PDS Gaming Corporation

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PDS Gaming Corporation

6170 McLeod Drive
Las Vegas, Nevada 89120
U.S.A.
Telephone: (702) 736-0700
Toll Free: (800) 479-3612
Fax: (702) 740-8692
Web site: http://www.pdsgaming.com

Public Company
Incorporated: 1988 as Progressive Distribution Systems
Employees: 56
Sales: $52.9 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: PDSG
NAIC: 522220 Sales Financing; 713210 Casinos (Except Casino Hotels); 713290 Other Gambling Industries

PDS Gaming Corporation (PDS) provides a variety of products and services to casino operators and is licensed for different casino services and operations in more than eleven states and for certain Native American locales. The core business of PDS is the financing and leasing of casino gaming machines and casino-related furniture, fixtures, and equipment. The company reconditions used slot equipment, offering the equipment for sale or lease. PDS owns Digital Card System, a technology being applied to the development of new electronically-based table games, such as Digital 21 blackjack. PDS also owns and operates The Gambler casino in Reno.

From General Leasing to Casino Financing

Husband and wife team Johan and Lona Finley started PDS Gaming in the Minneapolis area in 1988 as Progressive Distributions Systems. Operating under the name PDS Leasing Services, the company handled leasing transactions for vehicles and general equipment. PDS originated the lease transactions and then sold the contracts for immediate profit.

The direction of the company changed in 1991 when Grand Casino, Inc. of Minnesota approached PDS to lease and finance slot machines for Native American casinos then in the initial stages of development. PDS began to finance new gaming operations in Minnesota, Mississippi, Wisconsin, Colorado, and Canada by leasing gaming devices such as slot machines and video games and by financing casino-related fixtures, furniture, including hotel and restaurant furniture and equipment, including computers and office equipment, vehicles, and security and surveillance equipment. To serve these risky new ventures the company formed a new subsidiary, PDS Casinos International, Inc., to handle the transactions. In 1991, 90 percent of the company’s business originated with casino-related contracts. By 1993, with all business centered on the gaming industry, PDS revenues and profits reached $4.3 million and $500,000, respectively.

Operating as PDS Financial, the company began to finance larger ventures with the support of its May 1994 initial public offering (IPO) of stock. Through the sale of 1.5 million shares at $5.00 per share, PDS raised $7.5 million. That year PDS financed $110 million in gaming devices and casino-related equipment. The company’s new customers included Boom-town, Inc., with PDS providing financing for casinos in Reno, Las Vegas, New Orleans, and Biloxi, entering new and established gaming markets. The IPO allowed PDS to retain more of its financing contracts for recurring revenues, rather than selling them for one-time profit. In 1994, PDS recorded revenues of $8.6 million and pro forma net income of $2.3 million.

In its largest transaction to date, PDS entered into a joint venture, called Maritime Gaming Management, with First Nations Gaming, Ltd. (FNG) in November 1994. PDS entered a new area of business with the venture by financing the construction of Eagles Nest Gaming Palace in Woodstock, New Brunswick, Canada. In exchange for $13.2 million in financing, PDS was to receive a percentage of distributable income from FNG. Under a management contract with First Nation Indian Tribe, FNG received 49 percent of distributable income. Of those fees, FNG agreed to pay PDS 70 percent for the first six years and 50 percent for the next four years.

PDS halted financing in June 1995, however, when FNC did not receive government approval to operate blackjack, roulette, full-fledged slot machines, or video poker. When Eagles Nest opened in July 1995, the project had been reduced in scale, >offering high stakes bingo, pull-tabs, and video lottery terminals in a 28,000 square-foot Sprung tent structure. Low attendance exacerbated the problems at the casino. While Eagles Nest seemed to be a good investment—as many casinos in rural, high traffic locations without nearby competition had succeeded in similar circumstances—but industry experts suggested that the investment had exceeded actual financing capacity of PDS. PDS lost $7 million, including interest, closing points, and $4.6 million in financing. Its stock value dropped to $1.87. The failed financing venture resulted in 1995 revenues of $4.6 million and a loss of $4.7 million. The company’s own credit line shrank from $50 million to $1 million, inhibiting the company’s ability to do business. PDS recovered $400,000 when the company sold its interest in the loans to Dion Entertainment in a stock transaction in summer 1996.

In early 1997, PDS entered into a joint venture, this time with Dion Entertainment, to revive the Eagles Nest gaming enterprise. PDS contributed the amount equal to the loans that Dion purchased and also funded opening costs and operating capital. PDS then owned 80 percent of Transcanada 2 Corporation which reopened the Eagles Nest Gaming Palace under new management in February 1997. PDS purchased Dion’s interest in the casino in April 1997.

Seeking Stability in Established Gaming Markets in Mid-1990s

As PDS regained its revolving credit line, which rebounded to $26 million during 1996, the company introduced its Slot Lease program. The program restructured gaming equipment financing by offering operating leases to casino operators for slot machines and other electronic gaming devices. Leasing new machines provided casinos with a cost effective method of obtaining state-of-the-art slot machines while PDS obtained long-term revenues from the transactions. The leases gave customers the option to purchase or return gaming equipment when the lease expired. In June 1996, the company opened a sales office in Las Vegas to market its Slot Lease program in the vicinity of its potential customers, with plans to relocate its administrative offices to Las Vegas the following year. Also, after the difficult situation with FNG, PDS sought to obtain more business from established gaming markets at less risk. At the end of 1996, revenues had increased to $6 million and the company’s lease portfolio, those contracts retained for recurring revenues, increased from $6 million in 1995 to $24 million in 1996.

An essential aspect of the company’s growth strategy involved obtaining operational licenses from local gaming authorities, allowing PDS to receive a percentage of gaming revenues from the equipment it leased. Under these arrangements, PDS retained more leases for long-term income, rather than sell them for immediate profit. PDS obtained equipment sales and distributor licenses in Iowa and Nevada in November 1996, in New Jersey (as a Casino Service Industry license) in 1997, and a manufacturer/distributor license in Colorado in 1997.

PDS continued to regain its borrowing capacity, which rose to $56 million by summer 1997, boosted by the April agreement with Bank of New York for a $20 million revolving credit facility and $10 million from Heller Financial. By October 1997 the company’s share value had rebounded to $8.25 per share, compared to $1.75 per share in January 1997. In 1997 the company maintained a lease portfolio value of $24 million, with a total of $84 million in finance originations.

As an extension of the Slot Lease program, PDS introduced its Slot Source program in 1997, offering previously leased, reconditioned slot machines for sale or lease. PDS decided to handle equipment reconditioning in-house and established a reconditioning shop at its new headquarters in Las Vegas. The company restructured some gaming equipment transactions as sales-type leases, designed for reconditioned equipment or equipment purchased at a discount. PDS sold the contracts to remove the equipment as an asset from its balance sheet.

The company marketed reconditioned equipment to small and mid-sized casino operators in Nevada, at Native American reservations, and in the Caribbean. These operators required only standard, spinning-reel slots and video poker games. Slot Source also filled the demand for machines with bill acceptors. While small operators with little capital liked the low-cost program, major casinos, such as Caesar’s Palace, also used the service to provide their customers with a wide variety of gaming equipment. Slot Source succeeded from the outset with $2.2 million in sales during the second half of 1997 and $13.1 million in 1998.

By the end of 1997, PDS derived revenues from five distinct sources: equipment sales; sales-type leases; rental revenue on operating leases, with monthly payments and depreciation on equipment; fee income from the sale of lease or notes receivable contracts; and finance income from direct financing of leases or notes receivable that the company retained for ongoing revenues. The company recorded $17.5 million in equipment sales, $14.5 million in sales-type leases, and $11.4 million in rental revenue in 1997. With finance originations at $84.4 million and notes receivable at $3 million, PDS recorded fee income of $1.7 million and finance income of $1.6 million. Total revenues increased nearly 700 percent to $47.4 million, with net earnings at just under $1 million.

Company Perspectives:

Our mission is to be the leading diversified gaming company by providing dynamic solutions to our gaming industry customers. We provide value adding proprietary table games, unique slot distribution methodologies, creative financing and leasing alternatives, and niche casino operations. We constantly endeavor to provide our employees a satisfying work environment and strive to build long-term value for our shareholders.

While capital leases tended to range in the $500,000 to $2.5 million range, PDS obtained several large contracts in 1998. Sterling Casino Lines contracted for 855 slot machines, valued at $4 million, with shipments taken during spring and summer 1998. By late 1998, PDS obtained $55 million in new business involving $36 million in operating leases and financing commitments for 1998 and 1999. New contracts included $13 million in lease financing with Isle of Capri-Blackhawk LLC and $9 million with Blackhawk Brewery and Casino LLC, both contracts being for facilities in Colorado, and up to $33 million in contracts with The Resort at Summerlin in Las Vegas. The lease agreements provided slot machines, furniture, fixtures, and equipment. An offering of $11 million in subordinated debentures supported new financing contracts. The company shipped 6,500 gaming devices in 1998, including 3,100 of the high margin, reconditioned units. One customer’s delay in shipment of 300 units in late 1998, a $6.4 million value, resulted in a net loss for the fourth quarter, however.

While PDS maintained its five areas of revenue in 1998, the actual sources of revenue shifted. Equipment sales increased to $20.5 million, primarily originating from higher sales of reconditioned equipment. Higher sales of used equipment and higher finance income offset declines in sales of leased assets and in sales-type leases and operating leases. While original financing decreased 29 percent to $60.3 million, a dramatic increase in notes receivable, at $21.9 million, resulted in an increase in fee income to $2.7 million, while finance income nearly doubled to $3 million. Rental revenue declined 41 percent to $6.8 million and sales-type leases declined from $14.5 million to $4 million as PDS decided to offer the leases for reconditioned equipment only. The company experienced a 16 percent increase in interest expense, however, to fund leasing operations and the retention of notes receivable. Total revenues of $36 million reflected a 24 percent decrease and net income dropped by more than half to $356,000.

In an effort to expand its market reach, PDS continued to obtain new gaming licenses. In 1998, the company gained approval for a supplier license from Indiana’s licensing commission. In 1999, the company received a manufacturer/distributor license in Mississippi and a supplier license in Illinois, as well as a gaming device manufacturers license from the Nevada Gaming Commission. Under the license Nevada allowed PDS to manufacture certain replacement components for reconditioning slot machines, thus reducing time required for reconditioning process. The license allowed PDS to offer more games, including proprietary games, as well. Also, PDS obtained approval as a slot machine route operator in Nevada. The company did not intend to use the license for operating route, but to offer an alternative financing structure to its gaming equipment customers. This involved lower fixed monthly payments supplemented by sharing in revenue generated by the gaming equipment. Washington became the eleventh state to grant PDS a supplier license, approved in April 2000.

Diversification in the Late 1990s

In September 1999, PDS purchased DigiDeal Corporation’s proprietary Digital Card System. The technology utilized high quality graphics to display virtual playing cards to the dealer and players. Intellectual property rights included the Digital 21 Blackjack game and the rights to manufacture and distribute the game in the United States and to sovereign nations within the United States, as well as to apply the technology to other games. PDS established the Table Games Division to handle the new product as well as traditional table games.

PDS began field-testing Digital 21 Blackjack at The Cities of Gold Casino in Santa Fe in February 2000, and at the Sunset Station Hotel and Casino in Henderson, Nevada, outside Las Vegas in June. The Nevada Gaming Commission approved the game for further marketing the following September. PDS began assembly and installation on initial orders immediately. Laboratories Inc. approved the game for operation in California, Iowa, and New Mexico.

Revenues at PDS remained steady in 1999, while the sources of revenue continued to fluctuate. The company’s lease portfolio improved with $62 million in leases from $81 million in originated finance transactions. Hence finance income and fee income increased to $5.5 million and $3.7 million respectively. These gains were countered by bad debt, as PDS recorded higher than usual collection and asset impairment expenses of $1.4 million. Equipment sales dropped dramatically, to $6.2 million, as demand for spinning-reel slots declined, resulting in a $609,000 loss from liquidation of excess inventory. Revenues from sales-type leases and operating leases increased to $6.6 million and $12.4 million, respectively. PDS finished 1999 with stable revenues, at $35.5 million, but with a loss of $700,000.

With the slowdown in used equipment sales, PDS expanded it Slot Source program with the acquisition of Casino-SlotExchange.com. The web site listed used slot equipment for sale by casinos, manufactures, and distributors in a “virtual warehouse.” After browsing through the inventory a customer chose to buy, lease, and/or finance equipment “as is” or refurbished. The acquisition sales doubled, allowing PDS to maintain sales comparable to 1999. In 2000, PDS sold a total of 5,500 units, compared to 5,300 in 1999. Many customers took equipment in “as is” condition, however, lowering average per unit price. PDS planned to add other casino-related equipment for sale or lease at the site. The company renamed PDS Slot Source to Casino Slot Exchange.

Key Dates:

1991:: PDS begins to lease gaming machines to new casino ventures.
1994:: PDS IPO raises $7.5 million to fund expansion.
1995:: A joint venture in casino construction results in losses.
1996:: PDS opens a sales office in Las Vegas to promote its new Slot Lease program.
1997:: Slot Source is introduced for the sale and lease of used, reconditioned slot machines.
1999:: PDS acquires the rights to the Digital Card System technology for electronic table games.
2001:: The Nevada Gaming Commission grants the company its approval to operate a casino.

PDS sought to diversify in the ownership and operation of casinos in established gaming markets. Though negotiations for the Four Queens Hotel and Casino in downtown Las Vegas stalled in spring 2000, the following December PDS purchased The Gambler casino in Reno. The company leased the casino back to the owner until it received approval from the Nevada Gaming Commission to operate a casino, in January 2001. The 7,500 square foot gaming hall offered 175 gaming devices. PDS planned to replace one-third of the slot machines with newer models and to redecorate and initiate gaming on the unused second floor of the casino. The company wanted to expand further into casino operations, but had not found appropriate opportunities. PDS explored the possibility of acquiring the PTC Gaming chain of sports bars with betting facilities, but terminated the agreement in July 2001.

The Table Games Division was off to slow start, as few established casinos were willing to lease or purchase Digital 21 Blackjack. Casino operators did not want to relinquish space from a successful table game on the gaming floor to try an unproven game. Sales tended to originate with new casino operations that did not have space dedicated to established games. PDS made some adjustments to the game to make it more appealing. In order to penetrate the market with its technology, PDS formed an agreement with Action Gaming Inc. to develop Digital Card System platforms for Action Gaming’s popular Double Play Blackjack and 21 Stud table games. The licensing agreement involved rights to manufacture, market, and distribute the resulting products worldwide. To reflect the company’s expansion into game design and production, as well as casino operations, PDS changed its name to PDS Gaming in May 2001.

PDS returned to profitability in 2000 and experienced dramatic increase in business in early 2001. In 2000, revenues reached $52.9 million, with net income of $728,000, bolstered by revenues from sales-type leases that more than tripled in 2000, to $23 million. During the first half of 2001, PDS efforts to increase recurring revenues resulted in spectacular improvements. The company financed $38.2 million in transactions during the first six months, compared to $11.3 million over the same period in 2000. Also shipments of gaming devices doubled compared to the first six months of 2000. PDS continued to seek new markets, seeking licensing in Connecticut, Kansas, and Minnesota, and for Native American tribes in California, Iowa, New Mexico, and North Dakota.