SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-21754 SODAK GAMING, INC. (Exact name of registrant as specified in its charter) SOUTH DAKOTA 46-0407053 (State of Incorporation) (I.R.S. Employer Identification No.) 5301 S. Highway 16 Rapid City, South Dakota 57701 (Address of principal executive offices) (605) 341-5400 (Registrant's telephone number, including area code) 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 _____ At June 30, 1997, there were outstanding 22,758,408 shares of the Company's common stock. Sodak Gaming, Inc. INDEX Page ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Statements of Earnings for the three months ended June 30, 1997 and 1996 3 Consolidated Statements of Earnings for the six months ended June 30, 1997 and 1996 4 Consolidated Balance Sheets as of June 30, 1997 and December 31, 1996 5 Consolidated Statements of Cash Flows for the six months ended June 30, 1997 and 1996 7 Note to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II. OTHER INFORMATION Item 1. Legal proceedings 19 Item 2. Changes in Securities 20 Item 3. Defaults Upon Senior Securities 20 Item 4. Submission of Matters to a Vote of Security Holders 20 Item 5. Other Information 21 Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES 22 EXHIBIT INDEX 23 PART I - FINANCIAL INFORMATION Item I. Consolidated Financial Statements Sodak Gaming, Inc. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Three Months Ended June 30, ---------------------------- 1997 1996 ----------- ----------- Revenue: Product sales $14,229,925 $26,095,641 Gaming operations 14,331,280 5,396,376 Wide area progressive systems 3,479,657 1,858,252 Financing income on notes receivable and other financing arrangements 1,297,189 1,440,738 Other 3,396 8,265 ----------- ----------- Total revenue 33,341,447 34,799,272 ----------- ----------- Costs and expenses: Cost of product sales 10,547,418 20,393,810 Gaming operations 13,522,427 2,962,672 Selling, general and administrative 4,596,558 4,522,758 Interest and financing costs 834,408 518,853 ----------- ----------- Total costs and expenses 29,500,811 28,398,093 ----------- ----------- Income from operations 3,840,636 6,401,179 Other income 12,026 8,974 ----------- ----------- Earnings before income taxes 3,852,662 6,410,153 Provision for income taxes 1,425,481 2,328,828 ----------- ----------- Net earnings $ 2,427,181 $ 4,081,325 =========== =========== Earnings per common and common equivalent share $ 0.11 $ 0.18 =========== =========== Weighted average number of common and common equivalent shares outstanding 22,900,152 22,894,150 =========== =========== The accompanying note is an integral part of the consolidated financial statements. Sodak Gaming, Inc. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Six Months Ended June 30, ---------------------------- 1997 1996 ----------- ----------- Revenue: Product sales $25,667,179 $40,578,248 Gaming operations 27,788,786 9,239,039 Wide area progressive systems 5,913,355 3,613,110 Financing income on notes receivable and other financing arrangements 3,068,973 2,902,865 Other 7,070 15,047 ----------- ----------- Total revenue 62,445,363 56,348,309 ----------- ----------- Costs and expenses: Cost of product sales 19,974,809 31,293,408 Gaming operations 26,446,856 4,481,555 Selling, general and administrative 9,074,056 8,931,024 Interest and financing costs 1,623,202 967,227 ----------- ----------- Total costs and expenses 57,118,923 45,673,214 ----------- ----------- Income from operations 5,326,440 10,675,095 ----------- ----------- Other income: Gain on sale of receivables 536,527 0 Other 20,665 15,761 ----------- ----------- Total other income 557,192 15,761 ----------- ----------- Earnings before income taxes 5,883,632 10,690,856 Provision for income taxes 2,176,940 3,911,804 ----------- ----------- Net earnings $ 3,706,692 $ 6,779,052 =========== =========== Earnings per common and common equivalent share $ 0.16 $ 0.30 =========== =========== Weighted average number of common and common equivalent shares outstanding 22,926,165 22,877,962 =========== =========== The accompanying note is an integral part of the consolidated financial statements. Sodak Gaming, Inc. CONSOLIDATED BALANCE SHEETS ASSETS June 30, December 31, 1997 1996 * ------------- ------------- (Unaudited) Current assets: Cash and cash equivalents $ 5,848,733 $ 4,077,107 Receivables: Trade accounts, net of allowance for doubtful accounts 13,351,961 20,258,980 Short-term notes receivable 14,940,740 391,018 Notes receivable, current maturities 19,348,766 23,197,351 Accrued interest 717,512 570,024 Inventories: Gaming machines 13,388,408 16,410,597 Parts and other gaming accessories 3,377,898 4,225,674 Prepaid expenses 1,516,075 1,674,172 Refundable income taxes 0 875,000 Deferred income taxes 824,000 553,000 ------------- ------------- Total current assets 73,314,093 72,232,923 ------------- ------------- Property and equipment: Land and improvements 1,512,744 1,357,616 Buildings and improvements 19,723,903 17,758,478 Leasehold improvements 1,350,806 1,083,466 Riverboat 13,687,115 13,687,115 Gaming operations equipment 24,186,086 23,314,614 Office furniture and equipment 2,780,173 2,496,142 Transportation equipment 2,176,242 2,150,488 Shop equipment 521,843 503,652 Systems, in progress 1,274,331 0 ------------- ------------- 67,213,243 62,351,571 Less accumulated depreciation and amortization (7,111,033) (4,410,249) ------------- ------------- Total property and equipment, net 60,102,210 57,941,322 ------------- ------------- Other assets: Notes receivable, net of current maturities 22,961,480 26,657,133 Real estate held for sale 596,658 596,658 Goodwill, net 7,876,192 8,155,401 Other assets, net 6,676,460 4,697,196 ------------- ------------- Total other assets 38,110,790 40,106,388 ------------- ------------- $ 171,527,093 $ 170,280,633 ============= ============= * From audited financial statements. The accompanying note is an integral part of the consolidated financial statements. Sodak Gaming, Inc. CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY June 30, December 31, 1997 1996 * ------------- ------------- (Unaudited) Current liabilities: Accounts payable $ 16,479,076 $ 28,328,425 Current maturities of long-term debt 1,792,000 1,751,000 Income taxes payable 930,773 161,615 Accrued liabilities 4,911,181 4,263,912 ------------- ------------- Total current liabilities 24,113,030 34,504,952 ------------- ------------- Long-term debt, net of current maturities 34,963,728 27,188,869 ------------- ------------- Deferred income taxes 1,758,000 1,350,000 ------------- ------------- Shareholders' equity: Preferred stock at $0.001 par value, 25,000,000 shares authorized, none issued and outstanding 0 0 Common stock at $0.001 par value, 75,000,000 shares authorized, 22,758,408 and 22,757,688 shares issued and outstanding at June 30, 1997 and December 31, 1996, respectively 22,758 22,758 Additional paid-in capital 64,075,996 64,072,273 Retained earnings 47,474,570 43,767,878 Cumulative translation adjustment (880,989) (626,097) ------------- ------------- Total shareholders' equity 110,692,335 107,236,812 ------------- ------------- $ 171,527,093 $ 170,280,633 ============= ============= * From audited financial statements. The accompanying note is an integral part of the consolidated financial statements. Sodak Gaming, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six months ended June 30, ------------------------------- 1997 1996 ------------ ------------ Cash flows from operating activities: Net earnings $ 3,706,692 $ 6,779,052 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 3,271,386 832,955 Provision for doubtful accounts 357,061 303,000 Deferred income taxes 137,000 47,000 Gain on sale of receivables (536,527) 0 Changes in operating assets and liabilities: Trade receivables 5,902,469 (7,894,637) Notes receivable relating to financed sales 1,416,668 (883,038) Inventories (1,131,516) (3,855,064) Prepaid expenses 158,097 60,253 Accounts payable (12,093,288) 7,690,970 Accrued liabilities 647,269 (50,920) Income taxes payable, net of refundable income taxes 1,644,158 403,133 ------------ ------------ Net cash provided by operating activities 3,479,469 3,432,704 ------------ ------------ Cash flows from investing activities: Cash advanced on notes receivable (3,874,961) (29,739) Payments received on notes receivable 1,734,756 2,259,475 Purchases of property and equipment (4,997,994) (6,140,300) Increase in amounts due from riverboat lessee, prior to acquisition 0 (2,630,945) Principal payments received on direct financing-type lease 0 338,057 Increase in other assets (2,241,883) (1,911,898) ------------ ------------ Net cash used in investing activities (9,380,082) (8,115,350) ------------ ------------ Cash flows from financing activities: Proceeds from long-term borrowings 22,750,000 16,250,000 Principal repayments of long-term debt (14,934,141) (8,777,526) Net proceeds from exercise of stock options 3,723 73,317 ------------ ------------ Net cash provided by financing activities 7,819,582 7,545,791 ------------ ------------ Effect of exchange rate changes on cash and cash equivalents (147,343) 0 ------------ ------------ Net increase in cash and cash equivalents 1,771,626 2,863,145 Cash and cash equivalents, beginning of period 4,077,107 974,221 ------------ ------------ Cash and cash equivalents, end of period $ 5,848,733 $ 3,837,366 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 1,600,370 $ 786,300 Cash paid during the period for income taxes $ 395,782 $ 3,461,671 Supplemental schedule of noncash investing activity: Gaming machine inventory transferred to gaming operations equipment $ 0 $ 2,477,133 The accompanying note is an integral part of the consolidated financial statements. SODAK GAMING, INC. NOTE TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1997 (Unaudited) Note 1 - Unaudited Consolidated Financial Statements The accompanying unaudited consolidated financial statements of Sodak Gaming, Inc. and its consolidated subsidiaries have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the consolidated financial statements have been condensed or omitted. The results for the periods indicated are unaudited, but reflect all adjustments (consisting only of normal recurring adjustments) which management considers necessary for a fair presentation of operating results. Results of operations for interim periods are not necessarily indicative of a full year of operations. These condensed consolidated financial statements should be read in conjunction with the 1996 consolidated financial statements and notes thereto. Certain 1996 amounts have been reclassified to conform to 1997 presentation. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL After its inception in 1989, the Company's sole line of business was the marketing and distribution of gaming equipment to Native American casinos. Since 1993, a part of the Company's business strategy has been to diversify its revenue base and has focused on the development of gaming opportunities that generate recurring revenue sources. As part of this strategy, the Company implemented the first interstate wide area progressive systems and has entered the Iowa riverboat casino market and emerging gaming markets in Latin America, where it develops, equips and operates gaming halls and routes and a casino. In 1996, the Company acquired the operating company of the MISS MARQUETTE riverboat casino, Gamblers Supply Management Company (GSMC), and assumed full operational responsibility of the casino entertainment facility, which also includes a restaurant, lounge, marina and hotel. The Company also began a casino operation in Ecuador and a video bingo gaming hall in Brazil. The Company also entered into an agreement in 1996 with the Confederacao Brasileira de Futebol (CBF, or the Brazilian Soccer Federation) to own and operate linked progressive video gaming systems in Brazil. In January 1997, the Company entered into a joint venture agreement with IGT and Dreamport (a wholly-owned subsidiary of GTECH Holdings) to proceed with the development and operations of this system. The three companies will share equally in the investment funding, expenses and profits or losses of the CBF project. RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1996 Net earnings for the three months ended June 30, 1997 decreased 41% to $2.4 million, or $0.11 per share, compared to net earnings of $4.1 million, or $0.18 per share, for the three months ended June 30, 1996. The primary factors causing the decrease in net earnings were decreased product sales and lower margins in gaming operations. Total revenue decreased 4% to $33.3 million in 1997, compared to $34.8 million in 1996. Total costs and expenses increased 4% to $29.5 million in 1997, compared to $28.4 million in 1996. Earnings before interest, taxes, depreciation and amortization (EBITDA) decreased 14% to $6.4 million in 1997 compared to $7.4 million in 1996. EBITDA is a commonly used calculation to measure operating performance. The Company includes EBITDA in its results of operations to assist interpretation of financial performance; however, the Company's principal financial measures are net earnings and earnings per share. PRODUCT SALES Revenue from product sales decreased 45% to $14.2 million in 1997 compared to $26.1 million in 1996. The decrease was due to a 41% decrease in machine sales revenue to $11.1 million in 1997 compared to $18.9 million in 1996 (including $1.9 million and $0.2 million of used machines sales in 1997 and 1996, respectively) and a 57% decrease in ancillary gaming and non-gaming product sales revenue to $3.1 million in 1997 compared to $7.2 million in 1996. In 1997, the Company is continuing its strategy of being a full-service provider to its customers by expanding its product line to include additional gaming and non-gaming products and supplies. New gaming machine shipments decreased 52% to approximately 1,470 machines in 1997 compared to approximately 3,030 machines in 1996. In 1997, 65% of the new machine shipments were to casinos in Connecticut, Iowa and Michigan. Sales of used machines increased to approximately 450 machines in 1997 compared to approximately 70 machines in 1996. The Company does not anticipate that new machine shipments in 1997 will attain last year's record level. Growth of gaming in Native American jurisdictions is outside the control of the Company and is influenced by the legal, electoral and regulatory processes of those jurisdictions. The cost of product sales decreased 48% to $10.5 million in 1997, from $20.4 million in 1996. This decrease was attributable to the decreased sales volume of new machines and ancillary gaming and non-gaming products. The gross margin on product sales increased to 25.9% in 1997 as compared to 21.8% in 1996. The improvement in the gross margin was primarily due to larger margins obtained on the sale of approximately $1.9 million of used machines. GAMING OPERATIONS Gaming operations revenue increased 166% to $14.3 million in 1997, from $5.4 million in 1996. This increase was primarily attributable to the July 1, 1996 acquisition of GSMC and the growth of gaming operations in Latin America. Direct costs of gaming operations increased $10.5 million to $13.5 million in 1997, compared to $3.0 million in 1996. DOMESTIC GAMING OPERATIONS THE MISS MARQUETTE. GSMC, the management company of the MISS MARQUETTE, was acquired on July 1, 1996. The acquisition was accounted for using the purchase method of accounting. Accordingly, the operations of the MISS MARQUETTE since July 1, 1996, are included in the consolidated statements of earnings. The riverboat casino and entertainment facility had 682 machines and 36 table games at June 30, 1997. It is located on the Mississippi River at Marquette, Iowa. Revenue from the MISS MARQUETTE amounted to $8.1 million and direct operating costs were $7.6 million in 1997. Prior to its acquisition, the Company leased the riverboat vessel to GSMC, providing the Company $1.6 million in lease revenue in 1996. Management is implementing measures to reduce costs in an effort to improve operating performance. However, there can be no assurance that such improvement will be realized due to the regulatory nature of gaming, the public's acceptance of gaming and other factors affecting performance. PARTICIPATION WITH HARRAH'S. The Company recognized revenue of $0.5 million in 1997 and $0.4 million in 1996 as its share of Harrah's Entertainment, Inc.'s (Harrah's) management fee from the Harrah's Phoenix Ak-Chin casino located near Phoenix, Arizona (Harrah's is a 14% shareholder of the Company). The Company receives this revenue from Harrah's in connection with its role in introducing Harrah's to tribal leaders of the Ak-Chin community, which led to the formation of a business relationship and management contract. INTERNATIONAL GAMING OPERATIONS As part of its strategy to increase its recurring revenue sources, in 1996 the Company expanded its operation of gaming halls and routes in Peru, established a gaming hall in Brazil, and established a casino in Ecuador. PERU. The Company operates gaming halls and route operations in Peru. Revenue increased 33% to $3.8 million in 1997 compared to $2.8 million in 1996. The increase is primarily the result of an increase in the average number of machines in operation. Direct operating costs increased $1.7 million to $4.1 million in 1997 compared to $2.4 million in 1996 as a result of an increase in the average number of machines in operation and the Company's adaptation to a new regulatory structure and requirements, including a 200% increase in the per-machine tax which became effective in October 1996, the expensing of leasehold improvements and pre-opening costs at locations where leases were terminated in order to comply with new regulations, and increased administrative and reorganization costs relating to regulatory changes. In January 1997, the Peruvian government announced regulatory changes in conjunction with the transfer of gaming regulatory authority to the federal government. Included in these changes were minimum machine requirements at gaming halls. In Lima, gaming halls must have at least 120 machines per location and gaming halls in other cities must have at least 80 machines per location. In accordance with regulatory requirements, the Company submitted documentation of its reorganization under the new regulations. The Company is also in the process of complying with new certification requirements on machine refurbishments. Licensing at four additional locations is in process, pending machine certification. The number of machines in operation has decreased to approximately 940 at 15 locations at June 30, 1997, compared to approximately 1,300 at 21 locations at December 31, 1996 and 1,080 at 19 locations at June 30, 1996. The decrease from the end of previous quarters is a result of the Company's preparation in complying with new regulations. BRAZIL. The Company established a gaming hall with 200 machines in the Arpoador district of Rio de Janeiro in June 1996. Revenue was $1.4 million in 1997 compared to $0.2 million in 1996. Direct costs were $1.4 million in 1997 compared to $0.2 million in 1996. Management is implementing measures to reduce costs in an effort to improve operating performance. However, there can be no assurance that such improvement will be realized due to the regulatory nature of gaming, the public's acceptance of gaming and other factors affecting performance. In 1996, the Company entered into an agreement with the CBF to provide and operate a video gaming system in Brazil. In January 1997, the Company entered into a joint venture agreement with IGT and Dreamport to proceed with the development and operations of this system. The three companies will share equally in the investment funding, expenses and profits or losses of the CBF project. The operation of the system is subject to the CBF obtaining regulatory approval in each state where the proposed system is to be offered. The agreement provides for systems to be operational no later than 180 days after regulatory authorization is obtained by the CBF. Project documentation and requests for regulatory authorization have been submitted for approval in four states or jurisdictions: Rio de Janeiro, Goias, the Federal District of Brasilia, and Minas Gerais. In addition, regulatory approval is being pursued in the states of Sao Paulo and Rio Grande de Sul. However, there can be no assurance that such approvals will be obtained or that systems can become operational in the indicated time frame. ECUADOR. The Company established a casino operation in Quito, Ecuador, in March 1996. The casino is located in the Crowne Plaza Hotel and has 150 machines and 10 table games. Revenue in 1997 was $0.5 million compared to $0.3 in 1996. Direct costs associated with the operation were $0.4 million in 1997 compared to $0.3 million in 1996. WIDE AREA PROGRESSIVE SYSTEMS Wide area progressive systems revenue increased 87% to $3.5 million in 1997 compared to $1.9 million in 1996. This increase is a result of the increase in the number of machines on the systems. Comparing June 30, 1997 to June 30, 1996, the Company offered systems in two additional states, Oregon and Kansas; three new systems became operational, DOLLARS DELUXE, FABULOUS 50'S and WHEEL OF FORTUNE; and the number of machines on the systems increased to approximately 1,480 from approximately 950. At June 30, 1997, the Company offered wide area progressive systems in Arizona (which permits the operation of intrastate systems in lieu of interstate systems), Connecticut, Iowa, Kansas, Louisiana, Michigan, New Mexico, North Dakota, Oregon, South Dakota and Wisconsin. At June 30, 1997, nine systems were in operation: MEGABUCKS (one interstate and one intrastate), DOLLARS DELUXE, FABULOUS 50'S, QUARTERMANIA (one interstate and two intrastate), NICKELMANIA and WHEEL OF FORTUNE (which began operating in March 1997). In July 1997, the WHEEL OF GOLD system and in August 1997, the HIGH ROLLERS system were introduced and became operational. Based on current market trends, the Company anticipates increased revenue from its wide area progressive systems in 1997 as it proceeds with its strategy to place additional systems and machines in jurisdictions currently permitting the operation of wide area progressive systems. The Company believes additional jurisdictions may authorize the operation of such systems, thereby enabling additional growth. However, there can be no assurance that necessary regulatory approvals will be obtained in those prospective jurisdictions. Furthermore, public acceptance of these systems and the entry of competing systems of other gaming companies could affect the Company's future revenue. FINANCING Financing income on notes receivable and other financing arrangements decreased 10% to $1.3 million in 1997, compared to $1.4 million in 1996. This decrease was primarily due to a decrease in the amount of financed sales during 1997. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased 2% to $4.6 million in 1997, from $4.5 million in 1996. As a percentage of total revenue, selling, general and administrative expenses increased to 13.8% in 1997 compared to 13.0% in 1996. This increase as a percentage of total revenue is primarily due to a decrease in product sales revenue. INTEREST AND FINANCING COSTS Interest and financing costs increased 61% to $0.8 million in 1997, from $0.5 million in 1996. The increase in interest and financing costs was primarily attributable to increased borrowings for the expansion of gaming operations in Latin America and for the assumption of debt in connection with the acquisition of GSMC. The Company believes that interest and financing costs will continue to increase in future years as the Company pursues its growth strategy. INCOME FROM OPERATIONS The cumulative effect of the above described changes resulted in a 40% decrease in income from operations to $3.8 million in 1997, from $6.4 million in 1996. As a percentage of revenue, income from operations decreased to 11.5% in 1997, from 18.4% in 1996. The decrease in the operating margin was primarily the result of decreased product sales and lower margins in gaming operations that commenced subsequent to the second quarter of 1996. OTHER Earnings before income taxes decreased 40% to $3.9 million in 1997, compared to $6.4 million in 1996. Provision for income taxes was $1.4 million in 1997, compared to $2.3 million in 1996, representing 37% and 36.3% of earnings before income taxes for 1997 and 1996, respectively. RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1996 Net earnings for the six months ended June 30, 1997 decreased 45% to $3.7 million, or $0.16 per share, compared to net earnings of $6.8 million, or $0.30 per share, for the six months ended June 30, 1996. The primary factors causing the decrease in net earnings were decreased product sales and lower margins in gaming operations. Total revenue increased 11% to $62.4 million in 1997, compared to $56.3 million in 1996. Total costs and expenses increased 25% to $57.1 million in 1997, compared to $45.7 million in 1996. EBITDA decreased 14% to $10.8 million in 1997 compared to $12.5 million in 1996. EBITDA is a commonly used calculation to measure operating performance. The Company includes EBITDA in its results of operations to assist interpretation of financial performance; however, the Company's principal financial measures are net earnings and earnings per share. PRODUCT SALES Revenue from product sales decreased 37% to $25.7 million in 1997 compared to $40.6 million in 1996. The decrease was due to a 38% decrease in machine sales revenue to $18.6 million in 1997 compared to $30.2 million in 1996 (including $5.3 million and $0.6 million of used machines sales in 1997 and 1996, respectively) and a 32% decrease in ancillary gaming and non-gaming product sales revenue to $7.0 million in 1997 compared to $10.4 million in 1996. In 1997, the Company is continuing its strategy of being a full-service provider to its customers by expanding its product line to include additional gaming and non-gaming products and supplies. New gaming machine shipments decreased 57% to approximately 2,100 machines in 1997 compared to approximately 4,880 machines in 1996. In 1997, 75% of the new machine shipments were to casinos in Connecticut, Iowa, Kansas, Michigan and Wisconsin. Sales of used machines increased to approximately 1,810 machines in 1997 compared to approximately 160 machines in 1996. The Company does not anticipate that new machine shipments in 1997 will attain last year's record level. Growth of gaming in Native American jurisdictions is outside the control of the Company and is influenced by the legal, electoral and regulatory processes of those jurisdictions. The cost of product sales decreased 36% to $20.0 million in 1997, from $31.3 million in 1996. This decrease was attributable to the decreased sales volume of new machines and ancillary gaming and non-gaming products. The gross margin on product sales declined to 22.2% in 1997 as compared to 22.9% in 1996. The decrease in the gross margin was primarily due to the sale of approximately $5.3 million of used machines, which had a gross margin of 18.1%. GAMING OPERATIONS Gaming operations revenue increased 201% to $27.8 million in 1997, from $9.2 million in 1996. This increase was primarily attributable to the July 1, 1996 acquisition of GSMC and the growth of gaming operations in Latin America. Direct costs of gaming operations increased $21.9 million to $26.4 million in 1997, compared to $4.5 million in 1996. DOMESTIC GAMING OPERATIONS THE MISS MARQUETTE. GSMC, the management company of the MISS MARQUETTE, was acquired on July 1, 1996. The acquisition was accounted for using the purchase method of accounting. Accordingly, the operations of the MISS MARQUETTE since July 1, 1996, are included in the consolidated statements of earnings. The riverboat casino and entertainment facility had 682 machines and 36 table games at June 30, 1997. It is located on the Mississippi River at Marquette, Iowa. Revenue from the MISS MARQUETTE amounted to $15.5 million and direct operating costs were $14.9 million in 1997. Prior to its acquisition, the Company leased the riverboat vessel to GSMC, providing the Company $3.3 million in lease revenue in 1996. Management is implementing measures to reduce costs in an effort to improve operating performance. However, there can be no assurance that such improvement will be realized due to the regulatory nature of gaming, the public's acceptance of gaming and other factors affecting performance. PARTICIPATION WITH HARRAH'S. The Company recognized revenue of $1.0 million in 1997 and $0.9 in 1996 as its share of Harrah's Entertainment, Inc.'s (Harrah's) management fee from the Harrah's Phoenix Ak-Chin casino located near Phoenix, Arizona (Harrah's is a 14% shareholder of the Company). The Company receives this revenue from Harrah's in connection with its role in introducing Harrah's to tribal leaders of the Ak-Chin community, which led to the formation of a business relationship and management contract. INTERNATIONAL GAMING OPERATIONS As part of its strategy to increase its recurring revenue sources, in 1996 the Company expanded its operation of gaming halls and routes in Peru, established a gaming hall in Brazil, and established a casino in Ecuador. PERU. The Company operates gaming halls and route operations in Peru. Revenue increased 66% to $7.6 million in 1997 compared to $4.6 million in 1996. The increase is primarily the result of an increase in the average number of machines in operation. Direct operating costs increased $4.1 million to $8.0 million in 1997 compared to $3.9 million in 1996 as a result of an increase in the average number of machines in operation and the Company's adaptation to a new regulatory structure and requirements, including a 200% increase in the per-machine tax which became effective in October 1996, the expensing of leasehold improvements and pre-opening costs at locations where leases were terminated in order to comply with new regulations, and increased administrative and reorganization costs relating to regulatory changes. In January 1997, the Peruvian government announced regulatory changes in conjunction with the transfer of gaming regulatory authority to the federal government. Included in these changes were minimum machine requirements at gaming halls. In Lima, gaming halls must have at least 120 machines per location and gaming halls in other cities must have at least 80 machines per location. In accordance with regulatory requirements, the Company submitted documentation of its reorganization under the new regulations. The Company is also in the process of complying with new certification requirements on machine refurbishments. Licensing at four additional locations is in process, pending machine certification. The number of machines in operation has decreased to approximately 940 at 15 locations at June 30, 1997, compared to approximately 1,300 at 21 locations at December 31, 1996 and 1,080 at 19 locations at June 30, 1996. The decrease from the end of previous quarters is a result of the Company's preparation in complying with new regulations. BRAZIL. The Company established a gaming hall with 200 machines in the Arpoador district of Rio de Janeiro in June 1996. Revenue was $2.7 million in 1997 and $0.2 million in 1996. Direct costs were $2.7 million in 1997 and $0.2 million in 1996. Management is implementing measures to reduce costs in an effort to improve operating performance. However, there can be no assurance that such improvement will be realized due to the regulatory nature of gaming, the public's acceptance of gaming and other factors affecting performance. In 1996, the Company entered into an agreement with the CBF to provide and operate a video gaming system in Brazil. In January 1997, the Company entered into a joint venture agreement with IGT and Dreamport to proceed with the development and operations of this system. The three companies will share equally in the investment funding, expenses and profits or losses of the CBF project. The operation of the system is subject to the CBF obtaining regulatory approval in each state where the proposed system is to be offered. The agreement provides for systems to be operational no later than 180 days after regulatory authorization is obtained by the CBF. Project documentation and requests for regulatory authorization have been submitted for approval in four states or jurisdictions: Rio de Janeiro, Goias, the Federal District of Brasilia, and Minas Gerais. In addition, regulatory approval is being pursued in the states of Sao Paulo and Rio Grande de Sul. However, there can be no assurance that such approvals will be obtained or that systems can become operational in the indicated time frame. ECUADOR. The Company established a casino operation in Quito, Ecuador, in March 1996. The casino is located in the Crowne Plaza Hotel and has 150 machines and 10 table games. Revenue in 1997 was $1.0 million compared to $0.3 million in 1996. Direct costs associated with the operation were $0.9 million in 1997 compared to $0.3 million in 1996. WIDE AREA PROGRESSIVE SYSTEMS Wide area progressive systems revenue increased 64% to $5.9 million in 1997 compared to $3.6 million in 1996. This increase is a result of the increase in the number of machines on the systems. Comparing June 30, 1997 to June 30, 1996, the Company offered systems in two additional states, Oregon and Kansas; three new systems became operational, DOLLARS DELUXE, FABULOUS 50'S and WHEEL OF FORTUNE; and the number of machines on the systems increased to approximately 1,480 from approximately 950. At June 30, 1997, the Company offered wide area progressive systems in Arizona (which permits the operation of intrastate systems in lieu of interstate systems), Connecticut, Iowa, Kansas, Louisiana, Michigan, New Mexico, North Dakota, Oregon, South Dakota and Wisconsin. At June 30, 1997, nine systems were in operation: MEGABUCKS (one interstate and one intrastate), DOLLARS DELUXE, FABULOUS 50'S, QUARTERMANIA (one interstate and two intrastate), NICKELMANIA and WHEEL OF FORTUNE (which began operating in March 1997). In July 1997, the WHEEL OF GOLD system and in August 1997, the HIGH ROLLERS system were introduced and became operational. Based on current market trends, the Company anticipates increased revenue from its wide area progressive systems in 1997 as it proceeds with its strategy to place additional systems and machines in jurisdictions currently permitting the operation of wide area progressive systems. The Company believes additional jurisdictions may authorize the operation of such systems, thereby enabling additional growth. However, there can be no assurance that necessary regulatory approvals will be obtained in those prospective jurisdictions. Furthermore, public acceptance of these systems and the entry of competing systems of other gaming companies could affect the Company's future revenue. FINANCING Financing income on notes receivable and other financing arrangements increased 6% to $3.1 million in 1997, compared to $2.9 million in 1996. This increase was due to a $0.5 million fee earned from arranging interim financing for a casino project during the first three months of 1997. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased 2% to $9.1 million in 1997, from $8.9 million in 1996. As a percentage of total revenue, selling, general and administrative expenses decreased to 14.5% in 1997 compared to 15.8% in 1996. This decrease as a percentage of total revenue is primarily due to the $6.1 million increase in revenue in 1997, which was mostly a result of the increase in gaming operations revenue. INTEREST AND FINANCING COSTS Interest and financing costs increased 68% to $1.6 million in 1997, from $1.0 million in 1996. The increase in interest and financing costs was primarily attributable to increased borrowings for the expansion of gaming operations in Latin America and for the assumption of debt in connection with the acquisition of GSMC. The Company believes that interest and financing costs will continue to increase in future years as the Company pursues its growth strategy. INCOME FROM OPERATIONS The cumulative effect of the above described changes resulted in a 50% decrease in income from operations to $5.3 million in 1997, from $10.7 million in 1996. As a percentage of revenue, income from operations decreased to 8.5% in 1997, from 18.9% in 1996. The decrease in the operating margin was primarily the result of decreased product sales and lower margins in gaming operations that commenced subsequent to the second quarter of 1996. OTHER Other income includes $0.5 million of income recognized as a result of the sale of receivables at a premium in 1997. Earnings before income taxes decreased 45% to $5.9 million in 1997, compared to $10.7 million in 1996. Provision for income taxes was $2.2 million in 1997, compared to $3.9 million in 1996, representing 37% and 36.6% of earnings before income taxes for 1997 and 1996, respectively. LIQUIDITY AND CAPITAL RESOURCES WORKING CAPITAL Working capital increased $11.5 million to $49.2 million during the six months ended June 30, 1997. This increase is due to a $10.4 million decrease in current liabilities and a $1.1 million increase in current assets. CASH FLOWS During the six months ended June 30, 1997, the Company's cash and cash equivalents increased $1.8 million to $5.8 million. Cash provided by operating activities was $3.5 million in 1997 compared to $3.4 million provided in 1996. The cash flows from operations for 1997 were primarily affected by net income, depreciation and amortization, and changes in receivables, inventories and accounts payable. Cash used in investing activities amounted to $9.4 million in 1997 and $8.1 million in 1996. Cash used in investing activities consisted primarily of $3.9 million advanced on notes receivable for customer financing in 1997; $5.0 million and $6.1 million used to purchase property and equipment in 1997 and 1996, respectively; $2.2 million and $1.9 million increase in other assets in 1997 and 1996, respectively; and $2.6 million increase in amounts due from riverboat lessee, prior to the acquisition of GSMC, in 1996. The 1997 property and equipment purchases were primarily attributable to a building addition to the corporate facility, progress costs for purchase of hardware and software and implementation of a new corporate information system and gaming operations equipment. The increase in other assets during 1997 was primarily due to capitalizing start-up costs associated with the CBF project. Cash used in investing activities was partially offset by $1.7 million and $2.3 million in payments received on notes receivable from casino development financing in 1997 and 1996, respectively. Financing activities provided $7.8 million cash in 1997 compared to $7.5 million provided in 1996, primarily from the net proceeds of long-term borrowings under a revolving credit facility in both years. The increase in debt since December 31, 1996 was primarily used to fund working capital needs. INDEBTEDNESS/LINES OF CREDIT The Company had $36.8 million of debt outstanding at June 30, 1997. Of that amount, $32 million was borrowed under a long-term revolving credit facility from a syndicate of banks. The revolving line has two components, a $20 million tranche (Tranche A) to be used for general corporate purposes and a $30 million tranche (Tranche B) for acquisitions and major capital equipment expenditures. The amount available under Tranche B is reduced by $1.875 million quarterly beginning in June 1997. As a result, the maximum credit amount under the revolving credit facility was $48.125 million at June 30, 1997. Tranche A matures in February 1999, plus two one-year renewal options subject to bank approval, and Tranche B matures in February 2001. The unused portion of the revolving credit facility is subject to a commitment fee, based upon a calculation as defined in the revolving credit agreement. Interest is payable based on variable rates which, at the Company's option, are based on the prime rate, federal funds rate plus 1% or a Eurodollar rate plus an applicable margin. Amounts borrowed are secured by substantially all Company assets, excluding real estate, but including a first preferred ship mortgage on the MISS MARQUETTE riverboat. Of the remaining $4.8 million of debt, $3.2 million relates to debt payable to the former shareholders of GSMC, $1.1 million relates to various other debt secured by certain property of the MISS MARQUETTE riverboat casino and $0.5 million is secured by certain transportation equipment. CAPITAL COMMITMENTS During 1994, the Company assisted a casino management company in acquiring $8 million in financing from a financial institution. The Company also guaranteed the $8 million debt and in return receives a loan guarantee fee based on a percentage of the outstanding loan balance. As of August 2, 1997, the outstanding loan balance was approximately $1.4 million. During 1996, the Company entered into an agreement with the CBF to own and operate, on behalf of the CBF, linked progressive video gaming systems in Brazil. In January 1997, the Company, IGT and Dreamport formed a joint venture for purposes of development and operation of the CBF project under which equity, loans, and profits or losses will be shared equally. Under the terms of the joint venture agreement, the Company has committed to provide initial equity and loans of up to $4 million. In addition, as of June 30, 1997, the Company has incurred start-up costs associated with the CBF project of approximately $4.7 million which are included in other assets in the consolidated balance sheets. If and when the CBF project becomes operational, these costs will be amortized on a straight-line basis over the life of the contract, but not to exceed five years. INTERNATIONAL OPERATIONS Approximately 18% of total revenue for the six months ended June 30, 1997 was derived outside of the United States, compared to 9% in 1996. International operations are subject to certain risks, including but not limited to unexpected changes in regulatory requirements, fluctuations in exchange rates, tariffs and other barriers, and political and economic instability. There can be no assurance that these factors will not have an adverse impact on the Company's operating results. To date, the Company has not experienced significant translation or transaction losses related to foreign exchange fluctuations due to the limited size of its international operations. As the Company continues to expand its international operations, exposure to gains and losses on foreign currency transactions may increase. The Company has not yet engaged, but may in the future engage, in currency hedging transactions intended to reduce the effect of fluctuations in foreign currency exchange rates. IMPACT OF INFLATION Inflation did not have a significant effect on the Company's operations during the six months ended June 30, 1997. CAUTIONARY NOTICE This report contains forward-looking statements reflecting the Company's expectations or beliefs concerning future events which could materially affect Company performance in the future. Terms indicating future expectation, optimism about future potential, anticipated growth in revenue, earnings of the Company's business lines and like expressions typically identify such statements. Actual results and events may differ significantly from those discussed in forward-looking statements. All forward-looking statements are subject to the risks and uncertainties inherent with predictions and forecasts. They are necessarily speculative statements, and unforeseen factors, such as competitive pressures, changes in regulatory structure, failure to gain the approval of regulatory authorities, changes in customer acceptance of gaming, general risks associated with the conduct of international business (such as foreign currency exchange rate fluctuation, changes of governmental control or laws, changes in relations between the United States and other countries, or changes in economic conditions) could cause results to differ materially from any that may be expected. Forward-looking statements are made in the context of information available as of the date stated. The Company undertakes no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. PART II - OTHER INFORMATION Item 1. Legal Proceedings On April 26, 1994, the Company was named as a defendant in a class action filed in the United States District Court, Middle District of Florida, by William A. Poulos and William Ahearn, respectively, each of whom asserted claims on behalf of themselves and "all other similarly situated" parties (the plaintiffs). The suit was filed against Sodak and approximately 41 other defendants (the defendants). These initial two lawsuits were transferred to Nevada and consolidated with a September 16, 1995 third lawsuit filed in the United States District Court, District of Nevada, by Larry Schreier, which also named the Company as a defendant, along with the same 41 other defendants. Additionally, a class action was filed in the United States District Court, Middle District of Florida, by William Poulos, against various cruise lines (the "Cruise Ship" case). While the "Cruise Ship" case did not name the Company as a defendant, it has been transferred to Nevada and consolidated with the above named cases pursuant to an order issued by Judge David Ezra in December, 1996. All of the above mentioned actions (the consolidated action) involve defendants who are involved in the gaming business as either a gaming machine manufacturer, distributor, casino operator, or cruise ship operator. The consolidated action arises out of alleged fraudulent marketing and operation of casino video poker machines and electronic slot machines. The plaintiffs allege that the defendants have engaged in a course of fraudulent and misleading conduct intended to induce people into playing their gaming machines based on a false belief concerning how those machines actually operate as well as the extent to which there is actually an opportunity to win on any given play. The plaintiffs allege that the defendants' actions constitute violations of the Racketeer Influenced and Corrupt Organizations Act (RICO) and give rise to claims of common law fraud and unjust enrichment. The plaintiffs are seeking monetary damages in excess of $1 billion and are asking that any damage awards be trebled under applicable federal law. In his consolidation order of December, 1996, Judge Ezra ordered the plaintiffs to file a consolidated amended complaint. He also ordered that all prior motions to dismiss be deemed withdrawn, with leave for the defendants to refile them upon receipt of the consolidated amended complaint. He also ordered that the consolidated amended complaint have no substantive changes from the original complaints on file. Contrary to Judge Ezra's order, the consolidated amended complaint was filed with many substantive changes, some of them directly contradicting the order. Consequently, the defendants, through a "steering committee" formed pursuant to the same order, filed a motion to strike the consolidated amended complaint. The defendants, also through the steering committee, filed motions to dismiss on the grounds of failure to state a claim and failure to plead fraud with particularity. The plaintiffs responded to defendants' motions of May 2, 1997 and the defendants filed their replies on May 23, 1997. The motions are currently under advisement and the parties are awaiting a ruling by the court. The Company believes the Consolidated action is without merit. The Company intends to vigorously pursue all legal defenses available to it and to participate in the defense as fully as possible through the defendants' steering committee. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders The Company held its annual meeting of shareholders on May 6, 1997 for the purposes of electing members of the Board of Directors of the Company and to ratify the selection of KPMG Peat Marwick LLP as independent auditors of the Company for the fiscal year ending December 31, 1997. There were 22,757,688 shares of Common Stock entitled to vote at the meeting and a total of 21,934,598 shares (96.38%) were represented at the meeting. The shareholder voting was as follows: 1. Election of Directors: WITHHOLD FOR AUTHORITY ---------- --------- Michael G. Wordeman 21,912,934 21,664 Roland W. Gentner 21,912,934 21,664 Thomas Celani 21,913,034 21,564 Colin V. Reed 21,912,734 21,864 Manuel Lujan, Jr. 21,911,934 22,664 Ronnie Lopez 21,912,734 21,864 2. To ratify the selection of KPMG Peat Marwick LLP as independent auditors of the Company for the fiscal year ending December 31, 1997: For - 21,913,611 Against - 4,099 Abstain - 16,888 Broker Non-Vote - 0 Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K a. Exhibits 11.1 Calculation of Earnings Per Common and Common Equivalent Share. b. Reports on Form 8-K None. Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 13, 1997 SODAK GAMING, INC. By: \s\ David R. Johnson David R. Johnson Chief Financial Officer EXHIBIT INDEX Exhibit Sequentially Number Numbered Page - ------ ------------- 11.1 Calculation of Earnings Per Common and Common 24 Equivalent Share 27 Financial Data Schedule (submitted with the EDGAR filing only)