10-Q 1 shuffe013574_10q.txt SHUFFLE MASTER, INC. FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q -------------------------------------------------------------------------------- (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 31, 2001 OR [ ] 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 (IRS Employer Identification No.) of Incorporation or Organization) 1106 Palms Airport Drive NV 89119 (Address of Principal Executive Offices) (State) (Zip Code) Registrant's Telephone Number, Including Area Code: (702) 897-7150 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 _____ As of August 31, 2001, there were 18,067,824 shares of the Company's $.01 par value common stock outstanding. 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. CONSOLIDATED BALANCE SHEETS
ASSETS (unaudited) JULY 31, OCTOBER 31, (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2001 2000 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 3,643 $ 2,810 Investments 14,815 3,809 Accounts receivable, net 4,862 4,571 Current portion of note receivable from related parties 18 17 Inventories 6,880 6,194 Deferred income taxes 408 580 Other current assets 2,544 594 ------------ ------------ Total current assets 33,170 18,575 SYSTEMS AND EQUIPMENT LEASED AND HELD FOR LEASE, NET 7,276 6,676 PROPERTY AND EQUIPMENT, NET 2,334 2,441 INTANGIBLE ASSETS, NET 8,942 5,802 NON-CURRENT DEFERRED INCOME TAXES 673 710 LONG-TERM NOTE RECEIVABLE FROM RELATED PARTIES 477 300 OTHER ASSETS 111 110 ------------ ------------ TOTAL ASSETS $ 52,983 $ 34,614 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 3,998 $ 1,489 Accrued liabilities 2,328 2,576 Current portion of long-term obligation to related party 245 580 Customer deposits and unearned revenue 2,685 1,862 ------------ ------------ TOTAL CURRENT LIABILITIES 9,256 6,507 LONG-TERM OBLIGATION TO RELATED PARTY -- 97 CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $.01 par value; 67,500 shares authorized 181 163 Additional paid-in capital 12,172 5,263 Retained earnings 31,374 22,584 ------------ ------------ TOTAL SHAREHOLDER'S EQUITY 43,727 28,010 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 52,983 $ 34,614 ============ ============
See notes to unaudited consolidated financial statements 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, ---------------------------- ---------------------------- 2001 2000 2001 2000 ------------ ------------ ------------ ------------ REVENUE: Shuffler lease $ 4,063 $ 3,333 $ 12,015 $ 9,382 Shuffler sales and service 2,794 2,255 9,646 6,146 Table games 3,897 3,089 11,115 8,958 Slot games 1,766 274 3,049 1,136 Other 64 237 317 1,701 ------------ ------------ ------------ ------------ 12,584 9,188 36,142 27,323 ------------ ------------ ------------ ------------ COST AND EXPENSES: Cost of products 3,230 2,517 9,623 7,813 Selling, general and administrative 3,381 2,363 9,275 7,040 Research and development 1,384 1,169 4,316 3,239 ------------ ------------ ------------ ------------ 7,995 6,049 23,214 18,092 ------------ ------------ ------------ ------------ Income from operations 4,589 3,139 12,928 9,231 Interest income, net 195 97 493 183 ------------ ------------ ------------ ------------ Income before income taxes 4,784 3,236 13,421 9,414 Provision for income taxes 1,566 1,197 4,631 3,422 ------------ ------------ ------------ ------------ NET INCOME $ 3,218 $ 2,039 $ 8,790 $ 5,992 ============ ============ ============ ============ EARNINGS PER COMMON SHARE, BASIC $ .18 $ .13 $ .52 $ .37 ============ ============ ============ ============ EARNINGS PER COMMON SHARE, DILUTED $ .17 $ .12 $ .48 $ .35 ============ ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES, BASIC 17,687 16,238 17,021 16,319 ============ ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES, DILUTED 18,939 17,269 18,474 16,936 ============ ============ ============ ============
See notes to unaudited consolidated financial statements 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
NINE MONTHS ENDED JULY 31, ----------------------------- (IN THOUSANDS) 2001 2000 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,790 $ 5,992 ADJUSTMENTS TO RECONCILE NET INCOME TO CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation and amortization 4,102 3,619 Provision for bad debts 25 75 Provision for inventory obsolescence 500 350 Deferred income taxes 209 990 Stock options issued for services 92 (10) CHANGES IN OPERATING ASSETS AND LIABILITIES: Accounts and notes receivable (279) (449) Inventories (624) (258) Other current assets (1,941) (488) Accounts payable and accrued liabilities 1,605 (2,135) Customer deposits and unearned revenue 823 41 Income taxes payable (238) (141) ------------ ------------ Net cash provided by operating activities 13,064 7,586 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments (14,832) (4,883) Proceeds from the sales and maturities of investments 4,331 4,752 Payments for products leased and held for lease (3,081) (3,569) Purchases of property and equipment (473) (194) Purchases of intangible assets (362) (910) Acquisition of business, net of cash acquired (4,015) -- Other (200) (109) ------------ ------------ Net cash (used by) investing activities (18,632) (4,913) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of common stock (2,162) (3,267) Proceeds from issuance of common stock 8,854 912 Payments on long-term obligation to related party (291) (407) ------------ ------------ Net cash (used) provided by financing activities 6,401 (2,762) ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 833 (89) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,810 1,476 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,643 $ 1,387 ============ ============ NON-CASH TRANSACTION: Payment of obligation to related party with common stock $ 141 $ 141 ============ ============ CASH PAID FOR: Income taxes $ 4,546 $ 2,610 ============ ============ Interest $ 9 $ 36 ============ ============
See notes to unaudited consolidated financial statements 4 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- 1. INTERIM FINANCIAL STATEMENTS: The financial statements as of July 31, 2001, and for the three and nine month periods ended July 31, 2001 and 2000, are unaudited, but, in the opinion of management, include all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the financial results for the interim periods. The results of operations for the three and nine months ended July 31, 2001 are not necessarily indicative of the results to be expected for any subsequent quarter or for the year ending October 31, 2001. These interim statements should be read in conjunction with the Company's October 31, 2000, financial statements and notes thereto included in its Form 10-K. Certain reclassifications have been made to the July 31, 2000 consolidated financial statements to conform with the July 31, 2001 financial statement presentation. These reclassifications had no effect on the operating results for the three and nine months ended July 31, 2000, as previously reported. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141 "Business Combinations" ("SFAS No. 141") and SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS Nos. 141 and 142 prescribe new accounting guidance for business combinations and related acquired intangible assets, including goodwill. Under SFAS No. 142, goodwill as well as other intangibles determined to have an infinite life will no longer be amortized; however, these assets will be reviewed for impairment on a periodic basis. SFAS No. 142 also includes provisions for the reclassification of certain existing recognized intangibles such as goodwill, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. The Company plans to adopt these standards on November 1, 2001. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. 2. INVENTORIES: JULY 31, OCTOBER 31, DESCRIPTION 2001 2000 ----------------------------------- ------------ ------------ (In thousands) Raw materials $ 3,850 $ 3,294 Work-in-progress 1,125 823 Finished goods 1,905 2,077 ------------ ------------ $ 6,880 $ 6,194 ============ ============ 3. SYSTEMS AND EQUIPMENT LEASED AND HELD FOR LEASE: JULY 31, OCTOBER 31, DESCRIPTION 2001 2000 ----------------------------------- ------------ ------------ (In thousands) Game equipment $ 9,741 $ 10,176 Gaming products 6,505 4,292 ------------ ------------ 16,246 14,468 Less: Accumulated depreciation (8,970) (7,792) ------------ ------------ $ 7,276 $ 6,676 ============ ============ 5 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- 4. COMMON STOCK: In the first nine months of fiscal 2001, the Company repurchased 130,000 shares at a total cost of $2,162,000, compared to 392,500 shares repurchased at a total cost of $3,267,000 in the first nine months of fiscal 2000. Additionally, the Company issued 1,831,000 shares of common stock for $8,854,000 pursuant to stock options exercised by employees and directors under the Company's stock options plans. On September 10, 2001 the Board of Directors voted to terminate all prior common share repurchase authorizations and authorized the repurchase of up to $5,000,000 of the Company's common shares. 5. EARNINGS PER SHARE: The following table shows the reconciliation of basic earnings per share to diluted earnings per share. (All amounts have been restated to reflect the effects of the Company's three for two stock splits in November 2000 and June 2001):
THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, ------------------------ ------------------------ 2001 2000 2001 2000 ---------- ---------- ---------- ---------- (In thousands, except for per share amounts) NET INCOME $ 3,218 $ 2,039 $ 8,790 $ 5,992 ========== ========== ========== ========== BASIC: Weighted average shares outstanding 17,663 16,165 16,997 16,233 Shares to be issued under asset purchase 24 73 24 86 ---------- ---------- ---------- ---------- Weighted average common shares, basic 17,687 16,238 17,021 16,319 ========== ========== ========== ========== ASSUMING DILUTION: Weighted average common shares, basic 17,687 16,238 17,021 16,319 Dilutive impact of options outstanding 1,252 1,031 1,453 617 ---------- ---------- ---------- ---------- Weighted average common shares, diluted 18,939 17,269 18,474 16,936 ========== ========== ========== ========== EARNINGS PER SHARE, BASIC $ .18 $ .13 $ .52 $ .37 ========== ========== ========== ========== EARNINGS PER SHARE, DILUTED $ .17 $ .12 $ .48 $ .35 ========== ========== ========== ==========
6. OPERATING SEGMENTS: The Company operates in two business segments: game equipment and gaming products. The game equipment segment includes the manufacturing, marketing, installing and servicing of the Company's proprietary shuffler product line and, until the sale of this product line in January 2001, the distribution and servicing of casino chip sorting machines and accessories all for sale or recurring lease revenue. The gaming products segment includes the design, marketing, installation and servicing of proprietary table games, slot games, and the Company's new slot operating system. Gaming products generally produce recurring revenue through fixed or participation leases and licenses. The Company does not allocate corporate expenses to its business segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker is the Chief Executive Officer. 6 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------
THREE MONTHS ENDED, NINE MONTHS ENDED, JULY 31, JULY 31, ------------------------- ------------------------- (in thousands) 2001 2000 2001 2000 ---------- ---------- ---------- ---------- REVENUE Game equipment $ 6,921 $ 5,826 $ 21,978 $ 16,529 Gaming products 5,663 3,362 14,164 10,794 ---------- ---------- ---------- ---------- 12,584 9,188 36,142 27,323 ========== ========== ========== ========== OPERATING INCOME Game equipment 3,810 3,372 12,818 9,286 Gaming products 3,039 1,218 6,449 4,764 Corporate expenses (2,260) (1,451) (6,339) (4,819) ---------- ---------- ---------- ---------- 4,589 3,139 12,928 9,231 ========== ========== ========== ========== DEPRECIATION AND AMORTIZATION Game equipment 559 451 1,626 1,296 Gaming products 685 618 1,855 1,802 Corporate 216 180 621 521 ---------- ---------- ---------- ---------- 1,460 1,249 4,102 3,619 ========== ========== ========== ========== CAPITAL EXPENDITURES Game equipment 325 1,023 533 2,567 Gaming products 1,345 779 2,910 1,912 Corporate 136 173 473 194 ---------- ---------- ---------- ---------- $ 1,806 $ 1,975 $ 3,916 $ 4,673 ========== ========== ========== ========== AS OF JULY 31, ------------------------- 2001 2000 ---------- ---------- ASSETS Game equipment $ 14,762 $ 10,872 Gaming products 15,349 10,744 Corporate 22,872 9,974 ---------- ---------- $ 52,983 $ 31,590 ========== ==========
7. CONTINGENCIES: On April 5, 2001, the Company was sued by Innovative Gaming Corporation of America, a Minnesota corporation ("IGCA"). The suit was filed in the District Court of the State of Nevada, in Washoe County, Nevada. The defendants are the Company and Joseph Lahti, the Company's Chairman. The complaint alleges breach of contract, negligence, misrepresentation and related theories of liability, all relating to a confidentiality agreement with respect to what IGCA claims to be its intellectual property. The Company has answered the complaint by denying any liability and raising various affirmative defenses. The Company completely denies IGCA's claims and believes it will prevail in the lawsuit. 7 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SHUFFLE MASTER, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- As part of the finalized settlement of the Company's litigation with International Game Technology ("IGT") in July 2001, the Company entered into several confidential definitive agreements relating to the development of future games. Certain of these agreements provide that IGT and the Company will develop five new game titles based upon licenses to be provided by the Company. In consideration of certain work to be performed by IGT in connection with the new game titles, IGT may become entitled to a $400,000 completion payment from the Company for each game title developed. IGT will become entitled to such completion payments only if IGT timely meets certain performance obligations respective to each game, and if each specific game achieves defined minimum placement levels in the competitive marketplace. 8 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS -------------------------------------------------------------------------------- The following table sets forth selected financial percentages derived from the Company's unaudited Consolidated Statements of Income:
THREE MONTHS NINE MONTHS ------------------- ------------------- PERIOD ENDED JULY 31, 2001 2000 2001 2000 ---------------------------------- ------ ------ ------ ------ Revenue 100.0% 100.0% 100.0% 100.0% Cost of Products 25.7 27.4 26.6 28.6 ------ ------ ------ ------ Gross Margin 74.3 72.6 73.4 71.4 ------ ------ ------ ------ Selling, general and administrative 26.9 25.7 25.7 25.8 Research and development 11.0 12.7 11.9 11.9 ------ ------ ------ ------ Income from operations 36.4 34.2 35.8 33.7 Interest income, net 1.6 1.0 1.3 0.7 ------ ------ ------ ------ Income before income taxes 38.0 35.2 37.1 34.4 Provision for income taxes 12.4 13.0 12.8 12.5 ------ ------ ------ ------ Net Income 25.6% 22.2% 24.3% 21.9% ====== ====== ====== ======
REVENUE: Revenue for the third fiscal quarter ended July 31, 2001, was $12,584,000, an increase of $3,396,000 or 37.0% from the same period last year. This increase was attributable to increased revenue in all business segments. Shuffler sales and service revenue increased to $2,794,000 in the current quarter, compared to $2,255,000 in the third quarter last year. Current quarter shuffler sales were 250 units at an average price of $9,800, while sales in the third quarter of the prior fiscal year were 215 units at an average price of $9,100. Average unit sales prices increased 7.7% due to increased sales of higher-priced ACE(R) shufflers in the current quarter. Shuffler sales and service revenue also includes revenue from the sale of extended service contracts, which increased to $265,000 in the current third quarter from $248,000 in the third quarter of the prior fiscal year. Shuffler lease revenue increased by $730,000 or 21.9% to $4,063,000 in the current fiscal year third quarter. The shuffler installed lease base was 3,085 at July 31, 2001, compared to 2,807 at July 31, 2000 and 2,935 at October 31, 2000. This increase in the installed lease base from the prior year was due to the Company's fiscal 2000 and 2001 business objectives to increase its installed base of leased ACE(R) and King(TM) shufflers. The 146 unit increase in the installed lease base during the first nine months of fiscal 2001 was attributable to the net placement of 229 ACE(R) and 93 King(TM) shufflers, and the net removal of 72 multi-deck and 104 single deck BG shufflers. In the current year fiscal third quarter, sales of units converted from lease totaled 17 units, compared to 22 leased units converted to sales in the prior year fiscal third quarter. Revenue from table games was $3,897,000, an increase of $808,000 or 26.2% from the third fiscal quarter last year. This increase was primarily due to placement of Three Card Poker(R) table games. There were 500 Three Card Poker(R) games installed at July 31, 2001, compared to 259 installed tables at July 31, 2000 and 293 installed tables at October 31, 2000. Additionally, the installed base of Let It Ride Bonus(R) tables was 540 at July 31, 2001, compared to 469 installed Bonus tables at July 31, 2000 and 500 installed Bonus tables at October 31, 2000. The increase in installed Bonus tables compared to the prior year third fiscal quarter was due to new placements and conversion of Let It Ride(R) basic table games to Bonus table games. Let It Ride(R) table revenue also includes revenue from the Let It Ride(R) basic game. Revenue from both games is generated from monthly fixed fees, with the prices of the Bonus game significantly higher than those of the basic game. There were 160 installed basic tables at July 31, 2001, compared to 205 installed basic tables at July 31, 2000 and 186 installed basic tables at October 31, 2000. The decrease in installed basic tables from July 31, 2000 was primarily due to conversions from the basic game to the Bonus game. 9 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS (CONTINUED) -------------------------------------------------------------------------------- Slot revenue increased by $1,492,000 or 544.5% to $1,766,000 in the current fiscal year third quarter from the prior year fiscal third quarter. Included in current quarter slot revenue is $1,000,000 in revenue related to provisions of the Company's fiscal 2000 video slot game agreements with IGT. These agreement provisions prescribed minimum profits due to the Company based on video game rollout schedules. This revenue relates to these minimums and is in addition to revenue currently being generated by units installed in casinos. The slot video installed lease base was 511 slot units as of July 31, 2001, compared to 445 installed units as of July 31, 2000 and 545 units as of October 31, 2000. The increase in the installed base from the prior year fiscal third quarter was due to the placement of The Three Stooges(R) and Let's Make A Deal(R) slot games under the Company's agreements with IGT. Accordingly, recurring slot lease revenue increased by $613,000 to $762,000 in the current fiscal third quarter compared to the prior year third fiscal quarter. Other revenue decreased to $64,000 in the current fiscal third quarter from $237,000 in the prior year fiscal third quarter due to the termination of the Company's joint marketing agreement with TCS America, Inc. in January 2001. Revenue for the nine months ended July 31, 2001 was $36,142,000, an increase of $8,819,000 or 32.3% over the nine month period ended July 31, 2000. Shuffler lease revenue increased by $2,633,000 or 28.1% to $12,015,000 in the current year nine months, compared to $9,382,000 in the prior fiscal year nine months, while shuffler sales and service revenue increased by $3,500,000 or 57.0% to $9,646,000 in the current nine months compared to $6,146,000 in the prior year nine months. This shuffler sales increase was due to the sale of 873 shufflers in the current year nine months compared to 530 units in the prior year nine months. Table game revenue increased by $2,157,000 or 24.1% to $11,115,000 in the current year nine months as compared to $8,958,000 in the prior year nine months, as total table placements increased by 269 tables to 1,225 tables at July 31, 2001 from 956 tables at July 31, 2000, due primarily to placements of the Three Card Poker(R) game. Video slot game revenue increased by $1,913,000 or 168.4% to $3,049,000, due primarily to the recording in the current nine months of the $1,000,000 in revenue from IGT related to minimum profit provisions in the Company's fiscal 2000 video slot game agreements with IGT, as well as increasing lease revenue from current year installations of Press Your Luck(TM), Let's Make A Deal(R), and The Three Stooges(R). Other revenue in the current year nine months decreased by $1,384,000 from the prior year nine months, principally due to the termination of the Company's joint marketing agreement with TCS America, Inc. in January 2001 and the receipt of $700,000 in technology license and evaluation fees in the prior year nine months. COSTS AND EXPENSES: Gross margin was 74.3% and 73.4% in the current fiscal third quarter and nine months year to date, compared to 72.6% and 71.4% in the comparable prior year periods. Current quarter gross margin includes the $1,000,000 in slot revenue recorded pursuant to the Company's fiscal 2000 video slot game agreements with IGT. Excluding this slot revenue item, gross margin for the current third fiscal quarter and nine months would have been 72.1% and 72.6% respectively. This decrease in gross margin was primarily due to service, installation, and indirect production costs, which, expressed as a percentage of sales, increased to 13.2% in the current year fiscal third quarter from 12.5% in the prior year fiscal year third quarter. Selling, general and administrative expenses increased by $1,018,000 or 43.1% to $3,381,000 in the current third fiscal quarter and by $2,235,000 to $9,275,000 in the current nine month period. Selling, general and administrative expenses increased in the current fiscal third quarter and nine months, due to increases in information systems modifications, bad debt, investor relations and executive staffing expenses totaling $480,000 and $728,000, respectively. Legal expenses increased by $191,000 and $137,000 from the prior year fiscal third quarter and nine months, respectively, due to ongoing litigation with Innovative Gaming Corporation of America and the settlement of litigation with IGT in the current third fiscal quarter. General and administrative expenses in the Company's recently acquired Australian shuffler production unit were $308,000 for the current fiscal third quarter. 10 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS (CONTINUED) -------------------------------------------------------------------------------- Research and development expenses increased by $215,000 or 18.4% over the prior year fiscal quarter to $1,384,000, and by $1,077,000 over the prior year nine month period to $4,316,000. These increases resulted from new game and slot operating system development costs. INTEREST INCOME, NET: Interest income, net, was $195,000 in the current third fiscal quarter, compared to $97,000 in the prior year third fiscal quarter. Cash and investments increased to $18,458,000 at July 31, 2001, from $6,619,000 at October 31, 2000. This increase in interest-bearing cash and investments was due primarily to the Company increasing its operating profits in fiscal 2001 and receiving $8,854,000 in proceeds from the issuance of common stock through the exercise of employee and director common stock options during the first nine months of fiscal 2001. INCOME TAXES: The Company recorded income tax expense at an effective rate of 32.7% for the current third quarter, compared to the tax provision of 37.0% for the third quarter of fiscal 2000. This decrease reflects a shift of the Company's taxable income to more favorable tax jurisdictions and increased available federal research and experimental credits for the current year as well as a corresponding adjustment in the current quarter of the tax provision to reflect a year-to-date effective tax rate of 34.5%. EARNINGS PER SHARE: The Company earned $.17 per share, assuming dilution, for the current year fiscal third quarter, compared to $.13 per share, assuming dilution, in the prior fiscal year. Weighted average shares outstanding, assuming dilution, increased to 18,939,000 from 11,269,000 in the third fiscal quarter of 2000 due to the exercise of 1,831,000 stock options during fiscal year 2001 and an increase in the dilutive impact of remaining common stock options outstanding. The dilutive impact of common stock options outstanding on earnings per share increased by 221,000 shares to 1,252,000 shares during the quarter ended July 31, 2001, from 1,031,000 shares during the quarter ended July 31, 2000. The increase in dilutive effects is a result of the increase in the market price of the Company's common stock throughout the past year. This increase in market price increased the number and dilutive impact of common stock options that could be exercised. Per share and shares outstanding amounts for current year and prior year fiscal quarters reflect the two three-for-two stock splits effective in November 2000 and June 2001. RECENTLY ISSUED ACCOUNTING STANDARDS: In July 2001, the Financial Accounting Standards Board issued SFAS No. 141 "Business Combinations" ("SFAS No. 141") and SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS Nos. 141 and 142 prescribe new accounting guidance for business combinations and related acquired intangible assets, including goodwill. Under SFAS No. 142, goodwill as well as other intangibles determined to have an infinite life will no longer be amortized; however, these assets will be reviewed for impairment on a periodic basis. SFAS No. 142 also includes provisions for the reclassification of certain existing recognized intangibles such as goodwill, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. The Company plans to adopt these standards on November 1, 2001. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. 11 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS (CONTINUED) -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES WORKING CAPITAL: As of July 31, 2001, the Company had cash, cash equivalents and investments totaling $18,458,000, compared to $6,619,000 at October 31, 2000. The current ratio increased to 3.6 from 2.9 at October 31, 2000, while working capital increased by $11,846,000 to $23,914,000 at July 31, 2001 from $12,068,000 at October 31, 2000. The increase in cash, working capital, and the current ratio at July 31, 2001 is primarily the result of the Company's increased operating profits during the current fiscal year nine months and receipt of proceeds from the issuance of common stock from employee and director stock options exercised during the same period. CASH FLOWS: Cash provided by operations totaled $13,064,000 in the current year nine months compared to cash provided by operations of $7,586,000 in the first nine months of last year. Significant items in the cash flows from operating activities in the current period include net income of $8,790,000 and non-cash charges for depreciation and amortization as well as for provisions for bad debts, inventory obsolescence, deferred taxes, and stock options issued for services, all of which totaled $4,928,000, compared to net income of $5,992,000 and non-cash charges of $5,024,000 in the first nine months of last year. Significant uses and sources of cash flow from operating activities in the current nine months also included an increase in accounts receivable, inventory, and accounts payable of $279,000, $624,000, and $1,605,000, respectively, primarily due to the purchase of game components and increased video slot game lease activities, which include recently approved versions of The Three Stooges(R) and Let's Make A Deal(R) games. Additionally, in the current third fiscal quarter, the Company recorded, in other current assets, payments receivable from IGT for $1,750,000, of which $1,000,000 was currently recognized as revenue and $750,000 was deferred to future quarters, all related to its fiscal 2000 video slot game agreements with IGT. Investing activities in the first nine months of the current fiscal year included the acquisition in April 2001 of Gaming Products, an Australian manufacturer of the QuickDraw(R) shuffler product line, for $4,015,000, net of cash acquired. Additionally, the Company invested $3,894,000 for gaming equipment and game products leased to customers, new game licenses and other fixed assets. The Company also increased its investment portfolio by $11,006,000 to $14,815,000 in the same period. Financing activities during the first nine months of the current fiscal year included the repurchase of 130,000 shares of common stock using cash of $2,162,000 and the issuance of 1,831,000 shares of common stock for $8,854,000 pursuant to stock options exercised by employees and directors under the Company's stock option plans. CAPITAL RESOURCES: The Company believes its current cash and investments, cash provided by operations and $10,000,000 in unused borrowing capacity under its revolving line of credit facility will be sufficient to finance its current operations, share repurchase program, and new product development and roll-outs in the immediate future. FORWARD LOOKING STATEMENTS This report contains forward-looking statements. Such statements reflect and are subject to risks and uncertainties that could cause actual results to differ materially from expectations. Factors that could cause actual results to differ materially from expectations include, but are not limited to, the following: changes in the level of consumer or commercial acceptance of the Company's existing products and new products as introduced; competitive advances; acceleration and/or deceleration of various product development and roll out schedules; higher than expected manufacturing, service, selling, administrative, product development and/or 12 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS (CONTINUED) -------------------------------------------------------------------------------- roll out costs; current and/or unanticipated future litigation; regulatory and jurisdictional issues involving Shuffle Master or its products specifically, and for the gaming industry in general; general and casino industry economic conditions; the financial health of the Company's casino and distributor customers both nationally and internationally; and the risks and factors described from time to time in the Company's reports filed with the Securities and Exchange Commission. 13 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On April 5, 2001, the Company was sued by Innovative Gaming Corporation of America, a Minnesota corporation ("IGCA"). The suit was filed in the District Court of the State of Nevada, in Washoe County, Nevada. The defendants are the Company and Joseph Lahti, the Company's Chairman. The complaint alleges breach of contract, negligence, misrepresentation and related theories of liability, all relating to a confidentiality agreement with respect to what IGCA claims to be its intellectual property. The Company has answered the complaint by denying any liability and raising various affirmative defenses. The Company completely denies IGCA's claims and believes it will prevail in the lawsuit and has accrued no liability related to this litigation. Effective July 31, 2001, the Company finalized the terms of its settlement with IGT that was entered into on May 31, 2001 and that was disclosed in the Company's fiscal 2001 second quarter 10-Q. All claims raised in the litigation have been settled and the case has been dismissed with prejudice. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits 10.28 Articles of Amendment to the Articles of Incorporation of Shuffle Master, Inc. dated June 6, 2001. b) Reports on Form 8-K: none 14 SIGNATURES Pursuant to the requirements 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. (Registrant) Date: September 14, 2001 /s/ Gary W. Griffin ------------------------------------------- Gary W. Griffin Chief Financial Officer (Principal Financial Officer) /s/ Gerald W. Koslow ------------------------------------------- Gerald W. Koslow Corporate Controller (Principal Accounting Officer) 15