-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PlCD8jxhHKJPTLkJZdKHqW9XttiZtBxXNOELnJM4YdzOGJvz4r1V01sCg4vDzry0 I9j0dEWzId+F63FebHdAMg== 0000897101-02-000053.txt : 20020414 0000897101-02-000053.hdr.sgml : 20020414 ACCESSION NUMBER: 0000897101-02-000053 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011031 FILED AS OF DATE: 20020129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SHUFFLE MASTER INC CENTRAL INDEX KEY: 0000718789 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS MANUFACTURING INDUSTRIES [3990] IRS NUMBER: 411448495 STATE OF INCORPORATION: MN FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-20820 FILM NUMBER: 02520572 BUSINESS ADDRESS: STREET 1: 10921 VALLEY VIEW RD CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 BUSINESS PHONE: 6129431951 10-K405 1 shuffle020338_10k.txt SHUFFLE MASTER, INC. FORM 10-K405 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, 2001, or _____ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NO. (0-20820) ----------------------------- SHUFFLE MASTER, INC. (Exact name of registrant as specified in its charter) MINNESOTA 41-1448495 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1106 PALMS AIRPORT DRIVE LAS VEGAS, NEVADA 89119 (Address of principal executive offices) (Zip Code) 702-897-7150 (Registrant's telephone number, including area code) ----------------------------- Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, par value $.01 per share ----------------------------- Indicate by check mark 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 _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. __X__ As of January 24, 2002, 17,740,941 shares of Common Stock of the registrant were outstanding. The aggregate market value of Common Stock beneficially owned by non-affiliates on that date was $286,927,000 based upon the last reported sale price of the Common Stock at that date by The Nasdaq Stock Market. 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 13, 2002 (Fiscal 2001 Proxy Statement). TABLE OF CONTENTS PART I PAGE Item 1. Business 1 Item 2. Properties 12 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 12 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder 13 Matters Item 6. Selected Financial Data 14 Item 7. Management's Discussion and Analysis of Financial Condition 15 and Results of Operations Item 7A. Quantitative and Qualitative Disclosures about Market Risk 21 Item 8. Financial Statements and Supplementary Data 22 Item 9. Changes in and Disagreements with Accountants on 40 Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant 40 Item 11. Executive Compensation 40 Item 12. Security Ownership of Certain Beneficial Owners and Management 40 Item 13. Certain Relationships and Related Transactions 40 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 40 PART I ITEM 1. BUSINESS FORWARD LOOKING STATEMENTS This report contains forward-looking statements. The Company considers such statements to be made under the safe harbor created by the federal securities laws to which it is subject, and assumes no obligation to update or supplement such statements. Forward-looking 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; product performance issues; higher than expected manufacturing, service, selling, administrative, product development and/or roll out costs; changes in the Company's business systems or in technologies affecting the Company's products or operations; current and/or unanticipated future litigation; regulatory and jurisdictional issues (e.g., delays in obtaining necessary approvals, or changes in a jurisdiction's regulatory scheme) involving the Company or its products specifically, and the gaming industry in general; general and casino industry economic conditions; and the financial health of the Company's casino and distributor customers both nationally and internationally. Additional information on these and other risk factors that could potentially affect the Company's financial results may be found in documents filed by the Company with the Securities and Exchange Commission, including the Company's most recent 10-Q and 10-K filings. GENERAL The Company develops, manufactures and markets automatic card shuffling equipment (shufflers), and gaming products such as table games, slot machine game software and slot machine operating system software for the gaming industry. The Company's growth plans are to develop or acquire innovative gaming products and systems, including productivity enhancing equipment, new table and slot games, and slot game technology, and market these products worldwide. Casino gaming is found in 32 states in the United States (including states in which such gaming is found only on Indian lands, card rooms or off-shore cruises) as well as in numerous countries worldwide. The Company estimates that there are approximately 16,000 table games in North America, and over 8,000 additional tables worldwide. Casino gaming has grown tremendously since the early 1990's, and the Company believes both the North American and international markets for gaming-related products will continue to expand. In the last year in particular, the expansion of gaming has been the subject of either renewed or fresh discussion in many domestic and international jurisdictions. The mix of table games and slot machines varies and will vary considerably by casino and jurisdiction, resulting in differing rates of historical and future expansion within the markets for each product group. The Company develops and markets shuffler products suitable for use with the vast majority of card based table games. The initial model in the Company's shuffler product line was first placed in casinos in January 1992. As of October 31, 2001, the Company estimates that there are approximately 8,180 of the Company's shufflers installed in casinos or other legal gaming establishments: 3,075 units on lease and 5,105 units sold. The Company also develops and markets table games and licenses these products to casinos. Current revenue generating table games include the Let It Ride(R) basic game, the Let It Ride Bonus(R) game and the Three Card Poker(R) game. The Let It Ride(R) basic game was introduced in October, 1993. Let It Ride The Tournament(R) was launched in May 1995 and, in August 1997, the Company introduced the Bonus version of the game. The Bonus version has since replaced the Tournament version in virtually all jurisdictions. In May 1999, the Company acquired the Three Card Poker(R) table card game from its developer and distributor. As of October 31, 2001, there were 1,269 of the Company's table games installed. In addition to table games in its line of gaming products, the Company also develops and markets games for slot machines. As of October 31, 2001, the Company was actively marketing The Three Stooges(R), Let's Make A Deal(R), Press Your Luck(TM) and Five Deck Poker,(R) with additional games under development. As of October 31, 2001, the Company had 720 slot machine games installed in casinos. During fiscal 2001, the Company made progress in the development of its slot game business in a number of areas: 1 ITEM 1. BUSINESS (CONTINUED) * The Company began the rollout of The Three Stooges(R) slot machines in April 2001, the rollout of Let's Make A Deal(R) slot machines in July 2001, and the rollout of The Honeymooners(TM) in November 2001. These games were brought to market in a cooperative arrangement with International Game Technology ("IGT") whereby IGT developed and manufactured slot games based on the Company's related licensed intellectual properties. The Company is responsible for the marketing and installation of the slot machines and provides administrative services for the project. * In November 2001, the Company entered into a licensing, development, and marketing agreement with Anheuser-Busch, Inc., to develop reel and video slot machines using logos and promotional images of Anheuser-Busch's flagship brand, Budweiser(R) beer. THE COMPANY'S PRODUCTS GAME EQUIPMENT SHUFFLERS. The Company's card shuffler products, marketed under the trademarks Shuffle Master Gaming(R), ACE(R), King(TM) and QuickDraw(R) are automatic card shuffling machines designed to be used with table games in casinos and other legal gaming establishments. The Company's shufflers offer several benefits to the Company's casino customers, including enhanced security and increased productivity. Opportunity for card manipulation by dealers is significantly reduced, resulting in increased security. Because the shufflers shuffle or sort 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. In fiscal 2000, the Company introduced a revolutionary continuous multi-deck shuffler marketed to casino customers under the King(TM) name. This product represents the state of the art in continuous card shuffling, featuring a design that eliminates card counting and tracking and also provides increased productivity over the Company's multi-deck batch shuffler. In fiscal 2001, the Company acquired Gaming Products Pty Ltd, the QuickDraw(R) shuffler product line and certain other assets related to the Gaming Products business, which is located in Queensland, Australia. The QuickDraw(R) line represents an alternate approach to continuous shuffler design, and the Company believes it will benefit from ownership of the product line and related patents. Shuffler lease and sales revenue accounted for approximately 58% of the Company's revenue in fiscal 2001. The Company markets three types of shufflers: * SINGLE DECK. The Company's single deck shufflers automatically shuffle a deck of playing cards and deposit each player's hand into an integrated holding tray for use by the dealer. A second deck is shuffled while the first deck is being played on the table. When the game is completed, the hands of the second deck are automatically moved into the holding tray for use. The initial model single deck shuffler was introduced in 1992, and that model and its variations are designated as the BG series. While BG units are still operating, a substantial portion of those on lease have been replaced by the Company's newer ACE(R) single deck model, introduced in fiscal 1999. Single deck shufflers are used with specialty card games such as the Company's own Let It Ride(R) and Three Card Poker(R) games and other non-Shuffle Master games such as Caribbean Stud Poker(R) and Pai Gow Poker. Since the Company's single deck machines form hands of cards from a "fresh" deck prior to each round of play, the security of these games is enhanced by reducing the opportunity for dealer card manipulation. The Company's single deck shufflers also minimize dealer errors in delivering the proper number of cards and speed up game play. Since its introduction in 1999, sales and lease placements of the Company's ACE(R), its newest single deck card delivery system, have grown significantly. Unlike the BG models, the ACE(R) does not shuffle cards in a mechanical manner that mimics a hand shuffle. Instead, the ACE(R) sorts cards into shelves on a vertically moving elevator in random order according to computer generated instructions. Software instructs the ACE(R) to put the appropriate number of randomly selected cards in each shelf as necessary to create the required hands for the specific game being played. Shelves then dispense the hands in random order. Hands are delivered more quickly than the Company's BG model single deck shufflers. The ACE(R) is smaller, has fewer moving parts, requires less service, has a universal power supply for international electrical power requirements, is easily programmable by casino pit personnel to be used with a variety of single deck games, and tracks and displays usage and hands played data for the casino operator. * MULTI-DECK BATCH. The Company's MD series multi-deck card shufflers shuffle a batch of two to eight decks of cards at a time, primarily for blackjack or mini-baccarat table games. When the shuffling of a batch is complete, the dealer then manually unloads the batch of shuffled decks and places the batch into a standard card shoe. The multi-deck shuffler is then available to shuffle a second batch of cards while the first batch is played. The majority of blackjack games are played with multiple decks of 2 ITEM 1. BUSINESS (CONTINUED) cards. Certain jurisdictions require that blackjack be played with four or more decks. The Company estimates that blackjack tables represent approximately 70% of casino table games, excluding poker rooms. * MULTI-DECK CONTINUOUS. During fiscal 2000, the Company introduced its next generation multiple deck card delivery system, the King(TM), which continuously "reshuffles" cards immediately after they are played using a similar sorting process as the ACE(R). Designed for use with multi-deck blackjack and mini-baccarat table games, the King(TM) is based on the same basic design and chassis as the ACE(R). The continuous model uses a larger elevator with more shelves and an integrated mechanical shoe. Cards played in any given hand are collected by the dealer at the completion of the hand, reloaded into the machine and immediately sorted in random order. Cards are then mechanically delivered into the shoe when sensors in the shoe call for additional cards. The speed of the shuffling and delivery action allows the shoe to operate with only a small buffer of cards, and the machine can shuffle cards quickly enough to keep up with the normal pace of dealing hands. The lack of visibility of cards and the possibility that cards dealt in one hand might be re-dealt in the next hand virtually eliminates card counting and tracking. The Company believes that casino demand for its continuous shufflers will continue to be driven by interest in improved game security and table productivity. In fiscal 2001, the Company further expanded its range of continuous shuffling methods and designs by purchasing the QuickDraw(R) product line and related intellectual property. DISTRIBUTED EQUIPMENT. Prior to early fiscal 2001 the Company distributed, serviced and shared in the profits from the lease and sale in the U.S. and the Caribbean of TCS America, Inc.'s' Chipper Champ(TM) chip sorting product line and certain other TCS products. Chipper Champ(TM) machines sort chips at roulette tables and serve both to save labor and add security by detecting counterfeit chips. This business arrangement was phased out early in fiscal 2001. GAMING PRODUCTS TABLE GAMES. The Company first began offering table games to increase demand for its shuffler line. Driven primarily by the success of Let It Ride(R) and Three Card Poker(R), table games accounted for approximately 32% of the Company's revenue in fiscal 2001. For fiscal 2001, all of the Company's table game products were licensed to casinos for a fixed monthly license fee. The Company markets the following table games to casinos: * LET IT RIDE(R). The basic Let It Ride(R) table game is a patented five card stud poker game in which players are paid according to a fixed payout schedule. Players place three separate, but equal bets and are dealt three cards face down. Two community cards are also dealt face down in front of the dealer. After looking at their cards, players then have the option to withdraw their first bet. The dealer then turns over one of the community cards, which becomes a common fourth card to all players at the table, and the players each have the opportunity to withdraw their second bet (the third bet always remains on the table and cannot be withdrawn). The dealer then turns over the second community card, which becomes a common fifth and final card to all players and winning hands are paid according to a predetermined payout schedule. The Let It Ride(R) basic game was approved by the Nevada Gaming Control Board in August 1993 and the Company began licensing it to casinos in October 1993. As of October 31, 2001, the basic Let It Ride(R) table game was approved for play in 36 United States gaming jurisdictions in 25 states, seven Canadian provinces and 19 other foreign countries. * LET IT RIDE BONUS(R). The Let It Ride Bonus(R) game was introduced in August 1997 and provides a format that adds a bonus bet and paytable bonuses to the basic Let it Ride(R) table game. It is played in the same manner as the basic game except that the player has an option to make an additional $1 side wager, also known as the bonus bet. The bonus bet qualifies the player to be eligible to receive large bonus payouts from a separate payout schedule, in addition to the underlying payouts of the basic game. Participation data gathered in 2000 indicated that participation percentages in the bonus bet in major gaming venues were in excess of 85%. As of October 31, 2001, the Let It Ride Bonus(R) game was approved for use in 31 United States gaming jurisdictions in 22 states, including all major gaming markets, as well as five Canadian provinces, and eight other foreign jurisdictions. * LET IT RIDE THE TOURNAMENT(R). This version of Let It Ride(R) was launched in May 1999. In Let It Ride The Tournament(R) players were eligible for both bonus payouts and the opportunity to advance to a multi-round playoff. Formerly offered on a company-sponsored jurisdiction-wide basis in Nevada and Mississippi, the Tournament is now offered only as requested by casino customers who wish to host a playoff event and is currently operated on a continual basis in only one tribal casino. The Company generates revenue from this tribal casino on a monthly fixed-fee basis. The casino is solely responsible for payout of the Tournament cash awards. 3 ITEM 1. BUSINESS (CONTINUED) * THREE CARD POKER(R). The Company acquired the rights to Three Card Poker(R), a patented table game, in May 1999. In this game, players place wagers on three card stud hands, with options to bet against the dealer, bet on the value of their own hand, or both. Winning hands are paid according to a pre-determined payout schedule and bonus payouts may be earned on certain hands when wagering against the dealer. As of October 31, 2001, the Three Card Poker(R) game was approved for use in 35 United States gaming jurisdictions in 25 states, three Canadian provinces, and three other foreign jurisdictions. SLOT MACHINE OPERATING SYSTEM. In fiscal 2000, the Company completed the development of the first generation of its open-access slot machine operating system and began licensing the system to third party game developers and manufacturers. In fiscal 2001, the Company focused its development efforts on enhancements to the system. The Company continues to work with current and prospective licensees and has recently begun to generate licensing revenue in early fiscal 2002. The operating system software is used in conjunction with a standard PC-based computer circuit board driving an interface board customized to a particular cabinet. The software is Linux-based and drives game and game machine functions in a manner analogous to the functions of popular operating systems in personal computers. The Company believes that by providing a standard software and firmware environment, which may be used either in new slot machines or, with a specific interface board, to retrofit older slot machines, it will attract the commercial interest of gaming machine manufacturers, game developers and casino operators. The standardized development environment is expected to allow game developers to bring new slot games to the market in a more cost effective and timely manner. The Company expects that the system will allow casino operators to update existing machines with new games and technology relatively inexpensively, and extend the useful life of machines by allowing for the sequential use of multiple games on the same machine. The Company expects to continue to generate revenue from the operating system by charging a daily or annual fee for a use license that includes maintenance and upgrades for the system and may in the future generate revenue from selling a particular version of the operating system without maintenance or upgrades. Installations of the operating system are expected to be driven by the Company's ability to procure and/or develop and market games to be used in retrofitting older slot machines, by the Company marketing new proprietary or custom designed games directly to casinos, and by third party licensees marketing their own games using the operating system. The Company believes that the success of its operating system plans will depend primarily on its ability to demonstrate, to the satisfaction of OEM customers and game developers, the functionality and efficiency of the operating system for developing games, and on the Company's ability to procure sources of games, and/or develop games for the operating system internally. To demonstrate the capabilities of the operating system, the Press Your Luck(TM) video slot game was developed by the Company and launched in fiscal 2000. Contract vendors manufacture the cabinets and components for Press Your Luck(TM), and final assembly work is completed in the Company's Las Vegas, Nevada manufacturing facility. Additional operating system-based games are in development by the Company and third party developers. SLOT GAMES. The Company develops and markets game concepts and software programs for use on slot machines, either on its own or through agreements with third parties. Actively marketed products include Press Your Luck(TM), The Three Stooges(R), Let's Make A Deal(R), and The Honeymooners(TM). The Company is developing (either on its own or in cooperation with IGT) or awaiting gaming approval on a number of additional game products for future commercialization, including extensions of The Three Stooges(R), Let's Make A Deal(R) and first versions of Hollywood(TM) and Bigfoot(R). Slot game revenue accounted for slightly less than 10% of the Company's revenue in fiscal 2001. Descriptions of revenue-generating slot products follow: * LET'S MAKE A DEAL(R), THE THREE STOOGES(R) AND THE HONEYMOONERS(TM). During fiscal 2001, the Company and IGT received approvals for Let's Make A Deal(R), The Three Stooges(R), and The Honeymooners(TM) slot games in multiple markets. The Company commenced marketing of these games following approval and has made progress installing each game. Approvals in additional regulatory jurisdictions are expected in fiscal 2002. * PRESS YOUR LUCK(TM). In fiscal 2000, the Company received approvals in multiple markets for Press Your Luck(TM), its first video wagering game that runs on the Company's own operating system and platform. The Company continues to market Press Your Luck(TM) and has updated the game since first introduction. * FIVE DECK POKER(R). Originally purchased in 1997 as part of the acquisition of a slot games library from Dr. Mark Yoseloff (now a Director and Chairman-elect of the Company), Five Deck Poker(R) is a variation of video draW poker that deals cards in each of the five card positions on the screen from a separate and independent deck. The possibility of suited hands that is not available in single deck video poker, such as a suited three of a kind, allows a greater variety of winning poker hands and greater frequency of middle pay hands. Five Deck Poker(R) games are installed in New Jersey, Nevada, Connecticut and Minnesota. 4 ITEM 1. BUSINESS (CONTINUED) Games in development and expected to be introduced in fiscal 2002 include: * OTHER OPERATING SYSTEM-BASED GAMES. In October 2001, at the Global Gaming Expo, the Company showcased a variety of slot games running on its new operating system. The Company expects to obtain initial gaming regulatory approvals for certain of these games in time for market introduction during fiscal 2002. The Company anticipates that it will use a variety of gaming machine cabinets for these games, all configured using the Company's operating system. Individual slot games may be marketed in new cabinets purchased from slot machine manufacturers or by retrofitting casino-owned slot machines with Company supplied electronics and software. * S+ AGREEMENT. Under its settlement agreement with IGT, the Company is permitted to retrofit, with operating system based games, up to 15,000 IGT S+ model reel slot machines over a multi-year period. The Company's agreements with IGT are subject to certain limitations. * BUDWEISER(R) GAMES. In fiscal late 2002, the Company plans to introduce its first games related to A licensing agreement with Anheuser-Busch, Inc. The Company expects that there will ultimately be a variety of games under this agreement, on both reel and video slot machine platforms. Some games may be programmed cooperatively with third parties, while others may be programmed by Company staff. PRODUCT - RELATED AGREEMENTS The Company has historically entered into licensing and cooperative development, manufacturing and marketing agreements with various participants in the gaming supply industry and with licensors of intellectual property applicable to the Company's gaming supply business. The Company expects that it will continue to pursue such arrangements to the extent it expects to derive a strategic and/or financial benefit. The listing below, while not exhaustive, provides an overview of such agreements and arrangements that were of benefit to the Company in fiscal 2001 or may be of potential future benefit, though they may not represent material income, in either case. Most individual entertainment theme licenses entered into by the Company have been excluded from this listing due to their similar nature (involving payment of royalties by the Company in exchange for use of specified intellectual property for game products) and earlier disclosure, or because they remain confidential. * ANHEUSER-BUSCH LICENSE AGREEMENT. In November 2001, the Company entered into a licensing agreement with Anheuser-Busch, Inc. ("A-B") enabling the Company to use certain trademarks and copyrights relating to A-B and the Budweiser(R) brand in slot machines in licensed gaming establishments in the United States. The agreement provides that A-B will be compensated with daily royalties based on slot games placed in service. * RECREATIVOS FRANCO, S.A. LICENSE AND SUPPLY AGREEMENTS. In January 2001, the Company entered into an agreement with Recreativos Franco, S.A. ("Franco"), a Spanish corporation, permitting the Company to use Franco's library of games on the Company's slot machine operating system in non-Native American jurisdictions in the United States and Canada. For new machines using licensed Franco games, the Company has agreed to purchase slot machine cabinets from Franco. As payment for use of intellectual property associated with the licensed games, the Company will share gross profits from the games equally with Franco. * LICENSING, DEVELOPMENT, MARKETING AGREEMENTS WITH IGT FOR LET'S MAKE A DEAL(R), THE THREE STOOGES(R) AND THE HONEYMOONERS(TM). In July 2000, the Company entered into agreements that granted a license to IGT to develop aND manufacture gaming machines based on these television game and comedy shows. Under the agreements, IGT developed the games for, and manufactures the games for use on, IGT's 80960 igame(TM) platform, and the Company markets tHE games in North America (except for The Three Stooges(R) in the state of Washington). After the Company and IGT each recover certain expenses, the revenues generated from these games are split equally between the Company and IGT in consideration of resources and services provided by each. * SLOT GAME OPERATING SYSTEM AGREEMENTS. The Company has entered into license agreements for its operating system with Mikohn Gaming Corporation ("Mikohn") and Fleetwood Manufacturing, Inc. ("Fleetwood"). These agreements provide that the licensees may use the Company's operating system to program and operate gaming devices and, in return, will pay the Company a 5 ITEM 1. BUSINESS (CONTINUED) fixed rate per machine per day for each revenue-generating gaming device in which the operating system is used. The Company is responsible for the maintenance and upgrade of the operating system. Revenue was first generated by the Fleetwood license in early fiscal 2002, and the Company seeks to secure additional licensees and revenues for the use of its operating system. * CROSS-LICENSING AND CROSS-SUPPLIER AGREEMENTS WITH MIKOHN. Under these agreements the Company receives approximately $580,000 per year from Mikohn through fiscal 2004 for the license by the Company to Mikohn of certain intellectual property. The Company has also entered into cross-supplier agreements covering the purchase of shufflers from the Company by Mikohn and the purchase of signage, controllers, and table game displays from Mikohn by the Company. * LICENSING AGREEMENT WITH IGT. In October 1998, the Company entered into a licensing agreement with IGT that allows the Company to develop and market its games for use on IGT slot machine platforms. In exchange for the license the Company pays IGT a royalty based on a percentage of revenue generated by the Company's games installed on IGT slot machine platforms. The Company is currently leasing Five Deck Poker(R) games under thiS agreement. * LET'S MAKE A DEAL(R) LICENSE AGREEMENT WITH BALLY GAMING, INC. ("Bally"). In April 1998, the Company entereD into a joint marketing agreement with Bally to market a video slot version of Let's Make A Deal(R), the popular anD long-running television game show hosted by Monty Hall. In August 2000, the Company amended this agreement to make the license of intellectual property under this agreement non-exclusive. The Company receives a preferential share of game net operating profits and has rights to sell Let's Make A Deal(R) slot machines back to Bally at the Company's adjusted net book value. CUSTOMERS AND MARKETING The Company created the market for shufflers with the introduction of its innovative product line in 1992, focusing its early marketing efforts in Nevada casinos. Today the Company's shuffler products are broadly placed in casinos domestically and internationally. As of October 31, 2001, the Company had placed its game equipment and gaming products in over 540 casinos throughout the world. The Company leases and sells its shufflers to casinos and other lawful gaming establishments. As part of its strategy to maintain and expand its market position in the automatic shuffler business, the Company has made a commitment to maintain a high level of service to its customers. For casinos within the Company's service areas, the Company provides regular preventive maintenance service and on-demand repair service on its leased equipment. The Company also provides service training to its lease customers' personnel as well as a reasonable number of back-up shuffler units to the lessee. To customers that purchase shufflers, the Company offers a service contract that provides service benefits similar to that on leased units, or a parts warranty contract. The Company's table game product line includes Let It Ride(R) and Three Card Poker(R). The Let It Ride(R) TABle game was introduced to the gaming market in Nevada in 1993, and has become an established specialty game due to its broad appeal to players who enjoy a more casual, social card game, or who are new to or intimidated by table games. In North America, the Company markets the different versions of the game directly to casinos. In selected international jurisdictions, the Company markets the game through its international distributor, Technical Casino Supplies, Ltd. ("TCS"). In May 1999, the Company acquired Three Card Poker(R), which the CompanY believes to be the fastest growing (in revenues) table game in the casino industry. The game is marketed in the same manner as the Company's other table games. In fiscal 2000, the Company began marketing Three Card Poker(R) internationally. In North, Central and South America, Shuffle Master sells and services its shuffler, table game and slot products through its own direct sales force and service department. As of October 31, 2001, the Company had 15 sales employees and 80 service employees, with 53 service employees in 21 field locations and 27 service employees based in the Company's Las Vegas facility. In the Eastern Hemisphere, service on the Company's products is performed by TCS and TCS' related companies. The Company's detailed marketing and distribution plans for its slot operating system are being developed in conjunction with the evolution of the technology and changing business conditions. The Company's business plans involve establishing multiple points of market entry for its operating system, including direct and OEM channels for placement and use of the operating system in new slot machines and in older slot machines through retrofit installations. In order to market its products, the Company is subject to jurisdictional licensing requirements, and must obtain approvals for all of its products. The Company intends to apply for future approvals or clearances where it believes sufficient demand for products exists. See additional discussion under "Regulation." 6 ITEM 1. BUSINESS (CONTINUED) EXPORT SALES In fiscal 2001, 2000, and 1999, the Company had export shuffler sales and shuffler lease revenue, primarily to Canada and Australia, which totaled 18%, 22%, and 17% respectively, of total revenue. PRODUCT SUPPLY OPERATIONS The Company's product supply operations consist primarily of the procurement, assembly, warehousing and shipment of shufflers, Let It Ride Bonus(R) tables, slot machines, slot machine operating system conversion kits, and associated parts and equipment. Parts include off-the-shelf items as well as components manufactured to the Company's specifications. The Company also manufactures a small number of parts in house, using its own machine tools. Parts are used for product assembly as well as service needs. Slot product supply operations include procuring slot machines, slot machine cabinets and associated equipment for lease or sale as required for the business, and also include procuring and stocking parts needed to retrofit casino-owned machines for new games. The Company strives to ensure that multiple suppliers exist for critical components, and periodically solicits bids from various suppliers to ensure competitive pricing. Purchasing, warehousing, quality control, final assembly and shipping are conducted primarily at the Company's Las Vegas, Nevada facility, although small inventories are maintained and repairs are performed by the Company's field service organization. RESEARCH AND DEVELOPMENT The Company believes that one of its strengths involves identifying new product opportunities and developing new products anywhere from the conceptual stage through to commercialization. The Company believes it has achieved a reputation for innovation and service, based on its development and the market success of its shuffler and table game products, and most recently, its development of a PC and Linux-based slot machine operating system. The Company expects to continue to spend a significant portion of its annual revenues on research and development, including the acquisition of intellectual property from third parties. GAME EQUIPMENT. The Company employs a staff of electrical, mechanical and software engineers to improve and upgrade its existing products and to develop new products. The engineering staff has extensive experience in card shuffling requirements and solutions and, excluding the conceptual beginning of the first single deck shuffler, has been instrumental in the development of all of the Company's shuffler products. During fiscal 2001, substantial progress was made on continuing development of the Company's shuffler products, resulting in further enhancement of the King(TM) continuous shuffler and progress in the design of future shuffler products, such as the Deuce(TM), a model targeted for the poker room market and adapted from design concepts acquired in the Company's purchase of the QuickDraw(R) shuffler line. Resources will continue to be allocated to such projects to support the Company's efforts to maintain and enhance its market leader position. GAMING PRODUCTS. In fiscal 2001, the Company's gaming product development group continued to improve and enhance its new slot game operating system, developed gaming-related technology and slot game concepts internally, and fostered development by third party game partners. The Company's game development efforts include work in market research, creative game design, game programming, prototype development, and statistical paytable evaluation and design. Operating system work includes efforts in core software, protocol and driver programming, development kit programming and documentation, and game programming. With significant emphasis on new gaming products as a future revenue source, the Company expects to increase the resources devoted to game, protocol and gaming technology development. Overall, the Company is committed to developing innovative products for the gaming market, as well as continuously testing and upgrading its existing products. The Company anticipates that research and development will continue to account for a significant portion of its total expenditures. Research and development expenses were $6,021,000, $4,958,000 and $3,468,000 in fiscal 2001, 2000, and fiscal 1999 respectively. 7 ITEM 1. BUSINESS (CONTINUED) COMPETITION GAME EQUIPMENT. Several other companies have developed automatic card shufflers and the Company believes that those companies are continually working to obtain regulatory approval and commercial placement of their equipment. In recent years, several competitive shuffler products have been placed in casinos in modest quantities, including those offered by Casinos Austria Research and Development (an Austrian company marketing the Shuffle Star continuous shuffler), Gaming Products (an Australian business that markets and manufactures the QuickDraw(R) continuous shuffler and was purchased in April 2001 by the Company) and Casinovations (a U.S. company marketing a multi-deck batch shuffler). While reliable information on all competitive placements is not practically obtainable, the Company believes that no product has achieved worldwide placements in excess of 600 units. The Shuffle Star has no substantive presence in the U.S., while Casinovations has little presence outside the U.S. In general terms, competition has achieved placements by offering products at prices that are often lower than the Company's prices. The Company believes that it has the only complete line of shuffler products, including single deck, multi-deck batch and multi-deck continuous shufflers, and that its products provide higher levels of reliability and security. In addition, the Company's shuffler products are supported by a national and international service network that other companies cannot easily duplicate. These beliefs notwithstanding, the Company cannot provide assurances that a competitive product will not gain substantial placements in the future. GAMING PRODUCTS. The success of table games such as Let It Ride Bonus(R), Let It Ride(R) basic and Three Card Poker(R) and slot games such as the Company's The Three Stooges(R), Let's Make A Deal(R), The Honeymooners(TM), PresS Your Luck(TM) and Five Deck Poker(R), depend not only on casinos deciding to use such products, but also on acceptance By players. Player acceptance of a game often correlates to the frequency and amount of money returned during play, as well as the availability and appeal of the game compared to other games. In general, there are continual efforts by small companies and entrepreneurs to develop and market table games. The Company's major competitor in specialty table games is Mikohn, which markets the Caribbean Stud(R) Poker game through its Progressive Games, Inc. subsidiary. The Company believes that there are fewer than 900 Caribbean Stud(R) Poker tables worldwide. The marketing of slot games to the casino industry is highly competitive. A number of the Company's slot game competitors and potential competitors have significantly greater research, development, manufacturing and marketing capabilities and have greater financial and personnel resources than the Company. The competitive environment relating to slot game operating system software is constantly evolving and difficult to observe. The Company is aware that a number of large, well established slot machine manufacturers are developing or have developed PC-based hardware and software platforms that may directly or indirectly compete with the Company's slot machine operating system. The Company is unable to compare its technology to that of its potential competitors because such competing technology is not yet in the marketplace and is generally kept confidential. The Company is not aware of any other competitor that has introduced or announced plans to offer a standardized software and hardware platform that is open to all potential users and that is applicable to a variety of gaming machines, new or used. To use the Company's operating system in a given slot machine, it is necessary for the Company to create the electronic interface boards and software interfaces to operate the components in a particular machine design. While no assurance can be given, the Company believes that slot machine manufacturers that depend on new slot machine sales for revenue growth are unlikely to pursue the Company's strategy of marketing an open access, industry standard operating system because of the likelihood that such a strategy would reduce new machine sales. PATENTS AND TRADEMARKS PATENTS. Since 1989, the Company and its subsidiaries have been awarded or have acquired 36 United States utility patents, two United States design patents and 29 international patents related to its shuffler and game technologies. Products protected in whole or in part by these patents include the BG single deck shufflers, the MD multi-deck shufflers, the ACE(R) single deck shuffler, the King(TM) and QuickDraw(R) continuous shufflers, Let It Ride(R) stud poker, Five Deck Poker(R), Three Card Poker(R), the Yoseloff proprietary reel mapping algorithm, video game play scoring methods, a variety of new games that have not yet been introduced, and some additional bet detection and card shuffler technology. Most of these patents have a life of 20 years from the date the patent application was filed. No patent will expire before the year 2007. Ten new U.S. utility patents, and two international patents were issued to the Company in fiscal 2001 and it expects to continue its current trend of receiving more patents in fiscal 2002 than were issued to it in fiscal 2001. Patent applications filed in 8 ITEM 1. BUSINESS (CONTINUED) 2001 seek protection for innovations and improvements in card handling technology, slot and video game system architecture, live table game equipment and game play methods. No assurance can be given that any such patents will issue, or that the patents currently held or new patents that may issue will be valid or will provide any competitive protection for the Company's products. TRADEMARKS. The Company owns 30 federal trademark registrations in the United States and 44 international trademark registrations including U.S. and/or foreign registrations for Let It Ride(R), Let It Ride Bonus(R), Let It Ride The Tournament(R), Three Card Poker(R), Shuffle Master Gaming(R), ACE(R), QuickDraw(R) and others. The Company currently has 41 pending U.S. trademark applications, as well as numerous foreign trademark applications. The Company has sought protection for a number of names it plans to use in the future. INFRINGEMENT AND INTELLECTUAL PROPERTY PROTECTION. The Company is not aware that any of its card handling products, game play methods or operating system technology infringe the patents and other intellectual property rights of others. In addition to patents, the Company protects much of its intellectual property with copyrights, trademarks and non-disclosure agreements. No assurance can be given that the Company will be successful in maintaining the confidentiality of its proprietary information. In the absence of a valid patent, copyright, trademark or trade secret protection, the Company would be vulnerable to competitors who would lawfully attempt to copy the Company's products. EMPLOYEES As of December 31, 2001, the Company had 218 full-time, four part-time and two temporary employees. The Company is not subject to any collective bargaining agreement and believes that its employee relations are good. REGULATION OVERVIEW. The manufacture, sale, lease, license and distribution of the Company's products require various licenses, permits and approvals and the Company is subject to laws and regulations by authorities in most jurisdictions in which its products are used by persons or entities licensed to conduct gaming activities. The gaming regulatory requirements vary from jurisdiction to jurisdiction, and licensing, other approval or finding of suitability processes with respect to the Company and its management, can be lengthy and expensive. Generally, each product must also be reviewed and approved by each gaming authority. The detail and extent of the review process 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. In general, gaming regulatory authorities may deny applications for licenses, other approvals or findings of suitability for any cause they may deem reasonable. The Company is licensed as a manufacturer and distributor of gaming devices, an operator of inter-casino linked systems and a slot route operator in Nevada. The Company is a gaming related casino service industry licensee in New Jersey and holds supplier, manufacturer and/or distributor licenses in numerous other jurisdictions throughout North America. Most Company licenses must be renewed annually. The Company has never been denied a license, permit or approval necessary to do business in any jurisdiction. Although approvals for the Company's current products have been granted by gaming regulatory agencies, there can be no assurance that the Company, its current or future products or its management personnel will receive nor maintain any necessary gaming licenses, other approvals or findings of suitability. SHUFFLERS. The Company has obtained approvals for its shuffler products in 52 jurisdictions in North America and has filed for approval of its shuffler products and related software in certain other jurisdictions. The Company's card shufflers and related software are classified and approved as associated equipment in Mississippi, Louisiana, Illinois, and a number of other jurisdictions and as gaming equipment in Nevada, New Jersey, Missouri and Iowa. 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 to meet licensing or suitability requirements prior to or concurrent with the use of such equipment in the respective jurisdiction. Gaming equipment is defined in New Jersey as "any electronic, electrical, or mechanical contrivance or machine used in connection with gaming or any game." Although the classification of the shufflers vary among jurisdictions, most, if not all, jurisdictions require specific hardware and software approvals and certain licenses or permits to be held by companies, their key personnel, and service technicians in connection with the manufacture, distribution, service, and repair of such equipment. TABLE GAMES AND RELATED EQUIPMENT. The Company has developed the Let It Ride(R) basic and the Let It Ride Bonus(R) table games. The basic Let It Ride(R) game is approved in all major gaming markets in North America and numerous other gaming 9 ITEM 1. BUSINESS (CONTINUED) jurisdictions. The Let It Ride Bonus(R) table game, including the rules of play and related equipment, is approved in 38 jurisdictions in North America and the Company has filed for additional approvals in certain other jurisdictions. Apparatus related to the Let It Ride Bonus(R) table game is regulated in Nevada, Mississippi, New Jersey and most other jurisdictions as associated equipment. Three Card Poker(R) is approved for use in 39 jurisdictions in North America and submitted for approval in certain others. Similar approvals are required before the Company's additional table games in development and apparatus related to such table games can be marketed. The Company conducts business only in those jurisdictions where it has secured required approvals for its products. SLOT GAMES. Most, if not all, gaming authorities classify the Company's slot game machines and software as gaming devices. A gaming device is generally defined as a video slot or video machine or mechanical, electrical device the operation of which, upon payment of consideration, entitles a person to receive something of value. Although the regulations may vary by each jurisdiction in which the Company distributes its slot products, there are approval, reporting, and notice requirements common to all major gaming markets in North America. Additionally, slot game machines and software are classified as gambling devices under federal law. The Company is registered pursuant to the Federal Gambling Devices Act of 1962 (the "Federal Act"). The Federal Act makes it unlawful for a person or business entity to manufacture, deliver, receive, operate, lease or sell gambling devices in interstate or foreign commerce unless that person or entity has first registered with the Attorney General of the United States. In order to manufacture, sell, deliver or operate certain of its current and proposed products, the Company must renew its federal registration annually. In addition, various record keeping and equipment identification requirements are imposed by the Federal Act. Violation of the Federal Act may result in seizure and forfeiture of the equipment, as well as other penalties. GENERAL REGULATION OF STOCKHOLDERS OF PUBLICLY TRADED CORPORATIONS. In most jurisdictions, any beneficial owner of the Company's common stock is subject, on a discretionary basis, to being required to file applications with gaming regulatory authorities, and undergo investigation to be found suitable or qualified as such. The gaming laws and regulations of most jurisdictions provide that beneficial owners of 5% or more of the Company's common stock are subject to certain reporting procedures and may be subject to background investigations, including submission of personal and financial information required in order to be licensed, qualified or found suitable as such. ADDITIONAL NEVADA REGULATORY MATTERS. The Company is 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. The Company has registered with the Nevada Commission as a publicly traded corporation in addition to being 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 gaming laws were violated by the Company, the approvals and licenses it holds could be limited, conditioned, suspended or revoked, and the Company and the persons 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, table game or associated equipment manufactured, distributed, leased, licensed or sold in Nevada must first be approved by the Nevada Board and, in most cases, the Nevada Commission. The Company 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. Changes in legislation or in judicial or regulatory interpretations could occur which could adversely affect the Company. Officers, directors and certain key employees of the Company 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 issuing agency. Changes in 10 ITEM 1. BUSINESS (CONTINUED) certain key positions must be reported to the issuing agency. 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 who the authorities find unsuitable to act in such capacities. The Nevada Commission may also require anyone having a material relationship or involvement with the Company 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. Any person who acquires more than 5% of the Company's voting securities must report the acquisition to the Nevada Commission; any person who becomes a beneficial owner of 10% or more of the Company's voting securities will be 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 15% of the Company's 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. An Institutional Investor will not be deemed to hold voting securities for investment purposes unless 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 the Board of Directors of the Company, any change in the Company's corporate charter, bylaws, management, policies or operations of the Company, or any of its gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding the Company's 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. The same restrictions apply to a record owner if the record owner, after request, 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. The Company is subject to disciplinary action if, after it receives notice that a person is unsuitable to be a security holder or to have any other relationship with the Company, the Company: (i) pays that person any dividend or interest upon voting securities of the Company; (ii) allows that person to exercise, directly or indirectly, any voting right conferred through securities held by that person; or (iii) gives remuneration in any form to that person. If a security holder is found unsuitable, the Company may itself be found unsuitable if it fails to pursue all lawful efforts to require such unsuitable person to relinquish his or her voting securities for cash at fair market value. Additionally, the Clark County (Nevada) authorities have taken the position that they have the authority to approve all persons owning or controlling the stock of any corporation controlling a gaming license. The Nevada Commission has also advised the Company that it may, in its discretion, require holders of a debt or equity security of a corporation registered under the Nevada Act to file applications, be investigated and be found suitable to own the debt or equity security of a registered corporation. 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, the registered corporation may be sanctioned, including the loss of its approvals, if, without the prior approval of the Nevada Commission, it: (i) pays to the unsuitable person any dividends, interest or any distribution whatsoever; (ii) recognizes any voting right by such unsuitable person in connection with such securities; (iii) pays the unsuitable person remuneration in any form; or (iv) makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction. The Company is 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 its stockholders. The Nevada Commission has the power to require the Company's 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 the Company. The Company may not make certain public offerings of its securities without the prior approval of the Nevada Commission. Also, changes in control of the Company 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 of the Nevada Commission. Approvals are required from the Nevada Commission before the Company can make exceptional repurchases of voting securities above the current market price thereof and before a corporate acquisition opposed by management can be consummated. Nevada's gaming regulations also require prior approval by the Nevada Commission if the Company were to 11 ITEM 1. BUSINESS (CONTINUED) adopt a plan of recapitalization proposed by the Company's Board of Directors in opposition to a tender offer made directly to its shareholders for the purpose of acquiring control of the Company. OTHER JURISDICTIONS. All jurisdictions that have legalized gaming require various licenses, permits and/or approvals for and reporting of certain transactions by manufacturers and distributors of gaming devices, table games and associated equipment. In general, such requirements are similar to those of Nevada. APPLICATION OF FUTURE OR ADDITIONAL REGULATORY REQUIREMENTS. In the future, the Company intends to seek the necessary licenses, approvals and findings of suitability for the Company, its products and its management personnel in other jurisdictions where significant sales are anticipated to be made. However, there can be no assurance that such licenses, approvals or findings of suitability will be obtained and will not be revoked, suspended or conditioned or that the Company will be able to obtain the necessary approvals for its future products as they are developed in a timely manner, or at all. If a license, approval or finding of suitability is required by a regulatory authority and the Company fails to seek or does not receive the necessary license or finding of suitability, the Company may be prohibited from distributing its products for use in the respective jurisdiction or may be required to provide its products through other licensed entities at a reduced profit to the Company. ITEM 2. PROPERTIES The Company leases an approximately 32,000 square foot facility in Nevada for substantially all of its business activities, except shuffler machine and table game apparatus research and development, which operates out of an approximately 5,000 square foot facility in Minnesota and for slot operating system and game software research and development, which operates out of an approximately 6,700 square foot facility in Colorado. As a result of the Company's acquisition of Gaming Products in April 2001, the Company also leases a 4,200 square foot facility in Queensland, Australia for the production of QuickDraw(R) shufflers. The Company continues to maintain an office in Minnesota, following completion of the consolidation of its facilities in Nevada in 1998. The Company also leases space for service centers in various locations in the United States and Canada. The Company believes that its existing properties are suitable and adequate for its current needs. ITEM 3. 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. In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and regulatory government investigations. The Company believes that the final disposition of these matters will not have a material adverse effect on its financial position, results of operations or liquidity. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended October 31, 2001. 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS STOCK LISTING The Company's common stock is traded on The Nasdaq Stock Market under the symbol SHFL. As of January 24, 2002, there were 295 shareholders of record. There are a significantly greater number of shareholders whose shares are held in street name. Based on information collected as of January 18, 2002, the Company estimates that it has 9,100 beneficial holders in total. The following table sets forth quarterly high and low prices for trades of the Company's common stock for the years ended October 31, 2001 and 2000 and that are adjusted to reflect the three-for-two stock splits of the Company's common stock effective in November 2000 and June 2001: 2001 2000 ---------------------------- ---------------------------- HIGH LOW HIGH LOW ---------------------------- ---------------------------- First quarter $ 13.17 $ 7.25 $ 4.39 $ 2.92 Second quarter 19.90 10.08 5.94 3.78 Third quarter 23.30 15.15 7.67 5.11 Fourth quarter 18.80 8.70 10.00 5.83 DIVIDEND POLICY The Company has not paid dividends on its common stock, but has retained its earnings to provide for the Company's future growth. No cash dividends are expected to be paid on the Company's common stock in the foreseeable future. TRANSFER AGENT The Company's 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. 13 ITEM 6. SELECTED FINANCIAL DATA
IN THOUSANDS, EXCEPT PER SHARE AND RATIO AMOUNTS 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED OCTOBER 31, INCOME STATEMENT Revenue $ 47,960 $ 38,860 $ 28,926 $ 27,124 $ 28,736 Income from Operations 17,000 13,149 5,286 4,313 6,686 Net Income from Continuing Operations 11,595 8,537 3,598 3,343 5,122 Net Income 11,595 8,537 3,598 3,343 5,122 Weighted Average Shares Outstanding, assuming dilution 18,518 17,107 17,913 21,945 24,412 AS OF OCTOBER 31, BALANCE SHEET Cash, Cash Equivalents and Investments $ 18,703 $ 6,619 $ 5,641 $ 8,472 $ 16,306 Working Capital 19,290 12,068 7,427 11,352 20,736 Total Assets 52,399 34,614 30,605 28,293 40,726 Long-term Debt -- 97 677 1,217 1,718 Shareholders' Equity 40,566 28,010 21,402 21,895 34,111 Common Shares Outstanding 17,609 16,315 16,818 18,033 22,428 Current Ratio 2.6 2.9 1.9 3.2 5.4 PER COMMON SHARE Earnings per Common Share, basic $ .67 $ .52 $ .20 $ .15 $ .21 Earnings per Common Share, assuming dilution .63 .50 .20 .15 .21 Book Value 2.30 1.72 1.27 1.21 1.52 Dividends Declared -- -- -- -- --
14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OVERVIEW Shuffle Master, Inc. (the "Company") is a supplier of card shuffler products, table and slot games, and gaming related software to the gaming industry. The foundation of the Company's business has been the development, manufacturing and marketing of automatic card shufflers and table games, with slot games and operating system software having been added more recently. The Company's current shuffler offering is available to casinos through either a purchase or lease option, table game products are available on a monthly license basis, and slot games and the Company's operating system are generally offered on a daily fee basis. The Company markets its shuffler products in most domestic gaming jurisdictions directly, and internationally through representatives and a distributor. The Company's lease and licensing of its shuffler, table game and slot products to casino customers involves purchasing inventory for the manufacture and servicing of products and subsequently transferring such inventory to systems and equipment leased. RESULTS OF OPERATIONS FISCAL 2001 COMPARED TO FISCAL 2000 REVENUE AND COST OF PRODUCTS Revenue for fiscal 2001 was $47,960,000, an increase of $9,100,000, or 23.4% from the prior year. This increase was attributable to increased revenue in its two business segments. Shuffler lease revenue was $16,026,000 in fiscal 2001 compared to $13,118,000 in the prior year, an increase of 22.2%. The installed base of shufflers on lease increased by 140 units, or 4.8%, to 3,075 at October 31, 2001, from 2,935 units at October 31, 2000. As of October 31, 2001 the installed lease base of single deck shufflers on lease was 1,937 units, a net increase of 132 units, or 7.3%, between the years. This increase was attributable to the net placement of 245 ACE(R) shufflers on lease in fiscal 2001, offset by a net reduction of 113 BG shufflers, the majority of which were exchanged for ACE(R) shufflers. Included in the total installed lease base of single deck shufflers were 1,862 ACE(R) and 75 BG shufflers as of October 31, 2001. In addition, as of October 31, 2001, the installed lease base of multi-deck shufflers was 1,138 units, an increase of eight units, or 0.7%, between the years. This slight increase relates to the net placement in fiscal 2001 of 95 King(TM) leased shufflers, offset by a net reduction of 87 leased multi-deck batch shufflers. Included in the total installed lease base of multi-deck shufflers were 469 continuous King(TM) shufflers and 669 multi-deck batch shufflers as of October 31, 2001. Shuffler sales in fiscal 2001 increased 34.4% to $10,364,000, compared to $7,709,000 in fiscal 2000. Unit sales totaled 1,050 in fiscal 2001 compared to 770 in fiscal 2000, an increase attributable to the sales of 459 ACE(R), 321 King(TM) continuous and 222 multi-deck batch shufflers. Current year unit sales included sales of 672 units plus 378 units converted to a sale from a lease, as compared to 618 unit sales and 152 conversions in the prior year. The average revenue per shuffler sold decreased to $9,870 in fiscal 2001 from $10,012 in fiscal 2000 due to a change in the mix of shufflers sold toward sales of lower-priced multi-deck shufflers. Revenue from table games increased by $3,024,000 or 24.8% to $15,223,000 in fiscal 2001. Included in this category for fiscal 2001 was revenue from Let It Ride Bonus(R), Let It Ride(R) basic, sales of associated equipment for Let It Ride Bonus(R) and Three Card Poker(R). Let It Ride Bonus(R) table revenue increased by $1,151,000 to $9,628,000 as bonus table counts increased by 7% to 535 at October 31, 2001 from 500 at October 31, 2000. Let It Ride(R) basic table revenue decreased by $277,000 to $1,114,000 as the installed base of basic tables in casinos decreased to 143 at October 31, 2001 from 186 tables as of October 31, 2000. Substantially all of the net decrease in basic tables resulted from casinos converting basic tables to Let It Ride Bonus(R) tables. Three Card Poker(R) revenue increased by $2,057,000 to $3,299,000 in fiscal 2001 as table counts increased by 94.5% to 570 units at October 31, 2001 from 293 units at October 31, 2000. Slot revenue increased by $2,546,000, or 119.2%, to $4,682,000 in fiscal 2001. This increase was primarily due to the rollout in fiscal 2001 of games under the Company's fiscal 2000 slot game agreements with IGT as well as the recording of $1,500,000 in revenue related to other provisions of those same agreements. The two new games introduced under the slot game agreements with IGT, The Three Stooges(R) and Let's Make A Deal(R), added an incremental $915,000 in video slot revenue for 2001 compared to 2000. Additionally, the company earned an incremental $1,058,000 in 2001 compared to 2000 from having a full year of daily fee video slot revenue and operating system fee revenue on its Press Your Luck(TM) game. The installed base of video slot games increased to 720 units at October 31, 2001 from 545 units at October 31, 2000. This installed base included 272 The Three Stooges(R) games and 199 IGT Let's Make A Deal(R) games under the IGT slot game agreements as well as 106 Five Deck Poker(R) games, 92 Press Your Luck(TM) games and 51 Bally Let's Make A Deal(R) games. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Other revenue decreased to $339,000 from $2,508,000 due to the receipt in fiscal 2000 of $1,000,000 in non-exclusive license fees related to the Company's math algorithm technology used in slot game design and the receipt of a $200,000 technology evaluation fee. Additionally, other revenue decreased beginning in January 2001 when the Company sold its interest in the revenue and assets associated with Chipper Champ(TM) machines in January 2001 and stopped recurring related lease and sales revenue. Gross margin increased to 73.9% in fiscal 2001 from 73.1% in fiscal 2000. Excluding the recording of $1,500,000 in revenue related to provisions of the Company's agreements with IGT in fiscal 2001 and the receipt of $1,200,000 in non-recurring license and evaluation fee income in fiscal 2000, gross margin would have been 73.0% in fiscal 2001 and 72.2% in fiscal 2000. This increase in gross margin in fiscal 2001 is attributed to a shift in sales mix toward and higher margins in the Company's gaming products segment, offset slightly by an increase in unapplied manufacturing overhead. OPERATING EXPENSES Selling, general and administrative expenses increased by $2,120,000 or 20.6% to $12,417,000 in fiscal 2001 compared to $10,297,000 in fiscal 2000. The Company incurred $547,000 in administrative costs in its Australian QuickDraw(R) subsidiary after acquiring it in April 2001. Executive costs increased by $503,000 in fiscal 2001 due to the additions of an executive vice president and an additional in-house counsel along with other recruiting expenses. Information system staffing and hardware expenses increased by $365,000 in fiscal 2001 as part of the Company's ongoing program to upgrade the Company's information systems. Compliance, marketing and accounting expenses increased by $267,000, $161,000, and $160,000, respectively, from the prior year due to increased staffing, regulatory licensing, and product approvals in support of the Company's growing product lines. Outside legal expenses increased by $80,000 to $453,000 in fiscal 2001 due to litigation with IGT, which was settled in July 2001, and other pending litigation. Research and development expenses increased by $1,063,000, or 21.4%, to $6,021,000 in fiscal 2001. Substantially all of this increase related to having a full year of increased staffing for video slot game and operating system development, contract programming, and the purchase of development hardware and parts. OTHER INCOME AND EXPENSE Other income, net, was primarily interest income for both years. Interest income increased to $728,000 from $339,000 in fiscal 2001 due to the increase in cash and investment balances during fiscal 2001. Interest expense was $13,000 and $45,000 in fiscal 2001 and 2000, respectively. INCOME TAXES The provision for income taxes was based on an effective tax rate of 34.5% in fiscal 2001 compared to 36.5% in fiscal 2000. This rate decrease reflects a shift of the Company's taxable income to more favorable tax jurisdictions and increased available federal research and experimental credits for fiscal 2001. NET INCOME AND EARNINGS PER COMMON SHARE Net income was $11,595,000, or $.63 per diluted share in fiscal 2001, compared to $8,537,000, or $.50 per diluted share in fiscal 2000. Weighted average common shares - assuming dilution, increased to 18,518,000 shares in fiscal 2001 from 17,107,000 in the prior year due to the exercise of 1,935,000 stock options during fiscal 2001, net of the repurchase of 690,000 shares. The dilutive impact of common stock options outstanding increased by 494,000 shares to 1,293,000 shares as of October 31, 2001 because the average market price of the Company's common stock increased by 153% during the year. The effect of these dilutive options outstanding was to reduce earnings per share by $.04 to $.63 per share for the fiscal year ended October 31, 2001. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) FISCAL 2000 COMPARED TO FISCAL 1999 REVENUE AND COST OF PRODUCTS Revenue for fiscal 2000 was $38,860,000, an increase of $9,934,000, or 34.3% from fiscal 1999. Shuffler lease revenue was $13,118,000 in fiscal 2000 compared to $11,168,000 in the fiscal 1999, an increase of 17.5%. The installed base of shufflers on lease increased to 2,935 at October 31, 2000, from 2,253 units at October 31, 1999, an increase of 682 units, or 30.3%. Lease revenue increased at a lower rate than the unit increase due to both the first full year of the Company's strategy of leasing shufflers to certain customers on a part-time basis and the effect of competitive pricing in certain jurisdictions. As of October 31, 2000 the installed lease base of single deck shufflers on lease was 1,805 units, an increase of 401 units, or 28.6%, between the years. This increase was attributable to the net placement of 882 ACE(R) shufflers on lease in fiscal 2000, offset by a net reduction of 481 BG shufflers, the majority of which were exchanged for ACE(R) shufflers. In addition, as of October 31, 2000, the installed lease base of multi-deck shufflers was 1,130 units, an increase of 281 units, or 33.1%, between the years. This increase relates to the introduction and installation of 374 units of the Company's new continuous multi-deck shuffler, the King(TM), during fiscal 2000. Included in the total installed lease base of multi-deck shufflers were 756 multi-deck batch shufflers as of October 31, 2000, a decrease of 83 units, or 9.9%, from October 31, 1999. Shuffler sales in fiscal 2000 increased 62.6% to $7,709,000, compared to $4,740,000 in fiscal 1999. Unit sales totaled 770 in fiscal 2000 compared to 541 in fiscal 1999, an increase attributable to the sales of 344 ACE(R) and 151 King(TM) shufflers, new products introduced in 1999 and 2000, respectively. Fiscal 2000 unit sales included sales of 618 units and 152 units converted to a sale from a lease, as compared to 430 new unit sales and 111 conversions in fiscal 1999. The average revenue per shuffler sold increased to $10,012 in fiscal 2000 from $8,761 in fiscal 1999 due to a change in the mix of shufflers sold toward domestic sales of higher-priced ACE(R) and King(TM) shufflers. Revenue from table games increased by $2,572,000 or 26.7% to $12,198,000 in fiscal 2000. Included in this category for fiscal 2000 was revenue from Let It Ride Bonus(R), Let It Ride(R) basic, sales of associated equipment for Let It Ride Bonus(R) and Three Card Poker(R). Let It Ride Bonus(R) table revenue increased by $1,651,000 to $8,477,000 as bonus table counts increased by 17.9% to 500 at October 31, 2000 from 424 at October 31, 1999. Let It Ride(R) basic table revenue decreased by $366,000 to $1,391,000 as the installed base of basic tables in casinos decreased to 186 at October 31, 2000 from 233 tables as of October 31, 1999. Substantially all of the net decrease in basic tables resulted from casinos converting basic tables to Let It Ride Bonus(R) tables. Three Card Poker(R) revenue increased by $809,000 to $1,242,000 in fiscal 2000 as table counts increased by 55.9% to 293 units at October 31, 2000 from 188 units at October 31, 1999. Finally, the Company received an incremental $577,000 in fiscal 2000 in royalty income from Mikohn from cross-license agreements. Slot revenue increased by $1,039,000, or 94.7%, to $2,136,000 in fiscal 2000. This increase was primarily due to an increase of $837,000 to $1,170,000 in the Company's share of a full year's revenue from the Let's Make A Deal(R) video slot games jointly owned with Bally Gaming, Inc. Additionally, slot revenue included revenue from The Three Stooges(R), Press Your Luck(TM), and Five Deck Poker(R), as well as revenue from the licensing of the Company's new operating system. The installed base of slot games increased to 545 units at October 31, 2000 from 526 units at October 31, 1999. Other revenue increased to $2,508,000 from $1,189,000 due to the receipt in fiscal 2000 of $1,000,000 in non-exclusive license fees related to the Company's math algorithm technology used in slot game design and the receipt of a $200,000 technology evaluation fee. Gross margin improved to 73.1% in fiscal 2000 from 68.4% in fiscal 1999. Excluding the receipt of $1,200,000 in non-recurring license and evaluation fee income, gross margin would have been 72.2% in fiscal 2000. Gross margin increased due to a shift in product mix in 2000 toward higher margin ACE(R) shuffler and table lease revenue. Additionally, gross margin as a percent of slot revenue increased 39% from fiscal 1999. OPERATING EXPENSES Selling, general and administrative expenses increased by $1,804,000 or 21.2% to 10,297,000 in fiscal 2000 compared to $8,493,000 in fiscal 1999. Sales staffing, commissions and travel increased by $869,000 to $2,331,000 in fiscal 2000, resulting from new hires and increased commissions on increased sales during the year. Performance based incentive compensation increased by $978,000 from the prior fiscal year. Legal expenses decreased $462,000 to $373,000 in fiscal 2000 due to the settlement with Progressive Games, Inc. in December 1999. Also, advertising and promotion expenses increased by $203,000 in fiscal 2000 because of additional expenses incurred for special events and trade shows. Finally, information system staffing, consulting and hardware expenses increased by $201,000 in fiscal 2000 as part of a year-long program to upgrade the Company's information systems. 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Research and development expenses increased by $1,490,000, or 43%, to $4,958,000 in fiscal 2000. Approximately $940,000 of the increase was due to increased staffing, consulting and contract programming for new game and operating system development. Amortization expense of intellectual property increased $405,000 in fiscal 2000 to $1,170,000, due to the effects of having a full year's amortization of intellectual property in the Three Card Poker(R) game and Let's Make A Deal(R) in 2000, as well as introducing The Three Stooges(R) and Press Your Luck(TM) video slot games. Legal expenses related to securing and maintaining domestic and international patents and trademarks increased by $110,000 to $390,000 during fiscal 2000. OTHER INCOME AND EXPENSE Other income, net, was interest income for both years. Interest income decreased to $339,000 in fiscal 2000 from $418,000 in fiscal 1999 due to the decrease in cash and investment balances during fiscal 2000. Interest expense was $45,000 and $81,000 in fiscal 2000 and 1999, respectively. INCOME TAXES The provision for income taxes was based on an effective tax rate of 36.5% in fiscal 2000 compared to 36.0% in fiscal 1999. The fiscal year 2000 provision included a 1.3% benefit from the foreign sales corporation compared to 2.7% in fiscal 1999, due to a decrease in qualified export revenue as a percentage of total revenue. The provision for state income taxes, net of federal tax benefits, decreased to 2.3% from 3.6% in fiscal 1999 as the Company slightly decreased its revenue and profits in states requiring filing and payment of income-based taxes. Additionally, the tax benefit resulting from utilizing the research and experimental tax credit decreased by 0.3% in fiscal 2000. NET INCOME AND EARNINGS PER COMMON SHARE Net income was $8,537,000, or $.50 per diluted share in fiscal 2000, compared to $3,598,000, or $.20 per diluted share in fiscal 1999. Fiscal 1999 net income included royalty settlement expenses of $2,750,000 ($1,760,000 after taxes or $.10 per share). Weighted average common shares - assuming dilution, decreased to 17,107,000 shares in fiscal 2000 compared to 17,913,000 in fiscal 1999 due to the repurchase of 884,000 shares in fiscal 2000. The dilutive impact of common stock options outstanding increased by 709,000 shares to 799,000 shares as of October 31, 2000 because the market price of the Company's common stock increased throughout fiscal 2000 and increased the number of options that could be exercised and converted into common stock equivalent shares. The effect of these dilutive options outstanding was to reduce earnings per share by $.02 to $.50 per share for the fiscal year ended October 31, 2000. RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and hedging activities and is effective for the Company's year ending October 31, 2001. The adoption of SFAS 133 in fiscal year 2001 did not have an impact on the Company's consolidated financial statements. In July 2001, the FASB issued SFAS 141, "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The company does not believe the adoption of SFAS 141 will have a significant an impact on its financial statements. Also in July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets," which is effective November 1, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the statement includes provisions for the reclassification of certain existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The net unamortized goodwill balance at October 31, 2001 was $3,258,000 and goodwill amortization in the year ended October 31, 2001 was $112,000 and would have been approximately $225,000 in 2002 under previous accounting standards. 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective January 1, 2002. SFAS 144 requires that long-lived assets expected to be held longer than one year are subject to depreciation and must be written down to fair value upon impairment. Long-lived assets that are to be sold within one year must be separately identified and carried at the lower of carrying value or fair value less costs to sell. Long-lived assets no longer expected to be sold within one year, such as foreclosed real estate, must be written down to the lower of current fair value or fair value at the date of foreclosure adjusted to reflect depreciation since acquisition. The Company does not believe that the adoption of SFAS 144 will have a significant impact on its consolidated financial statements. LIQUIDITY & CAPITAL RESOURCES FISCAL 2001 COMPARED TO FISCAL 2000 WORKING CAPITAL As of October 31, 2001, the Company had cash, cash equivalents, and investments totaling $18,703,000 compared to $6,619,000 at October 31, 2000. Working capital increased by $7,222,000 to $19,290,000 at October 31, 2001 from $12,068,000 at October 31, 2000. The current ratio decreased to 2.6 from 2.9 at October 31, 2000. The increase in cash and working capital was a result of the Company's increased operating profits during fiscal 2001 and the receipt of proceeds from the issuance of common stock from the exercise of employee and director stock options during the same period. The current ratio decreased as accounts payable increased by $4,192,000 during fiscal 2001 primarily due to payables related to the purchase of slot machines under the fiscal 2000 slot games agreement with IGT. CASH FLOWS Cash flows provided by operations totaled $18,391,000 in fiscal 2001 compared to $9,498,000 in fiscal 2000. Significant items in the cash flows from operating activities in fiscal 2001 include net income of $11,595,000 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 $6,447,000, compared to net income of $8,537,000 and non-cash charges of $6,079,000 in the prior fiscal year. Significant uses and sources of cash flow from operating activities in fiscal 2001 also included an increase in accounts receivable and deferred income of $835,000 and $258,000, respectively, primarily due to increased slot game revenue during fiscal 2001 and deferral of $250,000 in revenue to future quarters under the Company's fiscal 2000 slot game agreements with IGT. Investing activities in fiscal 2001 included the acquisition in April 2001 of certain assets of Gaming Products, an Australian manufacturer of the QuickDraw(R) shuffler product line, for $4,127,000, net of cash acquired. The Company also invested $2,818,000 for gaming equipment and game products leased to customers, new game licenses, and other fixed assets. Additionally, in non-cash transactions, the Company purchased $3,898,000 of slot machines on extended terms from IGT for the fiscal 2001 roll out of The Three Stooges(R) and Let's Make A Deal(R) slot games. The Company also increased its investment portfolio by $11,812,000 to $15,621,000 in the same period. Financing activities during fiscal 2001 included the issuance of 1,935,000 shares of common stock for $9,247,000 upon the exercise of stock options issued to employees and directors under the Company's stock option plans. Additionally, the Company repurchased 690,000 shares of common stock at a cost of $8,568,000. As of October 31, 2001, the Company was authorized to repurchase an additional $1,590,000 of its shares within specified price limits as a result of a 2001 Board of Directors resolution. CAPITAL RESOURCES The Company believes its existing cash, investments and cash provided by operations will be sufficient to finance the Company's current operations and new product development for the foreseeable future. Additionally, the Company maintains a $15,000,000 revolving credit agreement from U.S. Bank, N.A. to provide quick access to funds that might be required for working capital needs related to product rollouts, product or intellectual property acquisitions and share repurchases. The credit agreement matures in October 2003. The Company does not have any long-term debt or capital lease obligations as of October 31, 2001. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) FISCAL 2000 COMPARED TO FISCAL 1999 WORKING CAPITAL At October 31, 2000, the Company had cash, cash equivalents and investments of $6,619,000 compared to $5,641,000 at October 31, 1999. Working capital increased to $12,068,000 at October 31, 2000, compared to $7,427,000 at October 31, 1999, and the current ratio increased to 2.9 at October 31, 2000, from 1.9 at the end of fiscal 1999. The increase in cash, working capital and the current ratio at October 31, 2000 relates to the Company increasing its operating profits while reducing its stock repurchases by $1,325,000 to $3,267,000 in fiscal 2000 and receiving increased proceeds from the issuance of common stock through the exercise of employee stock options by $962,000 to $1,118,000. Additionally, the Company increased the cash component of its working capital by reducing its capital expenditures, including purchases of equipment for lease, property and equipment, and intangible assets, by $816,000 to $5,988,000 during fiscal 2000. CASH FLOWS Cash provided by operating activities was $9,498,000 in fiscal 2000. The significant items comprising such cash provided in fiscal 2000 were net income of $8,537,000 and non-cash charges for depreciation, amortization and valuation provisions of $5,274,000. Deferred income taxes, net, decreased by $775,000, principally due to the fiscal 2000 realization of the income tax deduction for the royalty settlement with Progressive Games, Inc. ("PGI") and the excess of book over tax depreciation and amortization. Changes in operating assets and liabilities included an increase in inventories of $2,195,000 from October 31, 1999 to October 31, 2000. The Company purchased raw materials related to the production of its new continuous multi-deck shuffler, the King(TM), and slot machine finished goods in anticipation of placing Press Your Luck(TM) video slot games. Accounts payable and accrued expenses decreased by $2,173,000 in fiscal 2000 due to the payment of the royalty settlement with PGI and amounts owed to Bally Gaming, Inc. under the Company's amended joint marketing agreement with Bally. Investing activities used $5,658,000 of cash during fiscal 2000. Investments in leased and available for lease assets totaled $4,231,000 and included the transfer from inventory of $3,338,000 in new shufflers and $762,000 in new slot machines purchased. The Company also invested $1,255,000 in intellectual property relating to licenses and patents for slot and shuffler products. Financing activities used $2,506,000 of cash in fiscal 2000. The Company repurchased 589,000 shares of its common stock at a total cost of $3,267,000 during fiscal 2000. Additionally, the Company issued 221,000 shares of stock yielding proceeds of $1,118,000 upon the exercise of stock options by employees. At October 31, 2000, there was an outstanding authorization for share repurchases of up to $2,000,000 of common stock, at specific price limits set by the Board of Directors. CAPITAL RESOURCES The Company did not have any long-term debt or capital leases, except for the debt incurred by the Company to acquire intellectual property from a related party. As of October 31, 2000, the long-term balance remaining under this acquisition was $97,000, compared to $677,000 as of October 31, 1999, a reduction of $580,000 due to payments made in cash and stock during fiscal 2000. IMPACT OF INFLATION To date, inflation has not had a material effect on the Company's operations. 20 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of October 31, 2001, the Company had approximately $15.6 million in investments. The investments are primarily in fixed income and investment grade securities. The Company's investment policy emphasizes return of principal and liquidity and is focused on fixed returns that limit volatility and risk of principal. Because of the Company's investment policies, the primary market risk associated with its portfolio is interest rate risk. Assuming interest rates were to change by 100 basis points, the net hypothetical change in fair value of stockholders' equity related to financial instruments is estimated to be $107,000 after tax (0.26% of total stockholders' equity). The Company believes that such a change in interest rates would not have a material impact on future earnings or cash flows, as it is unlikely that the Company would need or choose to substantially liquidate its investment portfolio. The effect of interest rate risk on potential near-term net income, cash flow and fair value was determined based on interest rate sensitivity analyses. The models project the impact of interest rate changes on a wide range of factors, including duration and prepayment. Fair value was estimated based on the net present value of cash flows or duration estimates, assuming an immediate 1% increase in interest rates. Because duration is estimated, rather than a known quantity, for certain securities and because other market factors may impact security valuations, there can be no assurance that the Company's portfolio would perform in line with the estimated values. As of October 31, 2001, the Company had no borrowings outstanding under its revolving credit agreement. 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA INDEX TO FINANCIAL STATEMENTS PAGE Independent Auditors' Report 23 Consolidated Statements of Income for the years ended October 31, 2001, 2000, and 1999 24 Consolidated Balance Sheets as of October 31, 2001 and 2000 25 Consolidated Statements of Changes in Shareholders' Equity for the years ended October 31, 2001, 2000, and 1999 26 Consolidated Statements of Cash Flows for the years ended October 31, 2001, 2000, and 1999 27 Notes to Consolidated Financial Statements 28 - 39 Quarterly Financial Data (unaudited) 39 22 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Shuffle Master, Inc.: We have audited the accompanying consolidated balance sheets of Shuffle Master, Inc. (the "Company") as of October 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity, and of cash flows for each of the three years in the period ended October 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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. as of October 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Minneapolis, Minnesota December 12, 2001 23 CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED OCTOBER 31, -------------------------------------------- 2001 2000 1999 ------------ ------------ ------------ REVENUE: Shuffler lease $ 16,026 $ 13,118 $ 11,168 Shuffler sales and service 11,690 8,900 5,846 Table games 15,223 12,198 9,626 Slot games 4,682 2,136 1,097 Other 339 2,508 1,189 ------------ ------------ ------------ TOTAL REVENUE 47,960 38,860 28,926 ------------ ------------ ------------ COSTS AND EXPENSES: Cost of products 12,522 10,456 9,142 Selling, general and administrative 12,417 10,297 8,493 Research and development 6,021 4,958 3,468 Royalty settlement -- -- 2,750 Office relocation expenses -- -- (213) ------------ ------------ ------------ TOTAL COSTS AND EXPENSES 30,960 25,711 23,640 ------------ ------------ ------------ Income from operations 17,000 13,149 5,286 Other income, net 702 293 337 ------------ ------------ ------------ Income before income taxes 17,702 13,442 5,623 Provision for income taxes 6,107 4,905 2,025 ------------ ------------ ------------ NET INCOME $ 11,595 $ 8,537 $ 3,598 ============ ============ ============ EARNINGS PER COMMON SHARE, BASIC $ .67 $ .52 $ .20 ============ ============ ============ EARNINGS PER COMMON SHARE, DILUTED $ .63 $ .50 $ .20 ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES, BASIC 17,225 16,308 17,823 ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES, DILUTED 18,518 17,107 17,913 ============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 24 CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS
AS OF OCTOBER 31, ---------------------------- 2001 2000 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 3,082 $ 2,810 Investments 15,621 3,809 Accounts receivable, net 5,419 4,722 Current portion of note receivable from related party 60 17 Inventories 6,210 6,194 Deferred income taxes 323 580 Other current assets 408 443 ------------ ------------ Total current assets 31,123 18,575 SYSTEMS AND EQUIPMENT LEASED AND HELD FOR LEASE, NET 8,646 6,676 PROPERTY AND EQUIPMENT, NET 2,367 2,441 INTANGIBLE ASSETS, NET 8,745 5,802 NON-CURRENT DEFERRED INCOME TAXES 984 710 LONG-TERM NOTE RECEIVABLE FROM RELATED PARTIES 441 300 OTHER ASSETS 93 110 ------------ ------------ TOTAL ASSETS $ 52,399 $ 34,614 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 5,681 $ 1,489 Accrued liabilities 3,935 2,576 Current portion of long-term obligation to related party 97 580 Customer deposits and unearned revenue 2,120 1,862 ------------ ------------ TOTAL CURRENT LIABILITIES 11,833 6,507 LONG-TERM OBLIGATION TO RELATED PARTY -- 97 CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $.01 par value; 67,500 shares authorized; 17,609 and 16,315 shares issued and outstanding 176 163 Additional paid-in capital 6,211 5,263 Retained earnings 34,179 22,584 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 40,566 28,010 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 52,399 $ 34,614 ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 25 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK ADDITIONAL TOTAL ----------------------------- PAID-IN RETAINED SHAREHOLDERS' SHARES AMOUNT CAPITAL EARNINGS EQUITY ------------ ------------ ------------ ------------ ------------ BALANCE, OCTOBER 31, 1998 18,033 180 11,266 10,449 21,895 Common stock repurchased (1,317) (13) (4,579) -- (4,592) Common stock options exercised 53 1 155 -- 156 Options issued for services -- -- 156 -- 156 Other common stock issued 49 -- 189 189 Net income -- -- -- 3,598 3,598 ------------ ------------ ------------ ------------ ------------ BALANCE, OCTOBER 31, 1999 16,818 168 7,187 14,047 21,402 Common stock repurchased (884) (9) (3,258) -- (3,267) Common stock options exercised 332 3 1,116 -- 1,119 Options issued for services -- -- 30 -- 30 Other common stock issued 49 1 188 -- 189 Net income -- -- -- 8,537 8,537 ------------ ------------ ------------ ------------ ------------ BALANCE, OCTOBER 31, 2000 16,315 163 5,263 22,584 28,010 Common stock repurchased (690) (7) (8,561) -- (8,568) Common stock options exercised 1,935 20 9,227 -- 9,247 Options issued for services -- -- 93 -- 93 Other common stock issued 49 -- 189 -- 189 Net income -- -- -- 11,595 11,595 ------------ ------------ ------------ ------------ ------------ BALANCE, OCTOBER 31, 2001 17,609 176 6,211 34,179 40,566 ============ ============ ============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 26 CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED OCTOBER 31, ---------------------------------------------- 2001 2000 1999 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 11,595 $ 8,537 $ 3,598 ADJUSTMENTS TO RECONCILE NET INCOME TO CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation and amortization 5,816 4,742 4,416 Office relocation and other charges -- -- (213) Provision for bad debts 25 7 139 Provision for inventory obsolescence 531 525 470 Deferred income taxes (17) 775 (1,250) Stock options issued for services 92 30 156 CHANGES IN OPERATING ASSETS AND LIABILITIES Accounts and notes receivable (835) (1,096) 81 Notes receivable from related party (43) 57 268 Inventories 16 (2,195) (2,689) Other current assets 195 168 65 Accounts payable and accrued liabilities 759 (2,173) 3,495 Customer deposits and unearned revenue 258 121 81 ------------ ------------ ------------ Net cash provided by operating activities 18,391 9,498 8,617 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments (20,519) (6,376) (10,080) Proceeds from the sales and maturities of investments 9,211 6,732 11,823 Payments for products leased and held for lease (1,648) (4,231) (3,042) Purchases of property and equipment (722) (502) (378) Purchases of intangible assets (448) (1,255) (3,384) Acquisition of business, net of cash acquired (4,127) -- -- Other (154) (26) 126 ------------ ------------ ------------ Net cash used by investing activities (18,407) (5,658) (4,935) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of common stock (8,568) (3,267) (4,592) Payments on long-term obligation to related party (391) (357) (334) Proceeds from issuance of common stock 9,247 1,118 156 ------------ ------------ ------------ Net cash provided (used by) financing activities 288 (2,506) (4,770) ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 272 1,334 (1,088) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,810 1,476 2,564 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,082 $ 2,810 $ 1,476 ============ ============ ============ NON-CASH TRANSACTION: Payment of obligation to related party with common stock 189 189 189 Purchase of video equipment on extended terms 3,898 -- -- ============ ============ ============ CASH PAID FOR: Income taxes $ 4,706 $ 4,030 $ 2,704 ============ ============ ============ Interest $ 13 $ 45 $ 81 ============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: DESCRIPTION OF BUSINESS: Shuffle Master, Inc. (the "Company") is a supplier of card shuffler products, table and slot games, and gaming related software to the gaming industry. The foundation of the Company's business has been the development, manufacturing and marketing of automatic card shufflers and table games, with slot games and operating system software having been added more recently. The Company's current shuffler offering is available to casinos through either a purchase or lease option. Table game products are available on a monthly license basis, and slot games and the Company's operating system are generally offered on a daily fee basis and may, in the future, be offered for sale. The Company markets its shuffler products in most domestic gaming jurisdictions directly, and internationally through representatives and a distributor. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly-owned domestic and foreign subsidiaries. All significant inter-company accounts and transactions have been eliminated. FOREIGN CURRENCY TRANSLATION: The Company's foreign subsidiary's assets and liability accounts, which are originally recorded in the appropriate local currency, are translated into United States dollar amounts at the year-end exchange rates. Revenue and expense accounts are translated at the average rates for the year. Transaction gains and losses, the amounts of which are immaterial, are included in other income. Foreign exchange translation adjustments, if material, are recorded as a separate component of stockholders' equity. INVENTORIES: Inventories are stated at the lower of cost or market and are reviewed for obsolescence quarterly. LEASING OPERATIONS: The Company's products are primarily leased to customers pursuant to operating leases. Products leased and held for lease are stated as assets at cost, net of depreciation. Depreciation on leased products is calculated using the straight-line method over up to three years. The Company provides maintenance of its products on lease as part of its normal lease agreements. Leases of shufflers generally require prepayment of two months' lease payments, which are included on the consolidated balance sheets as customer deposits. The Company licenses its proprietary gaming machine operating system and proprietary slot games for a monthly license fee. Licenses purchased related to these slot games are either amortized over the life of the license or expensed as per machine per day royalties in accordance with license terms. REVENUE RECOGNITION: In general, the Company recognizes revenue when the following criteria are met: the Company secures a signed contract or customer purchase order that states a fixed determinable price, the collectability of the sale revenue is reasonably assured and the goods or services have been delivered or rendered. In particular, the Company recognizes sales revenue upon the shipment of shuffler units for which it has signed orders. If a customer purchases an existing leased shuffler system, revenue is recorded on the effective date of the purchase. Shuffler lease revenue is generated on a monthly basis, generally through indefinite term operating leases. The Company also recognizes revenue through the sale of service and warranty contracts on its sold shufflers. Prepaid service and warranty contracts are included in the consolidated balance sheets as unearned revenue. Revenue on service and warranty contracts is recognized on a straight-line basis over the life of the contract. Table and slot revenue is generated by monthly or daily fixed license fees, revenue participation license and royalty fees, and equipment sales and leases. Lease, license and royalty revenue commences upon the completed installation of the shuffler, table or slot products. 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) RESEARCH AND DEVELOPMENT: Research and development costs are expensed as incurred. CONCENTRATION OF CREDIT RISK: The Company has a concentration of credit risk in so far as all of its receivables are with customers in the gaming industry. The Company has no material concentration of accounts receivable among any of its casino customers. PROPERTY AND EQUIPMENT: Property and equipment is stated at cost. Depreciation and amortization is recorded using the straight-line method over the estimated useful life of the asset of three to ten years, or lease terms for leasehold improvements. INTANGIBLE ASSETS: Intangible assets include purchased intellectual property for games, patents, trademarks, copyrights and licenses as well as for goodwill. Intangible assets are amortized over a period of two to fifteen years, commencing with the purchase or, in the case of licenses, with receipt of related revenue. IMPAIRMENT OF LONG-LIVED ASSETS: Management periodically reviews the carrying value of long-lived assets for potential impairment by comparing the carrying value of these assets to the estimated undiscounted future cash flows expected to result from the use of these assets. Should the sum of the related, expected future net cash flows be less than the carrying value, an impairment loss would be recognized. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset with fair value being determined using discounted cash flows. USE OF ESTIMATES: Management uses estimates and assumptions in preparing financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenue and expenses. Actual results could vary from the estimates that were used. EARNINGS PER COMMON SHARE: Basic earnings per common share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding and to be issued during the year. Diluted earnings per common share is similar to basic, except that the weighted average number of common shares outstanding is increased to give effect to all potentially dilutive common shares, such as stock options, outstanding during the period using the treasury stock method. RECENTLY ISSUED OR ADOPTED ACCOUNTING STANDARDS: In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and hedging activities and is effective for the Company's year ending October 31, 2001. The adoption of SFAS 133 in fiscal year 2001 did not have an impact on the Company's consolidated financial statements. In July 2001, the FASB issued SFAS 141, "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The adoption of SFAS 141 in fiscal 2001 did not have an impact on the Company's consolidated financial statements. Also in July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets," which is effective November 1, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the statement includes provisions for the reclassification of certain existing recognized intangibles, reclassification of certain intangibles out of previously 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The unamortized goodwill balance at October 31, 2001 was $3,258,000 and goodwill amortization in the year ended October 31, 2001 was $112,000 and would have been approximately $225,000 in 2002 under previous accounting standards. In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective January 1, 2002. SFAS 144 requires that long-lived assets expected to be held longer than one year are subject to depreciation and must be written down to fair value upon impairment. Long-lived assets that are to be sold within one year must be separately identified and carried at the lower of carrying value or fair value less costs to sell. Long-lived assets no longer expected to be sold within one year, such as foreclosed real estate, must be written down to the lower of current fair value or fair value at the date of foreclosure adjusted to reflect depreciation since acquisition. The Company does not believe that the adoption of SFAS 144 will have a significant impact on its consolidated financial statements. RECLASSIFICATIONS: Certain reclassifications have been made to the October 31, 2000 and 1999 consolidated financial statements to conform to the October 31, 2001 financial statement presentation. These reclassifications had no effect on the operating results for the years ended October 31, 2000 and 1999, as previously reported. 2. FINANCIAL INSTRUMENTS: CASH AND CASH EQUIVALENTS: Cash and cash equivalents include short-term investments with original maturities of three months or less. The Company maintains cash balances that occasionally exceed federally insured limits; however, the Company has incurred no losses on such accounts. INVESTMENTS: The Company classifies all of its securities as available-for-sale. The Company records investments at fair market value, which, as of October 31, 2001 and 2000, approximated amortized cost. Investments at fair value consisted of the following:
AS OF OCTOBER 31, 2001 2000 ----------------- ---------- ---------- (IN THOUSANDS) United States Government and Agency Obligations $ 11,995 $ 3,809 Corporate Bonds 3,626 -- ---------- ---------- $ 15,621 $ 3,809 ========== ==========
FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS: The estimated fair value of accounts receivable, notes receivable, and accounts payable approximates the carrying value due to the relatively short-term nature of the instruments. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. OTHER FINANCIAL STATEMENT DATA: The following provides additional disclosures for selected information from the consolidated financial statements:
AS OF OCTOBER 31, 2001 2000 ----------------- ---------- ---------- (IN THOUSANDS) ACCOUNTS RECEIVABLE, NET: Trade receivables $ 5,654 $ 4,781 Less: Allowance for doubtful accounts (235) (210) ---------- ---------- $ 5,419 $ 4,571 ========== ========== INVENTORIES: Raw materials and component parts $ 4,560 $ 3,294 Work-in-process 527 823 Finished goods 1,423 2,077 ---------- ---------- $ 6,510 $ 6,194 ========== ========== SYSTEMS AND EQUIPMENT LEASED AND HELD FOR LEASE, NET: Game equipment $ 8,765 $ 10,176 Gaming products 8,604 4,292 ---------- ---------- 17,369 14,468 Less: Accumulated depreciation (8,723) (7,792) ---------- ---------- $ 8,646 $ 6,676 ========== ========== PROPERTY AND EQUIPMENT, NET: Office furniture and computer equipment $ 3,081 $ 2,495 Leasehold improvements 2,099 2,072 Production equipment and other 739 639 ---------- ---------- 5,919 5,206 Less: Accumulated depreciation (3,552) (2,765) ---------- ---------- $ 2,367 $ 2,441 ========== ========== INTANGIBLE ASSETS, NET: Purchased table games $ 3,400 $ 3,400 Purchased slot games 3,370 3,370 Goodwill 3,370 -- Patents and licenses 2,510 1,540 ---------- ---------- 12,650 8,310 Less: Accumulated amortization (3,905) (2,508) ---------- ---------- $ 8,745 $ 5,802 ========== ========== ACCRUED LIABILITIES: Compensation $ 1,978 $ 1,781 Income taxes 1,511 352 Other 446 443 ---------- ---------- $ 3,935 $ 2,576 ========== ========== YEAR ENDED OCTOBER 31, 2001 2000 1999 ---------------------- ---------- ---------- ---------- (IN THOUSANDS) COST OF PRODUCTS: Game equipment $ 8,210 $ 6,768 $ 6,220 Gaming products 4,312 3,688 2,922 ---------- ---------- ---------- $ 12,522 $ 10,456 $ 9,142 ========== ========== ========== OTHER INCOME, NET: Interest income $ 728 $ 338 $ 418 Interest expense (13) (45) (81) Other (13) -- -- ---------- ---------- ---------- $ 702 $ 293 $ 337 ========== ========== ==========
31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES: Deferred income taxes are recorded to reflect the income tax consequences in future years between the financial reporting and income tax bases of assets and liabilities using current tax laws and statutory rates. Income tax expense is the sum of the tax currently payable and the change in deferred taxes during the period. The components of the provision for income taxes are as follows for the years ended October 31:
(IN THOUSANDS) 2001 2000 1999 ---------- ---------- ---------- CURRENT: Federal $ 5,488 $ 3,640 $ 2,817 State 531 400 388 Foreign 105 90 70 ---------- ---------- ---------- 6,124 4,130 3,275 DEFERRED: (17) 775 (1,250) ---------- ---------- ---------- $ 6,107 $ 4,905 $ 2,025 ========== ========== ==========
Deferred tax assets consisted of the following as of October 31:
(IN THOUSANDS) 2001 2000 ---------- ---------- CURRENT DEFERRED TAX ASSETS: Inventory write-down and asset valuation allowances $ 104 $ 164 Accrued vacation 92 60 Joint venture -- 218 Other 127 138 ---------- ---------- $ 323 $ 580 ========== ========== NON-CURRENT DEFERRED TAX ASSETS: Intangibles amortization $ 697 $ 493 Depreciation 250 149 Options issued for services 37 68 ---------- ---------- $ 984 $ 710 ========== ==========
The Company recognized no valuation allowance as of October 31, 2001 and 2000 to offset its deferred tax assets. Management believes that it is more likely than not that the Company will realize the full benefit of its deferred tax assets on the basis of its evaluation of the Company's anticipated profitability over the years when the underlying temporary differences are expected to become tax deductions. The reconciliation of the federal statutory rate to the effective income tax rate for the years ended October 31 are as follows:
2001 2000 1999 ---------- ---------- ---------- Federal income tax at the statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 2.0 2.3 3.6 Benefit due to foreign sales corporation (1.3) (1.3) (2.7) Benefit due to graduated rates (0.3) (1.0) (1.0) Other (0.9) 1.5 1.1 ---------- ---------- ---------- Effective tax rate 34.5% 36.5% 36.0% ========== ========== ==========
5. CREDIT AGREEMENT: In October 2001, the Company renewed and increased its revolving credit agreement with a bank by $5,000,000 to $15,000,000 to meet working capital needs, stock repurchases, new product rollouts, and the acquisition of new games and businesses. Borrowings under this increased credit agreement must be repaid no later than October 31, 2003, though the Company may annually request that the maturity of the credit agreement be extended by another year. 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Additionally, current borrowings are limited in amount to the lesser of $15,000,000 or twice the Company's earnings before interest, taxes, depreciation, and amortization for the most recent cumulative four quarters. The Company may borrow funds, provided that it maintains certain current, fixed charge coverage and leverage ratios. The interest rate on borrowings under the credit agreement will be, at the Company's option, either the bank's prime rate, or LIBOR, adjusted for a premium determined by the Company's leverage ratio as of the most recent quarter. Borrowings under the credit agreement are secured by substantially all accounts receivable, inventory, and products leased and held for lease. The Company had no outstanding borrowings under the credit agreement during the year ended October 31, 2001. 6. COMMITMENTS AND CONTINGENCIES: OPERATING LEASES: The Company leases office, production, warehouse and service facilities, and service vans under operating leases. The facility leases are for a period of four to ten years, have renewal options of three to fifteen years, and include an allocation of real estate taxes and other operating expenses to the Company. Total rent expense under operating leases was $740,000, $688,000 and $525,000 for the years ended October 31, 2001, 2000, and 1999, respectively. Estimated future minimum lease payments under operating leases as of October 31, 2001, are as follows: YEAR ENDED OCTOBER 31, ---------------------- (IN THOUSANDS) 2002 $ 764 2003 593 2004 412 2005 260 2006 260 Thereafter 216 ---------- $ 2,487 ========== 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. In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and regulatory government investigations. The Company believes that the final disposition of these matters will not have a material adverse effect on its financial position, results of operations or liquidity. 7. STOCK OPTIONS: In November 1993 the Company's Board of Directors adopted the 1993 Stock Option Plan which permits the granting of incentive stock options meeting the requirements of Section 422 of the Internal Revenue Code as well as nonqualified options which do not meet the requirements of Section 422. A total of 3,397,500 shares of the Company's common stock have been reserved for issuance under the plan. Also, in November 1993, the Company's Board of Directors adopted the Outside Directors' Option Plan for the purpose of compensating outside directors with grants of stock options upon their election and re-election to the Board. There will be an annual option grant to each eligible director at a price equal to the fair market value of the Company's common stock on the date of the grant. Each option is immediately exercisable and expires seven years from the grant date. A total of 337,500 shares of the Company's stock have been reserved for issuance under the plan. The Board of Directors granted to consultants options to purchase 22,500 shares at $10.03 per share in fiscal 2001 and options to purchase 22,500 shares at prices ranging from $4.47 to $7.67 per share in fiscal 2000. A summary of stock option activity and weighted average exercise prices follows: 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED OCTOBER 31, 2001 2000 1999 - ----------------------- ------------------------- ------------------------- ------------------------- (SHARES IN THOUSANDS) EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------------------------- ------------------------- ------------------------- Outstanding beginning of year 2,534 $ 4.05 2,689 $ 3.91 2,527 $ 3.95 Granted 1,255 11.78 414 4.37 286 3.22 Exercised (1,935) 4.78 (332) 3.38 (51) 2.93 Forfeited 23 4.95 (238) 3.91 (73) 3.86 ------------------------- ------------------------- ------------------------- Outstanding at end of year 1,831 8.56 2,534 $ 4.05 2,689 $ 3.91 ========================= ========================= ========================= Exercisable at end of year 961 $ 6.93 2,001 $ 4.02 1,992 $ 4.00 ========================= ========================= =========================
The following table summarizes information concerning options outstanding and options exercisable as of October 31, 2001:
(SHARES IN THOUSANDS) WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - ------------------------------------ --------------------------------------- ------------------------ $3 - $6 764 6.2 $ 3.88 588 $ 3.95 $6 - $9 68 6.8 7.43 39 7.23 $9 - $12 750 9.3 10.90 220 10.03 $12 - $20 249 7.5 16.21 114 16.19 --------------------------------------- ------------------------ 1,831 7.6 $ 8.56 961 $ 6.93 ======================================= ========================
The Company follows the guidance of APB No. 25 for measurement and recognition of stock-based transactions with employees and directors. No compensation cost has been recognized for stock options issued to employees and directors since the exercise price for all options granted was at least equal to the fair value of the common stock on the date of grant. If compensation cost for the Company's stock option plans had been determined based on the fair value at the grant dates for grants during fiscal 2001, 2000, and 1999, the Company's net income and earnings per share would have been as follows:
YEAR ENDED OCTOBER 31, 2001 2000 1999 - ---------------------- ---------- ---------- ---------- Net income (IN THOUSANDS): As reported $ 11,595 $ 8,537 $ 3,598 Pro forma 6,888 7,826 3,181 Earnings per common share, basic: As reported $ .67 $ .52 $ .20 Pro forma .23 .48 .18 Earnings per common share, assuming dilution: As reported $ .63 $ .50 $ .20 Pro forma .21 .46 .18 Weighted average fair value of options granted during the year $ 9.28 $ 4.29 $ 3.42
The fair value of options granted during fiscal 2001, 2000, and 1999 was estimated on the date of grant using the Black-Sholes option-pricing model with the following weighted average assumptions and results: 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED OCTOBER 31, 2001 2000 1999 ---------------------- ---------- ---------- ---------- Dividend yield None None None Expected volatility 79.2% 52.4% 60.9% Risk-free interest rate 2.9% 5.9% 6.2% Expected life of options 8.40 years 8.79 years 8.14 years
The Black-Sholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock based compensation has characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can significantly affect the fair value estimate, in management's opinion, use of the existing models for valuation does not necessarily provide a reliable single measure of the fair value of its employee stock based compensation. 8. EARNINGS PER COMMON SHARE:
YEAR ENDED OCTOBER 31, 2001 2000 1999 ---------------------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS): NET INCOME $ 11,595 $ 8,537 $ 3,598 ========== ========== ========== BASIC: Weighted average shares outstanding 17,213 16,248 17,715 Shares to be issued under asset purchase agreement 12 60 108 ---------- ---------- ---------- Weighted average common shares, basic 17,225 16,308 17,823 ========== ========== ========== Earnings per common share, basic $ .67 $ .52 $ .20 ========== ========== ========== ASSUMING DILUTION: Weighted average common shares, basic 17,225 16,308 17,823 Dilutive impact of options outstanding 1,293 799 90 ---------- ---------- ---------- Weighted average common shares and potential dilutive shares outstanding 18,518 17,107 17,913 ========== ========== ========== Earnings per common share, assuming dilution $ .63 $ .50 $ .20 ========== ========== ==========
Share and per share amounts for the year ended October 31, 2000 and 1999 reflect the effect of the three-for-two stock splits of the Company's common stock effective as of November 30, 2000 and June 18, 2001. 9. SHAREHOLDERS' EQUITY: COMMON STOCK: As of October 31, 2001, the Company was authorized to repurchase an additional $1,590,000 of its shares within specified price limits as a result of a 2001 Board of Directors' resolution. PREFERRED STOCK: On June 26, 1998, the Board of Directors designated and established 225,070 shares of no par value Series A Junior Participating Preferred Stock (Preferred Stock). Holders of Preferred Stock are entitled to one hundred votes on any matters submitted to vote by the shareholders of the Company, an aggregate dividend of one hundred times any dividend declared on common stock and a liquidation preference of one hundred times any liquidation payment amount to common shareholders. No shares of Preferred Stock have been issued. 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SHAREHOLDER RIGHTS PLAN: On June 26, 1998, the Board of Directors of the Company adopted a shareholder rights plan and declared a dividend distribution of one preferred stock purchase right (a Right) for each outstanding common share to shareholders of record on July 10, 1998. Additionally, the Board of Directors further authorized and directed the issuance of one Right for each share of common stock that shall become outstanding between July 10, 1998, and the earliest of the Distribution Date, Redemption Date and the Final Expiration Date, all as defined in the plan. Each Right will entitle the registered holder (unless the holder is an Acquiring Person, as defined) to purchase from the Company one one-hundredth of a share of Preferred Stock at $8 per one one-hundredth of a share of Preferred Stock, subject to adjustments (the Purchase Price). The Rights generally become exercisable if a person or group acquires, or tenders for, 20% or more of the Company's common shares. In such event, upon exercise of the Right, the holder of a Right may receive common shares having a value of two times the Purchase Price. The Rights will expire on June 26, 2008, unless they become exercisable or are amended before that date, but may be redeemed by the Company for $.01 per Right. After a person or group becomes an Acquiring Person, the Rights may not be redeemed and may only be amended in limited circumstances. 10. RELATED PARTY TRANSACTIONS: In fiscal 1997, the Company advanced $300,000 to its then Chairman of the Board. This note receivable was amended in May 2000 to mature in January 2004, to bear interest at seven percent, and to be secured by a right of offset against the Company's obligation to pay its Chairman of the Board under an employment agreement. As of October 31, 2001, the balance of the note receivable was $316,936, including $16,936 in accrued interest due by January 2002. In January 2002, the Chairman paid all accrued interest and reduced the outstanding note receivable to $233,000. The Company has a non-interest bearing obligation to its Chief Executive Officer related to the purchase of certain intellectual property, payable in cash and common stock. The cash portion of the obligation has been discounted at a rate of seven percent. The obligation of $97,000 outstanding as of October 31, 2001 was fully paid in December, 2001. In June 2001, the Company advanced $1,000,000 to its Chief Executive Officer. This note receivable was to mature on October 31, 2001, bore interest at 6%, and was secured by 43,200 shares of Company common stock beneficially owned by the Chief Executive Officer. This note and accrued interest was paid in full on July 12, 2001, when the Chief Executive Officer surrendered to the Company 47,660 shares of common stock that had a fair market value of $21.00 per share. 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. ACQUISITION: On April 28, 2001 the Company completed the purchase of the assets and certain liabilities of three separate Australian companies operating under the Gaming Products name as well as all the common stock of Gaming Product Pty Ltd, a fourth company that holds patents relating to the QuickDraw(R) line of continuous multi-deck shufflers that the Gaming Products Group manufactured. The acquisition cost $4,127,000 and funds for the acquisition were provided by internally generated cash flows. This acquisition was accounted for by the purchase method of accounting and, accordingly, the statements of consolidated income include the results of the acquired businesses beginning on April 28, 2001. Additionally, the assets acquired and liabilities assumed were recorded at estimated fair values determined by the Company's management and based on information currently available and on current assumptions as to future operations. A summary of the allocation of the purchase price follows:
(IN THOUSANDS) ESTIMATED FAIR VALUE ---------- Inventory $ 562 Patents 500 Accounts receivable and other 86 ---------- Total assets acquired 1,148 Accounts payable (279) Accrued expenses (112) ---------- Total liabilities assumed (391) Goodwill 3,370 ---------- Allocated purchase price $ 4,127 ==========
This allocation of the purchase price is subject to adjustment in fiscal 2002 based on the resolution of certain distributor obligations and other contingencies. The Company has held back from the sellers $440,000 of the purchase price pending resolution of these items. The excess of the purchase price over the fair value of the assets acquired of approximately $3,370,000 was recorded to goodwill. During the year ended October 31, 2001, the Company amortized $112,000 in goodwill, reflecting a 15-year amortization period. 12. DEFINED CONTRIBUTION PLAN: The Company sponsors a defined contribution plan, which qualifies under Section 401(k) of the Internal Revenue Code and covers employees who meet certain age and service requirements. The Company may make matching contributions to the plan based on a percentage of employee compensation and actual contributions. In the fiscal years ended October 31, 2001, 2000 and 1999, the Company elected to make matching contributions of 50% of employee contributions up to 4% of compensation, totaling $127,000, $94,000 and $71,000, respectively. 13. EXPORT SALES: In fiscal 2001, 2000, and 1999, the Company had export shuffler sales and shuffler lease revenue, primarily to Canada and Australia, which totaled 18%, 22%, and 17%, respectively, of total revenue. 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. OPERATING SEGMENTS: The Company operates in two business segments: game equipment and gaming products. The game equipment segment includes the manufacturing, marketing, installation and servicing of the Company's proprietary shuffler product line as well as the distribution and servicing of casino chip sorting machines and accessories all for sale or recurring lease revenue. The latter business activity was discontinued in January 2001. The gaming products segment includes the design, marketing, installation and servicing of proprietary table games and slot games and the Company's new slot operating system. Gaming products generally produce recurring revenue through fixed or participation leases and licenses, but may include sales of software and equipment. 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.
YEAR ENDED OCTOBER 31, 2001 2000 1999 ---------------------- ------------ ------------ ------------ (IN THOUSANDS) REVENUE Game equipment $ 28,053 $ 23,826 $ 18,203 Gaming products 19,907 15,034 10,723 ------------ ------------ ------------ 47,960 38,860 28,926 ============ ============ ============ OPERATING INCOME Game equipment 16,156 14,052 9,896 Gaming products 9,388 6,239 1,155 Corporate (8,544) (7,143) (5,765) ------------ ------------ ------------ 17,000 13,149 5,286 ============ ============ ============ DEPRECIATION AND AMORTIZATION Game equipment 2,181 1,836 1,948 Gaming products 2,791 2,270 1,609 Corporate 844 636 859 ------------ ------------ ------------ 5,816 4,742 4,416 ============ ============ ============ ASSETS Game equipment 14,035 12,637 8,644 Gaming products 14,985 11,200 10,388 Corporate 23,379 10,777 11,573 ------------ ------------ ------------ 52,399 34,614 30,605 ============ ============ ============ CAPITAL EXPENDITURES Game equipment 4,859 3,272 1,960 Gaming products 5,262 2,222 4,466 Corporate 722 494 378 ------------ ------------ ------------ $ 10,843 $ 5,988 $ 6,804 ============ ============ ============
38 QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended ------------------------------------------------------------ IN THOUSANDS, EXCEPT PER COMMON SHARE January 31 April 30 July 31 October 31 - --------------------------------------------------------------------------------------------------------------------------- FISCAL 2001 Revenue $ 11,217 $ 12,341 $ 12,584 $ 11,818 Gross Profit 8,076 9,089 9,354 8,919 Operating Income 3,821 4,518 4,589 4,072 Net Income 2,546 3,026 3,218 2,805 Earnings per Common Share, basic (1) (2) .15 .18 .18 .16 Earnings per Common Share, assuming dilution (1) (2) .14 .16 .17 .15 FISCAL 2000 Revenue $ 8,500 $ 9,635 $ 9,188 $ 11,537 Gross Profit 5,838 7,001 6,671 8,894 Operating Income 2,725 3,367 3,139 3,918 Net Income 1,767 2,186 2,039 2,545 Earnings per Common Share, basic (1) (2) .16 .20 .19 .24 Earnings per Common Share, assuming dilution (1) (2) .16 .19 .18 .22
(1) The sum of the quarterly earnings per common share does not equal the amount reported for the fiscal year as quarterly calculations are made independently during the fiscal year. (2) Quarterly per share amounts have been restated to reflect the effect of the three for two splits of the Company's common stock effective as of November 30, 2000 and June 18, 2001. 39 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Directors of the Registrant. The information under the caption "Election of Directors" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. (b) Executive Officers of the Registrant. The information under the caption "Executive Officers" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. (c) Compliance With Section 16 (a) of the Exchange Act. The information under the caption "Section 16 (a) Beneficial Ownership Reporting Compliance" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information under the captions "Executive Compensation," "Compensation of Directors," "Report of Compensation Committee on Executive Compensation" and "Stock Performance Graph" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information under the caption "Certain Relationships and Related Transactions" in the Company's Fiscal 2001 Proxy Statement is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)1. Financial Statements The following consolidated financial statements and independent auditors' report are filed as part of this Report on Form 10-K. Independent Auditors' Report Consolidated Statements of Income for the years ended October 31, 2001, 2000, and 1999 Consolidated Balance Sheets as of October 31, 2001 and 2000 Consolidated Statements of Shareholders' Equity for the years ended October 31, 2001, 2000, and 1999 Consolidated Statements of Cash Flows for the years ended October 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements Quarterly Financial Data (unaudited) 40 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED) 2. Financial Statement Schedules All financial statement schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes. 3. Exhibits 3.1 Articles of Incorporation of Shuffle Master, Inc. as amended July 15, 1992, and June 23, 1995 (Incorporated by reference to the same exhibit number in the Company's Report on Form 10-K for the year ended October 31, 1995). 3.2 Bylaws of Shuffle Master, Inc. (Incorporated by reference to the same exhibit number included in the Company's Registration Statement on Form S-18, Registration No. 33- 53994C). 3.3 Articles of Amendment of Articles of Incorporation of Shuffle Master, Inc. dated October 26, 2000 (Incorporated by reference to exhibit 3.3 in the Company's Report on Form 10K for the year ended October 31, 2000). 3.4 Articles of Amendment to the Articles of Incorporation of Shuffle Master, Inc. dated June 6, 2001 (Incorporated by reference to exhibit 10.28 in the Company's Report on Form 10Q for the quarter ended July 31, 2001). 10.1 Shuffle Master, Inc. 1993 Stock Option Plan (Incorporated by reference to exhibit 10.8 included in the Company's Registration Statement on Form SB-2, Registration No. 33-72224). 10.2 Shuffle Master, Inc. Outside Directors' Option Plan (Incorporated by reference to exhibit 10.7 included in the Company's Registration Statement on Form SB-2, Registration No. 33-72224). 10.3 Office lease dated August 9, 1995, between Shuffle Master, Inc. and Airport Center Associates, a joint venture of Airport Partners, and Copley Investors Limited Partnership (Incorporated by reference to exhibit 10.6 in the Company's Report on Form 10-K for the year ended October 31, 1995). 10.4 Employment Contract, by and between Shuffle Master, Inc. and Mark Yoseloff, dated March 7, 1997 (Incorporated by reference to exhibit 10.1 in the Company's Report on Form 10Q for the quarter ended July 31, 1997). 10.5 Purchase Agreement, by and between Shuffle Master, Inc., and Well Suited L.L.C., and Mark Yoseloff, dated March 7, 1997 (Incorporated by reference to exhibit 10.2 in the Company's Report on Form 10Q for the quarter ended July 31, 1997). 10.6 Purchase/License Agreement, by and between Shuffle Master, Inc., and Visual Communications Consultants, Inc. dba Advanced Gaming Concepts, and Mark Yoseloff, dated March 7, 1997 (Incorporated by reference to exhibit 10.3 in the Company's Report on Form 10Q for the quarter ended July 31, 1997). 10.8 Shareholder Rights Plan, dated June 26, 1998 (Incorporated by reference to the Company's Report on Form 8K dated June 26, 1998). 10.9 Revolving Credit Agreement, dated September 30, 1999, by and between Shuffle Master, Inc. and affiliates and U.S. Bank National Association (Incorporated by reference to exhibit 10.9 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.10 Credit Agreement, dated September 30, 1999, by and between Shuffle Master, Inc. and affiliates and U.S. Bank National Association (Incorporated by reference to exhibit 10.10 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.11 Security Agreement, dated September 30, 1999, by and between Shuffle Master, Inc. and affiliates and U.S. Bank National Association (Incorporated by reference to exhibit 10.11 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.12 Settlement Agreement, dated December 28, 1999, by and between Shuffle Master, Inc., Progressive Games, Inc. and Mikohn (Incorporated by reference to exhibit 10.12 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.13 Non-exclusive License Agreement (Exhibit 4), dated December 28, 1999, by and between Shuffle Master, Inc. and Progressive Games, Inc. (Incorporated by reference to exhibit 10.13 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.14 Non-exclusive License Agreement (Exhibit 5), dated December 28, 1999, by and between Shuffle Master, Inc. and Progressive Games, Inc. (Incorporated by reference to exhibit 10.14 in the Company's Report on Form 10K for the year ended October 31, 1999). 41 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTINUED) 10.15 Exclusive License Agreement (Exhibit 6), dated December 28, 1999, by and between Shuffle Master, Inc., Progressive Games, Inc. and Mikohn (Incorporated by reference to exhibit 10.15 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.16 Non-exclusive License Agreement (Exhibit 7), dated December 28, 1999, by and between Shuffle Master, Inc., Progressive Games, Inc. and Mikohn (Incorporated by reference to exhibit 10.16 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.17 Cross Supplier Agreement (Exhibit 8), dated December 28, 1999, by and between Shuffle Master, Inc. and Mikohn (Incorporated by reference to exhibit 10.17 in the Company's Report on Form 10K for the year ended October 31, 1999). 10.19 Executive Employment Agreement, by and between Shuffle Master, Inc. and Gary W. Griffin, dated December 1, 1999 (confidential treatment requested as to portions) (Incorporated by reference to exhibit 10.19 in the Company's Report on Form 10Q for the quarter ended July 31, 2000). 10.20 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated September 30, 1995 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.21 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated December 9, 1995 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.22 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated March 29, 1996 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.23 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated March 19, 1998 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.24 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated October 26, 1998 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.25 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, dated March 17, 1999 (Incorporated by reference to the specified exhibit in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.26 Employment Agreement, by and between Shuffle Master, Inc. and Mark Lipparelli, dated April 30, 2001 (confidential treatment requested as to portions) (Incorporated by reference to exhibit 10.26 in the Company's Report on Form 10Q for the quarter ended April 30, 2001). 10.27 Amendment to the Shuffle Master, Inc. 1993 Stock Option Plan, approved by the shareholders on March 22, 2001, (Incorporated by reference to the exhibit 10.8 in the Registrant's Registration Statement on Form S-8, Registration No. 333-39060). 10.29 Executive Employment Agreement, by and between Shuffle Master, Inc. and Joseph J. Lahti, dated September 1, 2001 (confidential treatment requested as to portions). 10.30 Amendment to Shuffle Master, Inc. Outside Directors' Option Plan dated October 24, 1997. 10.31 Amendment to Shuffle Master, Inc. Outside Directors' Option Plan dated March 28, 2001. 10.32 Shuffle Master, Inc. Restated Outside Directors' Option Plan dated January 24, 2002. 23.1 Independent Auditors' Consent. (b) Reports on Form 8-K No reports on Form 8-K were filed during the fourth quarter of the year ended October 31, 2001. 42 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 29, 2002 By: /s/ Mark L. Yoseloff ----------------------------------- 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/ Joseph J. Lahti Chairman of the Board January 29, 2002 ---------------------------- Joseph J. Lahti /s/ Mark L. Yoseloff Chief Executive Officer January 29, 2002 ---------------------------- Mark L. Yoseloff /s/ Mark A. Lipparelli President January 29, 2002 ---------------------------- Mark A. Lipparelli /s/ Gary W. Griffin Chief Financial Officer January 29, 2002 ---------------------------- Gary W. Griffin /s/ Gerald W. Koslow Corporate Controller January 29, 2002 ---------------------------- Gerald W. Koslow /s/ Patrick R. Cruzen Director January 29, 2002 ---------------------------- Patrick R. Cruzen /s/ Howard P. Liszt Director January 29, 2002 ---------------------------- Howard P. Liszt /s/ Kenneth J. Robson Director January 29, 2002 ---------------------------- Kenneth J. Robson /s/ Thomas A. Sutton Director January 29, 2002 ---------------------------- Thomas A. Sutton 43 EX-10.29 3 shuffle020338_ex10-29.txt EXECUTIVE EMPLOYMENT AGREEMENT CONFIDENTIAL TREATMENT REQUESTED Exhibit - 10.29 Executive Employment Agreement - Joseph J. Lahti EXECUTIVE EMPLOYMENT AGREEMENT JOSEPH J. LAHTI THIS AGREEMENT is made and entered into effective as of the 1st day of September 2001, by and between SHUFFLE MASTER, INC., a Minnesota corporation (the "Company"), and Joseph J. Lahti (the "Employee"). RECITALS A. The Company is in the business of developing, manufacturing, distributing and otherwise commercializing gaming equipment, games, and operating systems for gaming equipment and related products and services throughout the United States and in Canada and other countries (the "Business"). B. Company and Employee want to create an employment relationship for a specific term that protects the Company and potential successors with appropriate confidentiality and non-compete covenants and rewards the Employee with appropriate consideration therefore, including a stay bonus, and incentivizes him to remain in the employment of the Company. C. The Company and Employee desire that Employee be employed by the Company on the terms and conditions of this Agreement. AGREEMENT In consideration of the mutual promises contained herein, Employee and the Company agree as follows: 1. EMPLOYMENT. The Company hereby employs Employee from the effective date of this Agreement through January 31, 2005. This employment relationship may be terminated by Employee at any time subject to certain consequences as hereinafter set forth, and by the Company only for just cause as hereinafter set forth. Employee shall initially be employed as Chairman to provide assistance to the CEO of the Company. Employee shall be employed full-time by the Company through October 31, 2001; thereafter, Employee shall provide services part-time as reasonably requested by the CEO regarding acquisitions, matters of strategic significance, business development, and marketing strategy, but without "line" responsibility. If Employee resigns or is removed as Chairman, his employment relationship with the Company and his remuneration pursuant to Section 2 hereof shall continue unaffected. 2. SALARY AND BENEFITS. Employee will be paid as follows: (a) During the period from September 1, 2001 through October 31, 2001, Employee shall be paid a base salary of Forty-two Thousand Six Hundred Forty Dollars ($42,640), paid in the same intervals as other employees of the Company. (b) If Employee is employed with the Company through October 31, 2001, Employee will be 1 eligible to receive an executive bonus in accordance with the terms and conditions of the executive bonus program authorized by the Board of Directors of the Company, as set forth on Exhibit A attached hereto. (c) During the period from November 1, 2001, through January 31, 2002, Employee will be paid a base salary of Fifty Thousand Dollars ($50,000.00), paid in the same intervals as other employees of the Company during this period. (d) During the period from February 1, 2002, through January 31, 2003, Employee will be paid a base salary of Two Hundred Thousand Dollars ($200,000.00) plus an amount equal to 33 1/3% of the bonus paid pursuant to subsection (b), above, paid in the same intervals as other employees of the Company. (e) During the period from February 1, 2003, through January 31, 2004, Employee will be paid a base salary of One Hundred Fifty Thousand Dollars ($150,000.00) plus an amount equal to 33 1/3% of the bonus paid pursuant to subsection (b), paid in the same intervals as other employees of the Company. (f) During the period from February 1, 2004, through January 31, 2005, Employee will be paid a base salary of One Hundred Thousand Dollars ($100,000.00) plus an amount equal to 33 1/3% of the bonus paid pursuant to subsection (b), paid in the same intervals as other employees of the Company. (g) Employee has received a stock option grant to purchase one hundred thousand (100,000) shares of the Company's Common Stock in accordance with and subject to the terms and conditions imposed by the Board of Directors at its November 21, 2000 meeting. (h) In the event of a change in the control of the Company defined as set forth in Section 20 hereof, all amounts that would be payable hereunder through January 31, 2005 shall be due and payable effective as of the date of the change in control and Employee's employment hereunder shall cease as of that date. Employee's salary during the period from September 1, 2001 through October 31, 2001, is set on the expectation (except for vacation days and holidays) that Employee's time will be spent as reasonably needed to perform his duties to assist the Company's new Chief Executive Officer. Company will not require that Employee travel more than two (2) nights per month. The Company agrees to provide Employee with the general benefits it provides its executive team through October 31, 2001, and to provide Employee with the general benefits it provides its non-executive employees thereafter during the term of this Agreement. Employee will not, however, be eligible to participate in the Company's non-executive bonus program at any time during the term of this Agreement, nor will Employee be eligible to participate in the Company's executive bonus program or the employees stock option plan on or after November 1, 2001. 2 3. OUTSIDE CONSULTING. Employee may render consulting services to other businesses from time to time if Employee meets all of the following requirements: (a) the consulting services are not rendered to any business which may compete with the Company in any area of the Business; (b) the consulting services do not relate to any products or services which form part of the Business. Company acknowledges that Employee currently provides consulting services to, serves on the Board of Directors of, and/or holds equity positions in various companies, as set forth in a confidential memorandum to the General Counsel of the Company dated concurrently herewith. 4. NON-COMPETITION. Employee's non-compete period has been extended for two (2) years so that Employee shall not, for a period of five (5) years (which includes the two (2) year extension) following November 1, 2001, nor shall the Employee while employed by the Company or its successor: (a) directly or indirectly own, manage, operate, participate in, consult with or work for any business which is engaged in the Business anywhere in the United States or Canada (provided, that the foregoing shall not prohibit Employee from owning up to 1% of any publicly traded company in the Business); (b) either alone or in conjunction with any other person, partnership or business, directly or indirectly, solicit or divert or attempt to solicit or divert any of the employees or agents of the Company or its affiliates to work for or represent any competitor of the Company or its affiliates or to call upon any of the customers of the Company or its affiliates for any gaming related products or services. The foregoing covenants shall benefit as well any successor to the Company. 5. PAYMENT FOR NON-COMPETE COVENANT. In consideration of only the covenants in Section 4 hereof, including the extended two (2) year period of non-competition, the Company agrees to compensate Employee as follows: (a) On January 5, 2002 (if Employee is employed by the Company on such date) and on each January 5, thereafter, that Employee is employed by the Company through January 5, 2006, the Company shall pay to Employee the sum of One Hundred Fifty Thousand ($150,000.00); (b) Upon the termination for any reason of Employee's employment whether voluntary or involuntary, or in the event of a change in control of the Company, the Company shall pay to Employee a sum equal to Seven Hundred Fifty Thousand ($750,000.00) on or before the date of termination as compensation for the five-year covenant set forth above, less a credit, if any, for each One Hundred Fifty Thousand ($150,000.00) payment previously made to Employee under Section 5 (a). All such payments shall be subject to applicable withholding. 3 6. CONFIDENTIALITY; INVENTIONS. (a) Employee shall fully and promptly disclose to the Company all inventions, discoveries, software and writings that Employee may make, conceive, discover, develop or reduce to practice either solely or jointly with others during Employee's employment with the Company, whether or not during usual working hours. Employee agrees that all such inventions, discoveries, software and writing shall be and remain the sole and exclusive property of the Company, and Employee hereby agrees to assign, and hereby assigns all of Employee's right, title and interest in and to any such inventions, discoveries, software and writings to the Company. Employee agrees to keep complete records of such inventions, discoveries, software and writings, which records shall be and remain the sole property of the Company, and to execute and deliver, either during or after Employee's employment with the Company, such documents as the Company shall deem necessary or desirable to obtain such letters patent, utility models, inventor's certificates, copyrights, trademarks or other appropriate legal rights of the United States and foreign countries as the Company may, in its sole discretion, elect, and to vest title thereto in the Company, its successors, assigns, or nominees. (b) "Inventions," as used herein, shall include inventions, discoveries, improvements, ideas and conceptions, developments and designs, whether or not patentable, tested, reduced to practice, subject to copyright or other rights or forms of protection, or relating to data processing, communications, computer software systems, programs and procedures. (c) Employee understands that all copyrightable work that Employee may create while employed by the Company is a "work made for hire," and that the Company is the owner of the copyright therein. Employee hereby assigns all right, title and interest to the copyright therein to the Company. (d) The three immediately preceding paragraphs do not apply to inventions in which a Company claim or any rights will create a violation of Chapter 47 Minnesota Revised Statutes, Section 1-181.78, reproduced below and constituting the written notification of its Subdivision 3. SUBDIVISION 1. ANY PROVISION IN AN EMPLOYMENT AGREEMENT WHICH PROVIDES THAT AN EMPLOYEE SHALL ASSIGN OR OFFER TO ASSIGN ANY OF THE EMPLOYEE'S RIGHTS IN AN INVENTION TO THE EMPLOYER SHALL NOT APPLY TO AN INVENTION FOR WHICH NO EQUIPMENT, SUPPLIES, FACILITY OR TRADE SECRET INFORMATION OF THE EMPLOYER WAS USED AND WHICH WAS DEVELOPED ENTIRELY ON THE EMPLOYEE'S OWN TIME, AND (1) WHICH DOES NOT RELATE (A) DIRECTLY TO THE BUSINESS OF THE EMPLOYER OR (B) TO THE EMPLOYER'S ACTUAL OR DEMONSTRABLY ANTICIPATED RESEARCH OR DEVELOPMENT, OR (2) WHICH DOES NOT RESULT FROM ANY WORK PERFORMED BY THE EMPLOYEE FOR THE EMPLOYER. ANY PROVISION WHICH PURPORTS TO APPLY TO SUCH AN INVENTION IS TO THAT EXTENT AGAINST THE PUBLIC POLICY OF THIS STATE AND IS TO THAT EXTENT VOID AND UNENFORCEABLE. SUBDIVISION 2. NO EMPLOYER SHALL REQUIRE A PROVISION MADE VOID AND UNENFORCEABLE BY SUBDIVISION 1 AS A CONDITION OF EMPLOYMENT OR CONTINUING EMPLOYMENT. SUBDIVISION 3. IF AN EMPLOYMENT AGREEMENT ENTERED INTO AFTER AUGUST 1, 1997 CONTAINS A PROVISION REQUIRING THE EMPLOYEE TO ASSIGN OR OFFER TO ASSIGN ANY OF THE EMPLOYEE'S RIGHTS IN ANY INVENTION TO AN EMPLOYER, THE EMPLOYER MUST ALSO, AT THE TIME THE AGREEMENT IS MADE, PROVIDE A WRITTEN NOTIFICATION TO THE EMPLOYEE THAT THE AGREEMENT DOES NOT APPLY TO AN INVENTION FOR WHICH NO EQUIPMENT, SUPPLIES, FACILITY OR TRADE SECRET INFORMATION OF THE EMPLOYER WAS 4 USED AND WHICH WAS DEVELOPED ENTIRELY ON THE EMPLOYEE'S OWN TIME, AND (1) WHICH DOES NOT RELATE (A) DIRECTLY TO THE BUSINESS OF THE EMPLOYER OR (B) TO THE EMPLOYER'S ACTUAL OR DEMONSTRABLY ANTICIPATED RESEARCH OR DEVELOPMENT, OR (2) WHICH DOES NOT RESULT FROM ANY WORK PERFORMED BY THE EMPLOYEE FOR THE EMPLOYER. (e) Employee will not publish or otherwise disclose, either during or after Employee's employment with the Company, any unpublished or proprietary or confidential information or secret relating to the Company, the Business, the Company's operations or the Company's products or services. Employee will not publish or otherwise disclose proprietary or confidential information of others to which Employee has had access or obtained knowledge in the course of Employee's employment with the Company. Upon termination of Employee's employment with the Company, Employee will not, without the prior written consent of the Company, retain or take with Employee any drawing, writing or other record in any form or nature which relates to any of the foregoing. (f) Employee understands that Employee's employment with the Company creates a relationship of trust and confidence between Employee and the Company. Employee understands that Employee may encounter information in the performance of Employee's duties that is confidential to the Company or its customers. Employee agrees to maintain in confidence all confidential information pertaining to the Business or the Company to which Employee has access including, but not limited to, confidential information relating to the Company's products, inventions, trade secrets, formulas, compositions, customer information and lists, research projects, costs, sales volume or strategy, pricing, profitability, plans, marketing strategy, expansion or acquisition or divestiture plans or strategy and information of similar nature received from others with whom the Company does business. Employee agrees not to use, communicate or disclose or authorize any other person to use, communicate or disclose such confidential information orally, in writing, or by publication, either during employee's employment with the Company or thereafter except as expressly authorized in writing by the Company unless and until such information becomes public without fault on employee's part, or as required by law. 7. TERMINATION WITHOUT JUST CAUSE; STAY BONUS. In the event of the termination of Employee's employment by the Company without just cause, as defined in Section 8, the Employee will receive all compensation that would be provided under this Agreement through January 31, 2005 including all salary, benefits and bonuses; in addition, any stock option previously granted to the Employee (not already exercisable and vested) will become exercisable and all stock options will become fully vested on the first day immediately following Employee's last day of employment. Employee will be entitled to exercise said options in accordance with the terms of the Company's stock option plan as amended from time to time. In the event of such a change in control Employee will reasonably cooperate with the Company, and exercise his stock options in a way as to not hinder the progress or closing of the sale or merger transaction, and in no event later than three (3) months following the closing. 5 In the event Employee does not voluntarily resign as the Chairman of the Board of Directors of Shuffle Master, Inc., on or before February 1, 2002, Employee will be paid a stay bonus of Two Hundred Fifty Thousand Dollars ($250,000.00) on February 2, 2002. 8. TERMINATION BY COMPANY FOR JUST CAUSE. The Company may only terminate Employee for just cause. In the event the Company terminates the Employee for just cause, the Employee will remain bound under the covenant not to compete and confidentiality obligations contained in Sections 4 and 6 and will not be entitled to the remaining salary and general employment benefits (e.g. health insurance, dental, life) to be provided following the date of such termination. Notwithstanding any termination for just cause, Employee is entitled to the accelerated non-compete payments provided for in Section 5 of this Agreement. Termination for "just cause" shall be limited to: (a) dishonesty as to a matter which is materially injurious to the Company; (b) the commission of a willful act or omission intended to materially injure the business of the Company; or (c) a substantial violation of the provisions of Sections 4 and 6 hereof. 9. TERMINATION BY EMPLOYEE. In the event Employee voluntarily terminates his employment with the Company (or its successor) prior to February 1, 2005, Employee will remain bound under the confidentiality and non-compete obligations of Sections 4 and 6 and will not be entitled to the remaining salary and general employment benefits (e.g. health insurance, dental, life) to be provided following the date of such voluntary termination. Notwithstanding any voluntary termination by employee, Employee is entitled to the accelerated non-compete payments provided for in Section 5 of this Agreement. Voluntary termination means an intentional termination by the Employee without good reason and without pressure by the Company. Voluntary termination does not mean a termination caused by the death or disability of the Employee. In the event a termination occurs due to the death or disability of Employee, Employee is entitled to and will receive the full benefits (including salary) remaining through January 31, 2005 under this Agreement at the time of such termination. 10. NO CONFLICTING AGREEMENTS. Employee has the right to enter into this Agreement, and hereby confirms Employee has no contractual or other impediments to the performance of Employee's obligations including, without limitation, any non-competition or similar agreement in favor of any other person or entity. 6 11. COMPANY POLICIES. During the period of Employee's employment, Employee shall engage in no activity or employment which may conflict with the interest of the Company, and Employee shall comply with all policies and procedures of the Company including, without limitation, all policies and procedures pertaining to ethics. 12. INDEPENDENT COVENANTS. The covenants on the part of the Employee contained in Sections 4 and 6 hereof shall be construed as agreements independent of any other provision in this Agreement; it is agreed that the relief for any claim or cause of action of the Employee against the Company, whether predicated on this Agreement or otherwise, shall be measured in damages and shall not constitute a defense to enforcement by the Company of those covenants. 13. INJUNCTIVE RELIEF; ATTORNEYS' FEES. In recognition of the irreparable harm that a violation by Employee of any of the covenants contained in Sections 4 and 6 hereof would cause the Company, the Employee agrees, notwithstanding the provisions of Section 17 hereof, that in addition to any other relief afforded by law, an injunction (both temporary and permanent) against such violation or violations may be issued against him or her and every other person and entity concerned thereby, it being the understanding of the parties that both damages and an injunction shall be proper modes of relief and are not to be considered alternative remedies. Employee consents to the issuance of such injunction relief without the posting of a bond or other security. In the event of any such violation, the successful party in any action for an injunction is entitled to recover from the unsuccessful party the successful party's costs, expenses and reasonable attorneys' fees incurred in such injunction action, in addition to any other actual damages sustained by the successful party. 14. NOTICE. Any notice sent by registered mail to the last known address of the party to whom such notice is to be given shall satisfy the requirements of notice in this Agreement. 15. ENTIRE AGREEMENT. This Agreement is the entire agreement of the parties hereto concerning the subject matter hereof and supercedes and replaces any oral or written existing agreements between the Company and the Employee relating generally to the same subject matter. Company and Employee hereby acknowledge that there are no agreements or understandings of any nature, oral or written, regarding Employee's employment, apart from this Agreement. 7 16. SEVERABILITY. It is further agreed and understood by the parties hereto that if any provision of this Agreement should be determined by a court to be unenforceable in whole or in part, it shall be deemed modified to the minimum extent necessary to make it reasonable and enforceable under the circumstances. 17. GOVERNING LAW. This Agreement shall be construed and enforced in accordance with the laws of the State of Minnesota, without giving effect to the principles of conflicts of laws thereof. Except as provided in Section 13 hereof, any dispute relating hereto or arising hereunder shall be resolved by binding arbitration pursuant to the procedures of the American Arbitration Association held in Minneapolis, Minnesota. In the event that injunctive relief is sought, pursuant to Section 13 hereof or otherwise, said action shall be venued in the federal or state courts located in Minneapolis, Minnesota. 18. HEIRS, SUCCESSORS AND ASSIGNS. The terms, conditions, and covenants hereof shall extend to, be binding upon, and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns. 19. EXCISE TAX PAYMENTS. (a) In the event that any payment or benefit (within the meaning of Section 28OG(b)(2) of the Internal Revenue Code of 1986, as amended (the "Code")), paid or payable to the Employee or for his benefit or distributed or distributable pursuant to the terms of this Agreement or otherwise in connection with, or arising out of, his employment with the Company or a Change in Control of the Company (a "Payment" or "Payments"), would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Employee with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Employee will be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Employee of all taxes (including any interest or penalties, other than interest and penalties imposed by reason of the Employee's failure to file timely a tax return or pay taxes shown as due on his return, imposed with respect to such taxes and the Excise Tax), including any Excise Tax imposed upon the Gross-Up Payment, the Employee retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) An initial determination as to whether a Gross-Up Payment is required pursuant to this Agreement and the amount of such Gross-Up Payment shall be made at the Company's expense by an accounting firm selected by the Employee and reasonably acceptable to the Company which is designated as one of the ten (10) largest accounting firms in the United States (the "Accounting Firm"). The Accounting Firm shall provide its determination (the "Determination"), together with detailed supporting calculations and documentation, to the Company and the Employee promptly following the date of termination of the Employee's employment, if applicable, or such other time as requested by the Company or the Employee. The Gross-Up Payment, if any, as determined pursuant to this Section 19(b) shall be paid by the Company to the Employee within five days of the receipt of the Determination. In the event that the tax returns of either Employee or the Company are audited with respect to this issue, the same accounting firm shall be retained in connection with the audit and any appeal, and the amount of the 8 Gross-Up Payment shall be subject to revision, depending upon the final outcome of the audit. (c) Notwithstanding anything contained in this Agreement to the contrary, in the event that, according to the Determination, an Excise Tax will be imposed on any Payment or Payments, the Company shall pay to the applicable government taxing authorities as Excise Tax withholding, the amount of the Excise Tax that the Company has actually withheld from the Payment or Payments. 20. CHANGE IN CONTROL. For purposes of this Agreement, a "Change in Control" is defined as a completed transaction or series of transactions, regardless of form, by which any person, entity or group of persons and entities, acting together, obtain control, directly or indirectly, of more than 50% of the voting power of the Company and shall include, but not be limited to, mergers, tender offers, sales of assets, proxy contests involving a change in control of the Board, and the like. 21. WAIVER OF CONFLICT OF INTEREST. Employee has been represented in this matter by Moss & Barnett; the Company has been represented by Thomas G. Barry, Jr., General Counsel. The parties acknowledge that Moss & Barnett has previously represented both the Employee and the Company on other matters, both unrelated and related. Both parties nonetheless waive any potential or actual conflict of interest relating to Moss & Barnett's representation of Employee in this matter. The Company further waives any objections to Moss & Barnett's continued representations of Employee in this matter, and Employee waives any objections to Moss & Barnett's continued representation of the Company in other matters. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day, month and year first above written. EMPLOYER: EMPLOYEE: SHUFFLE MASTER, INC. By: /s/ Gary W. Griffin /s/ Joseph J.Lahti --------------------------------------- ------------------------------- Its: Chief Financial Officer Joseph J. Lahti ---------------------------------- By: /s/ Patrick R. Cruzen --------------------------------------- Its: Chairman of Compensation Committee ---------------------------------- 9 EXHIBIT A Employee may earn a percentage of Employee's base salary as a bonus during fiscal year 2001, which will vary depending on the percentage of targeted income before taxes (REDACTED; CONFIDENTIAL TREATMENT REQUESTED) earned by the Company: COMPANY EARNINGS AS % OF TARGETED INCOME BEFORE TAXES BONUS - ------------ ----- a. Less than 90% 0 b. 90% $102,336.00 (40% of base salary) c. 90% - 100% $102,336.00 + $2,558.40 for each increase of one percent (1%) over ninety percent (90%) d. 100% $127,920.00 (50% of base salary) e. 100% - 120% $127,920.00 + $1,279.20 for each increase of one percent over 100% f. 120% $153,504.00 (60% of base salary) g. over 120% 60% of base salary plus an additional 1% of base salary for each increase of one percent over 120%. For example, if the Company earns 100% of its targeted income before taxes during fiscal 2000, Employee would be paid a performance bonus of $127,920.00 ($255,840.00 x 50%). If the Company earns 90% of its targeted income before taxes during fiscal 2000, Employee would be paid a performance bonus of $102,336.00 ($255,840.00 x 40%). If the Company earns 120% of its targeted income before taxes, then Employee's performance bonus would be $153,504.00 ($255,840.00 x 60%). If the Company earns more than 120% of its targeted income before taxes, Employee's performance bonus would further increase by an amount equal to one percent ( 1% ) of his base salary for each percent by which the percentage increase in income before taxes exceeds the target. In no event shall the amount of the bonus exceed twice Employee's annual base salary. 10 EX-10.30 4 shuffle020338_ex10-30.txt AMENDMENT TO OUTSIDE DIRECTORS' OPTION PLAN Exhibit - 10.30 Amendment to Shuffle Master, Inc. Outside Directors' Option Plan Effective October 24, 1997 AMENDMENT TO SHUFFLE MASTER, INC. OUTSIDE DIRECTORS' OPTION PLAN EFFECTIVE OCTOBER 24, 1997 The undersigned, the Chief Executive Officer of Shuffle Master, Inc. a Minnesota corporation (the "Corporation"), does hereby certify that, effective as of the 24th day of October, 1997, the following resolution was adopted by the Board of Directors of the Corporation in accordance with the applicable provisions of Minnesota law: Resolution Amending Outside Directors' Option Plan (the "Plan") - --------------------------------------------------------------- RESOLVED, that the undersigned, the members of the Board of Directors of the Corporation, pursuant to Section 10 of the Plan and applicable Minnesota law, hereby resolve that Section 5. (01) of the Plan be amended by adding a new Section 5. (01)(c) as follows: "(c) Discretionary Grants. In addition to the method of granting options in subparagraphs (a) and (b) set forth above in this section, the Board may grant additional options to Directors. Options granted under this subparagraph (c) shall be in accordance with the terms and conditions of the Outside Directors Option Plan as amended provided, however, that the Board may at the time of grant place additional conditions and restrictions on any option granted." IN WITNESS WHEREOF, I have hereunto subscribed my name this 24th day of October, 1997. /s/ Joseph J. Lahti ---------------------------------------- Joseph J. Lahti, Chief Executive Officer EX-10.31 5 shuffle020338_ex10-31.txt AMENDMENT TO OUTSIDE DIRECTORS' OPTION PLAN Exhibit - 10.31 Amendment to Shuffle Master, Inc. Outside Directors' Option Plan Effective March 28, 2001 AMENDMENT TO SHUFFLE MASTER, INC. OUTSIDE DIRECTORS' OPTION PLAN EFFECTIVE MARCH 28, 2001 The undersigned, the Chief Executive Officer of Shuffle Master, Inc. a Minnesota corporation (the "Corporation"), does hereby certify that effective as of the 28th day of March, 2001, the following resolution was adopted by the Board of Directors of the Corporation in accordance with the applicable provisions of Minnesota law: Resolution Amending Outside Directors' Option Plan, as amended, (the "Plan") - ---------------------------------------------------------------------------- RESOLVED, that the undersigned, the members of the Board of Directors of the Corporation, pursuant to Section 10 of the Plan and the applicable provisions of Minnesota law, hereby resolve that Section 5 of the Plan be amended by deleting the existing Section 5. (02) in its entirety and replacing it with the following new section 5. (02): "(02) Exercise Price. The exercise price of an Option granted pursuant to Section 5. (01) (a) or (b) shall be 100% of the value of the Stock on the grant date determined in accordance with Section 6 hereof. The exercise price of an Option granted under Section 5. (01) (c) shall be such price as determined by the Board of Directors at the time it makes the grant, including a price which can be determined on the basis of future events." IN WITNESS WHEREOF, I have hereunto subscribed my name this 28th day of March, 2001. /s/ Joseph J. Lahti ---------------------------------------- Joseph J. Lahti, Chief Executive Officer EX-10.32 6 shuffle020338_ex10-32.txt RESTATED OUTSIDE DIRECTORS' OPTION PLAN Exhibit - 10.32 Shuffle Master, Inc. Restated Outside Directors' Option Plan Dated January 24, 2002 SHUFFLE MASTER, INC. RESTATED OUTSIDE DIRECTORS' OPTION PLAN (JANUARY 2002) TABLE OF CONTENTS 1.) Purposes.................................................................1 2.) Definitions..............................................................1 3.) Option Stock Available Under Plan........................................3 4.) Administration...........................................................3 5.) Eligibility for Options..................................................4 6.) Terms and Conditions of Options..........................................4 7.) Adjustments..............................................................9 8.) Acceleration of Vesting and Exercisability Upon Certain Events...........9 9.) Rights as Shareholder...................................................12 10.) No Obligation to Exercise Option; Maintenance of Relationship...........12 11.) Withholding Taxes.......................................................12 12.) Purchase for Investment; Rights of Holder on Subsequent Registration....12 13.) Modification of Outstanding Options.....................................13 14.) Approval of Shareholders................................................13 15.) Liquidation.............................................................13 16.) Restrictions on Issuance of Shares......................................13 17.) Amendment, Suspension or Termination of the Plan........................14 18.) Effective Date..........................................................14 19.) General Provisions......................................................14 SHUFFLE MASTER, INC. RESTATED OUTSIDE DIRECTORS' OPTION PLAN (JANUARY 2002) 1.) Purposes. The principal purposes of the Shuffle Master, Inc. (the "Company") Restated Outside Directors' Option Plan (the "Plan") are to attract and retain the best available candidates for the Board, to provide additional equity incentives to Eligible Directors through their participation in the growth value of the Stock, and to promote the success of the Company's business. To accomplish the foregoing objectives, this Plan provides a means whereby Eligible Directors will receive Options to purchase Stock. Options granted prior to the effective date of this Restated Outside Directors' Option Plan continue to be governed by the Outside Directors' Stock Option Plan as in effect and as amended prior to the effective date of this Restated Outside Directors' Option Plan. Options granted under this Plan will be Non-Qualified Stock Options. 2.) Definitions. For purposes of this Plan, the following terms shall have the meanings indicated below: (a) "Board" means the Board of Directors of the Company. (b) "Capital Stock" means any of the Company's authorized but unissued shares of voting common stock, par value of One Cent ($0.01) designation. (c) "Code" means the Internal Revenue Code of 1986, as amended from time to time. (d) "Committee" means a committee consisting solely of not less than two members of the Board of Directors of the Company who are "Non-Employee Directors" within the meaning of and to the extent required by the general rules and regulations promulgated pursuant to Section 16 of the Exchange Act (the "Section 16 Regulations"). The term "Committee" shall refer to the Board of Directors of the Company during such times as no committee is appointed by the Board of Directors and during such times as the Board of Directors is acting in lieu of the Committee. (e) "Company" means Shuffle Master, Inc., a Minnesota Company, and any of its Subsidiaries or its Parent. (f) "Director" means a member of the Board. (g) "Eligible Director" means a Director who is not also an employee of the Company. A director who also serves as Corporate Secretary, and is not otherwise employed by the Company, is an Eligible Director. (h) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (i) "Exercise Price" means the price per share at which an Option may be exercised. (j) "Fair Market Value" means the price per share determined as follows: (i) if the security is listed for trading on one or more national securities exchanges or is quoted on the Nasdaq National Market System ("Nasdaq NMS"), the reported last sales price on such principal exchange or system on the date in question (if such security shall not have been traded on such principal exchange on the Nasdaq NMS on such date, the reported last sales price on such principal exchange or on Nasdaq NMS on the first day prior thereto on which such security was so traded); or (ii) if the security is not listed for trading on a national securities exchange and is not quoted on Nasdaq NMS but is quoted on the Nasdaq Small Cap System or is otherwise traded in the over-the-counter market, the mean of the highest and lowest bid prices for such security on the date in question (if there are no such bid prices for such security on such date, the mean of the highest and lowest bid prices on the most recent day prior thereto (not to exceed ten (10) days prior to the date in question) on which such prices existed); or (iii) if neither (i) nor (ii) is applicable, by any means deemed fair and reasonable by the Committee, which determination shall be final and binding on all parties. (k) "Family Member" includes any child, stepchild, grandchild, parent, stepparent, grandparent, spouse, former spouse, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, including adoptive relationships, any person sharing the Optionee's household (other than a tenant or employee), a trust in which Family Members have more than fifty percent (50%) of the beneficial interest, a foundation in which these persons (or the Optionee) control the management of assets, and any other entity in which these persons (or the Optionee) own more than fifty percent (50%) of the voting interests. (l) "Option" means an option to purchase Stock as described in Section 6 hereof. An Option granted under this Plan is a nonstatutory option to purchase Stock which does not meet the requirements of an incentive stock option set forth in Section 422 of the Code. (m) "Option Agreement" means a written agreement pursuant to which the Company grants an option to an Optionee and sets the terms and conditions of the Option. (n) "Option Date" means the date upon which an Option Agreement for an Option granted pursuant to this Plan is duly executed by or on behalf of the Company. (o) "Option Stock" means the voting common stock of the Company (subject to adjustment as described in Section 7) reserved for Options pursuant to this Plan, or any other class of stock of the Company which may be substituted therefor by exchange, stock split or otherwise. (p) "Optionee" means an Eligible Director who has been granted an Option. (q) "Plan" means this Restated Outside Directors' Option Plan (January 2002), as amended hereafter from time to time. (r) A "Subsidiary" means any company in an unbroken chain of companies beginning with the Company, if, at the time of granting the option, each of the companies other than the last company in the chain owns stock possessing more than fifty percent (50%) of the 2. total combined voting power of all classes of stock in one of the other companies in such chain. The term shall include any subsidiaries which become such after adoption of this Plan. (s) A "Parent" means a company that directly, or indirectly through related companies, owns more than fifty percent (50%) of the voting power of the shares entitled to vote for directors of the Company. The term shall include a company which becomes such after adoption of this Plan. (t) "Securities Act" means the Securities Act of 1933, as amended. (u) "Termination Date" means the date on which an Optionee ceases to be a Director of the Company. 3.) Option Stock Available Under Plan. (a) Stock Subject to the Plan. The maximum number of shares of Stock that may be issued upon the exercise of Options is 337,500 (which number reflects three 3-for-2 stock splits effected by the Company since the date this Plan was first adopted and does not reflect a change in the number of Options authorized under the Plan). The shares of Stock covered by the portion of any Option that expires or otherwise terminates unexercised under this Plan shall become available again for grant. (b) The aggregate number of shares available under this Plan shall be subject to adjustment on the occurrence of any of the events and in the manner set forth in Section 7. Except as provided in Section 7, in no event shall the number of shares reserved be reduced below the number of shares issuable upon exercise of outstanding Options. If an Option shall expire or terminate for any reason without having been exercised in full, the unpurchased shares, shall (unless the Plan shall have been terminated) become available for other Options under the Plan. 4.) Administration. The Plan shall be administered by the Committee. The Company shall grant Options pursuant to the Plan upon determinations of the Committee as to which of the eligible persons shall be granted Options, the number of shares to be optioned, the Exercise Price, the vesting, the term of exercise, the term during which any such Options may be exercised and the other terms and provisions of the Options. The Committee may from time to time adopt rules and regulations for carrying out the Plan and shall have authority and discretion to interpret and construe any provision of the Plan. Each determination, interpretation or other action made or taken by the Committee pursuant to the provisions of the Plan shall be final and conclusive. No member of the Committee will be liable for any action or determination made in good faith with respect to the Plan or any Option granted under the Plan. 3. 5.) Eligibility for Options. Options may be granted only to an Eligible Director of the Company. If an Eligible Director becomes an employee of the Company subsequent to any Option Grant pursuant to this Plan, such Option shall remain in effect and exercisable in accordance with this Plan. 6.) Terms and Conditions of Options. Whenever the Committee shall grant an Option, it shall communicate to the Secretary of the Company the name of the Optionee, the number of shares to be optioned and such other terms and conditions as it shall determine, not inconsistent with the provisions of this Plan. The President or other officer of the Company shall then enter into an Option Agreement with the Optionee, complying with and subject to the following terms and conditions and setting forth such other terms and conditions of the Option as determined by the Committee: (a) Grant of Option. Options shall be granted pursuant to this Plan as follows: (1) Grant upon Election or Appointment - Upon the initial election or appointment of an Eligible Director, the Committee shall grant Options to such new Eligible Director. Such Options shall entitle the Eligible Director to purchase such number of shares of Capital Stock as the Committee shall determine, if any. If more than one Eligible Director is elected or appointed at the same time, the Committee may vary the number of Options granted to each. (2) Annual Grant - Each person who remains an Eligible Director on the date of the Company's annual shareholder meeting shall be granted an Option to purchase such number of shares of Capital Stock as the Committee shall determine, if any. If more than one Eligible Director is re-elected at the same time, the Committee may vary the number of Options granted to each. (3) Discretionary Grants. - In addition to the automatic granting of options pursuant to subsections (1) and (2) set forth above in this section, the Committee may grant additional options to Eligible Directors at such times as the Committee shall determine. Options granted under this subsection shall contain such terms and conditions as determined by the Committee at the time of grant. (b) Exercise Price. (1) The Exercise Price of an Option granted under subsection 6(a)(1) or (2) shall be one hundred percent (100%) of the Fair Market Value of the Option Stock at the Option Date. 4. (2) The Exercise Price of an Option granted under Section 6(a)(3) shall be such price as determined by the Committee at the time it makes the grant, including a price which can be determined on the basis of future events. If the Committee fails to state an Exercise Price at the time of grant, the Exercise Price shall be the Fair Market Value of the Option Stock at the Option Date. (3) The Exercise Price shall be subject to adjustment as provided in Section 7 hereof. (c) Time and Manner of Exercise of Option. Except as set forth in this Plan or in the action of the Committee at the grant of an Option, all Options shall vest immediately upon grant. Fifty percent (50%) of Options granted upon election or appointment shall vest on the Option Date and the remaining fifty percent (50%) shall vest on the first anniversary of the Option Date. No Option may be exercised after ten (10) years from the date on which the option was granted. (d) Termination, Except Death or Disability. An Optionee who ceases to be an Eligible Director of the Company shall have the right to exercise any vested outstanding Options which were exercisable at the time of such event at any time within twelve (12) months after such event or until the earlier date of termination of exercisability of such option under this Plan or the Option Agreement, unless otherwise set forth in the Option Agreement. Any vested Options not exercised within the twelve (12) month period shall terminate at the expiration of such period, unless otherwise set forth in the Option Agreement. Nothing in this subsection shall act to permit the exercise of an Option if such Option otherwise expires pursuant to this Plan. (e) Death or Disability of Optionee. If an Optionee shall die or become disabled while an Eligible Director of the Company and in any such case shall not have fully exercised his or her vested Options, any vested Options granted pursuant to the Plan which were exercisable at the date of death or disability shall be exercisable only within twelve (12) months following his or her date of death or disability or until the earlier originally stated expiration thereof, unless otherwise set forth in the Option Agreement. In the case of death, such Option shall be exercised pursuant to subsection (f) of this Section 6 by the person or persons to whom the Optionee's rights under the Options shall pass by the Optionee's will or by the laws of descent and distribution, but only to the extent that such Options were exercisable at the time of death. For purposes of this Plan, "disabled" shall not have the same meaning as set forth in Section 22(e)(3) of the Code but, recognizing that service as a director involves substantially less effort than employment, shall refer to an inability to carry out the duties of a director of a publicly-held corporation. All determinations as to whether an Optionee has become so disabled as to be unable to continue to function as a director shall be made by the Committee (not including the Optionee) and shall be final and binding upon the Optionee. The fact that the Committee does not have power to remove a director from their directorship shall not affect the validity of any determination of disability by the Committee. 5. (f) Transfer of Option. (1) Non-Transferability. Except as permitted by the next subsection, each Option granted hereunder shall, by its terms, not be transferable by the Optionee and shall be, during the Optionee's lifetime, exercisable only by the Optionee or Optionee's guardian or legal representative. Except as permitted by the next subsection, each Option granted under the Plan and the rights and privileges thereby conferred shall not be transferred, assigned or pledged in any way (whether by operation of law or otherwise), and shall not be subject to execution, attachment or similar process. Upon any attempt to so transfer, assign, pledge, or otherwise dispose of the Option, or of any right or privilege conferred thereby, contrary to the provisions of the Option or the Plan, or upon levy of any attachment or similar process upon such rights and privileges, the Option, and such rights and privileges, shall immediately become null and void. (2) Permitted Transfers. Each Option granted hereunder shall, by its terms, be transferable: a. by the Optionee to an Optionee's Family Member by a bona fide gift or pursuant to a domestic relations order in settlement of marital property rights; b. by will or pursuant to the laws of descent and distribution; or c. as otherwise permitted pursuant to the rules or regulations adopted by the Securities and Exchange Commission ("SEC") under the Act or the interpretations of such rules and regulations as announced by the SEC from time to time. Any permitted transfer shall be effective only when accepted by the Company subject to the Company receiving documentation reasonably satisfactory to it of such gift, transfer pursuant to domestic relations order, or transfer pursuant to will or pursuant to the laws descent and distribution. Upon effectiveness of any permitted transfer, the rights under any Option shall be exercisable only by the permitted transferee or such transferee's guardian or legal representative. Except as permitted by this subsection, each Option granted under the Plan and the rights and privileges thereby conferred shall not be further transferred, assigned or pledged in any way (whether by operation of law or otherwise), and shall not be subject to execution, attachment or similar process. Upon any attempt to so further transfer, further assign, pledge, or otherwise further dispose of the Option, or of any right or privilege conferred thereby, contrary to the provisions of the Option or the Plan, or upon levy of any attachment or similar process upon such rights and privileges, the Option, and such rights and privileges, shall immediately become null and void. No permitted transfer shall cause any change in the terms of any Option except the identity of the person(s) entitled to exercise such Option and to receive the common stock issuable upon exercise of the Option. 6. Without limiting the generality of the foregoing, any Option shall be subject to termination upon the Optionee ceasing to be an Eligible Director, death or disability of the Optionee to whom the Option was originally granted by the Company without reference to the status as an Eligible Director, death or disability of any permitted transferee. In the event of any transfer of an Option, the obligations of the Company owed to the Optionee shall be owed to the transferee and references in this Plan or in any Option Agreement to the Optionee shall, unless the context otherwise requires, refer to the transferee. (g) Manner of Exercise of Options. An Option may be exercised, in whole or in part, at such time or times and with such rights with respect to such shares which have accrued and are in effect. Such Option shall be exercisable only by: (i) written notice to the Company of intent to exercise the Option with respect to a specified number of shares of stock; (ii) tendering the original Option Agreement to the Company; and (iii) payment to the Company of the Exercise Price for the number of shares of stock with respect to which the Option is then exercised. Except as set forth in the next sentence, payment of the Exercise Price may be made in any of the following manners: (1) cash, including certified check, bank draft or postal or express money order; (2) personal check (provided that if payment of the Exercise Price is made by personal check and such personal check is not timely paid by the drawer's bank, such payment shall be deemed not to have been made and any shares issued upon such exercise shall be deemed void and never issued); (3) by surrender for cancellation of shares of common stock of the Company either: a. Acquired by the Optionee other than by exercise of an Option; b. Acquired by the Optionee upon exercise of an Option where the Option Shares being surrendered have been held by the Optionee for at least six (6) months after such exercise; or c. Acquired by the Optionee upon exercise of an Option where the Option Shares being surrendered have been held by the Optionee for six months or less after such exercise but only if the Optionee has obtained prior approval of the specific surrender (such approval to include at least the date of grant of the Option being exercised, the dates of grant and exercise of the Option pursuant to which shares to be surrendered were acquired, and the number of Option Shares to be surrendered) by the Committee; and having a Fair Market Value equal to the exercise price of the Options being exercised (if the shares surrendered have a Fair Market Value in 7. excess of the Exercise Price of the Options being exercised, the Company shall promptly pay to the Optionee an amount equal to the excess of such Fair Market Value over the Exercise Price, not to exceed the Fair Market Value of one share); (4) by any other method of payment which the Committee shall approve before, at, or after the date of grant of such Options. Notwithstanding the foregoing listing of permissible manners of payment of Exercise Price, the Committee shall have the right, from time to time, to cancel, limit or suspend the right to make payment under any one or more manners of payment (other than the payment by cash, certified check, bank draft or postal or express money order), including other methods of payment previously approved by the Committee under the authority granted in subsection (g)(4) of this Section 6, including the right to cancel, limit or suspend such right as to any one, some, or all Option(s) and as to any one, some, or all Option Holder(s). There shall be no exercise at any one time as to fewer than one hundred (100) shares (or such lesser number of shares as the Committee may from time to time determine in its discretion) or all of the remaining shares then purchasable by the Optionee or person exercising the Option. When shares of stock are issued pursuant to the exercise of an Option, the fact of such issuance shall be noted on the Option Agreement by the Company before the Option Agreement is returned. When all shares of Optioned stock covered by the Option Agreement have been issued, or the Option shall expire, the Option Agreement shall be canceled and retained by the Company. (h) Delivery of Certificate. An Option shall be deemed to have been exercised immediately prior to the close of business on the date the Company is in receipt of the original Option Agreement, written notice of intent to exercise the Option, and payment for the number of Shares being acquired upon exercise of the Option. The Optionee shall be treated for all purposes as the holder of record of the Option Stock as of the close of business on such date, except where shares are held for unpaid withholding taxes. As promptly as practicable on or after such date, the Company shall issue and deliver to the Optionee a certificate or certificates for the Option Stock issuable upon such exercise; provided, however, that such delivery shall be deemed effected for all purposes when the Company, or the stock transfer agent for the Company, shall have deposited such certificates in the United States mail, postage prepaid, addressed to the Optionee at the address specified in the written notice of exercise. (i) Other Provisions. The Option Agreements under this Section shall contain such other provisions as the Committee shall deem advisable. 8. 7.) Adjustments. In the event that the outstanding shares of the common stock of the Company are changed into or exchanged for a different number or kind of shares or other securities of the Company or of another company by reason of any reorganization, merger, consolidation, recapitalization, reclassification, stock split-up, combination of shares or dividends payable in capital stock, appropriate adjustment shall be made in the number and kind of shares as to which Options may be granted under the Plan and as to which outstanding Options or portions thereof then unexercised shall be exercisable, to the end that the proportionate interest of the participant shall be maintained as before the occurrence of such event; such adjustment in outstanding Options shall be made without change in the total price applicable to the unexercised portion of such Options and with a corresponding adjustment in the Exercise Price per share. If the Company is a party to a merger, consolidation, reorganization or similar corporate transaction and if, as a result of that transaction, its shares of common stock are exchanged for: (i) other securities of the Company or (ii) securities of another company which has assumed the outstanding options under the Plan or has substituted for such Options its own Options, then each Optionee shall be entitled (subject to the conditions stated herein or in such substituted Options, if any), in respect of that Optionee's Options, to purchase that amount of such other securities of the Company or of such other company as is sufficient to ensure that the value of the Optionee's Options immediately before the corporate transaction is equivalent to the value of such Options immediately after the transaction, taking into account the Exercise Price of the Option before such transaction, the Fair Market Value per share of the common stock immediately before such transaction and the fair market value, immediately after the transaction, of the securities then subject to that Option (or to the option substituted for that Option, if any). Upon the happening of any such corporate transaction, the class and aggregate number of shares subject to the Plan which have been heretofore or may be hereafter granted under the Plan shall be appropriately adjusted to reflect the events specified in this Section. 8.) Acceleration of Vesting and Exercisability Upon Certain Events. (a) Acceleration of Vesting. Notwithstanding any requirements for vesting and time of exercisability of any Option as set forth in the Option Agreement with each Optionee or as otherwise determined by the Committee, any Option granted under this Plan, to the extent not already terminated, shall become vested and immediately exercisable if any of the following occur: (1) Any person (other than the Company) shall make a tender offer to acquire such number of shares of the Company's common stock as shall constitute twenty percent (20%) or more of the Company's outstanding common stock; (2) The Company shall issue or the Company's officers and directors shall transfer (and/or assign their voting rights related to) shares of common stock (or other securities convertible into or exchangeable for common stock) representing at least twenty percent (20%) of the outstanding 9. common stock of the Company (including a series of similar transactions effected within six (6) months which, in the aggregate, result in the issuance and/or transfer of (and/or assignment of voting rights related to) at least twenty percent (20%) of the Company's outstanding common stock) (the percentages set forth in this paragraph to be computed after completion of the subject transactions and as though shares "beneficially owned," as defined in Rule 13d-3 under the Exchange Act, were, in fact, owned); (3) A proxy statement, whether issued by the Company or another shareholder, proposes a vote at a shareholder meeting related to any merger of the Company, any sale of substantially all of the Company's assets or any reorganization of the Company involving a change in beneficial ownership of the Company; (4) A change in control of the Company of a nature that would be required to be reported pursuant to Section 13 of 15(d) of the Exchange Act, whether or not the Company is then subject to such reporting requirements, including, without limitation, such time as any person becomes, after the effective date of the Plan, the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of forty percent (40%) or more of the combined voting power of the Company's outstanding securities ordinarily having the right to vote at elections of directors; (5) The individuals who constitute the Board of Directors on the effective date of the Plan cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to the effective date of the Plan whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors comprising the Board on the effective date of the Plan will, for purpose of this subsection (a)(5) of this Section, be considered as though such persons were a member of the Board of Directors on the effective date of the Plan. (6) Any other event which the Committee determines is of similar effect, such determination to be made by the Committee on an event-by-event basis. (b) No Limitation on Exercise Period. Nothing in this Section shall limit or shorten the period during which any such option is exercisable. If an option provides for exercisability during a limited period after a contingency is satisfied, and the initial exercisability of the option is accelerated by means of this Section, the expiration of such option shall be delayed until the contingency has been satisfied and the option shall, thereafter remain exercisable for the balance of the period initially contemplated by the option grant. (For example, if an option is granted providing that it shall be exercisable for a period of ninety (90) days after a triggering event, and such option is subject to the provisions of this Section providing that it shall 10. become immediately exercisable, it shall thereafter remain exercisable until such triggering event has occurred and ninety (90) days has passed.) (c) No Extension of Exercise Period. Any acceleration or extension of exercisability pursuant to this Section shall not extend such exercisability beyond the expiration or maximum term set forth in Section 6. (d) Acceleration DUE to Company Call of Options. Notwithstanding any requirements for vesting and time of exercisability of any Option as set forth in the Option Agreement with each Optionee or as otherwise determined by the Committee, any Option granted under this Plan, to the extent not already terminated and subject to a call provision, shall become vested and immediately exercisable if the Company gives notice of its intention to exercise its right to call such option. (e) Cash Payment for Options. If an event described in Section 8 occurs, then the Committee in its sole discretion either in an agreement evidencing an Option grant at the time of grant or at any time after the grant of an Option, and without the consent of any Option recipient affected thereby, may determine that some or all recipients holding outstanding Options will receive, with respect to and in lieu of some or all of the shares of Option Stock, as of the effective date of any such Section 8 event, cash in an amount equal to the excess of the Fair Market Value of such shares either immediately prior to the effective date of such Section 8 event or, if greater, determined on the basis of the amount paid as consideration by the other party(ies) to the Section 8 event over the Exercise Price per share of such Options. (f) Limitation on Payments. Notwithstanding anything in Sections 8(a), 8(d) or 8(e) of the Plan to the contrary, if the Company is then subject to the provisions of Section 280G of the Code, and if the acceleration of the vesting of an Option as provided in Section 8(a) or 8(d) or the payment of cash in exchange for all or part of an Option as provided in Section 8(e) (which acceleration or payment could be deemed a "payment" within the meaning of Section 280G(b)(2) of the Code), together with any other payments which such recipient has the right to receive from the Company or any company that is a member of an "affiliated group" (as defined in Section 1504(a) of the Code without regard to Section 1504(b) of the Code) of which the Company is a member, would constitute a "parachute payment" (as defined in Section 280G(b)(2) of the Code), then the payments to such recipient pursuant to Sections 8(a), 8(d) or 8(e) will be reduced to the largest amount as will result in no portion of such payments being subject to the excise tax imposed by Section 4999 of the Code; provided, however, that if such recipient is subject to a separate agreement with the Company or a Subsidiary which specifically provides that payments attributable to one or more forms of employee stock incentives or to payments made in lieu of employee stock incentives will not reduce any other payments under such agreement, even if it would constitute an excess parachute payment, then the limitations of this Section 8(e) will, to that extent, not apply. 11. 9.) Rights as Shareholder. An Optionee shall not, by reason of any Option granted hereunder, have any right of a shareholder of the Company with respect to the shares covered by his or her Option until the exercise of such Option is effective. 10.) No Obligation to Exercise Option; Maintenance of Relationship. The granting of an Option shall impose no obligation upon the Optionee to exercise such Option. Nothing in the Plan or in any Option Agreement entered into pursuant hereto shall be construed to confer any obligation on the part of the Board to nominate any Director for re-election by the Company's shareholders, or confer upon any Director the right to remain a member of the Board for any period of time, or at any particular rate of compensation or interfere in any way with the right of the Company to terminate his or her relationship with the Company at any time. 11.) Withholding Taxes. If applicable, whenever, under the Plan, shares of Option Stock are to be issued upon exercise of the Options granted hereunder and prior to the delivery of any certificate or certificates for said shares by the Company, the Company shall have the right to require the Optionee to remit to the Company an amount sufficient to satisfy any federal and state withholding or other employment taxes resulting from such exercise. In the event that withholding taxes are not paid by the date of exercise, to the extent permitted by law, the Company shall have the right, but not the obligation, to cause such withholding taxes to be satisfied by reducing the number of shares of stock deliverable or by offsetting such withholding taxes against amounts otherwise due from the Company to the Optionee as wages, salary, consulting fees, director's fee or otherwise. If withholding taxes are paid by reduction of the number of shares deliverable to Optionee, such shares shall be valued at the Fair Market Value as of the business day preceding the date of exercise. 12.) Purchase for Investment; Rights of Holder on Subsequent Registration. Unless the shares to be issued upon exercise of an Option granted under the Plan have been effectively registered under the Securities Act, the Company shall be under no obligation to issue any shares covered by any Option unless the person who exercises such Option, whether such exercise is in whole or in part, shall give a written representation and undertaking to the Company which is satisfactory in form and scope to counsel for the Company and upon which, in the opinion of such counsel, the Company may reasonably rely, that he or she is acquiring the shares issued to him or her pursuant to such exercise of the Option for his or her own account as an investment and not with a view to, or for sale in connection with, the distribution of any such shares, and that he or she will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act, or any other applicable law, and that if shares are issued without such registration a legend to this effect may be endorsed on the securities so issued and a "stop transfer" restriction may be placed in the stock transfer records of the Company. 12. In the event that the Company shall, nevertheless, deem it necessary or desirable to register under the Securities Act or other applicable statutes anyshares with respect to which an Option shall have been exercised, or to qualify any such shares for exemption from the Securities Act or other applicable statutes, then the Company shall take such action at its own expense and may require from each participant such information in writing for use in any registration statement, prospectus, preliminary prospectus or offering circular as is reasonably necessary for such purpose and may require reasonable indemnity to the Company and its officers and directors from such holder against all losses, claims, damages and liabilities arising from such use of the information so furnished and caused by any untrue statement of any material fact required to be stated therein or necessary to make the statement therein not misleading in light of the circumstances under which they were made. 13.) Modification of Outstanding Options. The Committee may accelerate the exercisability of an outstanding Option and may authorize modification of any outstanding Option with the consent of the Optionee when and subject to such conditions as are deemed to be in the best interests of the Company and in accordance with the purposes of the Plan. 14.) Approval of Shareholders. The Outside Directors' Stock Option Plan, prior to this restatement, was previously approved by the Company's shareholders. All amendments thereto, including this restatement have been approved by the Board and do not require further shareholder approval for such amendments or restatement. 15.) Liquidation. Upon the complete liquidation of the Company, any unexercised Options theretofore granted under this Plan shall be deemed canceled, except as otherwise provided in Section 8 in connection with a merger, consolidation or reorganization of the Company. 16.) Restrictions on Issuance of Shares. Notwithstanding the provisions of Section 6, the Company may delay the issuance of shares covered by the exercise of any Option and the delivery of a certificate for such shares until one of the following conditions shall be satisfied: (a) The shares with respect to which the Option has been exercised are at the time of the issue of such shares effectively registered under applicable Federal and state securities acts as now in force or hereafter amended; or (b) A no-action letter in respect of the issuance of such shares shall have been obtained by the Company from the Securities and Exchange Commission and any applicable state securities commissioner; or (c) Counsel for the Company shall have given an opinion, which opinion shall not be unreasonably conditioned or withheld, that such shares are exempt from registration under applicable federal and state securities acts as now in force or hereafter amended. 13. It is intended that all exercises of Options shall be effective, and the Company shall use its best efforts to bring about compliance with the above conditions within a reasonable time, except that the Company shall be under no obligation to cause a registration statement or a post-effective amendment to any registration statement to be prepared at its expense solely for the purpose of covering the issue of shares in respect of which any option may be exercised. 17.) Amendment, Suspension or Termination of the Plan. The Committee may at any time amend, alter, suspend, or discontinue this Plan, except to the extent that shareholder approval is required for any amendment or alteration: (a) by Rule 16b-3 or applicable law in order to exempt from Section 16(b) of the Exchange Act any transaction contemplated by this Plan; (b) by the rules of the New York Stock Exchange, if the Company's securities are listed thereon; or (c) by the rules of NASDAQ pertaining to the National Market System, if the Company's securities are quoted thereon; provided, however, no amendment, alteration, suspension or discontinuation shall be made that would impair the rights of any Optionee under an Option without such Optionee's consent; and provided further, that any provision in this Plan relating to the eligibility of Directors to participate in this Plan, the timing of Option grants made under this Plan, or the amount of Options granted to a Director under this Plan, shall not be amended more than once every six months, other than to comport with the changes in the Code or the rules thereunder. Subject to the foregoing, the Committee shall have the power to make such changes in the regulations and administrative provisions hereunder, or in any Option (with the Optionee's consent), as in the opinion of the Committee may be appropriate from time to time. 18.) Effective Date. This Restatement of the Outside Directors' Option Plan became effective on January 24, 2002 when it was adopted by the Board. 19.) General Provisions. (a) If any day on or before which action under the Plan must be taken falls on a Saturday, Sunday, or legal holiday, such action may be taken on the next succeeding day not a Saturday, Sunday or legal holiday. (b) To the extent that federal laws do not otherwise control, the Plan and all determinations made and actions taken pursuant hereto shall be governed by and construed under the laws of the State of Minnesota. Adopted by the Board of Directors: January 24, 2002 14. IN WITNESS WHEREOF, the undersigned hereby acknowledges that the Company has caused this document to be finalized and approved as the "Restated Outside Directors' Option Plan" as of this twenty-fourth day of January, 2002. SHUFFLE MASTER, INC. By: /s/ Gary W. Griffin ------------------------------------ Its: Secretary ------------------------------- 15. EX-23.1 7 shuffle020338_ex23-1.txt INDEPENDENT AUDITORS' CONSENT INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33-88124, No. 33-88180, No. 333-09623, No. 333-39060, No. 333-39064, No. 333-39290, and No. 333-61588 on Form S-8 of our report dated December 12, 2001, relating to the financial statements as of and for the years ended October 31, 2001, 2000 and 1999, appearing in this Annual Report on Form 10-K of Shuffle Master, Inc. for the year ended October 31, 2001. Minneapolis, Minnesota January 29, 2002 Deloitte & Touche LLP -----END PRIVACY-ENHANCED MESSAGE-----