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| SHFL > SEC Filings for SHFL > Form 10-Q on 9-Sep-2009 | All Recent SEC Filings |
9-Sep-2009
Quarterly Report
There are statements herein which are forward-looking statements that are based on management's beliefs, as well as on assumptions made by and information available to management. We consider such statements to be made under the safe harbor created by the federal securities laws to which we are subject, and, other than as required by law, we assume no obligation to update or supplement such statements. These statements can be identified by the fact that they do not relate strictly to historical or current facts, and are based on management's current beliefs and expectations about future events, as well as on assumptions made by and information currently available to management. These forward-looking statements include statements that reflect management's beliefs, plans, objectives, goals, expectations, anticipations, and intentions with respect to our financial condition, results of operations, future performance and business, including statements relating to our business strategy and our current and future development plans. When used in this report, words such as "anticipate," "believe," "estimate," "expect," "intend," "project," "plan," "predict," "might," "may," "could," and similar expressions or the negative thereof, as they relate to us or our management, identify forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A,"Risk Factors." The following discussion should be read in conjunction with "Item 8. Financial Statements and Supplementary Data" in the Annual Report on Form 10-K ("Form 10-K") filed on January 14, 2009 and the condensed consolidated financial statements and notes hereto included elsewhere in this Form 10-Q. All information presented herein is based on our fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended in October and the associated quarters of those fiscal years. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Overview
We develop, manufacture and market technology and entertainment-based products for the gaming industry for placement on the casino floor. We specialize in providing casino and other gaming customers with products and services that improve their speed, profitability, productivity and security. We offer our products worldwide in markets that are highly regulated. We manufacture our products at our North American headquarters and manufacturing facility in Las Vegas, Nevada, as well as at our Australian headquarters and manufacturing facility in Milperra, New South Wales, Australia. In addition, we outsource the manufacturing of certain of our sub-assemblies in the United States, Europe and Australasia.
Our business is segregated into the following four product segments: Utility, Proprietary Table Games ("PTG"), Electronic Table Systems ("ETS") and Electronic Gaming Machines ("EGM"). Each segment's activities include the design, development, acquisition, manufacture, marketing, distribution, installation and servicing of a distinct product line.
See Note 1 to our condensed consolidated financial statements for a more detailed discussion of our four segments.
Strategy
We are proud of the products that we develop and market and believe we can have continued growth and expansion. To that end, we have devised and are implementing the following ongoing strategic plan:
Develop a true "strategic partner" relationship with our customers
To partner with our customers in order to provide enhanced efficiencies and maximize profitability on the casino floor.
A continuing emphasis on leasing versus selling
We intend to continue executing this strategy primarily in North America although we will implement modest leasing programs in other parts of the world.
Continued development of technology to drive new products across all product lines
This includes our card reading shoes and shufflers, shuffler interface with table systems, table game progressive systems and development of new titles for all of our e-Table platforms on a worldwide basis.
An effort to increase the return from existing assets already in the field by adding new value elements
This includes the replacement cycle for our shufflers, shuffler interface with table systems, table game progressive systems, table game felt-based bonuses and other side bets and proprietary add-ons to existing e-Table gaming products.
Value engineering to reduce manufacturing costs across all product lines
Our focus is currently on savings attributable to component parts, product redesign and lower cost manufacturing opportunities.
A continuing commitment to reduce expenses throughout the Company without compromising the quality of our products or service
Our goal is to reduce expenses through cost savings initiatives as well as thoroughly examining our infrastructure to improve our operating margins without compromising the quality of our products or service.
Current Economic Environment
The gaming industry in both the United States and abroad has been particularly affected by the downturn in general worldwide economic conditions, which has had negative consequences on our results for the three and nine months ended July 31, 2009, and is likely to continue to have a negative impact throughout fiscal 2009. The activity in the credit markets and in the broader global economy and financial markets has exacerbated these trends and consumer confidence has been significantly impacted, as seen in broader economic activities such as declines in auto and other retail sales, the weakness in the housing market and increased unemployment.
As a result, the outlook for the gaming, travel and entertainment industries both domestically and internationally remains highly uncertain. Due to disruptions in the financial markets, gaming operators have been less able to secure financing for development projects and have scaled back such projects considerably. Customers have made significant cuts in expenditures, including layoffs of workers and management employees as well as delayed expansions or new openings. For example, domestically, Nevada's Gaming Control Board has reported record decreases in winnings during 2009. Additionally, auto traffic into Las Vegas and air travel to McCarran International Airport has declined, resulting in lower casino volumes. Internationally, casino revenues in Macau have decreased and casino openings are expected to decrease significantly in 2009. Additionally, Chinese authorities have placed restrictions on travel to Macau for residents of mainland China, which may impact the gaming industry in Macau. The European market has also shown declines due to the deterioration of their credit markets, the impact of smoking bans in key gaming jurisdictions and to a lesser extent, the dissolution of the Russian gaming market due to regulatory changes. Our exposures to these economic conditions are not limited to these jurisdictions mentioned above, as they are used for example purposes only. These economic conditions may cause both our domestic and international customers to decrease their expenditures on gaming equipment and our financial condition, results of operations and stock price may be negatively affected as a result.
We believe that our products provide cost advantages for casino operators and that demand for our products may be enhanced by the need for our customers to reduce their operating costs. However, we have experienced certain pricing pressures and have provided customer discounts consistent with others in the gaming, travel and entertainment industries during the current economic downturn. We are being aggressive in working with our customers to maximize the contribution of our products to their continued profitability.
Sources of Revenue
We derive our revenue from the lease, license and sale of our products and by providing service to our installed base. Consistent with our strategy, we continue to emphasize the leasing of our products. When we lease or license our products, we generally negotiate a month-to-month operating lease or license fee, which includes a service component. When we sell our products, we offer our customers a choice between a sale, a longer-term sales-type lease or other long-term financing. We also offer a majority of our products for sale with an optional parts and service contract.
The following points should be noted as they relate to our strategy to emphasize leasing over selling as this strategy can differ by segment and geography:
· We expect to continue to increase our lease revenues in our Utility segment within the United States. As it relates to geography, we expect to continue to realize a large proportion of our Utility revenues outside of the United States from sales rather than leases. This segment has a planned replacement cycle which will always drive a fair amount of sales activity in any one period.
· Our leasing model is strongest in our PTG segment. We have already experienced strength in our leasing model in the United States. We are looking to expand our proprietary table games in other parts of the world where the current penetration of proprietary table games is lower.
· We expect to continue to increase our lease revenues in our ETS segment within the United States. Geographically, we expect to continue to realize a large proportion of our ETS revenues outside of the United States from sales rather than leases.
· Our EGM segment is predominantly a sales model and we expect to continue to realize substantially all of our EGM revenues from sales of EGMs in our primary market, Australasia.
· To assist us with our strategy to encourage leasing, we have increased the retail sales price of many of our products across the Utility, PTG and ETS segments such that we believe a large proportion of our customers are inclined to lease rather than purchase our products.
Currently, Utility segment revenue is derived substantially from our automatic card shufflers. In addition to leasing shufflers, we also sell and service them. In the PTG segment, the majority of games placed are licensed to our customers, which provides us with royalty revenue. In the ETS segment, we derive revenue from leases, sales and service contracts. In the EGM segment, we derive revenue from selling the full EGM complement and conversion kits which allow existing EGM terminals to be converted to other games on the PC3 and PC4 platforms.
Expenses
Our direct expenses primarily include cost of products sold, depreciation of leased assets, amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation. Indirect expenses include other costs directly identified with each segment, such as research and development, product approval costs, product-related litigation expenses, amortization of patents and other product-related intellectual property, sales commissions and other directly-allocable sales expenses. We continue to devote significant research and development ("R&D") efforts on the development of our next generation shuffler products, such as the one2six Plus™, our card recognition products, as well as other table accessories, such as the i-Shoe™ Auto and i-Score™. With our expansion into the e-Table markets, we continue to spend significant R&D dollars on developing and implementing new game concepts, such as the i-Table™, our newest e-Table that combines a variety of our products to create an exciting new table game experience. Finally, we have incurred significant R&D expense related to the operating system upgrades from the PC3 to the PC4 platforms for Vegas Star®, Rapid Table Games™ and EGMs. We believe that one of our strengths is identifying new product opportunities, as well as refining current products. We expect to continue to spend a significant portion of our annual revenue on R&D.
The amounts classified as unallocated corporate expenses consist primarily of costs related to overall corporate management and support functions. These include costs related to executive management, accounting and finance, general sales support, legal and compliance costs, office expenses, and other amounts for which allocation to specific segments is not practicable.
We have made significant reductions in our infrastructure costs to improve our overall operating margins. We generally expect to support our growing global business using an infrastructure similar to that in place currently. However, as our operations expand and our revenues grow, we will expect some increases in the infrastructure costs. Our goal is to maintain or exceed our existing operating margins.
Gross Margin
The number and mix of products placed and the average lease or sales price are
the most significant factors affecting our gross margins. Our continued emphasis
on leasing versus selling, the shift in product mix, timing of installations and
related upfront installation charges, as well as increases in non-cash
depreciation and amortization expenses attributable to our acquisitions have
impacted our margins.
In general, lease gross margin is greater than the sales gross margin for the same products. However, total gross profit on leased assets will be lower in a given reporting period than those of a sale due to the much higher price of a sale versus a lease. For example, in our PTG segment, certain proprietary table games warrant a higher average lease price than a PTG bonusing add-on such as a felt side bet or a progressive. For Utility products, when a new shuffler is introduced into the market, we use introductory lease pricing. This is consistent with our rollout strategy whereby we provide very favorable lease rates at the inception of a lease to entice the customer to try our new product. We expect the impact of introductory pricing to have a short-term impact on our margins. Notwithstanding the factors that can impact our gross margins during any given period, lease margins are generally greater than the sales margins for the same product. Accordingly, we anticipate that gross margins will increase under our leasing model. Our segments are all burdened with certain fixed amortization, so margins can vary depending on the amount of revenue in a segment for each period.
Our product pricing strategy reflects our desire to shift to a leasing model from a sales model. We have increased the sales price of certain products such that a large proportion of our customers are inclined to lease rather than purchase our products. Our leasing strategy is primarily focused in the United States, in that many foreign customers prefer to purchase rather than lease product as it is a customary business practice. Last, our pricing strategy recognizes that our Utility products are always subject to sales activity as part of our "replacement cycle" whereby we sell our prior generation shufflers before the introduction of our next generation product. We sell and less often lease refurbished products which command lower average sales or lease prices than new products.
In addition to the leasing versus selling strategy, we expect to improve our gross margins through value engineering to reduce manufacturing costs. Our focus is currently on savings attributable to component parts, product redesign and lower cost manufacturing opportunities.
The following table presents our various revenues and expenses as a percentage of revenue:
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