**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-K/A**

**(Mark one)**
| x | ** ** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|-----------------------------------------------------------------------------------------------------|

 

**For the fiscal year ended October 31, 2006**

**OR**

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

 

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

----

**SHUFFLEMASTER, 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)

----

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**

----

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 Exchange Act. (Checkone):
| 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.

**DOCUMENTS INCORPORATED BY REFERENCE**

Parts II and III of this Annual Report on Form 10-Kincorporate by reference information from the Registrant’s Proxy Statement forits Annual Meeting of Shareholders to be held on March 14, 2007 (“Fiscal2006 Proxy Statement”) to be filed with the SEC within 120 days of the endof the fiscal year covered by this report.

 

----

**EXPLANATORY NOTE**

Shuffle Master, Inc. amends its Annual Report on Form 10-Kfor the fiscal year ended October 31, 2006 that we filed yesterday on January 16,2007 in order to add certain language to the Report of Independent RegisteredPublic Accounting Firm regarding the nature, timing and extent of audit testsapplied and reference to the financial statement schedule. This was the onlychange to our previously filed Form 10-K.

----

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

**TABLE OFCONTENTS**
|                   | ** ** |                                                                                                                     | ** ** | **Page** | ** ** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **Part I**   | ** ** |                                                                                                                |
| Item 1.           |       | Business                                                                                                            |       | 1        | ** ** |   |
| Item  1A.         |       | Forward Looking  Statements and Risk Factors                                                                        |       | 20       | ** ** |   |
| Item  1B.         |       | Unresolved Staff  Comments                                                                                          |       | 28       | ** ** |   |
| Item 2.           |       | Properties                                                                                                          |       | 28       | ** ** |   |
| Item 3.           |       | Legal Proceedings                                                                                                   |       | 29       | ** ** |   |
| Item  4.          |       | Submission of  Matters to a Vote of Security Holders                                                                |       | 29       | ** ** |   |
| **Part II**  | ** ** |                                                                                                                |
| Item  5.          |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 30       | ** ** |   |
| Item  6.          |       | Selected Financial Data                                                                                             |       | 32       | ** ** |   |
| Item  7.          |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations          |       | 34       | ** ** |   |
| Item  7A.         |       | Quantitative and  Qualitative Disclosures about Market Risk                                                         |       | 67       | ** ** |   |
| Item  8.          |       | Financial  Statements and Supplementary Data                                                                        |       | 67       | ** ** |   |
| Item 9.           |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                |       | 112      | ** ** |   |
| Item 9A.          |       | Controls and Procedures                                                                                             |       | 112      | ** ** |   |
| Item 9B.          |       | Other Information                                                                                                   |       | 117      | ** ** |   |
| **Part III** | ** ** |                                                                                                                |
| Item  10.         |       | Directors and  Executive Officers of the Registrant                                                                 |       | 118      | ** ** |   |
| Item  11.         |       | Executive Compensation                                                                                              |       | 118      | ** ** |   |
| Item  12.         |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 118      | ** ** |   |
| Item  13.         |       | Certain  Relationships and Related Transactions                                                                     |       | 118      | ** ** |   |
| Item  14.         |       | Principal  Accounting Fees and Service                                                                              |       | 118      | ** ** |   |
| **Part IV**  | ** ** |                                                                                                                |
| Item  15.         |       | Exhibits and  Financial Statement Schedules                                                                         |       | 119      | ** ** |   |

 

----

**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.

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 gatherdata and to enable casinos to track table game players, such as our. Theseproducts are intended to cost-effectively provide casinos and our othercustomers with data on table game play for security and marketing purposes,which in turn allows them to increase their profitability. To enhance our TableiD product offerings, we entered into a worldwide product integration agreementwith International Game Technology (“IGT”) and Progressive Gaming InternationalCorporation (“PGIC”) to create a comprehensive, automated table 

1

----

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 enhance our casino customers’ table game operations. Currently,Entertainment Products segment revenue is derived substantially from our liveproprietary table game content selection and our multiple electronic contentdelivery systems. We develop or acquireand market a broad range of proprietary table game entertainment content tocasinos and other licensed operators. Products in this segment include ourtraditional live proprietary poker based, baccarat, pai gow poker and blackjacktable games. The majority of these products are licensed to our customers,which provides us with recurring revenue. We also produce and distributemultiple electronic content delivery systems including the Table MasterTM, VegasStarTM, and Rapid Table Games multi-terminalelectronic table game platforms, and video slot machines for select markets.Products in this segment focus on cost-effectively delivering to casinos andother licensed operators popular table game content on either live table,multi-player video platforms, or wireless platforms. We also offer live tablegame tournaments developed and managed under our Shuffle Up ProductionsTM (“Shuffle Up”) subsidiary formedin January 2005 to leverage our intellectual property and developlive and broadcast tournament events as well as licensed merchandise based onour extremely popular gaming offerings.

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                      |       |                                           | 48.9       | % |   |   | 55.6 | % |   |   | 52.9 | % |   |
| Chippers                       |       |                                           | 3.7        | % |   |   | 2.6 | % |   |   |   | * |   |
| Table iD and Bloodhound        |       |                                           |       | * |   |   |   | * |   |   |   | * |   |
| **Entertainment  Products:**   | ** ** |                                           | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |   |
| Proprietary Table Games        |       |                                           | 23.4       | % |   |   | 35.4 | % |   |   | 44.4 | % |   |
| Multi-Terminal Gaming Machines |       |                                           | 10.1       | % |   |   | 4.3 | % |   |   | 1.2 | % |   |
| Electronic Gaming Machines     |       |                                           | 13.1       | % |   |   | 1.0 | % |   |   |   | * |   |
| Other Entertainment            |       |                                           |       | * |   |   |   | * |   |   |   | * |   |
| **Other  revenue**             |       |                                           |       | * |   |   |   | * |   |   |   | * |   |
|                           |       |                                           | 100.0      | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
|                                |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

* 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.

2

----

**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 gameoperations. 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. Singledeck shufflers are generally used on proprietary table games such as our ownLet It Ride® and Three Card Poker® games. Multi-deck shufflers, which includecontinuous and 

3

----

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.   |

 

4

----

***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”). Wesell and lease our Utility Products. When we lease our products, we generallynegotiate a month-to-month operating lease. When we sell our products, we offerour customers a choice between a sale or a longer-term sales-type lease orother financing arrangements, depending on the needs of each customer.

5

----

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.

6

----

***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.                                                                                                                                                                                                                                                                                                                                                                                                                         |

7

----

 

| *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. |

8

----

 

| *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 StarTM*   | 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. |

9

----

 

|                           | 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 Australiansubsidiary Stargames, we offer an extensive selection of video slot titlesdeveloped for select markets including Australia/New Zealand, Asia and LatinAmerica. Featuring a wide variety of denominations and configurations, our EGMtitles include a wide range of bonus round options and can be configured as anetwork of machines or as stand-alone units. Utilizing SAS 6.01 with supportfor AFT, all EGM titles are offered in the ergonomic eStar® cabinet and are compatible with a variety ofback of house systems.

***Customers and Marketing.******  ***We market ourEntertainment Products to the same customers to whom we market our UtilityProducts. We first began offering table games in 1993 to increase the demandfor our shuffler products and we still routinely install shufflers andproprietary table games together. We design our proprietary table games to havebroad appeal to players who enjoy a more casual and social card game or who arenew to or intimidated by traditional table games. Our various table games offercasinos and players a wide variety of betting propositions and risk and rewardtrade-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.

10

----

The market for live table games is characterized bynumerous competitors who develop and license proprietary table games. Some ofour competitors’ 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. RapidTable Games have been developing Rapid BaccaratTM, including the Dragon Bonusside bet, as well as Rapid CrapsTM to add to the current titles of Roulette, SicBo and Big Wheel. The EGM product development produced a large range of newtitles including a selection of jackpot games for the diverse internationalmarket. The cabinet and platform technology for Vegas Star, Rapid Table Gamesand EGM have undergone a program of continuous improvement to the design andcapabilities of the technology.

**INTELLECTUAL PROPERTY**

We believe that our patents, trademarks, licenses,copyrights and trade secrets are significant assets that provide us with acompetitive advantage and are critical to our future profitability and growth. Weprotect our investment in research and development by seeking patent, trademarkand copyright 

11

----

protection for our technologies. We also acquire andlicense patents and other intellectual property from third parties. Infringementclaims, patent invalidity or expiration, license non-renewal, failure to stopinfringers, delays in using our intellectual property to develop products orthe costs of protecting our intellectual property could adversely affect ourfuture results of operations and 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 beenintroduced, potential product modifications and improvements and to products wedo not currently sell. A majority of these technologies are internallydeveloped. Some of our technology is purchased and licensed.

In 2006, we purchased a controlling interest in StargamesLimited of Sydney, Australia. Stargames has a broad range of intellectualproperty that complements our existing portfolio. In particular, theintellectual property relating to multi-player gaming platforms significantlyexpands the types of proprietary game systems that are now available to ourcustomers.

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. Wealso 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-licensearrangement.

We granted a multiple game license to DeltaRangers, Inc. for the play of a number of our proprietary games oninternet gaming sites outside of the United States.

12

----

***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.***   We are party tocertain cross-licensing agreements. Under these agreements, we have certainrights to third party intellectual property. There are no royalty obligationswith respect to any of these agreements that are material to our results ofoperations. Further, none of the royalties that we receive from theseagreements 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 that beneficialowners of 5% or more of our common stock are subject to reporting procedures andmay be subject to licensure that includes suitability investigations andsubmission of personal and financial information as required. Furthermore, mostjurisdictions have ongoing reporting requirements for certain transactions andare concerned with our accounting practices, internal controls, businessrelationships, and the fair operation of our products. Gaming regulatoryrequirements vary from jurisdiction to jurisdiction and licensing, approval,and processes related to findings of suitability, qualifications or licensureof the Company, our products, key personnel, and certain shareholders can belengthy 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 

13

----

the specifics of Nevada gaming law requirements areprovided below as being representative of gaming regulations to which we aresubject in other jurisdictions.

***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. Certainloans, leases, sales of securities and similar financing transactions must alsobe 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 

14

----

regulations pertaining to Institutional Investors totemporarily allow an Institutional Investor to beneficially own more than 15%,but not more than 19%, if the ownership percentage results from a stockrepurchase program. These Institutional Investors may not acquire anyadditional shares and must reduce their holdings within one year fromconstructive notice of exceeding 15%, or must file a suitability application. AnInstitutional Investor will be deemed to hold voting securities for investmentpurposes only if the voting securities were acquired and are held in theordinary course of business as an Institutional Investor and not for thepurpose of causing, directly or indirectly, the election of a majority of ourboard of directors, any change in our corporate charter, bylaws, management,policies or operations, or any of our gaming affiliates, or any other actionwhich the Nevada Commission finds to be inconsistent with holding our votingsecurities for investment purposes only.

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.

15

----

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. TheNevada Commission may also require controlling shareholders, officers,directors and other persons having a material relationship or involvement withthe entity proposing to acquire control, to be investigated and licensed aspart 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.  ***Wehave obtained or are in the process of obtaining all licenses/permits requiredby jurisdictions 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 

16

----

to great uncertainty as to the length of theregulatory approval process. Additionally, product testing is subject tochanging standards, as a result of which, we may be required to upgrade orrevise our products. We believe the laboratories responsible for testing arehandling a great number of product submissions and are under the pressure oflimited funding and resources. Such limitations could cause our productapprovals to be delayed for unknown periods of time. A description of regulatorystatus and issues related to each of our product segments follows:

*UtilityProducts—**We*have obtained approvals for ourshuffler products, excluding developmental models*,*in all gaming markets in North America where casino andpoker gaming is legalized. We have also received or filed (directly or throughour international distributors) for approval of our shuffler products andrelated software in additional international jurisdictions where required. Ourshufflers and related software are typically classified and approved asassociated equipment or as gaming equipment, depending on the particularjurisdiction and their regulations. Associated equipment is equipment that is notclassified as a gaming device or gaming equipment but, which due to itsintegral relationship to the conduct of licensed gaming, regulatory authoritieshave discretion to require manufacturers and distributors to meet licensing orsuitability requirements prior to or concurrent with the use of such equipmentin the respective jurisdiction. Although the classifications of shufflers varyamong jurisdictions, most, if not all, jurisdictions require specific hardwareand software 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 CardPoker table games are approved in all major casino gaming markets in NorthAmerica and numerous other international gaming jurisdictions. Four Card Poker,Ultimate Texas Hold’em, Fortune Pai Gow Poker, and Royal Match 21 are approvedin most jurisdictions in North America, with additional approvals expectedthroughout fiscal 2007. We intend to submit Black Jack Press, Streak Shooter,and progressive versions Three Card Poker and Fortune Pai Gow Poker toregulatory laboratories for approvals in the first two quarters of fiscal 2007.Similar approvals will be required for any future table games and relatedequipment.

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 Bonus was approvedin certain jurisdictions in fiscal 2005. We will continue to submit TableMaster with other proprietary games to various regulatory laboratories fortesting during fiscal 2007.

Our Vegas Star multi-player video table game unit withRoulette was first submitted for regulatory testing in the fourth quarter offiscal 2003 and is currently approved in key Australian jurisdictions, tribalNorth American jurisdictions and Macau. Additional games have included Sic Bo,Dragon Bonus, Blackjack, Bet the Set “21” and a Wide Area ProgressiveBlackjack. Vegas Star is currently submitted for approval for GamingLaboratories International, Inc. markets across North America and hasa variety of new games under development for all markets.

17

----

**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 and Development Costs.******  ***Because webelieve that one of our strengths is identifying new product opportunities anddeveloping new products, we expect to continue to spend a significant portionof our annual revenues on research and development, including the acquisitionof intellectual property from third parties. Our total research and developmentexpenses for continuing operations were $13,340, $7,784, and $6,185 in fiscal2006, 2005, and 2004, respectively.

***Significant Customer Sales, Foreign Sales and ForeignAssets.*****  **For theyears ended October 31, 2006, 2005 and 2004, sales to customers outsidethe United States accounted for 45%, 23%, and 23%, respectively, ofconsolidated revenue. At October 31, 2006, one customer’s balanceaccounted for 12% of our trade accounts receivable, net. No single customer’sbalance exceeded 10% of our investment in sales-type leases and notesreceivable. At October 31, 2006, no individual customer accounted for morethan 10% of consolidated revenue. As of October 31, 2006, approximately71.6% of our long-lived assets, primarily acquired intangible assets, wereoutside the United States. Additional information regarding our foreign salesand long-lived assets by geographic region is included in Note 14 to ourconsolidated 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 2 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 7 and Note 16 to our consolidated financial statements.

18

----

Stargames is based inSydney, Australia and develops, manufactures and distributes a wide range ofinnovative electronic entertainment gaming products to worldwide markets. Itsproduct offerings include Rapid Table Games, Vegas Star multi-terminal gamingmachines, and a broad line of traditional video slot machines designed mostspecifically for the Australian, Asian and Latin American gaming markets. TheRapid series of games, which we previously distributed in the Americas and theCaribbean, combines a live dealer with multi-terminal electronic wagering.Current offerings include Rapid RouletteTM, Rapid Sic-BoTM and Rapid Big WheelTM.Vegas Star multi-terminal gaming machines feature animated dealers and aselection 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.Stargames has approximately 210 employees including 80 in design anddevelopment.

Additional information regarding our acquisition ofStargames is included in Note 2 to our consolidated financial statements.

19

----

**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-looking statements reflect and are subject toinherent known and unknown risks and uncertainties that could cause actualresults to differ materially from those expressed or implied. Risk factors thatcould cause actual results to differ materially from expectations include, butare not limited to, the following:

·       changes in the level ofconsumer or commercial acceptance of our existing products and newproducts as introduced;

·       increased competition fromexisting and new products for floor space in casinos;

·       continued consolidation ofgaming operators which could negatively impact our product pricing;

·       acceleration and/ordeceleration of various product development, promotion and distributionschedules;

·       product performance issues;

·       higher than expectedmanufacturing, service, selling, legal, administrative, product development,promotion and/or distribution costs;

·       changes in ourbusiness systems or in technologies affecting our products or operations;

·       reliance on strategicrelationships with distributors and technology and manufacturing vendors;

·       current and/or futurelitigation, claims and costs or an adverse judicial finding;

·       tax matters includingchanges in state, federal, or foreign state tax legislation or assessments bytaxing authorities;

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

·       changes to ourintellectual property portfolio, such as the issuance of new patents, newintellectual property licenses, loss of licenses, claims of infringement orinvalidity of patents;

20

----

·       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;

·       the financial healthof our casino and distributor customers, suppliers and distributors, bothnationally and internationally;

·       our ability tomeet debt service obligations, including our senior convertible notes andour senior secured revolving credit facility, which will depend on ourfuture performance and other conditions or events and will be subject to manyfactors that are beyond our control;

·       adverse changes in thecreditworthiness of parties with whom we have significant receivables;

·       various risks relatedto our customers’ operations in countries outside the United States,including currency fluctuation risk, which could increase the volatilityof our results from such operations; and

·       our ability to successfullyand economically integrate the operations of any acquired companies such asStargames.

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. Theseinclude, 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 similar technologyor otherwise obtain access to our unpatented technology. To protect our tradesecrets and other proprietary information, we require employees, consultants,advisors and collaborators to enter into confidentiality agreements. We cannotassure you that these agreements will provide meaningful protection for ourtrade secrets, know-how or other proprietary information in the event of anyunauthorized use, misappropriation or disclosure of such trade secrets, 

21

----

know-how or other proprietary information. If we areunable to maintain the proprietary nature of our technologies, it could have amaterial adverse effect on our business.

We rely on our trademarks, trade names, and brand names to distinguishour products from the products of our competitors, and have registered orapplied to register many of these trademarks. We cannot assure you that ourtrademark applications will be approved. Third parties may oppose our trademarkapplications, or otherwise challenge our use of the trademarks. In the eventthat our trademarks are successfully challenged, we could be forced to rebrandour products, which could result in loss of brand recognition and could requireus to devote resources towards advertising and marketing new brands. Further,we cannot assure you that competitors will not infringe our trademarks or thatwe will have adequate resources to enforce our trademarks.

We also face the risk that we have infringed thirdparties’ intellectual property rights. We have many competitors in both theUnited States and foreign countries, some of which have substantially greaterresources and have made substantial investments in competing technologies. Somecompetitors have applied for and obtained, and may in the future apply for andobtain, patents that may prevent, limit or otherwise interfere with our abilityto make and sell our products.

Significant litigationregarding intellectual property rights exists in our industry. We have in thepast made, are currently making, and may in the future make, enforcement claimsagainst third parties, and third parties have in the past made, are currentlymaking, and may in the future make, claims of infringement against us oragainst our licensees or manufacturers in connection with their use of ourtechnology. For information on Legal Proceedings, see Note 15 to ourconsolidated financial statements included in Item 8 of this Annual Report on Form 10-Kfor the year ended October 31, 2006. As discussed in Note 15 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 

22

----

responsibility, financial stability and character ofthe owners, managers, and persons with financial interests in gamingoperations, including makers of gaming equipment such as ourselves. Somejurisdictions, however, empower their regulators to investigate participationby licensees in gaming outside their jurisdiction and require access to andperiodic reports concerning gaming activities. Violations of laws in onejurisdiction could result in disciplinary action in other jurisdictions. For asummary of gaming regulations that affect our business, see “Gaming Regulation”in Item 1 of this Annual Report on Form 10-K for the year ended October 31,2006.

In addition, legislative and regulatory changes mayaffect demand for our products. Such changes could affect us in a variety ofways. Legislation or regulation may introduce limitations on our products oropportunities for the use of our products, and could foster competitive gamesor technologies at our or our customers’ expense. For example, current regulationsin a number of jurisdictions where our customers operate limit the amount ofspace allocable to slot machines, and substantial changes in those regulationsmay adversely affect demand for our products. Our business will also suffer ifour products became obsolete due to changes in laws or regulations or theregulatory 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 subject us to significant legalexpenses 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 15 to ourconsolidated financial statements included in Item 8 of this Annual Report on Form 10-Kfor the year ended October 31, 2006. As discussed in Note 15 to ourconsolidated financial statements for the fiscal year ended October 31,2006, we are currently in litigation over various intellectual property matters.Our current assessment of each matter may change based on future unknown orunexpected events. Litigation requires the expenditure of significant time andresources, and is inherently unpredictable. If any litigation were to have anunanticipated adverse result, there could be a material impact on our resultsof operations or financial position.

***Our products currently in development may not achievecommercial success.***

We have a number of products in various stages ofdevelopment. We believe that our future success will depend in large part uponour ability to enhance our existing products and to develop, introduce andmarket new products and improvements to our existing products. As a result, weexpect, as needed, to continue to make significant investments in productdevelopment. Our development of products is dependent on factors such asreaching definitive agreements with third parties and obtaining requisitegovernmental approvals.

Future technological advances in the gaming productsindustry may result in the availability of new products or increase theefficiency of existing products. We may not be able to access or financecapital expenditures for new technologies that are more cost-effective orcreate superior products. We cannot assure you that existing, proposed or asyet undeveloped technologies will not render our technology less profitable orless viable, or that we will have available the financial and other resourcesto compete effectively against companies possessing such technologies.

23

----

While we are pursuing and will continue to pursueproduct development opportunities, there can be no assurance that such productswill come to fruition or become successful. Furthermore, while a number ofthose products are being tested, we cannot provide any definite date by whichthey will be commercially available. We cannot assure you that these productswill prove to be commercially viable, or that we will be able to obtain thevarious gaming licenses necessary to distribute them to our customers. We mayexperience operational problems with such products after commercial introductionthat could delay or defeat the ability of such products to generate revenue oroperating profits. Future operational problems could increase our costs, delayour plans or adversely affect our reputation or our sales of other productswhich, in turn, could have a material adverse effect on our success and ourability to satisfy our obligations with respect to our indebtedness, includingthe notes and the senior secured revolving credit facility. We cannot predictwhich of the many possible future products will meet evolving industrystandards and consumer demands. We cannot assure you that we will be able toadapt to such technological changes, offer such products on a timely basis orestablish or maintain a competitive position.

***We compete in a singleindustry, and our business would suffer if our products become obsolete ordemand 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 very competitive business environment.***

There is intense competition in the gaming productsindustry, and it is characterized by dynamic customer demand and rapidtechnological advances. The development of new competitive products or theenhancement of existing competitive products in any market in which we operatecould have a negative impact on our business in that market.

In general, we compete with other gaming andentertainment products for space on the casino customer’s floor, as well as forour customers’ capital spending. Some of the larger gaming supply companieswith whom we compete with are IGT, Bally Technologies, Inc., WMSIndustries, Inc., and Aristocrat Leisure Limited.

In the Utility Products segment, we compete withVendingData Corporation, a United States company that markets batch andcontinuous versions of its multi-deck shuffler, the Random Ejection ShufflerTMand more recently their single deck shuffler, the Poker OneTM. Additionally,other companies may develop and market shufflers and seek to develop and obtainregulatory approvals of additional shuffler products. We cannot provideassurance that a competitive product will not gain substantial placements orcause price erosion of our shufflers in the future. Several companies alsomanufacture and sell chipper products which are competitive with ourrecently-introduced Easy Chipper product. 

24

----

We believe the most successful of these products isthe Chipper Champ PlusTM, sold by TCS John Huxley.

In our Entertainment Products segment, the market forlive table games is characterized by numerous competitors who develop andlicense proprietary table games. Some of our competitors’ widely knownproprietary table game titles include PGIC’s Caribbean Stud® and Texas Hold’em BonusTM,Galaxy Gaming’s Lucky LadiesTM and Masque Publishing’s Spanish 21®. Competition in the table game market istypically based on price, brand recognition, and the strength of underlyingintellectual property. There is more competition from smaller developers andvendors in the table games segment because of the lower cost and complexityassociated with the development of these products. In the future, table gamecompetitors could market table games that might displace our products.

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 Gaming Machines also compete forcasino floor space with gaming suppliers such as IGT and Aristocrat LeisureLimited.

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.

25

----

***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 of September 11,2001 and other recent terrorist incidents have had a significant impact on thetravel, tourism and gaming industries in which our customers operate. Thesignificant reduction in both business and leisure travel 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 business and results of operations. Future acts of terror orhostilities may again reduce our customers’ guests’ willingness to travel, withthe result that our customers’ operations will suffer, which could have animpact 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 45% ofour consolidated revenue in fiscal 2006. We expect the percentage of our internationalsales to increase in fiscal 2007 and thereafter due to our acquisition ofStargames in February 2006. Accordingly, our future results could beharmed 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.

26

----

Fluctuations in thevalue of the U.S. dollar, the Euro or the Australian dollar may adverselyaffect our results of operations. Because our financial results are reported indollars, if we generate sales or earnings in other currencies, the translationof those results into dollars can result in a significant increase or decreasein the amount of those sales or earnings.

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 faceconsiderable business and financial risk in 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 liabilities and an increase inamortization expenses, which could have a material adverse effect upon ourbusiness, financial condition and results of operations.

The risks associated with acquisitions could have amaterial adverse 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.

27

----

***Our business is subjectto 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 meet debt service obligations issubject to many factors that are beyond our control and may affect futureoperations.***

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 Trust Company Americas, as Administrative Agent, Deutsche BankSecurities Inc. and Wells Fargo, N.A., as Joint Lead Arrangers and BookManagers and Wells Fargo, N.A. as Syndication Agent. We drew $71,180 on thefacility, which was used to repay in its entirety the Old Credit Agreement (asdefined below). Any remaining amount available under the revolving creditfacility will be used for working capital, capital expenditures and generalcorporate purposes, including share repurchases. The revolving credit facilityunder the New Credit Agreement will mature on November 30, 2011. Ourability to meet debt service obligations, including our convertible notesand the New Credit Agreement, will depend on our future performance andother conditions or events and will be subject to many factors that are beyondour 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.

28

----

**ITEM 3. LEGALPROCEEDINGS**

For information onLegal Proceedings, see Note 15 to our consolidated financial statementsincluded in Item 8 of this Annual Report.

Litigationis inherently unpredictable. Our current assessment of each matter may changebased on future unknown or unexpected events. If any litigation were to have anadverse result that we did not expect, there could be a material impact on ourresults of operations or financial position. We believe costs associated withlitigation will not have a material impact on our financial position orliquidity, but may be material to the results of operations in any given period.We assume no obligation to update the status of pending litigation, except asmay be required by applicable law, statute or regulation. We believe that thefinal disposition of these matters will not have a material adverse effect onour financial 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.

29

----

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

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

***Stock***Listing.***  ***Our commonstock is traded on The NASDAQ National Market under the symbol SHFL. As of January 12,2007, we had approximately 260 shareholders of record. There are asignificantly greater number of shareholders whose shares are held in streetname. Based on information we collected as of January 12, 2007, weestimate that we have approximately 14,000 beneficial holders in total. Thefollowing table sets forth quarterly high and low prices for trades of ourcommon stock during fiscal 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.***  ***Wehave not paid dividends on our common stock.

***Transfer***Agent.***  ***Ourstock transfer agent and registrar is Wells Fargo Bank Minnesota, N.A., ShareownerServices, 161 North Concord Exchange, South St. Paul, Minnesota 55075, (800) 468-9716.

***Securities***Authorized for Issuance Under EquityCompensation Plans.****  **The informationunder the caption “Equity Compensation Plan Information” in our 2006 ProxyStatement is incorporated herein 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 $69 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.

30

----

***Stock***Repurchases.***  ***Thefollowing table provides monthly detail regarding our share repurchases duringthe three month period ended October 31, 2006 (in thousands, except pershare 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        |   |   |   |   |   |   |

----

*                    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.

31

----

**ITEM 6. SELECTEDFINANCIAL DATA**

| ** **                                            | ** ** | **Year Ended October 31,**                                                              | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share, ratios, and unit amounts)** | ** ** |
| **Operating Results:**                                | ** ** | ** **                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenue                                         |       | $                                                                                                      | 163,468    |   | $ | 112,860 |   | $ | 84,783 |   | $ | 58,351 |   | $ | 48,677 |   |
| Cost of revenue                                       |       | 54,656                                                                                                 |       | 29,260 |   | 19,403 |   | 11,599 |   | 11,092 |   |
| Gross margin                                          |       | 108,812                                                                                                |       | 83,600 |   | 65,380 |   | 46,752 |   | 37,585 |   |
| Selling, general and  administrative                  |       | 51,099                                                                                                 |       | 30,559 |   | 22,953 |   | 15,788 |   | 12,890 |   |
| Research and  development                             |       | 13,340                                                                                                 |       | 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                               |       | 29,794                                                                                                 |       | 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    |       | 21,024                                                                                                 |       | 43,600 |   | 34,642 |   | 27,037 |   | 22,678 |   |
| Provision for income  taxes                           |       | 13,976                                                                                                 |       | 14,496 |   | 12,125 |   | 9,458 |   | 7,937 |   |
| Income from continuing  operations                    |       | $                                                                                                      | 7,048      |   | $ | 29,104 |   | $ | 22,517 |   | $ | 17,579 |   | $ | 14,741 |   |
| **Earnings  per share — continuing operations:** | ** ** | ** **                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                 |       | $                                                                                                      | 0.20       |   | $ | 0.83 |   | $ | 0.63 |   | $ | 0.47 |   | $ | 0.37 |   |
| Diluted                                               |       | $                                                                                                      | 0.20       |   | $ | 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                                       |       | $                                                                                                      | (17,054    | ) | $ | 57,634 |   | $ | 65,671 |   | $ | 25,809 |   | $ | 31,775 |   |
| Total assets                                          |       | $                                                                                                      | 306,128    |   | $ | 193,117 |   | $ | 185,292 |   | $ | 59,418 |   | $ | 60,603 |   |
| Long-term obligations                                 |       | $                                                                                                      | 164,308    |   | $ | 162,659 |   | $ | 157,648 |   | $ | 250 |   | $ | 1,518 |   |
| Shareholders’ equity                             |       | $                                                                                                      | 34,258     |   | $ | 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           |       | $                                                                                                      | 0.98       |   | $ | 0.39 |   | $ | 0.42 |   | $ | 1.29 |   | $ | 1.29 |   |
| **Cash  Flow Data:**                                  | ** ** | ** **                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash provided by  operating activities                |       | $                                                                                                      | 35,771     |   | $ | 34,508 |   | $ | 26,587 |   | $ | 20,630 |   | $ | 18,957 |   |
| Cash (used) provided  by investing activities         |       | $                                                                                                      | (105,892   | ) | $ | (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                                             |       | 22,357                                                                                                 |       | 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 |   | 110 |   | — |   | — |   |
| Electronic Gaming Machine  Seats                      |       | 16,279                                                                                                 |       | — |   | — |   | — |   | — |   |

 

32

----

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

Effective February 1, 2006, we acquired Stargames.Effective May 1, 2004, we acquired Casinos Austria Research &Development GmbH & Co KG and its wholly-owned subsidiaries (“CARD”). EffectiveFebruary 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 2 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 and nextgeneration products. Some sold units or seats may no longer be in use by ourcasino customers or may have been replaced by other models. Accordingly, we areunable to determine precisely the number of units or seats currently in use.

33

----

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

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

We develop, manufacture and market technology andentertainment-based products for the gaming industry for placement on thecasino floor. 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. Inaddition, we outsource the manufacturing of certain of our products in the UnitedStates, 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 entertainment gaming products to worldwide markets, by purchasing95% of the outstanding Stargames shares. Effective March 8, 2006, we hadacquired 100% of the outstanding Stargames shares for AU $1.55 per share. Accordingly,the results of Stargames have been included in our consolidated financialstatements beginning February 1, 2006.

34

----

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 weassigned, transferred, and conveyed to IGT, our 50% share of future royaltiesfrom the licensing of the ENPAT patents to any third party or from otherwisepermitting any third party to use the ENPAT patents. The total royalties to bereceived by IGT is limited to an amount equal to a net present value of $3,000utilizing a discount factor of 12% (the “Royalty Amount”). Upon the receipt byIGT of the Royalty Amount, all royalty payments with respect to our 50% shareof the ENPAT patents shall resume and be paid to us. The total non-refundableconsideration paid 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 months ended October 31, 2006, whichrepresents our pro rata share of Sona’s net loss for the period.

35

----

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 $1,655during 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 products operationsand assets, based on our determination that this product line was no longer astrategic fit with our refocused core business strategy of providing productsand services for the table game area of casinos. Revenues and costs associatedwith our slot products are reported as discontinued operations for all periodspresented. In January 2004, we entered into agreements pursuant to whichwe sold substantially all of our slot products’ assets and substantiallycompleted 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 our EntertainmentProducts and Utility Products segments. Accordingly, we entered into anagreement to sell Stargames’ equity interests in PVS including settlement ofall existing liabilities of PVS. The estimated liabilities exceeded assets inthe amount of approximately $654. The fair value of PVS’ working capital hasbeen valued at zero in our preliminary purchase price allocation. The resultsof operations for PVS were included in Discontinued Operations until thedisposition was completed in September 2006.

36

----

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

| ** **                                    | ** ** | **Year Ended October 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Utility products                              |       | $                                         | 87,095     |   | 53.3% |   | $ | 67,029 |   | 59.4% |   | $ | 45,947 |   | 54.2% |   |
| Entertainment products                        |       | 76,135                                    |       | 46.6% |   | 45,539 |   | 40.3% |   | 38,705 |   | 45.7% |   |
| Other                                         |       | 238                                       |       | 0.1% |   | 292 |   | 0.3% |   | 131 |   | 0.1% |   |
| Total revenue                                 |       | 163,468                                   |       | 100.0% |   | 112,860 |   | 100.0% |   | 84,783 |   | 100.0% |   |
| Cost of revenue                               |       | 54,656                                    |       | 33.4% |   | 29,260 |   | 25.9% |   | 19,403 |   | 22.9% |   |
| Gross margin                                  |       | 108,812                                   |       | 66.6% |   | 83,600 |   | 74.1% |   | 65,380 |   | 77.1% |   |
| Selling, general and  administrative          |       | 51,099                                    |       | 31.3% |   | 30,559 |   | 27.0% |   | 22,953 |   | 27.1% |   |
| Research and  development                     |       | 13,340                                    |       | 8.2% |   | 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                       |       | 29,794                                    |       | 18.2% |   | 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 |       | 21,024                                    |       | 12.8% |   | 43,600 |   | 38.7% |   | 34,642 |   | 40.8% |   |
| Provision for income  taxes                   |       | 13,976                                    |       | 8.5% |   | 14,496 |   | 12.8% |   | 12,125 |   | 14.3% |   |
| Income from  continuing operations            |       | 7,048                                     |       | 4.3% |   | 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                                    |       | $                                         | 6,802      |   | 4.1% |   | $ | 29,180 |   | 26.0% |   | $ | 24,144 |   | 28.4% |   |

 

Our revenue and results ofoperations are most affected by unit or seat placements, through sale or lease,of our products. The number and mix of products placed and the average lease orsales price are the most significant factors affecting our gross margins. Thesefactors are, in turn, affected by the gaming industry generally and ourcustomers’ assessment of our products. To a lesser extent, our overallfinancial results are affected by fluctuations in selling, general andadministrative expenses and our continued investment in research anddevelopment activities. Our results for the year ended October 31, 2006,also include a one-time charge recorded in the three months ended April 30,2006 related to the acquisition of Stargames of $19,145 for in-process researchand development (“IPR&D”). Our margins are also negatively impacted by theamortization of product related intangibles through our acquisition of CARD andStargames.

37

----

**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             |       | 113,679                                   |       | 63,997                     |       | 41,537 |   | 77.6% |   |   | 54.1% |   |   |
| Other                         |       | 238                                       |       | 292                        |       | 131 |   | (18.5%) |   |   | 122.9% |   |   |
| Total                         |       | $                                         | 163,468    |                       | $          | 112,860 |   | $ | 84,783 |   | 44.8% |   |   | 33.1% |   |   |
| **Cost of  revenue:**         |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |
| Leases and royalties          |       | $                                         | 11,531     |                       | $          | 9,692 |   | $ | 8,206 |   | 19.0% |   |   | 18.1% |   |   |
| Sales and service             |       | 43,125                                    |       | 19,568                     |       | 11,197 |   | 120.4% |   |   | 74.8% |   |   |
| Total                         |       | $                                         | 54,656     |                       | $          | 29,260 |   | $ | 19,403 |   | 86.8% |   |   | 50.8% |   |   |
| **Gross  margin:**            |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |
| Leases and royalties          |       | $                                         | 38,020     |                       | $          | 38,879 |   | $ | 34,909 |   | (2.2%) |   |   | 11.4% |   |   |
| Sales and service             |       | 70,554                                    |       | 44,429                     |       | 30,340 |   | 58.8% |   |   | 46.4% |   |   |
| Other                         |       | 238                                       |       | 292                        |       | 131 |   | (18.5%) |   |   | 122.9% |   |   |
| Total                         |       | $                                         | 108,812    |                       | $          | 83,600 |   | $ | 65,380 |   | 30.2% |   |   | 27.9% |   |   |
| **Gross  margin percentage:** |       |                                      |       |                       |       |   |   |   |   |   |   |   |   |
| Leases and royalties          |       | 76.7%                                     |       | 80.0%                      |       | 81.0% |   |   |   |   |   |   |   |
| Sales and service             |       | 62.1%                                     |       | 69.4%                      |       | 73.0% |   |   |   |   |   |   |   |
| Total                         |       | 66.6%                                     |       | 74.1%                      |       | 77.1% |   |   |   |   |   |   |   |

 

We earn our revenue in several ways, including leasingor licensing our products to casino customers, generally under month-to-monthfixed fee contracts. Product lease contracts typically include parts andservice. We also offer a majority of our products for sale with an optionalparts and service contract. A more detailed discussion of our revenuecomponents and related revenue recognition policies is included under theheading “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 to Fiscal 2005***

Overall, total revenue increased for the year ended October 31,2006 as compared to the prior year period. Consolidated revenue for the yearwas $163,468 as compared to $112,860 in the prior year. The increase was aresult of strong performance in both operating segments as well as our leaseand royalties and sales and service business models. We experienced strongresults in our sold units installed base within our Utility segment. Our Entertainmentsegment was favorably impacted by organic growth as well as our acquisition ofStargames effective February 1, 2006. The increase in the number of unitssold resulted from greater placements of our products, acquisitions ofproducts, 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 7.5% 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 

38

----

margins of the Stargamesproducts are lower than those traditionally experienced in our EntertainmentProducts segment. Additionally, amortization of Stargames product relatedintangibles of $1,545 is included in cost of sales and service in ourconsolidated statements of income for the year ended October 31, 2006compared to $0 for the same prior year period. Our sales of Easy Chipper® andTable Master, which are higher cost products, have also increasedyear-over-year and have unfavorably impacted our overall margin. Additionally,we had fewer lifetime license sales than in the prior period which resulted inan unfavorable impact on gross margin dollars.

***Fiscal 2005 compared toFiscal 2004***

Overall, total revenueincreased for the year ended October 31, 2005 as compared to the prioryear period. Consolidated revenue for the year was $112,860 as compared to$84,783 in the prior year. Our overall revenue growth of $28,077 is attributableto sales and service revenue in both the Utility and Entertainment segments,and to a lesser extent lease and royalty revenue for both operating segments. Additionally,a full year of results for CARD contributed to the year over year growth. Revenuecontributed by CARD was approximately $16,089 in fiscal 2005 compared toapproximately $7,100 in fiscal 2004. A more detailed discussion of our revenueis included for each of our operating segments under the heading “SegmentOperating 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 margin percentageyear over year is primarily attributed to increased sales of our Table Masterand Easy Chipper products which carry slightly lower margins. Additionally,intellectual property amortization expense associated with products related toour CARD and other acquisitions is recorded as cost of sales which reduces ourgross margin percentage. Amortization expense related to 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 in gross marginpercentage 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 |       | $                                         | 51,099     |                       | $          | 30,559 |   | $ | 22,953 |   |   | 67.2% |   |   |   | 33.1% |   |   |
| Percentage of revenue                |       | 31.3%                                     |       | 27.0%                      |       | 27.1% |   |   |   |   |   |   |   |   |   |
| Research and development             |       | $                                         | 13,340     |                       | $          | 7,784 |   | $ | 6,185 |   |   | 71.4% |   |   |   | 25.9% |   |   |
| Percentage of revenue                |       | 8.2%                                      |       | 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             |       | $                                         | 83,584     |                       | $          | 38,343 |   | $ | 29,138 |   |   | 118.0% |   |   |   | 31.6% |   |   |
| Percentage of revenue                |       | 51.2%                                     |       | 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.

39

----

·       Corporatelegal fees were $4,746 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 15 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.

·  Favorable collections efforts, primarily atStargames, resulted in a credit of ($537) in the provision for bad debts forthe year ended October 31, 2006 compared to $229 for the same prior yearperiod.

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 27.6% 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 thirdparty to use the ENPAT patents. The consideration for the remaining 50%ownership of the ENPAT patents was the $3,000 previously received from IGTpursuant to the April Agreement between us and IGT, plus a payment of anadditional $4,500. This payment was in lieu of the $4,875 that would have beendue, at IGT’s discretion, under the patent purchase agreement entered into on June 13,2005 between us and IGT. As a result, IGT shall receive 100% of the futureroyalties on the ENPAT patents until IGT has earned a total of $17,400 in grossroyalties; thereafter IGT will pay us 17 1⁄2% of any gross royalties. Thetransaction has been reflected in the accompanying consolidated statements of incomeby recording a gain 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 amortizationof our patents for products still under development. Amortization for the yearended October 31, 2006 included amortization of our 50% ownership interestin the ENPAT 

40

----

patents. Our R&D costswill be favorably impacted in the future by the sale of our remaining 50%ownership interest in the ENPAT patents to IGT on July 31, 2006. See Note2 to our consolidated financial statements.

As required by FASBInterpretation No. 4, “*Applicability of FASBStatement No. 2 to Business Combinations Accounted for by the PurchaseMethod*” (“FIN 4”), the portion of the purchase price allocated toIPR&D of $19,145 was immediately expensed during the three months ended April 30,2006.

A project-by-project valuationusing the guidance in FASB Statement of Financial Accounting Standard No. 141,“*Business Combinations*” (“SFAS 141”) andthe American Institute of Certified Public Accountants (“AICPA”) Practice Aid “*Assets Acquired in a Business Combination to Be Used In Research andDevelopment Activities: A Focus on Software, Electronic Devices andPharmaceutical Industries*” is in the process of being performed byus with the assistance of a valuation specialist to determine the fair value ofresearch and 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 a project-by-projectbasis. This method is based on the present value of earnings attributable tothe asset or costs avoided as a result of owning the assets. This methodincludes risk factors, which include applying an appropriate discount rate thatreflects the project’s stage of completion, the nature of the product, thescientific data associated with the technology, the current patent situationand market competition. The expensing of IPR&D through purchase accountingallows for the expensing of certain R&D efforts at the acquisition dateconsistent with the expensing of R&D efforts as they are incurred forin-house development efforts. This charge is preliminary pending completion ofour final purchase price allocation which will be finalized within one year fromthe date of acquisition. Any adjustments to this charge will be adjusted to theincome 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 decreasedprimarily as a result of a reduction in our investment portfolio. Proceeds ofmatured investments were not re-invested, but were used to pay down thetemporary bridge financing associated with the acquisition of Stargames andstock repurchases. This decrease was partially offset by an increase ininterest income attributable to increased interest bearing sales-type leasesand notes receivable as of October 31, 2006. For the year ended October 31,2006, interest income related to our investment in sales type leases and notesreceivable was $1,229 as compared to $948 for the same prior year period.

Interest expense is primarilyrelated to the $150,000 of contingent convertible senior notes due in April 2024and the temporary bridge financing which matured in November 2006. A moredetailed discussion is 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. 

41

----

Such contracts do not meet theaccounting criteria for hedge accounting, and accordingly, the foreign currencyexchange loss is included in our operating results for the year ended October 31,2004. As of October 31, 2006 and 2005, we had no outstanding foreignexchange 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        |       | 31.9%    |       | 0.0%     |       | 0.0%     |       |
| Foreign dividend  inclusion                 |       | 8.8%     |       | 0.0%     |       | 0.0%     |       |
| Other permanent  differences                |       | (5.3%)   |       | (1.9%)   |       | (1.4%)   |       |
| State income taxes,  net of federal benefit |       | 2.3%     |       | 2.1%     |       | 2.0%     |       |
| Tax credits                                 |       | (7.5%)   |       | (1.8%)   |       | (1.4%)   |       |
| Effect from foreign  tax rate differences   |       | 0.4%     |       | 0.7%     |       | 0.9%     |       |
| Other                                       |       | 0.9%     |       | (0.8%)   |       | (0.1%)   |       |
| Effective tax rate                          |       | 66.5%    |       | 33.3%    |       | 35.0%    |       |

 

Excluding the impact of the one-time IPR&D chargein relation to the Stargames acquisition, which is non-deductible for taxpurposes, the effective tax rate for the year ended October 31, 2006 wouldhave been 34.8%.

Looking forward, our annual effective tax rate mayfluctuate due to changes in our amount and mix of U.S. and foreign income,changes in tax legislation and changes in our estimates of federal tax creditsand other tax deductions. We estimate that our fiscal 2007 annual effective taxrate will be approximately 35.0%.

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 is subject to United States tax basedupon earnings and profits of Shuffle Master Management - Service GMBH. Thisdividend resulted in $733 of net additional income taxes which is comprised ofadditional United States tax of approximately $1,855 and a correspondingforeign tax credit benefit of $1,122.

During each of the years ended October 31, 2006,2005 and 2004, we recorded income tax benefits of $3,908, $5,287 and $5,388,respectively, related to deductions for employee stock option exercises. Thesetax benefits, which reduced income taxes payable and increased additionalpaid-in capital by an equal amount, had no effect on our provision for incometaxes. Additionally, as part of the fiscal 2004 income tax provision to taxreturn true-up, we recorded a $229 tax benefit related to employee stock optionexercises which reduced income taxes payable and increased additional paid-incapital 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 operating loss carryforwards and other tax credits. Deferredtax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the years in which the differences are 

42

----

expected to reverse. Weprovide valuation allowances to reduce deferred tax assets to an amount that ismore likely than not to be realized. We evaluate the likelihood of recoveringour deferred tax assets by estimating sources of future taxable income. Theprovision for income taxes is the sum of the tax currently payable and thechange in deferred taxes during the year. Additional information regardingincome taxes is included in Note 13 to our consolidated financial statements.

**EARNINGS PER SHARE**

| ** **                                            | ** ** | **Year Ended October 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income from  continuing operations                    |       | $                                         | 7,048      |   | $ | 29,104 |   | $ | 22,517 |   |
| Basic earnings per  share, continuing operations      |       | $                                         | 0.20       |   | $ | 0.83 |   | $ | 0.63 |   |
| Diluted earnings per  share, continuing operations    |       | $                                         | 0.20       |   | $ | 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 beenadjusted for 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 ofContingently Convertible Debt on Diluted Earnings Per Share” which requires usto include the dilutive effect of our outstanding Notes shares in our dilutedearnings per share calculation, regardless of whether the market price triggeror other contingent conversion feature has been met. Because our Notes includea mandatory 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.

43

----

**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 and othergaming locations, including our own proprietary table games. In addition toselling 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 totaled22,357 units, a 20.3% 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 Easy Chippersimplifies the handling of gaming chips and accurately tracks chip volume andvalue, which increases the productivity and security on high volume chip tablessuch as Roulette. During May 2005, we announced our first Easy Chipperorders, the first release of a new product developed by CARD since theacquisition. During the year ended October 31, 2006, we sold 233 EasyChipper units, and placed 5 Easy Chipper units on lease. For fiscal 2006, totalrevenue contribution from the Easy Chipper was approximately $4,859 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. Ourcurrent table game portfolio consists of 21 revenue generating titles,including industry leading brands such as Three Card Poker®*,* Let It Ride®, Four Card Poker® andFortune Pai Gow Poker®. Themajority of these games are licensed to our customers, which provides us withrecurring revenue. In fiscal 2003, we began selling lifetime licenses ofcertain of our proprietary table games. As of October 31, 2006, ourproprietary table game installed base totaled 4,219 games, a 14.6% increasefrom 3,681 games as of October 31, 2005. Our growth strategy for our liveproprietary table games business is to broaden our content through increaseddevelopment and/or acquisition. As a result, we expect to further increase thepenetration of our content in the marketplace, as well as create a longer-termreplacement opportunity.

44

----

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. Our growthstrategy for the multi-terminal gaming products is to position these productsas a more cost-effective way to offer lower stakes table games to our casinocustomers.

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-based proprietarytable game content, including Royal Match 21 Blackjack, Three Card Poker, LetIt 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.

45

----

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                          |       |                                                                             | 50,474     |                                                                             |       |           | 34,868     |       |   |   | 15,606 |   |   |   | 44.8% | ** ** |   |
| Sales — Chipper                           |       |                                                                             | 5,559      |                                                                             |       |           | 2,930      |       |   |   | 2,629 |   |   |   | 89.7% | ** ** |   |
| Service and other                              |       |                                                                             | 7,014      |                                                                             |       |           | 5,510      |       |   |   | 1,504 |   |   |   | 27.3% | ** ** |   |
| Total sales and service                        |       |                                                                             | 63,047     |                                                                             |       |           | 43,308     |       |   |   | 19,739 |   |   |   | 45.6% | ** ** |   |
| Total Utility Products segment revenue         |       |                                                                             | $          | 87,095                                                                           |       |           |       | $          | 67,029 |   |   |   | $ | 20,066 |   |   |   | 29.9% | ** ** |   |
| **Utility Products segment operating income**  |       |                                                                             | $          | 44,449                                                                           |       |           |       | $          | 32,595 |   |   |   | $ | 11,854 |   |   |   | 36.4% | ** ** |   |
| **Utility  Products segment operating margin** |       |                                                                             | 51.0%      |                                                                             |       |           | 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                               |       |                                                                             | 4,307      |                                                                             |       |           | 3,062      |       |   |   | 1,245 |   |   |   | 40.7% | ** ** |   |
| Less trade-ins and exchanges                   |       |                                                                             | (447       | )                                                                                |       |           | (433       | )          |   |   | (14 | ) |   |   | 3.2% | ** ** |   |
| Subtotal                                       |       |                                                                             | 17,640     |                                                                             |       |           | 13,780     |       |   |   | 3,860 |   |   |   | 28.0% | ** ** |   |
| Total installed base                           |       |                                                                             | 22,357     |                                                                             |       |           | 18,589     |       |   |   | 3,768 |   |   |   | 20.3% | ** ** |   |
| **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                               |       |                                                                             | 233        |                                                                             |       |           | 122        |       |   |   | 111 |   |   |   | 91.0% | ** ** |   |
| Subtotal                                       |       |                                                                             | 355        |                                                                             |       |           | 122        |       |   |   | 233 |   |   |   | 191.0% | ** ** |   |
| Total installed base                           |       |                                                                             | 370        |                                                                             |       |           | 132        |       |   |   | 238 |   |   |   | 180.3% | ** ** |   |
|                                                |            |                                                                                  |            |                                                                                  |            |                |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Utility Products segment revenue is derived substantiallyfrom our shuffler product line and secondarily from our chipper product line.

For the year ended October 31, 2006, UtilityProducts segment revenue increased 29.9%, compared to the prior year, primarilydue to a 45.6% increase in Utility Products sales and service revenue.Additionally, Utility Products lease revenue increased by 1.4% as compared tothe prior year.

46

----

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 1,245 shuffler units sold from 3,062 to 4,307, a 40.7% increase.

·       Theincrease in sold shuffler units was comprised primarily of additional sales ofDeck Mate, one2six and MD2 shufflers of 1,188, 1,154 and 1,097, 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 233. Chipper sale revenue of$5,559 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 $4,775 as compared to $2,600 in the same prior yearperiod.

Utility Products segmentoperating income for the year ended October 31, 2006, increased 36.4%,compared to the same prior year period, and operating segment margin increasedfrom 48.6% to 51.0%, 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.

47

----

***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% | ** ** |   |
| Subtotal                                       |       |                                                                 | 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 the prior 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.

48

----

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. Amortizationexpense associated with the one2six shuffler and the Easy Chipper was $2,799for the year ended October 31, 2005, compared to $1,165 for the prioryear.

49

----

**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                          |       | 14,791                                    |       | 4,990        |       | 9,801          |       |   | 196.4% |   |   |
| 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                                      |       | 50,632                                    |       | 20,689       |       | 29,943         |       |   | 144.7% |   |   |
| Total Entertainment Products  segment revenue                         |       | $                                         | 76,135     |         | $          | 45,539         |       | $ | 30,596 |   |   | 67.2% |   |   |
| **Entertainment  Products segment operating income**                  |       | $                                         | 17,648     |         | $          | 33,529         |       | $ | (15,881) |   |   | (47.4%) |   |   |
| **Entertainment Products segment  operating margin**                  |       | 23.2%                                     |       | 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% |   |   |

 

50

----

For the year ended October 31, 2006,Entertainment Products segment revenue increased 67.2%, 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 of ThreeCard Poker and Let It Ride.

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

As discussed above, the increase in EntertainmentProducts sales and service revenue for the year ended October 31, 2006, comparedto the same prior year period is primarily attributed to the Stargames productline contribution. Other contributions include:

·       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 segment operating income forthe year ended October 31, 2006 decreased $15,881 or 47.4% and operatingmargin for the year ended October 31, 2006 decreased to 23.2% from 73.6%for the same prior year period. The decrease in segment operating income aswell as segment operating margin was predominantly caused by the one-timeIPR&D charge recognized during the three months ended April 30, 2006related to the acquisition of Stargames. Entertainment Products segmentoperating margin, excluding IPR&D, for the year ended October 31,2006, decreased to 48.3% 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.

51

----

***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 

52

----

additional proprietary games including Jackpot Pai GowPoker® and Progressive Jackpot Pai Gow Poker.The acquired installed base of games was 53 units as of the acquisition dateand 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 incomeincreased 13.3% for the year ended October 31, 2005, compared to theprior year. 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.

53

----

**LIQUIDITY AND CAPITAL RESOURCES**

**(In thousands, exceptratios 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                          |       | $                    | (17,054    | )            | $          | 57,634         |       | $ | (74,688 | ) |   | (129.6%) |   |   |
| 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.

Excluding the short-termbridge financing of $70,000, the current ratio was approximately 2.4 as of October 31,2006.

***Cash Flows.***

*OperatingActivities*—Significantitems included in cash flows from operating activities are as follows:

| ** **                                                   | ** ** | **Year Ended October 31,** | ** ** | **Increase** | ** ** | **Percentage** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                                   | ** ** | **2006**                                  | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Income from  continuing operations                           |       | $                                         | 7,048      |         | $          | 29,104         |       | $ | (22,056 | ) |   | (75.8% | ) |   |
| Non-cash items                                               |       | 38,488                                    |       | 13,028       |       | 25,460         |       |   | 195.4% |   |   |
| Income tax related  items                                    |       | (2,615                                    | )          | 9,614        |       | (12,229        | )          |   | (127.2% | ) |   |
| 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           |       | (6,100                                    | )          | (10,438      | )          | 4,338          |       |   | (41.6% | ) |   |
| Discontinued  operations, net of tax                         |       | (246                                      | )          | 76           |       | (322           | )          |   | (423.7% | ) |   |
| Cash flow provided by  operating activities                  |       | $                                         | 35,771     |         | $          | 34,508         |       | $ | 1,263 |   |   | 3.7% |   |   |

 

·       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 andamortization, share-based compensation expense, provision for bad debts, equitymethod investment loss, and provision for inventory obsolescence. The increasein non-cash items for the year ended October 31, 2006, is substantiallydue to a charge for IPR&D related to the Stargames acquisition of $19,145and share-based compensation of $5,512 for the year ended October 31, 2006,compared to $759 in the same prior year period. Additionally, amortization ofintangible assets was $9,045 and $5,954 for the years ended October 31,2006 and 2005, respectively.

54

----

·       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.

*InvestingActivities*—Significant items included in cash flows frominvesting 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 |       | (116,358                                  | )          | (228         | )          | (116,130       | )          | 50,934.2% |   |
| 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      |       | $                                         | (105,892   | )            | $          | (6,526         | )          | $ | (99,366 | ) | 1,522.6% |   |

 

·       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.

55

----

*FinancingActivities*—Significant items included in cash flows fromfinancing 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 andmade installment payments of $2,609 for the ENPAT note payable and $1,726 forBTI liabilities.

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

***LONG-TERM LIABILITIES***

***Contingent convertible senior notes.******  ***In April 2004, we issued$150,000 of contingent convertible senior notes due 2024 (the “Notes”) througha private placement under Rule 144A of the Securities Act of 1933. TheNotes are unsecured and bear interest at a fixed rate of 1.25% per annum. Interestis payable semi-annually in arrears on April 15 and October 15 ofeach year, beginning October 15, 2004.

Holders may convert anyoutstanding Notes into cash and shares of our common stock at an initialconversion price per share of $28.07. This represents a conversion rate ofapproximately 35.6210 shares of common stock per $1,000 in principal amount ofNotes. The value of the cash and shares of our common stock, if any, to bereceived by a holder converting $1,000 principal amount of the Notes will bedetermined based on the applicable Conversion Rate, Conversion Value, PrincipalReturn, and other factors, each as defined in the indenture covering theseNotes.

The Notesare convertible, at the holders’ option, into cash and shares of our commonstock, 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;

56

----

·       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 theNotes at any time on or after April 21, 2009, at a redemption price,payable in cash, of 100% of the principal amount of the Notes, plus accrued andunpaid interest and including liquidated damages, if any, up to but notincluding the date of redemption. In addition, the holders may require us torepurchase all or a portion of their Notes on April 15, 2009, 2014 and2019, at 100% of the principal amount of the Notes, plus accrued and unpaidinterest and including liquidated damages, if any, up to but not including thedate of repurchase, payable in cash. Upon a change in control, as defined inthe indenture governing the Notes, holders may require us to repurchase all ora portion of their Notes, payable in cash equal to 100% of the principal amountof the Notes plus accrued and unpaid interest and 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. AmendmentNo. 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 compliance with all of the affirmative and negative covenantspursuant to the Old Credit Agreement. Additional information on these covenantsmay be found in Section 7 and Section 8 of the Old Credit Agreementincluded in our Current Report on Form 8-K, dated January 25,2006. The principal balance on the Bridge Loan as of October 31, 2006 was$70,000.

On November 30, 2006, weentered into a $100,000 senior secured revolving credit facility (the “New CreditAgreement”) with Deutsche Bank AG Cayman Islands Branch, as a Lender, DeutscheBank Trust Company Americas, as Administrative Agent, Deutsche Bank SecuritiesInc. and Wells Fargo, N.A., as Joint Lead Arrangers and Book Managersand Wells Fargo, N.A. as Syndication Agent. We drew $71,180 on the facility,which was used to repay in its entirety the Old Credit Agreement. Any remainingamount available under the revolving credit facility will be used for working 

57

----

capital, capital expendituresand general corporate purposes, including share repurchases. The revolvingcredit facility under the New Credit Agreement will mature on November 30,2011.

Theinterest rate under the New Credit Agreement is based on the sum of therelevant Base Rate or Eurodollar Rate plus the Applicable Margin, as defined,each as in effect from time to time. The obligations under the revolving creditfacility are guaranteed by each wholly-owned domestic subsidiary of ours thatis not an immaterial subsidiary and each wholly-owned domestic subsidiary thatis not an immaterial subsidiary of the Company established, created or acquiredafter November 30, 2006, if any. The New Credit Agreement containscustomary affirmative and negative covenants for transactions of this nature,including but not limited to 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 costsincurred with the issuance of long-term debt and the Bridge Loan arecapitalized and amortized as interest expense using the effective interestmethod. Amortization of debt issuance costs were $1,511 and $961 for the yearended October 31, 2006 and 2005, respectively. Unamortized debt issuancecosts of $2,369 and $3,328 as of October 31, 2006 and 2005, respectively,are included in Other long term assets on the consolidated balance sheets.

***Stargames credit facility.***   Stargameshas banking facilities with the Australia and New Zealand Banking Group (“ANZ”).The facilities have a borrowing capacity of AU $12,700; amounts outstanding asof October 31, 2006 were AU $5,000 or US $3,872 at a weighted averageinterest rate of 6.45%. The banking facilities are comprised of two maincomponents: a flexible bank overdraft that acts as a working capital facilityand a bank loan facility which is an interchangeable facility comprised ofcommercial bills, overdrafts and advances. Interest rates are based on the bankbill swap yield, as defined, plus a margin.

The facilities are secured bya cross guarantee and indemnity between all the operating entities of theStargames group. The agreements provide for collateralization of all the assetsand operations of all members of the Stargames group as well as the operatingfacilities of Stargames based in Milperra, New South Wales, Australia.

The facilities include certainfinancial covenants which are tested annually by ANZ at the end of eachfinancial year. These financial covenants include a minimum working capitalratio, a minimum ratio of 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.

58

----

***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 and2005, of $5,823 and $8,518, respectively, represents the discounted presentvalue of the future payments, including imputed interest of approximately $265and $352, respectively. Principal and interest payments of $3,000 each are duein December 2006 and 2007.

***Bet the Set “21” contingent consideration.******  ***In connection with ouracquisition of Bet the Set “21”, we recorded contingent consideration of $560. Thecontingent consideration consists of quarterly payments of 22.5% of “adjustedgross revenues,” as defined, attributed to the Bet the Set “21” side bet tablegames up to a maximum of $560. The balance of this liability as of October 31,2006 and 2005, was $526 and $549, respectively.

***VIP note payable.******  ***In connection with ouracquisition of VIP in August 2005, we recorded a note payable with annualinstallments due each July through 2010. The balance of this liability asof October 31, 2006 and 2005, was $329 and $318, respectively.

**CAPITAL RESOURCES**

Excluding any significantacquisitions of businesses, and considering the $100,000 senior securedrevolving credit facility entered into on November 30, 2006, we believeour existing cash, investments, debt financing and projected cash flow fromfuture operations will be sufficient to fund our operations, long-termobligations, capital expenditures, and new product development for theforeseeable future. Projected cash flows from operations are based on ourestimates of revenue and expenses and the related timing of cash receipts anddisbursements. If actual performance differs from estimated performance, projectedcash 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 ofthese 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.

**STOCK REPURCHASE AUTHORIZATIONS**

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 $69 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.

59

----

Share and per share amountshave been adjusted for all periods presented herein to reflect both the January 2005Split and the April 2004 Split.

Our board of directorsperiodically authorizes us to repurchase shares of our common stock. Under ourexisting board authorizations, during the year ended October 31, 2006, werepurchased 317 shares of our common stock for a total cost of $8,665 at anaverage price of $27.39 per share. Under our board authorizations, during theyears ended October 31, 2005 and 2004, we repurchased 1,473 and 1,991shares of our outstanding stock at total costs of $38,643 and $42,524, respectively.We cancel shares that we repurchase. In addition, in April 2004, our boardof directors authorized and we repurchased, in private transactions, anadditional 2,806 shares of our common stock at a total cost of $57,500 withfunds provided from the issuance of our contingent convertible senior notes.

On September 5, 2006, ourboard of directors voted a new authorization to repurchase shares of our commonstock by an additional $30,000. As of October 31, 2006, $30,166 remainedoutstanding under 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 fromtime to time, as to the most prudent uses of our capital resources, includingcash and borrowing capacity. Alternatives that we consider as possible uses ofour capital resources include investment in new products, acquisitions,principal payments on our long term obligations, funding of internal growth inworking capital, and investments in sales-type leases and notes receivable.

**CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEETARRANGEMENTS**

***ContractualObligations.***   The following tablesummarizes our material obligations and commitments to make future paymentsunder certain contracts, including long-term debt obligations, purchasecommitments 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      |                |       | —              |       | —             |       |   | — |   |   |
| VIP note payable                               |       | 329        |       |               | 132        |                |       | 132                 |       | 65                 |       |   | — |   |   |
| ENPAT note payable, including imputed interest |       | 6,000      |       |               | 3,000      |                |       | 3,000               |       | —             |       |   | — |   |   |
| Magnum Gaming                                  |       | 526        |       |               | —     |                |       | —              |       | —             |       |   | 526 |   |   |
| 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    |               |       | $                   | 95,061     |                |       | $                  | 158,034    |   | $ | 957 |   |   | $ | 5,478 |   |   |

 

Our contingent convertible notes may be called onApril 15, 2009 as discussed in Note 7 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.

***Purchasecommitments.***   From time to time,we enter into commitments with our vendors to purchase inventory at fixedprices or in guaranteed quantities. As of October 31, 2006, oursignificant inventory purchase commitments totaled $14,703.

60

----

***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. AmendmentNo. 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 7 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 and2005, of $5,823 and $8,518, respectively, represents the discounted presentvalue of the future payments, including imputed interest of approximately $265and $352, respectively. Principal and interest payments of $3,000 each are duein 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 ouracquisition of VIP in August 2005, we recorded a note payable with annualinstallments due each July through 2010. The balance of the liability asof October 31, 2006 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 

61

----

will” employment agreements, under which the employeeor we may terminate employment. If we terminate any of these employees withoutcause, then we are obligated to pay the employee severance benefits asspecified in their individual contract. As of October 31, 2006, minimumaggregate 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 make estimatesand assumptions that affect our reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities, and our reported amounts ofrevenue and expenses. We periodically evaluate our policies, estimates andrelated assumptions, including: revenue recognition; the amortization,depreciation, and valuation of long-lived tangible and intangible assets;inventory obsolescence and costing methods; provisions for bad debts;accounting for stock-based compensation; and contingencies. We base ourestimates 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.

*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. 

62

----

Revenue from the sale oflifetime licenses, under which we have no continuing obligations, is recordedon 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*” and EITF 00-21, “*Revenue Arrangements with Multiple Deliverables*”.Deliverables are divided into separate units of accounting if:

·  Each item has value to the customer on a standalone 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 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 

63

----

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. Weamortize 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.  In the first step, we estimate the fair valueof the reporting unit and compare it to the book value of the reporting unit,including its goodwill. If the fair value is less than the book value, then wewould perform a second step to compare the implied fair value of the reportingunit’s goodwill to its book value. The implied fair value of the goodwill isdetermined based on the estimated fair value of the reporting unit less thefair value of the reporting unit’s identifiable assets and liabilities. Wewould record an impairment charge to the extent that the book value of thereporting unit’s goodwill exceeds 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 lives, recoverability and fair values. An adverse changeto the estimate of these cash flows could necessitate an impairment charge thatcould adversely affect operating results.

***Inventory  Obsolescence and Costing Methods.******  ***We value our inventory at thelower of cost, determined on a first-in-first-out basis, or market and estimatea provision for obsolete or unsalable inventories based on assumptions aboutthe future demand for our products and market conditions. If future demand andmarket conditions are less favorable than our assumptions, additionalprovisions 

64

----

for obsolete inventory could be required. Likewise,favorable future demand could positively impact future operating results iffully-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.

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.

65

----

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.Although we have no current application for this statement, the adoption ofthis statement may affect our future results of operations, financial positionor cash flows.

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 8 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.

66

----

**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, and accordingly, ourexposure to foreign currency risk has been immaterial. With our acquisition ofCARD in May 2004 and our recent acquisition of Stargames, we expect to continueto increase our volume of business that is denominated in foreign currency. Assuch, we expect an increase in the exposure to our cash flows and earnings thatcould result from fluctuations in foreign currency exchange rates. Whenappropriate, we may attempt to limit our exposure to changing foreign exchangerates by entering into foreign currency exchange contracts.

**ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**
|                                                                                                                                  | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                         |       |     | 68         |   |   |
| Consolidated Statements  of Income for the years ended October 31, 2006, 2005, and 2004                                     |       |     | 69         |   |   |
| Consolidated  Balance Sheets as of October 31, 2006 and 2005                                                                |       |     | 70         |   |   |
| Consolidated Statements of  Changes in Shareholders’ Equity for the years ended October 31, 2006,  2005, and 2004 |       |     | 71         |   |   |
| Consolidated Statements of Cash  Flows for the years ended October 31, 2006, 2005, and 2004                            |       |     | 72         |   |   |
| Notes to  Consolidated Financial Statements                                                                                      |       |     | 74         |   |   |
| Quarterly Financial Data (unaudited)                                                                                             |       |     | 110        |   |   |
| Financial Statement Schedule II—Valuation and  Qualifying Accounts for the years ended October 31, 2006, 2005 and 2004 |       |     | 111        |   |   |

 

67

----

**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

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 of October 31,2006 and 2005, and the related consolidated statements of income, shareholders'equity, and cash flows for each of the three years in the period ended October31, 2006. Our audits also included the financial statement schedule listed inthe Index at Item 8. These consolidated financial statements and the financialstatement schedule are the responsibility of the Company's management. Ourresponsibility is to express an opinion on the consolidated financialstatements and the financial statement schedule based on our 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, and the resultsof their operations and their cash flows for each of the three years in theperiod ended October 31, 2006, in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion, thefinancial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, present fairly, in allmaterial 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.

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 criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated January 16, 2007, expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an adverse opinion on the effectiveness of theCompany’s internal control over financial reporting because of a materialweakness.

**/s/Deloitte & Touche LLP**

Las Vegas, NevadaJanuary 16, 2007

68

----

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

| ** **                                                                        | ** ** | **Year Ended October 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue:**                                                                      |       |                                      |       |   |   |   |   |
| Utility products leases                                                           |       | $                                         | 24,048     |   | $ | 23,721 |   | $ | 19,415 |   |
| Utility products sales and service                                                |       | 63,047                                    |       | 43,308 |   | 26,532 |   |
| Entertainment products leases and royalties                                       |       | 25,503                                    |       | 24,850 |   | 23,700 |   |
| Entertainment products sales and service                                          |       | 50,632                                    |       | 20,689 |   | 15,005 |   |
| Other                                                                             |       | 238                                       |       | 292 |   | 131 |   |
| **Total revenue**                                                                 |       | 163,468                                   |       | 112,860 |   | 84,783 |   |
| **Costs and expenses:**                                                           |       |                                      |       |   |   |   |   |
| Cost of leases and royalties                                                      |       | 11,531                                    |       | 9,692 |   | 8,206 |   |
| Cost of sales and service                                                         |       | 43,125                                    |       | 19,568 |   | 11,197 |   |
| Selling, general and administrative                                               |       | 51,099                                    |       | 30,559 |   | 22,953 |   |
| Research and development                                                          |       | 13,340                                    |       | 7,784 |   | 6,185 |   |
| Gain on sale of patent                                                            |       | (4,566                                    | )          | — |   | — |   |
| In-process research and development                                               |       | 19,145                                    |       | — |   | — |   |
| **Total costs and expenses**                                                      |       | 133,674                                   |       | 67,603 |   | 48,541 |   |
| **Income from operations**                                                        |       | 29,794                                    |       | 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**                                 |       | 21,024                                    |       | 43,600 |   | 34,642 |   |
| **Provision  for income taxes**                                                   |       | 13,976                                    |       | 14,496 |   | 12,125 |   |
| **Income  from continuing operations**                                            |       | 7,048                                     |       | 29,104 |   | 22,517 |   |
| **Discontinued  operations, net of tax**                                          |       | (246                                      | )          | 76 |   | 1,627 |   |
| **Net  income**                                                                   |       | $                                         | 6,802      |   | $ | 29,180 |   | $ | 24,144 |   |
| **Basic  earnings per share:**                                                    |       |                                      |       |   |   |   |   |
| **Continuing operations**                                                         |       | $                                         | 0.20       |   | $ | 0.83 |   | $ | 0.63 |   |
| **Discontinued operations**                                                       |       | —                                    |       | 0.01 |   | 0.04 |   |
| **Net income**                                                                    |       | $                                         | 0.20       |   | $ | 0.84 |   | $ | 0.67 |   |
| **Diluted  earnings per share:**                                                  |       |                                      |       |   |   |   |   |
| **Continuing operations**                                                         |       | $                                         | 0.20       |   | $ | 0.80 |   | $ | 0.60 |   |
| **Discontinued operations**                                                       |       | (0.01                                     | )          | — |   | 0.04 |   |
| **Net income**                                                                    |       | $                                         | 0.19       |   | $ | 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 to consolidated financial statements

69

----

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

| ** **                                                                                                       | ** ** | **October 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                       | ** ** | **2006**             | ** ** | **2005** | ** ** |
| **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                                                                                                      |       | 26,073               |       | 9,428 |   |
| Prepaid income taxes                                                                                             |       | 1,052                |       | — |   |
| Deferred income taxes                                                                                            |       | 6,149                |       | 1,837 |   |
| Other current assets                                                                                             |       | 5,591                |       | 3,255 |   |
| **Total  current assets**                                                                                        |       | 90,508               |       | 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**                                                                                  |       | 8,841                |       | 4,144 |   |
| **Intangible assets, net**                                                                                       |       | 77,904               |       | 48,477 |   |
| **Goodwill**                                                                                                     |       | 92,447               |       | 36,017 |   |
| **Deferred income taxes**                                                                                        |       | 4,294                |       | 2,400 |   |
| **Other assets**                                                                                                 |       | 9,342                |       | 7,088 |   |
| **Total  assets**                                                                                                |       | $                    | 306,128    |   | $ | 193,117 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                   | ** ** | ** **           | ** ** | ** ** | ** ** |
| **Current liabilities:**                                                                                         |       |                 |       |   |   |
| Accounts payable                                                                                                 |       | $                    | 11,166     |   | $ | 3,540 |   |
| Accrued liabilities                                                                                              |       | 11,326               |       | 6,547 |   |
| Customer deposits                                                                                                |       | 5,378                |       | 2,023 |   |
| Deferred revenue                                                                                                 |       | 1,657                |       | 1,495 |   |
| Income taxes payable                                                                                             |       | 938                  |       | 371 |   |
| Note payable and current  portion of long-term liabilities                                                       |       | 77,097               |       | 3,082 |   |
| **Total  current liabilities**                                                                                   |       | 107,562              |       | 17,058 |   |
| **Long-term liabilities, net of  current portion**                                                               |       | 158,951              |       | 162,659 |   |
| **Deferred income taxes**                                                                                        |       | 5,357                |       | — |   |
| **Total  liabilities**                                                                                           |       | 271,870              |       | 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                                                                                                |       | 24,100               |       | 17,298 |   |
| Accumulated other  comprehensive income                                                                          |       | 9,092                |       | 1,545 |   |
| **Total  shareholders’ equity**                                                                             |       | 34,258               |       | 13,400 |   |
| **Total liabilities and shareholders’ equity**                                                              |       | $                    | 306,128    |   | $ | 193,117 |   |

 

See notes to consolidated financial statements

70

----

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

| ** **                                    | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|--------------|------------|-------------------|------------|-------------------|------------|------------|------------|
| ** **                                    | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Deferred** | ** ** | **Retained**      | ** ** | **Other**         | ** ** | **Share-** | ** ** |
| ** **                                    | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Compen-**    | ** ** | **Earnings** | ** ** | **Comprehensive** | ** ** | **holders’** | ** ** |
| ** **                                    | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **sation**   | ** ** | **(Deficit)**     | ** ** | **Income**        | ** ** | **Equity** | ** ** |
| **Balance, October 31, 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                                    |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | 6,802 |   |   |   | — |   |   | 6,802 |   |
| Currency translation                          |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | — |   |   |   | 7,382 |   |   | 7,382 |   |
| Unrealized loss on investments                |       |                  | —     |        |       |           | —     |         |       |              | —     |              |       |       | —     |   |   |   | — |   |   |   | 165 |   |   | 165 |   |
| *Total comprehensive income*                  |       |                  |       |        |       |           |       |         |       |              |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   | 14,349 |   |
| 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**           |       |                  | 34,895     |        |       |           | $          | 349          |       |              |       | $                 | 717        |       |       |   | $ | — |   |   |   | $ | 24,100 |   |   |   | $ | 9,092 |   |   | $ | 34,258 |   |

 

Seenotes to consolidated financial statements

71

----

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

| ** **                                                                     | ** ** | **Year Ended October 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash flows from operating  activities:**                                     |       |                                      |       |   |   |   |   |
| Net income                                                                     |       | $                                         | 6,802      |   | $ | 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                                                                    |       | (5,448                                    | )          | (3,483 | ) | (1,168 | ) |
| Accounts payable and accrued liabilities                                       |       | (729                                      | )          | 2,318 |   | (3,259 | ) |
| Customer deposits and deferred revenue                                         |       | 2,901                                     |       | (48 | ) | 1,009 |   |
| Deferred income taxes                                                          |       | (2,477                                    | )          | (2,403 | ) | 938 |   |
| Prepaid income taxes and income taxes payable                                  |       | 3,318                                     |       | 6,730 |   | (1,084 | ) |
| Other                                                                          |       | (417                                      | )          | (2,699 | ) | 132 |   |
| **Net cash provided by operating activities**                                  |       | 35,771                                    |       | 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, net of cash acquired                                |       | (116,358                                  | )          | (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**                                      |       | (105,892                                  | )          | (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 financing 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 |   |

 

See notes toconsolidated financial statements

72

----

**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 transactions:**                                                                        |       |                                      |       |   |   |   |   |
| Note payable for patent purchase                                                                  |       | $                                         | —     |   | $ | 9,229 |   | $ | — |   |
| Note payable and liabilities incurred 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 |   |
| Unrealized gain on investments, net of tax                                                        |       | —                                    |       | 165 |   | — |   |
| **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

73

----

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

**1.DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Description of business.******  ***We develop, manufacture andmarket technology and entertainment-based products for the gaming industry forplacement on the casino floor. Our products primarily relate to our casinocustomers’ table game activities and focus on either increasing theirprofitability, productivity and security or expanding their gamingentertainment 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 delivery system platformsincluding Table MasterTM, Vegas StarTM , Rapid Table Games and wireless Casino OnDemandTM.

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 offerings areclassified as Entertainment Products and include Rapid Table Games and VegasStar multi-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 RouletteTM, Rapid Sic-BoTM and Rapid Big WheelTM.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.See Note 2 for more information related to the Stargames acquisition.

***Principles ofconsolidation.******  ***Ourconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) and include alladjustments necessary to fairly present our consolidated results of operations,financial position, and cash flows for each period presented.

74

----

**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 inunconsolidated affiliate.******  ***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 the investment,or the inability of the investee to sustain an earnings capacity which wouldjustify 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 123Rrequires that all stock-based compensation, including shares and share-basedawards to employees, be valued at fair value. We measure the fair value ofshare-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 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 previously issuedgrants 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 

75

----

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

provisions of SFAS 123R-3, “Transition ElectionRelated to Accounting for Tax Effects of Share-Based Payment Awards” and haveelected the alternative method for establishing the APIC pool. Accordingly, the$3,682 of excess tax benefits are classified as an operating cash outflow and afinancing cash inflow. See Note 8 for more information.

***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, the disclosureof contingent assets and liabilities, and the reported revenue and expenses. Actualresults 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 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.

*Sales and service revenue*—We generate sales revenue through the saleof equipment 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.

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.

76

----

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

·        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 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 combined witha 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*”and EITF 00-21, “*Revenue Arrangements withMultiple Deliverables*”. Deliverables are divided into separate unitsof accounting if:

·        Eachitem has 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 judgment and utilized a variety ofassumptions 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 

77

----

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

have a material impact to our future reported results.For instance, 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.***  ***Weexpense advertising and promotional costs as incurred, which totaledapproximately $2,069, $576, and $1,150 for the fiscal years ended October 31,2006, 2005 and 2004, respectively.

***Research***and development 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 credit risk.***  ***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 and held 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. Weprovide 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.***  ***Propertyand equipment is stated at cost. Depreciation is recorded using thestraight-line method over the estimated useful life of the asset of three toeight years, or lease terms, if shorter, for leasehold improvements.

***Intangible***assets.***  ***Intangibleassets include intellectual property for games, patents, trademarks,copyrights, licenses and non-compete agreements that were purchased separatelyor acquired in connection with a business combination. Except for the trademarkrelated to the Stargames and CARD acquisitions, which is not subject toamortization and is tested periodically for impairment, all of our significantintangible assets are definite lived and, accordingly, amortized over theirexpected useful lives which range from 2 to 15 years. We amortize substantiallyall of our intangible assets proportionate to the related projected revenuefrom the utilization of the intangible asset. We believe this method reflectsthe pattern in which the economic benefits of the intangible asset are consumedor otherwise used up. For certain other intangibles, we use the straight-lineamortization method. See Note 6 for more information.

***Impairment******of long-lived assets.******  ***We estimatethe useful lives of our long-lived assets, excluding goodwill, based onhistorical experience, estimates of products’ commercial lives, the likelihoodof 

78

----

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

technological obsolescence, and estimates of the duration of commercialviability 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 animpairment loss if the carrying amount of the asset or asset group is notrecoverable and the carrying amount exceeds its estimated fair value. Fairvalue is determined based on discounted expected future cash flows.

***Goodwill.******  ***In accordance with Statementof Financial Accounting Standards 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 estimate the fair valueof the reporting unit and compare it to the book value of the reporting unit,including its goodwill. If the fair value is less than the book value, then wewould perform a second step to compare the implied fair value of the reportingunit’s goodwill to its book value. The implied fair value of the goodwill isdetermined based on the estimated fair value of the reporting unit less thefair value of the reporting unit’s identifiable assets and liabilities. Wewould record an impairment charge to the extent that the book value of thereporting unit’s goodwill exceeds its fair value. No goodwill impairments wererecorded 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. Foreignexchange translation adjustments are recorded as a separate component ofshareholders’ 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 other expenseon 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.

***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.

79

----

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

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 do not expect the adoption of thisstatement to have a material impact on our results of operations, financialposition or cash flows.

In March 2005, the SECissued SAB 107, “*Share-Based Payment”*(“SAB 107”*)*, providing interpretive guidance on SFAS 123R valuationmethods, assumptions used in valuation models, and the interaction of SFAS 123Rwith existing SEC guidance. The additional SAB 107 requirement for theclassification of stock compensation expense to the same financial statementline as cash compensation affected our cost of product sales and gamingoperations, related gross profits and margins, R&D, and SG&A expenses.We adopted the provisions of SFAS 123R and SAB 107 in the first quarter offiscal 2006. See Note 8 for additional information.

**2. 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 7 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 |   |

 

80

----

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

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 an appraiser,the fair values based on discounted cash flows and estimates by us. Thepurchase price allocation is preliminary and may be adjusted for up to one yearafter the acquisition. The following table sets forth the preliminaryallocation of the purchase price:

| Accounts receivable,  net of allowance for bad debts of $1,907 |   | $        | 10,733  |   |
|----------------------------------------------------------------|--------|----------|---------|--------|
| Inventory                                                      |   | 11,338   |    |
| Other current assets  (including cash of $98)                  |   | 4,240    |    |
| Other long-term  assets                                        |   | 7,134    |    |
| Assumed liabilities                                            |   | (19,016) |    |
| Deferred tax  liabilities                                      |   | (5,685)  |    |
| Developed technology,  average life of 4 years                 |   | 8,338    |    |
| Customer relationships,  average life of 10 years              |   | 10,015   |    |
| Tradename                                                      |   | 17,291   |    |
| Goodwill                                                       |   | 53,479   |    |
| In-process research  and development                           |   | 19,145   |    |
| PVS disposal  liability                                        |   | (654)    |    |
|                                                           |   | $        | 116,358 |   |

 

The acquisition of Stargames enhances the products inour Entertainment Products segment as well as providing for additionalelectronic platforms for our branded content. Additionally, we acquired astrong brand name as well as an experienced and talented management team. Thesefactors result in the recognition of certain intangible assets, discussedbelow, and significant goodwill. Developed technology is being amortized on astraight-line basis over its useful life and is charged to cost of sales andservice, a component of gross margin. Customer relationships are being amortizedon a straight-line basis over their useful life and are reflected in selling,general and administrative expenses in the consolidated statement ofoperations.

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.

81

----

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

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.

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                     |       |                              | $          | 173,111                           |       |   |   | $ | 162,557 |   |   |
| Operating income            |       |                              | 34,911     |                              |       |   | 38,115 |   |   |
| Discontinued  operations    |       |                              | (413       | )                                 |       |   | (123 | ) |   |
| Net income                  |       |                              | 22,264     |                              |       |   | 25,124 |   |   |
| Basic earnings per share:   |       |                              |       |                              |       |   |   |   |   |
| Net income                  |       |                              | $          | 0.64                              |       |   |   | $ | 0.72 |   |   |
| Diluted earnings per share: |       |                              |       |                              |       |   |   |   |   |
| Net income                  |       |                              | $          | 0.62                              |       |   |   | $ | 0.69 |   |   |

 

The unaudited pro forma condensed consolidatedfinancial statements have been prepared based upon currently availableinformation and assumptions that are deemed appropriate by management. The proforma information 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 

82

----

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

transactions occurred on the dates indicated, nor doesthis information represent a forecast of the consolidated financial position atany future date or the combined financial results 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 $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 

83

----

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

part of the second private equity investment, we alsoreceived an additional 833 warrants to purchase shares of Sona’s common stockat prices as specified in the agreement. The investment in Sona is accountedfor under the equity method of accounting in accordance with FinancialAccounting 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 months ended October 31, 2006, whichrepresents our 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 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 ended October 31,2006 and is reflected in the accompanying consolidated balance sheets inintangible assets.

**3. FINANCIALINSTRUMENTS**

***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 and accounts payable approximate their carrying values due tothe relatively short-term nature of the instruments.

84

----

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

We estimate that the fair value of our ContingentConvertible Senior Notes as of October 31, 2006, is $172,313 based onquoted market prices.

**4. RECEIVABLESAND 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 |   |

 

| ** **                                                              | ** ** | **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     |       |

 

85

----

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

**5.   OTHER BALANCESHEET DATA**

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

| ** **                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| **Inventories:**                             |       |     |       |     |       |
| Raw materials and component parts            |       | $        | 9,585      |     | $          | 4,235 |   |
| Work-in-process                              |       | 3,051    |       | 820      |       |
| Finished goods                               |       | 13,437   |       | 4,373    |       |
|                                         |       | $        | 26,073     |     | $          | 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                       |       | 3,735    |       | 2,629    |       |
| Production equipment and other               |       | 9,672    |       | 3,923    |       |
|                                         |       | 20,242   |       | 10,412   |       |
| Less: accumulated depreciation               |       | (11,401  | )          | (6,268   | )          |
|                                         |       | $        | 8,841      |     | $          | 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 |   |

 

86

----

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

**6. INTANGIBLEASSETS 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.

87

----

**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                      |   | 53,479 |   |
| Foreign currency translation adjustment |   | 3,294  |   |
| Other                                   |   | (343   | )      |
| Balance at October 31,  2006       |   | $      | 92,447 |   |

 

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.

**7. 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                                                                        |       | 1,057    |       | 189      |       |
|                                                                         |       | 236,048  |       | 165,741  |       |
| Less: current portion                                                        |       | (77,097  | )          | (3,082   | )          |
|                                                                         |       | $158,951 |       | $162,659 |       |

 

***Contingent convertiblesenior notes.******  ***InApril 2004, we issued $150,000 of contingent convertible senior notes due 2024(the “Notes”) through a private placement under Rule 144A of the Securities Actof 1933. 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 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.

88

----

**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 yet occurred;

·       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% of theprincipal 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 of theNotes, plus accrued and unpaid interest and including liquidated damages, ifany, 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 entered intoAmendment No. 1 (the “Amendment”) to the Old Credit Agreement. The Amendmentextended the maturity date for the Bridge Loan to July 24, 2006 and we agreedto use our commercially reasonable efforts to secure the loan extended underthe Old Credit Agreement. On July 24, 2006, we entered into Amendment No.2 (“Amendment No. 2”) to the Old Credit Agreement. Amendment No. 2 extended thematurity date for the Bridge Loan to September 30, 2006. On July 31, 2006, weentered into a security agreement, as required by Amendment No. 2, with DeutscheBank AG New York Branch, as collateral agent. On September 29, 2006, we enteredinto Amendment No. 3 (“Amendment No. 3”) to the Old Credit Agreement. AmendmentNo. 3 extended the maturity date for the Bridge Loan to October 31, 2006. OnOctober 31, 2006, we entered into Amendment No. 4 (“Amendment No. 4”) to theOld Credit Agreement. Amendment No. 4 extended the maturity date for the BridgeLoan to November 30, 2006.

89

----

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

As of October 31, 2006, we were in compliance with allof the affirmative and negative covenants pursuant to the Old Credit Agreement.Additional information on these covenants may be found in Section 7 andSection 8 of the Old Credit Agreement included in our Current Report onForm 8-K, dated January 25, 2006. The principal balance on the BridgeLoan 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 onNovember 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.

Additional information on these covenants may be foundin Section 7 and Section 8 of the New Credit Agreement included inour Current Report on Form 8-K, dated December 5, 2006.

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. 

90

----

**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 long termassets 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, 2006were AU $5,000 or US $3,872 at a weighted average interest rate of 6.45%. Thebanking 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 was incompliance with all financial covenants. The facilities are subject to the nextcompliance assessment as of October 31, 2006. 

***BTI liabilities.***   In connection with ouracquisition of certain assets from BTI, we recorded an initial estimatedliability of $7,616 for contingent installment payments computed as the excessfair value of the acquired assets over the fixed installments and other directcosts. In November 2004, we began paying monthly note installments based on apercentage of certain revenue 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 and2005, was $4,441 and $6,167, respectively. 

***ENPAT note payable.***   In December 2004, we purchasedtwo RFID technology patents from ENPAT for $12,500. The purchase price wascomprised of an initial payment of $2,400 followed by a $1,100 payment inJanuary 2005 and non-interest bearing annual installments through December 2007.The balance as of October 31, 2006 and 2005, of $5,823 and $8,518,respectively, represents the discounted present value of the future payments,including imputed interest of approximately $265 and $352, respectively.Principal and interest payments of $3,000 each are due in December 2006 and2007.

***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 ouracquisition of VIP in August 2005, we recorded a note payable with annualinstallments due each July through 2010. The balance of this liability as ofOctober 31, 2006 and 2005, was $329 and $318, respectively.

91

----

**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                                       |       | $          | 77,097     |       |
| 2008                                       |       | 3,138      |       |
| 2009                                       |       | 150,204    |       |
| 2010                                       |       | 270        |       |
| 2011                                       |       | 98         |       |
| Thereafter                                 |       | 5,241      |       |
| **Total**                                  |       | $          | 236,048    |       |

 

**8. 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)(“SFAS 123R”), “*Share-Based Payment*”, and SECStaff Accounting Bulletin No. 107 (“SAB 107”), “*Share-BasedPayment*”, 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 StockIssued to Employees*”, and the Financial Accounting Standards Board’sInterpretation No. 44, “*Accounting for CertainTransactions Involving Stock Compensation, an Interpretation of APB OpinionNo. 25*”, and disclosed supplemental information in accordancewith Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “*Accounting for Stock-Based Compensation*.” Under thesestandards, we did not incur compensation expense for employee stock optionswhen the exercise price was at least 100% of the market value of our commonstock 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 onNovember 1, 2005, and began recognizing expense for the unvested portionof previously issued grants at the same time, based on the valuation andattribution methods originally 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*

92

----

**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 award plans.***   InFebruary 2004, our board of directors adopted and, in March 2004, ourshareholders approved the Shuffle Master, Inc. 2004 Equity Incentive Plan(the “2004 Plan”) and the Shuffle Master, Inc. 2004 Equity Incentive Planfor Non-Employee Directors (the “2004 Directors’ Plan”). These approved plansreplaced our prior plans and no further options may be granted from the priorplans. Both the 2004 Plan and the 2004 Directors’ Plan provide for the grant ofstock options, stock appreciation rights (none issued), and restricted stock,individually or in any combination (collectively referred to as “Awards”).Stock options may not be granted at an exercise price less than the marketvalue of our common stock on the date of grant and may not be subsequentlyrepriced. Options granted under the 2004 Plan generally vest in equalincrements over four years and expire in ten years. Options granted under the2004 Directors’ Plan generally vest immediately 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 October31, 2006, 1,125 and 883 shares are available for grant under the 2004 Plan and2004 Directors’ 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.

93

----

**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 summary of activity relatedto restricted stock for the year ended October 31, 2006 is presentedbelow:

| ** **                     | ** ** | ** ** | ** ** | **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 |   |

 

94

----

**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 |   |

 

95

----

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

***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 the yearsended 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     |       |

 

**9. 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                          |       | $        | 7,048      |     | $          | 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                                    |       | $        | 0.20       |     | $          | 0.83     |       | $ | 0.63 |   |
| Diluted earnings per share                                  |       | $        | 0.20       |     | $          | 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 

96

----

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

averagefair value of our common stock exceeded $28.07, and accordingly, the dilutiveeffect is included in our diluted shares calculation.

**10. 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.

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 per share.Under ourboard authorizations, during the years ended October 31, 2005 and 2004, werepurchased 1,473 and 1,991 shares of our outstanding stock at total costs of$38,643 and $42,524, respectively. We cancel shares that we repurchase. Inaddition, 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.

97

----

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

***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. Theamendment (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 agent to Wells Fargo Bank, N.A.The amendment eliminated from the Rights Agreement those provisions commonlyreferred to as “dead hand” 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 with respect toeach share of our common stock that shall become outstanding thereafter untilthe Rights become exercisable or they expire as described below. Each Rightinitially entitles holders of our common stock to buy one one-hundredth of ashare of our Preferred Stock at a price of $5.33 (as currently adjusted),subject to adjustment. The Rights will generally become exercisable after aperson or group acquires beneficial ownership of 20% or more of our commonstock or announces a tender offer upon consummation of which such person orgroup 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.

**11.   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. Wemay make matching contributions to the plan based on a percentage of 

98

----

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

employee compensation and actual contributions. In theyears ended October 31, 2006, 2005 and 2004, we elected to make matchingcontributions of 50% of employee contributions up to 4% of compensation, totaling$248, $234, and $194, respectively.

***Austrian pension commitments.******  ***In April and May 2004, we formalized our defined contributionpension agreements with certain Austrian employees. We pay contributions to anexternal pension fund administered by ÖPAG Pensionskassen AG. Aggregate pensionexpense relating to our Austrian agreements in the years ended October 31,2006, 2005 and 2004 were $53, $36 and $25, respectively.

**12.   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 year ended October 31, 2006, interest income related to our investmentin sales type leases and notes receivable was $1,229 as compared to $948 forthe same prior year period.

Interest expense as of October 31, 2006, isprimarily related to the $150,000 of Notes due in April 2024 and theBridge Loan which matures in November 2006. A more detailed discussion ofthe Notes and the Bridge Loan are included below under the heading “Liquidityand Capital Resources.”

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.

**13. 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 

99

----

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

is more likely than not to be realized. We evaluatethe likelihood of recovering our deferred tax assets by estimating sources offuture taxable income. The provision for income taxes is the sum of the taxcurrently payable and the change in deferred taxes during the year.

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

| ** **               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Continuing operations    |       | $        | 13,976     |     | $          | 14,496   |       | $ | 12,125 |   |
| Discontinued  operations |       | (90      | )          | 44       |       | 876      |       |
| Total                    |       | $        | 13,886     |     | $          | 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       |       | $        | 13,675     |     | $          | 16,364   |       | $ | 9,447 |   |
| State         |       | 664      |       | 1,210    |       | 1,082    |       |
| Foreign       |       | 1,290    |       | (526     | )          | 526      |       |
|          |       | 15,629   |       | 17,048   |       | 11,055   |       |
| **Deferred:** |       |     |       |     |       |     |       |
| Federal       |       | (1,276   | )          | (2,980   | )          | 718      |       |
| State         |       | (57      | )          | (312     | )          | —   |       |
| Foreign       |       | (320     | )          | 740      |       | 352      |       |
| ** **    |       | (1,653   | )          | (2,552   | )          | 1,070    |       |
| **Total**     |       | $        | 13,976     |     | $          | 14,496   |       | $ | 12,125 |   |

 

100

----

**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                                 |       | $          | 3,866      |       | $          | 976 |   |
| Accounts receivable                         |       | 684        |       | 368        |       |
| Employee benefits                           |       | 768        |       | 234        |       |
| Deferred revenue                            |       | 835        |       | 44         |       |
| Investment impairment reserves              |       | 1,033      |       | 376        |       |
| Other reserves                              |       | 242        |       | 415        |       |
| Restricted stock                            |       | 2,081      |       | 380        |       |
| Depreciation                                |       | 391        |       | 87         |       |
| Foreign net operating loss carryforward     |       | 1,385      |       | 407        |       |
| Contingent consideration on patent purchase |       | 1,926      |       | 2,525      |       |
| Foreign tax credits / receivables           |       | 332        |       | —     |       |
| Other                                       |       | 304        |       | 133        |       |
| **Total  gross deferred tax assets**        |       | 13,847     |       | 5,945      |       |
| **Less:  valuation allowance**              |       | (880       | )          | (363       | )          |
| **Deferred  tax assets**                    |       | 12,967     |       | 5,582      |       |
| **Deferred tax liabilities:**               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Goodwill                                    |       | 1,608      |       | 908        |       |
| Intangible amortization                     |       | 5,959      |       | 273        |       |
| Other                                       |       | 314        |       | 164        |       |
| **Total  gross deferred tax liabilities**   |       | 7,881      |       | 1,345      |       |
| **Net deferred tax assets**                 |       | $          | 5,086      |       | $          | 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.

101

----

**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        |       | 31.9     | %          | 0.0      | %          | 0.0      | %          |
| Foreign dividend inclusion                  |       | 8.8      | %          | 0.0      | %          | 0.0      | %          |
| Other permanent  differences                |       | (5.3     | %)         | (1.9     | %)         | (1.4     | %)         |
| State income taxes,  net of federal benefit |       | 2.3      | %          | 2.1      | %          | 2.0      | %          |
| Tax credits                                 |       | (7.5     | %)         | (1.8     | %)         | (1.4     | %)         |
| Effect from foreign  tax rate differences   |       | 0.4      | %          | 0.7      | %          | 0.9      | %          |
| Other                                       |       | 0.9      | %          | (0.8     | %)         | (0.1     | %)         |
| Effective tax rate                          |       | 66.5     | %          | 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 34.8%.

**14. 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.

102

----

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

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 an activity-basedallocation of other general product-related costs, the most significant ofwhich are service and selling expenses, including stock option expense, andmanufacturing overhead. Corporate general and administrative expenses are notallocated to segments. Capital expenditures include amounts reported in ourconsolidated statements of cash flows for purchases of leased products,property and equipment, and intangible assets plus the financed or non-cashportion of these purchases which is excluded from cash flows.

As discussed in Note 2, 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 $54,579 and $0 as of October 31, 2006 and 2005, respectively,has been allocated to the Entertainment product segment.

103

----

**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                   |       | $        | 87,095     |     | $          | 67,029   |       | $ | 45,947 |   |
| Entertainment products             |       | 76,135   |       | 45,539   |       | 38,705   |       |
| Corporate                          |       | 238      |       | 292      |       | 131      |       |
|                               |       | $        | 163,468    |     | $          | 112,860  |       | $ | 84,783 |   |
| **Income (Loss) from operations:** |       |     |       |     |       |     |       |
| Utility products                   |       | $        | 44,449     |     | $          | 32,595   |       | $ | 21,362 |   |
| Entertainment products             |       | 17,648   |       | 33,529   |       | 29,586   |       |
| Corporate                          |       | (32,303) |       | (20,867) |       | (14,706) |       |
|                               |       | $        | 29,794     |     | $          | 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                   |       | $        | 111,103    |     | $          | 99,265   |       | $ | 88,019 |   |
| Entertainment products             |       | 152,803  |       | 40,979   |       | 30,868   |       |
| Corporate                          |       | 42,222   |       | 52,873   |       | 66,405   |       |
|                               |       | $        | 306,128    |     | $          | 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 45%, 23%,and 23% of consolidated revenue, respectively. No individual customer accountedfor more than 10% of consolidated revenue.

104

----

**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                       |       | $        | 90,761     |     | 55.5%      |     | $          | 87,250 |   | 77.3% |   | $ | 65,392 |   | 77.1% |   |
| Canada                              |       | 7,103    |       | 4.3%     |       | 5,303    |       | 4.7% |   | 6,465 |   | 7.6% |   |
| Other North America                 |       | 2,922    |       | 1.8%     |       | 2,214    |       | 2.0% |   | 2,584 |   | 3.0% |   |
| Europe                              |       | 9,920    |       | 6.1%     |       | 8,147    |       | 7.2% |   | 4,176 |   | 4.9% |   |
| Australia                           |       | 27,149   |       | 16.6%    |       | 2,440    |       | 2.2% |   | 4,281 |   | 5.0% |   |
| Asia                                |       | 24,113   |       | 14.8%    |       | 6,631    |       | 5.9% |   | 1,216 |   | 1.4% |   |
| Other                               |       | 1,500    |       | 0.9%     |       | 875      |       | 0.8% |   | 669 |   | 0.8% |   |
|                                |       | $        | 163,468    |     | 100.0%     |     | $          | 112,860 |   | 100% |   | $ | 84,783 |   | 100% |   |
| **Long-lived assets, end of year:** |       |     |       |     |       |     |       |   |   |   |   |   |   |
| United States                       |       | $        | 61,152     |     | 28.4%      |     | $          | 56,143 |   | 47.4% |   | $ | 41,077 |   | 38.4% |   |
| Austria                             |       | 53,667   |       | 24.9%    |       | 53,799   |       | 45.4% |   | 59,755 |   | 55.8% |   |
| Australia                           |       | 100,173  |       | 46.5%    |       | 6,617    |       | 5.6% |   | 5,985 |   | 5.6% |   |
| Other                               |       | 628      |       | 0.3%     |       | 1,866    |       | 1.6% |   | 221 |   | 0.2% |   |
|                                |       | $        | 215,620    |     | 100.0%     |     | $          | 118,425 |   | 100.0% |   | $ | 107,038 |   | 100.0% |   |

 

**15.COMMITMENTS AND 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.

***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 

105

----

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

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 has establisheda liability of $120 for those matters where the amount of loss is probable andreasonably estimable. The amount of the liability is based on management’s bestestimate given the Company’s history with similar matters and interpretationsof 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 financial position.We believe costs associated with litigation will not have a material impact onour financial position or liquidity, but may be material to the results ofoperations in any given period. We assume no obligation to update the status ofpending litigation, except as may be required by applicable law, statute orregulation.

**Continuingoperations—**

*VendingData II —**In*October 2004, we fileda 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.

In March 2005, the Courtof Appeals for the Federal Circuit (the “Federal Circuit”) stayed the Injunctionbased on a technical defect in the Court’s process in granting the Injunction,and not on its merits. In May 2005, the Court held a Markman hearing forconstruction of the claims. On September 26, 2005, U.S. Magistrate JudgeLawrence R. Leavitt for the District of Nevada issued his Claim ConstructionReport and Recommendation in the Markman hearing concerning 

106

----

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

VendingData’s PokerOneTMshuffler. The Magistrate Judge’s findings were limited to his interpretation ofcertain words in the patent claim asserted by us, and he agreed with theinterpretation put forth by VendingData. The Magistrate Judge’s Recommendationis not a determination of whether the PokerOneTMinfringes the asserted patent, nor does itspeak to the validity of our claims. We have filed a written objection with theCourt to the Magistrate Judge’s ruling. This objection is now 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 that infringementexists under either our claim construction or VendingData’s claim construction,and we believe that our claim construction is the proper one. The FederalCircuit did not rule on which claim construction is the proper one. Therecan be no guarantee that the Court or, upon any further appeal, the FederalCircuit will agree with our claim construction. We intend to continue toenforce 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 infringementlawsuit against Gaming Entertainment, Inc. (“GEI”) in the U.S. DistrictCourt for the District of Nevada, in Las Vegas, Nevada. The lawsuit allegesthat GEI’s 3-5-7 PokerTM game infringes one of our 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 25 and April 26, 2005, ourrescission trial was held in the District Court in Clark County, Nevada in theAwada and Gaming Entertainment, Inc. case against us and our CEO, MarkYoseloff. At the conclusion of the trial, the court granted our rescissionmotion, ordering that the subject contract, called the “Game Option Agreement”,be rescinded and/or void. On May 18, 2005, the Court entered Findings ofFact/Conclusions of Law confirming the Court’s rescission ruling. Among thefindings, the Court found that the actions of plaintiffs Yehia Awada and GamingEntertainment, Inc. demonstrated that the plaintiffs never had anyintention of conveying to us the exclusive license to the 3-Way Actiongame, as they had agreed and were required to do under the Game OptionAgreement. The Court further found that we had established by a preponderanceof the evidence that the plaintiffs had materially failed to perform theirobligations under the Game Option Agreement and that we were entitled to theremedy of rescission. On May 5, 2005, the Court ruled on the parties’damages requests in connection with the case and as required under Nevada law.Plaintiffs were seeking approximately $13,000 in damages. The Court orderedthat the total damages under Nevada law due to the successful rescission of theGame Option Agreement was $130, including all interest. The damages amount waspaid in June 2006.

Plaintiffs have appealed the Court’sorder granting the rescission of the “Game Option Agreement” to the NevadaSupreme Court.

107

----

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

*Awada II —**On***September 12, 2005, we filed a new lawsuitagainst defendants Awada and Gaming Entertainment, Inc. The lawsuitalleges that our Four Card Poker® gameis being infringed and illegally copied by the defendants’ Play Four Pokergame. The lawsuit claims that the defendants are violating the federal LanhamAct by infringing the trademark/trade dress of our Four Card Poker® game layout, and that the defendants arecommitting acts of unfair competition, interference with prospective businessadvantage and conversion. Our action seeks appropriate injunctive relief againstdefendants’ Play Four Poker game layout, as well as unspecified monetarydamages. On September 15, 2005, the U.S. District Court for the Districtof Nevada issued a temporary restraining order prohibiting the defendants fromdisplaying or advertising the infringing layout.

On or about December 6, 2005, the defendantsanswered our complaint and denied all liability. They also filed counterclaimsfor alleged patent misuse, anti-trust violations based on said patent misuse,patent invalidity, unfair competition, unfair trade practices, and otherrelated claims. The counterclaims seek an unspecified amount of damages,disgorgement of our profits as a result of our alleged unfair trade practices,and preliminary and permanent injunctive relief against our alleged unfairtrade practices. The defendants filed these counterclaims against both us andour CEO. We completely and uncategorically deny the defendants’ counterclaims,and intend to vigorously oppose them. On January 9, 2006, we filed amotion 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 MPGames LLC and certain other defendants in the U.S. District Court for theDistrict of Nevada, in Las Vegas, Nevada. The complaint alleges that thedefendants’ MP21 System infringes two patents owned by us. The complaint alsoalleges misappropriation of trade secrets against certain, but not all, of thedefendants, and also includes claims for correction of named inventor oncertain related patents held in the name of certain of the defendants. We areseeking a permanent injunction and an as yet undetermined amount of damagesagainst all of the defendants. The defendants have answered our complaintdenying infringement and also claiming that the two patents are invalid. Thedefendants have also counterclaimed against us, claiming that we infringeseveral of their patents, and that we misappropriated certain of their tradesecrets, and are seeking damages against us. We deny any infringement,misappropriation or wrongdoing. In May 2005, the Court dismisseddefendants’ breach of contract counterclaim. In a recent Two-Party Agreementtransaction with IGT, IGT purchased a 50% ownership interest in the two patentswhich are the subject of this lawsuit, and IGT has been added as a namedplaintiff in this lawsuit. On December 20, 2005, the Court entered itsMarkman order, construing the disputed claims in the various patents-in-suit.The Court ruled in our favor on a number of disputed terms and in thedefendants’ favor on others. Some or all of these rulings may be overturned onappeal. Litigation will continue on all claims in the case. In August 2006,the Court dismissed all but one of the defendants’ trade secretmisappropriation claims.

*MP Games II (Washington) —**In***June 2005, MP Games LLC, Alliance Gaming andBally Gaming, which are among the defendants in MP Games I, filed a complaintagainst us in the U.S. District Court for the Western District of Washington,in Seattle, Washington. The complaint included the breach of contract claimwhich had been dismissed from the MP Games Nevada litigation, discussed above,as well as related claims of misappropriation of trade secrets and patent 

108

----

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

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 invalidity counterclaimwithout prejudice.

**Discontinued operations—**

*Fleetwood —**In January 2004, we filed a complaint in District Courtin Clark County, Nevada seeking a declaratory judgment that we did not commitany breach of a non-binding Memorandum of Understanding with FleetwoodManufacturing, Inc. (“Fleetwood”) regarding our sale of our then slotoperating system, and that said Memorandum of Understanding did not create alegally binding contract on the parties. Fleetwood filed a counterclaimalleging breach of the obligation to negotiate in good faith. On October 6,2006, the District Court granted our Motion for Summary Judgment on Fleetwood’scounterclaim and entered a final judgment in our favor in the case. In December 2006,Fleetwood agreed to reimburse 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.

**16.SUBSEQUENT EVENTS**

***$100,000 RevolvingCredit Facility.******  ***OnNovember 30, 2006, we entered into a $100,000 senior secured revolving creditfacility (the “New Credit Agreement”) with Deutsche Bank AG Cayman IslandsBranch, as a Lender, Deutsche Bank Trust Company Americas, as AdministrativeAgent, Deutsche Bank Securities Inc. and Wells Fargo, N.A., as Joint LeadArrangers and Book Managers and Wells Fargo, N.A. as Syndication Agent. We drew$71,180 on the facility, which was used to repay in its entirety the Old CreditAgreement. Any remaining amount available under the revolving credit facilitywill be used for working capital, capital expenditures and general corporatepurposes, including share repurchases. The revolving credit facility under theNew Credit Agreement will mature on November 30, 2011. Additionalinformation on the New Credit Agreement may be found in our Current Report on Form 8-K,dated December 5, 2006.

109

----

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

| ** **                                      | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **January 31**    | ** ** | **April 30** | ** ** | **July 31** | ** ** | **October 31** | ** ** |
| **2006:**                                       | ** ** |                   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenue                                         |       |                   | $          | 33,318 | ** ** |   | $ | 43,303 |   | $ | 40,737 |   |   | $ | 46,110 | ** ** |   |
| Gross profit                                    |       |                   | 23,396     | ** ** |   | 28,849 |   | 27,388 |   |   | 29,179 | ** ** |   |
| Income from  continuing operations              |       |                   | 7,218      | ** ** |   | (12,632 | ) | 7,443 |   |   | 5,019 | ** ** |   |
| Net income                                      |       |                   | 7,353      | ** ** |   | (12,720 | ) | 7,269 |   |   | 4,900 | ** ** |   |
| Earnings per share — continuing operations |       |                   |       | ** ** |   |   |   |   |   |   |   | ** ** |   |
| Earnings per share,  basic                      |       |                   | 0.21       | ** ** |   | (0.37 | ) | 0.21 |   |   | 0.15 | ** ** |   |
| Earnings per share,  diluted                    |       |                   | 0.20       | ** ** |   | (0.37 | ) | 0.20 |   |   | 0.14 | ** ** |   |
| **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 | ** ** |   |

 

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 10.

110

----

**SCHEDULE II — 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 |   |   |   |

----

(a)            For the year endedOctober 31, 2006, favorable collections efforts, primarily at Stargames,resulted in a credit of ($777) in the provision for bad debts related toaccounts receivable.

111

----

**ITEM 9. CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON 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 weakness in ourinternal control over financial reporting described below, as ofOctober 31, 2006 our disclosure controls and procedures were noteffective.

Notwithstanding management’sassessment that our internal control over financial reporting was ineffectiveas of October 31, 2006 due to the material weakness described below underManagement’s Report on Internal Control Over Financial Reporting, we believethat the consolidated financial statements included in this Annual Report onForm 10-K correctly present our financial condition, results ofoperations and cash flows for the fiscal years covered thereby in all materialrespects. As a result of the deficiency described above, we have performedadditional analysis and post closing procedures in order to prepare theconsolidated financial statements in accordance with generally acceptedaccounting principles.

**Internal Control overFinancial Reporting**

*Management’s Report onInternal Control Over Financial Reporting*

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 accounting principles. Management is responsible for establishing andmaintaining adequate internal control over our financial reporting.

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 

112

----

revenue for the year ended October 31, 2006 andapproximately 41.8% of our total assets at October 31, 2006. Based on suchevaluation, management identified deficiencies that were determined to be amaterial weakness.

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. Because of the material weaknessdescribed below, management concluded that our internal control over financialreporting was not effective as of October 31, 2006.

The specific material weakness identified bymanagement is described as follows:

The Company did not have adequate internal controlsover the evaluation and review of non-routine transactions involving judgmentsand estimates to determine that such transactions are recorded in accordancewith generally accepted accounting principles. This weakness in the operatingeffectiveness of internal controls resulted in adjustments to revenuerecognized and the impairment write-down of an equity method investment. Whilesuch adjustments were not deemed to be individually material to the financialstatements as of and for the year ended October 31, 2006 they were deemedto be material in the aggregate.

Deloitte & Touche LLPhas issued an attestation report on management’s assessment of our internalcontrol over financial reporting. This report follows this Item 9A.

***Changes in Internal Control Over Financial Reporting***

Except for the remediationinitiatives with respect to the prior year material weakness described below,there have been no changes in our internal control over financial reportingthat occurred during our fiscal year ended October 31, 2006, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**Remediation Initiatives- Prior Year Material Weakness**

As reported in Item 9A of our Annual Report onForm 10-K dated February 27, 2006, management previouslyconcluded that its internal control over financial reporting was not effectiveas of October 31, 2005. Such conclusion resulted from the identificationof deficiencies that were determined to be a material weakness. Specifically,we did not have appropriate internal controls specific to the recognition ofrevenue related to the identification and communication of non-standardtransactions. This included the lack of a comprehensive process to address thesales, legal and financial functions, and identification and communication, ofsuch non-standard transactions. The controls in place were not adequate toidentify and evaluate the appropriate accounting treatment for revenuetransactions with non-standard terms, including extended payment terms, futurecommitments and establishment of reasonable assurance of collectibility thataffected the timing and amount of revenue recognized. The deficiencies were concludedto be a material weakness based on the significance of the potentialmisstatement of the annual and interim financial statements and thesignificance of the controls over revenue recognition to the preparation ofreliable 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 

113

----

recognition. Additionally, provided training to oursales organization to heighten the awareness of revenue recognition concepts,with emphasis 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 suchremediation initiatives, as a result of the above material weakness identifiedat October 31, 2006 over the application of generally accepted accountingprinciples to non-routine transactions, the Chief Executive Officer and ChiefFinancial Officer have concluded that the material weakness related toinadequate controls in place to identify and evaluate the appropriateaccounting treatment for revenue transactions with non-standard terms stillexisted at October 31, 2006.

***Remediation Plan***

Subsequent toOctober 31, 2006, the Company will identify and adopt measures to remedythe material weakness described above. Such remedial measures include, but arenot limited 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.

The implementation of these initiatives and additionalprocedures being developed is a priority for us in fiscal year 2007.

114

----

**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, that Shuffle Master, Inc. and Subsidiaries (the “Company”) didnot maintain effective internal control over financial reporting as ofOctober 31, 2006, because of the effect of the material weaknessidentified 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, management excluded from their assessment the internal control overfinancial reporting of Stargames Limited, which was acquired inFebruary 2006 and whose financial statements reflect total assets andrevenues constituting 41.8 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, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis 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. Acompany’s internal 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 reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and(3) provide reasonable assurance regarding prevention or timely detectionof unauthorized acquisition, use, or disposition of the company’s assets thatcould 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.

115

----

A material weakness is a significant deficiency, orcombination of significant deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesshas been identified and included in management’s assessment: the Company didnot have adequate internal controls over the evaluation and review ofnon-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 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 endedOctober 31, 2006 they were deemed to be material in the aggregate. Thismaterial weakness was considered in determining the nature, timing, and extentof audit tests applied in our audit of the consolidated financial statementsand financial statement schedule as of and for the year ended October 31, 2006,of the Company and this report does not affect our report on such financialstatements and financial statement schedule.

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 materialweakness 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, expressed an unqualified opinion onthose financial statements and financial statement schedule and includes anexplanatory paragraph relating to the adoption of Statement of FinancialAccounting Standards No. 123(R), *Share-Based Payment*,**on November 1, 2005.

**/s/ Deloitte & Touche LLP**

Las Vegas, NevadaJanuary 16, 2007

116

----

**ITEM 9B. OTHER INFORMATION**

None.

117

----

**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 we grantany 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 ANDRELATED 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.

118

----

**PART IV**

**ITEM 15. EXHIBITSAND 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). |

 

119

----

 

|        |   | 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).                                                                                                                                                                                                          |

 

120

----

 

|        |   | 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.                                                                                                                                                                                                                |

----

*                         Exhibits32.1 and 32.2 are furnished to accompany this report on Form 10-Kbut 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.

121

----

**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: | January 16, 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  |       | January 16, 2007 |
| Mark L. Yoseloff       |       | (Principal Executive  Officer)         |       |                  |
| /s/ PAUL C. MEYER      |       | President and Chief  Operating Officer |       | January 16, 2007 |
| Paul Meyer             |       |                                   |       |                  |
| /s/ RICHARD L. BALDWIN |       | Chief Financial  Officer and Chief     |       | January 16, 2007 |
| Richard Baldwin        |       | Accounting Officer                     |       |                  |
|                   |       | (Principal Accounting  Officer)        |       |                  |
| /s/ LOUIS CASTLE       |       | Director                               |       | January 16, 2007 |
| Louis Castle           |       |                                   |       |                  |
| /s/ TODD D. JORDAN     |       | Director                               |       | January 16, 2007 |
| Todd D. Jordan         |       |                                   |       |                  |
| /s/ GARRY W. SAUNDERS  |       | Director                               |       | January 16, 2007 |
| Garry W. Saunders      |       |                                   |       |                  |

 

 

122

----