UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K


(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, 2010


OR


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


For the transition period from              to


Commission file number: 0-20820





SHUFFLE MASTER, INC.


(Exact name of registrant as specified in its charter)


Minnesota

41-1448495(State or Other Jurisdiction of Incorporation or Organization)

(IRS Employer Identification No.)1106 Palms Airport Drive, Las Vegas
NV
89119(Address of Principal Executive Offices)
(State)
(Zip Code)


Registrant’s Telephone Number, Including Area Code: (702) 897-7150





Securities registered pursuant to Section 12(b) of the Act:


Title of each class
Name of each exchange on which registeredCommon Stock, $0.01 par value per share
The NASDAQ Stock  Market LLC





Securities registered pursuant to Section 12(g) of the Act: None





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


Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o


Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendments to this Form 10-K. o


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:


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

(Do not check if a smaller reporting company)
Smaller reporting company o


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





The aggregate market value of voting Common Stock held by non-affiliates of the Registrant on April 30, 2010 was approximately $514,442,333.





As of January 11, 2011, 54,015,949shares of Common Stock of the Registrant were outstanding.





DOCUMENTS INCORPORATED BY REFERENCE


Part III of this Annual Report on Form 10-K incorporates by reference information from the Registrant’s Proxy Statement for its Annual Meeting of Shareholders to be held on March 17, 2011 (“Fiscal 2010 Proxy Statement”) to be filed with the SEC within 120 days of the end of the fiscal year covered by this report.





SHUFFLE MASTER, INC.


ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED OCTOBER 31, 2010





TABLE OF CONTENTS





PageForward Looking StatementsPart IItem 1.
Business
5Item 1A.
Risk Factors
15Item 1B.
Unresolved Staff Comments
23Item 2.
Properties
23Item 3.
Legal Proceedings
23Item 4.
Removed and Reserved
23Part IIItem 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
24Item 6.
Selected Financial Data
26Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
27Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
62Item 8.
Financial Statements and Supplementary Data
63Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
102Item 9A.
Controls and Procedures
102Item 9B.
Other Information
103Part IIIItem 10.
Directors, Executive Officers and Corporate Governance
103Item 11.
Executive Compensation
103Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
103Item 13.
Certain Relationships and Related Transactions and Director Independence
103Item 14.
Principal Accounting Fees and Service
103Part IVItem 15.
Exhibits, Financial Statement Schedules
104





2


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS





This Form 10-K contains forward-looking statements. The forward-looking statements are contained principally in the sections entitled, “Risk Factors,” “Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” but are also contained elsewhere in this Form 10-K. In some cases, you can identify forward-looking statements by the following words: “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology intended to identify performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we currently believe that we have a reasonable basis for each forward-looking statement contained in this Form 10-K, we caution you that these statements are based on a combination of facts and factors currently known by us, as well as our projections of the future, about which we cannot be certain. Forward-looking statements reflect and are subject to inherent known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Risk factors that could cause actual results to differ materially from expectations include, but are not limited to, the following:





·
We are dependent on our intellectual property and trade secrets and we may be unable to protect our intellectual property and trade secrets from infringement, misappropriation, or claims of infringement or invalidity;





·
our existing patents may be found invalid or unenforceable and any current or future patent applications may not be approved;





·
our efforts to protect our unpatented proprietary technology may not be successful;





·
we may not be able to establish or maintain our trademarks;





·
we may not be able to adequately protect our foreign intellectual property rights;





·
the intellectual property rights of others may limit our ability to make and sell our products;





·
significant litigation regarding intellectual property rights exists in our industry;





·
the gaming industry is highly regulated and we must adhere to various regulations and maintain our licenses to continue our operations.  Failure to obtain and/or maintain our licenses could be disruptive to our business and could adversely affect our operations;





·
we may be unable to obtain licenses in new jurisdictions where our customers operate;





·
legislative and regulatory changes could negatively affect our business and the business of our customers;





·
a continued downturn in general worldwide economic conditions or in the gaming industry or a reduction in demand for gaming may adversely affect our results of operations.  As a result, the market price of our common stock may decline;





·
the gaming industry has been notably impacted by the general economic downturn;





·
our domestic and global growth and ability to access capital markets are subject to a number of economic risks;





·
risks that impact our customers may impact us;





·
economic, political, legal and other risks associated with our international sales and operations could adversely affect our operating results;





·
litigation may subject us to significant legal expenses, damages and liability and is inherently unpredictable and risky;





·
our products currently in development may not achieve commercial success and if we are unable to maintain a competitive technological position, we may suffer a material adverse effect on our business, results of operations or financial condition;





·
we compete in a single industry and our business may suffer if our products become obsolete or demand for them decreases, including without limitation, as a result of the downturn in the gaming industry;




3




·
any disruption in our manufacturing processes, any significant increase in manufacturing costs or any inability to manufacture a sufficient number of our products to meet demand could adversely affect our business and operating results;





·
the products in each of our segments may experience losses due to technical difficulties or fraudulent activities;





·
we operate in a very competitive business environment and if we do not adapt our approach and our products to meet this competitive environment, our business, results of operations or financial condition could be adversely impacted;





·
we are dependent on the success of our customers and are subject to industry fluctuations;





·
certain market risks may affect our business, results of operations and prospects;





·
we are exposed to interest rate and foreign currency risk;





·
we could face considerable business and financial risk in implementing acquisitions;





·
if our products contain defects, our reputation could be harmed and our operating results and financial results could be adversely affected;





·
we may not be able to attract, retain, or motivate the management or employees necessary to remain competitive in our industry;





·
our continued compliance with our financial covenants in our Senior Secured Revolving Credit Facility, as defined below, is subject to many factors, some of which are beyond our control and if we are unable to remain compliant under our financial covenants, our results of operations could be adversely affected by servicing costs;





·
the restrictive covenants in our Senior Secured Revolving Credit Facility may limit our ability to finance future operations or capital needs or engage in other business activities that may be in our interest; and





·
our business is subject to quarterly fluctuation.





In addition, refer to the “Risk Factors” section for a discussion of other important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure that the forward-looking statements will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, these statements should not be regarded as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by each of these cautionary statements above.


4
  PART I


(Numbers used herein are in thousands, except units, per unit/seat amounts and square footage)





ITEM 1. BUSINESS





BUSINESS





Unless the context indicates otherwise, references to “Shuffle Master, Inc.,” “we,” “us,” “our” or the “Company,” include Shuffle Master, Inc. and its consolidated subsidiaries.





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





Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), are filed with the U.S. Securities and Exchange Commission (the “SEC”). Such reports and other information filed by us with the SEC are available free of charge on our website at www.shufflemaster.com when such reports are available on the SEC website. The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K.





We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor.  Our products primarily relate to licensed casino operators’ table games activities and focus on either increasing their profitability, productivity and security or expanding their gaming entertainment offerings in the form of proprietary table games, electronic table games or electronic slot machines. Our business is segregated into the following four operating segments: Utility, Proprietary Table Games (“PTG”), Electronic Table Systems (“ETS”) and Electronic Gaming Machines (“EGM”).





Utility.Our Utility segment develops products for our customers that enhance table game speed, productivity, profitability and security. We introduced the first successful automatic card shuffling equipment to the gaming industry and we continue to develop and market a full complement of automatic card shufflers for use with the vast majority of card-based table games placed in casinos and other gaming locations, including our own proprietary table games. We are working on the development of next generation shufflers and technological advancements in the areas of card recognition and remote diagnostics, among other developments. Currently, our Utility segment revenue is derived substantially from the lease and sale of our automatic card shufflers and associated service revenue. We also offer chip sorting products that simplify the handling of gaming chips on high volume roulette tables. Additionally, we have acquired or are developing products to gather data and to enable casinos to track table game play such as our i-Shoe AutoTM card reading shoe, our i-ScoreTM baccarat viewer that displays current game results and trends and our Deck CheckerTM card deck checking device.  These products are intended to cost-effectively provide casinos and our other customers with data on table game play for security and marketing purposes, which in turn allows them to increase their profitability.





Proprietary Table Games.   We develop and deliver proprietary titles that enhance our casino and other gaming customers’ table game operations. Products in this segment include our live and electronic proprietary table games as well as progressive upgrades and proprietary features added to public domain games such as poker, baccarat, pai gow poker and blackjack table games. Our current proprietary table games titles include eleven of the top fifteen most popular proprietary titles in the world (by revenue) as of October 31, 2010.





We intend to broaden our PTG content through development and acquisition. By enhancing the value of our existing proprietary table games in the marketplace with side bets, add-ons and progressives and by increasing our footprint with new titles, we hope to increase our domestic market penetration and expand further into international markets. We also intend to expand the domestic presence of our proprietary titles on electronic platforms such as our Table Master® and i-TableTM.  We also plan to continue to install proprietary progressives and side bets on public domain table games in addition to our proprietary table games.





Electronic Table Systems.   Our ETS segment develops and delivers various products involving popular table game content using e-Table game platforms. Our primary ETS products are the Table Master, Vegas Star®, Rapid Table Games® and the i-Table platforms.  Our Table Master and some of our Vegas Star products feature a virtual dealer which enables us to offer table game content in markets where live table games are not permitted, such as racinos, video lottery and arcade markets. Our Rapid Table Games product enables the automation of certain components of traditional table games such as data collection, placement of bets, collection of losing bets and payment of winning bets combined with live dealer and game outcomes. This automation provides benefits to both casino operators and players, including greater security and faster speed of play.  Our i-Table platform combines an electronic betting interface with a live dealer who deals physical cards from a Shuffle Master card reading shoe or shuffler and is designed to dramatically improve game speed and security while reducing many operating expenses associated with live tables.




5




Electronic Gaming Machines.  Our EGM segment develops and delivers our PC-based video slot machines into select markets, primarily in Australia and, to a lesser extent, Asia and Latin America.  We offer an extensive selection of video slot titles which include a range of bonus round options that can be configured as a network of machines or as stand-alone units. During fiscal 2010 we introduced a new EGM cabinet model, the EquinoxTM.  In addition to selling the full EGM complement, we sell software conversion kits that allow existing EGM terminals to be converted to other games on the PC3 and PC4 platform. Popular titles for our EGMs include Rise of the DragonTM, Golden FortunesTM, Lucky PandaTM, The ConquerorTM, Emperor GuanTM, Tiki TotemsTM, Drifting SandsTM, NinjaTM, iChingTM, Kelly CountryTM, Deep Sea DollarsTM, CubaTM, Galapagos WildTM, Sunset on the SerengetiTM and Lonesome GeorgeTM, as well as the Pink PantherTM and Grand CentralTM progressive links.





For additional information about our segments, including segment revenue, operating income (loss) and assets, see “Item 6. Selected Financial Data,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.





The table below presents our product lines and the percentage of total revenue from continuing operations contributed by each product line in the fiscal years ended October 31:




Percentage of Total RevenueProduct Segment

2010


2009


2008Utility


38.4
%


40.0
%


42.5
%Proprietary Table Games


20.1
%


21.6
%


20.3
%Electronic Table Systems


21.1
%


12.4
%


14.5
%Electronic Gaming Machines


20.4
%


26.0
%


22.6
%Other revenue


0.0
%


0.0
%


0.1
%100.0
%


100.0
%


100.0
%
 
 OUR STRATEGY




We are proud of the products that we develop and market and believe we can have continued growth and expansion. To that end, we have devised and are implementing the following ongoing strategic plan:





Develop a true “strategic partner” relationship with our customers





Our first strategic goal focuses on partnering with our customers, not only to provide enhanced efficiencies, maximize security and maximize profitability on the casino floor, but also work diligently to develop innovative products that anticipate and respond to their needs. To demonstrate our top strategic initiative, we rolled out a 12 Point Pledge that outlines our commitment to our customers:





We will be a strategic partner to our customers.We will work diligently to meet our customers’ needs.We will provide solutions, not just products.We will never forget: we’re in the business of fun.We will foster trust from the very first handshake.We will provide innovative products.We will be tireless in our pursuit of excellence.We will provide answers, not excuses.We will set a high bar for service.We will identify creative ways to improve our customers’ performance.We will collaborate with our customers to fuel their profitability.We will know we’ve reached our full potential when we’ve enabled our customers to reach theirs.





Continued emphasis on leasing versus selling





We intend to continue executing this strategy primarily in North America although we will encourage leasing programs in other parts of the world.





6





Continued development of technology to drive new products across all product lines





This strategic initiative includes our card reading shoes and shufflers, shuffler interface with table systems, live and electronic table game progressive systems and the development of new titles for all of our e-Table platforms on a worldwide basis.





Value engineering to reduce manufacturing costs across all product lines





Our focus is currently on savings attributable to component parts, product redesign and lower cost manufacturing opportunities.





Continued commitment to reduce expenses throughout the Company without compromising the quality of our products or service





Our goal is to reduce expenses through cost savings initiatives as well as thoroughly examining our infrastructure to improve our operating margins without compromising the quality of our products or service.





This ongoing strategic plan assists us in defining and implementing our specific product strategies for the future, which in no particular order are:





·
To focus on developing, manufacturing and marketing products that increase the speed, profitability, productivity and security of our casino and other customers in their table game operations.





·
To develop and market shufflers with advanced features and capabilities, such as optical card recognition and deck validation, to replace older generation shufflers and to further penetrate domestic and foreign markets.





·
To broaden our PTG segment by developing or acquiring additional table game content to increase our penetration of casino customers' table game operations. In addition, our analysis has shown that there exists a strong correlation between proprietary table game growth and demand for automatic shufflers.





·
To develop a variety of felt-based and e-Table solutions to increase revenue from existing assets in the field by adding new proprietary features such as progressives and side bets.





·
To market our e-Table platforms to provide a cost-effective brand extension of our PTG content to existing casino and new casino customers and to explore other venues in which the platforms could be reasonably modified to fulfill market demands.





·
To continue our commitment to develop new and exciting titles for our EGM products, allowing us to maintain our niche product offering.





·
To develop or acquire patents, licenses and other intellectual property both to broaden our product offerings and to vigorously protect our patents and products from potential infringement.





OUR UTILITY SEGMENT





Since our founding, we have developed and marketed products that include a combination of technology to enhance the speed, productivity, security and profitability of the table game operations of our customers. Our automatic card shufflers were the first such products.  We believe that our customers are seeking to increase the operating returns of their table game operations.





Our Shuffler Products. We currently market a complete range of shufflers, including single deck, batch and continuous shufflers. Single deck shufflers that deliver randomized hands of cards such as our i-Deal®and ACE® shufflers are generally used on proprietary table games such as our own Three Card PokerTM and Ultimate Texas Hold ‘em® games. Additionally, we offer a single deck/double deck batch shuffler, the Deck Mate®, for use on live stakes poker tables and single or double deck blackjack games.  For multiple deck “shoe” games such as Blackjack, Blackjack variants, Baccarat and Casino War® we offer the one2six® family of continuous shufflers.  For casinos that prefer to shuffle “shoe” games in a batch shuffler, we offer the MD2® and MD2CRTM shufflers with card recognition.  Shuffled batches of cards may then be delivered to one of our secure card reading i-ShoeTM and i-Shoe Auto shoes.





Our single-deck shuffler, the i-Deal, combines a number of enhanced features such as optical card recognition technology, card re-sorting, an ergonomic design with flush mount load and a programmable multi-game function to enhance game security and provide cost savings for the casino.





Our shufflers significantly reduce the opportunity for card manipulation by dealers, resulting in increased security. By allowing cards to be shuffled continuously or in frequent batches, our shufflers reduce or eliminate card counting and shuffle tracking. Because our shufflers shuffle one or more decks while a game is being played, down-time related to dealer shuffling is also significantly reduced, with the potential for a corresponding increase in playing time and win for the casino.





7


Our Chip Sorting Machines. Our chip sorting machines simplify the handling of gaming chips, which increases the productivity and security on roulette tables.





Our existing Utility products are the following:


ACE®


Deck Mate®


i-Deal®


one2six®


one2six PlusTM


Easy Chipper C®


ChipmasterTM


i-ScoreTM


i-ShoeTM


i-Shoe AutoTM


i-VerifyTM


MD2®


MD2CRTM





OUR PROPRIETARY TABLE GAMES SEGMENT





Our Proprietary Table Games and Other Proprietary Features. Our PTG segment includes our live and electronic proprietary table games, progressive table games with bonusing options and proprietary side bets. We are continuously developing new table games to complement our existing offerings and to extend our penetration of proprietary table games on the casino floor.





Our more popular titles, including progressive table games with bonusing options and proprietary side bets are listed below in four categories: premium titles, side bets, add-ons and progressives.  The combination of premium titles and side bets represents the equivalent of casino floor space while add-ons and progressives generate incremental revenue on existing casino floor space.





Premium titles:


Caribbean Stud®


Casino War®


Crazy 4 Poker®


Four Card Poker®


Fortune Three Card PokerTM


Let It Ride®


Let It Ride Bonus®


Mississippi StudTM


Texas Hold 'em Bonus®


Three Card PokerTM


Ultimate Texas Hold ‘em®





Side bets:


Bet the Set "21"®


Dragon Bonus®


Fortune Pai Gow Poker®


King’s Bounty blackjackTM


Royal Match 21®


Streak ShooterTM





Add-ons:


Bad Beat Bonus bets


Three Card Poker Bonus bets





Progressives:


Fortune Pai Gow ProgressiveTM


Progressive Blackjack®


Progressive Texas Hold ‘em Bonus®


Three Card Poker ProgressiveTM





8





OUR ELECTRONIC TABLE SYSTEMS SEGMENT





Our Electronic Table Systems. Our ETS products are e-Table platforms developed for multi-player use. We have developed or acquired technology or platforms to deliver our proprietary table game content or public domain games on multi-player terminals. Some of our e-Table products enable us to offer table game content in markets where live table games are not permitted, such as racino, video lottery and arcade markets. We are developing these e-Table platforms to enable the marketing and deployment of our table game content into previously unpenetrated international and domestic casino, racino and other gaming markets.





Our existing ETS products are the following:


i-TableTM


Rapid Table Games®


Table Master®


Vegas Star®





OUR ELECTRONIC GAMING MACHINES SEGMENT





Our Electronic Gaming Machines.  We offer an extensive selection of video slot titles developed for select markets primarily in Australia and, to a lesser extent, Asia and Latin America.  Featuring a wide variety of denominations and configurations, EGMs can be configured as a network of machines or as stand-alone units. EGM titles are offered in the ergonomic eStarTM cabinet and are available on both the Stargames PC3 operating platform and more recently the PC4 operating platform. The PC4 operating platform features enhanced audiovisual capabilities as well as greater capacity to integrate with technical advancements expected in the coming years.





During fiscal 2010 we introduced a new EGM cabinet model, the Equinox. Equinox offers widescreen displays and substantially improved graphics and user interfaces over older-style EGM products.  Initial deliveries of Equinox began in July 2010.





OTHER SEGMENT INFORMATION





Customers and marketing. We market our products to casinos and other legal gaming establishments around the world with our direct domestic and international sales force and several domestic and international distributors and/or representatives. We also market several of our e-Table products to a variety of gaming venues not permitted to offer live table games, such as racinos and other legal gaming establishments around the world. We currently maintain sales and marketing offices on six continents and have relationships with various distributors worldwide.





We believe the quality and breadth of our customer base is a strong testament to the effectiveness and quality of our product offerings, technological innovation and customer service. Our customer base includes the leading casino operators on all six continents that allow casino style gaming, including operators in leading established gaming markets such as the United States, Canada, Latin America, Macau, Singapore, Malaysia, Australia, Europe and Africa. Moreover, our customer base includes all of the top 20 global gaming companies measured by annual revenues. Our customers include, among others, Caesar’s Entertainment Corp., MGM Resorts International, Mohegan Tribal Gaming Authority, Las Vegas Sands Corp., Crown Ltd., Wynn Resorts, Limited, Sociedade de Jogos de Macau S.A., Genting Groups, Galaxy Entertainment Group Limited, The Rank Group, Sun International Resorts, Tabcorp Holdings Ltd., Star City Pty Ltd. and Federal Group Tasmania.





Our products and the locations in which we may sell them are subject to the licensing and product approval requirements of various national, state, provincial and tribal jurisdictional agencies that regulate gaming around the world.  See “Business—Gaming Regulation” section below.  We both lease and sell our products, although we implemented a strategy to continue our emphasis on leasing versus selling, primarily in the United States.  When we lease our products, we generally negotiate a month-to-month operating lease or license for our products for a fixed fee, or to a lesser extent, enter into participation arrangements whereby casinos pay a fee to us based on a percentage of net win. When we sell certain of our products, we sometimes offer our customers a choice between a sale or a longer-term sales-type lease or other financing arrangements, depending on the needs of each customer. We service the products we sell and lease with those on lease including a service contract. We also offer service packages to customers who purchase products from us.





Competition. We compete with other gaming products and supply companies for space on the casino customer's floor, as well as for our customer's capital spending. With respect to our Utility segment, namely shufflers and other gaming equipment, we compete on this basis as well as on the basis of offering a complete line of shufflers, product reliability, a superior service network, the strength of our intellectual property and the breadth of our sales, regulatory and distribution channels. Other companies may develop and market shufflers and seek to develop and obtain regulatory approvals of additional shuffler products. Our shufflers also compete against hand shuffling, which remains the most common shuffling option on casino card games around the world. Finally, since the need for our shufflers is dependent upon the casino’s use of live table games, our shufflers also compete against any products that live table games compete against.   We cannot provide assurances that a competitive product will not gain substantial placements or that a competitive product or hand shuffling will cause price erosion of our shufflers in the future.  As it relates to our Easy Chipper C and Chipmaster roulette chip sorting products, competition is primarily limited to the Chipper Champ PlusTM and the more current Chipper Champ 2TM, both sold by TCSJohnHuxley. Competition with our i-Shoe card reading shoe is primarily limited to Angel Co. Ltd.'s Angel Eye® card reading shoe and the Bee Electronic Baccarat Dealing Shoe (U.S. Playing Card Company).





9


With respect to our PTG segment, in addition to companies such as International Game Technology (“IGT”), Bally Technologies, Inc. (“Bally”), Aristocrat Gaming (“Aristocrat”) and WMS Industries Inc. (“WMS”) that primarily market EGMs, we also compete with both non-proprietary table games such as blackjack and several companies which primarily develop and license proprietary table games. Some of those competitors' widely known proprietary table game titles include Galaxy Gaming's Lucky LadiesTM and Emperor's Challenge®, Masque Publishing's Spanish 21® and DEQ Systems EZ BaccaratTM.Additionally, competition with our progressive bet system for table games includes DEQ Systems. Competition in this segment is particularly based on price, brand recognition, player appeal and the strength of underlying intellectual property. Smaller developers and vendors are more able to participate in developing and marketing table games, compared to other gaming products, because of the lower cost and complexity associated with the development of these products and a generally less stringent regulatory environment. We compete on these bases, as well as on the strength of our extensive sales, service and distribution channels. We have been able to increase our placements of table games not only because of the general growth of table games, but also by displacing other table game products. In the future, table game competitors as well as slot machine companies could market table games that might displace our products.





With respect to our ETS segment, there are numerous other companies that manufacture and/or sell e-Tables that are similar to the products in our ETS segment. These companies include, but are not limited to, TCSJohnHuxley, Aristocrat, Interblock (member of Elektroncek Group), Aruze Corporation (“Aruze”), Novomatic Industries (“Novomatic”), IGT, PacificNet Inc. (“PacificNet”), PokerTek, Inc. (“PokerTek”) and TableMAX Holdings (“TableMAX”). Our e-Tables, as well as those of other companies, also compete for casino floor space with live table games and EGMs.  One of our competitive strengths in this segment is the ability to offer our proprietary table game titles on various e-Table platforms.





Our EGM segment is part of a highly competitive international slot market. The Australasian market reflects other worldwide markets insofar as most of the major international manufacturers have a presence there. The major competitors to our EGM products in these markets are Aristocrat, IGT, Bally, WMS, Konami Gaming, Inc. (“Konami”), Aruze and Ainsworth Game Technology (“Ainsworth”).  In Asia, these competitors are also active along with further competition from a myriad of Asian and European slot manufacturers.





Finally, some of our product segments may compete against each other for space on the casino floor.





Product supply. We obtain most of the parts for our products from outside suppliers, including both off-the-shelf items as well as components manufactured to our specifications. We also manufacture a small number of parts in-house that are used both for product assembly and for servicing existing products. We generally perform warehousing, quality control, final assembly and shipping ourselves from our facilities in both Las Vegas and Sydney, Australia, although small inventories are maintained and repairs are performed by our field service employees.





Additionally, some of our products are manufactured by subcontract manufacturers, located in Des Plaines, Illinois, Phoenix, Arizona and Salzburg, Austria, all of which also inventory and ship these products. We believe that our sources of supply for components and raw materials are adequate and that alternative sources of materials are available.





Research and development (“R&D”).  We employ a staff of electrical, mechanical and software engineers, graphic artists and game developers to support, improve and upgrade our existing shufflers, to develop new shufflers, to develop technology and game content for our PTG, e-Table platforms and EGM products and to develop and explore other potential table-related products.  We perform the majority of our research and development ourselves in the U.S. and in Australia. We also conduct research and development through the use of a foreign, third party developer for certain of our international product offerings.





We believe that one of our strengths is identifying new product opportunities and developing new products, therefore we expect to continue to spend a significant portion of our annual revenues on research and development, including the acquisition of intellectual property from third parties.  Total R&D expense was $21,811, $17,349 and $18,474 for fiscal 2010, 2009 and 2008, respectively.





INTELLECTUAL PROPERTY





We believe that our patents, trademarks, licenses, copyrights and trade secrets are significant assets that provide us with a competitive advantage and are critical to our future profitability and growth. We protect our investment in research and development by seeking patent and trademark protection for our technologies. We also acquire and license patents and other intellectual property from third parties. Infringement claims, patent invalidity or expiration, license non-renewal, failure to stop infringers, inadequacy of patent and other intellectual property coverage, delays in using our intellectual property to develop products or the costs of protecting our intellectual property and changes to the intellectual property laws could adversely affect our future results of operations and our financial position.





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Patents. We own numerous United States and international patents and applications related to our existing products and methods, future products that have not yet been introduced, potential product modifications and improvements and to products we do not currently sell.  Some of the patents (primarily our game play method patents) we own are issued only in the United States.  A majority of the technology is internally developed, however, some of our technology has been purchased and is licensed.





Most of the patents that we own have a life of 20 years from the filing date of the first non-provisional patent application in a family of patents.  While some of our older owned game patents and progressive patents expire in the next 2-4 years and some older technology shuffler patents expire in 2014, the majority of our patents, including those with our newest technology, expire thereafter.  Under the laws of the United States, when a patent expires, a competitor would be legally able to make, use, offer to sell or sell the invention claimed in the patent.  We believe that the expiration of any of our patents prior to 2015 will not have a material adverse effect on our business. A number of our licensed patents expired in 2009, but the expirations have not and are not expected to materially affect our business. We also have numerous patent applications pending for our existing, planned and potential products. No assurance can be given that any such patents will be issued, or that the patents we currently hold or have licensed or any new patents that we acquire are, will be, or will remain valid, will provide any competitive protection for our products, or will adequately cover our competitors' products. We may decide to sell in the ordinary course of business patents that we no longer continue to believe are strategic to our business.





Trademarks. We own numerous United States and international trademark registrations and common law trademarks. Some of the more important marks include: Shuffle Master, Incorporated®, the Shuffle Master 4-square logo®, ACE, Deck Mate, i-Deal, MD1®, MD2, one2six, Deck Checker, Easy Chipper C, i-Shoe, i-Shoe Auto, Bet the Set “21,” Blackjack Press®, Caribbean Stud, Casino War, Crazy 4 Poker, Dragon Bonus, Fortune Blackjack®, Fortune Pai Gow Poker, Four Card Poker, Jackpot BaccaratTM, Let It Ride, Let It Ride Bonus, shufflemaster.com®,, Mississippi Stud, Royal Match 21, Texas Hold ‘em Bonus, Three Card Poker, Ultimate Draw Poker®, Ultimate Texas Hold' Em, i-Table, Table Master, Rapid Table Games and Vegas Star.  We believe that our trademarks and trade dress are an important component of the brand identity of our products. We also license trademarks from others.





Intellectual property licenses.We obtain licenses to intellectual property from third parties. These licenses are subject to various conditions and restrictions and typically involve us paying royalties on a fixed or unit basis. While we do not believe that any of these current license agreements are in jeopardy of being terminated, we can make no assurance that all of these license agreements will remain in effect or that such licenses can be extended under terms favorable to us.





In addition, when we license our products to our customers, we also license the right to use our intellectual property to casino customers. We typically earn license royalties on a periodic basis. We do not license our intellectual property to other gaming equipment suppliers, except occasionally as part of a cross-license arrangement.





Other intellectual property. In addition to patents, we also own intellectual property in the form of copyrights (registered and unregistered), trademarks (registered and unregistered), trade dress and as trade secrets. No assurance can be given that we will be successful in maintaining the confidentiality of our trade secrets and other proprietary information. Costs associated with defending and pursuing infringement claims can be substantial. In the absence of valid and enforceable patent, copyright, trademark or trade secret protection, we would be vulnerable to competitors who could lawfully copy our products and technology.





Product-related agreements. We are a party to certain licensing agreements. Under some of these agreements, we have certain rights to third party intellectual property. There are no royalty obligations with respect to any of these agreements that are material to our results of operations. Further, none of the royalties that we pay or receive under these agreements are material to our results of operations. Our Australian subsidiary is a party to a co-ownership agreement of certain intellectual property with a customer. There are royalty sharing obligations under this agreement.





Infringement and litigation. We do not believe that any of our products, methods or technologies infringes the valid and enforceable patents or other intellectual property rights of others. However, we have been and are subject to litigation claiming that we have infringed the rights of others and that certain of our patents and other intellectual property are invalid or unenforceable. We have also brought actions against others to protect our rights. For a discussion of these cases see “Item 3. Legal Proceedings” and Note 15 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.





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GAMING REGULATION





Overview. We are subject to a wide range of complex gaming laws and regulations in over 200 jurisdictions, both foreign and domestic, in which we are licensed or have applications pending. Jurisdictions require us to be licensed, our key personnel to be found suitable, qualified or licensed, and our products to be reviewed and approved before placement. Additionally, gaming laws and regulations of most jurisdictions provide that beneficial owners of 5% or more of our common stock are subject to reporting procedures and may be subject to licensure that includes suitability investigations and submission of personal and financial information as required, unless the owner is eligible for and obtains an exemption or waiver. Under certain circumstances, an “Institutional Investor,” as such term is defined by certain gaming jurisdictions' statutes or regulations, who acquires more than 5%, may apply for a waiver of the suitability requirement. Generally, gaming jurisdictions may permit an Institutional Investor to hold up to 25% upon a showing that they meet the jurisdiction's definition of an “Institutional Investor” and certification as to their passive investment intent. Furthermore, most jurisdictions have ongoing reporting requirements for certain transactions and are concerned with our accounting practices, internal controls, business relationships and the fair operation of our products. Gaming regulatory requirements vary from jurisdiction to jurisdiction and licensing, approvals and processes related to findings of suitability, qualifications or licenses, our products, key personnel and certain shareholders can be lengthy and expensive.





General regulatory licensing and approvals. We intend to maintain our existing licenses and to seek the necessary licenses, approvals, qualifications and findings of suitability for us, our products and our management personnel in new jurisdictions where we anticipate sales or leasing opportunities. We have never been denied a license, permit or approval necessary to do business in any jurisdiction, nor had a license suspended or revoked. However, there can be no assurance that new licenses, approvals, qualifications or findings of suitability will be obtained or that our existing licenses will be renewed or will not be revoked, suspended or conditioned. If a license, approval, qualification or finding of suitability is required by a regulatory authority and we fail to seek or do not receive the necessary license, qualification or finding of suitability, then we may be prohibited from distributing our products for use in the respective jurisdiction or may be required to provide our products through other licensed entities at a reduced profit to us. There can also be no assurance that we will be able to obtain the necessary approvals for our products as they are developed. In addition, changes in legislation or in judicial or regulatory interpretations could occur which could adversely affect us.





We are licensed as a manufacturer and distributor of gaming devices, an operator of inter-casino linked systems and a slot route operator in Nevada. We are a gaming-related casino service industry licensee in New Jersey and hold supplier, manufacturer and distributor licenses in numerous other jurisdictions throughout North America and elsewhere. Due to variations in jurisdictional regulatory transaction reporting, as well as manufacturer, distributor and product licensing requirements, only the specifics of Nevada gaming law requirements are provided below as being representative of gaming regulation to which we are subject in other jurisdictions.





Nevada regulatory matters. We are subject to the Nevada Gaming Control Act (the “Nevada Act”) and to the licensing and regulatory control of the Nevada State Gaming Control Board (the “Nevada Board”), the Nevada Gaming Commission (the “Nevada Commission”) and various local, city and county regulatory agencies (collectively, the “Nevada Gaming Authorities”).





The laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy which are concerned with, among other things: (i) the character of persons having any direct or indirect involvement with gaming to prevent unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity; (ii) application of appropriate accounting practices and procedures; (iii) maintenance of effective control over the financial practices and financial stability of licensees, including procedures for internal controls and the safeguarding of assets and revenues; (iv) record-keeping and reporting to the Nevada Gaming Authorities; (v) fair operation of games; and (vi) the raising of revenues through taxation and licensing fees.





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





Certain officers, directors and key employees are required to be found suitable by the Nevada Commission and employees associated with gaming must obtain work permits which are subject to immediate suspension under certain circumstances. An application for suitability may be denied for any cause deemed reasonable by the Nevada Commission. Changes in specified key positions must be reported to the Nevada Commission. In addition to its authority to deny an application for a license, the Nevada Commission has jurisdiction to disapprove a change in position by an officer, director or key employee. The Nevada Commission has the power to require licensed gaming companies to suspend or dismiss officers, directors or other key employees and to sever relationships with other persons who refuse to file appropriate applications or whom the authorities find unsuitable to act in such capacities.





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The Nevada Commission may also require anyone having a material 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 the Nevada Board in connection with the investigation. We customarily reimburse such costs and fees. Any person who acquires more than 5% of any class of our voting securities must report the acquisition to the Nevada Commission. Any person who becomes a beneficial owner of more than 10% of any class of our voting securities is required to apply for a finding of suitability. Under certain circumstances, an “Institutional Investor,” as such term is defined in the regulations of the Nevada Commission, which acquires more than 10% but not more than 25% of any class of our voting securities, may apply to the Nevada Commission for a waiver of such finding of suitability requirements, provided the Institutional Investor holds the voting securities for investment purposes only. (It should be noted that in many other states the requirement of a suitability finding or of a licensure applies to any holder of 5% or more of our stock, unless the owner is eligible for and obtains an exemption or waiver.) The Nevada Commission has amended its regulations pertaining to Institutional Investors to allow an Institutional Investor to beneficially own more than 25%, but not more than 29%, if the ownership percentage results from a stock repurchase program. In addition, an institutional investor not previously granted a waiver may nevertheless own more than 10% but not more than 11% of any class of our voting securities without being required to apply to the Nevada Commission for a finding of suitability or a waiver and is subject only to reporting requirements as prescribed by the chairman of the Nevada Board (unless otherwise notified by the chairman of the Nevada Board), if such additional ownership results from a stock repurchase program. These Institutional Investors may not acquire any additional shares that would result in an increase in its ownership percentage. An Institutional Investor will be deemed to hold voting securities for investment purposes only if the voting securities were acquired and are held in the ordinary course of business as an Institutional Investor and not for the purpose of causing, directly or indirectly, the election of a majority of our board of directors, any change in our corporate charter, bylaws, management, policies or operations, or any of our gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding our voting securities for investment purposes only.





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





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





We are required to maintain a current stock ledger in Nevada which may be examined by the Nevada Commission at any time and to file with the Nevada Commission, at least annually, a list of our shareholders. The Nevada Commission has the power to require our stock certificates to bear a legend indicating that the securities are subject to the Nevada Act and the regulations of the Nevada Commission. However, to date, the Nevada Commission has not imposed such a requirement on us.





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





On April 22, 2010, the Nevada Commission granted us prior approval to make public offerings for a period of two years, subject to certain conditions (the “Shelf Approval”). This Shelf Approval may be rescinded for good cause without prior notice upon the issuance of an interlocutory stop order by the chairman of the Nevada Board. The Shelf Approval does not constitute a finding, recommendation or approval by the Nevada Commission or the Nevada Board as to the accuracy or adequacy of the prospectus or the investment merits of the securities offered. Any representation to the contrary is unlawful.





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Changes in control of us through merger, consolidation, acquisition of assets, management or consulting agreements or any form of takeover cannot occur without prior investigation by the Nevada Board and approval by the Nevada Commission. Entities seeking to acquire control of us must satisfy the Nevada Board and the Nevada Commission concerning a variety of stringent standards prior to assuming control of us. The Nevada Commission may also require controlling shareholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process of the transaction.





Approvals are required from the Nevada Commission: (i) before we can make exceptional repurchases of voting securities above the current market price and (ii) before a corporate acquisition opposed by management can be consummated.





We have formally adopted a compliance plan and appointed a compliance committee in accordance with Nevada Commission requirements. Our compliance committee meets quarterly and is responsible for implementing and monitoring our compliance with regulatory matters. This committee also reviews information and reports regarding the suitability of potential key employees or other parties who may be involved in material transactions or relationships with us.





Federal registration. As a manufacturer and distributor of gaming devices, we are registered pursuant to and have complied with the Federal Gambling Devices Act of 1962 (the “Federal Act”). In order to manufacture, sell, deliver, or operate our gaming devices, we must renew our federal registration annually and comply with its various record-keeping and equipment identification requirements. The Federal Act makes it unlawful for a person or business entity to manufacture, deliver, receive, operate, lease or sell gaming devices in interstate or foreign commerce unless that person or entity has first registered with the Attorney General of the United States. Violation of the Federal Act may result in seizure and forfeiture of the equipment, as well as other penalties.





Native American gaming regulation. Gaming on Native American lands is governed by the Federal Indian Gaming Regulatory Act of 1988 (“IGRA”) and specific tribal ordinances and regulations. Class III gaming, as defined under IGRA, also generally requires a Tribal-State Compact, which is a written agreement between a specific tribe and the respective state. This compact authorizes the type of Class III gaming activity and the standards, procedures and controls under which the Class III gaming activity must be conducted. The National Indian Gaming Commission (“NIGC”) has oversight authority over gaming on Native American lands and generally monitors tribal gaming including the establishment and enforcement of required minimum internal control standards. Each Tribe is sovereign and must have a tribal gaming commission or office established to regulate tribal gaming activity to ensure compliance with IGRA, NIGC and its Tribal-State Compact. We have complied with each of the numerous vendors licensing and specific product approval and shipping notification requirements imposed by Tribal-State Compacts and enforced by tribal and/or state gaming agencies under IGRA in the Native American lands in which we do business.





Other jurisdictions. We have obtained or are in the process of obtaining all licenses/permits required by jurisdictions having legalized gaming. In general, such requirements are similar to Nevada in that there are company approvals as well as individual licensing and product approvals.





Product approvals. Each of our products is subject to extensive testing and reviews by multiple state, jurisdictional or third party laboratories. The detail and extent of the review generally depends upon the classification of the product by the respective gaming authority as a new game, game variation, associated equipment, gaming equipment or gaming device. Associated equipment is equipment that is not classified as a gaming device or gaming equipment but due to its integral relationship to the conduct of licensed gaming, regulatory authorities have discretion to require manufacturers and distributors of such associated equipment to meet licensing or suitability requirements prior to or concurrently with the use of such equipment in the respective jurisdiction. The time required for product testing can be extensive and is subject to a wide range of formal and informal standards that can lead to great uncertainty as to the length of the regulatory approval process. Additionally, product testing is subject to changing standards, as a result of which, we may be required to upgrade or revise our products.





OTHER BUSINESS INFORMATION





Customer service. As part of our strategy to maintain and expand our market position, we have made a commitment to maintain a high level of service to our customers. We have numerous field service centers in the United States as well as at most of our foreign locations. Within our service areas, we provide regular corrective and preventative maintenance service and on-demand repair service for our leased equipment, provide service training to our customers and provide back-up units to our lessees. For casinos that purchase our products, we offer service contracts providing service benefits similar to those of leased units or parts-only warranty contracts.





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Significant customer sales, foreign sales and foreign assets. For fiscal 2010, 2009 and 2008, sales to customers outside the United States accounted for approximately 51%, 50% and 53% of consolidated revenue; and no individual customer accounted for more than 10% of consolidated revenue in each of those years. As of October 31, 2010, approximately 20% of our revenues was in our EGM segment, which revenues relate primarily to outside the U.S. As of October 31, 2010, approximately 26% of our long-lived assets, excluding deferred income taxes, goodwill and acquired intangible assets, was outside the U.S. As of October 31, 2010 and 2009, no single customer balance exceeded 10% of our net trade accounts receivable. As of October 31, 2010, two customers and as of October 31, 2009, one customer exceeded 10% of our net investment in sales-type lease and notes receivable. These customers have well-established histories of payments to Shuffle Master as well as credit ratings that support the credit lines they have been extended. Additional information regarding our foreign sales and long-lived assets by geographic region is included in Note 14 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K





Seasonality and business fluctuations. Quarterly revenue and net income may vary based on the timing of the opening of new gaming jurisdictions, the opening or closing of casinos or the expansion or contraction of existing casinos, gaming regulatory approvals or denial of our products and corporate licenses, the introduction of new products, the seasonality of customer capital budgets, or fluctuation in general economic conditions. Historically, our operating results have been lowest in our first fiscal quarter ending January 31, primarily due to the seasonality of customer capital budgets as well as the December holiday season.





Employees. As of October 31, 2010, we had approximately 705 employees.  We are not subject to any collective bargaining agreements and we believe that our environment will continue to be union free.





ITEM 1A. RISK FACTORS





RISKS RELATED TO OUR BUSINESS





We are dependent on our intellectual property and trade secrets and we may be unable to protect our intellectual property and trade secrets from infringement, misappropriation, or claims of infringement or invalidity.





The gaming industry is characterized by the use of various forms of intellectual property to entertain. We are dependent upon patented technologies, trademarked brands and proprietary information for our business. We endeavor to protect our intellectual property rights and our products through a combination of patent, trademark, trade dress, copyright and trade secret laws, as well as licensing agreements and third-party nondisclosure and assignment agreements.  We cannot assure you that any trademark, copyright, issued patent or other types of intellectual property will provide competitive advantages for us.  We cannot assure you that our efforts to protect our intellectual property rights or products will be successful.





Our existing patents may be found invalid or unenforceable and any current or future patent applications may not be approved.





We have numerous patents and trademarks and we utilize patent protection in the United States relating to certain existing and proposed processes and products. We cannot assure you that all of our existing patents would be found valid or enforceable or will continue to be valid or enforceable, or that any pending patent applications will be approved. Our competitors have in the past challenged, are currently challenging and may in the future challenge the validity or enforceability of certain of our patents. The patents we own could be challenged, invalidated or circumvented by others and may not be of sufficient scope or strength to provide us with any meaningful protection or commercial advantage. Competitors may infringe our patents and we may not have adequate resources or there may be other reasons we do not enforce our patents. Our patents may not adequately cover a competitor's products.  The future interpretation by courts of United States laws regarding the validity of patents could negatively affect the validity or enforceability of our current or future patents.





Our efforts to protect our unpatented proprietary technology may not be successful.





We rely on unpatented proprietary technology. It is possible that others will independently develop the same or similar technology or otherwise obtain access to our unpatented technology. To protect our trade secrets and other proprietary information, we generally require employees, consultants, advisors and collaborators to enter into confidentiality agreements. We cannot assure you that these agreements are fully enforceable or will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. If we are unable to maintain the proprietary nature of our technologies, it could have a material adverse effect on our business.





We may not be able to establish or maintain our trademarks.





We rely on our trademarks, trade names, trade dress, copyrights and brand names to distinguish our products from the products of our competitors. We have registered or applied to register many of these trademarks. Our trademark applications may not be approved and/or all of the above intellectual property may not remain valid or enforceable. We may not be able to build and maintain goodwill in our trademarks or other intellectual property. Third parties may oppose our trademark applications or challenge our use of the trademarks. Our trademarks may become so well known by the public that their use becomes generic and they lose trademark protection. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources towards advertising and marketing new brands. Further, our competitors may infringe our trademarks or other intellectual property and we may not have adequate resources or there may be other reasons we do not enforce our trademarks or other types of intellectual property.





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We may not be able to adequately protect our foreign intellectual property rights.





Because of the differences in foreign patent, trademark, trade dress, copyright and other laws concerning proprietary rights, our intellectual property frequently does not receive the same degree of protection in foreign countries as it would in the United States. Our failure to possess, obtain or maintain adequate protection of our intellectual property rights for any reason could have a material adverse effect on our business, results of operations and financial condition.





The intellectual property rights of others may limit our ability to make and sell our products.





The gaming industry is characterized by the rapid development of new technologies, which requires us to continuously introduce new products using these technologies and innovations, as well as to expand into new markets that may be created. Therefore, our success depends in part on our ability to continually adapt our products and systems to incorporate new technologies and to expand into markets that may be created by new technologies. However, to the extent technologies are protected by the intellectual property rights of others, including our competitors, we may be prevented from introducing products based on these technologies or expanding into markets created by these technologies. If the intellectual property rights of others prevent us from taking advantage of innovative technologies, our financial condition, operating results or prospects may be harmed.





We have many competitors in both the United States and foreign countries, some of which have substantially greater resources and have made substantial investments in competing technologies. Some competitors have applied for and obtained and may in the future apply for and obtain, patents that may prevent, limit or otherwise interfere with our ability to make and sell our products. Any royalty, licensing or settlement agreements, if required, may not be available to us on acceptable terms or at all.





Significant litigation regarding intellectual property rights exists in our industry.





We have in the past made, are currently making and may in the future make, enforcement claims against third parties and third parties have in the past made, are currently making and may in the future make, claims of infringement, invalidity or enforceability against us or against our licensees or manufacturers in connection with their use of our technology. For more information, see “Item 3. Legal Proceedings” and Note 15 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data,” included in this Form 10-K.  A successful challenge to or invalidation of one of our patents or trademarks, a successful claim of infringement by a third party against us, our products, or one of our licensees in connection with the use of our technology, or an unsuccessful claim of infringement made by us against a third party or its products could adversely affect our business or cause us financial harm. We are currently in litigation over various intellectual property matters. Any claims -- whether with or without merit -- could:





·
be expensive and time consuming to defend;





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





·
cause us to cease making, licensing or using products that incorporate the challenged intellectual property;





·
require us to redesign, reengineer or rebrand our products;





·
divert management's attention and resources;





·
require us to pay significant amounts in damages;





·
require us to enter into royalty, licensing or settlement agreements in order to obtain the right to use a necessary product, process or component;





·
limit our ability to bring new products to the market in the future; or





·
cause us by way of injunction to have to remove products on lease and/or stop selling or leasing new products.




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The gaming industry is highly regulated and we must adhere to various regulations and maintain our licenses to continue our operations.  Failure to obtain and/or maintain our licenses could be disruptive to our business and could adversely affect our operations.





We and our products are subject to extensive regulation under federal, state, local and foreign laws, rules and regulations of the jurisdictions in which we do business and our products are used. These laws, rules and regulations generally concern the responsibility, financial stability, character and suitability of our officers, directors, major stockholders, key personnel or business partners in gaming operations, including makers of gaming equipment such as ourselves. In many jurisdictions, shareholders owning greater than 5% of our shares must be licensed under applicable gaming regulations unless they qualify for and are able to obtain an exemption or waiver from licensing in those jurisdictions. Some jurisdictions empower their regulators to investigate participation by licensees in gaming outside their jurisdiction and require access to periodic reports concerning gaming activities. Violations of laws in one jurisdiction could result in disciplinary action in other jurisdictions. Licenses, approvals or findings of suitability may be revoked, suspended or conditioned. We may not be able to obtain or maintain all necessary registrations, licenses, permits or approvals. We cannot assure you that the licensing process will not result in delays or adversely affect our operations and our ability to maintain key personnel, or that complying with these regulations will not increase our costs. For a summary of gaming regulations that affect our business, see “Item 1. Business–Gaming Regulation,” included in this Form 10-K.





We may be unable to obtain licenses in new jurisdictions where our customers operate.





We will become subject to regulation in any other jurisdiction where our customers operate in the future. To expand into any such jurisdiction, we may need to be licensed, obtain approvals of our products and/or seek licensure of our officers, directors, major shareholders, key personnel or business partners. If we fail to seek, do not receive or receive a revocation of a license in a particular jurisdiction for our products, we would not be able to sell or place on a leased or participation basis our products in that jurisdiction.





Legislative and regulatory changes could negatively affect our business and the business of our customers.





Legislative and regulatory changes including, but not limited to, changes related to internet gaming, may affect demand for or place limitations on the placement of our products. Such changes could affect us in a variety of ways. Legislation or regulation may introduce limitations on our products or opportunities for the use of our products and could foster competitive games or technologies at our or our customers' expense. For example, current regulations in a number of jurisdictions where our customers operate limit the amount of space allocable to our products and substantial changes in those regulations may adversely affect demand for our products. Our business will also suffer if our products became obsolete due to changes in laws or the regulatory framework.





Legislative or regulatory changes negatively impacting the gaming industry as a whole or our customers in particular could also decrease the demand for our products. Opposition to gaming could result in restrictions or even prohibitions of gaming operations in any jurisdiction or could result in increased taxes on gaming revenues. Tax matters, including changes in state, federal or other tax legislation or assessments by tax authorities could have a negative impact on our business. A reduction in growth of the gaming industry or in the number of gaming jurisdictions or delays in the opening of new or expanded casinos could reduce demand for our products. Changes in current or future laws or regulations or future judicial intervention in any particular jurisdiction may have a material adverse effect on our existing and proposed foreign and domestic operations. Any such adverse change in the legislative or regulatory environment could have a material adverse effect on our business, results of operations or financial condition.





A continued downturn in general worldwide economic conditions or in the gaming industry or a reduction in demand for gaming may adversely affect our results of operations.  As a result, the market price of our common stock may decline.





Our business operations are affected by international, national and local economic conditions. The current recession and continued downturn in the general economy, or in a region constituting a significant source of our customers, or a reduction in demand for gaming, may harm the health of casino operators and our other customers and consequently result in fewer customers leasing or purchasing our products, which would adversely affect our results.





General worldwide economic conditions continue to be unfavorable. These conditions continue to make it difficult for our customers and us to accurately forecast and plan future business activities and they continue to cause our domestic and foreign customers to slow their spending on both our lease- and sales-based products.  We cannot predict the effect or duration of this economic slowdown or the timing or strength of a subsequent economic recovery, worldwide or in the gaming industry. If the domestic and foreign markets for our products significantly deteriorate due to these macroeconomic effects, our business, financial condition and results of operations will likely be materially and adversely affected and the market price of our common stock may decline.





The gaming industry has been notably impacted by the general economic downturn.





Due to recent disruptions in the financial markets, gaming operators have been less able to secure financing for development projects and have scaled back such projects considerably.  Clients have made significant cuts in expenditures, including layoffs of workers and management employees as well as delayed expansions or new openings.   Current economic conditions may cause both our domestic and international clients to decrease their expenditures on gaming equipment and our financial condition, results of operations and stock price may be negatively affected thereby.





17





Our domestic and global growth and ability to access capital markets are subject to a number of economic risks.





Financial markets in the United States, Europe and Asia continue to experience disruption, including, among other things, diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. It is possible that the disruption in financial markets will continue or even that there will be a further deterioration in financial markets and confidence in major economies.





These financial market conditions affect our business in a number of ways. The current tightening of credit in financial markets adversely affects the ability of our customers to obtain financing for purchases and operations and could result in a decrease in or cancellation of lease and sale orders for our products and services.  Current financial market conditions could also affect our ability to raise funds in the capital and bank lending markets.  Our Senior Secured Revolving Credit Facility matures on October 29, 2015. If economic conditions do not improve by such time, we might not be able to refinance such facilities on favorable economic terms, or at all.





Risks that impact our customers may impact us.





If fewer players visit our customers' facilities, if such players have less disposable income to spend at our customers' facilities or if our customers are unable to devote resources to purchasing and leasing our products, there could be an adverse effect on our business. Such risks that affect our customers include, but are not limited to:





·
adverse economic and market conditions in gaming markets such as those being currently experienced, including recession, economic slowdown, higher interest rates, higher airfares and higher energy and gasoline prices;





·
global geopolitical events such as terrorist attacks and other acts of war or hostility; and





·
natural disasters such as major fires, floods, hurricanes and earthquakes.





Economic, political, legal and other risks associated with our international sales and operations could adversely affect our operating results.





Since we sell or lease our products worldwide, our business is subject to risks associated with doing business internationally. Our sales to customers outside the United States, primarily Canada, Europe and Australasia accounted for approximately 50.9% of our consolidated revenue from continuing operations for fiscal 2010. Accordingly, our future results could be harmed by a variety of factors, including:





·
changes in foreign currency exchange rates;





·
exchange controls;





·
changes in regulatory requirements, such as, without limitation, caps on the number of table games in locations such as Macau;





·
changes in a specific country's or region's political or economic conditions;





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





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





·
difficulty in staffing and managing widespread operations;





·
changing labor regulations;





·
requirements relating to withholding taxes on remittances and other payments by subsidiaries;





·
different regimes controlling the protection of our intellectual property and the ability for us to repossess our equipment or products in the event of a lease default;





·
restrictions on our ability to own or operate subsidiaries, make investments or acquire new businesses in these jurisdictions;





·
restrictions on our ability to repatriate dividends from our subsidiaries; and





·
the intellectual property laws in certain foreign countries provide for criminal penalties for actions that would be civil penalties in the United States and such criminal penalties may affect all of our gaming licenses.





18


Our international operations are affected by global economic and political conditions. Changes in economic or political conditions in any of the countries in which we operate could result in exchange rate movement, new currency or exchange controls or other restrictions being imposed on our operations.





We also have agreements with casinos in Native American jurisdictions, which may subject us to sovereign immunity risks and could subject us to additional compliance costs.





Litigation may subject us to significant legal expenses, damages and liability and is inherently unpredictable and risky.





We are currently engaged in litigation on a variety of matters, including, in particular, several suits regarding our intellectual property rights and related anti-trust and trade practice issues. For information on our current material litigation and our assessments, see “Item 3. Legal Proceedings” and Note 15 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data,” included in this Form 10-K. Our assessment of each matter may change based on future unknown or unexpected events, or we may simply be wrong. Litigation requires the expenditure of significant time and resources and is inherently unpredictable and risky. We are unable at this time to estimate the likely outcome of pending litigation. An adverse judgment or injunction in any pending or future litigation could have a material impact on our business operations, intellectual property, results of operations or financial position.





Our products currently in development may not achieve commercial success and if we are unable to maintain a competitive technological position, we may suffer a material adverse effect on our business, results of operations or financial condition.





We have a number of products in various stages of development. We believe that our future success will depend in large part upon our ability to enhance our existing products and to develop, introduce and market new products and improvements to our existing products. As a result, we expect to continue to make significant investments in product development, as needed. Our development of products is dependent on factors such as reaching definitive agreements with third parties, obtaining requisite governmental approvals, having the necessary financial and other resources and the performance and financial and operational viability of various third parties.





Future technological advances in the gaming products industry may result in the availability of new products or increase the efficiency of existing products. However, we may not be able to finance capital expenditures for new technologies that are more cost-effective or create superior products.  Existing, proposed or as yet undeveloped technologies may render our current technology less profitable or less viable and we may not have available the financial and other resources to compete effectively against companies possessing such technologies.





While we are pursuing and will continue to pursue product development opportunities, we cannot assure you that such products will come to fruition or become successful. Furthermore, a number of those products are being tested and we cannot provide any definite date by which they will be commercially available. These products may not prove to be commercially viable and even if they do, we may not be able to obtain the various gaming licenses necessary to distribute them to our customers. Additionally, subsequent to the commercial introduction of such products, we may experience operational problems that could delay or defeat the ability of such products to generate revenue or operating profits. Future operational problems could increase our costs, delay our plans or adversely affect our reputation or our sales of other products which, in turn, could have a material adverse effect on our success. We cannot predict which of the many possible future products, if any, will meet evolving industry standards and consumer demands. Should we be unable to adapt to such technological changes, offer such products on a timely basis or establish or maintain a competitive position, we may suffer a material adverse effect on our business, results of operations or financial condition.





We compete in a single industry and our business may suffer if our products become obsolete or demand for them decreases, including without limitation, as a result of the downturn in the gaming industry.





We derive substantially all of our revenues from leasing, licensing, selling and other financing arrangements of products for the gaming industry. The gaming industry is currently suffering from a significant downturn, with several casinos announcing layoffs and major reductions in spending. Because of this downturn, our business may materially suffer if our products become obsolete or if use of our products decreases. Additionally, if table games are particularly affected by this market downturn, we may also materially suffer.  Our operating lease agreements with our customers are typically month-to-month and provide for termination upon 30 days' prior notice by either party.  Accordingly, consistent demand for and satisfaction with our products by our customers is critical to our financial condition and future success and problems, defects or dissatisfaction with our products could cause us to lose customers or revenues from leases with minimal notice. Additionally, our success depends on our ability to keep pace with technological advances in our industry and to adapt and improve our products in response to evolving customer needs and industry trends. If demand for our products weakens due to lack of market acceptance, technological change, competition, regulatory changes, or other factors, it could have a material adverse effect on our business, results of operations or financial condition.





19





Any disruption in our manufacturing processes, any significant increase in manufacturing costs or any inability to manufacture a sufficient number of our products to meet demand could adversely affect our business and operating results.





We manufacture our products at our headquarters and manufacturing facility in Las Vegas, Nevada, as well as our facility in Sydney, Australia. We also outsource the manufacturing of certain of our sub-assemblies in the United States, Europe and Australasia. Should any of these manufacturing processes be disrupted, we cannot provide assurance that we would be able to timely remedy such disruption. In such a case, we may be unable to produce a sufficient quantity of our products to meet the demand of our customers. In addition, manufacturing costs may increase significantly and we may not be able to successfully recover these cost increases with increased pricing to our customers. Either case could have an adverse impact on our business, results of operations or financial condition.





The products in each of our segments may experience losses due to technical difficulties or fraudulent activities.





Our success partly depends on our ability to avoid, detect, replicate and correct software and hardware errors and fraudulent manipulation of our systems. We incorporate security features into the design of our gaming products in order to prevent us or our patrons from being defrauded. To the extent any of our gaming products or software experience errors or fraudulent manipulation, our customers may replace our products and services with those of our competitors. In addition, the occurrence of errors in, or fraudulent manipulation of, our gaming products or software may give rise to claims for lost revenues and related litigation by our customers and may subject us to investigation or other action by gaming regulatory authorities, including suspension or revocation of our gaming licenses and disciplinary action, which may lead to a material adverse effect on our business, results of operations or financial condition. Further, in the event of such issues with our gaming products or software, substantial engineering and marketing resources may be diverted from other areas to rectify the problem.





We operate in a very competitive business environment and if we do not adapt our approach and our products to meet this competitive environment, our business, results of operations or financial condition could be adversely impacted.





There is intense competition in the gaming products industry, which is characterized by dynamic customer demand and rapid technological advances. We must continually adapt our approach and our products to meet this demand and match these technological advances and if we cannot do so, our business, results of operations or financial condition may be adversely impacted. Conversely, the development of new competitive products or the enhancement of existing competitive products in any market in which we operate could have an adverse impact on our business, results of operations or financial condition.  Due to the downturn in the economy in general and particularly in the gaming industry, we may not be able to adapt to the market adequately.  If we are unable to remain dynamic in the face of changes in the market, it could have a material adverse effect on our business, results of operations or financial condition.





In general, we compete with other gaming and entertainment products for space on the casino customers’ floor, as well as for our customers' capital and operational spending. Our shufflers also compete with hand shuffling. Some of the larger gaming supply companies with whom we compete are IGT, Bally, WMS and Aristocrat. New competitors may also enter our key markets.





In the Utility segment, namely shufflers and other gaming equipment, we compete with hand shuffling and other shuffler providers. Additionally, other companies may develop, “reverse engineer,” or market shufflers and seek to develop and obtain regulatory approvals of additional shuffler products. A competitive product may gain substantial placements or cause price erosion of our shufflers in the future.  Casinos may choose to shift from automatic to hand shuffling which would cause price erosion of our shufflers. Several companies also manufacture and sell chipper products which are competitive with our Easy Chipper product line. Competition with our i-Shoe card reading shoe is predominantly limited to Angel Co. Ltd.'s Angel Eye card reading shoe and the Bee Electronic Baccarat Dealing Shoe (U.S. Playing Card Company).





With respect to our PTG segment, in addition to companies such as IGT, Bally, Aristocrat and WMS that primarily market slot machines, we also compete with both non-proprietary table games such as blackjack and several companies which primarily develop and license proprietary table games. Some of those competitors’ widely known proprietary table game titles include Galaxy Gaming's Lucky Ladies and Emperor's Challenge, Masque Publishing's Spanish 21 and DEQ Systems EZ Baccarat. Additionally, competition with our progressive bet system for table games is predominantly limited to DEQ Systems. Competition in this segment is particularly based on price, brand recognition, player appeal and the strength of underlying intellectual property. Smaller developers and vendors are more able to participate in developing and marketing table games, compared to other gaming products, because of the lower cost and complexity associated with the development of these products and a generally less stringent regulatory environment.  In the future, slot manufacturers, as well as table game competitors or others, could market table games that might displace our products.





20


With our continued expansion, we have increased our ETS segment to expand our e-Table platforms. This product line has significant competition, perhaps more than our traditional Utility and PTG segment product offerings. There are numerous other companies that manufacture and/or sell e-Table games, which are similar to our Table Master, Vegas Star and Rapid Table Games. These companies include, but are not limited to, Elektroncek (also known as Interblock), Aruze, PacificNet, Novomatic, IGT and TableMAX. Our e-Tables, as well as those of other companies, also compete for casino floor space with live table games and EGMs.





Our EGM segment competes for casino floor space with products of other gaming suppliers. The international slot environment is competitive. The Australasia market reflects other worldwide markets as most of the major international manufacturers have a presence there. The major competitors in these markets are IGT, Bally, Aristocrat, WMS, Konami, Aruze and Ainsworth. In Asia, these competitors are also active along with further competition from myriad European slot manufacturers.





Finally, some of our product segments may compete against each other for space on the casino floor.





We are dependent on the success of our customers and are subject to industry fluctuations.





Our success depends on our customers leasing or buying our products to expand their existing operations, replace existing gaming products or equip a new casino. Any slowdown in the replacement cycle as a result of the current downturn in the gaming industry may negatively impact our operations.





Additionally, to the extent existing or potential customers choose to allocate capital to expenditures other than gaming products, such as real estate acquisitions, hotel furnishings, restaurants and other improvements, or generally to reduce expenditures, particularly in response to the current downturn in the gaming industry, we may suffer a material adverse effect on our business, results of operations or financial condition.





Certain market risks may affect our business, results of operations and prospects.





In the normal course of our business, we are routinely subjected to a variety of market risks, examples of which include, but are not limited to, interest rate movements, fluctuating commodities markets, higher labor costs, increased fuel prices, collectability of receivables and recoverability of residual values on leased assets such as those in certain international markets. Further, some of our customers may experience financial difficulties, possibly as a result of the current downturn in the gaming industry, or may otherwise not pay accounts receivable when due, resulting in increased write-offs. Material losses may be incurred in these areas in the future.





We are exposed to interest rate and foreign currency risk.





The indebtedness under the Senior Secured Revolving Credit Facility has variable rates of interest, which exposes us to the risk of increased interest rates. As of October 31, 2010, we had approximately $66,000 of variable rate debt. Assuming a 1% change in the average interest rate as of October 31, 2010, our annual interest cost would change by approximately $660.





We are exposed to foreign currency exchange rate risk inherent in our lease and sales commitments, anticipated leases and sales, anticipated purchases of inventory in foreign jurisdictions and assets, liabilities and debt denominated in currencies other than the U.S. dollar. We transact business in numerous countries around the world in a variety of foreign currencies.  Fluctuations in the value of the Euro, the Australian dollar, the Singapore dollar, the Pataca or the Rand may adversely affect our results of operations, of which the most significant to our operations for fiscal 2010 were the Australian dollar and the Euro. We expect that a significant portion of the volume of our business will continue to be denominated in foreign currency and because our financial results are reported in U.S. dollars, if we generate sales or earnings in other currencies, the translation of those results into U.S. dollars can result in a significant increase or decrease in the amount of those sales or earnings. As such, we expect our cash flows and earnings to continue to be exposed to the risks that may arise from fluctuations in foreign currency exchange rates.





We could face considerable business and financial risk in implementing acquisitions.





As part of our overall growth strategy, we have in the past acquired and will continue to seek to acquire, complementary products, assets and businesses. We regularly engage in discussions with respect to and investigate possible acquisitions. Future acquisitions could result (and past acquisitions have resulted) in potentially dilutive issuances of equity securities, significant expenditures of cash, the incurrence of debt and contingent liabilities and an increase in amortization expenses, which could have (and have, in the past, had) a material adverse effect upon our business, financial condition and results of operations.





The risks associated with acquisitions could have (and have, in the past, had) a material adverse effect upon our business, financial condition and results of operations. We may not be successful in consummating future acquisitions on favorable terms or at all or that any future acquisition will work out as we expect.





Our past acquisitions and any other future potential acquisitions may not produce the revenues, earnings or business synergies that we anticipate and may not perform as expected for a variety of reasons, including:




21




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





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





·
difficulties in the use, development or sale of intellectual property or future or present products;





·
the potential loss of employees;





·
currency fluctuations or changes in exchange rates in connection with sales to customers and the purchase of inventory in foreign currencies;





·
diversion of management's attention away from other business concerns;





·
expenses of any undisclosed or potential legal liabilities;





·
difficulties in staffing and managing worldwide operations; and





·
impairments in acquired assets.





Any one or a combination of these factors may cause our revenues or earnings to decline.





If our products contain defects, our reputation could be harmed and our operating results and financial results could be adversely affected.




Some of our products are complex and may contain undetected defects. The occurrence of defects or malfunctions in one or more of our products could result in financial losses for our customers and in turn termination of leases, cancellation of orders, product returns and diversion of our resources, and could additionally result in lost revenues, civil damages and regulatory penalties, as well as possible rescission of product approvals. Any of these occurrences could also result in the loss of or delay in market acceptance of our products and loss of placements.





We may not be able to attract, retain, or motivate the management or employees necessary to remain competitive in our industry.





The competition for qualified personnel in the gaming industry is intense.  Our future success depends on the retention and continued contributions of our key management, finance, marketing, development, technical and staff personnel, many of whom would be difficult or impossible to replace.  Our success is also tied to our ability to recruit additional key personnel in the future. We may not be able to retain our current personnel or recruit any additional key personnel required.  The loss of services of


any of our personnel or our inability to recruit additional necessary key personnel could have a material adverse effect on our business, financial condition, results of operations and prospects.





Our continued compliance with our financial covenants in our Senior Secured Revolving Credit Facility is subject to many factors, some of which are beyond our control and if we are unable to remain compliant under our financial covenants, our results of operations could be adversely affected by servicing costs.





Our Senior Secured Revolving Credit Facility contains material financial and other covenants, which, if breached, would trigger certain events of default.  If our operating results decline, we may need to seek an amendment to our existing facility or refinance the indebtedness outstanding under such facility. Depending on the debt market conditions at the time such an amendment or refinancing is necessary, it is possible that such amendment or refinancing could lead to a significant increase in debt service costs and interest expense, or result in additional restrictions being put on our operations.  In such a circumstance, if we are unable to obtain an amendment or refinancing, then we may be forced to file for bankruptcy protection or allow proceedings to take place whereby the lender’s security interests are exercised.





The restrictive covenants in our Senior Secured Revolving Credit Facility may limit our ability to finance future operations or capital needs or engage in other business activities that may be in our interest.





The agreement governing the Senior Secured Revolving Credit Facility imposes and the terms of any future indebtedness may impose, operating and other restrictions on us. Such restrictions will affect and in many respects limit or prohibit, among other things, our ability to take certain actions. The terms of the agreement may make it difficult to obtain financing in the future for working capital, capital expenditures, acquisitions and other purposes.  See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” included in this Form 10-K for further details.





See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations —Contractual Obligations and Off-Balance Sheet Arrangements” included in this Form 10-K for years beyond 2010.





22





Our business is subject to quarterly fluctuation.





Historically, our operating results have been lowest in our first fiscal quarter ending January 31, primarily due to the seasonality of customer capital budgets and the December holiday season. Our quarterly operating results may vary based on the timing of the opening of new gaming jurisdictions, the opening or closing of casinos, the expansion or contraction of existing casinos, approval or denial of our products and corporate licenses under gaming regulations, the introduction of new products, the mix of domestic versus international sales and the mix of lease and royalty revenue versus sales and service revenue. As a result, our operating results could be volatile, particularly on a quarterly basis.





ITEM 1B. UNRESOLVED STAFF COMMENTS





None.





ITEM 2. PROPERTIES





Properties. We lease facilities in various locations throughout North America for office, research and development, warehouse and service totaling approximately 105,000 square feet to support our American operations.  Our corporate headquarters, as well as our research and development and manufacturing of utility and e-Table products, are located in Las Vegas, Nevada and account for 76,000 square feet.





We lease facilities in various locations throughout Australia and New Zealand, totaling approximately 54,000 square feet for office, service and warehouse space to support our Australasia operations.  In addition, we own an approximately 59,000 square foot facility in Milperra, New South Wales, Australia that we use for research and development and manufacturing space for our e-Table and EGM products.





We lease facilities in Vienna, Austria, totaling approximately 14,000 square feet for office, warehouse and apartment rental space to support our European operations.





We lease approximately 6,000 square feet facilities in Macau, China and Singapore for office and warehouse space to support our Asia operations.





We lease an approximately 3,000 square feet facility in Johannesburg, South Africa for office and warehouse space to support our Africa operations.





We believe that our existing properties are suitable and adequate for our current needs and that additional facilities/space are available to us to support expansion, if required.





ITEM 3. LEGAL PROCEEDINGS





For information on Legal Proceedings, see Note 15 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.





Litigation is inherently unpredictable and risky. Our current assessment of each matter may change based on future unknown or unexpected events. 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 on our financial position or liquidity, 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 as may be required by applicable law, statute or regulation. We believe that the final disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.





ITEM 4. REMOVED AND RESERVED


23


PART II


(In thousands, except per share amounts)





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





Stock Listing.  Our common stock is traded on The NASDAQ Stock Market under the symbol SHFL. As of January 8, 2011, we had approximately 230 shareholders of record. There are a significantly greater number of shareholders whose shares are held in street name. Based on information available to us as of January 11, 2011, we estimate that we have approximately 13,100 beneficial holders in total. The following table sets forth quarterly high and low prices for trades of our common stock during fiscal 2010 and 2009:





2010


2009High


Low


High


LowFirst Quarter

$
9.81


$
7.16


$
$5.43


$
2.50Second Quarter


9.72



7.72



4.12



1.97Third Quarter


10.19



7.33



7.63



3.72Fourth Quarter


9.55



7.55



9.90



6.67





The closing price of our common stock on January 11, 2011, was $11.12 per share.





Dividend Policy.  We have not paid dividends on our common stock in our two most recent fiscal years and certain covenants in our Senior Secured Revolving Credit Facility restrict our ability to pay dividends or make other distributions with respect to our equity securities.





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


24




Performance Graph. The following graph compares a shareholder’s cumulative total return for the last five fiscal years, assuming $100 invested at October 31, 2005, with the reinvestment of all dividends, as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the S&P Small Cap 600 Index: (iii) the stocks included in the NASDAQ Index Composite; (iv) the stocks included in the Dow Jones U.S. Gambling Index; and (v) an index of selected issuers in our industry, or Peer group, composed of IGT, Aristocrat, WMS, Bally and Progressive Gaming International Corporation (“PGIC”).










Company Name / Index
Investment Value as of October 31,2005
2006
2007
2008
2009
2010Shuffle Master, Inc.
100.00
110.33
53.94
15.22
30.80
37.11S&P Smallcap 600
100.00
116.10
129.51
87.49
92.35
116.62NASDAQ Composite
100.00
113.22
136.41
80.89
97.96
120.80Dow Jones US Gambling
100.00
139.97
203.93
60.05
74.81
126.35Peer Group
100.00
149.00
160.13
58.80
87.35
80.82
  25


ITEM 6. SELECTED FINANCIAL DATA





SELECTED CONSOLIDATED FINANCIAL DATA





The following summary consolidated financial data should be read in conjunction with and is qualified by reference to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.  The consolidated statements of operations data for the years ended October 31, 2010, 2009, 2008, 2007 and 2006, and the consolidated balance sheet data are derived from our consolidated financial statements. The amounts shown below for the years ended 2006, 2007, 2008 and 2009 have been revised to reflect the effect of the retrospective application of accounting standards adopted beginning on November 1, 2009, related to convertible debt. The historical results are not necessarily indicative of future results.


Year Ended October 31,2010


2009


2008


2007


2006(In thousands, except per share and unit/seat amounts)Summary financial statements (a):RevenueUtility

$
77,357


$
71,707


$
80,893


$
78,457


$
86,792Proprietary Table Games


40,430



38,697



38,594



33,125



38,316Electronic Table Systems


42,398



22,342



27,461



27,890



16,555Electronic Gaming Machines


41,117



46,598



42,898



39,269



21,090Unallocated Corporate


-



83



160



110



238Total revenue


201,302



179,427



190,006



178,851



162,991Cost of revenue


77,332



73,756



79,104



74,985



56,721Gross profit


123,970



105,671



110,902



103,866



106,270Income (Loss)  from continuing operations


23,083



14,974



(15,373
)


12,914



2,134Discontinued operations, net of tax


-



-



(1
)


78



(246
)Net Income (loss)

$
23,083


$
14,974


$
(15,374
)

$
12,992


$
1,888Earnings (loss) per share - continuing operations:Earnings (loss) per share, basic and diluted (b)

$
0.43


$
0.28


$
(0.38
)

$
0.37


$
0.06Weighted average shares, basic (b)


53,258



53,120



40,006



34,680



34,585Weighted average shares, diluted(b)


54,199



53,449



40,006



35,276



36,052Balance Sheet Data (end of year):Cash, cash equivalents, and investments

$
9,988


$
7,840


$
5,374


$
4,392


$
8,917Total assets

$
303,960


$
285,469


$
261,930


$
359,535


$
304,823Total debt

$
66,262


$
93,210


$
124,335


$
226,151


$
220,609Total long-term liabilities

$
68,973


$
96,109


$
86,428


$
225,076


$
149,985Shareholders' equity

$
186,148


$
156,074


$
103,363


$
93,097


$
41,399Cash Flow Data:Cash provided by operating activities

$
51,325


$
40,142


$
44,018


$
33,048


$
34,021Cash (used) by investing activities

$
(20,433
)

$
(9,045
)

$
(5,812
)

$
(33,119
)

$
(104,142
)Cash (used) provided by financing activities

$
(28,659
)

$
(30,124
)

$
(37,256
)

$
(3,513
)

$
65,923


(a)  In September 2007, we purchased PGIC's table games division. Effective February 1, 2006, we acquired Shuffle Master Australasia Holdings Pty Ltd. These acquisitions, in addition to less significant acquisitions, are included in our consolidated financial statements beginning on the effective date of the transactions.





(b)  Earnings per share and weighted average share amounts reflect the effects of our 3 for 2 common share stock splits in January 2005. Earnings per share and weighted average share amounts for the years ended October 31, 2008, 2009 and 2010 reflect our equity offering in July 2008 of an additional 20,294 common shares.  For fiscal 2008, the dilution of 75 shares related to our options, restricted stock and contingent convertible notes have not been included in the diluted loss per share computation as their inclusion would be anti-dilutive.


26
  ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(In thousands, except per share, unit/seat amounts and product lease/sale prices)





The following is a discussion and analysis of our financial condition, results of operations and liquidity and capital resources as of October 31, 2010 and 2009 and for the fiscal years ended October 31, 2010, 2009 and 2008. This discussion should be read together with our audited consolidated financial statements and related notes included in “Item 8. Financial Statements and Supplementary Data” included in this Annual Report on Form 10-K (“Form 10-K”).  Some of the information contained in this discussion includes forward-looking statements that involve risks and uncertainties; therefore our "Special Note Regarding Forward-Looking Statements" and "Risk Factors" should be reviewed  for a discussion of important factors that could cause actual results to differ materially from the results described in, or implied by, such forward-looking statements.





OVERVIEW





We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor.  Our products primarily relate to licensed casino operators’ table games activities and focus on either increasing their profitability, productivity and security or expanding their gaming entertainment offerings in the form of proprietary table games, electronic table games or electronic slot machines. Our products are offered in highly regulated markets throughout the world.   Our products are manufactured at our headquarters and manufacturing facility in Las Vegas, Nevada, at our Australian headquarters in Milperra, New South Wales, Australia, as well as outsourced, for certain sub-assemblies in the United States, Europe and Australasia.





Our business is segregated into the following four product segments: Utility, Proprietary Table Games (“PTG”), Electronic Table Systems (“ETS”) and Electronic Gaming Machines (“EGM”). Each segment's activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.





See “Item 1. Business” included in this Form 10-K for a more detailed discussion of our business, strategy and each of our four segments.





Current Economic Environment





The gaming industry in both the United States and abroad has been particularly affected by the downturn in general worldwide economic conditions, which continued to have negative consequences on our results in fiscal 2010 and is likely to continue to have a negative impact in fiscal 2011. The activity in the credit markets and in the broader global economy and financial markets has exacerbated these trends.  Consumer confidence has been significantly impacted, as seen in broader economic trends such as declines in auto and other retail sales, the weakness in the housing market and increased unemployment.





As a result, the outlook for the gaming, travel and entertainment industries both domestically and internationally remains highly uncertain.  Due to recent disruptions in the financial markets, gaming operators have been less able to secure financing for development projects and have scaled back such projects considerably.  Customers have made significant cuts in expenditures, including layoffs of workers and management employees as well as delayed expansions or new openings. These economic conditions may cause both our domestic and international clients to decrease their expenditures on gaming equipment and our financial condition, results of operations and stock price may be negatively affected thereby.





Sources of Revenue





We derive our revenue from the lease, license and sale of our products and by providing service to our leased and in some cases, previously sold units. Consistent with our strategy, we have a continuing emphasis on leasing or licensing our products.  When we lease or license our products, we generally negotiate month-to-month fixed fee contracts, or to a lesser extent, enter into participation arrangements whereby casinos pay us a fee based on a percentage of net win.  Product lease contracts typically include parts and service. When we sell our products, we offer casinos a choice between a cash sale or to a lesser extent, long-term financing. We also offer a majority of our products for sale with an optional parts and service contract.





Currently, Utility segment revenue is derived substantially from our automatic card shufflers. In addition to leasing shufflers, we also sell and service them. In the PTG segment, the majority of games placed are licensed to our customers, which provides us with royalty revenue. In the ETS segment, we derive revenue from leases, sales and service contracts. In the EGM segment, we derive revenue from selling the full EGM complement, as well as game conversion kits.





27









Utility





·
We expect to continue increasing lease revenues in our Utility segment within the United States.  One of the current growth drivers for this segment has been the Aceshuffler replacement cycle. The i-Deal shuffler is our next generation replacement for the Ace specialty shuffler. As the Ace reaches its end of life where we cannot provide replacement parts, our strategy is to encourage our customers to replace the Ace shufflers, both leased and previously sold, with the i-Deal shuffler. Approximately 80% of current i-Deal shuffler placements (both sales and leases) have been driven by the Ace replacement cycle.  The majority of these placements are leases.





·
Our markets for shuffler lease and sale revenue have grown recently in the United States with the approval of live table gaming in several jurisdictions such as Pennsylvania and Delaware.  A substantial share of our Utility revenue growth in the current year has been from these new jurisdictions.





·
We expect to continue seeing volatility in sales revenue in our Utility segment outside the United States.  While we encourage leasing outside the United States, a large majority of our international Utility product placements are sales.  Growth drivers for the Utility segment outside the United States are expected to be new jurisdictional openings, such as the new openings in Singapore and the Philippines during fiscal 2010, as well as the expansion of existing markets such as Macau.  In the current fiscal year, new markets such as Singapore have contributed significantly to growth of our total global revenue base.





Proprietary Table Games





·
Our lease model is strongest in our PTG segment with more than 90% of our total PTG revenue coming from royalties and leases.  While we have a strong leasing presence in the United States, we are constantly looking to expand our proprietary table games in other parts of the world where the current penetration of proprietary table games is lower.  With the opening of new casino markets in Asia, we have recently seen some successes with new lease placements of our premium table games as well as progressives and side bets.




·
Although the majority of our PTG revenue comes from our premium table games, we also offer a number of progressive upgrades and side bets.  These products are available for our own proprietary table game titles as well as public domain games such as poker, blackjack, baccarat and pai gow poker.  These progressives and side bets, offered almost exclusively through leases, are providing a growing share of our total PTG revenue.





·
We also aggressively pursue opportunities to place PTG products in new properties and jurisdictions in the United States.  As noted above, several states have recently approved live table games, and we have seen significant placements of our table game products in those new jurisdictions.





Electronic Table Systems





·
We expect to continue to increase our lease revenues in our ETS segment within the United States.  During the current year, we have seen new opportunities due to favorable regulatory changes in states such as Florida that have allowed for significant new placements of our Table Master product.





·
Outside the United States, we continue to realize a large portion of our ETS revenues from sales rather than leases.  Favorable regulatory changes in some Australian jurisdictions have allowed for significant placements of new Vegas Star and Rapid Table Games products during the current year.  We have seen new opportunities for lease placements with the opening of new casino properties in Singapore, and we intend to continue pursuing new lease placements whenever possible.





·
As we have seen revenue growth in our Utility and PTG segments as some states approve live table games, we have seen some of our leased ETS products returned from those same markets.  Although this will cause some short-term setbacks in the growth of our domestic ETS business, we have been able to return these products to active service in other markets such as Mexico and South America.





·
During the current year we have begun generating revenue from placements of our new i-Table product.  We expect this product, which combines an electronic betting interface with a live table game, to provide us with substantial growth opportunities as it achieves acceptance in the market.





Electronic Gaming Machines





·
Our EGM segment is primarily a sales model and we expect to continue to realize substantially all of our EGM revenues from sales of EGMs in our primary market, Australia.





·
During the first three fiscal quarters of fiscal 2010, sales of EGM products in this market have been down from prior year levels.  We believe a significant portion of this decreased demand has resulted from the anticipated release of our new Equinox cabinet.  We believe that customers have been delaying new EGM placements until they can buy the newest product.  Equinox offers widescreen displays and substantially improved graphics and user interfaces over older-style EGM products.




28




·
Initial deliveries of Equinox began in July 2010, and we experienced record placements during the fourth quarter of fiscal 2010.  We anticipate strong demand in future periods as Equinox gains broader market acceptance.





·
A significant portion of our EGM revenue base comes from conversions of existing units to new game titles.  We are continually developing new titles for our existing machines, and installation of these new titles provides us with an ongoing source of conversion revenue.





Expenses





Our direct expenses primarily include cost of products sold, depreciation of leased assets, and amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation.  Indirect operating expenses include other costs directly identified with each segment, such as R&D, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses.  We continue to expend significant R&D efforts on the development of our newer generation shuffler products, such as the next generation MD2CR and one2six Plus, our card recognition products, as well as other table accessories, such as the i-Shoe and i-Score. With our expansion into the e-Table markets, we continue to spend significant R&D dollars on developing and implementing new gaming mediums, such as the i-Table, our newest e-Table that combines a variety of our products to create an exciting new table game experience. During fiscal 2010, we spent significant R&D efforts developing the new EGM Equinox cabinets.





The amounts classified as unallocated corporate expenses consist primarily of costs related to overall corporate management and support functions. These include costs related to executive management, accounting and finance, general sales support, legal and compliance costs, office expenses and other amounts for which allocation to specific segments is not practicable.





Gross Margin





The number and mix of products placed and the average lease or sales price are the most significant factors affecting our gross margins. Our continuing emphasis on leasing versus selling, the shift in product mix, timing of installations and related upfront installation charges, as well as increases in non-cash depreciation and amortization expenses attributable to our acquisitions, impact our margins.





In general, lease gross margin is greater than the sales gross margin for the same products. However, total gross profit from leasing will be lower in a given reporting period than those of a sale due to the much higher price of a sale versus a lease.  A number of factors impact gross margins, including the number and mix of products placed and the average lease or sales price of those products. For example, in our PTG segment, premium table games warrant a higher average lease price than a PTG add-on such as a felt side-bet or a progressive. For Utility products, when a new shuffler is introduced into the market, we use introductory lease pricing. This is consistent with our rollout strategy whereby we provide very favorable lease rates at the inception of a lease to entice the customer to try our new product. After the introductory pricing period expires, the price generally increases to the monthly “list” lease price, which we believe will increase future revenues because most customers keep the products beyond the introductory pricing period. Accordingly, we anticipate that gross margins will increase under our lease model.





In addition to the lease versus sell strategy, we expect to see continual improvement in our gross margins through value engineering to reduce manufacturing costs. Our focus is currently on savings attributable to component parts, product redesign and lower cost manufacturing opportunities within each of our segments.





SIGNIFICANT TRANSACTIONS





Prime Table Games, LLC.On December 21, 2010, we entered into a License and Release agreement (the “License and Release Agreement”) with Prime Table Games, LLC and related parties (collectively “Prime Table Games”) to settle existing litigation between the parties and to acquire intellectual property licenses related to our PTG segment. For a further discussion of this case, see Note 15 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K. Total consideration paid by us was $5,500. Accordingly, we recorded a legal settlement charge of approximately $2,200 for the year ended October 31, 2010 which represents the fair value associated with the effective settlement of the existing litigation. The remaining $3,300 will be recorded as intangible assets in December 2010.The $3,300 of intangible assets will be amortized on a straight line basis over an approximate 9 year period.





29





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States. Our accounting policies are more fully described in Note 1 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.  Some of our accounting policies require us to make difficult, complex and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We periodically evaluate our policies, estimates and related assumptions and base our estimates on historical experience, current trends and expectations of the future. We considered the following critical accounting policies to be the most important to understanding and evaluating our financial results and require the most subjective and complex judgments made by management. We have discussed the development, selection and disclosure of our critical accounting policies and estimates with the Audit Committee of our Board of Directors. Actual results may differ from our estimates under different conditions and assumptions.





Revenue recognition.We recognize revenues when all of the following have been satisfied:





·
persuasive evidence of an arrangement exists;





·
the price to the customer is fixed and determinable;





·
delivery has occurred and any acceptance terms have been fulfilled; and





·
collection is reasonably assured.




Revenues are reported net of incentive rebates, discounts, sales taxes, and other taxes of a similar nature. Amounts billed prior to completing the earnings process are deferred until revenue recognition criteria are met.





Product lease and royalty revenue —Lease and royalty revenue is earned from the leasing of our tangible products and the licensing of our intangible products, such as our proprietary table games. When we lease or license our products, we generally negotiate month-to-month fixed fee contracts, or to a lesser extent, enter into participation arrangements whereby casinos pay a fee to us based on a percentage of net win.   Lease and royalty revenue commences upon the completed installation of the product. Lease terms are generally cancellable with 30 days notice.  We recognize revenue from our leases and licenses upon installation of our product on a month to month basis.





Product sales and service revenue— We generate sales revenue through the sale of equipment in each product segment, including sales revenue from sales-type leases and the sale of lifetime licenses for our proprietary table games. Our credit sales terms are primarily 60 days or less.  Financing for intangible property and sales-type leases for tangible property have payment terms ranging generally from 24 to 36 months and are interest-bearing at market interest rates. Revenue from the sale of equipment is recorded in accordance with the contractual shipping terms. If a customer purchases existing leased equipment, revenue is recorded on the effective date of the purchase agreement. Revenue on service and warranty contracts is recognized as the services are provided over the term of the contracts, which are generally one year. Revenue from the sale of lifetime licenses, under which we have no continuing obligation, is recorded on the effective date of the license agreement.





Our EGMs, Table Masters and Vegas Star products that contain both software and non-software components that function together to deliver the product’s essential functionality were previously subject to software revenue recognition rules. Under the new ASUs adopted for new and materially modified arrangements entered into after the beginning of our first quarter of fiscal 2010 (discussed below under Recently Issued Accounting Standards), our EGMs, Table Masters and Vegas Star products no longer fall under the scope of software revenue recognition rules and are generally recognized upon delivery and customer acceptance.





Multiple element arrangements— Some of our revenue arrangements contain multiple deliverables, such as a product sale combined with a service element or the delivery of a future product.  The new ASUs adopted provide for a more economically aligned model for allocating revenues among multiple deliverables in a multi-element arrangement, based on relative selling prices. In order of preference, relative selling prices will be estimated based on vendor specific objective evidence (“VSOE”), third-party evidence (“TPE”), or management’s best estimate of selling price (“BESP”), and the residual method is no longer allowed.





Most of our products and services qualify as separate units of accounting, and the new guidance does not change this premise. When VSOE or TPE is not available, BESP is the amount we would sell the product or service for individually. The determination of BESP is made based on our normal pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs, and profit objectives. Under the new guidance, revenues for certain products in our EGM and ETS segments and other software-enabled equipment in certain bundled arrangements previously deferred because VSOE was not available for undelivered elements will no longer be deferred. Generally, revenues allocated to future performance obligations elements will be recognized upon delivery and customer acceptance.





30


The adoption of these new standards did not have a material impact on our operating results, financial position or cash flows for the period ended October 31, 2010. Although this new accounting guidance is not currently expected to have a significant effect on the timing or amount of revenues in periods after the initial adoption, the impact is dependent upon the prevalence of future multi-element arrangements and the evolution of new sales strategies.





Goodwill and other indefinite lived intangible assets. We review our goodwill for impairment annually in October or when circumstances indicate that the carrying amount of goodwill may not be fully recoverable.  The review is performed at the operating segment level. The goodwill impairment test is a two-part test.  In the first step, we selected a discounted cash flow model (income approach) and the Guideline Public Company Model (market approach) to assess the fair values of our operating segments.  These two methodologies were weighted equally in determining fair values.  The fair value of the operating segment is then compared to the book value of the operating segment, including its goodwill. If the fair value is less than the book value, then we would perform a second step to compare the implied fair value of the operating segment's goodwill to its book value. The implied fair value of the goodwill is determined based on the estimated fair value of the operating segment less the fair value of the operating segment's identifiable assets and liabilities. We would record an impairment charge to the extent that the book value of the operating segment's goodwill exceeds its fair value.





Our income approach analysis is based on the present value of two components: the sum of our three-year projected cash flows and a terminal value assuming a long-term growth rate. The cash flow estimates are prepared based on our business plans for each operating segment, considering historical results and anticipated future performance based on our expectations regarding product introductions and market opportunities. The discount rates used to determine the present value of future cash flows were derived from the weighted average cost of capital of a group of comparable companies with consideration for the size and specific risks of each our operating segments. The discount rates used for each operating segment were 12.5% for our fiscal 2010 test and 13.0% for our fiscal 2009 test.





As of October 31, 2010 and 2009, our goodwill totaled $75,932 and $74,662, respectively. Our fiscal 2010 annual goodwill impairment test indicated the fair value of each operating segment was in excess of its carrying value. Inherent in such fair value determinations are significant judgments and estimates, including assumptions about our future revenues, profitability, cash flows and long-term growth rates, as well as our operational plans and our ability to execute such plans and our interpretation of current economic indicators and market valuations.





If our assumptions do not prove correct or economic conditions affecting future operations change, our goodwill could become impaired and result in a material adverse effect on our results of operations and financial position. To illustrate the sensitivity of the fair value calculations on our goodwill impairment test, if the discount rates used for the 2010 analysis increased to 13.5% for each operating segment (all other assumptions held constant), the fair value of each operating segment would still be in excess of their carrying value by at least 43%.





For fiscal 2010, 2009 and 2008, we recorded impairment charges of $0, $0 and $22,137, respectively.





We review our indefinite lived intangible assets (“tradenames”) for impairment annually in October or when circumstances indicate that the carrying amount of the tradename may not be fully recoverable. We would record an impairment loss if the carrying amount of the indefinite lived intangible asset exceeds its estimated fair value.





In October 2010, we performed our annual indefinite lived intangible asset impairment analysis for our Stargames and CARD tradenames, which is discussed in Note 6 to our Consolidated Financial Statements, by comparing the discounted, estimated future cash flows using the income approach as compared to the carrying value of the tradenames and determined that no impairment was indicated.





Other intangible assets.Other intangible assetsinclude intellectual property for games, patents, trademarks, copyrights, licenses, developed technology, customer relationships and non-compete agreements that were purchased separately or acquired in connection with a business combination. All of our significant other intangible assets are definite lived and, accordingly, amortized over their expected useful lives which range from 1 to 15 years. We amortize certain of our intangible assets (related to revenue production) proportionate to the ratio of actual revenue to total actual plus expected revenue from the utilization of the intangible asset. We believe this method reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. For certain other intangibles, such as covenants not to compete, we amortize on a straight-line basis over their useful lives.





Impairment of long-lived assets.We estimate the useful lives of our long-lived assets, excluding goodwill and indefinite lived intangible assets, based on historical experience, estimates of products' commercial lives, the likelihood of technological obsolescence and estimates of the duration of commercial viability for patents, licenses and games.





We review our long-lived assets, excluding goodwill and indefinite lived intangible assets, for impairment whenever events or circumstances indicate the carrying value may not be recoverable or warrant a revision to the estimated remaining useful life.  We would record an impairment loss if the carrying amount of the asset or asset group is not recoverable (as determined by undiscounted cash flows) and the carrying amount exceeds its estimated fair value.  For fiscal 2010, 2009 and 2008 we did not have any such impairment loss.





31


Inventories.  Inventories are stated at the lower of cost, determined on a first-in-first-out basis, or market.  Cost elements included in work-in-process and finished goods include raw materials, direct labor and manufacturing overhead. We regularly review inventory quantities and update estimates for the net realizable value of inventories. This process includes examining the carrying values of new and used gaming devices, parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of our inventories, the current and projected sales levels for such products, the projected markets for such products, the costs required to sell the products, including refurbishment costs and importation costs for international shipments and the overall projected demand for products once the next generation of products are scheduled for release.





As a result of our ongoing analysis of inventory, we recognized inventory write-downs of $1,019, $1,523 and $72 for fiscal years 2010, 2009 and 2008, respectively.  Additional valuation charges could occur in the future as a result of changes in the factors listed above.





Provisions for bad debts. We maintain provisions for bad debts for estimated credit losses that result from the inability of our customers to make required payments. Provisions for bad debts are estimated based on historical experience and specific customer collection issues. Changes in the financial condition of our customers could result in the adjustment upward or downward in the provisions for bad debts, with a corresponding impact to our operating results.





Income Taxes.We are subject to income taxes in the U.S. and other foreign jurisdictions where we operate.   Accounting standards require the recognition of deferred tax assets, net of applicable reserves, and liabilities for the estimated future tax consequences attributable to differences between financial reporting amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which the differences are expected to be recovered or settled.  Accounting standards requires a reduction of the carrying amounts of deferred tax assets by a valuation allowance, if based on the available evidence, it is more likely than not that such assets will not be realized





As of October 31, 2010, we recorded a valuation of $1,526 tax affected against certain foreign deferred tax assets based on our estimate of future realization.  Management will reassess the realization of deferred tax assets each reporting period.  To the extent that the financial results of certain foreign operations improve and it becomes more likely than not that the deferred tax assets are realizable, the Company will be able to reduce the valuation allowance through earnings.





In the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain.  Accounting standards regarding uncertainty in income taxes provides a two-step approach to recognizing and measuring uncertain tax positions.  The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates its more-likely-than-not that such position will be sustained on audit, including resolution of related appeals, if any.  The second step is to measure the tax benefit as the largest amount which is more than 50% likely, based solely on the technical merits, of being sustained on examinations.  Changes in facts or information as well as the expiration of statutes of limitations and/or settlements with tax authorities may result in material adjustments to these estimates in the future.





Share based compensation.  We measure and recognize all share-based compensation, including shares and share-based awards to employees, under the fair value method.  We measure the fair value of share-based awards using the Black-Scholes model.





Compensation is attributed to the periods of associated service and such expense is recognized on a straight-line basis over the vesting period of the awards. Forfeitures are estimated at the time of grant, with such estimate updated when the expected forfeiture rate changes.





In addition, the excess tax benefit from stock-option exercises—tax deductions in excess of compensation cost recognized—is classified as a financing activity.





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





RECENTLY ISSUED ACCOUNTING STANDARDS





Other recently issued accounting standards that may impact our financial statements, as well as those noted below in this Management’s Discussion and Analysis of Financial Condition and Results of operations (“MD&A”), are discussed further in Note 1 of our Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" included in this Form 10-K.





32


Revenue recognition. In October 2009, the FASB issued new revenue recognition accounting standards with respect to certain software-enabled products and multi-element arrangements. We elected to early adopt this new guidance prospectively effective November 1, 2009. Under the new guidance, tangible products, containing both software and non-software components that function together to deliver a tangible product’s essential functionality is now considered to be a “non-software” element and, accordingly, will no longer be subject to software revenue accounting. The new guidance also established a more economically aligned model for allocating revenues among multiple deliverables in a multi-element arrangement, based on relative selling prices. In order of preference, relative selling prices will be estimated based on vendor specific objective evidence (“VSOE”), third-party evidence (“TPE”), or management’s best estimate of selling price (“BESP”), and the residual method is no longer allowed.





Most of our products and services qualify as separate units of accounting, and the new guidance does not change this premise. When VSOE or TPE is not available, BESP is the amount we would sell the product or service for individually. The determination of BESP is made based on our normal pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs, and profit objectives. Under the new guidance, revenues for certain products in our EGM and ETS segments and other software-enabled equipment in certain bundled arrangements previously deferred because VSOE was not available for an undelivered element will no longer be deferred. Generally, revenues allocated to non-software elements will be recognized upon delivery and customer acceptance, and only revenues allocated to software elements may require deferral and recognition over the lease or license term.





The adoption of these new standards did not have a material impact on our operating results, financial position or cash flows for the period ended October 31, 2010. Although this new accounting guidance is not currently expected to have a significant effect on the timing or amount of revenues in periods after the initial adoption, the impact is dependent upon the prevalence of future multi-element arrangements and the evolution of new sales strategies.





Convertible debt instruments. Effective November 1, 2009, we adopted new authoritative guidance from the Financial Accounting Standards Board (“FASB”) related to the accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlements).  The new guidance applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement of the conversion option. Even though we extinguished our contingent convertible senior notes (“Notes”) by May 2009, we were required to apply the new guidance retrospectively to our previously issued financial statements for the periods in which the Notes were outstanding. The new guidance requires bifurcation of the instrument into a debt component that is initially recorded at fair value and an equity component. The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity. The liability component of the debt instrument is accreted to par using the effective interest rate method; accretion is reported as a non-cash component of interest expense. The equity component is not subsequently re-valued as long as it continues to qualify for equity treatment.





We separated the Notes into two accounting components:




1.
a debt component, representing the fair value of the Notes as if they had no conversion rights, and


2.
an equity component, representing the difference between the proceeds from the issuance of the Notes and their fair value.





The amount allocated to the equity component was accounted for as debt discount.  We also allocated the transaction costs to the liability and equity components in proportion to the allocation of proceeds and accounted for them as debt issuance costs and equity issuance costs, respectively.  Debt discount and debt issuance costs not allocated to equity were amortized over the period to the first conversion date (5 years) using the effective interest rate method and recorded as interest expense.


33




The following table presents our various items of revenue and expense as a percentage of total revenue:





CONSOLIDATED STATEMENTS OF OPERATIONS




Year Ended October 31,2010


2009


2008(In thousands)Revenue:Utility

$
77,357


38.4
%

$
71,707


40.0
%

$
80,893


42.5
%Proprietary Table Games


40,430


20.1
%


38,697


21.6
%


38,594


20.3
%Electronic Table Systems


42,398


21.1
%


22,342


12.4
%


27,461


14.5
%Electronic Gaming Machines


41,117


20.4
%


46,598


26.0
%


42,898


22.6
%Other


-


0.0
%


83


0.0
%


160


0.1
%Total revenue


201,302


100.0
%


179,427


100.0
%


190,006


100.0
%Cost of revenue


77,332


38.4
%


73,756


41.1
%


79,104


41.6
%Gross profit


123,970


61.6
%


105,671


58.9
%


110,902


58.4
%Selling, general and administrative


66,817


33.2
%


63,647


35.5
%


71,350


37.6
%Research and development


21,811


10.8
%


17,349


9.7
%


18,474


9.7
%Impairment of goodwill


-


0.0
%


-


0.0
%


22,137


11.7
%Income (Loss) from operations


35,342


17.6
%


24,675


13.7
%


(1,059
)

(0.6
%)Other income (expense):Interest income


577


0.3
%


860


0.5
%


1,759


0.9
%Interest expense


(4,015
)

(2.0
%)


(6,047
)

(3.4
%)


(11,642
)

(6.1
%)Other, net


282


0.1
%


731


0.4
%


1,261


0.7
%Total other income (expense)


(3,156
)

(1.6
%)


(4,456
)

(2.5
%)


(8,622
)

(4.5
%)Gain (loss) on early extinguishment of debt


(1,123
)

(0.6
%)


1,841


1.0
%


(435
)

(0.2
%)Impairment of investments


-


0.0
%


-


0.0
%


(1,560
)

(0.8
%)Income (loss) from continuing operations before tax


31,063


15.4
%


22,060


12.2
%


(11,676
)

(6.1
%)Income tax (benefit) provision


7,980


3.9
%


7,086


3.9
%


3,697


2.0
%Income (loss) from continuing operations


23,083


11.5
%


14,974


8.3
%


(15,373
)

(8.1
%)Discontinued operations, net of tax


-


0.0
%


-


0.0
%


(1
)

(0.0
%)Net income (loss)

$
23,083


11.5
%

$
14,974


8.3
%

$
(15,374
)

(8.1
%)


34


The following table provides additional information regarding our revenue, gross profit and gross margin:





REVENUE AND GROSS MARGIN




Year Ended October 31,


Percentage Change2010


2009


2008


10 vs. 09


09 vs. 08(In thousands)Revenue:Leases and royalties

$
86,717


$
76,231


$
70,898


13.8
%

7.5
%Sales and service


114,585



103,113



118,948


11.1
%

(13.3
%)Other


-



83



160


(100.0
%)

(48.1
%)Total

$
201,302


$
179,427


$
190,006


12.2
%

(5.6
%)Cost of revenue:Leases and royalties

$
28,008


$
24,559


$
21,866


14.0
%

12.3
%Sales and service


49,324



49,197



57,238


0.3
%

(14.0
%)Total

$
77,332


$
73,756


$
79,104


4.8
%

(6.8
%)Gross profit:Leases and royalties

$
58,709


$
51,672


$
49,032


13.6
%

5.4
%Sales and service


65,261



53,916



61,710


21.0
%

(12.6
%)Other


-



83



160


(100.0
%)

(48.1
%)Total

$
123,970


$
105,671


$
110,902


17.3
%

(4.7
%)Gross margin:Leases and royalties


67.7
%


67.8
%


69.2
%Sales and service


57.0
%


52.3
%


51.9
%Total


61.6
%


58.9
%


58.4
%
  RESULTS OF OPERATIONS





Fiscal 2010 compared to Fiscal 2009





Revenue





Our revenue for fiscal 2010increased $21,875 over fiscal 2009, primarily due to the following:





·
Market expansion and favorable regulatory changes


o
Opening of two casinos in Singapore drove increased sales revenue of $7,200 and increased lease revenue of $2,700 in our Utility, PTG and ETS segments


o
Casino opening in the Philippines drove increased Utility lease revenue of approximately $800


o
Regulatory changes in Pennsylvania and Delaware allowed for the placement of Utility and PTG products, driving increased lease revenues in those segments totaling approximately $1,400 and increased sales revenue of approximately $5,800


o
Regulatory changes in Florida allowed for the placement of Table Master seats which led to increased ETS lease and sales revenue of approximately $1,300


o
Favorable regulatory changes in certain Australian jurisdictions drove increased ETS sales revenue of approximately $12,000


o
The favorable regulatory changes in Pennsylvania and Delaware that drove new placements of Utility and PTG products were partially offset by the return of approximately 420 Table Master seats previously leased in that market.  This resulted in a decrease in ETS lease revenue of approximately $1,600 compared to the prior year.  We have begun to return these Table Masters to active service in other markets such as Mexico and South America





·
Increase in our leases and royalties revenue


o
Driven primarily by increased Utility lease revenue due to a 21.7% increase in shuffler units on lease


o
Increased PTG lease and royalty revenue due to a 15.8% increase in units on lease


o
Increased ETS lease revenue driven by a 11.4% increase in seats on lease




35




·
Increase in our sales and service revenue


o
Increase most notably in our ETS segment driven by a 201.6% increase in sold seats


o
Increased Utility sales revenue due to a 5.2% increase in sold shuffler units





·
Partially offset by a decrease in our EGM segment


o
Decrease of $5,481 in total revenue due primarily to a 22.1% decline in the number of sold units





·
Impact of foreign currency fluctuations


o
Total revenue was positively impacted by approximately $9,200 due to the exchange effect of a weakening U.S. dollar





Gross margin





Our gross margin for fiscal 2010increased 270 bps to 61.6% as compared to fiscal 2009, reflecting the following:





·
Increase segment margin performance


o
ETS was favorably impacted by reduced amortization of intangible assets and by high margin sales of Rapid Table Games and Vegas Star


o
Utility was favorably impacted by strong revenue growth overall and reduced amortization of intangible assets


o
EGM was favorably impacted by reduced amortization of intangible assets and reductions in materials and production costs due to value engineering and cost savings. A portion of the cost savings related to favorable foreign exchange fluctuations which may not be repeatable





·
Partially offset by reduced PTG margins due to a write-off of certain tangible and intangible assets





·
Product mix


o
Strong performance by our more profitable segments led to higher overall profitability





Fiscal 2009 compared to Fiscal 2008





Revenue


Our revenue in fiscal 2009 decreased $10,579 over fiscal 2008, primarily due to the following:





·
Impact of foreign currency fluctuations


o
Total revenue was negatively impacted by approximately $10,135 due to the exchange effect of a strengthening U.S. dollar





·
Reduction in our sales and service revenues


o
A decrease of approximately 21.8% in the Utility segment primarily representing a reduction in sales in the European market. The European market has experienced credit market deterioration, smoking bans and the dissolution of the Russian gaming market due to regulatory changes


o
A decrease of approximately 42.2% in the ETS segment due to declines in sales of our Vegas Star and Rapid Table Games products in Australia and our Table Master products in the United States





The decreases were offset by the following increases:





·
Increases in our lease and royalty revenue


o
The ETS segment provided the largest increase at 28.8% due to increased Table Master seats on lease


o
The Utility segment demonstrated an 8.2% increase due to placements of our i-Deal shuffler


o
The PTG segment increased 1.2% due to growth in our Ultimate Texas Hold ‘em premium title and Fortune Pai Gow Poker Progressive®





·
EGM sales revenue


o
A 7.8% increase in revenue driven primarily by the strength of our newer titles and the success of our progressive links, Pink Panther and Grand Central





36




Gross margin
 
 Our gross margin in fiscal 2009 increased 50 basis points ("bps") bps to 58.9% from fiscal 2008, reflecting the following:


·
Mix of revenue


o
A proportionate increase in lease and royalty revenue which generates higher gross margins than sales and service revenue primarily driven by increased placements and average lease prices


o
Increased average sales prices, primarily in our Utility segment and EGM segment, on a local currency basis





Offsetting these increases were the following decreases:





·
Impact of foreign currency fluctuations


o
The strength of the U.S. dollar negatively impacted margins by 3.1%





·
Write-down for inventory obsolescence


o
A decrease in gross margin of approximately 0.8% related to lower of cost or market adjustments primarily on older generation products.  These were mostly in the Utility and ETS segments.





The following table provides additional information regarding our operating expenses:





OPERATING EXPENSES




Year Ended October 31,


Percentage Change2010


2009


2008


10 vs. 09


09 vs. 08(In thousands)Selling, general and administrative

$
66,817


$
63,647


$
71,350



5.0
%


(10.8
%)Percentage of revenue


33.2
%


35.5
%


37.6
%Research and development

$
21,811


$
17,349


$
18,474



25.7
%


(6.1
%)Percentage of revenue


10.8
%


9.7
%


9.7
%Impairment of goodwill

$
-


$
-


$
22,137



0.0
%


(100.0
%)Percentage of revenue


0.0
%


0.0
%


11.7
%Total operating expenses

$
88,628


$
80,996


$
111,961



9.4
%


(27.7
%)Percentage of revenue


44.0
%


45.1
%


58.9
%
 
 Fiscal 2010 compared to Fiscal 2009





Selling, general & administrative (“SG&A”) expenses





SG&A increased $3,170 in fiscal 2010 as compared to fiscal 2009.  This increase primarily reflects the following:





·
Legal settlement with Prime Table Games


o
Increase in legal expenses of approximately $2,200 which represents the fair value associated with the effective settlement of the litigation. See Note 15 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” for more information





·
Impact of foreign currency fluctuations


o
Net increase of approximately $2,700 at our foreign subsidiaries due to the exchange effect of a weakening U.S. dollar





·
Sales and profit-driven compensation


o
Increase of approximately $1,240 primarily driven by improved revenue and profitability at our United States and Australian locations





·
Product compliance


o
Increased costs of approximately $800 associated with obtaining regulatory approval for our products in new jurisdictions





·
Professional fees


o
Increase in legal expenses of approximately $500. Corporate legal expenses increased as a result of higher legal expenses incurred on our TableMax and SSI Case litigations offset by a reduction in costs related to the Elixir Gaming purchase and settlement agreement incurred during fiscal 2009




37




The increases in SG&A expense were partially offset by the following decreases:





·
Severance costs


o
Severance costs decreased approximately $4,200 primarily due to the retirement of our former CEO and the departure of several senior executives in fiscal 2009 offset by severance costs incurred during fiscal 2010 due to the passing of our CEO and the departure of a senior executive





Research & development (“R&D”) expenses





R&D expense increased $4,462 in fiscal 2010 as compared to fiscal 2009.  This increase primarily reflects:





·
Impact of foreign currency fluctuations


o
Net increases of approximately $2,000 at our foreign subsidiaries due to the weakening of the U.S. dollar





·
Increased R&D in our EGM segment





The following projects have been the focus of our R&D efforts during fiscal 2010:





·
EGM


o
Expenses primarily related to development of the new Equinox cabinet


o
Additional R&D efforts were spent on developing additional EGM games for the new Equinox cabinet and to support ongoing business growth





·
ETS


o
Expenses primarily related to the further development of the i-Table and Rapid Table Games, including the development of proprietary titles for our i-Table


o
We believe that one of our strengths is identifying new product opportunities, developing new products and refining current products.  We expect R&D expense as a percentage of revenue to remain at current levels





·
Utility


o
Expenses primarily related to development of the next generation of our MD2 shuffler, the MD2CR





Fiscal 2009 compared to Fiscal 2008





SG&A expenses





SG&A decreased $7,703 in fiscal 2009 as compared to fiscal 2008.  This decrease primarily reflects the following:





·
Impact of foreign currency fluctuations


o
Net decreases of approximately $2,262 at our foreign subsidiaries due to the strengthening of the U.S. dollar





·
Salaries, benefits and consultants


o
Decreased costs of approximately $9,521, excluding cash salary and related benefits severance costs, due to cost rationalization efforts


o
Severance costs of $6,838, which primarily related to the retirement of our former CEO and the departure of several senior executives.  The $6,838 of severance costs were primarily comprised of $3,628 of accelerated stock compensation expense and $3,210 of cash salary and related benefits





·
Professional fees


o
Decreased legal expenses of $2,214, excluding the effect of the Elixir item discussed below.  Corporate legal expense decreased as a result of lower legal expenses incurred on our shareholder derivative and VendingData II lawsuits, settlement of prior cases, which primarily included MP Games LLC, and decreased costs related to other general corporate matters


o
Decreased costs of approximately $1,500 for professional fees, primarily related to reductions in accounting and other professional fees


o
Legal charge of $400 related to the Elixir purchase and settlement agreement, which approximates the fair value of the effective settlement related to the previous lawsuit between us and Elixir





38





R&D expenses





R&D expense decreased $1,125 in fiscal 2009 as compared to fiscal 2008.  This decrease primarily reflects:





·
Impact of foreign currency fluctuations


o
Net decreases of approximately $1,114 at our foreign subsidiaries due to the strengthening of the U.S. dollars





The following projects have been the focus of our R&D efforts during fiscal 2009:





·
Utility


o
Expenses primarily related to finalizing the mechanical, hardware and software development of the i-Shoe Auto featuring optical card recognition and an auto-card feeding mechanism, finalizing hardware and software for the one2six Plus continuous shuffler featuring optical card recognition and developing and improving other Utility products, including developing generic card recognition technology to replace card libraries.  Additional R&D efforts were focused on developing the i-Score Baccarat display system, including new computer hardware





·
PTG


o
Expenses primarily related to development of implementing progressives onto existing proprietary games as well as developing or licensing a large variety of new games including Dealer Bluff Six Card Poker®


o
Additional R&D efforts were spent on developing the Video Progressive Display System (“ViPS”) to support our PTG progressive products





·
ETS


o
Expenses primarily related to the final development of the i-Table, our first product that benefited from an emphasis on “globalizing” our research and development by combining resources from our Utility, PTG and ETS segments and utilizing product knowledge from both our U.S. operations as well as our operations in Australia


o
Additional R&D efforts were spent on creating and implementing new game content for our Table Master, Vegas Star and Rapid Table Games





·
EGM


o
Expenses primarily related to development of new game titles and themes. This was in conjunction with the continued commercialization of existing linked jackpot products, Pink Panther and Grand Central





Impairment of goodwill





In October 2008, we performed our annual goodwill impairment analysis.  The goodwill impairment test is a two-part test.  We selected a discounted cash flows model (income approach) and the Guideline Public Company Model (market approach) to assess the fair values of our operating segments.  These two methodologies were weighted in determining a fair value.  Step one of the impairment test compares the fair values of each of our operating segments to their carrying value.  If the fair value is less than the carrying value for any of our operating segments, step two must be completed.  Based on the step one analysis performed, we concluded the fair value was less than the net carrying value of the assets assigned to our ETS operating segment.  As such, step two of the goodwill impairment test was performed.  Step two required that we allocate the fair value of the ETS segment to all of the assets and liabilities, as if the segment was acquired in a business combination.  The goodwill calculated in step two is then compared to the recorded goodwill, with an impairment charge recorded in the amount that the book value of goodwill exceeds the amount calculated in this step.  Based on the step two analysis performed, we concluded that the goodwill assigned to our ETS segment was impaired as of October 31, 2008.  As such, we recorded an impairment charge related to the goodwill assigned to the ETS segment of $22,137 on our consolidated statements of operation in “Item 8. Financial Statements and Supplementary Data” included in the Annual Report on Form 10-K for fiscal 2008.  No tax benefit is associated with this impairment charge. There was no such charge necessary in fiscal 2010 or 2009.





39





DEPRECIATION AND AMORTIZATION EXPENSES


Year Ended October 31,


Percentage Change2010


2009


2008


10 vs. 09


09 vs. 08(In thousands)Gross margin:Depreciation

$
8,960


$
7,312


$
5,929



22.5
%


23.3
%Amortization


8,283



10,481



12,037



(21.0
%)


(12.9
%)Total


17,243



17,793



17,966



(3.1
%)


(1.0
%)Operating expenses:Depreciation


2,916



2,632



2,780



10.8
%


(5.3
%)Amortization


2,709



3,090



2,694



(12.3
%)


14.7
%Total


5,625



5,722



5,474



(1.7
%)


4.5
%Total:Depreciation


11,876



9,944



8,709



19.4
%


14.2
%Amortization


10,992



13,571



14,731



(19.0
%)


(7.9
%)Total

$
22,868


$
23,515


$
23,440



(2.8
%)


0.3
%


Depreciation expense is primarily comprised of depreciation associated with products leased and held for lease and to a lesser extent depreciation of property, plant and equipment. Amortization expense is primarily comprised of amortization associated with intellectual property, acquired developed technology and customer relationships.





Fiscal 2010 compared to Fiscal 2009





Total depreciation and amortization included in gross margin decreased 310 bps in fiscal 2010 as compared to fiscal 2009.  Increased depreciation in gross margin is attributable to increases in leased assets.  Decreased amortization in gross margin is due to reduced amortization of intangible assets in our Utility, ETS and EGM segments as the underlying intangible assets reached the end of their estimated useful lives. Depreciation and amortization included in operating expenses decreased 1.7% in fiscal 2010 as compared to fiscal 2009. Amortization decreased as various intangible assets reached the end of their estimated useful lives. Increased depreciation related to additions of property, plant and equipment in the normal course of business.





Fiscal 2009 compared to Fiscal 2008





Total depreciation and amortization included in gross margin decreased 100 bps in fiscal 2009 as compared to fiscal 2008.  Increased depreciation in gross margin is attributable to increases in leased assets.  Decreased amortization in gross margin is due to the strengthening of the U.S. dollar related to amortization at our foreign subsidiaries.  Depreciation and amortization included in operating expenses increased 4.5% in fiscal 2009 as compared to fiscal 2008. The increase relates primarily to amortization of the covenant not to compete acquired as part of the Elixir Purchase and Settlement Agreement entered into during our second quarter ended April 30, 2009, as well as additions of property, plant and equipment in the normal course of business.


40




The following table provides additional information regarding our non-operating expenses:





NON-OPERATING EXPENSES





Other income (expense), gain on early extinguishment of debt, net and impairment of investment




Year Ended October 31,


Percentage Change2010


2009


2008


10 vs. 09


09 vs. 08(In thousands)Other income (expense)Interest income

$
577


$
860


$
1,759



(32.9
%)


(51.1
%)Interest expense


(4,015
)


(6,047
)


(11,642
)


(33.6
%)


(48.1
%)Other, net


282



731



1,261



(61.4
%)


(42.0
%)Total other income (expense)

$
(3,156
)

$
(4,456
)

$
(8,622
)


(29.2
%)


(48.3
%)Gain (loss) on early extinguishment of debt, net

$
(1,123
)

$
1,841


$
(435
)


(161.0
%)


523.2
%Impairment of investment

$
-


$
-


$
(1,560
)


0.0
%


(100.0
%)
 
 Fiscal 2010 compared to Fiscal 2009





Total other income (expense) decreased $1,300, or 29.2% in fiscal 2010 as compared to fiscal 2009, primarily due to the following:





·
A decrease in interest expense of $2,032 in fiscal 2010 as compared to 2009, due to a decrease in total outstanding debt





·
A decrease in net foreign currency gains of $537 in fiscal 2010 as compared to 2009. This year over year change was primarily caused by fluctuations of the U.S. dollar versus the Australian dollar and the Euro during fiscal 2010.  Our foreign subsidiaries engage in activities with us and certain customers in U.S. dollar and other foreign denominated contracts





·
Partially offset by a reduction in interest income of $283 in fiscal 2010 as compared to fiscal 2009, due to a 20.5% reduction in the total amount of our investment in sales-type leases and notes receivable





Loss on early extinguishment of debt, net of $1,123 and gain on early extinguishment of debt, net of $1,841, relate to the following:





·
For fiscal 2010, debt issuance costs of $1,123 related to our Deutsche Bank Senior Secured Credit Facility (as defined in Liquidity and Capital Resources below) were charged off when the underlying facility was terminated





·
Fiscal 2009 includes approximately $1,800 related to the PGIC / IGT agreements entered into in January 2009





Fiscal 2009 compared to Fiscal 2008





Total other income (expense) decreased $4,166, or 48.3% in fiscal 2009 as compared to fiscal 2008, primarily due to the following:





·
A decrease in interest expense of $5,595 in fiscal 2009 as compared to fiscal 2008, due to a decrease in total outstanding debt and reduced effective interest rates





·
Net foreign currency gains of $825 in fiscal 2009 as compared to net foreign currency gains of $3,356 in fiscal 2008.  This year over year change was caused by foreign currency fluctuations, primarily between the U.S. dollar, the Australian dollar and the Euro during fiscal 2009.  Our foreign subsidiaries engage in activities with us and certain customers in U.S. dollar and other foreign denominated contracts





·
Partially offset by a reduction in interest income of $899 in fiscal 2009 as compared to fiscal 2008, due to a 50.8% reduction in the total amount of our investment in sales-type leases and notes receivable




41




Gain on early extinguishment of debt, net relates to the following:





·
Loss on early extinguishment of debt, net of $435, relate to the following:


o
Fiscal 2008 includes a net loss realized from the early extinguishment of our Notes





INCOME TAXES




Year Ended October 31,


Percentage Change2010


2009


2008


10 vs. 09


09 vs. 08(In thousands)Income tax provision (benefit)

$
7,980


$
7,086


$
3,697



12.6
%


91.7
%Effective tax rate


25.7
%


32.1
%


31.7
%


Our effective income tax rate may fluctuate due to changes in our amount and mix of United States and foreign income (loss), changes in tax legislation, changes in our estimates of federal tax credits, changes in our assessment of uncertainties, as well as accumulated interest and penalties and other deductions.





Fiscal 2010 compared to Fiscal 2009





Income tax provision and the respective effective tax rate decreased for fiscal 2010 as compared to fiscal 2009, primarily due to the following:





·
Mix of United States and foreign income (loss)





·
Changes in uncertain tax positions





Fiscal 2009 compared to Fiscal 2008





Income tax provision and the respective effective tax rate increased for fiscal 2009 as compared to fiscal 2008, primarily due to the following:





·
Changes to goodwill impairment





·
Changes to interest expense





·
Changes to the valuation allowance





·
Mix of United States and foreign income (loss)


42
  SEGMENT BUSINESS INFORMATION





Segment revenues include leasing, licensing, or selling of products within each reportable segment. We measure segment performance in terms of revenue, gross profit, gross margins and unit / seat placements. We believe that unit / seat placements is an important gauge of segment performance because it measures historical market placements of leased and sold units / seats and provides insight into potential markets for next-generation products and service. We do not present a cumulative installed base as previously sold units / seats may no longer be in use by our customers or may have been replaced by other models or products.





We evaluate the performance of our operating segments based on net revenues, gross profit and operating income (loss). Segment operating income (loss) includes net revenues attributable to third parties and expenses directly and indirectly associated with the product lines included in each segment. Our direct expenses primarily include cost of products sold, depreciation of leased assets, amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation.  Indirect expenses include other costs directly identified with each segment, such as research and development, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses.  Operating income (loss) for each segment excludes other income and expense and certain expenses that are managed outside of the operating segments. The amounts classified as unallocated corporate expenses consist primarily of costs related to overall corporate management and support functions. These include costs related to executive management, accounting and finance, general sales support, legal and compliance costs, office expense and other amounts for which allocation to specific segments is not practicable.


43
  SEGMENT OPERATING RESULTS





(In thousands, except units, per unit/seat amounts and product lease/sale prices)





Utility Segment Operating Results





Fiscal 2010 compared to Fiscal 2009





Year EndedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)Utility Segment Revenue:Lease

$
34,649


$
30,443


$
4,206



13.8
%Sales - Shuffler


29,347



29,301



46



0.2
%Sales - Chipper


1,880



1,500



380



25.3
%Service


6,979



6,998



(19
)


(0.3
%)Other


4,502



3,465



1,037



29.9
%Total sales and service


42,708



41,264



1,444



3.5
%Total Utility segment revenue

$
77,357


$
71,707


$
5,650



7.9
%Utility segment gross profit

$
47,024


$
40,513


$
6,511



16.1
%Utility segment gross margin


60.8
%


56.5
%Utility segment operating income

$
40,233


$
32,742


$
7,491



22.9
%Utility segment operating margin


52.0
%


45.7
%Shuffler unit information:Lease units, end of year


6,934



5,697



1,237



21.7
%Average monthly lease price

$
416


$
445


$
(29
)


(6.5
%)Sold units during the period


2,100



1,997



103



5.2
%Average sales price

$
13,975


$
14,673


$
(698
)


(4.8
%)Chipper unit information:Lease units, end of year


184



36



148



411.1
%Sold during year


84



71



13



18.3
%Average sales price

$
22,381


$
21,127


$
1,254



5.9
%


Utility segment revenue increased $5,650 for fiscal 2010 as compared to fiscal 2009, primarily due to the following:





·
A 13.8% increase in lease revenue, in line with our focus on leasing


o
An increase in the number of shuffler and chipper units on lease, driven primarily by new lease placements in Singapore and the Philippines


o
Lease placements in the United States continue to be enhanced by the Aceshuffler replacement cycle


Ø
The i-Deal shuffler is our next generation replacement for the Ace specialty shuffler. As the Ace reaches its end of life where we cannot provide replacement parts, our strategy is to encourage our customers to replace the Ace shufflers (both leased and sold) with the i-Deal shuffler. Current year Ace replacements totaled approximately 1,100 units, leading to a net revenue increase of approximately $4,900





·
Shuffler sales revenue was relatively flat year over year


o
An increase of 5.2% in the number of units sold, driven primarily by placements of approximately 310 shufflers in Pennsylvania and Delaware during the third fiscal quarter due to favorable regulatory changes and the sale of approximately 240 shufflers in Singapore. These new placements included MD2, Deckmate, and one2six shufflers


o
Partially offset by a 4.8% reduction in average sales price, primarily the result of volume discounts related to the Pennsylvania placements





·
A 25.3% increase in chipper sales revenue


o
An increase of 18.3% in the number of units sold, primarily driven by stronger sales in the United States and Europe


o
A 5.9% increase in average sales price, driven by improved pricing in the United States and by increased sales of Chip Master units in Europe. Chip Master units have a higher average sales price than Easy Chipper units




44




·
A 29.9% increase in other revenue


o
An increase in the number of sold i-Shoe and i-Score units, primarily representing a large sale to a single customer during the first quarter





Utility gross profit increased 16.1% for fiscal 2010 as compared to fiscal 2009. Utility gross margin also increased 430 bps to 60.8% for fiscal 2010 as compared to fiscal 2009. The increase in gross profit and gross margin primarily relate to the following:





·
The overall increase in total revenue as noted above





·
Non-cash charges—a reduction of approximately $1,700 in amortization expense associated with the one2six shuffler and Easy Chipper C as the underlying intangible assets approach the end of their estimated useful lives





Utility operating income increased 22.9% for fiscal 2010 as compared to fiscal 2009.  Utility operating margin also increased 630 bps to 52.0% for fiscal 2010 as compared to fiscal 2009. The increases in operating income and operating margin primarily relate to the following:





·
The overall increases in sales revenues and gross profits as discussed above





·
A slight decrease in the amount of R&D expense associated with the Utility segment


45
  Fiscal 2009 compared to Fiscal 2008


Year EndedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)Utility Segment Revenue:Lease

$
30,443


$
28,145


$
2,298



8.2
%Sales - Shuffler


29,301



37,738



(8,437
)


(22.4
%)Sales - Chipper


1,500



3,992



(2,492
)


(62.4
%)Service


6,998



6,718



280



4.2
%Other


3,465



4,300



(835
)


(19.4
%)Total sales and service


41,264



52,748



(11,484
)


(21.8
%)Total Utility segment revenue

$
71,707


$
80,893


$
(9,186
)


(11.4
%)Utility segment gross profit

$
40,513


$
46,097


$
(5,584
)


(12.1
%)Utility segment gross margin


56.5
%


57.0
%Utility segment operating income

$
32,742


$
36,078


$
(3,336
)


(9.2
%)Utility segment operating margin


45.7
%


44.6
%Shuffler unit information:Lease units, end of year


5,697



5,318



379



7.1
%Average monthly lease price

$
445


$
441


$
4



0.9
%Sold units during the period


1,997



2,624



(627
)


(23.9
%)Average sales price

$
14,673


$
14,382


$
291



2.0
%Chipper unit information:Lease units, end of year


36



26



10



38.5
%Sold during year


71



154



(83
)


(53.9
%)Average sales price

$
21,127


$
25,922


$
(4,795
)


(18.5
%)


46


Our Utility segment revenue in fiscal 2009 decreased $9,186 as compared to fiscal year 2008, primarily due to the following:


·
A 26.2% reduction in our sales revenue


o
A reduction in shuffler and chipper sales in the European market which has experienced credit market deterioration, smoking bans and the dissolution of the Russian gaming market due to regulatory changes


o
Reduction in sold shuffler units in markets outside of Europe, offset by a slight increase in average sales prices


o
Reduction in sold Chipmaster units, which have a higher sale price than our Easy Chipper C





These decreases were offset by the following increases:





·
An 8.2% increase in our lease revenue


o
Increased units on lease, mostly our i-Deal and one2six shufflers due to our replacement cycle and lease strategy


o
Increased average monthly lease price





Utility gross profit decreased 12.1% for fiscal 2009 as compared to fiscal 2008.  Utility gross margin also decreased 50 bps, to 56.5% for fiscal 2009 as compared to fiscal 2008. The decreases in gross profit and gross margin primarily relate to the following:





·
Mix of revenue


o
The overall reduction in sale revenue which generally generates a higher initial gross profit, but a lower gross margin





·
Non-cash charges


o
A 16.6% decrease in amortization expense associated with the one2six shuffler and Easy Chipper, due to foreign currency fluctuations. In local currency, amortization decreased 7.1%





Utility operating income decreased 9.2% for fiscal 2009 as compared to fiscal 2008.  However, Utility operating margin increased 110 bps to 45.7% for fiscal 2009 as compared to fiscal 2008.





The decrease in operating income primarily related to the following:





·
The overall reduction in sale revenue as discussed above





The increase in operating margin primarily related to the following:





·
Proportionate decreases in R&D, legal and sales commission costs attributable to the Utility segment


47


Proprietary Table Games Segment Operating Results





Fiscal 2010 compared to Fiscal 2009




Year EndedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)PTG segment revenue:Royalties and leases

$
37,427


$
34,048


$
3,379



9.9
%Sales


2,541



3,581



(1,040
)


(29.0
%)Service


148



170



(22
)


(12.9
%)Other


314



898



(584
)


(65.0
%)Total sales and service revenue


3,003



4,649



(1,646
)


(35.4
%)Total PTG segment revenue

$
40,430


$
38,697


$
1,733



4.5
%PTG segment gross profit

$
32,356


$
32,079


$
277



0.9
%PTG segment gross margin


80.0
%


82.9
%PTG segment operating income

$
27,880


$
29,035


$
(1,155
)


(4.0
%)PTG segment operating margin


69.0
%


75.0
%PTG unit information:Preminum units, end of year


2,414



2,241



173



7.7
%Side bet units, end of year


1,836



1,646



190



11.5
%Progressive units, end of year


580



359



221



61.6
%Add-on units, end of year


134



39



95



243.6
%Total revenue generating lease base


4,964



4,285



679



15.8
%Average monthly lease/license price

$
628


$
662


$
(34
)


(5.1
%)Sold during year


82



165



(83
)


(50.3
%)Average sales price

$
30,988


$
21,703


$
9,285



42.8
%


Total PTG segment revenue increased $1,733 for fiscal 2010 as compared to fiscal 2009.  The PTG segment revenue increase was primarily due to the following:





·
A 9.9% increase in royalties and leases revenue, in line with our focus on licensing and leasing


o
Increased placements of premium table games and progressive units in the United States, primarily Ultimate Texas Hold ‘em and Three Card Poker Progressive. These placements were largely driven by favorable regulatory changes in Pennsylvania and Delaware


o
New placements of premium table games and progressives in Singapore drove increased revenues of approximately $400


o
Offset by a slight decrease in the average monthly lease / license price, driven by placements of progressives and add-ons. Progressives, add-ons and side bets have lower average lease price than premium titles





The increase was partially offset by the following decreases:





·
A decrease of 29.0% in PTG sales revenue, driven by a 50.3% reduction in sales of premium table game lifetime licenses. The prior year results included two large conversions of leased units to sold units. The increase in average sales price primarily reflects changes in product mix





·
A 65.0% decrease in other revenue


o
$580 of revenue was included in the prior year from our Three Card Poker World Championship Tournament. No such tournament was held in the current year





PTG gross profit was essentially constant year over year, although gross margin decreased 290 bps to 80.0% as compared to the same prior year period. The decrease in gross margin primarily related to the following:





·
The write-off of certain intangible licenses and related equipment totaling approximately $500





·
Initial equipment and installation costs on the new side bet and progressive units





48


PTG operating income decreased 4.0% year over year. The increase in operating income primarily related to the following:





·
Increase in legal expenses of approximately $2,200 related to settlement with Prime Table Games. See Note 15 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” for more information





·
Offset by a reduction in the amount of fixed amortization of intangible assets related to the PTG segment





Fiscal 2009 compared to Fiscal 2008




Year EndedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)PTG segment revenue:Royalties and leases

$
34,048


$
33,639


$
409



1.2
%Sales


3,581



4,332



(751
)


(17.3
%)Service


170



276



(106
)


(38.4
%)Other


898



347



551



158.8
%Total sales and service revenue


4,649



4,955



(306
)


(6.2
%)Total PTG segment revenue

$
38,697


$
38,594


$
103



0.3
%PTG segment gross profit

$
32,079


$
31,983


$
96



0.3
%PTG segment gross margin


82.9
%


82.9
%PTG segment operating income

$
29,035


$
28,957


$
78



0.3
%PTG segment operating margin


75.0
%


75.0
%PTG unit information:Preminum units, end of year


2,241



2,245



(4
)


(0.2
%)Side bet units, end of year


1,646



1,806



(160
)


(8.9
%)Progressive units, end of year


359



137



222



162.0
%Add-on units, end of year


39



34



5



14.7
%Total revenue generating lease base


4,285



4,222



63



1.5
%Average monthly lease/license price

$
662


$
664


$
(2
)


(0.3
%)Sold during year


165



154



11



7.1
%Average sales price

$
21,703


$
28,130


$
(6,427
)


(22.8
%)
 
 Total PTG segment revenue increased $103 for fiscal 2009 as compared to fiscal 2008.  The PTG segment revenue increase was primarily due to the following:





·
Increase in PTG royalty and lease revenue and other revenue


o
Increased placements of premium table games, specifically our Ultimate Texas Hold ‘em


o
Increased placements of add-ons, specifically Fortune Pai Gow Poker Progressive


o
Average monthly lease price remained relatively flat, even with increased placements of progressive units, which generally have a lower monthly average lease price than premium game titles


o
An increase in net revenue from our Three Card Poker World Championship Tournament, which was held in December 2008, to approximately $580 from $130





These increases were partially offset by the following:





·
A 17.3% decrease in PTG sales revenue


o
A decrease in average sales price resulting from the sale of approximately 80 Royal Match 21 table game side bet lifetime licenses in 2009. Excluding this sale, our average sales price would have been approximately $38,800, an increase over 2008 driven by two large conversion sales of Three Card Poker table games in 2009





·
A reduction of $368 related to license fees for the use of certain of our proprietary table game content on certain legalized internet gaming sites to $195 in fiscal 2009 as compared to fiscal 2008




49




·
PTG gross profit and gross margin  remained constant year over year





·
PTG operating income and operating margin remained constant year over year





Electronic Table Systems Segment Operating Results





Fiscal 2010 compared to Fiscal 2009




Year EndedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)ETS segment revenue:Royalties and leases

$
14,373


$
11,730


$
2,643



22.5
%Sales


24,010



8,326



15,684



188.4
%Service


649



509



140



27.5
%Other


3,366



1,777



1,589



89.4
%Total sales and service revenue


28,025



10,612



17,413



164.1
%Total ETS segment revenue

$
42,398


$
22,342


$
20,056



89.8
%ETS segment gross profit

$
21,580


$
9,430


$
12,150



128.8
%ETS segment gross margin


50.9
%


42.2
%ETS segment operating income

$
11,802


$
3,427


$
8,375



244.4
%ETS segment operating margin


27.8
%


15.3
%ETS unit information:Lease seats, end of year


2,377



2,134



243



11.4
%Average monthly lease price

$
504


$
458


$
46



10.0
%Sold during year


1,327



440



887



201.6
%Average sales price

$
18,093


$
18,923


$
(830
)


(4.4
%)


Total ETS segment revenue increased $20,056 for fiscal 2010 as compared to fiscal 2009. The increase was primarily due to the following:





·
A 188.4% increase in sales revenue


o
Increase of 197.2% in Vegas Star and Rapid Table Games seats sold, resulting in ETS revenue of approximately $15,700


Ø
The sale of approximately 740 Vegas Star and Rapid Table Games seats, primarily to several large casinos in Australia. These sales, totaling approximately $15,700, were driven primarily by favorable regulatory changes in certain Australian jurisdictions during the second fiscal quarter


Ø
The sale of approximately 370 Rapid Table Game seats to a single customer in Singapore during the second half of the fiscal year drove increased revenue of approximately $4,100


o
A 266.7% increase in sold Table Master seats, primarily due to several large customers in the U.S. These sales were the result of the opening of new geographic jurisdictions, such as Florida, during the second fiscal quarter


o
Partially offset by a 4.4% reduction in the average sales price caused primarily by changes in product mix





·
A 22.5% increase in royalties and lease revenue


o
An 11.4% increase in seats on lease, driven primarily by Table Master seats in Florida due to favorable regulatory changes and by Rapid Table Games seats in Singapore


o
An increase of 10.0% in the average lease price, driven by the newly-placed Table Master seats


o
The increase in royalties and lease revenue noted above was partially offset by the return of approximately 420 Table Master seats previously leased in Pennsylvania and Delaware. This resulted in a decrease in ETS lease revenue of approximately $1,600 during the second half of fiscal 2010.  We have begun to return these Table Masters to active service in other markets such as Mexico and South America





·
A 89.4% increase in parts and peripherals driven by a large sale of hardware combined with software conversion kits to a single customer during the second fiscal quarter of 2010





·
Impact of foreign currency fluctuations


o
Total revenue was positively impacted by approximately $3,300 due to the exchange effect of a weakening U.S. dollar





50


ETS gross profit increased 128.8% for fiscal 2010 as compared to the prior year. ETS gross margin also increased 870 bps to 50.9% for fiscal 2010 as compared to the prior year.  These increases are due to the following:





·
Mix of revenue


o
The significant increase in sales revenues which drove proportionate increases in gross profit


o
The increase in lease revenues, which typically drive higher gross margins


o
Improvements in average lease prices which also drove higher lease margins


o
The increased amount of parts and peripheral sales, which have a substantially higher margin than completed units





·
Fixed amortization


o
A reduction of approximately $1,100 in amortization expense associated with Vegas Star and Rapid Table Games product lines as the underlying intangible assets became fully amortized during the first quarter of fiscal 2010





ETS operating income increased 244.4% for fiscal 2010 as compared to the prior year.  ETS operating margin also increased 1,250 bps for fiscal 2010 as compared to the prior year.  These increases in both operating income and operating margin primarily related to the following:





·
The increases in gross profit and gross margin noted above





·
Offset partially by an increase in R&D costs associated with the ETS segment





Fiscal 2009 compared to Fiscal 2008




Year EndedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)ETS segment revenue:Royalties and leases

$
11,730


$
9,110


$
2,620



28.8
%Sales


8,326



14,911



(6,585
)


(44.2
%)Service


509



405



104



25.7
%Other


1,777



3,035



(1,258
)


(41.4
%)Total sales and service revenue


10,612



18,351



(7,739
)


(42.2
%)Total ETS segment revenue

$
22,342


$
27,461


$
(5,119
)


(18.6
%)ETS segment gross profit

$
9,430


$
13,068


$
(3,638
)


(27.8
%)ETS segment gross margin


42.2
%


47.6
%ETS segment operating income

$
3,427


$
(16,105
)

$
19,532



(121.3
%)ETS segment operating margin


15.3
%


(58.6
%)ETS unit information:Lease seats, end of year


2,134



1,445



689



47.7
%Average monthly lease price

$
458


$
525


$
(67
)


(12.8
%)Sold during year


440



740



(300
)


(40.5
%)Average sales price

$
18,923


$
20,150


$
(1,227
)


(6.1
%)


Total ETS segment revenue decreased $5,119 for fiscal 2009 as compared to fiscal 2008. The decrease was primarily due to the following:





·
Impact of foreign exchange fluctuations


o
Total revenue was negatively impacted by $1,292 due to the exchange effect of a strengthening U.S. dollar





·
A 43.7% decrease in sales and other revenue


o
A 80.4% decline in the number of Table Mastersold seats consistent with our lease strategy


o
A decrease in the average sales price. This decrease was driven primarily by fluctuations in the exchange rate between the Australian dollar and the U.S. dollar related to our Vegas Star and Rapid Table Game products sold in Australia.  The average sales price in Australian dollars remained constant from the prior year period


o
A 41.4% decrease in parts and other peripheral sales related to previously sold ETS seats, primarily relating to our Vegas Star products and secondarily relating to our Rapid Table Games





51




Slightly offsetting these decreases was an increase in the following:





·
A 28.8% increase in royalty and lease revenue


o
A 47.7% increase in seats on lease, driven mostly by Table Master seats.  These leases are primarily our Royal Match 21, Three Card Poker and Bet The Set 21 proprietary games


o
Offset by a decrease in our average monthly lease price caused by installations of our ETS product in markets where they compete with live table games





ETS gross profit decreased 27.8% for fiscal 2009 as compared to fiscal 2008.  ETS gross margin also decreased 540 bps to 42.2% for fiscal 2009 as compared to fiscal 2008.  These declines are due to the following:





·
Fixed amortization


o
The ETS segment is burdened with substantial amounts of fixed amortization which can have a large impact on gross margin depending on total revenue.  Accordingly, gross margin can vary materially from period to period.  Gross margin in the current period was negatively impacted by 7.2%





·
Mix of revenue


o
The decreases in sales revenue as noted above


o
Sale of refurbished units at reduced prices and reduced margins


o
The decrease in other revenue, primarily parts and other peripherals, as noted above.  Parts and other peripheral sales generally have a higher margin than completed units





ETS operating income increased 121.3%, to $3,427 for fiscal 2009 as compared to ($16,105) for fiscal 2008.  ETS operating margin also increased 73.9% to 15.3% for fiscal 2009 as compared to (58.6%) for fiscal 2008.  These increases in both operating income and operating margin primarily related to the following:





·
The $22,137 impairment of goodwill associated with our ETS segment in fiscal 2008, which did not recur in 2009


o
Excluding the impact of the impairment, operating margin in 2008 would have been 22.0%. The 6.7% decrease in margin, excluding the impact of the goodwill impairment, related to the decreases in both operating income and operating margin as discussed above


52
  Electronic Gaming Machines Segment Operating Results





Fiscal 2010 compared to Fiscal 2009




Year EndedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)EGM segment revenue:Lease revenue

$
269


$
45


$
224



497.8
%Sales


33,284



35,502



(2,218
)


(6.2
%)Service


23



-



23



100.0
%Other


7,541



11,051



(3,510
)


(31.8
%)Total sales and service revenue


40,848



46,553



(5,705
)


(12.3
%)Total EGM segment revenue

$
41,117


$
46,598


$
(5,481
)


(11.8
%)EGM segment gross profit

$
23,010


$
23,643


$
(633
)


(2.7
%)EGM segment gross margin


56.0
%


50.7
%EGM segment operating income

$
14,690


$
16,529


$
(1,839
)


(11.1
%)EGM segment operating margin


35.7
%


35.5
%EGM unit information:Lease units, end of year


28



17



11



64.7
%Sold during year


2,135



2,741



(606
)


(22.1
%)Average sales price

$
15,590


$
12,952


$
2,638



20.4
%


Total EGM segment revenue decreased $5,481 for fiscal 2010, as compared to fiscal 2009:





·
Impact of foreign exchange fluctuations


o
Total revenue was positively impacted by approximately $5,300 due to the exchange effect of a weakening U.S. dollar. Total revenue decreased approximately $10,800 excluding  the exchange effect





·
A 6.2% decrease in sales revenue


o
Driven by the 22.1% decrease in sold units


o
The decrease in units sold is partly the result of the market’s anticipation of our new Equinox cabinet as customers postponed spending to receive the latest product.  Equinox offers widescreen displays and substantially improved graphics and user interfaces over our older eStar machines.  Placements of Equinox units began in July 2010 and totaled 1,025 units for the fiscal year


o
The 20.4% increase in average sales price was primarily due to exchange effects; the average sales price in Australian dollars improved approximately 1.0% due to higher average sale prices on Equinox. Our new Equinox cabinet carries a higher average sales price than our older eStar cabinet





·
A 31.8% decrease in other revenue, driven by a decrease in sales of conversion kits and other parts and peripherals.  The prior year included a large sale of hardware combined with software conversion kits to a single customer





EGM gross profit decreased 2.7% for fiscal 2010, as compared to fiscal 2009. EGM gross margin increased 530 bps to 56.0% for fiscal 2010, as compared to the prior year. The decrease in gross profit primarily related to the following:





·
The decrease in EGM sales revenue as noted above





The increase in gross margin primarily related to the following:





·
Reductions in materials and production costs due to value engineering and cost savings. A portion of the cost savings related to favorable foreign exchange fluctuations which may not be repeatable





·
A reduction of approximately $550 in royalty expense





·
A reduction of approximately $300 in amortization expense associated with EGM products as the underlying intangible assets became fully amortized in first quarter of fiscal 2010




53




·
The impact of a $150 refund of previously assessed import duties in Australia, which is not expected to have a recurring impact





EGM operating income decreased 11.1% for fiscal 2010, as compared to fiscal 2009. EGM operating margin increased 20 bps as compared to the prior year.





The decrease in operating income primarily related to the following:





·
The decrease in EGM sales revenue as noted above





The increase in operating margin primarily related to the following:





·
The same factors that led to gross margin improvements as noted above





·
Offset by increased R&D costs related to the development of the new Equinox cabinet




Fiscal 2009 compared to Fiscal 2008




Year EndedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands, except for units and per unit/seat amounts)EGM segment revenue:Lease revenue

$
45


$
-


$
45



100.0
%Sales


35,502



32,946



2,556



7.8Other


11,051



9,952



1,099



11.0Total sales and service revenue


46,553



42,898



3,655



8.5Total EGM segment revenue

$
46,598


$
42,898


$
3,700



8.6
%EGM segment gross profit

$
23,643


$
19,662


$
3,981



20.2
%EGM segment gross margin


50.7
%


45.8
%EGM segment operating income

$
16,529


$
11,693


$
4,836



41.4
%EGM segment operating margin


35.5
%


27.3
%EGM unit information:Lease seats, end of year


17



-



17



100.0
%Sold during year


2,741



2,328



413



17.7
%Average sales price

$
12,952


$
14,152


$
(1,200
)


(8.5
%)
 
 Total EGM segment revenue increased $3,700 for fiscal 2009 as compared to fiscal 2008 primarily due to the following:





·
Impact of foreign currency fluctuations


o
Total revenue was negatively impacted by $7,362 due to foreign currency fluctuations between the U.S. dollar and the Australian dollar. Excluding the impacts of foreign currency fluctuations, revenue would have increased $11,062





·
A 7.8% increase in sales revenue


o
A 17.7% increase in sold seats driven primarily by the strength of our newer titles and the success of our progressive links: Pink Panther and Grand Central


o
Partially offset by a decrease in average sales price, driven by fluctuations in the exchange rate between the Australian dollar and the U.S. dollar.  The average sales price in Australian dollars increased approximately 4.1% over the prior year period





·
An 11.0% increase in other revenue


o
A 25.1% increase in parts and peripherals. Fiscal 2009 includes a large sale of hardware combined with software conversion kits to a single customer


o
Offset by a 13.9% decrease in EGM software conversion kits





EGM gross profit increased 20.2% for fiscal 2009 as compared to fiscal 2008.  EGM gross margin also increased 490 bps to 50.7% for fiscal 2009 as compared to fiscal 2008.  These increases in both gross profit and gross margin primarily related to the following:




54




·
The increases in EGM sales revenue as noted above





·
The increased amount of parts and peripheral sales which have a substantially higher margin than completed units.  As noted above, fiscal 2009 includes a large sale of hardware combined with software conversion kits to a single customer





·
The impact of a $662 refund of previously assessed import duties in Australia, which is not expected to have a recurring impact





EGM operating income increased 41.4% for fiscal 2009 as compared to fiscal 2008.  EGM operating margin also increased 820 bps to 35.5% for fiscal 2009 as compared to fiscal 2008.  These increases in both operating income and operating margin primarily related to the following:





·
The revenue increases as noted in our gross profit discussion





·
A decrease of $399 in the amount of R&D costs directly related to the EGM segment





LIQUIDITY AND CAPITAL RESOURCES


(In thousands, except ratios and per share amounts)





Our primary historical source of liquidity and capital resources has been cash on hand, cash from operations and various forms of debt. We use cash to fund growth in our operating assets, including inventory, products leased and held for lease and sales-type leases and to fund new products through both research and development and strategic acquisitions of businesses and intellectual property. Based on past performance and current expectations, we believe these resources will satisfy our needs for working capital, capital expenditures, debt service, and other liquidity requirements associated with our existing operations for the foreseeable future.





Our Senior Secured Revolving Credit Facility contains three financial maintenance covenants: a Total Leverage Ratio, Senior Leverage Ratio and an Interest Expense Coverage Ratio.  Under the facility, we are required to maintain a Total Leverage Ratio, as defined therein, of not more than 3.75 to 1.0.  Our Total Leverage Ratio as of October 31, 2010 was 1.03 to 1.0.  Furthermore, we are required to maintain a Senior Leverage Ratio, as defined therein, of not more than 3.0 to 1.0 until October 31, 2013 and not more than 2.75 to 1.00 after October 31, 2013. Our Senior Leverage Ratio as of October 31, 2010 was 1.02 to 1.0. We are also required to maintain an Interest Coverage Ratio, as defined therein, in excess of 3.0 to 1.0 at the end of any fiscal quarter. Our Interest Coverage Ratio as of October 31, 2010 was 21.55 to 1.0.





Working capital





The following summarizes our cash, cash equivalents and working capital:




October 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands, except ratios)Cash and cash equivalents

$
9,988


$
7,840


$
2,148



27.4
%Working capital

$
58,628


$
59,272


$
(644
)


(1.1
%)Current ratio

2.2 : 1


2.8 : 1



(0.6
)
 
 55
 
 CASH FLOW SUMMARY





Fiscal 2010 compared to Fiscal 2009




Year EndedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands)Net cash provided by operating activities

$
51,325


$
40,142


$
11,183



27.9
%Net cash used in investing activities


(20,433
)


(9,045
)


11,388



125.9
%Net cash used in financing activities


(28,659
)


(30,124
)


(1,465
)


(4.9
%)Effects of exchange rates


(85
)


1,493



(1,578
)


(105.7
%)Net change in cash and cash equivalents

$
2,148


$
2,466
 
 Operations





Cash flows provided by operating activities increased $11,183 year over year, primarily due to the following:





·
Strong operating performance led to an increase in net income of approximately $8,100





·
An increase in cash provided by accounts payable, accrued liabilities, deferred revenue and customer deposits of approximately $16,200. This increase was primarily due to the settlement of our Class Action Lawsuits and Shareholder Derivative Suits. See Note 5 to our Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" included in this Form 10-K for more information. The increase was offset by a net decrease in year-end compensation accruals as well as the recognition of revenue on a large transaction for which revenue was deferred until regulatory approval was granted. Excluding the settlement, an increase in cash provided by accounts payable, accrued liabilities, deferred revenue and customer deposits was approximately $5,200





·
The increase in accrued liabilities related to the settlement of our Class Action Lawsuits and Shareholder Derivative Suits was offset by an increase in other current assets representing reimbursements receivable under our D&O insurance policy





·
A decrease in cash used for inventory of approximately $1,400, reflecting our efforts to optimize inventory levels. We intend to continue working to improve our operational efficiencies surrounding inventory management through continued value engineering of our more popular products. Inventory turns improved to 3.4 times as of October 31, 2010 from 3.3 times in the prior year





·
Offset by a decrease in non-cash items of $2,616, to $24,997 in fiscal 2010 from $27,613 in fiscal 2009.  In fiscal 2010 and 2009, non-cash items primarily consisted of depreciation and amortization, share-based compensation, amortization of debt issuance costs, profit on sales of leased assets, loss (gain) on early extinguishment of debt and write-down for inventory obsolescence.





·
An increase in accounts receivable of approximately $4,800 was consistent with growth in sales. Average days sales outstanding (“DSO”) for fiscal 2010 remained relatively constant at approximately 75 days in fiscal 2010 compared to 74 days in 2009





Capital expenditures





Significant items included in cash flows related to capital expenditures are as follows:




Year endedOctober 31,


Increase


Percentage2010


2009


(Decrease)


Change(In thousands)Payments for products leased and held for lease

$
(19,956
)

$
(11,990
)

$
7,966



66.4
%Purchases of property and equipment


(5,293
)


(1,150
)


4,143



360.3
%Purchases of intangible assets


(2,404
)


(4,493
)


(2,089
)


(46.5
%)Total capital expenditures

$
(27,653
)

$
(17,633
)
 
 We expect our capital expenditures to grow in a proportionate ratio to our revenue and/or mix of revenue, as our leasing model extends into our more capital-intensive products.





56





Investing





Cash flows used for investing activities increased $11,388 year over year, primarily due to the following:





·
Increased cash used for products leased and held for lease of approximately $8,000. This increase was primarily driven by the increase in ETS seats and shufflers on lease as well as seats / units expected to be placed





·
Increase in cash used for purchases of property and equipment of approximately $4,100 primarily related to internal systems improvements being implemented at each of our subsidiaries during the current fiscal year





·
Offset by a decrease in cash used for purchases of intangible assets.  The prior year included acquisitions of intangible assets related to the Elixir purchase and settlement agreement





·
Offset by an increase in cash proceeds from the sale of leased assets of approximately $1,900. This increase was primarily driven by an increase in shuffler conversion sales during the current fiscal year





Financing





Cash flows used in financing activities decreased $1,465, primarily due to the following:





·
During the year ended October 31, 2010, we entered into a Senior Secured Revolving Credit Facility and drew approximately $65,000. The funds were primarily used to repay in its entirety and close the Deutsche Bank Senior Secured Credit Facility and the Term Loan, as defined below





·
Cash used for debt payments was approximately $104,000 during the year ended October 31, 2010 as compared to approximately $78,000 in the prior year. Debt payments in the current year primarily related to repayment of the Deutsche Bank Senior Secured Credit Facility and the Term Loan. Debt payments in fiscal 2009 primarily related to the repurchase of our contingent convertible senior notes, as discussed above, and payments on Deutsche Bank Senior Secured Credit Facility





Fiscal 2009 compared to Fiscal 2008




Year EndedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands)Net cash provided by operating activities

$
40,142


$
44,018


$
(3,876
)


(8.8
%)Net cash used in investing activities


(9,045
)


(5,812
)


3,233



55.6
%Net cash used in financing activities


(30,124
)


(37,256
)


(7,132
)


(19.1
%)Effects of exchange rates


1,493



32



1,461



4,565.6
%Net change in cash and cash equivalents

$
2,466


$
982
 
 Operations





Cash flows provided by operating activities decreased $3,876 year over year, primarily due to the following:





·
An increase in cash used for inventory of $10,884, to a use of cash of ($2,304) in fiscal 2009 from $8,580 cash provided from inventory in fiscal 2008. In fiscal 2009, we experienced an increase in our inventory balance primarily related to increased demand for our ETS and shuffler products.  We intended to focus our operational efforts in fiscal 2010 to optimize level of inventory to fulfill sales orders with a focus on increasing our turnover ratio.  We also intended to improve our operational efficiencies surrounding inventory management through continued value engineering of our more popular products





·
An increase in accounts receivable of $7,376, to a use of cash of ($5,120) in fiscal 2009 from a source of cash of $2,256 in fiscal 2008.  Average days sales outstanding (“DSO”) for fiscal 2009 increased to approximately 74 days from approximately 55 days in fiscal 2008 on higher receivables and lower revenues





·
A decrease in non-cash items of $22,688, to $27,613 in fiscal 2009 from $50,301 in fiscal 2008.  In fiscal 2009, non-cash items primarily consisted of depreciation and amortization, share-based compensation, amortization of debt issuance costs, profit on sales of leased assets, gain on early extinguishment of debt and write-down for inventory obsolescence.  In fiscal 2008, non-cash items also included an impairment of goodwill and an impairment related to our former equity method investment in Sona Mobile Holdings Inc.  No such charges are included in fiscal 2009





57





Capital expenditures





Significant items included in cash flows related to capital expenditures are as follows:




Year endedOctober 31,


Increase


Percentage2009


2008


(Decrease)


Change(In thousands)Payments for products leased and held for lease

$
(11,990
)

$
(13,670
)

$
(1,680
)


(12.3
%)Purchases of property and equipment


(1,150
)


(2,554
)


(1,404
)


(55.0
%)Purchases of intangible assets


(4,493
)


(1,202
)


3,291



273.8
%Total capital expenditures

$
(17,633
)

$
(17,426
)
 
 Investing





Cash flows used for investing activities increased $3,233 in fiscal 2009 as compared to fiscal 2008, primarily due to the following:





·
Increase in cash used for purchases of intangible assets of $3,291 related to the Elixir asset purchase during March 2009





·
Cash inflows increased from the release of our $3,000 cash security, plus interest earned thereon, posted in 2004 that related to a patent infringement lawsuit with Elixir





·
The prior year included $2,302 received from the sale of assets, primarily related to the sale of our fractional ownership in a corporate airplane.  No such sales occurred in 2009





Financing





Cash flows used by financing activities decreased $7,132, primarily due to the following:





·
In 2008, we executed a multi-step refinancing plan (the “Refinancing”) that involved a public offering of our common stock, a Second Amendment (as defined below) to our Deutsche Bank Senior Secured Credit Facility and a cash tender offer for our Notes


o
We issued 20,294 shares of our common stock at $4.25 per share for net proceeds of $80,453. We offered no common stock for public sale in 2009


o
We entered into a Second Amendment to our Deutsche Bank Senior Secured Credit Facility which, among other things, provided for a new Term Loan.  Net proceeds from the Term Loan were $63,438.  No such amendment occurred in 2009


o
We executed a Tender Offer to repurchase our Notes.  Under the Tender Offer, we repurchased $89,350 in aggregate principal amount of our Notes.  No such Tender Offer occurred in 2009


o
We repurchased $20,384 of our Notes in separate transactions in the open market





·
Cash provided by debt proceeds decreased by $47,100. In fiscal 2009, debt proceeds primarily related to borrowings under Deutsche Bank Senior Secured Credit Facility. In fiscal 2008, debt proceeds related to both our Term Loan and Deutsche Bank Senior Secured Credit Facility as part of the Refinancing. Debt proceeds in fiscal 2009 include approximately $40,000 of borrowings on Deutsche Bank Senior Secured Credit Facility used to satisfy the remaining Notes outstanding that had not been repurchased in fiscal 2008.





·
A decrease in cash used for debt repayments of $125,403, or 60.9%, to $80,420 for fiscal 2009 compared to $205,823 in fiscal 2008. For fiscal 2009, debt repayments primarily related to the repurchase of our remaining outstanding Notes, as part of the Refinancing, payments on Deutsche Bank Senior Secured Credit Facility and payments on the remaining liability to Bet Technology, Inc.  For fiscal 2008, debt payments related primarily to our Notes, as part of the Refinancing and Deutsche Bank Senior Secured Credit Facility.





58





Indebtedness (See Note 7 of our Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" included in this Form 10-K)





$200,000 senior secured revolving credit facility. On October 29, 2010, we entered into a new senior secured credit agreement (the “Senior Secured Revolving Credit Facility”) with Wells Fargo Securities, LLC and Banc of America Securities LLC, as joint lead arrangers and joint lead bookrunners, Bank of America, N.A. as syndication agent and Union Bank, N.A. as  documentation agent. The Senior Secured Revolving Credit Facility provides for senior secured credit facilities in an aggregate principal amount of $200,000 consisting of a 5-year revolving credit facility (the “Revolver”) in an aggregate principal amount of $200,000 with a sub-facility for letters of credit of $25,000, a sub-facility for multicurrency borrowings in Euros, Australian dollars and Canadian dollars of $25,000, and a sub-facility for swing line loans of $20,000, each on customary terms and conditions. The Senior Secured Revolving Credit Facility includes an option to increase the Revolver to $300,000 which would require syndication approval.





Loans under the Revolver (other than Swing Line Loans, as defined) bear interest based on the Base Rate, as defined or LIBOR, as elected by us. Base Rate interest is calculated at the Base Rate plus the applicable margin and the Base Rate is the highest of (a) the Federal Funds Rate plus .50%, (b) the prime commercial lending rate of the Administrative Agent, as defined and (c) the one month LIBOR rate for such day plus 1.00%. Swing Line Loans bear interest at the Base Rate plus the applicable margin. The initial interest rate will be LIBOR +200bps.





The amount drawn under the Revolver was $65,445 as of October 31, 2010, which was used to repay in its entirety our previous $65,000 term loan and $100,000 revolving credit facility and used to pay fees and expenses in connection with the refinancing. After considering restrictive financial covenants under the Senior Secured Revolving Credit Facility, we had approximately $127,000 of available remaining credit under the Revolver as of October 31, 2010. The Revolver matures on October 29, 2015.





$100,000 revolving credit facility.On November 30, 2006, the Company entered into a senior secured credit facility (the “Deutsche Bank Senior Secured Credit Facility”) with Deutsche Bank Trust Company Americas, as a Lender and as the Administrative Agent, Deutsche Bank Securities Inc. and Wells Fargo Bank, N.A., as Joint Lead Arrangers and Book Managers and Wells Fargo Bank, N.A. as Syndication Agent. The Deutsche Bank Senior Secured Credit Facility was satisfied and terminated as of October 31, 2010. As of October 31, 2009 the amount drawn under the Deutsche Bank Senior Secured Credit Facility was $28,000. The Deutsche Bank Senior Secured Credit Facility consisted of a $100,000 revolving credit facility. Loans under the Deutsche Bank Senior Secured Credit Facility bore interest at a margin over LIBOR or Base Rate, as elected by the Company. The applicable margins fluctuated based on our total leverage ratio from time to time. The Company’s effective interest rates for Deutsche Bank Senior Secured Credit Facility for the years ended October 31, 2010 and 2009 were 3.9% and 2.3%, respectively.




Second Amendment and Term Loan.On July 14, 2008, the Company entered into a second amendment (the “Second Amendment”), to our Deutsche Bank Senior Secured Credit Facility.  Among other things, the Second Amendment provided for a new $65,000 term loan facility (“Term Loan”), which was funded in full on August 25, 2008, resulting in net proceeds of $63,438. The amendment left in place our Deutsche Bank Senior Secured Credit Facility discussed above.  In addition to the Term Loan and Deutsche Bank Senior Secured Credit Facility, the Second Amendment provided a $35,000 incremental facility (the “Incremental Facility”) pursuant to which we could request (but no lender was committed to provide) additional loans under the facility, subject to customary conditions. The Term Loan was satisfied and terminated as of October 31, 2010.





The Term Loan bore interest at 2.75% over the Base Rate or 3.75% over LIBOR, as elected by the Company.  The Term Loan had scheduled amortization payments of 0.25% of the principal every quarter starting with the quarter ending on January 31, 2009.  The mandatory prepayment provisions also required us to prepay the Term Loan (i) up to 75% of our domestic excess cash flow (as defined) or up to 50% of our worldwide excess cash flow (as defined), whichever is less (with step-downs based on total leverage) (the “Excess Cash Flow Payment”); (ii) 100% of the proceeds of certain issuances of debt; and (iii) the proceeds of asset sales or recovery events in excess of $1,500, to the extent not reinvested.


59
  CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS





Contractual obligations.  The following table summarizes our current and long-term liabilities, material obligations and commitments to make future payments under certain contracts, including current and long-term debt obligations, purchase commitments and operating leases.




Less than


1 - 3


3 - 5


More thanTotal


1 Year


Years


Years


5 Years(In thousands)Contractual obligations:DebtSenior Secured Revolving Credit Facility (1)

$
65,445


$
-


$
-


$
65,445


$
-Interest on the Senior Secured Revolving Credit Facility (2)


7,567



1,513



3,027



3,027



-Other Debt (3)


845



32



513



-



300OtherPurchase commitments (4)


10,683



10,683



-



-



-Operating leases (5)


6,576



2,440



3,096



798



242Uncertain tax positions (6)


1,246



-



-



-



-Other (7)


1,883



490



650



299



444Total contractual obligations

$
94,245


$
15,158


$
7,286


$
69,569


$
986


(1)
Represents the amount outstanding on our Senior Secured Revolving Credit Facility as of October 31, 2010.  The Senior Secured Revolving Credit Facility matures on October 29, 2015





(2)
Represents interest based on original borrowing rate, LIBOR+200bps, on the outstanding balance as of October 31, 2010, on the Senior Secured Revolving Credit Facility assuming no changes to such balance.





(3)
Represents contingent interest payments in connection with our purchase of the Play Four PokerTM patent and trademark from Kings Gaming Inc. and contingent consideration in connection with our acquisition of Bet the Set “21.”


(4)
Represents short-term open purchase orders with our vendors.


(5)
Represents operating lease agreements for our Las Vegas headquarters, Australian facilities and other field service facilities.





(6)
Represents the total uncertain tax positions.  We are unable to determine the year in which our uncertain tax positions will resolve.





(7)           Represents other current and long term liabilities.





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





Impact of Inflation. To date, inflation has not had a material effect on our operations.


60
  SELECTED QUARTERLY FINANCIAL DATA




Quarter EndedJanuary 31,


April 30,


July 31,


October 31,(In thousands, except per share amounts)2010Revenue

$
40,336


$
50,816


$
51,547


$
58,603Gross profit


24,847



32,299



31,667



35,157Net income


3,679



7,885



5,842



5,677Earnings per share:Basic


0.07



0.15



0.11



0.11Diluted


0.07



0.15



0.11



0.102009:Revenue

$
34,489


$
45,304


$
45,066


$
54,568Gross profit


20,561



25,698



27,371



32,041Net income (loss): As previously reported


(973
)


4,577



5,611



6,244Adjustment pursuant to ASC 470-20(a)


(301
)


(184
)


-



-Revised net income (loss)


(1,274
)


4,393



5,611



6,244Revised earnings (Loss) per share, basic and diluted


(0.02
)


0.08



0.11



0.12Weighted average shares oustanding:Basic


53,058



53,087



53,161



53,171Diluted


53,058



53,192



53,584



53,841


(a) The adjustments relate to recording of additional amortization of debt discount and debt issuance costs and the related impact on the income tax provision (benefit).


61
  ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


(In thousands)





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





Interest rate risk.  As of October 31, 2010, we had approximately $66,000 of variable rate debt. Assuming a 1% change in the average interest rate as of October 31, 2010, our annual interest cost would change by approximately $660.





Foreign currency risk.  We are exposed to foreign currency exchange rate risk inherent in our leases and sales commitments, anticipated leases and sales, anticipated purchases and assets, liabilities and debt denominated in currencies other than the U.S. dollar. We transact business in numerous countries around the world using numerous currencies, of which the most significant to our operations for the fiscal years ended 2010, 2009 and 2008, were the Australian dollar and the Euro.  We settle inter-company trade balances, which results in the recognition of foreign currency fluctuations.  We expect that a significant portion of the volume of our business will continue to be denominated in foreign currencies. As such, we expect our cash flows and earnings to continue to be exposed to the risks that may arise from fluctuations in foreign currency exchange rates.





62


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS





PageReport of Independent Registered Public Accounting Firm,PricewaterhouseCoopers LLP

64Report of Independent Registered Public Accounting Firm, Deloitte & Touch LLP

65Consolidated Statements of Operations for the years ended October 31, 2010, 2009 and 2008

66Consolidated Balance Sheets as of October 31, 2010 and 2009

67Consolidated Statements of Changes in Shareholders’ Equity for the years ended October 31, 2010, 2009 and 2008

68Consolidated Statements of Cash Flows for the years ended October 31, 2010, 2009 and 2008

69Notes to Consolidated Financial Statements

71





63


Report of Independent Registered Public Accounting Firm








To the Board of Directors and Shareholders of


Shuffle Master, Inc.





In our opinion, the accompanying consolidated balance sheet as of October 31, 2010 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the year then ended present fairly, in all material respects, the financial position of Shuffle Master, Inc. and its subsidiaries at October 31, 2010, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audit.  We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.





As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for certain convertible debt instruments in 2010.





A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





/s/ PricewaterhouseCoopers LLP





Las Vegas, Nevada


January 13, 2011


64
  REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Board of Directors and Stockholders of


Shuffle Master, Inc.
 Las Vegas, Nevada


We have audited the accompanying consolidated balance sheet of Shuffle Master, Inc. and subsidiaries (the “Company”) as of October 31, 2009, and the related consolidated statements of operation, shareholders’ equity and cash flows for each of the two years in the period ended October 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.





We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.





In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Shuffle Master, Inc and subsidiaries as of October 31, 2009, and the results of their operations and their cash flows for each of the two years in the period ended October 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
 
 As discussed in Note 1 to the financial statements, the accompanying 2009 and 2008 financial statements have been retrospectively adjusted for the adoption ofnew authoritative guidance related to the accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlements).


/s/ Deloitte & Touche LLP


Las Vegas, Nevada


January 14, 2010 (December 7, 2010 as to Note 1)


65


SHUFFLE MASTER, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS





Year Ended October 31,2010


2009


2008(In thousands, except per share amounts)Revenue:Product leases and royalties

$
86,717


$
76,231


$
70,898Product sales and service


114,585



103,113



118,948Other


-



83



160Total revenue


201,302



179,427



190,006Costs and expenses:Cost of leases and royalties


28,008



24,559



21,866Cost of sales and service


49,324



49,197



57,238Gross profit


123,970



105,671



110,902Selling, general and administrative


66,817



63,647



71,350Research and development


21,811



17,349



18,474Impairment of goodwill


-



-



22,137Total costs and expenses


165,960



154,752



191,065Income (Loss)  from operations


35,342



24,675



(1,059
)Other income (expense):Interest income


577



860



1,759Interest expense


(4,015
)


(6,047
)


(11,642
)Other, net


282



731



1,261Total other income (expense)


(3,156
)


(4,456
)


(8,622
)Gain (loss) on early extinguishment of debt


(1,123
)


1,841



(435
)Impairment of investment


-



-



(1,560
)Income (loss) from continuing operations before tax


31,063



22,060



(11,676
)Income tax provision


7,980



7,086



3,697Income (loss) from continuing operations


23,083



14,974



(15,373
)Discontinued operations, net of tax


-



-



(1
)Net income (loss)

$
23,083


$
14,974


$
(15,374
)Basic and diluted earnings (loss) per share

$
0.43


$
0.28


$
(0.38
)Weighted average shares outstanding:Basic


53,258



53,120



40,006Diluted


54,199



53,449



40,006


See Notes to Consolidated Financial Statements


66
  SHUFFLE MASTER, INC.


CONSOLIDATED BALANCE SHEETS





October 31,2010


2009(In thousands, except per share amounts)ASSETSCurrent assets:Cash and cash equivalents

$
9,988


$
7,840Accounts receivable, net of allowance for bad debts of $466 and $630


41,176



36,371Investment in sales-type leases and notes receivable, net of allowancefor bad debts of $113 and $164


1,806



2,281Inventories


27,351



27,639Prepaid income taxes


7,086



5,893Deferred income taxes


5,091



6,637Other current assets


14,969



5,897Total current assets


107,467



92,558Investment in sales-type leases and notes receivable, net of current portion


1,104



1,295Products leased and held for lease, net


31,975



23,653Property and equipment, net


12,642



9,506Intangible assets, net


64,144



71,338Goodwill


75,932



74,662Deferred income taxes


7,523



9,414Other assets


3,173



3,043Total assets

$
303,960


$
285,469LIABILITIES AND SHAREHOLDERS' EQUITYCurrent liabilities:Accounts payable

$
7,013


$
6,336Accrued liabilities and other current liabilities


34,762



16,608Deferred income taxes, current


116



62Customer deposits


2,973



2,828Income tax payable


74



-Deferred revenue


3,901



6,802Current portion of long-term debt


-



650Total current liabilities


48,839



33,286Long-term debt, net of current portion


66,262



92,560Other long-term liabilities


2,641



3,549Deferred income taxes


70



-Total liabilities


117,812



129,395Commitments and Contingencies (See Note 15)Shareholders' equity:Common stock, $0.01 par value; 151,368 shares authorized;53,650 and 53,617 shares issued and outstanding


536



536Additional paid-in capital


108,705



105,094Retained earnings


49,248



26,165Accumulated other comprehensive income


27,659



24,279Total shareholders' equity


186,148



156,074Total liabilities and shareholders' equity

$
303,960


$
285,469





See Notes to Consolidated Financial Statements


67


SHUFFLE MASTER, INC.


CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY





Accumulated


TotalAdditional





Other


Share-Common Stock


Paid-in


Retained


Comprehensive


holders'Shares


Amount


Capital


Earnings


Income (loss)


Equity(In thousands)Balance, October 31, 2007: As previously reported

35,198


$
352


$
6,492


$
38,770


$
42,020


$
87,634Retrospective application of ASC 470-20

-



-



16,524



(11,061
)


-



5,463Balance, October 31, 2007: Revised

35,198


$
352


$
23,016


$
27,709


$
42,020


$
93,097Comprehensive Income:Net Income (loss)

-



-



-



(15,374
)


-



(15,374
)Currency translation

-



-



-



-



(50,152
)


(50,152
)Reclassification of loss on investments

-



-



-



-



(123
)


(123
)Tax on unrealized loss on investments

-



-



-



-



45



45Total comprehensive income





















(65,604
)Stock issued

20,294



202



80,250



-



-



80,452Stock repurchased

(2,000
)


(20
)


(7,105
)


-



-



(7,125
)Shares surrendered and retired for stock option exercises

(16
)


-



-



-



-



-Share-based compensation expense

-



-



4,189



-



-



4,189Tax effect from share-based compensation

-



-



(115
)


-



-



(115
)FIN 48 Adoption

-



-



-



(1,144
)


-



(1,144
)Effect of adopting ASC 470-20









(387
)










(387
)Issuance of restricted stock

59



1



(1
)










-Balance, October 31, 2008

53,535


$
535


$
99,847


$
11,191


$
(8,210
)

$
103,363Comprehensive Income:Net Income (loss)

-



-



-



14,974



-



14,974Currency translation

-



-



-



-



32,489



32,489Total comprehensive income





















47,463Stock repurchased

(25
)


-



(104
)


-



-



(104
)Share-based compensation expense

-



-



6,480



-



-



6,480Tax effect from share-based compensation

-



-



(1,108
)


-



-



(1,108
)Effect of adopting ASC 470-20

-



-



(20
)


-



-



(20
)Issuance of restricted stock

119



1



(1
)


-



-



-Other

(12
)


-



-



-



-



-Balance, October 31, 2009

53,617


$
536


$
105,094


$
26,165


$
24,279


$
156,074Comprehensive Income:Net Income (loss)

-



-



-



23,083



-



23,083Currency translation

-



-



-



-



3,380



3,380Total comprehensive income





















26,463Stock repurchased

(8
)


-



(63
)


-



-



(63
)Options exercised

73



1



472



-



-



473Share-based compensation expense

-



-



3,906



-



-



3,906Tax effect from share-based compensation

-



-



(705
)


-



-



(705
)Issuance of restricted stock

3



-



-



-



-



-Other

(35
)


(1
)


1



-



-



-Balance, October 31, 2010

53,650


$
536


$
108,705


$
49,248


$
27,659


$
186,148
 
 
 See Notes to Consolidated Financial Statements


68


SHUFFLE MASTER, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS





Year Ended October 31,2010


2009


2008(In thousands)Cash flows from operating activities:Net income (loss)

$
23,083


$
14,974


$
(15,374
)Adjustments to reconcile net income (loss) to cash provided by operating activities:Depreciation and amortization


22,868



23,515



23,440Amortization of debt issuance costs and debt discount


1,037



1,804



6,352Loss (gain) on early extinguishment of debt


1,123



(1,841
)


435Share-based compensation


3,969



6,480



4,189Impairment of investment


-



-



1,560Impairment of goodwill


-



-



22,137Provision for bad debts


541



301



92Write-down for inventory obsolescence


1,019



1,523



72Loss (Gain) on sale of assets


(123
)


110



(738
)Profit on sale of leased assets


(5,437
)


(4,279
)


(7,238
)Excess tax benefit from stock option exercises


(53
)


-



-Changes in operating assets and liabilities:Accounts receivable


(4,811
)


(5,120
)


2,256Investment in sales-type leases and notes receivable


191



4,067



7,597Inventories


(866
)


(2,304
)


8,580Accounts payable and accrued liabilities


17,933



(3,069
)


(5,640
)Customer deposits and deferred revenue


(2,688
)


2,149



(1,411
)Income taxes, net of stock option exercises


127



(23
)


(9
)Deferred income taxes


3,344



11



998Prepaid income taxes


(1,108
)


2,111



(4,691
)Other current and non-current assets


(8,824
)


(267
)


1,411Net cash provided by operating activities


51,325



40,142



44,018Cash flows from investing activities:Proceeds from sale and maturities of investments


-



3,050



65Proceeds from sale of assets


142



82



2,302Proceeds from sale of leased assets


8,332



6,400



9,247Payments for products leased and held for lease


(19,956
)


(11,990
)


(13,670
)Purchases of property and equipment


(5,293
)


(1,150
)


(2,554
)Purchases of intangible assets


(2,404
)


(4,493
)


(1,202
)Other


(1,254
)


(944
)


-Net cash used by investing activities


(20,433
)


(9,045
)


(5,812
)Cash flows from financing activities:Proceeds from Revolver


65,445



-



-Proceeds from the Deutsche Bank Senior Secured Credit Facility


12,126



50,400



32,500Payments on the Deutsche Bank Senior Secured Credit Facility


(40,125
)


(38,400
)


(92,180
)Proceeds from Term Loan


-



-



65,000Payment on Term Loan


(64,350
)


-



-Payments on Contingent convertible senior notes


-



(40,095
)


(107,969
)Payments on notes payable and other long-term debt


(61
)


(1,925
)


(5,674
)Repurchase of common stock


-



-



(7,125
)Proceeds from issuance of common stock, net


473



-



80,452Debt issuance costs


(2,242
)


-



(2,261
)Excess tax benefit from stock option exercises


53



-



-Other


22



(104
)


1Net cash used by financing activities


(28,659
)


(30,124
)


(37,256
)Effect of exchange rate changes on cash


(85
)


1,493



32Net increase (decrease) in cash and cash equivalents


2,148



2,466



982Cash and cash equivalents, beginning of year


7,840



5,374



4,392Cash and cash equivalents, end of year

$
9,988


$
7,840


$
5,374
  See Notes to Consolidated Financial Statements


69


SHUFFLE MASTER, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS





Supplemental Disclosures of Cash Flows Information—





Year Ended October 31,2010


2009


2008(In thousands)Non-cash Investing and Financing transactions:Recharacterization of prepaid royalty

$
-


$
4,667


$
-Cash paid for:Income taxes, net of refunds

$
6,110


$
6,417


$
6,007Interest

$
3,136


$
4,358


$
6,815


See Notes to Consolidated Financial Statements


70
  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.  Unless the context indicates otherwise, references to “Shuffle Master, Inc.,” “we,” “us,” “our” or the “Company,” includes Shuffle Master, Inc. and its consolidated subsidiaries.





We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor. Our products primarily relate to our casino customers’ table game activities and focus on either increasing their profitability, productivity and security or expanding their gaming entertainment offerings in the form of electronic table games or electronic slot machines. Our business is segregated into the following four operating segments: Utility, Proprietary Table Games (“PTG”), Electronic Table Systems (“ETS”) and Electronic Gaming Machines (“EGM”).





We lease, license and sell our products. When we lease or license our products, we generally negotiate a month-to-month operating lease. When we sell our products, we offer our customers a choice between a sale, a longer-term sales-type lease or other long-term financing. We offer our products worldwide in markets that are highly regulated. We manufacture our products at our headquarters and manufacturing facility in Las Vegas, Nevada, as well as at our headquarters and manufacturing facility in Milperra, New South Wales, Australia. In addition, we outsource the manufacturing of certain of our sub-assemblies in the United States, Europe and Australasia.





Utility.  Our Utility segment develops products for our casino customers that enhance table game speed, productivity, profitability and security. Utility products include automatic card shufflers and roulette chip sorters. Additionally, we have acquired or are developing products, such as our i-Shoe AutoTM card reading shoe, that gather data and enable casinos to track table game play and our i-ScoreTM baccarat viewer that displays current game results and trends. These products are intended to cost-effectively provide casinos and our other customers with data on table game play for security and marketing purposes, which in turn allows them to increase their profitability.





Proprietary Table Games.Our PTG segment develops and delivers proprietary table games that enhance our casino customers' and other licensed operators' table game operations. Products in this segment include our proprietary table games as well as proprietary features added to public domain games such as poker, baccarat, pai gow poker and blackjack table games.





We intend to broaden our PTG content through development and acquisition. By enhancing the value of our existing proprietary table games in the marketplace with side bets, add-ons and progressives and by increasing our footprint with new titles, we hope to increase our domestic market penetration and expand further into international markets. We also intend to expand the domestic presence of our proprietary titles on electronic platforms such as our Table Master® and i-TableTM.  We also plan to continue to install proprietary progressives and side bets on public domain table games in addition to our proprietary table games.




Electronic Table Systems.Our ETS segment develops and delivers various products involving popular table game content using e-Table game platforms. Our primary ETS products are the i-Table, Table Master, Vegas Star® and Rapid Table Games®.  Our i-Table platform combines an electronic betting interface with a live dealer who deals the cards from a Shuffle Master card reading shoe or shuffler and is designed to dramatically improve game speed and security while reducing many operating expenses associated with live tables. Our Table Master and Vegas Star feature a virtual dealer which enables us to offer table game content in both traditional gaming markets and in markets where live table games are not permitted, such as racinos, video lottery and arcade markets. Our Rapid Table Games product enables the automation of certain components of traditional table games such as data collection, placement of bets, collection of losing bets and payment of winning bets combined with live dealer and game outcomes. This automation provides benefits to both casino operators and players, including greater security and faster speed of play.





Electronic Gaming Machines.  Our EGM segment develops and delivers our PC-based video slot machines into select markets, primarily in Australasia.  We offer an extensive selection of video slot titles which include a range of bonus round options that can be configured as a network of machines or as stand-alone units. In addition to selling the full EGM complement, we sell software conversion kits that allow existing EGM terminals to be converted to other games on the PC3 and PC4 platform. Popular titles for our EGMs include Rise of the DragonTM, Golden FortunesTM, Lucky PandaTM, The ConquerorTM, Emperor GuanTM, Tiki TotemsTM, Drifting SandsTM, NinjaTM, iChingTM, Kelly CountryTM, Deep Sea DollarsTM, CubaTM, Galapagos WildTM, Sunset on the SerengetiTM and Lonesome GeorgeTM, as well as the Pink PantherTM and Grand CentralTM progressive links.





71


Principles of consolidation. Our consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States (“GAAP”) and include all adjustments necessary to fairly present our consolidated results of operations, financial position and cash flows for each period presented.





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





Use of estimates and assumptions. The preparation of our consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are used for, but not limited to: (1) the subjective and complex judgments for revenue recognition typically involve whether collectability is probable, whether fees under an arrangement are fixed or determinable and the identification of specific deliverables under multiple element arrangements.  In addition, multiple element arrangements must be analyzed to determine the relative fair value of each element, the amount of revenue to be recognized and the period and conditions under which deferred revenue should be recognized.  The ability to establish vendor specific objective evidence of fair value for our products and services also requires judgment by management; (2) allowance for doubtful accounts; (3) asset impairments, including determination of the fair value of goodwill and indefinite lived trade names; (4) depreciable lives of assets; (5) useful lives and amortization of intangible assets; (6) income tax valuation allowances and uncertain tax positions; (7) fair value of stock options; and (8) the need for contingency and litigation reserves. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis. Actual results could differ from those estimates.





Concentration of credit risk. Our financial instruments that have potential concentrations of credit risk include cash and cash equivalents, accounts receivable, investments in sales-type leases and notes receivable. We maintain cash balances that exceed federally insured limits; however, we have incurred no losses on such accounts. Accounts receivable, investments in sales-type leases and notes receivable have concentration of credit risk because they all relate to our customers in the gaming industry.  We grant customers credit terms for periods of 120 days or less or may grant extended credit terms, with interest at prevailing rates.  Notes receivable are generally collateralized by the related equipment sold, although the value of such equipment, if repossessed, may be less than the receivable balance outstanding and the ability to actually repossess the equipment may not always be undisputed or able to be effectively executed.





From time to time, we make significant sales to customers that exceed 10% of our then-outstanding accounts receivable balance. As of October 31, 2010 and 2009, no customer balance exceeded 10% of our net trade accounts receivable. As of October 31, 2010, two customers and as of October 31, 2009, one customer exceeded 10% of our net investment in sales-type lease and notes receivable. These customers have well-established histories of payments to us as well as credit ratings that support the credit lines they have been extended. For the fiscal years ended 2010, 2009 and 2008, no individual customer accounted for more than 10% of consolidated revenue.





Provisions for bad debts. We maintain provisions for bad debts for estimated credit losses that result from the inability of our customers to make required payments. Provisions for bad debts are estimated based on historical experience and specific customer collection issues. Changes in the financial condition of our customers could result in the adjustment upward or downward in the provisions for bad debts, with a corresponding impact to our operating results.





Inventories.  Inventories are stated at the lower of cost, determined on a first-in-first-out basis, or market.  Cost elements included in work-in-process and finished goods include raw materials, direct labor and manufacturing overhead. We regularly review inventory quantities and update estimates for the net realizable. This process includes examining the carrying values of new and used gaming devices, parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of our inventories, the current and projected sales levels for such products, the projected markets for such products, the costs required to sell the products, including refurbishment costs and importation costs for international shipments and the overall projected demand for products once the next generation of products are scheduled for release.





As a result of our ongoing analysis of inventory, we recognized inventory write-downs of $1,019, $1,523 and $72 for fiscal years 2010, 2009 and 2008, respectively.  Additional valuation charges could occur in the future as a result of changes in the factors listed above.





Products leased and held for lease. Our products are primarily leased to customers pursuant to operating leases. Products leased and held for lease are stated at cost, net of depreciation. Depreciation on leased products is calculated using the straight-line method over the estimated useful life of three to five years. We provide maintenance of our products on lease as part of our normal lease agreements.





72


Property and equipment. Property and equipment is stated at cost. Depreciation is recorded using the straight-line method over the estimated useful life or lease terms, if shorter, for leasehold improvements.





We also review these assets for impairment whenever events or changes in circumstances indicate that we may not be able to recover the asset's carrying amount.





Goodwill and other indefinite lived intangible assets. We do not renew or extend the term of our intangible assets. We review our goodwill for impairment annually in October or when circumstances indicate that the carrying amount of goodwill may not be fully recoverable.  The review is performed at the operating segment level. The goodwill impairment test is a two-part test.  In the first step, we selected a discounted cash flow model (income approach) and the Guideline Public Company Model (market approach) to assess the fair values of our operating segment.  These two methodologies were equally weighted in determining fair values.  The fair value of the operating segment is then compared to the book value of the operating segment, including its goodwill. If the fair value is less than the book value, then we would perform a second step to compare the implied fair value of the operating segment's goodwill to its book value. The implied fair value of the goodwill is determined based on the estimated fair value of the operating segment less the fair value of the operating segment's identifiable assets and liabilities. We would record an impairment charge to the extent that the book value of the operating segment's goodwill exceeds its fair value.





We review our indefinite lived intangible assets for impairment annually in October or when circumstances indicate that the carrying amount of the tradename may not be fully recoverable. We would record an impairment loss if the carrying amount of the indefinite lived intangible asset exceeds its estimated fair value.





Other intangible assets.Other intangible assetsinclude intellectual property for games, patents, trademarks, copyrights, licenses, developed technology, customer relationships and non-compete agreements that were purchased separately or acquired in connection with a business combination. All of our significant intangible assets are definite lived and, accordingly, amortized over their expected useful lives which range from 1 to 15 years. We amortize certain of our intangible assets proportionate to the related actual revenue from the utilization of the intangible asset. We believe this method reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. For certain other intangibles, such as covenants not to compete, we amortize on a straight-line basis over their useful lives.





Impairment of long-lived assets.We estimate the useful lives of our long-lived assets, excluding goodwill and indefinite lived intangible assets, based on historical experience, estimates of products' commercial lives, the likelihood of technological obsolescence and estimates of the duration of commercial viability for patents, licenses and games.





We review our long-lived assets, excluding goodwill and indefinite lived intangible assets, for impairment whenever events or circumstances indicate the carrying value may not be recoverable or warrant a revision to the estimated remaining useful life.  We would record an impairment loss if the carrying amount of the asset or asset group is not recoverable (as determined by undiscounted cash flows) and the carrying amount exceeds its estimated fair value.  For fiscal 2010, 2009 and 2008, we did not have any such impairment loss.





Deferred revenue.Deferred revenue consists of amounts collected or billed in excess of recognizable revenue.





Revenue recognition.We recognize revenues when all of the following have been satisfied:




·
persuasive evidence of an arrangement exists





·
the price to the customer is fixed and determinable





·
delivery has occurred and any acceptance terms have been fulfilled, and





·
collection is reasonably assured




Revenues are reported net of incentive rebates, discounts, sales taxes, and other taxes of a similar nature. Amounts billed prior to completing the earnings process are deferred until revenue recognition criteria are met.





Product lease and royalty revenue —Lease and royalty revenue is earned from the leasing of our tangible products and the licensing of our intangible products, such as our proprietary table games. When we lease or license our products, we generally negotiate month-to-month fixed fee contracts, or to a lesser extent, enter into participation arrangements whereby casinos pay a fee to us based on a percentage of net win.   Lease and royalty revenue commences upon the completed installation of the product. Lease terms are generally cancellable with 30 days notice.  We recognize revenue from our leases and licenses upon installation of our product on a month to month basis.





73


Product sales and service revenue— We generate sales revenue through the sale of equipment in each product segment, including sales revenue from sales-type leases and the sale of lifetime licenses for our proprietary table games. Our credit sales terms are primarily 60 days or less.  Financing for intangible property and sales-type leases for tangible property have payment terms ranging generally from 24 to 36 months and are interest-bearing at market interest rates. Revenue from the sale of equipment is recorded in accordance with the contractual shipping terms. If a customer purchases existing leased equipment, revenue is recorded on the effective date of the purchase agreement. Revenue on service and warranty contracts is recognized as the services are provided over the term of the contracts, which are generally one year. Revenue from the sale of lifetime licenses, under which we have no continuing obligation, is recorded on the effective date of the license agreement.





Our EGMs, Table Masters and Vegas Star products that contain both software and non-software components that function together to deliver the product’s essential functionality were previously subject to software revenue recognition rules. Under the new ASUs adopted for new and materially modified arrangements entered into after the beginning of our first quarter of fiscal 2010 (discussed below under Recently Issued Accounting Standards – Adopted), our EGMs, Table Masters and Vegas Star products no longer fall under the scope of software revenue recognition rules and are generally recognized upon delivery and customer acceptance.





Multiple element arrangements— Some of our revenue arrangements contain multiple deliverables, such as a product sale combined with a service element or the delivery of a future product.  The new ASUs adopted provide for a more economically aligned model for allocating revenues among multiple deliverables in a multi-element arrangement, based on relative selling prices. In order of preference, relative selling prices will be estimated based on vendor specific objective evidence (“VSOE”), third-party evidence (“TPE”), or management’s best estimate of selling price (“BESP”), and the residual method is no longer allowed.





Most of our products and services qualify as separate units of accounting, and the new guidance does not change this premise. When VSOE or TPE is not available, BESP is the amount we would sell the product or service for individually. The determination of BESP is made based on our normal pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs, and profit objectives. Under the new guidance, revenues for certain products in our EGM and ETS segments and other software-enabled equipment in certain bundled arrangements previously deferred because VSOE was not available for undelivered elements will no longer be deferred. Generally, revenues allocated to future performance obligations elements will be recognized upon delivery and customer acceptance.





The adoption of these new standards did not have a material impact on our operating results, financial position or cash flows for the period ended October 31, 2010. Although this new accounting guidance is not currently expected to have a significant effect on the timing or amount of revenues in periods after the initial adoption, the impact is dependent upon the prevalence of future multi-element arrangements and the evolution of new sales strategies.





Income taxes. We record deferred tax assets and liabilities based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse.  We reduce deferred tax assets by a valuation allowance when it is more likely than not that some or all of the deferred tax assets will not be realized.





Our provision for income taxes includes interest and penalties related to uncertain tax positions. We only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.





Share based compensation.  We measure and recognize all share-based compensation, including restricted shares and share-based awards to employees, under the fair value method.  We measure the fair value of share-based awards using the Black-Scholes model.





Compensation is attributed to the periods of associated service and such expense is recognized on a straight-line basis over the vesting period of the awards. Forfeitures are estimated at the time of grant with such estimate updated when the expected forfeiture rate changes.





In addition, the excess tax benefit from stock-option exercises—tax deductions in excess of compensation cost recognized—is classified as a financing activity in the consolidated statement of cash flows.





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





Advertising costs. We expense advertising and promotional costs as incurred, which totaled approximately $2,207, $1,882 and $2,769, for the fiscal years ended October 31, 2010, 2009 and 2008, respectively.





74


Research and development costs. We incur research and development costs to develop our new and next-generation products. Our products reach technological feasibility shortly before the products are released and therefore R&D costs are expensed as incurred. Employee related costs associated with product development are included in R&D costs.





Foreign currency translation. Our foreign subsidiaries' asset and liability accounts are translated into U.S. dollar amounts at the exchange rate in effect at the balance sheet date. Foreign exchange translation adjustments are recorded as a separate component of shareholders' equity. Revenue and expense accounts are translated at the average monthly exchange rates.  Inter-company trade balances, which we anticipate to settle in the foreseeable future, result in foreign currency gains and losses which are included in other expenses in our consolidated statements of operations.  Transaction gains and losses are included in other expense in our consolidated statements of operations.





Earnings per common share. Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding and issuable during the year. Diluted earnings per share is similar to basic, except that the weighted average number of shares outstanding is increased by the potentially dilutive effect of outstanding stock options, restricted stock and contingent convertible notes, if applicable, during the year, using the treasury stock method.





Cash and cash equivalents. Cash and cash equivalents include short-term investments with maturities of three months or less from their date of purchase. We maintain cash balances that exceed federally insured limits; however, we have incurred no losses on such accounts.





Fair value measurement. At the beginning of fiscal 2009, we adopted new fair value accounting guidance for financial assets and liabilities which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The guidance does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. We did not elect the fair value option for any of our existing financial instruments. Accordingly, we determined the adoption of the guidance did not have a material impact on our consolidated financial statements. The guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following fair value hierarchy:





Level 1:
Quoted prices for identical instruments in active markets.





Level 2:
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.





Level 3:
Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.





This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. For some products or in certain market conditions, observable inputs may not be available.





See Note 3 for further discussions of the valuations of certain of our financial instruments.





Participating securities in share-based payment transactions. For the period beginning November 1, 2009, we adopted new accounting guidance issued in June 2008 for determining whether instruments granted in share-based payment transactions are participating securities which should be included in the computation of EPS using the two-class method. Restricted stock granted under our share-based award plans is considered a participating security because it carries non-forfeitable rights to dividends. The adoption of the guidance did not have a material effect on our consolidated financial statements.





Convertible debt instruments. Effective November 1, 2009, we adopted new authoritative guidance from the Financial Accounting Standards Board (“FASB”) related to the accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlements).  The new guidance applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement of the conversion option. Even though we extinguished our contingent convertible senior notes (“Notes”) by May 2009, we were required to apply the new guidance retrospectively to our previously issued financial statements for the periods in which the Notes were outstanding. The new guidance requires bifurcation of the instrument into a debt component that is initially recorded at fair value and an equity component. The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity. The liability component of the debt instrument is accreted to par using the effective interest rate method; accretion is reported as a non-cash component of interest expense. The equity component is not subsequently re-valued as long as it continues to qualify for equity treatment.





75


We separated the Notes into two accounting components:





1.
a debt component, representing the fair value of the Notes as if they had no conversion rights, and2.
an equity component, representing the difference between the proceeds from the issuance of the Notes and their fair value.





The amount allocated to the equity component was accounted for as debt discount.  We also allocated the transaction costs to the liability and equity components in proportion to the allocation of proceeds and accounted for them as debt issuance costs and equity issuance costs, respectively.  Debt discount and debt issuance costs not allocated to equity were amortized over the period to the first conversion date (5 years) using the effective interest rate method and recorded as interest expense.


76




The effect of the adoption of the new authoritative guidance on our statements of operations, balance sheet and cash flows for all periods presented, is as follows:




AdjustmentsAs previously reported


Convertible Debt


As Revised(In thousands, except per share amounts)INCOME STATEMENTSFor the Year Ended October 31, 2008Interest expense

$
(6,630
)

$
(5,012
)

$
(11,642
)Total other income (expense)


(3,610
)

$
(5,012
)


(8,622
)Gain (loss) on early extinguishment of debt


1,773



(2,208
)


(435
)Income (loss) before tax


(4,456
)


(7,220
)


(11,676
)Income tax provision


6,346



(2,649
)


3,697Net income (loss)


(10,803
)


(4,571
)


(15,374
)Basic EPS

$
(0.27
)

$
(0.11
)

$
(0.38
)Diluted EPS

$
(0.27
)

$
(0.11
)

$
(0.38
)Basic weighted average shares outstanding


40,006



-



40,006Diluted weighted average shares outstanding


40,006



-



40,006For the Year Ended October 31, 2009Interest expense

$
(5,401
)

$
(646
)

$
(6,047
)Total other income (expense)


(3,810
)


(646
)


(4,456
)Gain on early extinguishment of debt


1,961



(120
)


1,841Income before tax


22,826



(766
)


22,060Income tax provision


7,367



(281
)


7,086Net income


15,459



(485
)


14,974Basic EPS

$
0.29


$
(0.01
)

$
0.28Diluted EPS

$
0.29


$
(0.01
)

$
0.28Basic weighted average shares outstanding


53,120



-



53,120Diluted weighted average shares outstanding


53,449



-



53,449BALANCE SHEETAt October 31, 2009Paid-in capital

$
88,977


$
16,117


$
105,094Retained earnings


42,282



(16,117
)


26,165STATEMENTS OF CASH FLOWSFor the Year Ended October 31, 2008OperationsNet income

$
(10,803
)

$
(4,571
)

$
(15,374
)Adjustments:Amortization of debt issuance costs and debt discount


1,339



5,013



6,352Loss (Gain) on early extinguishment of debt


(1,773
)


2,208



435Deferred income taxes


2,893



(1,895
)


998Prepaid income taxes


(3,937
)


(754
)


(4,691
)For the Year Ended October 31, 2009OperationsNet income

$
15,459


$
(485
)

$
14,974Adjustments:Amortization of debt issuance costs and debt discount


1,158



646



1,804Gain on early extinguishment of debt


(1,961
)


120



(1,841
)Deferred income taxes


260



(249
)


11Prepaid income taxes


2,143



(32
)


2,111


Earnings per share, other income (expense) and gain on early extinguishment of debt and income tax footnotes (footnote 9, 12 and 13, respectively) have been revised to reflect the retrospective application of accounting standards adopted beginning on November 1, 2009, related to convertible debt.





77


Other recently issued or adopted accounting standards. In July 2010, the FASB issued new accounting guidance related to credit quality of financing receivables and the allowance for credit losses to address concerns about the sufficiency, transparency, and robustness of credit risk disclosures for financing receivables and the related allowance for credit losses. This guidance is effective for our first quarter of fiscal 2011.  Additionally disclosures will require information at disaggregated levels, designed to enable a better understanding of:





·
The nature of credit risk inherent in our portfolio of financing receivables


·
how credit risk is analyzed to determine the allowance for credit losses


·
changes in and reasons for changes in the allowance for credit looses





The adoption of this guidance is not expected to have a material impact on our financial statements.





As of August 1, 2009, we adopted the new accounting guidance which establishes two levels of GAAP: authoritative and non-authoritative. The FASB Accounting Standards Codification (“ASC”) is now the single source of authoritative nongovernmental GAAP. All other literature is considered non-authoritative. The Company’s adoption of this statement did not have a material effect on the consolidated results of operations, financial position and cash flows, but rather changes the reference used to cite specific FASB accounting literature.





As of November 1, 2009, we adopted the new accounting guidance related to determining the useful life of intangible assets, which amended the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset.This guidance is applied prospectively to intangible assets acquired after November 1, 2009. However, the disclosure requirements must be applied prospectively to all intangible assets recognized in the Company’s financial statements as of November 1, 2009.  The adoption of the guidance did not have a material effect on our consolidated financial statements.





As of November 1, 2009, we adopted new accounting guidance related to business combinations which clarifies the accounting for certain separately identifiable intangible assets which an acquirer does not intend to actively use. This guidance requires an acquirer in a business combination to account for a defensive intangible asset as a separate unit of accounting which should be amortized to expense over the period the asset diminishes in value. Future effects will be dependent upon acquisitions of defensive intangible assets, if any, at that time. In addition, the new guidance requires that an acquiring entity recognize all of the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions, requires the expense of acquisition costs, and also includes a substantial number of new disclosure requirements. The adoption of the guidance did not have a material effect on our consolidated financial statements.





2. SIGNIFICANT TRANSACTIONS





Prime Table Games, LLC.On December 21, 2010, we entered into a License and Release agreement (the “License and Release Agreement”) with Prime Table Games, LLC and related parties (collectively “Prime Table Games”) to settle existing litigation between the parties and to acquire intellectual property licenses related to our PTG segment. For a further discussion of this case, see Note 15. Total consideration paid by us was $5,500. Accordingly, we recorded a legal settlement charge of approximately $2,200 for the year ended October 31, 2010 which represents the fair value associated with the effective settlement of the existing litigation. The remaining $3,300 will be recorded as intangible assets in December 2010.The $3,300 of intangible assets will be amortized on a straight line basis over an approximate 9 year period.





3. FINANCIAL INSTRUMENTS





Fair value disclosures of financial instruments. As discussed in Note 1, we utilize a three level hierarchy that defines the assumptions used to measure certain assets and liabilities at fair value.





Cash and cash equivalents, accounts receivable, the current portion of our investment in sales-type leases and notes receivable are not presented in the table below as their carrying value approximates fair value due to their short term nature.  It is impracticable to estimate the fair value of the long-term portion of our investment in sales-type leases and notes receivable as it is comprised of many insignificant balances, customers with different credit profiles and various interest rates.  The fair value of our Revolver approximates the carrying value as of October 31, 2010 as we closed on the Senior Secured Revolving Credit Facility on October 29, 2010.  The fair values of the Deutsche Bank Senior Secured Credit Facility and Term Loan have been calculated based on market borrowing rates available as of October 31, 2009 for debt with similar terms and maturities.  These market assumptions include a LIBOR-based yield curve, interest rate spread based on our specific risk and an original issue discount. The following table provides the fair value measurement information about the Company’s long-term debt as of October 31, 2010.





78




Carrying Value

Fair Value

Carrying Value

Fair Value

Fair ValueOctober 31, 2010

October 31, 2010

October 31, 2009

October 31, 2009

HierarchyRevolver

$
65,445

$
65,445

$
-

$
-

Level 2Deutsche Bank Senior Secured Credit Facility


-


-


28,000


25,312

Level 2Term Loan


-


-


64,350


62,806

Level 2Total

$
65,445

$
65,445

$
92,350

$
88,118
  4. RECEIVABLES AND INVESTMENTS IN SALES-TYPE LEASES





October 31,2010


2009(In thousands)Accounts receivable, net:Trade receivables

$
41,642


$
37,001Less: allowance for bad debts


(466
)


(630
)Total

$
41,176


$
36,371
  October 31,2010


2009(In thousands)Investment in sales-type leases and notes receivable, net:Minimum sales-type lease payments

$
3,367


$
3,570Notes receivable - table game lifetime licenses


264



998Sub-total sales-type leases and notes receivable


3,631



4,568Less: interest sales-type leases


(217
)


(321
)Less: deferred service revenue


(391
)


(507
)Less: allowance for bad debts


(113
)


(164
)Investment in sales-type leases and notes receivable, net


2,910



3,576Less: current portion sales-type leases


(1,638
)


(1,466
)Less: current portion notes receivable - table game licenses


(168
)


(815
)Long-term portion investment in sales-type leases and notes receivable

$
1,104


$
1,295
 
 We maintain allowances for bad debts for estimated credit losses that result from the inability of our customers to make required payments. The allowances for bad debts are estimated based on historical experience and specific customer collection issues.





Sales-type leases are interest-bearing at fixed market interest rates, require monthly installment payments over periods ranging generally from 24 to 36 months and contain bargain purchase options. Notes receivable include financing arrangements for sales of lifetime licenses. Amounts are interest-bearing at fixed market interest rates and require monthly installments ranging generally from 24 to 36 months.




79


Future minimum lease payments (principal, deferred revenue and interest) to be received for both sales-type leases and notes receivable are as follows:


October 31,2011


2012


2013


Total(In thousands)Investment in sales-type leasesand notes receivable, net:Future sales-type lease payments

$
2,091


$
1,141


$
135


$
3,367Notes receivable - table game licenses


183



57



24



264Sub-total sales-type leasesand notes receivable


2,274



1,198



159



3,631Less: interest sales-type leases


(163
)


(51
)


(3
)


(217
)Less: deferred service revenue


(234
)


(144
)


(13
)


(391
)Less: allowance for bad debts


(71
)


(37
)


(5
)


(113
)Investment in sales-type leasesand notes receivable, net

$
1,806


$
966


$
138


$
2,910


5. OTHER BALANCE SHEET DATA





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




October 31,2010


2009(In thousands)Net inventories:Raw materials and component parts

$
17,322


$
13,668Work-in-process


5,325



4,353Finished goods


4,704



9,618Total

$
27,351


$
27,639
 
 October 31,2010


2009(In thousands)Products leased and held for lease:Utility

$
41,262


$
32,828Less: accumulated depreciation


(24,439
)


(23,649
)Utility, net


16,823



9,179Proprietary Table Games


3,997



2,706Less: accumulated depreciation


(2,059
)


(1,498
)Proprietary Table Games, net


1,938



1,208Electronic Table Systems


25,437



22,258Less: accumulated depreciation


(12,223
)


(8,992
)Electronic Table Systems, net


13,214



13,266Total, net

$
31,975


$
23,653


80




October 31,Useful lives

2010


2009(In years)

(In thousands)Property and equipment:Office furniture and computer equipment
3 - 5

$
10,001


$
9,492Less: accumulated depreciation



(7,085
)


(6,772
)Property and equipment, net



2,916



2,720-Leasehold improvements:
2


6,476



4,751Less: accumulated depreciation



(3,374
)


(3,704
)Leasehold Improvements, net



3,102



1,047-Production equipment and other:
5


12,129



11,219Less: accumulated depreciation



(5,505
)


(5,480
)Production equipment and other, net



6,624



5,739Total, net


$
12,642


$
9,506
 
 October 31,2010


2009(In thousands)Other current assets:Deferred cost of goods sold

$
311


$
2,118Other prepaid expenses


2,483



1,956Other receivables


11,685



1,631Other


490



192Total

$
14,969


$
5,897
  Included in other current assets and other accrued current liability as of October 31, 2010 is an aggregate amount of approximately $11,000 related to the settlement of our Class Action Lawsuits and Shareholder Derivative Suits. In February and May 2010, we entered into settlement agreements to settle the Class Action Lawsuits and Shareholder Derivative Suits for $13,000 and $1,000, respectively. Under our Directors and Officers (“D&O”) insurance policy, the settlement amounts are fully insured and reimbursable; accordingly, we have recorded an insurance receivable in other current assets as we have determined that their recovery under our D&O insurance policy is probable.  As of October 31, 2010, we received approximately $3,000 from our insurers and paid those amounts to the beneficiaries of the Class Action Lawsuit. See Note 15 for more information related to these settlements.




October 31,2010


2009(In thousands)Accrued liabilities and other current liabilities:Accrued interest

$
-


$
155Accrued compensation


13,148



10,137Accrued taxes


1,896



2,083Other accrued liabilities


19,718



4,233Total

$
34,762


$
16,608


As of October 31, 2010, other accrued liabilities consisted primarily of approximately $11,000 related to the settlement of our Class Action Lawsuits and Shareholder Derivative Suits mentioned above, along with professional fees, and consulting fees. As of October 31, 2009, other accrued liabilities consisted primarily of professional fees, legal fees and consulting fees.





6. INTANGIBLE ASSETS AND GOODWILL





Amortizable intangible assets.  All of our recorded intangible assets, excluding goodwill and the Stargames and CARD tradenames, are subject to amortization. We amortize certain of our intangible assets proportionate to the related actual revenue from the utilization of the intangible asset. We believe this method reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. For certain other intangibles, such as covenants not to compete, we amortize on a straight-line basis over their useful lives. Amortization expense was $10,992, $13,571and $14,731 for fiscal 2010, 2009 and 2008, respectively. Amortization expenses are included in cost of leases and royalties and cost of sales and service, except for customer relationships which are included in selling, general and administrative expenses.





81


Amortizable intangible assets are comprised of the following as of October 31:




Weighted Average

October 31,Useful Life

2010


2009(In thousands)Amortizable intangible assets:Patents, games and products
10 years

$
64,344


$
65,345Less: accumulated amortization



(46,925
)


(42,697
)17,419



22,648Customer relationships
10 years


24,299



23,290Less: accumulated amortization



(9,563
)


(6,704
)14,736



16,586Licenses and other
6 years


13,328



12,722Less: accumulated amortization



(4,667
)


(2,934
)8,661



9,788Developed technology
4 years


10,755



9,934Less: accumulated amortization



(10,755
)


(9,313
)-



621Total


$
40,816


$
49,643
 
 Changes in other intangible assets relate primarily to foreign currency translation adjustments.





Estimated amortization expense related to recorded finite lived intangible assets is as follows:




Year ending October 31,

(In thousands)2011

$
8,9422012


7,3262013


5,7872014


4,5842015


4,511Thereafter


9,666$
40,816
 
 Tradenames.  Intangibles with an indefinite life, consisting of the Stargames and CARD tradenames, are not amortized and were $23,328 and $21,695 as of October 31, 2010 and 2009, respectively and are subject to an annual impairment analysis. The changes in balances are only related to foreign currency translation adjustments.





In October 2010, we performed our annual impairment analysis of our indefinite lived Stargames and CARD tradenames.  We utilized the income approach valuation technique to estimate the fair values of the Stargames and CARD tradenames and compared those estimates to related carrying values. The fair values of the tradenames were derived based upon discounted future cash flows dependent on a number of critical management assumptions including estimates of revenue growth, expected economic asset life and hypothetical royalty and discount rates. As of October 31, 2010 and 2009, based upon the results of the analysis, we determined that the implied fair values of the Stargames and CARD tradenames exceeded their carrying values and were not impaired.





Goodwill.  All of our goodwill originated from the acquisitions of foreign subsidiaries and the Progressive Gaming International Corporation (“PGIC”) Table Game Division.  Goodwill has been assigned to our Utility, PTG, ETS and EGM reporting segments. Changes in the carrying amount of goodwill as of October 31, 2010, are as follows:





82




ElectronicActivity by Segment As Of And For The Years




Proprietary


Electronic


GamingEnded October 31,

Utility


Table Games


Table Systems


Machines


Total(In thousands)2009-



-



-



-Goodwill

$
37,194


$
7,373


$
30,337


$
8,162


$
83,066Accumulated impairments


-



-



(22,137
)


-



(22,137
)37,194



7,373



8,200



8,162



60,929Foreign currency translation adjustment


6,941



-



2,931



2,917



12,789Other


-



944



-



-



944$
44,135


$
8,317


$
11,131


$
11,079


$
74,6622010Goodwill

$
44,135


$
8,317


$
33,268


$
11,079


$
96,799Accumulated impairments


-



-



(22,137
)


-



(22,137
)44,135



8,317



11,131



11,079



74,662Foreign currency translation adjustment


(1,820
)


-



920



916



16Other


245



1,009



-



-



1,254$
42,560


$
9,326


$
12,051


$
11,995


$
75,932


We performed our annual goodwill impairment analysis in October 2010.   Impairment assessment inherently involves judgment as to assumptions about expected future cash flows and the impact of market conditions on those assumptions. Future events and changing market conditions may impact our assumptions as to prices, costs, growth rates or other factors that may result in changes in our estimates of future cash flows.  Although we believe the assumptions used in testing for impairment are reasonable, significant changes in any one of our assumptions could produce a significantly different result. Based on our annual goodwill impairment analysis, there were no goodwill impairments as of October 31, 2010 and 2009. We recorded an impairment charge of $22,137 for the year ended October 31, 2008.





Approximately $1,000 of additional goodwill in our PTG segment relates to our acquisition of certain assets from Bet Technology, Inc. (“BTI”) in 2004. In 2004, we recorded an initial estimated liability of $7,616 for contingent installment payments computed as the excess fair value of the acquired assets over the fixed installments and other direct costs. During fiscal 2010, we paid amounts in excess of the remaining liability associated with the contingent consideration originally recorded as part of the acquisition. The excess amount of approximately $1,000 was recorded as an increase to goodwill.





7. DEBT





Debt consisted of the following:




October 31,2010


2009(In thousands)Revolver

$
65,445


$
-Deutsche Bank Senior Secured Credit Facility


-



28,000Term loan facility


-



64,350Other long term debt


817



860Total debt


66,262



93,210Less: current portion


-



(650
)Total long-term debt

$
66,262


$
92,560
 
 Senior Secured Revolving Credit Facility





$200,000 senior secured revolving credit facility. On October 29, 2010, we entered into a new senior secured credit agreement (the “Senior Secured Revolving Credit Facility”) with Wells Fargo Securities, LLC and Banc of America Securities LLC, as joint lead arrangers and joint lead bookrunners, Bank of America, N.A. as syndication agent and Union Bank, N.A. as  documentation agent. The Senior Secured Revolving Credit Facility provides for senior secured credit facilities in an aggregate principal amount of $200,000 consisting of a 5-year revolving credit facility (the “Revolver”) in an aggregate principal amount of $200,000 with a sub-facility for letters of credit of $25,000, a sub-facility for multicurrency borrowings in Euros, Australian dollars and Canadian dollars of $25,000, and a sub-facility for swing line loans of $20,000, each on customary terms and conditions. The Senior Secured Revolving Credit Facility includes an option to increase the Revolver to $300,000 which would require syndication approval.





83


Loans under the Revolver (other than Swing Line Loans, as defined) bear interest based on the Base Rate, as defined or LIBOR, as elected by us. Base Rate interest is calculated at the Base Rate plus the applicable margin and the Base Rate is the highest of (a) the Federal Funds Rate plus .50%, (b) the prime commercial lending rate of the Administrative Agent, as defined and (c) the one month LIBOR rate for such day plus 1.00%. Swing Line Loans bear interest at the Base Rate plus the applicable margin. The initial interest rate will be LIBOR +200bps.





The amount drawn under the Revolver was $65,445 as of October 31, 2010, which was used to repay in its entirety our previous $65,000 term loan and $100,000 revolving credit facility and used to pay fees and expenses in connection with the refinancing. After considering restrictive financial covenants under the Senior Secured Revolving Credit Facility, we had approximately $127,000 of available remaining credit under the Revolver as of October 31, 2010. The Revolver matures on October 29, 2015.





Covenants. Our Senior Secured Revolving Credit Facility contains three financial maintenance covenants requiring us to maintain a Total Leverage Ratio, as defined therein, of not more than 3.75 to 1.0, a Senior Leverage Ratio, as defined therein, of not more than 3.0 to 1.0 until October 31, 2013 and not more than 2.75 to 1.00 after October 31, 2013 and Interest Expense Coverage Ratio, as defined therein, in excess of 3.0 to 1.0 at the end of any fiscal quarter. As of October 31, 2010, Our Total Leverage Ratio, Senior Leverage Ratio and Interest Expense Coverage Ratio were 1.03 to 1.0, 1.02 to 1.0 and 21.55 to 1.0, respectively.





The Senior Secured Revolving Credit Facility also contains customary affirmative and negative covenants for transactions of this nature, including but not limited to restrictions and limitations on the following:





·
Incurrence of indebtedness;





·
Granting of incurrence of liens;





·
Asset dispositions





·
Mergers, acquisitions;





·
Investments;





·
Distributions, redemptions;





·
Change in business;





·
Payments of indebtedness;





·
Adopt or institute pension plan;





·
Transactions with affiliates;





·
Accounting changes;





·
Rate contracts;





·
Amendment of material documents;





·
Restrictive agreements;





·
Joint ventures;





·
Deposit accounts; and





·
Capital expenditures.





Guarantors and collateral. The Revolver obligations under our Senior Secured Revolving Credit Facility are guaranteed by each existing and future wholly-owned domestic subsidiary of ours that is not an immaterial subsidiary and are secured by a first priority lien on substantially all of our and our guarantors’ assets.  If loans are ever made pursuant to our Incremental Facility, such loans would share such collateral equally and ratably with our Revolver.





84


$100,000 senior secured credit facility.On November 30, 2006, we entered into a senior secured credit facility (the “Deutsche Bank Senior Secured Credit Facility”) with Deutsche Bank Trust Company Americas, as a Lender and as the Administrative Agent, Deutsche Bank Securities Inc. and Wells Fargo Bank, N.A., as Joint Lead Arrangers and Book Managers and Wells Fargo Bank, N.A. as Syndication Agent. The Deutsche Bank Senior Secured Credit Facility was satisfied and terminated as of October 31, 2010. As of October 31, 2009 the amount drawn under the Deutsche Bank Senior Secured Credit Facility was $28,000.  The Deutsche Bank Senior Secured Credit Facility consisted of a $100,000 revolving credit facility. Loans under the Deutsche Bank Senior Secured Credit Facility bore interest at a margin over LIBOR or Base Rate, as elected by the Company. The applicable margins fluctuated based on our total leverage ratio from time to time. The Company’s effective interest rates for Deutsche Bank Senior Secured Credit Facility for the years ended October 31, 2010 and 2009 were 3.9% and 2.3%, respectively.





Second Amendment and Term Loan.On July 14, 2008, the Company entered into a second amendment (the “Second Amendment”), to our Deutsche Bank Senior Secured Credit Facility.  Among other things, the Second Amendment provided for a new $65,000 term loan facility (“Term Loan”), which was funded in full on August 25, 2008, resulting in net proceeds of $63,438. The amendment left in place our Deutsche Bank Senior Secured Credit Facility discussed above.  In addition to the Term Loan and Deutsche Bank Senior Secured Credit Facility, the Second Amendment provided a $35,000 incremental facility (the “Incremental Facility”) pursuant to which we could request (but no lender was committed to provide) additional loans under the facility, subject to customary conditions. The Term Loan was satisfied and terminated as of October 31, 2010.





The Term Loan bore interest at 2.75% over the Base Rate or 3.75% over LIBOR, as elected by the Company.  The Term Loan had scheduled amortization payments of 0.25% of the principal every quarter starting with the quarter ending on January 31, 2009.  The mandatory prepayment provisions also required us to prepay the Term Loan (i) up to 75% of our domestic excess cash flow (as defined) or up to 50% of our worldwide excess cash flow (as defined), whichever is less (with step-downs based on total leverage) (the “Excess Cash Flow Payment”); (ii) 100% of the proceeds of certain issuances of debt; and (iii) the proceeds of asset sales or recovery events in excess of $1,500, to the extent not reinvested.





Bet Technology Inc. (“BTI”) liabilities. In connection with our acquisition of certain assets from BTI in February 2004, we recorded an initial estimated liability of $7,616 for contingent installment payments computed as the excess fair value of the acquired assets over the fixed installments and other direct costs.  In November 2004, we began paying monthly note installments based on a percentage of certain revenue from BTI games for a period of up to ten years, not to exceed $12,000. The remaining principal and interest payment of $98 related to our initial estimated liability of $7,616 was paid in February 2009 and therefore no outstanding balance existed as of October 31, 2010 and 2009. As of October 31, 2010, we paid approximately $9,569 of the $12,000 maximum amount since February 2004.





Debt issuance costs. Total debt issuance costs incurred with the issuance of long-term debt are capitalized and amortized as interest expense using the straight-line method which approximates the effective interest method. Amortization of debt issuance costs were $1,037, $1,125 and $1,186 in fiscal 2010, 2009 and 2008, respectively.  The unamortized portion of the debt issuance costs are expected to be recognized over a period of 5.0 years. Debt issuance costs capitalized in conjunction with the Revolver obtained in October 2010 were $2,343. As of October 31, 2009, debt issuance costs related to the refinancing of our Deutsche Bank Senior Secured Credit Facility and our Term Loan were $2,160.





Maturities of Long-Term Debt





Maturities of long-term debt for the five fiscal years ending subsequent to October 31, 2010 are as follows:




October 31,

(In thousands)2011

$
-2012


5172013


-2014


-2015


65,445Thereafter


300$
66,262
 
 85
  8. SHARE-BASED COMPENSATION





Share-based award plans.  In February 2004, our board of directors adopted and, in March 2004, our shareholders approved the Shuffle Master, Inc. 2004 Equity Incentive Plan (the “2004 Plan”) and the Shuffle Master, Inc. 2004 Equity Incentive Plan for Non-Employee Directors (the “2004 Directors’ Plan”). These approved plans replaced our prior plans and no further options may be granted from the prior plans. Both the 2004 Plan and the 2004 Directors’ Plan provide for the grant of stock options, stock appreciation rights (none issued) and restricted stock and restricted stock units, individually or in any combination (collectively referred to as “Awards”). Stock options may not be granted at an exercise price less than the market value of our common stock on the date of grant and may not be subsequently repriced. Equity granted under the 2004 Plan generally vests in equal increments over four years and expires in ten years. Equity granted under the 2004 Directors’ Plan generally vests immediately and expires in ten years, although initial equity grants to directors upon joining the Board can partially vest either immediately and/or partially over one or two years.





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





In January 2009, our board of directors adopted and, in March 2009, our shareholders approved the Shuffle Master, Inc. 2004 Equity Incentive Plan (as amended and restated on January 28, 2009) (the “Amended 2004 Plan”). The Amended 2004 Plan increased the number of shares available for issuance in addition to other related technical changes. Subject to the Amended 2004 Plan, the aggregate number of shares that may be granted under the Amended 2004 Plan shall not exceed 5,200 shares of which no more than 2,590 shares may be granted as restricted stock.





As of October 31, 2010, 2,101 and 332 shares are available for grant under the 2004 Plan and 2004 Directors’ Plan, respectively.





A summary of option activity under shared-based incentive awards for fiscal 2010 is presented below:




WeightedWeighted


AverageAverage


Remaining


AggregateExercise


Contractual


IntrinsicShares


Price


Term


Value(In thousands, except per share amount)Outstanding at November 1, 2009


4,365


$
14.56Granted


707



7.60Exercised


(73
)


6.51Forfeited or expired


(159
)


17.80Outstanding at October 31, 2010


4,840


$
13.56



5.7


$
7,690Fully vested and expected to vest at October 31, 2010


4,810


$
13.60



5.7


$
7,615Exercisable at October 31, 2010


3,402


$
14.77



4.7


$
4,734


The weighted average grant date fair value of stock options granted during the years ended October 31, 2010, 2009 and 2008, was $4.11, $2.21 and $3.80, respectively. The total intrinsic value of the stock options exercised for the years ended October 31, 2010, 2009 and 2008, was $180, $0 and $0, respectively.





During fiscal 2010, 73 shares were exercised. The tax effect/benefit from stock option exercises affected our deferred tax asset or income tax payable as well as our additional paid-in capital by an equal amount and had no effect on our income tax provision.  In fiscal 2009, there were no stock options exercised and therefore no related income tax benefit. As of October 31, 2010, there was a total of $2,760 of unamortized compensation related to stock options, which expense is expected to be recognized over a weighted-average period of 1.4 years.





During the fiscal years ended 2010, 2009 and 2008, we granted 707, 1,155 and 655 stock options, respectively, with a grant date fair value of $2,907, $2,549 and $2,485, respectively. Included in fiscal 2009 grants is inducement grants of 360 stock options granted to our Chief Executive Officer and Chief Financial Officer. These inducement awards were granted in reliance on The NASDAQ Stock Market Rule 435(i)(1)(A)(iv).




86








WeightedAverage


Remaining


AggregateGrant-Date


Vesting


IntrinsicShares


Fair Value


Period


Value(In thousands, except per share amount)Nonvested at November 1, 2009


442


$
19.55Granted


68



7.75Vested


(101
)


24.09Forfeited


(53
)


19.87Nonvested at October 31, 2010


356


$
16.25



0.88


$
3,348Expected to vest


351


$
16.37



0.86


$
3,305


During the fiscal years ended 2010, 2009 and 2008, we issued 68, 121 and 59 shares of restricted stock, respectively, with an aggregate fair value of $527, $526 and $686, respectively. The weighted average grant date fair value of nonvested shares granted during the years ended October 31, 2009 and 2008 was $19.55 and $24.15, respectively. The total value of each restricted stock grant, based on the fair market value of the stock on the date of grant, is amortized to compensation expense over the related vesting period.





As of October 31, 2010, there was $703 of unamortized compensation expense related to restricted stock, which is expected to be recognized over a weighted-average period of 1.2 years.





Recognition of compensation expense.  The following table shows information about compensation costs recognized for the years ended October 31:




Year Ended October 31,2010


2009


2008(In thousands)Compensation costs:Stock options

$
3,080


$
2,909


$
1,577Restricted stock


889



3,571



2,612Total compensation cost

$
3,969


$
6,480


$
4,189Related tax benefit

$
(1,285
)

$
(2,206
)

$
(1,131
)


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




Year Ended October 31,2010


2009


2008(In thousands)Cost of sales

$
63


$
32


$
25Selling, general and administrative


3,236



6,018



3,770Research and development


670



430



394Total share-based compensation

$
3,969


$
6,480


$
4,189


Option valuation models require the input of certain assumptions and changes in assumptions used can materially affect the fair value estimate. Expected volatility and dividends are based on historical factors related to our common stock. Expected term represents the estimated weighted-average time between grant and employee exercise. Risk free interest rate is based on U.S. Treasury rates appropriate for the expected term.





87


We estimate the fair value of each stock option award on the grant date using the Black-Scholes valuation model incorporating the weighted-average assumptions noted in the following table:




Year ended October 31,2010


2009


2008Option valuation assumptions:Expected dividend yield

None


None


NoneExpected volatility

67.7%


68.9%


47.1%Risk-free interest rate

2.1%


1.7%


3.0%Expected term

4.4 years


4.4 years


4.2 years
 
 9. EARNINGS PER SHARE





Shares used to compute basic and diluted earnings per share from continuing operations for the years ended October 31 are as follows:


Year Ended October 31,2010


2009


2008(In thousands, except per share amount)Net income available to common shares (1)

$
23,083


$
14,974


$
(15,373
)Basic:Weighted average shares


53,258



53,120



40,006Diluted:Weighted average shares, basic


53,258



53,120



40,006Dilutive effect of options and restricted stock


941



329



-Weighted average shares, diluted


54,199



53,449



40,006Basic and diluted earnings (loss) per share

$
0.43


$
0.28


$
(0.38
)Weighted average anti-dilutive shares excluded

from diluted EPS


3,237



5,432



16,292


(1) Net income available to participating securities was not significant.





10. SHAREHOLDERS’ EQUITY





Common stock repurchases.Our board of directors periodically authorizes us to repurchase shares of our common stock. However, we generally prioritize bank debt reduction over share repurchases. As of October 31, 2010, $21,077 remained outstanding under our board authorization. We cancel shares that are repurchased.





The timing of our common stock repurchases pursuant to our board of directors’ authorization is dependent on future opportunities and on our views, as they may change from time to time, as to the most prudent uses of our capital resources, including cash and borrowing capacity.





Tax effect from stock option exercises.  For fiscal 2010, the tax effect/benefit from stock option exercises affected our deferred tax asset or income tax payable as well as our additional paid-in capital by an equal amount and had no effect on our income tax provision. For fiscal 2009 and 2008, there were no income tax benefits from stock options exercised.





11. EMPLOYEE BENEFIT PLANS





U.S. defined contribution plan.  We sponsor a defined contribution plan, which qualifies under Section 401(k) of the Internal Revenue Code and covers United States employees who meet certain age and service requirements. We may make matching contributions to the plan based on a percentage of employee compensation and actual contributions. For fiscal 2010, 2009 and 2008, we elected to make matching contributions of 50% of employee contributions up to 6% of compensation, totaling $531, $473 and $430, respectively.





Austrian pension commitments. In April and May 2004, we formalized our defined contribution pension agreements with certain Austrian employees. We pay contributions to an external pension fund administered by ÖPAG Pensionskassen AG. Aggregate pension expense relating to our Austrian agreements for fiscal 2010, 2009 and 2008 were $74, $80 and $98, respectively.





88





12. OTHER INCOME (EXPENSE) AND GAIN ON EARLY EXTINGUISHMENT OF DEBT





Year Ended October 31,2010


2009


2008(In thousands)Other income (expense):Interest income


577



860



1,759Interest expense


(4,015
)


(6,047
)


(11,642
)Other, net


282



731



1,261Total other income (expense)

$
(3,156
)

$
(4,456
)

$
(8,622
)Gain (loss) on early extinguishment of debt

$
(1,123
)

$
1,841


$
(435
)
 
 Interest income relates primarily to our investment in sales-type leases, notes receivable portfolio and cash on hand. Interest expense for fiscal 2010 and 2009 primarily relates to interest on our Deutsche Bank Senior Secured Credit Facility and Term Loan.  Interest expense for fiscal 2008 primarily related to interest on our Deutsche Bank Senior Secured Credit Facility, Term Loan and contingent convertible senior notes (“Notes”) which were extinguished during the third quarter 2009.  For fiscal 2010, amortization of debt issuance costs of $1,037 related to our Deutsche Bank Senior Secured Credit Facility and for fiscal 2009, amortization of debt issue costs of $1,125 related to Deutsche Bank Senior Secured Credit Facility and our Term Loan.  For fiscal 2008, amortization of debt issue costs of $1,186 related to Deutsche Bank Senior Secured Credit Facility, our Term Loan and our Notes.





Other, net primarily relates to foreign currency gains or losses caused by fluctuations of the U.S. dollar, the Euro and the Australian dollar. Net foreign currency gains of $288, $825 and $2,655 were recognized in fiscal 2010, 2009 and 2008, respectively. Our foreign subsidiaries engage in activities with us and certain customers in U.S. dollar and other foreign denominated contracts.





Loss on early extinguishment of debt for fiscal 2010 consisted of debt issuance costs of $1,123 related to Deutsche Bank Senior Secured Credit Facility were charged off when the underlying facility was terminated.





Gain on early extinguishment of debt for fiscal 2009 related to agreements entered into with PGIC/IGT of $1,798 and the gain realized from the early extinguishment of our Notes of $43. We wrote-off the net book value of approximately $160 related to the covenants not to compete between us and PGIC. In addition, the prepaid royalty related to the SDLA was re-characterized as a lifetime license to be amortized over a 10 year life. The acquired SMI Patents were fair valued at $520.  The remaining discounted minimum consideration due under the Purchase Agreement of approximately $2,247 was relieved resulting in a net gain on early extinguishment of $1,798.





Loss on early extinguishment of debt for fiscal 2008 related to the loss realized from the early extinguishment of our Notes as a result of the Tender Offer. On July 14, 2008, the Company purchased $89,350 in aggregate principal amount of our outstanding Notes at 97.25% of the principal amount thereof plus accrued and unpaid interest. On September 29, 2008, the Company repurchased an additional $20,384 of our Notes in a separate transaction on the open market resulting in a total loss of $435, inclusive of external fee and direct costs associated with the cash tender offer for our Notes, for fiscal 2008.





13. INCOME TAXES





The following is a summary of income (loss) before taxes of U.S. and foreign operations for the fiscal years ended October 31:




Year Ended October 31,2010


2009


2008(In thousands)US

$
19,060


$
19,007


$
9,932Foreign


12,003



3,053



(21,608
)Total


31,063



22,060



(11,676
)
 89
 The components of the provision (benefit) for income taxes from continuing operations were as follows for the years ended October 31:
 Year Ended October 31,2010


2009


2008(In thousands)Current:Federal

$
1,529


$
6,590


$
5,982State


1,062



1,157



726Foreign


960



567



4733,551



8,314



7,181Deferred:Federal


2,304



(2,254
)


(4,009
)State


(84
)


(67
)


(272
)Foreign


2,209



1,093



7974,429



(1,228
)


(3,484
)Total

$
7,980


$
7,086


$
3,697
 The provision for income taxes differs from the amount computed using the statutory United States Federal income tax rate as follows for the fiscal years ended October 31:




Year Ended October 31,2010


2009


2008Federal income tax at the statutory rate


35.0
%


35.0
%


(35.0
%)State income taxes, net of federal benefits


2.3
%


1.9
%


1.8
%Foreign and U.S. tax rate differential


(2.8
%)


1.2
%


10.5
%Goodwill impairment


0.0
%


0.0
%


56.9
%Interest expense


(3.1
%)


(3.8
%)


(8.3
%)Domestic production activities


(0.6
%)


(1.5
%)


(3.5
%)Foreign dividend inclusion


0.0
%


2.1
%


3.9
%Tax credits


(5.5
%)


(6.6
%)


(9.0
%)Withholding tax


2.7
%


2.7
%


3.9
%Change in valuation allowance


(0.8
%)


0.2
%


5.1
%Change in liability for uncertain tax positions


(2.8
%)


(0.5
%)


1.8
%Other


1.3
%


1.4
%


3.6
%Effective tax rate


25.7
%


32.1
%


31.7
%





90





Deferred tax assets and liabilities consisted of the following as of October 31:




Year Ended October 31,2010


2009(In thousands)Deferred tax assets:Inventories

$
2,358


$
3,040Employee benefits


2,366



2,096Stock-based compensation


5,301



5,242Fixed assets


1,498



-Foreign net operating loss carryforward


6,917



8,036Intangible assets


4,883



6,125Other


3,223



4,612Total gross deferred tax assets


26,546



29,151Less: valuation allowance


(1,526
)


(1,869
)Deferred tax assets


25,020



27,282Deferred tax liabilities:Intangible assets


5,668



5,307Inventories


1,071



692Fixed assets


4,435



2,786Employee benefits


820



-Other


598



2,508Total gross deferred tax liabilities


12,592



11,293Net deferred tax assets

$
12,428


$
15,989
 
 We have income tax net operating loss carryforwards related to our international operations of approximately $25,518 which have an indefinite life.  As of October 31, 2010 and 2009 there were valuation allowances of $1,526 and $1,869, respectively, provided on foreign net operating loss carryforwards and other foreign deferred tax assets, as the Company believes these assets do not meet the “more likely than not” criteria for recognition.





We have estimated foreign tax credit carryforwards of $301 for U.S. Federal income tax purposes.  The United States foreign tax credit carryforward will begin to expire in 2020.  We believe that it is more likely than not that the benefit from this foreign tax credit carryforward will be realized within the carryforward period.




We have not provided U.S. Federal income tax on $16,000 of undistributed earnings of our foreign subsidiaries.  We intend to permanently reinvest such earnings outside the United States.  Upon distribution of these earnings in the form of dividends or capital gains, we would be subject to U.S. income tax net of applicable foreign tax credits. In addition, such distributions would be subject to withholding taxes in the various tax jurisdictions.  Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation.





A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:




Year Ended October 31,2010


2009


2008(In thousands)Balance at beginning of year

$
1,322


$
1,484



1,334Increases related to prior year tax positions


631



18



24Decreases related to prior year tax positions


-



(22
)


-Increases related to current year tax positions


54



100



126Reductions for settlements with taxing authorities


-



(258
)


-Reductions due to lapse of statutes of limitations


(883
)


-



-Balance at year end

$
1,124


$
1,322


$
1,484


The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $494 and $1,322 as of October 31, 2010 and 2009, respectively. No significant increases or decreases in unrecognized tax benefit are expected within the next 12 months.





91


We have a policy of recognizing interest and penalties related to unrecognized tax benefits within the income tax expense line in the consolidated statement of operations and within the related tax liability line in the consolidated balance sheet. For the years ended October 31, 2010 and 2009, we recognized a benefit of $107 and $26, respectively, related to interest and penalties in our consolidated statement of operations.  Our total accrued interest and penalties as of October 31, 2010 and 2009 is $122 and $229, respectively.





We filed numerous consolidated and separate income tax returns in the United States federal jurisdiction and in many state and foreign jurisdictions.  With few exceptions, we are no longer subject to United States federal, state and local, or foreign income tax examinations for years before 2005.





14. OPERATING SEGMENTS





We report segment information based on the “management approach.” The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments.





We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor. Our products primarily relate to our casino customers’ table game activities and focus on either increasing their profitability, productivity and security or expanding their gaming entertainment offerings in the form of electronic table games or electronic slot machines. Our business is segregated into the following four operating segments: Utility, Proprietary Table Games (“PTG”), Electronic Table Systems (“ETS”) and Electronic Gaming Machines (“EGM”).





See Note 1 for a detailed discussion of our four segments. Each segment’s activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of its product lines. We evaluate the performance of our operating segments based on net revenues, gross margin and operating income.





Segment revenues include leasing, licensing, or selling of products within each reportable segment. Segment operating income (loss) includes net revenues attributable to third parties and expenses directly and indirectly associated with the product lines included in each segment. Our direct expenses primarily include cost of products sold, depreciation of leased assets, amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation.  Indirect operating expenses include other costs directly identified with each segment, such as research and development, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses.  Capital expenditures include amounts reported in our consolidated statements of cash flows for purchases of leased products, property and equipment and intangible assets plus the financed or non-cash portion of these purchases which is excluded from cash flows.





Operating income (loss) for each segment excludes other income and expense, income taxes and certain expenses that are managed outside of the operating segments. The amounts classified as unallocated corporate expenses consist primarily of costs related to overall corporate management and support functions. These include costs related to executive management, accounting and finance, general sales support, legal and compliance costs, office expenses and other amounts for which allocation to specific segments is not practicable. Segment assets exclude corporate assets.


92




The following provides financial information concerning our reportable segments of our continuing operations for the years ended October 31:


Year Ended October31,2010


2009


2008(In thousands)Revenue:Utility

$
77,357


$
71,707


$
80,893Proprietary Table Games


40,430



38,697



38,594Electronic Table Systems


42,398



22,342



27,461Electronic Gaming Machines


41,117



46,598



42,898Unallocated Corporate


-



83



160$
201,302


$
179,427


$
190,006Gross profit (loss):Utility

$
47,024


$
40,513


$
46,097Proprietary Table Games


32,356



32,079



31,983Electronic Table Systems


21,580



9,430



13,068Electronic Gaming Machines


23,010



23,643



19,662Unallocated Corporate


-



6



92$
123,970


$
105,671


$
110,902Operating income (loss):Utility

$
40,233


$
32,742


$
36,078Proprietary Table Games


27,880



29,035



28,957Electronic Table Systems


11,802



3,427



(16,105
)Electronic Gaming Machines


14,690



16,529



11,693Unallocated Corporate


(59,263
)


(57,058
)


(61,682
)$
35,342


$
24,675


$
(1,059
)Depreciation and amortization:Utility

$
7,924


$
8,997


$
9,497Proprietary Table Games


6,390



4,836



4,310Electronic Table Systems


5,599



6,715



6,335Electronic Gaming Machines


144



840



1,422Unallocated Corporate


2,811



2,127



1,876$
22,868


$
23,515


$
23,440Capital expenditures:Utility

$
12,426


$
6,889


$
6,699Proprietary Table Games


1,492



1,469



1,338Electronic Table Systems


8,470



7,836



6,860Electronic Gaming Machines


-



24



691Unallocated Corporate


5,265



1,415



1,838$
27,653


$
17,633


$
17,426Assets, end of year:Utility

$
109,549


$
113,994


$
105,472Proprietary Table Games


52,667



52,722



47,281Electronic Table Systems


71,081



51,003



48,752Electronic Gaming Machines


37,773



41,468



26,170Unallocated Corporate


32,890



26,282



34,255$
303,960


$
285,469


$
261,930
 
 Certain information for the years ended October 31, 2009 and 2008, above has been reclassified to conform to the current presentation.


93


REVENUE BY GEOGRAPHIC AREA





Revenues by geographic area are determined based on the location of our customers. For fiscal 2010, 2009 and 2008, sales to customers outside the United States accounted for 51%, 50% and 53% of consolidated revenue, respectively. No individual customer accounted for more than 10% of consolidated revenue.





The following provides financial information concerning our operations by geographic area for the years ended October 31:





Year Ended October 31,2010


2009


2008(In thousands)Revenue:United States

$
98,886



49.1
%

$
89,073



49.7
%

$
90,292



47.5
%Canada


8,032



4.0
%


9,754



5.5
%


7,298



3.8
%Other North America


3,443



1.7
%


3,458



1.9
%


2,235



1.2
%Europe


9,114



4.5
%


7,751



4.3
%


14,631



7.7
%Australia


61,801



30.7
%


56,767



31.6
%


57,692



30.4
%Asia


17,930



9.0
%


10,251



5.7
%


11,761



6.2
%Other


2,096



1.0
%


2,373



1.3
%


6,097



3.2
%$
201,302



100.0
%

$
179,427



100.0
%

$
190,006



100.0
%Long-lived assets, end of year:United States

$
35,942



73.6
%

$
28,805



76.8
%

$
38,176



85.9
%Austria


2,954



6.0
%


1,225



3.3
%


1,004



2.3
%Australia


7,847



16.0
%


5,853



15.6
%


4,791



10.8
%Other


2,151



4.4
%


1,614



4.3
%


465



1.0
%$
48,894



100.0
%

$
37,497



100.0
%

$
44,436



100.0
%
 
 Long-lived assets for fiscal 2010 exclude deferred income taxes, goodwill and other intangible assets and fiscal 2009 and 2008 information above have been revised to conform to the current presentation. The 2009 and 2008 schedules previously included deferred income taxes, goodwill and other intangible assets of $43,796 and $37,286, respectively, for the Americas, $46,687 and $45,084, respectively, for Austria, $58,866 and $47,936, respectively, for Australia and $6,065 and $6,789, respectively, for other geographic locations.





15. COMMITMENTS AND CONTINGENCIES





Operating leases.We lease office, production, warehouse and service facilities, office equipment and service vans under operating leases. The facility leases are for periods ranging from one to ten years, include renewal options and include an allocation of real estate taxes and other operating expenses. Total rent expense under operating leases was $2,598, $2,570 and $2,389 for fiscal 2010, 2009 and 2008, respectively.





Estimated future minimum lease payments under operating leases subsequent to October 31, 2010 are as follows:




October 31,

(In thousands)2011


2,4402012


2,0022013


1,0942014


5022015


296Thereafter


242$
6,576


Employment agreements.We have entered into employment contracts with our Corporate Officers and certain other key employees with durations ranging from one to three years. Significant contract provisions include minimum annual base salaries, healthcare benefits, bonus compensation if performance measures are achieved and non-compete provisions. These contracts are primarily “at will” employment agreements, under which the employee or we may terminate employment. If we terminate any of these employees without cause, we are obligated to pay the employee severance benefits as specified in their individual contract. As of October 31, 2010 and 2009, minimum aggregate severance benefits totaled $5,670 and $6,063, respectively.





94


Severance obligations.Related to the departure of several senior executives as well as the passing of our former CEO, we have incurred severance costs of $2,631 for the year ended October 31, 2010. The $2,631 severance costs were comprised of $816 of accelerated stock compensation expense and $1,815 of cash salary and related benefits and are expected to be paid out over a three-year period. For the years ended October 31, 2009 and 2008, we incurred severance costs of $6,838 and $1,023, respectively.





Legal proceedings. In the ordinary course of business, we are involved in various legal proceedings and other matters that are complex in nature and have outcomes that are difficult to predict.  We record accruals for such contingencies to the extent that we conclude that it is probable that a loss has been incurred and the amount of the related loss can be reasonably estimated.  Our assessment of each matter may change based on future unexpected events.  An unexpected adverse judgment in any pending litigation could cause a material impact on our business operations, intellectual property, results of operations or financial position.  Unless otherwise expressly stated, we believe costs associated with litigation will not have a material impact on our financial position or liquidity, 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 as may be required by applicable law, statute or regulation.





GEI– In July 2004, we filed a patent infringement lawsuit against Gaming Entertainment, Inc. (“GEI”) and Yehia Awada (“Awada”) in the U.S. District Court for the District of Nevada, in Las Vegas, Nevada.  The lawsuit alleges that GEI/Awada's 3-5-7 PokerTMgame infringes one of our Three Card PokerTM patents and one of our Let-It-Ride®patents.  We were seeking a permanent injunction and an undetermined amount of damages at that time against GEI/Awada.





On March 6, 2008, the Court ordered the Clerk to enter default against GEI/Awada, which default was entered on that same date.  In accordance with the Court's order of March 6, 2008, we sought appropriate damages, an injunction and costs to be included in a default judgment.  On June 13, 2008, the Court issued a Default Judgment against Awada and GEI for $792 and also issued a permanent injunction against their 3-5-7 Poker game, which judgment was entered on July 8, 2008. The judgment is still outstanding. There is no assurance of collectability of this judgment.





In August 2008, we started certain proceedings to collect the judgment for $792 entered on July 8, 2008, including but not limited to, a lawsuit filed in the Eighth Judicial District Court, Clark County, Nevada, related to the fraudulent transfer of certain intellectual property assets by Awada/GEI.   The Court entered an order on August 11, 2008, that in part required GEI/Awada to remove all 3-5-7 Poker games by August 12, 2008, with which they complied, on a later date, to the best of our knowledge.





On October 29, 2009, Awada filed for bankruptcy which stays all collection activities against him, including those concerning our judgment.





On November 24, 2009, GEI joined Awada in filing for bankruptcy protection, and thus all collection activities with respect to our judgment against both GEI and Awada were stayed at that time.





On August 16, 2010, the bankruptcy court dismissed Awada’s bankruptcy case.  Collection efforts with respect to our judgment against Awada may be conducted after the dismissal.  The stay remains in effect as to GEI.





Class Action Lawsuits –





a.  Stocke—On June 1, 2007, a putative class action complaint for violation of the federal securities laws against the Company and our then Chief Executive Officer, Mark L. Yoseloff and  our then Chief Financial Officer, Richard L. Baldwin, was filed in the U.S. District Court for the District of Nevada on behalf of persons who purportedly purchased our stock between December 22, 2006 and March 12, 2007.  The case is entitled Joseph Stocke vs. Shuffle Master, Inc., Mark L. Yoseloff and Richard L. Baldwin.  The complaint asserts claims pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder.  These claims allegedly relate to our March 12, 2007, announcement that we would restate our fiscal fourth quarter and full year financial results.  The complaint sought compensatory damages in an unstated amount.  On or about August 4, 2007, four plaintiffs moved the Court for appointment as lead plaintiff.





b.  Armistead—On June 12, 2007, a second putative class action complaint for violation of the federal securities laws against the Company and Dr. Yoseloff and Mr. Baldwin was filed in the U.S. District Court for the District of Nevada.  The case is entitled Robert Armistead, Jr. vs. Shuffle Master, Inc., Mark L. Yoseloff and Richard L. Baldwin.  This lawsuit effectively mirrors the allegations in the Stocke lawsuit filed against these same defendants on June 1, 2007, except that the Armistead complaint was filed on behalf of persons who purchased our stock between March 20, 2006 and March 12, 2007.


95


c.  Tempel—On June 25, 2007, a third putative class action complaint for violation of the federal securities laws against the Company, Dr. Yoseloff and Mr. Baldwin was filed in the U.S. District Court for the District of Nevada.  The case is entitled Andrew J. Tempel vs. Shuffle Master, Inc., Mark L. Yoseloff and Richard L. Baldwin. This lawsuit is a “copycat” lawsuit of the Stocke lawsuit filed against these same defendants on June 1, 2007.





d.  Consolidated case of a - c above.





On June 22, 2007, a Joint Stipulation was filed in the U.S. District Court for the District of Nevada providing that all presently filed and any subsequently filed related class actions shall be consolidated and captioned In Re Shuffle Master, Inc. Securities Litigation.  We were not required to answer, move against or otherwise respond to any class action complaints until a consolidated complaint was filed.





On November 30, 2007, the Court appointed the “Shuffle Master Institutional Investor Group,” consisting of the Tulsa Municipal Employees' Retirement Plan and the Oklahoma Firefighters Pension and Retirement System, as lead plaintiffs.  Grant & Eisenhofer was the lead plaintiffs' counsel.





A Consolidated Amended Class Action Complaint (“Consolidated Complaint”) was filed on February 5, 2008.  The Consolidated Complaint asserted the same causes of action for violation of federal securities law as the initial lawsuits and applies to a class period of February 1, 2006 to March 12, 2007.  The Consolidated Complaint contained essentially the same material allegations as in the initial lawsuits and also contains allegations arising out of the Company's acquisition of Stargames and disclosures concerning the Company's internal controls.  This Consolidated Complaint superseded all previously filed lawsuits covering this class period.  On March 25, 2008, defendants filed a Motion to Dismiss.  On March 23, 2009, the Court denied our Motion to Dismiss.  The defendants answered on April 29, 2009.





On February 2, 2010, the lead plaintiffs filed a Motion for Preliminary Approval of Settlement.  The Motion was granted on February 4, 2010, and the Court set a hearing in May 2010, subsequently rescheduled to June 8, 2010, where the Court was to decide whether to give final approval for the settlement.  Our D&O insurance carriers escrowed the monetary settlement in full, equal to $13,000, subject to final court approval of the settlement, which, when obtained, was to be paid to plaintiffs in full by our D&O insurance carriers, accordingly, we have recorded an insurance receivable in other current assets of $10,000 and accrued for the settlement of $10,000 in other accrued current liabilities as of October 31, 2010, of which approximately $3,000 was received from our insurers and paid to the beneficiaries of the Class Action Lawsuit during July 2010. See Note 4 for more information.





At the June 8, 2010 hearing, the Court gave its final approval to this settlement.  On June 9, 2010, the Court entered an order and final judgment concluding the matter. No appeal has been filed from the order and final judgment.  We consider the matters to be materially concluded.





Shareholder Derivative Suits –





a.  Shareholder Derivative Lawsuit I (“Pirelli”) – On September 7, 2007, Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust filed a shareholder derivative complaint in the U.S. District Court for the District of Nevada against our then CEO, Mark Yoseloff, our then President, Paul Meyer, our then CFO, Richard Baldwin, our then General Counsel, Jerome R. Smith and the then current members of our Board of Directors.  The Company was also named as a nominal defendant.  On September 24, 2007, plaintiffs voluntarily dismissed Mr. Smith from the case without prejudice.  The complaint, on behalf of the Company, alleged breach of fiduciary duty and related causes of action against the defendants.  The allegations generally related to the restatement of the Company's fiscal 2006 annual results and our acquisition of Stargames and were very similar to the allegations in the class action lawsuits, discussed above.  The complaint sought an unspecified amount of damages.





A consolidated amended complaint was filed on October 2, 2009, and a corrected version thereof was filed on October 26, 2009.  The Special Demand Review Committee of the Board of Directors of Nominal Defendant Shuffle Master, Inc. filed a Motion to Dismiss in the consolidated Pirelli case on November 2, 2009.  This Motion has not been ruled upon.   As discussed in item c. below, in May 2010 the parties agreed in principle to a settlement of all derivative litigation, including this action, which settlement was embodied in a Stipulation of Settlement on July 29, 2010 and filed within the State Derivative Lawsuit (described below).  If the settlement is finally approved by the state court, the Pirelli case and all federal and state derivative litigation will be dismissed with prejudice.  The terms of the settlement are described more fully below.





b.  Shareholder Derivative Lawsuit II—On September 17, 2007, Chad Hodgkins filed a shareholder derivative complaint against our then CEO, Mark Yoseloff, our  then CFO, Richard Baldwin, former Board of Directors member Todd Jordan and current Board of Directors members Mr. Saunders and Mr. Castle.  The Company was also named as a nominal defendant.  The complaint was filed in the U.S. District Court for the District of Nevada.  The complaint, on behalf of the Company, alleged breach of fiduciary duty and related causes of action against the defendants.  The allegations generally related to the restatement of the Company's fiscal 2006 annual results and our acquisition of Stargames and were very similar to the allegations in the three class action lawsuits and the Pirelli case described above.  The complaint sought an unspecified amount of damages.


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On October 24, 2007, the Court approved a stipulation to transfer the Hodgkins case to Judge Dawson, who had already been assigned the Pirelli case.  On November 9, 2007, the Court ordered the Hodgkins case to be consolidated into the Pirelli case.





Additionally, any future federal court derivative actions alleging similar facts and legal theories will be consolidated into the Pirelli case.





c.  Shareholder Derivative Lawsuit III (the “State Derivative Lawsuit”)





On November 9, 2009, Gerard Denham, derivatively on behalf of Nominal Defendant Shuffle Master, Inc., filed a lawsuit in the Eighth Judicial District Court, Clark County, Nevada, against the following defendants:  Mark L. Yoseloff, Richard L. Baldwin, Garry W. Saunders, Louis Castle, Phillip Peckman, John Bailey, Todd D. Jordan, Ken Robson, William Warner and Nominal Defendant, Shuffle Master, Inc.  The claims in this case were substantively similar to Shareholder Derivative Lawsuits I and II discussed above.  Defendant Yoseloff is our former CEO.  Defendant Baldwin is our former CFO.  Defendants Saunders, Castle and Bailey are current members of our Board of Directors.  Defendants Jordan, Robson, Warner and Peckman are former members of our Board of Directors.  The claims stemmed from a demand made by the plaintiff on our Board of Directors in July 2007 and the September 2009 rejection of the demand in a letter by a Special Demand Review Committee created by our Board.  The complaint contains the following claims against all defendants:





1.
Breach of fiduciary duties for disseminating false and misleading statements2.
Breach of fiduciary duties for failing to maintain internal controls3.
Unjust enrichment4.
Abuse of control5.
Gross mismanagement





On December 21, 2009, a Special Demand Review Committee of the Company’s Board filed a motion to dismiss the State Derivative Lawsuit based upon its investigation and business judgment.





In May 2010, the parties, including the federal derivative plaintiffs, agreed upon a settlement in principle, subject to documentation and  state court approval with the following material terms if the settlement is approved:  (i) Shareholder Derivative Lawsuits I and II were to be dismissed with prejudice and all defendants released; (ii) we have made and will make certain corporate governance changes;  (iii) we continue to deny any wrongdoing; and (iv) we will not be paying any amounts  to the parties in the settlement, but a payment of the plaintiffs' attorneys' fees of $1,000 was made by our D&O insurance carriers on or about September 9, 2010.   Accordingly, we have recorded an insurance receivable in other current assets of $1,000 and accrued for the settlement of $1,000 in other accrued current liabilities as of October 31, 2010. See Note 4 for more information.





On or about May 25, 2010, pursuant to stipulation between the parties, Defendant Phillip Peckman and Defendant John Bailey were ordered by the Court to be dismissed from the case without prejudice.





On July 29, 2010, a Stipulation of Settlement reflecting the above terms of the settlement was filed by all parties.  On July 29, 2010, the Plaintiff filed a Motion for Order Preliminarily approving Derivative Settlement and Providing for Notice. The Motion was set for hearing on September 2, 2010.  The Motion also concerns Shareholder Derivative Lawsuits I and II.  The settlement that we sought to have approved was materially the same as the settlement in principle which was reached in May of 2010.





During the September 2, 2010 hearing, the Court preliminarily approved the settlement terms.  The Court set a hearing for October 26, 2010 to hear any objections to the proposed settlement and to decide whether to finally approve the settlement.On October 27, 2010, an order by the Court was filed finally approving the settlement.  The time to file an appeal of this order approving the settlement expired on November 30, 2010 without any appeal being filed.  Other than our compliance with the terms of the settlement, the Shareholder Derivative Lawsuit III is concluded.  Shareholder Derivative Lawsuits I and II were dismissed by the Court on December 16, 2010.


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Prime Table Games, et al. vs. Shuffle Master –





On August 25, 2008, Prime Table Games LLC, Derek Webb, Hannah O’Donnell and Prime Table Games UK (collectively, “Prime Table”) filed suit against the Company in the United States District Court for the Southern District of Mississippi.  The complaint primarily involves our Three Card Poker game and alleges that certain conduct of the Company constituted a violation of various federal antitrust laws and also asserts related claims.  Other claims included the following (some of which were related to Three Card Poker and others related to other games):  breach of contract (including certain equitable claims), breach of the duty of good faith and fair dealing, patent infringement, patent misuse and unfair trade practices.  Prime Table was seeking in excess of $15,000 in damages, plus various equitable remedies, including without limitation, rescission or reformation of the non-competition and first right of refusal provisions of our Three Card Poker purchase agreement with plaintiffs and a ruling that the Three Card Poker patents are unenforceable.





On August 29, 2008 and October 22, 2008, respectively, Prime Table filed amended complaints.  The amended complaints did not materially modify the allegations made in the complaint referenced above and filed on August 25, 2008.





On October 24, 2008, we filed a Motion to Transfer Venue pursuant to 28 U.S.C. § 1404(a).  The Motion asked the Court to transfer venue to the United States District Court for the District of Nevada, Southern Division.   On November 17, 2008, we filed a Motion to Dismiss several of Prime Table’s causes of action pursuant to Federal Rule of Civil Procedure 12(b)(6).  The Motion asked the Court to dismiss certain counts of the Second Amended Complaint, which included most of the antitrust claims.





On July 30, 2010, the Court indicated that the District Judge would hear the Motion to Transfer Venue on September 8, 2010.  On August 19, 2010, the Court set both our Motion to Transfer Venue and our Motion to Dismiss for hearing on September 8, 2010. In the September 8, 2010 hearing, the Court denied both motions.





On September 22, 2010 we filed an answer and counterclaims. The counterclaims revolved around claims of non-infringement/invalidity/unenforceability involving the patent upon which Prime Table sued us, alleging infringement and other claims relating to Prime Table’s obtaining certain patents that should belong to us. On October 15, 2010, Prime Table answered the counterclaims.  On November 12, 2010, Prime Table filed a Third Amended Complaint that is materially the same as the Second Amended Complaint with the exception that additional antitrust allegations were added relating to the counterclaims that we filed and the damages being sought were increased to in excess of $35,000. OnNovember 29, 2010, we answered the Third Amended Complaint and also made counterclaims that are materially similar to the counterclaims filed on September 22, 2010.
 
 On December 21, 2010, we entered into a License and Release Agreement with Prime Table to settle the existing litigation between the parties and to acquire intellectual property licenses related mostly to our PTG segment. Total consideration paid by us was $5,500. Accordingly, we recorded a legal settlement charge of approximately $2,200 for the year ended October 31, 2010, which represents the fair value associated with the effective settlement of the existing litigation. The remaining $3,300 will be recorded as intangible assets in December 2010. The $3,300 of intangible assets will be amortized on a straight line basis over an approximate 9 year period. On December 23, 2010, a stipulation signed by all parties was filed to dismiss this litigation.  On January 7, 2011, the Court entered an order dismissing this litigation.


TableMAX–





On April 14, 2009, TableMAX IP Holdings, Inc. and TableMAX Gaming, Inc. filed a complaint (the “First Complaint”) against us in the United States District Court for the District of Nevada.  This case is a patent infringement claim alleging that our Table MasterTMproduct infringes the following U.S. Patents: 5,688,174, 6,921,337 and 7,201,661.  The First Complaint seeks injunctive relief and an unspecified amount of damages including claims for attorney’s fees, costs, increased damages and disbursements.  On August 13, 2009, TableMAX Holdings, Inc. and TableMAX Gaming, Inc. voluntarily dismissed the First Complaint.  On the same date, TableMAX IP Holdings, Inc. and TableMAX Gaming, Inc. and Vegas Amusement, Inc. (the alleged owner of U.S. Patents: 5,688,174, 6,921,337 and 7,201,661) (hereinafter collectively “TableMAX”) filed a new complaint (the “New Complaint”) making allegations materially the same as the allegations in the First Complaint.  On August 19, 2009, TableMAX filed an amended complaint (the “Second Complaint”).  The Second Complaint superseded and is materially the same as the New Complaint, except that the plaintiffs added a new claim that Table Master infringes U.S. Patent 7,575,512.  U.S. Patent 7,575,512 was issued on August 18, 2009.  On August 19, 2009, the plaintiffs filed a Motion for Preliminary Injunction in the Second Complaint based on U.S. Patent 7,575,512.  The Motion for Preliminary Injunction sought to enjoin future sales of our Table Master  product.  On October 26, 2009, the Court denied the Motion for Preliminary Injunction without hearing oral argument.  The Court also denied without prejudice various motions for summary judgment which we filed. During the discovery process, TableMAX had made new allegations that certain of our Vegas Star products infringe one of the patents in the Second Complaint.  We deny these allegations and believe that these allegations are untrue.  On January 15, 2010, TableMAX filed a Second Amended Complaint (the "Third Complaint") which has materially the same allegations as the Second Complaint, except that it now alleges that our Vegas Star allegedly infringes all of the patents in suit which are the following US Patents: 5,688,174, 6,921,337, 7,201,661 and 7,575,512.  On June 1, 2010, in a document produced in the discovery process, it appears that TableMAX’s allegations of infringement in regards to our Vegas Star product is limited to US Patent 5,688,174.


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On August 12, 2010, the Court set a status/scheduling conference for the Markman hearing for September 9, 2010.  On September 9, 2010, the Court set the Markman hearing for December 15, 2010.  On September 29, 2010, we filed a Motion to Stay pending the reexamination of all of the patents in suit.  On November 16, 2010, the Court granted the Motion to Stay and the case is presently stayed.





We deny any liability or wrongdoing.  We believe that the above claims and litigation are without merit and intend to vigorously defend the case.  Due to the uncertainty of the ultimate outcome of this matter, the impact, if any, on future financial results is not subject to reasonable estimates.





At this time, subject to judicial and other risks beyond our control, we do not believe that we will suffer any loss, but if we did, such loss cannot be reasonably estimated.  Further, subject to judicial and other risks beyond our control, we do not believe that the loss, if any, would be material.





Smart Shoes, Inc. (the “SSI Case”) –





On April 22, 2009, we filed a complaint for declaratory relief against Smart Shoes, Inc. and Otho D. Hill (hereafter collectively “SSI”), in the Eighth Judicial District Court, Clark County, Nevada.  The declaratory relief claim seeks a judicial finding that we do not owe any money concerning SSI’s claim that we owe approximately $1,100 in regards to certain known material patents that we had acquired (hereinafter “Hill Patents”).  We believe that the approximate amount of $1,100, if it is owed, is owed by PGIC or possibly others, but not by us.  On May 26, 2009, the defendants removed the matter to the United States District Court for the District of Nevada.  On June 9, 2009, the defendants filed an Answer and Counterclaims which included the following claims:  rescission of the assignment agreements between the defendants and PGIC for certain patents and imposition of a constructive trust; declaration of priority of rights as to the certain patents under federal patent law; the defendants’ priority of rights as to the certain patents based on prior recorded assignments; the defendants’ priority of rights as to the certain patents based on prior assignments; and the defendants’ priority of rights in the certain patents based on the Nevada Uniform Commercial Code.  On July 2, 2009, we filed a Motion to Remand the entire case to the Eighth Judicial District Court, Clark County, Nevada, and a Motion to Dismiss all of the defendants’ counterclaims.  On October 14, 2009, the Court granted our Motion to Remand and denied the Motion to Dismiss as moot.  The case is no longer pending in Federal Court.





In an adversary proceeding by SSI in the United States Bankruptcy Court District of Nevada against the trustee of PGIC (the “Trustee”), the Trustee filed motions (“Trustee’s Motions”) to approve:  (1) compromise and settlement pursuant to Bankruptcy Rule 9019 approving settlement between Smart Shoes, Inc. and Otho D. Hill and Progressive Gaming International Corporation fdba Mikohn Gaming Corporation; and (2) conferral of derivative rights to sue by Smart Shoes, Inc. and Otho D. Hill, on behalf of the Trustee. The Trustee’s Motions were set for hearing on January 26, 2010 and were eventually continued to April 6, 2010.  If the Trustee’s Motions are granted by the Court then: (1) SSI’s agreement with PGIC regarding the Hill Patents would be rescinded; (2) SSI would have the right to try and bring an avoidance action against us and others regarding the earlier foreclosure of the assets of PGIC (hereinafter “Foreclosure”) which among other assets allegedly transferred to IGT the Hill Patents and the Binding Term Sheet of February 17, 2009 between us and IGT relating to the Hill Patents and related issues (hereinafter “Binding Term Sheet”).If the Court grants the Trustee’s Motions and SSI were able to succeed in an avoidance action against us then: (i) we may have to pay approximately $1,530 in additional royalties; and (ii)  the rights that we received in regards to the known material patents that are part of the PGIC Table Games Division acquisition and the associated patent license agreement may be adversely affected; and (iii) our agreement with IGT, as reflected in the Binding Term Sheet and another agreement with IGT, could be modified, terminated or otherwise adversely impact.  The Trustee withdrew the Trustee’s Motions on March 8, 2010.





On February 12, 2010, for certain immaterial monetary and non-monetary consideration, we settled all of SSI’s claims in its case against us, which case was pending in the Eighth Judicial District Court, Clark County, Nevada.  The case was dismissed with prejudice on February 22, 2010, with all parties to bear their attorney’s fees and costs.  This settlement also removes all of SSI’s claims that could have affected our legal title to the Hill Patents.


99


In February 2010, we also reached a separate settlement in principle with the Trustee in its bankruptcy case on behalf of the Estate of PGIC (the “Estate”), over related claims which could have also affected our legal title to the Hill Patents.  The settlement is subject to the Bankruptcy Court’s approval and finalization with the Trustee.  The proposed settlement would settle any claims that the Estate of PGIC/Trustee may have against us as a result of  the Foreclosure, the Hill Patents, our acquisition of the PGIC Table Games Division in September 2007, including but not limited to claims for $1,530 in additional royalties, the rights that we received in regard to the known material patents that are part of the acquisition of PGIC’s Table Game Division in September 2007 and the associated patent license agreement, and other issues.  The settlement will involve an immaterial cash payment by us to the Estate.  If approved by the Bankruptcy Court and not overturned on any appeal, all potential claims related to this matter should be materially resolved.  On July 15, 2010, the Trustee filed a Motion to Approve the above referenced settlement.  That motion was set for hearing on September 1, 2010.





During the September 1, 2010 hearing, the Court approved our settlement with the Trustee. Anorder approving our settlement was entered on September 10, 2010.  No appeal was filed and the time to appeal the order has expired.  We consider this matter to be concluded.





MacauRapid Baccarat Patent Issue–





On or about June 3, 2009, at the G2E Asia Gaming Show, customs officials from the Macau SAR seized a Rapid Baccarat®unit related to an alleged claim of patent infringement by a Macau patent owner.  There is a possibility of future legal proceedings being commenced against our subsidiary, Shuffle Master Asia Limited (“SMAL”) and its directors in Macau relating to this patent, although, at this time, no such proceedings have been commenced. Such proceedings, if initiated, would be for patent infringement, which is a criminal matter in Macau. On October 27, 2009, the governmental official in charge of the investigation elected to dismiss the investigation based on a finding that no patent infringement existed and on the report of the Macau Customs SAR.  On or about January 20, 2010, over our objection, the judge considering the patent holder’s appeal found that his appeal was timely filed.  The judge made no ruling on the patent holder’s appeal itself and thus no decision has yet been reached on whether a proceeding against our subsidiary SMAL will be opened. If the patent holder’s appeal to the Macau Court System is successful, then a criminal case for patent infringement against SMAL and its directors could be instituted (i.e., the case being opened).  No proceeding against either SMAL or any of its directors has yet been commenced.





On or about February 3, 2010, we filed an appeal (the “First SMI Appeal”) to the judge’s decision of January 20, 2010 that the patent holder’s appeal was timely.  On or about March 4, 2010, the judge declined to forward the First SMI Appeal to a higher Macau Court. We filed a further appeal (the “Second SMI Appeal”) to have the higher Macau Court hear the First SMI Appeal.   On June 2, 2010 the Judge denied the patent holder’s request to open a criminal proceeding, and decided that the investigation should remain dismissed against SMAL and its directors.  The patent holder subsequently appealed the June 2, 2010, decision to a higher Macau Court.





We deny any liability or wrongdoing.  At this time, subject to judicial and other risks beyond our control, we do not believe that we will suffer any loss, but if we did, such loss cannot be reasonably estimated.  Further, subject to judicial and other risks beyond our control, we do not believe that the loss, if any, would be material.





Wright Matter– On November 7, 2009, Sam Wright was playing a Vegas Star craps machine at the Harrah’s Casino New Orleans.  Mr. Wright played a game that ended in a losing result.  After the game concluded, as a result of a malfunction, a false credit meter value of approximately $42,000 appeared on the machine.  On April 26, 2010, we received notice for the first time that Mr. Wright had purported to file a patron dispute with the Louisiana State Police Gaming Division.  The purported patron dispute requests that Harrah’s New Orleans Casino and/or we acknowledge the gaming debt of $42,000 to Mr. Wright.  If Mr. Wright is successful in this purported patron dispute, we may have potential indemnity obligations to Harrah’s New Orleans Casino in the amount of approximately $42,000 plus attorney’s fees and costs or we may be liable directly to Mr. Wright for approximately $42,000.





On October 14, 2010, the Louisiana State Police Gaming Division concluded in regard to the patron dispute that there was no violation of state law, section rule or internal controls.





On November 5, 2010, Mr. Wright filed a Petition for Damages with the Civil District Court for the Parish of Orleans, State of Louisiana.  The defendants in the lawsuit are us, Jazz Casino Company, LLC d/b/a Harrah’s New Orleans Casino and Harrah’s New Orleans Management Company.  The Petition claims damages of approximately $43,000 plus possible treble damages, attorney’s fees and costs.  The Petition was served on us on January 11, 2011.





We deny any liability or wrongdoing.  At this time, subject to judicial and other risks beyond our control, we do not believe that we will suffer any loss, but if we did, such loss cannot be reasonably estimated.  Further, subject to judicial and other risks beyond our control, we do not believe that the loss, if any, would be material.


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Taiwan Fulgent case- On November 17, 2009, we filed a lawsuit for patent infringement against Taiwan Fulgent Enterprise, Co., LTD. (“Taiwan Fulgent”) in the United States District Court for the District of Nevada.  The lawsuit alleges that a certain type of Taiwan Fulgent product infringes the following U.S. patents: 6,588,751; 7,255,344 and 7,322,576 ( “SMI Patents in Suit”).  This Taiwan Fulgent product is a continuous shuffler similar to our one2six product.  We believe that the SMI Patents in Suit are valid and infringed, but, like in any patent lawsuit, there is a risk that a court will disagree with us on one or both of those issues. On January 25, 2010, the Defendant filed an Answer and Counterclaimed for a Declaratory Judgment that the Defendant does not infringe the SMI Patents in Suit and that the SMI Patents in Suit are invalid.  On February 22, 2010, we reached a settlement with Taiwan Fulgent whereby Taiwan Fulgent has agreed to respect our  patent rights in the United States but without any admission of infringement or liability by Taiwan Fulgent.  The settlement is otherwise confidential.  On February 23, 2010, all claims and counterclaims in the case were dismissed without prejudice with all parties to bear their own attorney’s fees and costs.





16. SUBSEQUENT EVENTS





Newton Shuffler LLC. On November 15, 2010, we entered into a purchase agreement and related agreements (the “Purchase Agreement”) with Newton Shuffler LLC and related parties (“Newton”) whereby we acquired substantially all of the intellectual property assets of Newton.  Under the terms of the Purchase Agreement, we paid Newton an upfront payment of $6,500.  The Purchase Agreement also calls for approximately $1,400 to be paid over a 9-year period.  In connection with the Purchase Agreement, we also entered into non-competition agreements with Newton and the major owners of Newton.


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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE





None.





ITEM 9A. CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and Procedures





We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.





As required by Rule 13a-15(b) promulgated under the Exchange Act, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the design and operating effectiveness as of October 31, 2010 of our disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Exchange Act.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of October 31, 2010.





Internal Control Over Financial Reporting





Management’s Report on Internal Control Over Financial Reporting





Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:





i.
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;





ii.
provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and





iii.
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





Management is responsible for establishing and maintaining adequate internal control over our financial reporting. We have evaluated the effectiveness of our internal control over financial reporting as of October 31, 2010. This evaluation was performed using the Internal Control - Integrated Framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management has concluded that, as of such date, our internal control over financial reporting was effective. The effectiveness of the company's internal control over financial reporting as of October 31, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which appears in the “Report of Independent Registered Public Accounting Firm” in this Form 10-K.





Changes in Internal Control Over Financial Reporting





As a part of our normal operations, we update our internal controls as necessary to accommodate any modifications to our business processes or accounting procedures. No change occurred during the most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting


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ITEM 9B. OTHER INFORMATION





None.





PART III





ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





·
Information regarding our directors, including the audit committee financial expert, appears under the caption “Election of Directors” in our Fiscal 2010 Proxy Statement and is incorporated herein by reference.





·
Executive Officers of the Registrant. The information under the caption “Executive Officers” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





·
Corporate Governance.  The information under the caption “Corporate Governance” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





·
Compliance with Section 16(a) of the Exchange Act. The information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





·
Information regarding our Code of Conduct appears in our Fiscal 2009 Proxy Statement, under the caption “Proposal 1—Election of Directors—Corporate Governance—Compliance Committee,” and is incorporated herein by reference.





·
Our Code of Conduct is publicly available on our website at www.shufflemaster.com and is also available in print to any shareholder upon request. Our website address is intended to be an inactive, textual reference only; none of the material on the website is part of this report. We may revise these policies from time to time and will promptly post any revisions on our website. If we grant any waiver from a provision of the Code of Conduct to our Chief Executive Officer or Chief Financial Officer, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K.





ITEM 11. EXECUTIVE COMPENSATION





The information under the captions “Compensation Discussion and Analysis,” “Executive Compensation Tables,” “Independent Director Compensation,” “Certain Relationships and Related Party Transactions—Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report,” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS





The information under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE





The information under the captions “Certain Relationships and Related Party Transactions” and “Corporate Governance—Director Independence” in our Fiscal 2010 Proxy Statement is incorporated herein by reference.





ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





Information regarding our principal accountant fees and services and the Audit Committee’s approval policies and procedures appears in our Fiscal 2010 Proxy Statement under the captions “Independent Registered Public Accountant” and “Report of the Audit Committee” and is incorporated herein by reference.


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  PART IV





ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES





(a)
1.
Financial StatementsSee index to consolidated financial statements included as Item 8 to this Annual Report on Form 10-K.2.
Financial Statement Schedules.See Item 8 to this Annual Report on Form 10-K for applicable financial statement schedules.3.
Management Contracts, Compensatory Plans and Arrangements.Management contracts, compensatory plans and arrangements are indicated by the symbol “†” in exhibits 10.1 through 10.39 included in Item 15(b) of this Annual Report.  (b)
Exhibits3.1
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
Amended and Restated Bylaws of Shuffle Master, Inc., effective November 11, 2008 (Incorporated by reference to exhibit 3.4 to our Current Report on Form 8-K, filed November 13, 2008).4.1
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).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†
Form of Indemnification Agreement (Incorporated by reference to exhibit 10.26 in our Current Report on Form 8-K, filed November 13, 2008).10.5†
The Shuffle Master, Inc. 2004 Equity Incentive Plan For Non-Employee Directors (As Amended and Restated on December 31, 2008) (Incorporated by reference to exhibit 10.2 in our Current Report on Form 8-K, filed January 7, 2009).10.6†
Amended and Restated Employment Agreement, by and between Shuffle Master, Inc. and David Lopez (Incorporated by reference to exhibit 10.6 in our Current Report on Form 8-K, filed January 7, 2009).10.7†
The Shuffle Master, Inc. 2004 Equity Incentive Plan (as Amended and Restated on January 28, 2009) (Incorporated by reference to Exhibit 10.1 of our Quarterly Report on Form 10-Q, filed June 9, 2009).10.8†
Employment Agreement, by and between Shuffle Master, Inc. and Linster W. Fox (Incorporated by reference to exhibit 10.1 in our Current Report on Form 8-K, filed August 6, 2009).10.9†
Employment Agreement, by and between Shuffle Master, Inc. and Roger Snow (Incorporated by reference to exhibit 10.1 of our Quarterly Report on Form 10-Q, filed September 8, 2010).10.10*
Credit Agreement, dated October 29, 2010, among Shuffle Master, Inc., Wells Fargo Securities, LLC and Banc of America Securities LLC, as joint lead arranger and joint lead bookrunner, Bank of America, N.A. as syndication agent and Union Bank, N.A. as a documentation agent.21
Subsidiaries of Registrant.23.1
Consent of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP.23.2
Consent of Independent Registered Public Accounting Firm, Deloitte & Touche LLP.31.1
Certification of Interim 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 Interim 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.





*
Certain parts of this document have been omitted based on a request for confidential treatment submitted to the SEC. The non-public information that has been omitted from this document has been separately filed with the SEC. Each redacted portion of this document is indicated by a “[***]” and is subject to the request for confidential treatment submitted to the SEC. The redacted information is confidential information to the Registrant.





**
Exhibits 32.1 and 32.2 are furnished to accompany this report on Form 10-K but shall not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise and shall not be deemed incorporated by reference into any registration statements filed under the Securities Act of 1933.


104
  SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




SHUFFLE MASTER, INC.Dated: January 13, 2011
By:
/s/ DAVID LOPEZInterim Chief Executive Officer





Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:





Signature
Title
Date/s/ DAVID LOPEZ
Interim Chief Executive Officer (Principal Executive Officer)
January 13, 2011David Lopez/s/ LINSTER W. FOX
Chief Financial Officer (Principal Financial and Accounting Officer)
January 13, 2011Linster W. Fox/s/ GARRY W. SAUNDERS
Chairman of the Board of Directors
January 13, 2011Garry W. Saunders/s/ JOHN R. BAILEY
Director
January 13, 2011John R. Bailey/s/ LOUIS CASTLE
Director
January 13, 2011Louis CastleDirectorEileen F. Raney *DirectorA. Randall Thoman */s/ DANIEL M. WADE
Director
January 13, 2011Daniel M. Wade