ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
For
the fiscal year ended December 31, 2006
OR
o
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
For
the transition period from:___________ to ___________
Commission
file number: 000-51703
FortuNet,
Inc.
(Exact
name of Registrant as specified in its charter)
Nevada
88-0252188
(State
or other jurisdiction of
incorporation
or organization)
(I.R.S.
Employer
Identification
Number)
2950
South Highland Drive, Suite C
Las
Vegas, Nevada 89109
(Address
of principal executive offices including Zip Code)
Registrant’s
telephone number, including area code: (702)
796-9090
Securities
registered pursuant to Section 12(b) of the Act: None
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, $0.001 par value
(Title
of Class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
o Yes xNo
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
o Yes xNo
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
x Yes oNo
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o Accelerated
filer o Non-accelerated
filer x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
o Yes xNo
As
of
June 30, 2006, the aggregate market value of the registrant’s common stock held
by non-affiilates was approximately $47,385,000 (based on a closing sale price
of $16.20 per share as reported by the Nasdaq Global Market). Shares of common
stock beneficially held by executive officers and directors and by each person
who beneficially owns 5% or more of the outstanding common stock have been
excluded since such persons may be deemed affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
There
were 11,351,612 shares of the registrant’s common stock issued and outstanding
as of March 15, 2007.
Documents
Incorporated by Reference
Portions
of the registrant’s definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 3, 2007 are incorporated by reference in Part
III
of this Form 10-K to the extent stated herein. Except as expressly incorporated
by reference, the registrant’s Proxy Statement shall not be deemed to be a part
of this Form 10-K.
FORTUNET,
INC.
ANNUAL
REPORT ON FORM 10-K
FOR
THE YEAR ENDED DECEMBER 31, 2006
Page
PART
I
ITEM
1.
Business
1
ITEM
1A.
Risk
Factors
21
ITEM
2.
Properties
37
ITEM
3.
Legal
Proceedings
37
ITEM
4.
Submission
of Matters to a Vote of Security Holders
38
PART
II
ITEM
5.
Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Repurchases of Equity Securities
38
ITEM
6.
Selected
Financial Data
41
ITEM
7.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
42
ITEM
7A.
Quantitative
and Qualitative Disclosure about Market Risk
54
ITEM
8.
Financial
Statements and Supplementary Data
54
ITEM
9.
Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
72
ITEM
9A.
Controls
and Procedures
72
ITEM
9B.
Other
Information
73
PART
III
ITEM
10.
Directors,
Executive Officers and Corporate Governance
73
ITEM
11.
Executive
Compensation
74
ITEM
12.
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
74
ITEM
13.
Certain
Relationships and Related Transactions, and Director
Independence
74
ITEM
14.
Principal
Accountant Fees and Services
74
PART
IV
ITEM
15.
Exhibits
and Financial Statement Schedules
74
Signatures
77
PART
I
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
Annual Report on Form 10-K contains forward-looking statements within the
“safe harbor” provisions of the Private Securities Litigation Reform Act of
1995. All statements included in this Annual Report, other than statements
that
are purely historical, are forward-looking statements. Words such as
“anticipate,” “contemplate,” “expect,” “intend,” “plan,” “believe,” “seek,”
“estimate,” “will,” “will continue to be,” or the negative of foregoing and
similar expressions regarding beliefs, plans expectations or intentions
regarding the future also identify forward-looking statements. Forward-looking
statements in this Annual Report include, without limitation, our statements
that:
(A)
in
Item 1, (1) if we obtain the necessary approvals, we will begin marketing our
wireless gaming platform to Nevada gaming establishments, most likely commencing
with casinos with bingo halls where our mobile gaming platforms are already
in
use for playing bingo games; (2) we believe the addition of traditional casino
games to our mobile platform will increase these casino operators’ revenues; (3)
we expect to subsequently expand our marketing to additional Nevada gaming
establishments that may be attracted to our mobile gaming platform by the
potential of new gaming revenues generated in the auxiliary gaming and
peripheral public areas of gaming establishments where playing of traditional
casino games, such as poker, keno and slots, was previously not available;
(4)
we expect to subsequently expand marketing efforts for our wireless gaming
platform beyond Nevada; (5) we intend to market our mobile casino gaming
platforms under the WIN-WIN brand name; (6) we anticipate deploying our WIN-WIN
platforms in Nevada casinos as soon as possible upon obtaining the required
product approvals from the Nevada gaming authorities; (7) our wireless player
terminals may stimulate players to play longer and will, in essence, expand
the
casino floor to auxiliary gaming and peripheral public areas while
simultaneously reducing energy and labor costs; (8) we believe that our current
facility is adequate for manufacturing sufficient volume of mobile gaming
products to satisfy the initially anticipated demand; (9) we believe that wide
acceptance of our mobile bingo gaming platform in Nevada will allow us to
succeed in the emerging Nevada mobile gaming market for playing traditional
casino games; (10) we believe the combination of the positive experiences of
our
casino customers and their patrons with our ability to maintain the security
and
integrity of our mobile gaming platform will be an essential marketing advantage
for us as the Nevada mobile gaming market develops; (11) we are planning to
deliver traditional casino games on our mobile gaming platform to our existing
customer base, Nevada bingo halls, where we already have a presence and a
substantial player affinity; (12) we believe that bingo players will embrace
the
opportunity to play traditional casino games on the same wireless player
terminals on which they already play bingo; (13) we are planning to gradually
introduce a variety of new games along with the existing traditional casino
games; (14) we plan to expand our sales by deploying our wireless gaming systems
in both the auxiliary gaming and peripheral public areas of gaming
establishments; (15) we are planning to aggressively market our mobile gaming
platform not only as a new revenue generating solution for auxiliary gaming
and
peripheral public areas of gaming establishments but also as a new marketing
tool aimed to attract bingo players to gaming establishments that have not
historically offered bingo; (16) assuming that other gaming jurisdictions enact
laws, regulations and regulatory licensing requirements like those enacted
in
Nevada, that we comply with such regulatory requirements and that we are
successful in the emerging Nevada mobile gaming market, we expect that we will
be successful in penetrating gaming jurisdictions outside of Nevada; (17) we
plan to increase our sales efforts outside of Nevada and to aggressively market
our mobile gaming products worldwide; (18) we anticipate that casino markets
will continue to be highly regulated, have stringent product requirements and
high system integrity and security requirements as the Nevada mobile gaming
market develops; (19) in the emerging mobile gaming market, we expect to
encounter competition from new entrants who seek to meet these market
requirements; (20) we expect to continue to emphasize the research and
development aspect of our business; (21) as the mobile gaming market develops
in
Nevada, we anticipate selling or leasing our mobile gaming platform products
to
a broader group of casino operators in Nevada and in other jurisdictions if
mobile gaming is approved in these jurisdictions and the operation of our mobile
gaming devices is specifically approved in these jurisdictions, and (22) we
intend to seek the necessary licenses, approvals and findings of suitability
for
our products and our personnel in other jurisdictions where there is an
opportunity to market our products;
(B)
in
Item 1A, (23) our future success depends to a significant degree on the skills,
experience and efforts of our key personnel; (24) 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; (25) we expect competition to increase and intensify
as the market for mobile gaming devices develops; (26) we expect fierce
competition from multiple large competitors dominating their respective markets
in our expansion efforts, such as Aristocrat Leisure, Ltd., International Game
Technology, Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle Master,
Inc., that may enter the market for mobile gaming devices; (27) initially,
we
intend to offer our customers equipment lease agreements under which we will
lease our wireless gaming terminals and the associated equipment; (28) we expect
to enter into agreements with customers that operate casinos and bingo halls
in
more than one location; (29) 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; (30) we
expect to spend substantial amounts on research and development; (31) we expect,
as needed, to continue to make a significant investment in product development;
(32) to manage any future growth effectively, we will have to expand our
management team, integrate new personnel and augment our marketing and
production capabilities; (33) 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; (34) 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; and (35) we expect a substantial portion
of
our future growth to result from the general expansion of the gaming
industry;
(C)
in
Item 3, (36) 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;
ITEM
1.BUSINESS
General
We
are a
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 POS terminals, self-service POS kiosks and game file
servers that conduct and control bingo games. Our gaming platforms have been
adapted to conduct traditional casino games, such as keno, poker and slots,
in
addition to bingo.
We
believe that our field-proven mobile gaming platform is in compliance with
the
regulations promulgated under Nevada’s new mobile gaming law, AB 471, or the
Nevada Mobile Gaming Law, as adopted by the Nevada Gaming Commission on March
23, 2006. We submitted our wireless gaming platform for review by the Nevada
gaming authoritiesin
2006.
If
we
obtain the necessary approvals, we will begin marketing our wireless gaming
platform to Nevada gaming establishments, most likely commencing with casinos
with bingo halls where our mobile gaming platforms are already in use for
playing bingo games. We believe the addition of traditional casino games to
our
mobile platform will increase these casino operators’ revenues. We expect to
subsequently expand our marketing to additional Nevada gaming establishments
that may be attracted to our mobile gaming platform by the potential of new
gaming revenues generated in the auxiliary gaming and peripheral public areas
of
gaming establishments where playing of traditional casino games, such as poker,
keno and slots, was previously not available. We expect to subsequently expand
marketing efforts for our wireless gaming platform beyond Nevada.
We
currently own and lease to our customers an inventory of third- and
fourth-generation wireless and stationary player terminals, marketed under
the
BingoStar® brand name, that are deployed in casinos and bingo halls in 27
jurisdictions in North America, including Nevada casinos operated by several
major casino operators. We derive essentially all of our revenue from leasing
our gaming platform to our customers. Our contracts are typically based on
a
fixed fee per use per bingo session, a fixed weekly fee per player terminal
or a
percentage of the revenue generated by each player terminal.
We
were
incorporated in Nevada in 1989. In 1993, we were licensed as a gaming equipment
manufacturer and distributor by the Nevada Gaming Commission. In 1994, we
received Nevada regulatory approval for our server-based, concurrent
multi-gaming, video gaming network, Mega Fortune®. In 2003, we were granted an
Operator of Inter-Casino Linked Systems, or OILS, license by the Nevada Gaming
Commission. The OILS license permits us to operate progressive jackpot linked
casino games offered simultaneously at a number of participating casinos. In
September of 2006, we were granted an Operator of Mobile Gaming Systems license
by the Nevada Gaming Commission.
In
January 2004, we became the 100% owner of Millennium Games, Inc., or Millennium,
which enabled us to consolidate our worldwide distribution rights and to
significantly reduce our overall distribution and operational costs. Millennium
serves as a distribution channel for our bingo products in Native American,
or
tribal, jurisdictions as well as other jurisdictions outside of
Nevada.
1
The
FortuNet Gaming Platform
Our
core
technology is embodied in the FortuNet® gaming platform that we currently lease
to casinos and bingo halls throughout North America. Our gaming platform serves
as the core foundation on which all of our mobile gaming platforms are based,
including our BingoStar electronic bingo gaming platform and our WIN-WIN mobile
casino gaming platform. The FortuNet gaming platform includes the following
major structural elements:
•
central
game file servers that conduct and control the playing of bingo and
traditional casino games on our wireless and stationary player
terminals;
•
a
comprehensive player tracking, accounting, inventory management and
reporting software package marketed under our Accounting and Inventory
Management System, or AIMS™, brand
name;
•
a
flexible gaming software package that executes on our multi-game,
multi-player gaming platform and provides a variety of downloadable
traditional casino games;
•
interactive
wireless and stationary player terminals that display the outcomes
of the
games determined by the central game file
servers;
•
cashier-operated
POS terminals and self-service POS kiosks, issuing money deposit
receipts
and dispensing payouts; and
•
internally
developed hardware and software wireless technology enabling efficient,
RF
noise-tolerant and reliable bi-directional RF communications between
central game file servers and wireless player terminals secured through
the use of our downloadable and disposable authentication
keys.
BingoStar
Electronic Gaming Platform
Our
BingoStar platform of integrated, multi-game, multi-player wireless and
stationary player terminals allows patrons to play over 4,000 bingo cards with
the option of concurrently playing entertainment games, such as solitaire.
Our
BingoStar platform enables many variations of bingo, including fast-paced
30-number bingo, 90-number British-style bingo, bonanza bingo, pari-mutuel
bingo, progressive-jackpot bingo, Class-II slot-style bingo and multi-site
linked bingo. BingoStar enables automatic and semi-automatic daubing of players’
electronic bingo cards that facilitates playing of numerous bingo cards in
each
bingo game, yielding higher revenues for bingo hall operators.
We
have
developed several proprietary sets of electronic bingo cards for generic and
custom applications, such as bonanza bingo games and double-action bingo games.
No card in our sets duplicates any card in any commercial set of paper bingo
cards known to us. In addition, our wireless and stationary player terminals
are
capable of storing in electronic format complete facsimiles of third-party
commercial sets of paper bingo cards. As a result, our player terminals can
monitor both paper and electronic bingo cards.
2
BingoStar
also allows the playing of do-it-yourself bingo cards, akin to a lottery ticket,
on the player’s terminal by registering all electronic and paper do-it-yourself
cards. The central game file server verifies all do-it-yourself cards and
automatically rejects all void and unregistered cards, which results in a high
degree of security and integrity for do-it-yourself bingo games. BingoStar
will
automatically disable a wireless player terminal if a POS cashier voids a
player’s bingo cards. This feature prevents an unscrupulous cashier from
pocketing the proceeds of the voided bingo cards.
Accounting
and Inventory Management System (AIMS)
Our
gaming platform includes a comprehensive accounting and inventory management
software package marketed under the brand name AIMS. Our AIMS software is a
distributed software package running on our central game file servers and POS
terminals. The AIMS software package runs in a mixed Windows-XP and Linux
environment and is an assembly of numerous functional modules, each addressing
the specific management needs of casinos and bingo halls. For example, AIMS
includes a comprehensive player tracking module that analyzes and reports
players’ spending and automatically issues electronic coupons that provide
players with incentives to play multiple bingo sessions. AIMS also automatically
tracks in real time the inventory of bingo packs as they are sold through POS
terminals or directly on the gaming floor. In addition, AIMS automatically
computes all payouts owed to bingo players and accrues progressive prizes,
including the reserve accounts for the prizes. Because AIMS includes data
exporting and importing modules that are fully compatible and integrated with
commercial casino management packages running on casino mainframes, AIMS
delivers full transparency into the operational results of our gaming platform
to casino management.
WIN-WIN
Mobile Gaming Platform
We
intend
to market our mobile casino gaming platforms under the WIN-WIN brand name.
These
platforms are comprised of our central game file servers, gaming software,
wireless player terminals and POS terminals and POS kiosks operated through
our
wireless communication technology, as described below. We anticipate deploying
our WIN-WIN platforms in Nevada casinos as soon as possible upon obtaining
the
required product approvals from the Nevada gaming authorities.
Redundant
Central Game File Servers
The
central game file server of our gaming platform is where bingo and traditional
casino games are actually conducted. Game outcomes are then displayed on our
wireless and stationary player terminals. Our redundant central game file
servers are internally developed, PC-compatible computers equipped with
non-modifiable and verifiable memory circuitry that we believe complies with
Nevada’s gaming device standards. Our central game file servers run on the
reliable Linux operating system and facilitate the concurrent playing of
multiple types of bingo games along with traditional casino games. In addition,
our central game file servers generate all random factors that determine the
outcomes of the games played. The central game file servers also generate
unique, disposable encryption and authentication keys that are downloaded into
the wireless player terminals and redundantly preserve game and financial
transaction histories.
3
Flexible
Gaming Software Package with Download Capabilities
Our
internally developed modular gaming software allows us to rapidly customize
our
gaming packages to meet the regulatory requirements of specific jurisdictions.
The architecture of our software is designed to provide multi-game, multi-player
functionality and facilitates rapid modifications of existing games as well
as
the ability to download a variety of traditional casino games to the wireless
player terminals. The package is written in the efficient C programming language
and is executed in the reliable Linux environment.
Wireless
Player Terminals
Our
wireless player terminal is a key component of the FortuNet gaming platform.
It
reflects many years of research and development in the areas of wireless
technology, communication security, software and hardware architecture, and
ergonomic user interface design. While available in a variety of models and
formats including smaller, monochrome units, the current models of our wireless
player terminals are fourth generation products that incorporate either an
8.40
inch color liquid crystal display and measure 9.75 inches long by 2.00 inches
wide and are 8.13 inches tall or 10.4 inch color liquid crystal display and
measure 9.5 inches long by 0.6 inches wide and are 8.25 inches tall. The
wireless player terminals are equipped with fast-recharge battery circuitry
and
sustain continuous operation for at least 12 hours.
Our
color
wireless player terminals are capable of playing not only bingo but also
traditional casino games. If required approvals are obtained, our wireless
player terminals will allow players to play traditional casino games anywhere
within permitted public areas of the casino. By providing a means to play in
a
comfortable environment, our wireless player terminals may stimulate players
to
play longer and will, in essence, expand the casino floor to auxiliary gaming
and peripheral public areas while simultaneously reducing energy and labor
costs.
We
believe that our mobile gaming platform meets the standards established by
the
Nevada Gaming Commission for mobile gaming devices, as well as many of the
standards for conventional slot machines. In particular, our internal testing
indicates that our wireless player terminal can withstand a 23,000 volt
electrostatic discharge, the standard that is required of slot machines. It
is
also equipped with tamper-evident features and alarms that render the unit
inoperable following a tampering event.
Stationary
Player Terminals
Our
stationary player terminals are secure PC-compatible computers equipped with
high-resolution, 15 inch flat liquid crystal color touch screens and are
available in different formats, such as slant-top, upright, coin-operated and
cashless ultra-thin video terminals. These high end terminals allow players
to
watch and listen to close-circuit television programs in adjustable
picture-in-picture windows while playing bingo or traditional casino games.
Our
stationary player terminals are housed in custom-made metal, slot-machine-like
cabinets. Our stationary player terminals run essentially the same software
as
our wireless player terminals.
4
Cashier-operated
POS terminals and self-service POS kiosks
Players
make all money deposits and receive payouts and refunds at our secure
PC-compatible cashier-operated POS terminals or at our self-service POS kiosks.
The functions of both POS configurations are nearly identical, as both POS
configurations issue bar-coded transaction receipts to the player, register
the
player’s identification from the player’s card, and register those transactions
with the central game file servers. The only difference is that in the case
of
the cashier-operated terminals, it is the cashier who accepts payments and
hands
out refunds and prizes, whereas, a kiosk acts much like a bank automated teller
machine.
Both
POS
configurations have optional features, such as the ability to accept credit
cards where permitted by law. The kiosk is configurable to dispense bills,
coins
or redeemable bar-coded vouchers and is also configurable to include a charger
rack housing wireless player terminals. In jurisdictions other than Nevada,
the
kiosk also optionally houses the central file server that operates games on
the
wireless player terminals dispensed from the kiosk. With optional wheels, a
mobile kiosk can be transported to different multi-use facilities, such as
theaters. The kiosk incorporates a player-operated touch screen that doubles
as
an advertising channel when the kiosk is not in use. The kiosk’s internal
systems are securely locked and alarmed and are accessible only to authorized
personnel who must identify themselves with a magnetic stripe user card and
a
password entered on the kiosk touch screen.
Because
self-service kiosks do not require cashiers, they can yield operators
significant savings in labor costs. In addition, kiosks shorten the waiting
lines, especially in bingo halls, and free more time for the patrons to play
casino games.
Internally
Developed, Secure and Reliable Wireless Communication
Technology
Our
mobile casino gaming platform uses our internally developed, fast-response,
secure, bi-directional spread-spectrum and narrow-band RF communication hardware
and software for wireless communications. Our communication hardware and
software offer reliable and secure data delivery to and from our wireless player
terminals, even in the noisy environments characteristic of modern casinos
that
are saturated with cellular telephones and security radio telephones. We use
disposable downloadable encryption and authentication keys to prevent hacking
of
our RF channels.
Our
wireless player terminals are also equipped with a close-proximity, secure,
infrared communication channel to download our authentication keys. At the
cashier-operated POS terminals and the self-service POS kiosks, we download
the
wireless player terminal with a file containing many disposable encryption
and
authentication keys. Each key is used only once to encrypt and authenticate
a
single gaming transaction performed over the RF channel. For example, each
poker
hand dealt by the file server to the player terminal is encoded separately
with
a unique key.
5
Our
mobile gaming platform can detect and automatically terminate operations on
the
wireless player terminals when they are taken beyond permitted areas by
automatically destroying the encryption and authentication keys. Our wireless
player terminals are also equipped with player identification circuitry to,
among other things, prevent under-age gaming.
Manufacturing
and Assembly
We
develop and own all technical documentation and intellectual property rights
to
manufacturing tools, such as plastic molding forms and printed circuit board
layout masks used to manufacture our wireless player terminals.
Once
a
product is designed and thoroughly tested at our facility, we subcontract the
volume production of parts and subassemblies to outside vendors. We subcontract
subassembly manufacturing jobs to a number of reputable second-source suppliers.
As a result, if demand for our products increases significantly, we can increase
our manufacturing capabilities by placing additional orders with multiple
manufacturers.
In
addition to subcontracting the manufacturing of our custom subassemblies, we
also purchase standard off-the-shelf components, such as video monitors, power
supplies and batteries in volume. In order to achieve economies of scale, we
carefully research the component markets for the best prices available and
often
adjust our designs to incorporate cost-efficient components that we can purchase
in large volumes.
Upon
receipt of ordered parts and subassemblies, we assemble the finished products
at
our facility in Las Vegas. We believe that our current facility is adequate
for
manufacturing sufficient volume of mobile gaming products to satisfy the
initially anticipated demand. Currently, we operate only one work shift.
However, we can add up to two extra work shifts at our current
facility.
Competitive
Advantages
We
are an
established and profitable company with field-proven products that are popular
in gaming establishments throughout the United States, including major gaming
establishments in Nevada. Our technological advantages include a flexible
multi-game, multi-player gaming platform incorporating a secure authenticated
wireless communication technology that we believe will be important for success
in the emerging mobile gaming market. We believe that our four Nevada
non-restricted gaming licenses, including our recently granted Operator of
Mobile Gaming Systems license, which are essentially prerequisites for
manufacturing, distributing and operating gaming devices in Nevada, give us
a
time advantage over the potential new entrants into the emerging mobile gaming
market in Nevada.
Field-proven,
player accepted gaming platform with a majority share of the Nevada mobile
bingo
gaming market.
Our
wireless bingo products are field-proven and well accepted by players nationwide
who have played our products for almost a decade. We supply a majority of the
mobile bingo gaming equipment in Nevada. We believe that wide acceptance of
our
mobile bingo gaming platform in Nevada will allow us to succeed in the emerging
Nevada mobile gaming market for playing traditional casino
games.
6
Flexible,
downloadable gaming platform.
Our
gaming platform is expected to provide casino operators with the flexibility
to
quickly add traditional casino games to our platform, when approved. By simply
changing the software on the game file server, operators can quickly enable
new
games on the wireless player terminals as well as adjust the pay-outs on games.
Our multi-game, multi-player gaming platform offers the ability to play bingo
and many popular traditional casino games such as keno, poker and slots on
a
single player terminal. In addition, the platform includes optional
small-footprint, self-service POS kiosks that are expected to facilitate gaming
in underperforming auxiliary gaming casino areas.
Secure,
authenticated wireless communication technology.
Our
gaming platform incorporates internally developed wireless security and
authentication hardware and software for communication between our servers
and
wireless player terminals, which we believe is beneficial in meeting the
requirements of the Nevada mobile gaming regulations as adopted. While serving
our customer base, we accumulated real-world experience with the challenges
of
secure data delivery to and from our wireless player terminals, even in the
noisy RF environments characteristic of modern casinos. In addition, our
wireless communication technology incorporates perimeter control and player
authentication features that automatically shut down any wireless player
terminal taken beyond permitted public areas and allow for periodic or on-demand
verification of the identity of the player. We believe the combination of the
positive experiences of our casino customers and their patrons with our ability
to maintain the security and integrity of our mobile gaming platform will be
an
essential marketing advantage for us as the Nevada mobile gaming market
develops.
Four
existing non-restricted Nevada gaming licenses that allow us to manufacture,
distribute and operate gaming devices including mobile gaming
devices.
Having
a
non-restricted Nevada distributor gaming license is a prerequisite for
distributing gaming products in the state of Nevada. In addition to having
such
a license, we also have non-restricted Nevada gaming license to manufacture
gaming devices. These existing licenses allow us to serve Nevada’s existing
mobile bingo gaming market and the emerging mobile casino market. The Nevada
Gaming Commission has also granted us an Operator of Inter-Casino Linked
Systems, or OILS, license, which permits us to operate multi-site games that
link several casinos into a wide area progressive jackpot. In September of
2006,
we were also granted an Operator of Mobile Gaming Systems license by the Nevada
Gaming Commission. Entrants that hope to serve the mobile gaming market enabled
by the Nevada Mobile Gaming Law must have, or obtain, non-restricted gaming
licenses to serve the Nevada market. Obtaining such licenses is costly, lengthy
process that entails rigorous levels of corporate due diligence and in-depth
scrutiny of officers and, in some cases, directors of the companies applying
for
such licenses.
7
Growth
Strategy
Our
business objective is to capitalize upon our competitive advantages in the
emerging mobile gaming market in casino public areas. Our primary business
strategies are to:
Initially,
deliver traditional casino games on our mobile gaming platform to our existing
Nevada casino bingo customer base.
We
are
planning to deliver traditional casino games on our mobile gaming platform
to
our existing customer base, Nevada bingo halls, where we already have a presence
and a substantial player affinity. We believe that bingo players will embrace
the opportunity to play traditional casino games on the same wireless player
terminals on which they already play bingo. Since our gaming platform is
flexible, and includes the ability to quickly change games, we are planning
to
gradually introduce a variety of new games along with the existing traditional
casino games.
Market
bingo and traditional casino games on our mobile gaming platform for use in
auxiliary gaming areas and subsequently market our mobile gaming platform for
use in peripheral public areas of Nevada casinos.
We
plan
to expand our sales by deploying our wireless gaming systems in both the
auxiliary gaming and peripheral public areas of gaming establishments.
Currently, casino operators derive limited gaming revenues from these areas.
We
believe casino operators would be interested in generating additional revenue
from these auxiliary gaming and peripheral public areas and will be receptive
to
our mobile gaming platform. Accordingly, we are currently marketing our mobile
gaming platform to gaming establishments by promoting our products as an
efficient means for offering casino games and bingo in these underutilized
spaces.
Currently,
very few casinos offer bingo to their patrons because of the high real estate
and operational costs associated with having dedicated bingo halls. Our mobile
gaming technology enables casinos to offer players a virtual bingo hall without
the high cost of maintaining a dedicated bingo hall. Accordingly, we are
planning to aggressively market our mobile gaming platform not only as a new
revenue generating solution for auxiliary gaming and peripheral public areas
of
gaming establishments but also as a new marketing tool aimed to attract bingo
players to gaming establishments that have not historically offered
bingo.
Expand
marketing efforts beyond Nevada.
We
believe there are significant business opportunities for mobile gaming products
not only in Nevada but also in many other domestic and foreign gaming
jurisdictions. Currently, Nevada is the first and the only jurisdiction to
enact
legislation authorizing mobile gaming for traditional casino games. However,
many gaming jurisdictions tend to follow Nevada’s lead concerning gaming laws
and regulations. Assuming that other gaming jurisdictions enact laws,
regulations and regulatory licensing requirements like those enacted in Nevada,
that we comply with such regulatory requirements and that we are successful
in
the emerging Nevada mobile gaming market, we expect that we will be successful
in penetrating gaming jurisdictions outside of Nevada. Accordingly, we plan
to
increase our sales efforts outside of Nevada and to aggressively market our
mobile gaming products worldwide.
8
Competition
We
experience intense competition from a number of established suppliers of gaming
equipment to the bingo market and the casino market. Many of our competitors
have longer operating histories, long-standing relationships with gaming
establishments and suppliers, greater name recognition and greater financial,
technical and marketing resources than we do. As a result, our competitors
may
have substantial competitive advantages over us. Additionally, the casino market
is characterized by a cautious attitude toward the reliability and security
of
emerging wireless gaming platforms, creating additional marketing challenges
for
us. We may not be able to exploit new or emerging technologies, adapt to changes
in customer requirements more quickly than our competitors or devote the
necessary resources to the marketing of our products and services. See “Item 1A.
Risk Factors.”
Bingo
Market
Currently,
our primary competitors in our existing electronic bingo market are VKGS, LLC,
or Video King, formerly a division of BK Entertainment Corp. and GameTech
International, Inc., or GameTech. We believe that we are focused on the high
performance segment of the electronic bingo market, while many of our
competitors serve the mass market segment where bingo player terminals are
less
expensive and have fewer features and technological capabilities.
In
addition to Video King and GameTech, a number of other companies compete in
the
electronic bingo market including the recently merged Planet Bingo, LLC and
Melange Computer Services, Inc., Blue Dog, Inc., Electronic Gaming Solutions,
Inc.and
California Concepts, Inc. Many of our bingo market competitors offer stationary
and portable bingo player terminals. We are not aware of any competitors with
an
installed base of bi-directional wireless player terminals and only a few of
them currently deliver any wireless technology. Our competitors’ existing
one-way RF communication technology may limit their ability to offer more
advanced versions of bingo or traditional casino games, such as keno, slots
and
poker on a wireless player terminal.
Emerging
Mobile Gaming Market
The
casino markets are highly regulated, have stringent product requirements and
high system integrity and security requirements. We anticipate that these
factors will continue to pertain as the Nevada mobile gaming market develops.
In
the emerging mobile gaming market, we expect to encounter competition from
new
entrants who seek to meet these market requirements.
Cantor
Fitzgerald LP, a large financial services company that already offers wireless
sports betting in the United Kingdom, is expected to seek Nevada’s approval for
its technology. At least two other gaming technology companies, Chimera
Technology Corp. and Diamond I, Inc. have announced their strong interest in
the
emerging mobile gaming market. Although we expect these and other companies
to
be attracted to the potentially lucrative Nevada mobile gaming market, we
believe it will be difficult for such companies to fully meet the market’s
requirements. For instance, obtaining Nevada gaming licenses can be difficult,
costly and time consuming. Also it can be difficult to gain market recognition
in the very demanding Nevada gaming market. Lastly, some of these companies
have
indicated that they plan to use off-the-shelf personal digital assistants as
their wireless gaming terminals. We question whether such products can achieve
regulatory and market acceptance.
9
In
addition, large gaming equipment manufacturers in the Nevada slot machine
market, including Aristocrat Leisure, Ltd., Alliance Gaming Corporation and
WMS
Gaming Inc., may also attempt to enter the emerging mobile gaming market. At
least three well established gaming equipment manufacturers, International
Game
Technology, or IGT, Shuffle Master, Inc., and Progressive Gaming International
Corporation have expressed interest in entering the emerging mobile gaming
market. These companies are much larger than we are and are well entrenched
in
the existing gaming market. The United States gaming equipment market has
historically been dominated by IGT, currently the largest gaming equipment
manufacturer in the world. However, we are not aware of any mobile gaming
devices being field tested by these companies with a possible exception of
Progressive Gaming International Corporation, which is currently field testing
wireless sports wagering terminals that may be viewed by some as mobile gaming
terminals, even though such sports wagering terminals are not considered to
be
gaming devices under the existing Nevada statutes and regulations.
Finally,
traditional casino operators may attempt to enter the emerging mobile gaming
markets themselves. Most of these companies are much larger than we are and
have
greater resources than we do.
Research
and Development
Since
our
inception in 1989, we have continuously developed innovative gaming and
entertainment products for our customers. We have internally developed all
critical aspects of our gaming platform and have outsourced only the volume
manufacturing of parts and subassemblies. We design all of our software,
including all of our source code and all of our user interfaces and graphic
art
for our player terminals. We also design all of our hardware, including both
electronic and mechanical components, all printed circuit board diagrams and
layouts, and all 3D and 2D mechanical drawings for all our plastic and metal
parts. We expect to continue to emphasize the research and development aspect
of
our business. Research and development costs for the year ending December 31,
2006 were $648,463.
Customers
Currently,
our customers are bingo hall operators in the commercial casino, tribal casino
and charitable bingo markets. As the mobile gaming market develops in Nevada,
we
anticipate selling or leasing our mobile gaming platform products to a broader
group of casino operators in Nevada and in other jurisdiction if mobile gaming
is approved in these jurisdictions and the operation of our mobile gaming
devices is specifically approved in these jurisdictions.
10
We
have a
broadly diversified and geographically dispersed customer base. Sales to
charitable organizations in Texas represented approximately 33% of our revenues
during 2006. Sales to entities affiliated with the Gila River Indian Community
represented approximately 4% of our revenues during 2006.
Sales,
Marketing and Distribution
Except
where we are contractually or statutorily prohibited from doing so, we market
our products to customers through direct and indirect channels. Our direct
channel consists of our own marketing efforts as well as marketing through
Millennium, our wholly-owned subsidiary.
We
also
distribute our products to our customers through our indirect channel consisting
of a network of authorized distributors, operating in the United States, Canada,
the United Kingdom and Australia. Our distributor agreements typically have
one-year initial terms with successive one-year automatic renewals. Our
distributors provide valuable services to our customers, including immediate
on-site customer support. During 2006, sales through our single-largest
distributor, K&B Sales Incorporated, doing business as Good Time Bingo,
represented approximately 33% of our revenues. During 2006, sales through
Atlantic Bingo Supply, Inc., another of our distributors, represented
approximately 11% of our revenues.
The
profit margins from the distributor facilitated accounts are lower than the
profit margins typical for our direct accounts because the latter do not involve
any commissions paid to distributors. We are focused on strengthening our direct
account sales and marketing capability, which we believe will result in a rising
proportion of higher margin direct house accounts.
We
generate a significant amount of our revenue from domestic customers. During
2004, 2005 and 2006, our domestic revenues were 98%, 98% and 98%, respectively.
During 2004, 2005 and 2006, our international revenues were 2%, 2% and 2%,
respectively.
Customer
Support
We
provide comprehensive support services to our customers either directly or
through our distributors. We also provide 24/7 hotline support to our customers.
Although most of the technical problems are typically resolved over the
telephone or by replacing failed equipment with spare parts, in critical cases,
our field service personnel have to perform on-site maintenance and technical
training. The on-site maintenance is provided by us as an accommodation to
our
customers and is not required by our contracts. We do not provide any
performance, fitness of use or similar warranty or guaranty to our
customers.
An
important part of customer service is the initial installation and training
of
customer personnel. From time to time, we also perform customer service at
locations directly serviced by our distributors, particularly when a distributor
is new or inexperienced. Our personnel, particularly our management team, are
composed of experts in the gaming field whose advice is well regarded by our
customers. We continually provide our advice to our customers regarding our
gaming platforms and compliance with regulatory matters related to our gaming
platforms.
11
Our
BingoStar platform can be easily configured by bingo hall personnel for any
desired bingo games, patterns, prizes and sessions, without the involvement
of
ourselves or the local distributor. Our BingoStar platform allows our
technicians to reprogram all stationary and wireless player terminals on-site.
Where permitted by law and authorized by our customers, we can also remotely
reprogram most of the components of our BingoStar platform utilizing secure
communication protocols.
Intellectual
Property
With
the
expiration of one of our patents in August of 2006, we hold two United States
patents expiring in 2010, which relates to a lottery-type wagering game, and
one
United States patent expiring in 2012, which relate to a magnetic bingo board.
We do not rely on any licensing revenue related to any of these patents. We
have
also filed additional patent applications that are currently pending in the
United States Patent and Trademark Office.
We
are
the registered owner of trademarks FortuNet®, Mega Fortune® and BingoStar®, as
well as pending trademark applications, including WIN-WIN™ and
AIMS™.
In
addition, each of our employees has executed an agreement to maintain the
confidentiality of our trade secrets and to assign to us any intellectual
property that they conceive of in the scope of and during their employment
with
us.
Government
Regulation
The
gaming industry and the gaming equipment manufacturing industry exist within
a
stringently controlled regulatory environment and are subject to federal, state,
tribal, local and foreign regulation. Companies participating in these
industries must hold the required gaming licenses, permits or other approvals
in
all jurisdictions in which they conduct business. Many jurisdictions also
require the licensing or a finding of suitability of officers, directors, major
stockholders and key employees, the termination or disassociation with such
officer, director, key employee or major stockholder that fails to file an
application or to obtain a license or finding of suitability; the submission
of
detailed financial and operating reports; and the submission of reports of
material loans, leases and financings; and the regulatory approval of some
commercial transactions, such as the transfer or pledge of equity interests
in
the company. These regulatory burdens are imposed upon gaming-related suppliers
or vendors on an ongoing basis. The regulatory agencies that oversee these
jurisdictions not only continually scrutinize license holders, but in some
cases
also approve the types of products that can be sold by equipment manufacturers
and used by operators. The standards for product approval vary from jurisdiction
to jurisdiction, although the Nevada standards are generally the most
stringent.
Various
aspects of our business are subject to gaming regulation. Depending on the
nature of the noncompliance, our failure to comply with these regulations may
result in the suspension or revocation of any license or registration at issue,
as well as the imposition of civil fines and criminal penalties.
12
Our
electronic bingo products, including the wireless and stationary units, are
subject to stricter scrutiny than traditional paper bingo products. We believe
electronic bingo player units are legal in all tribal jurisdictions, United
States Armed Forces bases, 27 states, and in a growing number of foreign
jurisdictions.
Electronic
bingo in charitable bingo halls is less widely permitted than paper bingo,
largely because many states’ laws and regulations were written before electronic
bingo technology was available. We believe that electronic bingo is permitted
in
27 of the 48 states in the United States in which paper bingo is legal.
Favorable changes in this regulatory environment occurred in the recent
decade.
Licensing
Requirements
Currently,
we are licensed as a gaming equipment manufacturer or distributor in several
states and tribal jurisdictions. We intend to seek the necessary licenses,
approvals and findings of suitability for our products and our personnel in
other jurisdictions where there is an opportunity to market our products. We
cannot assure you that we will obtain the necessary licenses, approvals or
findings of suitability in a timely fashion or at all. If obtained, we cannot
assure that the licenses, approvals or findings of suitability will not be
revoked, suspended or conditioned or that we will be able to obtain the
necessary approvals for our future products as they are developed. If a license,
approval or finding of suitability is required by a regulatory authority and
we
fail to receive the necessary license, approval or finding of suitability,
we
may be prohibited from distributing our products for use in the applicable
jurisdiction or may be required to distribute our products through other
licensed entities at a reduced profit.
Nevada
Regulation
The
Nevada Mobile Gaming Law
On
June
6, 2005, Nevada enacted the Nevada Mobile Gaming Law. This law enabled the
Nevada Gaming Commission, with the advice and assistance of the Nevada Gaming
Control Board, to promulgate regulations governing the operation of mobile
gaming and the licensing of operators, manufacturers and distributors of mobile
gaming equipment and systems in Nevada. Before adopting the regulations, the
Nevada Mobile Gaming Law required the Nevada Gaming Commission to determine
that
mobile gaming systems could be operated in compliance with all applicable laws,
be secure and reliable and provide reasonable assurance that gaming devices
would be operated only by players of lawful age and only in approved areas.
These determinations were made and the final regulations under the Nevada Mobile
Gaming Law were adopted on March 23, 2006.
The
Nevada Mobile Gaming Law defines “mobile gaming” as conducting gaming through
communication technology and devices that allow a player to transmit information
to a computer that assists in placing a bet or wager and corresponding
information related to the display of the game and its outcome. “Communications
technology” is defined to mean the method and components employed by a gaming
establishment to facilitate the transmission and reception of information,
including wireless networks, wireless fidelity, wire, cable, radio, microwave,
light, optics or computer data networks. Mobile gaming can only be conducted
in
“public areas” of a gaming establishment that operate at least 100 slot machines
and at least one other game. Public areas specifically exclude hotel rooms
or
living accommodations. The regulations as adopted define “mobile gaming
systems,” “operator of a mobile gaming system,” “equipment associated with
mobile gaming” and “public areas” for purposes of the law.
13
The
Nevada Mobile Gaming Law mandated that the revenue of operators and
manufacturers of mobile gaming systems will be subject to the same licensing
fee
provisions to which currently licensed gaming establishments are subject with
respect to the operation of other games and gaming devices and that mobile
gaming devices will be subject to the same fees and taxes as are slot machines.
Based upon the regulations as adopted, we believe that our current
non-restricted gaming licenses allow us to manufacture and distribute our mobile
gaming platforms in Nevada without additional licensing requirements. Our mobile
gaming platforms for playing traditional casino games will be required to be
approved before they may be deployed in Nevada casinos.
Policy
Concerns of Nevada Gaming Laws
The
laws,
regulations and supervisory practices of most gaming authorities are based
upon
declarations of public policy. In the case of Nevada, these public policy
concerns include, among other things:
•
preventing
unsavory or unsuitable persons from being directly or indirectly
involved
with gaming or the manufacture or distribution of gaming devices
at any
time or in any capacity;
•
establishing
and maintaining responsible accounting practices and
procedures;
•
maintaining
effective controls over the financial practices of licensees, including
establishing minimum procedures for internal fiscal affairs, and
safeguarding assets and revenue, providing reliable record keeping
and
requiring the filing of periodic reports with the Nevada gaming
authorities;
•
preventing
cheating and fraudulent practices; and
•
providing
a source of state and local revenue based on taxation and licensing
fees.
Changes
in these laws, regulations and procedures could have significant negative
effects on our operations, financial condition and results of
operations.
14
Individual
Licensing Requirements
The
Nevada gaming authorities may investigate any individual who has a material
relationship to, or material involvement with, us in order to determine whether
the individual is suitable or should be licensed as a business associate of
a
gaming licensee. Individual licensing is not a prerequisite to become an officer
of our company, but the person becoming an officer must apply for individual
licensing within 30 days of becoming an officer. Currently, Yuri Itkis, Boris
Itkis, Jack Coronel and William R Jacques Jr. are licensed. Licensing is not
a
prerequisite to become a director of FortuNet and we do not anticipate that
any
of our independent directors will be required to be licensed as a result of
serving as a director. The Nevada gaming authorities may deny any application
for any cause they deem reasonable. Granting of an individual license requires
a
concomitant determination of suitability of the applicant. A finding of
suitability and grant of an individual license requires submission of detailed
personal and financial information, followed by a thorough investigation. An
applicant for licensing or a finding of suitability must pay for all the costs
of the investigation. We reimbursed our employees for the cost of seeking and
maintaining licenses obtained at our request, including Yuri Itkis, Boris Itkis,
Jack B. Coronel and William R. Jacques, Jr. Changes in licensed positions must
be reported to the Nevada gaming authorities and, in addition to their authority
to deny an application for a finding of suitability or licensing, the Nevada
gaming authorities may disapprove a change in a corporate position, such as
a
change in job title or substantive job responsibilities.
If
the
Nevada gaming authorities were to find any of our personnel required to be
licensed unsuitable for licensing, we would have to sever all relationships
with
that person. In addition, the Nevada Gaming Commission may require us to
terminate the employment of any person who refuses to file appropriate
applications or refuses to pay the required investigative fees. Determinations
of suitability or of questions pertaining to licensing are not subject to
judicial review in Nevada.
Consequences
of Violating Gaming Laws
If
the
Nevada Gaming Commission determines we violated the Nevada Gaming Control Act
or
any of its regulations, it could limit, condition, suspend or revoke our
registrations and gaming licenses. In addition, we and the persons involved
could be subject to substantial fines for each separate violation of the Nevada
Gaming Control Act, or the regulations of the Nevada Gaming Commission, at
the
discretion of the Nevada Gaming Commission. Limitation, conditioning or
suspension of our gaming licenses or related registrations could, and revocation
of any gaming license or registration would, have a material adverse effect
on
our gaming operations.
Requirements
for Beneficial Securities Holders
Unless
we
are registered as a publicly traded corporation by the Nevada Gaming Commission,
no person may become a stockholder of, or receive any percentage of profits
from, us without first obtaining the necessary licenses and approvals from
the
Nevada Gaming Commission. We have also requested and obtained approval from
the
Nevada Gaming Commission for exemptions available under the Nevada Gaming
Control Act that will generally exempt the beneficial holders of our securities
from the mandatory licensing requirements. This exemption will apply to current
and future beneficial holders of our securities.
15
Regardless
of the number of shares held, any beneficial holder of our voting securities,
may be required to file an application, be investigated, and have that person’s
suitability as a beneficial holder of voting securities determined if the Nevada
Gaming Commission has reason to believe that the ownership would otherwise
be
inconsistent with the declared policies of the State of Nevada. An exemption
from the licensing requirements does not have the effect of exempting a
beneficial owner from a suitability determination if the Nevada Gaming
Commission requires such determination. If the beneficial owner of our voting
securities who must be found suitable is a corporation, partnership, limited
partnership, limited liability company or trust, it must submit detailed
business and financial information including a list of beneficial owners. The
applicant must pay all costs of investigation incurred by the Nevada gaming
authorities in conducting any investigation.
The
Nevada Gaming Control Act requires any person who acquires five percent or
more
of any class of the voting securities of a registered company to report the
acquisition to the Nevada Gaming Commission. The Nevada Gaming Control Act
requires beneficial owners of 10 percent or more of a registered company’s
voting securities to apply to the Nevada Gaming Commission for a finding of
suitability within 30 days after the Chairman of the Nevada Gaming Control
Board
mails the written notice requiring the filing. Under certain circumstances,
an
“institutional investor,” as defined in the Nevada Gaming Control Act, which
acquires 10 percent or more, but not more than 15 percent, of the registered
company’s voting securities may apply to the Nevada Gaming Commission for a
waiver of the finding of suitability if the institutional investor holds the
voting securities for investment purposes only. An application to be considered
as an institutional investor is a separate application and the applicant is
required to pay the applicable investigative fees.
An
institutional investor will not be deemed to hold voting securities for
investment purposes unless the voting securities were acquired and are held
in
the ordinary course of its business as an institutional investor and were not
acquired and are not held for the purpose of causing, directly or indirectly,
the election of a majority of the members of the board of directors of the
registered company, a change in the corporate charter, bylaws, management,
policies or operations or the registered company or any of its gaming affiliates
or any other action that the Nevada Gaming Commission finds to be inconsistent
with holding our voting securities for investment purposes only. Activities
that
are not deemed to be inconsistent with holding voting securities for investment
purposes only include:
•
voting
on all matters voted on by stockholders or interest
holders;
•
making
financial and other inquiries of management of the type normally
made by
securities analysts for informational purposes and not to cause a
change
in management, policies or operations;
and
•
other
activities the Nevada Gaming Commission may determine to be consistent
with the investment intent.
16
Our
Chief
Executive Officer and Chairman, Yuri Itkis, and our Chief Technical Officer,
Boris Itkis, and our Chief Marketing Officer, Jack Coronel, and our Chief
Financial Officer, William R Jacques Jr., who have been found suitable by
various gaming authorities. If a gaming authority in any jurisdiction fails
to
find any of our officers, directors or significant stockholders suitable, we
may
be prohibited from leasing, licensing or selling our products in that
jurisdiction. We are unaware of any facts or circumstances that would
categorically prevent a gaming authority from finding any of our officers,
directors or significant stockholders suitable.
Consequences
of Being Found Unsuitable
Any
person who fails or refuses to apply for a finding of suitability or a license
within 30 days after being ordered to do so by the Nevada Gaming Commission
or
the Chairman of the Nevada Gaming Control Board, or who refuses or fails to
pay
the investigative costs incurred by the Nevada gaming authorities in connection
with the investigation of its application, may be found unsuitable. The same
restrictions apply to an owner of record if the owner of record, after request,
fails to identify the beneficial owner. Any person found unsuitable and who
holds, directly or indirectly, any beneficial ownership of any voting security
or debt security of a registered company beyond the period of times as may
be
prescribed by the Nevada Gaming Commission may be guilty of a criminal offense.
We will be subject to disciplinary action if, after we receive notice that
a
person is unsuitable to hold an equity interest in us or to have any other
relationship with us, we:
•
pay
that person any dividend upon any voting securities;
•
allow
that person to exercise, directly or indirectly, any voting right
held by
that person relating to us;
•
pay
remuneration in any form to that person for services rendered or
otherwise; or
•
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.
A
finding
of suitability is generally determined based upon a myriad of facts and
circumstances surrounding the entity or individual in question and many gaming
authorities have broad discretion in determining whether a particular entity
or
individual is suitable. We are unaware of any facts or circumstances that would
categorically prevent a gaming authority from finding any of our officers,
directors or significant stockholders suitable.
Gaming
Laws Relating to Securities Ownership
The
Nevada Gaming Commission may, in its discretion, require the holder of any
common stock, debt or similar security of a registered company to file
applications, be investigated and be found suitable to own the common stock,
debt or other security of the registered company if the Nevada Gaming Commission
has reason to believe that the ownership would otherwise be inconsistent with
the declared policies of the State of Nevada. If the Nevada Gaming Commission
determines that a person is unsuitable to own the security, then under the
Nevada Gaming Control Act, the registered company may be sanctioned, including
the loss of its approvals, if without the prior approval of the Nevada Gaming
Commission, it:
17
•
pays
to the unsuitable person any dividend, interest, or other
distribution;
•
recognizes
any voting right by the unsuitable person in connection with the
securities;
•
pays
the unsuitable person remuneration in any form; or
•
makes
any payment to the unsuitable person by way of principal, redemption,
conversion, exchange, liquidation or similar
transaction.
We
are
required to maintain a current stock ledger in Nevada that may be examined
by
the Nevada gaming authorities at any time. If any securities are held in trust
by an agent or by a nominee, the record owner may be required to disclose the
identity of the beneficial owner to the Nevada gaming authorities. A failure
to
make the disclosure may be grounds for finding the record owner unsuitable.
We
will be required to render maximum assistance in determining the identity of
the
beneficial owners of our voting securities. The Nevada Gaming Commission has
the
power to require the stock certificates of any registered company to bear a
legend stating that the securities are subject to the Nevada Gaming Control
Act,
but has not imposed this requirement on us. If the Nevada Gaming Commission
were
to impose this requirement, we expect that we would seek an exemption from
this
requirement.
Approval
of Changes in Control
As
a
registered company, we must obtain prior approval of the Nevada Gaming
Commission with respect to a change in control through a merger, consolidation,
stock or asset acquisitions, management or consulting agreements, or any act
or
conduct by which anyone obtains control of us.
Entities
seeking to acquire control of a registered company must satisfy the Nevada
Gaming Control Board and the Nevada Gaming Commission with respect to a variety
of stringent standards before assuming control of a registered company. The
Nevada Gaming Commission also may require controlling stockholders, officers,
directors and other persons who have a material relationship or involvement
with
the entity proposing to acquire control to be investigated and licensed as
part
of the approval process relating to the transaction.
Approval
of Defensive Tactics
The
Nevada legislature has declared that some corporate acquisitions opposed by
management, repurchases of voting securities and corporate defense tactics
affecting Nevada gaming licensees, and registered companies that are affiliated
with those operations, may be harmful to stable and productive corporate gaming.
The Nevada Gaming Commission has established a regulatory scheme to reduce
the
potentially adverse effects of these business practices upon Nevada’s gaming
industry and to further Nevada’s policy to:
18
•
assure
the financial stability of corporate gaming licensees and their
affiliates;
•
preserve
the beneficial aspects of conducting business in the corporate form;
and
•
promote
a neutral environment for the orderly governance of corporate
affairs.
Because
we are a registered company, approvals may be required from the Nevada Gaming
Commission before we can make exceptional repurchases of voting securities
above
their current market price and before a corporate acquisition opposed by
management can be consummated. The Nevada Gaming Control Act also requires
prior
approval of a plan of recapitalization proposed by a registered company’s board
of directors in response to a tender offer made directly to its stockholders
for
the purpose of acquiring control.
Fees
and Taxes
We
pay
license fees and taxes computed in various ways depending on the type of gaming
or activity involved. These fees and taxes, depending upon their nature, are
payable monthly, quarterly or annually and are based upon either a percentage
of
the gross revenues received or the number of gaming devices operated. Annual
fees are also payable to the State of Nevada for renewal of our manufacturers
and distributors licenses, OILS license and our Mobile Gaming license. Our
cost
of fees and taxes for the years ending 2004, 2005 and 2006 were $97,503, $91,410
and $87,515 respectively.
Foreign
Gaming Investigations
Any
person who is licensed, required to be licensed, registered, required to be
registered, or who is under common control with those persons, collectively,
“licensees,” and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Gaming Control Board, and
thereafter maintain, a revolving fund in the amount of $10,000 to pay the
expenses of investigation by the Nevada Gaming Control Board of the licensee’s
or registrant’s participation in foreign gaming. We currently comply with this
requirement. The revolving fund is subject to increase or decrease at the
discretion of the Nevada Gaming Commission. Licensees and registrants are
required to comply with the reporting requirements imposed by the Nevada Gaming
Control Act. A licensee or registrant is also subject to disciplinary action
by
the Nevada Gaming Commission if it:
•
knowingly
violates any laws of the foreign jurisdiction pertaining to the foreign
gaming operation;
•
fails
to conduct the foreign gaming operation in accordance with the standards
of honesty and integrity required of Nevada gaming
operations;
19
•
engages
in any activity or enters into any association that is unsuitable
because
it poses an unreasonable threat to the control of gaming in Nevada,
reflects or tends to reflect, discredit or disrepute upon the State
of
Nevada or gaming in Nevada, or is contrary to the gaming policies
of
Nevada;
•
engages
in activities or enters into associations that are harmful to the
State of
Nevada or its ability to collect gaming taxes and fees;
or
•
employs,
contracts with or associates with a person in the foreign operation
who
has been denied a license or a finding of suitability in Nevada on
the
ground of unsuitability.
Federal
Registration
The
Federal Gambling Devices Act of 1962, the “Johnson Act,” makes it unlawful for a
person to manufacture, transport, or receive gambling machines, gambling devices
or components across interstate lines unless that person has first registered
with the United States Attorney General. We have complied with the registration
requirements of the Johnson Act. Gambling devices must also be identified and
we
must keep certain records in accordance with the Johnson Act’s requirements. If
we violate the Johnson Act, our equipment may be seized or forfeited and we
may
be subject to other penalties.
Tribal
Gaming Regulation
When
contracting with tribal owned or controlled gaming establishments, we become
subject to tribal laws and regulations that may differ materially from the
non-tribal laws and regulations under which we generally operate. In addition
to
tribal gaming regulations that may require us to provide disclosures or obtain
licenses or permits to conduct our business on tribal lands, we may also become
subject to tribal laws that govern our contracts. These tribal governing laws
may not provide us with processes, procedures and remedies that enable us to
enforce our rights as effectively and advantageously as the processes,
procedures and remedies that would be afforded to us under non- tribal laws,
or
to enforce our rights at all, and may expose us to an increased risk of contract
repudiation as compared to that inherent in dealing with non-tribal customers.
Many tribal laws permit redress to a tribal adjudicatory body to resolve
disputes; however, such redress is largely untested in our experience. We may
be
precluded from enforcing our rights against a tribal body under the legal
doctrine of sovereign immunity.
Gaming
on
tribal lands, including the terms and conditions under which gaming equipment
can be sold or leased to tribal users, is governed by federal law, tribal-state
compacts and tribal gaming regulations. The Indian Gaming Regulatory Act of
1988, “IGRA,” provides the framework for federal and state control over all
gaming on tribal lands and is administered by the National Indian Gaming
Commission and the Secretary of the United States Department of the Interior.
IGRA requires that the tribe and the state enter into a written agreement,
a
tribal-state compact that governs the terms of certain types of gaming
activities. We are not aware of any state in which a tribal-state compact seeks
to regulate bingo.
20
The
regulations and ordinances adopted by tribal authorities vary but generally
impose standards and technical requirements on gaming hardware and software,
and
may impose registration, licensing and background check requirements on gaming
equipment suppliers and their officers, directors and stockholders similar
to
typical requirements imposed by Nevada gaming authorities.
Traditional
Casino Game Regulation
Traditional
casino games, such as poker, keno and video slots, are regulated much more
stringently than bingo games. The number of jurisdictions in which traditional
casino games are currently permitted is relatively small in comparison to the
number of jurisdictions in which bingo is permitted. The State of California
just entered into compacts with a large number of tribal authorities. The
evolution of the regulation of traditional casino games is very difficult to
predict, and no assurance can be provided that our planned entrance into the
traditional casino game market with mobile gaming platforms will be
successful.
Employees
As
of
December 31, 2006, we had employed 47 employees, including 20 employees in
the
manufacturing and service department, 18 employees in the engineering
programming department and 9 employees in the administration and sales
department. None of our employees are covered by collective bargaining
agreements. We consider our employee relations to be good.
ITEM
1A.RISK
FACTORS
Risks
Relating to Our Business
Our
failure to obtain approvals under the regulations promulgated under the Nevada
Mobile Gaming Law will negatively impact our growth strategy.
Notwithstanding
our receipt of an Operator of Mobile Gaming Systems license by the Nevada Gaming
Commission, the regulations promulgated under the Nevada Mobile Gaming Law
require us to obtain specific approval of our mobile gaming devices for use
in
Nevada casinos. If we are unable to obtain or maintain approval of our mobile
gaming platform as required by the regulations, we will be unable to
manufacture, distribute and operate wireless player terminals that enable casino
players to play casino games in public areas of gaming establishments as
permitted by the Nevada Mobile Gaming Law.
Our
inability to comply fully, or at all, with the mobile gaming regulations may
result in substantial additional development costs and preclude us from
executing our growth strategy.
The
regulations require that our mobile gaming systems be approved by the Nevada
Gaming Lab before we may distribute these systems to Nevada casinos. The Nevada
Gaming Lab may impose significant requirements on the functionality or design
of
mobile gaming systems that may be manufactured, distributed or operated in
Nevada. To the extent that our existing mobile gaming platform may not comply
with such requirements, we would need to undertake additional research and
development activities that may be costly, time consuming or require the
procurement of components that are scarce in supply. Despite undertaking
additional research and development activities, we may not be able to design
or
develop a mobile gaming platform that complies with the standards adopted by
the
Nevada Gaming Lab, in which case we would be unable to manufacture, distribute
or operate wireless player terminals that enable casino players to play
traditional casino games in the public areas of gaming establishments permitted
under the Nevada Mobile Gaming Law, and therefore be unable to fully execute
our
growth strategy.
21
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. We are under
continuous scrutiny by the applicable regulatory authorities. Our or our
officers’ current regulatory approvals may be revoked, suspended or curtailed at
any time. Our or 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 similar
to the Nevada Mobile Gaming Law, these approval requirements may vary from
jurisdiction to jurisdiction. 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.
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 substantial experience with our
operations and the electronic gaming device industry, including Yuri Itkis,
our
Chief Executive Officer and Chairman; William Jacques, our Chief Financial
Officer and Controller; Jack Coronel, our Chief Marketing Officer and Director
of Compliance and Strategic Development; and Boris Itkis, our Chief Technical
Officer and Vice President of Engineering. 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 would have a material adverse effect on our business.
22
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.
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, 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; we may not be able to augment our current level of staffing with
qualified individuals on a timely basis. 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.
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.
23
Our
failure to obtain gaming licenses or other regulatory approvals in other
jurisdictions would preclude us from expanding our operations into and
generating revenue from these jurisdictions.
The
manufacture and distribution of gaming devices are subject to extensive federal,
state, local and tribal regulation. Some jurisdictions require licenses, permits
and other forms of approval for gaming devices. Most jurisdictions require
licenses, permits or other forms of approval of the manufacturers, distributors
and operators of gaming devices, including evidence of financial stability,
and
of the suitability of their officers, directors, major stockholders and key
employees. The regulatory agencies conduct in-depth investigations of gaming
device manufacturer licensees as well as detailed personal background checks
of
key employees and major stockholders of the licensees. Obtaining requisite
approvals of state and tribal gaming authorities is a time-consuming and costly
process. Even after incurring significant time and expense in seeking regulatory
approvals, we may not be able to obtain them. Our failure or the failure of
our
officers, directors, major stockholders or key personnel to obtain regulatory
approval in any jurisdiction will prevent us from distributing our products
and
generating revenue in that jurisdiction.
We
operate in a highly competitive industry and expect the market for mobile gaming
devices to become increasingly competitive, which may negatively affect our
operations and our ability to maintain relationships with gaming
establishments.
The
market for gaming devices generally is intensely competitive, and we expect
competition to increase and intensify as the market for mobile gaming devices
develops. We currently compete with other providers of electronic bingo
products, such as VKGS, LLC, or Video King, formerly a division of BK
Entertainment Corp., GameTech International, Inc., the recently merged Planet
Bingo, LLC and Melange Computer Services, Inc., Blue Dog, Inc. Electronic Game
Solutions, Inc.
and
California Concepts, Inc. in the marketing of our BingoStar wireless bingo
systems. Although none of our competitors that manufacture mobile bingo devices
is currently licensed in Nevada other than GameTech International, Inc., we
may
face competition from these providers in the market for mobile gaming devices
in
the future. Given the market penetration, name recognition, marketing resources
and familiarity with the gaming device industry generally, traditional casino
game device manufacturers could be a significant competitive threat to us.
We
expect fierce competition from multiple large competitors dominating their
respective markets in our expansion efforts, such as Aristocrat Leisure, Ltd.,
International Game Technology, Alliance Gaming Corporation, WMS Gaming Inc.
and
Shuffle Master, Inc., that may enter the market for mobile gaming devices.
In
addition, we may in the future face potential competition from new entrants
into
the gaming device market, such as Cantor Fitzgerald LP, a large financial
services company that already offers wireless sports betting in the United
Kingdom, and at least two other gaming technology companies, Chimera Technology
Corp. and Diamond I, Inc. Finally, traditional casino operators, most of whom
are much larger than us, may attempt to enter the emerging mobile gaming market.
Some of our competitors and potential competitors have significant advantages
over us, including greater name recognition, longer operating histories,
pre-existing relationships with current or potential customers, proprietary
technology, significantly greater financial, marketing and other resources
and
more readily available access to capital that could allow them to respond more
quickly to new or changing opportunities.
24
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.
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 2006 we derived
99.7% 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.
A
material reduction in the yield on our investment of the proceeds of our initial
public offering and our retained earnings could materially and adversely affect
our net income and earnings per share.
Because
we have not yet begun full-scale production of mobile gaming devices under
the
Nevada Mobile Gaming Law, we have invested the bulk of the proceeds of our
initial public offering and retained earnings. Our net income and earnings
per
share for the year ended December 31, 2006 depended substantially on the yield
that we achieved on these investments. Approximately 28% of our income before
tax during 2006 resulted from these investments. Although we have invested
these
proceeds in relatively conservative investments, there can be no assurance
that
we will continue to enjoy the same yields on these investments as we did during
2006. 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.
25
Losing
any of our small number of independent distributors upon whom we depend for
a
significant portion of our revenue would negatively impact our
operations.
We
are
dependent upon a small number of independent distributors to market and sell
our
products to casinos and bingo halls. For the fiscal year ended December 31,
2006, approximately 58.6% of our revenues were derived through nine
distributors. During the same period, we derived approximately 32.7% 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 may result in a material reduction
in
our revenue, resulting in a material adverse effect on our business, financial
condition and results of operations.
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.
26
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.
27
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
therefrom.
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.
28
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 radio frequency, or 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.
29
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.
30
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.
31
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;
·
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
·
Potential
write-offs of acquired assets.
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 expires in 2010 and one expire in 2012. The patents that we own now or
in
the future may not provide us with significant competitive advantages or may
be
impaired by challenges to the validity or enforceability of such patents. For
example, in the past the validity of one of our patents has been repeatedly
challenged. Others may independently develop similar or more advanced
technologies or products or design around aspects of our technology that may
be
patented.
It
is
possible that third parties may copy or otherwise obtain and use our information
and proprietary technology without our authorization or otherwise infringe
on
our intellectual property rights. We may have to rely on litigation to enforce
our intellectual property rights and contractual rights. For example, we are
pursuing a patent infringement action against Planet Bingo, LLC and Melange
Computer Services, Inc. to discontinue what we believe to be their infringement
of our rights arising under of our patents. Both defendants have counterclaimed
that our patents are invalid and Planet Bingo, LLC has alleged that our
operations infringe one of its patents. See “Item 3. Legal Proceedings” for a
more detailed discussion of this litigation. If these counterclaims are
successful, our patents may be invalidated or limited in scope or we may be
forced to modify or discontinue our operations or pay substantial damages.
If
litigation that we initiate is unsuccessful, including the litigation described
above, we may not be able to protect the value of our intellectual property
and
our business could be adversely affected.
32
We
have
patent applications that are currently pending before the United States Patent
and Trademark Office. These patent applications may not result in any patents
being issued. If these patent applications do not become issued patents, our
competitors would not be prevented from using these inventions described in
the
applications.
In
addition, we may face claims of infringement that could interfere with our
ability to use technology or other intellectual property rights that are
material to our business operations. If a claim of infringement against us
is
successful, we may be required to pay royalties to use technology or other
intellectual property rights that we had been using or we may be required to
enter into a license agreement and pay license fees, or we may be required
to
stop using the technology or other intellectual property rights that we had
been
using. We may be unable to obtain necessary licenses from third parties at
a
reasonable cost or within a reasonable time. Any litigation of this type,
whether successful or unsuccessful, could result in substantial costs to us
and
diversions of our resources.
In
addition, we may not be able to deter current and former employees, consultants,
and other parties from breaching confidentiality agreements with us and
misappropriating proprietary information from us. If we are unable to adequately
protect our intellectual property, it could have a material adverse effect
on
the value of our intellectual property, our reputation, our business and our
operating results.
We
may not be able to obtain additional financing if required, which could harm
our
operations and ability to generate revenue.
Our
ability to manufacture our gaming platforms on a large scale may require us
to
obtain additional financing necessary for the manufacture of such hardware
components and expansion of our inventory. The net proceeds that we have
received from the sale of the shares of common stock in our initial public
offering together with revenue that we generate from operations may not be
sufficient to execute our growth strategy.
If
we are
unable to generate sufficient revenue or if our working capital and
manufacturing capacity is not capable of keeping up with demand, we will need
to
seek additional equity or debt financing to provide the capital required to
maintain or expand our production capabilities. We may not be able to obtain
needed additional equity or debt financing on terms that are favorable to us,
or
at all. If we are able to obtain such financing, existing stockholders may
suffer dilution and the equity or debt securities issued to raise such financing
may have rights, preferences and privileges senior to those of existing
stockholders. If we require, but are unable to obtain, sufficient additional
financing in the future we may be unable to implement our business plan, respond
to changing business or economic conditions, withstand adverse operating results
and compete effectively. More importantly, if we are unable to raise further
financing when and if required, our continued operations may have to be scaled
down or even ceased and our ability to generate revenues would be materially
impaired.
33
Our
inability to lease suitable facilities may harm, delay or prevent our
operations.
The
long
term lease for our Las Vegas, Nevada facility, which is our only facility,
expires in December 2010. This facility provides us with a convenient central
location from which to service our customers. We may not be able to extend
the
lease on its current terms or, if required, locate new adequate manufacturing
facilities on commercially reasonable terms or at all.
Risks
Relating to Our Industry
A
decline in the popularity of gaming could reduce the demand for our
products.
We
provide mobile gaming platforms to gaming establishments to enable players
to
play bingo in several jurisdictions, including Nevada, and traditional casino
games on cruise lines. When legally permitted, we intend to provide mobile
gaming platforms to enable players to play traditional casino games using our
wireless player terminals in Nevada. As a result, our business depends on
consumer demand for the games that we enable. Gaming is a discretionary leisure
activity, and participation in discretionary leisure activities has in the
past,
and may in the future, decline during economic downturns because consumers
have
less disposable income. Therefore, during periods of economic contraction,
our
revenue may decrease while some of our costs remain fixed, resulting in
decreased earnings. Gaming activity may also decline based on changes in
consumer confidence related to general economic conditions or outlook, fears
of
war, future acts of terrorism, or other factors. A reduction in tourism could
also result in a decline in gaming activity. Finally, a legislature or
regulatory authority may prohibit all or some gaming activities all together
in
its jurisdiction. A decline in gaming activity as a result of these or any
other
factors would have a material adverse effect on our business and operating
results.
Changes
in consumer preferences could also harm our business. Gaming competes with
other
leisure activities as a form of consumer entertainment, and may lose popularity
as new leisure activities arise or as other leisure activities become more
popular. In addition, gaming in traditional gaming establishments competes
with
Internet-based gaming for gaming players, and we do not serve the Internet
gaming market. The popularity and acceptance of gaming is also influenced by
the
prevailing social mores, and changes in social mores could result in reduced
acceptance of gaming as a leisure activity. To the extent that the popularity
of
gaming in traditional gaming establishments declines as a result of either
of
these factors, the demand for our gaming platforms may decline and our business
may be adversely affected.
Expansion
of the gaming industry faces opposition that could limit our access to some
markets and impair our growth.
We
expect
a substantial portion of our future growth to result from the general expansion
of the gaming industry. The expansion of gaming activities in new markets can
be
very controversial and may depend heavily on the support of national, local
and
tribal governments. Changes in government leadership, failure to obtain
requisite voter support in referenda, failure of legislators to enact enabling
legislation and limitations on the volume of gaming activity that is permitted
in particular jurisdictions may prevent us from expanding our operations into
new markets. A failure by the gaming industry to expand at the rate that we
expect could have a material adverse effect on our business, growth rates,
financial condition and operating results.
34
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.
35
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:
·
pay
that person any dividend upon any voting
securities;
·
allow
that person to exercise, directly or indirectly, any voting right
relating
to us held by the person;
·
pay
remuneration in any form to that person for services rendered or
otherwise; or
·
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.
36
Certain
Nevada statutes have potential anti-takeover effects that could delay or prevent
a change in control of our company and depress the price of our common
stock.
Nevada
statutes regulating business combinations, takeovers and control share
acquisitions may hinder or delay a change in control of our company. In
addition, under Nevada law, any change of control of our company must also
be
approved by the Nevada gaming authorities. Other jurisdictions may have similar
requirements. These statutes could limit the price that investors might be
willing to pay in the future for shares of our common stock and may limit our
stockholders’ ability to receive a premium on their shares by discouraging
takeovers and tender offer bids, even if such events could be viewed as
beneficial by our stockholders.
ITEM
2.PROPERTIES
We
conduct our operations at our facility located at 2950 South Highland Drive,
Suite C, Las Vegas, Nevada, 89109. This facility is an approximately 22,000
square foot facility utilized for our administrative office, product showroom,
research and development and manufacturing functions. The lease for this
facility expires in December 2010. Although we believe that our current facility
is adequate for manufacturing a sufficient volume of mobile gaming products
to
satisfy the anticipated demand through the existing lease term, we may be forced
to lease additional manufacturing space if demand for our expanded line products
should exceed our capability to manufacture the products in our currently leased
facility.
ITEM
3.LEGAL
PROCEEDINGS
We
are
pursuing a patent infringement lawsuit against one of our competitors, the
recently merged Planet Bingo, LLC and Melange Computer Services, Inc. The
lawsuit involves two of our patents. We allege that both patents are being
infringed by Plant Bingo, LLC and one of the patents is being infringed by
Melange Computer Services, Inc. We filed this action in May 2004 in the United
States Federal Court, District of Nevada. We are seeking unspecified monetary
damages and injunctive relief. The defendants have counter-claimed that our
patents are invalid and one of the defendants, Planet Bingo, LLC, has alleged
that our operations infringe on one of its patents. The patent that Planet
Bingo, LLC alleges that we have infringed has been invalidated by a Federal
District Court in unrelated litigation. This decision is on appeal. If either
of
the counter-claims is successful, our patents may be invalidated, or limited
in
scope, or we may be forced to modify or discontinue our operations or pay
substantial damages.
In
2006,
we commenced a civil action under the federal Racketeer Influenced Corrupt
Organization (RICO) law proceeding against our competitor GameTech
International, Inc.
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, also prosecute various
collection claims against delinquent customers.
37
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.
ITEM
4.SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART
II
ITEM
5.
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY
SECURITIES
Market
Information
Since
our
initial public offering on January 31, 2006, our common stock has traded on
the
Nasdaq Global Market (formerly the Nasdaq National Market) under the symbol
“FNET”. Prior
to
that time, there was no public market for our stock.
The
following table sets forth, for the indicated periods, the high and low closing
sale prices of our common stock:
Year Ended
December 31, 2006
High
Low
First
Quarter (commencing January 31, 2006)
$
15.03
$
9.05
Second
Quarter
24.65
14.54
Third
Quarter
15.90
6.84
Fourth
Quarter
11.45
8.04
On
March
1, 2007, the closing sale price of our common stock on the Nasdaq Global Market
was $7.85.
As
of
December 31, 2006, our stock was held by approximately 10 stockholders of
record. Because many of our shares of common stock are held by brokers and
other
institutions on behalf of stockholders, we are unable to estimate the total
number of beneficial stockholders represented by these record
holders.
38
Dividends
During
2005, which was prior to our initial public offering, we paid dividends to
holders of our common stock on a quarterly basis. The dividends paid during
2005
were $2,370,000 in the aggregate. Since becoming a publicly traded entity in
2006 we have paid no dividends and may not pay any dividends on our common
stock
in the foreseeable future and instead, may retain our future earnings, if any,
to finance our business and for general corporate purposes. As long as there
are
funds legally available to do so, any future determination to pay cash dividends
will be at the discretion of our board of directors and will depend upon
earnings, financial condition, operating results, capital requirements, any
contractual restrictions and other factors that our board of directors deems
relevant. The terms of any future debt or credit facility may preclude us from
paying dividends on our common stock.
Use
of Proceeds
We
completed an initial public offering of our common stock during the first
quarter of 2006. Our registration statement on Form S-1 under the Securities
Act
(File No. 333-128391) was declared effective on January 30, 2006. The
aggregate net proceeds to us were approximately $23,728,995.
We
have
invested all of the net proceeds from our initial public offering in short-term
interest bearing investment grade securities. We may utilize a significant
amount of proceeds from our initial public offering to acquire parts and
components for the manufacture of our gaming products. However, we do not intend
to commence procuring any significant amount of component parts for manufacture
of our gaming products until we are more able to predict the duration of the
currently ongoing reviewing process of our mobile gaming systems by the Nevada
gaming authorities. We may also utilize a substantial portion, if not most,
of
the proceeds from this offering to acquire one or more businesses.
Performance
Graph
The
information contained in the following graph shall not be deemed to be
“soliciting material” or to be “filed” with the Securities and Exchange
Commission, nor shall such information be incorporated by reference into any
future filing under the Securities Act of 1933, as amended, or the 1934
Securities Exchange Act, as amended, except to the extent that the Company
specifically incorporates it by reference in such filing.
The
following graph compares the performance of an investment in our common stock
from January 31, 2006 (the first trading day following the Company’s initial
public offering) through December 31, 2006, with the S&P 500 Index and a
selected peer group index (the “Peer Group Index”). The Peer Group Index was
selected on an industry basis and consists of International Game Technology
and
Shuffle Master, Inc.
39
The
graph
assumes $100 was invested in each of our common stock, the Peer Group Index
and
in the S&P 500 Index at the close of market on January 31, 2006 (the first
trading day following the Company’s initial public offering) and the end of each
month through out 2006. No cash dividends have been declared on our common
stock
since our initial public offering. The comparisons in this graph are not
intended to forecast or be indicative of possible future performance of our
common stock.
The
table
below shows the cumulative total returns in dollars of our common stock, the
S&P 500 Index and the Peer Group Index at the end of each calendar month
since our initial public offering, assuming $100 was invested in each of our
common stock and the Peer Group Index and in the S&P 500 Index at the close
of market on January 31, 2006 (the first trading day following our initial
public offering), and assumes the reinvestment of dividends on the date of
payment without payment of any commissions. No cash dividends have been declared
on our common stock since our initial public offering. The comparisons in this
table are not intended to forecast or be indicative of possible future
performance of our common stock.
FortuNet,
Inc
Peer
Group Index
S&P
500 Index
1/31/06
100.00
100.00
100.00
2/28/06
104.98
101.38
100.02
3/31/06
158.57
119.54
101.13
4/30/06
194.48
125.70
102.36
5/31/06
201.22
123.76
99.19
6/30/06
179.01
117.50
99.20
7/31/06
124.09
111.36
99.71
8/31/06
76.91
108.78
101.83
9/30/06
115.91
110.36
104.57
10/31/06
88.84
114.23
107.62
11/30/06
96.36
121.00
109.30
12/31/06
111.83
116.06
110.77
40
ITEM
6. SELECTED FINANCIAL DATA
The
following selected consolidated financial data should be read in conjunction
with out audited consolidated financial statements and related notes and “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations” appearing elsewhere in this Annual Report on Form 10-K. The selected
consolidated financial data for the fiscal years ended December 31, 2002, 2003,
2004, 2005 and 2006 have been derived from our audited consolidated financial
statements. Our selected consolidated financial data may not be indicative
of
our future financial condition or results of operations.
For
the Years Ended December 31,
2002
2003
2004
2005
2006
Combined
and Consolidated Statements of Operations Data:
Sales
revenue
$
11,340,029
$
14,287,365
$
14,326,749
$
14,684,914
$
16,460,462
Cost
of revenue
1,585,996
2,172,777
2,228,545
2,328,190
2,132,702
Gross
profit
9,754,033
12,114,588
12,098,204
12,356,724
14,327,760
Operating
expenses:
General
and administrative
3,008,060
3,772,933
4,042,257
3,552,995
6,459,210
Sales
and marketing
2,912,675
3,936,187
3,930,135
4,380,529
5,301,331
Research
and development
285,462
484,921
367,821
927,800
648,463
Total
operating expenses
6,206,197
8,194,041
8,340,213
8,861,324
12,409,004
Income
from operations
3,547,836
3,920,547
3,757,991
3,495,400
1,918,756
Interest
expense
(127
)
(8,444
)
(64,178
)
(40,934
)
(13,327
)
Other
income
159,448
1,452
32,147
77,633
898,414
Income
before income taxes and minority interest
3,707,157
3,913,555
3,725,960
3,532,099
2,803,843
Provision
for income taxes
950,899
1,335,126
1,383,789
1,306,877
776,183
Income
before minority interest
2,756,258
2,578,429
2,342,171
2,225,222
2,027,660
Minority
interest
356,848
341,480
—
—
—
Net
income
$
2,399,410
$
2,236,949
$
2,342,171
$
2,225,222
$
2,027,660
Net
income per share
$
0.29
$
0.27
$
0.28
$
0.27
$
0.18
Shares
used in the calculation of net income per share
8,350,000
8,350,000
8,350,000
8,350,000
11,037,511
41
As
of December 31,
2002
2003
2004
2005
2006
Combined
and Consolidated Balance Sheet Data:
Current
assets
$
3,230,000
$
4,218,526
$
4,827,415
$
4,134,304
$
30,020,629
Property
and equipment, net of accumulated depreciation
3,187,000
3,892,307
5,202,847
5,016,573
6,642,372
Total
assets
6,636,000
9,746,790
11,195,100
11,048,503
37,600,435
Current
liabilities
1,144,000
1,106,100
890,189
1,394,864
997,353
Long
term liabilities
135,000
1,094,444
536,494
---
---
Stockholders’
equity
5,357,000
7,546,246
9,768,417
9,653,639
36,603,082
ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
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 bingo.
We
believe that the research and developments efforts that we undertook in 2006
have made our field-proven mobile gaming platform compliant with the wireless
gaming regulations promulgated by the Nevada Gaming Commission on March 23,
2006. Accordingly, we have submitted our mobile gaming platform for review
by
Nevada gaming authorities in 2006. 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 have also successfully
completed the field testing of our wireless player terminals that enable patrons
to play traditional casino games on a limited basis on cruise lines. 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 recently introduced our fourth generation wireless player
terminals for our gaming platform that enable patrons to play bingo and has
been
adapted to conduct traditional casino games in casino public areas. In addition
to adapting our wireless gaming platform to comply with the newly promulgated
Nevada gaming regulations for mobile gaming devices, we have developed and
begun
selling super-bright multicolor LED bingo flashboards that not only display
the
called bingo numbers but also verify bingo cards. We have filed a United States
patent application regarding certain aspects of this product.
42
We
currently generate revenue 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 growth is affected by player acceptance of electronic bingo as
an
addition or an alternative to paper bingo in our existing client establishments,
our ability to expand operations into new markets and our ability to increase
our market share. 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 occasional loss of existing
customers, we experience an increase in sales revenue due to the addition of
customers and a decrease in sales revenue due to the loss of customers. Our
sales revenue is also affected from period to period as a result of 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. 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 influenced by the then current price for our products
and our unit-volume sales.
We
envision that if we develop product revenue sales, we will also see a recurring
revenue component for both software upgrades and 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 do so in order to improve the quality
and reliability of our products;
43
(b)
general and administrative costs, consisting of activities associated with
management of our company and related support, which includes all payroll and
benefits other than payroll in connection with research and development
activities, amortization of our non-competition agreements, travel, professional
fees, facility expenses and bad debt expense reserves;
(c)
sales
and marketing costs, consisting primarily of commissions paid to distributors
for promoting and supporting our products and related marketing costs;
and
(d)
research and development costs associated with the internal research and
development activities geared to the further development of our gaming platform,
including labor and hardware and software testing, prototyping and
development.
We
envision that the development of our product revenue may require us to record
cost of products sold (rather than leased) revenue 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 and the exclusive distribution
of our bingo products in Nevada, Texas and Washington, are conducted by
FortuNet. Prior to November 2003, Yuri Itkis held approximately 72% of the
voting control over Millennium. In November 2003 Millennium purchased its
outstanding shares held by stockholders other than Yuri Itkis. In January 2004,
we became the 100% owner of Millennium through Yuri Itkis’ contribution to us of
the remaining outstanding shares. This enabled us to consolidate our worldwide
distribution rights and enabled significant expense reduction in our overall
distribution and operational costs.
In
2006,
we incurred $952,187 in legal expenses primarily due to (a) ongoing litigation
against defendants Planet Bingo, LLC, Melange Computer Services, Inc., and
Gametech International, Inc., and (b) our initial public offering. This compares
with $320,148 in comparable legal expenses for 2005. We may incur similar or
increasing levels of litigation expenses in the future.
Application
of Critical Accounting Policies and Estimates
Our
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, bingo unit 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 from these
estimates under different assumptions or conditions.
44
We
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
Revenue
Recognition
Revenue
is currently recognized for bingo terminals placed in bingo halls under lease
contracts based on (a) a fixed weekly fee per terminal available for bingo
(even
though our contracts are generally on a month to month basis); (b) a fixed
fee
per usage per bingo session; or (c) a percentage of the revenue generated by
each terminal for bingo sessions played. We do not enter into any financing
leases or sales type contracts with our customers. Our platform provides reports
of daily usage for billing and reporting purposes for the latter two types
of
contracts. We bill our customers on a weekly and monthly basis for these
revenues and recognize the revenue for the period the units are used or prorate
for weekly fees. Existing revenue recognition is a key component of our results
of operations, and determines the timing of certain expenses, such as
commissions, which are reported in the same period when related revenues are
recognized. We recognize revenue in accordance with accounting principles
generally accepted in the United States when all of the following factors exist:
(a) evidence of an arrangement with the customer; (b) installation of our gaming
platform; (c) a fixed or determinable fee; and (d) collectibility is reasonably
assured. We exercise judgment in assessing the credit worthiness of our
customers and therefore in our determination of whether collectibility is
reasonably assured. Should changes in conditions cause us to determine these
criteria are not met for future transactions, revenue recognized for future
reporting periods could be adversely affected.
Allowance
for Doubtful Accounts
We
estimate the possible losses resulting from non-payment of outstanding accounts
receivable. We perform ongoing evaluations of our customers and distributors
for
credit worthiness, economic trends, changes in our customer payment terms,
and
historical collection experience when evaluating the adequacy of our allowance
for doubtful accounts. In determining these percentages, we review historical
write-offs of our receivables, payment trends and other available information.
While such estimates have been within our expectations and the provisions
established, a change in financial condition of specific customers or in overall
trends experienced may result in future adjustments of our estimates of
recoverability of our receivables.
Depreciation
The
declining balance method of depreciation is used for furniture and fixtures,
machinery and equipment and vehicles with a useful life of five to seven years.
This method was selected because the productive usefulness of those assets
decline at a rate more rapid than straight line. Leasehold improvements are
depreciated over the life of the lease. Our rental assets are depreciated over
five years using the straight line method. The straight line method is used
because we believe this method most accurately matches the costs with the
revenues over the useful life of the product. We annually assess whether there
is a possible impairment of the assets and equipment and to date have concluded
that no impairments exist.
45
Software
Development Cost Policy
We
have
capitalized software development costs with the achievement of the technological
feasibility of our mobile gaming system. We have recorded these costs in
accordance with the Statement of Financial Accounting Standards No. 86
“Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed.”
Internal
Control Deficiencies
In
connection with the audit
of
our 2006 financial statements,
our
Chief Executive Officer & Chief Financial Officer have concluded that there
was a significant deficiency in our accounting for income taxes. In preparation
of our tax provision for year ending December 31, 2006, we identified certain
adjustments to our tax liability account and related income tax provision.
All
adjustments to correct these matters have been reflected in our consolidated
financial statements of the year ending December 31, 2006.
The
significant deficiency is the result of insufficient quantity of personnel
in
the accounting department to perform the necessary checks and balances for
daily
and year-end procedures, including the accounting for income taxes. Our
independent registered public accounting firm has recommended that we hire,
and
we are currently seeking to hire, an additional employee with the background
and
skills to perform duties typical of a controller.
Legal
Contingencies
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 as a percentage of revenue
for each of the periods indicated:
46
Consolidated
Income Statement
Years
Ended
December
31,
2004
2005
2006
Revenue
100.00
%
100.00
%
100.00
%
Cost
of revenue
15.50
%
15.90
%
13.00
%
Gross
profit
84.50
%
84.10
%
87.00
%
Operating
expenses:
General
and administrative
28.20
%
24.20
%
39.20
%
Sales
and marketing
27.40
%
29.80
%
32.20
%
Research
and development
2.60
%
6.30
%
3.90
%
Total
operating expenses
58.20
%
60.30
%
75.30
%
Income
from operations
26.30
%
23.80
%
11.70
%
Interest
expense
(0.40
)%
(0.30
)%
(0.10
)%
Other
income
0.10
%
0.50
%
5.40
%
Income
before income taxes
26.00
%
24.00
%
17.00
%
Provision
for income taxes
9.70
%
8.80
%
4.70
%
Net
income
16.30
%
15.20
%
12.30
%
Year
Ended December 31, 2006 and December 31, 2005
Sales
revenue.
Sales
revenue was $16,460,462 in the year ended December 31, 2006, compared to
$14,684,914 in the year ended December 31, 2005, an increase of $1,775,548,
or
12.1%. This increase was achieved mainly through the deployment of additional
player terminals into the bingo market to existing customers. During 2005 the
deployment of hand held units was intentionally curtailed by management in
anticipation of the substantial financial resources required for entering the
new emerging market for mobile gaming in Nevada. Our initial public offering
in
January 2006 provided us with sufficient financial resources to manufacture
a
large number of additional player terminals for lease into the bingo market.
For
the
year ended December 31, 2006, the net change in our revenue as a result of
changes in our customer base was an increase in revenue of $100,123 and the
net
change in revenue as a result of changes in operations at our existing customer
locations was an increase of revenue of $1,704,388.
Other
Income.
Other
income was $898,414 during 2006, approximately 11.5 times the amount of other
income of $77,633 in 2005. This increase in other income was almost entirely
the
result of the yield on our investment of the proceeds of our initial public
offering and retained earnings during 2006.
Cost
of revenue.
The cost
of revenue was $2,132,701 during 2006, compared to $2,328,190 for the year
ending December 31, 2005, a decrease of $195,489, or 8.4%. The decrease in
cost
of revenue was mainly attributable to the reduced depreciation cost in 2006
as
compared to 2005 as the third generation of products installed in the field
in
2001 became fully depreciated. Specifically, the depreciation cost for 2006
was
$1,740,858 as compared to $1,906,507 for 2005. Also contributing to the decrease
in the cost of revenue in 2006 was the decrease in the installation and
maintenance expenses from $356,966 for 2005 to $306,746 for 2006. This decrease
was partially attributable to our increased efficiencies and the beneficial
use
of our distributors’ services in deployment of additional units. As a result of
this overall decrease in costs, our gross margin increased from 84.1% in 2005,
to 87.0% in 2006. In the future, we anticipate the depreciation of deployed
products to increase or decrease in proportion to the increase or decrease
of
the aggregate cost basis of the equipment utilized in the field during a given
year.
47
General
and administrative.
The
general and administrative expenses were $6,459,210, or 39.2% of revenue, in
2006, compared to $3,552,995, or 24.2% of revenue, in 2005, a increase of
$2,906,215, or 81.8%. This cost increase was associated with our transition
from
a private company to a publicly traded company and was primarily attributable
to
(a) the consulting services provided by Spiegel Partners LLC with a cost of
$611,540, (b) the costs associated with the stock grants to certain of our
executives in the amount of $677,881 and (c) the costs associated with our
payments to our outside directors in the amount of $97,500.
The
increase in general and administrative expenses was also due in part to
additional costs associated with being a public company in an aggregate amount
of $349,379. These additional costs included the cost of director and officer’s
insurance, securities filings and additional audit costs. Also, our litigation
and other legal expenses increased from $320,148 during 2005 to $952,187 during
2006 an increase of $632,039 or 197.4%.
The
balance of the difference in general and administrative expenses between 2006
and 2005 consists primarily of an additional labor cost amounting to $345,870
which also includes the cost of share-based compensation cost resulting from
stock options granted during 2006 to some of our employees.
Sales
and marketing.
The
sales and marketing expenses were $5,301,332, or 32.2% of revenue, in 2006,
compared to $4,380,529, or 29.8% of revenue, in 2005, an increase of $920,803,
or 21.0%. This increase was attributable primarily to the expansion of our
distribution channel through our existing distributors network with resulting
increased commissions payments to our distributors.
Research
and development.
The
research and development expenses were $648,463, or 3.9% of revenue, in 2006,
compared to $927,800, or 6.3% of revenue, in 2005, a decrease of $279,337,
or
30.1%. The decrease in research and development expenses was primarily the
result of our compliance with the provisions of FASB SFAS No. 86, because
we achieved the stage of technological feasibility in the development of our
mobile gaming system in the beginning of the second quarter of 2006 and
therefore, capitalized $835,378 of our research and development expenses. We
anticipate additional capitalization of the cost of developing our gaming
platform until the deployment of our mobile gaming system is
achieved.
Other
income and expense. Other
income was $898,414, or 5.5% of 2006 revenue, compared to $77,633, or .05%
of
2005 revenue, an increase of $820,781 or 1,057.3%. The increase in other income
was primarily due to the interest earned through our investment of funds raised
in our initial public offering.
48
Provision
for income taxes.
An
income tax provision of $776,183 with an effective tax rate of 27.7% was
recorded in 2006, compared to $1,306,877 with an effective tax rate of 37.0%
in
2005, a decrease of $530,694, or 40.6%. This decrease in the provision for
income taxes was primarily due to the decision to invest available assets
primarily into tax exempt instruments and also from a decrease in taxable income
in 2006.
Year
Ended December 31, 2005 and December 31, 2004
Sales
revenue.
Sales
revenue was $14,684,914 in the year ended December 31, 2005, compared to
$14,326,749 in the year ended December 31, 2004, an increase of $358,165, or
2.5%. This increase was achieved despite the loss of customer revenues
associated with becoming the 100% owner of Millennium that represented $450,144
during 2005. After becoming the 100% owner of Millennium, we reevaluated the
customers of Millennium and subsequently ceased doing business with those
customers that did not meet our payment policies and also lost customers that
were apparently dissatisfied with the customer service previously provided
by
Millennium. Moreover, in connection with our relocation to a new and larger
facility at the end of September 2005, we were forced to stop our production
line in May 2005 and consequently had to suspend our marketing efforts until
we
restarted the production line in September 2005. The stoppage of our production
line affected our ability to deliver products to our customers during the year
ended December 31, 2005, which prevented us from significantly increasing our
sales revenue for the period.
For
the
year ended December 31, 2005, the net change in our revenue as a result of
changes in our customer base was an increase in revenue of $220,976 and the
net
change in revenue as a result of changes in operations at our existing customer
locations was an increase of revenue of $138,929.
Cost
of revenue.
Cost of
revenue was $2,328,190 during 2005, compared to $2,228,545 during 2004, an
increase of $99,645, or 4.5%. The increase in cost of revenue was attributable
to the deployment of our fourth generation wireless and stationary player
terminals into the market in 2004 that resulted in increased distribution costs
as well as depreciation costs during 2005. Specifically, the depreciation cost
for 2005 was $1,906,507 as compared to $1,646,091 for 2004. The increase in
the
depreciation of deployed products was partially offset by a corresponding
reduction in the installation and maintenance expenses of $582,454 for 2004
to
$356,966 for 2005. This decrease was partially attributable to our increased
efficiencies as a result of the integration of our field service operations
with
former field service operations of Millennium. As a result of this overall
increase in costs, our gross margin decreased slightly from 84.5% in 2004,
to
84.1% in 2005. In the future we anticipate the depreciation of deployed products
to increase or decrease in proportion to the increase or decrease of the
aggregate cost basis of the units in the field during a given year.
General
and administrative.
General
and administrative expenses were $3,552,995, or 24.2% of revenue, in 2005,
compared to $4,042,257, or 28.2% of revenue, in 2004, a decrease of $489,262,
or
12.1%. This decrease in costs was primarily attributable to efficiencies that
were achieved through the consolidation of operations and the elimination of
duplicative overhead costs that occurred during 2004 as we integrated the
operations of Millennium with the operations of FortuNet. We benefited from
the
lower operational cost during 2005. This decrease was also due in part to no
additional bad debt expense reserve related to Millennium customers being
accrued in 2005. We had accrued $212,011 of bad debt expense reserve related
to
Millennium in 2004. We were able to decrease our general and administrative
expenses despite a sharp increase in our litigation expenses related to patent
infringement suits we brought against certain competitors. Our litigation
expenses increased from $179,346 during 2004 to $320,148, or 78.5%, in
2005.
49
Sales
and marketing.
Sales
and marketing expenses were $4,380,529, or 29.8% of revenue, in 2005, compared
to $3,930,135, or 27.4% of revenue, in 2004, an increase of $450,394, or 11.5%.
This increase was attributable primarily to the expansion of our distribution
channel through the addition of new distributors.
Research
and development.
Research
and development expenses were $927,800, or 6.3% of revenue, 2005, compared
to
$367,821, or 2.6% of revenue, in 2004, an increase of $559,979, or 152.2%.
The
drastic increase in research and development expenses was primarily the result
of our increased investment in new development hardware and software development
tools and labor cost to enable us to accelerate development of upgrades to
our
hardware and software components of our gaming platform.
Provision
for income taxes.
An
income tax provision of $1,306,877 with an effective tax rate of 37% was
recorded in 2005, compared to $1,383,789 with an effective tax rate of 37.1%
in
2004, a decrease of $76,912, or 5.6%. This decrease was primarily due to a
decrease in taxable income in 2005.
Liquidity
and Capital Resources
Since
inception, we have financed our operations primarily with revenue generated
from
the leasing of our bingo products. At December 31, 2006, our principal sources
of liquidity were cash and cash equivalents of $26,468,808 and accounts
receivable (net of allowance for doubtful accounts) of $1,436,599. 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 manufacture 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. Although no additional
capital raise is currently being contemplated, we may seek, if necessary or
otherwise 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.
50
Summary
of Combined and Consolidated Statements of Cash Flow
Years
Ended December 31,
2004
2005
2006
Net
cash provided by operating activities
$
3,985,934
$
4,511,364
$
5,489,602
Net
cash (used in) investing activities
(3,010,750
)
(1,766,102
)
(3,410,533
)
Net
cash(used in) provided by financing activities
(735,382
)
(3,613,670
)
23,878,222
Net
increase (decrease) in cash and cash equivalents
239,802
(868,408
)
25,957,291
Cash
and cash equivalents, beginning
1,140,123
1,379,925
511,517
Cash
and cash equivalents, ending
$
1,379,925
$
511,517
$
26,468,808
Operating
Activities
For
fiscal year ended December 31, 2006, net cash of $5,489,602 provided by
operating activities was primarily due to net income of $2,027,660, depreciation
and amortization of $2,263,676, the issuing of common stock for certain services
of $1,132,140 and the change in operating assets and liabilities of $66,126.
For
2005, the net cash of $4,511,364 provided by operating activities was primarily
due to net income of $2,225,222, depreciation and amortization of $2,406,047
and
the change in operating assets and liabilities of $119,905. The increase in
net
cash provided by operating activities in 2006 as compared to 2005, was primarily
due to the issuing of stock for certain services provided for the Company in
connection with becoming a publicly traded entity.
For
2005,
the net cash of $4,511,364 provided by operating activities was primarily due
to
net income of $2,225,222, depreciation and amortization of $2,406,047 and the
change in operating assets and liabilities of $119,905. The relatively small
decrease in net cash provided by operating activities in 2005 as compared to
2004, was primarily due to the cash flow used to cover the costs associated
with
our initial public offering in February 2006.
For
2004,
the net cash of $3,985,934 provided by operating activities was primarily due
to
net income of $2,342,171, depreciation and amortization of $2,152,347 and the
change in operating assets and liabilities of $508,584. The substantial increase
in net cash provided by operating activities in 2004 as compared to 2003 was
primarily due to the increased cash flow from leasing activities coupled with
the non-cash benefits provided by the depreciation and amortization allowances.
51
Investing
Activities
For
2006,
$3,410,533 of net cash was used for investing activities, with $3,410,533 being
used to fund the manufacture of additional equipment for lease to our customers.
For
2005,
$1,766,102 of net cash was used for investing activities, with $1,561,750 being
used to fund the manufacture of additional equipment for lease to our customers
and the balance spent on other capital expenditures.
In
2004,
$3,010,750 of net cash was used for investing activities, with $2,973,601 being
used to fund the manufacture of additional equipment for lease to our customers
and the balance spent on other capital expenditures.
Financing
Activities
For
the
year 2006, $23,878,222 of net cash was raised through financing activities
associated with $24,710,625 raised as a result of the sale of our stock in
our
initial public offering less cost of issuing stock of $981,630 of which $685,722
was used for costs incurred in 2005, with $536,495 used for payments of a long
term debt obligation incurred as a result of our acquiring 100% ownership of
Millennium.
For
the
year 2005, $3,613,670 of net cash was used for financing activities, with
$557,948 used for payments of a long term debt obligation incurred as a result
of our acquiring 100% ownership of Millennium, $685,722 was used in costs
associated with our initial public offering which closed in 2006 and $2,340,000
used to pay dividends. On November 7, 2005, prior to our initial public
offering, we paid a dividend of $2,250,000 to persons who were our stockholders
of record on September 30, 2005.
For
the
year 2004, $735,382 of net cash was used for financing activities, with $615,382
used for payments of a long term debt obligation incurred as a result of our
acquiring 100% ownership of Millennium and $120,000 used to pay
dividends.
Off-Balance
Sheet Arrangements
As
of
December 31, 2006, we have no off-balance sheet arrangements as defined in
Item
303(a)(4) of the Securities and Exchange Commission’s Regulation
S-K.
Contractual
Obligations
The
following table describes our commitments to settle contractual obligations
in
cash as of December 31, 2006:
52
Payments
Due By Period
Less
Than
1
Year
1
to 3
Years
3
to 5
Years
Total
Location
lease
$
121,996
$
255,376
$
120,241
$
497,613
Purchase
commitments
1,600,719
—
—
1,600,719
Total
$
1,722,715
$
255,376
$
120,241
$
2,098,332
Recent
Accounting Pronouncements
SFAS
157
In
September 2006, the FASB issued SFAS 157, Fair
Value Measurements, which
defines fair value, establishes a framework for measuring fair value in GAAP,
and expands disclosures about fair value measurements. SFAS 157 does not require
any new fair value measurements, but provides guidance on how to measure fair
value by providing a fair value hierarchy used to classify the source of the
information. This statement is effective for us beginning in 2008. We are
evaluating whether adoption of this statement will result in a change to our
fair value measurements.
SAB
108
In
September 2006, the SEC issued SAB 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB 108 requires analysis of misstatements using both an income
statement (rollover) approach and a balance sheet (iron curtain) approach
in assessing materiality and provides for a one-time cumulative effect
transition adjustment. SAB 108 is effective for our fiscal year 2007 annual
financial statements. We do not expect the adoption of this statement to have
a
material impact on our results of operations, financial position or cash
flows.
FIN
48
In
June 2006, the FASB issued FIN 48, Accounting
for Uncertainty in Income Taxes-an interpretation of FASB Statement
No. 109. FIN
48
prescribes the recognition threshold and measurement criteria for determining
the tax benefit amounts to recognize in the financial statements. This
interpretation is effective for us beginning in 2007. We are evaluating the
potential impact of adopting this interpretation on our future results of
operations, financial position or cash flows and expect minimal effect on future
results of operations.
SFAS
123R (including FSP’s) and SAB 107
In
December 2004, the FASB issued SFAS 123R (revised 2004), Share-Based
Payment,
replacing and superseding both SFAS 123, Accounting
for Stock-Based Compensation,
and APB
25, Accounting
for Stock Issued to Employees.
SFAS
123R requires fair value measurement and recognition in the financial statements
for all share-based compensation arrangements. SFAS 123R also requires
additional accounting and disclosures related to income tax effects and cash
flows resulting from share-based compensation arrangements.
53
In
March 2005, the SEC issued SAB 107, Share-Based
Payment, providing
interpretive guidance on SFAS 123R valuation methods, assumptions used in
valuation models, and the interaction of SFAS 123R with existing SEC guidance.
The additional SAB 107 requirement for the classification of stock compensation
expense to the same financial statement line as cash compensation affected
our
SG&A expenses and fixed assets with the capitalization of R & D costs.
We adopted the provisions of SFAS 123R and SAB 107 in the first quarter of
fiscal 2006.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Market
risk is the risk of loss arising from adverse changes in market rates and
prices, including interest rates, foreign currency exchange rates, credit risk,
commodity prices and equity prices. Our primary exposure to market risk is
due
to the fact that certain parts, components, and subassemblies for our products
are manufactured outside of the United States, which exposes us to the risk
of
foreign currency fluctuations, political and economic instability and united
protection of intellectual property. We do not believe we are subject to
material variable interest risk, credit risk or similar market
risks.
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
We
have
audited the consolidated balance sheets of FortuNet, Inc and subsidiary as
of
December 31, 2005 and 2006, and the related consolidated statements of income,
stockholders’ equity and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the responsibility
of
the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the
financials statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provided a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of FortuNet, Inc and
subsidiaries as of December 31, 2005 and 2006, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with U.S. generally accepted accounting
principles.
As
discussed in Note 16, New Accounting Pronouncements, to the consolidated
financial statements, the Company adopted Statement 123(R), Shared-Based
Payments, as of the first fiscal quarter of fiscal 2006.
/s/
Schechter Dokken Kanter Andrews & Selcer Ltd.
Minneapolis,
Minnesota
March
20,
2007
55
FORTUNET,
INC.
CONSOLIDATED
BALANCE SHEETS
December
31,
2005
2006
Assets:
Current
assets:
Cash
and cash equivalents
$
511,517
$
26,468,808
Accounts
receivable, net of
allowance
for doubtful accounts
1,311,849
1,436,599
Inventories
1,270,445
1,333,970
Prepaid
expenses
957,889
668,536
Deferred
tax asset
82,604
112,716
Total
current assets
4,134,304
30,020,629
Property
and equipment, net of
accumulated
depreciation
5,016,573
6,642,372
Other
assets, net of accumulated
amortization
490,949
76,723
Deferred
offering costs
685,722
Deferred
tax asset
720,955
860,711
Total
assets
$
11,048,503
$
37,600,435
Liabilities
and stockholders’
equity:
Current
liabilities:
Accounts
payable
$
330,564
$
136,341
Commissions
payable
184,863
294,609
Accrued
expenses
184,496
231,195
Income
tax payable
158,446
335,208
Notes
payable, current portion
536,495
--
Total
current liabilities
1,394,864
997,353
Stockholders’
equity:
Common
stock
.001
par value 150,000,000
shares
authorized, 8,350,000
shares
issued and outstanding
at
December 31, 2005 and
11,341,612
shares issued and
Outstanding
at December 31, 2006
8,350
11,342
Additional
paid in capital
4,702,039
29,620,830
Retained
earnings
4,943,250
6,970,910
Total
stockholders’ equity
9,653,639
36,603,082
Total
liabilities and
stockholders’ equity
$
11,048,503
$
37,600,435
See
notes
to consolidated financial statements.
56
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF INCOME
Years
ended
December
31,
2004
2005
2006
Revenue
$
14,326,749
$
14,684,914
$
16,460,462
Cost
of revenue
2,228,545
2,328,190
2,132,702
Gross
profit
12,098,204
12,356,724
14,327,760
Operating
expenses:
General
and administrative
4,042,257
3,552,995
6,459,210
Sales
and marketing
3,930,135
4,380,529
5,301,331
Research
and development
367,821
927,800
648,463
Total
operating expenses
8,340,213
8,861,324
12,409,004
Income
from operations
3,757,991
3,495,400
1,918,756
Interest
expense
(64,178
)
(40,934
)
(13,327
)
Other
income
32,147
77,633
898,414
Income
before income taxes
3,725,960
3,532,099
2,803,843
Provision
for income taxes
1,383,789
1,306,877
776,183
Net
income
$
2,342,171
$
2,225,222
$
2,027,660
Weighted
average shares - basic
8,350,000
8,350,000
11,037,511
Earnings
per share - basic
.28
.27
.18
Weighted
average shares - diluted
8,350,000
8,350,000
11,067,301
Earnings
per share - diluted
.28
.27
.18
See
notes
to consolidated financial statements.
57
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
FortuNet,
Inc. and Subsidiary
FortuNet,
Inc.
Millennium
Games, Inc.
Additional
Total
Outstanding
Common
Outstanding
Common
Paid
in
Retained
Stockholders'
Shares
Stock
Shares
Stock
Capital
Earnings
Equity
Balance,
January 1, 2004
8,350,000
$
8,350
510
$
5
$
4,702,034
$
2,835,857
$
7,546,246
Contribution
of Millennium
(510
)
(5
)
5
stock
to FortuNet
Net
Income
2,342,171
2,342,171
Dividends,
$.01 per share
(120,000
)
(120,000
)
Balance,
December 31, 2004
8,350,000
$
8,350
-
$
-
$
4,702,039
$
5,058,028
$
9,768,417
Net
Income
2,225,222
2,225,222
Dividends,
$.28 per share
(2,340,000
)
(2,340,000
)
Balance,
December 31, 2005
8,350,000
$
8,350
-
$
-
$
4,702,039
$
4,943,250
$
9,653,639
Stock
Sale Net of Offering Costs (IPO)
2,875,000
2,875
23,726,120
23,728,995
Stock
Issued for Services
116,612
117
1,049,391
1,049,508
Stock
Options Granted
143,280
143,280
Net
Income
2,027,660
2,027,660
Balance,
December 31, 2006
11,341,612
$
11,342
-
$
-
$
29,620,830
$
6,970,910
$
36,603,082
See
notes
to consolidated financial statements.
58
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Years
ended December 31,
2004
2005
2006
Cash
flows from operating activities:
Net
income
$
2,342,171
$
2,225,222
$
2,027,660
Adjustments
to reconcile net income to net cash provided by operating
activities:
Depreciation
1,700,208
1,951,908
1,845,382
Amortization
452,139
454,139
418,294
Loss
on sale of property and equipment
468
Stock
for services
1,132,140
Increase
in allowance for doubtful accounts
70,443
Change
in operating assets and liabilities:
Accounts
receivable
85,698
3,655
(124,750
)
Inventories
(10,977
)
287,305
(63,525
)
Prepaid
expenses
(341,737
)
(567,207
)
289,353
Income
tax refund receivable
(136,525
)
136,525
Deferred
tax
(10,255
)
(523,733
)
(169,868
)
Other
assets
(6,753
)
(13,047
)
(4,068
)
Accounts
payable
60,457
236,762
(194,223
)
Accrued
expenses
67,941
28,581
46,699
Commissions
payable
(247,026
)
132,340
109,746
Income
taxes payable
(39,850
)
158,446
176,762
Net
cash provided by operating activities
3,985,934
4,511,364
5,489,602
Cash
flows from investing activities:
Purchase
of property and equipment
(3,010,750
)
(1,774,102
)
(3,410,533
)
Proceeds
from sale of equipment
8,000
Net
cash used in investing activities
(3,010,750
)
(1,766,102
)
(3,410,533
)
Cash
flows from financing activities:
Sale
of Stock, net of issuance costs
(685,722
)
24,414,717
Dividends
(120,000
)
(2,370,000
)
Payments
on notes payable
(615,382
)
(557,948
)
(536,495
)
Net
cash (used in) provided by financing activities
(735,382
)
(3,613,670
)
23,878,222
Net
increase (decrease) in cash and cash equivalents
239,802
(868,408
)
25,957,291
Cash
and cash equivalents, beginning
1,140,123
1,379,925
511,517
Cash
and cash equivalents, ending
$
1,379,925
$
511,517
$
26,468,808
Supplemental
cash flow information:
Cash
paid for:
Interest
$
58,979
$
38,699
$
15,377
Income
taxes
$
1,530,566
$
1,518,369
$
776,530
Non-cash
investing and financing activities:
Stock
options capitalized
60,648
Dividends
accrued
$
30,000
$
$
See
notes
to consolidated financial statements.
59
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2004, 2005 and 2006
1.
Nature
of business and summary of significant accounting policies:
Nature
of
business:
FortuNet,
Inc. or the Company was incorporated in 1989 in Nevada. FortuNet is engaged
primarily in the business of designing, manufacturing and leasing electronic
gaming and entertainment systems throughout North America.
FortuNet
and its wholly-owned subsidiary, Millennium Games (Millennium), derive
substantially all revenues from the gaming industry in the United States and
Canada. Changes in laws and regulations related to gaming in each state or
province can affect the Company’s revenues in any given state or province.
Principles
of consolidation:
The
consolidated financial statements for 2004, 2005 and 2006 include the accounts
of FortuNet and its wholly-owned subsidiary. All inter company transactions
have
been eliminated for all periods presented.
Cash
and
cash equivalents:
For
purposes of the statement of cash flows, the Company considers all liquid
investments with an initial maturity of three months or less as well as money
market mutual funds to be cash equivalents.
Cash
and
cash equivalents consist of cash in bank and investments of 90 days or less
in
municipal bonds and money markets consisting of the following:
2006
2005
Cash
in bank
$
902,908
$
(1,397,283
)
Money
market
2,590,900
1,908,800
Investments
22,975,000
-
Total
$
26,468,808
$
511,517
Inventories:
Inventories,
consisting primarily of parts and components to be used for manufacturing of
products to be sold, are valued at the lower of cost or market, as determined
by
the first-in, first-out basis. Also classified as inventories are Work In
Process components for installs that are being produced for a future period.
The
following schedule details inventory between raw materials and work in
process:
60
2006
2005
Inventory
$
1,222,107
$
1,267,570
Inventory
WIP
111,863
2,875
Total
Inventories
$
1,333,970
$
1,270,445
Prepaid
expenses:
Prepaid
expenses include various prepaid operating items and deposits for inventory
parts to be purchased.
Property
and equipment:
Property
and equipment are stated at cost. Depreciation is provided using the declining
balance method except for rental assets for which the straight line method
is
used. Estimated lives used for depreciation are as follows:
Rental
assets
5
years
Furniture
and fixtures
5-7
years
Machinery
and equipment
5
years
Vehicles
5
years
Improvements
2-7
years
In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting
for the Impairment or Disposal of Long-Lived Assets, the
Company periodically reviews the carrying amount of property and equipment
for
events or changes in circumstances that indicate that their carrying value
may
not be recoverable.
Software
development capitalization:
The
Company capitalizes internally developed software costs in accordance with
SFAS
No. 86, Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
Capitalization
of development costs of software products begins once the technological
feasibility of the product is established. Capitalization ceases when such
software is ready for general release, at which time amortization of the
capitalized costs begins. Starting in April 2006 through December 2006 the
Mobile Gaming System internal software development costs have been capitalized
as technological feasibility of the product has been established. Research
and
development costs relating principally to the design and development of products
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.
Revenue
recognition:
The
Company leases its products, using operating leases directly to gaming
facilities and through several regional distributors. The agreements generally
require lessees to pay rent for player terminals only when they are actually
used based upon an automated reporting system whereby each day’s usage by
customer is reported to the Company or a self-reporting system where the
customer submits sales information to the Company which is used as the basis
for
determining revenue. The Company recognizes revenue as the devices are used
in
accordance with each lease agreement. Most leases are on a per-use arrangement
with some lease payments being determined as a percentage of revenue that the
devices generates for the lessee and some devices are leased at a flat weekly
amount. The terms range from one to three years duration with annually renewable
leases; and month-to-month rentals. There are no significant leases with terms
greater than one year. The Company recognizes revenue as the devices are used
based upon the automated reporting system or self-reporting system described
above.
61
Commissions:
Commissions,
which are calculated as a percentage of actually collected revenues, are
recognized in the same period as related revenues.
Cost
of
revenue:
The
cost
of revenue includes depreciation of our capitalized leased equipment and the
cost of shipping to and installation of equipment in the field as well as the
cost of subsequent repairs and upgrades of installed equipment. Repairs are
expensed as incurred upon the return of the malfunctioning and/or damaged
equipment from the field subsequent to the re-deployment of equipment back
to
the field. Upgrades either for the hardware or the software components of our
systems that have been deployed at customer locations are expensed in the period
in which the upgrades are actually performed. Installation costs allocated
with
the new lease contracts are expensed in the period in which the equipment is
deployed in the field.
We
do not
provide any product warranties to any of our customers. However, it is in our
best interest to maintain our equipment in good working order. We apply our
best
effort to promptly repair and/or replace equipment in good working order. We
apply our best effort to promptly repair and/or replace equipment returned
from
customers. The cost of the repairs is expensed in the period incurred.
Accordingly, no liability has been established by the Company for future costs
to repair our products.
Accounts
receivable and allowance for doubtful accounts:
The
Company’s receivables are recorded when revenue is recognized in accordance with
its revenue recognition policy and represent claims against third parties that
will be settled in cash. The carrying value of the Company’s receivables, net of
allowance for doubtful accounts, represents their estimated net realizable
value.
The
Company estimates the possible losses resulting from non-payment of outstanding
accounts receivable. The Company evaluates the allowance for doubtful accounts
using current year account activity, historical trend information and specific
account identification. After all attempts to collect a receivable have failed,
the receivable is written off against the allowance.
62
Use
of
estimates:
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect certain reported amounts and disclosures. The principal estimate is
the
5 year life of rental assets. While actual results could differ from those
estimates, management believes that the estimates are reasonable.
Net
income per share:
In
accordance with the provisions of SFAS No. 128, Earnings
Per Share, earnings
per share is computed by dividing net income by the weighted average number
of
common shares outstanding during the period. A dual presentation of basic and
diluted earnings per share is required in 2006 to give effect for stock to
independent directors.
