10-K 1 shfl_10k-103111.htm FORM 10-K shfl_10k-103111.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2011
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to
Commission file number: 0-20820
SHUFFLE MASTER, INC.
(Exact name of registrant as specified in its charter)
Minnesota
 
41-1448495
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
     
1106 Palms Airport Drive, Las Vegas
NV
89119
(Address of Principal Executive Offices)
(State)
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (702) 897-7150

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, $0.01 par value per share
The NASDAQ Stock  Market LLC

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.         Yes o  No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes o  No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendments to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No x
 
The aggregate market value of voting Common Stock held by non-affiliates of the Registrant on April 30, 2011 was approximately $590,889,965.
 
As of January 3, 2012, 54,431,027 shares of Common Stock of the Registrant were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
 
Part III of this Annual Report on Form 10-K incorporates by reference information from the Registrant’s Proxy Statement for its Annual Meeting of Shareholders to be held on March 15, 2012 (“Fiscal 2011 Proxy Statement”) to be filed with the SEC within 120 days of the end of the fiscal year covered by this report.
 
 
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SHUFFLE MASTER, INC.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED OCTOBER 31, 2011
 
TABLE OF CONTENTS
 
   
Page
     
 
Forward Looking Statements
 
 
Part I
 
Item 1.
Business
5
Item 1A.
Risk Factors
16
Item 1B.
Unresolved Staff Comments
21
Item 2.
Properties
21
Item 3.
Legal Proceedings
21
Item 4.
Removed and Reserved
21
 
Part II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
22
Item 6.
Selected Financial Data
24
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
63
Item 8.
Financial Statements and Supplementary Data
64
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
100
Item 9A.
Controls and Procedures
100
Item 9B.
Other Information
100
 
Part III
 
Item 10.
Directors, Executive Officers and Corporate Governance
101
Item 11.
Executive Compensation
101
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
101
Item 13.
Certain Relationships and Related Transactions and Director Independence
101
Item 14.
Principal Accounting Fees and Service
101
 
Part IV
 
Item 15.
Exhibits, Financial Statement Schedules
102
 
 
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements. The forward-looking statements are contained principally in the sections entitled, “Risk Factors,” “Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” but are also contained elsewhere in this Form 10-K. In some cases, you can identify forward-looking statements by the following words: “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology intended to identify performance or achievements to be materially different from the information expressed or implied by these forward-looking statements.  Examples of such forward looking statements include, without limitation, statements about or relating to the following:

·  
Business strategies, including with respect to development of new or enhanced products, our focus on leasing structures for commercialization of certain products to increase returns and gross margins, and increasing our Proprietary Table Games ("PTG") content through development or acquisitions;

·  
Expectations of increases in gross margins and revenues from leasing of certain products;

·  
Expectations regarding continued freedom of our workforce from collective bargaining agreements;

·  
The growth and revenue potential from our i-Table® and MD3 Shuffler products;

·  
The benefits of our products;

·  
Continued volatility in sales revenue from our Utility segment and expected increases in leasing revenue in such segment;

·  
Expectations that Electronic Gaming Machines ("EGM") revenues will continue to come from sales of EGMs in Australia;

·  
Expectations of Equinox placement in 2012 exceeding 2011 levels;

·  
Expected decline of Ace® shuffler conversions;

·  
Expectations with respect to foreign currency exchange rate fluctuation risk;

·  
Cash and capital resources being sufficient to satisfy requirements for working capital, capital expenditures, debt service, and other liquidity requirements of existing operations for at least the next 12 months;

·  
The expected immaterial impact of the final disposition of pending litigation;

·  
The expected immaterial impact of the expiration of patents that may expire prior to 2015;

·  
The potential negative impact on manufacturing, resulting from supply chain streamlining efforts;

·  
Expectations regarding adoption of new accounting standards;

·  
Growing capital expenditures in proportion to revenue as a result of our leasing model extending into more capital-intensive products; and

·  
Expectations with respect to foreign currency exchange rate fluctuation risk.

Although we currently believe that we have a reasonable basis for each forward-looking statement contained in this Form 10-K, we caution you that these statements are based on a combination of facts and factors currently known by us, as well as our projections of the future, about which we cannot be certain. Forward-looking statements reflect and are subject to inherent known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Risk factors that could cause actual results to differ materially from those expressed or implied by our forward-looking statements include, but are not limited to, the following:

·  
Failure to maintain our regulatory licenses or obtain new licenses where necessary;

·  
Legislative and regulatory changes that impact us or our customers;

 
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·  
Non-compliance with the covenants in our senior secured credit agreement (“Senior Secured Revolving Credit Facility”), including as a result of factors that are beyond our control;

·  
High volatility or extreme changes in foreign currency exchange rates;

·  
Difficulties or delays in, or being prevented from, carrying out acquisitions and subsequent integration of acquired businesses;

·  
Difficulties in maintaining and protecting our intellectual property rights;

·  
Potential infringement of the intellectual property rights of third parties;

·  
Adverse outcomes with respect to litigation regarding intellectual property, including our payment of damages, constraints on our business and operations and invalidation of our intellectual property;

·  
Involvement in other legal proceedings, and adverse outcomes with respect to such proceedings which could have a materially adverse effect on our business or prospects;

·  
Disruption or delays in our or our suppliers’ manufacturing processes that could prevent us from meeting demand for our products;

·  
Revenue losses in any of our business segments due to technical difficulties or fraudulent activities experienced by end users;

·  
Inability to obtain market acceptance of  products currently in development;

·  
Inability to maintain a competitive technological position with respect to our competitors and competitive products;

·  
Lower than expected revenues from our transition in certain products to a lease-based commercialization model;

·  
Decreased demand for our products, including as a result of developments with respect to competitive products;

·  
Adverse economic conditions in the gaming industry, which is our sole industry of focus; and

·  
Adverse developments with respect to economic, political, legal and other risks associated with our international sales and operations.

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

ITEM 1. BUSINESS

BUSINESS

Unless the context indicates otherwise, references to “Shuffle Master, Inc.,” “we,” “us,” “our” or the “Company,” include Shuffle Master, Inc. and its consolidated subsidiaries.
 
We are a Minnesota corporation formed in 1983. We conducted our initial public offering and became a NASDAQ-listed public company in 1992. Our corporate offices are located at 1106 Palms Airport Drive, Las Vegas, Nevada 89119 and our telephone number is 702-897-7150.
 
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), are filed with the United States Securities and Exchange Commission (the “SEC”). Such reports and other information filed by us with the SEC are available free of charge on our website at www.shufflemaster.com when such reports are available on the SEC website. The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K.
 
We are a leading global gaming supplier committed to making gaming more fun for players and more profitable for operators through product innovation, and superior quality and service.  We operate in legalized gaming markets across the globe and provide state-of-the-art, value-add products in four distinct segments: Utility products, which include automatic card shufflers and roulette chip sorters; Proprietary Table Games (“PTG”), which include live games, side bets and progressives as well as our newly introduced i-Gaming, which features online versions of our table games, social gaming and mobile applications; Electronic Table Systems (“ETS”), which include various e-Table game platforms; and Electronic Gaming Machines (“EGM”), which include video slot machines.

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

Utility. Our Utility segment develops products for licensed casino operators that are designed to enhance table game speed, productivity, profitability and security. Utility products include automatic card shufflers,  roulette chip sorters and deck verification devices. This segment also includes our i-Shoe® Auto card reading shoe that gathers data and enables casinos to track table game play and our i-Score baccarat viewer that displays current game results and trends. These products are intended to cost-effectively provide licensed casino operators and other users with data on table game play for security and marketing purposes, which in turn allows them to increase their profitability.

Proprietary Table Games. Our PTG segment develops and delivers proprietary table games that enhance our casino customers' and other licensed operators' table game operations. Products in this segment include our proprietary table games, side bets, add-ons and progressives as well as our newly introduced i-Gaming products, which feature online versions of our table games, social gaming and mobile applications.  Our proprietary content and features are also added to public domain games such as poker, baccarat, pai gow poker and blackjack table games and to electronic platforms such as Table Master® and i-Table®.

Electronic Table Systems. Our ETS segment develops and delivers various products involving popular table game content using e-Table game platforms. Our primary ETS products are i-Table®, Table Master®, Vegas Star® and Rapid Table Games®.  Our i-Table® platform combines an electronic betting interface with a live dealer who deals the cards from our card reading shoe or shuffler that is designed to improve game speed and security while reducing many operating expenses associated with live tables. Our Table Master® and Vegas Star® products feature a virtual dealer which enables us to offer table game content in both traditional gaming markets and in markets where live table games are not permitted, such as some racinos, video lottery and arcade markets. Our Rapid Table Games® product enables the automation of certain components of traditional table games such as data collection, placement of bets, collection of losing bets and payment of winning bets combined with live dealer and game outcomes. This automation provides benefits to both casino operators and players, including greater security and faster speed of play.
 
 
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Electronic Gaming Machines.  Our EGM segment develops and delivers our PC-based video slot machines into select markets, primarily in Australasia.  We offer a selection of video slot titles which include a range of bonus round options that can be configured as a network of machines or as stand-alone units. In addition to selling the full EGM complement, we sell software conversion kits that allow existing EGM terminals to be converted to other games on the PC3 and PC4 platform. Popular titles for our EGMs include Cats Hats & Bats, Eureka Gold Mine 2, Emerald Fortunes and King of Babylon. In addition, we continued to develop a popular range of games utilizing the Pink Panther brand, under license from MGM Resorts International (“MGM”) consumer products. In July 2010, we began initial deliveries of Equinox, our newest EGM product. Equinox offers widescreen displays and substantially improved graphics and user interfaces over older-style EGM machines.

For additional information about our segments, including segment revenue, operating income and assets, see “Item 6. Selected Financial Data,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.
 
The table below presents our product lines and the percentage of total revenue from continuing operations contributed by each product line in the fiscal years ended October 31:
 
   
Percentage of Total Revenue
 
Product Segment
 
2011
   
2010
   
2009
 
Utility
    36.4 %     38.4 %     40.0 %
Proprietary Table Games
    19.3 %     20.1 %     21.6 %
Electronic Table Systems
    14.9 %     21.1 %     12.4 %
Electronic Gaming Machines
    29.4 %     20.4 %     26.0 %
      100.0 %     100.0 %     100.0 %
 
OUR STRATEGY
 
Our strategies to enhance our customer and shareholder value consist of the following:
 
·  
An unwavering commitment to create innovative solutions and services for casino operators and compelling gaming experiences for players through enhanced customer centricity.

·  
Reinforce our relationships with our customers by providing enhanced efficiencies, security and profitability on the casino floor. We will continue to work toward developing innovative products that anticipate and respond to their needs.

·  
Maintain a cost-conscious mindset, promote a lean culture, and serve as prudent stewards of shareholder capital.

·  
Seek long-term profitability and sustainability through our recurring revenue model. We plan to continue to invest capital in our lease business to maximize our return and build on our economic engine.

·  
Foster the spirit of invention and the commitment to innovation that is at the heart of our success.  With nearly 2,500 patents, trademarks and copyrights granted and pending, our pipeline for new intellectual property is robust. We believe our intellectual property collectively represents one of the strongest portfolios in the industry and our success depends upon our ability to preserve and protect these core assets.

·  
Capitalize on emerging markets and the worldwide proliferation of gaming.  A large part of our success in fiscal 2011 was turning opportunities into achievements.  As new markets continue to emerge across the globe and as existing gaming markets continue to evolve, we will strive to make the most of every opportunity that arises.

·  
Sound balance sheet management to fuel growth through:
o  
continued investment in our recurring revenue model, global intellectual property and research and development (“R&D”). We believe this will promote growth on the Company’s top and bottom line without relying on the introduction of significant new markets;
o  
continued examination of acquisitions.  We are seeking opportunities that are accretive to earnings, have strong existing recurring revenues, and merit our efforts of integration; and
o  
use of our financial resources to improve our return to shareholders through continued deleveraging.

 
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·  
Promote and foster internal staff development and deepen our bench strength.  We know our success is directly attributable to the caliber of our workforce and we remain committed to each and every employee’s development.  We will continue to set the talent bar high.

·  
Drive margin improvement across all product categories. Our overall gross margin has shown continuous improvement over the past three fiscal years.  We plan to continue our process improvement initiatives and uncover additional operational efficiencies.

·  
Capitalize on opportunities created from existing online gaming markets and prepare ourselves for the potential legalization of Internet gambling in the United States.  The gaming landscape is quickly evolving and we will strive to be a leading content-provider in this arena.  We believe online gaming represents a significant opportunity for our future growth.

We are focused on our customers and on value-creation for our shareholders.  We will maintain continuous improvement while keeping innovation at the core of our success. Through the continued execution of our strategic plan, we believe that will best foster the growth of our business in fiscal 2012.

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

Our Shuffler Products. We currently market a complete range of shufflers, including single deck, batch and continuous shufflers. Single deck shufflers that deliver randomized hands of cards such as our i-Deal® shuffler are generally used on proprietary table games such as our own Three Card Poker and Ultimate Texas Hold ‘Em® games. Additionally, we offer a single deck/double deck batch shuffler, the Deck Mate®, for use on live stakes poker tables and single or double deck blackjack games.  For multiple deck “shoe” games such as Blackjack, Blackjack variants, Baccarat and Casino War®, we offer the one2six® family of continuous shufflers.  For casinos that prefer to shuffle “shoe” games in a batch shuffler, we offer the MD2® and MD3 shufflers with card recognition.  Shuffled batches of cards may then be delivered to one of our secure card reading i-Shoe® and i-Shoe® Auto shoes.

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

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

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

Our existing Utility products include:

Deck Mate®
Deck Checker
i-Deal®
one2six®
one2six® Plus
Easy Chipper C®
Easy Chipper D
i-Score
i-Shoe®
i-Shoe® Auto
i-Verify
MD2®
MD3
Deck Checker
Chipstar
Chipmaster

 
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OUR PROPRIETARY TABLE GAMES SEGMENT

Our Proprietary Table Games and Other Proprietary Features. Our PTG segment includes our live and electronic proprietary table games, progressive table games with bonusing options and proprietary side bets as well as our newly introduced i-Gaming products, which feature online versions of our table games, social gaming, and mobile applications. We are continuously developing new table games to complement our existing offerings and to extend our penetration of proprietary table games on the casino floor.

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

Premium titles include:
Blackjack Switch®
Caribbean Stud®
Casino War®
Crazy 4 Poker®
Four Card Poker
Let It Ride®
Let It Ride Bonus®
Mississippi Stud®
Texas Hold 'Em Bonus
Three Card Poker
Ultimate Texas Hold ‘Em®

Side bets include:
Bet the Set "21"®
Dragon Bonus®
Fortune Pai Gow Poker®
King’s Bounty blackjack
Royal Match 21®
Sharp Shooter

Add-ons include:
Bad Beat Bonus bets
Three Card Poker Bonus bets

Progressives include:
Fortune Pai Gow Poker Progressive
Progressive Texas Hold ‘Em Bonus
Ultimate Texas Hold ‘Em Progressive
Three Card Poker Progressive
Four Card Poker Progressive
Royal Match 21 Progressive®

OUR ELECTRONIC TABLE SYSTEMS SEGMENT

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

Our existing ETS products include:
i-Table®
Rapid Table Games®
Table Master®
Vegas Star®

 
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OUR ELECTRONIC GAMING MACHINES SEGMENT

Our Electronic Gaming Machines.  We offer a selection of video slot titles developed for select markets primarily in Australia and, to a lesser extent, Asia and Latin America.  We design and develop an extensive array of video slot titles presented in the stylish and contemporary Equinox widescreen cabinet and operating on Shuffle Masters proprietary PC4 operating platform. Our EGM segment is primarily a sales based model with Australia and New Zealand being the largest markets. Asia and Latin America are important emerging markets for this segment and these regions utilize recurring lease and participation models as well as outright sales. 2011 saw the first deployment of Equinox cabinets in Asia.

Popular titles for fiscal 2011 include Cats Hats & Bats, Eureka Gold Mine 2, Emerald Fortunes and King of Babylon. In addition, we continue to develop a popular range of games utilizing the Pink Panther brand, under license from MGM consumer products.

OTHER SEGMENT INFORMATION

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

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

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

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

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

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

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

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

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

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

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

We believe that one of our strengths is identifying new product opportunities and developing new products, therefore we expect to continue to spend a significant portion of our annual revenues on research and development, including the acquisition of intellectual property from third parties.  Total R&D expense was $27.6 million, $21.8 million and $17.3 million for fiscal 2011, 2010 and 2009, respectively.

INTELLECTUAL PROPERTY

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

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

 
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Most of the patents that we own have a life of 20 years from the filing date of the first non-provisional patent application in a family of patents.  While some of our older owned game patents and some of our progressive patents expire in the next 2-3 years and some older shuffler patents expire in 2014, the majority of our patents, including those with our newest technology, expire thereafter.  Under the laws of the United States, when a patent expires, a competitor would be legally able to make, use, offer to sell or sell the invention claimed in the patent.  We believe that the expiration of any of our patents prior to 2015 will not have a material adverse effect on our business. A number of our patents expired in 2009, but the expirations have not and are not expected to materially affect our business. We also have numerous patent applications pending for our existing, planned and potential products. No assurance can be given that any such patents will be issued, or that the patents we currently hold or have licensed or any new patents that we acquire are, will be, or will remain valid, will provide any competitive protection for our products, or will adequately cover our competitors' products.

Trademarks. We own numerous United States and international trademark registrations and common law trademarks.  Some of the more important marks include: Shuffle Master®, Shuffle Master Incorporated®, the Shuffle Master 4-square design mark®, Deck Mate®, i-Deal®, MD2®, MD3, one2six®, Deck Checker, Easy Chipper®, i-Shoe, i-ShoeAuto, Bet the Set “21”®,  Blackjack Press®, Caribbean Stud®, Casino War®, Crazy 4 Poker®, Dragon Bonus®, Fortune Blackjack®, Fortune Pai Gow Poker®, Four Card Poker design mark®, Let It Ride®, Let It Ride Bonus®, shufflemaster.com®, Mississippi Stud®, Royal Match 21®, Texas Hold ‘Em Bonus®, Three Card Poker design mark®, the fan design mark®, Ultimate Texas Hold ‘Em®, Ultimate Three Card Poker design mark®, i-Table design mark®, i-Score, i-Verify, Table Master®, Rapid Table Games® and Vegas Star®.  We believe that our trademarks and trade dress are an important component of the brand identity of our products. We also license trademarks from others.

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

In addition, when we license our products to our customers we also license the right to use our intellectual property. We typically earn license royalties on a periodic basis. We generally do not license our intellectual property to other gaming equipment suppliers.

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

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

Infringement and litigation. We have been and are subject to litigation claiming that we have infringed the rights of others and that certain of our patents and other intellectual property are invalid or unenforceable. We have also brought actions against others to protect our rights. For a discussion of these cases see “Item 3. Legal Proceedings” and Note 15 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.

GAMING REGULATION

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

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

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

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

The laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy which are concerned with, among other things:

·  
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;

·  
application of appropriate accounting practices and procedures;

·  
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;

·  
record-keeping and reporting to the Nevada Gaming Authorities;

·  
fair operation of games; and

·  
the raising of revenues through taxation and licensing fees.

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

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

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

Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Commission may be found unsuitable based solely on such failure or refusal. The same restrictions apply to a record owner if the record owner, when requested, fails to identify the beneficial owner. Any security holder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the common stock beyond such period of time as may be prescribed by the Nevada Commission may be guilty of a gross misdemeanor. We are subject to disciplinary action if, after we receive notice that a person is unsuitable to be a security holder or to have any other relationship with us, we:

·  
pay that person any dividend or interest upon our voting securities;

·  
allow that person to exercise, directly or indirectly, any voting right conferred through securities held by that person; or

·  
give remuneration in any form to that person. If a security holder is found unsuitable, then we may be found unsuitable if we fail to pursue all lawful efforts to require such unsuitable person to relinquish his or her voting securities for cash at fair market value.

The Nevada Commission may also, in its discretion, require any other holders of our equity securities or any holders of our debt securities to file applications, be investigated and be found suitable to own our debt or equity securities. The applicant security holder is required to pay all costs of such investigation. If the Nevada Commission determines that a person is unsuitable to own such security, then pursuant to the regulations of the Nevada Commission, we may be sanctioned, including the loss of our approvals, if, without the prior approval of the Nevada Commission, we:

·  
pay to the unsuitable person any dividends, interest or any distribution whatsoever;

·  
recognize any voting right by such unsuitable person in connection with such securities;

·  
pay the unsuitable person remuneration in any form; or

·  
make any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction.

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

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

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

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

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

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

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

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

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

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

 
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OTHER BUSINESS INFORMATION

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

Significant customer sales, foreign sales and foreign assets. For fiscal 2011, 2010 and 2009, sales to customers outside the United States accounted for approximately 56%, 51% and 50% of consolidated revenue; and no individual customer accounted for more than 10% of consolidated revenue in each of those years. For the year ended October 31, 2011, approximately 29% of our revenues were in our EGM segment, which revenues relate primarily to outside the United States. As of October 31, 2011, approximately 34% of our long-lived assets, excluding deferred income taxes, goodwill and acquired intangible assets, were outside the United States. As of October 31, 2011 and 2010, no single customer balance exceeded 10% of our net trade accounts receivable. As of October 31, 2011, no customers exceeded 10% of our net investment in sales-type lease and notes receivable. As of October 31, 2010, two customers exceeded 10% of our net investment in sales-type lease and notes receivable, these customers have well-established histories of payments to Shuffle Master as well as credit ratings that support the credit lines they have been extended. Additional information regarding our foreign sales and long-lived assets by geographic region is included in Note 14 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.

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

Employees. As of October 31, 2011, we had approximately 740 employees.  We are not subject to any collective bargaining agreements and we believe that our environment will continue to be union free.

 
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ITEM 1A. RISK FACTORS
 
RISKS RELATED TO OUR BUSINESS

The gaming industry is highly regulated and failure to obtain or maintain our licenses could be disruptive to our business and could adversely affect our operations.

We are subject to regulation in all jurisdictions in which our customers operate and may need to be licensed, or seek licensure, approval or suitability of our officers, directors, major shareholders, key personnel or business partners.  These laws, rules and regulations generally concern the responsibility, financial stability, character and suitability of such individuals and entities in gaming operations.  For example, we have established due diligence procedures that we undertake on all of our potential business partners, including our potential business partners in our emerging Internet gaming business.  If any of these individuals or entities are determined to be unsuitable, we may be required to sever our relationship or not enter into the proposed business relationship.  If we do not obtain and maintain all such licenses, approvals or findings of suitability, or if we fail to seek, do not receive or receive a revocation of such a license, approval or finding of suitability in a particular jurisdiction, we will not be able to do business with our customers in that jurisdiction, which could have a material adverse effect on our business, results of operation or financial condition.

Similarly, our products are subject to extensive regulation under federal, state, local and foreign laws in the jurisdictions in which we do business. For example, our failure to meet the required federal, state or foreign testing standards, our breach of any such testing standards or our failure to comply with the rules and regulations regarding the distribution of our products, could result in disciplinary action or the revocation, suspension or conditioning of our licenses, registrations, permits or approvals.

Doing business with any individual or entity considered unsuitable or non-compliance with any of the laws, rules or regulations applicable to our products in any jurisdiction could result in fines, disciplinary actions or the revocation, suspension or conditioning of our licenses, approvals, findings of suitability, registrations or permits.  Regulators have wide ranging powers. A fine or the loss or suspension of a license or approval in one jurisdiction could have a similar effect in other jurisdictions in which we are licensed.  Such event could limit or eliminate our ability to continue our operations, all of which could have a material adverse effect on our business, results of operation or financial condition.

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

New or revised legislation or regulation, including, without limitation, changes to Internet gaming law, may affect demand for or place limitations on the placement of our products.  Such changes could affect us in a variety of ways. For example, current regulations in a number of jurisdictions where our customers operate, such as Macau, limit the amount of space allocated to our products and substantial changes in those regulations may adversely affect demand for our products. Our business may also suffer if our products become obsolete or barriers of entry are created due to changes in laws or the regulatory framework.

Legislative or regulatory changes negatively impacting the gaming industry as a whole or our customers in particular could also decrease the demand for our products. Opposition to gaming could result in restrictions or even prohibitions on gaming operations in any jurisdiction. Tax matters, including changes in state, federal or other tax legislation or assessments by tax authorities could have a negative impact on our business. Any of the foregoing could have a material adverse effect on our existing or proposed business, our results of operations or financial condition.

Compliance with the covenants in our Senior Secured Revolving Credit Facility is subject to many factors, some that are beyond our control and others that may limit our ability to engage in business activities.

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

The Senior Secured Revolving Credit Facility imposes, and the terms of any future indebtedness could impose, operating and other restrictions on us. Such restrictions could affect and in many respects limit or prohibit, among other things, our ability to take certain actions, including obtaining financing for working capital, capital expenditures and acquisitions, all of which could have a material adverse effect on our business, results of operation or financial condition.  Should we need to raise capital beyond or separate from our Senior Secured Revolving Credit Facility, current financial market conditions could affect our ability to raise funds in the capital and bank lending markets.

 
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The indebtedness under the Senior Secured Revolving Credit Facility has variable rates of interest, which exposes us to the risk of increased interest rates.

Our Senior Secured Revolving Credit Facility matures on October 29, 2015.  Depending on economic conditions at such time, we might not be able to refinance such facilities on favorable economic terms, or at all.

We are exposed to foreign currency exchange risk.

We transact business in numerous countries around the world and expect that a significant portion of our business will continue in international markets.  We are exposed to foreign currency exchange rate risk inherent in our leases and sales, purchases of inventory, and assets, liabilities and debt denominated in currencies other than the U.S. dollar. Consolidated revenues from customers outside the United States and denominated in foreign currencies was approximately $127 million in fiscal 2011.  Because our financial results are reported in U.S. dollars, if we generate revenues and earnings in other currencies, the translation of those results into U.S. dollars can result in a significant increase or decrease in the amount of those revenues and earnings. As such, we expect our revenues and earnings to continue to be exposed to the risks that may arise from fluctuations in foreign currency exchange rates, which could have a material adverse effect on our business, results of operation or financial condition.
 
We could face considerable business and financial risks in implementing acquisitions.

As part of our overall growth strategy, we may seek to acquire assets or businesses. We regularly discuss and investigate possible acquisitions. Such acquisitions could result in potentially dilutive issuances of equity securities, significant expenditures of cash, the incurrence of debt and contingent liabilities or an increase in amortization expenses.  The risks associated with acquisitions could have a material adverse effect upon our business, financial condition and results of operations.

We may not be successful in consummating acquisitions on favorable terms or at all. Any acquisition may not produce the revenues, earnings or business synergies we anticipate for a variety of reasons, including, without limitation:

·  
the integration of the operations, financial reporting, internal controls, technologies, products and personnel, including issues raised by national, geographic and cultural differences;

·  
potential impairments in acquired assets;

·  
entry into markets or acquisition of products or technologies in which we have limited or no prior experience;

·  
expenses associated with any unknown or potential legal liabilities;

·  
management of worldwide operations and diversion of management's attention away from our existing business; and

· 
the exploitation of acquired intellectual property or the development, sale or lease of acquired products or unanticipated increases in manufacturing expenses.
 
Our revenues are dependent on our intellectual property rights.

A significant portion of our revenues is derived from products, technologies and services that incorporate our intellectual property.  We have numerous patents, trademarks and copyrights.  We cannot assure you that all of our intellectual property protection would be found, or will continue to be, valid or enforceable, or that any pending intellectual property applications will be approved. The intellectual property we own or have rights to could be challenged, invalidated or circumvented by others and may not be of sufficient scope or strength to provide us with any meaningful protection or commercial advantage. Competitors may infringe our intellectual property and due to inadequate resources or other reasons we may not be able to enforce our intellectual property rights.

The future interpretation of intellectual property laws regarding the validity of intellectual property by United States governmental agencies and courts and courts in other jurisdictions in which we have rights could negatively affect the validity or enforceability of our current or future intellectual property.  This could have multiple negative impacts including, without limitation, the marketability of or anticipated revenue from certain of our products.  Additionally, because of the differences in intellectual property laws, our intellectual property may not receive the same degree of protection in foreign countries as it would in the United States. Our failure to possess, obtain or maintain adequate protection of our intellectual property rights for any reason could have a material adverse effect on our business, results of operations and financial condition.

 
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To the extent technologies are protected by the intellectual property rights of others, including our competitors, we may be prevented from introducing products based on these technologies or expanding into markets created by these technologies. If the intellectual property rights of others limit us from taking advantage of innovative technologies, we may be forced to enter into licensing arrangements in order to utilize such technology, be delayed in introducing such technology into the market or incur unexpected research and development expenses to develop alternative technologies.  We have many competitors in both the United States and foreign countries, some of which have substantially greater resources and have made substantial investments in competing technologies. Some competitors have applied for and obtained, and may in the future apply for and obtain, patents that may prevent, limit or otherwise interfere with our ability to make and sell our products or technologies. Any royalty, licensing or settlement agreements, if required, may not be available to us on acceptable terms or at all.

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

Litigation regarding our intellectual property could have a material adverse effect on our business, intellectual property, results of operation or financial condition.

A significant portion of our success depends on the protection of our intellectual property.  We are making and in the future may make claims of infringement, invalidity or enforceability against third parties.  For example, with the emergence of Internet gaming in legalized markets, we have increased avenues to seek enforcement against parties that infringe our intellectual property.  This enforcement could:

·  
cause us to incur greater costs and expenses in the protection of our intellectual property;

·  
otherwise potentially negatively impact our intellectual property rights;

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

·  
divert management's attention and resources.

In addition, third parties may allege claims of infringement, invalidity or enforceability against us or against our licensees or manufacturers in connection with their use of our technology.  A successful challenge to or invalidation of one of our patents or trademarks, a successful claim of infringement by a third party against us, our products, or one of our licensees in connection with the use of our technology, or an unsuccessful claim of infringement made by us against a third party or its products could adversely affect our business or cause us financial harm.  In addition to the potential negative impacts listed above, any claims could:

·  
be expensive and time consuming to defend or require us to pay significant amounts in damages;

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

·  
require us to redesign, reengineer, rebrand our products or limit our ability to bring new products to the market in the future;

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

·  
require us by way of injunction to have to remove products on lease or stop selling or leasing new products.
 
We are and in the future may be involved in legal proceedings which could materially adversely affect us.

We are currently engaged in litigation on a variety of matters that have arisen in the ordinary course of business and additional claims or disputes may arise in the future. Results of legal proceedings are subject to significant uncertainty and, regardless of the merit of the claims, litigation may be expensive, time-consuming, disruptive to our operations and distracting to management. In recognition of these considerations, we may enter into agreements to settle litigation or other claims or disputes.
 
 
18

 
 
Although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against us for amounts in excess of management’s expectations, our results of operations could be materially adversely affected. Further, such outcome could result in significant compensatory, punitive or trebled monetary damages, disgorgement of revenue or profits, remedial corporate measures or injunctive relief against us, all of which could have a material impact on our business, intellectual property, results of operations or cause us financial harm.
 
Any disruption in our manufacturing processes, any significant increase in manufacturing costs or any inability to manufacture a sufficient number of our products to meet demand could adversely affect us.

We manufacture our products in Las Vegas, Nevada, as well as our facility in Milperra, Australia. We also outsource the manufacturing of certain of our sub-assemblies in the United States, Europe and Asia. Should any of these manufacturing processes be disrupted, we cannot provide assurance that we would be able to timely remedy such disruption and accordingly may not be able to timely meet our business obligations or otherwise meet customer demand, all of which could negatively affect our revenues. To the extent we rely on a single source for any of our components used in our manufacturing process, any disruption to such source may result in a disruption to our manufacturing process and we cannot provide assurance that we will be able to timely remedy such disruption.  In either of such cases, we may be unable to produce a sufficient quantity of our products to meet the demand of our customers for our products or technology.  The impact of all of the foregoing is magnified and will continue to increase as we streamline our supply chain management by narrowing the number of our suppliers.  Further, manufacturing costs may unexpectedly increase and we may not be able to successfully recover any or some of such cost increases by increased pricing to our customers. Such events could have a material adverse impact on our business, results of operations or financial condition.

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

Our success partly depends on our ability to avoid, detect, replicate and correct software and hardware errors and fraudulent manipulation of our products or technology. We incorporate security features into the design of our products and technology in order to prevent us or our customers from being defrauded. To the extent any of our products or software experience errors or fraudulent manipulation, our customers may replace our products with those of our competitors. In addition, the occurrence of errors in, or fraudulent manipulation of, our products or software may give rise to claims by our customers or by our customers’ patrons, including claims by our customers for lost revenues and related litigation.

Software bugs or malfunctions, errors in distribution or installation of our software, failure of our products to perform as approved by the appropriate regulatory bodies, or other errors or malfunctions, may subject us to investigation or other action by gaming regulatory authorities, including fines, the requirement to remove such products or software from commercial use, suspension or revocation of our gaming licenses and disciplinary action. Further, in the event of such issues, substantial engineering and marketing resources and expenditures may be diverted from other areas to rectify the problem.  All of the foregoing could lead to a material adverse effect on our business, results of operations or financial condition.

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

There is intense competition in the gaming products industry.  Our success depends on our ability to keep pace with technological advances in our industry and to adapt and improve our products in response to evolving customer needs and industry trends.  As a result, we expect to continue to make significant investments in product development.  While we are pursuing and will continue to pursue product development and technology opportunities, we cannot assure you that such products or technologies will come to fruition or become successful or that we will realize a return on such investments.

Our development of products is dependent on multiple factors.  There is competition in our industry for skilled personnel, which means that our product development may be impacted by our not having the necessary qualified and talented employees.  We may not have sufficient research and development resources, including the necessary financial resources.  A number of products are being tested and we cannot provide any definite date by which they will be commercially available.  These products may not prove to be commercially viable and even if they do, we may not be able to obtain the various gaming licenses necessary to distribute them to our customers. Additionally, subsequent to the commercial introduction of such products, we may experience operational problems that could delay or defeat the ability of such products to generate revenue or operating profits.

Future technologies developed by our competitors may render our current products less desirable, profitable or viable.  We may not have available the financial and other resources to compete effectively against such competitors, which may, among other things, render our products obsolete or reduce their commercial value.  Future operational problems could increase our costs, delay our plans or adversely affect our reputation or our sales of other products which, in turn, could have a material adverse effect on our success. We cannot predict which of the many possible future products, if any, will meet evolving industry standards and consumer demands. Should we be unable to adapt to such technological changes, offer such products on a timely basis or establish or maintain a competitive position, we could suffer a material adverse effect on our business, results of operations or financial condition.

 
19

 
 
In general, we compete with other gaming and entertainment products for space on the casino customers’ floor, as well as for our customers' capital and operational spending.   For example, in our PTG segment, we compete with both non-proprietary table games such as blackjack and several companies that primarily develop and license proprietary table games.   Competition in this segment is particularly based on price, brand recognition, player appeal and the strength of underlying intellectual property.  Small developers and vendors are more easily able to participate develop and market table games, compared to other gaming products, because of the lower cost and complexity associated with the development of these products and a generally less stringent regulatory environment.

Our current strategy is focused on moving to a lease based model and our business may suffer if demand for our products decreases.

Our current strategy is to shift our customers from a sales based model to a lease based model for our Utility, PTG and ETS segments.  While this strategy is not possible in all jurisdictions, in fiscal 2011, 60.9% of our revenues were derived from leases in these segments.  Such lease agreements with our customers are typically month-to-month and provide for termination upon 30 days' prior notice by either party.  Accordingly, consistent demand for and satisfaction with our products by our customers is critical to our financial condition and future success. Problems, defects or dissatisfaction with our products could cause us to lose customers or revenues from leases with minimal notice, which may cause us to suffer a materially adverse effect on our business, results of operations or financial condition.

Economic conditions that have an adverse effect on the gaming industry will adversely affect our results of operations.

Our business operations are concentrated in a single industry that is affected by international, national and local economic conditions. A downturn in the economy or in a region constituting a significant source of our customers, or a reduction in demand for gaming, may harm our financial condition or that of our other customers.  We cannot predict the effect or duration of an economic slowdown or the timing or strength of any subsequent economic recovery, worldwide or in the gaming industry, or the impact such slowdown may have on the demand for gaming.  If fewer players visit our customers' facilities, if such players have less disposable income to spend at our customers' facilities or if our customers are unable to devote resources to purchasing and leasing our products, there could be an adverse effect on our business. Such events include, without limitation:
 
·  
adverse economic and market conditions, including fluctuating interest rates, higher airfares, energy and gasoline prices;
 
·  
political events such as terrorist attacks, acts of war, political instability and international economic crisis; and
 
·  
natural disasters such as major fires, floods, hurricanes and epidemics.
 
Such events may make it difficult for our customers and us to accurately forecast and plan future business activities and may cause our customers to slow their spending on our products. Our success depends on our customers leasing or buying our products to expand their existing operations, replace existing gaming products or equip new casinos. Any slowdown in the replacement cycle as a result of a downturn in the gaming industry may negatively impact our operations. If the domestic and foreign markets for our products significantly deteriorate, our business, financial condition and results of operations could be materially and adversely affected.
 
Economic, political, legal and other risks associated with our international sales and operations could adversely affect our operating results.

Our sales to customers outside the United States, primarily Canada, Europe and Australasia accounted for approximately 56% in fiscal 2011 of our consolidated revenue from continuing operations for fiscal 2011. Accordingly, our business results could be harmed by a variety of factors associated with our doing business internationally, including, without limitation:
 
·  
tariffs, other trade protection measures and import or export licensing requirements;
 
·  
changes in tax laws or application of such tax laws;
 
·  
labor regulations, staffing and management of widespread operations;
 
·  
requirements relating to withholding taxes on remittances, intercompany payments and restrictions on our ability to repatriate dividends from our subsidiaries;
 
 
20

 
 
·  
collectability of receivables and recoverability of residual values on leased assets resulting in increased write-offs;
 
·  
the ability for us to repossess our equipment or products in the event of a lease default; and
 
·  
restrictions on our ability to operate subsidiaries, make investments or acquire new businesses in foreign jurisdictions.
 
We also have agreements with casinos in Native American jurisdictions, which may subject us to sovereign immunity risks and could subject us to additional compliance costs.

ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2. PROPERTIES
 
Properties. We lease facilities in various locations throughout North America for office, research and development, warehouse and service space totaling approximately 113,000 square feet to support our American operations.  Our corporate headquarters, as well as our research and development and manufacturing of utility and e-Table products, are located in Las Vegas, Nevada and account for 76,000 square feet.

We lease facilities in various locations throughout Australia and New Zealand, totaling approximately 64,000 square feet for office, service and warehouse space to support our Australasia operations.  In addition, we own an approximately 59,000 square feet facility in Milperra, New South Wales, Australia that we use for research and development and manufacturing space for our e-Table and EGM products.

We lease facilities in Vienna and Salzburg, Austria, totaling approximately 16,000 square feet for office, warehouse and apartment rental space to support our European operations.

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

We lease approximately 4,000 square feet in Johannesburg, South Africa for office and warehouse space to support our Africa operations.

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

ITEM 3. LEGAL PROCEEDINGS
 
For information on Legal Proceedings, see Note 15 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.
 
Litigation is inherently unpredictable and risky. Our current assessment of each matter may change based on future unknown or unexpected events. If any litigation were to have an adverse result that we did not expect, there could be a material impact on our results of operations or financial position. We believe costs associated with litigation will not have a material impact on our financial position or liquidity, but may be material to the results of operations in any given period. We assume no obligation to update the status of pending litigation, except as may be required by applicable law, statute or regulation. We believe that the final disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.
 
ITEM 4. REMOVED AND RESERVED

 
21

 
 
PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Stock Listing.  Our common stock is traded on The NASDAQ Stock Market under the symbol SHFL. As of January 3, 2012, we had approximately 280 shareholders of record. There are a significantly greater number of shareholders whose shares are held in street name. Based on information available to us as of January 3, 2012, we estimate that we have approximately 13,110 beneficial holders in total. The following table sets forth quarterly high and low prices for trades of our common stock during fiscal 2011 and 2010:
 
   
2011
   
2010
 
   
High
   
Low
   
High
   
Low
 
First Quarter
 
$
11.80
   
$
9.07
   
$
9.81
   
$
7.16
 
Second Quarter
   
11.57
     
8.65
     
9.72
     
7.72
 
Third Quarter
   
11.35
     
8.71
     
10.19
     
7.33
 
Fourth Quarter
   
10.88
     
7.35
     
9.55
     
7.55
 

The closing price of our common stock on January 3, 2012, was $11.98 per share.
 
Dividend Policy.  We have not paid dividends on our common stock in our two most recent fiscal years and certain covenants in our Senior Secured Revolving Credit Facility restrict our ability to pay dividends or make other distributions with respect to our equity securities.
 
Transfer Agent.  Our stock transfer agent and registrar is Wells Fargo Bank N.A., Shareowner Services, 161 North Concord Exchange, South St. Paul, Minnesota 55075, (800) 468-9716.

 
22

 
 
Performance Graph. The following graph compares a shareholder’s cumulative total return for the last five fiscal years, assuming $100 invested at October 31, 2006, with the reinvestment of all dividends, as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the S&P Small Cap 600 Index: (iii) the stocks included in the NASDAQ Index Composite; and (iv) an index of selected issuers in our industry, or Peer groups. The old peer group consists of IGT, Aristocrat, WMS, Bally and Progressive Gaming International Corporation (“PGIC”). The new peer group excludes PGIC, which declared bankruptcy and is not considered a comparable peer and includes Scientific Games Corporation and Multimedia Games to provide a more comprehensive industry comparison.
 
 
 
23

 
 
ITEM 6. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL DATA

The following summary consolidated financial data should be read in conjunction with and is qualified by reference to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.  The consolidated statements of operations data for the years ended October 31, 2011, 2010, 2009, 2008 and 2007, and the consolidated balance sheet data are derived from our consolidated financial statements. The amounts shown below for the years ended 2007, 2008 and 2009 have been revised to reflect the effect of the retrospective application of accounting standards adopted beginning on November 1, 2009, related to convertible debt. The historical results are not necessarily indicative of future results. 
 
   
Year Ended October 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(In thousands, except per share and unit/seat amounts)
 
                               
Summary financial statements (a):
                             
Revenue
                             
Utility
  $ 82,942     $ 77,357     $ 71,707     $ 80,893     $ 78,457  
Proprietary Table Games
    43,986       40,430       38,697       38,594       33,125  
Electronic Table Systems
    33,937       42,398       22,342       27,461       27,890  
Electronic Gaming Machines
    66,906       41,117       46,598       42,898       39,269  
Unallocated Corporate
    -       -       83       160       110  
                                         
Total revenue
    227,771       201,302       179,427       190,006       178,851  
Cost of revenue
    85,216       77,332       73,756       79,104       74,985  
Gross profit
    142,555       123,970       105,671       110,902       103,866  
Income (Loss)  from continuing operations
    31,590       23,083       14,974       (15,373 )     12,914  
Discontinued operations, net of tax
    -       -       -       (1 )     78  
Net Income (loss)
  $ 31,590     $ 23,083     $ 14,974     $ (15,374 )   $ 12,992  
                                         
Earnings (loss) per share - continuing operations:
                                       
Basic earnings (loss) per share (b)
  $ 0.58     $ 0.43     $ 0.28     $ (0.38 )   $ 0.37  
Diluted earnings (loss) per share (b)
  $ 0.57     $ 0.43     $ 0.28     $ (0.38 )   $ 0.37  
Weighted average shares, basic (b)
    54,344       53,258       53,120       40,006       34,680  
Weighted average shares, diluted (b)
    54,997       54,199       53,449       40,006       35,276  
                                         
Balance Sheet Data (end of year):
                                       
Cash, cash equivalents, and investments
  $ 22,189     $ 9,988     $ 7,840     $ 5,374     $ 4,392  
Total assets
  $ 312,887     $ 303,960     $ 285,469     $ 261,930     $ 359,535  
Total debt
  $ 39,265     $ 66,262     $ 93,210     $ 124,335     $ 226,151  
Total long-term liabilities
  $ 42,668     $ 68,973     $ 96,109     $ 86,428     $ 225,076  
Shareholders' equity
  $ 233,615     $ 186,148     $ 156,074     $ 103,363     $ 93,097  
                                         
Cash Flow Data:
                                       
Cash provided by operating activities
  $ 63,969     $ 51,325     $ 40,142     $ 44,018     $ 33,048  
Cash (used) by investing activities
  $ (26,887 )   $ (20,433 )   $ (9,045 )   $ (5,812 )   $ (33,119 )
Cash (used) provided by financing activities
  $ (24,736 )   $ (28,659 )   $ (30,124 )   $ (37,256 )   $ (3,513 )
 
(a)  In September 2007, we purchased PGIC's table games division. Acquisitions, in addition to less significant acquisitions, are included in our consolidated financial statements beginning on the effective date of the transactions.

(b)  Earnings per share and weighted average share amounts for the years ended October 31, 2008, 2009, 2010 and 2011 reflect our equity offering in July 2008 of an additional 20.3 million common shares.  

 
24

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

The following is a discussion and analysis of our financial condition, results of operations and liquidity and capital resources as of October 31, 2011 and 2010 and for the fiscal years ended October 31, 2011, 2010 and 2009. This discussion should be read together with our audited consolidated financial statements and related notes included in “Item 8. Financial Statements and Supplementary Data” included in this Annual Report on Form 10-K (“Form 10-K”).  Some of the information contained in this discussion includes forward-looking statements that involve risks and uncertainties; therefore our "Special Note Regarding Forward-Looking Statements" and "Risk Factors" should be reviewed  for a discussion of important factors that could cause actual results to differ materially from the results described in, or implied by, such forward-looking statements.

OVERVIEW

We are a leading global gaming supplier committed to making gaming more fun for players and more profitable for operators through product innovation, and superior quality and service.  We operate in legalized gaming markets across the globe and provide state-of-the-art, value-add products in four distinct segments: Utility products, which include automatic card shufflers and roulette chip sorters; Proprietary Table Games, which include live games, side bets and progressives as well as our newly introduced i-Gaming, which features online versions of our table games, social gaming and mobile applications; Electronic Table Systems, which include various e-Table game platforms; and Electronic Gaming Machines, which include video slot machines.  Each segment's activities include the design, development, acquisition, manufacturing, marketing, distribution, installation and servicing of a distinct product line.  Our products are manufactured at our headquarters and manufacturing facility in Las Vegas, Nevada, at our Australian headquarters in Milperra, New South Wales, Australia, as well as outsourced, for certain sub-assemblies in the United States, Europe and Asia.

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

Sources of Revenue

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

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

 
25

 
 
The following points should be noted as they relate to each of our segments:
 
Utility

·  
We expect to continue increasing lease revenues in our Utility segment within the United States.  One of the current growth drivers for this segment has been the Ace® shuffler upgrade initiative. We expect the next revenue driver to be our new MD3 shuffler.  The MD3 is our next generation upgrade for the legacy MD series shufflers. As the MD1® reaches its end of life where replacement parts will no longer be available, our strategy is to encourage our customers to upgrade the MD1® shufflers, both leased and previously sold, with the MD3 shuffler. The majority of these placements are leases.

·  
Our markets for shuffler lease and sale revenue have grown recently in the United States with the approval of live table gaming in several jurisdictions such as Pennsylvania and Delaware.  

·  
We expect to continue seeing volatility in sales revenue in our Utility segment outside the United States.  While we encourage leasing outside the United States, a large majority of our international Utility product placements historically have been sales.  We are starting to see increased lease activity in international markets such as Australia, Asia and Latin America. Growth drivers for the Utility segment outside the United States are the new jurisdictional openings, such as the new openings in Singapore and the Philippines during fiscal 2010, as well as the expansion of existing markets such as Macau.

Proprietary Table Games

·  
More than 96% of our total PTG segment revenue is derived from royalties and leases.  While we have a strong leasing presence in the United States, we are constantly looking to expand our proprietary table games in other parts of the world where the current penetration of proprietary table games is lower.  With the opening of new casino markets in Asia, we have recently seen some successes with new lease placements of our premium table games as well as progressives and side bets.

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

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

·  
We intend to increase our PTG content through development and acquisition of new proprietary titles. By increasing our footprint with new titles, we hope to increase our domestic market penetration and expand further into international markets.

·  
We intend to seek enforcement against parties that infringe our intellectual properties for Internet gaming in legalized markets where legal systems and availability of cost-effective remedies are available to us.

Electronic Table Systems

·  
Although we continually pursue opportunities to increase lease revenues in our ETS segment within the United States, we have seen some of our leased ETS products returned from those same markets as some states have approved live table games.  While this has caused some setbacks in the growth of our domestic ETS business, we have been able to return some of these products to service in other markets such as Latin America.  However, the new placements are not yet performing to the same revenue and profitability levels as the units that were removed.

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

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

 
26

 
 
Electronic Gaming Machines

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

·  
Initial deliveries of Equinox began in July 2010, and we experienced record placements during the fourth quarter of fiscal 2011, as Equinox gained broader market acceptance. While we would not expect to see this record growth continue indefinitely, we expect Equinox placements in fiscal 2012 will continue above 2011 levels.

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

·  
In addition to our primary EGM market in Australia, we are pursuing opportunities for sales growth in Asia. Initial installations into Asia began during the third quarter 2011, of which a majority were Equinox.

Expenses

Our direct expenses primarily include cost of products sold, depreciation of leased assets, and amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation.  Indirect expenses include other costs directly identified with each segment, such as R&D, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses.  We continue to expend significant R&D efforts on the development of our newer generation shuffler products, such as the MD3 and one2six® Plus, our card recognition products, as well as other table accessories, such as the i-Shoe® and i-Score. With our expansion into the e-Table markets, we continue to spend significant R&D dollars on developing and implementing new gaming mediums, such as the i-Table®, our newest e-Table that combines a variety of our products to create an exciting new table game experience. We are also spending increased R&D dollars on the new Equinox EGM cabinets and related game content.

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

Gross Margin

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

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

Although our lease margins are generally very favorable, during the current period, we have experienced lower than normal margins on our ETS leases.  This margin reduction is primarily related to the removal of Table Master® seats from Pennsylvania and Delaware in the prior year as those jurisdictions converted to live table gaming.  As noted above, although we are returning those units to service in other markets such as Latin America, the new placements are not yet generating revenues or margins as favorable as the original placements.  Additionally, we continue to record depreciation on the units that have not yet been placed back into service.  This depreciation has caused additional downward pressure on our ETS lease margins.

We occasionally record inventory adjustments related to obsolescence or declines in the net realizable value of some products.  While those adjustments occur in the normal course of business, it can cause negative pressure on our margins. We also occasionally dispose of leased assets that are no longer in service and are no longer usable.

 
27

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

SIGNIFICANT TRANSACTIONS

Newton Shuffler LLC. On November 15, 2010, we entered into a purchase agreement and related agreements (the “Purchase Agreement”) with Newton Shuffler LLC and related parties (“Newton”) whereby we acquired substantially all of the intellectual property assets of Newton.  Under the terms of the Purchase Agreement, we paid Newton an upfront payment of $6.5 million.  The Purchase Agreement also calls for approximately $1.4 million to be paid over a 9 year period.  In connection with the Purchase Agreement, we also entered into non-competition agreements with Newton and the major owners of Newton for a period of 9 years.

We accounted for this acquisition as a business combination and allocated the total consideration of approximately $7.5 million to the assets acquired based on their fair values.  We recorded approximately $2.7 million to intangible assets which will be amortized on a straight line basis over a 9 year period.  The remaining amount of approximately $4.8 million was recorded to goodwill.  We also recorded a liability associated with future consideration of approximately $1.4 million due in non-interest bearing payments through 2019.  Upon acquisition, the balance of $1.0 million represented the discounted present value of the future payments, excluding imputed interest of approximately $0.4 million, using an effective interest rate of 4.2%. The Newton acquisition enhances our Utility segment by adding to our intellectual property portfolio and providing for further revenue opportunities.

Prime Table Games, LLC. On December 21, 2010, we entered into a license and release agreement (the “License and Release Agreement”) with Prime Table Games, LLC and related parties (collectively “Prime Table Games”) to settle existing litigation between the parties and to acquire intellectual property licenses related to our PTG segment. Total consideration paid by us was $5.5 million. Accordingly, we recorded a legal settlement charge of approximately $2.2 million for the year ended October 31, 2010, which represented the fair value associated with the effective settlement of the then existing litigation. The remaining $3.3 million was recorded as intangible assets which will be amortized on a straight line basis over a 9 year period.

On December 21, 2010, we also entered into a remote gambling intellectual property transfer agreement (the “Remote Gambling Agreement”) in which we acquired licenses to the Three Card Poker Internet rights in the British Isles for $1.5 million. The acquired Internet rights include Internet gambling and gambling via cell phones, in addition to certain social media uses such as play-for-fun applications on the Internet.  The $1.5 million was recorded as intangible assets which will be amortized on a straight line basis over a 9 year period.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

 
·
persuasive evidence of an arrangement exists;

 
·
the price to the customer is fixed and determinable;

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

 
·
collection is reasonably assured.
 
Revenues are reported net of incentive rebates and discounts. Amounts billed prior to completing the earnings process are deferred until revenue recognition criteria are met.

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

Product sales and service revenue — We generate sales revenue through the sale of equipment in each product segment, including sales revenue from sales-type leases and the sale of lifetime licenses for our proprietary table games. Our credit sales terms are primarily 60 days or less.  Financing for intangible property and sales-type leases for tangible property have payment terms ranging generally from 24 to 36 months and are usually interest-bearing at market interest rates. Revenue from the sale of equipment is recorded in accordance with the contractual shipping terms. Products placed with customers on a trial basis are not recognized as revenue until the trial period ends, the customer accepts the product and all other relevant criteria have been met. If a customer purchases existing leased equipment, revenue is recorded on the effective date of the purchase agreement. Revenue on service and warranty contracts is recognized as the services are provided over the term of the contracts. Revenue from the sale of lifetime licenses, under which we have no continuing obligation, is recorded on the effective date of the license agreement. Our EGM, Table Master® and Vegas Star® products are recognized upon delivery and customer acceptance.

Multiple element arrangements — Some of our revenue arrangements contain multiple deliverables, such as a product sale combined with a service element or the delivery of a future product.  Most of our products and services qualify as separate units of accounting. When vendor specific objective evidence or third-party evidence is not available, the management's best estimate of selling price ("BESP") is the amount we would sell the product or service for individually. The determination of BESP is made based on our normal pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs and profit objectives. Revenues allocated to future performance obligations elements are deferred and will be recognized upon delivery and customer acceptance.

Goodwill and other indefinite lived intangible assets. We review our goodwill for impairment annually in October or when circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  In the current year we adopted a new Accounting Standards Updates (“ASU”) that allows for the goodwill impairment analysis to start with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the qualitative factors, we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we will perform the a two-part impairment test.  In the first step, we would select a discounted cash flow model (income approach) and the Guideline Public Company Model (market approach) to assess the fair values of our reporting units, which are the same as our operating segments.  These two methodologies were weighted equally in determining fair values.  The fair value of the reporting unit is then compared to the book value of the reporting unit, including its goodwill. If the fair value is less than the book value, then we would perform a second step to compare the implied fair value of the reporting unit’s goodwill to its book value. The implied fair value of the goodwill is determined based on the estimated fair value of the reporting unit less the fair value of the reporting unit’s identifiable assets and liabilities. We would record an impairment charge to the extent that the book value of the reporting unit’s goodwill exceeds its fair value.

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

 
29

 
 
As of October 31, 2011 and 2010, our goodwill totaled $85.4 million and $75.9 million, respectively. Our fiscal 2011 annual goodwill impairment analysis included an assessment of certain qualitative factors including, but not limited to, the results of the prior year fair value calculation, the movement of the company’s share price and market capitalization, overall financial performance, and macro-economic and industry conditions.  We considered the qualitative factors and weighted the evidence obtained and determined that it is not more likely than not that the fair value of any reporting unit is less than its carrying amount. In the prior year we performed the first step test required under previous guidance using an income approach and market approach and the results of that valuation indicated that each of our reporting units’ fair values were significantly higher than their carrying values.   Although we believe the factors considered in the impairment analysis are reasonable, significant changes in any one of our assumptions could produce a significantly different result.

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

For fiscal 2011, 2010 and 2009, we did not have any goodwill impairment loss.

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

In October 2011, we performed our annual indefinite lived intangible asset impairment analysis for our Stargames and CARD tradenames, which is discussed in Note 6 to our Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data", by comparing the discounted, estimated future cash flows using the income approach as compared to the carrying value of the tradenames and determined that no impairment was indicated.

Other intangible assets. Other intangible assets include intellectual property for games, patents, trademarks, copyrights, licenses, developed technology, customer relationships and non-compete agreements that were purchased separately or acquired in connection with a business combination. All of our significant other intangible assets have finite useful lives and are amortized as the economic benefits of the intangible asset are consumed or otherwise used up.

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

We review our long-lived assets, excluding goodwill and indefinite lived intangible assets, for impairment whenever events or circumstances indicate the carrying value may not be recoverable or warrant a revision to the estimated remaining useful life.  We would record an impairment loss if the carrying amount of the asset or asset group is not recoverable (as determined by undiscounted cash flows) and the carrying amount exceeds its estimated fair value.  For fiscal 2011, 2010 and 2009, we did not have any such impairment loss.

Inventories.  Inventories are stated at the lower of cost, determined on a first-in-first-out basis, or market.  Cost elements included in work-in-process and finished goods include raw materials, direct labor and manufacturing overhead. We regularly review inventory quantities and update estimates for the net realizable value of inventories. This process includes examining the carrying values of new and used gaming devices, parts and ancillary equipment in comparison to the current fair market values for such equipment (less costs to sell or dispose). Some of the factors involved in this analysis include the overall levels of our inventories, the current and projected sales levels for such products, the projected markets for such products, the costs required to sell the products, including refurbishment costs and importation costs for international shipments and the overall projected demand for products once the next generation of products are scheduled for release.
 
As a result of our ongoing analysis of inventory, we recognized inventory write-downs of approximately $1.1 million, $1.0 million and $1.5 million for fiscal years 2011, 2010 and 2009, respectively.  Additional valuation charges could occur in the future as a result of changes in the factors listed above.

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

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

As of October 31, 2011, we have a valuation allowance of $1.3 million against certain foreign deferred tax assets based on our estimate of future realization.  Management will reassess the realization of deferred tax assets each reporting period.  To the extent that the financial results of certain foreign operations improve and it becomes more likely than not that the deferred tax assets are realizable, the Company will be able to reduce the valuation allowance through earnings.  

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

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

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

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

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

RECENTLY ISSUED ACCOUNTING STANDARDS

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

Credit quality of financing receivables and the allowance for credit losses – As of November 1, 2010, we adopted accounting standards related to the disclosure about the credit quality of financing receivables and allowances for credit losses which addresses concerns about the sufficiency, transparency and other robustness of credit risk disclosures for financing receivables and the related allowance for credit losses. This update is designed to provide disclosures that enable a better understanding of:

 
1.
the nature of credit risk inherent in our portfolio of financing receivables;

 
2.
how credit risk is analyzed to determine the allowance for credit losses; and

 
3.
changes in and reasons for changes in the allowances for credit losses.

Goodwill impairment testingIn September 2011, Financial Accounting Standards Board (“FASB”) issued an ASU to amend and simplify the rules related to testing goodwill for impairment. The revised guidance allows an entity to make an initial qualitative evaluation, based on the entity’s events and circumstances, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of this qualitative assessment determine whether it is necessary to perform the currently required two-step impairment test. During the fourth quarter 2011, we elected to early adopt this ASU.

 
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Not yet adopted -

Fair value measurement disclosureIn May 2011, FASB issued an ASU on fair value measurement on how to measure fair value and on what disclosures to provide about fair value measurements. The ASU expands disclosure requirements particularly for Level 3 inputs to include the following:

·  
For fair value categorized in Level 3 of the fair value hierarchy:

 
1. 
a quantitative disclosure of the unobservable inputs and assumptions used in the measurement;
 
2. 
a description of the valuation processes in place (e.g., how the entity decides its valuation policies and procedures, as well as changes in its analyses of fair value measurements, from period to period); and
 
3. 
a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs.

·  
The level in the fair value hierarchy of items that are not measured at fair value in the statement of financial position but whose fair value must be disclosed.
  
This ASU will be effective for our second quarter of fiscal 2012 and is not expected to have a material impact on our financial statements.

Comprehensive income – In June 2011, FASB issued an ASU on presentation of comprehensive income to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This update changes the requirements for the presentation of other comprehensive income, eliminating the option to present components of other comprehensive income as part of the statement of stockholders' equity, among other items. The guidance requires that all non-owner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements.

This ASU will be effective for our first quarter of fiscal 2013 and as the update only requires a change in presentation, we do not expect it to have a material impact on our financial statements.

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

CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Year Ended October 31,
 
   
2011
   
2010
   
2009
 
   
(In thousands)
 
Revenue:
                                   
Utility
  $ 82,942       36.4 %   $ 77,357       38.4 %   $ 71,707       40.0 %
Proprietary Table Games
    43,986       19.3 %     40,430       20.1 %     38,697       21.6 %
Electronic Table Systems
    33,937       14.9 %     42,398       21.1 %     22,342       12.4 %
Electronic Gaming Machines
    66,906       29.4 %     41,117       20.4 %     46,598       26.0 %
Other
    -       0.0 %     -       0.0 %     83       0.0 %
                                                 
Total revenue
    227,771       100.0 %     201,302       100.0 %     179,427       100.0 %
Cost of revenue
    85,216       37.4 %     77,332       38.4 %     73,756       41.1 %
                                                 
Gross profit
    142,555       62.6 %     123,970       61.6 %     105,671       58.9 %
Selling, general and administrative
    68,609       30.1 %     66,817       33.2 %     63,647       35.5 %
Research and development
    27,628       12.2 %     21,811       10.8 %     17,349       9.7 %
                                                 
Income (Loss) from operations
    46,318       20.3 %     35,342       17.6 %     24,675       13.7 %
Other income (expense):
                                               
Interest income
    635       0.3 %     577       0.3 %     860       0.5 %
Interest expense
    (2,636 )     (1.2 %)     (4,015 )     (2.0 %)     (6,047 )     (3.4 %)
Other, net
    (997 )     (0.4 %)     282       0.1 %     731       0.4 %
Total other income (expense)
    (2,998 )     (1.3 %)     (3,156 )     (1.6 %)     (4,456 )     (2.5 %)
Gain (loss) on early extinguishment of debt
    -       0.0 %     (1,123 )     (0.6 %)     1,841       1.0 %
                                                 
Income from continuing operations before tax
    43,320       19.0 %     31,063       15.4 %     22,060       12.2 %
Income tax provision
    11,730       5.1 %     7,980       3.9 %     7,086       3.9 %
                                                 
Net income
  $ 31,590       13.9 %   $ 23,083       11.5 %   $ 14,974       8.3 %
 
 
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The following table provides additional information regarding our revenue, gross profit and gross margin:

REVENUE AND GROSS MARGIN
 
   
Year Ended October 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
11 vs. 10
   
10 vs. 09
 
   
(In thousands)
             
Revenue:
                             
Leases and royalties
  $ 98,369     $ 86,717     $ 76,231       13.4 %     13.8 %
Sales and service
    129,402       114,585       103,113       12.9 %     11.1 %
Other
    -       -       83       0.0 %     (100.0 %)
                                         
Total
  $ 227,771     $ 201,302     $ 179,427       13.1 %     12.2 %
                                         
Cost of revenue:
                                       
Leases and royalties
  $ 34,089     $ 28,008     $ 24,559       21.7 %     14.0 %
Sales and service
    51,127       49,324       49,197       3.7 %     0.3 %
                                         
Total
  $ 85,216     $ 77,332     $ 73,756       10.2 %     4.8 %
                                         
Gross profit:
                                       
Leases and royalties
  $ 64,280     $ 58,709     $ 51,672       9.5 %     13.6 %
Sales and service
    78,275       65,261       53,916       19.9 %     21.0 %
Other
    -       -       83       0.0 %     (100.0 %)
                                         
 Total
  $ 142,555     $ 123,970     $ 105,671       15.0 %     17.3 %
                                         
Gross margin:
                                       
Leases and royalties
    65.3 %     67.7 %     67.8 %                
Sales and service
    60.5 %     57.0 %     52.3 %                
Total
    62.6 %     61.6 %     58.9 %                
 
RESULTS OF OPERATIONS

Fiscal 2011 compared to Fiscal 2010

Revenue

Our revenue for fiscal 2011 increased $26.5 million over fiscal 2010, primarily due to the following:
 
·  
Increase of $14.8 million in our sales and service revenue:
o  
Increase most notably in our EGM segment driven by a substantial increase in sold units due to the launch of our Equinox cabinet.

·  
During the prior year, we experienced a downturn in EGM sales of approximately 4.2% below historical levels, which we attributed to customers delaying purchases in anticipation of the new Equinox cabinet’s introduction. Since we began shipping Equinox in July 2010, we have seen a strong improvement in EGM sales. During the current year, EGM unit sales were 54.8% above prior year levels driven almost entirely by Equinox. While we would not expect to see this record growth continue indefinitely, we do expect that EGM sales in fiscal 2012 will continue above 2011 levels.

·  
Sales and service revenue in our Utility, PTG and ETS segments was down 14.8% collectively:
o  
Decreased Utility sales revenue due primarily to our continued strategic focus on lease versus sales;
o  
Prior year Utility sales were high due to the effect of new facility openings in Singapore and favorable regulatory changes in the United States; and
o  
Decrease in ETS sales revenue driven by a 39.3% decrease in sold seats. Prior year ETS sales were driven by favorable regulatory changes in Australia and by new facility openings in Singapore.

 
34

 
 
 
 
·  
Increase of $11.7 million in our leases and royalties revenue was primarily due to our strategic focus on leasing as well as events such as new facility openings and favorable regulatory changes:
o  
Driven primarily by increased Utility lease revenue due to a 11.7% increase in shuffler units on lease, primarily in the United Sates and Macau;
o  
Increased Utility lease revenue partially driven by new casino openings in Singapore during the prior year (prior year results only reflected a partial year of this revenue increase as units were placed into service);
o  
Increased PTG lease and royalty revenue due to a 14.5% increase in units on lease; and
o  
Decreased ETS lease revenue driven by a 14.5% reduction in Rapid Table Games®, Table Master® and Vegas Star® average monthly lease price in the United States, primarily due to Table Master® removals in Pennsylvania and Delaware in the prior year, partially offset by increased seats on lease due to favorable regulatory changes and new facility openings in the prior year.
 
·  
Impact of foreign currency fluctuations:
o  
Total revenue was positively impacted by approximately $10.1 million due to the exchange effect of a weakening U.S. dollar.

Gross margin

Our gross margin for fiscal 2011 increased 100 bps to 62.6% as compared to fiscal 2010, reflecting the following:
 
·  
Increased segment margin performance:
o  
Improved EGM margins due to increases in average sales prices and reductions in manufacturing costs; and
o  
Offset by decreased margins in ETS which were unfavorably impacted by reductions in average monthly lease prices in the United States and a decrease in the number of seats sold. Sales in the prior year included several large placements of Vegas Star® and Rapid Table Games® seats in Australia and Singapore at favorable margins.

Fiscal 2010 compared to Fiscal 2009

Revenue

Our revenue for fiscal 2010 increased $21.9 million over fiscal 2009, primarily due to the following:

·  
Market expansion and favorable regulatory changes:
o  
Opening of two casinos in Singapore drove increased sales revenue of $7.2 million and increased lease revenue of $2.7 million in our Utility, PTG and ETS segments;
o  
Casino opening in the Philippines drove increased Utility lease revenue of approximately $0.8 million;
o  
Regulatory changes in Pennsylvania and Delaware allowed for the placement of Utility and PTG products, driving increased lease revenues in those segments totaling approximately $1.4 million and increased sales revenue of approximately $5.8 million;
o  
Regulatory changes in Florida allowed for the placement of Table Master® seats which led to increased ETS lease and sales revenue of approximately $1.3 million;
o  
Favorable regulatory changes in certain Australian jurisdictions drove increased ETS sales revenue of approximately $12.0 million; and
o  
The favorable regulatory changes in Pennsylvania and Delaware that drove new placements of Utility and PTG products were partially offset by the return of approximately 420 Table Master® seats previously leased in that market.  This resulted in a decrease in ETS lease revenue of approximately $1.6 million compared to the prior year.  We have begun to return these Table Master® seats to active service in other markets such as Latin America.

·  
Increase in our leases and royalties revenue:
o  
Driven primarily by increased Utility lease revenue due to a 22.2% increase in shuffler units on lease;
o  
Increased PTG lease and royalty revenue due to a 15.9% increase in units on lease; and
o  
Increased ETS lease revenue driven by a 4.0% increase in Rapid Table Games®, Table Master® and Vegas Star® seats on lease.
 
·  
Increase in our sales and service revenue:
o  
Increase most notably in our ETS segment driven by a 201.6% increase in sold seats; and
o  
Increased Utility sales revenue due to a 5.2% increase in sold shuffler units.

 
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·  
Partially offset by a decrease in our EGM segment:
o  
Decrease of $5.5 million in total revenue due primarily to a 22.1% decline in the number of sold units.

·  
Impact of foreign currency fluctuations:
o  
Total revenue was positively impacted by approximately $9.2 million due to the exchange effect of a weakening U.S. dollar.

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

·  
Increase segment margin performance:
o  
ETS was favorably impacted by reduced amortization of intangible assets and by high margin sales of Rapid Table Games® and Vegas Star®;
o  
Utility was favorably impacted by strong revenue growth overall and reduced amortization of intangible assets; and
o  
EGM was favorably impacted by reduced amortization of intangible assets and reductions in materials and production costs due to value engineering and cost savings. A portion of the cost savings related to favorable foreign exchange fluctuations which may not be repeatable.

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

·  
Product mix:
o  
Strong performance by our more profitable segments led to higher overall profitability.

 
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The following table provides additional information regarding our operating expenses:

OPERATING EXPENSES
 
   
Year Ended October 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
11 vs. 10
   
10 vs. 09
 
   
(In thousands)
                         
                               
Selling, general and administrative
  $ 68,609     $ 66,817     $ 63,647       2.7 %     5.0 %
Percentage of revenue
    30.1 %     33.2 %     35.5 %                
                                         
Research and development
  $ 27,628     $ 21,811     $ 17,349       26.7 %     25.7 %
Percentage of revenue
    12.2 %     10.8 %     9.7 %                
                                         
 Total operating expenses
  $ 96,237     $ 88,628     $ 80,996       8.6 %     9.4 %
Percentage of revenue
    42.3 %     44.0 %     45.1 %                
 
Fiscal 2011 compared to Fiscal 2010

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

SG&A expenses increased $1.8 million for fiscal 2011, as compared to fiscal 2010. This increase primarily reflects the following:
 
·  
Sales and profit-driven compensation expense:
o  
Increase of approximately $2.2 million in compensation and related expenses driven by improved revenue and profitability at our United States, Australian and Macau locations.

·  
Impact of foreign currency fluctuations:
o  
Net increase of approximately $2.5 million at our foreign subsidiaries due to the exchange effect of a weakening U.S. dollar.

·  
Patents and trademark expenses:
o  
Increase of approximately $1.7 million in trademark, copyright and patent expenses related to new products and expansion into new markets.

·  
Office expense:
o  
Increase in depreciation expense of approximately $1.5 million driven by improvements to our information technology infrastructure during the prior year.

These increases were offset by:

·  
Legal settlement with Prime Table Games:
o  
Decrease of approximately $2.2 million due to higher legal expenses incurred in the prior year period related to the effective settlement of the litigation. See Note 2 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” for more information.

·  
Severance costs:
o  
Decrease of approximately $1.8 million, mainly due to severance costs related to the passing of our former CEO and the departure of a senior executive in the prior year period.

·  
Professional fees:
o  
Decrease of approximately $1.2 million due to higher legal expenses incurred in the prior year period related to the TableMAX litigation.

 
37

 
 
Research & development (“R&D”) expenses

R&D expenses increased $5.8 million for fiscal 2011, as compared to fiscal 2010. This increase primarily reflects the following:
 
·  
Impact of foreign currency fluctuations:
o  
Net increase of approximately $2.2 million at our foreign subsidiaries due to the exchange effect of a weakening U.S. dollar.
 
The following projects have been the focus of our R&D efforts during fiscal 2011:

·  
EGM:
o  
Expenses primarily related to expanding our range of EGM games for the new Equinox cabinet, as well as support of ongoing business growth, geographic expansion and demand for Equinox.

·  
ETS:
o  
Expenses primarily related to the further development of the i-Table®, Rapid Table Games®, Table Master® and Vegas Star® products , including the development of proprietary titles for our i-Table®, the development of the i-Table Roulette and addition of multi-game to Rapid Table Games®.

·  
Utility:
o  
Expenses primarily related to development of the next generation utility products, the MD3, the Deck Checker, the Easy Chipper D, as well as continuing development of our other Utility products.

·  
PTG:
o  
Expenses primarily related to ongoing enhancements to the successful progressive offering to our table game titles such as our Operator Wide Area Progressive, as well as ongoing development of new proprietary table games.

Fiscal 2010 compared to Fiscal 2009

SG&A expenses

SG&A increased $3.2 million in fiscal 2010 as compared to fiscal 2009.  This increase primarily reflects the following:

·  
Legal settlement with Prime Table Games:
o  
Increase in legal expenses of approximately $2.2 million which represents the fair value associated with the effective settlement of the litigation. See Note 2 of Notes to Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” for more information.

·  
Impact of foreign currency fluctuations:
o  
Net increase of approximately $2.7 million at our foreign subsidiaries due to the exchange effect of a weakening U.S. dollar.

·  
Sales and profit-driven compensation:
o  
Increase of approximately $1.2 million primarily driven by improved revenue and profitability at our United States and Australian locations.

·  
Product compliance:
o  
Increased costs of approximately $0.8 million associated with obtaining regulatory approval for our products in new jurisdictions.

·  
Professional fees:
o  
Increase in legal expenses of approximately $0.5 million. Corporate legal expenses increased as a result of higher legal expenses incurred on our TableMAX and Smart Shoes Inc. litigations offset by a reduction in costs related to the Elixir Gaming purchase and settlement agreement incurred during fiscal 2009.

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

·  
Severance costs:
o  
Severance costs decreased approximately $4.2 million primarily due to the retirement of our former CEO and the departure of several senior executives in fiscal 2009 offset by severance costs incurred during fiscal 2010 due to the passing of our CEO and the departure of a senior executive.
 
 
38

 
 
R&D expenses

R&D expense increased $4.5 million in fiscal 2010 as compared to fiscal 2009.  This increase primarily reflects:

·  
Impact of foreign currency fluctuations:
o  
Net increases of approximately $2.0 million at our foreign subsidiaries due to the weakening of the U.S. dollar.

·  
Increased R&D in our EGM segment.

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

·  
EGM
o  
Expenses primarily related to development of the new Equinox cabinet; and
o  
Additional R&D efforts were spent on developing additional EGM games for the new Equinox cabinet and to support ongoing business growth.

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

·  
Utility
o  
Expenses primarily related to development of the next generation of our MD2® shuffler, the MD2CR®, as well as continuing development of our other Utility products.

 
39

 
 
DEPRECIATION AND AMORTIZATION EXPENSES
 
   
Year Ended October 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
11 vs. 10
   
10 vs. 09
 
   
(In thousands)
             
Gross margin:
                             
 Depreciation
  $ 11,024     $ 8,960     $ 7,312       23.0 %     22.5 %
 Amortization
    6,944       8,283       10,481       (16.2 %)     (21.0 %)
 Total
    17,968       17,243       17,793       4.2 %     (3.1 %)
                                         
Operating expenses:
                                       
 Depreciation
    4,039       2,916       2,632       38.5 %     10.8 %
 Amortization
    3,128       2,709       3,090       15.5 %     (12.3 %)
 Total
    7,167       5,625       5,722       27.4 %     (1.7 %)
                                         
Total:
                                       
 Depreciation
    15,063       11,876       9,944       26.8 %     19.4 %
 Amortization
    10,072       10,992       13,571       (8.4 %)     (19.0 %)
 Total
  $ 25,135     $ 22,868     $ 23,515       9.9 %     (2.8 %)
 
Depreciation expense is primarily comprised of depreciation associated with products leased and held for lease and to a lesser extent depreciation of property, plant and equipment. Amortization expense is primarily comprised of amortization associated with intellectual property, acquired developed technology and customer relationships.

Fiscal 2011 compared to Fiscal 2010

Total depreciation and amortization included in gross margin increased 4.2% in fiscal 2011, as compared to fiscal 2010. Increased depreciation in gross margin is attributable to increases in leased assets. Decreased amortization in gross margin is due to reduced amortization of intangible assets in our Utility, ETS and EGM segments as the underlying intangible assets reached the end of their estimated useful lives.

Total depreciation and amortization included in operating expenses increased 27.4% in fiscal 2011, as compared to fiscal 2010. Increased depreciation relates to additions of property, plant and equipment in the normal course of business and improvements to our information technology infrastructure during the prior year. The increase in amortization expense relates primarily to amortization of the intellectual property acquired from Newton.
 
Fiscal 2010 compared to Fiscal 2009

Total depreciation and amortization included in gross margin decreased 3.1%  in fiscal 2010 as compared to fiscal 2009.  Increased depreciation in gross margin is attributable to increases in leased assets.  Decreased amortization in gross margin is due to reduced amortization of intangible assets in our Utility, ETS and EGM segments as the underlying intangible assets reached the end of their estimated useful lives. Depreciation and amortization included in operating expenses decreased 1.7% in fiscal 2010 as compared to fiscal 2009. Amortization decreased as various intangible assets reached the end of their estimated useful lives. Increased depreciation related to additions of property, plant and equipment in the normal course of business.
 
 
40

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

NON-OPERATING EXPENSES

Other income (expense), gain on early extinguishment of debt, net
 
   
Year Ended October 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
11 vs. 10
   
10 vs. 09
 
   
(In thousands)
             
Other income (expense)
                             
Interest income
  $ 635     $ 577     $ 860       10.1 %     (32.9 %)
Interest expense
    (2,636 )     (4,015 )     (6,047 )     (34.3 %)     (33.6 %)
Other, net
    (997 )     282       731       (453.5 %)     (61.4 %)
Total other income (expense)
  $ (2,998 )   $ (3,156 )   $ (4,456 )     (5.0 %)     (29.2 %)
                                         
Gain (loss) on early extinguishment of debt, net
  $ -     $ (1,123 )   $ 1,841       (100.0 %)     (161.0 %)
 
Fiscal 2011 compared to Fiscal 2010

Total other income (expense) decreased $0.2 million, or 5.0% in fiscal 2011 as compared to fiscal 2010, primarily due to the following:

·  
A decrease in interest expense of $1.4 million in fiscal 2011 as compared to 2010, due to a decrease in total outstanding debt; and

·  
An increase in net foreign currency loss of $1.2 million in fiscal 2011 as compared to 2010. This year over year change was primarily caused by fluctuations of the U.S. dollar versus the Australian dollar and the Euro during fiscal 2011.  Our foreign subsidiaries engage in activities with us and certain customers in U.S. dollar and other foreign denominated contracts.

Fiscal 2010 compared to Fiscal 2009

Total other income (expense) decreased $1.3 million, or 29.2% in fiscal 2010 as compared to fiscal 2009, primarily due to the following:

·  
Decrease in interest expense of $2.0 million in fiscal 2010 as compared to 2009, due to a decrease in total outstanding debt;

·  
A decrease in net foreign currency gains of $0.5 million in fiscal 2010 as compared to 2009. This year over year change was primarily caused by fluctuations of the U.S. dollar versus the Australian dollar and the Euro during fiscal 2010.  Our foreign subsidiaries engage in activities with us and certain customers in U.S. dollar and other foreign denominated contracts; and

·  
Partially offset by a reduction in interest income of $0.3 million in fiscal 2010 as compared to fiscal 2009, due to a 20.5% reduction in the total amount of our investment in sales-type leases and notes receivable.

Loss on early extinguishment of debt, net of $1.1 million and gain on early extinguishment of debt, net of $1.8 million, relate to the following:

·  
For fiscal 2010, debt issuance costs of $1.0 million related to our $100.0 million senior secured credit facility (“Deutsche Bank Senior Secured Credit Facility”) were charged off when the underlying facility was terminated in October 2010; and

·  
Fiscal 2009 includes approximately $1.8 million related to the PGIC / IGT agreements entered into in January 2009.
 
 
41

 
 
INCOME TAXES
 
   
Year Ended October 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
11 vs. 10
   
10 vs. 09
 
   
(In thousands)
             
                               
Income tax provision
  $ 11,730     $ 7,980     $ 7,086       47.0 %     12.6 %
                                         
Effective tax rate
    27.1 %     25.7 %     32.1 %                
 
Our effective income tax rate may fluctuate due to changes in our amount and mix of United States and foreign income (loss), changes in tax legislation, changes in our estimates of federal tax credits, changes in our assessment of uncertainties, as well as accumulated interest and penalties and other deductions.

Fiscal 2011 compared to Fiscal 2010

Income tax provision and the respective effective tax rate increased for fiscal 2011 as compared to fiscal 2010, primarily due to the following:

·  
Increase in worldwide pretax book income;

·  
The changes in uncertain tax positions and related interest expense;

·  
Mix of United States and foreign income (loss); and

·  
Benefit reduction in foreign tax credits and interest expense.

Refer to the effective tax rate schedule in Note 13 to our Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” included in this Form 10-K.

Fiscal 2010 compared to Fiscal 2009

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

·  
Mix of United States and foreign income (loss); and

·  
The changes in uncertain tax positions.
 
 
42

 
 
SEGMENT BUSINESS INFORMATION

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

We evaluate the performance of our operating segments based on net revenues, gross profit and operating income (loss). Segment operating income (loss) includes net revenues attributable to third parties and expenses directly and indirectly associated with the product lines included in each segment. Our direct expenses primarily include cost of products sold, depreciation of leased assets, amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation.  Indirect expenses include other costs directly identified with each segment, such as research and development, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses.  Operating income (loss) for each segment excludes other income and expense and certain expenses that are managed outside of the operating segments. The amounts classified as unallocated corporate expenses consist primarily of costs related to overall corporate management and support functions. These include costs related to executive management, accounting and finance, general sales support, legal and compliance costs, office expense and other amounts for which allocation to specific segments is not practicable.
 
 
43

 
 
SEGMENT OPERATING RESULTS
 
Utility Segment Operating Results

Fiscal 2011 compared to Fiscal 2010

   
Year Ended
             
   
October 31,
   
Increase
   
Percentage
 
   
2011
   
2010
   
(Decrease)
   
Change
 
   
(In thousands, except for units and per unit/seat amounts)
 
Utility Segment Revenue:
                       
Lease
  $ 42,141     $ 34,649     $ 7,492       21.6 %
Sales - Shuffler
    27,528       29,347       (1,819 )     (6.2 %)
Sales - Chipper
    1,286       1,880       (594 )     (31.6 %)
Service
    6,672       6,979       (307 )     (4.4 %)
Other
    5,315       4,502       813       18.1 %
Total sales and service
    40,801       42,708       (1,907 )     (4.5 %)
Total Utility segment revenue
  $ 82,942     $ 77,357     $ 5,585       7.2 %
                                 
Utility segment gross profit
  $ 49,973     $ 47,024     $ 2,949       6.3 %
Utility segment gross margin
    60.3 %     60.8 %                
                                 
Utility segment operating income
  $ 43,289     $ 40,233     $ 3,056       7.6 %
Utility segment operating margin
    52.2 %     52.0 %                
                                 
                                 
Shuffler unit information:
                               
Lease units, end of period (1)
    7,617       6,821       796       11.7 %
Average monthly lease price
  $ 443     $ 412     $ 31       7.5 %
                                 
Sold units during the period
    1,750       2,100       (350 )     (16.7 %)
Average sales price
  $ 15,730     $ 13,975     $ 1,755       12.6 %
                                 
Chipper unit information:
                               
Lease units, end of period (1)
    219