FORTUNET,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
|
6.
|
Stock
Based Compensation:
|
|
On
January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based
Payments” (“SFAS No. 123R”), which requires companies to measure the cost
of employee services received in exchange for an award of equity instruments
based on the grant date fair value of the award. The Company has equity
incentive plans that provide for the issuance of stock options, restricted stock
and other equity incentives.
On March 11,
2008, the Company issued 12,000 shares of restricted stock to independent
members of the board of directors. Subject to the recipients’ continued service
on our board of directors, 25% of these shares will vest upon the completion of
each fiscal quarter of 2008, and upon the termination of any recipient’s service
on our board of directors, all unvested shares will be forfeited back to the
Company.
Compensation
cost related to vested restricted stock for the three months ended
March 31, 2008, was $18,600. Costs associated with these expenses are
included in general and administrative expenses. A total of $55,800 of
unrecognized compensation costs related to nonvested restricted stock is
expected to be recognized over future periods.
|
7.
|
Commitments
and contingencies:
|
|
As
of March 31, 2008, the Company has entered into non-cancelable
purchase commitments for certain inventory components used in its normal
operations. The purchase commitments covered by these agreements are valid for
less than one year and, in the aggregate, amount to approximately
$300,000.
|
8.
|
Research
and development:
|
Research and
development costs are primarily for costs of software and hardware development
and continued enhancements for the electronic gaming systems that the Company
leases to customers. Research and development costs relating principally to the
design and development of products generating revenues are expensed as incurred.
Hardware, tools and tooling that have an alternative future use, such as for
manufacturing, are capitalized. Hand tools used in research and development, as
well as special purpose fixtures, are expensed when incurred. The total amount
of research and development was $280,547and $358,936 during the quarters ended
March 31, 2008 and 2007, respectively. A portion of overall research and
development costs totaling $106,911 and $212,918 were capitalized during the
quarters ended March 31, 2008 and 2007, respectively in accordance with SFAS
No. 86,
Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed.
We recorded
our income tax provision at an effective rate of 24.8% for the three months
ended March 31, 2008. This effective tax rate takes into account the tax exempt
interest received in the amount of $284,458 creating a reduction from the
statutory tax rate of approximately 8.3%.
As a result
of the adoption of FIN 48, as amended by FIN 48-1, at the beginning of fiscal
2007, we reclassified $102,000 to income tax payable (which would not
significantly impact our effective tax rate if recognized). This potential
liability for unrecognized tax benefits relates to state income taxes from prior
years. At the end of 2007, $102,000 was our potential liability for unrecognized
tax benefits, which included penalties and interest. During the quarter ended
March 31, 2008, $25,000 of the liability was applied as a benefit to income tax
expense as related to the lapse of the potential tax liability to certain taxing
jurisdictions. Our policy is to classify penalties and interest related to
income tax uncertainties as income tax expense.
|
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
Cautionary
Note Regarding Forward-Looking Statements
This
Quarterly Report on Form 10-Q contains forward-looking statements within
the “safe harbor” provisions of the Private Securities Litigation Reform Act of
1995. All statements included in this Quarterly 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 Quarterly Report include, without limitation, our statements
that:
(A) in Part I
Item 1, (1) 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; (2) 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; (3) 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; (4) our belief that we will have the ability to hold
any auction rate securities for which auctions fail until the market recovers;
(5) 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; (6)we
expect, as needed, to continue to make a significant investment in product
development; (B) in Part I Item 2, (7) 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; (8) our belief
that our field-proven mobile gaming platform is in compliance with the
regulations promulgated under Nevada’s new mobile gaming law; (9) our
intention to continue to introduce other new products for the conventional bingo
market segment; (10) our belief that our research and development efforts have
made our field proven mobile gaming platform compliant with the wireless gaming
regulations promulgated by the Nevada Gaming Commission to date; (11) we expect
to spend substantial amounts on research and development; (12) our anticipation
to begin selling our gaming platforms for use in conducting traditional bingo
games, instead of entering into lease contracts, as we do now, or pursuant to
purchase options contained in lease agreements; (13) our expectation to incur
similar levels of legal expenses in the future; (14) our expectation that
current legal claims and proceedings pending against us will not have a
significant effect on our financial position or results of operations; (15) we
anticipate that our leasing revenue will be sufficient to fund our operating
expenses in the short term; (16) our expectation that long term cash will be
generated from existing operations and potentially through selling or leasing
our products in new markets; (17) our belief that our cash flow from operations
will be adequate to meet our expenditures for the next 12 months and foreseeable
future; (18) 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; (19) our
anticipation that lease expenses will consume a substantial portion if not all
of our recurring lease revenues; (C) in Part II Item 1, (20) 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; (D) in Part II Item 1A, (21) we expect competition to
increase and intensify as the market for mobile gaming devices develops; (22) we
expect fierce competition from multiple large competitors dominating their
respective markets in our expansion efforts, such as Aristocrat Leisure, Ltd.,
International Game Technology Inc., Alliance Gaming Corporation, WMS Gaming Inc.
and Shuffle Master, Inc., that may enter the market for mobile gaming devices;
(23) we anticipate that competition in the mobile gaming market will become even
more fierce when and if, other licensed operators of mobile gaming systems
including, International Game Technology, Inc., Sona Mobile, Inc. and
GamTech International, Inc. enter the market; (24) our belief that we do
not foresee paying dividends on our common stock in the future; (25)
our belief that our revenues in 2008 will be reduced related to the loss of a
significant number of locations related to a distributor; (26)
our expectation that long term cash will be generated from existing operations
and potentially through selling or leasing our products in new markets; (27) 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; (28) we expect competition to increase and intensify
as the market for mobile gaming devices develops; (29) our belief 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; (30) initially, we intend to offer our customers
equipment lease agreements under which we will lease our wireless gaming
terminals and the associated equipment; (31) we expect to enter into agreements
with customers that operate casinos and bingo halls in more than one location;
(32) 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; and (33) we expect a substantial portion
of our future growth to result from the general expansion of the gaming
industry.
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 difficulties in
penetrating new markets as a result of regulatory, competitive or other reasons;
inability to devote additional resources to our marketing efforts; inability to
devote additional resources to our research and development initiatives to
enhance product development; 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; 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; inability to predict the cost of defending our pending 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; an
unanticipated need for additional funds for operating expenses, new business
opportunities or other unforeseen events; 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 in order to
expand our production efforts; unanticipated increase in expenditures during the
next 12 months; lack of growth in the gaming industry; inability to procure
additional customers and enter into new lease agreements; rapid technological
changes in the gaming industry that render our technology obsolete; inability to
demonstrate the economic benefits of our products; and inability to meet the
evolving industry standards and casino or player demands. failure to achieve
market acceptance of our products.
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 Quarterly Report on Form 10-Q. 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”), including our Annual Report on Form 10-K for the fiscal year
ending December 31, 2007 and our Current Reports on Form 8-K.
Overview
We are an
established and profitable manufacturer 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 terminals,
self-service point-of-sale 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, and concurrently
with, bingo. Our gaming platforms currently enable patrons to play bingo using
either our wireless or our stationary player terminals. In addition, our gaming
platforms currently enable patrons to play traditional casino games using our
stationary player terminals.
We believe
that our research and development efforts have made our
field-proven mobile gaming platform compliant with the wireless gaming
regulations promulgated by the Nevada Gaming Commission on March 23, 2006
and Mobile Gaming System Policies published by Nevada Gaming Commission on July
21, 2006. Accordingly, we submitted our mobile gaming platform for review by the
Nevada gaming authorities in 2006. If our wireless gaming devices are approved
by the Nevada gaming authorities, Nevada casino patrons will be able to play
traditional casino games using our wireless player terminals. However, there can
be no assurance that we will obtain such approval in the foreseeable future or
at all.
Since our
inception, we have been a technology innovator in the gaming equipment industry.
We helped to define the core concepts of modern gaming technologies including
server-based networks, concurrent multi-gaming, cashless gaming, downloadable
gaming and, notably, mobile gaming. We continue to focus on research and
development and have upgraded our fourth generation wireless player terminal to
serve as a multi-game platform that enables patrons to play traditional casino
games in casino public areas in addition to playing bingo. We also recently
introduced and started selling new advanced bingo and keno flashboards that
utilize long-life color light emitting diodes instead of conventional
incandescent lamps. We also recently introduced advanced automatic ball blowers
for bingo, keno and lottery applications working in conjunction with our
flashboards and player terminals. We intend to continue to introduce other new
products for the conventional bingo market segment.
Almost all of
our revenues are currently generated by placing electronic bingo systems in
bingo halls under contracts based on (a) a fixed fee per use per session, (b) a
fixed weekly fee per terminal, or (c) a percentage of the revenue generated by
each terminal. Our revenue is affected by player acceptance of electronic bingo
as an addition or an alternative to paper bingo in our existing customer
establishments, our ability to expand operations into new markets and our
ability to at least retain our market share in the existing markets. Our
stationary bingo player terminals generate greater revenue per player terminal
than our wireless bingo player terminals, but also require a greater initial
capital investment. As our customer base changes from period to period through
the addition of new customers or the loss of existing customers, we experience
an increase in rental revenue due to the addition of customers and a decrease in
rental revenue due to the loss of customers. Our rental revenue is also affected
from period to period by changes in operations at our existing customer
locations, that result from numerous factors over which we have little or no
control.
We typically
install our electronic bingo systems at no charge to our customers and we
capitalize all direct costs. We record depreciation of bingo equipment over a
five-year estimated useful life using the straight-line method of
depreciation.
We anticipate
that at some point in time, we may begin selling our gaming platforms for use in
conducting traditional casino games, instead of entering into lease contracts as
we do now, or pursuant to purchase options contained in lease contracts. At that
time, our revenue may include product revenue from sales of equipment, in
addition to our leasing revenue. At such time, our product revenue will be
determined by the then current price for our products and our unit-volume
sales.
We envision
that if we develop product sales revenue, we will also see a recurring revenue
component generated from software upgrades and/or maintenance of the software
components of our sold products.
Our expenses
currently consist of:
(a) cost of
revenue, depreciation of bingo terminals and other capitalized equipment under
lease to customers, maintenance, repair and refurbishment of bingo terminals and
related support equipment, and cost of shipping. Installation costs and initial
shipment expenses associated with new customer lease contracts are expensed as
cost of revenue in the period in which the equipment is deployed. Expenses
related to maintenance, repair and refurbishment of our existing equipment that
has been deployed at customer locations are expensed as cost of revenue in the
period in which the maintenance, repair or refurbishment is performed. These
expenses are incurred to, among other things, maintain our existing equipment in
working order, provide our customers with updated equipment, fix software bugs,
if any, provide new functionality and minimize the number of different
installation configurations that we must support. We are not obligated to
perform maintenance, repair or refurbishment under the terms of our rental
agreements with our customers, but we do so in order to improve the quality and
reliability of our products;
(b) general
and administrative expenses, including the costs of activities associated with
the management of our company and related support, which includes all payroll
and benefits other than payroll in connection with research and development
activities, travel costs, professional fees, facility lease expenses and bad
debt expense reserves;
(c) sales and
marketing expenses, consisting primarily of commissions paid to distributors for
promoting and supporting our products and related marketing costs;
and
(d) costs of
research and development activities geared to the further development of our
gaming platform, including labor costs and costs of hardware and software
testing, prototyping and development tools.
We envision
that the development of our product revenue will require us to record costs of
products sold (rather than leased) that include materials, labor, and direct and
indirect manufacturing costs and associated warranty costs.
Millennium,
our wholly owned subsidiary, distributes our bingo products in selected
territories in the United States. All of our other operations, including the
operation and maintenance of our bingo products in all territories and the
exclusive distribution of our bingo products in Nevada, Texas and Washington,
are conducted by FortuNet.
During the
three months ended March 31, 2008, we incurred $108,887 in legal expenses
incurred in a routine course of business. Our legal expenses decreased in
comparison to the $140,594 in legal expenses for the three months ended March
31, 2007, which expenses were related to the previously settled patent
infringement litigation against defendants Planet Bingo, LLC and Melange
Computer Services, Inc. and an ongoing civil RICO litigation against defendants
Game Tech International, Inc and Game Tech Arizona, Inc. We expect similar
levels of legal expenses in the future.
Deferred
taxes are primarily the result of differences in tax and financial amortization
lives of other assets and differences in property and equipment
depreciation.
Application
of Critical Accounting Policies and Estimates
Our condensed
consolidated financial statements have been prepared in accordance with United
States generally accepted accounting principles. The preparation of these
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the reporting date and reported amounts of revenue and
expenses during the reporting period. On an ongoing basis, we evaluate our
estimates and judgments, including those related to revenue recognition, bad
debts, player terminal depreciation and litigation. We base our estimates and
judgments on historical experience and on various other factors that are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ materially
from these estimates under different assumptions or conditions.
There has
been no material change in the critical accounting policies that affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements from the critical accounting policies described in our
Annual Report on Form 10-K for fiscal year ended December 31, 2007.
We are
currently involved in various legal claims and legal proceedings. We have not
accrued any liability for estimated losses related to legal contingencies at
this time. In management’s opinion, these matters are not expected to have a
significant effect on our financial position or results of operations.
Periodically, we review the status of each significant matter and assess our
potential financial exposure. If the potential loss from any claim or legal
proceeding is considered probable and the amount can be estimated, we accrue a
liability for the estimated loss. Significant judgment is required in both the
determination of probability and the determination as to whether an exposure can
be reasonably estimated. Because of uncertainties related to these matters,
accruals are based only on the best information available at the time. As
additional information becomes available, we reassess the potential liability
related to our pending claims and litigation and may revise our estimates. Such
revisions in the estimates of the potential liabilities could have a material
impact on our consolidated results of operations and financial
position.
Results
of Operations
The following
table sets forth our results of operations in dollars and as a percentage of
revenue for each of the periods indicated:
Consolidated
Income Statement
|
|
|
Three
months ended March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
4,121,633
|
|
|
|
100.0
|
%
|
|
$
|
4,332,668
|
|
|
|
100.0
|
%
|
|
Cost of
revenue
|
|
|
680,980
|
|
|
|
16.5
|
%
|
|
|
547,536
|
|
|
|
12.6
|
%
|
|
Gross
profit
|
|
|
3,440,653
|
|
|
|
83.5
|
%
|
|
|
3,785,132
|
|
|
|
87.4
|
%
|
|
Operating
costs & expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
& administrative
|
|
|
1,181,676
|
|
|
|
28.7
|
%
|
|
|
1,222,476
|
|
|
|
28.2
|
%
|
|
Sales
& marketing
|
|
|
1,130,918
|
|
|
|
27.4
|
%
|
|
|
1,384,488
|
|
|
|
32.0
|
%
|
|
Research
& development
|
|
|
173,636
|
|
|
|
4.2
|
%
|
|
|
146,018
|
|
|
|
3.4
|
%
|
|
Total
operating expenses
|
|
|
2,486,230
|
|
|
|
60.3
|
%
|
|
|
2,752,982
|
|
|
|
63.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from operations
|
|
|
954,423
|
|
|
|
23.2
|
%
|
|
|
1,032,150
|
|
|
|
23.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
5,276
|
|
|
|
0.1
|
%
|
|
|
469,600
|
|
|
|
10.8
|
%
|
|
Investment
income, net
|
|
|
295,457
|
|
|
|
7.2
|
%
|
|
|
233,542
|
|
|
|
5.4
|
%
|
|
Income
before taxes
|
|
|
1,255,156
|
|
|
|
30.5
|
%
|
|
|
1,735,292
|
|
|
|
40.0
|
%
|
|
Provision
for income taxes
|
|
|
311,605
|
|
|
|
7.6
|
%
|
|
|
463,770
|
|
|
|
10.7
|
%
|
|
Net
income
|
|
$
|
943,551
|
|
|
|
22.9
|
%
|
|
$
|
1,271,522
|
|
|
|
29.3
|
%
|
Three
Months Ended March 31, 2008 and March 31, 2007
Revenue.
Revenues were
$4,121,633 for the three months ended March 31, 2008, as compared to $4,332,668
for the three months ended March 31, 2007, a decrease of $211,035, or
4.9%. This decrease was due primarily to the reduction of unit deployment as a
result of a partial loss of revenue from charitable bingo halls from a single
distributor, partially offset by the deployment of new units in the last half of
2007.
For the three
months ended March 31, 2008, the net change in our revenue as a result of
changes in our customer base was an increase in revenue of $188,569 and the net
change in revenue as a result of changes in operations at our existing customer
locations was a decrease in revenue of $358,318.
Cost of revenue.
Cost of
revenue was $680,980 for the three months ended March 31, 2008, compared to
$547,536 for the three months ended March 31, 2007, an increase of $133,444, or
24.4%. The increase in cost of revenue was attributable primarily to the
increase in depreciation, installation and maintenance expenses. Specifically,
the depreciation cost for the three months ended March 31, 2008 was $485,365 as
compared to $431,014 for the three months ended March 31, 2007. Our
installation, maintenance and shipping expense also increased to $195,615 for
the three months ended March 31, 2008 from $116,522 for the three months ended
March 31, 2007. This increase was partially attributable to an increase in the
repairs and upgrades to the current generation of deployed units.
As a result
of this overall increase in costs as well as the overall decrease in revenues,
our gross margin decreased to 83.5% for the three months ended March 31, 2008
from 87.4% for the three months ended March 31, 2007.
General and Administrative.
General and administrative expenses were $1,181,676, or 28.7% of revenue,
for the three months ended March 31, 2008 compared to $1,222,476, or 28.2% of
revenue, for the three months ended March 31, 2007, a decrease of $40,800, or
3.3%. This cost decrease was achieved primarily as the cost of professional
services was reduced.
In the
quarter ending March 31, 2008 we had costs associated with stock grants to our
directors in the amount of $18,600. We will have costs similar to the costs
associated with the stock grants to our directors in each of the remaining
quarters of 2008.
Our legal
expenses decreased from $140,594 during the three months ended March 31, 2007 to
$108,887, or 22.6%, during the three months ended March 31,
2008.
Sales and marketing.
Sales
and marketing expenses were $1,130,918 or 27.4% of revenue, for the three months
ended March 31, 2008, compared to $1,384,488, or 32.0% of revenue, for the three
months ended March 31, 2007, a decrease of $253,570 or 18.3%. This decrease was
attributable primarily to the reduction of commissions paid to the distributors
as a result of the loss of revenue from some charitable bingo
locations.
Research and development.
Research and development expenses were $173,636, or 4.2% of revenue, for the
three months ended March 31, 2008, compared to $146,018, or 3.4% of
revenue, for the three months ended March 31, 2007, an increase of $27,618, or
18.9%. The overall increase in research and development costs was partially
offset by a reduction in capitalized labor costs related to the
ongoing development of our Mobile Gaming Platform. Specifically, in the quarter
ended March 31, 2008, approximately $106,911 was capitalized as compared to
$196,487 capitalized in the quarter ending March 31, 2007.
Other income and investment income.
Interest income from investments for the three months ended March 31,
2008 was $295,457 or 7.2% of revenue, compared to $233,542 or 5.4% of revenue,
for the three months ended March 31, 2007, an increase of $61,915, or 26.5%, the
increase is attributable primarily to the increase of interest rates on certain
auction rate securities that failed at auction. Overall other income
decreased $464,324 since we have received a one-time collection payment of
$469,586 in the first quarter of 2007.
Provision for income taxes.
An income tax provision of $311,605 with an effective tax rate of 24.8% was
recorded for the three months ended March 31, 2008, as compared to $463,770 with
an effective tax rate of 26.7% for the three months ended March 31, 2007, a
decrease of $152,165, or 32.8%. This decrease was primarily due to a decrease in
taxable income during the three months ended March 31, 2008. The decrease in the
effective tax rate is attributable primarily to the increase in earnings on tax
exempt instruments as a percentage of taxable income.
Liquidity
and Capital Resources
Since
inception, we have financed our operations primarily with revenue generated from
the leasing of our bingo products. In January 2006 we successfully completed our
initial public offering of our common stock. As of March 31, 2008, our principal
sources of liquidity were cash and cash equivalents and marketable securities of
$24,062,639 and accounts receivable (net of allowance for doubtful accounts) of
$1,381,781. We anticipate that our leasing revenue, which is our principal
source of revenue today, will be sufficient to fund our operating expenses in
the short term. Long term cash is expected to be generated from existing
operations and also through selling or leasing of our products in new
markets.
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 to take advantage of business opportunities. We
anticipate that these expenses will consume a substantial portion, if not all,
of our recurring lease revenues. Except to the extent we become obligated under
supply contracts that we enter into to procure equipment and components, our
fixed payment commitments are limited to our facilities lease.
We believe
that our cash flow from operations will be adequate to meet our anticipated
future requirements for working capital and capital expenditures for the next 12
months and for the foreseeable future. Currently, there is no plan to raise
additional capital, however, if necessary we may seek other advisable additional
financing through bank borrowings or public or private debt or equity
financings. Additional financing, if needed, may not be available to us, or, if
available, the financing may not be on terms favorable to us. The terms of any
financing that we may obtain in the future could impose additional limitations
on our operations and management structure. Our estimates of our anticipated
liquidity needs may not be accurate or new business development opportunities or
other unforeseen events may occur, resulting in the need to raise additional
funds.
Summary
of Consolidated Statements of Cash Flow
|
|
|
Three
Months
Ended
March 31
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
$
|
1,181,282
|
|
|
$
|
2,143,884
|
|
|
Net
cash provided by (used in) investing activities
|
|
|
6,192,422
|
|
|
|
(507,689
|
)
|
|
Net
increase in cash and cash equivalents
|
|
|
7,373,704
|
|
|
|
1,636,195
|
|
|
Cash
and cash equivalents, beginning
|
|
|
4,513,935
|
|
|
|
3,493,808
|
|
|
Cash
and cash equivalents, ending
|
|
$
|
11,887,639
|
|
|
$
|
5,130,003
|
|
Operating
Activities
For the three
months ended March 31, 2008, net cash of $1,181,282 provided by operating
activities was primarily due to net income of $943,551 depreciation and
amortization of $513,560, stock issued for services of $49,415 and change in
operating assets and liabilities of ($249,036). For the three months ended March
31, 2007 net cash of $2,143,884 provided by operating activities was primarily
due to net income of $1,271,522, depreciation and amortization of $456,754 stock
issued for services of $60,018 and change in operating assets and liabilities of
$498,071. The decrease in net cash provided by operating activities during the
three months ended March 31, 2008 as compared to the three months ended March
31, 2007 was primarily due to the decrease in operating income for the three
months ending March 31, 2008. compared to the three months ended March 31,
2007.
Investing
Activities
For the three
months ended March 31, 2008, $6,192,422 of net cash was used for investing
activities, with $188,207 spent on other capital expenditures and $9,700,000 of
marketable securities sold and $3,300,000 of marketable securities purchased
during the quarter.
For the three
months ended March 31, 2007, $507,689 of net cash was used for investing
activities, with $50,388 being used to fund the manufacturing of additional
equipment for lease to our customers, $457,301 spent on other capital
expenditures and $100,000 of marketable securities sold and purchased during the
quarter.
Financing
Activities
For the three
months ended March 31, 2008 and 2007, no net cash was provided by financing
activities.
Off-Balance
Sheet Arrangements
As of March
31, 2008, we have no off-balance sheet arrangements as defined in Item 303(a)(4)
of the Securities and Exchange Commission’s Regulation S-K.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
This
Quarterly Report does not include information described under Item 3 of Form
10-Q pursuant to the rules of the Securities and Exchange Commission that permit
“smaller reporting companies” to omit such information.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
We are
required to maintain disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be disclosed in our
reports under the Securities Exchange Act is recorded, processed, summarized and
reported within the time period specified in the Securities and Exchange
Commission’s rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
As required
by Rule 13a-15(b) promulgated under the Securities Exchange Act, our management,
with the participation of our Chief Executive Officer and Chief Financial
Officer, evaluated the design and operating effectiveness as of March 31, 2008
of our disclosure controls and procedures, as defined in Rule 13a-15(e)
promulgated under the Securities Exchange Act. Based on this evaluation our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were not effective as of March 31, 2008, at
the reasonable assurance level to enable the Company to record, process,
summarize and report information required under the Securities and Exchange
Commission’s rules in a timely fashion.
Changes
in Internal Control Over Financial Reporting
As reported
in Item 9A of our Annual Report on Form 10-K dated December 31, 2007,
management concluded that its internal control over financial reporting was not
effective as of December 31, 2007. Such conclusion resulted from the
identification of deficiencies that were determined to be significant
deficiencies. Specifically, we did not have appropriate internal controls in the
following areas:
|
|
•
|
|
Ineffective controls related to
staffing in finance and accounting:
For the year ended December 31,
2007, our CFO prepared the financial statements, reconciled numerous
accounts, prepared the tax accrual and the Form 10-K without review by
another qualified person that has sufficient accounting knowledge, skills
and understanding of the Company to detect errors and
omissions. Lack of review by an additional sufficiently
knowledgeable person produces the potential for misstatement in the
financial statements to occur and not be detected in a timely
manner. This deficiency could cause the financial statements
and the underlying financial records to be misrepresented. In
addition it creates the opportunity for possible irregularities to exist
and continue without detection in a timely basis.
|
|
|
•
|
|
Ineffective controls related to
accounting and access to cash receipts:
The control
designed to ensure the timely and accurate receipt and deposit of cash for
the year ended December 31, 2007 did not operate effectively as our CFO
had the responsibility of opening the mail and delivering the cash
receipts to the accountant to prepare for deposit. Because the
CFO had control over both the asset and accounting process, the failure to
segregate both duties creates an opportunity for errors or
misappropriation to occur undetected.
|
|
|
•
|
|
Ineffective controls related to
custody and authorization disbursements:
The control
designed to ensure the timely and accurate disbursement of cash for the
year ended December 31, 2007, did not operate effectively because the CFO
had the ability to authorize and sign checks for
disbursement. Because the CFO had control over both the
authorization and custodian duties related to our cash disbursements
process, the failure to segregate both duties creates an opportunity for
errors or misappropriation to occur
undetected.
|
Notwithstanding
management’s assessment that our internal control over financial reporting was
ineffective as of December 31, 2007 and the significant deficiencies described
above, we believe that the interim financial statements included in this
Quarterly Report on Form 10-Q correctly present in all material respects our
financial position, results of operations and cash flows for the interim periods
covered therein.
During the
three months ended March 31, 2008 and subsequent thereto, we have undertaken
work to remediate the significant deficiencies described above. This
includes, but is not limited to, the following remediation
measures:
|
·
|
We have
considered certain alternatives for the accounting of cash receipts,
access to cash receipts and custodian
duties.
|
|
·
|
We have
modified aspects of our cash disbursement
authorization
|
While
management believes that progress has been made on the implementation of these
initiatives, additional work needs to be done to remediate those
significant deficiencies.
Except for
the remediation initiative with respect to the significant deficiencies
described above, there have been no changes in our internal control over
financial reporting that occurred during the quarter ended March 31, 2008. that
have materially affected, or are reasonably likely to material effect our
internal controls over financial reporting.
PART
II OTHER INFORMATION
ITEM 1.
LEGAL
PROCEEDINGS
We believe
that the final resolution of any pending litigation, 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.
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.
In rare
instances, we are threatened with or named as a defendant in lawsuits arising in
the ordinary course of business, such as personal injury claims and
unemployment-related claims and from time to time, we also prosecute various
collection claims against delinquent customers.
ITEM 1A.
RISK FACTORS
The risk
factors below captioned “
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”
and
“
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”
have been materially modified from prior
versions of those risk factors set forth in our Annual Report on Form 10-K for
the year ended December 3, 2007.
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 Commission before we may distribute these systems to Nevada casinos. The
Nevada Gaming Commission 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 Commission, 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; our efforts 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 the three months
ended March 31, 2008 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 quarter ended March 31, 2008
approximately 56% of our revenues were derived through seven distributors.
During the same period, we derived approximately 38% 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 portion of revenues from 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, Inc., Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle
Master, Inc., that may enter the market for mobile gaming devices. In addition,
we may face a strong competition from Cantor Fitzgerald LP, a large financial
services company that already offers wireless sports betting in the United
Kingdom, holds an Operator of Mobile Gaming Systems license in Nevada and in
April of 2008 started field testing of a mobile gaming system in Las Vegas, NV.
The competition in the potentially lucrative Nevada market for mobile gaming
system is anticipated to become even more fierce when and if, other Nevada’s
currently licensed Operators of Mobile Gaming Systems including International
Game Technology, Inc., Sona Mobile, Inc. and GameTech
International, Inc. enter the market.
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 quarter ended March 31, 2008 depended substantially on the yield
that we achieved on these investments. Approximately 24% of our income before
tax during the quarter ended March 31, 2008 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 $18,509,505 at March
31, 2008.
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 through 2008, in which some auctions for ARS fail, or the
anticipated recovery in market values does not occur, we may be required to
record additional 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 the first quarter
of 2008. 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:
|
·
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;
|
|
·
Diversion
of financial and management resources from existing
operations;
|
|
·
Potential
loss of key employees;
|
|
·
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. If
litigation that we initiate is unsuccessful, 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 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.
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.
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
unfavorable changes in general economic conditions including recession, economic
slowdown, or higher fuel and transportation cost, may reduce the participation
in discretionary leisure activities as a result of consumers having 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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·
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.
|
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 6. EXHIBITS
See Exhibit
Index.
Exhibit
Index
|
Number
|
|
Description
|
|
|
|
|
|
|
3
|
.1
|
|
Amended
and Restated Articles of Incorporation of FortuNet, Inc.
(1)
|
|
3
|
.2
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|
Amended
and Restated Bylaws of FortuNet, Inc.
(2)
|
|
4
|
.1
|
|
Form of
Certificate Representing Common Stock, $.001 Par Value Per Share, of
FortuNet, Inc.
(1)
|
|
31
|
.1
|
|
Certification
of Yuri Itkis, Chairman of the Board of Directors and Chief Executive
Officer of FortuNet, Inc. dated May 13, 2008 in accordance with
Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act, as
amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
31
|
.2
|
|
Certification
of Kevin A. Karo, Chief Financial Officer of FortuNet, Inc. dated May 13,
2008 in accordance with Rules 13a-14(a) and 15d-14(a) of the
Securities Exchange Act, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
32
|
.1
|
|
Certification
of Yuri Itkis, Chairman of the Board of Directors and Chief Executive
Officer of FortuNet, Inc. dated May 13, 2008 in accordance with
18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
32
|
.2
|
|
Certification
of Kevin A. Karo, Chief Financial Officer of FortuNet, Inc. dated May 13,
2008 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002.
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*
Management contracts or
compensatory plans or arrangements.
|
(1)
|
Incorporated
by reference to Amendment No.1 of the Company’s Registration Statement
filed on Form S-1 (File No. 333-128391) filed with the Commission on
October 27, 2005.
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|
(2)
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Incorporated
by reference to Amendment No.3 of the Company’s Registration Statement
filed on Form S-1 (File No. 333-128391) filed with the Commission on
November 21, 2005.
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SIGNATURES
Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
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FortuNet,
Inc.
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By
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/s/
Yuri Itkis
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Yuri
Itkis, Chief Executive Officer and
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Chairman
of the Board
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By
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/s/
Kevin A. Karo
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Kevin
A. Karo, Chief Financial Officer
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Date: May 13,
2008