<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1998
------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- ----------
0-21426
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(Commission file number)
CASINO DATA SYSTEMS
-------------------
(Exact Name of Registrant as
Specified in its Charter)
NEVADA
------------------------------------------------------------
(State or other Jurisdiction of Incorporation or Organization)
88-0261839
----------
(I.R.S.Employer Identification No.)
3300 BIRTCHER DRIVE, LAS VEGAS, NEVADA 89118
-------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(702) 269-5000
--------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[ X ] Yes [ ] NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 18,065,897 shares of common
stock outstanding as of October 30, 1998.
Page 1 of 21
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CASINO DATA SYSTEMS
INDEX
PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Unaudited Consolidated Balance Sheet
September 30, 1998 and December 31, 1997 (audited) 3-4
Condensed Unaudited Consolidated Statements of Operations
For the nine months ended September 30, 1998 and 1997 5
Condensed Unaudited Consolidated Statements of Operations
For the three months ended September 30, 1998 and 1997 6
Condensed Unaudited Consolidated Statements of Cash Flows
For the nine months ended September 30, 1998 and 1997 7
Notes to Condensed Unaudited Consolidated Financial
Statements 8-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-17
PART II. OTHER INFORMATION
Items 1-6 18-20
Signatures 21
2
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CASINO DATA SYSTEMS
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(UNAUDITED)
------------- ------------
ASSETS
- ------
<S> <C> <C>
Current Assets:
Cash and cash equivalents, including restricted amounts
of approximately $10,478 and $15,600, respectively $ 19,413 $ 27,873
Investment securities including restricted amounts of
$1,442 and $11, respectively 3,116 11
Accounts receivable, net of allowance for doubtful
accounts of $3,668 and $5,390, respectively 14,617 9,683
Due from related parties -- 144
Current portion of notes receivable 2,305 1,392
Income tax receivable -- 4,000
Inventories, net of allowance for obsolescence of
$1,580 and $1,125, respectively 16,498 14,192
Deferred tax asset 360 360
Assets held for sale 1,183 880
Prepaid expenses and other current assets 410 1,244
-------- ---------
Total current assets 57,902 59,779
-------- ---------
Property and equipment, net of accumulated depreciation
of $4,698 and $3,547, respectively 19,817 17,736
Investment securities, including restricted amounts of
approximately $9,489 and $6,601, respectively 9,489 8,080
Notes receivable, excluding current portion 954 1,627
Intangible assets, net of accumulated amortization of $2,409
and $1,120, respectively 5,048 6,256
Software development costs, net of accumulated amortization
of $217 and $128, respectively 4,213 1,954
Deferred tax asset 1,140 1,140
Deposits 384 384
-------- ---------
Total non-current assets 41,045 37,177
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Total assets $ 98,947 $ 96,956
-------- ---------
-------- ---------
</TABLE>
3
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(continued)
LIABILITIES AND SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(UNAUDITED)
------------- ------------
Current liabilities:
<S> <C> <C>
Current portion of long-term debt $ 757 $ 2,187
Accounts payable 3,979 3,911
Accrued expenses and customer deposits 10,531 7,444
Accrued slot liability 3,244 4,723
---------- ----------
Total current liabilities 18,511 18,265
---------- ----------
Noncurrent liabilities:
Long-term debt, excluding current portion 17 267
Accrued slot liability 16,060 14,797
---------- ----------
Total noncurrent liabilities 16,077 15,064
---------- ----------
Shareholders' equity:
Common stock, no par value. Authorized
100,000,000 shares; issued and outstanding
18,065,897 shares at September 30, 1998 and
18,065,897 shares at December 31, 1997 83,790 83,790
Retained deficit (19,431) (20,163)
---------- ----------
Total shareholders' equity 64,359 63,627
---------- ----------
Total liabilities and shareholders' equity $ 98,947 $ 96,956
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
4
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CASINO DATA SYSTEMS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
---------- ---------
Revenues:
<S> <C> <C>
Systems and product sales $ 32,206 $ 24,361
Gaming operations 7,217 17,452
---------- ---------
39,423 41,813
Cost of goods sold 20,960 27,345
---------- ---------
Gross Margin 18,463 14,468
---------- ---------
Operating expenses:
Selling, general and administrative 13,052 17,789
Research and development 2,628 2,935
Loss from shareholder suit 1,000 --
Depreciation and amortization 1,893 3,858
---------- ---------
Total operating expenses 18,573 24,582
---------- ---------
Income (Loss) from operations (110) (10,114)
---------- ---------
Other income (expense):
Interest and other income 1,358 1,151
Interest expense (129) (260)
---------- ---------
Total other income 1,229 891
---------- ---------
Income (loss) before income taxes 1,119 (9,223)
Income tax expense (benefit) 387 (3,044)
---------- ---------
Net income (loss) $ 732 $ (6,179)
---------- ---------
---------- ---------
Basic net income (loss) per share $ 0.04 $ (0.34)
---------- ---------
---------- ---------
Diluted net income (loss) per share $ 0.04 $ (0.34)
---------- ---------
---------- ---------
Basic weighted average shares outstanding 18,066 18,036
---------- ---------
---------- ---------
Diluted weighted average shares outstanding 18,073 18,036
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
5
<PAGE>
CASINO DATA SYSTEMS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
Revenues:
<S> <C>
Systems and product sales $ 12,723 $ 5,242
Gaming operations 2,316 5,304
--------- ---------
15,039 10,546
Cost of goods sold 8,225 7,426
--------- ---------
Gross Margin 6,814 3,120
--------- ---------
Operating expenses:
Selling, general and administrative 4,399 4,759
Research and development 1,115 1,033
Loss from shareholder suit 1,000 --
Depreciation and amortization 640 1,243
--------- ---------
Total operating expenses 7,154 7,035
--------- ---------
Income (Loss) from operations (340) (3,915)
--------- ---------
Other income (expense):
Interest and other income 395 487
Interest expense 19 (76)
--------- ---------
Total other income 414 411
--------- ---------
Income (loss) before income taxes 74 (3,504)
Income tax expense (benefit) 26 (1,156)
--------- ---------
Net income (loss) $ 48 $ (2,348)
--------- ---------
--------- ---------
Basic net income (loss) per share $ 0.00 $ (0.13)
--------- ---------
--------- ---------
Diluted net income (loss) per share $ 0.00 $ (0.13)
--------- ---------
--------- ---------
Basic weighted average shares outstanding 18,066 18,038
--------- ---------
--------- ---------
Diluted weighted average shares outstanding 18,066 18,038
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
6
<PAGE>
CASINO DATA SYSTEMS AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Unaudited)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
------- -------
Cash flows from operating activities:
<S> <C> <C>
Net income $ 732 $(6,179)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,893 3,858
Gain on disposal of assets (25) --
Provision for accounts receivable -- 404
Changes in assets and liabilities:
Decrease (increase) in accounts receivable, due
from related parties and notes receivable (5,030) 11,280
Decrease in income tax receivable 4,000 --
Increase in inventories (2,306) (2,055)
Decrease (increase) in prepaid expenses and other
current assets and deposits 836 (397)
Increase (decrease) in accounts payable 68 (530)
Increase in accrued liabilities, customer
deposits and slot liability 2,871 7,415
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Net cash provided by operating activities 3,039 13,796
------- -------
Cash flows from investing activities:
Net Increase in investment securities (4,514) (557)
Decrease (increase) in intangible assets 905 (118)
Investment in software development (2,259) (4,570)
Acquisitions of property and equipment (3,951) (2,443)
------- -------
Net cash used in investing activities (9,819) (7,688)
------- -------
Cash flows from financing activities:
Repayment of notes payable (1,680) (1,511)
Net proceeds from issuance of common stock -- 109
------- -------
Net cash used in financing activities (1,680) (1,402)
------- -------
Net (decrease) increase in cash and cash equivalents (8,460) 4,706
Cash and cash equivalents at beginning of the period 27,873 21,482
------- -------
Cash and cash equivalents at end of the period $19,413 $26,188
------- -------
------- -------
Supplemental disclosure of non-cash activities:
Transfer to assets held for sale from fixed assets $ 303 $ --
------- -------
------- -------
Transfer to fixed assets from other assets $ 877 $ --
------- -------
------- -------
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Casino Data Systems, a Nevada corporation, was incorporated in June
1990. Each of the following corporations are wholly owned subsidiaries of
Casino Data Systems: CDS Services Company; CDS Graphics and Imaging Company;
CDS Signs, Inc.; TurboPower Software Company, and CDS Gaming Company
(collectively the "Company"). The Company's operations consist principally
of: (i) the development, licensing and sale of casino management information
systems (the Oasis-TM- II System); (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 and for use by the Company's
own software engineers. The Company currently operates solely in the U.S.
The consolidated financial statements include the accounts of Casino
Data Systems and all of the subsidiaries mentioned above. All significant
inter-company balances and transactions have been eliminated in consolidation.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These condensed
unaudited consolidated financial statements should be read in conjunction
with the audited consolidated financial statements and notes thereto included
in the Company's annual report as filed on Form 10-K.
The accompanying condensed unaudited consolidated financial statements
contain all adjustments which are, in the opinion of management, necessary
for a fair statement of the results of the interim periods presented. The
results of operations for the interim periods are not necessarily indicative
of the results of operations for an entire year.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 Earnings Per Share, (SFAS
128) which establishes standards for computing and presenting earnings per
share (EPS), which replaces the presentation of primary and fully diluted EPS
with a presentation of basic and diluted EPS. SFAS 128 is effective for
financial statements for both interim and annual periods ending after
December 15, 1997. Earlier application is not permitted. All prior period
EPS data have been restated to conform to SFAS 128.
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosure About Segments of an Enterprise and Related Information"
(SFAS No. 131). SFAS No. 131 establishes additional standards for segment
reporting in the financial statements and is effective for fiscal years
beginning after December 15, 1997. Adoption of this statement will have no
material impact on the Company's financial statements.
8
<PAGE>
(2) NET INCOME (Loss) PER COMMON SHARE: (IN THOUSANDS EXCEPT PER SHARE DATA)
The following is an analysis of the components of the shares used to compute
net income per common share pursuant to SFAS 128:
<TABLE>
<CAPTION>
Nine months Nine months Three months Three months
ended ended ended ended
------------ ----------- ------------ ------------
Sept. 30, Sept. 30, Sept. 30 Sept. 30,
------------ ----------- ------------ ------------
1998 1997 1998 1997
------------ ----------- ------------ ------------
<S> <C> <C> <C> <C>
Numerator for earnings per share - net
Income (Loss) $ 732 $ (6,179) $ 48 $ (2,348)
------------ ----------- ------------ ------------
Denominator:
Denominator for basic earnings per share-
weighted average shares 18,066 18,036 18,066 18,038
Effect of dilutive securities
Stock options 7 0 0 0
------------ ----------- ------------ ------------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 18,073 18,036 18,066 18,038
------------ ----------- ------------ ------------
------------ ----------- ------------ ------------
Basic earnings per share $0.04 $(0.34) $0.00 $(0.13)
------------ ----------- ------------ ------------
------------ ----------- ------------ ------------
Diluted earnings per share $0.04 $(0.34) $0.00 $(0.13)
------------ ----------- ------------ ------------
------------ ----------- ------------ ------------
</TABLE>
(3) COMMITMENTS & CONTINGENCIES
In connection with the operation of its MSP Systems, the Company is
liable for progressive jackpots, which are paid as an initial base jackpot
component followed by an annuity (progressive component) paid out over 20
years after the prize is won. The base jackpot component is charged against
income ratably over the amount of coin play expected to precede payout based
on a statistical analysis. The progressive jackpot component increases based
on the number of coins played. The accrual of these liabilities commensurate
with coin play matches recognition of costs and revenues. The possibility
exists that the winning combination may be hit before the Company has fully
accrued the base jackpot component, at which time any unaccrued portion would
be expensed. There was no unaccrued portion at September 30, 1998. To
ensure adequate funds are available to pay the slot liability and to comply
with gaming regulatory requirements, the Company has established segregated
cash accounts aggregating approximately $10,478,000 at September 30, 1998.
The Company also has approximately $10,931,000 segregated for the annuity
payments for jackpots already won.
9
<PAGE>
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. The
Company won a motion to dismiss the First Amended Complaint filed by Edwards.
The court, however, granted Edwards leave to amend his Complaint. On July 13,
1998, Edwards filed a Second Amended Complaint. Pending settlement, the
parties stipulated to stay the Company's response to this Complaint. On May
29, 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
were without merit, and did and would have continued to vigorously defend
against them. However, due to the inherent risks and ongoing expenses of
maintaining litigation, management determined it to be in the best interests
of the Company to settle the claims. Subject to court approval, the parties
have agreed to a settlement of all four related lawsuits, pursuant to which
the Company will pay $1 million in November 1998. The Company has accrued $1
million related to this settlement.
A patron dispute was filed against the Company in connection with 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 the patron. The patron appealed the
Commission's decision to the Circuit Court of Tunica County. On January 16,
1998, the Court issued an Order reversing the Commission's decision 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 reduced the
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 multi-site progressive system jackpot, as directed by the
Mississippi Gaming authorities. The Company has accrued $410,565 of interest
expense as of September 30, 1998 toward the judgment in the event the Company
loses its appeal. No hearing date has been set yet. CDS has filed its appeal
brief with Mississippi Supreme Court. 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 August of 1997, Casino Technology Incorporated ("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
10
<PAGE>
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 omissions of CTI and its principal. The Company filed its Answer and
Counterclaim on October 31, 1997, alleging misrepresentation/fraudulent
inducement and breach of contract on behalf of CTI. CTI filed a response to
the Company's counterclaim on or about the 16th day of December, 1997. No
arbitration date has been set. The case will proceed to arbitration unless
settled. While the outcome of the matter is not presently determinable,
management does not believe the outcome will have a material effect on the
Company's financial statements as a whole.
On May 19, 1998, Acres Gaming Corporation filed an action against the
Company, Mikohn Gaming Corporation, New York New York Hotel & Casino, LLC,
and Sunset Station Hotel & Casino, in the Federal Court for the State of
Nevada, alleging that the Company violated certain patent rights of Acres
Gaming. Acres Gaming also filed a Motion for Preliminary Injunction. The
Company filed its Response to the Motion for Preliminary Injunction
("Response") along with its own Motion for Summary Judgment ("MSJ")
requesting dismissal of Acres' claims. After reviewing the Company's Response
and Motion for Summary Judgment, Acres withdrew their Motion for Preliminary
Injunction. The Company's Motion for Summary Judgment remains on file,
awaiting a hearing date to be set by the court. The Company believes this
action is without merit and will continue to vigorously defend itself. While
the outcome of this lawsuit is not presently determinable, management does
not expect the outcome will have a material adverse effect on the Company's
consolidated financial statements taken as a whole.
The Company and its subsidiaries are also involved from time to time in
other various claims and legal actions arising in the ordinary course of
business including, but not limited to, administrative claims and legal
actions brought in state and federal courts by patrons of the Company's MSP
games, wherein the patron may allege the winning of jackpot awards or some
multiple thereof. Because of the size of the jackpots that a patron may play
for, related patron disputes often involve sizable claims. The loss of a
sizable patron dispute claim could have a material adverse effect on the
Company. 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.
11
<PAGE>
ITEM 2. 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 Unaudited Consolidated
Financial Statements and Notes thereto included elsewhere in this document
and the Consolidated Financial Statements and Notes thereto included in the
Company's annual report on Form 10-K.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED
TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES
Revenues decreased from $41,813,000 for the nine months ended September
30, 1997 to $39,423,000 for the same period in 1998, a decrease of $2,390,000
or 6%. The decrease in revenues is primarily attributable to a decrease in
revenues from progressive operations of $10,235,000 partially offset by
increases in system and product sales of $7,845,000. The decrease in
revenues from progressive operations is primarily attributable to the
termination of the Caribbean Stud Video Poker link in October 1997, the
termination of the Native American Cool Millions Dollar link in February 1998
and the termination of both the Nevada and Mississippi Cool Millions Dollar
links in April 1998, which was partially offset by the increase in revenue
from the Nevada Xtreme link. The increase in system and product sales is
primarily attributed to increased sales of OASIS II systems and increased
sales of gaming machines.
GROSS MARGIN
Costs of good sold decreased from $27,345,000 for the nine months ended
September 30, 1997, to $20,960,000 for the same period in 1998, a decrease of
$6,385,000. Gross margin as a percentage of revenues increased from 35% for
the nine months ended September 30, 1997 to 47% for the same period in 1998.
The increase in gross margin is primarily attributable to the increase in the
percentage of total revenue derived from system sales, which generally have
higher gross margins than other CDS products, in addition to increased
production efficiencies and stronger cost controls.
OPERATING EXPENSES
Operating expenses decreased from $24,582,000 for the nine months ended
September 30, 1997, to $18,573,000 for the same period in 1998, a decrease of
$6,009,000 or 24%. Operating expenses decreased from $24,582,000 for the
nine months ended September 30, 1997, to $17,573,000, excluding the
$1,000,000 charge for the loss from the shareholders suit, for the same
period in 1998, a decrease of 7,009,000 or 29%. Operating expenses decreased
as a percentage of revenues from 59% for the nine months ended September 30,
1997, to 47% for the same period in 1998 and to 45% for the same period in
1998 excluding the charge for the loss from the shareholders suit.
Selling, general and administrative expenses decreased from $17,789,000
for the nine months ended September 30, 1997, to $13,052,000 for the same
period in 1998, a decrease of $4,737,000 or 27%. Selling, general and
administrative expenses as a percentage of revenues decreased from 43% for
the nine months ended September 30, 1997, to 33% for the same period in 1998.
This decrease in
12
<PAGE>
selling, general and administrative expenses is due to overall cost
reductions during the nine months ended September 30, 1998 as compared to the
same period in 1997.
Research and development expenses decreased from $2,935,000 for the nine
months ended September 30, 1997, to $2,628,000 for the same period in 1998.
The decrease is primarily attributable to a decrease in personnel. Major
expenditures during the nine months ended September 30, 1998 primarily
included the development of additional video interactive games. Research and
development expenses as a percentage of revenues remained stable at 7% for
the nine months ended September 30, 1997, and 1998.
Depreciation and amortization decreased from $3,858,000 for the nine
months ended September 30, 1997, to $1,893,000 for the same period in 1998.
The decrease is primarily due to the decreased fixed asset balance as a
result of the restructuring and impairment charges in the fourth quarter of
1997.
OTHER INCOME
Other income is comprised of rental, interest and other forms of income,
offset by interest expense, that are not the result of normal operations.
Other income increased from $891,000 for the six months ended September 30,
1997, to $1,229,000 for the same period in 1998. The increase is primarily
due to increased interest income due to higher investment balances and
decreased interest expense due to lower debt levels during the nine months
ended September 30, 1998.
NET INCOME (LOSS)
Net income (loss) increased from a loss of ($6,179,000) for the nine
months ended September 30, 1997, to income of $732,000 for the same period in
1998, an increase of $6,911,000 or 112%. The increase in net income is the
result of the increase in gross margin, the decrease in operating expenses
and the increase in other income for the nine months ended September 30,
1998, compared to the same period ended September 30, 1997.
THE QUARTER ENDED SEPTEMBER 30, 1998 COMPARED
TO THE QUARTER ENDED SEPTEMBER 30, 1997
REVENUES
Revenues increased from $10,546,000 for the three months ended September
30, 1997 to $15,039,000 for the same period in 1998, an increase of
$4,493,000 or 43%. Revenues from system and product sales increased
$7,481,000 or 143% for the three months ended September 30, 1998 as compared
to the same period in 1997. This increase was partially offset by the
decrease in revenues from progressive operations of $2,988,000 or 56%. The
increase in revenues from system and product sales is primarily attributable
to the increased sales of gaming machines and increased revenue from OASIS II
system contracts. The decrease in revenues from progressive operations is
primarily attributable to the termination of the Native American Cool
Millions link in February 1998, the termination of the Caribbean Stud Video
poker link in October 1997 and the termination of both the Nevada and
Mississippi Cool Millions Dollar links in April 1998.
GROSS MARGIN
13
<PAGE>
Costs of good sold increased from $7,426,000 for the three months ended
September 30, 1997, to $8,225,000 for the same period in 1998, an increase of
$799,000. Gross margin as a percentage of revenues increased from 30% for
the three months ended September 30, 1997 to 45% for the same period in 1998.
The increase in gross margin is primarily attributable to the increase in
the percentage of total revenue derived from system sales which generally
have higher gross margins than other CDS products.
OPERATING EXPENSES
Operating expenses increased from $7,035,000 for the three months ended
September 30, 1997, to $7,154,000 for the same period in 1998, an increase of
$119,000 or 2%. Operating expenses decreased from $7,035,000 for the three
months ended September 30, 1997 to $6,154,000, excluding the $1,000,000
charge for the loss from the shareholders suit, for the same period in 1998,
a decrease of $881,000 or 13%. Operating expenses decreased as a percentage
of revenues from 67% for the three months ended September 30, 1997, to 48%
for the same period in 1998 and to 41% for the same period in 1998 excluding
the charge for the loss from the shareholders suit.
Selling, general and administrative expenses decreased from $4,759,000
for the three months ended September 30, 1997, to $4,399,000 for the same
period in 1998, a decrease of $360,000 or 8%. Selling, general and
administrative expenses decreased due to overall cost reductions during the
three months ended September 30, 1998 as compared to the same period in 1997.
Research and development expenses increased from $1,033,000 for the
three months ended September 30, 1997, to $1,115,000 for the same period in
1998. The increase is primarily attributable to an increase in lab and
prototype expense. Research and development expenses as a percentage of
revenues decreased from 10% for the three months ended September 30, 1997 to
7% for the same period in 1998.
Depreciation and amortization decreased from $1,243,000 for the three
months ended September 30, 1997, to $640,000 for the same period in 1998.
The decrease is primarily due to the decreased fixed asset balance as a
result of the restructuring and impairment charges in the fourth quarter of
1997.
OTHER INCOME
Other income is comprised of rental, interest and other forms of income,
offset by interest expense, that are not the result of normal operations.
Other income increased from $411,000 for the three months ended September 30,
1997, to $414,000 for the same period in 1998. The increase is primarily due
to decreased interest expense during the three months ended September 30,
1998.
NET INCOME (LOSS)
Net income (loss) increased from a loss of ($2,348,000) for the three
months ended September 30, 1997, to income of $48,000 for the same period in
1998, an increase of $2,396,000 or 102%. The increase in net income is the
result of the increase in gross margin, the decrease in operating expenses
and the increase in other income for the three months ended September 30,
1998 as compared to the same period in 1997.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has financed its operating and capital expenditures
primarily through cash flows from its operations and cash from proceeds of
its equity offerings. The Company had cash and cash equivalents of
$19,413,000 at September 30, 1998, as compared to $27,873,000 at December 31,
1997, of which $10,478,000 and $15,600,000, respectively, were restricted for
payment of slot liabilities. The Company generated cash from operations of
$3,039,000 during the nine months ended September 30, 1998.
The Company used $9,819,000 of cash in investing activities during the
nine months ended September 30, 1998 primarily related to $3,951,000 in
equipment to be used in operations; $2,259,000 invested in software
development; $4,514,000 invested in held-to-maturity securities; and a
decrease of $905,000 in the intangible asset balance.
The Company used $1,680,000 of cash in financing activities for payments
made on outstanding debt during the nine months ended September 30, 1998.
Certain jurisdictions in which MSP systems operate require that the
Company maintain segregated funds for the payment of jackpot prizes. The
amount of funds required is dependent on several factors including the type
and denomination of the games and the regulatory requirements. At September
30, 1998, the Company's accrued slot liability for its MSP systems aggregated
approximately $19,304,000. There was no unaccrued slot liability. In
connection with these slot liabilities and in accordance with gaming
requirements, the Company established segregated cash accounts aggregating
approximately $10,478,000 at September 30, 1998 to ensure availability of
adequate funds to pay this liability. The Company also has investment
securities approximating $10,931,000 segregated as of September 30, 1998 for
the payment of jackpots already won. Although statistically remote, a
possibility exists that multiple jackpots may be awarded prior to the time
period over which game play has generated sufficient revenue to accrue each
base jackpot amount. Such occurrences could have a material adverse impact
on the Company's results of operations in the reporting period in which the
jackpots are hit.
The Company has financed certain equipment under agreements for an
aggregate amount of $769,000. 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 current principal balance which mature, with these
obligations, in December 1998.
The Company's ratio of current assets to current liabilities is 3.1 to 1
at September 30, 1998, while the noncurrent liabilities to equity ratio is
.25 to 1. Based on this financial position, the Company believes it could
obtain additional long-term financing for growth that may result in working
capital additions that exceed available cash and cash equivalents to be
provided by operations. However, there can be no assurance that the Company
will be able to obtain additional sources of capital.
YEAR 2000
The year 2000 issue is the result of computer programs written using two
digits (rather than four) to define years. Computers or other equipment with
date-sensitive software may recognize "00" as 1900 rather than 2000. This
could result in system failures or miscalculations. If the Company, or its
customers, suppliers or other third parties fail to correct year 2000 issues,
business operations will be affected. The Company is continuing to assess
the impact of the year 2000 issues on the Company's internal processing and
the products produced and sold by the Company, which assessment is expected
to be completed by March 1, 1999.
The Company's internal information system, put into operation in the
second quarter of 1998, has been certified by the vendor as year 2000
compliant. The operating system that this software uses has also been
certified verbally as year 2000 compliant by the third party manufacturer.
Based on these assurances, the Company believes that it will not experience
any disruption in daily operations with this system related to year 2000
issues.
The Company operates its MSP systems using its own proprietary software
which utilizes a third party operating system. The Company is currently in
the process of upgrading the operating system to a certified year 2000
compliant version and will modify its proprietary software as necessary. This
upgrade will be completed in calendar year 1999 and the cost of completing
this upgrade is not expected to be material.
The Company continues to review the impact of year 2000 issues
concerning the Company's production facility. After a preliminary review, no
concerns have been identified. Therefore, at this time, the Company believes
that there will not be a material adverse affect on its production
capabilities resulting from year 2000 issues related to the Company's
production processes.
The Company also sells proprietary software to third parties. The
Company currently has year 2000 compliant versions of this software; however,
the majority of the Company's customer base uses a version of the software
that includes certain modules which are not year 2000 compliant. The Company
has contacted all of its customers that require the upgrade to become year
2000 compliant. The Company is performing these upgrades and plans to
complete all such upgrades on all customers covered by purchased maintenance
agreements in calendar year 1999. The Company also planned the resources
necessary to complete the upgrades for customers that are not currently under
maintenance agreements; however, performing these upgrades is contingent upon
the customers contracting with the Company to do so.
Based on current assessments and testing, the Company does not expect
year 2000 issues to have a material adverse effect on the Company's financial
position, results of operations or cash flows. However, risk exists regarding
year 2000 non-compliance including, but not limited to third parties with
operational importance to the Company, such as key suppliers and customers,
utilities, telecommunication providers, or financial institutions, which
could result in lost production, sales, or administrative difficulties on the
part of the Company. The Company is not presently aware of any such
situations; however, occurrences of this type, if severe, could have a
material effect on the Company. Pending completion of the year 2000
assessment, the Company will finalize a contingency plan to address possible
risk of year 2000 noncompliance on the Company's financial position.
15
<PAGE>
CAUTIONARY STATEMENT FOR THE PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company is including the following cautionary statement to take advantage
of the "safe harbor" provisions of the PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995 for any forward-looking statement made by, or on behalf of, the
Company. The factors identified in this cautionary statement are important
factors (but not necessarily all the important factors) that could cause
actual results to differ materially from those expressed in any
forward-looking statement made by, or on behalf of, the Company. Where any
such forward-looking statement includes a statement of the assumptions or
bases underlying such forward-looking statement, the Company cautions that,
while it believes such assumptions or bases to be reasonable and makes them
in good faith, assumed facts or bases almost always vary from actual results,
and the differences between assumed facts or bases and actual results can be
material, depending on the circumstances. Where, in any forward-looking
statement, the Company, or its Management, expresses an expectation or belief
as to future results, such expectation or belief is expressed in good faith
and believed to have a reasonable basis, but there can be no assurance that
the statement of expectation or belief will result, or be achieved or
accomplished. Taking into account the foregoing, the following are
identified as important risk factors that could cause actual results to
differ materially from those expressed in any forward-looking statement made
by, or on behalf of, the Company:
- - Risks associated with developing gaming machines that offer technological
advantages or unique entertainment features to enable the Company to
effectively compete in the gaming machine market.
- - Possible adverse effects upon revenues if the Company experiences delays in
developing or obtaining regulatory approval of new products.
- - Possible adverse effects on revenues if new products or enhancements do not
gain customer acceptance.
16
<PAGE>
- - Possible adverse effects on revenues due to the difficulty in competing
with well-established competitors in markets for the Company's products,
including without limitation, casino management information systems, MSP
products and gaming machines.
- - Possible adverse effects on revenues associated with the dependence upon
Steven A. Weiss, a key employee of the Company.
- - The general profitability of the gaming industry at large can substantially
affect the Company's revenues.
- - Even though the Company seeks to protect its intellectual property upon
which it relies to sell its products, there is the possibility of adverse
affects on revenue generation if such intellectual property were not
protected or available for use due to patents issued to competitors.
- - Possible adverse affects related to any negative outcome of pending or
threatened litigation.
- - The Year 2000 Project and the date on which the Company believes it will be
completed are based on Management's best estimates, which are derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, third-party modification plans and other
factors. However, there can be no assurance that there will be no delay in,
or no increased costs associated with, the implementation of the Year 2000
Project. Specific factors that might cause differences between the
estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, timely responses by
third-parties and suppliers, and similar uncertainties. The Company's
inability to implement Year 2000 changes could have an adverse effect on
future results of operations.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. 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. The
Company won a motion to dismiss the First Amended Complaint filed by Edwards.
The court, however, granted Edwards leave to amend his Complaint. On July 13,
1998, Edwards filed a Second Amended Complaint. Pending settlement, the
parties stipulated to stay the Company's response to this complaint. On May
29, 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
were without merit, and did and would have continued to vigorously defend
against them. However, due to the inherent risks and ongoing expenses of
maintaining litigation, management determined it to be in the best interests
of the Company to settle the claims. Subject to court approval, the parties
have agreed to a settlement of all four related lawsuits, pursuant to which
the Company will pay $1 million in November 1998. The Company accrued $1
million related to this settlement.
A patron dispute was filed against the Company in connection with 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 the patron. The patron appealed the
Commission's decision to the Circuit Court of Tunica County. On January 16,
1998, the Court issued an Order reversing the Commission's decision 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 reduced the
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 multi-site progressive system jackpot, as directed by the
Mississippi Gaming authorities. The Company has accrued $410,565 of interest
expense as of September 30, 1998 toward the judgment in the event the Company
loses its appeal. No hearing date has been set yet. CDS has filed its appeal
brief with Mississippi Supreme Court. While the outcome of the action
described above is not presently determinable, management does not expect the
outcome will
18
<PAGE>
have a material adverse effect on the Company's consolidated financial
statements taken as a whole.
In August of 1997, Casino Technology Incorporated ("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 omissions of CTI and
its principal. The Company filed its Answer and Counterclaim on October 31,
1997, alleging misrepresentation/fraudulent inducement and breach of contract
on behalf of CTI. CTI filed a response to the Company's counterclaim on or
about the 16th day of December, 1997. No arbitration date has been set. The
case will proceed to arbitration unless settled. While the outcome of the
matter is not presently determinable, management does not believe the outcome
will have a material effect on the Company's financial statements as a whole.
On May 19, 1998, Acres Gaming Corporation filed an action against the
Company, Mikohn Gaming Corporation, New York New York Hotel & Casino, LLC,
and Sunset Station Hotel & Casino, in the Federal Court for the State of
Nevada, alleging that the Company violated certain patent rights of Acres
Gaming. Acres Gaming also filed a Motion for Preliminary Injunction. The
Company filed its Response to the Motion for Preliminary Injunction
("Response") along with its own Motion for Summary Judgment ("MSJ")
requesting dismissal of Acres' claims. After reviewing the Company's Response
and Motion for Summary Judgment, Acres withdrew their Motion for Preliminary
Injunction. The Company's Motion for Summary Judgment remains on file,
awaiting a hearing date to be set by the court. The Company believes this
action is without merit and will continue to vigorously defend itself. While
the outcome of this lawsuit is not presently determinable, management does
not expect the outcome will have a material adverse effect on the Company's
consolidated financial statements taken as a whole.
The Company and its subsidiaries are also involved from time to time in
other various claims and legal actions arising in the ordinary course of
business including, but not limited to, administrative claims and legal
actions brought in state and federal courts by patrons of the Company's MSP
games, wherein the patron may allege the winning of jackpot awards or some
multiple thereof. Because of the size of the jackpots that a patron may play
for, related patron disputes often involve sizable claims. The loss of a
sizable patron dispute claim could have a material adverse effect on the
Company. 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.
19
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders was held on July 31, 1998.
The following members were elected to the Company's Board of Directors to
hold office for the ensuing year:
<TABLE>
<CAPTION>
Withheld
Nominee In Favor Authority
------- -------- ---------
<S> <C> <C>
Steve A. Weiss 15,804,624 1,269,219
Howard W. Yenke 15,816,109 1,257,734
Diana L. Bennett 15,787,284 1,286,559
Phil E. Bryan 15,783,811 1,290,032
Thomas E. Gardner 15,817,199 1,256,644
</TABLE>
Approval of amendment to the Company's 1993 Stock Option and Compensation
Plan to increase the number of shares of Common Stock reserved for issuance
thereunder by 750,000 shares.
<TABLE>
<CAPTION>
In Favor Opposed Abstained Broker Non-Vote
-------- ------- --------- ---------------
<S> <C> <C> <C>
5,009,551 3,831,757 113,167 8,119,368
</TABLE>
Approval of the creation of the Company's 1998 Employee Stock Purchase Plan
and the reservation for issuance thereunder of 500,000 shares of the
Company's Common Stock.
<TABLE>
<CAPTION>
In Favor Opposed Abstained Broker Non-Vote
-------- ------- --------- ---------------
<S> <C> <C> <C>
7,774,986 1,045,224 113,715 8,139,918
</TABLE>
The descriptions provided above of the matters considered at the 1998 Annual
Meeting of Shareholders are qualified in their entirety by reference to the
Company's Proxy Statement related to such meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits: Exhibit 27.1 Financial Data Schedule
There were no reports filed on Form 8-K for the nine month period ended
September 30, 1998.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CASINO DATA SYSTEMS
Registrant
Date: November 16, 1998 /s/ Howard Yenke
--------------------- ----------------------------------
Howard Yenke
Chief Executive Officer
Date: November 16, 1998 /s/ Lee Lemas
--------------------- ----------------------------------
Lee Lemas
Chief Financial Officer
and Vice President Finance
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 19,413
<SECURITIES> 12,605
<RECEIVABLES> 18,285
<ALLOWANCES> 3,668
<INVENTORY> 16,498
<CURRENT-ASSETS> 57,902
<PP&E> 24,515
<DEPRECIATION> 4,698
<TOTAL-ASSETS> 98,947
<CURRENT-LIABILITIES> 18,511
<BONDS> 774
0
0
<COMMON> 83,790
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 98,947
<SALES> 39,423
<TOTAL-REVENUES> 39,423
<CGS> 20,960
<TOTAL-COSTS> 18,573
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 51
<INTEREST-EXPENSE> 129
<INCOME-PRETAX> 1,119
<INCOME-TAX> 387
<INCOME-CONTINUING> 732
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 732
<EPS-PRIMARY> .04
<EPS-DILUTED> .04
</TABLE>
