Summary of SHFL ENTERTAINMENT INC.

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

The following is a discussion and analysis of our financial condition, results of operations and liquidity and capital resources as of October 31, 2012 and 2011 and for the fiscal years ended October 31, 2012, 2011 and 2010. This discussion should be read together with our audited consolidated financial statements and related notes included in "Item 8. Financial Statements and Supplementary Data" included in this Annual Report on Form 10-K ("Form 10-K"). Some of the information contained in this discussion includes forward-looking statements that involve risks and uncertainties; therefore our "Special Note Regarding Forward-Looking Statements" and "Risk Factors" should be reviewed for a discussion of important factors that could cause actual results to differ materially from the results described in, or implied by, such forward-looking statements.

OVERVIEW

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

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

Sources of Revenue

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

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

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

Utility

· We expect to continue increasing lease revenues in our Utility segment within the United States. One of the current growth drivers for this segment has been the MD3 shuffler upgrade initiative. We expect the next revenue driver to be our new Deck Mate 2 shuffler. The MD3 shuffler is our next generation upgrade for the legacy MD series shufflers. As the MD1 shuffler reaches its end of life where replacement parts will no longer be available, our strategy is to encourage our customers to upgrade the MD1 and MD2 shufflers, both leased and previously sold, with the MD3 shuffler. Our objective is that the majority of these placements will be leases.

· We expect to continue seeing volatility in sales revenue in our Utility segment. While we encourage leasing outside the United States, a large majority of our international Utility product placements historically have been sales. We are starting to see increased lease activity in international markets such as Asia and Latin America. Growth drivers for the Utility segment outside the United States are new jurisdictional openings, the expansion of existing markets, and growing demand for greater security and sophistication in existing casinos.

Proprietary Table Games

· The majority of our PTG segment revenue is derived from royalties and leases. While we have a strong leasing presence in the United States, we are constantly looking to expand our proprietary table games in other parts of the world where the current penetration of proprietary table games is lower. With global gaming expansion, most notably in Asia, we have recently seen some successes with new lease placements of our premium table games as well as progressives and side bets.

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

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

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

· We have successfully sought enforcement and remedies against parties that infringed our intellectual property and will continue to do so in legalized markets where legal systems and availability of cost-effective remedies are available to us.

Electronic Table Systems

· Although we continually pursue opportunities to increase lease revenues in our ETS segment within the United States, the nature of the gaming landscape has gradually evolved whereby there are fewer racinos and electronic-only markets and more live gaming markets. As a result, we have seen some of our leased ETS products returned from those electronic-only markets as some states have approved live table games. While this has caused some setbacks in the growth of our domestic ETS business, we have been able to return some of these products to service in other markets such as Latin America and even position these products as low-denomination, labor-free alternatives to live tables in live markets. However, the live market placements typically do not perform to the same revenue and profitability levels as units in electronic-only markets.

· Through development of new products and enhancements of our existing products we expect to generate revenue and growth for the ETS segment. New products include the following:

o In Australia and Asia, we have begun generating revenue from placements of our new multi-game feature on Rapid Table Games, which offers enhanced live statistics at the touch of a button and allows the player to choose between multiple games. Similarly, we recently debuted Rapid Fusion, which takes the multi-game concept one step further by enabling concurrent wagering.

o We recently upgraded the Vegas Star platform to offer modular 22-inch widescreen terminals, new graphic displays, and a variety of configurable options such as Vegas Star Live Roulette, which incorporates a live wheel.

o The i-Table and i-Table Roulette combine an electronic betting interface with a live table game and graphically-enhanced central display touchscreens. We expect these products to provide us with growth opportunities in domestic and international markets if they achieve customer and player acceptance.

Electronic Gaming Machines

· Our EGM segment is primarily a sales model and we expect to continue to realize the majority of our EGM revenues from sales of EGMs in the global marketplace, such as Australia, Asia, and other markets that make strategic sense.

· We expect that EGM revenue and placements in fiscal 2013 will continue above 2012 levels primarily driven by new game content and enhancements, continued momentum in emerging markets, and global market expansion. We also expect revenue and placements to increase through the continued use of long-term financing arrangements.

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

· We also expect global growth in markets such as Asia, Latin America and the United States. In the current year, we have grown our footprint in Mexico, Latin America, the Philippines and Macau.

Expenses

Cost of sales and service and cost of leases and royalties primarily include the cost of products sold, depreciation of leased assets, amortization of product-related intangible assets, service, manufacturing overhead, shipping and installation. Operating expenses allocated to segments include other costs directly identified with each segment, such as R&D, product approval costs, product-related litigation expenses, product management, sales commissions and other directly-allocable sales expenses. We continue to expend significant efforts on the development of our next generation products and product enhancements in each segment, which includes development of our online delivery platform, online versions of our table games, social gaming and mobile applications. Efforts related to product licensing and infrastructure are also included in operating expenses allocated to segments, which in the current year includes the licensing and startup expenses related to our iGaming offices in Gibraltar.

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

Gross Margin

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

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

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

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

· persuasive evidence of an arrangement exists;

· the price to the customer is fixed and determinable;

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

· collection is reasonably assured.

Revenues are reported net of incentive rebates and discounts. Amounts billed prior to completing the earnings process are deferred until revenue recognition criteria are met. Our standard sales contracts do not contain right of return provisions and we have not experienced significant sales returns. Therefore we have not recorded an allowance for sales returns.

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

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

Multiple element arrangements - Some of our revenue arrangements contain multiple deliverables, such as a product sale combined with a service element or the delivery of a future product. We allocate revenues among multiple deliverables in a multi-element arrangement, based on relative selling prices. In order of preference, relative selling prices will be estimated based on vendor specific objective evidence ("VSOE"), third-party evidence ("TPE"), or management's best estimate of selling price ("BESP").

When VSOE or TPE is not available, BESP is the amount we would sell the product or service for individually. The determination of BESP is made based on our normal pricing and discounting practices, which consider multiple factors, such as market conditions, competitive landscape, internal costs and profit objectives. Generally, revenues allocated to future performance obligations elements are deferred and will be recognized upon delivery and customer acceptance.

Goodwill and other indefinite lived intangible assets. We do not renew or extend the term of our intangible assets. We review our goodwill for impairment annually in October or when circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The goodwill impairment analysis may start with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the qualitative factors, we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we do not perform a qualitative assessment, we will perform a two-part impairment test. In the first step, we use a discounted cash flow model (income approach) and the Guideline Public Company Model (market approach) to assess the fair values of our reporting units, which are the same as our operating segments. These two methodologies are weighted equally to determine the reportable segment fair value. The fair value of the reporting unit is then compared to the book value of the reporting unit, including its goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired. If the fair value is less than the book value, we perform a second step to compare the implied fair value of the reporting unit's goodwill to its book value. The implied fair value of the goodwill is determined based on the estimated fair value of the reporting unit less the fair value of the reporting unit's identifiable assets and liabilities. We record an impairment charge to the extent that the book value of the reporting unit's goodwill exceeds its fair value.

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

As of October 31, 2012 and 2011, our goodwill totaled $85.0 million and $85.4 million, respectively. For the Utility, PTG and EGM reporting units our fiscal 2012 annual goodwill impairment analysis included an assessment of certain qualitative factors including, but not limited to, the results of the prior year fair value calculation, the movement of our share price and market capitalization, overall financial performance, and macro-economic and industry conditions. We considered the qualitative factors and weighted the evidence obtained and determined that it is not more likely than not that the fair value of any reporting unit is less than its carrying amount. In 2011 we adopted new accounting guidance and performed an assessment of qualitative factors similar to that described above and determined that it was not more likely than not that the fair value of any reporting unit was less than its carrying amount. In fiscal 2010 we performed the first step test required under previous guidance using an income approach and market approach and the results of that valuation indicated that each of these reporting units' fair values were significantly higher than their carrying values. We used a discount rate of 12.5% in the 2010 test and if we had increased the discount rate to 13.5% (all other assumptions held constant) the fair value of each reporting unit would have still exceeded its carrying value by at least 43%.

For the ETS reporting unit for fiscal 2012 we performed the two-part analysis described above. We used a discount rate of 14% and if we had increased the discount rate to 15% (all other assumptions held constant) the fair value of the reporting unit would have still exceeded its carrying value by 13%. In the Guideline Public Company Method we selected moderately lower multiples than the average of our peer companies and applied these multiples to our trailing twelve months revenue, projected 2013 revenue, and 2013 EBITDA. We weighted these multiples according to our judgment regarding the importance of each multiple as an indicator of value.

Although we believe the qualitative factors considered in the impairment analysis are reasonable, significant changes in any one of our assumptions could produce a significantly different result. If our quantitative assumptions do not prove correct or economic conditions affecting future operations change, our goodwill could become impaired and result in a material adverse effect on our results of operations and financial position. For fiscal 2012, 2011 and 2010, we did not have any goodwill impairment loss.

In the current year we adopted a new Accounting Standards Update ("ASU") issued by the Financial Accounting Standards Board ("FASB") that allows for the indefinite lived intangible asset impairment analysis to start with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of indefinite lived assets are less than their carrying amounts. If, after assessing the qualitative factors, we determine that it is more likely than not that our indefinite lived intangible assets are less than their carrying amounts, then we perform an impairment test. The impairment test consists of selecting the relief from royalty model (income approach) to assess the fair value of our indefinite lived intangibles. If the carrying amount of the indefinite lived intangibles exceeds its fair value, we recognize an impairment loss in an amount equal to that excess.

Our relief from royalty analysis is based on the projected revenue attributable to the asset, expected economic life of the asset, present value of the royalty rate (as a percentage of revenue) that would hypothetically be charged by a licensor of the asset to an unrelated licensee, and the discount rate that reflects the level of risk associated with receiving future cash flows attributable to the asset. The model estimates are prepared based on our business plans for each trade name, considering historical results and anticipated future performance and market opportunities. The discount rates used to determine the present value of future cash flows would be derived from our weighted average cost of capital adjusted for asset specific premiums (if any).

As of October 31, 2012 and 2011, our indefinite lived intangible assets totaled $24.5 million and $25.5 million, respectively. Our fiscal 2012 annual indefinite lived intangible asset impairment analysis included an assessment of certain qualitative factors including, but not limited to, the results of the prior year fair value calculation, overall financial performance, and macro-economic and industry conditions. We considered the qualitative factors and determined that it is not more likely than not that the fair value of the indefinite lived intangible assets are less than their carrying amounts. In the prior year we performed the quantitative test required under previous guidance using the relief from royalty method and the results of that valuation indicated that the fair values of our indefinite lived intangible assets were significantly higher than their carrying values. The discount rate used for each trade name was 12.5% for our fiscal 2011. The pre-tax royalty rate used for each trade name was 4.0% for fiscal 2011. If we had increased the discount rate to 13.5% (all other assumptions held constant) the fair value of each trade name would have still exceeded its carrying value by at least 57%.

Although we believe the qualitative factors considered in the impairment analysis are reasonable, significant changes in any one of our assumptions could produce a significantly different result. If our assumptions do not prove correct or economic conditions affecting future operations change, our indefinite lived intangible assets could become impaired and result in a material adverse effect on our results of operations and financial position

For fiscal 2012, 2011 and 2010 we did not have any indefinite lived intangible asset impairment loss.

Other intangible assets. Other intangible assets include intellectual property for games, patents, trademarks, copyrights, licenses, developed technology, customer relationships and non-compete agreements that were purchased separately or acquired in connection with a business combination. All of our significant other intangible assets have finite useful lives and are amortized as the economic benefits of the intangible asset are consumed or otherwise used up. Amortization of customer relationships and non-compete agreements is included in selling, general and administrative expense and the remaining components of amortization are included in cost of sales and service and cost of leases and royalties.

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

We review our long-lived assets, excluding goodwill and indefinite lived intangible assets, for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable or warrant a revision to the estimated remaining useful life. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or market price of the long-lived asset, a significant adverse change in legal factors or business climate that could affect the value of a long-lived asset, or a current period operating or cash flow loss combined with a history of operating or cash flow losses. We group long-lived assets for impairment analysis at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.

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