial statements as of and for the twelve-month periodended October 31, 2006. The error resulted from the inadvertent failure toeliminate intercompany profit on inventory that we purchased from ourwholly-owned subsidiary Casinos Austria Research & Development GmbH &Co KG (“CARD”), resulting in a $1,616 overstatement of inventory as of October 31,2006, a $1,616 understatement of cost of sales and service and a $1,211overstatement of our net income from continuing operations for the three-monthand twelve-month periods ended October 31, 2006.

On October 31, 2006, CARD shipped shufflers to usand correctly recorded the intercompany sale pursuant to our transfer pricingpolicy. As the shufflers were en route from Vienna on October 31, 2006 andhad not yet been received in Las Vegas, the inventory was accrued at theappropriate cost as defined in our transfer pricing policy; however, theremaining inter-company inventory profit was inadvertently not eliminated.

As a part of restating the twelve month period ended October 31,2006 and the unaudited selected quarterly financial information for thethree-month period ended October 31, 2006 our review of intercompanyinventory profit elimination resulted in certain other corrections beingrecorded primarily related to accrued in-transit inventory. The net effect ofthese corrections was an overstatement of net income for the three and twelvemonth periods ended October 31, 2006 of $169.

Deferred income taxes and the income tax provisionhave been adjusted for the impact of this correction to eliminate intercompanyprofit. 

***Other miscellaneousadjustments.***   As part of restating the twelvemonth period ended October 31, 2006 and the unaudited selected quarterlyfinancial information for the three-month period ended October 31, 2006,we also recorded certain other errors which previously had been consideredimmaterial. The following briefly describes the nature and amount of theerrors.

We identified a particular non-trade receivable as of October 31,2006 which should have been reserved for due to our assessment ofcollectibility on the balance of $200. The restated consolidated financialstatements were corrected to fully reserve for this amount as of October 31,2006.

We identified an instance in which revenue wasrecognized upfront on the sale of a Table Master under the terms of a financedsale. In accordance with SOP 97-2, any extended payment terms may indicate thatthe price is not fixed or determinable and revenue should be recognized aspayments from the customer become due. As of October 31, 2006, we do nothave sufficient history to overcome the presumption that the price is not fixedor determinable. As a result, $174 of revenue and $81 of net income wasdeferred until the payments from the customer become due. We will continue toanalyze our ability to collect under the original terms without makingconcessions for products that are subject to the provisions of SOP 97-2 inorder to substantiate upfront revenue recognition treatment.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

We identified two transactions in which revenue wasrecognized on a bill and hold basis, at the customer’s request to hold theshipment of goods, resulting in revenue recognition prior to the physicaldelivery of goods to the customer. We determined that revenue should not berecognized until the goods have been physically shipped. As a result, the $303of revenue and $105 of net income on these transactions was deferred until thephysical delivery of the goods has occurred.

We identified an accrual related to direct acquisitioncosts associated with the acquisition of Stargames for $1,750 as of October 31,2006, that should have been presented as a non-cash activity in theconsolidated statements of cash flows for the twelve month period ended October 31,2006. The restated consolidated statement of cash flows for the twelve monthperiod ended October 31, 2006 has been corrected by reducing net cashprovided by operating activities by $1,750 and reducing net cash used byinvesting activities by $1,750.

We corrected the classification of $430 ofamortization related to certain intangibles from Research and Development toCost of Goods Sold.

Subsequent to year-end, we received an interestpenalty notification related to our IRS exam for 2003 and 2004 in the amount of$51. This penalty has been recorded as of October 31, 2006. 

As part of our restatement procedures, we identifiedthe following additional adjustments which have been recorded. We identified$3,361 of deferred revenue that was previously classified as customer depositsas of October 31, 2006. The restated consolidated balance sheet as of October 31,2006 has been corrected to reclass $3,361 from customer deposits to deferredrevenue.

As part of our final analysis of the fair market valueof the assets and liabilities acquired from Stargames, with the assistance ofan appraiser, we determined that the value of the acquired building should beincreased by $938. The restated consolidated balance sheets as of October 31,2006 has been adjusted to increase property and equipment and reduce goodwill.

As a result of the errors described above, theaccompanying consolidated financial statements for the twelve month periodended October 31, 2006 and the unaudited selected quarterly financialinformation for the three-month period ended October 31, 2006 have beenrestated from the amounts previously reported.

Deferred taxes and the income tax provision have beenadjusted for the impact of these other miscellaneous corrections. 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Thefollowing is a summary of the effects of the restatements on the accompanyingconsolidated financial statements.

**Consolidated Statement of Income**

| ** **                                        | ** ** | **Year Ended October 31, 2006** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                        | ** ** | **As  Previously  Reported**                        | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| **Revenue:**                                      |       |                                                |       |   |   |   |   |   |   |
| Utility products sales and service                |       | $                                                   | 63,047     |   |   | $ | (303 | ) |   | $ | 62,744 |   |
| Entertainment products sales and service          |       | 50,632                                              |       |   | (174 | ) |   | 50,458 |   |
| Total revenue                                     |       | 163,468                                             |       |   | (477 | ) |   | 162,991 |   |
| **Costs  and expenses:**                          |       |                                                |       |   |   |   |   |   |   |
| Cost of leases and royalties                      |       | 11,531                                              |       |   | 263 |   |   | 11,794 |   |
| Cost of sales and service                         |       | 43,125                                              |       |   | 1,802 |   |   | 44,927 |   |
| Selling, general and administrative               |       | 51,099                                              |       |   | 200 |   |   | 51,299 |   |
| Research and development                          |       | 13,340                                              |       |   | (430 | ) |   | 12,910 |   |
| Total costs and expenses                          |       | 133,674                                             |       |   | 1,835 |   |   | 135,509 |   |
| **Income from operations**                        |       | 29,794                                              |       |   | (2,312 | ) |   | 27,482 |   |
| **Income  from continuing operations before tax** |       | 21,024                                              |       |   | (2,312 | ) |   | 18,712 |   |
| **Provision  for income taxes**                   |       | 13,976                                              |       |   | (603 | ) |   | 13,373 |   |
| **Income  from continuing operations**            |       | 7,048                                               |       |   | (1,709 | ) |   | 5,339 |   |
| **Net  income**                                   |       | 6,802                                               |       |   | (1,709 | ) |   | 5,093 |   |
| **Basic earnings per share:**                     |       |                                                |       |   |   |   |   |   |   |
| **Continuing operations**                         |       | $                                                   | 0.20       |   |   | $ | (0.05 | ) |   | $ | 0.15 |   |
| **Net income**                                    |       | $                                                   | 0.20       |   |   | $ | (0.05 | ) |   | $ | 0.15 |   |
| **Diluted earnings per share:**                   |       |                                                |       |   |   |   |   |   |   |
| **Continuing operations**                         |       | $                                                   | 0.20       |   |   | $ | (0.05 | ) |   | $ | 0.15 |   |
| **Net  income**                                   |       | $                                                   | 0.19       |   |   | $ | (0.05 | ) |   | $ | 0.14 |   |

 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**Consolidated Balance Sheet**

| ** **                                                | ** ** | **As of October 31, 2006** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                | ** ** | **As  Previously  Reported**                   | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| **ASSETS**                                                | ** ** | ** **                                     |       |   |   |   |   |   |   |   |   |
| **Current  assets:**                                      |       |                                           |       |   |   |   |   |   |   |   |   |
| Inventories, net                                          |       | $                                              | 26,073     |   |   | $ | (1,415 | ) |   |   | $ | 24,658 |   |   |
| Prepaid income taxes                                      |       | 1,052                                          |       |   | 86 |   |   |   | 1,138 |   |   |
| Deferred income taxes                                     |       | 6,149                                          |       |   | 636 |   |   |   | 6,785 |   |   |
| Other current assets                                      |       | 5,591                                          |       |   | (419 | ) |   |   | 5,172 |   |   |
| Total current assets                                      |       | 90,508                                         |       |   | (1,112 | ) |   |   | 89,396 |   |   |
| **Property  and equipment, net**                          |       | 8,841                                          |       |   | 938 |   |   |   | 9,779 |   |   |
| **Goodwill**                                              |       | 92,447                                         |       |   | (747 | ) |   |   | 91,700 |   |   |
| Total assets                                              |       | 306,128                                        |       |   | (921 | ) |   |   | 305,207 |   |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**            | ** ** | ** **                                     |       |   |   |   |   |   |   |   |   |
| **Current  liabilities:**                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Accounts payable                                          |       | $                                              | 11,166     |   |   | $ | 51 |   |   |   | $ | 11,217 |   |   |
| Customer deposits                                         |       | 5,378                                          |       |   | (3,361 | ) |   |   | 2,017 |   |   |
| Deferred revenue                                          |       | 1,657                                          |       |   | 3,842 |   |   |   | 5,499 |   |   |
| Note payable and current portion of long-term liabilities |       | 77,097                                         |       |   | 197 |   |   |   | 77,294 |   |   |
| Total current liabilities                                 |       | 107,562                                        |       |   | 729 |   |   |   | 108,291 |   |   |
| **Long-term  liabilities, net of current portion**        |       | 158,951                                        |       |   | (198 | ) |   |   | 158,753 |   |   |
| **Deferred  income taxes**                                |       | 5,357                                          |       |   | 257 |   |   |   | 5,614 |   |   |
| **Shareholders’ equity:**                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Retained earnings                                         |       | 24,100                                         |       |   | (1,709 | ) |   |   | 22,391 |   |   |
| Total shareholders’  equity                          |       | 34,258                                         |       |   | (1,709 | ) |   |   | 32,549 |   |   |
| Total liabilities and  shareholders’ equity          |       | 306,128                                        |       |   | (921 | ) |   |   | 305,207 |   |   |

 

| ** **                                    | ** ** | **Year Ended October 31, 2006** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **As  Previously  Reported**                        | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| **Consolidated  Statement of Cash Flows**     | ** ** | ** **                                          | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Cash flows from operating activities:**     | ** ** | ** **                                          | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net income                                    |       | $                                                   | 6,802      | ** ** |   | $ | (1,709 | ) |   |   | $ | 5,093 |   |   |
| Inventories                                   |       | (5,448                                              | )          |   | 1,415 |   |   |   | (4,033 | ) |   |
| Accounts payable and accrued liabilities      |       | (729                                                | )          |   | (1,705 | ) |   |   | (2,434 | ) |   |
| Customer deposits and deferred revenue        |       | 2,901                                               |       |   | 481 |   |   |   | 3,382 |   |   |
| Deferred income taxes                         |       | (2,477                                              | )          |   | (565 | ) |   |   | (3,042 | ) |   |
| Prepaid income taxes and income taxes payable |       | 3,318                                               |       |   | (86 | ) |   |   | 3,232 |   |   |
| Other                                         |       | (417                                                | )          |   | 419 |   |   |   | 2 |   |   |
| Net cash provided by operating activities     |       | 35,771                                              |       |   | (1,750 | ) |   |   | 34,021 |   |   |
| **Cash flows from investing activities:**     | ** ** | ** **                                          | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Acquisition of Stargames                      |       | (116,358                                            | )          |   | 1,750 | ** ** |   |   | (114,608 | ) |   |
| Net cash used by  investing activities        |       | (105,892                                            | )          |   | 1,750 | ** ** |   |   | (104,142 | ) |   |
|                                               |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |

 

82

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**3. ACQUISITIONS, OTHER SIGNIFICANTTRANSACTIONS** AND DISPOSITIONS

***Stargames.******  ***On February 1,2006, we announced that our wholly owned indirect subsidiary, Shuffle MasterAustralasia Pty. Ltd., had substantially completed its acquisition of Stargamesby purchasing 95% of the outstanding Stargames shares. Effective March 8,2006, we had acquired 100% of the outstanding Stargames shares for AU $1.55 pershare.

Considerationto Stargames consisted of an Australian-denominated cash payment of AU $148,441or US $112,147. In addition, we incurred total direct acquisition costs,consisting primarily of legal and due diligence fees, of approximately US$4,211. See Note 8 for information regarding the financing of the Stargamesacquisition. The following table sets forth the determination of theconsideration paid for Stargames at the date of acquisition:

| Cash                            |   | $     | 112,147 |   |
|---------------------------------|--------|-------|---------|--------|
| Other direct  acquisition costs |   | 4,211 |    |
| Total purchase price            |   | $     | 116,358 |   |

 

Thetransaction was accounted for as a purchase and, accordingly, the preliminarypurchase price was allocated to the underlying assets acquired and liabilitiesassumed based upon their estimated fair values at the date of the acquisition.We are currently in the process of determining, with the assistance of anappraiser, the fair values based on discounted cash flows and estimates by us.The purchase price allocation is preliminary and may be adjusted for up to oneyear after the acquisition. The following table sets forth the preliminaryallocation of the purchase price:

| Accounts receivable, net of  $1,907 allowance for bad debts |   | $       | 10,733  |   |
|-------------------------------------------------------------|--------|---------|---------|--------|
| Inventory                                                   |   | 11,338  |    |
| Other current assets (including  cash of $98)               |   | 4,240   |    |
| Other long-term assets                                      |   | 8,053   |    |
| Assumed liabilities                                         |   | (18,566 | )       |
| Deferred tax liabilities                                    |   | (5,872  | )       |
| Developed technology,  average life of 4 years              |   | 8,338   |    |
| Customer relationships,  average life of 10 years           |   | 10,015  |    |
| Tradename                                                   |   | 17,291  |    |
| Goodwill                                                    |   | 52,297  |    |
| In-process research and  development                        |   | 19,145  |    |
| PVS disposal liability                                      |   | (654    | )       |
|                                                        |   | $       | 116,358 |   |

 

The acquisition of Stargamesenhances the products in our Entertainment Products segment as well asproviding for additional electronic platforms for our branded content.Additionally, we acquired a strong brand name as well as an experienced andtalented management team. These factors result in the recognition of certainintangible assets, discussed below, and significant goodwill. Developedtechnology is being amortized on a straight-line basis over its useful life andis charged to cost of sales and service, a component of gross margin. Customerrelationships are being amortized on a straight-line basis over their usefullife and are reflected in selling, general and administrative expenses in theconsolidated statement of operations.

83

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

A project-by-project valuation using the guidance inSFAS No. 141, “*Business Combinations*”and the American Institute of Certified Public Accountants (“AICPA”) PracticeAid “*Assets Acquired in a Business Combination to BeUsed In Research and Development Activities: A Focus on Software, ElectronicDevices and Pharmaceutical Industries*” is in the process of beingperformed by us, with the assistance of a valuation specialist to determine thefair value of research and development projects of Stargames.

In-process research and development (“IPR&D”) isdefined as a development project that has been initiated and achieved materialprogress but has not yet resulted in a technologically feasible product and hasno alternative future use. The fair value is determined using the multi-periodexcess earnings approach on a project-by-project basis. This method is based onthe present value of earnings attributable to the asset or costs avoided as aresult of owning the assets and after a contributory charge on assets. Thismethod includes risk factors, which include applying an appropriate discountrate that reflects the project’s stage of completion, the nature of theproduct, the scientific data associated with the technology, the current patentsituation and market competition.

The forecast of futurecash flows required the following assumptions to be made:

·        Revenuethat is likely to result from specific IPR&D projects, including thelikelihood of approval of the product, estimated number of units to be sold,estimated selling prices, estimated market penetration and estimated marketshare and year-over-year rates over the product life cycles;

·        Costof sales related to the potential products using historical data, industry dataor other sources of market data;

·        Salesand marketing expense using historical data, industry data or other marketdata;

·        Generaland administrative expenses; and

·        Researchand development expenses.

As required by FIN 4, “*Applicabilityof FASB Statement No. 2 to Business Combinations Accounted for by thePurchase Method,”* the portion of the purchase price allocated toIPR&D of $19,145 was immediately expensed in the quarter ended April 30,2006.

As a part of the Stargames acquisition, we acquiredProfessional Vending Services Pty Ltd (“PVS”), a wholly-owned subsidiary ofStargames. PVS designs, develops and manufactures automatic vending machines.PVS offers exclusive equipment in all main vending segments including snacks,cold drinks, food (hot and cold), coffee and cigarettes. We have determinedthat the operations of PVS are non-core to our Entertainment Products andUtility Products segments. Accordingly, we entered into an agreement to sellStargames’ equity interests in PVS including settlement of all existingliabilities of PVS. The estimated liabilities exceeded assets in the amount ofapproximately $654. The results of operations for PVS were included inDiscontinued Operations until the disposition was completed in September 2006.

84

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Theoperating results for Stargames are included in the accompanying consolidatedstatements of income from the date of the acquisition. The following unauditedpro forma condensed consolidated financial information has been preparedassuming the Stargames acquisition had occurred on November 1, 2005 and November 1,2004, respectively, and is as follows:

| ** **                  | ** ** | **Twelve Months Ended** | ** ** | **Twelve Months Ended** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **October 31, 2006**    | ** ** | **October 31, 2005**    | ** ** |
| ** **                  | ** ** | **(Unaudited)**                   | ** ** | **(Unaudited)**                   | ** ** |
| Revenue                     |       |                              | $          | 172,633                           |       |   |   | $ | 162,557 |   |   |
| Operating income            |       |                              | 32,599     |                              |       |   | 38,115 |   |   |
| Discontinued operations     |       |                              | (413       | )                                 |       |   | (123 | ) |   |
| Net income                  |       |                              | 20,555     |                              |       |   | 25,124 |   |   |
| Basic earnings per share:   |       |                              |       |                              |       |   |   |   |   |
| Net income                  |       |                              | $          | 0.59                              |       |   |   | $ | 0.72 |   |   |
| Diluted earnings per share: |       |                              |       |                              |       |   |   |   |   |
| Net income                  |       |                              | $          | 0.57                              |       |   |   | $ | 0.69 |   |   |

 

The unaudited pro forma condensed consolidated financialstatements have been prepared based upon currently available information andassumptions that are deemed appropriate by management. The pro formainformation is for informational purposes only and is not intended to beindicative of the actual consolidated financial position or consolidatedresults that would have been reported had the transactions occurred on thedates indicated, nor does this information represent a forecast of theconsolidated financial position at any future date or the combined financialresults for any future period.

Historical financial information for Stargames for thetwelve months ended October 31, 2006 includes certain non-recurringexpenses of approximately $2,000 included in selling, general, andadministrative expenses. These expenses include a success fee related to theultimate sale of Stargames and the expense related to a potential AustralianGoods and Services Tax liability associated with export sales in the period December 2001through November 2005. The expense for IPR&D for the year ended October 31,2006, has not been included in the unaudited pro forma results since suchexpense is non-recurring in nature. Also excluded from the pro forma results isthe reduction in interest expense related to the $45,000 in principal paymentsmade on the Stargames bridge financing since the date of acquisition.

***IGT Agreement.******  ***On April 28,2006, we entered into an agreement (“April Agreement”) with InternationalGame Technology (“IGT”) whereby we assigned, transferred, and conveyed to IGT,our 50% share of future royalties from the licensing of the ENPAT patents toany third party or from otherwise permitting any third party to use the ENPATpatents. The total royalties to be received by IGT is limited to an amountequal to a net present value of $3,000 utilizing a discount factor of 12% (the “RoyaltyAmount”). Upon the receipt by IGT of the Royalty Amount, all royalty paymentswith respect to our 50% share of the ENPAT patents shall resume and be paid tous. The total non-refundable consideration paid to us was $3,000.

On July 31, 2006, we entered into a secondagreement with IGT whereby we sold to IGT our remaining 50% ownership in theENPAT patents. This agreement rescinded certain provisions of the April Agreementwhereby we assigned, transferred, and conveyed to IGT our 50% share of thefirst 

85

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

$3,000 of future royalties from the licensing of theENPAT patents to any third party or from otherwise permitting any third partyto use the ENPAT patents. The consideration for the remaining 50% ownership ofthe ENPAT patents was the $3,000 previously received from IGT pursuant to the April Agreementbetween us and IGT, plus a payment of an additional $4,500. This payment was inlieu of the $4,875 that would have been due, at IGT’s discretion, under thepatent purchase agreement entered into on June 13, 2005 between us andIGT. As a result, IGT shall receive 100% of the future royalties on the ENPATpatents until IGT has earned a total of $17,400 in gross royalties; thereafterIGT will pay us 17 1⁄2% of any gross royalties. The transaction has beenreflected in the accompanying consolidated statements of income by recording again on sale of patent of $4,566.

***Sona Mobile.******  ***In January 2006, weentered into a licensing and distribution agreement with Sona Mobile HoldingsCorp. (“Sona”) to license, develop, distribute and market “in-casino” wirelesshandheld gaming content and delivery systems to casinos and through other legalgaming modes throughout the world. On January 25, 2006, we completed aprivate equity investment and purchased approximately 2,300 shares of Sona’scommon stock at the price of $1.30 per share for approximately $3,000. Thisprivate equity investment is pursuant to a stock option agreement between usand Sona dated December 29, 2005. Additionally, as part of our investmentin Sona, we received one seat on the Sona Board of Directors and 1,200 warrantsto purchase shares of Sona’s common stock at a discount to the grant date fairvalue. On June 30, 2006, we purchased approximately 1,667 additionalshares of Sona’s common stock at the price of $0.60 per share for approximately$1,000. These shares were purchased through a private equity investment alongwith other accredited investors. As part of the second private equityinvestment, we also received an additional 833 warrants to purchase shares ofSona’s common stock at prices as specified in the agreement. The investment inSona is accounted for under the equity method of accounting in accordance withFinancial Accounting Standards Board (“FASB”) APB No. 18 (“APB 18”), “*The Equity Method of Accounting for Investments in Common Stock”,*and is included in Other long-term assets in our consolidated balance sheet asof October 31, 2006. Accordingly, we recognized Equity method investment lossesof $416 for the twelve months ended October 31, 2006, which represents ourpro rata share of Sona’s net loss for the period.

As of October 31, 2006, we determined that thedecline in fair value below the carrying value of our investment in Sona was otherthan temporary. To evaluate the fair value of our investment in Sona, we usedthe market price of a share of Sona common stock as of October 31, 2006,multiplied by the number of shares owned. In making that determination, weconsidered forecasts about the Sona’s financial performance and near-termprospects. As a result, we recognized a pre-tax impairment charge totaling$1,655 during the quarter and year ended October 31, 2006.

***Progressive Gaming Licenses.******  ***On September 29, 2006,we entered into an agreement whereby we obtained the “last license” rights toutilize an extensive portfolio of jackpot wagering hardware and method patentsheld by Progressive Gaming International Corporation (“PGIC”). Under the termsof the agreement, we have the right to utilize the suite of over forty patentson tables and other games in any form including live tables, electronic singleand multi-player units, and wireless wagering devices. Under the agreement, wealso acquired the right to sub-license use of the technology. PGIC has furtheragreed that it will not grant or permit any additional licenses to othermanufacturers or suppliers to the technology in the future. In exchange for afully-paid, royalty-free, fully-transferable world-wide license to the completepatent suite, we paid $3,500 to PGIC during the three months 

86

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

ended October 31, 2006and is reflected in the accompanying consolidated balance sheets in intangibleassets.

**4.FINANCIAL INSTRUMENTS**

***Cash and cashequivalents.******  ***Cashand cash equivalents include short-term investments with maturities of threemonths or less from their date of purchase. We maintain cash balances thatexceed federally insured limits; however, we have incurred no losses on suchaccounts.

***Investments.******  ***We classify all of our securities asavailable-for-sale. Our investments are recorded at fair market value, which,as of October 31, 2006 and 2005, includes $0 and $165 of unrealized gains,respectively.

Investmentsat fair value consisted of the following as of October 31:

| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| United States  government and agency obligations |       |     | $          | 11       |       |   | $ | 20,809 |   |
|                                                  |            |          |            |          |            |  |  |  |  |

 

***Fair value disclosuresof financial instruments.******  ***We estimatethat the fair values of accounts receivable, investment in sales-type leases,notes receivable, accounts payable and short term borrowings approximate theircarrying values due to the relatively short-term nature of the instruments.

We estimate that the fairvalue of our Contingent Convertible Senior Notes as of October 31, 2006,is $172,313 based on quoted market prices.

**5.RECEIVABLES AND INVESTMENT IN SALES-TYPE LEASES**

Thefollowing provides additional disclosure for accounts receivable, notesreceivable and investment in sales-type leases as of October 31:

| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| **Accounts receivable, net:**  |       |     |       |     |       |
| Trade receivables              |       | $        | 34,084     |     | $          | 18,148 |   |
| Less: allowance for  bad debts |       | (1,422   | )          | (283     | )          |
|                           |       | $        | 32,662     |     | $          | 17,865 |   |

 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

 

| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Investment in sales-type leases  and notes receivable, net:**         |       |     |       |     |       |
| Minimum sales-type  lease payments                                      |       | $        | 15,314     |     | $          | 13,329 |   |
| Notes receivable — table  game licenses                            |       | 11,395   |       | 10,269   |       |
| Sub-total sales-type leases and notes receivable                        |       | 26,709   |       | 23,598   |       |
| Less: interest on  sales-type leases                                    |       | (1,615   | )          | (1,579   | )          |
| Less: deferred  service revenue                                         |       | (2,839   | )          | (2,033   | )          |
| Less: allowance for  bad debts                                          |       | (681     | )          | (631     | )          |
| Investment in  sales-type leases and notes receivable, net              |       | 21,574   |       | 19,355   |       |
| Less: current portion  sales-type leases                                |       | (4,512   | )          | (3,929   | )          |
| Less: current portion  notes receivable — table game licenses      |       | (5,552   | )          | (4,290   | )          |
| Long-term portion investment  in sales-type leases and notes receivable |       | $        | 11,510     |     | $          | 11,136 |   |

 

We maintain provisions for bad debts for estimatedcredit losses that result from the inability of our customers to make requiredpayments. The provisions for bad debts are estimated based on historicalexperience and specific customer collection issues.

Sales-typeleases are interest-bearing at market interest rates, require monthlyinstallment payments over periods ranging generally from 30 to 60 months andcontain bargain purchase options. Notes receivable includes financingarrangements for sales of our intellectual property products. Amounts areinterest-bearing at market interest rates and require monthly installmentsranging generally from 30 to 60 months. Future minimum lease payments(principal, deferred revenue and interest) to be received for both sales-typeleases and notes receivable are as follows:

| **Year ending October 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                       |       | $          | 10,064     |       |
| 2008                                       |       | 7,871      |       |
| 2009                                       |       | 3,522      |       |
| 2010                                       |       | 117        |       |
| 2011                                       |       | —     |       |
|                                       |       | $          | 21,574     |       |

 

88

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**6.OTHER BALANCE SHEET DATA**

Thefollowing provides additional disclosure for selected balance sheet accounts asof October 31: 

| ** **                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| **Inventories:**                              |       |     |       |     |       |
| Raw materials and  component parts            |       | $        | 9,585      |     | $          | 4,235 |   |
| Work-in-process                               |       | 3,051    |       | 820      |       |
| Finished goods                                |       | 12,022   |       | 4,373    |       |
|                                          |       | $        | 24,658     |     | $          | 9,428 |   |
| **Products leased and held for  lease, net:** |       |     |       |     |       |
| Utility products                              |       | $        | 21,500     |     | $          | 18,091 |   |
| Entertainment  products                       |       | 5,482    |       | 3,183    |       |
|                                          |       | 26,982   |       | 21,274   |       |
| Less: accumulated  depreciation               |       | (15,700  | )          | (12,111  | )          |
|                                          |       | $        | 11,282     |     | $          | 9,163 |   |
| **Property and equipment, net:**              |       |     |       |     |       |
| Office furniture and  computer equipment      |       | $        | 6,835      |     | $          | 3,860 |   |
| Leasehold  improvements                       |       | 4,673    |       | 2,629    |       |
| Production equipment  and other               |       | 9,672    |       | 3,923    |       |
|                                          |       | 21,180   |       | 10,412   |       |
| Less: accumulated  depreciation               |       | (11,401  | )          | (6,268   | )          |
|                                          |       | $        | 9,779      |     | $          | 4,144 |   |
| **Other long-term assets:**                   |       |     |       |     |       |
| Debt issuance costs,  net                     |       | $        | 2,369      |     | $          | 3,328 |   |
| Deposits                                      |       | 3,507    |       | 3,331    |       |
| Equity method  investment                     |       | 1,931    |       | —   |       |
| Other                                         |       | 1,535    |       | 429      |       |
|                                          |       | $        | 9,342      |     | $          | 7,088 |   |

 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**7.INTANGIBLE ASSETS AND GOODWILL**

***Amortized intangible assets.******  ***All of our recordedintangible assets, excluding goodwill and the Stargames and CARD trademarks,are subject to amortization. Amortization expense was $9,045, $5,954 and $3,308for each of the years ended October 31, 2006, 2005, and 2004,respectively. Amortized intangible assets are comprised of the following as of October 31:

| ** **                     | ** ** | **Weighted Avg** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **Useful Life**  | ** ** | **2006**   | ** ** | **2005**   | ** ** |
| Amortized intangible assets:   | ** ** |                  | ** ** | ** ** |       | ** ** | ** ** | ** ** | ** ** |
| Patents, games and products    |       |                  | 10 years   | ** ** |       | $          | 53,452     |   | $ | 55,552 |   |
| Less: accumulated amortization |       |                  |       | ** ** |       | (15,159    | )          | (9,478 | ) |
|                           |       |                  |       | ** ** |       | 38,293     |       | 46,074 |   |
| Customer relationships         |       |                  | 10 years   | ** ** |       | 10,221     |       | — |   |
| Less: accumulated amortization |       |                  |       | ** ** |       | (767       | )          | — |   |
|                           |       |                  |       | ** ** |       | 9,454      |       | — |   |
| Licenses and other             |       |                  | 6 years    | ** ** |       | 6,313      |       | 3,053 |   |
| Less: accumulated amortization |       |                  |       | ** ** |       | (1,661     | )          | (1,536 | ) |
|                           |       |                  |       | ** ** |       | 4,652      |       | 1,517 |   |
| Developed technology           |       |                  | 4 years    | ** ** |       | 8,510      |       | — |   |
| Less: accumulated amortization |       |                  |       | ** ** |       | (1,596     | )          | — |   |
|                           |       |                  |       | ** ** |       | 6,914      |       | — |   |
| Total                          |       |                  |       | ** ** |       | $          | 59,313     |   | $ | 47,591 |   |

 

Estimatedamortization expense related to recorded intangible assets, excluding theStargames and CARD trademarks, is as follows:

| **Year ending October 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                       |       | $          | 10,487     |       |
| 2008                                       |       | 11,512     |       |
| 2009                                       |       | 11,296     |       |
| 2010                                       |       | 8,232      |       |
| 2011                                       |       | 6,229      |       |
| Thereafter                                 |       | 11,557     |       |
|                                       |       | $          | 59,313     |       |

 

***Trademarks.******  ***Intangibles with anindefinite life consisting of the Stargames and CARD trademarks are notamortized and were $18,591 and $886 as of October 31, 2006 and 2005,respectively.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

***Goodwill.***   Changesin the carrying amount of goodwill for the year ended October 31, 2006, are as follows:

| Balance at  October 31, 2005       |   | $      | 36,017 |   |
|-----------------------------------------|--------|--------|--------|--------|
| Stargames goodwill                      |   | 52,297 |   |
| Foreign currency translation adjustment |   | 3,729  |   |
| Other                                   |   | (343   | )      |
| Balance at October 31,  2006       |   | $      | 91,700 |   |

 

All of our goodwill originatedfrom the acquisitions of foreign subsidiaries. For foreign income tax purposes,goodwill is amortized using the straight-line method and deducted over itsstatutory fifteen year life. Goodwill has been assigned to our Utility and EntertainmentProducts segment, as defined under SFAS 131.

**8.** NOTEPAYABLE AND LONG-TERM LIABILITIES

Notepayable and long-term liabilities consisted of the following as of October 31:

| ** **                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Contingent  convertible senior notes, fixed rate interest at 1.25%, due 2024 |       | $        | 150,000    |     | $          | 150,000 |   |
| Bridge loan, due  November 2006                                         |       | 70,000   |       | —   |       |
| Stargames credit  facility                                                   |       | 3,872    |       | —   |       |
| BTI acquisition  contingent consideration                                    |       | 4,441    |       | 6,167    |       |
| ENPAT note payable,  non-interest bearing, due in installments through  2007 |       | 5,823    |       | 8,518    |       |
| Bet the Set “21”  contingent consideration                         |       | 526      |       | 549      |       |
| VIP note payable                                                             |       | 329      |       | 318      |       |
| Other                                                                        |       | 1,056    |       | 189      |       |
|                                                                         |       | 236,047  |       | 165,741  |       |
| Less: current portion                                                        |       | (77,294  | )          | (3,082   | )          |
|                                                                         |       | $        | 158,753    |     | $          | 162,659 |   |

 

***Contingent convertiblesenior notes.******  ***In April 2004,we issued $150,000 of contingent convertible senior notes due 2024 (the “Notes”)through a private placement under Rule 144A of the Securities Act of1933. The Notes are unsecured and bear interest at a fixed rate of 1.25% perannum. Interest is payable semi-annually in arrears on April 15 and October 15of each year, beginning October 15, 2004.

Holders may convert any outstanding Notes into cashand shares of our common stock at an initial conversion price per share of$28.07. This represents a conversion rate of approximately 35.6210 sharesof common stock per $1,000 in principal amount of Notes. The value of the cashand 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 applicableConversion Rate, Conversion Value, Principal Return, and other factors, each asdefined in the indenture covering these Notes.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

The Notes areconvertible, at the holders’ option, into cash and shares of our common stock,under any of the following circumstances:

·       duringany fiscal quarter commencing after the date of original issuance of the Notes,if the closing sale price of our common stock over a specified number oftrading days during the previous quarter is more than 120% of the conversionprice of the Notes on the last trading day of the previous quarter;

·       ifwe have called the Notes for redemption and the redemption has not yetoccurred;

·       duringthe five trading day period immediately after any five consecutive trading dayperiod in which the trading price of the Notes per $1,000 principal amount foreach day of such period was less than 95% of the product of the closing saleprice of our common stock on such day multiplied by the number of shares of ourcommon stock issuable upon conversion of $1,000 in principal amount of theNotes, provided that, if on the date of any conversion pursuant to this tradingprice condition, our common stock price on such date is greater than theconversion price but less than 120% of the conversion price, then the holderwill be entitled to receive Conversion Value (as defined in the indenturecovering these Notes) equal to the principal amount of the Notes, plus accruedand unpaid interest including liquidated damages, if any; or

·       uponthe occurrence of specified corporate transactions.

We may call some or all of the Notes at any time on orafter April 21, 2009, at a redemption price, payable in cash, of 100% ofthe principal amount of the Notes, plus accrued and unpaid interest and includingliquidated damages, if any, up to but not including the date of redemption. Inaddition, the holders may require us to repurchase all or a portion of theirNotes on April 15, 2009, 2014 and 2019, at 100% of the principal amount ofthe Notes, plus accrued and unpaid interest and including liquidated damages,if any, up to but not including the date of repurchase, payable in cash. Upon achange in control, as defined in the indenture governing the Notes, holders mayrequire us to repurchase all or a portion of their Notes, payable in cash equalto 100% of the principal amount of the Notes plus accrued and unpaid interestand liquidated damages, if any, up to but not including the date of repurchase.

***Bridge loan.******  ***On January 25, 2006, weentered into a credit agreement (the “Old Credit Agreement”), which has nowbeen paid off, with Deutsche Bank AG Cayman Islands Branch, as a Lender,Deutsche Bank AG New York Branch, as Administrative Agent, and Deutsche BankSecurities Inc., as Sole Arranger and Book Manager, pursuant to which weobtained a bridge loan (the “Bridge Loan”) in the amount of $115,000, in orderto finance the acquisition of Stargames. On April 24, 2006, we enteredinto Amendment No. 1 (the “Amendment”) to the Old Credit Agreement. TheAmendment extended the maturity date for the Bridge Loan to July 24, 2006and we agreed to use our commercially reasonable efforts to secure the loanextended under the Old Credit Agreement. On July 24, 2006, we entered intoAmendment No. 2 (“Amendment No. 2”) to the Old Credit Agreement.Amendment No. 2 extended the maturity date for the Bridge Loan to September 30,2006. On July 31, 2006, we entered into a security agreement, as requiredby Amendment No. 2, with Deutsche Bank AG New York Branch, as collateralagent. On September 29, 2006, we entered into Amendment No. 3 (“AmendmentNo. 3”) to the Old Credit Agreement. Amendment No. 3 extended thematurity date for the Bridge Loan to October 31, 2006. On October 31,2006, we entered into Amendment No. 4 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

(“Amendment No. 4”) to the Old Credit Agreement.Amendment No. 4 extended the maturity date for the Bridge Loan to November 30,2006.

As of October 31, 2006, we were in compliancewith all of the affirmative and negative covenants pursuant to the Old CreditAgreement. Additional information on these covenants may be found in Section 7and Section 8 of the Old Credit Agreement included in our Current Reporton Form 8-K, dated January 25, 2006. The principal balance onthe Bridge Loan as of October 31, 2006 was $70,000.

On November 30, 2006, we entered into a $100,000senior secured revolving credit facility (the “New Credit Agreement”) withDeutsche Bank AG Cayman Islands Branch, as a Lender, Deutsche Bank TrustCompany Americas, as Administrative Agent, Deutsche Bank Securities Inc. andWells Fargo, N.A., as Joint Lead Arrangers and Book Managers and Wells Fargo,N.A. as Syndication Agent. We drew $71,180 on the facility, which was used torepay in its entirety the Old Credit Agreement. Any remaining amount availableunder the revolving credit facility will be used for working capital, capitalexpenditures and general corporate purposes, including share repurchases. Therevolving credit facility under the New Credit Agreement will mature on November 30,2011.

The interest rate underthe New Credit Agreement is based on the sum of the relevant Base Rate orEurodollar Rate plus the Applicable Margin, as defined, each as in effect fromtime to time. The obligations under the revolving credit facility areguaranteed by each wholly-owned domestic subsidiary of ours that is not animmaterial subsidiary and each wholly-owned domestic subsidiary that is not animmaterial subsidiary of the Company established, created or acquired after November 30,2006, if any. The New Credit Agreement contains customary affirmative andnegative covenants for transactions of this nature, including but not limitedto restrictions and limitations on the following:

·       Permittedacquisitions;

·       Incurrenceof indebtedness;

·       Grantingor incurrence of liens;

·       Paydividends and make other distributions in respect of our equity securities;

·       Acquireassets and make investments;

·       Salesof assets;

·       Transactionswith affiliates;

·       Mergers;

·       TotalLeverage Ratio

·       InterestExpense Coverage ratio; and

·       Agreementsto restrict dividends and other payments from subsidiaries.

Total debt issuance costs incurred with the issuanceof long-term debt and the Bridge Loan are capitalized and amortized as interestexpense using the effective interest method. Amortization of debt issuancecosts were $1,511 and $961 for the year ended October 31, 2006 and 2005,respectively. 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Unamortized debt issuance costs of $2,369 and $3,328as of October 31, 2006 and 2005, respectively, are included in Other longterm assets on the consolidated balance sheets.

***Stargames creditfacility.***   Stargames has banking facilitieswith the Australia and New Zealand Banking Group (“ANZ”). The facilities have aborrowing capacity of AU $12,700; amounts outstanding as of October 31,2006 were AU $5,000 or US $3,872 at a weighted average interest rate of 6.45%.The banking facilities are comprised of two main components: a flexible bankoverdraft that acts as a working capital facility and a bank loan facilitywhich is an interchangeable facility comprised of commercial bills, overdraftsand advances. Interest rates are variable and based on the bank bill swapyield, as defined, plus a margin.

The facilities are secured by a cross guarantee andindemnity between all the operating entities of the Stargames group. Theagreements provide for collateralization of all the assets and operations ofall members of the Stargames group as well as the operating facilities ofStargames based in Milperra, New South Wales, Australia.

The facilities include certain financial covenantswhich are tested annually by ANZ at the end of each financial year. Thesefinancial covenants include a minimum working capital ratio, a minimum ratio ofnet profit, as defined, to interest expense and minimum liabilities to equityratio. As of June 30, 2005, the most recent date of review, Stargames wasin compliance with all financial covenants. The facilities are subject to thenext compliance assessment as of October 31, 2006.

***BTI liabilities.***   In connection with ouracquisition of certain assets from BTI, we recorded an initial estimated liabilityof $7,616 for contingent installment payments computed as the excess fair valueof the acquired assets over the fixed installments and other direct costs. In November 2004,we began paying monthly note installments based on a percentage of certainrevenue from BTI games for a period of up to ten years, not to exceed $12,000.The balance of this liability as of October 31, 2006 and 2005, was $4,441and $6,167, respectively.

***ENPAT note payable.***   In December 2004, wepurchased two RFID technology patents from ENPAT for $12,500. The purchaseprice was comprised of an initial payment of $2,400 followed by a $1,100payment in January 2005 and non-interest bearing annual installmentsthrough December 2007. The balance as of October 31, 2006 and 2005,of $5,823 and $8,518, respectively, represents the discounted present value ofthe future payments, including imputed interest of approximately $265 and $352,respectively. Principal and interest payments of $3,000 each are due in December 2006and 2007.

***Bet the Set “21”TMcontingent consideration.***   Inconnection with our acquisition of Bet the Set “21”, we recorded contingentconsideration of $560. The contingent consideration consists of quarterlypayments of 22.5% of “adjusted gross revenues,” as defined, attributed to theBet the Set “21” side bet table games up to a maximum of $560. The balance ofthis liability as of October 31, 2006 and 2005, was $526 and $549,respectively.

***VIP note payable.******  ***In connection with our acquisition of VIP in August 2005,we recorded a note payable with annual installments due each July through2007. The balance of the liability as of October 31, 2006 and 2005 was$329 and $318, respectively.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Maturitiesof long-term debt, excluding contingent consideration, for the five fiscalyears ending subsequent to October 31, 2006, are as follows:

| **Year ending October 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                       |       | $          | 77,294     |       |
| 2008                                       |       | 3,007      |       |
| 2009                                       |       | 150,204    |       |
| 2010                                       |       | 204        |       |
| 2011                                       |       | 98         |       |
| Thereafter                                 |       | 5,240      |       |
| **Total**                                  |       | $          | 236,047    |       |

 

**9.** SHARE-BASEDCOMPENSATION

***Adoption of SFAS 123R.***   EffectiveNovember 1, 2005, we account for stock-based compensation in accordancewith Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS123R”), “*Share-Based Payment*”, and SEC Staff AccountingBulletin No. 107 (“SAB 107”), “*Share-Based Payment*”,requiring the measurement and recognition of all share-based compensation underthe fair value method. We previously accounted for stock-based compensation inaccordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “*Accounting for Stock Issued to Employees*”, and the FinancialAccounting Standards Board’s Interpretation No. 44, “*Accountingfor Certain Transactions Involving Stock Compensation, an Interpretation of APBOpinion No. 25*”, and disclosed supplemental information inaccordance with Statement of Financial Accounting Standards No. 123 (“SFAS123”), “*Accounting for Stock-Based Compensation*.”Under these standards, we did not incur compensation expense for employee stockoptions when the exercise price was at least 100% of the market value of ourcommon stock on the date of grant. SFAS 123R requires that all stock-basedcompensation, including shares and share-based awards to employees, be valuedat fair value. We measure the fair value of share-based awards using theBlack-Scholes model.

Under SFAS 123R, compensation is attributed to theperiods of associated service. For awards granted prior to November 1,2005, such expense is being recognized on an accelerated basis since that isthe method that we previously applied in our supplemental disclosures.Beginning with awards granted on November 1, 2005, such expense is beingrecognized on a straight-line basis over the vesting period of the awards.Forfeitures are estimated at the time of grant, with such estimate updatedperiodically and with actual forfeitures recognized currently to the extentthey differ from the estimate.

We adopted SFAS 123R by applying themodified-prospective transition method and reclassified previously recordeddeferred compensation to additional paid-in capital. Under this method, webegan applying the valuation and other criteria of SFAS 123R on November 1,2005, and began recognizing expense for the unvested portion of previouslyissued grants at the same time, based on the valuation and attribution methodsoriginally used to calculate the disclosures.

In addition, SFAS 123R requires the excess tax benefitfrom stock-option exercises—tax deductions in excess of compensation costrecognized—to be classified as a financing activity. Previously, all taxbenefits from stock option exercises were classified as operating activities.We have evaluated the provisions of SFAS 123R-3, “*TransitionElection Related to Accounting for Tax Effects of Share-Based*

95

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

*Payment Awards*” and have electedthe alternative method for establishing the APIC pool. The $3,682 of excess taxbenefits are classified as an operating cash outflow and a financing cashinflow.

***Share-based awardplans.***   In February 2004, our board ofdirectors adopted and, in March 2004, our shareholders approved theShuffle Master, Inc. 2004 Equity Incentive Plan (the “2004 Plan”) and theShuffle Master, Inc. 2004 Equity Incentive Plan for Non-Employee Directors(the “2004 Directors’ Plan”). These approved plans replaced our prior plans andno further options may be granted from the prior plans. Both the 2004 Plan andthe 2004 Directors’ Plan provide for the grant of stock options, stockappreciation rights (none issued), and restricted stock, individually or in anycombination (collectively referred to as “Awards”). Stock options may not begranted at an exercise price less than the market value of our common stock onthe date of grant and may not be subsequently repriced. Options granted underthe 2004 Plan generally vest in equal increments over four years and expire inten years. Options granted under the 2004 Directors’ Plan generally vestimmediately and expire in ten years.

The 2004 Plan provides for the grants of Awards to ourofficers, other employees and contractors. The maximum number of Awards whichmay be granted is 2,700 of which no more than 1,890 may be granted asrestricted stock. The 2004 Directors’ Plan provides for the grants of Awards toour non-employee directors. The maximum number of Awards which may be grantedis 1,125 of which no more than 788 may be granted as restricted stock.

As of October 31,2006, 1,125 and 883 shares are available for grant under the 2004 Plan and 2004Directors’ Plan, respectively. A summary of activity under our share-basedpayment plans for the year ended October 31, 2006 is presented below:

| ** **                            | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                            | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at  October 31, 2005 |       |       | 3,822      |         |       |            | $          | 17.01         |       |   |   |   |   |   |   |   |   |   |
| Granted                               |       |       | 142        |         |       |            | 32.96      |          |       |   |   |   |   |   |   |   |   |
| Exercised                             |       |       | (697       | )            |       |            | 11.30      |          |       |   |   |   |   |   |   |   |   |
| Forfeited or expired                  |       |       | (136       | )            |       |            | 13.55      |          |       |   |   |   |   |   |   |   |   |
| Outstanding at  October 31, 2006 |       |       | 3,131      |         |       |            | $          | 19.16         |       |   |   | 7.0 |   |   |   | $ | 59,052 |   |   |
| Exercisable at October 31,  2006 |       |       | 2,114      |         |       |            | $          | 18.15         |       |   |   | 6.5 |   |   |   | $ | 38,374 |   |   |

 

The total intrinsic value of stock options exercisedduring the year ended October 31, 2006 and 2005 was $13,070 and $18,711,respectively. The total income tax benefits from stock option exercises duringthe year ended October 31, 2006 and 2005 were $3,908 and $5,287,respectively. As of October 31, 2006, there was a total of $5,674 ofunamortized compensation related to stock options, which expense is expected tobe recognized over a weighted-average period of 2.3 years. As noted earlier, weare recognizing expense for awards granted prior to November 1, 2005 on anaccelerated basis, so a disproportionate amount of unamortized expense will berecognized in the first 12 months of this weighted-average period.

96

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

During the year ended October 31, 2006 and 2005,we issued 64 and 193 shares of restricted stock, respectively, with anaggregate fair value of $2,113 and $4,781, respectively. The total value ofeach restricted stock grant, based on the fair market value of the stock on thedate of grant, is amortized to compensation expense over the related vestingperiod. Net income, as reported, for the year ended October 31, 2006 and2005, reflects $1,275 and $507 respectively, of amortization of restrictedstock compensation.

A summaryof activity related to restricted stock for the year ended October 31,2006 is presented below:

| ** **                          | ** ** | ** ** | ** ** | **Weighted**        | ** ** |
|-------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at  October 31, 2005 |       |       | 276        |                |       |   | $ | 19.11 |   |   |
| Granted                             |       |       | 64         |                |       |   | 33.27 |   |   |
| Exercised                           |       |       | —     |                |       |   | — |   |   |
| Forfeited                           |       |       | —     |                |       |   | — |   |   |
| Nonvested at  October 31, 2006 |       |       | 340        |                |       |   | $ | 26.01 |   |   |

 

No shares vested during the year ended October 31,2006. As of October 31, 2006, there was $5,904 of unamortized compensationexpense related to restricted stock, which expense is expected to be recognizedover a weighted-average period of 2.4 years.

***Recognition of compensation expense.***   Thefollowing table shows information about compensation costs recognized for theyears ended October 31:

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Compensation costs:                             |       |     |       |     |       |     |       |
| Stock options                                   |       | $        | 3,515      |     | $          | 60       |       | $ | — |   |
| Restricted stock                                |       | 1,997    |       | 759      |       | 191      |       |
| Total compensation cost                         |       | 5,512    |       | 819      |       | 191      |       |
| Less: Related tax  benefit                      |       | (1,720   | )          | (300     | )          | (70      | )          |
| Total compensation  expense, net of tax benefit |       | $        | 3,792      |     | $          | 519      |       | $ | 121 |   |
| Reduction in basic earnings per share           |       | $        | 0.11       |     | $          | 0.01     |       | $ | 0.00 |   |
| Reduction in diluted  earnings per share        |       | $        | 0.11       |     | $          | 0.01     |       | $ | 0.00 |   |

 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Reportedshare-based compensation expense was classified as follows for the years ended October 31:

| ** **                                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross margin                                                    |       | $        | 102        |     | $          | —   |       | $ | — |   |
| Selling, general and  administrative                            |       | 5,108    |       | 819      |       | 191      |       |
| Research and development                                        |       | 302      |       | —   |       | —   |       |
| Total share-based  compensation                                 |       | $        | 5,512      |     | $          | 819      |       | $ | 191 |   |
| Tax benefit                                                     |       | (1,720   | )          | (300     | )          | (70      | )          |
| Total share-based  compensation, net of tax                     |       | $        | 3,792      |     | $          | 519      |       | $ | 121 |   |
| SFAS 123R Expense as a% of Revenue:                             |       |     |       |     |       |     |       |
| Gross margin                                                    |       | 0.1      | %          | 0.0      | %          | 0.0      | %          |
| Selling, general and  administrative expenses as a % of revenue |       | 3.1      | %          | 0.7      | %          | 0.2      | %          |
| Research and development as a % of revenue                      |       | 0.2      | %          | 0.0      | %          | 0.0      | %          |

 

Weestimate the fair value of each stock option award on the grant date using theBlack-Scholes valuation model incorporating the weighted-average assumptionsnoted in the following table (assumptions in 2005 and 2004 were used to computethe pro forma compensation for disclosure purposes only). Option valuationmodels require the input of highly subjective assumptions, and changes inassumptions used can materially affect the fair value estimate. Expectedvolatility and dividends are based on historical factors related to our commonstock. Expected term represents the estimated weighted-average time betweengrant and employee exercise. Risk free interest rate is based on U.S. Treasuryrates appropriate for the expected term.

| ** **                    | ** ** | **Year Ended October 31,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Option valuation assumptions: |       |                                      |       |   |   |   |   |
| Expected dividend yield       |       | None                                      |       | None |   | None |   |
| Expected volatility           |       | 37.1                                      | %          | 49.5 | % | 62.7 | % |
| Risk-free interest rate       |       | 4.7                                       | %          | 3.4 | % | 3.1 | % |
| Expected term                 |       | 4.4 years                                 |       | 5.3 years |   | 4.8 years |   |

 

***Pro forma disclosures.***   Hadwe accounted for these plans during 2005 and 2004 under the fair value methodallowed by SFAS 123, our net income and earnings per share would have beenreduced to recognize the fair value of employee options, as follows for theyears ended October 31:

| ** **                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income                                                |       |     |       |     |       |
| As reported                                               |       | $        | 29,180     |     | $          | 24,144 |   |
| Incremental after-tax pro forma share-based  compensation |       | (10,485  | )          | (7,881   | )          |
| Comparative net income (prior year pro forma)             |       | $        | 18,695     |     | $          | 16,263 |   |
| Basic earnings per  share                                 |       |     |       |     |       |
| As reported                                               |       | $        | 0.84       |     | $          | 0.67 |   |
| Pro forma                                                 |       | 0.54     |       | 0.45     |       |
| Diluted earnings per  share                               |       |     |       |     |       |
| As reported                                               |       | $        | 0.80       |     | $          | 0.64 |   |
| Pro forma                                                 |       | 0.51     |       | 0.43     |       |

 

98

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**10.** EARNINGSPER SHARE

Sharesused to compute basic and diluted earnings per share from continuing operationsfor the years ended October 31 are as follows (all share and per shareamounts have been restated to reflect our three-for-two stock split in April 2004and January 2005): 

| ** **                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income from  continuing operations                          |       | $        | 5,339      |     | $          | 29,104   |       | $ | 22,517 |   |
| Basic:                                                      |       |     |       |     |       |     |       |
| Weighted average shares                                     |       | 34,585   |       | 34,924   |       | 35,955   |       |
| Diluted:                                                    |       |     |       |     |       |     |       |
| Weighted average shares, basic                              |       | 34,585   |       | 34,924   |       | 35,955   |       |
| Dilutive impact of options and restricted stock outstanding |       | 1,176    |       | 1,343    |       | 1,353    |       |
| Dilutive effect of contingent convertible notes             |       | 291      |       | 111      |       | —   |       |
| Weighted average shares, diluted                            |       | 36,052   |       | 36,378   |       | 37,308   |       |
| Basic earnings per share                                    |       | $        | 0.15       |     | $          | 0.83     |       | $ | 0.63 |   |
| Diluted earnings per share                                  |       | $        | 0.15       |     | $          | 0.80     |       | $ | 0.60 |   |

 

We account for our Notes inaccordance with EITF 04-08, “The Effect of Contingently Convertible Debton Diluted Earnings Per Share” which requires us to include the dilutive effectof our outstanding Notes shares in our diluted earnings per share calculation,regardless of whether the market price trigger or other contingent conversionfeature has been met. Because our Notes include a mandatory cash settlementfeature for the principal payment, we applied the treasury stock method. Thismethod results in incremental dilutive shares when the average fair value ofour common stock for a reporting period exceeds the initial conversion priceper share of $28.07. EITF04-08 also requires restatement of all prior periods. Because the averagefair value of our common stock did not exceed the initial conversion price inany period prior to the year ended October 31, 2005, no restatement ofprior periods was required. For certain quarters during the years ended October 31,2006 and 2005, the average fair value of our common stock exceeded $28.07, andaccordingly, the dilutive effect is included in our diluted shares calculation.

**11.** SHAREHOLDERS’EQUITY

***Stock splits.******  ***In December 2004, ourboard of directors approved a three-for-two common stock split, with new sharesdistributed in the form of a dividend on January 14, 2005, to shareholdersof record on January 3, 2005 (the “January 2005 Split”). Inconnection with the January 2005 Split, we paid cash of $68 for fractionalshares and reclassified to common stock the par value of $0.01 per newly issuedshare.

In****March 2004, our board of directors had earlierapproved another three-for-two common stock split, with new shares distributedin the form of a dividend on April 16, 2004, to shareholders of record on April 5,2004 (the “April 2004 Split”). In connection with the April 2004Split, we paid cash of $138 for fractional shares and reclassified to commonstock the par value of $0.01 per newly issued share.

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Share and per share amounts have been adjusted for allperiods presented herein to reflect both the January 2005 Split and the April 2004Split.

***Common stockrepurchases.***   Our board of directors periodically authorizes us torepurchase shares of our common stock. Under our existing board authorizations,during the year ended October 31, 2006, we repurchased 317 shares of ourcommon stock for a total cost of $8,665 at an average price of $27.39 pershare. Underour board authorizations, during the years ended October 31, 2005 and2004, we repurchased 1,473 and 1,991 shares of our outstanding stock at totalcosts of $38,643 and $42,524, respectively. We cancel shares that we repurchase.In addition, in April 2004, our board of directors authorized and werepurchased, in private transactions, an additional 2,806 shares of our commonstock at a total cost of $57,500 with funds provided from the issuance of ourcontingent convertible senior notes.

On September 5, 2006, our board of directorsvoted a new authorization to repurchase shares of our common stock by anadditional $30,000. As of October 31, 2006, $30,166 remained outstandingunder our board authorizations.

The timing of our repurchases of our common stockpursuant to our board of directors’ authorization is dependent on futureopportunities and on our views, as they may change from time to time, as to themost prudent uses of our capital resources, including cash and borrowingcapacity. Alternatives that we consider as possible uses of our capitalresources include investment in new products, acquisitions, principal paymentson our long term obligations, funding of internal growth in working capital,and investments in sales-type leases and notes receivable.

***Tax benefit from stockoption exercises.******  ***Duringeach of the years ended October 31, 2006, 2005 and 2004, we recordedincome tax benefits of $3,908, $5,287 and $5,388, respectively, related todeductions for employee stock option exercises. These tax benefits, whichreduced income taxes payable and increased additional paid-in capital by anequal amount, had no effect on our provision for income taxes. Additionally, aspart of the fiscal 2004 income tax provision to tax return true-up, we recordeda $229 tax benefit related to employee stock option exercises which reducedincome taxes payable and increased additional paid-in capital by an equalamount.

***Class A preferredstock.******  ***On June 26, 1998, in connectionwith the adoption of our shareholder rights plan, our board of directorsdesignated and established 506,409 (as currently adjusted) shares of no parvalue Class A Preferred Stock (the “Preferred Stock”). Holders of our PreferredStock are entitled to one hundred votes on any matters submitted to vote by ourshareholders, an aggregate dividend of one hundred times any dividend declaredon our common stock and a liquidation preference of one hundred times anyliquidation payment amount to our common shareholders. No shares of PreferredStock have been issued.

***Preferred stockpurchase rights.*****  **In February 2005, we amended ourShareholder Rights Agreement, dated June 26, 1998 (the “Rights Agreement”).As more fully described therein, and subject to the terms thereof, the RightsAgreement, as amended, generally gives holders of our common stock rights toacquire shares of our preferred stock upon the occurrence of specified events.The amendment (a) eliminated all requirements in the Rights Agreement thatactions, approvals and determinations to be taken or made by our board ofdirectors be taken or made by a majority of the “Continuing Directors,” and (b) reflectsthe change of the name of our stock transfer 

100

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

agent to Wells Fargo Bank, N.A. The amendmenteliminated from the Rights Agreement those provisions commonly referred to as “deadhand” provisions.

The Shareholder Rights Agreement was implemented bydistributing one preferred share purchase right (a “Right”) for eachoutstanding share of our common stock held of record as of July 10, 1998.Additionally, we further authorized and directed the issuance of one Right withrespect to each share of our common stock that shall become outstandingthereafter until the Rights become exercisable or they expire as describedbelow. Each Right initially entitles holders of our common stock to buy oneone-hundredth of a share of our Preferred Stock at a price of $5.33 (ascurrently adjusted), subject to adjustment. The Rights will generally becomeexercisable after a person or group acquires beneficial ownership of 20% ormore of our common stock or announces a tender offer upon consummation of whichsuch person or group would own 20% or more of our common stock.

If any person or group becomes the owner of 20% ormore of our common stock, then, in lieu of the right to purchase any PreferredStock, each Right will therefore entitle its holder (other than an acquiringperson or member of an acquiring group) to purchase shares of our common stockin an amount equal to the exercise price ($5.33, as currently adjusted) of oneone-hundredth share of the preferred stock divided by 50% of the then-currentmarket price of one share of common stock.

In addition, if we are acquired in a merger or otherbusiness combination transaction, or sell 20% or more of our assets or earningspower then, in lieu of the right to purchase Preferred Stock, each Right willthereafter generally entitle its holder to purchase common shares of theacquiring company using the same formula as for our common stock.

The Rights expire in June 2008unless earlier redeemed or terminated. At the option of our board of directors,we generally may amend the Rights or redeem the Rights at $0.01 per Right atany time prior to the time a person or group has acquired 20% of our commonstock.

**12.**   EMPLOYEEBENEFIT PLANS

***U.S. definedcontribution plan.******  ***We sponsor a defined contributionplan, which qualifies under Section 401(k) of the Internal RevenueCode and covers U.S. employees who meet certain age and service requirements.We may make matching contributions to the plan based on a percentage ofemployee compensation and actual contributions. In the years ended October 31,2006, 2005 and 2004, we elected to make matching contributions of 50% ofemployee contributions up to 4% of compensation, totaling $248, $234, and $194,respectively.

***Austrian pensioncommitments.******  ***In April and May 2004, we formalizedour defined contribution pension agreements with certain Austrian employees. Wepay contributions to an external pension fund administered by ÖPAGPensionskassen AG. Aggregate pension expense relating to our Austrian agreementsin the years ended October 31, 2006, 2005 and 2004 were $53, $36 and $25,respectively.

101

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

**13.**         OTHEREXPENSE

Otherincome (expense) is comprised of the following for the years ended October 31:

| ** **                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income               |       | $        | 1,998      |     | $          | 2,336    |       | $ | 888 |   |
| Interest expense              |       | (8,374   | )          | (3,263   | )          | (1,497   | )          |
| Foreign currency gain  (loss) |       | (414     | )          | 215      |       | (992     | )          |
| Other                         |       | 91       |       | 55       |       | 1        |       |
|                          |       | $        | (6,699     | )        | $          | (657     | )          | $ | (1,600 | ) |

 

Interest income decreased primarily as a result of areduction in our investment portfolio. Proceeds of matured investments were notre-invested, but were used to pay down the bridge financing associated with theacquisition of Stargames and stock repurchases. This decrease was partiallyoffset by an increase in interest income attributable to increased interestbearing sales-type leases and notes receivable as of October 31, 2006. Forthe years ended October 31, 2006, 2005 and 2004, respectively, interestincome related to our investment in sales type leases and notes receivable was$1,229 ,$948 and $480.

Interest expense for the periods ended October 31,2006, 2005 and 2004 is primarily related to the $150,000 of Notes due in April 2024.Interest Expense in 2006 also includes interest expense on the Bridge Loanwhich matures in November 2006. A more detailed discussion of the Notesand the Bridge Loan are included below under the heading “Liquidity and CapitalResources.”

Priorto the completion of our CARD acquisition in fiscal 2004, we entered intoforeign currency exchange contracts to fix the U.S. dollars estimated tobe required to fund the Euro-denominated cash component of the CARD purchaseprice which resulted in a foreign currency exchange loss of $703. Suchcontracts do not meet the accounting criteria for hedge accounting, andaccordingly, the foreign currency exchange loss is included in our operatingresults for the year ended October 31, 2004. As of October 31, 2006and 2005, we had no outstanding foreign exchange contracts.

**14.**         INCOMETAXES

We record deferred income taxes to reflect the incometax consequences in future years between the financial reporting and income taxbases of assets and liabilities, and future tax benefits such as net operatingloss carryforwards and other tax credits. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which the differences are expected to reverse. We provide valuationallowances to reduce deferred tax assets to an amount that is more likely thannot to be realized. We evaluate the likelihood of recovering our deferred taxassets by estimating sources of future taxable income. The provision for incometaxes is the sum of the tax currently payable and the change in deferred taxesduring the year.

102

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

The incometax provision (benefit) attributable to our continuing and discontinuedoperations is as follows for the years ended October 31:

| ** **               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Continuing operations    |       | $        | 13,373     |     | $          | 14,496   |       | $ | 12,125 |   |
| Discontinued  operations |       | (90      | )          | 44       |       | 876      |       |
| Total                    |       | $        | 13,283     |     | $          | 14,540   |       | $ | 13,001 |   |

 

Thecomponents of the provision for income taxes from continuing operations are asfollows for the years ended October 31:

| ** **    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| **Current:**  |       |     |       |     |       |     |       |
| Federal       |       | $        | 13,647     |     | $          | 16,364   |       | $ | 9,447 |   |
| State         |       | 658      |       | 1,210    |       | 1,082    |       |
| Foreign       |       | 1,290    |       | (526     | )          | 526      |       |
|          |       | 15,595   |       | 17,048   |       | 11,055   |       |
| **Deferred:** |       |     |       |     |       |     |       |
| Federal       |       | (1,343   | )          | (2,980   | )          | 718      |       |
| State         |       | (60      | )          | (312     | )          | —   |       |
| Foreign       |       | (819     | )          | 740      |       | 352      |       |
|          |       | (2,222   | )          | (2,552   | )          | 1,070    |       |
| **Total**     |       | $        | 13,373     |     | $          | 14,496   |       | $ | 12,125 |   |

 

103

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Deferredtax assets and liabilities consisted of the following as of October 31:

| ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| **Deferred tax assets:**                    |       |     |       |     |       |
| Inventories                                 |       | $        | 4,429      |     | $          | 976 |   |
| Accounts receivable                         |       | 684      |       | 368      |       |
| Employee benefits                           |       | 768      |       | 234      |       |
| Deferred revenue                            |       | 835      |       | 44       |       |
| Investment impairment reserves              |       | 1,033    |       | 376      |       |
| Other reserves                              |       | 317      |       | 415      |       |
| Restricted stock                            |       | 2,081    |       | 380      |       |
| Depreciation                                |       | 391      |       | 87       |       |
| Foreign net operating loss carryforward     |       | 1,410    |       | 407      |       |
| Contingent consideration on patent purchase |       | 1,926    |       | 2,525    |       |
| Foreign tax credits / receivables           |       | 331      |       | —   |       |
| Other                                       |       | 304      |       | 133      |       |
| **Total  gross deferred tax assets**        |       | 14,509   |       | 5,945    |       |
| **Less:  valuation allowance**              |       | (880     | )          | (363     | )          |
| **Deferred  tax assets**                    |       | 13,629   |       | 5,582    |       |
| **Deferred  tax liabilities:**              |       |     |       |     |       |
| Goodwill                                    |       | 1,608    |       | 908      |       |
| Intangible amortization                     |       | 5,959    |       | 273      |       |
| Other                                       |       | 597      |       | 164      |       |
| **Total  gross deferred tax liabilities**   |       | 8,164    |       | 1,345    |       |
| **Net  deferred tax assets**                |       | $        | 5,465      |     | $          | 4,237 |   |

 

As of October 31, 2006,we have available $1,479 of Australian net operating losses which can becarried forward indefinitely and $1,323 of New Zealand net operating losseswhich can be carried forward indefinitely. We have recorded a deferred taxasset of $880 related to these operating losses and a corresponding valuationallowance of $880 to fully provide for this deferred income tax benefit thatmay not be realized.

We have not provided U.S. Federal income tax on $4,258of undistributed earnings of our foreign subsidiaries because we intend topermanently reinvest such earnings outside the United States. Upon distributionof these earnings in the form of dividends or otherwise, we would be subject toU.S. income taxes, subject to adjustment for foreign tax credits. Determinationof the amount of unrecognized deferred U.S. income tax liability is notpracticable because of the complexities associated with its hypotheticalcalculation.

In October 2006, our wholly-owned subsidiary,Shuffle Master Management—Service GmbH, the parent entity to CARD, transferred$8,000 to Shuffle Master, Inc. in the form of a dividend. This dividend issubject to United States tax based upon earnings and profits of Shuffle MasterManagement—Service GMBH. This dividend resulted in $733 of net additionalincome taxes which is comprised of additional United States tax ofapproximately $1,855 and a corresponding foreign tax credit benefit of $1,122.

104

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Thereconciliation of the federal statutory rate to our effective income tax ratefor continuing operations for the years ended October 31 is as follows:

| ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal income tax at  the statutory rate   |       | 35.0%    |       | 35.0%    |       | 35.0%    |       |
| In-process research  and development        |       | 35.8%    |       | 0.0%     |       | 0.0%     |       |
| Foreign dividend  inclusion                 |       | 9.9%     |       | 0.0%     |       | 0.0%     |       |
| Other permanent  differences                |       | (6.0%)   |       | (1.9%)   |       | (1.4%)   |       |
| State income taxes,  net of federal benefit |       | 2.5%     |       | 2.1%     |       | 2.0%     |       |
| Tax credits                                 |       | (8.4%)   |       | (1.8%)   |       | (1.4%)   |       |
| Effect from foreign  tax rate differences   |       | 1.4%     |       | 0.7%     |       | 0.9%     |       |
| Other                                       |       | 1.3%     |       | (0.8%)   |       | (0.1%)   |       |
| Effective tax rate                          |       | 71.5%    |       | 33.3%    |       | 35.0%    |       |

 

**15.**         OPERATINGSEGMENTS

We have two reportable segments which are classifiedas continuing operations, Utility Products and Entertainment Products. UtilityProducts include our Shufflers, Chip Sorting Machines and ITS product lines.Entertainment Products include our Proprietary Table Games, Table Masterproducts, Shuffle Up Productions and the products developed, manufactured anddistributed by Stargames. The Stargames product offerings include Rapid TableGames and Vegas Star multi-terminal gaming machines and a broad line oftraditional video slot machines designed more specifically for the Australianand Asian gaming markets. Each segment’s activities include the design,development, acquisition, manufacture, marketing, distribution, installationand servicing of its product lines. All periods presented have beenreclassified to conform to our current reportable segments.

Segment revenues include sale, lease or licensing ofproducts within each reportable segment. Segment operating income includesrevenues and expenses directly and indirectly associated with the product linesincluded in each segment. Direct expenses primarily include depreciation ofleased assets, amortization of intangible assets, cost of products sold,shipping, installation, commissions, product approval costs, research anddevelopment and product related litigation. Indirect expenses include anactivity-based allocation of other general product-related costs, the mostsignificant of which are service and selling expenses, including stock optionexpense, and manufacturing overhead. Corporate general and administrativeexpenses are not allocated to segments. Capital expenditures include amountsreported in our consolidated statements of cash flows for purchases of leasedproducts, property and equipment, and intangible assets plus the financed ornon-cash portion of these purchases which is excluded from cash flows.

As discussed in Note 3, we recognized a one-timecharge for IPR&D of $19,145 related to the acquisition of Stargames. All ofthe products acquired from Stargames have been classified as EntertainmentProducts and accordingly, the Entertainment Products segment results for theyear ended October 31, 2006 include the impact of the IPR&D charge of$19,145.

Goodwill of $38,345 and $36,017 as of October 31,2006 and 2005, respectively, has been allocated to the Utility product segment.Goodwill of $53,355 and $0 as of October 31, 2006 and 2005, respectively,has been allocated to the Entertainment product segment.

105

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Thefollowing provides financial information concerning our reportable segments ofour continuing operations for the years ended October 31:

| ** **                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Revenue:**                        |       |     |       |     |       |     |       |
| Utility products                    |       | $        | 86,792     |     | $          | 67,029   |       | $ | 45,947 |   |
| Entertainment products              |       | 75,961   |       | 45,539   |       | 38,705   |       |
| Corporate                           |       | 238      |       | 292      |       | 131      |       |
|                                |       | $        | 162,991    |     | $          | 112,860  |       | $ | 84,783 |   |
| **Income  (Loss) from operations:** |       |     |       |     |       |     |       |
| Utility products                    |       | $        | 42,445     |     | $          | 32,595   |       | $ | 21,362 |   |
| Entertainment products              |       | 17,341   |       | 33,529   |       | 29,586   |       |
| Corporate                           |       | (32,304  | )          | (20,867  | )          | (14,706  | )          |
|                                |       | $        | 27,482     |     | $          | 45,257   |       | $ | 36,242 |   |
| **Depreciation  and amortization:** |       |     |       |     |       |     |       |
| Utility products                    |       | $        | 8,535      |     | $          | 7,186    |       | $ | 3,606 |   |
| Entertainment products              |       | 5,111    |       | 2,364    |       | 1,767    |       |
| Corporate                           |       | 4,527    |       | 2,629    |       | 1,846    |       |
|                                |       | $        | 18,173     |     | $          | 12,179   |       | $ | 7,219 |   |
| **Capital  expenditures:**          |       |     |       |     |       |     |       |
| Utility products                    |       | $        | 6,139      |     | $          | 11,395   |       | $ | 3,705 |   |
| Entertainment products              |       | 6,807    |       | 5,203    |       | 787      |       |
| Corporate                           |       | 2,730    |       | 2,371    |       | 2,628    |       |
|                                |       | $        | 15,676     |     | $          | 18,969   |       | $ | 7,120 |   |
| **Assets,  end of year:**           |       |     |       |     |       |     |       |
| Utility products                    |       | $        | 109,689    |     | $          | 99,265   |       | $ | 88,019 |   |
| Entertainment products              |       | 151,636  |       | 40,979   |       | 30,868   |       |
| Corporate                           |       | 43,882   |       | 52,873   |       | 66,405   |       |
| ** **                          |       | $        | 305,207    |     | $          | 193,117  |       | $ | 185,292 |   |

 

Revenues by geographic area are determined based onthe location of our customer. For the years ended October 31, 2006, 2005and 2004, sales to customers outside the United States accounted for 44%, 23%,and 23% of consolidated revenue, respectively. No individual customer accountedfor more than 10% of consolidated revenue.

106

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

Thefollowing provides financial information concerning our operations bygeographic area for the years ended October 31:

| ** **                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Revenue:**                        |       |     |       |     |       |     |       |   |   |   |   |   |   |
| United States                       |       | $        | 90,569     |     | 55.6%      |     | $          | 87,250 |   | 77.3% |   | $ | 65,392 |   | 77.1% |   |
| Canada                              |       | 7,103    |       | 4.4%     |       | 5,303    |       | 4.7% |   | 6,465 |   | 7.6% |   |
| Other North America                 |       | 2,747    |       | 1.7%     |       | 2,214    |       | 2.0% |   | 2,584 |   | 3.0% |   |
| Europe                              |       | 9,920    |       | 6.1%     |       | 8,147    |       | 7.2% |   | 4,176 |   | 4.9% |   |
| Australia                           |       | 27,149   |       | 16.7%    |       | 2,440    |       | 2.2% |   | 4,281 |   | 5.0% |   |
| Asia                                |       | 24,003   |       | 14.7%    |       | 6,631    |       | 5.9% |   | 1,216 |   | 1.5% |   |
| Other                               |       | 1,500    |       | 0.8%     |       | 875      |       | 0.7% |   | 669 |   | 0.9% |   |
|                                |       | $        | 162,991    |     | 100.0%     |     | $          | 112,860 |   | 100.0% |   | $ | 84,783 |   | 100.0% |   |
| **Long-lived assets, end of year:** |       |     |       |     |       |     |       |   |   |   |   |   |   |
| United States                       |       | $        | 61,152     |     | 28.3%      |     | $          | 56,143 |   | 47.4% |   | $ | 41,077 |   | 38.4% |   |
| Austria                             |       | 53,667   |       | 24.9%    |       | 53,799   |       | 45.4% |   | 59,755 |   | 55.8% |   |
| Australia                           |       | 100,364  |       | 46.5%    |       | 6,617    |       | 5.6% |   | 5,985 |   | 5.6% |   |
| Other                               |       | 628      |       | 0.3%     |       | 1,866    |       | 1.6% |   | 221 |   | 0.2% |   |
|                                |       | $        | 215,811    |     | 100.0%     |     | $          | 118,425 |   | 100.0% |   | $ | 107,038 |   | 100.0% |   |

 

**16.**         COMMITMENTSAND CONTINGENCIES

***Operating leases.*****  **We leaseoffice, production, warehouse and service facilities, and service vansunder operating leases. The facility leases are for periods ranging from one toten years, include renewal options, and include an allocation of real estatetaxes and other operating expenses. Total rent expense under operating leaseswas approximately $1,560, $1,116 and $979 for the years ended October 31,2006, 2005, and 2004, respectively.

Estimatedfuture minimum lease payments under operating leases as of October 31,2006, are as follows:

| **Year ending October 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                       |       | $          | 1,360      |       |
| 2008                                       |       | 983        |       |
| 2009                                       |       | 743        |       |
| 2010                                       |       | 294        |       |
| 2011                                       |       | 295        |       |
| Thereafter                                 |       | 239        |       |
| ** **                                 |       | $          | 3,914      |       |

 

***Purchase commitments.***   Fromtime to time, we enter into commitments with our vendors to purchase inventoryat fixed prices or in guaranteed quantities. As of October 31, 2006, oursignificant inventory purchase commitments totaled $14,703 which is primarily related to our one2six shufflers, Table Master,Vegas Star, Rapid Table Games and the Easy Chipper roulette chip sortermachine.

107

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

***Employment agreements.***   Wehave entered into employment contracts with our Corporate Officers and certainother key employees with durations ranging from one to three years. Significantcontract provisions include minimum annual base salaries, healthcare benefits,bonus compensation if performance measures are achieved, and non-competeprovisions. These contracts are primarily “at will” employment agreements,under which the employee or we may terminate employment. If we terminate any ofthese employees without cause, then we are obligated to pay the employeeseverance benefits as specified in their individual contract. As of October 31,2006, minimum aggregate severance benefits totaled $5,123.

***Tax contingencies.***   TheCompany has open tax years with various significant taxing jurisdictionsincluding the United States, Australia, Austria, and Canada. Such open yearscontain matters that could be subject to differing interpretations ofapplicable tax laws and regulations as they relate to the amount, timing orinclusion of revenue and expenses or the sustainability of income tax creditsfor a given audit period. As of October 31, 2006, the Company hasestablished a liability of $120 for those matters where the amount of loss isprobable and reasonably estimable. The amount of the liability is based onmanagement’s best estimate given the Company’s history with similar matters andinterpretations of current laws and regulations.

***Legal proceedings.***   Ourcurrent material litigation and our current assessments are described below.Litigation is inherently unpredictable. Our assessment of each matter maychange based on future unknown or unexpected events. Subject to the foregoing,we believe we will prevail in each of the material litigation actions describedbelow. If any litigation were to have an adverse result that we did not expect,there could be a material impact on our results of operations or financialposition. We believe costs associated with litigation will not have a materialimpact on our financial position or liquidity, but may be material to theresults of operations in any given period. We assume no obligation to updatethe status of pending litigation, except as may be required by applicable law,statute or regulation.

**Continuingoperations—**

*VendingData II —**In*October 2004,we filed a second patent infringement lawsuit (“VendingData II”) againstVendingData Corporation (“VendingData”). We settled our first patentinfringement lawsuit against VendingData on July 12, 2005 (“VendingData I”).This second suit alleges that the use, importation and offering for sale ofVendingData’s PokerOneTM shuffler infringes another patent owned by us (adifferent patent than the patents that were the subject of the VendingData Icase). VendingData II was filed in the U.S. District Court for the District ofNevada (the “Court”) in Las Vegas, Nevada. The complaint seeks an unspecifiedamount of damages against VendingData and a preliminary and permanentinjunction against VendingData’s infringing conduct. VendingData has deniedinfringement and has also filed a counterclaim for a declaratory judgment ofnon-infringement.

On November 29, 2004, theCourt granted our motion for a preliminary injunction (the “Injunction”). TheInjunction became effective upon our posting of a $3,000 cash security with theCourt on November 30, 2004. This security deposit is included in otherassets on our consolidated balance sheet. On December 17, 2004, the Courtdenied VendingData’s two emergency motions to modify the Injunction.

108

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

In March 2005, the Courtof Appeals for the Federal Circuit (the “Federal Circuit”) stayed theInjunction based on a technical defect in the Court’s process in granting theInjunction, and not on its merits. In May 2005, the Court held a Markmanhearing for construction of the claims. On September 26, 2005, U.S.Magistrate Judge Lawrence R. Leavitt for the District of Nevada issued hisClaim Construction Report and Recommendation in the Markman hearing concerningVendingData’s PokerOneTM shuffler. The Magistrate Judge’s findings were limitedto his interpretation of certain words in the patent claim asserted by us, andhe agreed with the interpretation put forth by VendingData. The MagistrateJudge’s Recommendation is not a determination of whether the PokerOneTMinfringes the asserted patent,nor does it speak to the validity of our claims. We have filed a writtenobjection with the Court to the Magistrate Judge’s ruling. This objection isnow pending.

On December 27, 2005, theFederal Circuit vacated the Injunction and ordered the Court to perform a morecomplete claim construction analysis in order to deal with any future motionson whether or not to reinstate the Injunction. Two of the three judges on theFederal Circuit panel stated that they did not believe that infringement existsunder VendingData’s claim construction. We continue to believe thatinfringement exists under either our claim construction or VendingData’s claimconstruction, and we believe that our claim construction is the proper one. TheFederal Circuit did not rule on which claim construction is the properone. There can be no guarantee that the Court or, upon any further appeal, theFederal Circuit will agree with our claim construction. We intend to continueto enforce our intellectual property rights by moving the litigation forward toresolve our patent infringement claim. In June 2006, we agreed withVendingData to a standstill in the litigation in order to pursue settlementnegotiations. The standstill expired on October 31, 2006.

*GEI**— In*July 2004,we filed a patent infringement lawsuit against Gaming Entertainment, Inc. (“GEI”)in the U.S. District Court for the District of Nevada, in Las Vegas, Nevada.The lawsuit alleges that GEI’s 3-5-7 PokerTM game infringes one ofour Three Card Poker® patents. We are seeking a permanent injunctionand an as yet undetermined amount of damages against GEI. GEI has answered ourcomplaint, denying infringement, and also seeking a ruling that the patent isinvalid. The case is presently in the discovery phase. In November 2005,the Court held a Markman hearing for construction of the claims. The Markmandecision is now pending.

*Awada**— On* April 25and April 26, 2005, our rescission trial was held in the District Court inClark County, Nevada in the Awada and Gaming Entertainment, Inc. caseagainst us and our CEO, Mark Yoseloff. At the conclusion of the trial, thecourt granted our rescission motion, ordering that the subject contract, calledthe “Game Option Agreement”, be rescinded and/or void. On May 18, 2005,the Court entered Findings of Fact/Conclusions of Law confirming the Court’srescission ruling. Among the findings, the Court found that the actions ofplaintiffs Yehia Awada and Gaming Entertainment, Inc. demonstrated thatthe plaintiffs never had any intention of conveying to us the exclusive licenseto the 3-Way Action game, as they had agreed and were required to dounder the Game Option Agreement. The Court further found that we hadestablished by a preponderance of the evidence that the plaintiffs hadmaterially failed to perform their obligations under the Game Option Agreementand that we were entitled to the remedy of rescission. On May 5, 2005, theCourt ruled on the parties’ damages requests in connection with the case and asrequired under Nevada law. Plaintiffs were seeking approximately $13,000 indamages. The 

109

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

*Courtordered that the total damages under Nevada law due to the successfulrescission of the Game Option Agreement was $130, including all interest. Thedamages amount was paid in June 2006.*

Plaintiffs have appealed theCourt’s order granting the rescission of the “Game Option Agreement” to theNevada Supreme Court.

*Awada II**— On* September 12,2005, we filed a new lawsuit against defendants Awada and Gaming Entertainment, Inc.The lawsuit alleges that our Four Card Poker® game is beinginfringed and illegally copied by the defendants’ Play Four Poker game. Thelawsuit claims that the defendants are violating the federal Lanham Act byinfringing the trademark/trade dress of our Four Card Poker® game layout,and that the defendants are committing acts of unfair competition, interferencewith prospective business advantage and conversion. Our action seeksappropriate injunctive relief against defendants’ Play Four Poker game layout,as well as unspecified monetary damages. On September 15, 2005, the U.S.District Court for the District of Nevada issued a temporary restraining orderprohibiting the defendants from displaying or advertising the infringinglayout.

On or about December 6,2005, the defendants answered our complaint and denied all liability. They alsofiled counterclaims for alleged patent misuse, anti-trust violations based onsaid patent misuse, patent invalidity, unfair competition, unfair tradepractices, and other related claims. The counterclaims seek an unspecifiedamount of damages, disgorgement of our profits as a result of our allegedunfair trade practices, and preliminary and permanent injunctive relief againstour alleged unfair trade practices. The defendants filed these counterclaimsagainst both us and our CEO. We completely and uncategorically deny thedefendants’ counterclaims, and intend to vigorously oppose them. On January 9,2006, we filed a motion to dismiss all of defendants’ counterclaims. On January 24,2006, the defendants filed an opposition to our motion to dismiss. On March 27,2006, the Court granted our motion for a preliminary injunction and dismissedfour of defendants’ seven counterclaims. The balance of the case is nowpending.

*MP Games I**— In* July 2004,we filed a complaint against MP Games LLC and certain other defendants in theU.S. District Court for the District of Nevada, in Las Vegas, Nevada. Thecomplaint alleges that the defendants’ MP21 System infringes two patents ownedby us. The complaint also alleges misappropriation of trade secrets againstcertain, but not all, of the defendants, and also includes claims forcorrection of named inventor on certain related patents held in the name ofcertain of the defendants. We are seeking a permanent injunction and an as yetundetermined amount of damages against all of the defendants. The defendantshave answered our complaint denying infringement and also claiming that the twopatents are invalid. The defendants have also counterclaimed against us,claiming that we infringe several of their patents, and that we misappropriatedcertain of their trade secrets, and are seeking damages against us. We deny anyinfringement, misappropriation or wrongdoing. In May 2005, the Courtdismissed defendants’ breach of contract counterclaim. In a recent Two-PartyAgreement transaction with IGT, IGT purchased a 50% ownership interest in thetwo patents which are the subject of this lawsuit, and IGT has been added as anamed plaintiff in this lawsuit. On December 20, 2005, the Court enteredits Markman order, construing the disputed claims in the variouspatents-in-suit. The Court ruled in our favor on a number of disputed terms andin the defendants’ favor on others. Some or all of these rulings may beoverturned on appeal. Litigation 

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**SHUFFLE MASTER, INC. Notes to Consolidated Financial Statements (Continued) (In thousands, except per share amounts)**

*willcontinue on all claims in the case. In August 2006, the Court dismissedall but one of the defendants’ trade secret misappropriation claims.*

*MP Games II (Washington)**— In* June 2005,MP Games LLC, Alliance Gaming and Bally Gaming, which are among the defendantsin MP Games I, filed a complaint against us in the U.S. District Court for theWestern District of Washington, in Seattle, Washington. The complaint includedthe breach of contract claim which had been dismissed from the MP Games Nevadalitigation, discussed above, as well as related claims of misappropriation oftrade secrets and patent infringement. The complaint sought a permanentinjunction against our MD2® shuffler with card recognition, an unspecifiedamount of damages and other relief. On September 29, 2006, the partiesreached a settlement regarding this dispute and the Court dismissed theplaintiffs’ claims with prejudice and dismissed our patent invaliditycounterclaim without prejudice.

**Discontinuedoperations—**

*Fleetwood**— In January 2004, we filed a complaint in DistrictCourt in Clark County, Nevada seeking a declaratory judgment that we did notcommit any breach of a non-binding Memorandum of Understanding with Fleetwood Manufacturing, Inc.(“Fleetwood”) regarding our sale of our then slot operating system, and thatsaid Memorandum of Understanding did not create a legally binding contract onthe parties. Fleetwood filed a counterclaim alleging breach of the obligationto negotiate in good faith. On October 6, 2006, the District Court grantedour Motion for Summary Judgment on Fleetwood’s counterclaim and entered a finaljudgment in our favor in the case. In December 2006, Fleetwood agreed toreimburse us $40 in attorneys’ fees and costs.*

In the ordinary course ofconducting our business, we are, from time to time, involved in otherlitigation, administrative proceedings and regulatory governmentinvestigations. We believe that the final disposition of any of these or othermatters will not have a material adverse effect on our financial position,results of operations or liquidity.

**17.**         SUBSEQUENTEVENTS

***$100,000 RevolvingCredit Facility.******  ***OnNovember 30, 2006, we entered into a $100,000 senior secured revolvingcredit facility (the “New Credit Agreement”) with Deutsche Bank AG CaymanIslands Branch, as a Lender, Deutsche Bank Trust Company Americas, asAdministrative Agent, Deutsche Bank Securities Inc. and Wells Fargo, N.A., asJoint Lead Arrangers and Book Managers and Wells Fargo, N.A. as SyndicationAgent. We drew $71,180 on the facility, which was used to repay in its entiretythe Old Credit Agreement. Any remaining amount available under the revolvingcredit facility will be used for working capital, capital expenditures andgeneral corporate purposes, including share repurchases. The revolving creditfacility under the New Credit Agreement will mature on November 30, 2011.

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**SHUFFLE MASTER, INC.QUARTERLY FINANCIAL DATA(Unaudited, in thousands except per share amounts)**

 

| ** **                                       | ** ** | **Quarter Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **January 31**    | ** ** | **April 30** | ** ** | **July 31** | ** ** |
| **2006:**                                        |       |                   |       |   |   |   |   |   |   |
| Revenue                                          |       |                   | $          | 33,318 |   |   | $ | 43,303 |   | $ | 40,737 |   |
| Gross profit                                     |       |                   | 23,396     |   |   | 28,849 |   | 27,388 |   |
| Income from continuing operations                |       |                   | 7,218      |   |   | (12,632 | ) | 7,443 |   |
| Net income                                       |       |                   | 7,353      |   |   | (12,720 | ) | 7,269 |   |
| Earnings per share — continuing operations: |       |                   |       |   |   |   |   |   |   |
| Earnings per share, basic                        |       |                   | 0.21       |   |   | (0.37 | ) | 0.21 |   |
| Earnings per share, diluted                      |       |                   | 0.20       |   |   | (0.37 | ) | 0.20 |   |
|                                                  |            |                        |            |  |  |  |  |  |  |  |  |  |

 

| ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **October 31**            | ** ** | **October 31***      | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|--------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **(As  Previously  Reported)** | ** ** | **(* As  Restated)** | ** ** |
| Revenue                                           |       |       |       |       |       |                           | $          | 46,110                    |       |   |   | $ | 45,633 |   |   |
| Gross profit                                      |       |       |       |       |       |                           | 29,179     |                      |       |   | 26,673 |   |   |
| Income from continuing operations                 |       |       |       |       |       |                           | 5,019      |                      |       |   | 3,310 |   |   |
| Net income                                        |       |       |       |       |       |                           | 4,900      |                      |       |   | 3,191 |   |   |
| Earnings per share —  continuing operations: |       |       |       |       |       |                           |       |                      |       |   |   |   |   |
| Earnings per share, basic                         |       |       |       |       |       |                           | 0.15       |                      |       |   | 0.09 |   |   |
| Earnings per share, diluted                       |       |       |       |       |       |                           | 0.14       |                      |       |   | 0.09 |   |   |
| **2005:**                                         |       |       |       |       |       |                           |       |                      |       |   |   |   |   |
| Revenue                                           |       | $          | 25,370     |       | $          | 27,128                         |       |                      | $          | 27,272 |   |   |   | $ | 33,090 |   |   |
| Gross profit                                      |       | 19,441     |       | 20,422     |       |                           | 20,275     |                      |       |   | 23,462 |   |   |
| Income from continuing operations                 |       | 6,079      |       | 6,829      |       |                           | 8,051      |                      |       |   | 8,145 |   |   |
| Net income                                        |       | 6,122      |       | 6,845      |       |                           | 8,059      |                      |       |   | 8,154 |   |   |
| Earnings per share —  continuing operations: |       |       |       |       |       |                           |       |                      |       |   |   |   |   |
| Earnings per share, basic                         |       | 0.17       |       | 0.19       |       |                           | 0.23       |                      |       |   | 0.24 |   |   |
| Earnings per share,  diluted                      |       | 0.17       |       | 0.19       |       |                           | 0.22       |                      |       |   | 0.23 |   |   |
|                                                   |            |            |            |            |            |                                |            |                           |            |  |  |  |  |  |  |  |  |

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*                    SeeNote 2

In December 2003, our board of directors approvedand we committed to a plan to divest our slot products operations and assets,based on our determination that this product line was no longer a strategic fitwith our refocused core business strategy of providing products and servicesfor the table game area of casinos. Revenues and costs associated with our slotproducts are reported as discontinued operations for all periods presented. In January 2004,we entered into agreements pursuant to which we sold substantially all of ourslot products assets and substantially completed our divestiture plans.

In December 2004, our board of directors approveda three-for-two common stock split, with new shares distributed in the form ofa dividend on January 14, 2005, to shareholders of record on January 3,2005. Additionally, ourboard of directors approved a three-for-two stock split, with new sharesdistributed in the form of a dividend on April 16, 2004, to shareholdersof record on April 5, 2004. Share and per share amounts have been adjustedto reflect these splits. See Note 11.

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**SCHEDULEII — VALUATION AND QUALIFYING ACCOUNTSYears Ended October 31, 2006, 2005 and 2004**

| **Column A**                                                                | ** ** | **Column B**   | ** ** | **Column C**   | ** ** | **Column D** | ** ** | **Column E** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                       | ** ** | ** **          | ** ** | **Additions**       | ** ** | ** **        | ** ** | ** **        | ** ** |
| ** **                                                                       | ** ** | **Balance at** | ** ** | ** **          | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                       | ** ** | **Beginning**       | ** ** | **Charged to** | ** ** | **Stargames**     | ** ** | **Deductions/**   | ** ** | **Balance at** | ** ** |
| ** **                                                                       | ** ** | **of Period**  | ** ** | **Expense(a)**      | ** ** | **Acquisition**   | ** ** | **Other**         | ** ** | **End of Period** | ** ** |
| Allowance for bad debts (Accounts receivable):                                   |       |                |       |                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2006                                                                             |       |                | $          | 283                 |       |              |       | $                 | (777       | ) |   |   | $ | 1,907 |   |   |   | $ | (9 | ) |   |   | $ | 1,422 |   |   |
| 2005                                                                             |       |                | $          | 740                 |       |              |       | $                 | (165       | ) |   |   | $ | — |   |   |   | $ | 292 |   |   |   | $ | 283 |   |   |
| 2004                                                                             |       |                | $          | 340                 |       |              |       | $                 | 202        |   |   |   | $ | — |   |   |   | $ | (198 | ) |   |   | $ | 740 |   |   |
| Allowance for bad  debts (Investment in sales-type leases and notes receivalbe): |       |                |       |                |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2006                                                                             |       |                | $          | 631                 |       |              |       | $                 | 240        |   |   |   | $ | — |   |   |   | $ | 190 |   |   |   | $ | 681 |   |   |
| 2005                                                                             |       |                | $          | 491                 |       |              |       | $                 | 394        |   |   |   | $ | — |   |   |   | $ | 254 |   |   |   | $ | 631 |   |   |
| 2004                                                                             |       |                | $          | 225                 |       |              |       | $                 | 301        |   |   |   | $ | — |   |   |   | $ | 35 |   |   |   | $ | 491 |   |   |

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(a)            Forthe year ended October 31, 2006, favorable collections efforts, primarilyat Stargames, resulted in a credit of ($777) in the provision for bad debtsrelated to accounts receivable.

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**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

None.

**ITEM 9A. CONTROLS ANDPROCEDURES**

**Evaluation ofDisclosure Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to provide reasonable assurance that information required to bedisclosed in our reports under the Securities Exchange Act of 1934 is recorded,processed, summarized, and reported within the time period specified in theSecurities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

As required by Rule 13a-15(b) promulgatedunder the Exchange Act, our management, with the participation of our ChiefExecutive Officer and Chief Financial Officer, evaluated the design andoperating effectiveness as of October 31, 2006 of our disclosure controlsand procedures, as defined in Rule 13a-15(e) promulgated underthe Exchange Act. Based on this evaluation our Chief Executive Officer andChief Financial Officer concluded that, because of the material weaknesses inour internal control over financial reporting described below, as of October 31,2006 our disclosure controls and procedures were not effective.

At the time that our Annual Report on Form 10-Kfor the year ended October 31, 2006 was filed on January 16, 2007,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were not effective as of October 31,2006, because of a material weakness in internal control over the evaluationand review of non-routine transactions involving judgments and estimates todetermine that such transactions are recorded in accordance with generallyaccepted accounting principles, as described below. Subsequent to suchevaluation, in connection with the restatement and filing of this Annual Reporton Form 10-K/A, our management, with the participation of our ChiefExecutive Officer and Chief Financial Officer, re-evaluated our disclosurecontrols and procedures and concluded again that our disclosure controls andprocedures were not effective as of October 31, 2006, and identified anadditional material weakness in our internal control over financial reportingrelating to the identification and elimination of inter-company inventorytransactions as described below.

Notwithstanding management’sassessment that our internal control over financial reporting was ineffectiveas of October 31, 2006 due to the material weaknesses described belowunder Management’s Report on Internal Control Over Financial Reporting (asrevised), we believe that the restated consolidated financial statementsincluded in this Annual Report on Form 10-K/A correctly present ourfinancial condition, results of operations and cash flows for the fiscal yearscovered thereby in all material respects. As a result of the deficienciesdescribed below, we have performed additional analysis and procedures in orderto prepare the restated consolidated financial statements in accordance withgenerally accepted accounting principles.

**Internal Control overFinancial Reporting**

*Management’s Report onInternal Control Over Financial Reporting (as revised)*

Internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the ExchangeAct) refers to the process designed by, or under the supervision of, our ChiefExecutive Officer and Chief Financial Officer, and effected by our board ofdirectors, management and other personnel, to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted 

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accounting principles. Management is responsible forestablishing and maintaining adequate internal control over our financialreporting.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also, theapplication of any evaluation of effectiveness to future periods is subject tothe risk that controls may become inadequate because of changes in conditions,or that compliance with the policies or procedures may deteriorate.

We have evaluated the effectiveness of our internalcontrol over financial reporting as of October 31, 2006. This evaluationwas performed using the *Internal Control -Evaluation Framework* developed by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). Our evaluation of andconclusion on the effectiveness of internal control over financial reportingexcludes Stargames Limited acquired in February 2006 whose financialstatements reflect approximately 24.8% of our total revenue for the year ended October 31,2006 and approximately 42.0% of our total assets at October 31, 2006. InManagement’s Report on Internal Control over Financial Reporting included inour original Annual Report on Form 10-K for the year ended October 31,2006 filed on January 16, 2007, management identified deficiencies thatwere determined to be a material weakness and concluded that our internalcontrol over financial reporting was not effective as of October 31, 2006.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected.

Management identified the following material weaknessin connection with its original assessment:

The Company did not haveadequate internal controls over the evaluation and review of non-routinetransactions involving judgments and estimates to determine that suchtransactions are recorded in accordance with generally accepted accountingprinciples. This weakness in the operating effectiveness of internal controlsresulted in adjustments to revenue recognized, and the impairment write-down ofan equity method investment. While such adjustments were not deemed to beindividually material to the financial statements as of and for the year ended October 31,2006 they were deemed to be material in the aggregate.

We have restated our consolidated financial statementsas of October 31, 2006 to correct an overstatement of inventory and anoverstatement of our net income from continuing operations as described in Note2 to our consolidated financial statements. In connection with the restatement,our management, including our Chief Executive Officer and Chief FinancialOfficer, has determined that an additional material weakness in our internalcontrol over financial reporting existed as of October 31, 2006, which isdescribed as follows:

We do not have adequateresources in our accounting and finance departments which we deemed to be amaterial weakness. This condition led to inadequate internal controls over thereconciliation and analysis of the intercompany inventory accounts. The controlover the elimination of intercompany profit was not designed to providereasonable assurance of the completeness of the inventory subject toelimination. Additionally, analytical review procedures did not operateeffectively in identifying the error in a timely manner. Certain checklists toensure the completeness and accuracy of the intercompany elimination processdid not exist. This weakness in the design and operating effectiveness ofinternal controls resulted in a restatement of the consolidated financialstatements.

Deloitte & Touche, LLP has issued anattestation report on management’s revised assessment of our internal controlover financial reporting. This report follows this Item 9A.

As a result of the additionalmaterial weakness identified in connection with the restatement of ourconsolidated financial statements as of and for the year ended October 31,2006 management has 

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revised its assessment toinclude such material weakness. Additionally, because of these materialweaknesses, our management concluded that the Company did not maintaineffective internal control over financial reporting as of October 31,2006, based on the criteria described in the COSO Internal Control—IntegratedFramework.

***Remediation of Material Weaknesses***

**Remediation of Material Weakness Relating toEvaluation and Review of Non-routine Transactions involving Judgments andEstimates**

Subsequent to October 31,2006, the Company has, and will continue to, identify and adopt measures toremedy the material weakness relating to evaluation and review of non-routinetransactions described above. Such remedial measures include, but are notlimited to, the following actions:

·       Improvingthe process related to non-routine events and transactions to ensureappropriate communication and evaluation of such events and transactions;

·       Managementwill review all current policies, practices, and controls related to revenuerecognition, and provide additional education and training to our organizationto heighten the awareness of revenue recognition concepts, with emphasis onnon-standard contracts; and

·       Managementwill review all current policies, practices, and controls related to evaluatingimpairment considerations in connection with its equity investments and othernon-routine transactions and provide additional education and training asnecessary.

**Remediation of Material Weakness Relating toIdentification and Proper Elimination of Inter-company Inventory Transactions**

Subsequent to October 31,2006, we have undertaken, and will continue to undertake, extensive work toremedy the material weakness relating to the identification and elimination ofinter-company inventory transactions, including identifying specificremediation initiatives. As of March 31, 2007, we have identified andbegun to implement the following actions:

·       Improvingour transfer pricing process to ensure identification and appropriateelimination of inter-company inventory transactions;

·       Providingadditional and on-going training to finance and accounting staff (including ourforeign subsidiaries) on the application of accounting pronouncements and policiesand procedures, especially in the area of transfer pricing and inter-companyinventory transactions; and

·       Employingadditional finance and accounting staff as well as adding additional qualifiedpersonnel and consultants to assist in implementing and operating controlsdesigned to remediate internal control deficiencies.

The implementation of theabove remedial measures and initiatives, and additional procedures beingdeveloped, is a priority for us in fiscal year 2007 and we anticipateremediation as of October 31, 2007.

***Changes in Internal Control Over Financial Reporting***

The remediation initiativeswith respect to the prior year material weakness described below havematerially affected, or are reasonably likely to materially affect our internalcontrol over financial reporting. There have been no other changes in ourinternal control over financial reporting that occurred during our fiscal yearended October 31, 2006, that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting. Thechanges 

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described above underRemediation of Material Weaknesses are in the process of being implementedsubsequent to the end of the fiscal period covered by this Amendment No. 2to our Annual Report on Form 10-K, and will have a material affecton our internal control over financial reporting.

**Remediation Initiatives—PriorYear Material Weakness**

As reported in Item 9A of our Annual Report on Form 10-Kdated February 27, 2006, management previously concluded that its internalcontrol over financial reporting was not effective as of October 31, 2005.Such conclusion resulted from the identification of deficiencies that weredetermined to be a material weakness. Specifically, we did not have appropriateinternal controls specific to the recognition of revenue related to the identificationand communication of non-standard transactions. This included the lack of acomprehensive process to address the sales, legal and financial functions, andidentification and communication, of such non-standard transactions. Thecontrols in place were not adequate to identify and evaluate the appropriateaccounting treatment for revenue transactions with non-standard terms,including extended payment terms, future commitments and establishment ofreasonable assurance of collectibility that affected the timing and amount ofrevenue recognized. The deficiencies were concluded to be a material weaknessbased on the significance of the potential misstatement of the annual andinterim financial statements and the significance of the controls over revenuerecognition to the preparation of reliable financial statements.

Throughout the fiscalyear ended October 31, 2006, the Company implemented certain controlimprovements to address the prior year material weakness described above. Theseincluded, but were not limited to, the following remediation initiatives:

·       Improvementand enhancement of the contract administration process, including review ofdistributor agreements, to ensure the circulation and review of non-standardcontracts, arrangements or transactions by the accounting department;

·       Providedadditional training to our finance and accounting staff (including our foreignsubsidiaries) on the application of technical accounting pronouncements in thearea of revenue recognition. Additionally, provided training to our salesorganization to heighten the awareness of revenue recognition concepts, withemphasis on non-standard contracts; and

·       Employedadditional finance and accounting staff as well as added qualified personneland consultants, as necessary, to further assist in the remediation andmonitoring of internal control deficiencies.

However, notwithstanding such remediation initiatives,as a result of the above material weakness identified at October 31, 2006over the application of generally accepted accounting principles to non-routinetransactions, the Chief Executive Officer and Chief Financial Officer haveconcluded that the material weakness related to inadequate controls in place toidentify and evaluate the appropriate accounting treatment for revenuetransactions with non-standard terms still existed at October 31, 2006.

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**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders ofShuffle Master, Inc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting (as revised), that Shuffle Master, Inc. and Subsidiaries (the“Company”) did not maintain effective internal control over financial reportingas of October 31, 2006, because of the effect of the material weaknessesidentified in management’s assessment based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.As described in Management’s Report on Internal Control Over FinancialReporting (as revised), management excluded from their assessment the internalcontrol over financial reporting of Stargames Limited, which was acquired inFebruary 2006 and whose financial statements reflect total assets andrevenues constituting 42 and 24.8 percent, respectively, of the relatedconsolidated financial statement amounts as of and for the year endedOctober 31, 2006. Accordingly, our audit did not include the internalcontrol over financial reporting for this acquired business. The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness ofinternal control, and performing such other procedures as we considerednecessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

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A material weakness isa significant deficiency, or combination of significant deficiencies, thatresults in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected. Thefollowing material weaknesses have been identified and included in management’sassessment:

1.         TheCompany did not have adequate internal controls over the evaluation and reviewof non-routine transactions involving judgments and estimates to determine thatsuch transactions are recorded in accordance with generally accepted accountingprinciples. This weakness in the operating effectiveness of internal controlsresulted in adjustments to revenue recognized, the impairment write-down of anequity method investment and adjustments to the presentation of the statementof cash flows. While such adjustments were not deemed to be individuallymaterial to the financial statements as of and for the year endedOctober 31, 2006 they were deemed to be material in the aggregate.

2.         TheCompany does not have adequate resources in their accounting and financedepartments, which constitutes a material weakness. This condition led toinadequate internal controls over the reconciliation and analysis of theintercompany inventory accounts. The control over the elimination ofintercompany profit was not designed to provide reasonable assurance of theinventory subject to elimination. Additionally, analytical review proceduresdid not operate effectively in identifying the error in a timely manner. Thisweakness in the design and operating effectiveness of internal controlsresulted in a restatement of the consolidated financial statements.

These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the consolidated financial statements and financial statement schedule as ofand for the year ended October 31, 2006, of the Company and this reportdoes not affect our report on such financial statements and financial statementschedule.

In our opinion, management’s assessment that theCompany did not maintain effective internal control over financial reporting asof October 31, 2006, is fairly stated, in all material respects, based onthe criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Also in our opinion, because of the effect of the materialweaknesses described above on the achievement of the objectives of the controlcriteria, the Company has not maintained effective internal control overfinancial reporting as of October 31, 2006, based on the criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements and financial statementschedule as of and for the year ended October 31, 2006, of the Company andour report dated January 16, 2007 (April 23, 2007 as to the effect ofthe restatement discussed in Note 2), expressed an unqualified opinion on thosefinancial statements and financial statement schedule and includes anexplanatory paragraph relating to the restatement described in Note 2 to theconsolidated financial statements and an explanatory paragraph related to theadoption of Statement of Financial Accounting Standards No. 123(R), *Share-Based Payment*,**onNovember 1, 2005.

/s/ Deloitte & ToucheLLP

Las Vegas, Nevada January 16, 2007 (April 23,2007 as to the effect of the second material weakness described above anddiscussed in Management’s Report on Internal Control over Financial Reporting)

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**ITEM 9B. OTHERINFORMATION**

None.

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**PART III**

**ITEM 10. DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT**

·       Informationregarding our directors, including the audit committee financial expert,appears under the caption “Election of Directors” in our Fiscal 2006 ProxyStatement and is incorporated herein by reference.

·       ExecutiveOfficers of the Registrant. The information under the caption “ExecutiveOfficers” in our Fiscal 2006 Proxy Statement is incorporated herein byreference.

·       Compliancewith Section 16(a) of the Exchange Act. The information under thecaption “Section 16(a) Beneficial Ownership Reporting Compliance” inour Fiscal 2006 Proxy Statement is incorporated herein by reference.

·       Informationregarding our Code of Conduct appears in our Fiscal 2006 Proxy Statement, underthe caption “Proposal 1—Election of Directors—Corporate Governance—ComplianceCommittee,” and is incorporated herein by reference.

·       Our Code of Conduct ispublicly available on our website at *www.shufflemaster.com*and is also available in print to any shareholder upon request. Our websiteaddress is intended to be an inactive, textual reference only; none of thematerial on the website is part of this report. We may revise these policiesfrom time to time and will promptly post any revisions on our website. If wegrant any waiver from a provision of the Code of Conduct to our Chief ExecutiveOfficer or Chief Financial Officer, we will disclose the nature of suchamendment or waiver on our website or in a report on Form 8-K.

**ITEM 11. EXECUTIVECOMPENSATION**

The information under thecaptions “Executive Compensation,” “Compensation of Directors,” “Report ofCompensation Committee on Executive Compensation,” and “Stock Performance Graph”in our Fiscal 2006 Proxy Statement is incorporated herein by reference.

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

The information under thecaptions “Security Ownership of Certain Beneficial Owners and Management” and “EquityCompensation Plan Information” in our Fiscal 2006 Proxy Statement isincorporated herein by reference.

**ITEM 13. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

The information under thecaption “Certain Relationships and Related Party Transactions” in our Fiscal2006 Proxy Statement is incorporated herein by reference.

**ITEM 14. PRINCIPALACCOUNTANT FEES AND SERVICES**

Information regarding our principal accountant feesand services and the Audit Committee’s approval policies and procedures appearsin our Fiscal 2006 Proxy Statement under the captions “Independent Auditor” and“Report of the Audit Committee” and is incorporated herein by reference.

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**PART IV**

**ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**
| (a)    |   | 1.     |   | Financial Statements                                                                                                                                                                    |
|--------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   | See index to consolidated  financial statements included as Item 8 to this Annual Report.                                                                                               |
|   |   | 2.     |   | Financial Statement  Schedules                                                                                                                                                          |
|   |   |   |   | All financial statement  schedules are omitted as the required information is inapplicable or the  information is presented in the consolidated financial statements or related  notes. |
|   |   | 3.     |   | Management Contracts,  Compensatory Plans and Arrangements                                                                                                                              |
|   |   |   |   | Management contracts,  compensatory plans and arrangements are listed as exhibits 10.1 through  10.18 included in Item 15(b) of this Annual Report.                           |

 
| (b)    |   | Exhibits |
|--------|--------|----------|
|   |   | 3.1      |   | Articles of Incorporation of  Shuffle Master, Inc. as amended July 15, 1992 (Incorporated by  reference to exhibit 3.2 in our Annual Report on Form 10-K for the  year ended October 31, 1995). |
|   |   | 3.2      |   | Articles of Amendment to Articles of Incorporation  of Shuffle Master, Inc., effective January 14, 2005 (incorporated  by reference to exhibit 3.2 to our Annual Report on Form 10-K,  filed January 13, 2005). |
|   |   | 3.3      |   | Articles of Correction of Articles of Amendment of  Articles of Incorporation of Shuffle Master, Inc., effective  March 15, 2005 (incorporated by reference to exhibit 3.1 to our Current  Report on Form 8-K, filed March 18, 2005). |
|   |   | 3.4      |   | Bylaws of Shuffle Master, Inc., as amended and  restated (Incorporated by reference to exhibit 3.2 in our Quarterly Report on  Form 10-Q for the quarter ended July 31, 2002). |
|   |   | 3.5      |   | Amendment to Shuffle Master’s Corporate Bylaws, as  adopted by our board of directors on January 11, 2005 (incorporated by  reference to exhibit 3.4 to our Annual Report on Form 10-K, filed  January 13, 2005). |
|   |   | 4.1      |   | Shareholder Rights Plan dated June 26, 1998  (Incorporated by reference to our Current Report on Form 8-K dated  June 26, 1998). |
|   |   | 4.2      |   | Amendment No. 1 to Rights Agreement dated  January 25, 2005 (Incorporated by reference to our Current Report on  Form 8-K dated February 10, 2005). |
|   |   | 4.3      |   | Registration Rights Agreement dated May 13,  2004, by and between Casinos Austria AG on the one hand and Shuffle  Master, Inc. on the other hand (Incorporated by reference to exhibit  10.2 in our Quarterly Report on Form 10-Q for the quarter ended  April 30, 2004). |
|   |   | 4.4      |   | Agreement and Guaranty dated May 12, 2004, by  and between Casinos Austria AG and Cai Casinoinvest Middle East GMBH on the  one hand and Shuffle Master, Inc. on the other hand (Incorporated by  reference to exhibit 10.3 in our Quarterly Report on Form 10-Q for  the quarter ended April 30, 2004). |
|   |   | 4.5      |   | Purchase Agreement, dated April 15, 2004, among  Shuffle Master, Inc. and Deutsche Bank Securities, Inc. relating to  the 1.25% Contingent Convertible Senior Notes due 2024 (Incorporated by  reference to exhibit 10.4 in our Quarterly Report on Form 10-Q for  the quarter ended April 30, 2004). |

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|        |   | 4.6   |   | Registration Rights Agreement dated April 21,  2004, among Shuffle Master, Inc. and Deutsche Bank Securities, Inc.  and Goldman, Sachs & Co relating to the 1.25% Contingent Convertible  Senior Notes due 2024 (Incorporated by reference to exhibit 10.5 in our  Quarterly Report on Form 10-Q for the quarter ended April 30,  2004).                                                          |
|--------|--------|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | 4.7   |   | Indenture, dated as of April 21, 2004, between  Shuffle Master, Inc. and Wells Fargo Bank, N. A. relating to the 1.25%  Contingent Convertible Senior Notes due 2024 (Incorporated by reference to  exhibit 10.6 in our Quarterly Report on Form 10-Q for the quarter  ended April 30, 2004).                                                                                                                   |
|   |   | 10.1  |   | Shuffle Master, Inc. 2002 Stock Option Plan  (Incorporated by reference to Exhibit B in our Proxy Statement dated  February 11, 2002).                                                                                                                                                                                                                                                                               |
|   |   | 10.2  |   | Amendment to the Shuffle Master, Inc. 2002  Stock Option Plan (Incorporated by reference to exhibit 10.33 in our  Quarterly Report on Form 10-Q for the quarter ended April 30,  2002).                                                                                                                                                                                                                              |
|   |   | 10.3  |   | Shuffle Master, Inc. Restated Outside  Directors’ Option Plan dated January 24, 2002 (Incorporated by reference  to Exhibit 10.32 in our Annual Report on Form 10-K for the  year ended October 31, 2001).                                                                                                                                                                                            |
|   |   | 10.4  |   | Shuffle Master, Inc. 2004 Equity Incentive Plan  (Incorporated by reference to our Proxy Statement dated February 23,  2004).                                                                                                                                                                                                                                                                                             |
|   |   | 10.5  |   | Shuffle Master, Inc. 2004 Equity Incentive Plan  for Non-Employee Directors (Incorporated by reference to our Proxy Statement  dated February 23, 2004).                                                                                                                                                                                                                                                                  |
|   |   | 10.6  |   | Employment Agreement, by and between Shuffle  Master, Inc. and Mark Yoseloff, dated February 23, 2004  (Incorporated by reference to exhibit 10.1 in our Quarterly Report on  Form 10-Q for the quarter ended January 31, 2004).                                                                                                                                                                                |
|   |   | 10.7  |   | Covenant Not to Compete by and between Shuffle  Master, Inc. and Mark L. Yoseloff, dated February 23, 2004  (Incorporated by reference to exhibit 10.2 in our Quarterly Report on  Form 10-Q for the quarter ended January 31, 2004).                                                                                                                                                                           |
|   |   | 10.8  |   | Employment Agreement, by and between Shuffle  Master, Inc. and Brooke Dunn, dated January 9, 2006 (Incorporated  by reference to exhibit 10.5 in our Annual Report on Form 10-K  for the year ended October 31, 2005).                                                                                                                                                                                     |
|   |   | 10.9  |   | Employment Agreement, by and between Shuffle  Master, Inc. and Richard L. Baldwin, dated November 30, 2006  (Incorporated by reference to exhibit 10.1 in our Current Report on  Form 8-K dated December 5, 2006).                                                                                                                                                                                              |
|   |   | 10.10 |   | Employment Agreement by and between Shuffle  Master, Inc. and Paul Meyer dated October 31, 2005 (Incorporated by  reference to exhibit 10.1 in our Current Report on Form 8-K filed  on November 4, 2005).                                                                                                                                                                                                      |
|   |   | 10.11 |   | Patent Purchase Agreement by and between  International Game Technology and Shuffle Master, Inc. dated  June 13, 2005 (request for confidential treatment filed with SEC)  (Incorporated by reference to exhibit 10.1 of our Quarterly Report on  Form 10-K, filed September 9, 2005).                                                                                                                          |
|   |   | 10.12 |   | Product Development and Integration Agreement by and  among Shuffle Master, Inc., Progressive Gaming International Corporation  and International Game Technology dated June 13, 2005 (request for  confidential treatment filed with SEC) (Incorporated by reference to exhibit  10.2 of our Quarterly Report filed September 6, 2006 (confidential Treatment  requested under 17 C. F. R. Section 240.24b-2). |
|   |   | 10.13 |   | Distributorship Agreement by and between Machines  Games Automatics, S.A. and Shuffle Master GMBH & CO KG dated  May 17, 2005 (request for confidential treatment filed with SEC) (filed  as exhibit 10.1 to our Current Report on Form 8-K filed  September 16, 2005)                                                                                                                                      |
|   |   | 10.14 |   | Call Option Deed by and between Shuffle  Master, Inc. and CVC Limited dated November 15, 2005 (Incorporated  by reference to exhibit 10.1 of our Current Report on Form 8-K  filed November 15, 2005).                                                                                                                                                                                                          |

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|        |   | 10.15 |   | Call Option Deed by and between Shuffle  Master, Inc. and CVC Communication and Technology Pty Ltd. dated  November 15, 2005 (Incorporated by reference to exhibit 10.2 of our  Current Report on Form 8-K filed November 15, 2005).                                                                 |
|--------|--------|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | 10.16 |   | Pre-Bid Agreement between Shuffle Master, Inc.  and Stargames Corporation Pty Limited dated November 15, 2005  (Incorporated by reference to exhibit 10.3 of our Current Report on  Form 8-K filed November 15, 2005).                                                                               |
|   |   | 10.17 |   | Shuffle Master Australasia Pty Ltd’s Bidder  Statement, along with Stargames’ Target Statement, each dated  November 15, 2005 (Incorporated by reference to exhibit 10.4 of our  Current Report on Form 8-K filed November 15, 2005).                                                           |
|   |   | 10.18 |   | Asia Representative Agreement among Shuffle Master, Inc.,  Stargames Limited, Melco International Development Limited and Elixir Group  Limited, dated April 13, 2006 (Request for Confidential Treatment filed  with SEC).                                                                                    |
|   |   | 10.19 |   | Patent Licensing Agreement between Shuffle  Master, Inc. and Progressive Gaming International Corporation dated  September 29, 2006 (Request for Confidential Treatment filed with SEC).                                                                                                                       |
|   |   | 10.20 |   | Credit Agreement, dated November 30, 2006,  among Shuffle Master, Inc., Deutsche Bank Trust Company Americas,  Deutsche Bank, Deutsche Bank Securities, Inc. and Wells Fargo Bank, N.A.  (Incorporated by reference to exhibit 10.1 of our Current Report on  Form 8-K filed December 6, 2006). |
|   |   | 10.21 |   | Security Agreement, dated November 30, 2006,  between Shuffle Master, Inc. and the guarantors party thereto in favor  of Deutche Bank Trust Company Americas (Incorporated by reference to exhibit  10.2 of our Current Report on Form 8-K filed December 6,  2006).                                 |
|   |   | 21    |   | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                               |
|   |   | 31.1  |   | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                |
|   |   | 31.2  |   | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                |
|   |   | 32.1* |   | Certification of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                |
|   |   | 32.2* |   | Certification of Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                |

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*                         Exhibits32.1 and 32.2 are furnished to accompany this report on Form 10-K/Abut shall not be deemed “filed” for the purposes of Section 18 of theSecurities Exchange Act of 1934 or otherwise and shall not be deemedincorporated by reference into any registration statements filed under theSecurities Act of 1933.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

|                                                                | SHUFFLE MASTER, INC. |
|----------------------------------------------------------------|----------------------|
| Dated:      April 23,  2007 | By:                  | /s/ MARK L. YOSELOFF |
|                                                           |                 | Chairman and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated:

| Signature              | ** ** | ** **                             | ** ** | **Title**           | ** ** | **Date** |
|------------------------|------------|----------------------------------------|------------|---------------------|------------|----------|
| /s/ MARK L. YOSELOFF   |       | Chairman and Chief  Executive Officer  |       | April 23, 2007 |
| Mark L. Yoseloff       |       | (Principal Executive  Officer)         |       |                |
| /s/ PAUL C. MEYER      |       | President and Chief  Operating Officer |       | April 23, 2007 |
| Paul Meyer             |       |                                   |       |                |
| /s/ RICHARD L. BALDWIN |       | Chief Financial  Officer and Chief     |       | April 23, 2007 |
| Richard Baldwin        |       | Accounting Officer                     |       |                |
|                   |       | (Principal Accounting  Officer)        |       |                |
| /s/ LOUIS CASTLE       |       | Director                               |       | April 23, 2007 |
| Louis Castle           |       |                                   |       |                |
| /s/ TODD D. JORDAN     |       | Director                               |       | April 23, 2007 |
| Todd D. Jordan         |       |                                   |       |                |
| /s/ GARRY W. SAUNDERS  |       | Director                               |       | April 23, 2007 |
| Garry W. Saunders      |       |                                   |       |                |

 

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