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FORM 10-K
UNITED STATES SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 0-21426
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CASINO DATA SYSTEMS
(Exact Name of Registrant as Specified in its Charter)
NEVADA 88-0261839
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3300 BIRTCHER DRIVE
LAS VEGAS, NEVADA 89118
(Address of principal executive (Zip Code)
offices)
(702) 269-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR
VALUE
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Indicate by check whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes /X/ No / /
As of March 21, 2000, 18,431,739 shares of the Registrant's Common Stock
were outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the Registrant on such date, based upon the last sale price of
the Common Stock as reported on the NASDAQ National Market on March 21, 2000,
was $55,499,838. For purposes of this computation, affiliates of the Registrant
are deemed only to be the Registrant's executive officers and directors.
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TABLE OF CONTENTS
PAGE
--------
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 22
Item 3. Legal proceedings........................................... 22
Item 4. Submission of Matters to a Vote of Security Holders......... 23
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters..................................................... 24
Item 6. Selected Financial Data..................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results Of Operations................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 33
Item 8. Consolidated Financial Statements and Supplementary Data.... 33
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure........................................ 60
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 60
Item 11. Executive Compensation...................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 60
Item 13. Certain Relationships and Related Transactions.............. 60
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 61
Signatures.................................................. 63
2
PART I
ITEM 1. BUSINESS
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Casino Data Systems (the "Company" or "CDS") is a designer and manufacturer
of innovative technology-driven products for the gaming industry. The Company is
including the following cautionary statement to take advantage of the "safe
harbor" provisions of the PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 for
any forward-looking statement made by, or on behalf of, the Company. The factors
identified in this cautionary statement are important factors (but not
necessarily all the important factors) that could cause actual results to differ
materially from those expressed in any forward-looking statement made by, or on
behalf of, the Company. Where any such forward-looking statement includes a
statement of the assumptions or bases underlying such forward-looking statement,
the Company cautions that, while it believes such assumptions or bases to be
reasonable and makes them in good faith, assumed facts or bases almost always
vary from actual results, and the differences between assumed facts or bases and
actual results can be material, depending on the circumstances. Where, in any
forward-looking statement, the Company, or its management, expresses an
expectation or belief as to future results, such expectation or belief is
expressed in good faith and believed to have a reasonable basis, but there can
be no assurance that the statement of expectation or belief will result, or be
achieved or accomplished. Taking into account the foregoing, the following are
identified as important risk factors that could cause actual results to differ
materially from those expressed in any forward-looking statement made by, or on
behalf of, the Company:
- A decline in demand for, or appeal of, the Company's products, or a
decline in the rate of growth of new and existing markets for the
Company's products.
- An increase in popularity of competitor's products.
- The entry into the market by new competitors and competition with more
well established manufacturers and distributors.
- The loss or retirement of our key executives.
- Approval of competitor's patent applications resulting in an inability to
use intellectual property upon which the Company relies to manufacture and
sell its products or denial of approval of the Company's patent
applications.
- Unfavorable public referendums or anti-gaming legislation.
- Unfavorable legislation affecting or directed at manufacturers or
operators of gaming products and systems.
- The effect of regulatory and governmental actions including, without
limitations, delays in regulatory approval for the Company's products, or
the limitation, conditioning, suspension or revocation of any of the
Company's licenses.
- Unfavorable determination of suitability by gaming regulatory authorities
with respect to our officers, directors, key employees or business
partners.
- With respect to legal actions pending against the Company, the discovery
of facts not presently known to the Company or determination by judges,
juries or other finders of fact which do not accord with the Company's
evaluation of the possible liability or outcome of existing litigation.
We do not undertake to update our forward looking statement to reflect
future events or circumstances.
3
GENERAL
The Company's primary products and services include the (i) design and
manufacture of casino management information systems, including the Company's
historical core product, the OASIS-TM- II (On-Line Accounting and Slot
Information System) System and its successor, OASIS
Windows-Registered Trademark- (Windows is a registered trademark of Microsoft
Corporation) (collectively referred to as "OASIS"); (ii) operation of multi-site
link progressive ("MSP") systems which link gaming machines in different casinos
to allow patrons to compete for large, lifestyle-changing progressive jackpots;
(iii) design and manufacture of innovative gaming machines, (iv) design and
manufacture of meters, signs and graphics which allow the Company to offer
integrated gaming systems with custom designed glass and graphics, progressive
meters and customized overhead signage and (v) development of advanced software
programming tools. The Company provides these products and services through
operation of five segments: systems and services, gaming devices, recurring
revenue, signs and TurboPower Software (TurboPower). Prior to 1998, the Company
also operated an additional graphics and imaging segment that sold graphics and
imaging products to third parties.
These segments contributed to consolidated revenue for each of the three
years ended December 31, 1999 as follows:
REVENUES
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SEGMENT 1999 1998 1997
- ------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Systems and Services............................. $30,075 $23,147 $19,314
Gaming Devices................................... 30,302 14,561 6,328
Recurring Revenue................................ 7,231 9,469 21,127
Signs............................................ 5,702 4,031 4,244
TurboPower....................................... 2,220 1,847 1,450
Graphics and Imaging............................. -- 125 2,041
------- ------- -------
Total.......................................... $75,530 $53,180 $54,504
======= ======= =======
Founded in 1990 by Steven Weiss, the Company's Chairman and Chief Executive
Officer, the Company grew rapidly by developing and marketing technologically
advanced products, including its DOS based OASIS casino management information
systems and its Cool Millions-TM- MSP system, and through strategic acquisitions
of businesses and technology to complement the Company's core products. The
Company's OASIS system is installed in over 123,000 gaming machines in
approximately 106 casinos throughout North America. Through the marketing and
enhancement of its OASIS systems, the Company has developed relationships with
many major casinos in North America, which the Company believes provides it with
a competitive advantage in marketing its other products and systems. In 1993,
the Company developed progressive meter technology and has since expanded and
diversified its operations through the acquisition of graphics, signs and
software businesses. In 1994, the Company launched its Cool Millions MSP system
in Mississippi and was licensed by Nevada as a manufacturer and distributor of
gaming devices. The Company's gaming devices product portfolio is comprised of
proprietary video poker and video slot games along with traditional reel
spinning slot machines.
BUSINESS STRATEGY
The Company's objective is to become the leading designer and manufacturer
of innovative technology-driven products and services to meet the gaming
industry's evolving needs. To meet this goal, the Company intends to continue to
enhance and refine its existing products and systems, develop new and
entertaining interactive gaming devices and continue its research and
development efforts to maintain its ability to offer technologically advanced
products in each of its businesses and further integrate its operations to
provide the best possible products and services to its customers. The Company
also continually reviews all components of its business for possible improvement
of future profitability and shareholder value through acquisition, divestiture,
reengineering or restructuring. The key elements of the Company's strategy are
described below in relation to the Company's lines of business.
4
BUSINESS SEGMENTS
SYSTEMS AND SERVICES
CASINO MANAGEMENT INFORMATION SYSTEMS
In order to maintain its position as a technological leader, the Company
continues to expand the functionality of its casino management systems. The
Company believes that innovative and reliable information systems will be a key
element in the continued growth and success of the gaming industry. The
Company's player tracking and gaming machine accounting systems traditionally
have been used by casinos to monitor player activity and to collect, integrate
and analyze data from electronic gaming devices. The Company has been evolving
its player tracking and gaming machine accounting systems into a casino-wide
management information system by using its technological expertise to develop
software modules that allow the OASIS-TM- system to support additional
marketing, accounting, security and maintenance functions for many areas of
casino operations. The Company has completed development of two versions of a
Windows-TM- NT compatible platform for OASIS software. The development of these
system enhancements enables OASIS to expand data analysis, improve
communications, and include data exchange with the other casino management
information systems. OASIS products recently introduced into the Windows product
line include PitBoss-TM- cage, credit and table games accounting; Diagnostic
Monitor floor analysis and Universal Gateway system interface. In addition, the
Company has wireless radio frequency communication capability on its OASIS
platforms. Casinos with OASIS systems have the ability to customize their casino
management information system operations by adding new modules and features to
their existing OASIS systems as expansions or upgrades.
OASIS, the Company's on-line gaming machine accounting and player tracking
system, forms the core of the Company's information management system. The
Company's casino management systems are comprised of modular software
applications designed to deliver real-time solutions to the gaming industry. The
system uses advanced electronic monitoring equipment to collect, integrate,
analyze and report data from traditional slot machines, multi-site progressive
link machines, video poker and other electronic devices. By linking on-line
accounting and player tracking information, the OASIS system allows casinos to
perform sophisticated and customized data analysis in real-time.
The Windows compatible version utilizes Microsoft-Registered Trademark- NT
Server operating software and incorporates Microsoft SQL Server relational
database and third party report generators. The OASIS/Windows version was
completed and approved for field trial in Nevada in April 1998. By
November 1998, the OASIS/ Windows field trial was completed and the product was
available for general sale in Nevada. The Windows compatible version was
approved for general sale in Gaming Laboratories International, Inc. ("GLI" is
an independent gaming consultant that many jurisdictions utilize to approve
electronic gaming devices, systems and associated equipment) territories in
October 1998.
BlackBart-TM-, the on-line gaming machine accounting module of the OASIS
system, consolidates all coins that enter, exit, or are retained by each
electronic gaming machine, records all jackpot and fill transactions, and
calculates coin and currency drop values. This information is rapidly and
continuously communicated to generate instant or "on-line" accounting of
revenues for all types of electronic gaming machines. Machine statistics and net
win analysis provide comprehensive revenue profiles for individual machines and
the entire casino floor. An automated jackpot and fill program provides
comprehensive jackpot accounting, security and control, including support for
the Company's ProTURBO line of progressive jackpot meters, automatic federal and
state tax withholding and automatic updates to the player tracking system.
The ProTURBO progressive system central controller provides cost and
operational advantages by eliminating individual progressive controllers for
each meter and by enabling casinos to control all meters from one central
workstation, allowing casinos to reset meters without manually configuring each
meter on
5
the casino floor. This feature provides the casino flexibility to design the
gaming floor to highlight specific areas within the casino to stimulate player
activity.
Super-PlayMate-TM-, the player tracking and marketing database functionality
within the OASIS system, allows casino operators to collect and access real-time
player marketing information. Casino marketing departments use OASIS data to
engage in target marketing, measure customer response to marketing efforts,
award "comps" to good customers and measure the cost effectiveness of various
"comp" and marketing programs by comparing the expenditures with revenues
generated by a player or group. To collect player information, casinos issue
coded and individualized "player club" cards to customers, which are inserted
into a card reader mounted on or in the gaming machines. The OASIS system
records the length of play, amount wagered and casino win on each machine
played, enabling the casino to keep a record of gaming activity for each
customer. In addition, the OASIS system integrates manually entered table game
data with gaming machine data to produce comprehensive player ratings.
The OASIS system features OmniVIEW, a dynamic, real-time graphic
representation of the electronic gaming floor, which provides a display of all
gaming activity as it occurs. By moving a cursor around the floor plan, the user
can obtain detailed current information about any gaming machine and any player.
Real-time information includes hopper level analysis, carded and cardless player
headcounts and maintenance event detail.
The Surveillance Monitor module is designed to assist security and
surveillance personnel by flagging certain types of transactions with
distinctive message or alarm attributes. These messages are displayed on screen
and may be printed on a security log. The Diagnostic Monitor-TM- module provides
a history of maintenance problems and procedures performed for each gaming
machine and can be programmed to automatically page maintenance personnel and
initiate work orders when failure codes are entered via keypad at the gaming
machine.
PitBOSS is the cage, credit, and table games accounting application that
ties the table games area into the OASIS casino management suite of products.
Marketing data is shared between OASIS and PitBOSS applications to provide
comprehensive player analysis for multiple locations of gaming activity. Full
accounting is provided for all cage transactions including checks, markers,
deposits, withdrawals and payments, and for all table games' transactions
including fills, credits, and table inventory.
The Universal Gateway application enables the casino management system to
interface with third party systems such as hotel systems or point of sale
systems, through customizable messages and communication protocols. This program
allows players to accumulate points with purchases throughout the resort in
addition to gaming activities. Additionally, with a swipe of the player's club
card, players may use their points throughout the resort to pay for meals, hotel
rooms, or resort services.
The Company continues to invest in its OASIS casino information management
systems to pursue its objective of technological leadership. The Company will
continue to enhance existing modules and will focus on developing new modules in
the future in an effort to increase the OASIS systems' functionality.
GAMING DEVICES
VIDEO INTERACTIVE GAMING MACHINES
The Company has developed a proprietary video interactive gaming machine
platform which supports high-speed, high resolution video displays and
CD-quality stereophonic sound with advanced memory and graphics capabilities. As
a result of its advanced platform, the Company is able to develop gaming devices
which automatically adjust the speed of its graphics displays to match the
player's speed of play, providing more rapid dealing action for fast players.
The Company intends to develop additional interactive video gaming machines
based on this platform and to develop more advanced platforms that will support
additional graphics, animation, and other secondary game features designed to
increase the entertainment value and interactivity of video gaming.
6
The Company believes that its success in the video gaming business will be
dependent upon its development and marketing of state-of-the-art interactive
video gaming machines which will add entertainment value and encourage social
interaction among players to enhance the gaming experience. To that end, the
Company has developed various video poker and video slot games along with
traditional reel spinning slot machines that are currently licensed in various
jurisdictions. In addition, the Company intends to develop new interactive video
gaming devices with enhancements in production value, computer graphics and
entertainment-focused secondary game features.
RECURRING REVENUE
MSP systems link a number of gaming machines in various casinos to a central
computer that allocates a portion of each wager made to one or more progressive
jackpots. By linking the machines together, larger life-style changing
progressive jackpots can be awarded more frequently than with stand alone
machines due to the increased number of wagers contributing to the jackpot on
the link. The Company had 301 games participating on its three MSP system links
as of December 31, 1999.
SIGNS
The Company believes that single, integrated product installations offer
customers a cost-effective product and are the most efficient marketing strategy
for the Company's meter and sign products. The Company intends to promote the
marketing of product packages including overhead signage, in-machine and
overhead progressive meters.
The Company has developed a full line of progressive meters, controllers and
progressive systems. A meter is a graphics display device for progressive
jackpots which displays current jackpot size to gaming patrons. The Company's
ProVIEW-TM- family of meters offers in-machine and overhead text messaging,
odometer jackpot effects and graphic animation sequences. The meters are
available in various sizes, configurations and resolutions. A controller is a
data transmission device that links gaming machines and meters into a
progressive system. The Company's ProLINK-TM- line of controllers allows
operation of proprietary progressive systems within one or more of a casino
operator's properties. A progressive system is comprised of meters and
controllers that link together slot machines, allocates a portion of each wager
to a progressive jackpot and displays the current jackpot size via overhead or
in-machine displays. The Company's ProSOLO one-machine progressive system
enables a single slot machine to offer a progressive jackpot. The Company's
ProTURBO progressive system links the ProLINK progressive technology with the
OASIS II system to create a single, highly-flexible controller that manages both
progressive communications and player tracking/slot accounting data collection.
The ProTURBO system allows the casino operator to customize or change any of the
meter-linked signs from a single networked work station, compared with competing
meter-linked signs that must be changed one at a time from the casino floor.
TURBOPOWER
The Company's TurboPower Software subsidiary (TurboPower) develops advanced
software programming tools used by software professionals to develop
applications for business and industry. Located in Colorado, TurboPower also
provides debugging tools for professional software developers.
GRAPHICS AND IMAGING
The Company's Graphics and Imaging subsidiary designed and manufactured
decorative flat glass and slot reel graphics, supplying the Company's games
division as well as outside gaming device manufacturers and casinos. Due to
losses reported for several consecutive quarters, the Company initiated a plan
in the fourth quarter of 1997 to discontinue external operations and service
only internal demand.
7
TECHNOLOGY AND CERTAIN OTHER BUSINESS RISKS
RISKS OF NEW AND EXPANDING BUSINESSES; RAPIDLY CHANGING TECHNOLOGY
The Company is continuing to expand and diversify its business by developing
and introducing new products that complement and enhance the Company's existing
businesses. The Company faces the risks, expenses and difficulties frequently
encountered by new and rapidly expanding businesses, including, but not limited
to, fluctuating cash flow, initial high development costs of new products
without corresponding sales, pending receipt of regulatory approvals and market
introduction and acceptance of new products. Of course, there is no assurance
that the Company's new products will be accepted in the marketplace or that
regulatory approvals will be obtained. Furthermore, in each area of the
Company's business, the Company will need to manage the transition to higher
volume operations, entry into new markets, control of overhead expense and the
addition, training and management of qualified personnel.
The Company's development as a gaming machine manufacturer and supplier is
dependent upon numerous factors, including its ability to design, manufacture,
market and service gaming machines that achieve player and casino acceptance
while maintaining product quality and acceptable margins. The Company must
compete against gaming machine suppliers with greater financial resources, name
recognition, established service networks and customer relationships. The
Company believes that it will need to develop gaming machines that offer
technological advantages or unique entertainment features in order for the
Company to be able to compete effectively in the gaming machine market.
TIME TO MARKET
Each area of the Company's business is characterized by rapidly changing
technology and frequent new product introductions and enhancements. The
Company's success will depend in part on its ability to continue to enhance its
existing products and to introduce in a timely manner new products that meet
evolving customer requirements and achieve market acceptance. There can be no
assurance that the Company will be successful in identifying, developing and
marketing new products or enhancing its existing products. The Company's
business will be adversely affected if the Company experiences delays in
developing new products or enhancements or if such products or enhancements do
not gain customer acceptance.
FACTORS AFFECTING PROFITABILITY AND GROWTH
Substantially all of the Company's revenues and profits are derived from the
gaming industry. The continued profitability and growth of the Company's
business is substantially dependent upon factors that are beyond the control of
the Company, including, among others, the pace of development, expansion and
renovation of casinos, the legalization of MSP systems and other forms of casino
gaming in new jurisdictions, the continued popularity of casino gaming as a
leisure activity and increased demand by gaming customers for progressive
jackpot games and game variations providing increased payout opportunities. The
expansion of the gaming industry has slowed in recent years and the continued
expansion of gaming markets is dependent upon political, legal and other factors
which are beyond the control of the Company. As a result of these and other
factors, there is no assurance of the Company's continued growth or
profitability.
RELIANCE ON KEY CUSTOMERS
The Company has historically maintained strong business relationships with
several key casino customers including, but not limited to, Boyd Gaming;
Mandalay Resort Group; Harrah's Entertainment; Foxwoods; Park Place
Entertainment Corporation, successor to Grand Casinos; Mirage Resorts; Showboat
and Station Casinos which have, in certain periods, accounted for a material
amount of the Company's sales. Combined, these entities accounted for
approximately 27%, 25% and 36% of the Company's total sales during the fiscal
years ended December 31, 1999, 1998 and 1997, respectively. While each sale of
8
casino management information systems and other large product contracts are
negotiated independently and do not occur with specific frequency, the loss or
reduction of a major customer could have a material adverse impact on the
financial results of the Company. There can be no assurance that the Company
will maintain strong business relationships with its key customers in the
future.
COMPETITION
The market for casino management information systems, MSP systems, gaming
machines and each of the Company's other products are difficult markets in which
to compete and there are a number of established, well-financed and well-known
companies that compete with each of the products and services offered by the
Company. IGT in particular enjoys a significant domestic and international
market position in the Company's primary markets, including casino management
information systems, gaming machines and MSP systems
The Company also competes with several other competitors in one or more
areas of the Company's markets, including, but not limited to, Alliance Gaming
(Bally Gaming International), Anchor Gaming, Sigma Gaming, Universal
Distributing, Mikohn, WMS Gaming, Acres Gaming, Silicon Gaming, Aristocrat,
Atronic, Unidesa, Gaming Systems International, Lodging Systems, Inc. and Yesco.
The development of a successful new product or product design by a competitor
could adversely affect sales of the Company's products and, although the Company
would endeavor to respond quickly with its own competing products, no assurance
can be made that a significant new product designed by a competitor would not
have a material adverse effect on the Company's results of operations.
MARKETING AND SALES
The Company has approximately 40 full time sales and marketing staff
focusing on the sales of OASIS casino management information systems, MSP games,
games, signs and meters. The Company's TurboPower Software subsidiary sells its
products primarily by telephone and the Internet. In addition to its corporate
headquarters in Las Vegas, Nevada, the Company maintains regional sales and
support offices in Sparks, Nevada; Gulfport, Mississippi; Atlantic City, New
Jersey and Plymouth, Minnesota.
INTELLECTUAL PROPERTY RIGHTS
The Company's business is dependent upon its ability to protect its
proprietary software, hardware and other intellectual property. The Company
relies primarily on a combination of non-disclosure agreements for its key
employees and other third parties, license agreements and nondisclosure
agreements with its customers and suppliers and trade secret protection to
protect such intellectual property. Despite the Company's precautions, it may be
possible for unauthorized parties to copy or to possibly reverse engineer
certain portions of the Company's products or to obtain and use information that
the Company believes is proprietary. Therefore, there is no assurance that
precautionary steps taken by the Company in this regard will be adequate to
deter misappropriation of its intellectual property or independent third party
development of functionally equivalent products or that the Company can
meaningfully protect its rights to such proprietary intellectual property. The
Company has applied for patents covering certain aspects of its MSP systems and
gaming devices. There is no assurance that such patents will be issued, or, if
issued, will offer meaningful protection of such intellectual property. In
addition, whether or not such patents are issued, others may hold or receive
patents which contain claims having a scope that covers products developed by
the Company. Furthermore, there can be no assurance that others have not
developed or will not develop similar products or technology, duplicate any of
the Company's products or technology, or design around any patents licensed or
granted to the Company, or any patents that may be issued in the future to the
Company.
9
EMPLOYEES
As of December 31, 1999, the Company had approximately 404 full-time
employees, approximately 70 of whom were software or hardware engineers. The
majority of the remaining employees are engaged in technical support and
customer service, production, field installation and support, sales and
marketing and administration. The Company also uses a temporary agency to
provide skilled workers for light manufacturing and assembly during high-demand
manufacturing periods. The Company is not currently subject to a collective
bargaining agreement and believes that its employee relations are good.
REGULATION
OVERVIEW
The Company is subject to regulation in jurisdictions in which it operates
MSP systems and in most jurisdictions in which its products are sold or are used
by persons or entities licensed to conduct gaming activities. Such gaming
regulations vary from jurisdiction to jurisdiction and the classification and
level of the regulatory licensing, approvals and compliance to which the Company
and its products must conform also vary by jurisdiction. In certain
jurisdictions, the Company or its subsidiaries may be operating pursuant to
temporary waivers or approvals. There can be no assurance that such temporary
waivers or approvals will be maintained or become permanent. Failure by the
Company or its subsidiaries to obtain, or the loss or suspension of, any
necessary licenses, approvals or suitability findings would prevent or restrict
the Company or its subsidiaries from operating, selling or distributing its
products in most jurisdictions, which would have a material adverse effect on
the Company. In the event gaming authorities determine that an officer,
director, key employee, stockholder or other person of the Company is unsuitable
to act in such a capacity, the Company will be required to terminate its
relationship with such person, which termination could have a material adverse
effect on the Company. Although the Company has the right to redeem shares of an
unsuitable stockholder under certain circumstances, such a finding of
unsuitability could in any event have a material adverse effect on the Company.
There can be no assurance that the Company or its subsidiaries will obtain all
the necessary licenses and approvals or that its officers, directors, key
employees, their affiliates and certain other stockholders will satisfy the
suitability requirements in each jurisdiction in which the Company or its
subsidiaries seeks to operate MSP systems or in which its products are sold or
used by persons licensed to conduct gaming activities. The failure to obtain
such licenses and approvals in one jurisdiction may affect the Company's
licensure and/or approvals in other jurisdictions. In addition, a significant
delay in obtaining such licenses and approvals could have a material adverse
effect on the business prospects of the Company.
The Company's OASIS casino information management systems and related
meters, controllers and progressive systems are generally classified as
"associated equipment." "Associated equipment" is equipment that is not
classified as a "gaming device," but which has such an integral relationship to
the conduct of licensed gaming that regulatory authorities have discretion to
require suppliers of such systems to meet licensing suitability requirements
prior to or concurrent with the use of such equipment in the respective
jurisdiction. Associated equipment generally must be approved in advance by the
regulatory authorities for its use at licensed locations within the
jurisdiction. The Company or its distributor has complied in all material
respects with the associated equipment approval process in each jurisdiction in
which it has sold OASIS systems.
The gaming machines that may be developed by the Company are defined as
"gaming devices" in many jurisdictions. Although gaming device and equipment
regulations vary among jurisdictions, each jurisdiction requires various
licenses, approvals or permits to be held by companies and their key personnel
in connection with the manufacture and distribution of gaming devices and
equipment. The Company or one of its subsidiaries is licensed as a manufacturer,
distributor and/or supplier of gaming devices in the states of Iowa, Louisiana,
Mississippi and Nevada, certain Native American jurisdictions and the city of
Windsor, Ontario, Canada, and has applied to be licensed in several other
jurisdictions. The Company has
10
operated pursuant to transactional waivers or as a supplier of associated
equipment in jurisdictions in which the Company's license applications are
pending. The Company will be required to apply for additional transactional
waivers in the event it seeks to make sales to additional casinos in such
jurisdictions prior to licensing. The Company will be required to apply for
licensing as a manufacturer, distributor and/or supplier of gaming devices or
associated equipment prior to making sales in each new jurisdiction.
As an operator of MSP systems, the Company, certain of its officers,
directors, key employees, stockholders and other affiliates are subject to
mandatory operator licensing and approval requirements, operator suitability
requirements and ongoing regulatory oversight in each jurisdiction in which it
operates MSP systems. On October 28, 1994, CDS Gaming received a gaming operator
license from the Mississippi Gaming Commission. On December 21, 1995, CDS Gaming
was licensed by the Nevada Gaming Commission as an operator of an inter-casino
linked system ("OILS"). The OILS license permits the Company to operate MSP
systems without being licensed to conduct gaming at each Nevada casino
participating in the MSP system. There can be no assurance that the Company or
its subsidiaries will obtain all of the necessary licenses and approvals or that
their officers, directors, key employees, other affiliates and certain other
stockholders will satisfy the suitability requirements in one or more
jurisdictions, or that such licenses, approvals and suitability findings, if
obtained, will not be revoked or not be renewed in the future. The laws,
regulations and procedures pertaining to gaming are subject to the
interpretation of the Regulatory Authorities and may be amended. Any changes in
such laws, regulations, or their interpretations could have a material adverse
effect on the Company.
GENERAL REGULATION OF STOCKHOLDERS OF PUBLICLY TRADED CORPORATIONS
In most jurisdictions, any beneficial owner of the Company's Common Stock is
subject on a discretionary basis to being required to file applications with
gaming regulatory authorities, be investigated and found suitable or qualified
as such. In addition, stockholders whose holdings of Common Stock exceed certain
designated percentages are subject to certain reporting and qualification
requirements imposed by state and federal gaming regulators and, any
stockholder, if found to be unsuitable, may be required to immediately dispose
of its holdings of Common Stock. See "--New Jersey Regulatory Matters,"
"--Nevada Regulatory Matters" and "--Mississippi Regulatory Matters." The
Company's Articles of Incorporation authorize the Company to redeem at fair
market value Common Stock held by any person whose status as a shareholder may
jeopardize the Company's gaming licenses or approvals.
NEVADA REGULATORY MATTERS
The manufacture, sale and distribution of gaming devices for use or play in
Nevada or for distribution outside of Nevada, the manufacture and distribution
of associated equipment for use in Nevada, and the operation of inter-casino
linked systems in Nevada are subject to: (i) The Nevada Gaming Control Act and
the regulations promulgated thereunder (collectively, the "Nevada Act"); and
(ii) various local ordinances and regulations. Such activities are subject to
the licensing and regulatory control of the Nevada Gaming Commission ("Nevada
Commission"), the Nevada State Gaming Control Board ("Nevada Board"), and
various local, city and county regulatory agencies (collectively referred to as
the "Nevada Gaming Authorities").
The Company is registered by the Nevada Commission as a publicly traded
corporation (a "Registered Corporation") and has also been licensed as a
manufacturer and distributor of gaming devices. The Company has also been found
suitable to own the stock of CDS Gaming (the "Nevada Subsidiary") which is
licensed as an operator of an inter-casino linked system. As a Registered
Corporation, the Company is required periodically to submit detailed financial
and operating reports to the Nevada Commission and furnish any other information
which the Nevada Commission may required. The Company and the Nevada Subsidiary
have obtained from the Nevada Gaming Authorities the various registrations,
findings or suitability, approvals, permits and licenses in order to engage in
manufacturing, distribution and inter-casino linked system activities in Nevada.
11
All gaming devices that are manufactured, sold or distributed for use or
play in Nevada, or for distribution outside of Nevada, must be manufactured by
licensed manufacturers and distributed or sold by licensed distributors. All
gaming devices manufactured for use or play in Nevada must be approved by the
Nevada Commission before distribution or exposure for play. The approval process
for gaming devices includes rigorous testing by the Nevada Board, a field trial
and a determination as to whether the gaming device meets strict technical
standards that are set forth in the regulations of the Nevada Commission.
Associated equipment must be administratively approved by the Chairman of the
Nevada Board before it is distributed for use in Nevada.
The Nevada Gaming Authorities may investigate any individual who has a
material relationship to, or material involvement with, the Company or the
Nevada Subsidiary in order to determine whether such individual is suitable or
should be licensed as a business associate of a gaming licensee. No person or
legal entity may acquire control of the Company without the prior approval of
the Nevada Commission. Any beneficial holder of the Company's voting securities,
regardless of the number of shares owned, may be required to file an
application, be investigated, and have his suitability determined as a
beneficial holder of the Company's voting securities if the Nevada Commission
has reason to believes that such ownership would otherwise be inconsistent with
the declared policies of the State of Nevada. The applicant must pay all costs
of investigation incurred by the Nevada Gaming Authorities in conducting any
such investigation.
The Nevada Act requires any person who acquires beneficial ownership of more
than 5% of a Registered Corporation's voting securities to report the
acquisition to the Nevada Commission. The Nevada Act requires that beneficial
owners of more than 10% of a Registered Corporation's voting securities apply to
the Nevada Commission for a finding of suitability within thirty days after the
Chairman of the Nevada Board mails the written notice requiring such filing.
Under certain circumstances, an "institutional investor," as defined in the
Nevada Act, which acquires more than 10%, but not more than 15%, of the
Registered Corporation's voting securities may apply to the Nevada Commission
for a waiver of such finding of suitability if such institutional investor holds
the voting securities for investment purposes only. An institutional investor
shall not be deemed to hold voting securities for investment purposes unless the
voting securities were acquired and are held in the ordinary course of business
as an institutional investor and not for the purpose of causing, directly or
indirectly, the election of a majority of the members of the board of directors
of the Registered Corporation, any change in the Registered Corporation's
corporate charter, bylaws, management, policies or operations of the Registered
Corporation, or any of its gaming affiliates, or any other action which the
Nevada Commission finds to be inconsistent with holding the Registered
Corporation's voting securities for investment purposes only. Activities which
are not deemed to be inconsistent with holding voting securities for investment
purposes only include: (i) voting on all matters voted on by stockholder;
(ii) making financial and other inquiries of management of the type normally
made by securities analysts for information purposes and not to cause a change
in its management, policies or operations; and (iii) such other activities as
the Nevada Commission may determine to be consistent with such investment
intent. If the beneficial holder of voting securities who must be found suitable
is a corporation, partnership or trust, it must submit detailed business and
financial information including a list of beneficial owners. The applicant is
required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or
license within thirty days after being ordered to do so by the Nevada Commission
or the Chairman of the Nevada Board, may be found unsuitable. The same
restrictions apply to a record owner if the record owner, after request, fails
to identify the beneficial owner. Any stockholder found unsuitable and who
holds, directly or indirectly, any beneficial ownership of the voting securities
of a Registered Corporation beyond such period of time as may be prescribed by
the Nevada Commission may be guilty of a criminal offense. The Company is
subject to disciplinary action if, after it receives notice that a person in
unsuitable to be a stockholder or to have any other relationship with the
Company or its subsidiaries, the Company (i) pays that person any dividend or
interest upon voting securities of the Company, (ii) allows that person to
exercise, directly or indirectly,
12
any voting right conferred through securities held by that person, (iii) pays
remuneration in any form to that person for services rendered or otherwise, or
(iv) failed to pursue all lawful efforts to require such unsuitable person to
relinquish his voting securities for cash at fair market value.
The Nevada Commission may, in its discretion, require the holder of any debt
security of a Registered Corporation to file applications, be investigated and
be found suitable to own the debt security of a Registered Corporation. If the
Nevada Commission determines that a person is unsuitable to own such security,
then pursuant to the Nevada Act, the Registered Corporation can be sanctioned,
including the loss of its approvals, if without the prior approval of the Nevada
Commission, it: (i) pays to the unsuitable person any dividend interest, or any
distribution whatsoever; (ii) recognizes any voting right by such unsuitable
person in connection with such securities; (iii) pays the unsuitable person
remuneration in any form; or (iv) makes any payment to the unsuitable person by
way of principal, redemption, conversion, exchange, liquidation, or similar
transaction.
The Company and the Nevada Subsidiary are required to maintain a current
stock ledger in Nevada which may be examined by the Nevada Gaming Authorities at
any time. If any securities are held in trust by an agent or by a nominee, the
record holder may be required to disclose the identity of the beneficial owner
to the Nevada Gaming Authorities. A failure to make such disclosure may be
grounds for finding the record holder unsuitable. The Company will also be
required to render maximum assistance in determining the identity of the
beneficial owner.
The Company may not make a public offering of its securities, such as the
Common Stock, without the prior approval of the Nevada Commission if the
securities or proceeds therefrom are intended to be used to construct, acquire
or finance gaming facilities in Nevada, or to retire or extend obligations
incurred for such purposes.
Changes in control of the Company through merger, consolidation, stock or
asset acquisitions, management or consulting agreements, or any act or conduct
by a person whereby he obtains control, may not occur without the prior approval
of the Nevada Commission. Entities seeking to acquire control of a Registered
Corporation must satisfy the Nevada Board and Nevada Commission in a variety of
stringent standards prior to assuming control of such Registered Corporation.
The Nevada Commission may also require controlling stockholders, 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 relating to the transaction.
The Nevada legislature has declared that some corporate acquisitions opposed
by management, repurchases of voting securities and corporate defense tactics
affecting Nevada gaming licensees, and Registered Corporations that are
affiliated with those operations, may be injurious to stable and productive
corporate gaming. The Nevada Commission has established a regulatory scheme to
ameliorate the potentially adverse effects of these business practices upon
Nevada's gaming industry and to further Nevada's policy to: (i) assure the
financial stability of corporate gaming operators and their affiliates;
(ii) preserve the beneficial aspects of conducting business in the corporate
form; and (iii) promote a neutral environmental for the orderly governance of
corporate affairs. Approvals are, in certain circumstances, required from the
Nevada Commission before the Company can make exceptional repurchases of voting
securities above the current market price thereof and before a corporate
acquisition opposed by management can be consummated. The Nevada Act also
requires prior approval of a plan of recapitalization proposed by the Company's
board of directors in response to a tender offer made directly to the Registered
Corporation's stockholders for the purposes of acquiring control of the
Registered Corporation.
Any person who is licensed, required to be licensed, registered, required to
be registered, or is under common control with such persons (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of investigation of
the Nevada Board of their
13
participation in such foreign gaming. The revolving fund is subject to increase
or decrease in the discretion of the Nevada Commission. Thereafter, licensees
are required to comply with certain reporting requirements imposed by the Nevada
Act. Licensees are also subject to disciplinary action by the Nevada Commission
if it knowingly violates any laws of the foreign jurisdiction pertaining of the
foreign gaming operation, fails to conduct the foreign gaming operation in
accordance with the standards of honesty and integrity required of Nevada gaming
operations, engages in activities that are harmful to the State of Nevada or its
ability to collect gaming taxes and fees, or employs a person in the foreign
operation who has been denied a license or finding of suitability in Nevada on
the grounds of personal unsuitability.
The loss or restriction of the Company's gaming licenses in Nevada would
have a material adverse effect on its business and could require the Company to
cease its manufacturing, distribution and inter-casino linked system activities
in Nevada.
NEW JERSEY REGULATORY MATTERS
Casino gaming in New Jersey is regulated by the New Jersey Casino Control
and regulations promulgated thereunder (the "NJCCA"). The NJCCA created the New
Jersey Casino Control Commission ("NJCCC"), which is authorized to decide all
license applications and other matters and to promulgate regulations, and
created the New Jersey Division of Gaming Enforcement (the "NJDGE"), which is
authorized to investigate all license applications, make recommendations to the
NJCCC, and prosecute violations of the NJCCA. Under the NJCCA, any enterprise
providing goods or services to a casino must register with or be licensed by the
NJCCC.
Business enterprises providing goods and services not directly related to
casino gaming or simulcast wagering must be registered with the NJCCC within
20 days of commencing business with the casinos and must be licensed by the
NJCCC if they conduct business with casinos on a regular or continuing basis,
the NJCCC will consider various factors, including the amount of business
transacted. Currently, any enterprise which transacts more than $75,000 in
business with any one casino in any one 12-month period or more than $225,000
with all casinos of Atlantic City within any one 12-month period or more than
$30,000 with one casino within each of three consecutive 12-month periods or
more than $100,000 with the casinos of Atlantic City within each of three
consecutive 12-month periods must be licensed.
Business enterprises providing goods or services directly related to casino
gaming or simulcast wagering must be licensed as a gaming related Casino Service
Industry ("CSI") prior to conducting business with New Jersey casino licensees
or must have filed a complete application for CSI licensure with the NJCCC and
received the permission of the NJCCC for each business transaction.
On November 4,1996, the Company was granted a Casino Service Industry
License by the NJCCC. In order for this license to be maintained, the Company's
officers, directors and key employees and all beneficial owners of more than
five percent (5%) of the Company's Common Stock must be found qualified by the
NJCCC. In order to be found qualified, the Company, its officers, directors, key
employees and five percent (5%) stockholders must demonstrate by clear and
convincing evidence their good character, honesty and integrity, their financial
stability, integrity and responsibility, and their business ability. Any other
stockholder or other person associated with the Company who the NJCCC deems
appropriate, in its discretion, is also required to be qualified. If a person is
required to and fails to submit to qualification or submits to qualification and
is found disqualified by the NJCCC, the NJCCC may prohibit casinos in New Jersey
from doing business with the Company. While the investigation by the NJDGE is
pending, there is no assurance that the Company or any of its directors,
officers, key persons or five percent (5%) shareholders will be found qualified
or suitable for licensure.
However, "institutional investors" (as defined in the NJCCA) may be granted
a waiver of the requirement to be found qualified by the NJCCC. An institutional
investor includes any retirement fund administered by a public agency for the
exclusive benefit of federal, state or local public employees, investment
company registered under the Investment Company Act of 1940, collective
investment trust
14
organized by banks under Part Nine of the Rules of the Comptroller of the
Currency, closed end investment trust, chartered or licensed life insurance
company or property and casualty insurance company, banking and other chartered
or licensed lending institution, and investment advisor registered under The
Investment Advisors Act of 1940. In the discretion of the NJCCC, a waiver of
qualification may be granted to such institutional investors provided the
securities are owned for investment purposes only and the institutional investor
certifies that it has no intention of influencing or affecting the affairs of
the issuer or its holding companies.
A CSI license is issued for an initial period of two (2) years and is
thereafter renewable for four (4) year periods. There is no guarantee that,
following the issuance of an initial CSI license or any renewal thereof, the
Company will continue to be granted renewals of the license. Additionally, upon
application of the NJDGE, the NJCCC may at any time review any license issued by
it and determine to suspend, revoke or place conditions on such license.
While the NJCCC may deny the CSI application or revoke the license of the
Company should any officer, director, principal employee security holder or
other person who is required to but fails to be found qualified, the Company's
Articles of Incorporation authorize the Company to redeem at fair market value
Common Stock held by any person whose status as a shareholder may jeopardize the
Company's gaming licenses or approvals. In the discretion of the NJCCC, such
divestiture may be deemed sufficient action by the Company to obtain or retain
its CSI license. A change in ownership of a controlling interest of a CSI
licensee will void the license and the licensee will be required to apply for a
new license.
In addition to the required licensure from the NJCCC, the gaming equipment
manufactured, distributed or sold by the Company to New Jersey casinos is
subject to a technical examination by the NJDGE and approval by the NJCCC for,
at a minimum, quality, design, integrity, fairness, honesty and suitability. As
part of this approval process, the NJCCC may require that the manufacturer of
any component of the gaming equipment which the NJCCC, in its discretion,
determines is essential to the gaming operation of the device submit to
licensing. Such components would include the computer control circuitry which
causes or allows the device to operate as a gambling device. The failure or
refusal of such a manufacturer to submit to licensing or the denial of a license
by the NJCCC to such manufacturer would result in the inability of the Company
to distribute and market that gambling device to New Jersey casinos. While the
Company's OASIS II casino information management system products are presently
in use in a New Jersey casino pursuant to the transactional waivers granted by
the NJCCC to the Company, there can be no assurance that any modifications to
such casino information management system or other component parts thereof would
be approved by the NJCCC or that any other gaming devices subject to approval by
the NJCCC prior to use in New Jersey casinos would receive such approval.
MISSISSIPPI REGULATORY MATTERS
The manufacture, sale and distribution of gaming devices and associated
equipment for use or play in Mississippi and the operation of inter-casino
linked systems in Mississippi are subject to the Mississippi Gaming Control Act
and the regulations promulgated thereunder (collectively, "Mississippi Act").
Although not identical, the Mississippi Act is similar to the Nevada Gaming
Control Act. Such activities are subject to the licensing and regulatory control
of the Mississippi Gaming Commission (the "Mississippi Commission") and the
Mississippi State Tax Commission (collectively referred to as the "Mississippi
Gaming Authorities").
The laws, regulations and supervisory procedures of the Mississippi Gaming
Authorities are based upon declarations of public policy which are concerned
with, among other things: (i) the prevention of unsavory or unsuitable persons
from having a direct or indirect involvement with gaming, or manufacturing or
distribution of gaming devices at any time or in any capacity; (ii) the
establishment and maintenance of responsible accounting practices and
procedures; (iii) the maintenance of effective controls over the financial
practices of licensees, including the establishment of minimum procedures for
internal fiscal
15
affairs and the safeguarding of assets and revenues, providing reliable record
keeping and requiring the filing of periodic reports with the Mississippi Gaming
Authorities; (iv) the prevention of cheating and fraudulent practices;
(v) provide a source of state and local revenues through taxation and licensing
fees, and (vi) to ensure that gaming licensees, to the extent practicable,
employ Mississippi residents. Change in such laws, regulations and procedures
could have an adverse effect on the Company and the Company's Mississippi
operations.
The Company is registered by the Mississippi Commission as a publicly traded
corporation (a "Registered Corporation") and holding company of CDS Services
Company and CDS Gaming Company (separately, a "Mississippi Subsidiary" or
collectively, the "Mississippi Subsidiaries"). As a Registered Corporation, the
Company is required periodically to submit detailed financial and operating
reports to the Mississippi Commission and furnish any other information which
the Mississippi Commission may require. No person may become a stockholder of,
or receive any percentage of profits from, the Mississippi Subsidiaries without
first obtaining licenses and approvals from the Mississippi Gaming Authorities.
The Company and the Mississippi Subsidiaries have obtained from the Mississippi
Gaming Authorities the various registrations, approvals, permits and licenses in
order to engage in manufacturing, distribution and gaming activities as
presently conducted in Mississippi.
Manufacturers' and distributors' licenses and gaming licenses are not
transferable, are initially issued for a two-year period and must be renewed
periodically thereafter.
All gaming devices that are manufactured, sold or distributed for use or
play in Mississippi must be manufactured by licensed manufacturers, and
distributed or sold by licensed distributors. All gaming devices manufactured
for use or play in Mississippi must be approved by the Mississippi Commission
before distribution or exposure for play. The approval process for gaming
devices includes rigorous testing by the Mississippi Commission, a field trial
and a determination as to whether the gaming device meets strict technical
standards that are set forth in the regulations of the Mississippi Commission.
Associated equipment must be administratively approved by the Executive Director
of the Mississippi Commission before it is distributed for use in Mississippi.
The Mississippi Commission may investigate any individual who has a material
relationship to, or material involvement with, the Company or the Mississippi
Subsidiaries in order to determine whether such individual is suitable or should
be licensed as a business associate of a gaming licensee. Officers, directors
and certain key employees of the Mississippi Subsidiaries are required to file
applications with the Mississippi Commission and may be required to be licensed
or found suitable by the Mississippi Commission. Officers, directors and key
employees of the Company who are actively and directly involved in gaming
activities of the Mississippi Subsidiaries may be required to be licensed or
found suitable by the Mississippi Commission. The Company believes that findings
of suitability with respect to such persons have been applied for or obtained,
although the Mississippi Commission in its discretion may require additional
persons to file applications for findings of suitability. The Mississippi
Commission may deny an application for licensing for any cause which they deem
reasonable. A finding of suitability is comparable to licensing, and both
require submission of detailed personal and financial information followed by a
thorough investigation. The applicant for licensing or a finding of suitability
must pay all the costs of the investigation. Changes in licensed positions must
be reported to the Mississippi Commission and in addition to its authority to
deny an application for a finding of suitability or licensure, the Mississippi
Commission has jurisdiction to disapprove a change in a corporate position.
If the Mississippi Commission were to find an officer, director or key
employee unsuitable for licensing or unsuitable to continue having a
relationship with the Company or the Mississippi Subsidiaries, the companies
involved would have to sever all relationships with such person. In addition,
the Mississippi Commission may require the Company or the Mississippi
Subsidiaries to terminate the employment of any person who refuses to file
appropriate applications or whom the authorities find unsuitable to act in such
capacity. Determinations of suitability or of questions pertaining to licensing
are not subject to judicial review in Mississippi.
16
The Mississippi Subsidiaries are required to submit detailed financial and
operating reports to the Mississippi Commission. Substantially all material
loans, leases, sales of securities and similar financing transactions by the
Mississippi Subsidiaries are required to be reported to or approved by the
Mississippi Commission.
If it were determined that the Mississippi Act was violated by the
Mississippi Subsidiaries, the licenses they hold could be limited, conditioned,
suspended or revoked, subject to compliance with certain statutory and
regulatory procedures. In addition, at the discretion of the Mississippi
Commission, the Mississippi Subsidiaries, the Company and the persons involved
could be subject to substantial fines for each separate violation of the
Mississippi Act. Limitation, conditioning or suspension of licenses held by the
Mississippi Subsidiaries could (and revocation of any license would) materially
adversely affect the Company's manufacturing, distribution and inter-casino
linked system operations.
Any beneficial holder of the Company's voting securities, regardless of the
number of shares owned, may be required to file an application, be investigated,
and have his suitability determined as a beneficial holder of the Company's
voting securities if the Mississippi Commission has reason to believe that such
ownership may be inconsistent with the declared policies of the State of
Mississippi. The applicant must reimburse all costs of investigation incurred by
the Mississippi Commission in conducting any such investigation.
The Mississippi Act requires any person who acquires beneficial ownership of
more than 5% of a Registered Corporation's voting securities to report the
acquisition to the Mississippi Commission and such person may be required to be
found suitable. The Mississippi Act requires that beneficial owners of more than
10% of a Registered Corporation's voting securities apply to the Mississippi
Commission for a finding of suitability. The Mississippi Commission has
generally exercised its discretion to require a finding of suitability of any
beneficial owner of more than 5% of a Registered Corporation's common stock.
Under certain circumstances, an "institutional investor," as defined by
Mississippi Commission policy, which acquires more than 3%, but not more than
10%, of the Registered Corporation's voting securities may apply to the
Mississippi Commission for a waiver of such finding of suitability if such
institutional investor holds the voting securities for investment purposes only.
If the beneficial holder of voting securities who must be found suitable is a
corporation, partnership or trust, it must submit detailed business and
financial information including a list of beneficial owners. The applicant is
required to pay all costs and fees that the Mississippi Commission incurs in
conducting the investigation.
Any person who fails or refuses to apply for a finding of suitability or a
license within thirty (30) days after being ordered to do so by the Mississippi
Commission or the Executive Director may be found unsuitable. The same
restrictions apply to a record owner if the record owner, after request, fails
to identify the beneficial owner. Any stockholder found unsuitable and who
holds, directly or indirectly, any beneficial ownership of the common stock of
the Company beyond such period of time as may be prescribed by the Mississippi
Commission may be guilty of a criminal offense. The Company will be subject to
disciplinary action if, after it receives notice that a person is unsuitable to
be a stockholder or to have any other relationship with the Company or the
Mississippi Subsidiaries, the Company (i) pays the unsuitable person any
dividends or interest upon voting securities of the Company, (ii) recognizes the
exercise, directly or indirectly, of any voting rights conferred through
securities held by the unsuitable person, (iii) pays the unsuitable person any
remuneration in any form for services rendered or otherwise, except in certain
limited and specific circumstances or (iv) fails to pursue all lawful efforts to
require the unsuitable person to relinquish his voting securities, including, if
necessary, the immediate purchase of said voting securities for cash at fair
market value.
The Company may be required to disclose to the Mississippi Commission upon
request the identities of security holders, including the holders of any debt or
equity securities. In addition, the Mississippi Commission under the Mississippi
Act may, in its discretion, (i) require holders of debt securities of such
Registered Corporations to file applications, (ii) investigate such holders, and
(iii) require such holders to
17
be found suitable to own such debt or equity securities. The Mississippi
Commission retains the discretion to require the holders of debt or equity
securities to be investigated and found suitable for any reason, including but
not limited to a default on a debt instrument, or where the holder of the debt
instrument or equity security exercises a material influence over the gaming
operations of the entity in question. Any holder of debt or equity securities
required to apply for a finding of suitability must pay all investigative fees
and costs of the Mississippi Commission in connection with such an
investigation.
The Mississippi Subsidiaries are required to maintain a current stock ledger
in their principal office in Mississippi and the Company must maintain a current
list of equity stockholders in the principal office of the Mississippi
subsidiaries which must reflect the record ownership of each outstanding share
of any class of equity security issued by the Company. The stock holder list may
thereafter be maintained by adding reports regarding the ownership of such
securities that it receives from the Company's transfer agent. The ledger and
stock holder lists must be available for inspection by the Mississippi
Commission at any time. If any securities are held in trust by an agent or by a
nominee, the record holder may be required to disclose the identity of the
beneficial owner to the Mississippi Commission. A failure to make such
disclosure may be grounds for finding the record holder unsuitable. The Company
will also be required to render maximum assistance to the Mississippi Commission
in determining the identity of the beneficial owner. The Mississippi Commission
has the power to require the stock certificates of the Company to bear a legend
indicating that the securities are subject to the Mississippi Act and the
regulations of the Mississippi Commission. The Company has received a waiver
from this requirement from the Mississippi Commission. The Mississippi
Commission has the power to impose additional restrictions on the holders of the
Company's securities at any time.
Substantially all loans, leases, sales of securities and similar financing
transactions by a Mississippi Subsidiary must be reported to or approved by the
Mississippi Commission. A Mississippi Subsidiary may not make a public offering
of its securities, but may pledge or mortgage casino facilities, if it obtains
the prior approval of the Mississippi Commission. The Company may not make a
public offering of its securities without the approval of the Mississippi
Commission if the securities or proceeds therefrom are intended to be used to
construct, acquire or finance gaming facilities in Mississippi, or to retire or
extend obligations incurred for such purposes. The Company has received an
annual renewal of continuous approval of all public offerings from the
Commission and therefore is only required to obtain the Executive Director's
approval of an offering of securities. Such approval does not constitute a
finding, recommendation or approval by the Mississippi Commission or the
Executive Director 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 of the Company through merger, consolidation, stock or
asset acquisitions, management or consulting agreements certain
recapitalizations and stock repurchases by the Company, or any act or conduct by
a person whereby he obtains control, may not occur without the prior approval of
the Mississippi Commission. Entities seeking to acquire control of the Company
must satisfy the Mississippi Commission with respect to a variety of stringent
standards prior to assuming control of such company. The Mississippi Commission
may also require controlling stockholders, 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
relating to the transaction.
The Mississippi legislature has declared that some corporate acquisitions
opposed by management, repurchases of voting securities and corporate defense
tactics affecting Mississippi corporate gaming licensees, and Registered
Corporations that are affiliated with those operations, may be injurious to
stable and productive corporate gaming. The Mississippi Commission has
established a regulatory scheme to ameliorate the potentially adverse effects of
these business practices upon Mississippi's gaming industry and to further
Mississippi's policy to: (i) assure the financial stability of corporate gaming
licensees and their affiliates, (ii) preserve the beneficial aspects of
conducting business in the corporate form; and (iii) promote a neutral
environment for the orderly governance of corporate affairs. Approvals are, in
18
certain circumstances, required from the Mississippi Commission before the
Company can make exceptional repurchases of voting securities in excess of the
current market price thereof and before a corporate acquisition opposed by
management can be consummated. The Mississippi Act and the Mississippi
Commission gaming regulations also require prior approval of a plan of
recapitalization proposed by the Company's Board of directors in response to a
tender offer made directly to the Company's stockholders for the purposes of
acquiring control of the Company.
Neither the Company nor any subsidiary may engage in gaming activities in
Mississippi while also conducting gaming operations outside of Mississippi
without approval of the Mississippi Commission. The Mississippi Commission may
require determinations that, among other things, there are means for the
Mississippi Commission to have access to information concerning the out-of-state
gaming operations of the Company and its affiliates. The current policy of the
Mississippi Commission has been to grant a waiver from this approval
requirement. CDS Gaming Company has received a waiver from the approval
requirement of the Mississippi Commission to operate in Nevada. The Mississippi
Commission will need to approve or grant a waiver from the approval requirement
for the Company's or it subsidiaries' future gaming operations outside
Mississippi or Nevada prior to engaging in such future operations.
If it were determined that the Mississippi Act or a gaming regulations was
violated by the Mississippi Subsidiaries, the licenses they hold could be
limited, conditioned, suspended or revoked, subject to compliance with certain
statutory and regulatory procedures, which action, if taken, could materially
adversely affect the Company's manufacturing, distribution and inter-casino
linked system.
Annual license fees are also payable to the State of Mississippi for gaming
licenses and manufacturers and distributor's licenses. The foregoing license
fees are allowed as a credit against the Company's Mississippi income tax
liability for the year paid.
FEDERAL REGULATION
The Federal Gambling Devices Act of 1962 (the "Johnson Act") makes it
unlawful, in general, for a person to manufacture, deliver, or receive gaming
machines, gaming machine type devices and components across state lines or to
operate gaming machines unless that person has first registered with the
Attorney General of the United States. The Company is required to register and
renew its registration annually. The Company has complied with such registration
requirements. In addition, various record keeping equipment identification
requirements are imposed by the Johnson Act. Violation of the Johnson Act may
result in seizure and forfeiture of the equipment, as well as other penalties.
NATIVE AMERICAN GAMING
Gaming on Native American lands, including the terms and conditions under
which gaming equipment can be sold or leased to Native American tribes, is or
may be subject to regulation under tribal ordinances, the terms of compacts
between the tribe and the host state, the Indian Gaming Regulatory Act of 1988
("IGRA"), which is administered by the National Indian Gaming Commission (the
"NIGC") and the Secretary of the U.S. Department of the Interior (the
"Secretary"), and also may be subject to the provisions of certain statutes
relating to contracts with Native American tribes, which are administered by the
Secretary. The regulations and guidelines under which the NIGC and the Secretary
will administer IGRA are incomplete and evolving. IGRA also is subject to
interpretation by the NIGC and the secretary, and may be subject to judicial and
legislative clarification or amendment.
IGRA prohibits substantially all forms of commercial gaming on Native
American lands, including gaming involving slot machines and gaming devices,
unless (i) the tribe on whose lands the gaming will take place has adopted an
ordinance, which has been approved by the NIGC, authorizing and regulating such
gaming, and (ii) the state in which the gaming will take place permits such
gaming by any person for any purpose. If the commercial gaming involves slot
machines and gaming devices, IGRA also requires that the tribe and the state
have entered into a written agreement (a "tribal-state compact") that
19
specifically authorizes such types of commercial gaming, and that has been
approved by the secretary, with notice of such approval published in the Federal
Register.
Tribal-state compacts vary from state to state. Many require that equipment
suppliers meet ongoing registration and licensing requirements of the state
and/or the tribe; some establish equipment standards that may limit or prohibit
the placement of progressive games on Indian lands; and some impose background
check requirements on the officers, directors, and shareholders of gaming
equipment suppliers.
In addition to federal and state governmental requirements pertaining to
gaming on Native American lands, Native American tribes are sovereign nations
with their own courts and governmental systems. Under IGRA, tribes are required
to regulate all commercial gaming under ordinances approved by the NIGC. Such
ordinances may impose standards and technical requirements on gaming hardware
and software, and may impose registration, licensing, and background check
requirements on gaming equipment suppliers and their officers, directors, and
shareholders.
Because of their sovereign status, Native American tribes possess sovereign
immunity from unconsented suit. The Company intends to seek waivers of such
immunity, where appropriate, from tribes with whom the Company does business,
but there can be no assurance that such waivers will be obtained. If they are
not, the extent of the Company's ability to enforce its agreements with Native
American tribes will be severely circumscribed.
Under doctrines enunciated by the Supreme Court of the United States,
federal and state courts are obliged, as a matter of law, to defer to the
jurisdiction of tribal courts in litigation where tribal interests are
substantially involved and where tribal courts may have jurisdiction. In such
instances, if a tribal court hears the litigation, its determinations likely
will be entitled to great deference in any state or federal court which later
might be asked to hear the matter. These facts may affect the ability of the
Company to effectively enforce its agreements with Native American tribes.
In addition to the foregoing, two federal statutes may have applicability to
commercial gaming contracts with Native American tribes:
1. Title 25, Section 81, of the United States Code states that "no agreement
shall be made by any person with any tribe of Indians, or individual Indians
not citizens of the United States, for the payment or delivery of any money
or other thing of value...in consideration of services for said Indians
relative to their lands...unless such contract or agreement be executed and
approved" by the Secretary or his or her designee. Agreements for services
relative to Native American lands which fail to conform with the
requirements of this section will be void and unenforceable, and all money
or other things of value paid under such void agreements is subject to
judicial forfeiture in litigation, which can be brought by any person, in
the name of the United States of America. In the Company's opinion, its
sales contracts are not for services, and therefore Title 25, section 81, of
the United States Code does not apply to the Company's contracts. The
Company also believes that its sales of its OASIS II systems are not
"relative to Native American lands" because, although the Company's products
ultimately may be used on Native American lands, the products themselves are
not related to such lands, and give the Company no control over such lands.
To date, the Secretary has not asserted that agreements for the sale of
goods to Indian tribes require his approval under Title 25, Section 81,
United States Code.
2. Title 25, Sections 261-264, United States Code (the "Indian Trader Licensing
Act" or "ITLA") creates a licensing requirement, and states that "any person
other than an Indian of the full blood who shall attempt to reside in the
Indian country, or on any Indian reservation, as a trader, or to introduce
goods, or to trade therein, without such license, shall forfeit all
merchandise offered for sale to the Indians or found in his possession, and
shall moreover be liable to a Penalty of $500..." The applicability of ITLA
to the Company's sale of systems on Native American reservations are
unclear. The Company has not obtained a license under ITLA because the
Company believes that (i) ITLA
20
does not apply to the sale of gaming equipment, (ii) ITLA has been
superseded by IGRA; and (iii) ITLA may have no applicability to any
transaction, since the Secretary has adopted no regulatory mechanism to
implement ITLA.
APPLICATION OF FUTURE OR ADDITIONAL REGULATORY REQUIREMENTS
In the future, the Company intends to seek the necessary registrations,
licenses, approvals and findings of suitability for the Company, its products
and its personnel in other jurisdictions throughout the world where significant
sales are anticipated to be made. However, there can be no assurance that such
registrations, licenses, approvals or findings of suitability will be obtained
and will not be revoked, suspended or conditioned or that the Company will be
able to obtain the necessary approvals for its future products as they are
developed in a timely manner, or at all. If a registration, license, approval or
finding of suitability is required by a regulatory authority and the Company
fails to seek or does not receive the necessary registration, license, approval
or finding of suitability, the Company may be prohibited from selling its
products for use in the respective jurisdiction or may be required to sell its
products through other licensed entities at a reduced profit to the Company.
NEVADA LEGISLATION
Two of the Nevada general corporation provisions, the "Acquisition of
Controlling Interest" and the "Combination with Interested Stockholders"
statutes, may have the effect of delaying or making it more difficult to effect
a change in control of the Company.
Generally, the Acquisition of Controlling Interest statutes prohibit an
acquiror, under certain circumstances, from voting shares of a target
corporation's stock after crossing certain threshold ownership percentages,
unless the acquiror obtains the approval of the target corporation's
disinterested stockholders. There are three thresholds: one-fifth or more but
less than one-third, one-third or more but less than a majority, and a majority
or more, of the outstanding voting power. Once an acquiror crosses one of the
above thresholds, those shares which an acquiring person or a person acting in
association with an acquiring person acquire or offer to acquire in an
acquisition, and acquire within 90 days after becoming an acquiring person
become "control shares" and such control shares are deprived of the right to
vote until disinterested stockholders restore the right. The Acquisition of
Controlling Interest statutes also provide that in the event control shares are
accorded full voting rights and the acquiring person has acquired control shares
with a majority or more of all voting power, any stockholder of record, other
than an acquiring person, who did not vote in favor of authorizing voting rights
to the control shares is entitled to demand payment for the fair value of his or
her shares. The Board of Directors must notify the dissenting stockholders,
within 20 days after the vote of the stockholders authorizing voting rights for
the control shares, that they have the right to receive the fair value of their
shares in accordance with statutory procedures established generally for
dissenters' rights.
In summary and subject to certain circumstances where they do not apply, the
Combination with Interested Stockholders statutes prevent a "resident domestic
corporation" from entering into a "combination" with an "interested stockholder"
unless certain conditions are met. A "resident domestic corporation" (hereafter
the "corporation") means any Nevada corporation that has 200 or more
stockholders. A "combination" is broadly defined and includes, among other
things, any merger or consolidation with an "interested stockholder," or an
affiliate or associate of the "interested stockholder," or any sale, lease,
exchange, mortgage, pledge, transfer or other disposition, in one transaction or
a series of transactions with an "interested stockholder," or any affiliate or
associate of an "interested stockholder," of assets of the resident domestic
corporation, or any subsidiary of a resident domestic corporation: (a) having an
aggregate market value equal to 5% or more of the aggregate market value of all
the assets of the corporation, (b) having an aggregate market value equal to 5%
or more of the aggregate market value of all outstanding shares of the
corporation, or (e) representing 10% or more of the earning power or net income
of the corporation. "Interested stockholder" means the beneficial owner,
directly or indirectly, of
21
10% or more of the voting power of the corporation, or an affiliate or associate
of the corporation that, at any time within three years immediately before the
date in question was the beneficial owner, directly or indirectly, of 10% or
more of the voting power of the corporation.
Effective October 1, 1993, the corporation may not engage in a combination
with an interested stockholder after the expiration of three years after the
interested stockholder acquired his shares, unless the combination or purchase
of shares by the interested stockholder is approved by the corporation's board
of directors before the interested stockholder acquired his shares. If such
board of directors' approval is not obtained, the combination may be approved by
a majority of the disinterested stockholders no earlier than three years
following the date of the interested stockholder's acquisition of the shares. A
combination engaged in with an interested stockholder of the corporation more
than three years after the date that the stockholder acquired his shares may be
permissible if (a) the consideration to be received by all of the disinterested
holders of outstanding common shares of the corporation is at least equal to the
higher of (i) the highest price per share paid by the interested stockholder
within three years immediately preceding the date of the announcement of the
combination, or within three years immediately before, or in, the transaction in
which he became an interested stockholder, whichever is higher, plus interest
compounded annually, less dividends paid, but no more may be subtracted than the
amount of interest or (ii) the market value per common share on the date of the
announcement of the combination or the interested stockholder's acquiring
shares, plus interest compounded annually, less dividends paid, but no more may
be subtracted than the amount of interest, or (b) if, in the case of shares
other than common shares, the consideration to be received by all of the
disinterested holders of outstanding shares other than common shares of the
corporation is at least equal to the highest of (i) the highest price per share
paid by the interested stockholder at a time when he was the beneficial owner of
5% or more of the outstanding voting shares of the corporation, for any shares
of that class or series of shares acquired by him within three years immediately
preceding the date of the announcement of the combination, or within three years
immediately before, or in, the transaction in which he became an interested
stockholder, whichever is higher, plus interest compounded annually, less
dividends paid, but no more may be subtracted than the amount of interest,
(ii) the highest preferential amount to which the holders of the class or series
are entitled in the event of the voluntary liquidation of the corporation or
(iii) the market value per share of the class or series of shares on the date of
the announcement of the combination or the interested stockholder's acquiring
shares, plus interest compounded annually, less dividends paid, but no more may
be subtracted than the amount of interest.
ITEM 2. PROPERTIES
The Company owns a 140,000 square foot office, production, warehouse and
distribution facility in Las Vegas, Nevada where it houses its administrative,
sales, engineering, research and development and Nevada MSP system support
staff. The Company also owns one building adjacent to its main facility which is
approximately 8,450 square feet and leases an adjacent 45,000 square foot
facility which houses its sign business.
The Company also leases regional sales and technical support offices in
Atlantic City, New Jersey; Plymouth, Minnesota; Sparks, Nevada and Gulfport,
Mississippi, which also houses the Mississippi MSP system monitoring, service
and support facility and owns a 6,000 square foot sales and technical support
office near Tunica, Mississippi. The Company also leases an approximately 4,500
square foot office in Colorado Springs, Colorado for the TurboPower Software
subsidiary.
ITEM 3. LEGAL PROCEEDINGS
On May 19, 1998, Acres Gaming Corporation filed an action against the
Company, Mikohn Gaming Corporation, New York New York Hotel & Casino, LLC, and
Sunset Station Hotel & Casino, in the Federal Court for the State of Nevada,
alleging that the Company's ProTurbo Software module violated certain patent
rights of Acres Gaming. Acres Gaming also filed a Motion for Preliminary
Injunction, which
22
was later withdrawn by Acres. The Company has answered the lawsuit asserting
defenses and counterclaims seeking a declaration of invalidity, noninfringement
and unenforceability of the patent asserted. The Company believes this action is
without merit and will continue to vigorously defend itself. While the outcome
of this lawsuit is not presently determinable, management does not expect the
outcome will have a material adverse effect on the Company's consolidated
financial position, results of operations or liquidity.
On November 17, 1998, Acres filed a second lawsuit against the Company
alleging that the Company's ProTurbo Software module violates certain patent
rights of a second Acres patent. CDS has filed an answer and a counterclaim
seeking a declaration of invalidity, noninfringement and unenforceability of the
patent asserted. The Company has filed additional counterclaims for alleged
patent misuse, spoliation of evidence, antitrust violations and unfair
competition. The Company believes that this action is without merit and will
continue to vigorously defend itself. While the outcome of this lawsuit is not
presently determinable, management does not expect the outcome will have a
material adverse effect on the Company's consolidated financial position,
results of operations or liquidity.
On October 20, 1999, International Game Technology ("IGT") filed but did not
serve, a complaint against the Company and three other slot machine
manufacturers alleging that CDS and others infringed a patent owned by IGT
through the Company's use of gaming devices containing touch screens with
redundant play buttons that control game outcome features. The Company believes
that substantial prior art exists that renders the IGT patent invalid. On
February 25, 2000, IGT dismissed the lawsuit against the Company, retaining its
right to refile the lawsuit in the future. Management does not expect the
outcome of this lawsuit to have a material adverse effect on the Company's
consolidated financial position, results of operations, or liquidity.
The Company and its subsidiaries are also involved from time to time in
other various claims and legal actions arising in the ordinary course of
business including, but not limited to, administrative claims and legal actions
brought in state and federal courts by patrons of the Company's MSP games,
wherein the patron may allege the winning of jackpot awards or some multiple
thereof. Because of the size of the jackpots that a patron may play for, related
patron disputes often involve sizable claims. The loss of a sizable patron
dispute claim could have a material adverse effect on the Company. For example,
the Company is currently litigating two patron disputes that it has won on every
level of review, however the patrons have continued to appeal the decisions. One
dispute has been appealed by the patron to the Supreme Court of the State of
Mississippi, and the patron alleges a claim for two identical jackpots of over
$2.7 million dollars each. A second dispute has been appealed by a patron to the
Supreme Court of the State of Nevada, who alleges a claim for over $8 million
dollars. In either case, if the patron were to win, the Company would be liable
to pay $1 million dollars immediately (plus interest) with the remainder to be
paid in installments over twenty years in an annuity. However, management
believes that the likelihood of success by those making such claims is remote
and that the ultimate outcome of these matters will not have a material adverse
effect on the Company's consolidated financial position, results of operations
or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's security-holders during
the fourth quarter of the fiscal year ended December 31, 1999.
23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's common stock has been traded on the NASDAQ National Market
under the symbol CSDS since April 5, 1993. The following table sets forth, for
the fiscal quarters indicated, the high and low sale prices per share for the
common stock, as reported on the NASDAQ National Market.
HIGH LOW
-------- --------
1998
First Quarter............................................. $4.56 $2.94
Second Quarter............................................ 4.19 2.63
Third Quarter............................................. 3.13 1.63
Fourth Quarter............................................ 2.69 1.25
1999
First Quarter............................................. $3.81 $1.56
Second Quarter............................................ 5.06 2.91
Third Quarter............................................. 7.50 4.00
Fourth Quarter............................................ 5.25 2.88
On March 8, 2000 the last reported sale price of the common stock was $5.50.
As of March 8, 2000, the Company had approximately 301 holders of record.
The Company has never declared or paid any cash dividends on its common
stock and the Board of Directors intends to retain all earnings, if any, for the
use in the Company's business for the foreseeable future. Any future
determination as to declaration and payment of dividends will be made at the
discretion of the Board of Directors.
24
ITEM 6. SELECTED FINANCIAL DATA (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
The selected data presented below should be read in conjunction with the
Financial Statements and notes thereto included elsewhere in this Form 10-K, and
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this Form 10-K. The selected
data presented below under the captions "Consolidated Statement of Operations
Data" for the years ended December 31, 1999, 1998, 1997, 1996 and 1995 and
"Consolidated Balance Sheet Data" as of the end of each of the years in the
five-year period ended December 31, 1999 are derived from the audited
consolidated financial statements of the Company and its subsidiaries. The
consolidated financial statements as of December 31, 1999 and 1998, and for each
of the years in the three-year period ended December 31, 1999 and the reports
thereon, are included elsewhere in this Form 10-K. All share and per share data
have been adjusted for a 3 for 2 stock split effected on October 11, 1995 to
shareholders of record on September 25, 1995 and an additional 3 for 2 stock
split effected on February 27, 1996 to shareholders of record as of
February 20, 1996.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA
Consolidated Statement of Operations Data:
Total revenues.............................. $75,530 $53,180 $ 54,504 $70,871 $32,894
Total costs and expenses.................... 68,541 53,934 96,790 68,901 26,653
------- ------- -------- ------- -------
Income (loss) from operations............... 6,989 (754) (42,286) 1,970 6,241
Total other income (expense)................ 1,022 1,620 (499) 5,077 885
------- ------- -------- ------- -------
Income (loss) before income taxes........... 8,011 866 (42,785) 7,047 7,126
Income tax (benefit) expense................ (7,201) (1,647) (3,070) 2,232 2,394
------- ------- -------- ------- -------
Net income (loss)......................... $15,212 $ 2,513 $(39,715) $ 4,815 $ 4,732
======= ======= ======== ======= =======
Basic net income (loss) per common share
(1)....................................... $ 0.83 $ 0.14 $ (2.20) $ 0.29 $ 0.35
Diluted net income (loss) per common share
(1)....................................... $ 0.82 $ 0.14 $ (2.20) $ 0.28 $ 0.34
Shares used in basic per share calculation
(1)....................................... 18,234 18,066 18,043 16,892 13,572
Shares used in diluted per share calculation
(1)....................................... 18,628 18,105 18,043 17,485 13,876
DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Consolidated Balance Sheet Data:
Cash and cash equivalents.................. $ 9,255 $13,268 $27,873 $ 21,482 $13,157
Working capital............................ 54,564 39,707 41,514 58,226 23,136
Total assets............................... 110,887 99,010 96,956 125,422 60,307
Total liabilities.......................... 28,361 32,870 33,329 22,246 12,239
Total long-term debt, including current
portion.................................. 214 211 2,454 4,482 4,304
Total shareholders' equity................. 82,526 66,140 63,627 103,177 48,068
- ------------------------
(1) The earnings per share numbers for years prior to 1997 were restated in 1997
to conform to the requirements of Statement of Financial Accounting Standard
No. 128 "Earnings Per Share."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and Notes thereto included elsewhere in this Form 10-K.
25
YEAR ENDED DECEMBER 31, 1999 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1998
Total revenue was $75,530,000 compared with $53,180,000 for the twelve
months ended December 31, 1999 and 1998, respectively, an increase of
$22,350,000 or 42%. This increase is primarily due to increased revenues from
the sale of gaming devices of $15,741,000, and systems and services sales of
$6,803,000.
Revenue from systems and services was $30,075,000 for the year ended
December 31, 1999 compared with $23,147,000 in 1998. This increase of $6,928,000
or 30%, is primarily due to sales of the Company's Windows-TM- based Oasis
product, which was introduced late in the fourth quarter of 1998. Among the key
factors affecting new OASIS systems orders are the rate of growth in the gaming
industry and replacement of existing systems. Although the Company believes that
the market for its system is strong, the continued existence and expansion of
gaming markets is dependent upon political, legal and other factors which are
beyond the control of the Company. Notable quarterly variations in revenue and
income may occur since casino management information systems constitute a
primary source of revenue.
Revenue from the sale of gaming devices increased 108% from the prior year
revenue of $14,561,000 to $30,302,000 for the twelve months ended December 31,
1999. The sale of machines on the Company's high-end multimedia Bandit-TM-
platform in 1999 was the principal reason for this increase in revenue.
Specifically, Bandit Bingo-TM- accounted for the majority of the increase, which
was launched in late 1998.
The recurring revenue segment experienced a decline in revenue of $2,238,000
in 1999 compared with 1998, primarily due to the decline in the number of
operating units in service and reduced levels of play due to the maturation of
the MSP models currently deployed. The number of recurring revenue units
declined from 556 at the end of December 1998 to 301 at the end of
December 1999. The Company plans on refreshing its MSP models in fiscal 2000.
Signs revenue increased $1,671,000 to $5,702,000 for the twelve months ended
December 31, 1999 compared with 1998. This increase is primarily the result of
increased effectiveness of marketing and sales efforts in 1999.
Revenue from the sale of software development tools was $2,220,000 in 1999,
an increase of $373,000 or 20% from 1998, principally attributable to new
product releases in 1999.
GROSS MARGIN
Total cost of goods sold increased from $28,398,000 for the twelve months
ended December 31, 1998, to $41,390,000 for the same period in 1999, an increase
of $12,992,000 or 46%. Consolidated gross margin increased from $24,782,000 for
the twelve months ended December 31, 1998 to $34,140,000 for the same period in
1999. The increase in gross margin is primarily attributable to the increase in
revenue from gaming devices and systems and services. Consolidated gross margin
as a percentage of revenue decreased from 47% for the twelve months ended
December 31, 1998 to 45% for the same period in 1999. The decrease in gross
margin as a percentage of revenue is primarily due to the change in revenue mix
in 1999, which reflected an increase in revenue from gaming devices as a
percentage of total revenue.
OPERATING EXPENSES
Operating expenses increased from $25,536,000 for the twelve months ended
December 31, 1998, to $27,151,000 for the same period in 1999, an increase of
$1,615,000 or 6%. These costs include a $1,000,000 charge for the loss from
shareholders suit in 1998, and a $1,852,000 net benefit from the terminated slot
liability associated with the Mississippi Cool Millions links, partially offset
by the write-off of related impaired intangible assets in 1999. Excluding these
items, operating expenses decreased as a percentage of revenues from 46% for the
twelve months ended December 31, 1998, to 38% for the same period in 1999, the
result of a greater revenue increase relative to expenses.
26
Selling, general and administrative expenses increased from $17,722,000 for
the twelve months ended December 31, 1998, to $19,709,000 for the same period in
1999, an increase of $1,987,000 or 11%. This increase is primarily due to
increased legal costs, primarily litigation costs associated with the Acres
lawsuit (see Note 16 of Notes to Consolidated Financial Statements), along with
increased sales commission expense in 1999 related to higher revenues. Selling,
general and administrative expenses as a percentage of revenue decreased from
33% for the twelve months ended December 31, 1998, to 26% for the same period in
1999.
Research and development expenses increased from $3,827,000 for the twelve
months ended December 31, 1998, to $5,121,000 for the same period in 1999, an
increase of $1,294,000 or 34%. This increase is primarily attributable to
increased engineering headcount and prototype expense. Research and development
expenses as a percentage of revenues remained stable at 7% for each of the
twelve months ended December 31, 1998 and 1999.
Depreciation and amortization increased from $2,987,000 for the twelve
months ended December 31, 1998, to $4,173,000 for the same period in 1999. The
increase is primarily due to a full year of depreciation expense in 1999 related
to the Xtreme MSP link which began operation in the second quarter of 1998,
combined with amortization of software development costs related to the Bandit
platform, which began in the fourth quarter of 1998.
OTHER INCOME, NET
Other income, net, is primarily comprised of interest income, interest
expense and gains and losses on disposal of assets. Other income decreased from
$1,620,000 for the twelve months ended December 31, 1998, to $1,022,000 for the
same period in 1999. This decrease is primarily due to lower interest income
partially offset by the reversal of approximately $411,000 of interest expense
related to a favorable lawsuit decision by a court of law, in the second quarter
of 1999.
INCOME TAX BENEFIT
Income tax benefit increased from a benefit of $1,647,000 for the twelve
months ended December 31, 1998 to a benefit of $7,201,000 for the same period in
1999. Although the Company recorded income before taxes for the year ended
December 31, 1999, it recorded an income tax benefit of $7,201,000 for the
twelve months ended December 31, 1999. This increase is primarily attributable
to the elimination of a $9,600,000 valuation allowance against deferred tax
assets that was established in 1997. Based on the Company's financial results in
1999, combined with expected financial results in future periods, management
believes it is more likely than not that the net deferred tax asset will be
realized; therefore, the valuation allowance was eliminated.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1997
REVENUES
Total revenue decreased to $53,180,000 for the twelve months ended
December 31, 1998 from $54,504,000 for the same period in 1997, a decrease of
$1,324,000 or 2%. This decrease was primarily attributable to a decrease in
revenue from recurring revenue products of $11,658,000 partially offset by
increases in systems and services sales of $3,833,000 and sales of gaming
devices of $8,233,000.
Systems and services revenue increased to $23,147,000 for the twelve months
ended December 31, 1998 from $19,314,000 for the same period in the prior year,
an increase of $3,833,000 or 20%. The Company experienced an increase in OASIS
systems sales in 1998 compared with 1997 due primarily to the increase in the
demand for new systems. Among the key factors affecting new OASIS systems orders
are the rate of growth in the gaming industry and replacement of existing
systems. Although the Company believes that the market for its system is strong,
the continued existence and expansion of gaming markets
27
is dependent upon political, legal and other factors which are beyond the
control of the Company. Notable quarterly variations in revenue and income may
occur since casino management information systems constitute a primary source of
revenue.
Revenue from the sale of gaming devices increased to $14,561,000 for the
twelve months ended December 31, 1998 from $6,328,000 for the same period in the
prior year, an increase of $8,233,000 or 130%. This increase is due primarily to
an expanded, and more popular, portfolio of game models available for sale.
Revenue from recurring revenue products decreased to $9,469,000 for the
twelve months ended December 31, 1998 from $21,127,000 for the same period in
the prior year, a decrease of $11,658,000 or 55%. This decrease is primarily
attributable to the termination of the Caribbean Stud Video Poker link in
October 1997, the termination of the Native American Cool Millions Dollar link
in February 1998 and the termination of both the Nevada and Mississippi Cool
Millions Dollar links in April 1998. Partially offsetting these terminations was
an increase in revenue from the Nevada and Native American Xtreme links that
were launched in 1998. The number of recurring revenue units was 556 at
December 31, 1998 as compared with 599 at December 31, 1997.
Revenue from signs decreased to $4,031,000 for the twelve months ended
December 31, 1998 from $4,244,000 for the same period in the prior year, a
decrease of $213,000 or 5%.
Revenue from software development tools increased to $1,847,000 for the
twelve months ended December 31, 1998 from $1,450,000 for the same period in the
prior year, an increase of $397,000 or 27%. This increase is primarily
attributable to new products released in 1998.
Revenue from graphics and imaging decreased to $125,000 for the twelve
months ended December 31, 1998 from $2,041,000 for the same period in 1997, a
decrease of $1,916,000 or 94%. This decrease is due to the restructuring of this
business unit resulting in the termination of external sales in the fourth
quarter of 1997. The $125,000 of revenue in 1998 represents fulfillment of
orders from 1997 and liquidation of inventory. The Company does not expect to
realize revenues from this business unit in future years.
GROSS MARGIN
Total cost of goods sold decreased from $39,212,000 for the twelve months
ended December 31, 1997, to $28,398,000 for the same period in 1998, a decrease
of $10,814,000 or 28%. Consolidated gross margin increased from $15,292,000 for
the twelve months ended December 31, 1997 to $24,782,000 for the same period in
1998. Consolidated gross margin as a percentage of revenues increased from 28%
for the twelve months ended December 31, 1997 to 47% for the same period in
1998. The increase in gross margin is primarily attributable to the increase in
the percentage of revenue derived from system and services sales, which
generally produce higher margins.
OPERATING EXPENSES
Operating expenses decreased from $57,578,000 for the twelve months ended
December 31, 1997, to $25,536,000 for the same period in 1998, a decrease of
$32,042,000 or 56%. Operating expenses decreased from $36,541,000, excluding the
restructuring and impairment charge, for the twelve months ended December 31,
1997, to $24,536,000, excluding the $1,000,000 charge for the loss from the
shareholders suit, for the same period in 1998, a decrease of $12,005,000 or
33%. Operating expenses decreased as a percentage of revenues from 106% for the
twelve months ended December 31, 1997, to 48% for the same period in 1998.
Selling, general and administrative expenses decreased from $23,306,000 for
the twelve months ended December 31, 1997, to $17,722,000 for the same period in
1998, a decrease of $5,584,000 or 24%. Selling, general and administrative
expenses as a percentage of revenues decreased from 43% for the twelve
28
months ended December 31, 1997, to 33% for the same period in 1998. These
decreases are due to overall cost reductions in virtually every component of
selling, general and administrative expenses during the twelve months ended
December 31, 1998 compared with the same period in 1997, with the largest
decreases coming from reductions in headcount, travel expenses, outside
consulting and advertising.
The provision for doubtful accounts decreased from $3,717,000 for the twelve
months ended December 31, 1997 to zero for the same period in 1998. The decrease
is attributable to better collections of accounts receivable in 1998 which
resulted in lower balances of accounts receivable considered to be
uncollectible.
Research and development expenses decreased from $3,959,000 for the twelve
months ended December 31, 1997, to $3,827,000 for the same period in 1998, a
decrease of $132,000 or 3%. The decrease is primarily attributable to a
reduction in lab and prototype expenses. Major expenditures during the twelve
months ended December 31, 1998 were primarily for the development of additional
video interactive games and the completion of development of the Windows
compatible version of the OASIS II system. Research and development expenses as
a percentage of revenues remained stable at 7% for each of the twelve months
ended December 31, 1997 and 1998.
Restructuring and impairment charges of $21,037,000 for the twelve months
ended December 31, 1997 did not occur in 1998.
Depreciation and amortization decreased from $5,559,000 for the twelve
months ended December 31, 1997, to $2,987,000 for the same period in 1998. The
decrease is primarily due to the decreased fixed asset balance as a result of
the restructuring and impairment charges in the fourth quarter of 1997.
OTHER INCOME, NET
Other income, net, is primarily comprised of interest income, interest
expense and gains and losses on disposal of assets. Other income increased from
a net expense of $499,000 for the twelve months ended December 31, 1997, to
income of $1,620,000 for the same period in 1998. This increase is primarily due
to loss on disposal of assets of $1,888,000 in 1997 compared with $60,000 in
1998.
INCOME TAX BENEFIT
Income tax benefit decreased from a benefit of $3,070,000 for the twelve
months ended December 31, 1997 to a benefit of $1,647,000 for the same period in
1998. Although the Company recorded income before taxes for the year ended
December 31, 1998, it recorded an income tax benefit of $1,647,000 for the
twelve months ended December 31, 1998. This benefit is primarily attributable to
a larger than expected refund from the 1997 federal income tax return of
$630,000, an expected income tax refund of $580,000 from the 1998 federal income
tax return, and a favorable change in the Company's net deferred tax asset
resulting in a decrease in income tax expense of $516,000, partially offset by
state income taxes of $80,000.
1997 RESTRUCTURING AND IMPAIRMENT
In the fourth quarter of 1997, the Company developed a restructuring plan
that encompassed nearly the entire organization and resulted in a charge to
income from operations of $14,998,000. Additionally, the Company recorded
impairment charges totaling $6,039,000. The components of the restructuring and
impairment charge, which aggregated $21,037,000, are as follows:
SYSTEMS AND SERVICES
In the fourth quarter of 1997, the Company created and began implementing a
plan to accelerate the development of the Windows compatible version of its
OASIS II system. Substantially all engineering resources were reassigned to the
Windows project and several DOS based projects in development were abandoned.
These abandoned projects will not be completed and have no residual value.
Capitalized costs
29
associated with the abandoned DOS projects totaled $1,200,000. These costs were
written off and were included as restructuring and impairment charges in the
accompanying consolidated statement of operations for the year ended
December 31, 1997.
COOL MILLIONS
In response to increasing competitive pressure, declining customer interest
and erosion in product performance, the Company decided to divest existing Cool
Millions operating assets. Operation of these links contributed $19,183,000 in
revenues and $7,480,000 of gross margin during the twelve months ended
December 31, 1997. The gaming devices had book value of $5,000,000 before
recognition of any restructuring charge. Fair values of these gaming devices
were determined through discussion with third party used gaming equipment
dealers. A charge of $4,206,000 is included in restructuring and impairment
charges in the consolidated statement of operations for the year ended
December 31, 1997 to reduce the book value of the assets to their fair value.
Throughout 1998, the Company liquidated these Cool Millions assets for prices at
or slightly greater than their book values. At December 31, 1999, Cool Millions
assets with a net book value of approximately $4,000 remained in operation.
Management expects to liquidate these remaining Cool Millions assets in fiscal
2000 and does not expect to recognize any loss on disposal.
The customized nature and aged design of the Cool Millions signage and
peripheral assets impair their fair value such that no material residual sales
value is expected. There is also no anticipated future operational use to the
Company. As a result, signage with a book value of $3,540,000 and peripheral
assets with a book value of $1,803,000 were written down to a fair value of
zero. These charges totaled $5,343,000 and are included in restructuring and
impairment charges in the accompanying consolidated statement of operations for
the year ended December 31, 1997.
CARIBBEAN STUD VIDEO POKER
The Company terminated the Caribbean Stud video poker link in October 31,
1997 due to the combination of lower than expected revenues and a fixed royalty
accruing to the licensor of the Caribbean Stud game technology (CTI). The
operation of this link contributed $1,944,000 in revenue and resulted in a
negative gross margin of $352,000 for the ten months ended October 31, 1997. The
gaming machines were converted into other video poker programs and sold as used
equipment. The signage and other peripheral assets were customized for the
Caribbean Stud video poker link; therefore, they offer no future operating use
to the Company. The customized nature and aged designs of the signage and
peripheral assets impair their value such that no material residual value is
expected. As such, their carrying values were written down to zero through a
charge of $1,104,000 which is included in restructuring and impairment charges
in the accompanying consolidated statement of operations for the year ended
December 31, 1997.
GRAPHICS & IMAGING
In the fourth quarter of 1997, the Company restructured the Graphics and
Imaging subsidiary to eliminate all sales operations. The subsidiary now
operates to satisfy internal demand only. Operation of this subsidiary
contributed $2,041,000 in revenue and resulted in a net loss of $43,000 for the
twelve months ended December 31, 1997 before restructuring and impairment
charges. The subsidiary's ongoing operations are limited to production of
graphic art and flat glass for use only in CDS manufactured gaming devices. The
restructure included a reduction in personnel of 23 employees and calls for the
disposition of all equipment determined to be nonessential in producing to
satisfy internal demand. The restructuring resulted in the recognition of an
expected loss on disposal, the elimination of goodwill and the write-off of
finished goods inventory.
Assets representing nonessential equipment with book value of $1,526,000
have been written down to their estimated fair value of $525,000. The fair value
was determined through discussion with used equipment brokers. The balance of
associated goodwill of $671,000 is not considered recoverable and has
30
been written down to zero. Additionally, finished goods inventory of $490,000
has been written down to zero. The finished goods inventory represents
replacement glass for previously processed customer orders which would normally
be sold in small lots as replacement supplies are needed. Without an external
sales force, and since customers generally prefer to purchase such replacement
glass only when needed, the Company does not expect to realize any material
recoverable value from the inventory. These write downs total $2,162,000 and are
included in restructuring and impairment charges in the consolidated statement
of operations for the year ended December 31, 1997.
TURBOPOWER SOFTWARE
In the fourth quarter of 1997, the Company committed to a plan to divest its
TurboPower Software subsidiary (TurboPower). Operation of this subsidiary
contributed $1,450,000 in revenues and resulted in a net loss of $595,000 for
the twelve months ended December 31, 1997. TurboPower was purchased in
January 1995 to assist in development of general products and the Windows
compatible version of the OASIS system specifically. The Windows development
effort by TurboPower was ceased in the third quarter of 1997. In the fourth
quarter of 1997, management concluded that TurboPower no longer fit within the
Company's overall market strategy and made the decision to actively pursue a
buyer. Based on an estimate of future cashflows and the estimated fair value of
its assets, the Company adjusted the book value of TurboPower's assets to down
to their fair value which resulted in a charge of $983,000. This charge is
included in restructuring and impairment charges in the consolidated statement
of operations for the year ended December 31, 1997. Due to TurboPower's stronger
financial performance in 1998 and to changes in various executive positions
within the Company, current management now believes that TurboPower will be an
important component of the Company's future success. Based on this, current
management discontinued its search for purchase candidates for TurboPower in the
fourth quarter of 1998 and reclassified its assets back to operating status.
IMPAIRMENT LOSS
In December 1997, the Company recorded a non-cash accounting charge related
to the impairment of certain long-lived assets as required by Statement of
Financial Accounting Standards (SFAS) No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVE ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF, in the amount of
$6,039,000. The impairment loss charge is comprised of three components: (i) a
charge of $4,401,000 related to capitalized amounts for payments to a third
party for game enhancements that were significantly behind schedule, materially
jeopardizing the possibility of recovering these costs, (ii) a charge of
$1,118,000 based on the cashflow projections for CDS Signs, Inc. which indicated
that the subsidiary will not generate enough cash to recover the $1,118,000 in
goodwill and (iii) a charge of $520,000 related to the capitalized costs
associated with a completed module application of the OASIS system from which no
revenues have yet been realized, expected future cash flows are not sufficient
to recover the associated capitalized costs and the net realizable value is
zero.
LIQUIDITY AND CAPITAL RESOURCES
The Company to date has financed its operating and capital expenditures
through cash flows from its operations and cash from proceeds from its equity
offerings, investment activities and borrowings. For the twelve months ended
December 31, 1999, cash provided by operating and financing activities was
$756,000 and $1,177,000, respectively and cash used in investing activities was
$208,000. The Company had cash and cash equivalents, including restricted
amounts, of $9,255,000 at December 31, 1999, compared with $13,268,000 at
December 31, 1998.
Certain jurisdictions in which MSP systems operate require that the Company
maintain allocated funds or instruments to guarantee payment of jackpot prizes.
The amount of funds required is dependent upon several factors such as the type
and denomination of games and the local regulatory requirements. At
December 31, 1999, the Company's accrued slot liability for its MSP systems
aggregated approximately
31
$18,153,000, and there was no unaccrued slot liability (the unaccrued slot
liability is the amount of the initial primary jackpots that have not been fully
accrued). In connection with these slot liabilities and in accordance with
gaming requirements, the Company has restricted cash accounts and short term
investments aggregating approximately $3,698,000 as of December 31, 1999 to
ensure availability of adequate funds to pay this liability. In addition, the
Company also has approximately $14,517,000 of restricted investment securities
as of December 31, 1999, for the payment of jackpots already won. Although
statistically remote, a possibility exists that multiple jackpots may hit prior
to the time period over which game play has generated sufficient revenue to
accrue each jackpot reset amount. Such occurrences could have a material adverse
impact on the Company's results of operations in the reporting period in which
the jackpots are hit.
The Company's ratio of current assets to current liabilities is 6.2 to 1 at
December 31, 1999, and the Company has no long-term debt. The Company expects to
continue to finance its operations and capital expenditures through cash flow
from operations; however, based on its financial position, management believes
additional long-term financing could be obtained in 2000 for growth resulting in
working capital requirements that exceed available cash, cash equivalents and
cash to be provided by operations. The Company entered into a loan agreement in
1999 with a financial institution, secured by property, that enables the Company
to borrow up to $6,975,000, of which approximately $6,800,000 is available at
December 31, 1999. However, there can be no assurance that the Company will be
able to obtain additional sources of capital during 2000 if needed.
YEAR 2000
The year 2000 issue was the result of computer programs written using two
digits (rather than four) to define years. Computers or other equipment with
date-sensitive software may recognize "00" as 1900 rather than 2000. This could
result in system failures or miscalculations. If the Company, or its customers,
suppliers or other third parties fail to correct year 2000 issues, businesses
operations will be affected.
The Company conducted a review of its computer systems to identify areas
that could be affected by year 2000 issues and completed updating many of its
existing systems to improve overall business performance and to accommodate
business for the year 2000. Management believes that critical systems were
remediated as of December 31, 1999. The Company incurred and expensed
approximately $350,000 in costs associated with year 2000 functionality.
The Company has experienced no material adverse impact on its production
capabilities, processes or other operational departments reliant on computer
systems resulting from year 2000 issues. Additionally, the Company has
experienced no material impact from year 2000 issues on its consolidated
financial position, results of operations or cash flows. Although management
believes the conversion process has been completed, there can be no assurance
that the Company will not be adversely impacted in the future by year 2000
issues.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, (SFAS 133) which
establishes accounting and reporting standards for derivative instruments and
hedging activities. This statement, as amended, shall be in effect for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure instruments at fair value. SFAS 133
is not expected to have a material effect on the Company's financial position or
results of operations.
32
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest rate changes and the
changes in the market values of its investments.
The Company's exposure to market rate risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company has not
used derivative financial instruments in its investment portfolio. The Company
invests its excess cash primarily in debt instruments of the U.S. Government and
its agencies and state and other municipal government agencies. By policy, the
Company limits the amount of credit exposure to any one issuer. The Company
protects and preserves its invested funds by limiting default, market and
reinvestment risk.
Investments in fixed rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted due to a rise in interest rates. The Company may suffer
losses in principal if forced to sell securities which have declined in market
value due to changes in interest rates.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
--------
Independent Auditors' Reports............................... 34
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... 36
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997.......................... 38
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1999, 1998 and 1997.............. 39
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... 40
Notes to Consolidated Financial Statements.................. 41
FINANCIAL STATEMENT SCHEDULES AND SUPPLEMENTARY DATA
Schedule II, Valuation and Qualifying Accounts, for the years 1999, 1998 and
1997 has been submitted in Item 14. Part IV, hereof where the schedule is
listed. All other schedules have been omitted since they are either not
required, are not applicable, or the required information is shown in the
consolidated financial statements and related notes.
33
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of
Casino Data Systems and Subsidiaries
Las Vegas, Nevada
We have audited the accompanying consolidated balance sheet of Casino Data
Systems and subsidiaries (the "Company") as of December 31, 1999, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
1999, and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States of America.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
February 25, 2000
34
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors
Casino Data Systems:
We have audited the accompanying consolidated balance sheet of Casino Data
Systems and subsidiaries as of December 31, 1998, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the two-year period ended December 31, 1998. In connection with our
audits of the consolidated financial statements, we have also audited the
financial statement schedule for each of the years in the two-year period ended
December 31, 1998. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Casino Data
Systems and subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
KPMG LLP
Las Vegas, Nevada
February 23, 1999
35
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(DOLLARS IN THOUSANDS)
ASSETS
DECEMBER 31,
-------------------
1999 1998
-------- --------
Current assets
Cash and cash equivalents................................. $ 6,866 $ 5,141
Restricted cash and cash equivalents...................... 2,389 8,127
Short-term investment securities, including restricted
amounts of $1,309 and $943 in 1999 and 1998,
respectively............................................ 2,581 2,634
Accounts receivable, net of allowance for doubtful
accounts of $1,886 and $3,516 in 1999 and 1998,
respectively............................................ 21,121 13,421
Current portion of notes receivable....................... 4,324 2,284
Income tax receivable..................................... 642 642
Inventories, net.......................................... 25,600 19,147
Deferred tax asset........................................ 1,265 1,176
Assets held for sale...................................... 40 922
Prepaid expenses and other current assets................. 196 244
-------- -------
Total current assets.................................... 65,024 53,738
-------- -------
Property and equipment, net................................. 17,762 19,828
Restricted investment securities............................ 14,517 14,623
Notes receivable, excluding current portion................. 539 1,137
Intangible assets, net...................................... 122 4,649
Software development costs, net of accumulated amortization
of $1,746 and $626 in 1999 and 1998, respectively......... 2,362 3,804
Deposits.................................................... 389 391
Deferred tax asset.......................................... 10,172 840
-------- -------
Total non-current assets................................ 45,863 45,272
-------- -------
Total assets............................................ $110,887 $99,010
======== =======
See accompanying Notes to Consolidated Financial Statements
36
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(DOLLARS AND SHARE DATA IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY
DECEMBER 31,
-------------------
1999 1998
-------- --------
Current liabilities
Current portion of long-term debt......................... $ 214 $ 211
Accounts payable.......................................... 1,427 3,687
Accrued expenses and customer deposits.................... 8,567 8,026
Accrued slot liability.................................... 252 2,107
-------- --------
Total current liabilities............................... 10,460 14,031
-------- --------
Non-current liabilities
Accrued slot liability.................................... 17,901 18,839
-------- --------
Total non-current liabilities........................... 17,901 18,839
-------- --------
Commitments and contingencies
Shareholders' equity
Common stock, no par value. Authorized 100,000; issued and
outstanding 18,401 and 18,066 at December 31, 1999 and
1998, respectively...................................... 84,964 83,790
Accumulated deficit....................................... (2,438) (17,650)
-------- --------
Total shareholders' equity.............................. 82,526 66,140
-------- --------
Total liabilities and shareholders' equity.............. $110,887 $ 99,010
======== ========
See accompanying Notes to Consolidated Financial Statements
37
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Revenue
Systems and services...................................... $30,075 $23,147 $ 19,314
Gaming devices............................................ 30,302 14,561 6,328
Recurring revenue......................................... 7,231 9,469 21,127
Signs..................................................... 5,702 4,031 4,244
Software development tools................................ 2,220 1,847 1,450
Graphics and imaging...................................... -- 125 2,041
------- ------- --------
Total revenue........................................... 75,530 53,180 54,504
Cost of goods sold........................................ 41,390 28,398 39,212
------- ------- --------
Gross margin.............................................. 34,140 24,782 15,292
------- ------- --------
Operating expenses
Selling, general and administrative....................... 19,709 17,722 23,306
Provision for doubtful accounts........................... -- -- 3,717
Research and development.................................. 5,121 3,827 3,959
Restructuring and impairment charge....................... -- -- 21,037
Other operating, net...................................... (1,852) 1,000 --
Depreciation and amortization............................. 4,173 2,987 5,559
------- ------- --------
Total operating expenses................................ 27,151 25,536 57,578
------- ------- --------
Income (loss) from operations........................... 6,989 (754) (42,286)
------- ------- --------
Other income (expense)
Interest and other income, net............................ 1,072 1,863 1,713
Loss on disposal of assets................................ (9) (60) (1,888)
Interest expense.......................................... (41) (183) (324)
------- ------- --------
Total other income (expense)............................ 1,022 1,620 (499)
------- ------- --------
Income (loss) before income taxes........................... 8,011 866 (42,785)
Income tax benefit.......................................... (7,201) (1,647) (3,070)
------- ------- --------
Net income (loss)........................................... $15,212 $ 2,513 $(39,715)
======= ======= ========
Basic net income (loss) per common share.................... $ 0.83 $ 0.14 $ (2.20)
======= ======= ========
Diluted net income (loss) per common share.................. $ 0.82 $ 0.14 $ (2.20)
======= ======= ========
Basic weighted average shares outstanding................... 18,234 18,066 18,043
Diluted weighted average shares outstanding................. 18,628 18,105 18,043
See accompanying Notes to Consolidated Financial Statements
38
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(AMOUNTS IN THOUSANDS)
RETAINED
COMMON STOCK EARNINGS
------------------- (ACCUMULATED
SHARES AMOUNT DEFICIT) TOTAL
-------- -------- ------------ --------
Balance at January 1, 1997........................... 18,034 $83,625 $ 19,552 $103,177
Exercise of stock options............................ 32 165 -- 165
Net loss............................................. -- -- (39,715) (39,715)
------ ------- -------- --------
Balance at December 31, 1997......................... 18,066 83,790 (20,163) 63,627
Net income........................................... -- -- 2,513 2,513
------ ------- -------- --------
Balance at December 31, 1998......................... 18,066 83,790 (17,650) 66,140
Exercise of stock options............................ 269 1,031 -- 1,031
Employee stock purchase plan......................... 66 143 -- 143
Net income........................................... -- -- 15,212 15,212
------ ------- -------- --------
Balance at December 31, 1999......................... 18,401 $84,964 $ (2,438) $ 82,526
====== ======= ======== ========
See accompanying Notes to Consolidated Financial Statements
39
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net income (loss)......................................... $15,212 $ 2,513 $(39,715)
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization......................... 4,173 2,987 5,559
Amortization of intangible assets..................... 1,348 1,347 337
Amortization of software development.................. 408 133 --
Deferred income taxes................................. (9,421) (516) 1,878
Restructuring and impairment charge................... -- -- 21,037
Loss on disposal of assets............................ 9 60 1,888
Write-off of net book value of assets................. 509 701 1,259
Loss on impairment of intangibles..................... 2,837 -- --
Provision for accounts receivable..................... -- -- 3,717
Provision for inventory obsolescence.................. 2,222 966 1,125
Changes in assets and liabilities:
Restricted cash and cash equivalents.................... 5,738 7,489 (3,600)
Accounts receivable, notes receivable and due from
related party.......................................... (9,142) (3,996) 11,119
Income tax receivable................................... -- 3,358 (2,711)
Inventories............................................. (8,675) (5,921) (587)
Other assets and deposits............................... 50 994 (42)
Accounts payable........................................ (2,260) (223) 971
Accrued expenses, customer deposits and slot
liability.............................................. (2,252) 2,008 12,141
------- -------- --------
Net cash provided by operating activities............... 756 11,900 14,376
------- -------- --------
Cash flows from investing activities:
Purchases of unrestricted investment securities........... (81) (84) (79)
Proceeds from sale of unrestricted investment
securities.............................................. 552 -- 924
Purchases of investment securities to fund liabilities to
jackpot winners......................................... (1,588) (9,728) (2,193)
Proceeds from sale of investment securities to fund
liabilities to jackpot winners.......................... 1,276 629 59
Purchases of intangible assets............................ (59) (67) (392)
Proceeds from sale of assets held for sale................ 425 -- --
Purchases of property, plant and equipment................ (973) (5,191) (2,684)
Investment in software development........................ -- (2,348) (5,356)
Proceeds from sale of property, plant and equipment....... 240 -- --
------- -------- --------
Net cash provided by (used in) investing activities..... (208) (16,789) (9,721)
------- -------- --------
Cash flows from financing activities:
Borrowings from operating bank loan....................... 204 -- --
Repayment of notes payable................................ (201) (2,243) (2,028)
Net proceeds from issuance of common stock................ 1,174 -- 165
------- -------- --------
Net cash provided by (used in) financing activities..... 1,177 (2,243) (1,863)
------- -------- --------
Net increase (decrease) in cash and cash equivalents........ 1,725 (7,132) 2,792
Cash and cash equivalents at beginning of year.............. 5,141 12,273 9,481
------- -------- --------
Cash and cash equivalents at end of year.................... $ 6,866 $ 5,141 $ 12,273
======= ======== ========
See accompanying Notes to Consolidated Financial Statements
40
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
Casino Data Systems, a Nevada corporation, was incorporated in June 1990.
Each of the following corporations are wholly owned subsidiaries of the Company:
CDS Services Company, CDS Signs, Inc., TurboPower Software Company and CDS
Gaming Company. The primary businesses of the Company are (i) the development,
licensing and sale of casino management information systems; (ii) the operation
of multi-site link progressive (MSP) systems; (iii) the design and manufacture
of video interactive gaming machines, and (iv) the design and manufacture of
casino meters, signs and graphics. The Company also creates software development
tools for sale to outside software professionals. The Company provides these
products through operation of five segments: systems and services, gaming
devices, recurring revenue, signs and TurboPower. Prior to 1998, the Company
also operated an additional graphics and imaging segment.
(b) CONSOLIDATION POLICY AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Casino Data
Systems and its subsidiaries (collectively the "Company"). All significant
inter-company balances and transactions have been eliminated in consolidation.
(c) REVENUE RECOGNITION
The Company sells Oasis systems, gaming machines, signs, meters, and
graphics products on normal credit terms (90 days or less) and installment
contracts (generally, less than one year). Revenue from Oasis system sales is
recorded in proportion to work completed using a method that approximates the
percentage-of-completion method, or if the contract does not provide for the
Company's installation of the system, the sale is recorded upon shipment.
Contracts for Oasis system sales generally specify that the price is to be paid
in three or four installments as progress is made toward completion and that
final payment under the contract is not made until the expiration of an
acceptance period during which time the customer and applicable regulatory
authorities may test and approve the Company's Oasis system. Revenue on the sale
of signs, meters and graphics is generally recognized upon delivery. The sale of
gaming machines is recognized upon delivery for a standard sale. When games are
placed on a trial basis, revenue is recognized upon notice from the customer of
their decision to purchase the games. In the gaming industry, it is
traditionally required that game manufacturers allow casinos to try new games on
the floor for a period of time before purchasing them. These games are
considered to be games on trial and remain on the Company's books until the
decision to purchase is made. Used games that return to the Company after
unsuccessful trial periods are generally sold at discounted prices that exceed
cost. Recurring revenues consist of revenues relating to the operations of the
multi-site linked progressive systems and a share of the coins wagered on
machines at customer locations. Revenue is recognized based on the Company's
share of the coins wagered.
(d) CASH AND CASH EQUIVALENTS
Cash equivalents consist of money market funds and short term debt
securities with original maturities of less than 90 days. These investments are
stated at cost, which approximates fair value. The Company maintains restricted
amounts to ensure availability of funds to pay jackpot liabilities.
41
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
(e) INVESTMENT SECURITIES
Investments consist principally of U.S. Government securities, tax-exempt
municipal obligations, and commercial paper. The Company accounts for its
short-term investments in accordance with the provisions of SFAS No. 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Under
SFAS 115, the Company currently classifies its securities as held-to-maturity.
Held-to-maturity securities are those investments in which the Company has the
ability and intent to hold the security until maturity. Held-to-maturity
securities are recorded at amortized cost, which approximates market value.
Dividend and interest income are recognized in the period earned.
(f) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS requires
all entities to disclose the fair value of financial instruments, both assets
and liabilities recognized and not recognized on the balance sheet, for which it
is practicable to estimate fair value. SFAS 107 defines fair value of a
financial instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties. At December 31, 1999 and 1998,
the carrying value of all financial instruments (cash and cash equivalents,
accounts receivable, notes receivable, accounts payable, accrued expenses and
customer deposits and long-term debt) approximates fair value due to the short
term nature of the instruments or interest rates are comparable with current
rates. See Note (5) for fair value regarding investment securities.
(g) INVENTORIES
Inventories are recorded at the lower of cost or market. Cost is determined
principally on the first-in first-out method. Inventories consist of computer
components and other hardware used in Oasis II casino information management
systems, gaming machines, meters, signs, and graphics production.
(h) ASSETS HELD FOR SALE
Assets held for sale are carried at the lower of net book or fair value less
costs to sell. Depreciation is discontinued when assets are transferred to "held
for sale" status.
(i) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the following estimated useful lives:
Buildings............................................. 40 years
Furniture, fixtures and equipment..................... 3 to 10 years
Gaming devices........................................ 2 to 3 years
Service vehicles...................................... 5 to 7 years
Leasehold improvements are amortized over the shorter of the lease term
(including expected renewals) or the useful life of the assets.
Normal repairs and maintenance are charged to expense when incurred.
Betterments and expenditures which materially extend the useful life of the
asset are capitalized.
42
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
(j) INTANGIBLE ASSETS
Intangible assets consist of costs associated with the establishment of
trademarks, the purchase of a patent sublicense and gaming licenses in various
jurisdictions, all of which are capitalized and amortized using the
straight-line method over a period of 5 to 15 years.
(k) SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs paid to third parties
after technological feasibility is established and ceases when the product is
ready for release. Software development costs are amortized over the greater of
the ratio that current gross revenues for a product bear to the total of current
and anticipated future gross revenues for that product or the straight line
method over the remaining estimated economic life of the product including the
current period reported on. Amortization of software development costs begins
when the products are ready for general release.
The Company capitalized no costs for software development in 1999. The
Company capitalized $2,348,000 and $5,356,000 of software development costs for
the years ended December 31, 1998 and 1997, respectively and, as discussed in
Note (3), the Company wrote software development costs down due to impairment in
the fourth quarter of 1997. The Company recorded software amortization of
$1,442,000 and $498,000 for the years ended December 31, 1999 and 1998,
respectively. Research and development costs incurred to establish technological
feasibility have been expensed when incurred.
(l) RESEARCH AND DEVELOPMENT COSTS
Research and development costs related to designing, developing and testing
products are charged to expense as incurred. The Company accounts for research
and development tax credits as a reduction of the provision for income taxes in
the year in which the credits are realized.
(m) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying 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 apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(n) SLOT LIABILITY
In connection with the operation of its MSP Systems, the Company is liable
for progressive jackpots, which are paid as an initial reset amount (the base
component) followed by an annuity (the progressive component) paid out over 19
or 20 years after the winning combination is hit. Base jackpots are charged to
cost of goods sold ratably with the level of play expected to precede payout
based on a statistical analysis. The progressive component increases at a rate
based on the number of coins played. The accrual of the liability and the
associated charge to cost of sales as the amount of the jackpot increases
results in
43
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
recognition of liabilities and matching costs with revenues. The possibility
exists that the winning combination may be hit before the Company has fully
accrued the base component amount at which time any unaccrued portion would be
expensed.
In the fourth quarter of 1999, the Company recognized a benefit of
$4,689,000 related to the termination of slot liabilities associated with its
Cool Millions MSP links in Mississippi and Nevada. The Mississippi portion is
$4,137,000 and represents an unawarded jackpot. Its related benefit was
recognized upon notification from that state's gaming regulatory authority that
the unawarded jackpot funds could be retained by the Company. The Nevada portion
is $552,000 and represents a jackpot accrual related to a jackpot prize that
will not be awarded. In the fourth quarter of 1999, management notified its
customers of its plan to terminate the Nevada Cool Millions MSP link after the
next jackpot prize is awarded. The $552,000 represents the jackpot accrual
amount beyond that required to pay the current jackpot liability. The
$4,689,000, partially offset by the write-off of related impaired intangible
assets (see Note 9), is reported as "Other operating, net" in the consolidated
statement of operations for the year ended December 31, 1999.
(o) OTHER OPERATING, NET
In the fourth quarter of 1999, the Company recognized a benefit of
$4,689,000 related to the termination of slot liabilities associated with its
Cool Millions MSP links in Mississippi and Nevada (see Note 1 (n)). Also in the
fourth quarter of 1999, the Company wrote off the net book values of its
technology release agreement (TRA) and Telnaes patent in the amounts of $927,000
and $1,910,000, respectively (see Note 9). The $4,689,000, partially offset by
the write-off of related impaired intangible assets, is reported as "Other
operating, net" in the Consolidated Statement of Operations for the year ended
December 31, 1999.
In November 1998 the Company settled four shareholder lawsuits for
$1,000,000, which is reflected in "Other operating, net" in the Consolidated
Statement of Operations for the year ended December 31, 1998.
(p) NET INCOME PER SHARE
Basic and diluted net income (loss) per share were computed in accordance
with SFAS No. 128 EARNINGS PER SHARE. All share and per share data presented in
the consolidated financial statements and notes thereto have been retroactively
restated to give effect to stock splits.
(q) STOCK OPTION PLAN
Prior to January 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board Opinion No. 25
(APB 25), ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
January 1, 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS 123 also allows entities to continue to apply the provisions
of APB 25 and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants made in 1995 and future years as if
the fair-value-based method defined in SFAS 123 had been
44
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
applied. The Company has elected to continue to apply the provisions of APB 25
and provide the pro forma disclosure provisions of SFAS 123 (see Note 11).
(r) WARRANTY COSTS
The Company warrants its products for a period ranging from three to six
months from the date of delivery, provided the products are used under normal
operating conditions. The Company accrues a reserve for product warranty at the
time of sale.
(s) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews its long-lived assets and intangibles for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash
flows (undiscounted and without interest) expected to be generated by the asset.
If such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
(t) USE OF ESTIMATES
Management has made a number of estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities to prepare these consolidated financial statements in conformity
with generally accepted accounting principles. Actual amounts could differ from
these estimates.
(u) RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
(v) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, (SFAS 133) which
establishes accounting and reporting standards for derivative instruments and
hedging activities. This statement, as amended, shall be in effect for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure instruments at fair value. SFAS 133
is not expected to have a material effect on the Company's financial position or
results of operations.
(2) MANAGEMENT'S PLAN
The Company continually reviews all components of its business for possible
improvement of future profitability and shareholder value through acquisition,
divestiture, reengineering or restructuring. In the fourth quarter of 1997, the
Company developed and initiated a restructuring plan designed to improve the
Company's cost structure, streamline operations and divest the Company of
underperforming assets.
45
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) MANAGEMENT'S PLAN (CONTINUED)
Implementation of the plan has resulted in certain asset impairment and
various expected losses to be incurred upon the disposal of assets to be
divested. These impairment losses and expected losses on disposal have been
recognized as required by the provisions of SFAS 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF.
Although the restructuring plan had a materially adverse affect on the 1997
results of operations, management believes that the plan was necessary in order
for the Company to achieve the greatest possible profitability in the future.
(3) 1997 RESTRUCTURING AND IMPAIRMENT
In the fourth quarter of 1997, the Company developed a restructuring plan
that encompassed nearly the entire organization and resulted in a charge to
income from operations of $14,998,000. Additionally, the Company recorded
impairment charges totaling $6,039,000. The components of the restructuring and
impairment charge which aggregate $21,037,000 are as follow:
SYSTEMS AND SERVICES
In the fourth quarter of 1997, the Company created and began implementing a
plan to accelerate the development of the Windows compatible version of its
OASIS system. Substantially all engineering resources were reassigned to the
Windows project and several DOS based projects in development were abandoned.
These abandoned projects will not be completed and have no residual value.
Capitalized costs associated with the abandoned DOS projects totaled $1,200,000.
These costs were written off and were included as restructuring and impairment
charges in the accompanying consolidated statement of operations for the year
ended December 31, 1997.
COOL MILLIONS
In response to increasing competitive pressure and erosion in product
performance, the Company decided to replace existing Cool Millions operating
assets. Operation of these links contributed $19,183,000 in revenues and
$7,480,000 of gross margin during the twelve months ended December 31, 1997. The
gaming devices had book value of $5,000,000 before recognition of any impairment
charge. Fair values of these gaming devices was determined through discussion
with third party used gaming equipment dealers. A charge of $4,206,000 is
included in restructuring and impairment charges in the consolidated statement
of operations for the year ended December 31, 1997 to reduce the book value of
the assets to their fair value. Throughout 1999 and 1998, the Company liquidated
these Cool Millions assets for prices at or slightly greater than their book
values. As of December 31, 1999, assets with book values of approximately $4,000
remain in operation. Management expects to liquidate these remaining Cool
Millions assets in 2000 and does not expect to recognize any loss on disposal.
The customized nature and aged design of the Cool Millions signage and
peripheral assets impair their fair value such that no material residual sales
value is expected. There is also no anticipated future operational use to the
Company. As a result, signage with a book value of $3,540,000 and peripheral
assets with a book value of $1,803,000 were written down to a fair value of
zero. These charges totaled $5,343,000 and are included in restructuring and
impairment charges in the accompanying consolidated statement of operations for
the year ended December 31, 1997.
46
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) 1997 RESTRUCTURING AND IMPAIRMENT (CONTINUED)
CARIBBEAN STUD VIDEO POKER
The Company terminated the Caribbean Stud video poker link in October 31,
1997 due to the combination of lower than expected revenues and a fixed royalty
accruing to the licensor of the Caribbean Stud game technology (CTI). The
operation of this link contributed $1,944,000 in revenue and resulted in a
negative gross margin of $352,000 for the ten months ended October 31, 1997. The
gaming machines have been converted into other video poker programs and sold as
used equipment. The signage and other peripheral assets were customized for the
Caribbean Stud video poker link; therefore, they offer no future operating use
to the Company. The customized nature and aged designs of the signage and
peripheral assets impair their value such that no material residual value is
expected. As such, their carrying values were written down to zero through a
charge of $1,104,000 which is included in restructuring and impairment charges
in the accompanying consolidated statement of operations for the year ended
December 31, 1997.
GRAPHICS & IMAGING
In the fourth quarter of 1997, the Company restructured its Graphics and
Imaging subsidiary to eliminate all sales operations. The subsidiary now
operates to satisfy internal demand only. Operation of this subsidiary
contributed $2,041,000 in revenue and resulted in a net loss of $43,000 for the
twelve months ended December 31, 1997 before restructuring and impairment
charges. The subsidiary's ongoing operations are limited to production of
graphic art and flat glass for use only in CDS manufactured gaming devices. The
restructure included a reduction in personnel of 23 employees and calls for the
disposition of all equipment determined to be nonessential in producing to
satisfy internal demand. The restructuring resulted in the recognition of an
expected loss on disposal, the elimination of goodwill and the write-off of
finished goods inventory.
Assets representing nonessential equipment with book value of $1,526,000
have been written down to their estimated fair value of $525,000. The fair value
was determined through discussion with used equipment brokers. The balance of
associated goodwill of $671,000 is not considered recoverable and has been
written down to zero. Additionally, finished goods inventory of $490,000 has
been written down to zero. The finished goods inventory represents replacement
glass for previously processed customer orders which would normally be sold in
small lots as replacement supplies are needed. Without an external sales force,
and since customers generally prefer to purchase such replacement glass only
when needed, the Company does not expect to realize any material recoverable
value from the inventory. These write downs total $2,162,000 and are included in
restructuring and impairment charges in the consolidated statement of operations
for the year ended December 31, 1997.
TURBOPOWER SOFTWARE
In the fourth quarter of 1997, the Company committed to a plan to divest its
TurboPower Software subsidiary (TurboPower). Operation of this subsidiary
contributed $1,450,000 in revenues and resulted in a net loss of $595,000 for
the twelve months ended December 31, 1997. TurboPower was purchased in
January 1995 to assist in development of general products and the Windows
compatible version of the OASIS system specifically. The Windows development
effort by TurboPower was ceased in the third quarter of 1997. In the fourth
quarter of 1997, management concluded that TurboPower no longer fit within the
Company's overall market strategy and made the decision to actively pursue a
buyer. Based on an estimate of future cashflows and the estimated fair value of
its assets, the Company adjusted the book
47
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) 1997 RESTRUCTURING AND IMPAIRMENT (CONTINUED)
value of TurboPower's assets down to their fair value which resulted in a charge
of $983,000. This charge is included in restructuring and impairment charges in
the consolidated statement of operations for the year ended December 31, 1997.
Due to TurboPower's stronger financial performance in 1998 and to changes in
various executive positions within the Company, management now believes that
TurboPower will be an important component of the Company's future success. Based
on this, current management discontinued its search for purchase candidates for
TurboPower in the fourth quarter of 1998 and reclassified its assets back to
operating status.
IMPAIRMENT LOSS
In December 1997, the Company recorded a non-cash accounting charge related
to the impairment of certain long-lived assets as required by SFAS 121 in the
amount of $6,039,000. The impairment loss charge is comprised of three
components: (i) a charge of $4,401,000 related to capitalized amounts for
payments to a third party for game enhancements that were significantly behind
schedule, materially jeopardizing the possibility of recovering these costs,
(ii) a charge of $1,118,000 based on the cash flow projections for CDS
Signs, Inc. which indicated that the subsidiary will not generate enough cash to
recover the $1,118,000 in goodwill and (iii) a charge of $520,000 related to the
capitalized costs associated with a completed module application of the OASIS
system from which no revenues have yet been realized, expected future cash flows
are not sufficient to recover the associated capitalized costs and the net
realizable value is zero. The SFAS 121 charge had no impact on the Company's
1997 cash flow or its ability to generate cash flow in the future.
48
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) BUSINESS SEGMENTS
The items that management utilizes in measuring the profit or loss of each
of the Company's segments are as follows:
PROPERTY AND EQUIPMENT,
NET
------------------------
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
----------- ----------
(DOLLARS IN THOUSANDS)
Systems and Services................................. $ 1,837 $ 1,932
Gaming Devices....................................... 1,181 1,098
Recurring Revenue.................................... 2,143 3,462
Signs................................................ 716 833
TurboPower........................................... 216 273
Corporate............................................ 11,669 12,230
------- -------
Total.............................................. $17,762 $19,828
======= =======
REVENUES
------------------------------
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
Systems and Services............................. $30,075 $23,147 $19,314
Gaming Devices................................... 30,302 14,561 6,328
Recurring Revenue................................ 7,231 9,469 21,127
Signs............................................ 5,702 4,031 4,244
TurboPower....................................... 2,220 1,847 1,450
Graphics & Imaging............................... -- 125 2,041
------- ------- -------
Total.......................................... $75,530 $53,180 $54,504
======= ======= =======
In 1997, the Company had sales to one customer which totaled approximately
16% of total revenue.
DEPRECIATION AND
AMORTIZATION
------------------------------
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
Systems and Services................................ $1,035 $ 873 $ 618
Gaming Devices...................................... 770 344 467
Recurring Revenue................................... 1,507 988 2,817
Signs............................................... 180 181 168
TurboPower.......................................... 54 -- 84
Graphics & Imaging.................................. -- 79 370
Corporate........................................... 627 522 1,035
------ ------ ------
Total............................................. $4,173 $2,987 $5,559
====== ====== ======
49
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) BUSINESS SEGMENTS (CONTINUED)
TurboPower assets were held for sale during 1998; therefore, there was no
depreciation or amortization expense for that segment in 1998. Corporate
depreciation and amortization is related to assets utilized in the corporate
administration of the consolidated Company as a whole.
INCOME (LOSS) FROM OPERATIONS
------------------------------
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
Systems and Services............................ $12,447 $ 5,122 $(11,219)
Gaming Devices.................................. (6,006) (5,718) (9,683)
Recurring Revenue............................... (44) (610) (14,435)
Signs........................................... 40 523 (1,989)
TurboPower...................................... 552 148 (2,010)
Graphics & Imaging.............................. -- (219) (2,950)
------- ------- --------
Total......................................... $ 6,989 $ (754) $(42,286)
======= ======= ========
Corporate expenses have been allocated to each segment based on management's
estimate of each segment's utilization of corporate resources. Included in
consolidated loss from operations for the year ended December 31, 1997 is a
restructuring and impairment charge of $21,037,000 as described in Note (3). The
above reported 1997 loss from operations for each segment includes amounts
related to this charge as follows: systems and services of $1,720,000; games of
$4,401,000; recurring revenue of $10,653,000; signs of $1,118,000; TurboPower of
$983,000; and graphics and imaging of $2,162,000.
(5) INVESTMENT SECURITIES
The amortized cost, gross unrealized holding gains, and fair value for
held-to-maturity securities by major security type and class of security at
December 31, 1999 and 1998 are as follows:
DECEMBER 31, 1999
----------------------------------
AMORTIZED UNREALIZED FAIR
COSTS GAIN/(LOSS) VALUE
--------- ----------- --------
(DOLLARS IN THOUSANDS)
Securities to be held to maturity:
U.S. Government and agency securities........ $15,826 $(1,437) $14,389
======= ======= =======
AMORTIZED UNREALIZED FAIR
COSTS GAIN/(LOSS) VALUE
--------- ----------- --------
(DOLLARS IN THOUSANDS)
Securities to be held to maturity:
U.S. Government securities................... $15,566 $ -- $15,566
======= ==== =======
50
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INVESTMENT SECURITIES (CONTINUED)
The approximate fair values of securities held to maturity at December 31,
1999 by contractual maturity, are as follows:
DECEMBER 31,
1999
----------------------
(DOLLARS IN THOUSANDS)
Due in one year or less.................................. $ 1,406
Due in one to five years................................. 5,577
Due in five to ten years................................. 3,948
Due in ten to fifteen years.............................. 2,800
Due in fifteen to twenty years........................... 658
-------
$14,389
=======
(6) NOTES RECEIVABLE
The Company has granted customers extended payment terms under contracts of
sale evidenced by notes. These notes are generally for terms of one to two
years, with interest recognized at prevailing rates, and are secured by the
related equipment sold.
(7) INVENTORIES
Inventories consist of the following:
DECEMBER 31,
----------------------
1999 1998
--------- ----------
(DOLLARS IN THOUSANDS)
Raw materials.......................................... $15,710 $ 9,734
Work in process........................................ 292 711
Finished goods......................................... 11,368 10,139
------- -------
27,370 20,584
Less reserve for obsolescence.......................... (1,770) (1,437)
------- -------
$25,600 $19,147
======= =======
Finished goods inventory includes gaming machines on trial at various casino
sites of $1,826,000 and $2,182,000 at December 31, 1999 and December 31, 1998,
respectively.
51
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
----------------------
1999 1998
--------- ----------
(DOLLARS IN THOUSANDS)
Furniture, fixtures and equipment...................... $ 9,082 $ 9,174
Gaming devices......................................... 4,110 4,079
Service vehicles....................................... 572 554
Leasehold improvements................................. 744 744
Buildings.............................................. 9,162 8,810
Land................................................... 1,609 1,816
------- -------
25,279 25,177
Less accumulated depreciation.......................... (7,517) (5,349)
------- -------
$17,762 $19,828
======= =======
(9) INTANGIBLE ASSETS
Intangible assets consist of the following:
DECEMBER 31,
----------------------
1999 1998
--------- ----------
(DOLLARS IN THOUSANDS)
Trademarks............................................. $ 31 $ 31
Licensing costs........................................ 1,092 1,033
Technology release agreement........................... -- 1,437
Telnaes patent......................................... -- 4,943
------- -------
1,123 7,444
Less accumulated amortization.......................... (1,001) (2,795)
------- -------
$ 122 $ 4,649
======= =======
In the fourth quarter of 1999, the Company wrote off the net book values of
its technology release agreement (TRA) and Telnaes patent in the amounts of
$927,000 and $1,910,000, respectively. The TRA was related to the Company's
Nevada MSP links. Performance of those products have significantly declined
throughout the fourth quarter and management adopted a plan to terminate Nevada
MSP products upon the next jackpot hit. With adoption of the termination plan,
future cash flows are expected to only cover the operating costs; therefore,
cash flows are not expected to be sufficient to recover any of the unamortized
TRA balance.
The Telnaes patent is utilized in certain gaming devices that operate
mechanical reel spinning formats. The Company's plans to terminate Nevada MSP
activity, combined with its planned emphasis on marketing video gaming devices
which do not utilize the Telnaes patent, have impaired this asset such that the
expected future cash flows will not be sufficient to recover any of the
unamortized balance.
The effects of these write-offs are included in "Other operating, net" in
the Consolidated Statement of Operations for the year ended December 31, 1999
(See Note 1(o)).
52
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31,
----------------------
1999 1998
--------- ----------
(DOLLARS IN THOUSANDS)
Notes payable with interest rates between 8.75% and 11.12%,
due in monthly installments between $9,000 and $43,000
including interest, with final payment due between
February 1999 and January 2000, secured by personal
property.................................................. $ 10 $211
Loan agreement, interest due in monthly installments,
secured by personal property.............................. 204 --
---- ----
214 211
Less current portion........................................ 214 211
---- ----
Long term portion........................................... $ -- $ --
==== ====
In November 1999, the Company entered into a loan agreement with a financial
institution, whereby up to $6,975,000 can be borrowed on a draw-down basis. This
agreement expires in July 2002, is secured by personal property, and has a fixed
interest rate of 9.375%. At December 31, 1999, the Company had borrowed $204,000
under this facility.
(11) SHAREHOLDERS' EQUITY
(a) EMPLOYEE STOCK PURCHASE PLAN
On March 16, 1998, the Board of Directors of the Company adopted the 1998
Employee Stock Purchase Plan (the "1998 Purchase Plan"), which was approved by
the Company's stockholders in July 1998. Under the terms of the 1998 Purchase
Plan, employees may acquire shares of the Company's stock at a 15 percent
discount from their fair market value. In addition, the 1998 Purchase Plan
provides a mechanism whereby employees may pay for their share purchases with
periodic deductions from their payroll. The 1998 Purchase Plan authorizes the
issuance of up to 500,000 shares of common stock to eligible participants. In
1999, 66,414 shares of the Company's common stock were purchased under this
plan.
(b) STOCK OPTION AND COMPENSATION PLAN
In January 1993, the Company adopted the 1993 Stock Option and Compensation
Plan (the "Plan"), pursuant to which options and other awards to acquire an
aggregate of 1,012,500 shares of Common Stock may be granted. The number of
shares issuable under the Plan was increased to an aggregate 1,350,000 shares in
June 1994, 2,025,000 shares in July 1996, and 2,775,000 in July 1998. In 1994,
the Company adopted the 1994 Nonemployee Director Stock Option Plan pursuant to
which 225,000 shares are issuable.
53
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) SHAREHOLDERS' EQUITY (CONTINUED)
The following table provides additional information regarding stock options:
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
--------- --------
Outstanding at January 1, 1997........................... 1,319,650 $11.50
Granted.................................................. 460,675 4.60
Exercised................................................ (32,250) 5.21
Canceled................................................. (385,585) 10.46
---------
Outstanding at December 31, 1997......................... 1,362,490 4.75
Granted.................................................. 1,167,520 2.50
Exercised................................................ -- --
Canceled................................................. (954,375) 5.28
---------
Outstanding at December 31, 1998......................... 1,575,635 3.37
Granted.................................................. 275,262 3.76
Exercised................................................ (127,322) 3.70
Canceled................................................. (704,711) 3.54
---------
Outstanding at December 31, 1999......................... 1,018,864 $ 3.32
=========
Exercisable at December 31, 1999......................... 384,497 $ 4.41
=========
The per share weighted average fair value of stock options granted during
1999, 1998 and 1997 was $1.58, $1.31 and $2.50, respectively, on the date of
grant using the Black Scholes option-pricing model with the following weighted
average assumptions for 1999, 1998 and 1997: expected dividend yield of 0% for
all three years; risk free interest rate of 5.25%, 5.25% and 5.75%,
respectively; volatility of 50%, and expected lives varying from one month to
three years. The following table summarizes information about stock options
outstanding at December 31, 1999:
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OUT- CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICE STANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
$1.41-1.81...... 387,788 8.82 years $ 1.74 94,568 $ 1.74
1.82-3.00...... 293,288 4.75 years 2.87 79,016 2.89
3.01-4.88...... 141,788 6.04 years 3.85 52,438 3.67
4.89-6.75...... 157,213 3.18 years 5.28 122,288 5.19
6.76-16.00..... 38,787 2.63 years 12.72 36,187 13.11
--------- -------
$ 1.41 to
$16.00......... 1,018,864 6.16 years $ 3.32 384,497 $ 4.41
========= =======
54
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) SHAREHOLDERS' EQUITY (CONTINUED)
The Company applies APB Opinion No. 25 in accounting for its Plan and no
compensation cost has been recognized for its stock options in the financial
statements. Had the Company determined compensation cost based on the fair value
at the grant date for its stock options under SFAS 123, the Company's net income
(loss) would have been reduced to the pro forma amounts indicated below:
INCOME (LOSS) FROM OPERATIONS
------------------------------
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
Net income (loss):
As reported.................................... $15,212 $2,513 $(39,715)
Pro forma...................................... $13,653 $1,836 $(40,865)
Basic net income (loss) per common share:
As reported.................................... $ 0.83 $ 0.14 $ (2.20)
Pro forma...................................... $ 0.75 $ 0.10 $ (2.26)
Diluted net income (loss) per common share:
As reported.................................... $ 0.82 $ 0.14 $ (2.20)
Pro forma...................................... $ 0.73 $ 0.10 $ (2.26)
(e) NET INCOME (LOSS) PER COMMON SHARE
The following is an analysis of the components of the shares used to compute
net income (loss) per common share:
DECEMBER 31,
----------------------------------------
1999 1998 1997
----------- ----------- ------------
Numerator for basic and diluted earnings per share--
income (loss) available to common stockholders...... $15,212,000 $ 2,513,000 $(39,715,000)
=========== =========== ============
Denominator:
Denominator for basic earnings per share--weighted
average shares.................................... 18,234,000 18,066,000 18,043,000
Effect of dilutive securities--stock options........ 394,000 39,000 --
----------- ----------- ------------
Denominator for diluted earnings per share--adjusted
weighted average shares and assumed conversions... 18,628,000 18,105,000 18,043,000
=========== =========== ============
Basic earnings per share.............................. $ 0.83 $ 0.14 $ (2.20)
Diluted earnings per share............................ $ 0.82 $ 0.14 $ (2.20)
In 1997, conversion of employee stock options would have been anti-dilutive;
accordingly, they were not considered in the calculation of diluted earnings per
share.
55
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) INCOME TAXES
Income tax (benefit) expense attributable to income from continuing
operations consists of:
CURRENT DEFERRED TOTAL
-------- -------- --------
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, 1999:
U.S. Federal.................................... $ 2,042 $(9,043) $(7,001)
State........................................... 178 (378) (200)
------- ------- -------
$ 2,220 $(9,421) $(7,201)
======= ======= =======
YEAR ENDED DECEMBER 31, 1998:
U.S. Federal.................................... $(1,211) $ (516) $(1,727)
State........................................... 80 -- 80
------- ------- -------
$(1,131) $ (516) $(1,647)
======= ======= =======
YEAR ENDED DECEMBER 31, 1997:
U.S. Federal.................................... $(5,253) $ 1,878 $(3,375)
State........................................... 305 -- 305
------- ------- -------
$(4,948) $ 1,878 $(3,070)
======= ======= =======
The effective income tax rate differs from the U.S. federal statutory rate
of 35% for the years ended December 31, 1999, 1998 and 1997, respectively, as
follows:
1999 1998 1997
-------- -------- --------
(DOLLARS IN THOUSANDS)
Computed "expected" income tax expense
(benefit)..................................... $ 2,804 $ 294 $(14,975)
Tax exempt interest income...................... -- (28) (116)
State taxes, net of federal income tax
benefit....................................... (130) 53 107
Tax credits..................................... (275) (1,604) --
Tax rate difference............................. (11) (307) 1,036
Change in valuation allowance................... (10,006) -- 10,006
Other, net...................................... 417 (55) 872
-------- ------- --------
$ (7,201) $(1,647) $ (3,070)
======== ======= ========
56
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 1999 and
1998 are as follows:
CHANGE IN
1999 DEFERRED TAXES 1998
-------- ---------------- --------
(DOLLARS IN THOUSANDS)
Deferred tax assets:
Accrued jackpot liability.............. $ 6,637 $ (707) $ 7,344
Accrued expenses....................... 640 242 398
Allowance for doubtful accounts........ 103 (285) 388
Intangible assets...................... 4,862 732 4,130
Inventory.............................. 647 162 485
Tax credits............................ 2,708 1,105 1,603
NOL carryforward....................... -- (1,858) 1,858
------- ------- --------
15,597 (609) 16,206
Valuation allowance...................... -- 10,006 (10,006)
------- ------- --------
Net deferred tax assets.............. 15,597 9,397 6,200
------- ------- --------
Deferred tax liabilities:
Depreciation of property and
equipment............................ 4,012 (130) 4,142
Deferred rent and prepaid expenses..... 148 106 42
------- ------- --------
Total gross deferred tax
liabilities........................ 4,160 (24) 4,184
------- ------- --------
Net deferred tax asset............... $11,437 $ 9,421 $ 2,016
======= ======= ========
In the fourth quarter of 1999, a tax benefit of $9,600,000 was recognized
related to the elimination of a valuation allowance established in 1997. Based
on the Company's financial results in 1999, combined with expected financial
results in future periods, management believes it is more likely than not that
the net deferred tax asset will be realized; therefore, the valuation allowance
was eliminated.
(13) RELATED PARTY TRANSACTIONS
A shareholder and former director of the Company and the spouse
(collectively the "Principals") of the Chairman of the Company are majority
shareholders in Kiland Distributing Corporation ("KDC"), a former distributor of
the Company's products. Prior to the third quarter of 1997, the Company utilized
KDC for substantially all sales in the mid-west region of the United States.
During the year ended December 31, 1997, the Company made sales to KDC of
approximately $169,000. The sales, recorded net of distributor discounts,
represent less than 1% of the Company's revenues for the year ended
December 31, 1997.
In September 1997, the Company and KDC reached an agreement regarding the
settlement of accounts receivable of $3,059,000 for approximately $2,400,000 The
settlement included the transfer of substantially all of KDC's assets to the
Company which included cash, accounts receivable and fixed assets. The
settlement also included forgiveness of certain accounts payable from the
Company to KDC and the execution of a $144,000 unsecured promissory note from
the Principals to the Company which was paid in full in March 1998. Concurrent
with the settlement, the Company terminated its business relationship with KDC.
57
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) OPERATING LEASES
The Company has non-cancelable operating leases, primarily for office and
warehouse space, that expire over the next five years. Rent expense under
operating leases was $609,000, $836,000 and $951,000 for the years ended
December 31, 1999, 1998 and 1997, respectively.
Future minimum lease payments under non-cancelable building operating leases
(with initial or remaining lease terms in excess of one year) as of
December 31, 1999 are as follow:
PAYMENTS
----------------------
(DOLLARS IN THOUSANDS)
Year ending December 31:
2000................................................... $474
2001................................................... 88
2002................................................... 64
2003................................................... 11
----
Total minimum lease payments........................... $637
====
(15) EMPLOYEE BENEFIT PLAN
Effective January 1, 1996, the Company adopted a qualified 401(k) Plan (the
"Plan"). Eligible employees of the Company who have satisfied the Plan's
eligibility requirements may participate in the Plan. Eligible employees may
elect to contribute up to 15% of their compensation up to a maximum $10,000 in
1999. The Company may elect to make contributions to the Plan. The Company did
not elect to make a contribution to the Plan during 1999, 1998 or 1997.
(16) COMMITMENTS AND CONTINGENCIES
On May 19, 1998, Acres Gaming Corporation filed an action against the
Company, Mikohn Gaming Corporation, New York New York Hotel & Casino, LLC, and
Sunset Station Hotel & Casino, in the Federal Court for the State of Nevada,
alleging that the Company's ProTurbo Software module violated certain patent
rights of Acres Gaming. Acres Gaming also filed a Motion for Preliminary
Injunction, which was later withdrawn by Acres. The Company has answered the
lawsuit asserting defenses and counterclaims seeking a declaration of
invalidity, noninfringement and unenforceability of the patent asserted. The
Company believes this action is without merit and will continue to vigorously
defend itself. While the outcome of this lawsuit is not presently determinable,
management does not expect that the outcome will have a material adverse effect
on the Company's consolidated financial position, results of operations or
liquidity.
On November 17, 1998, Acres filed a second lawsuit against the Company
alleging that the Company's ProTurbo Software module violates certain patent
rights of a second Acres patent. CDS has filed an answer and a counterclaim
seeking a declaration of invalidity, noninfringement and unenforceability of the
patent asserted. The Company has filed additional counterclaims for alleged
patent misuse, spoliation of evidence, antitrust violations and unfair
competition. The Company believes that this action is without merit and will
continue to vigorously defend itself. While the outcome of this lawsuit is not
presently determinable, management does not expect the outcome will have a
material adverse effect on the Company's consolidated financial position,
results of operations or liquidity.
58
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) COMMITMENTS AND CONTINGENCIES (CONTINUED)
On October 20, 1999, International Game Technology ("IGT") filed but did not
serve, a complaint against the Company and three other slot machine
manufacturers alleging that CDS and others infringed a patent owned by IGT
through the Company's use of gaming devices containing touch screens with
redundant play buttons that control game outcome features. The Company believes
that substantial prior art exists that renders the IGT patent invalid. On
February 25, 2000, IGT dismissed the lawsuit against the Company, retaining its
right to refile the lawsuit in the future. Management does not expect the
outcome of this lawsuit to have a material adverse effect on the Company's
consolidated financial position, results of operations, or liquidity.
The Company and its subsidiaries are also involved from time to time in
other various claims and legal actions arising in the ordinary course of
business including, but not limited to, administrative claims and legal actions
brought in state and federal courts by patrons of the Company's MSP games,
wherein the patron may allege the winning of jackpot awards or some multiple
thereof. Because of the size of the jackpots that a patron may play for, related
patron disputes often involve sizable claims. The loss of a sizable patron
dispute claim could have a material adverse effect on the Company. For example,
the Company is currently litigating two patron disputes that it has won on every
level of review, however the patrons have continued to appeal the decisions. One
dispute has been appealed by the patron to the Supreme Court of the State of
Mississippi, and the patron alleges a claim for two identical jackpots of over
$2.7 million dollars each. A second dispute has been appealed by a patron to the
Supreme Court of the State of Nevada, who alleges a claim for over $8 million
dollars. In either case, if the patron were to win, the Company would be liable
to pay $1 million dollars immediately (plus interest) with the remainder to be
paid in installments over twenty years in an annuity. However, management
believes that the likelihood of success by those making such claims is remote
and that the ultimate outcome of these matters will not have a material adverse
effect on the Company's consolidated financial position, results of operations
or liquidity.
(17) SUPPLEMENTAL FINANCIAL INFORMATION
CASH FLOW INFORMATION
Payments for interest expense for the years ended December 31, 1999, 1998
and 1997 were approximately $50,000, $183,000 and $324,000, respectively.
Payments for income taxes for the year ended December 31, 1999 were
approximately $770,000. There were no payments for income taxes for the years
ended December 31, 1998 and 1997.
59
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Effective November 23, 1999 the Company dismissed KPMG LLP ("KPMG"). The
decision to change accountants was approved by the Audit Committee and the Board
of Directors of the Company.
The reports of KPMG on the Company's consolidated balance sheets as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the years in the
two-year period ended December 31, 1998, did not contain an adverse opinion or
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope, or accounting principles.
During the two most recent fiscal years and the interim periods subsequent
to December 31, 1998 through November 23, 1999, there were no disputes between
the Company and KPMG as to matters of accounting principles or practices,
financial statement disclosure, or audit scope or procedure, which
disagreements, if not resolved to the satisfaction of KPMG, would have caused it
to make a reference to the subject matter of the disagreement in connection with
its reports on the Company's financial statements. KPMG has furnished the
Company with a letter addressed to the Commission stating that it agrees with
the above statements. A copy of this letter was included as an exhibit to the
Report on Form 8-K.
The Company has engaged the firm of Deloitte & Touche LLP as independent
accountants for the Company's fiscal year ending December 31, 1999 to replace
KPMG. The Company's Board of Directors approved the selection of Deloitte &
Touche LLP as independent accountants upon recommendation of the Company's Audit
Committee.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information beginning immediately following the caption "Election of
Directors" to, but not including, the caption "Executive Compensation" in the
Company's Proxy Statement, to be filed with the Securities and Exchange
Commission within 120 days of the close of the Company's year ended
December 31, 1999 and forwarded to stockholders prior to the Company's 2000
Annual Meeting of Stockholders (the "2000 Proxy Statement"), is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information in the 2000 Proxy Statement beginning immediately following
the caption "Executive Compensation" to, but not including, the caption
"Compensation Committee Interlocks and Insider Participation" is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the 2000 Proxy Statement beginning immediately following
the caption "Voting Securities and Principal Holders Thereof" to, but not
including, the caption "Election of Directors" is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the 2000 Proxy Statement under the caption "Certain
Transactions" is incorporated herein by reference.
60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) These documents are listed in the Index to Consolidated Financial
Statements and Supplementary Data in Item 8 of this report
(a)(2) Schedules
See Schedule attached.
(a)(3) EXHIBITS
EXHIBIT DESCRIPTION
- --------------------- -----------
3.1 Articles of Incorporation, as amended (incorporated herein
by reference to Exhibit 3.1 of the Company's Registration
Statement on Form SB-2 (File No. 33-59148LA)).
3.2 By-laws (incorporated herein by reference to Exhibit 3.2 of
the Company's Registrations Statement on Form SB-2 (File
No. 33-59148LA)).
10.1 1993 Employee Stock Option and Compensation Plan, as amended
(incorporated herein by reference to Exhibit 10.9 of the
Company's Registration Statement on Form SB-2 (File
No. 33-59148LA)). *
10.2 1994 Non-Employee Director Option Plan (incorporated by
reference to Exhibit A of the Registrant's Proxy Statement
dated June 13, 1995). *
21 Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP
23.2 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
- ------------------------
* Executive Compensatory Plan or Arrangement
61
FORM 10-K
CASINO DATA SYSTEMS AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COST AND OTHER END OF THE
THE YEAR EXPENSES ACCOUNTS DEDUCTIONS YEAR
------------ ---------- ---------- ---------- ----------
Year ended December 31, 1999:
Allowance for doubtful accounts..... $3,516,000 $ -- $ -- $1,630,000 $1,886,000
Allowance for obsolescence.......... $1,437,000 $2,222,000 $ -- $1,889,000 $1,770,000
Year ended December 31, 1998:
Allowance for doubtful accounts..... $5,390,000 $ -- $ -- $1,874,000 $3,516,000
Allowance for obsolescence.......... $1,125,000 $ 966,000 $ -- $ 654,000 $1,437,000
Year ended December 31, 1997:
Allowance for doubtful accounts..... $2,868,000 $3,717,000 $ -- $1,195,000 $5,390,000
Allowance for obsolescence.......... $ -- $1,125,000 $ -- $ -- $1,125,000
See accompanying independent auditors' reports
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Casino Data Systems has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized:
CASINO DATA SYSTEMS
(Registrant)
Date: March 29, 2000 By: /s/ STEVEN A. WEISS
-----------------------------------------
Steven A. Weiss
CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD
(PRINCIPAL EXECUTIVE OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
Chief Executive Officer and
/s/ STEVEN A. WEISS Chairman of the Board
------------------------------------------- (Principal Executive March 29, 2000
Steven A. Weiss Officer)
Vice President of Finance,
/s/ RONALD ROWAN Secretary and Treasurer
------------------------------------------- (Principal Financial and March 29, 2000
Ronald Rowan Accounting Officer)
/s/ PHIL BRYAN
------------------------------------------- Director March 29, 2000
Phil Bryan
/s/ HOWARD YENKE
------------------------------------------- Director March 29, 2000
Howard Yenke
/s/ THOMAS GARDNER
------------------------------------------- Director March 29, 2000
Thomas Gardner
/s/ JOHN HARVEY
------------------------------------------- Director March 29, 2000
John Harvey
63