FORM 10-K
UNITED STATE SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
____________ TO ___________
Commission File No. 0-21426
CASINO DATA SYSTEMS
(Exact name of registrant as specified in its charter)
NEVADA 88-0261839
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3300 BIRTCHER DRIVE
LAS VEGAS, NEVADA 89118
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(Address of principal executive offices) (Zip Code)
(702) 269-5000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
NO PAR VALUE --------------
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
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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
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As of March 2, 1998, 18,065,897 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 2,
1998, was $3-3/8. The aggregate market value of the common stock on that
date was $60,972,402. For purposes of this computation, affiliates of the
Registrant are deemed only to be the Registrant's executive officers and
directors.
DOCUMENTS INCORPORATED BY REFERENCE
PART III - Portions of the Registrant's definitive proxy statement in
connection with the 1998 Annual Meeting of Shareholders are incorporated by
reference into Items 10 through 13, inclusive.
ITEM 1. BUSINESS
GENERAL
Casino Data Systems (the "Company" or "CDS") is a designer and
manufacturer of innovative technology-driven products for the gaming
industry. The Company's primary products and systems 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; (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 and (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.
CDS was incorporated on June 18, 1990 in Nevada. The Company grew
rapidly by developing and marketing technologically advanced products,
including its OASIS II 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. Since their
introduction in 1991, the Company's OASIS systems have been installed in
approximately 85 casinos throughout North America encompassing over 110,000
gaming machines. Through the marketing and enhancement of its OASIS II
systems, the Company has developed relationships with many major casinos in
North America, which the Company believes provides it with an advantage in
marketing and introducing its other products and systems. During 1993, the
Company developed progressive meter technology and has since expanded and
diversified its operations through the acquisition of graphics, signs and
software businesses. During 1994, the Company launched its Cool Millions MSP
system in Mississippi and was licensed by Nevada as a manufacturer and
distributor of gaming devices. In February 1996, the Company entered into a
series of agreements (the "Telnaes Agreements") to obtain certain
non-exclusive rights to use certain patented virtual reel technology. Such
technology can be used in reel spinning slot machines and enables the Company
to create the high odds necessary to allow large progressive jackpots. In
September 1996, pursuant to a confidential settlement agreement, in exchange
for CDS and certain other companies granting back to International Game
Technology ("IGT") all their respective rights under the Telnaes patent, IGT
has granted the Company a fully paid, nontransferable (including change of
control limitation), and royalty free license under the Telnaes patent. The
Company currently uses the Telnaes Technology in its Safebuster game, the
first reel spinning gaming device manufactured and sold by the Company. The
Company will also use the Telnaes Technology in other reel spinning machines
and in any future games that are added to its MSP systems. The Company also
currently has approximately 50 proprietary video poker games and four
proprietary video slot games licensed for general sale in various
jurisdictions.
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 into the next century. 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, divesture, 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. 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. Although the restructuring plan will have a materially adverse
affect on the 1997 results of operations, management believes that the plan
is necessary in order for the Company to achieve the greatest possible
profitability in the future. The key elements of the Company's strategy are
described below in relation to the Company's systems, products and other
lines of business.
BUSINESS SEGMENTS
SYSTEMS AND PRODUCTS
CASINO MANAGEMENT INFORMATION SYSTEMS
In order to maintain its position as a technological leader, the
Company is continuing to expand its casino management information systems.
The Company believes that sophisticated and reliable information systems will
be a key element in the continued growth and success of the gaming industry.
The Company's slot accounting and player tracking systems traditionally have
been used by casinos to monitor play and to collect, integrate and analyze
data from slot machines, MSP systems, video poker machines and other
electronic gaming devices. The Company is expanding its slot accounting and
player tracking system into a multi-faceted casino floor information system
by using its technological expertise to develop software modules that allow
the OASIS II system to support additional casino marketing, accounting,
security and maintenance functions. OASIS II products introduced include
ProTURBO-TM-, Surveillance Monitor-TM-, Maintenance Monitor-TM-,
RapidPAGE-TM-, OASIS/Windows-TM- and PitBoss-TM-. In addition, the Company
has wireless radio frequency communication capability in its OASIS II system.
The Company continues the development of a Windows-Registration Mark-* and a
Windows-Registration Mark- NT compatible version of OASIS II. The development
of these system enhancements will enable OASIS II to improve communications
and data exchange with the customer's hotel and other information management
systems. Customers will have the ability to customize their casino
management information systems either by adding new modules and features to
their existing OASIS II systems as expansions or upgrades or by purchasing
complete systems.
OASIS II forms the core of the Company's casino management
information system. The Company's casino management information systems
comprise 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 games. By linking on-line slot accounting and player
tracking information, the OASIS II system allows casinos to perform
sophisticated and customized data analysis in real-time.
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The Company's current DOS version of the OASIS-TM- II System's
database is year 2000 compliant; however, certain modules are not. The
Company expects to release an upgraded DOS version in the fourth quarter of
1998 that brings the non-compliant modules into year 2000 compliance. In
addition, the Windows-Registration Mark- compatible version of the OASIS II
System will fully integrate all modules of the system into year 2000
compliance. There is a plan in place to convert all OASIS II Systems being
operated by customers of CDS to a year 2000 compliant version. The Company
does not anticipate these conversions to have a materially adverse effect on
operations. The Company believes that its MSP software is year 2000
compliant. The Company believes that its internal operating systems are year
2000 compliant.
BlackBart-TM-, the on-line slot accounting feature of the OASIS
II system, continuously records each coin that enters, exits, or is retained
by each electronic gaming machine, monitors all jackpots and fills and
calculates coin and currency drop values. This information is rapidly and
continuously communicated to generate instant or "on-line" accounting of
revenues and net win to casinos for all types of electronic gaming machines.
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 central controller provides cost and operational advantages by
eliminating individual controllers for each meter and by enabling casinos to
control all meters from one central workstation, allowing casinos to reset
meters without manually adjusting each meter.
Super-PlayMate, the player tracking and marketing database
feature of the OASIS II system, allows casino operators to collect and access
real-time player marketing information. Casino marketing departments use
OASIS II system data to engage in target marketing, measure customer response
to marketing efforts, award "comps" to good customers and to 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 to slot players coded and individualized "slot
club" cards which are inserted into a card reader mounted on or in the slot
machines. The OASIS II system records the length of play, amount bet and
casino win on each machine played, enabling the casino to keep a record of
gaming activity for each customer. In addition, the OASIS II system can
integrate manually-entered table game data with slot machine readout to
produce combined player ratings.
The OASIS II system features OmniVIEW, a dynamic, real-time
graphic representation of the electronic gaming floor, which provides a
record of all gaming activity as it occurs. By moving a cursor around the
floor plan, the user can obtain detailed current information about any slot
machine and any player. Also included is a quarter-hour trend analysis that
provides 15 minute snapshots of casino player activity, trend activity
reports for carded and uncarded players, machine utilization and coin-in,
coin-out information to help identify trends.
The Company continues to invest in its OASIS II casino management
information systems to pursue a technology leadership position. The Company
introduced a wireless radio frequency communications option for its OASIS II
system. The Windows-based OASIS II systems will offer additional features,
including enhanced SQL capability and open base connectivity, enabling the
OASIS II system to exchange data with most property-wide information
management systems. The Company will continue to enhance existing modules
and develop new modules in the future; however, the Company is currently
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focusing its resources on completing the Windows compatible version of the
OASIS II system. The Windows compatible version of the OASIS II system is
scheduled for Alpha test in the second quarter of 1998. Delays in the
completion of this test could have a materially adverse effect on the future
sales of the OASIS II system.
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 have the ability to 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.
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 the
approximately 50 video poker games and four video slot games that are
currently licensed in certain 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.
In November 1996, the Company entered into an agreement with a
third party for the development of art to be used in several innovative and
interactive gaming machines. The agreement provided for a specific number of
game enhancements to be completed within a specific period of time. The
third party was not able to supply the Company with the number of adequately
developed game enhancements as specified by the agreement and as of January
1998, the remaining payments due the third party were suspended pending
completion of the contracted deliverables. Due to the significant delay in
bringing any of these game enhancements to market and to various competitive
developments in the fourth quarter of 1997, management does not expect that
the Company will recover the entire cost of the payments made through
December 31, 1997; therefore, the Company recorded a $4,402,000 impairment
charge in the fourth quarter of 1997 related to capitalized amounts paid to
the third party. Certain games will be submitted for regulatory approval in
the second quarter of 1998.
REEL SPINNING SLOT MACHINES
The Company intends to use the Telnaes Technology to manufacture
reel spinning slot machines for general sale to casino customers and for use
in its MSP systems. The reel spinning slot machines currently used by the
Company in its MSP systems are manufactured by a third party supplier. The
Company believes that currently only a small number of entities have the
right to use the Telnaes Technology to produce traditional reel spinning slot
machines. In addition, the Company also intends to use its position as an
innovative designer of gaming technology to produce reel spinning slot
machines incorporating advanced graphics and innovative secondary game
features. The first of which is the Company's Safe Buster-TM- game. Safe
Buster, jointly marketed by the Company and Anchor Gaming, features a three
reel spinning slot machine with a prominent back-lit safe dial which, when
matched to a random three number combination, can "crack" a mythical safe
containing a jackpot payout. The Company will seek to distinguish itself
from other manufacturers by offering customized interactive games that offer
increased entertainment value to meet the gaming industry's evolving needs.
METERS, SIGNS AND GRAPHICS
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, signs and graphics
products. The Company intends to promote the marketing of product packages
including overhead signage, in-machine and overhead progressive meters and
customized glass design.
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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
comprises 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.
The Company's Graphics and Imaging subsidiary designed and
manufactured decorative flat glass and slot reel graphics, supplying the
Company's MSP system operation and video interactive games division as well
as outside slot machine manufacturers and casinos. Due to losses reported
for several consecutive quarters, the Company initiated a plan in the fourth
quarter of 1997 to restructure CDS Graphics and Imaging. The plan consisted
mainly of discontinuing external operations and servicing only internal
demand which resulted in a reduction of personnel of 23 employees and the
planned disposition of equipment and inventory. The planned restructuring of
CDS Graphics and Imaging resulted in a restructuring charge to income from
operations in the fourth quarter of 1997 of $2,162,000 representing the
amount required to write CDS Graphics and Imaging's assets down to their net
realizable value. The Company will continue to design and manufacture
decorative flat glass and slot reel graphics for the Company's MSP system
operation and video interactive games division.
The Company's CDS Signs subsidiary designs and manufactures
high-quality internal and external casino signs, including electric, fiber
optic, animated and neon displays and signs incorporating the Company's
meters, which are used as overhead displays for progressive jackpot systems.
The subsidiary designs and manufactures the overhead signs for the Company's
MSP systems and video interactive games. Based on current cashflow
projections, management does not expect the CDS Signs subsidiary to generate
enough cashflow to recover the $1,118,000 of unamortized goodwill.
Therefore, an impairment charge for the entire amount of the unamortized
goodwill was recognized in the fourth quarter of 1997.
PROFESSIONAL SOFTWARE DEVELOPMENT TOOLS
The Company's TurboPower Software subsidiary (TurboPower)
develops advanced software programming tools used by software professionals
to develop applications for business and industry. In the fourth quarter of
1997, the Company committed to a plan to sell the TurboPower Software
subsidiary after concluding that TurboPower no longer fit within the
Company's overall market strategy. Based on an estimate of future cashflows
and the estimated fair value of its assets, the Company has adjusted the book
value of TurboPower's assets down to their fair value which resulted in a
charge of $983,000. This charge is reflected as a restructuring charge in
the consolidated statement of operations.
PROGRESSIVE OPERATIONS
MSP SYSTEMS
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 599 games participating on its
six MSP system links as of December 31, 1997.
The Company introduced its first Cool Millions system in
Mississippi in November 1994. Cool Millions is a traditional three-coin,
three-reel spinning, dollar slot machine. Cool Millions offers a large
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primary progressive jackpot and a smaller more frequent secondary progressive
jackpot. Cool Millions differs from competing MSP systems by offering an
immediate cash pay out of $1 million on the primary jackpot with the balance
of the jackpot paid out as an annuity. Competing MSP systems currently pay
out the entire primary jackpot as an annuity.
The Company introduced its Cool Millions Quarters, a quarter
denomination version of Cool Millions, in Nevada in April 1996 and in
Mississippi in June 1996. The Company's Cool Millions Quarters MSP systems
features a million coin ($250,000) initial payment on the primary jackpot,
with the balance of the jackpot paid out as an annuity.
The Company introduced both its Cool Millions and Cool Millions
Quarters games in Native American lands in August 1996. Due to decreased
play, the Company terminated the dollar denomination portion of the Cool
Millions link in Native American lands in February of 1998.
In launching its Cool Millions system, the Company depended upon
a single manufacturer to supply it with slot machines. Because the Company
did not manufacture the Cool Millions games, the Company could not modify the
games to respond to shifts in player appeal or competitive pressures which
resulted in declining interest and erosion of product performance. As a
result, the Company has decided to replace existing Cool Millions assets with
assets produced by the Company in fiscal 1998. The Company intends on only
using gaming devices manufactured by the Company for future expansion of its
MSP operations. Assets currently deployed on the Cool Millions links have no
future operational use and will be sold to third party equipment brokers. As
a result, the Company recognized a $9,548,000 restructuring charge to income
from operations in the fourth quarter of 1997 to reduce the Cool Millions
assets to the companies estimated net realizable value.
On February 5, 1996, the Company entered into an agreement (the
"CTI Agreement") with CTI, licensee of certain property rights for the
Caribbean Stud video poker game, pursuant to which the Company obtained an
exclusive five-year license from CTI to use CTI's Caribbean Stud intellectual
property rights to develop and manufacture Caribbean Stud video poker
machines for sale or lease within the United States, excluding Indiana, South
Carolina and land owned by the Grand Traverse Tribe of Michigan (the
"Territory"). The Company introduced its Caribbean Stud video poker game
link in field trial in Nevada in April 1996 and in Mississippi in September
1996. Unlike the Cool Millions MSP products, where the Company receives a
percentage of each coin wagered, the Company received only a percentage of
the progressive bets on the Caribbean Stud MSP system. The Company was
responsible for paying the primary and secondary jackpots as well as paying a
fixed royalty payment, based on the number of days each machine is in
operation, to its joint venture partner, CTI.
Due to losses attributable to lower than expected progressive
wagering, combined with the fixed nature of the royalty accruing to CTI, the
Company terminated the Caribbean Stud video poker link operations in
Mississippi and Nevada effective October 31, 1997. On November 1, 1997, the
Company surrendered the intellectual property rights in the Caribbean Stud
video poker game back to CTI. The Company is currently in arbitration with
CTI concerning several issues. See Item 3 - Legal Procedings. The gaming
machines will be 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 fair value such that no material residual
sales value is expected. As such, their carrying values have been written
down to zero through a charge of $1,104,000 which is reflected in
restructuring charges in the consolidated statement of operations.
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The Company has enhanced its MSP system software to permit its
MSP system central monitoring facilities to monitor data from multiple MSP
systems, including Cool Millions, Cool Millions Quarters and Million Coin
Poker MSP systems. The multi-game MSP system allows the Company to add new
games to existing MSP systems at a lower incremental cost by allowing one
central site to monitor MSP systems for several games.
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. There is no assurance that the Company's new products will be
accepted in the marketplace and 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, entrance into new markets,
integration of operations and personnel from new lines of business, control
of overhead expense and the addition, training and management of qualified
personnel. There is no assurance that the Company can successfully manage the
expansion of its MSP systems and other businesses.
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 had historically maintained strong business
relationships with several key casino customers including, but not limited
to, Boyd Gaming, Circus Circus Enterprises, Foxwoods, Grand
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Casinos, Mirage Resorts, Showboat and Station Casinos which have, in certain
periods, accounted for a material amount of the Company's sales. These
entities accounted for approximately 36%, 33% and 38% of the Company's total
sales during the fiscal years ended December 31, 1997, 1996 and 1995. While
each sale of 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. Sales to Station
Casinos for 1997 and 1995 and to Grand Casinos in 1996 each individually
exceed 10% of total sales. No other customers accounted greater than 10% of
total sales. 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
Company's products and services. IGT in particular enjoys a significant
domestic and international market position in the Company's primary markets,
including casino management information systems and gaming machines, and MSP
systems. In addition to its greater resources and established position in
domestic and international markets, management believes that IGT's ability to
link sales of gaming machines, casino information management systems and
placement of MSP systems provides IGT with a competitive advantage in the
development, marketing and sale of new casino management information systems,
MSP systems and gaming machines. The Company has established a meaningful
market share in casino management information systems in North America and
modest market penetration in multi-site progressives in Nevada, Mississippi
and on Native American lands.
The Company also competes with several other competitors in one
or more areas of the Company's markets, including Alliance Gaming (Bally
Gaming International), Anchor Gaming, Sigma Gaming, Universal Distributing,
Mikohn, WMS Gaming, Acres Gaming, Video Lottery Consultants, 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 25 full time sales and marketing
staff focusing on the sales of OASIS II casino management information
systems, MSP games, video poker gaming machines, and meters and signs. 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 and Tunica, 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, customers, suppliers and other third parties, license
agreements 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.
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EMPLOYEES
As of December 31, 1997, the Company had approximately 360
full-time employees, approximately 50 of whom are 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 II 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 II systems.
The gaming machines that may be developed by the Company are
defined as "gaming devices." 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 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.
9
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.
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
10
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 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.
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"),
11
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.
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 required
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
12
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, 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
s 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.
13
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 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.
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 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
14
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.
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
15
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 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
16
approval of all public offerings from the Commission and therefore is only
required to obtain the Executive Director's approval of an offering or
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 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 operation s 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
17
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 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 equipments 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:
l. 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
18
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 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.
19
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 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
In 1995, the Company completed substantial improvements to an
approximately 140,000 square foot office, production, warehouse and
distribution facility in Las Vegas, Nevada which facility is owned and fully
utilized by the Company. The Company has consolidated its administrative,
sales, engineering, research and development and Nevada MSP system support
staffs at this facility. The Company has also leased an adjacent 45,000
square foot facility which the Company's sign business occupies and an
approximate 6,000 square foot building that formerly housed its electronic
prepress services. This facility is currently used for storage.
20
The Company purchased two additional buildings adjacent to its
main facility, one of which is approximately 9,100 square feet and the other
facility is approximately 8,450 square feet. In 1997, these facilities were
utilized for field service and storage of gaming devices. Both functions have
been moved to the main facility and both buildings are being offered for sale.
The Company currently leases two additional facilities in Las
Vegas which are subleased to third parties. The Company does not expect to
renew these leases and subleases when they expire.
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. In March 1997, the Company
opened a 12,500 square foot regional office in Atlantic City, New Jersey on a
three year lease.
ITEM 3 LEGAL PROCEEDINGS
In December, 1996, a Class Action Complaint was filed in the
United States District Court, District of Nevada, by Gary A. Edwards against
the Company and certain present and former Company executives. Three
additional purported shareholder class actions were filed in 1997 in
connection with the same drop in stock price following the December 16, 1996
press release. On May 27, 1997, SCHWARTZ V. CASINO DATA SYSTEMS, was filed
in the United States District Court for the District of Nevada, alleging
violations of Sections 10(b) and 20(a) of the 1934 Act and SEC Rule 10b-5 and
seeking economic recovery on behalf of the same alleged class of investors.
On December 16, 1997, GRANT V. CASINO DATA SYSTEMS, was filed in the District
Court of the State of Nevada alleging common law fraud and seeking economic
recovery on behalf of the same alleged class of investors. On December 9,
1997, GIOVANNONI V. CASINO DATA SYSTEMS, was filed in the Superior Court of
the State of California in San Francisco alleging violation of California
Corporations Code Sections 25400 and 25500 and California Business and
Professions Code Sections 17200 and 17500. Management believes these claims
to be without merit, and intends to vigorously defend against them. In
addition, the Company maintains a policy of insurance pursuant to which it
has tendered these claims to the insurance carrier. This insurance policy
may cover all or a portion of the claims. While the outcome of the actions
described above is not presently determinable, management does not expect the
outcome will have a material adverse effect on the Company's consolidated
financial statements taken as a whole.
A patron dispute was filed against the Company which allegedly
arose while a patron played the Company's Cool Millions dollars progressive
slot machine at Splash Casino in Tunica, Mississippi. The dispute was heard
by the Mississippi Gaming Commission, who decided that the patron had won
only $5.00 rather than the jackpot of $1,742,000 as alleged by Ms. Freeman.
Ms. Freeman appealed the Commission's decision to the Circuit Court of Tunica
County. On January 16, 1998, the Court issued an Order reversing the
Commission and ordered the Company to pay the jackpot plus interest from
April 8, 1995. The Company contends the ruling is in error and has appealed
the decision to the Mississippi Supreme Court. As a result of the Circuit
Court's Order, and with the consent of the Mississippi Gaming authorities,
the Company has reduced the current Cool Millions dollar Mississippi jackpot
by $1,742,000. If successful on appeal, the Company would return this amount
to the Company's then-existing outstanding jackpot, as directed by the
Mississippi Gaming authorities. The Company has accrued $327,700 of interest
expense as of yearend toward the judgement in the event the Company loses
its appeal. While the outcome of the action described above is not presently
determinable, management does not expect the outcome will have a material
adverse effect on the Company's consolidated financial statements taken as a
whole.
In November of 1997, a customer of the Company filed for
protection under Chapter 11 of the United States Bankruptcy Code. The
pre-petition debt owed the Company is approximately $1,700,000, which amount
has been included in a Proof of Claim filed by the Company in the Bankruptcy
action. The Debtor has submitted a Plan of Reorganization to the Court that
has not yet been approved. Pursuant to the Plan of Reorganization, the
Company is treated as a secured creditor in the action. In addition, the
Company has obtained personal guarantees from certain of the principals of
the debtor. While the outcome of the Bankruptcy is not presently
determinable, management does not expect the outcome will have a material
adverse effect on the Company's consolidated financial statements taken as a
whole.
21
In August of 1997, Casino Technology, Inc. ("CTI") filed a demand for
arbitration of certain issues arising out of a Cross-License Agreement
between CTI and the Company pursuant to which the Company marketed the
Caribbean Stud video poker game. CTI alleged that the Company failed to pay
royalty fees due under the agreement. The Company has accrued approximately
$2,000,000 with respect to potential obligations arising out of this
agreement. The Company is contesting this amount because it believes it
has been damaged as a result of certain actions and/or inactions of CTI and
its principal. The Company has answered the demand for arbitration. No
arbitration date has been set yet. While the outcome of the arbitration is
not presently determinable, management does not believe the outcome will have
a material adverse effect on the Company's financial statements taken as a
whole.
The Company and its subsidiaries are also involved from time to
time in 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. 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 statements taken as a whole.
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, 1997.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY 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. The
following sale prices have been adjusted to reflect a 3 for 2 stock split
effected on February 27, 1996 to shareholders of record on February 20, 1996.
High Low
------ ------
1996
First Quarter.............................. 21.00 11.50
Second Quarter............................. 19.38 12.50
Third Quarter.............................. 20.13 12.50
Fourth Quarter............................. 20.13 6.25
1997
First Quarter.............................. 8.75 4.69
Second Quarter............................. 5.38 3.44
Third Quarter.............................. 7.63 3.38
Fourth Quarter............................. 6.88 2.50
On March 2, 1998, the last reported sale price of the common
stock was $3-3/8. As of March 2, 1998, the Company had approximately 330
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.
23
ITEM 6. SELECTED FINANCIAL DATA
The selected data presented below should be read in conjunction
with the Consolidated 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, 1997, 1996, 1995, 1994 and 1993 and "Consolidated Balance Sheet
Data" as of the end of each of the years in the five-year period ended
December 31, 1997 are derived from the consolidated financial statements of
the Company and its subsidiaries, which financial statements have been
audited by KPMG Peat Marwick LLP, independent certified public accountants.
The consolidated financial statements as of December 31, 1997 and 1996, and
for each of the years in the three-year period ended December 31, 1997 and
the report 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,
- -------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
- -------------------------------------------------------------------------------------------------------------------------------
Total revenues 54,504,203 70,870,875 32,893,502 27,297,075 11,150,029
- -------------------------------------------------------------------------------------------------------------------------------
Total costs and expenses 96,790,018 68,900,757 26,652,511 18,086,753 6,382,623
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (42,285,815) 1,970,118 6,240,991 9,210,322 4,767,406
- -------------------------------------------------------------------------------------------------------------------------------
Total other income (expense) (499,093) 5,076,656 884,917 879,833 126,728
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (42,784,908) 7,046,774 7,125,908 10,090,155 4,894,134
- -------------------------------------------------------------------------------------------------------------------------------
Income taxes (3,069,647) 2,232,192 2,394,214 3,555,000 1,626,000
- -------------------------------------------------------------------------------------------------------------------------------
Net (loss) income (1) $(39,715,261) $ 4,814,582 $ 4,731,694 $ 6,535,155 $ 3,268,134
- -------------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) (1) per common
share (1) $(2.20) $0.29 $0.35 $0.51 $.34
Diluted net (loss) income per common
share (1) $(2.20) $0.28 $0.34 $0.50 $0.33
- -------------------------------------------------------------------------------------------------------------------------------
Shares used in basic per share calculations (1) 18,043,000 16,892,000 13,572,000 12,860,000 9,697,500
Shares used in diluted per share calculations 18,043,000 17,485,000 13,876,000 13,114,000 9,807,750
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
- -------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $27,873,422 $21,482,173 $13,156,998 $14,083,024 $3,832,020
- -------------------------------------------------------------------------------------------------------------------------------
Working capital 41,513,539 58,226,061 23,136,362 29,950,318 7,678,297
- -------------------------------------------------------------------------------------------------------------------------------
Total assets 96,955,867 125,422,344 60,307,019 43,296,252 9,123,380
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities 33,329,533 22,245,801 12,239,496 1,567,190 528,055
- -------------------------------------------------------------------------------------------------------------------------------
Total term debt 2,453,993 4,482,346 4,304,004 587,911 --
- -------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 63,626,334 103,176,543 48,067,523 41,141,151 8,595,325
- -------------------------------------------------------------------------------------------------------------------------------
24
(1) The earnings per share numbers have been restated to conform to recently
issued Statement of Financial Accounting Standard No. 128 "Earnings Per Share."
25
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.
GENERAL
Casino Data Systems is a designer and manufacturer of technology-driven
products for the gaming industry. The Company was founded in 1990 to develop
and manufacture casino slot accounting systems. Since 1990, the Company has
expanded its original slot accounting system into a multi-faceted casino
floor information system. In 1992, the Company developed its first
generation of multi-site link progressive ("MSP") systems technology which
links gaming machines in different casinos to allow patrons to compete for
large, lifestyle-changing progressive jackpots. In 1993 and 1994, the
Company developed the next generation of MSP systems technology capable of
supporting a large capacity state-wide MSP system, and designed the Cool
Millions MSP system, which it launched in Mississippi in November 1994. The
Company also expanded and diversified its business and augmented its ability
to design, manufacture and customize gaming machines and MSP systems by
acquiring graphics and signs businesses in 1994 and 1995. In 1995, the
Company introduced its Cool Millions MSP system in Nevada on a test basis in
May and commenced state-wide rollout in August. The Company also established
its Video Interactive Gaming Division in 1995 to develop innovative gaming
devices. In September 1996, pursuant to a confidential settlement agreement,
in exchange for CDS and certain other companies granting back to
International Game Technology ("IGT") all their respective rights under the
Telnaes patent, IGT has granted CDS a fully paid, nontransferable (including
change of control limitation), and royalty free license under the Telnaes
patent. The Company currently uses the Telnaes Technology in its Safebuster
game, the first reel spinning gaming device manufactured and sold by the
Company. The Safebuster game is distributed jointly by the Company and
Anchor Gaming. The Company plans to use the Telnaes Technology in other reel
spinning machines and in any games that are added to its MSP systems in the
future.
The Company's strategic objective is to be the leading innovative
designer and manufacturer of a diversified line of technology-driven products
for the gaming industry. The Company has grown and diversified its product
portfolio through investment in research and development. The Company
invested $4.0 million on research and development in 1997 and $3.1 million in
1996. These investments have enabled the Company to enhance its OASIS II
system, develop a new version of its meter product, establish manufacturing
capability and to explore the creation and development of new and innovative
video interactive gaming devices of which the Company has currently has
approximately 50 video poker games and four video slot games licensed in
certain jurisdictions.
The Company sells OASIS II systems, gaming machines, meters and signs on
a cash basis, on normal credit terms (90 days or less), and over longer term
installment contracts. Revenue from OASIS II 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 II 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 called for upon completion of the
system installation. Revenue from all other products is recognized when
legal title transfers to the customer or as play occurs as is the case in the
Company's MSP products.
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.
Implementation of the plan has resulted in the recognition, for
financial reporting purposes, of changes relating to 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
26
been recognized as required by the provisions of SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED
OF. Assets to be disposed of are reported at the lower of the carrying amount
or fair value less costs to sell.
Although the restructuring plan will have a materially adverse affect on
the 1997 results of operations, management believes that the plan is
necessary in order for the Company to achieve the greatest possible
profitability in the future.
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 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 PRODUCTS
The Company intends to continue to add new software modules to further
increase the functionality of the OASIS II system. The Company is
developing a Windows compatible version of the OASIS II system and several
additional software modules. These new products will further increase the
portion of system revenues generated from software sales which could increase
the overall gross margins on OASIS II system sales. However, no assurance
can be made that the Company will successfully complete such products or that
the products will be accepted in the market place.
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 associated with the abandoned
DOS projects total $1,200,000. These costs have been written off and are
included as restructuring charge and impairment charges in the consolidated
statement of operations.
The Company's current DOS version of the OASIS-TM- II System's database
is year 2000 compliant; however, certain modules are not. The Company expects
to release an upgraded DOS version in the fourth quarter of 1998 that brings
the non-compliant modules into year 2000 compliance. In addition, the
Windows-Registered-TM- compatible version of the OASIS II System will fully
integrate all modules of the system into year 2000 compliance. There is a plan
in place to convert all OASIS II Systems being operated by customers of CDS
to a year 2000 compliant version. The Company does not anticipate these
conversions to have a materially adverse effect on operations. The Company
believes that its MSP software is year 2000 compliant. The Company believes
that its internal operating systems are year 2000 compliant.
The Company experienced a decrease in OASIS II systems sales in 1997
compared to 1996 due primarily to the lack of casino openings and a decrease
in the demand for new gaming systems. Among the key factors affecting the
receipt of new OASIS II systems orders are the rate of growth in the gaming
industry, replacement of existing systems and continued acceptance of casino
information management systems by the marketplace. For Casino Data Systems,
a key factor for future system sales will be successful completion of
development of the Windows version of the OASIS II system, which is scheduled
for Alpha testing in the second quarter of 1998. Delays in the completion of
this test could have a materially adverse effect on future system sales.
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.
27
PROGRESSIVE OPERATIONS - COOL MILLIONS
The Company introduced its first MSP system, Cool Millions, in
Mississippi in November 1994 and in Nevada in May 1995. The Company
introduced its Cool Millions Quarters product in Nevada in April 1996 and in
Mississippi in June 1996. The Company also introduced its Cool Millions and
Cool Millions Quarters products in Native American lands in August 1996. An
MSP system links slot machines at various locations electronically to a
central monitoring system operated by the Company. The Company installs Cool
Millions slot machines, signage, and required communications equipment within
each participating casino in a jurisdiction at virtually no cost to the
casino operator. The Company derives revenues from the operation of its MSP
systems by billing individual casino operators on a fixed percentage basis of
the coin-in or "handle" of the games at the respective location. The Company
maintains ownership of the Cool Millions equipment placed in casinos and
depreciates such assets over 3 to 7 years. The Company is responsible for
paying the primary and secondary jackpots awarded by the machines. The
Company pays the first million coins of the progressive jackpot immediately
and pays the remainder in an annuity.
In response to increasing competitive pressure, declining customer
interest and erosion in product performance, the Company has decided to
replace existing Cool Millions operating assets in fiscal 1998. Operation of
these links contributed $19,182,872 in revenues and $7,480,189 of gross
margin during the twelve months ended December 31, 1997. The gaming devices
have book value of $5,000,000 before recognition of any restructuring charge.
The Company plans to sell these devices to third party used equipment
dealers throughout fiscal 1998. Fair values of these gaming devices was
determined through discussion with these used gaming equipment dealers. A
charge of $4,206,000 is included in restructuring and impairment charges in
the consolidated statement of operations to reduce the book value of the
assets to their fair value.
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 have been written down to a
fair value of zero. These charges total $5,343,000 and are included in
restructuring and impairment charges in the consolidated statement of
operations.
PROGRESSIVE OPERATIONS - 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
the fixed royalty accruing to the licensor of the Caribbean Stud game
technology (CTI). The operation of this link contributed $1,944,172 in
revenue and resulted in a negative gross margin of $351,853 for the ten
months ended October 31, 1997. The Company plans to convert the gaming
machines into other video poker programs and sell them 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 have been 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.
CDS GRAPHICS & IMAGING
In the fourth quarter of 1997, the Company restructured the its Graphics
and Imaging subsidiary to eliminate all external sales operations. The
Company 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. The subsidiary's
ongoing operations will be 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 $1,500,000,
which will be disposed of during the first two quarters of fiscal 1998, have
been written down to their estimated fair value of $525,000. The fair value
was determined through discussion with used equipment brokers. 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. Finished goods inventory of $490,000 has been written down to
zero. The unamortized balance of the associated goodwill of $671,000 is not
considered recoverable and has been written down to zero. These write downs
total $2,162,000 and are included in restructuring and impairment charges in
the accompanying consolidated statement of operations.
28
TURBOPOWER SOFTWARE
In the fourth quarter, 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 II 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 has 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 charge
in the accompanying consolidated statement of operations.
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 $4,402,000 related to capitalized amounts
for payments to a third party for game enhancements that are 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 indicate that the subsidiary will not generate enough cash
to recover the $1,118,000 in goodwill net of amortization and (iii) a charge
of $520,000 related to the capitalized costs associated with a completed
module application of the OASIS II 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 cashflow or its ability to
generate cash flow in the future.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
TOTAL REVENUES
Total revenues decreased from $70,870,875 for the year ended December
31, 1996, to $54,504,203 for the same period in 1997, a decrease of
$16,366,672 or 23.1%. The decrease in total revenues is primarily attributable
to the $16,842,139 decrease in OASIS II system sales for the twelve months
ended December 31, 1997, as compared to the same period in 1996. This
decrease in revenues is primarily attributable to the decrease in new casino
openings and decrease in demand from existing casinos for new systems.
Revenues from the sale of graphics, signs, meters and software also decreased
from $8,579,701 for the year ended December 31, 1996, to $7,735,111 for the
same period in 1997 due to generally lower performance in each of those
businesses. These decreases in revenues were partially offset by the
increase in revenues from the sale of gaming machines from $2,431,698 for the
year ended December 31, 1996, to $6,327,803 for the same period in 1997. The
increase is primarily due to the increase in the number of games models
available for sale in 1997 as compared to 1996. Revenues from progressive
operations decreased from $23,703,094 for the year ended December 31, 1996,
to $21,127,043 for the same period in 1997. This decrease in primarily
attributable to the decrease in the number of games linked to the system from
1,201 at December 31, 1996, to 599 at December 31, 1997 and overall lower
levels of play on the Company's progressive games.
29
COSTS AND EXPENSES
Cost and expenses increased from $68,900,757 for the year ended December
31, 1996, to $96,790,018 for the same period in 1997, an increase of
$27,889,262. Total costs and expenses, excluding cost of goods sold,
increased as a percentage of total revenues from 43% for the year ended
December 31, 1996, to 106% for the same period in 1997. Costs and expenses,
excluding costs of goods sold and restructuring and impairment charge
increased $6,260,344 from $30,281,073 for the year ended December 31, 1996 to
$36,541,417 for the same period in 1997. Cost of goods sold increased from
$38,619,684 for the year ended December 31, 1996, to $39,211,785 for the same
period in 1997. Gross margin decreased from 46% for the year ended December
31, 1996, to 28% for the same period in 1997. The decrease in gross margin
is primarily attributable to the increase in the percentage of revenue
contributed by progressive operations and gaming machine sales, which
generally have lower gross margins than the Company's systems business and to
an inventory adjustment for obsolescence of approximately $3,500,000 taken in
the fourth quarter.
Selling, general and administrative expenses increased from $21,004,297
for the year ended December 31, 1996, to $23,306,083 for the same period in
1997, an increase of $2,301,786. The increase is primarily attributable to
an increase in the use of outside professional services. Selling general and
administrative expenses as a percentage of net revenues increased from 30%
for the year ended December 31, 1996, to 43% for the same period in 1997.
The Company expects selling, general and administrative expenses to decrease
as a percentage of revenues as greater efficiencies and economies of scale are
realized.
The provision for doubtful accounts increased from $2,792,747 for the
year ended December 31, 1996, to $3,717,389 for the same period in 1997. The
increase is primarily attributable to certain accounts receivable that have
been outstanding in excess of twelve months.
Research and development expenses increased from $3,113,599 for the year
ended December 31, 1996, to $3,958,554 for the same period in 1997, an
increase of $844,955. Research and development expenses as a percentage of
revenue increased from 4% for the year ended December 31, 1996, to 7% for the
same period in 1997. The Company will continue to invest substantial assets
in research and development as it is committed to developing and producing
technologically innovative products.
Depreciation and amortization increased from $3,370,430 for the year
ended December 31, 1996, to $5,559,391 for the same period in 1997, an
increase of $2,188,961. This increase was primarily attributable to a full
year of depreciation on the increase in assets placed in service during 1996.
The Company expects that depreciation and amortization will decrease in 1998
due to the reduction of assets related to the restructuring plan discussed
above.
OTHER INCOME (EXPENSE)
Other income (expense) is primarily comprised of net earnings on
investments, interest expense, rental income and non-recurring payments that
are not the result of normal operations. Interest and other income decreased
from $5,558,039 for the year ended December 31, 1996, to $1,712,661 for the
same period in 1997. The decrease is primarily due to a one-time settlement
payment from IGT to the Company during the third quarter of 1996. Interest
expense decreased from $481,383 for the year ended December 31, 1996 to
$324,360 for the same period in 1997 due to decreased levels of long term
liabilities. Other income (expense) also includes a non-cash charge of
$1,900,000 in 1997 for the loss on disposal of certain assets, primarily
computers and laboratory equipment, which have been disposed of.
INCOME TAXES
Income tax expense decreased from $2,232,192 for the year ended December
31, 1996, to a benefit of ($3,069,647) for the same period in 1997, a
decrease of $5,301,839. The decrease is primarily attributable to the
decrease in income from operations for the year ended December 31, 1997 as
compared to the same period in 1996.
30
NET (LOSS) INCOME
Net income decreased from $4,814,582 for the year ended December 31,
1996, to a loss of ($39,715,261) for the same period in 1997, a decrease of
$44,529,844. The decrease in net income is primarily attributable to the
impairment of assets charged to income and the restructuring plan discussed
above of totaling $21,036,816 and to the loss from operations of $21,248,999.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
TOTAL REVENUES
Total revenues increased from $32,893,502 for the year ended December
31, 1995, to $70,870,875 for the same period in 1996, an increase of
$37,977,373 or 115%. The increase in total revenues is primarily
attributable to an increase in the sale of OASIS II systems and products from
$19,351,830 for the year ended December 31, 1995, to $36,156,385 for the year
ended December 31, 1996, and the increase in MSP revenues from $8,233,125 for
the year ended December 31, 1995, to $23,703,094 for the year ended December
31, 1996. Revenues from the sale of graphics, signs and software also
increased from $5,308,547 for the year ended December 31, 1995, to $8,579,701
for the year ended December 31, 1996. Revenues from the sale of video poker
machines, a new product in 1996, totaled $2,431,695.
COSTS AND EXPENSES
Cost and expenses increased from $26,652,511 for the year ended December
31, 1995, to $68,900,757 for the same period in 1996, an increase of
$42,275,246. Total costs and expenses, excluding cost of goods sold,
increased as a percentage of total revenues from 40% for the year ended
December 31, 1995, to 43% for the same period in 1996. Cost of goods sold
increased from $13,626,488 for the year ended December 31, 1995, to
$38,619,684 for the same period in 1996. Gross profit as a percentage of
total revenues decreased from 59% for the year ended December 31, 1995, to
46% for the same period in 1996. The decrease in gross margin is primarily
attributable to an increase in the proportion of revenue provided by the
Company's MSP operations and the initial sale of video poker machines. Gross
margin from the Company's MSP operations, particularly the gross margin
related to Caribbean Stud video poker, and video poker machine sales is
generally lower than the gross margins contributed by its other products.
Gross margin from the sale of OASIS systems also decreased due to an increase
in the cost of certain components and an approximate $1,800,000 charge
related to inventory obsolescence and shrinkage. The Company anticipates a
continued decrease in its gross margin as revenues from its MSP systems
operations, sale of gaming devices and meters, signs and graphics subsidiary
account for a greater portion of the Company's total revenue.
Selling, general and administrative expenses increased from $8,878,040
for the year ended December 31, 1995, to $21,004,297 for the same period in
1996, an increase of $12,223,257. The increase is primarily attributable to
the following factors: (i) increased personnel and associated payroll and
occupancy expenses necessary to establish the CDS Games division and regional
sales and support offices, (ii) increased marketing and advertising expenses
primarily relating to the roll-out of Cool Millions Quarters and
introductions of Cool Millions products in Native American lands and (iii)
the additional selling, general and administrative expenses for the expansion
of the signs and software businesses. Selling, general and administrative
expenses as a percentage of net revenues increased from 27% for the year
ended December 31, 1995, to 30% for the same period in 1996.
The provision for doubtful accounts increased to $2,792,747 for the year
ended December 31, 1996, as compared to $88,848 for the same period in 1995.
The increase was primarily attributed to a significant receivable from a
customer that filed for bankruptcy subsequent to December 31, 1996, combined
with an overall increase in accounts receivable related to the increased
sales over the year ended December 31, 1996, compare to 1995.
Research and development expenses increased from $2,883,296 for the year
ended December 31, 1995, to $3,113,599 for the same period in 1996, an
increase of $230,303. Research and development expenses as a percentage of
total revenues decreased from 9% for the year ended December 31, 1995, to 4%
for the same period in
31
1996. The Company capitalized $641,629 of software development costs for the
year ended December 31, 1995, as compared to $2,316,395 for the same period
in 1996.
Depreciation and amortization increased from $1,272,839 for the year
ended December 31, 1995, to $3,370,430 in 1996, and increase of $2,097,591.
The increase is primarily attributable to a greater number of gaming devices
placed in service.
OTHER INCOME (EXPENSE)
Other income (expense) is primarily comprised of net earnings on
investments, interest expense, rental income, and non-recurring payments
that are not the result of normal operations. Other income increased from
$958,368 for the year ended December 31, 1995 to $5,558,039 for the same
period in 1996 due primarily to a one-time payment from International Game
Technology (IGT). Interest expense increased from $73,451 for the year ended
December 31, 1995 to $481,383 for the same period in 1996 due to increased
borrowings.
NET INCOME
Net income increased from $4,731,694 for the year ended December 31,
1995, to $4,814,582 for the same period in 1996, an increase of $82,888. Net
income as a percentage of revenues decreased from 14% for the year ended
December 31, 1995, to 7% for the same period in 1996. The decrease is
primarily attributable to (i) the charge for the provision for doubtful
accounts and inventory obsolescence and shrinkage (ii) the increase in
revenues from MSP operations and the sale of video poker machines which have
traditionally lower margins, and (iii) an increase in selling, general and
administrative costs.
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. The Company had cash
and cash equivalents of $27,873,422 at December 31, 1997, as compared to
$21,482,173 at December 31, 1996.
The Company generated $16,378,756 of cash from operations during the
year ended December 31, 1997, compared to cash used in operations of
$9,800,811 during the same period of 1996. The most significant factor
contributing to the generation of operating cash was the decrease in the
accounts receivable balance and the increase in accrued expenses, customer
deposits and slot liability.
The Company's 1997 investing activities included $1,289,011 invested in
held-to-maturity securities; $55,233 for the purchase of certain intangible
assets; $5,355,801 investment in software development; and $1,424,161 to
purchase equipment. These investment activities were funded by proceeds
from operating cash and resulted in a net decrease of $8,124,206 in cash from
investing activities. During 1997, the Company obtained $165,052 in cash from
the sale of the Company's Common Stock through its 1993 Employee Stock Option
and Compensation Plan and reduced debt by $2,028,353.
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, 1997, the Company's accrued slot liability for
its MSP systems aggregated approximately $19,500,000, 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 established segregated cash accounts aggregating approximately
$15,600,000 at December 31, 1997 to ensure availability of adequate funds to
pay this liability. The Company also has approximately $6,600,000 segregated
as of December 31, 1997, for the payment of jackpots already won. Although
statistically remote, a possibility exists that multiple jackpots may be hit
prior to the time period over which game play has generated sufficient
revenue to
32
accrue each jackpot reset amount. Such occurances could have a material
adverse impact on the Company's results of operations in the reporting period
in which the jackpots are hit.
During May 1996, the Company entered into a $20,000,000 revolving line
of credit ("line of credit") with U.S. Bank of Nevada which expires in May
1998. The line of credit is secured by the Company's accounts receivable,
inventory and general intangibles. The line of credit bears interest at a
variable rate equal to the bank's base rate, which was 8.25% at September 30,
1997. There was no amount outstanding or available under the line of credit
at December 31, 1997. Advances under the line are limited to a multiple of
the Company's earnings before interest, taxes, depreciation, and amortization
over the past four quarters and are also subject to maintenance of certain
financial covenants and ratios. The Company has reserved $5 million of this
line of credit to secure an irrevocable letter of credit pursuant to
equipment financing agreements. The equipment financing agreements are
collateralized by the related equipment and contain certain restrictive
covenants, including the requirement for a three year letter of credit
securing payment in the amount of 50% of the outstanding principal balance.
The Company has financed certain equipment under agreements for an
aggregate amount of $2,212,539. These equipment agreements are
collateralized by the related equipment and contain certain restrictive
covenants, including the requirement for a three year letter of credit
securing payment in the amount of 50% of the outstanding principal balance.
The Company's ratio of current assets to current liabilities decreased
from 6.5 to 1 at December 31, 1996 to 3.3 to 1 at December 31, 1997, while
the noncurrent liabilities to equity ratio increased from .11 to 1 at
December 31, 1996 to .24 to 1 at December 31, 1997. After eliminating the
effect of restricted cash and the related noncurrent accrued slot liability,
the Company's ratios of current assets to current liabilities and noncurrent
liabilities to equity are 2.4 to 1 and .004 to 1 at December 31, 1997. While
there can be no assurance, based on this financial position, the Company
believes it could obtain additional long-term financing in 1998 for
anticipated growth that may result in working capital additions that exceed
available cash and cash equivalents, cash to be provided by operations, and
funds available under its line of credit. However, there can be no assurance
that the Company will be able to obtain additional sources of capital during
1998.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting Standard No. 128
"Earnings Per Share" in 1997. This statement's objective is to simplify the
computation of earnings per share to make the U.S. standard for computing
earnings per share more comparable to international earnings per share
standards. This statement requires and the Company has provided restatement
of all prior period earnings per share data presented.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 130 "Reporting Comprehensive Income". This statement
requires the reporting of all components of net income by all entities that
provide a full set of financial statements. This statement is effective for
financial statements for periods beginning after December 15, 1997, including
interim periods. Management does not believe that this recently issued
standard will impact reporting of the Company's results of operations when
implemented.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 131 "Disclosures About Segment of an Enterprise and
Related Information". This statement supersedes Statement No. 14 and
provides accounting guidance for reporting information about operating
segments in annual financial statements and requires public business
enterprises to report selected information about operating segments in
interim financial reports. This statement is effective for financial
statements for periods beginning after December 15, 1997. Management believes
that this recently issued standard will result in expanded disclosure
regarding reporting the results of the Company's operations.
33
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 132 "Employers' Disclosure About Pension and Other
Postretirement Benefits." This statement amends the disclosure requirements
of Statements Nos. 87, 88 and 106. The statement requires additional
disclosure requirements to facilitate financial analysis and eliminates some
required disclosures no longer considered useful. The Statement is effective
for financial statements for periods beginning after December 15, 1997.
Management believes that this recently issued standard will not impact the
reporting of the Company's results of operations.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The foregoing discussion contains various "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Sections 21E of the Securities Exchange Act of 1934, as amended, which
represent the Company's expectations or beliefs concerning future events that
involve a number of risks and uncertainties. The actual results of
operations of the Company could differ materially from historical results of
operations and those discussed in the forward-looking statements contained
herein. Factors that could cause actual results to differ materially
include, but are not limited to, those identified in the Sections above
entitled, "Technology Risks and Certain Other Business Risks and "Item 7,
Management's Discussions and Analysis of Financial Conditions and Results of
Operations." In addition, statements containing expressions such as
"believes," "anticipates," "plans" or "expects" used in the Company's
periodic reports on Forms 10-K and 10-Q filed with the SEC are intended to
identify forward-looking statements. The Company cautions that these and
other forward-looking statements included in this report and in previously
filed periodic reports including reports filed on Forms 10-K and 10-Q are
further qualified by important factors that could cause actual results to
differ materially from those in a forward-looking statement, including,
without limitation, the following: decline in demand for gaming products or
reduction in the growth rate of new and existing markets; delays of scheduled
openings of newly constructed casinos; the effect of economic conditions; a
decline in the market acceptability of gaming; unfavorable public referendums
or anti-gaming legislation; competitive factors, such as improvements in
rival player tracking system functionality or game acceptance, timing of
software system products introductions and upgrades, timely development
implementation, production and customer acceptance of new gaming devices in a
cost effective manner, execution of the manufacturing ramp, the ability to
successfully enter new market segments and manage the growth of such
businesses, unanticipated costs or other adverse effects of changes in the
gaming industry, a decrease in the desire of established casinos to upgrade
machines in response to added competition from newly constructed casinos;
changes in player appeal for gaming products; pricing pressures; changes in
interest rates causing a reduction of investment income; loss or retirement
of key executives; approval of pending patent applications or infringement
upon existing patents; the effect of regulatory and governmental actions;
unfavorable determination of suitability by regulatory authorities with
respect to officers, directors or key employees; the limitation, conditioning
or suspension of any gaming license; the discovery of facts not presently
known to the Company or determinations 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, and other risk factors
identified from time to time in the Company's SEC filings.
34
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE
----
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-2
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 F-6
Notes to Consolidated Financial Statements F-7
FINANCIAL STATEMENT SCHEDULES AND SUPPLEMENTARY DATA
Schedule II, Valuation and Qualifying Accounts, for the years 1997, 1996
and 1995 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.
35
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors
Casino Data Systems:
We have audited the consolidated financial statements of Casino
Data Systems and subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule as listed in the accompanying
index. 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, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 1997, 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.
/S/ KPMG Peat Marwick LLP
Las Vegas, Nevada
March 24, 1998
F-1
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
DECEMBER 31,
-------------------------------
1997 1996
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents, including segregated amounts of approximately $15,600,000
and $12,000,000 in 1997 and 1996, respectively $27,873,422 $21,482,173
Investment securities, including restricted amounts of approximately
$10,926 and $440,000 in 1997 and 1996, respectively 10,926 844,303
Accounts receivable, net of allowance for doubtful accounts of
$5,390,000 and $2,367,747 in 1997 and 1996, respectively 9,682,756 20,369,624
Due from related party, net of allowance for doubtful accounts of
$500,000 in 1996 144,000 2,512,143
Current portion of notes receivable 1,392,191 3,520,542
Income tax receivable 4,000,000 1,288,561
Inventories, net of reserve of $1,125,000 in 1997 14,191,542 15,219,571
Deferred tax asset 360,000 2,261,877
Assets held for sale 879,884 --
Other current assets 1,244,076 1,265,601
----------- ------------
Total current assets 59,778,797 68,764,395
Property and equipment, net 17,735,871 35,435,854
Investment securities, including restricted amounts of approximately
$6,601,000 and $4,474,000 in 1997 and 1996, respectively 8,080,344 5,957,956
Notes receivable, excluding current portion 1,627,285 1,280,321
Intangible assets, net 6,255,731 9,539,254
Software development costs, net of accumulated amortization of
$127,936 and $54,736 in 1997 and 1996, respectively 1,954,086 2,903,288
Deposits 383,753 425,331
Deferred tax asset 1,140,000 1,115,945
----------- ------------
Total assets $96,955,867 $125,422,344
----------- ------------
----------- ------------
F-2
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion long term-debt $ 2,186,948 $ 2,032,187
Accounts payable 3,911,245 2,939,888
Accrued expenses and customer deposits 7,444,260 2,691,341
Accrued slot liability 4,722,805 2,874,918
----------- ------------
Total current liabilities 18,265,258 10,538,334
----------- ------------
Noncurrent liabilities:
Long-term debt, excluding current portion 267,045 2,450,159
Accrued slot liability 14,797,230 9,257,308
----------- ------------
Total noncurrent liabilities 15,064,275 11,707,467
----------- ------------
Commitments and contingencies
Shareholders' equity:
Capital stock, no par value. Authorized 100,000,000 shares; issued and
outstanding 18,065,897 shares in 1997 and 18,033,647 shares in 1996 83,789,500 83,624,448
Retained earnings (deficit) (20,163,166) 19,552,095
----------- ------------
Total shareholders' equity 63,626,334 103,176,543
----------- ------------
Total liabilities and shareholders' equity $96,955,867 $125,422,344
----------- ------------
----------- ------------
F-3
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
1997 1996 1995
------------ ----------- -----------
Revenues:
Systems and product sales $ 33,377,160 $47,167,781 $24,660,377
Progressive operations 21,127,043 23,703,094 8,233,125
------------ ----------- -----------
54,504,203 70,870,875 32,893,502
------------ ----------- -----------
Costs and expenses:
Cost of goods sold 39,211,785 38,619,684 13,626,488
Selling, general and administrative 23,306,083 21,004,297 8,781,040
Provision for doubtful accounts 3,717,389 2,792,747 88,848
Research and development 3,958,554 3,113,599 2,883,296
Restructuring and impairment charge 21,036,816 -- --
Depreciation and amortization 5,559,391 3,370,430 1,272,839
------------ ----------- -----------
Total costs and expenses 96,790,018 68,900,757 26,652,511
------------ ----------- -----------
(Loss) income from operations (42,285,815) 1,970,118 6,240,991
------------ ----------- -----------
Other income (expense):
Interest and other income 1,712,661 5,558,039 958,368
Loss on disposal of assets (1,887,394) -- --
Interest expense (324,360) (481,383) (73,451)
------------ ----------- -----------
Total other income (expense) (499,093) 5,076,656 884,917
------------ ----------- -----------
Income before income taxes (42,784,908) 7,046,774 7,125,908
Income tax (benefit) provision (3,069,647) 2,232,192 2,394,214
------------ ----------- -----------
Net (loss) income $(39,715,261) $4,814,582 $4,731,694
------------ ----------- -----------
------------ ----------- -----------
Basic net (loss) income per share ($2.20) $0.29 $0.35
------------ ----------- -----------
------------ ----------- -----------
Diluted net (loss) income per share ($2.20) $0.28 $0.34
------------ ----------- -----------
------------ ----------- -----------
Basic weighted average shares outstanding 18,043,000 16,892,000 13,572,000
------------ ----------- -----------
------------ ----------- -----------
Diluted weighted average shares outstanding 18,043,000 17,485,000 13,876,000
------------ ----------- -----------
------------ ----------- -----------
F-4
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
COMMON STOCK DEFERRED TREASURY RETAINED
SHARE AMOUNT DISCOUNT STOCK EARNINGS TOTAL
----------- ----------- ---------- ------------ ----------- -----------
Balance at December 31, 1994 13,905,900 $36,081,238 $(25,333) $(4,920,574) $10,005,819 $41,141,150
Issuance of common stock, pursuant
to employee stock option plan 236,590 1,162,106 -- -- -- 1,162,106
Income tax benefits derived from
exercise of stock options by grantees -- 657,240 -- -- -- 657,240
Issuance of common stock pursuant
to purchase of TurboPower
Software Company 112,500 350,000 -- -- -- 350,000
Retirement of shares held in treasury (517,500) (4,920,574) -- 4,920,574 -- --
Net income -- -- -- -- 4,731,694 4,731,694
Installment sale discount, additional
capital -- -- 25,333 -- -- 25,333
----------- ----------- --------- ----------- ----------- -----------
Balance at December 31, 1995 13,737,490 33,330,010 -- -- 14,737,513 48,067,523
Issuance of common stock, pursuant
to employee stock option plan 334,195 1,989,345 -- -- -- 1,989,345
Income tax benefits derived from
exercise of stock options by
grantees -- 1,347,120 -- -- -- 1,347,120
Issuance of common stock, pursuant
to purchase of Telnaes patent 166,962 1,733,234 -- -- -- 1,733,234
Issuance of common stock 3,795,000 45,224,739 -- -- -- 45,224,739
Net income -- -- -- -- 4,814,582 4,814,582
----------- ----------- --------- ----------- ----------- -----------
Balance at December 31, 1996 18,033,647 83,624,448 -- -- 19,552,095 103,176,543
Issuance of common stock, pursuant
to employee stock option plan 32,250 165,052 -- -- -- 165,052
Net loss -- -- -- -- (39,715,261) (39,715,261)
----------- ----------- --------- ----------- ----------- -----------
Balance at December 31, 1997 18,065,897 $83,789,500 $ -- $ -- $(20,163,166) $63,626,334
----------- ----------- --------- ----------- ----------- -----------
----------- ----------- --------- ----------- ----------- -----------
F-5
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995
------------- ------------ -------------
Cash flows from operating activities:
Net income $(39,715,261) $ 4,814,582 $ 4,731,694
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 5,559,391 3,370,430 1,272,839
Deferred income taxes 1,877,822 (2,871,741) (414,081)
Restructuring and impairment charge 21,036,816 -- --
Loss on disposal of assets 1,887,394 -- --
Installment sale discount, additional capital -- -- 25,333
Tax benefit derived from exercised options by grantees -- 1,347,120 657,240
Provision for accounts receivable 3,717,389 2,792,747 88,848
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 11,119,009 (18,675,340) (3,420,942)
Increase in income tax receivable (2,711,439) (1,288,561) --
Decrease (increase) in inventories 538,029 (9,905,161) (1,072,836)
Decrease (increase) in other current assets and deposits (42,480) 711,682 (1,571,502)
Increase in accounts payable 971,357 428,332 2,680,027
Increase in accrued expenses, customer deposits and
slot liability 12,140,729 9,475,099 3,316,850
------------- ------------ -------------
Net cash provided by (used in) operating activities 16,378,756 (9,800,811) 6,293,470
------------- ------------ -------------
Cash flows from investing activities:
Purchase of securities held to maturity (1,289,011) (6,802,259) --
Sale and maturities of securities held to maturity -- -- 5,674,895
Increase in intangible assets (55,233) (3,658,465) (1,700,810)
Investment in software development (5,355,801) (2,316,395) (641,629)
Payment for purchase of TurboPower Software Company, net of
cash acquired -- -- (600,000)
Payment for purchase of CDS Signs, Inc., net of cash -acquired -- -- (1,349,700)
Acquisitions of property and equipment (1,424,161) (16,489,321) (13,456,517)
------------- ------------ -------------
Net cash used in investing activities (8,124,206) (29,266,440) (12,073,761)
------------- ------------ -------------
Cash flows from financing activities:
Borrowings from operating line-of-credit -- 1,800,000 --
Principal payments on operating line-of-credit -- (1,800,000) --
Repayment of notes payable (2,028,353) (1,900,225) (23,934)
Proceeds from issuance of note payable -- 2,078,567 3,716,093
Net proceeds from issuance of common stock 165,052 47,214,084 1,162,106
------------- ------------ -------------
Net cash provided by financing activities (1,863,301) 47,392,426 4,854,265
------------- ------------ -------------
Net increase (decrease) in cash and cash equivalents 6,391,249 8,325,175 (926,026)
Cash and cash equivalents at beginning of year 21,482,173 13,156,998 14,083,024
------------- ------------ -------------
Cash and cash equivalents at end of year $27,873,422 $ 21,482,173 $ 13,156,998
------------- ------------ -------------
------------- ------------ -------------
F-6
CASINO DATA SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(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 Graphics and Imaging 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.
In January 1995, the Company purchased substantially all of the assets of
TurboPower Software, a Colorado sole proprietorship. TurboPower Software
designs, develops, and markets programming tools to professionals.
In September 1995, the Company purchased 100% of the outstanding voting stock
of CDS Signs, Inc. (formerly known as Fifty-Seven Corporation). CDS Signs,
Inc. designs and manufacturers both indoor and outdoor signage, primarily for
casinos.
In April 1996, CDS Graphics and Imaging Company acquired 100% of the
outstanding common stock of Imageworks, Inc. for 27,000 restricted shares of
the Company's common stock. The acquisition was accounted for as a pooling
of interests combination, and accordingly, the consolidated financial
statements for periods prior to the combination have been restated to include
the results of operations of Imageworks, Inc.
The results of operations previously reported by the separate enterprises and
the combined amounts presented in the accompanying consolidated financial
statements are summarized below:
DECEMBER 31,
------------
1995
------------
REVENUES:
Casino Data Systems and Subsidiaries $31,583,986
Imageworks, Inc. 1,309,516
------------
Combined $32,893,502
------------
------------
NET INCOME (loss):
F-7
Casino Data Systems and Subsidiaries $ 4,728,084
Imageworks, Inc. 3,610
------------
Combined $ 4,731,694
(B) CONSOLIDATION POLICY AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Casino
Data Systems, CDS Services Company, CDS Graphics and Imaging
Company, Inc., CDS Signs, Inc., TurboPower Software Company, and CDS
Gaming Company (collectively the "Company"). All significant
inter-company balances and transactions have been eliminated in
consolidation.
(C) REVENUE RECOGNITION
The Company sells Oasis II systems, gaming machines, signs, meters,
and graphics sales on normal credit terms (90 days or less) and
installment contracts (generally, less than one year). Revenue from
Oasis II 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 II 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 II system. Revenue on the sale of
signs, meters and graphics is generally recognized upon delivery.
Revenue on sale of gaming machines is recognized upon delivery for a
standard sale and when a convert to sale is executed for games on
trial. 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 in the Company's inventory until the
decision to purchase is made. CDS Gaming Company's 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, auction market
preferred stock, and short term securities with original maturities
of less than 90 days. These investments are stated at cost, which
approximates fair value.
(E) INVESTMENT SECURITIES
The Company classifies its debt and equity securities in one of
three categories: trading, available-for-sale, or held-to-maturity.
Trading securities are bought and held principally for the purpose
of selling them in the near term. Held-to-maturity securities are
those securities in which the Company has the ability and intent to
hold the security until maturity. All other securities not included
in trading or held-to-maturity are classified as available-for sale.
Trading and available-for-sale securities are recorded at fair
value. Held-to-maturity securities are recorded at amortized cost,
adjusted for the amortization or accretion of premiums or discounts.
Unrealized holding gains and losses, net of the related tax effect,
on available-for-sale securities are excluded from earnings and are
reported as a separate component of shareholders' equity until
realized. Realized gains and losses from the sale of
available-for-sale securities are determined on a specific
identification basis.
A decline in the market value of any available-for-sale or
held-to-maturity security below cost that is deemed to be other than
temporary results in a reduction in carrying amount to fair value.
The impairment is charged to earnings and a new cost basis for the
security is established. Premiums and discounts are amortized or
accreted over the life of the related held-to-maturity security as
an adjustment to yield using the effective interest method.
Dividend and interest income are recognized when earned.
F-8
(F) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosure
About Fair Value of Financial Instruments (SFAS 107) 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, 1997 and 1996, the carrying value
of all financial instruments (cash and cash equivalents, accounts
receivable, notes receivable, accounts payable, other accrued
expense 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 investments
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
and components used in gaming machines, meters, signs, and graphics
production.
(H) ASSETS HELD FOR SALE
Assets held for sale are carried at the lower of net book value or
estimated net realizable value. Depreciation is discontinued when
assets are transferred to held for sale.
(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:
Building 40 years
Furniture, fixtures and equipment 3 to 10 years
Gaming devices 3 to 7 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.
(J) INTANGIBLE ASSETS
Intangible assets consist of costs associated with the establishment
of trademarks, purchase of a patent sublicense, gaming licenses in
various jurisdictions, the excess of the purchase price over the net
assets of acquired businesses (goodwill), and the unamortized
balance of a technology release agreement, all of which are
capitalized and amortized using the straight-line or revenue
matching method over a period of 5 to 15 years.
(K) SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs when
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 $5,449,649 and $2,316,395 of software
development costs for the years ended December 31, 1997 and 1996,
respectively and, as discussed in Note 3, the Company wrote software
development costs down due to impairment analysis. The Company
amortized approximately $73,200 and $54,736 for the years ended
December 31, 1997 and 1996, respectively. Research and development
costs incurred to establish technological feasibility have been
expensed when incurred.
F-9
(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 recognition of liabilities and matching
costs and 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.
(O) NET INCOME PER SHARE
Basic and diluted 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.
(P) 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 ("APB") Opinion No. 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 Statement of Financial
Accounting Standards ("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 No. 123 also allows entities to
continue to apply the provisions of APB Opinion No. 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 No. 123 had been
applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
(Q) WARRANTY COSTS
The Company warrants its products for a period ranging from three
months to one year 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.
(R) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE
DISPOSED OF
The Company adopted the provisions of SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of, on January 1, 1996. This Statement requires that
long-lived assets and certain identifiable intangibles be reviewed
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 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. Adoption of this Statement did not have a material impact
on the Company's financial position, results of operations, or
liquidity.
(S) USE OF ESTIMATES
Management of the Company 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.
(T) RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year presentation.
(U) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting
Standard No. 128 "Earnings Per Share" in 1997. This statement's
objective is to simplify the computation of earnings per share to
make the U.S. standard for computing earnings per share more
comparable to international earnings per share standards. This
statement requires and the Company has provided restatement of all
prior period earnings per share data presented.
The Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130 "Reporting Comprehensive
Income". This statement requires the reporting of all components
of net income by all entities that provide a full set of financial
statements. This statement is effective for financial statements
for periods beginning after December 15, 1997, including interim
periods. Management does not believe that this recently issued
standard will impact reporting of the Company's results of
operations when implemented.
The Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131 "Disclosures About Segment
of an Enterprise and Related Information". This statement
supersedes Statement No. 14 and provides accounting guidance for
reporting information about operating segments in annual financial
statements and requires public business enterprises to report
selected information about operating segments in interim financial
reports. This statement is effective for financial statements for
periods beginning after December 15, 1997. Management believes
that this recently issued standard will result in expanded
disclosure regarding reporting the results of the Company's
operations.
The Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 132 "Employers' Disclosure About
Pension and Other Postretirement Benefits." This statement amends
the disclosure requirements of Statements Nos. 87, 88 and 106.
The statement requires additional disclosure requirements to
facilitate financial analysis and eliminates some required
disclosures no longer considered useful. The Statement is
effective for financial statements for periods beginning after
December 15, 1997. Management believes that this recently issued
standard will not impact the reporting of the Company's 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.
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
F-10
disposal have been recognized as required by the provisions of SFAS No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS
TO BE DISPOSED OF. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
Although the restructuring plan will have a materially adverse affect on the
1997 results of operations, management believes that the plan is necessary in
order for the Company to achieve the greatest possible profitability in the
future.
(3) 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 $14,997,449. Additionally, the Company recorded
impairment charges totaling $6,039,367. The components of the restructuring
and impairment charge which aggregates $21,036,816 are as follow:
(a) MSP SYSTEMS - CARIBBEAN STUD VIDEO POKER
The Company terminated the Caribbean Stud video poker link on
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 $1,944,172 in revenue and resulted in a negative gross
margin of $351,853 for the ten months ended October 31, 1997. The
gaming machines will be 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 fair value such that no material residual sales value is
expected. As such, their carrying values have been written down to
zero through a charge of $1,104,061 which is included in
restructuring and impairment charges in the consolidated statement
of operations.
(b) MSP SYSTEMS - COOL MILLIONS
In response to increasing competitive pressure and erosion in
product performance, the Company has decided to replace existing
Cool Millions assets in fiscal 1998. Operation of these links
contributed $19,182,872 in revenues and $7,480,189 of gross margin
during the twelve months ended December 31, 1997. The gaming
devices have book value of $5,000,058, before recognition of any
impairment charge. The Company plans to sell these devices to third
party used equipment dealers throughout fiscal 1998. Fair values of
these gaming devices was determined through discussion with these
used game equipment dealers. A charge of $4,206,000 is included in
restructuring and impairment charges in the consolidated statement
of operations to reduce the book value of the assets down to their
fair value.
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 $3,540,021, and peripheral assets with a book value of
$1,802,656, have been written down to a fair value of zero. These
charges total $5,342,677 and are included in restructuring and
impairment charges in the accompanying consolidated statement of
operations.
(c) CDS GRAPHICS & IMAGING
In the fourth quarter of 1997, the Company restructured the CDS
Graphics and Imaging subsidiary to eliminate all external sales
operations. The Company now operates the subsidiary to satisfy
internal demand only. Operation of this subsidiary contributed
$2,041,375 in revenues and resulted in a net loss of $43,000 for the
twelve months ended December 31, 1997. The subsidiary's ongoing
operations will be 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
F-11
and calls for the disposition of all equipment determined to be
nonessential in satisfying only 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
$1,448,744, which will be disposed of during the first two quarters
of fiscal 1998, have been written down to their estimated fair value
of $524,984. The fair value was determined through discussion with
used equipment brokers. 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. Finished goods inventory of
$490,000 has been written down to zero. The unamortized balance of
the associated goodwill of $671,000 is not considered recoverable
and has been written down to zero. These write downs total
$2,162,455 and are included in restructuring and impairment charges
in the accompanying consolidated statement of operations.
(d) SYSTEMS AND SERVICES SOFTWARE DEVELOPMENT COSTS
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.
Management believes that successful development of a Windows
compatible version of its OASIS II system is imperative in
sustaining or increasing sales of the OASIS II system. Capitalized
costs associated with the abandoned DOS projects total $1,199,285.
These costs have been written off and are included in restructuring
and impairment charges in the consolidated statement of operations.
(e) TURBOPOWER SOFTWARE
In the fourth quarter, the Company committed to a plan to divest its
TurboPower Software subsidiary (TurboPower). Operation of this
subsidiary contributed $1,450,037 in revenues and resulted in a net
loss of $595,439 for the twelve months ended December 31, 1997.
TurboPower was purchased in January 1995 to assist in development of
general software products and the Windows compatible version of the
OASIS II 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
has adjusted the book value of TurboPower's assets to down to their
fair value which resulted in a charge of $983,103. This charge is
included in restructuring and impairment charges in the accompanying
consolidated statement of operations.
(f) 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 $6,039,367. The impairment loss charge
is comprised of three components: (i) a charge of $4,401,500 related
to capitalized amounts for payments to a third party for game
enhancements that are significantly behind schedule and realizing
competitive, market and pricing pressure, all of which materially
jeopardize the possibility of recovering these costs, (ii) a charge
of $1,117,498 based on the cashflow projections for CDS Signs, Inc.
which indicate that the subsidiary will not generate enough cash to
recover the $1,117,498 in goodwill net of amortization and (iii) a
charge of $520,369 related to the capitalized costs associated with
a module of the OASIS II system for which the net realizable value
is zero. The SFAS 121 charge had no impact on the Company's 1997
cashflow or its ability to generate cash flow in the future.
F-12
(4) 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, 1997 follows:
AMORTIZED UNREALIZED FAIR
COST GAIN(LOSS) VALUE
---------- ---------- ----------
Securities to be held to maturity:
U.S. Government and agency securities $6,601,078 $0 $6,601,078
State and municipal securities 1,479,266 (3,979) 1,475,287
---------- ---------- ----------
$8,080,344 $(3,979) $8,076,365
---------- ---------- ----------
---------- ---------- ----------
The approximate market values of securities held to maturity at
December 31, 1997 by contractual maturity, are as follows:
FAIR VALUE
-----------
Due in one year or less $2,482,265
Due in one to five years 2,516,179
Due in five to ten years 1,331,919
Due in ten to fifteen years 1,193,496
Due in fifteen to twenty years 552,506
-----------
$8,076,365
-----------
-----------
(5) 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.
(6) INVENTORIES
Inventories consists of the following:
DECEMBER 31,
-----------------------------
1997 1996
------------ ------------
Raw Materials $ 8,507,561 $ 9,943,220
Work in process 268,770 663,340
Finished Goods 6,540,211 4,613,011
----------- -----------
15,316,542 15,219,571
Less Reserve for obsolescence (1,125,000) --
----------- -----------
$14,191,542 $15,219,571
----------- -----------
----------- -----------
Finished goods inventory includes gaming machines on trial at
various casino sites of $2,708,000 at December 31, 1997. The Company had
no games on trial at December 31, 1996.
F-13
(7) PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
1997 1996
----------- -----------
Furniture, fixtures and equipment $7,361,345 $11,182,807
Gaming devices 949,597 15,708,564
Service vehicles 553,964 548,232
Leasehold improvements 930,812 913,465
Buildings 9,671,570 9,594,540
Land 1,815,721 1,815,721
----------- -----------
21,283,009 39,763,329
Less accumulated depreciation and amortization (3,547,138) (4,327,475)
----------- -----------
$17,735,871 $35,435,854
----------- -----------
----------- -----------
The net book value of collateral for equipment financing agreements
was $2,418,091 and $4,298,000 at December 31, 1997 and 1996,
respectively.
(8) INTANGIBLE ASSETS
Intangible assets consist of the following:
DECEMBER 31,
----------------------------
1997 1996
------------ ------------
Trademarks $ 31,200 $ 31,200
Licensing costs 964,829 919,596
Goodwill resulting from the acquisition of:
CDS Graphics and Imaging Company 0 909,391
TurboPower Software Company 0 815,000
CDS Signs, Inc. 0 1,340,998
Technology release agreement 1,437,500 1,437,500
Telnaes patent 4,942,646 4,932,646
----------- -----------
7,376,175 10,386,331
Less accumulated amortization (1,120,444) (847,077)
----------- -----------
$ 6,255,731 $ 9,539,254
----------- -----------
----------- -----------
Goodwill associated with CDS Graphics and Imaging Company, TurboPower
Software Company and CDS Signs, Inc. were charged to operations in the
fourth quarter of 1997. See Note 3, Restructuring and Impairment
Charge.
(9) LONG TERM OBLIGATIONS
Long term debt at December 31, 1997 and 1996 consists of the
following:
DECEMBER 31,
----------------------------
1997 1996
----------- -----------
9.0% note payable due in monthly installments of $42,790, including
interest, with final payment of $43,235 due February 28, 1999; secured
by personal property $ 566,626 $1,007,754
9.15% note payable due in monthly installments of $115,250, including
interest, with final payment due December 29, 1998; secured by personal
property 1,317,098 2,518,936
8.75% note payable due in monthly installments of $23,221, including
F-14
interest, with final payment due March 13, 1999; secured by personal
property 328,815 567,249
11.12% note payable due in monthly installments of $9,245 including
interest, with final payment due January 1, 2000; secured by personal
property 205,552 288,504
Other unsecured notes payable 35,902 99,903
----------- -----------
Total 2,453,993 4,482,346
----------- -----------
Less current portion 2,186,948 2,032,187
----------- -----------
Long term portion $ 267,045 $2,450,159
----------- -----------
----------- -----------
Future minimum payments under equipment financing agreements are as
follow:
PAYMENTS
-----------
Year ending December 31:
1998 $ 2,323,299
1999 267,173
2000 9,315
2001 0
-----------
Total minimum payments 2,599,787
Less interest (145,794)
-----------
Present value of future minimum payments 2,453,993
Less current portion (2,186,948)
-----------
$ 267,045
-----------
-----------
During May 1996, the Company entered into a $20,000,000 revolving
line of credit("line of credit") with U.S. Bank of Nevada which
expires in May 1998. The line of credit is secured by the Company's
accounts receivable, inventory and general intangibles. The line of
credit bears interest at a variable rate equal to the bank's base
rate, which was 8.25% at December 31, 1997. There was no amount
outstanding or available under the line of credit at December 31,
1997. Advances under the line are limited to a multiple of the
Company's earnings before interest, taxes, depreciation and
amortization over the past four quarters and are also subject to
maintenance of certain financial covenants and ratios. The Company
has reserved $5 million of this line of credit to secure an
irrevocable letter of credit pursuant to other equipment financing
agreements. These equipment agreements are collateralized by the
related equipment and contain certain restrictive covenants,
including the requirement for a three year letter of credit securing
payment in the amount of 50% of the outstanding principal balance.
(10) SHAREHOLDERS' EQUITY
(A) GENERAL
Pursuant to the TurboPower Software purchase agreement, on January
18, 1995, the Company issued 112,500 shares of restricted stock
valued at $3.11 per share.
On April 15, 1995 the Board of Directors approved an increase in
the authorized common stock in the Company from 10,000,000 shares to
100,000,000 shares of no par value common stock.
Pursuant to the purchase of the Telnaes patent sublicense on
February 19, 1996, the Company issued 121,847 shares of restricted
stock valued at $10.83 per share. On April 22, 1996, the Company
F-15
issued an additional 4,615 shares of restricted stock valued at
$10.83 per share. On August 6, 1996, the Company issued a final
installment 40,500 shares of restricted stock valued at
approximately $8.97 per share.
Pursuant to the Imageworks, Inc. agreement, on July 15, 1996, the
Company issued 27,000 shares of restricted stock in exchange for
100% of the outstanding common stock of Imageworks, Inc.
In March 1996, the Company issued 3,795,000 shares of common stock
in a Secondary Public Offering at $12.75 per share.
(B) STOCK SPLITS
On January 31, 1996, the Company's Board of Directors authorized a
three-for-two stock split, effected in the form a stock dividend to
be distributed on February 27, 1996, to shareholders of record on
February 20, 1996.
All share and per share data presented have been retroactively
restated to give effect to these stock splits.
(C) 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 and
2,025,000 shares in July 1996. Stock options, stock appreciation
rights, restricted stock, deferred stock and other stock-based
awards and cash awards may be granted under the Plan.
The Plan is administered by the Stock Option Committee, which is
comprised of two of the Company's outside directors. Awards under
the Plan may be made to Company employees, including directors and
officers of and consultants to the Company, its subsidiaries and
affiliates. The Plan confers on the Stock Option Committee
discretion to determine the number and exercise price of the stock
options, which may be below the fair market value of the Common
Stock on the date granted, the term of each option, and the time or
times during the option period when the option becomes exercisable.
The grant price has been equal to the fair market value of the
Company's common stock on the date of grant for all options granted.
In April 1993, the Company filed a registration statement on Form
S-8 with the Securities and Exchange Commission to register
1,102,500 shares of its Common Stock consisting of 1,012,500
shares reserved for issuance under the Plan and 90,000 shares
reserved for options granted to two outside directors of the
Company. An S-8 covering the additional 337,500 shares issuable
under the Plan as amended was filed in September 1994. In
December 1994, the Company granted options to purchase an
aggregate 22,500 shares to two outside directors. In September
1995, a Form S-8 was filed covering 225,000 shares issuable under
the Company's 1994 Nonemployee Director Stock Option Plan. The
following table provides additional information regarding stock
options:
WEIGHTED
OPTIONS AVERAGE
--------- ---------------
Outstanding at December 31, 1994 934,537 $ 7.14
Granted 851,348 6.12
Exercised (236,590) 5.30
Canceled (349,875) 5.33
--------- ---------------
Outstanding at December 31, 1995 1,199,420 6.14
Granted 793,474 15.79
Exercised (334,195) 5.55
F-16
OPTIONS RANGE
--------- ---------------
Canceled (339,049) $11.10
--------- ---------------
Outstanding at December 31, 1996 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
--------- ---------------
--------- ---------------
The per share weighted-average fair value of stock options granted
during 1997, 1996 and 1995 was $2.50, $2.12 and $.69,
respectively, on the date of grant using the Black Scholes
option-pricing model with the following weighted-average
assumptions for 1997, 1996 and 1995: expected dividend yield of 0%
for all three years; risk free interest rate of 5.75%, 6.50% and
6.50%, respectively; and expected lives varying from one month to
three years.
The following table summarizes information about stock options
outstanding at December 31, 1997:
Weighted
Number out- average Weighted Number Weighted
Range of standing at remaining average exercisable average
exercise December 31, contractual exercise December 31, exercise
price 1997 life price 1997 price
--------- ------------ ----------- -------- ------------ --------
$3.44 317,000 2.29 years $ 3.30 238,688 $ 3.30
$3.75 285,000 4.93 years $ 3.75 -- $ 3.75
$5.00 266,025 4.39 years $ 4.93 229,775 $ 5.00
$5.33 318,778 1.31 years $ 5.33 317,276 $ 5.33
$17.63 175,687 3.21 years $13.71 92,263 $13.51
------------ ----------- -------- ------------ --------
$2.22 to
$17.63 1,362,490 2.11 years $4.75 878,002 $5.55
------------ ----------- -------- ------------ --------
------------ ----------- -------- ------------ --------
The Company applies APB Opinion No. 25 in accounting for its Plan
and, accordingly, 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 No. 123, the Company's net
income would have been reduced to the pro forma amounts indicated
below:
1997 1996 1995
------------ ----------- -----------
Net (loss) income
As reported $(39,715,216) $ 4,814,582 $ 4,731,694
Pro forma $(40,864,920) $ 3,699,727 $ 4,429,285
Pro forma net income reflects only options granted in 1997 and
1996. Therefore, the full impact of calculating compensation cost
for stock options under SFAS No. 123 is not reflected in the pro
forma net income amounts presented above because compensation cost
is reflected over the options' vesting period of three years and
compensation cost for options granted prior to January 1, 1995 is
not considered.
(D) NET INCOME PER COMMON SHARE
The following is an analysis of the components of the shares used to
compute net income per common share:
DECEMBER 31,
----------------------------------------
1997 1996 1995
---------- ---------- ----------
Numerator for diluted earnings per share--income
available to common stockholders (39,715,261) 4,814,582 4,731,694
---------- ---------- ----------
Denominator:
Denominator for basic earnings per share-
weighted average shares 18,043,000 16,892,000 13,572,000
Effect of dilutive securities-
Stock options 0 593,000 304,000
---------- ---------- ----------
Denominator for diluted earnings per share-
adjusted weighted average shares and assumed
conversions 18,043,000 17,485,000 13,876,000
---------- ---------- ----------
---------- ---------- ----------
Basic earnings per share (2.20) 0.29 0.35
---------- ---------- ----------
Diluted earnings per share (2.20) 0.28 0.34
---------- ---------- ----------
(11) INCOME TAXES
Total income tax expense for the years ended December 31, 1997, 1996
and 1995, was allocated as follows:
1997 1996 1995
----------- ----------- -----------
Tax expense on income from continuing operations $ 3,069,647 $ 2,232,192 $ 2,394,214
Shareholder's equity, tax benefit for compensation
expense for tax purposes in excess of amounts
recognized for financial reporting purposes -- (1,347,120) (657,240)
----------- ----------- -----------
$ 3,069,647 $ 885,072 $ 1,736,974
----------- ----------- -----------
----------- ----------- -----------
F-17
Income tax expense attributable to income from continuing operations
consists of:
CURRENT DEFERRED TOTAL
----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1997:
U.S. Federal $(5,252,738) 1,877,822 (3,374,916)
State 305,269 -- --
----------- ----------- -----------
(4,947,469) $ 1,877,822 $(3,069,647)
----------- ----------- -----------
----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1996:
U.S. Federal $ 4,869,334 $(2,871,741) $ 1,997,593
State 234,599 -- 234,599
----------- ----------- -----------
$ 5,103,933 $(2,871,741) $ 2,232,192
----------- ----------- -----------
----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1995:
U.S. Federal $ 2,773,295 $ (414,081) $ 2,359,214
State 35,000 -- 35,000
----------- ----------- -----------
$ 2,808,295 $ (414,081) $ 2,394,214
----------- ----------- -----------
----------- ----------- -----------
The effective income tax rate differs from the U.S. federal statutory
rate of 35% for the years ended December 31, 1997 and 1996 and 34% for
the year ended December 31, 1995, respectively, as follows:
1997 1996 1995
------------ ----------- -----------
Computed "expected" income tax expense (benefit) $(14,974,718) $ 2,466,371 $ 2,422,809
Tax exempt interest income (116,357) (366,115) (119,000)
State taxes, net of federal income tax benefit 106,844 152,489 23,100
Research and development tax credit -- -- (165,000)
Tax rate difference in carry back years 1,036,266 -- --
Change in valuation allowance 10,005,781 -- --
Other, net 872,537 (20,553) 232,305
------------ ----------- -----------
$ (3,069,647) $ 2,232,192 $ 2,394,214
------------ ----------- -----------
------------ ----------- -----------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31,
1996 and 1995 are as follows:
CHANGE IN
DEFERRED
1997 TAXES 1996
----------- ----------- -----------
Deferred tax assets:
Accrued jackpot liability $ 6,832,013 $(2,597,518) $ 4,234,495
Accrued expenses not currently deductible
for income tax purposes 230,886 (173,457) 57,429
Accounts receivable, principally due to
allowance for doubtful accounts 587,821 415,890 1,003,711
Intangible assets 4,608,423 (4,608,423) 0
Inventory 1,700,332 (1,426,482) 273,850
----------- ----------- -----------
13,959,475 (8,389,990) 5,569,485
----------- ----------- -----------
Valuation allowance (10,005,781) 10,005,781 --
F-18
----------- ----------- -----------
Net deferred tax assets 3,953,694 1,615,791 5,569,485
----------- ----------- -----------
Deferred tax liabilities:
Property and equipment, principally due to
depreciation methods 2,244,534 (554,669) 1,689,865
Intangible assets 0 425,951 425,951
Other 209,160 (133,313) 75,847
----------- ----------- -----------
Total gross deferred tax liabilities 2,453,694 (262,031) 2,191,663
----------- ----------- -----------
Net deferred tax asset $ 1,500,000 $(1,877,822) $ 3,377,822
----------- ----------- -----------
----------- ----------- -----------
Management has considered certain tax planning strategies as permitted by
SFAS No. 109.
A valuation allowance in the amount of $10,005,781 has been established.
Realization of the recorded deferred tax asset is dependent upon generating
sufficient taxable income in the future to offset future tax deductions.
Although realization is not assured, management believes it is more likely
than not that the net deferred tax asset will be realized. The amount of the
net deferred tax asset considered realizable, could be reduced in the near
term if estimates of future taxable income are reduced.
(12) 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 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 nine months ended September 30, 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 nine months ended September 30, 1997.
In September 1997, the Company and KDC reached an agreement regarding
the settlement of accounts receivable of $3,059,497 for approximately $2.4
million. 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. The promissory note bears interest
at 10% and matures on February 7, 1998. Concurrent with the settlement, the
Company terminated its business relationship with KDC.
(13) OPERATING LEASES
The Company has several non-cancelable operating leases, primarily for
office and warehouse space, that expire over the next five years. Rent
expense under operating leases was $951,499, $862,822, and $519,276, for
the years ended December 31, 1997, 1996 and 1995, respectively.
Future minimum lease payments and receipts under non-cancelable operating
leases and subleases of the building (with initial or remaining lease terms
in excess of one year) as of December 31, 1997 are as follows:
PAYMENTS RECEIPTS
----------- --------
Year ending December 31:
1998 $ 769,127 $ 40,130
1999 675,672 0
2000 520,354 0
2001 368,257 0
2002 252,888 0
----------- --------
Total minimum lease payments $ 2,586,298 $ 40,130
(14) EMPLOYEE BENEFIT PLAN
Effective January 1, 1996, the Company adopted a 401(k) Plan (Plan)
qualified under Section 401 of the Internal Revenue Code of 1986. 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 $9,500 in 1997.
The Company may elect to make profit sharing contributions to the Plan.
During 1997, the Company did not elect to make a contribution to the Plan.
F-19
(15) SALES TO PRINCIPAL CUSTOMERS
Sales to principal customers as a percentage of total revenues for the
years ended December 31, 1997, 1996, and 1995, are as follow:
1997 1996 1995
---- ---- ----
Circus Circus Enterprises 1% 5% 3%
Boyd Gaming 2 - 8
Grand Casinos 7 13 6
Stations Casinos 16 6 16
Kiland Distributing Corporation - 3 5
Mirage 2 6 -
Showboat 8 - -
Other 64 67 62
---- ---- ----
100% 100% 100%
---- ---- ----
---- ---- ----
(16) COMMITMENTS AND CONTINGENCIES
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 when the winning combination is hit. The base
component is 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 recognition of
liabilities and matching costs and revenues. The possibility exists that
the winning combination may be hit before the Company has fully accrued the
base component, at which time any unaccrued portion would be expensed. The
unaccrued slot liability at December 31, 1996 was approximately $2,300,000
and there was no unaccrued slot liability at December 31, 1997. In
connection with the accrued slot liability and in accordance with gaming
requirements, the Company has established segregated cash accounts
aggregating approximately $15,600,000 and $16,474,000 at December 31, 1997
and 1996, respectively, to ensure adequate funds are available to pay this
liability. The Company also has approximately $6,600,000 segregated for
the payment of jackpots already won at December 31, 1997.
The Company has purchase agreements with various suppliers of electronic
components. Subject to the supplier's quality and performance, the
purchases covered by these agreements approximates $250,000 at December 31,
1997, all of which will be filled in the current period.
In November 1996, the Company entered into an agreement with a third party
requiring that the Company pay $330,000 in monthly installments through
March 1998 in exchange for the enhancement of certain aesthetic qualities
of existing and future products. Due to issues related to performance
under the agreement, as of January 1998 all remaining payments were placed
on hold pending delivery of completed product.
The Company's current DOS version of the OASIS-TM- II System's database
is year 2000 compliant; however, certain modules are not. The Company
expects to release an upgraded DOS version in the fourth quarter of 1998
that brings the non-compliant modules into year 2000 compliance. In
addition, the Windows-Registered Trademark- compatible version of the
OASIS II System will fully integrate all modules of the system into year
2000 compliance. There is a plan in place to convert all OASIS II
Systems being operated by customers of CDS to a year 2000 compliant
version. The Company does not anticipate these conversions to have a
materially adverse effect on operations. The Company believes that its
MSP software is year 2000 compliant. The Company believes that its
internal operating systems are year 2000 compliant.
In December, 1996, a Class Action Complaint was filed in the United States
District Court, District of Nevada, by Gary A. Edwards against the Company
and certain present and former Company executives. Three additional
purported shareholder class actions were filed in 1997 in connection with
the same drop in stock price following the December 16, 1996 press release.
On May 27, 1997, SCHWARTZ V. CASINO DATA SYSTEMS, was filed in the United
States District Court for the District of Nevada, alleging violations of
Sections 10(b) and 20(a) of the 1934 Act and SEC Rule 10b-5 and seeking
economic recovery on behalf of the same alleged class of investors. On
December 16, 1997, GRANT V. CASINO DATA SYSTEMS, was filed in the District
Court of the State of Nevada alleging common law fraud and seeking economic
recovery on behalf of the same alleged class of investors. On December 9,
1997, GIOVANNONI V. CASINO DATA SYSTEMS, was filed in the Superior Court of
the State of California in San Francisco alleging violation of California
Corporations Code Sections 25400 and 25500 and California Business and
Professions Code Sections 17200 and 17500. Management believes these
claims to be without merit, and intends to vigorously defend against them.
In addition, the Company maintains a policy of insurance pursuant to which
it has tendered these claims to the insurance carrier. This insurance
policy may cover all or a portion of the claims. While the outcome of the
actions described above is not presently determinable, management does not
expect the outcome will have a material adverse effect on the Company's
consolidated financial statements taken as a whole.
A patron dispute was filed against the Company which allegedly arose while
a patron played the Company's Cool Millions dollars progressive slot
machine at Splash Casino in Tunica, Mississippi. The dispute was heard by
the Mississippi Gaming Commission, who decided that the patron had won only
$5.00 rather than the jackpot of $1,742,000 as alleged by Ms. Freeman. Ms.
Freeman appealed the Commission's decision to the Circuit Court of Tunica
County. On January 16, 1998, the Court issued an Order reversing the
Commission and ordered the Company to pay the jackpot plus interest from
April 8, 1995. The Company contends the ruling is in error and has
appealed the decision to the Mississippi Supreme Court. As a result of
the Circuit Court's Order, and with the consent of the Mississippi Gaming
authorities, the Company has reduced the current Cool Millions dollar
Mississippi jackpot by $1,742,000. If successful on appeal, the Company
would return this amount to the Company's then-existing outstanding
jackpot, as directed by the Mississippi Gaming authorities. The Company
has accrued $327,700 of interest expense as of yearend toward the
judgment in the event the Company loses its appeal. While the outcome of
the action described above is not presently determinable, management does
not expect the outcome will have a material adverse effect on the
Company's consolidated financial statements taken as a whole.
In November of 1997, a customer of the Company filed for protection under
Chapter 11 of the United States Bankruptcy Code. The pre-petition debt
owed the Company is approximately $1,700,000, which amount has been
included in a Proof of Claim filed by the Company in the Bankruptcy action.
The Debtor has submitted a Plan of Reorganization to the Court that has not
yet been approved. Pursuant to the Plan of Reorganization, the Company is
treated as a secured creditor in the action. In addition, the Company has
obtained personal guarantees from certain of the principals of the debtor.
While the outcome of the Bankruptcy is not presently determinable,
management does not expect the outcome will have a material adverse effect
on the Company's consolidated financial statements taken as a whole.
In August of 1997, Casino Technology, Inc. ("CTI") filed a demand for
arbitration of certain issues arising out of a Cross-License Agreement
between CTI and the Company pusuant to which the Company marketed the
Caribbean Stud video poker game. CTI alleged that the Company failed to
pay royalty fees due under the agreement. The Company has accrued
approximately $2,000,000 with respect to potential obligations arising out
of this agreement. The Company is contesting this amount because it
believes it has been damaged as a result of certain actions and/or
inactions of CTI and its principal. The Company has answered the demand
for arbitration. No arbitration date has been set yet. While the outcome
of the arbitration is not presently determinable, management does not
believe the outcome will have a material adverse effect on the Company's
financial statements taken as a whole.
The Company and its subsidiaries are also involved from time to time in
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. 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 statements taken as a whole.
F-20
(17) SUPPLEMENTAL FINANCIAL INFORMATION
(A) CASH FLOW INFORMATION
During the year ended December 31, 1996, the Company issued
approximately 166,962 shares of restricted stock valued at $1,733,234
pursuant to the purchase of Telnaes patent.
Payments for interest expense for the years ended December 31, 1997,
1996 and 1995 were approximately $324,360, $481,382, and $73,451,
respectively.
Payments for income taxes for the years ended December 31, 1997, 1996 and
1995 were approximately $0, $5,039,195, and $1,792,014, respectively.
(B) OTHER INCOME
During 1996, the Company and International Game Technology (IGT) entered
into a multi-faceted agreement which included a substantial one-time cash
payment by IGT to the Company, which is reflected in other income.
(18) FOURTH QUARTER CHARGES
The Company recorded various restructuring and impairment charges during
the fourth quarter of 1997, see Note 3, Restructuring and Impairment. In
addition to these charges, the Company recorded the following: (i) an
inventory adjustment of $3,645,514, (ii) an increase to the allowance for
doubtful accounts of $2,894,000, (iii) loss on disposal of assets primarily
related to computers and laboratory equipment of $ 1,887,000 and (iv) a
valuation allowance sufficient to offset certain deferred tax assets as of
December 31, 1997 which resulted in a charge to earnings of $10,005,781 which
offsets $13,075,428 of tax benefits recorded during the year resulting in a
net tax benefit of $3,069,647 for the year. In management's opinion, the
impact on the first three quarters of these charges recorded in the fourth
quarter of 1997 is not material.
(19) SUBSEQUENT EVENT
Subsequent to December 31, 1997, the Company offered for sale, two
facilities previously utilized by field service personnel and for storage.
The Company expects to sell the facilities for amounts exceeding their
carrying value.
F-21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS:
Reference is made to the Index to Financial Statements and Related
Information under Item 8 in Part II hereof where these documents
are listed.
(a)(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULE:
Schedule II - Valuation and Qualifyinng Accounts
(a)(3) EXHIBITS
Exhibit Description
- ------- -----------
3.1 Articles of Incorporation, as amended (incorporated herein by reference to
the Company's Form 10K for the year ended December 31, 1994).
3.2 By-laws (incorporated herein by reference to the Company's registration
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 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 to the Registrant's Proxy Statement dated June 13, 1995).+
10.3 Employment Agreement dated as of January 1, 1996 between Steven Weiss and
Casino Data Systems.*+
10.4 Cross-License and Development Agreement dated as of February 5, 1996.*
10.5 Employment Agreement dated as of January 27, 1997 between Diana L.
Bennett and Casino Data Systems*+
10.6 Employment Agreement dated as of November 26, 1997 between Kenneth
S. Hardesty and Casino Data Systems+
10.7 Employment Agreement dated as of January 13, 1998 between Michael
J. Perez and Casino Data Systems+
10.8 Letter of Intent Agreement dated November 22, 1996 between Casino
Data Systems amd Prolific Publishing Inc.**
22 Subsidiaries of the Registrant.*
24.1 Consent of KPMG Peat Marwick LLP.
27.1 Financial Data Schedule
27.2 Financial Data Schedule
* Incorporated by reference to the Company's Registration Statement on Form
S-3 (File No. 333-1114)
** Incorporated by reference to the Company's Form 10-K for the fiscal year
ended December 31, 1996
+ Executive Compensatory Plan or Arrangement
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
58
FORM 10-K
CASINO DATA SYSTEMS AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Balance at Charged to Charged Balance at
beginning cost and to other end of
of the year expenses accounts Deductions the year
----------- ----------- ---------- ------------ ------------
Year ended at December 31, 1997:
Allowance for doubtful accounts
(deducted from accounts receivable) $2,867,747 $3,717,389 $ -- $ 1,195,136 $5,390,000
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Allowance for obsolescence
(deducted from inventory) $ -- $1,125,000 $ -- $ -- $1,125,000
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Year ended at December 31, 1996:
Allowance for doubtful accounts
(deducted form accounts receivable) $88,848 $2,792,747 $ -- $ (513,848) $2,867,747
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Allowance for obsolescence
(deducted from inventory) $ -- $ -- $ -- $ -- $ --
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Year ended December 31, 1995
Allowance for doubtful accounts
(deducted from accounts receivable) $ -- $ 88,848 $ -- $ -- $ 88,848
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Allowance for obsolescence
(deducted from inventory) $ -- $ -- $ -- $ -- $ --
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
59
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
CASINO DATA SYSTEMS
By: /s/ Kenneth S. Hardesty
-------------------------
Kenneth S. Hardesty
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
registration statement has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Steven A. Weiss Chairman of the Board and March 30, 1998
- ---------------------------- President, Research and
Steven A. Weiss Development Division
/s/ Kenneth S. Hardesty Chief Executive Officer and March 30, 1998
- ---------------------------- and Director (principal
Kenneth S. Hardesty executive officer)
/s/ Diana L. Bennett President, Chief Operating March 30, 1998
- ---------------------------- Officer and Director
Diana L. Bennett
/s/ Michael J. Perez Senior Vice President and Chief March 30, 1998
- ---------------------------- Financial Officer
Michael J. Perez (principal financial and
accounting officer)
/s/ William M. Mower Director March 30, 1998
- ----------------------------
William M. Mower
/s/ Phil Bryan Director March 30, 1998
- ----------------------------
Phil Bryan
/s/ Russell C. Mix Director March 30, 1998
- ----------------------------
Russell C. Mix
60