PART
I
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual
Report on Form 10-K contains forward-looking statements within the “safe
harbor” provisions of the Private Securities Litigation Reform Act of 1995. All
statements included in this Annual Report, other than statements that are purely
historical, are forward-looking statements. Words such as “anticipate,”
“contemplate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,”
“will,” “will continue to be,” or the negative of foregoing and similar
expressions regarding beliefs, plans expectations or intentions regarding the
future also identify forward-looking statements. Forward-looking statements in
this Annual Report include, without limitation, our statements
that:
(A) in Item
1, (1) our belief that our field-proven mobile gaming platform is in compliance
with the regulations promulgated under Nevada’s new mobile gaming law; (2) if we
obtain the necessary approvals, we will begin marketing our wireless gaming
platform to Nevada gaming establishments, most likely commencing with casinos
with bingo halls where our mobile gaming platforms are already in use for
playing bingo games; (3) we believe the addition of traditional casino games to
our mobile platform will increase these casino operators’ revenues; (4) we
expect to subsequently expand our marketing to additional Nevada gaming
establishments that may be attracted to our mobile gaming platform by the
potential of new gaming revenues generated in the auxiliary gaming and
peripheral public areas of gaming establishments where playing of traditional
casino games, such as poker, keno and slots, was previously not available; (5)
we expect to subsequently expand marketing efforts for our wireless gaming
platform beyond Nevada; (6) we intend to market our mobile casino gaming
platforms under the WIN-WIN brand name; (7) we anticipate deploying our WIN-WIN
platforms in Nevada casinos as soon as possible upon obtaining the required
product approvals from the Nevada gaming authorities; (8) our belief that our
current facility is adequate for manufacturing sufficient volume of mobile
gaming products to satisfy the initially anticipated demand; (9) we anticipate
that casino markets will continue to be highly regulated, have stringent product
requirements and high system integrity and security requirements as the Nevada
mobile gaming market develops; (10) in the emerging mobile gaming market, we
expect to encounter competition from new entrants who seek to meet these market
requirements; (11) we expect to continue to emphasize the research and
development aspect of our business, including investing in our Smart products;
(12) as the mobile gaming market develops in Nevada, we anticipate selling or
leasing our mobile gaming platform products to a broader group of casino
operators in Nevada and in other jurisdictions if mobile gaming is approved in
these jurisdictions and the operation of our mobile gaming devices is
specifically approved in these jurisdictions, (13) we believe that electronic
bingo player units are legal in all tribal jurisdictions, United States Armed
forces bases, in a majority of the states in which paper bingo is
legal, and in a growing number of foreign jurisdictions; (14) we intend to seek
the necessary licenses, approvals and findings of suitability for our products
and our personnel in other jurisdictions where there is an opportunity to market
our products; (15) our belief that our current non-restricted gaming licenses
allow us to manufacture and distribute our mobile gaming platforms in Nevada
without additional licensing requirements; (16) we do not anticipate that any of
our independent directors will be licensed as a result of serving as a director
on the Company’s board of directors; (B) in Item 1A, (17) our future success
depends to a significant degree on the skills, experience and efforts of our key
personnel; (18) our future success depends upon our ability to attract, train
and retain key marketing personnel and key managers as we further develop our
products and as we enter new markets and expand in existing markets; (19) we
expect, based on 2007 revenues, that our revenues attributable to sales
generated through a certain distributor for 2008 will be reduced by
approximately $1,500,000; (20) we expect competition to increase and intensify
as the market for mobile gaming devices develops; (21) we expect fierce
competition from multiple large competitors dominating their respective markets
in our expansion efforts, such as Aristocrat Leisure, Ltd., International Game
Technology, Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle Master,
Inc., that may enter the market for mobile gaming devices; (22) our belief that
the failed auctions that we experienced during the first quarter of 2008 are not
a result of the deterioration of the underlying credit quality of the auction
rate securities, although valuation of them is subject to uncertainties that are
difficult to predict; (23) our belief that any unrealized gain or loss
associated with the auction rate securities will be temporary and will be
recorded in accumulated other comprehensive income (loss) in our financial
statements; (24) our belief that based on our cash and cash equivalents balances
in the first quarter of 2008, the current lack of liquidity in the credit market
and capital markets will not have a material impact on our liquidity, cash
flows, financial flexibility, or our ability to fund our operations; (25) we
will continue to monitor the market for our auction rate securities and consider
its impact (if any) on the fair market value of our investments; (26) our belief
that we will have the ability to hold any auction rate securities for which
auctions fail until the market recovers; (27) we do not anticipate having to
sell the auction rate securities in order to operate our business; (28)
initially, we intend to offer our customers equipment lease agreements under
which we will lease our wireless gaming terminals and the associated equipment;
(29) we expect to enter into agreements with customers that operate casinos and
bingo halls in more than one location; (30) we anticipate that our agreements
with multi-location customers will provide that the customer will be responsible
for providing, at its expense, a dedicated high-speed computer network
connection between our server-based gaming systems in the various locations
operated by the customer to a remote central gaming server supporting such
systems; (31) we expect to spend substantial amounts on research and
development; (32) we expect, as needed, to continue to make a significant
investment in product development; (33) to manage any future growth effectively,
we will have to expand our management team, integrate new personnel and augment
our marketing and production capabilities; (34) to rapidly produce large volumes
of wireless gaming terminals, we will have to formulate and implement design,
production planning, manufacturing and quality assurance plans that are unlike
those we have used in the past; (35) when legally permitted, we intend to
provide mobile gaming platforms to enable players to play traditional casino
games using our wireless player terminals in Nevada; (36) we expect a
substantial portion of our future growth to result from the general expansion of
the gaming industry; (C) in Item 2, (37) our belief that our current facility is
adequate for manufacturing a sufficient volume of mobile gaming products to
satisfy the anticipated demand through the existing lease term; (D) in Item 3,
(38) we believe that the final resolution of any of the threatened or pending
litigation described above, individually or in the aggregate, is not likely to
have a material adverse effect on our business, cash flow, results of operations
or financial position; (E) in Item 5, (39) our belief that we do not foresee
paying dividends on our common stock in the future; (40) our belief that we do
not intend to commence procuring any significant amount of component parts to
manufacture our gaming products until we can determine the duration of the
currently ongoing review process of our mobile gaming systems with the Nevada
gaming authorities; (41) our belief that our research and development efforts in
2007 have made our field proven mobile gaming platform compliant with the
wireless gaming regulations promulgated by the Nevada Gaming Commission to date;
(42) our belief that our revenues in 2008 will be reduced related to the loss of
a significant
number of locations related to a distributor; (43) we anticipate that our
leasing revenue will be sufficient to fund our operating expenses in the short
term; (44) our expectation that long term cash will be generated from existing
operations and potentially through selling or leasing our products in new
markets; (45) we expect to incur significant additional expenses in connection
with the procurement of equipment and components and the manufacturing of
additional stationary and wireless player terminals and that the expenses will
consume a substantial portion of our recurring lease revenues; (46) our belief
that our cash flow from operations will be adequate to meet our expenditures for
the next 12 months and foreseeable future; (47) our expectation that the
adoption of certain accounting pronouncements will not have a material effect on
the Company’s financial condition, results of operations or cash flows; and (48)
our anticipation to continue to capitalize costs related to the research and
development of our gaming platforms until the field deployment of our mobile
gaming system is achieved.
Our
expectations, beliefs, objectives, anticipations, intentions and strategies
regarding the future, including, without limitation, those concerning expected
operating results, revenues and earnings are not guarantees of future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from results contemplated by the forward-looking
statements including, but not limited to: unexpected changes to
Nevada’s new mobile gaming laws, a protracted delay in the Nevada Gaming Control
Board’s review of our mobile gaming platform or its rejection of our product;
inability to obtain the necessary approvals, licenses and findings of
suitability; unexpected difficulties in penetrating new markets as a result of
regulatory, competitive or other reasons; lack of resources to devote to
marketing efforts; unexpected changes to zoning laws that effect our ability to
continue to manufacture products in our current facility; inability to cut our
costs resulting in a loss of our existing customers; legality of our electronic
bingo players; unanticipated need of our directors to be licensed in order to
serve on our board of directors; unexpected loss of key personnel; inability to
provide competitive compensation packages to retain qualified personnel; our
inability to create or introduce new products for the conventional bingo market;
our failure to gain approval for our gaming platforms to play traditional casino
games; unanticipated decreases in our manufacturing capabilities; unanticipated
final resolution of our litigation matters; our loss of existing distributors or
our failure to further broaden our distribution channel; inability to accurately
predict the impact of a loss of a major portion of revenue from a certain
distributor on our revenues for 2008; unanticipated substantial decrease or
increase in our research and development expenses; unexpected changes to credit
ratings of the auction rate securities, difficulty in evaluating the value of
the auction rate securities; inability to accurately value the underlying assets
supporting auction rate securities; changes in default rates applicable to the
underlying assets, underlying collateral value, and the strength and quality of
the market and liquidity; inability to accurately predict the impact
of the recordation of any unrealized gain or loss associated with auction rate
securities in our financial statements; unexpected changes in our liquidity,
cash flows due to unexpected changes in the credit and capital markets;
inability to predict the impact of market changes with respect to our auction
rate securities; unanticipated need to liquidate our auction rate securities;
unanticipated changes to applicable tax rates or laws or changes in our tax
position; an unanticipated need for additional funds for operating expenses, new
business opportunities or other unforeseen events; the uncertainty of the
outcome of any pending or threatened litigation; our inability to obtain
additional financings through bank borrowings or debt or equity financing at all
or on terms that are favorable to us; our inability to protect our intellectual
property rights; the failure of the overall gaming industry to expand at the
rate we expect; unexpected need to expand our operations and enter into a new
lease; unanticipated drop or increase in inventory levels; inability of our
leasing revenue to meet our operating expenses in the short and long term;
(inability to finance additional expenses related to the procurement of
equipment and the manufacturing of equipment and component parts; unanticipated
increase in expenditures during the next 12 months; inability to accurately
predict the impact of certain accounting pronouncements; and inability to
capitalize our research and development costs.
We assume no
obligation to update any forward-looking statements. Readers are cautioned not
to place undue reliance on forward-looking statements, which speak only as of
the date of this Annual Report on Form 10-K. Readers should also review the
cautionary statements and discussion of the risks of our business set forth
elsewhere herein under the heading “Risk Factors” under Part I,
Item 1A and our other filings with the Securities and Exchange Commission
(“SEC”).
ITEM
1.
BUSINESS
General
We are a
designer, manufacturer, and field service provider of multi-game and
multi-player server-based gaming platforms. Our gaming platforms include
networks of both wireless and stationary player terminals, cashier-based point
of sale, or POS, terminals, self-service POS kiosks and game file servers that
conduct and control bingo games. Our gaming platforms have been adapted to
conduct traditional casino games, such as keno, poker and slots, in addition to
bingo.
We believe
that our field-proven mobile gaming platform is in compliance with the
regulations promulgated under Nevada’s new mobile gaming law, AB 471, or the
Nevada Mobile Gaming Law, as adopted by the Nevada Gaming Commission. We
submitted our wireless gaming platform for review by the Nevada gaming
authorities
in
2006.
If we obtain
the necessary approvals, we will begin marketing our wireless gaming platform to
Nevada gaming establishments, most likely commencing with casinos with bingo
halls where our mobile gaming platforms are already in use for playing bingo
games. We believe the addition of traditional casino games to our mobile
platform will increase these casino operators’ revenues. We expect to
subsequently expand our marketing to additional Nevada gaming establishments
that may be attracted to our mobile gaming platform by the potential of new
gaming revenues generated in the auxiliary gaming and peripheral public areas of
gaming establishments where playing of traditional casino games, such as poker,
keno and slots, was previously not available. We expect to subsequently expand
marketing efforts for our wireless gaming platform beyond Nevada.
We currently
own and lease to our customers an inventory of third- and fourth-generation
wireless and stationary player terminals, marketed under the BingoStar® brand
name, that are deployed in casinos and bingo halls in 27 jurisdictions in North
America, including Nevada casinos operated by several major casino operators. We
derive essentially all of our revenue from leasing our gaming platform to our
customers. Our contracts are typically based on a fixed fee per use per bingo
session, a fixed weekly fee per player terminal or a percentage of the revenue
generated by each player terminal.
We were
incorporated in Nevada in 1989. In 1993, we were licensed as a gaming equipment
manufacturer and distributor by the Nevada Gaming Commission. In 1994, we
received Nevada regulatory approval for our server-based, concurrent
multi-gaming, video gaming network, Mega Fortune®. In 2003, we were granted an
Operator of Inter-Casino Linked Systems, or OILS, license by the Nevada Gaming
Commission. The OILS license permits us to operate progressive jackpot linked
casino games offered simultaneously at a number of participating casinos. In
September of 2006, we were granted an Operator of Mobile Gaming Systems license
by the Nevada Gaming Commission.
In January
2004, we became the 100% owner of Millennium Games, Inc., or Millennium, which
enabled us to consolidate our worldwide distribution rights and to significantly
reduce our overall distribution and operational costs. Millennium serves as a
distribution channel for our bingo products in Native American or tribal
jurisdictions as well as other jurisdictions outside of Nevada.
The
FortuNet Gaming Platform
Our core
technology is embodied in the FortuNet® gaming platform that we currently lease
to casinos and bingo halls throughout North America. Our gaming platform serves
as the core foundation on which all of our mobile gaming platforms are based,
including our BingoStar electronic bingo gaming platform and our WIN-WIN mobile
casino gaming platform. The FortuNet gaming platform includes the following
major structural elements:
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central
game file servers that conduct and control the playing of bingo and
traditional casino games on our wireless and stationary player
terminals;
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a
comprehensive player tracking, accounting, inventory management and
reporting software package marketed under our Accounting and Inventory
Management System, or AIMS™, brand
name;
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a
flexible gaming software package that executes on our multi-game,
multi-player gaming platform and provides a variety of downloadable
traditional casino games;
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interactive
wireless and stationary player terminals that display the outcomes of the
games determined by the central game file
servers;
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Cashier-operated
POS terminals and self-service POS kiosks, issuing money deposit receipts
and dispensing payouts; and
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internally
developed hardware and software wireless technology enabling efficient, RF
noise-tolerant and reliable bi-directional RF communications between
central game file servers and wireless player terminals secured through
the use of our downloadable and disposable authentication
keys.
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BingoStar
Electronic Gaming Platform
Our BingoStar
platform of integrated, multi-game, multi-player wireless and stationary player
terminals allows patrons to play over 4,000 bingo cards with the option of
concurrently playing entertainment games, such as solitaire. Our BingoStar
platform enables many variations of bingo, including fast-paced 30-number bingo,
90-number British-style bingo, bonanza bingo, pari-mutuel bingo,
progressive-jackpot bingo, Class-II slot-style bingo and multi-site linked
bingo. BingoStar enables automatic and semi-automatic daubing of players’
electronic bingo cards that facilitates playing of numerous bingo cards in each
bingo game, yielding higher revenues for bingo hall operators.
We have
developed several proprietary sets of electronic bingo cards for generic and
custom applications, such as bonanza bingo games and double-action bingo games.
No card in our sets duplicates any card in any commercial set of paper bingo
cards known to us. In addition, our wireless and stationary player terminals are
capable of storing in electronic format complete facsimiles of third-party
commercial sets of paper bingo cards. As a result, our player terminals can
monitor both paper and electronic bingo cards.
BingoStar
also allows the playing of do-it-yourself bingo cards, akin to a lottery ticket,
on the player’s terminal by registering all electronic and paper do-it-yourself
cards. The central game file server verifies all do-it-yourself cards and
automatically rejects all void and unregistered cards, which results in a high
degree of security and integrity for do-it-yourself bingo games. BingoStar will
automatically disable a wireless player terminal if a POS cashier voids a
player’s bingo cards. This feature prevents an unscrupulous cashier from
pocketing the proceeds of the voided bingo cards.
In 2007, we
have supplemented our BingoStar platform with a broad new line of bingo
products, dubbed Smart (patents pending). The Smart product line includes
progressive signs, solid state bingo flashboards, bar coded bingo balls and
automatic bingo ball blowers. We have started field deployment of the Smart
progressive signs and flashboards and anticipate the deployment of Smart bingo
ball blowers in 2008. Following the unveiling of samples of our innovative bar
coded Smart paper bingo cards in 2007, we are constructing an advanced printing
press that will allow us to supply bingo halls with secure paper bingo cards in
volume.
Accounting
and Inventory Management System (AIMS)
Our gaming
platform includes a comprehensive accounting and inventory management software
package marketed under the brand name AIMS. Our AIMS software is a distributed
software package running on our central game file servers and POS terminals. The
AIMS software package runs in a mixed Windows-XP and Linux environment and is an
assembly of numerous functional modules, each addressing the specific management
needs of casinos and bingo halls. For example, AIMS includes a comprehensive
player tracking module that analyzes and reports players’ spending and
automatically issues electronic coupons that provide players with incentives to
play multiple bingo sessions. AIMS also automatically tracks in real time the
inventory of bingo packs as they are sold through POS terminals or directly on
the gaming floor. In addition, AIMS automatically computes all payouts owed to
bingo players and accrues progressive prizes, including the reserve accounts for
the prizes. Because AIMS includes data exporting and importing modules that are
fully compatible and integrated with commercial casino management packages
running on casino mainframes, AIMS delivers full transparency into the
operational results of our gaming platform to casino management.
WIN-WIN
Mobile Gaming Platform
We intend to
market our mobile casino gaming platforms under the WIN-WIN brand name. These
platforms are comprised of our central game file servers, gaming software,
wireless player terminals and POS terminals and POS kiosks operated through our
wireless communication technology, as described below. We anticipate deploying
our WIN-WIN platforms in Nevada casinos as soon as possible upon obtaining the
required product approvals from the Nevada gaming authorities.
Redundant
Central Game File Servers
The central
game file server of our gaming platform is where bingo and traditional casino
games are actually conducted. Game outcomes are then displayed on our wireless
and stationary player terminals. Our redundant central game file servers are
internally developed, PC-compatible computers equipped with non-modifiable and
verifiable memory circuitry that we believe complies with Nevada’s gaming device
standards. Our central game file servers run on
a reliable operating system and facilitate the concurrent
playing of multiple types of bingo games along with traditional casino games. In
addition, our central game file servers generate all
random
factors that determine the outcomes of the games played. The central game file
servers also generate unique, disposable encryption and authentication keys that
are downloaded into the wireless player terminals and redundantly preserve game
and financial transaction histories.
Flexible
Gaming Software Package with Download Capabilities
Our
internally developed modular gaming software allows us to rapidly customize our
gaming packages to meet the regulatory requirements of specific jurisdictions.
The architecture of our software is designed to provide multi-game, multi-player
functionality and facilitates rapid modifications of existing games as well as
the ability to download a variety of traditional casino games to the wireless
player terminals. The package is written in the efficient C programming language
and is executed in the reliable Linux environment.
Wireless
Player Terminals
Our wireless
player terminal is a key component of the FortuNet gaming platform. It reflects
many years of research and development in the areas of wireless technology,
communication security, software and hardware architecture, and ergonomic user
interface design. While available in a variety of models and formats including
smaller, monochrome units, the current models of our wireless player terminals
are fourth generation products that incorporate either an 8.40 inch color liquid
crystal display and measure 9.75 inches long by 2.00 inches wide and are 8.13
inches tall or 10.4 inch color liquid crystal display and measure 9.5 inches
long by 0.6 inches wide and are 8.25 inches tall. The wireless player terminals
are equipped with fast-recharge battery circuitry and sustain continuous
operation for at least 12 hours.
Our color
wireless player terminals are capable of playing not only bingo but also
traditional casino games. If required approvals are obtained, our wireless
player terminals will allow players to play traditional casino games anywhere
within permitted public areas of the casino. By providing a means to play in a
comfortable environment, our wireless player terminals may stimulate players to
play longer and will, in essence, expand the casino floor to auxiliary gaming
and peripheral public areas while simultaneously reducing energy and labor
costs.
We believe
that our mobile gaming platform meets the standards established by the Nevada
Gaming Commission for mobile gaming devices, as well as many of the standards
for conventional slot machines. In particular, our internal testing indicates
that our wireless player terminal can withstand a 23,000 volt electrostatic
discharge, the standard that is required of slot machines. It is also equipped
with tamper-evident features and alarms that render the unit inoperable
following a tampering event.
Stationary
Player Terminals
Our
stationary player terminals are secure PC-compatible computers equipped with
high-resolution, 15 inch flat liquid crystal color touch screens and are
available in different formats, such as slant-top, upright, coin-operated and
cashless ultra-thin video terminals. These high end terminals allow players to
watch and listen to close-circuit television programs in adjustable
picture-in-picture windows while playing bingo or traditional casino games. Our
stationary player terminals are housed in custom-made metal, slot-machine-like
cabinets. Our stationary player terminals run essentially the same software as
our wireless player terminals.
Cashier-operated
POS terminals and self-service POS kiosks
Players make
all money deposits and receive payouts and refunds at our secure PC-compatible
cashier-operated POS terminals or at our self-service POS kiosks. The functions
of both POS configurations are nearly identical, as both POS configurations
issue bar-coded transaction receipts to the player, register the player’s
identification from the player’s card, and register those transactions with the
central game file servers. The only difference is that in the case of the
cashier-operated terminals, it is the cashier who accepts payments and hands out
refunds and prizes, whereas, a kiosk acts much like a bank automated teller
machine.
Both POS
configurations have optional features, such as the ability to accept credit
cards where permitted by law. The kiosk is configurable to dispense bills, coins
or redeemable bar-coded vouchers and is also configurable to include a charger
rack housing wireless player terminal. In jurisdictions other than Nevada, the
kiosk also optionally houses the central file server that operates games on the
wireless player terminals dispensed from the kiosk. With optional wheels, a
mobile kiosk can be transported to different multi-use facilities, such as
theaters. The kiosk incorporates a player-operated touch screen that doubles as
an advertising channel when the kiosk is not in use. The kiosk’s internal
systems are securely locked and alarmed and are accessible only to authorized
personnel who must identify themselves with a magnetic stripe user card and a
password entered on the kiosk touch screen.
Because
self-service kiosks do not require cashiers, they can yield operators
significant savings in labor costs. In addition, kiosks shorten the waiting
lines, especially in bingo halls, and free more time for the patrons to play
casino games.
Internally
Developed, Secure and Reliable Wireless Communication Technology
Our mobile
casino gaming platform uses our internally developed, fast-response, secure,
bi-directional spread-spectrum and narrow-band radio frequency, or RF,
communication hardware and software for wireless communications. Our
communication hardware and software offer reliable and secure data delivery to
and from our wireless player terminals, even in the noisy environments
characteristic of modern casinos that are saturated with cellular telephones and
security radio telephones. We use disposable downloadable encryption and
authentication keys to prevent hacking of our RF channels.
Our wireless
player terminals are also equipped with a close-proximity, secure, infrared
communication channel to download our authentication keys. At the
cashier-operated POS terminals and the self-service POS kiosks, we download the
wireless player terminal with a file containing many disposable encryption and
authentication keys. Each key is used only once to encrypt and authenticate a
single gaming transaction performed over the RF channel. For example, each poker
hand dealt by the file server to the player terminal is encoded separately with
a unique key.
Our mobile
gaming platform can detect and automatically terminate operations on the
wireless player terminals when they are taken beyond permitted areas by
automatically destroying the encryption and authentication keys. Our wireless
player terminals are also equipped with player identification circuitry to,
among other things, prevent under-age gaming
Manufacturing
and Assembly
We develop
and own all technical documentation and intellectual property rights to
manufacturing tools, such as plastic molding forms and printed circuit board
layout masks used to manufacture our wireless player terminals.
Once a
product is designed and thoroughly tested at our facility, we contract the
volume production of parts and subassemblies to outside vendors. We contract
subassembly manufacturing jobs to a number of reputable second-source suppliers.
As a result, if demand for our products increases significantly, we can increase
our production capabilities by placing additional orders with multiple
manufacturers.
In addition
to contracting the manufacturing of our custom subassemblies, we also purchase
standard off-the-shelf components, such as video monitors, power supplies and
batteries in volume. In order to achieve economies of scale, we carefully
research the component markets for the best prices available and often adjust
our designs to incorporate cost-efficient components that we can purchase in
large volumes.
Upon receipt
of ordered parts and subassemblies, we assemble the finished products at our
facility in Las Vegas. We believe that our current facility is adequate for
manufacturing sufficient volume of mobile gaming products to satisfy the
initially anticipated demand. Currently, we operate only one work shift.
However, we can add up to two extra work shifts at our current
facility.
Competition
We experience
intense competition from a number of established suppliers of gaming equipment
to the bingo market and the casino market. Many of our competitors have longer
operating histories, long-standing relationships with gaming establishments and
suppliers, greater name recognition and greater financial, technical and
marketing resources than we do. As a result, our competitors may have
substantial competitive advantages over us. Additionally, the casino market is
characterized by a cautious attitude toward the reliability and security of
emerging wireless gaming platforms, creating additional marketing challenges for
us. We may not be able to exploit new or emerging technologies, adapt to changes
in customer requirements more quickly than our competitors or devote the
necessary resources to the marketing of our products and services. See “Item 1A.
Risk Factors.”
Bingo
Market
Currently,
our primary competitors in our existing electronic bingo market are VKGS, LLC,
or Video King, formerly a division of BK Entertainment Corp. and GameTech
International, Inc., or GameTech. We believe that we are focused on the high
performance segment of the electronic bingo market, while many of our
competitors serve the mass market segment where bingo player terminals are less
expensive and have fewer features and technological capabilities.
In addition
to Video King and GameTech, a number of other companies compete in the
electronic bingo market including the recently merged Planet Bingo, LLC and
Melange Computer Services, Inc., Blue Dog, Inc., Electronic Gaming Solutions,
Inc.
and California
Concepts, Inc. Many of our bingo market competitors offer stationary and
portable bingo player terminals. We are not aware of any competitors with an
installed base of bi-directional wireless player terminals and only a few of
them currently deliver any wireless technology. Our competitors’ existing
one-way RF communication technology may limit their ability to offer more
advanced versions of bingo or traditional casino games, such as keno, slots and
poker on a wireless player terminal.
Emerging
Mobile Gaming Market
The casino
markets are highly regulated, have stringent product requirements and high
system integrity and security requirements. We anticipate that these factors
will continue to pertain as the Nevada mobile gaming market develops. In the
emerging mobile gaming market, we expect to encounter competition from new
entrants who seek to meet these market requirements.
Cantor
Fitzgerald LP, a large financial services company that already offers wireless
sports betting in the United Kingdom, is expected to seek Nevada’s approval for
its technology. At least two other gaming technology companies, Chimera
Technology Corp. and Diamond I, Inc. have announced their strong interest in the
emerging mobile gaming market. Although we expect these and other companies to
be attracted to the potentially lucrative Nevada mobile gaming market, we
believe it will be difficult for such companies to fully meet the market’s
requirements. For instance, obtaining Nevada gaming licenses can be difficult,
costly and time consuming. Also it can be difficult to gain market recognition
in the very demanding Nevada gaming market. Lastly, some of these companies have
indicated that they plan to use off-the-shelf personal digital assistants as
their wireless gaming terminals. We question whether such products can achieve
regulatory and market acceptance.
In addition,
large gaming equipment manufacturers in the Nevada slot machine market,
including Aristocrat Leisure, Ltd., Alliance Gaming Corporation and WMS Gaming
Inc., may also attempt to enter the emerging mobile gaming market. At least
three well established gaming equipment manufacturers, International Game
Technology, or IGT, Shuffle Master, Inc., and Progressive Gaming International
Corporation have expressed interest in entering the emerging mobile gaming
market. These companies are much larger than we are and are well entrenched in
the existing gaming market.
The United
States gaming equipment market has historically been dominated by IGT, currently
the largest gaming equipment manufacturer in the world. However, we are not
aware of any mobile gaming devices being field tested by these companies with a
possible exception of Progressive Gaming International Corporation, which is
currently field testing wireless sports wagering terminals that may be viewed by
some as mobile gaming terminals, even though such sports wagering terminals are
not considered to be gaming devices under the existing Nevada statutes and
regulations.
Finally,
traditional casino operators may attempt to enter the emerging mobile gaming
markets themselves. Most of these companies are much larger than we are and have
greater resources than we do.
Research
and Development
Since our
inception in 1989, we have continuously developed innovative gaming and
entertainment products for our customers. We have internally developed all
critical aspects of our gaming platform and have outsourced only the volume
manufacturing of parts and subassemblies. We design all of our software,
including all of our source code and all of our user interfaces and graphic art
for our player terminals. We also design all of our hardware, including both
electronic and mechanical components, all printed circuit board diagrams and
layouts, and all 3D and 2D mechanical drawings for all our plastic and metal
parts. We expect to continue to emphasize the research and development aspect of
our business. Research and development costs for the fiscal years ending
December 31, 2006 and 2007, were $1,483,841 and $1,494,724,
respectively.
We
plan to continue to invest in the research and development of our Smart
products.
Customers
Currently,
our customers are bingo hall operators in the commercial casino, tribal casino
and charitable bingo markets. As the mobile gaming market develops in Nevada, we
anticipate selling or leasing our mobile gaming platform products to a broader
group of casino operators in Nevada and in other jurisdiction if mobile gaming
is approved in these jurisdictions and the operation of our mobile gaming
devices is specifically approved in these jurisdictions.
Although we
have a broadly diversified and geographically dispersed customer base, sales to
charitable organizations in Texas represented approximately 34% of our revenues
during 2007. We generate a significant amount of our revenue from domestic
customers. During 2005, 2006 and 2007, our domestic revenues were 98%, 98% and
98%, respectively.
Sales,
Marketing and Distribution
Except where
we are contractually or statutorily prohibited from doing so, we market our
products to customers through direct and indirect channels. Our direct channel
consists of our own marketing efforts as well as marketing through Millennium,
our wholly-owned subsidiary.
We also
distribute our products to our customers through our indirect channel consisting
of a network of authorized distributors, operating in the United States, Canada,
the United Kingdom and Australia. Our distributor agreements typically have
one-year initial terms with successive one-year automatic renewals. Our
distributors provide valuable services to our customers, including immediate
on-site customer support. During 2007, sales through our single-largest
distributor, K&B Sales Incorporated, doing business as Good Time Bingo,
represented approximately 34% of our revenues.
Generally,
the profit margins from the distributor facilitated accounts are lower than the
profit margins typical for our direct accounts because the latter do not involve
any commissions paid to distributors.
Customer
Support
We provide
comprehensive support services to our customers either directly or through our
distributors. We also provide 24/7 hotline support to our customers. Although
most of the technical problems are typically resolved over the telephone or by
replacing failed equipment with spare parts, in critical cases, our field
service personnel have to perform on-site maintenance and technical training.
The on-site maintenance is provided by us as an accommodation to our customers
and is not required by our contracts. We do not provide any performance, fitness
of use or similar warranty or guaranty to our customers.
An important
part of customer service is the initial installation and training of customer
personnel. From time to time, we also perform customer service at locations
directly serviced by our distributors, particularly when a distributor is new or
inexperienced. Our personnel, particularly our management team, are composed of
experts in the gaming field whose advice is well regarded by our customers. We
continually provide our advice to our customers regarding our gaming platforms
and compliance with regulatory matters related to our gaming
platforms.
Our BingoStar
platform can be easily configured by bingo hall personnel for any desired bingo
games, patterns, prizes and sessions, without the involvement of ourselves or
the local distributor. Our BingoStar platform allows our technicians to
reprogram all stationary and wireless player terminals on-site. Where permitted
by law and authorized by our customers, we can also remotely reprogram most of
the components of our BingoStar platform utilizing secure communication
protocols.
Intellectual
Property
We hold two
United States patents expiring in 2010, which relate to a lottery-type wagering
game, and one United States patent expiring in 2012, which relates to a magnetic
bingo board. We do not rely on any licensing revenue related to any of these
patents. We have also filed additional patent applications that are currently
pending in the United States Patent and Trademark Office.
We are the
registered owner of trademarks FortuNet®, Mega Fortune® and BingoStar®, as well
as pending trademark applications, including WIN-WIN™ and AIMS™.
In addition,
each of our employees has executed an agreement to maintain the confidentiality
of our trade secrets and to assign to us any intellectual property that they
conceive of in the scope of and during their employment with us.
Government
Regulation
The gaming
industry and the gaming equipment manufacturing industry exist within a
stringently controlled regulatory environment and are subject to federal, state,
tribal, local and foreign regulation. Companies participating in these
industries must hold the required gaming licenses, permits or other approvals in
all jurisdictions in which they conduct business. Many jurisdictions also
require the licensing or a finding of suitability of officers, directors, major
stockholders and key employees, the termination or disassociation with such
officer, director, key employee or major stockholder that fails to file an
application or to obtain a license or finding of suitability; the submission of
detailed financial and operating reports; and the submission of reports of
material loans, leases and financings; and the regulatory approval of some
commercial transactions, such as the transfer or pledge of equity interests in
the company. These regulatory burdens are imposed upon gaming-related suppliers
or vendors on an ongoing basis. The regulatory agencies that oversee these
jurisdictions not only continually scrutinize license holders, but in some cases
also approve the types of products that can be sold by equipment manufacturers
and used by operators. The standards for product approval vary from jurisdiction
to jurisdiction, although the Nevada standards are generally the most
stringent.
Various
aspects of our business are subject to gaming regulation. Depending on the
nature of the noncompliance, our failure to comply with these regulations may
result in the suspension or revocation of any license or registration at issue,
as well as the imposition of civil fines and criminal penalties.
Our
electronic bingo products, including the wireless and stationary units, are
subject to stricter scrutiny than traditional paper bingo products. We believe
electronic bingo player units are legal in all tribal jurisdictions, United
States Armed Forces bases, 27 states, and in a growing number of foreign
jurisdictions.
Electronic
bingo in charitable bingo halls is less widely permitted than paper bingo,
largely because many states’ laws and regulations were written before electronic
bingo technology was available. We believe that electronic bingo is permitted in
27 of the 48 states in the United States in which paper bingo is legal.
Favorable changes in this regulatory environment occurred in the recent
decade.
Licensing
Requirements
Currently, we
are licensed as a gaming equipment manufacturer or distributor in several states
and tribal jurisdictions. We intend to seek the necessary licenses, approvals
and findings of suitability for our products and our personnel in other
jurisdictions where there is an opportunity to market our products. We cannot
assure you that we will obtain the necessary licenses, approvals or findings of
suitability in a timely fashion or at all. If obtained, we cannot assure that
the licenses, approvals or findings of suitability will not be revoked,
suspended or conditioned or that we will be able to obtain the necessary
approvals for our future products as they are developed. If a license, approval
or finding of suitability is required by a regulatory authority and we fail to
receive the necessary license, approval or finding of suitability, we may be
prohibited from distributing our products for use in the applicable jurisdiction
or may be required to distribute our products through other licensed entities at
a reduced profit.
Nevada
Regulation
The Nevada Mobile Gaming
Law
On June 6,
2005, Nevada enacted the Nevada Mobile Gaming Law. This law enabled the Nevada
Gaming Commission, with the advice and assistance of the Nevada Gaming Control
Board, to promulgate regulations governing the operation of mobile gaming and
the licensing of operators, manufacturers and distributors of mobile gaming
equipment and systems in Nevada. Before adopting the regulations, the Nevada
Mobile Gaming Law required the Nevada Gaming Commission to determine that mobile
gaming systems could be operated in compliance with all applicable laws, be
secure and reliable and provide reasonable assurance that gaming devices would
be operated only by players of lawful age and only in approved areas. These
determinations were made and the final regulations under the Nevada Mobile
Gaming Law were adopted on March 23, 2006.
The Nevada
Mobile Gaming Law defines “mobile gaming” as conducting gaming through
communication technology and devices that allow a player to transmit information
to a computer that assists in placing a bet or wager and corresponding
information related to the display of the game and its outcome. “Communications
technology” is defined to mean the method and components employed by a gaming
establishment to facilitate the transmission and reception of information,
including wireless networks, wireless fidelity, wire, cable, radio, microwave,
light, optics or computer data networks. Mobile gaming can only be conducted in
“public areas” of a gaming establishment that operate at least 100 slot machines
and at least
one other game. Public areas specifically exclude hotel rooms or living
accommodations. The regulations as adopted define “mobile gaming systems,”
“operator of a mobile gaming system,” “equipment associated with mobile gaming”
and “public areas” for purposes of the law.
The Nevada
Mobile Gaming Law mandated that the revenue of operators and manufacturers of
mobile gaming systems will be subject to the same licensing fee provisions to
which currently licensed gaming establishments are subject with respect to the
operation of other games and gaming devices and that mobile gaming devices will
be subject to the same fees and taxes as are slot machines. Based upon the
regulations as adopted, we believe that our current non-restricted gaming
licenses allow us to manufacture and distribute our mobile gaming platforms in
Nevada without additional licensing requirements. Our mobile gaming platforms
for playing traditional casino games will be required to be approved before they
may be deployed in Nevada casinos.
Policy Concerns of Nevada
Gaming Laws
The laws,
regulations and supervisory practices of most gaming authorities are based upon
declarations of public policy. In the case of Nevada, these public policy
concerns include, among other things:
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preventing
unsavory or unsuitable persons from being directly or indirectly involved
with gaming or the manufacture or distribution of gaming devices at any
time or in any capacity;
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establishing
and maintaining responsible accounting practices and
procedures;
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maintaining
effective controls over the financial practices of licensees, including
establishing minimum procedures for internal fiscal affairs, and
safeguarding assets and revenue, providing reliable record keeping and
requiring the filing of periodic reports with the Nevada gaming
authorities;
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preventing
cheating and fraudulent practices;
and
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providing
a source of state and local revenue based on taxation and licensing
fees.
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Changes in
these laws, regulations and procedures could have significant negative effects
on our operations, financial condition and results of operations.
Individual Licensing
Requirements
The Nevada
gaming authorities may investigate any individual who has a material
relationship to, or material involvement with, us in order to determine whether
the individual is suitable for and/or should be licensed as a business associate
of a gaming licensee. Although licensing of an individual is not a
prerequisite for becoming an officer of our company, such person becoming an
officer is required to file necessary disclosures with Nevada gaming authorities
within thirty (30) days of becoming an officer. Currently, only our Chief
Executive Officer, or CEO, Yuri Itkis, Chief Technology Officer, or CTO, Boris
Itkis, and Chief Marketing Officer, or CMO, Jack Coronel are licensed
individuals. Additionally, our newly appointed Chief Financial Officer, or CFO,
Kevin A. Karo has recently filed his application for a finding of suitability as
a corporate officer with the Nevada Gaming Control Board.
Licensing is
not a prerequisite to becoming an independent director of FortuNet, and we do
not anticipate that any of our independent directors will be required to be
licensed as a result of serving as a director on the Company’s board of
directors. The Nevada gaming authorities may deny any application for any cause
they deem reasonable. Granting of an individual license requires a concomitant
determination of suitability of the applicant. A finding of suitability and
grant of an individual license requires submission of detailed personal and
financial information, followed by a thorough investigation. An applicant for
licensing or a finding of suitability must pay for all the costs of the
investigation. We reimbursed our employees for the cost of seeking and
maintaining licenses obtained at our request, including Yuri Itkis, Boris Itkis,
Jack B. Coronel and Kevin A. Karo. Changes in licensed positions must be
reported to the Nevada gaming authorities and, in addition to their authority to
deny an application for a finding of suitability or licensing, the Nevada gaming
authorities may disapprove a change in a corporate position, such as a change in
job title or substantive job responsibilities.
If the Nevada
gaming authorities were to find any of our personnel required to be licensed
unsuitable for licensing, we would have to sever all relationships with that
person. In addition, the Nevada Gaming Commission may require us to terminate
the employment of any person who refuses to file appropriate applications or
refuses to pay the required investigative fees. Determinations of suitability or
of questions pertaining to licensing are not subject to judicial review in
Nevada.
Consequences of Violating
Gaming Laws
If the Nevada
Gaming Commission determines we violated the Nevada Gaming Control Act or any of
its regulations, it could limit, condition, suspend or revoke our registrations
and gaming licenses. In addition, we and the persons involved could be subject
to substantial fines for each separate violation of the Nevada Gaming Control
Act, or the regulations of the Nevada Gaming Commission, at the discretion of
the Nevada Gaming Commission. Limitation, conditioning or suspension of our
gaming licenses or related registrations could, and revocation of any gaming
license or registration would, have a material adverse effect on our gaming
operations.
Requirements for Beneficial
Securities Holders
Unless we are
registered as a publicly traded corporation by the Nevada Gaming Commission, no
person may become a stockholder of, or receive any percentage of profits from,
us without first obtaining the necessary licenses and approvals from the Nevada
Gaming Commission. We have also requested and obtained approval from the Nevada
Gaming Commission for exemptions available under the Nevada Gaming Control Act
that will generally exempt the beneficial holders of our securities from the
mandatory licensing requirements. This exemption will apply to current and
future beneficial holders of our securities.
Regardless of
the number of shares held, any beneficial holder of our voting securities, may
be required to file an application, be investigated, and have that person’s
suitability as a beneficial holder of voting securities determined if the Nevada
Gaming Commission has reason to believe that the ownership would otherwise be
inconsistent with the declared policies of the State of Nevada. An exemption
from the licensing requirements does not have the effect of exempting a
beneficial owner from a suitability determination if the Nevada Gaming
Commission requires such determination. If the beneficial owner of our voting
securities who must be found suitable is a corporation, partnership, limited
partnership, limited liability company or trust, it must submit detailed
business and financial information including a list of beneficial owners. The
applicant must pay all costs of investigation incurred by the Nevada gaming
authorities in conducting any investigation.
The Nevada
Gaming Control Act requires any person who acquires five percent or more of any
class of the voting securities of a registered company to report the acquisition
to the Nevada Gaming Commission. The Nevada Gaming Control Act requires
beneficial owners of 10 percent or more of a registered company’s voting
securities to apply to the Nevada Gaming Commission for a finding of suitability
within 30 days after the Chairman of the Nevada Gaming Control Board mails the
written notice requiring the filing. Under certain circumstances, an
“institutional investor,” as defined in the Nevada Gaming Control Act, which
acquires 10 percent or more, but not more than 15 percent, of the registered
company’s voting securities may apply to the Nevada Gaming Commission for a
waiver of the finding of suitability if the institutional investor holds the
voting securities for investment purposes only. An application to be considered
as an institutional investor is a separate application and the applicant is
required to pay the applicable investigative fees.
An
institutional investor will not be deemed to hold voting securities for
investment purposes unless the voting securities were acquired and are held in
the ordinary course of its business as an institutional investor and were not
acquired and are not held for the purpose of causing, directly or indirectly,
the election of a majority of the members of the board of directors of the
registered company, a change in the corporate charter, bylaws, management,
policies or operations or the registered company or any of its gaming affiliates
or any other action that the Nevada Gaming Commission finds to be inconsistent
with holding our voting securities for investment purposes only. Activities that
are not deemed to be inconsistent with holding voting securities for investment
purposes only include:
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voting
on all matters voted on by stockholders or interest
holders;
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making
financial and other inquiries of management of the type normally made by
securities analysts for informational purposes and not to cause a change
in management, policies or operations;
and
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other
activities the Nevada Gaming Commission may determine to be consistent
with the investment intent.
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Our CEO and
Chairman of the board of directors, Yuri Itkis, our CTO, Boris Itkis, and our
CMO, Jack Coronel have been found suitable for licensing by various gaming
authorities. Our newly appointed CFO, Kevin A. Karo is currently in the process
of applying for such licenses with various gaming authorities. If a gaming
authority in any jurisdiction fails to find any of our officers, directors or
significant stockholders suitable, we may be prohibited from leasing, licensing
or selling our products in that jurisdiction. We are unaware of any facts or
circumstances that would categorically prevent a gaming authority from finding
any of our officers, directors or significant stockholders
suitable.
Consequences of Being Found
Unsuitable
Any person
who fails or refuses to apply for a finding of suitability or a license within
30 days after being ordered to do so by the Nevada Gaming Commission or the
Chairman of the Nevada Gaming Control Board, or who refuses or fails to pay the
investigative costs incurred by the Nevada gaming authorities in connection with
the investigation of its application, may be found unsuitable. The same
restrictions apply to an owner of record if the owner of record, after request,
fails to identify the beneficial owner. Any person found unsuitable and who
holds, directly or indirectly, any beneficial ownership of any voting security
or debt security of a registered company beyond the period of times as may be
prescribed by the Nevada Gaming Commission may be guilty of a criminal offense.
We will be subject to disciplinary action if, after we receive notice that a
person is unsuitable to hold an equity interest in us or to have any other
relationship with us, we:
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pay
that person any dividend upon any voting
securities;
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allow
that person to exercise, directly or indirectly, any voting right held by
that person relating to us;
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pay
remuneration in any form to that person for services rendered or
otherwise; or
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fail to
pursue all lawful efforts to require the unsuitable person to relinquish
such person’s voting securities including, if necessary, the immediate
purchase of the voting securities for cash at fair market
value.
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A finding of
suitability is generally determined based upon a myriad of facts and
circumstances surrounding the entity or individual in question and many gaming
authorities have broad discretion in determining whether a particular entity or
individual is suitable. We are unaware of any facts or circumstances that would
categorically prevent a gaming authority from finding any of our officers,
directors or significant stockholders suitable.
Gaming Laws Relating to
Securities Ownership
The Nevada
Gaming Commission may, in its discretion, require the holder of any common
stock, debt or similar security of a registered company to file applications, be
investigated and be found suitable to own the common stock, debt or other
security of the registered company if the Nevada Gaming Commission has reason to
believe that the ownership would otherwise be inconsistent with the declared
policies of the State of Nevada. If the Nevada Gaming Commission determines that
a person is unsuitable to own the security, then under the Nevada Gaming Control
Act, the registered company may be sanctioned, including the loss of its
approvals, if without the prior approval of the Nevada Gaming Commission,
it:
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pays to
the unsuitable person any dividend, interest, or other
distribution;
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Recognizes
any voting right by the unsuitable person in connection with the
securities;
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pays
the unsuitable person remuneration in any form;
or
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makes
any payment to the unsuitable person by way of principal, redemption,
conversion, exchange, liquidation or similar
transaction.
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We are
required to maintain a current stock ledger in Nevada that may be examined by
the Nevada gaming authorities at any time. If any securities are held in trust
by an agent or by a nominee, the record owner may be required to disclose the
identity of the beneficial owner to the Nevada gaming authorities. A failure to
make the disclosure may be grounds for finding the record owner unsuitable. We
will be required to render maximum assistance in determining the identity of the
beneficial owners of our voting securities.
The Nevada
Gaming Commission has the power to require the stock certificates of any
registered company to bear a legend stating that the securities are subject to
the Nevada Gaming Control Act, but has not imposed this requirement on us. If
the Nevada Gaming Commission were to impose this requirement, we expect that we
would seek an exemption from this requirement.
Approval of Changes in
Control
As a
registered company, we must obtain prior approval of the Nevada Gaming
Commission with respect to a change in control through a merger, consolidation,
stock or asset acquisitions, management or consulting agreements, or any act or
conduct by which anyone obtains control of us.
Entities
seeking to acquire control of a registered company must satisfy the Nevada
Gaming Control Board and the Nevada Gaming Commission with respect to a variety
of stringent standards before assuming control of a registered company. The
Nevada Gaming Commission also may require controlling stockholders, officers,
directors and other persons who have a material relationship or involvement with
the entity proposing to acquire control to be investigated and licensed as part
of the approval process relating to the transaction.
Approval of Defensive
Tactics
The Nevada
legislature has declared that some corporate acquisitions opposed by management,
repurchases of voting securities and corporate defense tactics affecting Nevada
gaming licensees, and registered companies that are affiliated with those
operations, may be harmful to stable and productive corporate gaming. The Nevada
Gaming Commission has established a regulatory scheme to reduce the potentially
adverse effects of these business practices upon Nevada’s gaming industry and to
further Nevada’s policy to:
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assure
the financial stability of corporate gaming licensees and their
affiliates;
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preserve
the beneficial aspects of conducting business in the corporate form;
and
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promote
a neutral environment for the orderly governance of corporate
affairs.
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Because we
are a registered company, approvals may be required from the Nevada Gaming
Commission before we can make exceptional repurchases of voting securities above
their current market price and before a corporate acquisition opposed by
management can be consummated. The Nevada Gaming Control Act also requires prior
approval of a plan of recapitalization proposed by a registered company’s board
of directors in response to a tender offer made directly to its stockholders for
the purpose of acquiring control.
Fees and
Taxes
We pay
license fees and taxes computed in various ways depending on the type of gaming
or activity involved. These fees and taxes, depending upon their nature, are
payable monthly, quarterly or annually and are based upon either a percentage of
the gross revenues received or the number of gaming devices operated. Annual
fees are also payable to the State of Nevada for renewal of our manufacturers
and distributors licenses, OILS license and our Mobile Gaming license. Our cost
of fees and taxes for the years ending December 31, 2006 and 2007 were $87,515
and $92,821 respectively.
Foreign Gaming
Investigations
Any person
who is licensed, required to be licensed, registered, required to be registered,
or who is under common control with those persons, collectively, “licensees,”
and who proposes to become involved in a gaming venture outside of Nevada, is
required to deposit with the Nevada Gaming Control Board, and thereafter
maintain, a revolving fund in the amount of $10,000 to pay the expenses of
investigation by the Nevada Gaming Control Board of the licensee’s or
registrant’s participation in foreign gaming. We currently comply with this
requirement. The revolving fund is subject to increase or decrease at the
discretion of the Nevada Gaming Commission. Licensees and registrants are
required to comply with the reporting requirements imposed by the Nevada Gaming
Control Act. A licensee or registrant is also subject to disciplinary action by
the Nevada Gaming Commission if it:
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knowingly
violates any laws of the foreign jurisdiction pertaining to the foreign
gaming operation;
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fails
to conduct the foreign gaming operation in accordance with the standards
of honesty and integrity required of Nevada gaming
operations;
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engages
in any activity or enters into any association that is unsuitable because
it poses an unreasonable threat to the control of gaming in Nevada,
reflects or tends to reflect, discredit or disrepute upon the State of
Nevada or gaming in Nevada, or is contrary to the gaming policies of
Nevada;
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engages
in activities or enters into associations that are harmful to the State of
Nevada or its ability to collect gaming taxes and fees;
or
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employs,
contracts with or associates with a person in the foreign operation who
has been denied a license or a finding of suitability in Nevada on the
ground of unsuitability.
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Federal
Registration
The Federal
Gambling Devices Act of 1962, the “Johnson Act,” makes it unlawful for a person
to manufacture, transport, or receive gambling machines, gambling devices or
components across interstate lines unless that person has first registered with
the United States Attorney General. We have complied with the registration
requirements of the Johnson Act. Gambling devices must also be identified and we
must keep certain records in accordance with the Johnson Act’s requirements. If
we violate the Johnson Act, our equipment may be seized or forfeited and we may
be subject to other penalties.
Tribal
Gaming Regulation
When
contracting with tribal owned or controlled gaming establishments, we become
subject to tribal laws and regulations that may differ materially from the
non-tribal laws and regulations under which we generally operate. In addition to
tribal gaming regulations that may require us to provide disclosures or obtain
licenses or permits to conduct our business on tribal lands, we may also become
subject to tribal laws that govern our contracts. These tribal governing laws
may not provide us with processes, procedures and remedies that enable us to
enforce our rights as effectively and advantageously as the processes,
procedures and remedies that would be afforded to us under non- tribal laws, or
to enforce our rights at all, and may expose us to an increased risk of contract
repudiation as compared to that inherent in dealing with non-tribal customers.
Many tribal laws permit redress to a tribal adjudicatory body to resolve
disputes; however, such redress is largely untested in our experience. We may be
precluded from enforcing our rights against a tribal body under the legal
doctrine of sovereign immunity.
Gaming on
tribal lands, including the terms and conditions under which gaming equipment
can be sold or leased to tribal users, is governed by federal law, tribal-state
compacts and tribal gaming regulations. The Indian Gaming Regulatory Act of
1988, or IGRA, provides the framework for federal and state control over all
gaming on tribal lands and is administered by the National Indian Gaming
Commission and the Secretary of the United States Department of the Interior.
IGRA requires that the tribe and the state enter into a written agreement, a
tribal-state compact that governs the terms of certain types of gaming
activities. We are not aware of any state in which a tribal-state compact seeks
to regulate bingo.
The
regulations and ordinances adopted by tribal authorities vary but generally
impose standards and technical requirements on gaming hardware and software, and
may impose registration, licensing and background check requirements on gaming
equipment suppliers and their officers, directors and stockholders similar to
typical requirements imposed by Nevada gaming authorities.
Traditional
Casino Game Regulation
Traditional
casino games, such as poker, keno and video slots, are regulated much more
stringently than bingo games. The number of jurisdictions in which traditional
casino games are currently permitted is relatively small in comparison to the
number of jurisdictions in which bingo is permitted. The State of California
just entered into compacts with a large number of tribal authorities. The
evolution of the regulation of traditional casino games is very difficult to
predict, and no assurance can be provided that our planned entrance into the
traditional casino game market with mobile gaming platforms will be
successful.
Employees
As of
December 31, 2007, we had employed 56 employees, including 28 employees in the
manufacturing and service departments, 19 employees in the engineering and
programming departments and 9 employees in the administration and sales
departments. None of our employees are covered by collective bargaining
agreements. We consider our employee relations to be good.
ITEM
1A.
RISK
FACTORS
Risks
Relating to Our Business
Our
failure to obtain approvals under the regulations promulgated under the Nevada
Mobile Gaming Law will negatively impact our growth strategy.
Notwithstanding
our receipt of an Operator of Mobile Gaming Systems license by the Nevada Gaming
Commission, the regulations promulgated under the Nevada Mobile Gaming Law
require us to obtain specific approval of our mobile gaming devices for use in
Nevada casinos. If we are unable to obtain or maintain approval of our mobile
gaming platform as required by the regulations, we will be unable to
manufacture, distribute and operate wireless player terminals that enable casino
players to play casino games in public areas of gaming establishments as
permitted by the Nevada Mobile Gaming Law which would have a material adverse
affect on our business and operations.
Our
inability to comply fully, or at all, with the mobile gaming regulations may
result in substantial additional development costs and preclude us from
executing our growth strategy.
The
regulations require that our mobile gaming systems be approved by the Nevada
Gaming Lab before we may distribute these systems to Nevada casinos. The Nevada
Gaming Lab may impose significant requirements on the functionality or design of
mobile gaming systems that may be manufactured, distributed or operated in
Nevada. To the extent that our existing mobile gaming platform may not comply
with such requirements, we would need to undertake additional research and
development activities that may be costly, time consuming or require the
procurement of components that are scarce in supply. Despite undertaking
additional research and development activities, we may not be able to design or
develop a mobile gaming platform that complies with the standards adopted by the
Nevada Gaming Lab, in which case we would be unable to manufacture, distribute
or operate wireless player terminals that enable casino players to play
traditional casino games in the public areas of gaming establishments permitted
under the Nevada Mobile Gaming Law, and therefore be unable to fully execute our
growth strategy.
Our
failure to maintain our current licenses and regulatory approvals or failure to
maintain or obtain licenses or approvals for our gaming devices in any
jurisdiction will prevent us from operating in that jurisdiction and possibly
other jurisdictions, leading to reduced overall revenue.
As a
manufacturer, distributor and operator of gaming platforms, we currently hold
licenses in a number of jurisdictions, including Nevada. Our officers, including
our major stockholder, Yuri Itkis, are required to obtain and maintain licenses,
permits and other forms of approval in certain jurisdictions. Our CFO, Kevin
Karo, has applied for, but has not yet received, a finding of suitability as a
corporate officer with various gaming authorities. We are under continuous
scrutiny by the applicable regulatory authorities. Our officers’
current regulatory approvals may be revoked, suspended or curtailed at any
time. Our officers’ failure to obtain or maintain regulatory approval
in any jurisdiction may prevent us from obtaining or maintaining regulatory
approval in other jurisdictions. The failure to maintain a license in a single
jurisdiction or a denial of a license by any new jurisdiction may cause a
negative “domino effect” in which the loss of a license in one jurisdiction
could lead to regulatory investigation and possible loss of a license in other
jurisdictions.
Some
jurisdictions also require licenses, permits or other forms of approval for
specific gaming devices. If other jurisdictions adopt mobile gaming laws, these
approval requirements may vary from jurisdiction to jurisdiction and the
license, permit and approval process may be costly and more difficult to obtain
that the licenses we have obtained in Nevada pursuant to the Nevada Mobile
Gaming Law. As a general matter, the regulatory approval of devices involving
traditional casino games is more difficult to obtain than those for bingo
products. Some jurisdictions require the regulatory approval of entities and
individuals before the pursuit of regulatory approval of specific gaming
devices, but other jurisdictions allow the pursuit of such regulatory approvals
concurrently. Although we and the individuals associated with us may obtain
regulatory approval in a particular jurisdiction, we may not be able to
manufacture, distribute or operate our mobile gaming platforms in that
jurisdiction without separate and specific regulatory approval of our mobile
gaming platform. Any failure of our gaming platform to meet the requirements for
approval or to obtain the approval in any jurisdiction will cause us to not be
able to distribute our gaming platforms in the jurisdiction which would have a
material adverse affect upon our business and operations.
If
we are unable to retain our senior employees or attract other key personnel our
operations may suffer.
Our future
success depends to a significant degree on the skills, experience and efforts of
our key personnel. We depend heavily on the ability and experience of a small
number of senior executives who have experience with our operations and the
electronic
gaming device
industry, including Yuri Itkis, our CEO and Chairman of the board of directors;
Kevin A. Karo, our CFO; Jack Coronel, our CMO and Director of Compliance and
Strategic Development; and Boris Itkis, our CTO, Vice President of Engineering
and member of the Company’s board of directors. The loss of any of these senior
executives or the failure of any of these senior executives to obtain or
maintain the requisite regulatory licenses, permits or determination of
suitability may have a material adverse effect on our business and
operations.
Changes in
licensed positions must be reported to the Nevada gaming authorities and, in
addition to their authority to deny an application for a finding of suitability
or licensing, the Nevada gaming authorities may disapprove a change in a
corporate position, such as a change in job title or substantive job
responsibilities. Any such disapproval would prevent us from redeploying our
senior executive talent in new functional roles even if management desires to do
so. A loss of one of our senior executives due to a finding of
disapproval from the Nevada gaming authorities could have a material adverse
effect on our business and operations.
Our future
success depends upon our ability to attract, train and retain key marketing
personnel and key managers as we further develop our products and as we enter
new markets and expand in existing markets. In connection with the audit of our
financial statements for 2006 and 2007, our independent registered public
accounting firm identified a significant deficiency in our internal control over
financial reporting arising from the current level of staffing in our accounting
department; to augment our staffing with qualified individuals on a timely basis
may not remediate this significant deficiency. Due to licensing requirements of
these personnel that may be imposed by gaming authorities, our pool of potential
employees may be more limited than in other industries. Competition for
individuals with the skills required is intense, and we may not be successful in
recruiting such personnel. In addition, we may not be able to retain such
individuals as they may leave our company and go to work for our competitors. If
we are unable to attract or retain key personnel, our business, financial
condition and operating results could be materially adversely
affected. We rely heavily on a corporate culture of lean
staffing. While helpful to our efforts to contain our costs, our lean
staffing exposes us to increased risks of internal control deficiencies and
increased harm upon employee departures.
Our
failure to retain and extend our existing contracts with customers and to win
new customers would negatively impact our operations.
All of our
lease contracts relate to our electronic bingo products. In 2007 we derived 99%
of our revenues and cash flow from our portfolio of contracts to lease
electronic bingo products to gaming establishments, such as casinos, and bingo
halls. Our contracts are typically for a term ranging from one to three years in
duration and several are on a month-to-month basis. Not all of our contracts
preclude our customers from using bingo devices of our competitors. Upon the
expiration of one of our contracts, a gaming establishment may award a contract
through a competitive procurement process, in which we may be unsuccessful in
winning the new contract or forced to reduce the price that we charge the gaming
establishment in order to renew our contract. In addition, some of our contracts
permit gaming establishments to terminate the contract at any time for our
failure to perform and for other specified reasons. The termination of or
failure to renew or extend one or more of our contracts, or the renewal or
extension of one or more of our contracts on materially altered terms could,
depending upon the circumstances, have a material adverse effect on our
business, financial condition, results and prospects.
We derive a
substantial portion of our revenue from direct sales to our customers, or house
accounts, which we service ourselves, without any involvement of outside
distributors. Although such accounts typically involve higher profit margins,
the competition for these accounts is very keen. We typically negotiate one to
three year, automatically renewable leases for our bingo units with our direct
customers. The house account contracts tend to be challenging to maintain and
enforce, especially those with tribal gaming operators, and therefore, we may
not be able to retain lucrative house accounts indefinitely. A loss of any such
account may have a severe negative impact on our revenue.
Losing
any of our small number of independent distributors upon whom we depend for a
significant portion of our revenue, or losing the business of a significant
number of customers of those distributors, would negatively impact our
operations.
We are
dependent upon a small number of independent distributors to market and sell our
products to casinos and bingo halls. For the fiscal year ended December 31,
2007, approximately 55% of our revenues were derived through seven distributors.
During the same period, we derived approximately 34% of our revenue from our
single largest distributor. Due to our payment of commissions to distributors,
our customer contracts derived from distributors generate lower profit margins
than our contracts derived from direct sales, or house accounts. Because we do
not directly control our distributors or their customer intake practices,
contracts with customers derived from distributors may be susceptible to higher
default rates and lower profit margins than our house accounts.
Some of our
distributors are not contractually prohibited from marketing or selling products
of our competitors. Our contracts with our distributors typically cover one to
three year terms and are automatically renewed for one year unless terminated
upon the expiration of the then current term. Upon the expiration of a contract
term, we may not be able to renew any of these contracts on terms that are
favorable to us, or at all. Our competitors may provide incentives to our
distributors to market and sell their products in addition to or in lieu of
ours. The loss of any of our
distributors
or the loss of business from any customer of any of our distributors may result
in a material reduction in our revenue, resulting in a material adverse effect
on our business, financial condition and results of
operations. Towards the end of 2007 and at the beginning of 2008, we
lost a significant number of charitable bingo hall customer locations that were
serviced through one of our distributors, and it is expected, based on 2007
revenues, that our revenues attributable to sales generated through this
distributor for 2008 will be reduced by approximately $1,500,000.
If
other gaming jurisdictions do not adopt mobile gaming legislation similar to the
Nevada Mobile Gaming Law, or on any terms at all, we will be unable to implement
our growth strategy outside of Nevada.
Our ability
to execute fully our growth strategy in jurisdictions other than Nevada depends
upon other gaming jurisdictions adopting mobile gaming legislation involving
traditional casino games. Currently, Nevada is the first and the only state to
enact legislation authorizing mobile gaming for traditional casino games.
Although we are not aware of any tribal gaming authority that has specifically
prohibited mobile casino gaming involving traditional casino games, we are also
not aware of any that have approved it, even though many tribal gaming
authorities in practice allow mobile bingo gaming. The adoption of gaming
legislation can be affected by a variety of political, social and public policy
forces and gaming jurisdictions other than Nevada may not adopt mobile gaming
legislation involving traditional casino games in the foreseeable future. To the
extent that other jurisdictions do adopt mobile gaming legislation involving
traditional casino games, we may not be able to comply fully with the
legislation without incurring substantial additional development costs, or at
all. If we are required to modify our mobile gaming platform to comply with such
potential legislation, we may suffer the increased costs of maintaining multiple
variants of our mobile gaming platform to comply with the differing legislation
of different jurisdictions. If other gaming jurisdictions fail to adopt mobile
gaming legislation involving traditional casino games or we are unable to comply
with such legislation without substantial additional costs, we may be unable to
execute our growth strategy.
Our
failure to obtain gaming licenses or other regulatory approvals in other
jurisdictions would preclude us from expanding our operations into and
generating revenue from these jurisdictions.
The
manufacture and distribution of gaming devices are subject to extensive federal,
state, local and tribal regulation. Some jurisdictions require licenses, permits
and other forms of approval for gaming devices. Most jurisdictions require
licenses, permits or other forms of approval of the manufacturers, distributors
and operators of gaming devices, including evidence of financial stability, and
of the suitability of their officers, directors, major stockholders and key
employees. The regulatory agencies conduct in-depth investigations of gaming
device manufacturer licensees as well as detailed personal background checks of
key employees and major stockholders of the licensees. Obtaining requisite
approvals of state and tribal gaming authorities is a time-consuming and costly
process. Even after incurring significant time and expense in seeking regulatory
approvals, we may not be able to obtain them. Our failure or the failure of our
officers, directors, major stockholders or key personnel to obtain regulatory
approval in any jurisdiction will prevent us from distributing our products and
generating revenue in that jurisdiction.
We
operate in a highly competitive industry and expect the market for mobile gaming
devices to become increasingly competitive, which may negatively affect our
operations and our ability to maintain relationships with gaming
establishments.
The market
for gaming devices generally is intensely competitive, and we expect competition
to increase and intensify as the market for mobile gaming devices develops. We
currently compete with other providers of electronic bingo products, such as
VKGS, LLC, or Video King, formerly a division of BK Entertainment Corp.,
GameTech International, Inc., the recently merged Planet Bingo, LLC and Melange
Computer Services, Inc., Blue Dog, Inc. Electronic Game Solutions, Inc
.
and California Concepts,
Inc. in the marketing of our BingoStar wireless bingo systems. Although none of
our competitors that manufacture mobile bingo devices is currently licensed in
Nevada other than GameTech International, Inc., we may face competition from
these providers in the market for mobile gaming devices in the future. Given the
market penetration, name recognition, marketing resources and familiarity with
the gaming device industry generally, traditional casino game device
manufacturers could be a significant competitive threat to us. We expect fierce
competition from multiple large competitors dominating their respective markets
in our expansion efforts, such as Aristocrat Leisure, Ltd., International Game
Technology, Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle Master,
Inc., that may enter the market for mobile gaming devices. In addition, we may
in the future face potential competition from new entrants into the gaming
device market, such as Cantor Fitzgerald LP, a large financial services company
that already offers wireless sports betting in the United Kingdom, and at least
two other gaming technology companies, Chimera Technology Corp. and Diamond I,
Inc. Finally, traditional casino operators, most of whom are much larger than
us, may attempt to enter the emerging mobile gaming market. Some of our
competitors and potential competitors have significant advantages over us,
including greater name recognition, longer operating histories, pre-existing
relationships with current or potential customers, proprietary technology,
significantly greater financial, marketing and other resources and more readily
available access to capital that could allow them to respond more quickly to new
or changing opportunities.
Other
providers of electronic bingo products have in the past reduced, and may in the
future continue to reduce, the prices of their products to gaming establishments
in order to win those gaming establishments as customers and to gain market
share. To the extent that competitive pressures force us to reduce our prices or
provide other incentives to establish or maintain relationships with gaming
establishments, our business and operating results could be adversely
affected.
A
material reduction in the yield on our investment of the proceeds of our initial
public offering and our retained earnings could materially and adversely affect
our net income and earnings per share.
Because we
have not yet begun full-scale production of mobile gaming devices under the
Nevada Mobile Gaming Law, we have invested the bulk of the proceeds of our
initial public offering and retained earnings. Our net income and earnings per
share for the year ended December 31, 2007 depended substantially on the yield
that we achieved on these investments. Approximately 10% of our income before
tax during 2007 resulted from these investments.
Our primary
investment objective is to preserve principal while maximizing yield without
significantly increasing our risk. Our investments consist of non taxable
auction rate securities, or ARS. Our investments totaled $25,125,000 at December
31, 2007.
The ARS that
we purchase consist of municipal bonds with maturities greater than five years
and have credit ratings of at least AAA, and do not include mortgage-backed
instruments. The auction process for ARS is intended, in part, to provide a
liquid market for these securities. In the event of an auction
failure, the interest rate on the security is reset according to the contractual
terms in the underlying indenture. The funds associated with failed
auctions will not be accessible until a successful auction occurs, the issuer
calls or restructures the underlying security, the underlying security matures
and is paid or a buyer outside the auction process emerges. The auction process
for some of our ARS began to deteriorate during 2007, and during the first
quarter of 2008, we began to reduce the principal amount of ARS in our
portfolio. Although we did not suffer any auction failures of our ARS during
2007, a few of the ARS we hold experienced auction failures during the first
quarter of 2008. As a result, when we attempted to liquidate some of our ARS
through auction, we were unable to do so. We believe that the
failed auctions that we have experienced during the first quarter of 2008 are
not a result of the deterioration of the underlying credit quality of these
securities, although valuation of them is subject to uncertainties that are
difficult to predict, such as changes to credit ratings of the securities and/or
the underlying assets supporting them, default rates applicable to the
underlying assets, underlying collateral value, discount rates, counterparty
risk and ongoing strength and quality of market credit and liquidity. We
believe that any unrealized gain or loss associated with these securities will
be temporary and will be recorded in accumulated other comprehensive income
(loss) in our financial statements.
The credit
and capital markets have continued to deteriorate in 2008. Continuation or
acceleration of instability in these markets and/or deterioration in the ratings
of our investments may affect our ability to liquidate these securities, and
therefore may affect our financial condition, and cash flows. We believe that,
based on our cash and cash equivalents balances in the first quarter of 2008,
the current lack of liquidity in the credit and capital markets will not have a
material impact on our liquidity, cash flows, financial flexibility or ability
to fund our obligations.
We continue
to monitor the market for our ARS and consider its impact (if any) on the fair
market value of our investments. If the market conditions of the first quarter
of 2008 continue, in which some auctions for ARS fail, or the anticipated
recovery in market values does not occur, we may be required to record
unrealized losses or impairment charges in 2008. As auctions have closed
successfully in 2008, we have converted our investments in ARS to money market
funds. We believe we will have the ability to hold any ARS for which auctions
fail until the market recovers. We do not anticipate having to sell these
securities in order to operate our business.
Although we
have invested these proceeds in relatively conservative investments, based on
the current market conditions, there can be no assurance that we will continue
to enjoy the same yields on our investments as we did during 2007. Moreover,
there can be no assurance that these investments will continue to generate a
positive yield. Assuming no other changes in our sources of revenues, any
decrease in the yield on these investments, and any loss on these investments,
would directly reduce our revenues.
Difficulties
with the limited number of manufacturers and suppliers upon whom we rely for
components of our products would negatively impact our production capacity,
customer relationships and operations.
We purchase
most of the parts, components and subassemblies necessary for the manufacture of
our products from outside sources. We assemble these parts, components and
subassemblies into finished products in our manufacturing facility. While most
of the parts, components and subassemblies are produced by more than one
manufacturer and can be purchased through more than one supplier, we currently
rely upon approximately 12 vendors from whom we purchase substantially all of
our components. We currently obtain the touch screens for our wireless gaming
terminals from a single supplier. While changing suppliers for this component is
not impossible, doing so would require significant time and effort on the part
of our engineering and management teams and may cause us to miss revenue
generating opportunities until we are
able to
obtain touch screen monitors from a new supplier. In addition, the supplies of
the central processing units, memory and peripheral drives for our mobile gaming
platforms are often uncertain and subject to significant backlogs from time to
time due to spikes in general demand for such products. We compete with other
companies for the production capacity of third party manufacturers and suppliers
of these and other components. Certain of these competing companies have
substantially greater financial and other resources than we have and thus we may
be at a competitive disadvantage in seeking to procure production
capacity.
To procure
certain parts, components and subassemblies, we sometimes commit to supply
contracts in which we commit to purchase large quantities over extended periods
of time. By doing so, we are exposed to a number of risks. If the market prices
of these components drop below the prices at which we are committed to purchase
them, our purchase commitments may preclude us from taking advantage of
reductions in market prices. If the components are surpassed by superior
technology that becomes available after we make our purchase commitments, our
purchase commitments may preclude us from taking advantage of technological
advancements. If a change in the design or specifications of our products
results in a substitution or elimination of a component, we may be forced to
write off a substantial quantity of obsolete inventory of components or to sell
such components in the open market at a loss.
Our inability
to contract with third-party manufacturers and suppliers to provide a sufficient
supply of our components on acceptable terms and on a timely basis could
negatively impact our relationships with customers and materially and adversely
harm our business. For those components that we procure under supply contracts,
if any of such supply contracts were to be terminated or breached, we may not be
able to procure an alternate supply on terms as favorable to us in time, or at
all. We may suffer lengthy delays in our manufacturing process while we seek to
procure an alternate supply. A delay in our ability to manufacture products may
adversely affect our goodwill with customers, expose us to liability to
customers and result in the loss of business opportunities. Any alternate supply
of parts, components or subassemblies may be more expensive to us or may require
us to undertake additional engineering activities to integrate the alternate
supply into our products or manufacturing process.
Certain
parts, components and subassemblies for our products are manufactured outside of
the United States, which exposes us to the risks of foreign currency
fluctuations, political and economic instability and limited protection of
intellectual property.
If
our wireless gaming terminals do not achieve and maintain widespread acceptance
by gaming establishments and casino game players as a means to play traditional
casino games, our business operations will not grow as anticipated.
Our current
business depends on the preferences of gaming establishment players that play
bingo games, and our growth strategy depends on the preferences of gaming
establishment players that play traditional casino games, such as poker, keno
and slots. The tastes and preferences of players of bingo and traditional casino
games are known to change over time. If the bingo games or traditional casino
games that we enable gaming establishment players to play using our wireless
gaming terminals do not appeal to players to the degree anticipated, our mobile
gaming platforms will not be fully utilized and our business will
suffer.
The success
of our growth strategy will depend to a large extent on broad market acceptance
of our wireless gaming terminals among casinos and their players who play
traditional casino games. The only market acceptance that our wireless gaming
terminals currently enjoy is as a means to play bingo games electronically. Even
if we are successful in deploying mobile gaming platforms that enable casino
players to play traditional casino games, gaming establishments and their
players may still not use our wireless gaming terminals for a number of reasons,
including preference for live dealers, preference to play casino games in a
traditional environment using traditional equipment, mistrust of technology and
perceived lack of reliability. We believe that the acceptance of our wireless
gaming terminals by gaming establishments and their players will depend on our
ability to demonstrate the economic and other benefits of our products to gaming
establishments, casino players becoming comfortable with using our wireless
gaming terminals, the attractiveness of the casino games that players can play
using our wireless gaming terminals, ease of use, and the reliability of the
hardware and software that comprise our mobile gaming platforms.
Initially, we
intend to offer our customers equipment lease agreements under which we will
lease our wireless gaming terminals and the associated equipment. However, if
and when market acceptance of our wireless gaming platforms has been
established, we may be required to sell wireless gaming platforms to customers
rather than lease them because of the prevailing practices of casino operators
to purchase rather than lease equipment. However, if our wireless gaming
terminals fail to quickly achieve market acceptance as a means to play
traditional casino games, our customers may not renew their leases or may not
purchase our mobile gaming platforms, which would have a material adverse effect
on our business, financial condition and results of operation.
Any
change in our business model from the lease of wireless gaming terminals to the
sale of gaming terminals may result in an eventual reduction of our
revenues.
We currently
derive substantially all of our revenues by leasing our wireless gaming
terminals and associated equipment to our gaming establishment customers. If and
when market acceptance of our wireless gaming terminals is established, our
gaming establishment customers may prefer to purchase our wireless gaming
terminals rather than lease them. If we sell our wireless gaming terminals in
the future, we must price them in a manner that reflects the ongoing lease
revenues that leasing them generates. If we are unable to sell our wireless
gaming terminals for a sales price in excess of the lease revenues that we would
otherwise receive, our revenues may eventually decline.
Our
failure to comply with tribal regulation and tribal laws would preclude us from
operating in tribal jurisdictions and deriving revenue there from.
We are
required to obtain licenses and approvals from tribal authorities in order to
operate in tribal jurisdictions. When seeking approvals from or licensing with
tribal-owned or tribal-controlled gaming establishments, we become subject to
tribal laws and regulations. These laws and regulations may differ materially
from the non-tribal laws and regulations under which we generally operate. A
change in tribal laws and regulations or our inability to obtain required
licenses of our gaming platforms or licenses to operate on tribal lands could
have a material adverse effect on our business, financial condition and
operating results.
We
may not be able to enforce our contractual rights against tribal governments or
agencies, which may negatively impact our operations.
In addition
to tribal gaming regulations that may require us to provide disclosures or
obtain licenses or permits to conduct our business on tribal lands, we may also
become subject to tribal laws that govern our contracts. These tribal governing
laws may not provide us with processes, procedures and remedies that enable us
to enforce our rights as effectively and advantageously as the processes,
procedures and remedies that would be afforded to us under non-tribal laws, or
to enforce our rights at all. Many tribal laws permit redress to a tribal
adjudicatory body to resolve disputes; however, such redress is largely untested
in our experience and tribal judiciaries are not always independent. We may be
precluded from enforcing our rights against a tribal body under the legal
doctrine of sovereign immunity. Our inability to enforce our contract rights
under tribal law could negatively impact our operations.
Disrupted
operation of our server-based gaming systems caused by the network
infrastructure of the casinos in which they are installed would cause
dissatisfaction among customers and gaming establishments and may harm our
operating results.
We expect to
enter into agreements with customers that operate casinos and bingo halls in
more than one location. In such cases, we anticipate that our agreements with
such customers will provide that the customer will be responsible for providing,
at its expense, a dedicated high-speed computer network connection between our
server-based gaming systems in the various locations operated by the customer to
a remote central gaming server supporting such systems. Failures or disruptions
of a customer’s dedicated high-speed connection that result in the stoppage of
play or in reduced performance of our server-based gaming system could disrupt
players’ gaming experience, adversely affect the casinos’ or bingo halls’
satisfaction with our gaming devices, delay market acceptance of our mobile
gaming platforms and harm our reputation, business, operating results and
financial condition. In addition, our customers have to reserve, for our
exclusive use, certain RF channels of adequate capacity to accommodate reliable
and expedient wireless communication between our wireless player terminals and
central game file servers.
We
expect to spend substantial amounts on research and development, but these
efforts may fail or lead to operational problems that could negatively impact
our operations.
In order to
compete effectively in an era of technological changes, we must continuously
enhance our existing products and develop, introduce and market new products and
services. As a result, we expect, as needed, to continue to make a significant
investment in product development. Our development of products is dependent on
factors such as assessing market trends and demands and obtaining requisite
governmental approvals. Although we are pursuing and will continue to pursue
product development opportunities, we may fail to develop any new products or
services or enhancements to existing products. Even if new products or services
are developed, these products or services may not prove to be commercially
viable, or we may not be able to obtain the various gaming licenses and
approvals necessary to manufacture and distribute these products or provide
these services to our customers. We may experience operational problems with
such products after commercial introduction that could delay or defeat the
ability of such products to generate revenue or operating profits. Future
operational problems could increase our costs, delay our plans or adversely
affect our reputation or our sales of other products, which, in turn, could
materially adversely affect our success. We cannot predict which of the many
possible future products will meet evolving industry standards and casino or
player demands.
Changes
in technology may make our inventory obsolete and cause significant
losses.
Future
technological advances in the gaming equipment market may result in the
availability of new products or increase the efficiency of existing products. We
may not be able to adapt to such technological changes. If a technology becomes
available that is more cost-effective or creates a superior product, we may be
unable to access such technology or its use may involve substantial capital
expenditures that we may be unable to finance. Existing, proposed or as yet
undeveloped technologies may render our technology less viable, less profitable
or obsolete. We may not have available the financial and other resources to
compete effectively against companies possessing such technologies. If we were
to fail to develop our product and service offerings to take advantage of
technological developments, we may fall behind our competitors and our business,
financial condition, results and prospects could suffer. If technological
advances render our current inventory of products obsolete, we may suffer
significant revenue losses and write-downs of our assets.
Defects
in, and fraudulent manipulation of, our gaming platforms could reduce our
revenue, increase our costs, burden our engineering and marketing resources,
involve us in litigation and adversely affect our gaming licenses.
The real and
perceived integrity and security of mobile gaming is critical to its ability to
attract players. We strive to set exacting standards of system security for the
systems that we provide to gaming establishments, and our reputation in this
regard is an important factor in our business dealings with our customers and
regulators, such as the Nevada Gaming Commission and other governmental
agencies. For this reason, an actual or alleged system security defect or
failure attributable to us could have a material adverse effect upon our
business, financial condition, results and prospects, including our ability to
retain existing contracts or obtain new contracts.
Our success
will depend on our ability to avoid, detect and correct software and hardware
defects and prevent fraudulent manipulation of our mobile gaming platforms.
Although our mobile gaming platforms are subject to rigorous internal testing
and will be subject to additional testing by regulators in certain gaming
jurisdictions, we may not be able to build and maintain products that are free
from defects or manipulations and that satisfy these tests. Although we have
taken rigorous steps to prevent defects and manipulations, our gaming platforms
could suffer from such defects and manipulation after they are put into
operation.
Although we
do not believe it is likely, it is possible that an individual could breach the
security systems of a casino or bingo hall, gain access to the central game file
server on which our server-based mobile gaming platform operates and
fraudulently manipulate its operations. The occurrence of such fraudulent
manipulation or of defects or malfunctions could result in financial losses for
our customers and, in turn, termination of leases, cancellation of orders,
product returns and diversion of our resources. Even if our customers do not
suffer financial losses, casinos and bingo halls may replace our gaming
platforms if they do not perform according to expectations. Any of these
occurrences could also result in the loss of or delay in market acceptance of
our server-based gaming platform and loss of licenses, leases and
sales.
In addition,
the occurrence of defects in, or fraudulent manipulation of, our gaming
platforms may give rise to claims for lost revenue and related litigation by our
gaming establishment customers and may subject us to investigation or other
disciplinary action by regulatory authorities that could include suspension or
revocation of our regulatory approvals.
Improper
conduct of our employees could harm our reputation and adversely affect our
business operations.
The real and
perceived integrity and security of mobile gaming is critical to its ability to
attract players. We strive to set exacting standards of personal integrity for
our employees and reliable security for the gaming platforms that we provide to
our customers, and our reputation in this regard is an important factor in our
business dealings with Nevada Gaming Commission and other governmental agencies.
For this reason, any allegation or a finding of improper conduct on our part, or
on the part of one or more of our employees, or an actual or alleged security
defect with our gaming platform or failure attributable to us, could have a
material adverse effect upon our business, financial condition, results and
prospects, including our ability to retain existing contracts or obtain new or
renewal contracts, or the loss of gaming licenses or other regulatory
approvals.
Our
failure to properly manage growth would adversely affect our business
operations.
In order to
implement our business strategy, we must effectively manage rapid growth in our
manufacturing, sales and customer support operations. This rapid growth will
strain our existing management, financial and other resources. To manage any
future growth effectively, we will have to expand our management team, integrate
new personnel and augment our marketing and production capabilities. To rapidly
produce large volumes of wireless gaming terminals, we will have to formulate
and implement design, production planning, manufacturing and quality assurance
plans that are unlike those we have used in the past. These plans may strain our
manufacturing and industrial engineering capabilities and resources. Rapid
growth would also require us to improve our financial, accounting and
operational systems and controls. Expansion into new
geographic
areas would further strain our limited operational and marketing resources. If
we are unable to effectively manage our growth, we may fail to execute our
business strategy and our operations and financial results may be adversely
affected.
Possible
future acquisitions could prove difficult to integrate, disrupt our business,
dilute stockholder value and strain our resources.
As part of
our business strategy, we may seek to acquire businesses, services and
technologies that we believe could complement or expand our business, augment
our market coverage, enhance our technical capabilities, provide us with
valuable customer contacts or otherwise offer growth opportunities. If we fail
to achieve the anticipated benefits of any acquisitions we may complete, our
business, operating results, financial condition and prospects may be impaired.
Acquisitions and investments involve numerous risks, including:
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Difficulties
in integrating operations, technologies, services, accounting and
personnel;
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Difficulties
in supporting and transitioning customers of our acquired companies to our
technology platforms and business processes;
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Diversion
of financial and management resources from existing
operations;
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Potential
loss of key employees;
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Inability
to generate sufficient revenues to offset acquisition or investment costs;
and
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Potential
write-offs of acquired assets.
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Acquisitions
also frequently result in recording of goodwill and other intangible assets,
which are subject to potential impairments in the future that could harm our
operating results. In addition, if we finance acquisitions by issuing
convertible debt or equity securities, our existing stockholders may be diluted.
Such dilution could adversely affect the market price of our stock. It is also
possible that at some point in the future we may decide to enter new markets,
thus subjecting ourselves to new risks associated with those
markets.
Our
patents and proprietary rights may not be enforceable, may not be cost effective
to enforce or may not provide significant competitive advantage, which could
negatively impact our operations.
Our success
depends to a significant degree upon protecting our intellectual property
rights. We have three United States patents relating to our products and
corresponding patents in certain foreign countries. Of the three patents, two
expire in 2010 and one expires in 2012. The patents that we own now or in the
future may not provide us with significant competitive advantages or may be
impaired by challenges to the validity or enforceability of such patents. For
example, in the past the validity of one of our patents has been repeatedly
challenged. Others may independently develop similar or more advanced
technologies or products or design around aspects of our technology that may be
patented.
It is
possible that third parties may copy or otherwise obtain and use our information
and proprietary technology without our authorization or otherwise infringe on
our intellectual property rights. We may have to rely on litigation to enforce
our intellectual property rights and contractual rights. For example, we are
pursuing a patent infringement action against Planet Bingo, LLC and Melange
Computer Services, Inc. to discontinue what we believe to be their infringement
of our rights arising under our patents. Both defendants have counterclaimed
that our patents are invalid and Planet Bingo, LLC has alleged that our
operations infringe one of its patents. See “Item 3. Legal Proceedings” for a
more detailed discussion of this litigation. If these counterclaims are
successful, our patents may be invalidated or limited in scope or we may be
forced to modify or discontinue our operations or pay substantial damages. If
litigation that we initiate is unsuccessful, including the litigation described
above, we may not be able to protect the value of our intellectual property and
our business could be adversely affected.
We have
patent applications that are currently pending before the United States Patent
and Trademark Office. These patent applications may not result in any patents
being issued. If these patent applications do not become issued patents, our
competitors would not be prevented from using these inventions described in the
applications.
In addition,
we may face claims of infringement that could interfere with our ability to use
technology or other intellectual property rights that are material to our
business operations. If a claim of infringement against us is successful, we may
be required to pay royalties to use technology or other intellectual property
rights that we had been using or we may be required to enter into a license
agreement and pay license fees, or we may be required to stop using the
technology or other intellectual property rights that we had been using. We may
be unable to obtain necessary
licenses from
third parties at a reasonable cost or within a reasonable time. Any litigation
of this type, whether successful or unsuccessful, could result in substantial
costs to the Company and divert our resources which may have a material adverse
effect on our growth initiatives.
In addition,
we may not be able to deter current and former employees, consultants, and other
parties from breaching confidentiality agreements with us and misappropriating
proprietary information from us. If we are unable to adequately protect our
intellectual property, it could have a material adverse effect on the value of
our intellectual property, our reputation, our business and our operating
results.
We
may not be able to obtain additional financing if required, which could harm our
operations and ability to generate revenue.
Our ability
to manufacture our gaming platforms on a large scale may require us to obtain
additional financing necessary for the manufacture of such hardware components
and expansion of our inventory. The net proceeds that we have received from the
sale of the shares of common stock in our initial public offering together with
revenue that we generate from operations may not be sufficient to execute our
growth strategy.
If we are
unable to generate sufficient revenue or if our working capital and
manufacturing capacity is not capable of keeping up with demand, we will need to
seek additional equity or debt financing to provide the capital required to
maintain or expand our production capabilities. We may not be able to obtain
needed additional equity or debt financing on terms that are favorable to us, or
at all. If we are able to obtain such financing, existing stockholders may
suffer dilution and the equity or debt securities issued to raise such financing
may have rights, preferences and privileges senior to those of existing
stockholders. If we require, but are unable to obtain, sufficient additional
financing in the future we may be unable to implement our business plan, respond
to changing business or economic conditions, withstand adverse operating results
and compete effectively. More importantly, if we are unable to raise further
financing when and if required, our continued operations may have to be scaled
down or even ceased and our ability to generate revenues would be materially
impaired.
Our
inability to lease suitable facilities may harm, delay or prevent our
operations.
The long term
lease for our Las Vegas, Nevada facility, which is our only facility, expires in
December 2010. This facility provides us with a convenient central location from
which to service our customers. We may not be able to extend the lease on its
current terms or, if required, locate new adequate manufacturing facilities on
commercially reasonable terms or at all.
Risks
Relating to Our Industry
A
decline in the popularity of gaming could reduce the demand for our
products.
We provide
mobile gaming platforms to gaming establishments to enable players to play bingo
in several jurisdictions, including Nevada, and traditional casino games on
cruise lines. When legally permitted, we intend to provide mobile gaming
platforms to enable players to play traditional casino games using our wireless
player terminals in Nevada. As a result, our business depends on consumer demand
for the games that we enable. Gaming is a discretionary leisure activity, and
participation in discretionary leisure activities has in the past, and may in
the future, decline during economic downturns because consumers have less
disposable income. Therefore, during periods of economic contraction, our
revenue may decrease while some of our costs remain fixed, resulting in
decreased earnings. Gaming activity may also decline based on changes in
consumer confidence related to general economic conditions or outlook, fears of
war, future acts of terrorism, or other factors. A reduction in tourism could
also result in a decline in gaming activity. Finally, a legislature or
regulatory authority may prohibit all or some gaming activities all together in
its jurisdiction. A decline in gaming activity as a result of these or any other
factors would have a material adverse effect on our business and operating
results.
Changes in
consumer preferences could also harm our business. Gaming competes with other
leisure activities as a form of consumer entertainment, and may lose popularity
as new leisure activities arise or as other leisure activities become more
popular. In addition, gaming in traditional gaming establishments competes with
Internet-based gaming for gaming players, and we do not serve the Internet
gaming market. The popularity and acceptance of gaming is also influenced by the
prevailing social mores, and changes in social mores could result in reduced
acceptance of gaming as a leisure activity. To the extent that the popularity of
gaming in traditional gaming establishments declines as a result of either of
these factors, the demand for our gaming platforms may decline and our business
may be adversely affected.
Expansion
of the gaming industry faces opposition that could limit our access to some
markets and impair our growth.
We expect a
substantial portion of our future growth to result from the general expansion of
the gaming industry. The expansion of gaming activities in new markets can be
very controversial and may depend heavily on the support of national, local and
tribal governments. Changes in
government
leadership, failure to obtain requisite voter support in referenda, failure of
legislators to enact enabling legislation and limitations on the volume of
gaming activity that is permitted in particular jurisdictions may prevent us
from expanding our operations into new markets. A failure by the gaming industry
to expand at the rate that we expect could have a material adverse effect on our
business, growth rates, financial condition and operating results.
Gaming
opponents continue to persist in efforts to curtail the expansion of legalized
gaming. Unfavorable public referendums, anti-gaming legislation or unfavorable
legislation affecting or directed at manufacturers or operators of gaming
products may materially and adversely impair our business and growth prospects.
Gaming opponents may be successful in preventing the legalization of mobile
gaming in jurisdictions where mobile gaming may be presently prohibited or in
limiting the expansion of mobile gaming where it is currently permitted, in
either case to the detriment of our business, financial condition, results and
prospects.
Future
acts of terrorism, as well as other factors affecting discretionary consumer
spending and air travel, may impact our industry and may harm our operating
results.
Future
terrorist attacks similar to those of September 11, 2001, may have a significant
impact on the travel and tourism industries upon which the gaming industry, and
we in turn, depend. In general, our Nevada-based gaming establishment customers
are adversely affected by disruptions in air travel, regardless of cause.
Although, our gaming establishment customers in markets outside of Nevada, which
are not as dependent on air travel, may not experience as much business
disruption, the potential for future terrorist attacks, the national and
international responses to terrorist attacks and other acts of war or hostility
have created many economic and political uncertainties that could adversely
affect our business and results of operations. Future acts of terror in the
United States or an outbreak of hostilities involving the United States may
reduce players’ willingness to travel, with the result that our operations will
suffer. The amounts that our customers pay to us are based on usage of our
devices. Accordingly, reduced usage results in reduced payments to us. Although
the revenue we generate from our gaming devices may decline as a result of
reductions in air travel or consumer spending, our contracts do not generally
provide our customers with the right to terminate their contracts with us as a
result of reductions in air travel or consumer spending.
We
operate our business in regions subject to natural disasters and other severe
catastrophic events, including hurricanes. We have suffered casualty losses as a
result of natural disasters (e.g. Hurricane Katrina), and any disruption to our
business resulting from natural disasters will adversely affect our revenue and
results of operations.
The strength
and profitability of our business depends on player demand for our products at
gaming establishments. The impact of natural disasters, the outbreak of
infectious diseases and other factors affecting discretionary consumer spending
could negatively affect gaming activity and consequently, the demand for and use
of our products at affected gaming establishments. Disruptions of gaming
establishment operations, as a result of natural disasters and other
catastrophic events beyond our control, would also reduce the number of gaming
establishments that offer our products.
We operate
our business primarily through gaming platforms, including wireless and
stationary player terminals, cashier-based POS terminals and self-service POS
kiosks, used by players at gaming establishments and bingo halls. Accordingly, a
substantial portion of our physical assets are in locations beyond our direct
control, including areas of Louisiana that sustained major damage as a result of
Hurricane Katrina. Generally, our business may also be adversely affected by any
damage to or loss of equipment that we install at gaming establishments
resulting from theft, vandalism, terrorism, flood, fire or any other natural
disaster. Our insurance may not be adequate to recover our losses from these
events. The amounts that our customers pay to us are based on usage of our
devices. Accordingly, reduced usage results in reduced payments to us. Although
the revenue we generate from our gaming devices may decline as a result of a
natural disaster, our contracts do not generally provide our customers with the
right to terminate their contracts with us as a result of a natural
disaster.
Beneficial
holders of our securities are subject to regulation by the Nevada gaming
authorities, which may result in required applications for license, findings of
suitability and mandatory redemption of shares.
Because we
are a registered company under the Nevada Gaming Control Act, any person who
acquires five percent or more of any class of our voting securities is required
to report the acquisition to the Nevada Gaming Commission. The Nevada Gaming
Control Act requires any person who acquires 10 percent or more of our voting
securities to apply to the Nevada Gaming Commission for a finding of suitability
within 30 days after the Chairman of the Nevada Gaming Control Board mails a
written notice requiring the filing. If such person fails or refuses to apply
for a finding of suitability or license within 30 days after being ordered to do
so by the Nevada gaming authorities, or if such person refuses or fails to pay
the investigative costs incurred by the Nevada gaming authorities in connection
with such person’s application, the person may be found unsuitable. The same
restrictions apply to the owner of record if the owner of record, after request,
fails to identify the beneficial owner. Any person found
unsuitable
and who holds any voting security may be guilty of a criminal offense. We will
be subject to disciplinary action if, after we receive notice that a person is
unsuitable to hold an equity interest or to have any other relationship with us,
we:
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pay
that person any dividend upon any voting
securities;
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allow
that person to exercise, directly or indirectly, any voting right relating
to us held by the person;
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pay
remuneration in any form to that person for services rendered or
otherwise; or
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fail to
pursue all lawful efforts to require the unsuitable person to relinquish
such person’s voting securities including, if necessary, the immediate
purchase of the voting securities for cash at fair market
value.
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Our Amended
and Restated Articles of Incorporation provide that persons who acquire five
percent or more of the beneficial ownership of our outstanding capital stock
notify us and consent to any background investigation or other requirements
imposed by any gaming authority. Our Amended and Restated Articles of
Incorporation also provide for mandatory redemption of its shares if the
beneficial owner fails to comply with any applicable gaming law
requirements.
Certain
Nevada statutes have potential anti-takeover effects that could delay or prevent
a change in control of our company and depress the price of our common
stock.
Nevada
statutes regulating business combinations, takeovers and control share
acquisitions may hinder or delay a change in control of our company. In
addition, under Nevada law, any change of control of our company must also be
approved by the Nevada gaming authorities. Other jurisdictions may have similar
requirements. These statutes could limit the price that investors might be
willing to pay in the future for shares of our common stock and may limit our
stockholders’ ability to receive a premium on their shares by discouraging
takeovers and tender offer bids, even if such events could be viewed as
beneficial by our stockholders.
ITEM
2.
PROPERTIES
We conduct
our operations at our facility located at 2950 South Highland Drive, Suite C,
Las Vegas, Nevada, 89109. This facility is approximately 22,000 square feet and
is utilized for our administrative office, product showroom, research and
development and manufacturing functions. The lease for this facility expires in
December 2010. Although we believe that our current facility is adequate for
manufacturing a sufficient volume of mobile gaming products to satisfy the
anticipated demand through the existing lease term, we may be forced to lease
additional manufacturing space if demand for our expanded line products should
exceed our capability to manufacture the products in our currently leased
facility.
ITEM
3.
LEGAL
PROCEEDINGS
In 2007, the
Company settled a patent infringement lawsuit against Planet Bingo, LLC and its
subsidiary, Melange Computer Services, Inc. H
owever, terms
of the settlement have not been finalized.
Currently,
the Company is the plaintiff in a civil lawsuit filed in the United States
Federal Court, District of Nevada under the federal Racketeer Influenced Corrupt
Organization, or RICO, law against GameTech International Incorporated and its
wholly owned subsidiary, GameTech Arizona Corporation.
The
Company believes that the final resolution of pending litigations,, is not
likely to have a material adverse effect on the Company’s business, cash flow,
results of operations or financial position.
ITEM
4.
SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS
None.