Shuffle Master Asks Investors To Ignore Spending On Unproductive Research

| About: SHFL entertainment, (SHFL)

Mid Cap Watch List member Shuffle Master, Inc. (NASDAQ:SHFL) announced its results from continuing operations for the second quarter and six months ended April 30, 2007. Revenue, adjusted EBITDA and GAAP earnings per share from continuing operations totaled $44.6 million, $13.7 million and $0.10, respectively.

The Wall Street consensus expectation was for $0.13 on $43 million in sales. Obviously with sales above expectations but earnings below, there was a margin problem:

A decrease in gross margins and operating margins compared to last year. The decrease in gross margins was primarily due to product sales mix, namely the contribution from lower margin sales of Stargames slot product and to a lesser extent, electronic table game sales. Operating margins were lower primarily due to increased R&D at Stargames and to a lesser extent, an increase in overall SG&A to support current growth initiatives.

Last year the company took a large writeoff for acquired in-process research and development when it acquired Stargames. These writeoffs are supposed to represent money paid for the acquired company’s research and development projects that don’t have a predictable outcome. Since this type of expense is not expected to occur often, its amount is listed separately on the income statement and the acquiring company generally asks investors to ignore it. However, an investor might want to consider what it would have cost the company to develop the products itself rather than buy them in process, and assign those costs to future years for comparative purposes.

Apparently, in this case not only did the written-off projects fail to materialize, but even more was spent on unproductive research.